Prospective Philippine Stock Market 'Decoupling' Due To "Economic Success"?

One suggestion is that a "decoupling" of the Philippine assets with the US is likely for reasons of relative "economic success".

I doubt the cogency of this premise, for the simple reason that the rigidities from the current political economic structure has been rendering the Philippines as "less competitive", which equally translates to a high "hurdle rate" for investors.

The table from CATO.org, reveals that economic freedom has lagged or has marginally regressed in 2007 compared to the earlier years.

And worst, the Philippines ranked in the bottom half among 141 nations in the CATO study, particularly on the aspects of Legal Structure & Security of Property Rights (91th) and Regulation of Credit, Labor, and Business (102nd).

Where property rights isn't secured, the risk premium is high. That's because investment returns may be subject to political appropriation.

And the labyrinth of regulations similarly translates to high transaction and business costs.

So rigidities from an "unfree" economy results to a big informal or shadow economy and the inefficiency of wealth distribution which are mostly skewed towards the minority who operate in the ambit of the political class. This called crony capitalism.

And according to the following charts from CATO, economic freedom has been strongly correlated with.....

economic growth and

per capita income

Yet one should not mistaken rising stock markets as signs of "economic success". That's because equities may rise even if the economy slumps or is in a recession, as in the recent case of Hungary or Venezuela which was discussed earlier. Or as in the case of Zimbabwe in 2008 or in Weimar Germany in the early 1920s.

The reason is that equity prices in such instances were driven MAINLY by inflation. Equity assets, thereby, assimilate the function of money's "store of value" as governments ravage by stealth society's wealth by debasing currency's purchasing power during these circumstances.

As spelled out in my last post "Why The Philippine Phisix Will Climb The Global Wall Of Worries", decoupling is a relative term.

Barring another bout of liquidity seizure from a banking crisis elsewhere, the reason the Philippines (as well as major ASEAN economies) have been manifesting signs of partial decoupling is that the local markets and the economy seem to be more receptive to current globally coordinated "inflationist" policies.

Relative to globalization, the lack of depth in global integration appears to amplify local developments, which overshadows international events, since the country's shortcomings have turned into "blessings" by virtue of being less to susceptible to extraneous shocks.

So we may be witnessing the ramifications of inflationist policies overwhelming developments abroad where relative liquidity is proving more beneficial to the domestic asset class.

Although as we have earlier pointed out the ASEAN Free Trade Agreement along with China and major Asian nations should help bolster economic reforms and increase the breadth of market activities that should be beneficial to the Philippine economy in the long run. Again this is a medium to long term proposition and will depend on the new adminstration's willingness to abide by the pact.

Moreover, another prospect for a decoupling to occur is when Americans become ostensibly cognizant of inflationist policies that would send their local investors scampering for a safehaven outside their currency. But that has hardly been the case today yet. There is indeed a debt problem in the US (chart below from Bloomberg), but prospective policies will determine the outcome.

In short, this is an ex-ante proposition. Therefore the outcome hasn't been fixed.

Besides, what happens in this scenario is merely a transference of one bubble to another, which hardly makes the case for a sound paradigm of "economic success".

Japan, for instance, was deemed as an "economic success" story in the early 80s, until the illusion from inflationism was popped which only revealed the false sense of prosperity.

Major ASEAN nations also benefited from the bust in Japan's bubble as Japanese money reportedly sought returns in ASEAN assets, which was accommodated by loose policies in the region as well as abroad. The boom eventually imploded in 1997, popularly known as the Asian Crisis.

In sum: Economic success comes with more economic freedom. Inflationism doesn't exhibit signs of a sound and sustainable economic growth. Stock market activities don't necessarily reflect on the health of the economy. And economic development will depend on the prospective direction of policies.

Thus, the assumption that the Philippines will diverge from the US based on relative economic performance could be seen more from an angle of endowment effect- "where people place a higher value on objects they own than objects that they do not" or a form of cognitive bias rather than an objective assessment.

How Minsky's Ponzi Dynamics Applies To Asia's Guarantees On Local Bonds

It's great news to hear Asia's efforts to boost her financial markets as these would enhance her ability to intermediate savings into investments, which should improve on her capital accumulation process or prosperity.

This from the ADB, (bold highlights mine)

``The Asian Development Bank (ADB) and ASEAN nations, along with People’s Republic of China, Japan, and the Republic of Korea, are moving to establish a jointly owned credit guarantee facility, which is aimed at promoting financial stability and boosting long-term investment in the region.

``ADB's Board of Directors approved the establishment of the Credit Guarantee and Investment Facility (CGIF) as a trust fund with a capital contribution of $130 million. The ASEAN+3 governments will provide a combined $570 million to create the $700 million facility.

``The pilot CGIF, due to start operations in 2011, will provide guarantees on local currency denominated bonds issued by companies in the region. Such guarantees will make it easier for firms to issue local bonds with longer maturities. This will help reduce the currency and maturity mismatches which caused the 1997-1998 Asian financial crisis and make the regional financial system more resilient to volatile global capital flows and external shocks.

