Phisix: How Sustainable is the Bernanke Put?

“Highly accommodative monetary policy for the foreseeable future is what's needed…If financial conditions were to tighten to the extent that they jeopardized the achievement of our inflation and employment objectives, then we would have to push back against that…

The above statements[1] made by US Federal Reserve Chairman Dr. Ben Bernanke this week had been enough to power or push the previously uncommitted global financial markets into a risk ON environment and to the setting of records for US stock markets[2]. 

If this is so, then why does the mainstream adamantly insist that prices in the financial markets are supposedly set by the conventional notion of fundamentals such as “valuations” or statistical “economics” rather than by monetary policies?

The implication is that the monetary landscape determines the conventional notion of “fundamentals” and that the corollary—drastic changes in the monetary environment—will radically alter “fundamentals”.

Thus a financial and economic environment nurtured by easy money will have almost been entirely dependent on the continuity of such dynamic; such that, to reiterate, a reversal of which translates to a massive dislocation or a withdrawal “shock” from which the current financial and economic environment has been implanted on.

Of course the basic question is how sustainable are these free lunch monetary policies?

As previously pointed out, the recent riots in the global bond markets seem as signs of the unintended consequences or a growing backlash from these policies[3].

Yields of US long term bonds have gradually been ascendant since July 2012. The Fed’s QEternity last September (which had only a 3 months effect), Kuroda’s Abenomics in April and the ECB’s interest rate cut have all failed to stem rising yields.

Yet the rate of increases only intensified when the financial markets selectively ‘focused’ on the ‘tapering’ aspect of the rather ambivalent Fed’s communiqué last May[4].

The US bond market rout quickly cascaded into a pandemonium in the stock and bond markets particularly in the emerging markets, as well as parts, of the US fixed income markets.

And given the estimated $225 trillion capital markets where 78% comprises the interest rate sensitive bond and loans markets, combined with the $490 trillion interest rate swap derivatives markets, a sustained spike in bond yields will only aggravate the bedlam in the global financial markets[5].

Thus, the Fed’s signaling channel or communications strategy or inflation expectations management fiasco has immediately been remedied by promises to contain interest rates by the announcement of “forward guidance” by Mark Carney of the Bank of England, the jettisoning of the non-committal stance by the European Central Bank where Mario Draghi declared low levels for an “extended period of time” and finally Dr. Bernanke’s “highly accommodative monetary policy for the foreseeable future”. 

This time the steroid starved markets focused on Dr. Bernanke’s missives while ignoring the fact that in the minutes of the FOMC meeting about half of the participants wanted to halt the $85 billion in monthly bond purchases by year end[6].

The predicament is that what seems as diminishing marginal efficiency or returns and of the narrowing window of impact of such policies, it remains to be seen if jawboning alone will be enough to sustain the risk ON environment based on the Bernanke Put.

Greater Risks from China’s Selective Interventions

The hunger for policy steroids has infected China too.

Rumors floated that China’s government may soften her stance on monetary policy, which prompted for a one day 3.23% surge on the Shanghai Composite index.

The following day China’s economic data showed of mixed outlook in terms of monetary affairs.

Money supply growth showed of a marginal decline. M2 rose by only 14% in June from May’s 15.8% growth. Meanwhile, new currency loans soared by 860.5 billion yuan in June vastly up from 667.4 billion yuan in May. This according to the Bloomberg[7], accounted for about 83 percent of aggregate financing last month. 

Yet a big part of this credit expansion has been coursed through China’s four biggest state owned banks which stood at an “unusually large 170-billion yuan ($27.7bn) in the first week of July”[8].

Friday, the Shanghai composite index gave up about half of the Thursday’s gains, but still posted a positive 1.61% return for the week.

The Chinese government’s declared measures of stamping out the shadow banking system but at the same time expanding loans via state owned banks extended to mostly State Owned Enterprises and politically connected firms will most likely backfire as political distribution of money will only compound on the existing distortions[9] on the marketplace by increasing the yield chasing phenomenon that increases systemic risks via further inflation of the debt driven property bubble.

One clue of this is that given China’s underdeveloped capital markets or with the limited options for the average Chinese to invest, falling stock markets has prompted for a record flows into the shadow banking system’s wealth management products[10] during the last two weeks of June.

And my guess is that some, if not a big portion of these funds, will also flow into the shadow banking system.

The Chinese government can control the stock of money issuance, but they will not be able to control the flows of money.

The Chinese government’s selective targeting of monetary interventions has already been affecting her merchandise trade activities as exports and imports jointly fell last June[11]. 

In addition, the cash crunch has prompted many car dealers to have reportedly withheld shipments without upfront payments[12]. The cash squeeze has also caused a drought on sales of dollar-denominated junk bond or Chinese speculative-grade companies[13].

Meanwhile consumer price inflation rose 2.7% beyond median estimates at 2.5%, even as producer prices fell by 2.7%[14], which shows of the stagflation setting the Chinese economy has transitioned into.

The distribution of credit by political means where the incumbent Chinese government expands credit via state owned banks will likely be policy trend going forward. Such interventions are likely to heighten risks of a disorderly adjustment in China’s highly fragile debt laden economy.

As Columbia University finance and economics Professor Charles Calomiris wrote in a 2009 paper on banking crises[15]

This pandemic of bank failures has been traced empirically to the expanded role of the government safety net, as well as government involvement in directed credit. Government protection of banks and government direction of credit flows has encouraged excessive risk taking by banks and created greater tolerance for incompetent risk management(as distinct from purposeful increasesing risk). The government safety net, which was designed to forestall the (overestimated) risks of contagion, ironically has become the primary source of systemic instability in banking.

The more the interventions, the more the risks of a policy error.

ASEAN Stocks: Sharp volatilities hardly mean stabilization

Another huge beneficiary from Dr. Bernanke’s “highly accommodative monetary policy for the foreseeable future” has been ASEAN bourses.

