Will the Phisix Divergence Last?

My source of livelihood has almost entirely been from the local stock market, particularly investing, as I am hardly or rarely a short term trader.

Thus, objective and thorough investigations, assessments and analysis have been IMPERATIVE on me. And as part of my investing philosophy, I try to avoid getting married to a position, in as much as assuming the HIGH RISK role of becoming a stock market CHEERLEADER.

Losing money means my family will starve and this is why I cannot afford to lose money. Therefore such punctilious efforts, on my part, to deal with risks represent what have been known as stakeholder’s problem—where my incentives to attain relevant knowledge are prompted by the degree of my stakes in the financial marketplace. Since I depend on the markets thus I have to know the possible risks attendant to my positions.

And this outlook which I share with you, has not only been based on my battle hardened experience, but also from my candid evaluations of the conditions of the risk environment.

I am not here for an egotistical trip as many have been wont to.

Separating Signals from Noise

I have long been an adherent to the wisdom of the legendary trader Jesse Livermore. I have repeatedly been posting one of my favorite Mr. Livemore’s aphorisms here (bold emphasis mine)

I began to realize that the big money must necessarily be in the big swing. Whatever might seem to give a big swing its initial impulse, the fact is that its continuance is not the result of manipulation by pools or artifice by financiers, but depends on underlying conditions. And no matter who opposes it, the swing must inevitably run as far and as fast and as long as the impelling forces determine.

Simply said, profits are to be made based on underlying conditions which drives the general trend, and importantly, serves as the critical source of big swings.

And this is why I give heavy emphasis at the unfolding events based on the big picture. Unlike most practitioners, I am hardly swayed by vacillations from ticker tape activities.

Yet, ticker tape activities and the big picture frequently represent the noise and signal problem

Nassim Nicolas Taleb in his forthcoming book wonderfully explains the psychological impact from noise and signal[1]

we are not made to understand the point, so we overreact emotionally to noise. The best solution is to only look at very large changes in data or conditions, never small ones.

Just as we are not likely to mistake a bear for a stone (but likely to mistake a stone for a bear), it is almost impossible for someone rational with a clear, uninfected mind, one who is not drowning in data, to mistake a vital signal, one that matters for his survival, for noise. Significant signals have a way to reach you. In the tonsillectomies, the best filter would have been to only consider the children who are very ill, those with periodically recurring throat inflammation.

There was even more noise coming from the media and its glorification of the anecdote. Thanks to it, we are living more and more in virtual reality, separated from the real world, a little bit more every day, while realizing it less and less. Consider that every day, 6,200 persons die in the United States, many of preventable causes. But the media only reports the most anecdotal and sensational cases (hurricanes, freak incidents, small plane crashes) giving us a more and more distorted map of real risks. In an ancestral environment, the anecdote, the “interesting” is information; no longer today. Likewise, by presenting us with explanations and theories the media induces an illusion of understanding the world.

And the understanding of events (and risks) on the part of members of the press is so retrospective that they would put the security checks after the plane ride, or what the ancients call post bellum auxilium, send troops after the battle. Owing to domain dependence, we forget the need to check our map of the world against reality. So we are living in a more and more fragile world, while thinking it is more and more understandable.

The bottom line is that many people get confused when working to separate the proverbial wheat from the chaff or when filtering signal from noise. People with lesser stakeholdings are likely to emphasize on the noise which usually signify as “an illusion of understanding the world” and or embrace steeply biased (but unworkable and highly flawed) theories.

The Dopamine Fetish

I would also add that part of the psychological-neuroscience aspect in dealing with markets has been about dopamine neurons.

People’s dopamine neurons, or brain chemicals, gets fired up when rewards attained are GREATER than expected. In contrast, REGRETS are symptoms of depressed dopamine neurons. Thus short term thinking and short term trading have MOSTLY been about the fetish for dopamine trips.

A study on neuroscience suggests that dopamine flows are pervasive during early stages of a ballooning bubble, reflecting desire for profit. However as the bubble peaks, dopamine flows tend to culminate in a cessation just before the market burst[2]

Monetary policies by central banks also whet or induce dopamine powered speculative behaviors[3].

The lesson here is that we should manage our dopamine flows rather than allowing dopamine neurons to dominate the risk-reward tradeoffs that confront our investing decisions. This is basically about Emotional Intelligence (EI)

Let me further add that the technical construct of the Philippine Stock Exchange has been skewed to inculcate upon the public of the upside bias for issues listed on the markets, as well as, the component index.

The rational for this seems to be part of the political designs to exhibit economic booms.

Take shorting. While shorting has been legalized, rigorous procedural and regulatory compliance requirements have made shorting impractical. So we have a facility that has hardly been used.

And since market participants only earn from an UPSIDE price move, thus logically, the dominant entrenched PSYCHOLOGICAL bias would be for the public to yearn for the stock market to go only in one direction—UP.

Next, complimenting the psychological and physiological aspect, monetary policies have also been rewarding speculative activities at the expense of savings and production.

So intensifying speculative activities extrapolates to the herd effect in motion.

Where the basic function of the stock market has been about the cost of buying future income stream relative to insecurities (risk and uncertainty), such functionality has been negated or substituted by rationalizations for price chasing momentum.