``Providing credit protection to investors should also help unlock the region’s vast savings for badly needed investment in infrastructure and other key areas.

"The Credit Guarantee and Investment Facility will make it possible for corporations to issue bonds in their domestic markets and in neighboring markets and across ASEAN+3," said Noy Siackhachanh, advisor with ADB's Office of Regional Economic Integration. "Channeling regional savings into regional investments will support economic growth, creating jobs and alleviating poverty."

However, the overeagerness of the region's policymakers to provide "guarantees" on issuing companies risks exacerbating the seeds of the next bubble.

How? Via the Moral Hazard.

A refresher quote from Hyman Minksy [see How Moralism Impacts The Markets]

``It should be noted that this stabilizing effect of big government has destabilizing implications in that once borrowers and lenders recognize that the downside instability of profits has decreased there will be an increase in the willingness and ability of business and bankers to debt-finance. If the cash flows to validate debt are virtually guaranteed by the profit implications of big government then debt-financing of positions in capital assets is encouraged. An inflationary consequence follows from the way the downside variability of aggregate profits is constrained by deficits.”

So yes, markets will likely respond positively to such policy efforts but this will likely skew the market's incentives for risk taking.

In short, moral hazard leads to Ponzi dynamics.

Asia Needs Investments More Than Consumption

The Economist NAILS IT this time (well conceptually speaking).

Asia needs more investments more than consumption.

According to The Economist, (bold highlights mine-and comments added)

``ASIA’S current-account surpluses have been widely (if unfairly) blamed for causing the global financial crisis. Large inflows of foreign money helped inflate America’s housing bubble, the argument runs. Many Western economists say that Asians should squirrel away less of their income and consume much more. But a more rigorous analysis suggests that in most Asian economies it is investment, not consumption, that is too low.

[I would add that experts proposing a currency elixir to resolve so-called global imbalances, are those living in NEVERLAND ignoring the fact that every economy operates on different structures, e.g. market, capital or production, regulatory and etc., would mean more than just a single dimensional approach. The implication, say for example, for China to expand domestic demand is to generate a credit bubble, similar to the Japan in the 80s]

``Even economists who believe that most of the blame for the crisis lies in Washington, DC, argue that Asian economies need to shift from exports and investment to consumption as their new engine of growth. In “The Next Asia”, a recently published book, Stephen Roach, chairman of Morgan Stanley in Asia, calculates that consumption in emerging Asian economies fell from 65% of GDP in 1980 to 47% in 2008. American consumer spending, by contrast, accounts for more than 70% of GDP. “Until export-led growth gives way to increased support from private consumption,” he argues, “the dream of an Asian century is likely to remain just that.” His prescription certainly applies to China, where private consumption fell to only 35% of GDP in 2008. But what about the rest of Asia?

``A country’s current-account surplus is, by definition, equal to its domestic saving minus its domestic investment. So Asian economies can reduce their surpluses by saving less (ie, consuming more) or by investing more. Which route is appropriate depends in part on why their current-account surpluses widened during the past decade. In China the blame lies entirely with saving, which rose faster than its investment rate. (India’s saving rate climbed just as steeply, but it was matched by an even bigger jump in investment, which kept its current account in deficit.)

As we tackled in Dueling Keynesians Translates To Protectionism? the principal goal is to produce so as to be able consume, as Adam Smith argued centuries ago, ``Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce."

Hence any arguments based on heuristics (mental shortcuts) and or oversimplification of facts and theories, particularly on the currency magic wand, would be fallacious.

Besides, for experts to argue for imposing on other countries is to engage in reckless overweening presumptions- this risks provoking antagonism that would undermine or worsen the present conditions that would likely result to the opposite goals.

chart from SocGen's Albert Edward/Tyler Durden of Zero Hedge

Moreover, the liberals' proclivity to immerse in fingerpointing fundamentally shifts domestic policy failure accountability to other parties. As in the above, global investments has been MORE than savings which implies that the world, specifically the G-7 countries, has engaged in inflationism. Therefore, theories such as the "global savings glut" is nothing but an attempt to divert policy failures to others and at the same time justify inflationism.

Finally back to the Economist, ``A report by the Asian economics team at Barclays Capital concludes that to reduce their excess saving, most Asian economies need to invest more rather than consume more. Higher investment, especially in infrastructure, they argue, would not only reduce current-account surpluses but also boost growth and living standards. Better roads and railways would help farmers get their produce to cities and enable manufacturers to export their goods abroad. Clean water and sanitation could raise the quality of human capital, thereby lifting labour productivity."

Here we depart with the Economist or with Barclays Capital.

As seen in the earlier chart, Asia has engaged in massive spending during the early 90s but this didn't translate to the desired outcome. Yet the article didn't touch on why higher spending didn't engender domestic demand.

