Phisix 8,000 in the Shadow of the EPHE

As an old saw goes, what you see depends on where you stand.

Well, perhaps it could be more than just the position, but rather the positional effect of a defined optical activity. In a word, bias.

Bias shapes people’s perception, observation, discernment and eventual actions.

Biases, anchored on the mental “law of least efforts”, are often associated with heuristics or mental shortcuts.

And heuristics are often a product of crowd wisdom.

For instance, the current vertical price actions of several issues at the Philippine Stock Exchange represent symptoms of deeply held convictions that free lunches not only exists but has become an entitlement mostly for the financial industry.

The shibboleth of G-R-O-W-T-H has pillared the free lunch creed.

When the markets move higher, such heuristic goes into motion. When the market falls, the intuitive excuse would then shift to “expensive”.

Neither G-R-O-W-T-H nor expensive explains the causality of price movements. Although through the conditioning of mainstream experts such misperceptions have become embedded on the public.

 

Charts serve as great examples of how one would apply biases in the analysis.

For the bulls, the Phisix chart would look like a bullish ascending triangle whose resistance levels at 8,100 are presently being tested.

Forget the double top. Forget too of the steep rising wedge formations that have doomed the three previous vertical rallies since 2013.

This time MUST be different.

Aside from the Phisix chart, I offer another perspective: The US listed Philippine ETF, the EPHE. (see lower window)

iShares defined the EPHE or the iShares MSCI Philippines ETF as seeking “to track the investment results of a broad-based index composed of Philippine equities”.

The EPHE is NOT the Phisix.

Unlike the elite 30 of the Phisix, the EPHE represents a constituent of 44 Philippine equities, 25 of which are PSEi components. EPHE includes non PSEi 30 issues such as DNL, BLOOM, MRP, DD, VLL, MWC, CEB, COSCO, CHP, FLI, LPZ, FPH, CNPF, X, NIKL, PLC, RCB and ABSP. It has a cash account BLKFDS which serves as the 44th component. And excluded from the EPHE are PSEi issues MER, SMC, SCC, PGOLD and LTG.

The EPHE is listed on the NYSE and denominated in USD.

The EPHE’s top 5 issues with their attendant share weightings are Ayala Land (9.53%), SMPH (9.25%), BDO (7.5%), JGS (7.13%) and Ayala Corp (6.68%). Strikingly, SM ranked only sixth with 5.91% share.

The top 5 issues account for 40.09% share of the ETF’s basket

On the other hand, the top 5 PSEi issues are SM (11.1%), SMPH (8.49%), ALI (8.42%), BDO (6.39%) and JGS (6.17%). The top 5 issues of the PSEi 30 have a 40.57% share of the index.

From a chart perspective, both the PSEi and the EPHE has shown serial accounts of vertical prices as manifested through the rising wedge formation.

Unlike the PSEi where a new record beckons, the EPHE’s present vertical actions have severely lagged the 2015 and 2016 peers.

Unlike the PSEi’s ascending triangle, EPHE offers an opposite outlook, a bearish descending triangle.

Even more, though the differences in market share weights have also been a factor, diminishing returns appears to have plagued the EPHE mainly from the weakening peso and the inclusion of a relatively broader number of firms.

It would take a combined massive rally in the peso and at least Phisix 8,500 for the EPHE to reach its old high

Just look at how the Phisix 8,000 level was reached last week.

 

Because SM, SMPH and ALI have a combined 28.02% market weight share, their staggering gains for the week, specifically 3.97%, 3.7% and 1.45% respectively, contributed to about an astronomical 80% share of the week’s 1.04% output!!!

If PLDT and ICTSI would be included, the share of combined contributions rockets vastly above 100%! Losses on the rest diminish their gains.

The Phisix catapulted higher this week, but losses dominated the broader based components: decliners outclassed advancers 16 to 13 with one unchanged!

Considering the explosive price volatility, the average gain by the Phisix was only .31%!!!!