Writes Kevin Dowd, Martin Hutchinson, and Gordon Kerr at Cato Forum for monetary policies[4],

Low interest rate policies not only set off a malinvestment cycle but also generate destabilizing asset price bubbles, a key feature of which is the way the policy rewards the bulls in the market (those who gamble on the boom continuing) at the expense of the sober minded bears who keep focused on the fundamentals, instead of allowing the market to reward the latter for their prudence and punish the former for their recklessness. Such intervention destabilizes markets by encouraging herd behavior and discouraging the contrarianism on which market stability ultimately depends. A case in point is the Fed’s low interest rate policy in the late 1990s: this not only stoked the tech boom but was maintained for so long that it wiped out most of the bears, who were proven right but (thanks to the Fed) too late, and whose continued activities would have softened the subsequent crash. The same is happening now but in many more markets (financials, general stocks, Treasuries, junk bonds, and commodities) and on a much grander scale. Such intervention embodies an arbitrariness that is wrong in principle and injects a huge amount of unnecessary uncertainty into the market.

In essence, the inflationary boom psychology has been distorting economic reasoning.

Add to this the leash effects of bailout policies.

The bottom line is that inflation fueled bull markets have become a religion to many.

And advises to undertake prudent positions—based on appraising the risk environment that may adversely affect one’s portfolio—has been seen as sacrilege.

Short Selling Not Recommendable; Contagion Risks

I also do NOT recommend shorting in the Philippines for the following reasons

-the cost to undertake shorts positions have been enormous relative to prospective gains (if a short position is required the best is to do it from overseas)

-a full blown BEAR market for the Philippines has NOT been yet established, although the RISKS from such scenario seem to be STRENGHTENING.

-global regulators have periodically been intervening. The degree of intervention mostly through bailout policies comes with such INTENSITY such that these can TORCH shorts on short notice. A good example has been Europe’s LTRO which singed Euro shorts at the start of the year[5]

-global regulators have innate biases against short sellers. They have done so lately through direct market interventions, such as drastic imposition of shorting bans which forces short covering to investors at a loss. A great example has been the shorting bans on Europe stock markets in mid-2011[6] in the political belief that speculations, and NOT insolvency, have been the fundamental problem that besets the Eurozone. Yet in spite of the bans, European stock markets continue to bleed PROFUSELY. This represents a vivid example of the “illusion of understanding the world” by political agents who always try to shift what has truly been their mistake to the markets.

Lastly I do NOT wish or DESIRE for a bear market.

Because of the limitations to take on hedge positions, bear markets or even phases of consolidation with a downside bias or volatility translates to income drought for me or most market participants (see the structural bull market bias above)

While I am an optimist who believes that the Phisix will reach 10,000 sometime in the future, I am also a REALIST who understands that external forces have a HUGE influence to actions of the local stock markets and that NO trend goes in a straight line.

In suggesting of the countercyclical trend amidst a secular trend I wrote in March[7],

I am not certain whether we will see a repeat of the discontinuities similar to the 1986-1997 bull market cycle or will suffer more than the past cycle before reaching my goal or if the Phisix will proceed to double. What needs to be monitored are drivers of the current trends and the whereabouts of the present boom cycle based on internal and external dynamics.

In short, the PHISIX, despite the secular trend, is VULNERABLE to a CONTAGION risk.

Could this week’s Phisix Divergence Represent an Anomaly?

The local benchmarket, the Phisix, majestically bucked the global stock market carnage last week.

As one would note, the Phisix has not only outperformed the region, the local benchmark basically defied gravity.

China and Malaysia joined the Phisix, as outliers, with hefty gains amidst a sea of red.

Yet such divergences have given the dopamine to Pollyanna trippers the ammunition to declare “bottom” for the market.

I have yet to be convinced.

The gist of the weekly gains or 52% of the Phisix came from Thursday’s activities.

Ironically, the sizable gains occurred in the backdrop of staggering US and global markets.

Media and experts has alluded to reports of sturdy domestic economic growth[8], the hints of a possible upgrade[9] by US rating agency Moody’s on the credit standing of the Philippines and the closure of milestone impeachment trial[10] with a conviction of the accused which favors the administration as reasons for this.

I beg to differ.

I raised this concern on this last Thursday[11]. The Phisix went down to as low as 67 points at the early session, dragged by the selloffs in the US and Europe. But suddenly, aggressive and systematic buying of heavyweights (blue chips) throughout the day pushed the Phisix to close at almost at the peak (76.81) at 73 points. The pendulum swing from loss to gain represented an astounding 2.8%!!!

Buyers seem to have, ironically, been resolutely aggressive to push up prices in an environment of MOSTLY falling stock market prices globally, perhaps in the assumption that local stocks will soon experience a strong surge.

Or is it?

The weekly performance of the heavy cap issues reveals that gains of the Phisix were mostly seen through Ayala Corp (AC), JG Summit (JGS), Banco De Oro (BDO), Metrobank (MBT), SM Investments (SM), International Container (ICT), PLDT (TEL) and Bank of the Philippine Islands (BPI).

The logical part for any buyers under such scenario would be to make use of the dour sentiment to take advantage of price declines to bargain hunt. Yet these have not been the case.

Let me lay out my suspicions.

I do not think that these has been due to general market sentiment, although pushing up the PHISIX index succeeded to give a boost to the general market sentiment.

Thursday closed with a mixed showing between advancers and decliners with the latter having a slight edge. On a weekly basis advancers took a slight lead over decliners showing modest improvement in the market breadth or sentiment.

Second my naughty thoughts suggests that Thursday actions was likely executed to create an impression of economic ‘confidence’. I am not so sure why though. Perhaps to squelch demand for signing waivers for top officials.

Buyers suddenly became price insensitive. The likelihood is that non-market entities may have been responsible for aggressively pushing up Big Caps. I would suspect that these may have been government institutions such as the SSS, GSIS or others.