Well it's because investments then hasn't been directed at WHAT the market wants or needs, but instead had been fostered by bubble policies and profligate government spending which eventually led to the Asian Financial Crisis of 1997.

Moreover, as we previously argued, the protectionist-state capitalism model adapted by many Asian nations, e.g. ASEAN states, severely impeded market based investments.

Nevertheless, ASEAN and East Asia's thrust to integrate regionally and globally can be read as a major positive development going forward. [see Asia Goes For Free Trade]

East Asia And The ASEAN Yield Curve

This is a sequel to our earlier post What’s The Yield Curve Saying About Asia And The Bubble Cycle?, but this time in graphs.

The idea is that steep yield curves emanating from central bank policies incentivize the market to engage in various interest rates arbitrages like carry trades, stock market speculations and other borrow-short-invest-long transactions which essentially fuels bubble cycles.

A reminder is that interest rate policies and the shape of the yield curves impact the asset markets with a time lag. Said differently, asset markets respond to rate curves belatedly.

As earlier shown, in the US yield curve has been extraordinarily steep which most likely implies strong support to her asset markets. Importantly, because the US government has reflating its banking system, the arbitrages are likely to support global markets more as investors seek to optimize returns at the long end.

This means that the US dollar carry trade is likely to inflate further. And carry trades aren't likely to be confined to the US dollar but diffused to major currencies which have all engaged in competitive devaluation via a combination of suppressed interest rates, fiscal spending and most importantly, quantitative easing programs.

In addition, because asset market reflect a time lag on the curve, credit systems hobbled by deleveraging (such as in the US, UK and parts of Europe) could probably see belated marginal positive responses or improvements but would not likely reach the level it had during the last boom.

It is in Asia and emerging markets where a credit fueled bubble cycle is likely to take place.

In Asia where low interest rates have generated more policy traction than in crisis affected Western developed economies, the yield spreads also remain elevated.

And as earlier pointed out, combined with the other policies all these have been manifested in asset outperformance.

Again the steepness of the yield curve in the region should lend support to the asset markets for the meantime. As local investors and speculators and the domestic financial institutions will be incentivized to take advantage of the wide chasm in interest rates.

The following charts are all from Asian Development Bank's Asianbondsonline.com.

China

Japan

South Korea

Singapore

IndonesiaMalaysia

Philippines

Thailand

Finally, it would be foolish for anyone to think that stock markets move in a straight line, because in reality they don't.

Nevertheless, any attendant weaknesses should be construed as countercyclical or temporary events because aside from many other factors, steep yield curves are likely to support credit activities that should work favorably for asset markets.

Emerging Market guru and Franklin Templeton's chief honcho Mark Mobius nails it when he recently wrote, ``what I said was that in a bull market as we are now experiencing, there will be corrections as the market continues to march upwards, and such corrections could be anywhere from 15 to 20%, or even 30%. We have to be ready for such short-term volatility. The markets in China, Asia, and Dubai have seen corrections of 20% or more during the recent crisis, so these kinds of corrections should not be surprising.I want to emphasize that I am not predicting any specific correction but I am just saying that we have to prepare for such corrections and that we not be alarmed by them given current market conditions. Overall, I believe we will continue to see markets rise in the long run." (bold emphasis mine)

In short, market operates in cycles.

Asia Goes For Free Trade

Here is what we wrote in Poker Bluff: The Exit Strategy Theme For 2010

``there are many other reasons to suggest why emerging markets seem to be on a secular trend to play catch up with advanced economies, particularly positive demographic trend, urbanization, high savings rate, low debt or systemic leverage, unimpaired banking system, rising middle class and most importantly a trend towards embracing economic freedom via more freer trade, investments, financial and migration flows [e.g. see Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone]

We found this from the Investor's Business Daily, (all bold highlights mine) [hat tip: Professor Mark Perry]

``Largely ignored over the weekend, Jan. 1 signaled the arrival of the world's third-biggest free trade area. China and Asia's Tigers — the Association of Southeast Asian Nations — scrapped 7,000 different tariffs to form a $200 billion open market for about 2 billion consumers, one-third of the world's population.

``That's not the half of it. Jan. 1 also heralded another ASEAN free-trade pact with mighty India, ending tariffs on 4,000 products staggered through 2016. This deal will expand a $50 billion market for 1.5 billion consumers into something even bigger.

``ASEAN also signed off on free trade with Australia and New Zealand, tacking on another $50 billion market to expand for their 600 million consumers. It follows ASEAN's Dec. 1 agreement with Japan, which created a $240 billion market for 670 million. In addition, Thailand and South Korea completed the last step of 2007's ASEAN-Korea pact, finalizing expansion of the zone to a $72 billion market for 600 million.

``ASEAN's six freest members — Thailand, Indonesia, Singapore, Philippines, Malaysia, Brunei — even enacted a free-trade deal among themselves on Jan. 1, ending tariffs on goods sold to each other, freeing a $60 billion market for 500 million consumers.

