Phisix 7,200: Up, up and away! The Illusions of Comfort

I said quoted Superman last week on the Phisix: Up, up and away!

And so it seems. 

This week, the Phisix soared by a whopping 2.7%. Woot! This adds to the accrued year to date gains now at a mammoth 24%. Woot! This comes amidst a seeming return of the “Risk On” environment in the global equity markets. 

If the current rate of returns at 5-6% a month will be sustained, this means that Phisix 10,000 will be reached by this yearend. Woot!

The Phisix Ascendancy. Malaysia as Periphery to Core?

The Philippine stock market has now assumed the role of the undisputed leader of Southeast Asia as three of our neighbors stumbled over the week.

In contrast to the Philippines, Indonesia’s downgrade by the S&P[1] has been attributed to this week’s modest decline. I am confident that such downgrade will unlikely to deter the Indonesia’s mania phase from unfolding.

But developments in Malaysia seem interesting and may have diverged from other ASEAN economies.

Since the year’s start, Malaysia’s equity benchmark, the KLCI, has been zigzagging between positive and negative territory. This could partly be due to the pre-elections uncertainty which culminates today, or could be due to signs of puffing on her homegrown property bubble.

Charts from global property guide[2] indicate that based on year on year changes, Malaysia housing prices have begun to materially decelerate (left). Malaysia’s home price index has ramped up as the global central banks flushed the world with a tsunami of money in 2008. 

Malaysia has also cut policy interest rates[3] from about 3.5% in 2008 to 2% in 2010, but raised them back to the 3% level in 2011. Nonetheless the banking system’s average lending rates are at the lowest levels (chart not included).

Housing loans now have grown to account for 25% of the GDP. Part of the slowdown could be due to recent anti-speculation or anti-bubble policies. But the fastest growth segment of both commercial and Islamic banks has been from unsecured loans or loans based on borrowers creditworthiness rather than backed by collateral as previously discussed[4].

Yet these mostly represent the demand side of Malaysia’s housing market. Housing is just a segment of the property markets which also includes office and commercial properties. I also lack data on the supply side to make further comments.

Yet it would seem that should Malaysia’s economy substantially slow, this heightens the risk of a regional bubble bust.

Are developments in Malaysia’s housing signs of the periphery to core dynamics?

We will see.

Nonetheless major global equity benchmarks have been reenergized by more central bank actions, particularly the ECB’s interest rate cut aside from plans to adapt a negative deposit rate policy[5].

Notice that the announcements of easing policies from central banks of developed economies have become more bolder and more frequent.

The Reflexivity Theory Nearly in Full Circle

The escalating vibrancy of the Phisix only continues to prove my point: we are in manic phase of a bubble cycle.

The 3-year chart (top) of the Phisix depicts of the 3 phased transition of the current uptrend which appears to be accelerating. A closer look via the six-month chart shows of renewed signs of parabola or the steepening of the price trend slope or what seems as a transition to a vertical ascent. Such price actions reveal of the rapidly expanding risk appetite and of the growing aggressiveness of market players to bid up equity prices.

So who says markets are about the conventional wisdom called “valuations”? Who says that there is such a thing called “expensive” in an environment where the public has decisively determined that there is no other way but up for Philippine assets?

The mainstream apparently doesn’t get it. Such dynamics has not been about statistics or about chart patterns. Instead all these have been about incentives and actions, where incentive drives people’s actions.

Why should the 5-6% statistical economic growth and supposed “fiscal discipline”, which are, in reality, masked by credit boom-embellished-growth data, justify a sustained upside trajectory of asset prices?

The domestic market has apparently lost its function as discounting mechanism and has transformed been into an object of speculative frenzy, underpinned by the prevailing bias of new paradigm, new order or “this time is different” mindset.

By prevailing bias, this means a self-reinforcing trend which tends to not only to influence market psychology channelled or expressed through prices but also through “fundamentals”[6]. 