Thursday, Bernanke’s announcement prompted Thailand’s SET to fly 4.22% (upper window) while Indonesia’s Jakarta Composite Index jumped by 2.8% (lower window). Both bourses[16] were up this week by .86% and .66% respectively. The marginal weekly gains reveal of the sharp volatilities experienced by both equity markets which means earlier steep losses were recouped from Dr. Bernanke’s blandishments.

I noted in the past that one consolation from the recent bear market foray by the Phisix has been that none of our neighbors has touched the bear market.

I wrote back then[17],

A consoling factor has been that the stock markets of Thailand and Indonesia has not fallen into the bear market zone…at least not yet. If these three major ASEAN markets will synchronically submit into the domain of the bears, then the bigger the risks of a full bear market cycle.

But charts of the SET and the JCI has not been comforting, while the SET has managed to slightly break above the downtrend, it is unclear if this can be sustained.

On the other hand, the JCI can be interpreted two ways depending on one’s bias, a descending triangle (bearish) and a potential double bottom (bullish).

The point being, the sustainability of momentum molded from the Fed’s policy guidance seems uncertain. This will most likely be determined by actions of the global bond markets.

And amidst the bond market turmoil, the Indonesian government managed to raise US $1 billion of dollar bonds last week which media cheered since this has been “twice oversubscribed”. But this comes with a catch; they were oversubscribed because of significantly higher rates.

From the Jakarta Post[18] (bold mine)

Investors were attracted by the 10-year dollar securities’ high yields, which reached 5.4 percent — the highest in three years. The yield, which is 282 basis points below the premium US treasuries, was also significantly higher than the government’s last global bonds auction on April, which offered the 10-year dollar notes at 3.5 percent.

So yes, one can still raise money but at significantly higher yields.

Developments in the bond markets continue to cast a pall over the stock markets.

Sharp volatilities hardly mean stabilization.

The Phisix posted a modest 1.13% gain over the week. But this comes after three days of sluggishness which resulted to a little over 3% loss. Bernanke’s guarantees incited a remarkable two day 4.17% snapback which reversed the weekly losses. Overall the Phisix endured a pendulum swing by about 7%. Simply amazing.

Yields of 10-year Philippine bonds also significantly retrenched while the Peso was unchanged for this week which are positive signs.

Again given the immense volatilities in the financial markets here and abroad, external developments are likely to influence market movements more than by internal dynamics.

In short, the Phisix will likely move in the direction along with her regional peers as influenced by the direction of global bond markets.

Excessive volatility also translates to a risky environment.

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[1] Reuters.com Bernanke: Highly accommodative policy needed for 'foreseeable future July 10, 2013

[2] See US Stocks Hit Record Highs as the US Dollar Dives July 12, 2013

[3] See How Volatile Bond Markets May Affect the Phisix, June 3, 2013

[4] See Phisix in the Shadows of a Bursting Global Bond Market Bubble June 24, 2013

[5] See How Rising US Treasury Yields May Impact the Phisix July 8, 2013

[6] See China, ASEAN Stocks Fly on Hopes for Steroids July 11, 2013

[7] Bloomberg.com China Squeezes Shadow Banking as Li Grapples With Growth, July 13, 2013

[8] Business Day Live South Africa Global equities rise on US Fed comments July 11, 2013

[9] See Confessions of a Shadow Banker in China: It's the Formal Sector that it at Risk, July 10, 2013

[10] Bloomberg.com Shadow Bank Assault Backfires as Rates Lure Cash: China Credit July 4, 2013

[11] Bloomberg.com China Exports Unexpectedly Drop; Imports in Economy Drag, July 10, 2013

[12] Bloomberg.com Chinese Cash Squeeze Causes Auto Dealer Panic, Group Says July 10, 2013

[13] Bloomberg.com Junk Sales Halt as Morgan Stanley Recommends Hedge: China Credit July 10, 2013

[14] Bloomberg.com China Faltering Demand Proved as Producer Prices Slump July 9, 2013

[15] Charles W. Calomiris BANKING CRISES AND THE RULES OF THE GAME NBER Working Papers October 2009

[16] Bloomberg.com Asia-Pacific Stock Indexes

[17] See Phisix: Don’t Ignore the Bear Market Warnings June 30, 2013

[18] Jakarta Post Dollar bonds sold out, but with high yields July 12, 2013

US Stocks Hit Record Highs as the US Dollar Dives

Ben Bernanke’s Midas Touch via record stock market highs

From the International Business Times: (bold mine)

U.S. stocks shot into record territory Thursday after the head of the U.S. central bank hinted that its current unprecedented quantitative easing policy will not end any time soon.

On Wednesday, Federal Reserve Chairman Ben Bernanke, speaking after the bank's key interest-rate setting panel issued a nondefinitive statement of its intentions, said that the current employment level is overstating the health of the job market.

That comment suggested the central bank would keep buying large amounts of bonds, a policy it has been pursuing to suppress long-term interest rates. That policy also has helped lift U.S. equities.

Bad news is good news. Each account of bad news extrapolates to the prospects of more financial market bailout via the Bernanke Put. And Wall Street loves this transfer or implicit subsidy at the expense of the economy. [This isn't isolated to the US but applies everywhere]

Here is what I wrote last Sunday

Yet a stock market boom can be engineered by governments that could destroy historical precedents. Venezuela should be an example. Venezuela’s stock market has been up a stratospheric 160% year to date. This translates to star bound 460% in one and a half years. But Venezuela’s deceiving outperformance comes at a heavy toll: the collapse of her currency the Bolivar which means rising stocks are symptoms of hyperinflation.

Well record US stock market highs came in the backdrop a huge dive in the US dollar.

More signs of financial market engineering.

Central Banks Buy Stock Markets in Record Amounts!

I always try to point out of the parallel universe or the detachment between financial markets and the real economy.

I also kept pounding on the table that stock markets are being propped up by central banks via QE and zero bound rates and not by any conventional methodology.

Now many central banks admit to buying record amounts of equities.