``ASEAN wasn't the only one moving on free trade. Over the same weekend, India announced that three years of talks with South Korea were complete, uniting the third- and fourth-largest economies in the Far East. India's leaders said a one-year deadline for negotiating a pact with the European Union was set this week, too.

``All this points to something major: While the Obama administration has put its energy into trade wars with China, enacting punitive tariffs on steel, tires, nylon, paper, and other goods and has signed no new pacts in 2009, free trade is marching on without the U.S."

Here we have a clear case of policy divergence. Asia (most especially ASEAN) openly goes for free trade while the Obama regime seems backtracking on economic freedom.

Guess where capital will flow?

Lastly this goes in patent defiance to the mercantilist perspective that the world will go protectionist.

Asian Regional Integration Deepens With The Advent Of China ASEAN Free Trade Zone

Finally, the dream for an Asian regional integration has finally got the ball rolling.

This from the AFP/Google, (all bold highlights mine)

``China and Southeast Asia establish the world's biggest free trade area (FTA) on Friday, liberalising billions of dollars in goods and investments covering a market of 1.7 billion consumers.

`Eight years in the making, the ASEAN-China FTA will rival the European Union and the North American Free Trade Area in terms of value and surpass those markets in terms of population.

``Officials hope it will expand Asia's trade reach while boosting intra-regional trade that has already been expanding at 20 percent a year....

``China has just overtaken the United States to become ASEAN's third largest trading partner, and will leap Japan and the EU to become "number one" within the first few years of the FTA, said Pushpanathan, Deputy Secretary-General for the ASEAN Economic Community.

``Under the agreement, China and the six founding ASEAN countries -- Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand -- are to eliminate barriers to investment and tariffs on 90 percent of products.

``Later ASEAN members, including Vietnam and Cambodia, have until 2015 to follow suit...

``Average tariffs imposed on Chinese goods by ASEAN states will fall to 0.6 percent from 12.8 percent.

``ASEAN-China trade has exploded in the past decade, from 39.5 billion dollars in 2000 to 192.5 billion last year, Pushpanathan said.

``At the same time, ASEAN-China trade with the rest of the world has reached 4.3 trillion dollars, or about 13.3 percent of global trade.

Well the trend towards the deepening economic and financial integration has already been in place (see above charts from ADB), in spite of the just concluded pact.

This means that the implementation of the regional trade agreement has been merely a furtherance of an existing trend and that would likely get more entrenched in region's pursuit of freer markets.

Yet, this flies in the face of rabid mercantilists who continue to predict protectionism as imbecilic outcomes (actually desired solutions) in response to today's crisis.

According to ADB's Emerging Asian Regionalism, ``Asia is now broadly as interdependent in trade as the EU and North America each is. Indeed, Asia now trades more with itself than either the EU or North America did at the outset of their integration efforts."

Here are the benefits of the a regional trade integration as enumerated by the ADB:

"An integrated Asia can:

• link the competitive strengths of its diverse economies in order to boost their productivity and sustain the region’s exceptional growth;

• connect the region’s capital markets to enhance financial stability, reduce the cost of capital, and improve opportunities for sharing risks;

• cooperate in setting exchange rate and macroeconomic policies in order to minimize the effects of global and regional shocks and to facilitate the resolution of global imbalances;

• pool the region’s foreign exchange reserves to make more resources available for investment and development;

• exercise leadership in global decision making to sustain the open global trade and financial systems that have supported a half century of unparalleled economic development;

• build connected infrastructure and collaborate on inclusive development to reduce inequalities within and across economies and thus to strengthen support for pro-growth policies; and

• create regional mechanisms to manage cross-border health, safety, and environmental issues better."

While freer trade doesn't necessarily guarantee everyone's success, this should enhance opportunities in trade, investments, financing and migration flows aside from the benefiting consumers via lower prices and a greater array of choices of available products and services in the marketplace.

In short, benefits enjoyed by society would likely be immensely greater than the costs.

In addition, increased competition should bring about greater technological advancements via innovation, expands the division of labor and comparative advantages of producers which allows for more pricing and resource allocation efficiency.

As Austrian economist Hans F. Sennholz wrote, ``Surely, it is no easy task; it requires continuous changes in economic structure and adjustment processes. Labor markets need freedom and flexibility in order to create ever new employment opportunities that offset unavoidable job losses. Workers must have the opportunity and incentive to acquire knowledge and ability needed in a globalized economy. General education and vocational knowledge are becoming ever more important as are entrepreneurship, research, and development. But above all, the economic future of many businesses in a globalized economy greatly depends on the margin of political and social freedom they enjoy."

Nevertheless competition and greater choice translates to lower rates of inflation.