Rising prices reinforce the belief of ‘good governance’ economics and “controlled deficits” meme. The deepening of public’s conviction has led bolder, more audacious and more adventurous moves from market players. Their actions raise the price levels of equity securities, most especially the popular ones.

Rising price levels has also prompted for the trifecta upgrades from the big three US credit rating agencies. This, in turn, boosts the craving for more equity market speculations. Thus, high prices will rationalize actions that will lead to even higher prices or the deepening of the price chasing or yield chasing dynamics: the mania phase.

Such two-way feedback loop mechanism between one, expectations, which are shaped by prices, and two, by the outcome, as signified by people’s responses and actions to the changes in prices, represent as the “reflexivity theory” as introduced by George Soros. The “reflexivity theory” essentially takes into account the sequential transformation of people’s psychology during the bubble cycle.

Yet the two way reflexive feedback loop that runs from expectations to outcome and from outcome to expectations “gives rise to initially self-fulfilling but eventual self-defeating prophesies and process”[7] and thus the boom bust cycles. 

The crucial psychological features[8] of boom bust sequence can identified as

-The Unrecognized trend

-The beginning of a self-reinforcing process

-The successful tests

-The growing conviction resulting in a widening divergence between reality and expectations

-The flaw in perception

-The climax

-A self-reinforcing process in the opposite direction

Today’s actions suggest that the Phisix operates anywhere between “the flaw in perception” to “the climax”

Credit markets are equally affected by the reflexive bubble behavior, again Mr. Soros, “when people are eager to borrow and when banks are willing to lend, the value of the collateral rises in a self-reinforcing manner and vice versa”[9]

In short, the reflexive feedback loop mechanism also works between markets and credit.

Phisix at 7,200 likewise means another month of significant expansion of credit growth.

The Philippine central bank, the Bangko Sentral ng Pilipinas (BSP) correctly notes that overall credit growth moderated in March[10]

Loans for production activities—which comprised more than four-fifths of banks’ aggregate loan portfolio—grew at a slower pace of 14.2 percent in March from 15.1 percent (revised) in February. Similarly, the growth in consumer loans eased to 10.8 percent in March from 11.9 percent in February due mainly to the slowdown across all types of household loans.

The expansion in production loans was driven primarily by increased lending to the following sectors: real estate, renting, and business services (25.2 percent); financial intermediation (28.8 percent); transportation, storage and communication (26.2 percent); wholesale and retail trade (10.4 percent); and, electricity, gas and water (15.4 percent). Meanwhile, lending to agriculture, hunting, and forestry (-10.3 percent) continued to decline in March.

But looking at the average omits the specifics. I would call this as hiding beneath the statistical averages. 

Financial intermediation and real estate loans, critical areas of the property stock-market bubble remains at same levels or even slightly higher. These sectors have been expanding by more than 25% even when statistical economic growth has only been 5-6%.

While growth in loans to the wholesale and retail trade shrunk in March, construction loans surged at still an astonishing rate of near 50%. I use wholesale and retail trade as gauge on the shopping mall bubble.

A better picture can be seen in the changes in the sectoral share of loans by the banking system.

By the end of 2012, the construction, trade, financial intermediation and real estate loans constituted 45.97% of all the production loans issued.

By March, this figure has swelled to 47.79%. In short, the growth of loans of these bubble sectors has been outpacing the rate of growth of loans from the other non-bubble sectors. And if such rate of growth will be sustained, by the yearend, the share of loans by the banking system on these bubble sensitive sectors will easily become the dominant force and will expose the banking system to unnecessary credit risk.

This despite all the blarney about the banking system as having adequate “capital” ratios. Banks in Cyprus supposedly passed the banking stress test held in 2011. The Bank of Cyprus also received many awards in 2011-2012[11]. Today, bank depositors in Cyprus will see large haircuts on their money.

Easy money from bank lending has also been reflected on liquidity conditions. Again the BSP on March activities[12].