While it is true that Thursday a net foreign buying, the bulk of these buying can be traced to cross trades at DM Consunji.

Besides, net foreign buying data may not reveal of the real extent of activities that took place. Foreign buying can represent overseas based subsidiaries or branches of locally owned corporate vehicles or tycoons, as well as, foreign based politically allied corporations.

Of course I may be wrong and that there may have been special factors driving up the Phisix.

But if my suspicions are valid then such interventions are likely to produce short term effects.

As example the Bank of Japan’s (BoJ) $13.3 billion[12] interventions DID bring down the Yen for about a month. However the Yen has been regaining lost grounds since. This effectively has neutered tax payer financed interventions. In short $13.3 billion down the drain.

Another question that begs to be asked is WHY the PHSIX alone?

While Malaysia did post hefty weekly gains next to the Phisix, the Malaysia’s benchmark (FBMKLCI:IND, green) has almost missed out the recent bull market. On the other hand, Thailand (SET:IND, orange) and Indonesia (JCI:IND, red) which shared or alternated the lead with the Phisix, since last year, has wilted significantly.

Yet it can be observed that ASEAN’s stock markets have been nearly been moving in nearly synchronous fashion UNTIL the peak in May of this year.

This only means that last week’s gains by the Phisix either represents an ANOMALY or that the Phisix LEADS Asia.

My bet is on the former.

The Decoupling Myth

I have been saying that current environment have been dominated by POLITICAL uncertainty which for the Philippines and ASEAN represents a CONTAGION risk.

If global markets stock markets have been pricing in a bust or the unwinding of malinvestments which is being transmitted to the global economies, then it would dangerous, if not reckless, to presume immunity or “decoupling” where trade and investment linkages of ASEAN economies have been deepening relative to the world.

ASEAN economies have largely been exposed to developments abroad through merchandise trade (exports and imports).

The Philippines merchandise trade represents over 50% of GDP, while Malaysia and Thailand are over 100%.

This means any meaningful economic slowdown in the region or in the world will negatively impact economic growth.

Add to this the potential slowdown effect on remittances and supply chain networks.

The deepening of financial globalization also means the integration of emerging Asia’s capital markets[13] with the world (left chart) and with intra-region (right pane).

In short, the false notion of DECOUPLING will likely melt in the face of a global recession or when a full blown financial crisis, if such phenomenon transpires.

Let me be clear, the conditional term is an IF, while global economies have indeed been slowing down, a global recession or worldwide contagion from euro’s financial crisis has yet to become evident in Asia.

Of course a decoupling COULD happen if there should be massive inflation or even hyperinflation from any of these major economies. However, under the current circumstances this is unlikely to happen.

This means that for those in the belief that the Philippines can decouple from the world, the following chart should be a helpful reminder…

2007-2008 signifies as the contagion based bear market.

Neither has there been an economic recession during the said period nor did earnings fall materially. But the Phisix entered a full blown BEAR Market and lost about 50% peak-to-trough as a result of an exogenously driven financial crisis in 2007-2008.

Of course 2008 is different from today. In fact, today has been worst compared to the 2008 crisis. In 2008 the crisis was limited to the banking, property and mortgage industry. Today the crisis dynamics has shifted to envelop banks AND sovereigns. Not to mention that world wide government debts have surged[14] and that US fiscal deficits have skyrocketed (at $1.327 trillion or 8.2 times larger than 2007[15]).

Yet for those who should insist on decoupling, then I wish you the best of luck.

---

[1] Taleb Nassim Nicolas Noise and Signal — Nassim Taleb Farnam Street, May 29, 2012

[2] ChangingMinds.org The Neuroscience of Financial Bubbles

[3] See How US Federal Reserve Policies Stimulates the Public’s Speculative Behavior, May 8, 2012

[4] Dowd Kevin, Hutchinson Martin, and Kerr Gordon The Coming Fiat Money Cataclysm

and the Case for Gold

[5] Marketwatch.com Euro hits 3-month high on LTRO hopes, February 24, 2012

[6] Wall Street Journal, Europe Short Bans Extended, August 26, 2011

[7] See Phisix: The Journey Of A Thousand Miles Begins With A Single Step, March 12, 2012

[8] ABS-CBNnews.com.ph PH eco grows 6.4% in Q1; highest in ASEAN, May 31, 2012

[9] Businessmirror.com.ph Moody’s raises PHL to ‘positive’ May 29, 2012

[10] See The Lessons and Validity of Public Choice Theory Applied to the Chief Justice’s Corona Impeachment, May 29, 2012

[11] See Phisix: Very Impressive Day or Month End Close for May 2012, May 31, 2012

[12] Bloomberg.com Japan Adopts Stealth Intervention As Yen Gains Threaten Exporter Earnings February 7, 2012

[13] ADB ONLINE Asia Capital Markets Monitor August 2011

[14] Zero Hedge, Presenting Dave Rosenberg's Complete Chartporn, June 1, 2012

[15] Weiss Martin Lehman-Type Megashock Looming, Money and Markets May 21, 2012

Is ASEAN Resilient from Euro Debt Woes?

A World Bank economist declares ASEAN as "resilient" to the shocks from the Eurozone

Reports the Bloomberg,

Economies in the Association of Southeast Asian Nations are “resilient” to Europe’s sovereign debt woes, with governments having room for monetary and fiscal policy changes, World Bank Managing Director Sri Mulyani Indrawati said.

“For countries, especially Asean countries who are very resilient to the crisis, they still have the ability to maneuver from their own policy space, whether this is on a fiscal side or a monetary side,” Sri Mulyani said in an interview in Tokyo yesterday. “That’s very important.”