This has seen with the price of gold in the 1990s where the greater degree of global integration has resulted to what has been known as the "great moderation"

As we wrote in Gold: An Unreliable Inflation Hedge?, ``Global Exports sharply accelerated during the 1990s, which underpinned almost the same degree of expansion in Global GDP per capita.

``So increased global trade meant more US dollar financing, as manifested by the burgeoning trade deficits, yet the increased output from the world resulted to higher productivity and thus generally growth deflation or “disinflation”. Ergo, lower gold and commodity prices."

Of course, vested interest groups or economic rent seekers who profited from political privileges are exasperated,

Again the AFP/Google, ``Not everyone is happily singing the free-trade anthem, however.

``At the 11th hour, industry groups in Indonesia, Southeast Asia's biggest economy, and the Philippines are frantically pressing their governments to keep tariffs on vulnerable sectors until 2012."

SO it is yet unclear whether such trade pact will turn out successful because of the vast diversity of culture and political structures which could be sources of pressures or conflicts, aside from the required recalibration and standardization of trade and investment policies, to conform with and enforce on the trade pact.

Finally and importantly, the trade pact reinforces what we see as China's attempt to bolster or flex her geopolitical muscles by advocating that the world's largest free trade zone to utilize her currency, the yuan or the remimbi as the region's medium of settlement or transaction currency.

According to Xinhua, ``Beijing had embarked on the first step on a long road toward making the yuan one of the world's top currencies, allowing Chinese exporters and importers to start settling trade in yuan rather than dollars.

``Wichai [Wichai Kiatrengsuk, vice president of the Bangkok Bank] believes that after the launching of the ASEAN-China FTA in January, how to push forward the RMB-dominated trade settlement would become an immediate issue in this area." [emphasis added]

In short, the FTA appear to be a stepping stone for the yuan or the remimbi's long term path towards the goal to challenge the US dollar hegemony as a major international currency reserve as repeatedly discussed in this blog, such as in Central Bank Policies: Action Speaks Louder Than Words, The Fallacies of US Dollar Carry Bubble.

Bottom line: The fate of the China-ASEAN FTA would likely determine the success of China's tacit plan to become the world's premier geopolitical power. And this likewise could be reflected on her key trading partners.

GDP Per Capita Per Country

An interesting site on the GDP per Capita Per Country from snippets.com.

Sample graphs:

Highest World

ASEAN

Phisix: The Case For A Bull Run

``Joseph Schumpeter analysed the Great Depression in terms of "creative destruction". He thought that cyclical recessions and depressions wiped away obsolete economic systems and allowed them to be replaced by fresh structures. Recessions are necessary to speed up the capitalist forces of change. For the last 33 years, the Chinese economy has been growing two to three times as fast as the United States, and that has continued even in a year of recession. The Asian economy has been taking over the lead from the Western economy, though the performance of the Japanese economy has been disappointing. I expect that this Chinese outperformance will continue as the world moves into recovery. We can now see the pattern of the three centuries: 1815–1914 the British Empire; 1945–2008, the American era; about 2030–2100 or beyond, the new Chinese era. China is overtaking the West and the process has been accelerated by the recession. William Rees-Mogg The New Chinese Era

It’s a refreshing return from an extended vacation.

Not only have most people have recharged their energies, but even our Philippine Stock Exchange appears to have been rejuvenated as well.

Amidst persistent gloom, this analyst has been reiteratively asserting the case for a return of the bullmarket. For instance last March in Why An Increasingly Asset Friendly Environment Should Benefit The Phisix we outlined the reasons as: 1. Extremely Depressed Mainstream Sentiment, 2. Creative Destruction, 3. Perspective Shift from the Macro to Micro environment, 4. Policy Incentives Are Directed Towards Aggressive Risk Taking, 5. Signs of Improving Trends in the Marketplace, 6. Phisix: Learning From Market Cycles.

Already substantial segments of these variables have begun to sink in the collective psyche.

Global markets have been on a tear lately principally led by Emerging Markets and Asia. Key emerging markets (BRIC) have tallied double digit gains on a year to date basis [see Global Stock Market Performance Update: The BRICs and Emerging Markets Dominate Gains] against G-7 economies (except Canada) who still are on the red (as of April 16^th), despite the March 9^th rally using the US markets as the reference point.

This glaring disparity of performance in both the financial markets and economic growth rate (China registered a first quarter growth of 6.1% growth in 2009 while India reportedly grew less than 7% for 2008 relative to negative growth in G-7 economies) appears as significant validation of the much derogated or demeaned “decoupling” theme in 2008.

The Policies of Greed

Against mainstream macroeconomists and their coterie of followers, who tend to “tunnel” their visions of a world rigidly driven solely by US demand, and of the misguided worries of “deflation” given the premise of intractable debt, oversupplies and excess capacity as their elementary case for a global “stagdeflation” bust setting, the ping pong surges between global stock markets and commodities have been corroborating our case of a market response towards a collective policy overdrive from inflationary actions by global governments.