Speaking of price instability, 14 of the 30 issues or 47% had price changes of at least 2%. And price changes of at least 3% were recorded in 6 issues or 20% of the PSEi. Remarkable!

 

Because of the mechanical pumping on the Sy group of companies, SM + SMPH’s share of the PSEi has rocketed to the highest level at 19.6%. The share of the trio (including BDO) has surged to stunning 25.99% of the PSEi 30. (see upper pane)

In other words, Phisix 8,000 has become acutely, if not entirely dependent on the sustained vertical pumping of top 5 issues, in particular, the Sy-owned group.

The Philippine Stock Exchange updated its Price Earnings Ratio (PER) last week to incorporate 2016 eps.

The average PER of the Phisix as of June 9 was at 20.48, which resonates with the EPHE PER at 20.43 as of June 8.

Yet the market weighted PER for the Phisix rockets to 25.35! That’s because of the clustering of the priciest securities at the top 5 which comprise 54.65% of index PER! (see lower pane)

Because of the prevailing bias, this clearly shows how prices have only become the sole factor for the Philippine Stock Exchange. This is especially true for those manipulating the Phisix higher via synchronized relentless pumping of the top 5 issues (or mostly on the Sy-group)

As it stands, the near record PSEi signifies a mirage, a function of brazen and rampant manipulation and is UNSUSTAINABLE.

Is the US Federal Reserve Indirectly Putting Down Gold Prices?

Have US Federal Reserve officials been indirectly trying to take down gold prices?

In barely 2 weeks of 2013, gold prices attempted twice to move higher (See ellipses). One peaked during New Year just right after the fiscal cliff deal. The second was during Thursday of this week.

However, both gains had been cut short. This appears coincidentally timed with two occasions where Fed communications (FOMC minutes) had been released and when Fed officials went on air expressing doubts over QE 4.0.

The first came with the announcement of the FOMC minutes which revealed of growing dissension over unlimited asset purchases, a day after the fiscal deal.  I earlier wrote that this signifies another of the Fed’s serial Poker bluff. 

Last night, while switching channel after watching another TV program, I happen to stumble upon Federal Reserve Bank of Philadelphia President Charles Plosser’s Bloomberg interview, where he hinted of his bias against pursuing more balance sheet expansion. If memory serves me right, prices of gold was then trading at $1,669-1,670. Bloomberg seem to have featured this interview in a follow up article

Then I learned today that other Fed officials featured by mainstream outlets also covered the FED hawks.

And in both occasions where hawkish sentiments by FED officials were aired, the earlier gains scored by gold prices had nearly been erased.

Gold has been marginally up this week.

Considering that FED employs communication strategies to influence market behavior called as “signaling channel”, my suspicion is that this has been part of the implicit tactic to mute the public’s inflation expectations, expressed via gold prices.

Nonetheless, I expect such mind manipulation ploys to be ephemeral.

That’s because as I pointed out during my last stock market commentary for 2012

Evidence suggest that gold prices may have departed from real world activities. Sales of physical gold have exploded to record highs. Moreover central bank buying has been gathering steam, which seems on path to hit new highs this year (500 tons), along with record ETF gold holdings at 2,627 tons.

It seems that only after a month, we are getting more proof on this

In the US, sales of physical gold and silver has been exploding: The US mint reports 57,000 gold ounce sales for the first two days of the year and sale of silver coins tripled from December.

In the meantime, India’s gold imports reportedly surged amidst fears that the Indian government may continue to act to suppress demand for gold. According to Mineweb.com, after two earlier hikes of import duties, gold smuggling has also reached new levels. Smuggling is a typical reaction to prohibitions or quasi-prohibitions edicts via tax increases.

In addition, central bank gold buying have also been ramping up. According to International Business Times

In the third quarter, according to the World Gold Council (WGC), the world's central banks bought a total 97.6 metric tons of gold.

In six out of the last seven quarters, central bank demand has been around 100 metric tons, which is a sharp increase from as recently as 2010, the bank said in a statement, adding that through the third quarter of this year, total central bank buying was up 9 percent.