Domestic liquidity (M3) increased by 11.4 percent year-on-year (y-o-y) in March to reach  P5.1 trillion. This growth was faster than the 9.4 percent (revised) expansion recorded in the previous month. On a monthly basis, seasonally-adjusted M3 also expanded at a faster pace of   1.5 percent compared to the 0.2 percent (revised) month-on-month growth in February.

The growth in money supply was driven largely by the sustained expansion in net domestic assets (NDA). NDA increased by 20.4 percent y-o-y in March from 16.5 percent (revised) in the previous month due largely to the continued increase in credits to the private sector, reflecting the robust lending activity of commercial banks. Claims on the private sector increased by 12.7 percent in March. Similarly, claims on the public sector increased by 12.3 percent in March, reversing the 6.5 percent decline (revised) in the previous month, a result of the increase in credits to the National Government (NG) and the decline in NG deposits.

Yield chasing tends to gravitate on the most popular sectors. Foreign money via portfolio investments has also participated in them. Again from the BSP[13]

Capital inflows went to PSE-listed securities (US$2.0 billion or 84.2 percent), Peso GS (US$351 million or 15.0 percent) and Peso time deposits (US$18 million or 0.8 percent). For PSE-listed securities, the main beneficiaries were holding firms (US$510 million), property companies (US$454 million), banks (US$333 million), telecommunication firms (US$185 million), and food, beverage and tobacco companies (US$183 million).

The biggest beneficiaries from the combined credit growth, portfolio flows and yield chasing activities can be seen mainly in the property, holding and financial sectors.

So we have the reflexivity theory running nearly in full circle.

The Concentrated Economy: Economic Boom and Booming Joblessness

When the S&P’s upgrade of the Philippines hit the headlines on Thursday, ironically, at the lower section of the same front page, I saw an article saying that domestic unemployment continues to swell.

From the Inquirer.net[14]

Joblessness in the country worsened in the first quarter of the year, the latest Social Weather Stations (SWS) survey found, with an economist tracing the rise in unemployment rate to fresh graduates joining the labor pool.

Filipino adults without jobs numbered 11.1 million, up 10 percent from the 10.1 million recorded at the end of 2012, results of the survey that SWS conducted from March 19 to 22 showed.

Wow a “boom” in joblessness.

Looking at the statistical unemployment figures[15], one would note that the biggest improvement came during 2005 where jobless rate fell from 14% to current levels, which paradoxically was prior to this booming regime.

Yet from 2006-2012, unemployment seems to have fluctuated in a range of 6.9 to 8%.

I do not trust surveys and unemployment data for the simple reason that significantly more than 40% of the Philippine economy has been informal or shadow or underground[16]. So if informal economies can hardly be measured, then the likelihood of substantial errors from statistical estimates.

Nonetheless what arouses my curiosity is that the much ballyhooed economic boom tagged as the “Rising Star of Asia”[17] seems to have been “concentrated” on few sectors of the economy. And this is most likely the reason behind the supposed “boom” in joblessness, as pointed out by the survey.

Even the government’s statistics has not shown any material improvement in joblessness, despite Phisix at 7,200, the Peso at 40s or 6.6% GDP growth in 2012.

Of course, such adverse information has been and will be ignored by the brainwashed gullible public. Hardly any of domestic media seems to have carried the recent warnings of ASEAN asset bubbles by the IMF[18] or from a report by the CNBC[19]. 

Apparently real world developments have been vacuumed into a vortex. People with rose colored glasses will think that all these signify as mere political rant, or that such systemic threats will not be enough to undermine today’s blissful nirvana, or political authorities will ride like the knight to save the damsel in distress in time, or that bad events will hardly befall on them (denigration of history).

Yet all these suggest that people openly embrace illusions in order to escape reality. As Nobel laureate psychologist and author Daniel Kahneman explains[20],

The illusion that one understands the past feeds further illusion that one can predict and control the future. These illusions are comforting. They reduce the anxiety that would experience if we allowed ourselves to fully acknowledge the uncertainties of existence. We all need for the reassuring message that actions have appropriate consequences, and that success will reward wisdom and courage. Many business books are tailor-made to satisfy this need.