Put differently, inflationary policies in many parts of the world have started to offset losses from the financial and economic system and has begun to “leak” or percolate into financial assets as the stock markets and the commodities.

For as long as global government will continue to “print money” and adopt negative real rates, savers will be penalized, and “printed money” (if not from the private sector then by government spending) will find its way into assets as speculation have been the order of the day. Where unlimited money will be chasing limited goods or assets, the end result will be inflation.

For our blessed dear Pope Benedict XVI, let it be known that GREED is the OFFICIAL POLICY of collective governments. The seeds for the next crisis are patently being legally sown. People are being impelled to borrow and speculate than to save and produce. Hence, blame not greed on the public when the next crisis arrives because people would be simply responding to the incentives set forth by policymakers in order to survive. Otherwise, defiance to these policies translates to a loss of purchasing power.

And as day follows night, inflation will be succeeded by deflation. Last year’s collapse in the economic and financial system was a manifestation of a market response to an unsustainable system. Today’s government induced efforts to revive the marketplace with too much debt charged to the expense of the citizenry will ultimately end up with the same results- a crisis.

For as long as people continue to trust governments, governments will have the ability to counter deflationary forces with “money from thin air” or the printing press. But as history shows, the grandest experiment with the paper money system will ultimately reach a limit.

Nonetheless, the genesis of the next crisis begins almost always with a government sponsored boom.

Who Will Finance This Boom?

In contrast to 2003-2007 boom, which saw much of the easy money policies absorbed by real estate industry in developed economies which had been facilitated or greased by financial alchemy by both the banking system and the moneyness of Wall Street’s “shadow banking system”, this boom will probably be financed by financial conduits that would cater to the stock market and commodities boom.

Figure 1: US Global Investors: Credit as % of GDP

Aside from global governments, it is not apparent yet where the private sector funding will emanate from, but our guess is that the scope of debt absorption will be greater for economies in the emerging markets where the leverage in the system have been low relative to developed economies see figure 1.

This is a chart I’ve shown in Will Deglobalization Lead To Decoupling?.

For instance the Philippines have one of the lowest exposures to credit by households. This explains why there have been aggressive marketing efforts to sell credit cards which I can attest to (I receive many offers to subscribe to bank credit cards).

Since most emerging markets are bank financed more than capital market financed, then we should see substantial growth in activities in these lagging but high growth areas. Although, for emerging markets to further capitalize in the speculative fever, we should equally expect a tremendous surge in non-banking finance to complement the growth in the banking system.

Figure 2: US Global Investors: Exploding Loan Growth in China

We have already been partly witnessing the emergence of this phenomenon in China, as loan growth amidst loose monetary policies has been exploding at a vertiginous pace see figure 2.

From Wang, Yam, Zhang and Tai of Morgan Stanley, ``In particular, policy-driven monetary expansion drove money and loan growth to record highs in March, up 25.5% and 29.8%Y, respectively, with new loans made in 1Q09 totaling Rmb4.6 trillion, almost 3.5 times the amount in the year-ago period, or 93% of 2008’s total.” Apparently the present policies have buttressed urban fixed asset or real estate investments and domestic consumption even as the external environment (exports) remains feeble.

The fact that such dramatic pace of growth in loans is unsustainable means that at some point this year these trends will need to moderate which likewise suggests of a meaningful correction in Shanghai’s index (up 37.5% year to date).

In addition, if China tacitly expects to expand the use of its currency, as possible challenger to the reign of the US dollar as the world’s international reserve currency, then it would have to make its currency convertible by liberalizing its capital account and importantly by deepening its capital markets. Importantly in terms of politics, it would have to expand its military might, which it has been doing reticently. According to the Wall Street Journal, ``The Pentagon views China as the country most to acquire the capacity to challenge the U.S. likely, at some point down the road, military on a global scale.” But this is a discussion for another day.

Hence, ASEAN and East Asian markets will likely revolve around the progress of China to augment the liberalization and the integration process of its markets and its economy to the region and to the world.

Has correlation an implied causation? Perhaps. See figure 3.

Figure 3 US Global Investors: Chinese Demand a Driver for Emerging Europe?

According to US Global Investors, ``Rapid monetary expansion in China would not only provide fundamental support for government-mandated fixed asset investment vital to reinvigorate domestic growth, but could also serve as a precursor to global economic recovery and sustain positive investor sentiment toward emerging markets in general. That Chinese money supply growth has been leading Emerging European equities in the past four years should not be mere fortuity.”

Hence, this crisis has only begun to show of China immensely expanding leverage in the global economy. As we wrote last October in Phisix and Asia: Watch The Fires Burning Across The River? ,

``In the “Secrets Of War: The 36 Stratagems” published by an unknown writer during the Ming Dynasty 300 years ago, one of the war stratagems include “Watch the Fires Burn Across the River”, which means to watch over your enemies wreak havoc upon themselves before making your move. As senseis.xmp.net interprets ``This is a kind of long-term, strategic version of the idea behind an inducing move. Before you intervene, see that the flow of the game started by action elsewhere brings the opportunity to its peak.”