Moreover, China's government via the PBoC reportedly will increase gold acquisition to diversify from her foreign exchange holdings.

The China Daily notes,

China may decide to increase the percentage of gold holdings in its monetary reserves in the next few years, said the report, an analysis of the world monetary system commissioned by the World Gold Council.

Demand for gold is likely to rise amid the uncertainty about the stability of the US dollar and the euro, the main assets held by central banks and sovereign funds, it added.

China almost doubled its gold reserves in the last five years. The country had holdings of 1,054metric tons in July 2012 and is now the sixth-largest holder of monetary gold.

In 2011, gold accounted for 14.4 percent of the world's total monetary reserves.

In a country-by-country comparison, the figure was 1.6 percent in China, while it was 74.5percent in the United States, 71.4 percent in Germany and 71.1 percent in France, according to data from the World Gold Council and the International Monetary Fund.

China holds the world's largest foreign exchange reserves, which were worth more than $3.31trillion by the end of 2012, according to figures from the People's Bank of China, the country's central bank.

China has been approaching gold with “talk the talk” as November gold imports have doubled from October.

According to Zero Hedge, (italics original)

at 90.8 tons, this was the second highest gross import number of 2012, double the 47 tons imported in October (which many saw,incorrectly, as an indication of China's waning interest in the yellow metal), and brings the Year to Date total to a massive 720 tons of gold through November. If last year is any indication, the December total will be roughly the same amount, and will bring the total 2012 import amount to over 800 tons, double the 392.6 tons imported in 2011.

Meanwhile, ETF holdings of gold remain at record levels

 

According to my digital financial chronicle,

Exchange traded funds (ETFs), with gold as the underlying asset, have contributed to its prices. Institutional and retail inflows into global gold ETFs are at record levels. ETF holdings have been a key indicator of price movements in the recent years. Reports suggest that at November end last year ETF holdings were at an all-time high of over $150 billion. Till November, holdings in ETFs had risen by 12 per cent to 2,630 tonnes.

In short, the strings of record highs from various activities such as buying of physical gold, ETF holdings, record imports of China and India (two largest gold consumers) and lastly central bank buying simply doesn’t square with current consolidation phase.

Interventions to suppress gold prices are likely to have short term impact.

Competition Fueled Global Stock Exchange Automation

Transition to electronic trading in global stock exchanges only gained traction after the derivatives exchanges gave them a challenge

Professor Michael Gorham of the Illinois Institute of Technology narrates (World Federation of Stock Exchanges) [bold emphasis mine]

As we have seen, the early pioneers of electronic derivatives trading created brand new exchanges starting in the mid 1980s. It took almost another decade before existing floor-based exchanges began fully converting to screens. Aside from the fact that conversions from floors to screens met stiff resistance from member-owners whose livelihoods were threatened, derivatives trading, especially in financial products, was still in its infancy and many countries did not yet have derivatives exchanges. New Zealand, Sweden, Switzerland, Germany, South Africa and China all had no derivatives exchanges. So during the mid 1980s and early 1990s, all these countries created new derivatives exchanges, and they were all electronic right out of the box.

Stock exchanges, on the other hand, were relatively mature institutions, and most countries of any size already had one or more stock exchanges and were not generally building new ones. And given the natural resistance of member-owners, the existing stock exchanges, just like the existing derivatives exchanges, were not likely to quickly convert to screens. Consequently, early electronic activity on the securities side was carried out on an experimental basis, typically only for stocks that were relatively inactive. So in figure 6.2, we see that except for the isolated event of the Cincinnati Stock Exchange becoming electronic in 1980, it was not until 1989 that stock exchanges began to start converting to electronic trading in earnest

Some observations;

Most stock exchanges being monopolies or oligopolies have been slow to adapt to changes.

It took the introduction of derivative markets which threatened to compete with these traditional exchanges to prompt the latter to automate.

Nevertheless automation revolutionized trading. It facilitated increases in transparency, enabled outsourcing of traditional functions such as trading floor operations, product development, marketing, legal, regulatory and often clearing and settlement, which has contributed to the precipitous decline in the cost of trading, promoted direct access to exchange matching engines, introduced new order types, and fuelled a leap in merger and acquisitions activities.