Asian policy makers are under renewed pressure to support growth as the world grapples with the threat of a Greek exit from the euro. Greece’s political impasse has deepened the European crisis and sent Asian currencies and stocks tumbling, adding to the uncertain outlook for exports and growth.

Really?

The panic in the Eurozone have partly incited the slump in global equity markets. Europe’s Stox50 has led the recent market rout which spread to ASEAN (ASEA) and other global benchmarks, such as the S&P and Emerging Markets (EEM).

I say “partly” because it would seem misguided to fixate solely at the Eurozone as the key contributing factor in driving the conditions of the global financial markets, as well as, the global economy.

The overall doldrums of global equity markets, possibly includes the China factor and perhaps uncertainty over US monetary policies and or US politics among many others

Yet the transmission from current shocks has likewise become evident in the region’s currencies. The the ringgit, the peso, the baht and the rupiah (left to right) have been conjointly whacked.

Add to this picture, the weakening of global commodity prices.

In short, seen from the actions of financial markets, there hardly has been evidence to support claims of “resiliency” or innuendos of “decoupling”.

Of course, actions in the financial markets may not exhibit the performance of the real economy as had been the case of 2007-2008.

But my point is that it would seem as an appeal to the heuristic and oversimplification of analysis to project on so-called 'resiliency' when the extent of uncertainty have yet to be identified and ascertained in today’s complex and vastly interconnected world.

As the great Professor Ludwig von Mises explained,

Economics does not allow of any breaking up into special branches. It invariably deals with the interconnectedness of all the phenomena of action.

Quote of the Day: Under ZIRP, Corporate Balance Sheets DO NOT Matter

What, however, people do not know is that under ZIRP, when every basis point of debt return over 0% is praised, and an epic scramble ensues among hedge for any yielding paper no matter how worthless, the balance sheets of companies just do not matter. In other words, for companies that have massive leverage, high interest rates, negative cash flow, which all were corporate death knells as recently as 2008, the capitalization structure is completely irrelevant.

(bold highlights original)

That’s from the anonymous Tyler Durden at the Zero Hedge, discussing the boom in high yield debt. The unprecedented or uncharted scale of interventionism and inflationism has been massively distorting the way asset markets are being valued. The result has been magnified volatility and boom bust episodes.

David Stockman: The US Federal Reserve is Destroying the Capital Markets

David Stockman, former Republican U.S. Congressman and director of the Office of Management and Budget, founding partner of Heartland Industrial Partners and the author of The Triumph of Politics: Why Reagan's Revolution Failed and the soon-to-be released The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy in an interview at the Gold Report has this biting message. [bold emphasis mine]

The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. The yield curve signals nothing anymore because it is totally manipulated by the Fed. The very idea of "Operation Twist" is an abomination.

Capital markets are at the heart of capitalism and they are not working. Savers are being crushed when we desperately need savings. The federal government is borrowing when it is broke. Wall Street is arbitraging the Fed's monetary policy by borrowing overnight money at 10 basis points and investing it in 10-year treasuries at a yield of 200 basis points, capturing the profit and laughing all the way to the bank. The Fed has become a captive of the traders and robots on Wall Street…

I think the likely catalyst is a breakdown of the U.S. government bond market. It is the heart of the fixed income market and, therefore, the world's financial market.

Because of Fed management and interest-rate pegging, the market is artificially medicated. All of the rates and spreads are unreal. The yield curve is not market driven. Supply and demand for savings and investment, future inflation risk discounts by investors – none of these free market forces matter. The price of money is dictated by the Fed, and Wall Street merely attempts to front-run its next move.

As long as the hedge fund traders and fast-money boys believe the Fed can keep everything pegged, we may limp along. The minute they lose confidence, they will unwind their trades.

On the margin, nobody owns the Treasury bond; you rent it. Trillions of treasury paper is funded on repo: You buy $100 million (M) in Treasuries and immediately put them up as collateral for overnight borrowings of $98M. Traders can capture the spread as long as the price of the bond is stable or rising, as it has been for the last year or two. If the bond drops 2%, the spread has been wiped out.

If that happens, the massive repo structures – that is, debt owned by still more debt – will start to unwind and create a panic in the Treasury market. People will realize the emperor is naked.

Read the rest here.

Many people believe that the numerous incidences of irregularities seen in financial markets emanate from unscrupulous behavior by some market agents, little has been understood that central bank policies, together policies that cater to crony capitalism, have been incentivizing or fostering such behavioral anomalies.

And importantly, the nature of capital markets have been intensely distorted to the point where conventional wisdom of its mechanics has nearly been rendered obsolete.

Either we face up to such evolving realities or suffer from our recalcitrance to adjust when the day of reckoning arrives.

The Message Behind the Phisix Record High

The theory of reflexivity developed by billionaire (and crony) George Soros underscores the dynamics of bubble psychology, as expressed through a feedback loop mechanism between people’s expectations and their attendant actions in response to the changes in the prices.

Mr. Soros wrote[1]

The underlying trend influences the participants' perceptions through the cognitive function; the resulting change in perceptions affects the situation through the participating function. In the case of the stock market, the primary impact is on stock prices. The change in stock prices may, in turn, affect both the participants' bias and the underlying trend.

Reflexive Theory Applied to the Phisix

The foundation of this theory seems to be anchored on the confirmation bias, where changes in prices that reinforces the underlying trend, gives confidence or strengthens the convictions of people to undertake action in the direction of the same trend. Such action feeds into the price mechanism and thus the feedback loop.