From Bloomberg:

Central banks, guardians of the world’s $11 trillion in foreign-exchange reserves, are buying stocks in record amounts as falling bond yields push even risk- averse investors toward equities.

In a survey of 60 central bankers this month by Central Banking Publications and Royal Bank of Scotland Group Plc, 23 percent said they own shares or plan to buy them. The Bank of Japan, holder of the second-biggest reserves, said April 4 it will more than double investments in equity exchange-traded funds to 3.5 trillion yen ($35.2 billion) by 2014. The Bank of Israel bought stocks for the first time last year while the Swiss National Bank and the Czech National Bank have boosted their holdings to at least 10 percent of reserves…

Managers of banks’ assets are looking for alternatives to holding government bonds after efforts to stimulate growth from the Federal Reserve, the Bank of Japan and the Bank of England helped send yields near to record lows. Central banks’ foreign- exchange holdings have increased by about $8.5 trillion globally in the past decade, exceeding levels needed for day-to-day currency administration.

First, central banks put up a zero interest rate environment. Then they flood the system with cash via asset purchases principally directed to bonds.

Next, they use low interest rates (as a strawman) to justify supposed asset “reallocation” into equities.

Media projects yield chasing phenomenon to have seeped into the central bankers mentality. From the same article.

Central banks’ purchases of shares show how the “hunger for yield” is changing the behavior of even the most conservative investors, according to Matthew Beesley, head of equities at Henderson Global Investors Holding Ltd. in London, which oversees about $100 billion.

While part of equity purchases may indeed signify as yield chasing, a bigger segment has been politics.

Central bank investing in equity markets functions as subsidy or via redistribution of public money to stock market participants. That subsidy comes in support of the one of the biggest owners of stock markets whom are financial institutions e.g. investment trust, pension funds and insurance. Below chart from Bank of Japan’s flow of funds.

As I have long pointed out, central banks have imbued the Bernanke doctrine of propping up the economy via a supposed rekindling the “animal spirits” through stock market friendly policies.

As an academe Ben Bernanke wrote:

History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.

Mr. Bernanke’s preference of supporting asset markets has been converted into policies. This has been expressed in his 2010 speech, the portfolio balance channel, which explicitly states that the Fed’s buying of long term securities had been designed to “affect financial conditions by changing the quantity and mix of financial assets held by the public”. He reiterated the same in his Q&A segment in February report to congress stating the need to boost “household wealth--for example, through higher home prices” in order to promote spending. 

We really don’t need conspiracy theories. Market manipulation via indirect and direct interventions have been made official. 

Central banks outside the US has only made interventions more direct.

Nonetheless all these propping up of asset markets via inciting of the speculative frenzy, has reduced the incentive for the public to invest in productive enterprises (see UK as example) and has been ballooning a global pandemic of bubbles which commensurately has been increasing fragility of the overall financial economic system.

Rising stocks has engendered a manic phase as manifested by the portrayal of central bankers as superheroes.

Yet when stock market bubbles go bust, taxpayer money will get vacuumed into the sinkhole. Otherwise if the currency will be destroyed, skyrocketing stocks like in Zimbabwe in 2008 may only buy 3 eggs.

Phisix: Holiday Abridged Sessions Unlikely an Obstacle to the Year End Rally

Methodological Individualism Applied to Holiday Shortened Trading Sessions

Trading sessions will be limited to just three days in the coming week as two days have been declared as public holidays by the Philippine government in the tradition of paying homage to the dead.

Since not everyone practices the tradition, others have used such occasion for leisure and travel.

Yet such extended holidays are likely to divert the attention of market participants on how and what to do during the mandated respite from work.

When markets are on a vacation mode, I expect trading activities to slowdown which may be reflected on Peso volume (excluding block and special block sales).

But lethargic trading does not necessarily reduce volatility.

For the past two years, holiday abbreviated weeks with three day trading sessions have posted substantial over 1% moves

*Aug 29 and 30 in 2011, Eidul Fitr and National Heroes Day[1]

**August 20 2012 Ninoy Aquino Day (Replaced to Monday)[2]

The same goes with All Saint’s Day week celebrations since 2007.

The natural intuition for the mainstream would be to impute from the above facts statistical correlations and or to seek out patterns from which to project into the future.

For instance, it would be easy to deduce of the dominance of negative returns by simple observation and the employment of heuristics without examining the operating conditions which had led to such outcomes

Let’s say, the -1.43% from November of 2011 came amidst the oversold bounce from the flash September market meltdown, as most likely an offshoot to the US Federal Reserve chairman Ben Bernanke’s jilting of market’s expectations of QE 3.0[3]

The other instances have shown to be responses to what seems as short term overbought conditions (in April and August 2012 marked by blue arrows) following new highs.

Thus, losses from Holiday shortened week have most likely accounted for profit taking.

Nonetheless the losses from the above incidentally marked the interim bottoms which eventually led to milestone highs.

Or how about the negative output during November’s of 2007 and 2008? The unfolding bear market cycle during the said period can serve as convenient explanation.

Today, considering that the Phisix has just been marginally off the record highs, along with the ASEAN peers, this means that price volatility can go in either direction.

On the downside, profit taking, possibly to fund vacations, leisure or traditional activities, could partly explain why the proclivity for negative returns.

On the upside, aggressive participants may take advantage of any new information that could eclipse such profit taking activities that may push the market higher.

In essence, there are no linear and clear cut answers to such short term events

What this implies is that even if the week’s results should turn out negative, this may not be suggests of an inflection point as the general market trend remains on the upside. This is unless of course, exogenous tail risk events may rattle the highly interconnected and intercorrelated global markets and gets transmitted to the ASEAN equity markets and to the Phisix.

The bottom line is that it would signify a serious mistake to perceive history as mechanically repeating itself for the simple reason that history is a complex phenomenon.

History as factual episodes represents heterogeneously embedded unique circumstances as consequence to “multiple causes” where “none of the factors are in constant relationship with the others” [Rothbard 1976[4]].