Automation has been a significant part of financial globalization which means that the trend for stock exchanges here (in the Philippines) and abroad will likely incorporate new trading platforms/services.

For instance, the Philippine Stock Exchange has derivatives on the pipeline (via Red Hat) and has seen participation in new Exchange Traded Funds (ETFs) traded offshore, e.g. for ASEAN, the FTSE ASEAN Index Series and iShares MSCI Philippines Investable Market Index Fund (EPHE)

Deep and sophisticated capital markets are prerequisites to progressing market economies.

PSE: The Handicaps Of A One Directional Reward Based Platform

``A free market has to and does coordinate current and future production against future unknown demands, supplies, and shocks; and it has to and does find ways to alleviate the negative effects of shocks. People generally accomplish this by planning, forecasting, conservative practices, saving, hedging, insuring, and diversifying. There are countless ways, each tailored to particular circumstances. When a man has a backup trade, he is hedging against being laid off in his main occupation. When a family saves, it is hedging against loss of income. When family members help one another in hard times, they are insuring each other. When a business is conservative in obtaining credit and expanding, it is hedging against possible stringent business conditions. When a person diversifies investments, he is hedging against loss in one part of the portfolio. When a business controls inventories, it is managing the risk of shocks to the business.”- Michael S. Rozeff, Destination Collapse

Over at a recent huddle, a good friend asked me “how does one maintain discipline if it is an extended bear market?” The underlying concern was that the temptation or the urge to “catch the falling knife” or to “scalp (day trades)” had been quite strong given the nearly 2 years of drought in profit opportunities.

I would believe that such sentiment fundamentally embodies the unappreciated circumstance that inhibits the progress of our capital markets.

The principal problem with the Philippine Stock Exchange (PSE) is that the sustainability of the equity market industry is almost entirely dependent on a UNIDIRECTIONAL trend- that’s because people and the industry generally make money only when the Phisix goes up or is in a bullmarket!

True, “short” or the securities borrowing and lending facilities lending have been recently introduced. But apparently unfamiliar to the public or to the authorities or regulators is that any regulatory framework operates on economic dimensions : It’s always about the tradeoffs between costs and benefits.

If brokers don’t implement these, for reasons of perceived cost outweighing perceived benefits, primarily due to the compliance albatross, then effectively the program is rendered inoperative. Even if it seems noteworthy in paper, what good is a new trading platform if it can’t be used at all?

Unforeseen Consequences

Nonetheless a one dimensional reward based market has these unforeseen consequences:

1. Deprives market participants to earn

Obviously since markets operate on secular cyclical trends, then the industry or the public profits only from a bullmarket and suffers from a period of agony of “deprivation” once the bearmarket reign.

In Biblical analogy, the PSE is reduced to FAT and LEAN years with basically nothing in between. This, sadly to say, reflects on the primitive state of our financial markets.

2. Limits Liquidity

Industry participants whine of the lack of liquidity or volume. But this is exactly why hardly volume hardly progresses:

In a bullmarket, the volume of trade improves because the public churn trades profitably. In contrast, in a bearmarket, buyers have essentially been confined to a “catching a falling knife” position, where loses from wrong market “timing” or “expectations” would compel a mostly “long” position, thereby containing incidences of trades which effectively shrivels volume.

And reduced liquidity diminishes the incentives for private companies to get publicly listed, increases the market’s risk profile and exaggerates volatility.

3. Restrains growth potential of the industry

Moreover, major industry participants, particularly, brokers, mutual funds or Unit Investor Trust Funds (UITFs) would be reluctant to invest for expansion under the recognition of operational handicaps of a unidirectional reward based market, hence, the growth rate mediocrity of the Philippine capital markets.

Figure 1: ADB Bond Monitor 1^st Quarter 2009: Year on Year Performance

The chart above (which shows the year on year changes) also shows state of the Philippine equity markets in terms of market capitalization calculated in US dollars, which has severely lagged the region.