Applied to the Philippine equity market, many people will interpret the current state of the Phisix, which is at fresh record levels, as positive changes in the real economy. Believers would see this as having raised confidence levels, which that merits further actions through additional investments. Again this eventually feeds into higher prices.

An article at the Financial Times sings hallelujah to the Philippines[2],

Whisper it if you will, but the Philippines may at last be getting its act together. These are early days. But there are definite signs that the country – with its young population of nearly 100m people, the world’s 12th largest – has turned a corner…

The Philippines may still be the llama of south-east Asia. But, for the moment at least, the llama has broken into a trot.

President Noynoy Aquino has also used this opportunity to grab credit

From the Inquirer.net[3]

“Investors and Filipinos alike see what is happening: Here is a country determined to turn the corner by instituting genuine, wide-ranging, meaningful reform, and acting on its belief that good governance is the bedrock of equitable progress,” the President said.

We have had six positive ratings actions since we took over government a little less than two years ago—a stark contrast to the single upgrade and six downgrades in the nine years of the previous administration,” he added.

He said the country’s stock market also experienced 27 all-time highs in his 22 months in office.

Let’s put this into perspective.

While the Philippine equity bellwether has indeed been at record levels, such gains have not been unique or limited to the Philippines. In reality, major ASEAN bellwethers have ALL been on a bullish rampage. In other words, what has been portrayed as a special case is, in fact, a regional phenomenon.

Three of the ASEAN-4 majors are in ALL time record highs, particularly Indonesia [JCI:IND, dark orange], the Philippines [PCOMP:IND, green] and the seemingly underperforming Malaysia [FBMKLCI:IND, light orange] whom has marginally encroached the 2007 highs.

Meanwhile, Thailand [SET:IND, yellow] treads at a milestone 14-year high, but has yet to breach the 1993 record.

Yet these can hardly be construed as coincidental, as the undulations of the ASEAN-4 stock markets have eerily been similar for the last 5 years.

The other way to say this is that there has been a seemingly tight correlation between the Phisix and ASEAN markets. While correlation is not causation, there has been linking factor to their parallel performances.

So if there should be any special developments this must be attributable to the region and not to specific nations.

On a year-to-date basis, the Philippine Phisix, posted a 21.17% gain as of Friday’s close, ranked third only in the Asian region.

The top spot has been Vietnam with 35% returns, while Pakistan has is in second with 28.77% gains.

Notice that except for India, equity benchmarks of Asian majors Japan, Singapore and Hong Kong have yielded over 10%.

In short, Asia in general has posted substantial gains, but emerging Asia has outperformed.

Nonetheless while it may be true that the Philippines has exhibited material improvements on the dimensions of fiscal balances and debt[4], the bulk of the improvements came prior to the incumbent Aquino administration.

In relative dimensions, the degree of progress of the Philippines has been subordinate to the ASEAN peers.

Importantly, ASEAN in general has shown similar path of improvements in both aspects.

Real Reforms? Informal Economy Says No

So admittedly while there have been noteworthy advances in the management of government finances, the question is, has the Philippines been adapting reforms to encourage investments through a business friendly environment?

Well, the World Bank figures suggest otherwise.

Out of 183 countries, the Philippine scorecard[5] for Ease of Doing Business for 2012 has seen marginal improvements in 3 aspects (getting electricity, trading across borders, and enforcing contracts) while 7 areas posted declines in 2012.

Overall, the Philippines fell from 134^th ranking in 2011 to 136^th in 2012, where 1 accounts for the easiest place to do business while the last rank represents the most difficult place for business.

The above diagram from Doing Business report on the Philippines for 2012[6] gives as a better view of the domestic business climate.

Fundamentally, the Philippines have long lagged the region and the world because of the manifold political hurdles that has undermined relative competitiveness and has raised the bars (or hurdle rate) for attracting investments.

More, while the mainstream meme has touted remittances, which signifies about 8.9% of the economy (Wikipedia.org[7]), as powering the Philippine economy, what they don’t tell you is that there has been a far far far larger of the share of the domestic economy that has a more significant influence: the informal or shadow economy.

The Philippines has one of the largest informal sectors in the world[8], which accounts for nearly half of the economy. They are the balut (fertilized duck egg), peanut and cigarette vendors, carinderias, family drivers, household helps, and etc…

People tend to ignore the obvious.

As Black Swan author Nassim Taleb posted on his facebook account[9]

We are all, in a way, handicapped in a similar way, unable to recognize ideas when presented in a different contexts. It is as if we were doomed to be fooled by the most possibly superficial part of things, the packaging, the gift-wrapping paper around the object. This is why we don’t see antifragility in places that are obvious, too obvious.

For instance, the mainstream overemphasizes on the much heralded 10% (remittances) while ignoring the 45% (informal economy). In behavioral finance, the fixation on the visible while overlooking the others is a logical error that is called the survivorship bias[10]

About a year ago, I interviewed a balut and a peanut vendor from our neighborhood. The peanut vendor told me that he earns about 400-500 pesos a day. But because he can’t read and write, he has been reluctant to open a bank account and instead keeps his money in some physical storage (I think in a can). Yet over the years, his savings has enabled him to buy 2 tricycles which he lent out to 2 relatives for business.

The balut vendor on the other hand told me that his eldest son has been self financing his college engineering education. The son rides the bike which he uses to sell balut at night, and goes to school in the late mornings until the afternoon. The balut vendor father is even in a better position than I am. He owns his house.