Ironically despite the credit upgrade, which has been anchored mostly on strong external position and on the supposed improvement of debt burden, the credit rating agency S&P underscored what seems as the same theme of “concentrated growth”

From the Inquirer[21]:

S&P estimated that the country’s per capita income (the total value of the economy’s output divided by the population) would settle at $2,850 this year, a level lower than those of most countries with the same credit rating.

“The Philippine economy’s low income level remains a key rating constraint. The concentrated nature of the economy, infrastructure shortfalls and restrictions on foreign ownership, which deter foreign investment, are factors that hamper growth,” S&P said.

The good part is that in order to attract investments, the S&P recommended liberalization of the “regulatory environment in a manner that allows easier entry of foreign investors, according to S&P.” The S&P also recommends more infrastructure spending.

The S&P likewise acknowledges of the fundamental shortcomings of the Philippine political economy but bizarrely rewards or subsidizes such via a credit upgrade. By doing so, there will be lesser incentives for the incumbent officials to embrace real economic reform via liberalization.

Think Europe. Central bank’s backstopping (or subsidies) of the banking system which has led to lofty financial markets have prompted politicians and the mainstream to rationalize the jettisoning of reforms based on phony “austerity”[22], thereby resuscitating the risks of prolonged depression as well as the risks of a breakup of the euro.

Perhaps the S&P thinks that by putting their stamp of approval on the Philippine government they will heroically be able to convince investors.

Or perhaps, the S&P’s sees the need to be a part of the bandwagon because these have been the chic. 

The trenchant iconoclast and Black Swan author Nassim Nicolas Taleb warned of folly from the groupthink[23]

Alas, one cannot assert authority by accepting one’s own fallibility. Simply people need to be blinded by knowledge—we are made to follow leaders who can gather people together because the advantages of being in groups trump the disadvantages of being alone. It has been more profitable for us to bind together in the wrong direction than to be alone in the right one. Those who have followed the assertive idiot rather than the introspective wise person have passed us some of their genes

Ivory Tower Prescription: Solve Investment Problems with More Interventions

So if investments have been the problem, how does the BSP governor, Amando Tetangco Jr. propose to solve them? The following article gives a clue.

From the Inquirer[24]:

To avoid the middle-income trap, one must increase investments and expand the economy’s absorptive capacity. Now is a very good time to do that given the low interest rates and sufficient liquidity that can be tapped for investment activities

Government spending has gone up over the last three years, and it has significantly contributed to the country’s growth. The private sector should now invest more and serve as the main growth driver of the economy

Some important nuggets of wisdom from such comments:

One, as pointed out last week, aside from sectors driven by massive credit expansion, government spending has been artificially bolstering the statistical economy. This is the reason the why the Philippine government has been tightening the noose on taxes and why the government has launched a shame “class warfare” campaign against wealthy Chinese and members of the Forbes billionaires list.

Does it not seem odd or a logical self-contradiction to think that taxes increases have been thought as being compatible with investments?

Raising taxes increases a firm or an enterprise’s cost of doing business which also means the reduction of the rate of profitability or increases the hurdle rate required for a business to survive, all these extrapolates to penalizing investments. So how will raising taxes lead to more investments?

Yet there are also other political aspects serving as obstacles to promoting businesses, such as more regulations, mandates, inflation, bureaucracy, welfare and other political interventions.

Does the good governor also not realize that by the government’s engagement of class warfare rhetoric translates to the heightening risks of political instability? Will companies invest in economies where property rights are not secured and whose assets are at the risks of arbitrary confiscation from populist policies?

The sad part is that ivory tower based experts have little idea of what goes on in the real world and have been blinded by math based models.

Two, the good governor appears to be saying join the bubble! Interest rates will forever be low. The laws of economics do not exist in the Philippines.

But an economy operating in bubbles would translate to relative price instability. And price instability will impact economic calculation. Price instability will be pronounced especially in the input costs of sectors experiencing bubbles. Economic calculation problems will reduce the investor’s motivation to invest. People will be induced to speculate more in financial markets than to invest in productive activities. 