4. Handicapped Financial Industry Is Transmitted To Suboptimal Economic Growth

Another underappreciated dimension is that a unidirectional reward based market has an economic wide impact.

While for most people, the stock market is seen as a gambling casino or as some form of legal embellishment, for us, the stock market functions as a fundamental pillar to national development. And to reprise its importance, from our A Primer On Stock Markets-Why It Isn’t Generally A Gambling Casino:

-The stock market is a vital part of the process from which we coordinate production. Ideally stock prices should reflect the productivity of business firm aside from market’s discernment of the entrepreneurial judgments concerning future productivity.

-It competes with the banking sector in determining the degree of mobilization of savings into investment. From a national scale this becomes a formidable channel for economic advancement in terms of efficiency of capital deployment.

-Unknown to many, stock markets often function as forward indicators, such that they have been known to predict upcoming recessions or prospective recoveries. Thus, movements in the financial and stock markets can give a clue to the transitioning business environment, which should help management or businessmen, in allocating resources or in applying their business strategies going forward.

-It operates as alternative avenues for fund raising (public listing), intermediation (using shares as collateral for borrowing-lending) or liquidity generation (buying or selling a company).

-Because the markets operate as an organized platform of exchange, the ease from a market’s liquidity allows companies to save on transaction costs: search cost (matching buyers and sellers), contracting costs (cost of negotiation) and coordination cost (meshing securities of different industries into a single platform), which frees up capital for other usage.

-Allows wider public participation in the ownership of major companies, which expands the concept of private property ownership.

-Allows some individuals to save from taxation (e.g. inheritance taxes)

-Because stock markets function as repository of collateral or store of value, it can serve as protection or safehaven against hyperinflation or a severe form of a loss of purchasing power of a currency.

Hence in a unidirectional reward based market the following factors have been compromised:

-market pricing efficiency (reduced liquidity amplifies volatility and structurally raises risk premium or the hurdle rate),

-the optimum channeling of savings into investment or capital deployment (which translates to lesser investment opportunities and suboptimal returns),

-access to alternative financing (extrapolates to high cost of financing, which implies low public listings),

-investment opportunities that allows for a wider public participation or the “trickle down effect” (limited income growth opportunities for the public),

-the lowering of transactional costs (reduces the incentives for attracting wholesale or bulk institutional investments and requires higher hurdle rate) and

-hedging and other opportunity costs as seen from any sophisticated and deep markets (increases risk profile or premium, and heightens volatility)

From which all of these translates to lost opportunities for national wealth generation.

5. Emits Wrong Impressions and Reduces Role of Specialization

A unidirectional rewards based market exacerbated by Principal Agent problem reinforces the public’s perspective of the simplistic functionality of stock markets.

Information derived from commission based Sell Side institutions accentuates on the short term orientation of market exposure to most retail investors. And this also applies to some institutional accounts as well.

Where markets are seen as operating in a short term framework, the degree of risk taking appetite would be intensified by cyclical extremities. Again this magnifies volatility, increases perception of risk from the international institutional standpoint and diminishes the requirement or the need for division of labor or the role of specialization for domestic industry participants.

Who would want to invest in mutual funds, or UITFs or broker discretionary accounts, when the impression portrayed is -what the so-called experts can do is available to anyone? Who cares about risk, when mainstream literature almost always expounds on momentum, preened in the fundamental or technical charting garb?

To respond to such objections local sell side institutions would then expound on emphasizing on their capability to trade short term fluctuations-which is nothing more than a hokum operating on the graces of lady luck!

It’s is of no wonder why losses suffered by retail investors during bearmarkets, in many occasion, leads to abhorrence and complete desertion of the markets. This is mainly due to the wrong expectations inculcated from misleading foundations of how markets operate and the lack of alternative instruments to protect market participants from market losses during cyclical transitions.

6. Distorts Incentives

Some discretionary accounts operating under a bearmarket would prefer to withdraw proceeds than leave them with industry fund managers.