Even if people from the informal sectors have been beyond the radar screens of the government and of the institutions of the establishment, the money they save (capital accumulation) helps increase the standard of living of Filipinos. And amazingly these are stuffs which statistics has not been able capture and has left mainstream experts lost at explaining the consumption economy which they mistakenly attribute to “multiplier” from remittances.

And this is why I have long believed that the statistics has understated the real savings rate of Philippines. And it is from such unseen sources of savings that has enabled the Philippines to have 3 out of the 10 largest shopping malls in the world (as of 2008)[11].

Yet the informal sector is an offshoot to economies that has been unduly burdened by a labyrinth of regulations, stifling taxes, onerous social security payments, restrictions in the official labor market, mandated wage rates and other labor restrictions, maze of bureaucratic red tape, politicization of economic opportunities and the many other various forms of interventions[12].

The peanut vendor told me that because he has been a mainstay in the area where he operates, local officials have not been a menace to him, because he got acquainted with them. But other vendors have not been as fortunate, many has to shell out “under-the-table” money for them to operate even during night time, while the others operate on a dictum of “when the cat’s away the mouse will play”.

That’s precisely why informal economies have been associated with greater incidence of corruption.

A weak rule of law, which emanates from unilateral, arbitrary, partisan, repressive and selectively enforceable laws, edicts, regulations, ordinances, impels people to circumvent them, much of it through bribery. And this has been further exacerbated by weak institutions.

As Ms. Ana Eiras at the Heritage Foundation writes[13],

Informality is a response to economic repression, not to something inherently unethical in those who circumvent legislation. What is most unethical about informality is the condition in which the government forces the poor to live. Informally employed people are condemned to a standard of living that is significantly lower than that of formally employed people, who have credit access. Also, informality creates a culture of contempt for the law and fosters corruption and bribery in the public sector as a necessary means to navigate the bureaucracy.

And as the great Austrian economist Professor Ludwig von Mises reminds us[14],

Corruption is a regular effect of interventionism.

So talks about abolishing corruption have simply been misleading. That’s because informal economies, again, exist as consequences of repressive and abusive laws which fosters corruption and are symptoms of economically unfree nations.

Yet if we should give credit where credit is due, then it is the informal economy through the various domestic entrepreneurs and the silent labor force, whom has been defying all these regulatory and political obstacles, that has mostly breathed life to the Philippine economy. Otherwise, chaos would rule.

Until the government meaningfully dismantles the obstacles that inhibit commercial activities, then the “good governance is the bedrock of equitable progress” represents nothing more than a flimflam.

Remittances are Partly Symptoms of Unfree Economies

Politics has always been about distortion of the truth.

The mainstream savors the romanticized notion that OFWs are the “modern day heroes”. In a way they are. Yet hardly any of these experts deal with why OFWs thrives and why they are heroes, outside of the context of $ remittances.

People seem to have mental blackout if we point out that today’s modern day heroes, the OFWs, like their shadow economy counterparts, have been products of unfree economies.

The inadequacy or insufficiency of economic opportunities (particularly for investments which has been diffused into jobs, yes about 4 out of 10 college graduates have been unemployed), have been prompting Filipinos to seek livelihood or greener pastures abroad (13% of graduates go abroad[15]).

Emerging economies whom have been highly dependent on remittance contributions have mostly been unfree economies.

Of the 30 countries on the table, 20 are mostly unfree if not repressed economies. While others like Lebanon, Samoa, El Salvador, Kyrgyz Republic, Jamaica, Albania, Guatemala, Cape Verde, Armenia and the Domincan Republic are moderately free according to the rankings based from Heritage Foundation[16]. Yet many of these “moderately free” nations are on the “borderline”.

The remittance phenomenon serves as an incredible paradox: The lack of economic opportunities as manifested by high unemployment which has been the outcome of the towering walls of arbitrary regulations and the politicization of markets, has been offset through migration and overseas employment. Yet politicians and media glorify what in reality has been exposing on their flagrant mistakes of collectivization.

Yet the heroic part of the OFW is this; oppressive laws have not prevented them from finding ways and means to survive. So they go abroad and elude domestic government. This has been the part not seen by the mainstream. What has been mostly seen has been the dollars sent and social costs of parting ways with the family, a theme that has been assimilated in media (tv series or movies).

To wit, individuals work to find ways to survive and thrive through circumventing laws by either going to the informal sectors, by corruption (bribery) or by voting with their feet through working abroad as OFW or emigration.

This is the real world and not a figment of someone’s political alter ego (in psychology these are dissociative identity disorders[17] where people live in their dreams and to have a life of what they had always wanted.[18]). Yet it has been inherent for politicians to engage in semantical abstractions to hoodwink the gullible public.

Bottom line: For Filipino politicians to deservingly claim credit for their deeds, we need to see three outcomes from the thrust to promote a business friendly environment or economic freedom: an explosion of legitimate small medium scale businesses, a natural decline in the informal economy out of the reduction of politicization of commerce and a voluntary repatriation of OFWs as a result of the increased economic opportunities at home.

The Disconnect: Stock Market and the Economy

This brings us back to the reflexivity theory.

Whatever “progress” that is largely being interpreted from buoyant financial markets has not yet been representative of the actual performance of the real economy.

If we go by the simple theory where corporate earnings growth has been a part of GDP[19] the implication is that stock prices should be somehow reflect on the expected GDP growth trend.

But the volatility of prices of the Phisix simply does not match with such measures. [As a side note, aside from earnings, a portion of GDP growth[20] also comes from capital increases such as new share issuances, rights issues, or IPOs].

Take note that the Phisix fell by over 50% in 2007-2008 yet the GDP growth hardly turned negative.