``If the US took the hegemon away from the UK after the latter had suffered immensely from the harrowing years of devastation wrought by World War II, could Asia be in a seemingly parallel position in terms of fortuitously eluding the systemic calamity of a banking crisis besetting the West?”

Or has China used today’s opportunities to position herself for prospective strategic dominance?

Locally Driven Global Markets

Another important difference from the 2003-2007 boom: This emerging boom seems to be driven locally.

Figure 4: Danske Emerging Briefer: Phisix and Peso Lagged Emerging Markets in March

The Philippine Peso and the Philippine Phisix have lagged its emerging market peers last March.

One possible reason for this is that the Philippine Peso hasn’t been pummeled as the rest of its contemporaries during the most recent rout, where much of the recent spike in global equity markets have equally translated to a marked rebound in these downtrodden emerging market currencies. Said differently, the sharp volatile downturn resulted to an equally rapid upturn. This is in contrast to the Peso which had been impacted less and has similarly had muted improvements.

The other possible reason is that foreign participants remain as significant net sellers. The volume to push blue chip issues higher is relatively sizable, hence considering the low penetration level of local participants in the stock market (less than 1% percent directly invested, according to the PSE; our estimates at 1% including indirect placements), the market improvements have been seen mainly broadbased or spilling over to second or third tier issues- where less volume is required to spark upside volatility- but moderated in terms of blue chip issues or issues composing the Phisix.

Last week’s foreign selling had been substantial (Php 2.25 billion), such degree of volume foreign liquidation usually coincides with significant downsides in the Phisix. Yet the Phisix climbed 1% over the week.

In addition, the recent controversial “political” deals might have partly contributed to the persistent foreign disinterest to hold local equity assets.

In short, for the meantime there has been a dearth of firepower from local investors to sturdily power up blue chip issues. Yet foreign selling has weighed on both the Phisix and the Peso. But this is likely to change in the future as confidence or improving market sentiment gets reinforced. Perhaps local investors will be increasing their or we could see a return of foreign investors, possibly from Asia than from the West.

Has the Philippine experience likewise been reflected on its contemporaries? Perhaps.

An article from US Today appears to have misread an emerging market flow data because of its misleading headline “Emerging markets funds up, but rely on developed world”. The article reports that,

``This year, investors have put $5.5 billion of net new money into emerging market stock funds, says Brad Durham, managing director of Emerging Portfolio Fund Research, which tracks the funds.

``To put that into perspective, the funds have attracted new money equal to about 2% of their assets each week for the past month, according to TrimTabs.com, which also tracks fund flows.”

According to FP Trading Desk the market capitalization of Emerging Markets is around $12.8-trillion in March of 2008. Considering that half of this has been lost, this takes market cap to around $6.5 trillion, yet it is inconsistent to see how $5.5 billion or even 2% of assets could have made emerging markets “rely” on developed world.

Figure 5: US Global Investors Russia’s Investor’s Profile

Well Russian markets appear to be confirming the developments in the Phisix-local investors are driving the market.

According to US Global Investors, ``There was a significant increase in activity recently in Russian equity markets, mainly driven by domestic buyers. As the chart from J.P. Morgan shows, local activity outnumbers long international money by a two-to-one ratio.”

A locally driven stock market boom will be less susceptible to global gyrations and strengthen our case for decoupling.

Phisix: Rising Tide From Inflationary Forces

As we have noted earlier, the Philippine Stock Exchange have been experiencing a broad based recovery.

This can be seen in virtually ALL of our market internal indicators: advance-decline spread, number of traded issues, number of trades, peso volume or even the seeming emergence of a “rising tide lifts all boats” among sectoral trends see figure 6.

Figure 6: PSE: Rising Tide Lifts All Boats?

As you will note in the chart, ALL of the indices have turned positive, whereas only two of them, particularly the Industrial and Mining indices were on the upside early this year.

And leading the pack anew is the Industrial index, which has been up 35.01% year to date (pink), followed by Mining index up 28.26% (green), the Banking index 15.05% (black candle), the Sunlife and Manulife dominated ALL index 13.53% (maroon), the Holding index 13.11% (red), the Service Index 4.32% (silver) and the Property index 4.18%.

And as opposed to mainstream domestic analysts who are paid to peddle the uncorrelated, unproven and unconfirmed premise that “fundamentals” drive the stock prices, we have long argued from a contrarian standpoint that stock prices have essentially been propelled by mostly INFLATION and INFLATION DRIVEN SENTIMENT, with accentuated influence for the underdeveloped Philippine market setting. Hence the “rising tide lifts all boats phenomenon”.

All the rest are mere nattering nabobs of cognitive biases disguised as expert opinions.