In my mind’s eye, the perception is that cash would be better off under the clients’ management since there would be no alternative options to put these at work in the capital markets. Hence, these risks skewing the incentives for managers to long the client’s account, despite the realities of an unfolding bearmarket cycle, than to lose handle.

In other words, because the operational arrangements of the fund industry could be impaired by the lack of instruments to employ idle funds in a market which only profits from one direction, fund managers could be motivated to take on more risks than required. Again, the Principal Agent Problem at work here.

From my standpoint, bearmarkets can be classified into two strains: structural or contagion based/cyclical. Both of which requires different investment approaches.

The latter of which is one that can be longed or endured with, since the national economy has no major fundamental impairment (mostly clustering errors from malinvestments from bubble policies) and could be expected to recover and to profit from a reversal of the cycle in the fullness of time. The 2007-2008 financial crises serves as lucid example of this scenario applied to the Philippine setting.

Nonetheless, the former requires total exodus regardless of the conditions of the portfolio when such a cycle emerges. That’s because bubble afflicted markets or industries can vaporize issues regardless of its previous stature. Think AIG, Bear Stearns, Lehman Brothers, General Motors and Chyrsler.

In short, there are no blue chips in an unwinding bubble afflicted industry! The idea that paper losses are merely paper losses without liquidations consummating the transaction is false.

So the analytical approach of the analyst or fund manager ultimately distinguishes between portfolio salvation and damnation, and matters more than what the public normally expects of them.

7. Cognitive Biases Also Shaped In One Direction

Again since markets are basically psychologically driven, participants are thereby influenced by cognitive biases or the reflexivity theory.

Analysts or experts as well as the general public, here, are predisposed towards a bullish bias simply because the current operating environment rewards participants only when the markets move in a sustained upward trajectory.

And we see the same dynamics applied to politics, market participants audibly cheer upon policies that temporarily boost market prices at the expense of the future simply because the public’s general expectation is predisposed towards the short term expectations.

And it is the same reason why many participants, like my good friend, despite the understanding of key market tenets, have been tempted to defy such guidelines to engage in ‘catching a falling knife’ trades- out of the psychology directed by the reward incentives provided for by the present operational market mechanism.

And such a bias doesn’t elude me entirely.

Conclusion and Recommendations

And so what could be done?

For PSE authorities:

We suggest that the “ease of use” principle founded on a sound legal framework, or the proverbial horse before the cart, as the main thrust to introduce market reforms.

New market platforms depend on the functionality or utility more than mere technical legal vernaculars which risks of high compliance costs or choking regulatory requirements that could render reforms inapplicable.

Remember, all regulations operate on latent economic dimensions. Fundamentally, success of any market platform will depend on the cost-benefit tradeoffs and not on intricate legalese.

Moreover, it would be more convenient and pragmatic to rush market reforms to include expanded local investor access to markets as Exchange Traded Funds, basic derivatives (such as options-put or call) and commodity spot and futures markets (I’d say currency markets as secondary) to enable local investors:

-the ability to hedge on or minimize risks by diversification or by utilizing hedge instruments,

-to increase capital efficiency allocation, and

-to utilize moderate leverage to augment returns

Markets that profits from the upside or the downside or sideways complimented with the ability to minimize risks by hedging or diversification will likely attract a larger and more diversified base of capital and deepen the local financial markets that should translate to value added economic growth.

For market participants:

We can only operate under the platform from which the PSE operates on, this means identifying and positioning based on cyclical or secular trends.

Next, for sophisticated investors is to tap the same aforementioned hedge instruments such as ETFs (an inventory list here), basic derivatives or commodity markets overseas. [For a related article see my previous outlook see Should Filipinos Invest Abroad?]

Finally, choose wisely on your investment analyst for guidance or for managing your funds. Avoid from selecting opinions which merely confirms your biases and from embracing viewpoints that merely deduce present price signals as basis for prospective market action. Market analysis should be objective and dispassionate where risk must always be weighed against prospective gains.

In short, avoid the bias traps.