Also, note that in the same context GDP growth fell from 8% in 2010 to a little less than 4% yet in late 2011 yet the Phisix continued to set record after record.

In other words, such disconnect simply means either one of the two measures (the Phisix or the GDP) has been emitting false signals or that reality simply defies conventional wisdom.

And where “a flaw in the participants’ perception of the fundamentals” becomes recognized and escalates, this “sets the stage for a reversal of the prevailing bias”[21].

In short, the artificially embellished boom transforms into an ugly bust.

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[1] Soros George The Alchemy of Finance p.53 John Wiley & Sons

[2] Pilling David South-east Asia’s llama breaks into a trot, April 25, 2012 Financial Times

[3] Inquirer.net Aquino tells ADB: Corruption over, May 5, 2012

[4] HSBC Global Research Step by step October 11, 2011

[5] Doingbusiness.org Ease of Doing Business in Philippines

[6] Doingbusiness.org Economy Profile: Philippines 2010

[7] Wikipedia.org Philippines Remittance

[8] Pyramid Research Emerging Market Operators Go Underground, January 29, 201

[9] Taleb Nassim Nicholas Facebook

[10] Wikipedia.org Survivorship bias

[11] See A Nation Of Shoppers??!!, April 9, 2008

[12] See Does The Government Deserve Credit Over Philippine Economic Growth? May 31, 2010

[13] Eiras Ana, Ethics, Corruption, and Economic Freedom December 9, 2003 Heritage Foundation

[14] Mises, Ludwig von 6. Direct Government Interference with Consumption XXVII. THE GOVERNMENT AND THE MARKET

[15] See College Isn’t For Everybody, February 3, 2011

[16] World Bank Migration and Remittances: Top Countries Migration and Remittances Factbook

[17] Wikipedia.org Alter ego

[18] Healthguidance.org Alter Ego Definition

[19] Wikipedia.org Relationship with GDP growth Earnings growth

[20] MSCI Barra Is There a Link Between GDP Growth and Equity Returns?, May 2010

[21] Soros, op. cit. p.57

“Pump and Dump” Policies Pumps Up Miniature and Grand Bubbles

A friend recently called to say that there have been numerous accounts of “miniature bubbles” in the local markets. Others claim that these have been brought about by unscrupulous people engaged in “pump and dump”.

In reality as I have been pointing out, miniature bubbles are symptoms of the ultimate bubble blower—central bank policies. Central bank policies distort people’s incentives towards money. Savings, investment and consumption patterns will have all been skewered. Where negative real rates punish savers, naturally people whose savings are being diminished through the erosion of purchasing power will seek higher yield, and thus, redeploy their savings into other activities which may include more consumption activities, speculation or high risk investments and or take up more debt to fund these activities. Even private sector Ponzi schemes has been flourishing under today’s environment[1]

In essence policies that tamper with money motivates the public to value short term over the long term.

Thus heightened price volatilities which are deemed as “pump and dump” or as “miniature bubbles” represent as symptoms rather than the cause. People will look for excuses to push up prices or speculate for the simple reason that policies have egged them to do so.

The easy money climate lures the vulnerable public to go for momentum and chase prices using any available tools (charts, corporate fundamentals or even tips[2] and rumors) to do so. And this is why pump and dumps happen.

Large price swings make some people think that stock market operators are culpable for such swing. But this would be mistaking trees for the forests. Absent easy money policies, bubbles and pump and dumps hardly has been a feature. Had there been mini bubbles or pump and dumps during the bear market of 2007-2008? No, because inflated assets were all deflating in response or as contagion to the real estate-banking crisis abroad.

Broken Markets

And as earlier pointed out[3], the US today has not been different, junk bonds or high yielding debt has been booming.

Writes the Buttonwood (Philipp Coggan) of the Economist[4]

Of course, the broader point is that investors are being pushed into these high-yielding assets because of the policy of the Fed (and most developed world central banks) of keeping interest rates close to zero. Similar reasoning drove the enthusiasm for structured products that financed the subprime boom.

Zero bound rates have prompted for yield chasing actions, here or in the US.

The mainstream finally comes to admit what I have been saying all along—that markets have been vastly distorted where one cannot use “fundamentals” in the traditional and conventional sense to evaluate investments.

The excessive price volatility in today’s markets does not match with the fluctuations of conventional metrics of financial ratios. Today’s price volatility has been incongruent with trends of corporate fundamentals. And thus as I earlier pointed out[5], anyone who believed in “fundamentals” would have sold as early as March.

Considering the huge jump in prices from the start of the year, we should be around at near the peak of 2007. So anyone who believes in this stuff ought to be shorting or selling the market. I won’t.

The left window from the chart above as I earlier posted last March has a time series that ended November of 2011. The right chart from DBS represents a more updated one albeit was updated until last March. Considering that the Phisix has now been drifting at over 5,150 which means valuations continues to climb higher away from these charts, the Phisix has become “priciest” stock market in Asia.

Yet leaning on earnings or conventional fundamental metrics, like the Heisenberg uncertainty principle, becomes a permanently moving target which is impossible to pin down, especially punctuated under today’s easy market climate.

Will I sell on the account of earnings/fundamentals? My answer is still no. Not until interest rates climb in response to consumer price inflation, or through heightened demand for credit, or questions over credit quality of government papers or the scarcity of capital becomes apparent[6]. Nominal interest rates are not a one-size-fits-all thing, and there are many measures (like real interest rates, CDS, yield curve et.al.) to gauge if the monetary environment has begun to tighten for one reason or another. This also should come in the condition that the hands of central bankers have also been shackled and would be unable to respond forcefully as they have been doing today.