Some of the previous concluding quotes by Vienna Professor Fritz Machlup (1902-1983) from his invaluable paper The Stock Market, Credit and Capital Formation I cited in our January article Are Stock Market Prices Driven By Earnings or Inflation?, which I’d like to reemphasize (all bold highlights mine):

-A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply.

-Extensive and lasting stock speculation by the general public thrives only on abundant credit.

-Abundant funds, especially those of inflationary origin, may not find ready outlets in real investment.

-Any decrease in the effective supply of money capital is likely to cause disturbances in the production process.

-An inflated rate of investment can probably be maintained only with a steady or increasing rate of credit expansion. A set-back is likely to occur when credit expansion stops.

And if this is the genuine incipient boom phase of the next chapter of the imminent bubble cycle as we think it is, we’d most likely see “basura” issues or third tier highly speculative issues to SPECTACULARLY OUTPERFORM blue chips.

The Hazards and Relevance of Chart Reading, My Technical Outlook

Lastly as we have previously mentioned, the cogency of our bullmarket can be identified from several indicators, particularly: signals from market internal activities, regional performances, benchmark credit spreads and finally technical picture.

Figure 7: Stockcharts.com: PHISIX: Missing One Element To A Full Blow Bullmarket

A short notice on chart reading: Although I began my market analyst work as a chart reader, I came to realize that charts depend only on past information and the subsequent pattern recognition as basis for predictions.

Despite the so-called “market efficiency” where all necessary information as supposedly imbued in the depicted prices, this isn’t accurate at all. Considering that markets have been repeatedly distorted by government intervention, with accelerating emphasis today, markets hardly convey price “efficient” signals as many dogmatic practitioners infer them to be. Hence, they have been highly vulnerable to “tail” risks.

Moreover, charting as a primary device for market reading is a tool beneficial for those who benefit from churning trades than from those working to achieve or generate ALPHA returns. Besides, by assuming only past information as the principal basis for market analysis, this represents, for me, as highly prone to cognitive biases, since our reflexes would be oriented towards spotting pattern recognition through the significance of the historically determined path dependent outcome (hindsight bias) and the oversimplification in the understanding of events as related to unfolding market action.

Thereby, I’d recommend the use of charts as vital guidepost for determining phases of the market cycle, as confirmation metric of inter-market developments to ascertain the whereabouts of the market cycle or of the stages of an investment theme and as for entry-exit parameters for a defined trade and NOT as primary “investment” or “HOLY GRAIL” formula for determining the risk reward tradeoffs.

Institutions that accustom clients towards short term trades are only subjecting the latter to low-return high-risk exposure, which serve nothing more than a euphemism for punts, especially for momentum trades. That’s where we always warn of the perils of the “agency problem” or the conflict of interest issues.

Going back to the market, the Phisix alongside the Asian bourses ex-Japan (DJP2), the Emerging Market (EEM) index and the Southeast Asian (FSEAX) index appears to have carved a similar basing feature which may be indicative of the bottoming phase of the present market cycle (double bottom?).

Moving forward, all four indices have simultaneously broken above their resistance levels which could be indicative of an advancing momentum tilted towards a transition to a full blown bullmarket. The Phisix recently overcame its hurdle (see green circle) at Friday’s close by going over the resistance (red horizontal line).

Although, only the EEM index has had a material breach above the resistance level, it remains to be seen if the other indices will suffer from a “head fake” or sustain a breakout that validates the advent of a nascent bullmarket for regional and emerging market equities. This will be evident in the coming sessions.

Given the near convergence of the motions of the major indicators, particularly market internal signals, regional performance, credit spreads and technical picture; it seems to be the first time in nearly two years where the alignment of these forces strongly suggests of a continuity of the present trend than of a reversal.

In addition, except for the Shanghai index which is not shown in the chart above, all four indices above are likewise closing in on their respective 200-day moving averages (for the Phisix the red descending line at approximately the 2,200 level), which serves as my last major obstacle for the Phisix (and the other equity benchmarks) to officially reclaim the next phase of the market cycle.

And after a successful breach of the 200-moving averages we can expect the Phisix to perhaps to recapture or regain some of the lost grounds in between the two targets (2,289 or 2,300 and 2,750 or 2,800) by the yearend. And optimistically, a full recovery and even an attempt at 5,000 during the market friendly Presidential election cycle year.

Because there seems to be no other asset class in Western nations that can absorb much of the paper money being thrown into the global financial system, as the tug of war between deflation and inflation will persist to generate extended market volatility, perhaps the inflation in the stock markets in Asia and Emerging Markets and in the commodities frontier will accelerate faster than the previous, as the ``inflated rate of investment can probably be maintained only with a steady or increasing rate of credit expansion” as Professor Machlup explains. Governments at the moment will resist a setback in the credit expansion that may reverse the present trends simply because rescues by printing money have become a political trend.

In short, the odds are greatly favoring a bull run for the Phisix, Asia, Emerging Markets and commodities going forward.