This also means that historical facts, according to the great Austrian Professor Ludwig von Mises[5], “cannot be used as building material for the construction of theories and the prediction of future events. Every historical experience is open to various interpretations, and is in fact interpreted in different ways”.

This also implies that while history can give us some clues, it is the understanding of science of human actions which is most important.

Again Professor Mises from the same material[6]

The subject matter of all historical sciences is the past. They cannot teach us anything which would be valid for all human actions, that is, for the future too. The study of history makes a man wise and judicious. But it does not by itself provide any knowledge and skill which could be utilized for handling concrete tasks.

Author Samuel Langhorne Clemens popularly known as Mark Twain[7] nailed it when said ‘history does not repeat itself, but it does rhyme’.

Financial Markets Are Now About Bernanke Put

Some have expressed alarm over the recent downside volatility seen in the overseas markets.

It’s all about framing, I’d say.

This week’s retracements (blue bar) seem to be in response to last week’s gains (red bars). While the degree of price changes has been different from last week to the other week, the scale of volatility has been evident. Heightened volatility from market distortions brought about by interventionism has been the crux of the current market environment.

Yet for some, declining US markets serves as a reason for concern.

The S&P 500, which I use as a key benchmark for the US markets, have lost 1.48% this week. Add to such loss the current level of the S&P 500, which represents nearly 4% loss from the most recent or September peak, we have a short term bear market story.

But there is the other view; year-to-date the major US benchmark has still been robustly up 12.27%. This remarkable advance by the US markets as exemplified by the S&P 500 has lubricated the outperformance of the Philippine Phisix and Thai’s SET and an animated global equity markets.

There are also those who claim that declining earnings will drive US markets lower.

But this concern seems valid when markets operated on merely the platform of the barrage of promises by the FED.

Expectations of the FED’s coming steroids provided the shot in the arm that produced a risk ON environment despite material signs of disconnect with the real economy or in terms of declining earnings and of the weakening of the economy[8].

Since promises are subject to diminishing returns, they are unsustainable. Rising markets based on empty talks simply increased the sensitivity to enormous downside risks or that this represents a recipe for a market crash.

Either trapped by their own policy signalling measures, or in the realization that failed expectations could bring chaos and relive the September 2011 flash meltdown, the FED and the ECB HAD to deliver.

And they DID. Both will be flooding the world with money to the preliminary tune of $2 trillion.

Add to this that this fact that it will not just be the FED-ECB but other major central banks as well. The Bank of Japan (BoJ) just joined the bandwagon with additional stimulus[9] while the Bank of England (BoE) has once again signaled its intent to expand her balance sheet further[10].

And most importantly, the US Fed Chairman Ben Bernanke made explicit that QE Forever/QEternity has been meant to sustain asset prices[11].

Many seem to forget that it is central bank actions that really matters since the market’s price mechanism has been skewered by their repeated interventionism.

Today’s risk environment has dramatically shattered conventional thinking. In a recent “Bagehot” lecture at the Buttonwood in New York City, PIMCO’s chief Mohamed El-Erian poignantly remarked[12]

What we are ultimately talking about is an “unusually uncertain” distribution of potential baseline outcomes, as well as unusually shaped tails. This inevitably undermines the robustness of lots of conventional wisdom, as well as a range of historical contracts and entitlements. It also challenges the agility of institutions in both the public and private sectors.

If corporate earnings have hardly been a factor in driving up market prices, then why should corporate earnings become a factor in marking down prices?

Earnings have recently become a matter of concern only after central bank’s rescue mechanism has been put in place. What this really shows is of the market dynamic of “buy the rumor sell on news”.

And given the reality of the slated expansion of money supply from central banks via asset purchases, this will also mean that sales revenues of enterprises will rise faster than the costs of business, where the latter has been incurred during the time prior to additional money infusions.

This implies that inflation creates the illusion of greater ‘corporate profits or earnings’, where the more the inflation, the greater the profit margins.

As financial analyst Kel Kelly explains[13] 

Another way of looking at it is that, with more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing. Thus, because of inflation, the total monetary value of business costs in a given time frame is smaller than the total monetary value of the corresponding business revenues. Were there no inflation, costs would more closely equal revenues, even if their recognition were delayed…

Since business sales revenues increase before business costs, with every round of new money printed, business profit margins stay widened; they also increase in line with an increased rate of inflation. This is one reason why countries with high rates of inflation have such high rates of profit. During bad economic times, when the government has quit printing money at a high rate, profits shrink, and during times of deflation, sales revenues fall faster than do costs.

This profit mirage from monetary inflation represents the ephemeral boom phase of business cycle.

Also as previously noted, the seeming recovery in the US real estate sector[14] will likely to be used as pretext to boost stock prices.

So far, the Dow Jones US Real Estate ($DJUSRE) and the iShares Real estate (IYR) along with Regional Bank Index (KRE) and the Philadelphia Bank Index (BKX) have all backed off from the recent highs. Although there has been little signs of any material deterioration,

Finally given the explicit goal by the FED to support asset prices via the “Wealth Effect” or Portfolio Balance Channel[15], any adjustments to the newly instituted QE Forever policies will likely be in accordance to the conditions of the financial markets.

In short, the Bernanke Put is in motion: conditions of the financial markets will dictate on the FED’s actions.

This also implies of the policy of redistributing resources from main street into the financial sector.

And any attendant tail risks will likely come from rising consumer prices (inflation risk) or the escalation of political squabbles e.g. the risks of growing secession movements in Europe[16] (political risks) or the recognition of insolvency of crisis afflicted nations or the lack of capital (credit risks), all of which will be manifested through interest rate channel.

How Interest Rate Regimes Affect Asian Stock Markets

Current easing policies by developed economies have translated into a boom through most of Asia.

That’s because most of Asia has mimicked their developed economy counterparts but from a lesser aggressive stance.