And this could be why the seeming preference by foreigners on portfolio flows (US $3.911 billion; 2012) rather than to foreign direct investments[25] (US$1.053 billion; 2012) as shown above.

In short, price instability and distortion in the capital structures leads to a shrinking of the markets or real economy and capital losses. How then will these attract investments?

Third, the middle income trap is a macroeconomic hooey. Just take a look at the Phisix. Do the punters and speculators stop buying the Phisix after hitting certain income or price level? Or are they “trapped” at certain income or price levels? Apparently not.

On the contrary, the yield chasing phenomenon into voguish themes based on flawed perception of reality that has been enabled and facilitated by credit expansions has been dramatically escalating. This signifies of the deepening of the mania phase. Such mania has been frequently characterized as “greed”.

While people operate within their own “comfort zones” or limits on the activities they engage in, these are subjectively and individually determined. These cannot be captured by aggregates or by statistics as they are constantly changing.

Yet when people’s income rises or when the middle class grows, they don’t really get “trapped” or get caught in a stasis which is a very foolish way to see the world.

Instead, political officials see and use such as opportunities to impose expansions on myriad political programs. Such diversion of productive resources to non-productive use essentially becomes the “trap”.

As I previously pointed out[26],

the more intervention, the lesser the capital accumulation or reduced economic growth. When politicians become greedy enough to divert much wealth into policy driven consumption activities then productivity diminishes. And that's where the so-called statistical 'trap' comes in.

The fallacious middle income trap theory does not even see people as human beings but as some statistical abstract, who are incapable of thinking.

The problem of investments will not be solved by interventionist policies, but by the promotion economic freedom through the dismantling of anti-competitive laws that benefits the concentrated few.

Philippines Government Balks at ASEAN Integration: Delays Joining ASEAN Trading Link

But real reforms haven’t really been on the cards.

Just take a look at the latest ASEAN integration talks. The Philippine president threw cold water on the possibility of a free trade zone in 2015

From the Rappler[27]:

Southeast Asia's efforts to create a single market by 2015 are in their hardest phase owing to protectionist reflexes on sensitive sectors, Philippine President Benigno Aquino said.

Despite the challenges, however, leaders of the Association of Southeast Asian Nations are working hard to meet the target, Aquino told reporters on Wednesday night, April 24, in Brunei where he is attending ASEAN's annual summit.

"They have finished with the easy parts but the accomplishments will not be as fast as in discussing the hard parts. When you reach that point, there can be some protectionist measures taken by each economy," Aquino said.

"But since we are focused on reaching the target, everyone who believes that one community is beneficial to everybody concerned will really try hard (to reach the goal)."

“Protectionist reflexes on sensitive sectors” represents as the “concentrated” segments of the economy that are controlled by the unholy alliance of political elites and their cronies. They are the key beneficiaries of today’s central bank asset market friendly policies. Many of them are into the yield chasing bubbles in the real economy. And so the unevenness of the much touted economic boom.

Yet like typical politicians, promises have been made but fulfilment will be pushed into the future.

Proof?

Take the ASEAN Trading Link[28]. This is milestone pan-Asian financial platform project aimed at linking 7 stock exchanges from 6 countries that would allow more than 3,600 companies to be traded within the ASEAN region.

Think of trading Thai, Malaysian, Singaporean, Vietnam, Indonesian stocks under the PSE platform. Integrating these exchanges would mean vastly expanded supply of equities (more choice), greater access to capital and investors (bigger markets), lower transaction costs, trading efficiency, promote competition and transparency, more integrated economies which should promote REAL economic growth, and many other multiplier effects as cross cultural relations and more. Think about communicating with more ASEAN people due to cross border trading (e.g. stock market forums, or annual meetings)

As of 2012, Thailand has joined Singapore and Malaysia[29]. Vietnam has conducted a roadshow on INVEST ASEAN 2013 and will join sometime within the year[30].