For now central banks around will continue to find ways and means to push more easing measures in support of the asset markets which was highlighted by last week’s additional stimulus by the Bank of Japan (BoJ)[7]

The following excerpt from the mainstream loudly resonates on what I have been saying.

From the Financial Times[8],

Markets are broken. Accepted investment wisdom has been overturned and the basic tenets of value and diversification no longer work. The financial crisis put the market into a volatile “risk on, risk off” – or Roro – mode for which there is no cure.

For many investors, this has made stockpicking seemingly an impossible task. Markets once responded to their fundamentals. Now, disparate assets have a much greater tendency to move together, individual characteristics lost. Trusted strategies such as relative value and currency carry trades are nearly useless, overwhelmed by daily market-wide volatility.

“Assets now behave as either risky assets or safe havens, and their own fundamentals are secondary,” writes HSBC strategist Stacy Williams in a recent note. “In a world where most asset classes are synchronised, it becomes very difficult to achieve diversification. It also means that since most individual assets are dominated by a common price component, it becomes increasingly futile to invest in them based on their usual fundamentals.”

Though asset classes had been moving in closer correlation since the start of the financial crisis in 2007, the Roro trend became most apparent after the collapse of Lehman Brothers a year later. The uncertainty helped turn investing bimodal, where every price has been contaminated by systemic risk. Everything became a bet on whether we were closer to a global recovery or to deeper crisis.

So what recommendations do they offer for the public to deal with the state of “broken markets? They have three. One is to pick a position from the boom or the bust scenario, second is to chase momentum and third is to hedge positions through index futures.

I would like to emphasize on the second option, not because this is my preferred approach but because of its relevance to the conditions of the local markets, from the same article,

Another option is to seek out an investment strategy that still works. Momentum investing – in effect, buying the winners and selling the losers – is a method that HSBC analysts highlight as having been largely impervious to the risk trade. To chase a trend aims to harvest small but systematic mispricing of assets, and there is no reason to suppose these anomalies would disappear in bimodal markets, the broker argues. (In this context, the growth of high-frequency trading since the start of the crisis is unlikely to be coincidental.)

This simply means that the mainstream will largely be chasing momentum, by targeting frequency over magnitude through “harvest small but systematic mispricing of assets”. So in essence, high risk speculative activities or gambling (a.k.a “miniature bubbles” and “pump and dump”) has been recognized as the common or standardized feature of the current market place. So history will rhyme and a bust will be around the corner.

I would rather “time” the bubble cycle rather than go chasing prices. And this is why it is imperative for any serious investors to understand the bubble process or the boom bust cycle.

Stock Market is about Human Action

Finally financial markets signify a social phenomenon. There is a popular aphorism from former President John F. Kennedy, who said in the aftermath of the failed Bay of Pigs Invasion[9], which seems relevant to the financial markets,

Victory has a thousand fathers; defeat is an orphan.

Winning issues and or market tops tend to attract substantial participants as a function of easy money (get rich quick mentality), keeping up with the Joneses (bandwagon effect) or survivorship bias (focus on survivors or winners at the expense of the others) or social signaling (desire for greater social acceptance, elevated social status and or ego trips).

On the other hand market bottoms results to the opposite: depression, avoidance, isolation and animus behaviour for those caught by the crash.

Most people don’t realize that emotional intelligence or self discipline is key to surviving the market’s volatility, not math models or charts or any Holy Grail or Greek formulas. And this comes from the desire to attain self discipline than from advices of other people.

Yet self discipline is earned and acquired through knowledge and through the whetting of one’s skills based on these accrued knowledge. Alternatively, self discipline cannot be not given or inherited. And that’s why I vehemently opposed the suggestion by a popular religious personality, who had investments on a mutual fund, to get housemaids to invest in the stock market[10].

The incentive to acquire the desired knowledge and skills varies from individual to individual because they are largely driven by the degree of stakeholdings or the stakeholder’s dilemma or stakeholder’s problem[11].

Today’s information age has democratized access to information. What can be given are information relevant to attaining knowledge and skills. What can NOT be given is the knowledge that dovetails to one’s personality for the prudent management of one’s portfolio. Like entrepreneurship this involves a self-discovery process.

And most importantly, what can NOT be given are the attendant actions to fulfill the individual’s objectives.

Stock market investing is about people and their actions. That’s why this is a social phenomenon. No more, no less.

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[1] See After 5,000: What’s Next for the Phisix?, March 5, 2012

[2] See New Record Highs for the Philippine Phisix; How to Deal with Tips February 20, 2012

[3] See Self-Discipline and Understanding Market Drivers as Key to Risk Management, April 12, 2012

[4] Buttonwood Hooked on junk, April 27, 2012, The Economist

[5] See Earnings Drive Stock Prices? International Container Terminal and Ayala Land, March 6, 2012

[6] See Global Equity Market’s Inflationary Boom: Divergent Returns On Convergent Actions, February 13, 2002

[7] See Bank of Japan Adds More Stimulus, April 17, 2012

[8] Financial Times ‘Roro’ reduces trading to bets on black or red April 20, 2012

[9] Quotationspage.com Quotation Details John F. Kennedy, "A Thousand Days," by Arthur M. Schlesinger Jr [1965]., p289. Comment made by JFK in the aftermath of the failed Bay of Pigs invasion, 1961.

[10] See Should Your Housemaid Invest In The Stock Market? September 5, 2010

[11] See Knowledge Acquisition: The Importance of Information Sourcing and Quality, March 6, 2011