In the region, interest rate regimes can be categorized as[17]

-rate cuts in 2012: These include China, South Korea, Singapore, Thailand, Philippines, India, Pakistan and Australia

-previous rate changes prior to 2012, but remains on hold through 2012: These includes New Zealand who cut in 2011, Taiwan increased in 2010 until July 2011, Vietnam raised rates in 2010 until early 2011, Indonesia cut rates from last quarter of 2011 until January 2012 and Malaysia increased rates in mid 2011.

-increased rates in 2012: Bangladesh, Sri Lanka, Mongolia 

The relationship between interest rates and equity market performance has been striking.

Countries who cut rates in 2012 mostly outperformed: Pakistan, India, Philippines and Thailand. For those whose rates were unchanged, e.g. Malaysia, Indonesia and Taiwan, the benchmark equity performance has largely been the median.

The losers or the laggards are economies that have been raising rates: Bangladesh, Sri Lanka and Mongolia.

The Philippine central bank, the Bangko Sentral ng Piliipinas (BSP) appears to have succumbed to pressures from the external agents during the recent IMF-World Bank annual gathering by raising interest rates for the fourth time this year last week[18].

The BSP announced through Mr. Amando Tetangco that such measures were meant to “help ward off risks associated with weaker external demand by encouraging investment and consumption.”[19]

Consumption does not emerge from a vacuum. Consumption would need to be satisfied through exchange via division of labor that arises out of production.

This means production has to come from capital good investments which are financed by capital or through savings, and not from printing of money or digital creation of money.

As a reminder all economic growth stems from savings. According to the great Professor von Mises[20],

At the outset of every step forward on the road to a more plentiful existence is saving--the provisionment of products that makes it possible to prolong the average period of time elapsing between the beginning of the production process and its turning out of a product ready for use and consumption. The products accumulated for this purpose are either intermediary stages in the technological process, i.e. tools and half-finished products, or goods ready for consumption that make it possible for man to substitute, without suffering want during the waiting period, a more time-absorbing process for another absorbing a shorter time. These goods are called capital goods. Thus, saving and the resulting accumulation of capital goods are at the beginning of every attempt to improve the material conditions of man; they are the foundation of human civilization. Without saving and capital accumulation there could not be any striving toward non-material end

Inflationism, thus, only dilutes the purchasing power (even Lenin and Keynes recognized this[21]), as well as, creates economic imbalances that promote bubbles and social instability.

The BSP further admits that there has been increasing risks of price inflation through “impending electricity rate increases and rising global prices for some grains could upset the inflation outlook” but recklessly assumes that “subdued global demand should temper the overall picture by easing price pressures on oil imports”

But price inflation has been creeping upward[22] in spite of “subdued global demand” and falling Philippine exports[23]. Perhaps local monetary officials have yet to discover that there exists an economic phenomenon called stagflation—high price inflation, high unemployment and economic stagnation[24]--which dominated the 1970-80s

Nonetheless with diminishing recession risks from the US despite the recent corrections in the equity markets, explicit policy support from global central bankers led by FED-ECB on the financial markets, the still “benign” domestic price inflation, the deepening domestic negative real rates regime and the recently established momentum from the breakout, we should expect domestic financial markets (the Phisix, the Peso) to outperform at least until the year end unless external shocks will derail the above dynamics

We should also expect that sluggish commodity prices in the environment of near coordinated monetary easing implemented by almost every major economy to make an eventual rally, not entirely because of ‘consumption demand recovery’ but because of reservation demand[25] or the “demand to hold stock” or “hoard” out of anticipation of higher prices or greater use of the good or more exchange opportunities of the good for other goods.

Applied to the local stock market, stocks will rise barely because of conventional wisdom of earnings or economic growth, but because of the growing urgency to chase for yields, to gamble and to punt which all represent as products of the policy regime of negative real rates. And proof of such progression has been the growing incidences of miniature bubbles[26].

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[1] PublicHoliday.org Philippines 2011 Holidays Calendar

[2] PublicHoliday.org Philippines Holidays 2012 Calendar

[3] See Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms, September 22, 2011

[4] Murray N. Rothbard Praxeology: The Methodology of Austrian Economics Mises.org

[5] Ludwig von Mises 1. Praxeology and History Chapter II. The Epistemological Problems of the Sciences of Human Action, Human Action Mises.org

[6]Mises, Ibid

[7] Wikipedia.org Mark Twain

[8] See ECB-China Stimulus: Has the Risk ON Environment Returned? September 10, 2012

[9] see Bank of Japan Adds More Stimulus October 27, 2012

[10] Bloomberg.com King Says BOE Is Ready to Add to QE If U.K. Recovery Fades October 24, 2012

[11] see FED-ECB’s Nuclear Policies: Risk ON is Back! September 17, 2012

[12] Mohamed El-Erian Mohamed El-Erian's Bagehot Lecture From Buttonwood Minyanville.com October 24, 2012

[13] Kel Kelly How the Stock Market and Economy Really Work September 1, 2012 Mises.org

[14] See US Federal Reserve Policies Re-Inflate US Property Bubble October 20, 2012

[15] See Phisix-ASEAN Bellwethers at Fresh Record Highs October 8, 2012

[16] Atlantic Sentinel Secessionist Movements Threaten Foundation of Europe, October 17, 2012

[17] Asian Bonds Online Asia Bond Monitor September 2012

[18] ABS-CBNNEWS.com BSP ready to ease policy rates anew – Tetangco October 14, 2012

[19] Inquirer.net Philippines trims key interest rates again October 25, 2012

[20] Ludwig von Mises 2. Capital Goods and Capital XV. THE MARKET Human Action

[21] See IMF’s Christine Lagarde Inflationist Delusions October 20, 2012

[22] Danske Bank Brighter global outlook but every rose has it thorns, Emerging Market Briefer October 15, 2012

[23] See I Told You So Moment: Philippine Exports Hit in August October 12, 2012

[24] Wikipedia.org Stagflation

[25] See Are Surging Oil Prices Symptoms of a Crack-up Boom? February 24, 2012

[26] See Will Frothy Bond Markets Drive the Phisix Higher? October 22, 2012

Phisix: Managing Through Volatile Times

Understanding the effect of emotion on your actions has never been more important than it is now. In the midst of this great financial and economic crisis that grips the world, Central Banks are printing money in one form or another. This makes our investment world even more prone to bubbles and panics than it has been in the past. Either plague can kill you.-Barton Biggs (1932-2012)

My mantra of “Bad News is Good News” has gone mainstream.