But the Philippines for two years or from 2011[31] has resorted to dilatory manoeuvres to defer on participating in the trading link. In 2012 the PSE, a monopoly regulated by the SEC, will be delayed due to flimsy reasons; supposedly for getting the system into place and for updating regulations[32].

Let me guess, should there emerge a crisis from anywhere that will affect the region, this will again be used as pretext for postponement.

Yet the refusal to integrate with the region can be seen as parallel to the absence of spot or commodity futures markets. Reason: vested interests. We are the only major ASEAN country without commodity markets. That’s because commodity markets will displace the highly connected middlemen.

Such refusal to equitably distribute economic opportunities via marketplace particularly through economic freedom is simply a sign of protecting economic interest of the politically connected or cronyism.

Good governance? Duh!

This also means that the statistical growth based on government spending, concentrated “crony” based economy and credit driven expansion all adds up illusions from a credit driven asset bubble.

George Magnus: Asia’s Vulnerabilities

The prominent economist George Magnus, who coined the Minsky Moment, recently wrote that Asia needs to rely on real reforms than from “miracles”. He states that one of the six major vulnerabilities of Asia as[33]:

Asia's 'financial' indicators are flashing warning signs, even if there does not appear any immediate threat of instability, and many financial regulation lessons from the Asia crisis have remained 'learned'.

But excluding China, the ratio of credit to GDP has risen to over 100% — higher than it was in 1997. Also, land loan to deposit ratios in Asian banking systems are rising significantly again.

Those who refuse to learn the lessons of history are bound to repeat them.

Yet the other vulnerabilities cited by Mr. Magnus are China’s economic performance, the export centric models of ASEAN and East Asian giants, more complex Asian economies, India’s demographic dividends, and income inequality.

Except for China, I am not so concerned for the others as these problems that are mostly products of interventions which economic liberalization should be able to address. For instance, wealth or income inequality, as shown above, has been products of cronyism and corporate protectionism or corporatism.

While the public is being deceived by an artificial boom masked by credit expansion, the real beneficiaries are the financial asset holders, since central bank policies essentially provide subsidies to these assets at the expense of the real economy whether in the US, or Philippines or elsewhere.

As analyst Doug Noland enunciates of the nature of inflationism[34]

Once its takes root, monetary expansion enjoys powerful momentum and powerful constituents. The bias is always to get bigger, with system deficiencies amply available for justification and rationalization.

Record US Stocks, Near Record Net Margin Debt

Finally as the US stock markets soar to unprecedented heights this chart is a must look

US Stock markets has likewise been driven by a credit bubble, as margin debt nearly hits record highs[35]. Margin debt is just one of the many symptoms of blossoming credit bubble in the US. But such would be a subject for another day.

For now, the mania phase seems as gaining more momentum.

Up, Up and Away!

Trade cautiously.

---

[1] Jakarta Globe Indonesian Officials Confident Economy to Grow Despite Rating Outlook Downgrade, May 3, 2013

[2] Global Property Guide Malaysian house prices continue to rise, albeit at a slower pace April 11, 2013

[3] Tradingeconomics.com MALAYSIA INTEREST RATE

[4] See More Signs of Manic Phase in The Phisix, ASEAN and the US March 4, 2013

[5] See ECB Cuts Rates, Mulls Negative Deposit Rates May 3, 2013

[6] See Reflexivity Theory In Commodity Markets November 3, 2008

[7] George Soros The Alchemy of Finance John Wiley $ Sons 2003 p.5

[8] Soros ibid p. 58

[9] Soros ibid p .23

[10] Bangko Sentral ng Pilipinas Bank Lending Growth Sustained in March April 30, 2013

[11] See Example of the Mania Phase: Awards Received by the Bank of Cyprus March 27,2013

[12] Bangko Sentral ng Pilipinas Domestic Liquidity Growth Higher in March April 30, 2013

[13] Bangko Sentral ng Pilipinas Foreign Portfolio Investments Grow in March April 11, 2013