I begin this week’s outlook with an excerpt from the Wall Street Journal’s Real Time Economics Blog[1],

The U.S. stock market has recently been buoyed by notions of central bank nirvana, an expectation of more easing help for economies and therefore a boon for riskier assets such as stocks here and in Europe.

So a ‘bad’ jobs number for the economy might still have been interpreted as ‘good’ in stock markets because of the presumed certainty of easing in September from the Federal Reserve.

Stocks are indeed rallying, perhaps on the notion that the economy is not destined to decelerate into full stall, and because the gain might not be ‘good’ enough to be ‘bad,’ ‘bad’ meaning it would deter an active Fed from moving.

“Bad news is good news is” may also extrapolate to permanent quasi-booms in that if true, means that there will never be a bust. Political talk have almost always wished away economic laws.

Symptoms of Bipolar Disorder from Bubble Policies

“Bad news is good news” today emanates from the entrenched expectations by financial markets that central bank interventions will effectively counteract on the unfolding negative developments in the economic realm.

In the past, financial securities including the stock markets reflected on the adverse changes in the economic and financial dimensions through price declines.

Today, the concept of central bank inflationist “nirvana”, which represents in psychology “conditioned stimulus”[2], has severely been distorting the price mechanism of the financial marketplace.

Financial markets become operationally detached from reality. And central bank assurances and pledges of rescues have only underscored the moral hazard of policy making that has been evident through policy induced rampant speculations.

The popularity of inflationism as the great Professor Ludwig von Mises once warned is about getting something from nothing[3].

The popularity of inflation and credit expansion, the ultimate source of the repeated attempts to render people prosperous by credit expansion, and thus the cause of the cyclical fluctuations of business, manifests itself clearly in the customary terminology. The boom is called good business, prosperity, and upswing. Its unavoidable aftermath, the readjustment of conditions to the real data of the market, is called crisis, slump, bad business, depression. People rebel against the insight that the disturbing element is to be seen in the malinvestment and the overconsumption of the boom period and that such an artificially induced boom is doomed. They are looking for the philosophers' stone to make it last.

This has not just been theory. To my experience such policies have indeed been manifesting negative influence to the unsuspecting public. For instance, my counsel to take on a defensive posture have been begrudged and misinterpreted by some as depriving them of the opportunity to earn [and of course, the urge to satisfy one’s dopamine neurons...or the gambling instinct]

Yes inflationism brings out the worst in many people.

Yet for the past two weeks, global equity markets have exhibited increasing symptoms of a bipolar disorder[4] through flashes of abruptly shifting manic-depressive moods that has been ventilated on the markets through sharp volatilities.

Under pressure from increasing evidences of a global economic slowdown, financial markets have been treated promises to inflate—such as European Central Bank’s Mario Draghi recent pledge to do “whatever it takes to save the Euro[5]”—that has prompted financial markets to soar[6]

The two day risk ON mode from the pep talk by ECB President Mario Draghi resulted to a short term price convergence from supposedly disparate asset classes that has been labeled as the “Super Mario’s trifecta”[7].

The furious synchronized rally in global stocks (represented by the US S&P 500), can also be seen in gold and in US 10 treasury prices.

An almost similar pattern has emerged this week.

Again following early accounts of weaknesses in the financial markets, reports of a concession have been in the works by ECB and EU officials that could likely facilitate for the much anticipated “Big Bazooka”, fired up the global equity markets on Friday[8].

Most of the biggest gains last Friday were seen in major European equities bellwethers such as the Stox 50, the German Dax and UK’s FTSE 100.

However in contrast to the previous week, in the bond markets, US treasuries fell (yields increased) but Spanish (orange) and Italian (green) 10 year bonds climbed or yields fell.

For the past two weeks, each time reality returned to the markets (as seen by the spike in yields and selling pressures in equity) the recourse of ECB’s Mario Draghi has been to wheedle the markets with pledges.

Friday’s massive rally in the US came despite the questionable gains in the job report (as indicated by the above opening excerpt)—the improvements in the US job markets has eclipsed the increase in the unemployment rates, and importantly, has discounted on the large number of the people who dropped out of the labor force[9].

This implies that the real reason behind the rally in the US markets has been about the return of the global RISK ON mode initiated from the prospective ECB-EU deal which may be forged anytime.

Nonetheless, despite all the popular attributions of the recent rally, the constant declarations of support by central bankers have apparently been mainly designed to keep short sellers at bay.

Yet any deal will likely prompt Spain (and or Italy) to access the fast depleting European Financial Stability Facility EFSF (temporary fund) first. The ECB would likely function as bridge financier as the access to the European Stability Mechanism (permanent fund) will have to be fully ratified by EU member states, notwithstanding the much awaited German Supreme Court ruling on the opposition filed by several German lawmakers against the German parliament’s swift passage of the bailout fund or the ESM[10].

As I noted in a blog, I think that the US Federal Reserve may defer on the mulled QE as they are likely to wait for the ECB to take the initiative and consequently watch for the effect before taking action.

The Foggy Outlook of US Markets and the US Economy

Let me add that the strong Friday rally in the US stock markets may not be that convincing as market internals reveals of a “narrowing breadth” or declining participation of gains by key index issues. This means that the large gains posted by the S&P 500 have been mostly concentrated to a few index heavyweights.

Also the Dow transports appear to diverge with the Dow Jones Industrials. According to one of the 6 basic tenets of the Dow Theory[11], the averages must confirm each other. A genuine economic recovery will become evident in the profits of both transports and industrials which should get reflected on the respective prices of these benchmarks. Thus, the conflicting signals translate to market ambiguity.

The jumbled outlook in the market internals may even signify signs of distribution or of the diminishing forces of the bulls.

This could also signal indirect interventions by political authorities via ETFs as the Bank of Japan (BoJ) has been openly conducting.

Bad news is good news.

US stocks markets respond to Pavlovian classical conditioning even as the quarterly spread between companies raising or lowering earnings guidance has been materially deteriorating during the past four consecutive quarters[12].

With 45% of revenues of the S&P 500 index companies exposed to the world economy[13] the decline in earnings guidance should be expected considering the intensifying downdraft of global economies[14].

Mohamed El-Erian, CEO of one of the leading investment firms, PIMCO, has even expressed apprehensions by citing “frightening”, “serious, synchronized slowdown”[15]

But a US slowdown may come from both internal and external forces

Capital spending in the US as measured by new factory orders has also shown significant downturn.

Dr. Ed Yardeni observes[16], (see left chart on the left window)

As go profits, so goes business spending. The recent stall in S&P 500 forward earnings isn’t a good omen for new factory orders, which have already stalled so far this year. Profitable companies expand their capacity by spending more on plant and equipment. Unprofitable companies scramble to cut their costs by reducing their capital outlays. In the real GDP accounts, the pace of capital spending has been slowing. It rose 5.3% (saar) during Q2 following a gain of 7.5% during Q1. Last year, such spending increased 8.6%.

And this has also been true with US export orders (right window from Sean Corrigan/Zero hedge[17])

There always will be something to be optimistic about. The question is which force will likely have a more powerful influence, the positive or the negative?

So far the continuing expansion of US business and industrial loans looks like one of the major bullish signs, but this would be highly dependent on business or capital spending indicators.

Also seasonality of stock market performances during US presidential elections, as well as, extreme bearishness of hedge funds (right window) and continued efflux by retail investors (left window Wall Street Journal[18]) represent as “crowded trade” sentiment.

Overall, I cannot see how seasonal forces and or how sentiment will overcome current fundamental deficiencies brought about the global central banking tentativeness and political gridlocks which has been prompting for today’s sluggish (bubble popping) economic outlook.

Seasonal forces mainly rely on the statistical probabilities of historical performance. This assumes previous historical conditions in the context of mathematical aggregates, as if the past had similar conditions. In reality conditions of the past have been unique. This makes reliance on statistics as a poor road map of the future.

Black Swan author and distinguished mathematician and iconoclast Nassim Nicolas Taleb in an interview with McKinsey Quarterly[19] warns about the inappropriate use of statistics

The field of statistics is based on something called the law of large numbers: as you increase your sample size, no single observation is going to hurt you. Sometimes that works. But the rules are based on classes of distribution that don’t always hold in our world. All statistics come from games. But our world doesn’t resemble games. We don’t have dice that can deliver. Instead of dice with one through six, the real world can have one through five—and then a trillion. The real world can do that.

The world is complex while aggregates rely on constants and assume simplifications.

Sentiments, on the other hand, signify as symptoms to an underlying cause.

The Phisix Ascendancy Depends on the Developments in the US

What do all these have to do with the Phisix and ASEAN stocks?

Everything.

I believe that the Phisix outperformance may continue for as long as the US does not fall into a recession.

China remains to be a significant factor too but she will likely be subordinate to the developments in the US. [I may be wrong here, as a deeper downturn in China may likely to affect many emerging market commodity exporters as well as the global supply chain networks]

However should the US economy and the financial markets capitulate to market forces, who will be exposing the massive misdirected investments through falling asset prices and through an economic recession, the chances are local and regional financial markets will likewise suffer from such agonizing cyclical adjustments.

Again like in 2007-2008 the Philippines and ASEAN may be subject to the risk of contagion.

Yet there has been little evidence in support of a regional decoupling.

And this brings us to the risk-reward trade off: I believe that under current conditions excessive optimism for the sustained ascension of the Phisix seems unwarranted. This is until central banks of major economies lay down their cards on the table or until we see some substantial improvements in the economic dimensions for major economies. However considering that inflationist policies has dominated much of the world’s economic and financial markets much of the misallocated capital will likely translate to the unwinding of speculative positions through economic and financial losses.

Also given the fluidity of developments as manifested by the alternating manic-depressive phases of how events unfold, the risks seems high that any policy errors may prompt for a swift and dramatic deterioration of conditions that may wipe any gains that may be temporarily acquired.

For me, to be excessively sanguine over local stock markets under the present conditions means the following;

1. unbounded faith in the capabilities of global and local central bankers (as well as politicians) to fix the current predicament.

2. belief that geopolitical and national political gridlocks will be resolved soon

3. a firm disposition to the theory of decoupling where the Philippines is presumed as having distinctive immunity to the risks of a global recession

4. to be hopeful that current global economic slowdown has reached an inflection point and will recover immediately

5. to simply believe for the sake of believing.

All the above simply posits of the severe underestimation of the risks conditions.

As English biologist Thomas Henry Huxley[20] once commented,

Logical consequences are the scarecrows of fools and the beacons of wise men

A US recession may not be in the cards yet, as we need to see more evidence on this. However considering the heavy dependency on the Fed’s or central banking steroids, much of the fate of the US economy will likely depend on how US political authorities will react. For instance if the FED forcefully inflates then this would likely produce a temporary patch.

While the risks of a US recession may not be imminent, such risks seem to be growing.

More Symptoms of the Philippine Boom-Bust Cycle

One of the big factors that has, so far, worked in favor of domestic stock market, as I have repeatedly been pointing out[21], has been the negative real rates which has impelled for a domestic version of yield chasing dynamic.

This yield chasing dynamic in the domestic financial market and the economy has been supported by a steep yield curve, which is likely to accelerate a credit driven boom. The Philippines has the steepest yield curve in Asia (chart from ADB[22]).

Such credit boom has already been visible via a double digit loan growth of the banking industry last May[23].

Also the business cycle has become quite evident in the performance of the stocks.

The banking and capital intensive property sectors have outclassed all other sectors. [If there should be no US recession, my guess is that mining and oil will resume as the market’s darlings in 2013]

As I wrote last November[24]

Although I am not sure which sector should give the best returns over the short term, I am predisposed towards what Austrian economics calls as the higher order stages of production or the capital goods industries, which are likely the beneficiaries of the business cycle, specifically, mining, property-construction and energy, as well as financials whom are likely to serve as funding intermediaries for these projects.

But again such credit driven boom will likely be subject or sensitive to the developments in the international sphere, and given the current conditions, I suspect that the credit boom may be deferred.

Miniature Bubbles: The Calata Episode

Negative real rates also give us miniature boom bust cycles or bubbles within bubbles.

I think the experience by Calata Corporation[25] [PSE: CAL], the recently listed agri product distributor, looks like a great example.

I recall of the passionate or even heated debates on a social network forum over the so-called merits of ‘investing’ based on corporate ‘fundamentals’.

Since the company listed in May, the wild price fluctuations of the issue exhibits, not of public’s perception about the company’s business model, but about the quick buck or short term mentality and the emotionally charged (greed and fear) speculative activities.

My guess is that most of those who dabbled with the issue have suffered excruciating losses than gains as Calata now trades below the IPO price at 7.5 pesos a share.

And yet due to the excessive volatility, like their counterparts in the Eurozone and elsewhere, the local authorities via the Security and Exchange Commission (SEC) recently launched an investigation for possible “stock market manipulation”[26].

This would seem more like chapter of witch-hunting that will likely end up nowhere. Nonetheless, such activities are seen as good for the populist politics of “do something”.

This unfortunate Calata incident also reveals of the way government deals with symptoms rather the disease, and who adroitly shifts the blame of the unintended consequences of social policies to the private sector.

While the Calata episode may not be representative of the entire Philippine stock markets yet, the basic lesson is that negative real rate regime molds the public’s orientation towards short term thinking, and importantly, whets on the public’s gambling appetite.

Yes many will always find ‘excuses’ to endeavor on supposed rationally based ‘investments’ when in reality they are only after “high risk-low return” dopamine seeking punts.

Negative real rates compel them towards speculative activities which in aggregate will become the dominant feature of the financial marketplace and the economy. Political suppression of interest rates therefore lays the foundations to the business or bubble cycles as speculations replace productive undertakings.

The Calata event signifies as the tip of the iceberg. Eventually as the markets go higher there will be more incidences of miniature bubbles ahead. Yet as the Japan bubble bust of 1990, Tequila crisis of 1994, Asian crisis of 1997, LTCM episode of 1998, dot.com bust in 2000 and US housing mortgage bubble bust 2008 have all shown, the broader market will likely transform into a full scale credit driven bubble if social policies remain attuned towards inflationism or the creation false prosperity from policy induced credit expansion.

As for the present state of the markets my bottom line is: For as long as global central bankers remain hesitant and only resorts to talking up the markets, in the face of a deepening slump in the global economy, I think global financial markets including the Philippines will be subject to intense price oscillations or a high risk environment.

Given the high correlationships of financial markets which has been the reason for RISK ON RISK OFF environments. Prudent investing means not having to put all your eggs in one basket.

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[1] Real Time Economic Blog Are Jobs Data Bad Enough to Be Good for Stocks? Wall Street Journal, August 3, 2012

[2] Wikipedia.org Classical conditioning

[3] Mises, Ludwig von 9. The Market Economy as Affected by the Recurrence of the Trade Cycle XX. INTEREST, CREDIT EXPANSION, AND THE TRADE CYCLE, Human Action, Mises.org

[4] Wikipedia.org Bipolar disorder

[5] See What Draghi’s Statement “The ECB is Ready to do Whatever it Takes to Preserve the Euro” Means, July 29, 2012

[6] See The Magic of Central Banking Talk Therapy, July 28, 2012

[7] See Explaining Super Mario’s Trifecta, August 4, 2012

[8] See Will the Accord by the ECB-EU Politicians Pave Way for the Big Bazooka? August 3, 2012

[9] See Has Friday’s Surge by the US Stock Markets Been about the ‘Positive’ Jobs Report? August 4, 2012

[10] See Global Financial Markets: Will the EU Summit’s Honeymoon Last? July 2, 2012

[11] Wikipedia.org Dow theory

[12] Bespoke Invest Bad Guidance Continues, July 29, 2012

[13] See Why Current Market Conditions Warrants a Defensive Stance, July 9, 2012

[14] US Global Investors The Race for Resources, Investor Alert, August 3, 2012

[15] See PIMCO’s Mohamed El-Erian: “Frightening” Global Synchronized Slowdown, August 3, 2012

[16] Yardeni Ed, Capital Spending, Dr. Ed’s Blog July 31, 2012

[17] Zero Hedge US Export Orders Are Collapsing August 2, 2012

[18] Zweig Jason When Will Retail Investors Call It Quits? August 2, 2012, Wall Street Journal

[19] Mckinsey Quarterly Taking improbable events seriously: An interview with the author of The Black Swan December 2008

[20] Wikipedia.org Thomas Henry Huxley

[21] See Investing in the PSE: Will Negative Real Rates Generate Positive Real Returns? November 20, 2011

[22] ADB Key Developments in Asian Local Currency Markets AsianBondsOnline July 30, 2012

[23] Business Inquirer, Bank lending maintains double-digit growth rate in May—BSP, July 11, 2011

[24] See Phisix-ASEAN Equities: Awaiting for the Confirmation of the Bullmarket November 13, 2012

[25] Philippine Stock Exchange Calata Corporation

[26] Business Mirror Calata shares plummet as SEC confirms probe, August 2, 2012