[14] Inquirer.net 1M join ranks of jobless Filipinos, May 3, 2013

[15] Tradingeconomics.com PHILIPPINES UNEMPLOYMENT RATE

[16] See Shopping Mall Bubble: Will Remittances, BPOs and the Informal Economy Save the Day? January 21, 2013

[17] See Phisix 7,000: Why Asia’s Rising Star is a Symptom of Mania April 29, 2013

[18] See IMF to Asia: Put a Brake on Credit Bubbles! April 30, 2013

[19] See CNBC: The Growing Risks from ASEAN’s Asset Bubbles May 1, 2013

[20] Daniel Kahneman Thinking, Fast and Slow p.204-205

[21] Inquirer.net S&P gives PH second credit ratings upgrade May 03, 2013

[22] Bloomberg.com European Leaders’ Softening on Austerity May Accelerate April 29, 2013

[23] Nassim Nicolas Taleb, The Black Swan The Impact of the Highly Improbable, Allen Lane p.192

[24] Inquirer.net BSP: PH likely to avoid ‘middle-income trap’ May 2, 2013

[25] BSP Foreign Direct Investments Post US$576 Million Net Inflows in January 2013 April 10, 2013

[26] See The Myth of the Middle Income Trap March 28, 2013

[27] Rappler.com ASEAN single market push in hardest phase: Aquino, April 25, 2013

[28] Asiaetrading.com THE ASEAN TRADING LINK EXPLAINED

[29] Wikipedia.org ASEAN Exchanges

[30] Thetradenews.com ASEAN Trading Link extends to Vietnam April 3, 2013

[31] ABS-CBN PSE delays joining ASEAN trading link November 18, 2011

[32] Business Mirror Cross-border e-trading link will just have to wait for PSE December 9, 2012

[33] George Magnus Is Asia's Miracle Over? May 02, 2013

[34] Doug Noland Too Much Asset Inflation Credit Bubble Bulletin Prudent Bear May 3, 2013

[35] Bloomberg.com Near-Record NYSE Margin Debt Leads to Caution: Chart of the Day, May 2, 2013

Phisix 7,000: Why Asia’s Rising Star is a Symptom of Mania

7,000. The Phisix has finally breached the psychological 7,000 level. This represents an amazing 20.86% gain year to date. This accrues to an average of about 5.2% a month since the start of the year. At the rate at of such gains, 10,000 will be reached by the end of the year which should translate to over 40% nominal currency peso returns.

Up, Up and Away!

Financial markets are supposed to represent as discounting mechanisms. Considering the heavy expectation built on “credit rating” upgrades, after an earlier upgrade by Fitch Rating[1], last week’s upgrade by Moody’s should have been a yawner.

But no, the local stock markets used such events instead to furiously bid up on the markets. The Phisix zoomed by 2.32% on Monday on rumors of the upgrade (left window, chart from technistock.com).

The following day, the local benchmark retrenched 80% of the Monday gains or fell by 1.94% day on day on supposedly on “valuation” issues.

Analysts, foreign and local, had been quoted as saying the local equities were “beyond the correct valuation” and therefore “expensive”[2]. But again no one explained or was quoted to elucidate on how and why local stocks “have gone up and become expensive”. 

Contrary to such ‘expert’ rationalization, the public evidently liked “expensive”. They pushed the markets beyond the 7,000 levels. Whoever said market traded on valuations[3]?

The Phisix was up .98% over the week, along with ASEAN peers with the exception of Indonesia’s JCE. Suddenly there had been a marked rebound on global equity markets, in what appears to be a sign of the resumption of a “risk ON” environment.

US markets have also been exhibiting signs of a parallel universe where earnings expectations and stock prices have gone in opposite directions[4].

As one would note, the recycling of supposedly good news means that bulls have been steadfastly refusing for the need to correct or for normal cycles to prevail, and this only means that the mania phase has deepened.

There is no way but, to borrow from Superman, up, up and away!  

The Secret of Asia’s Rising Star: Credit Bubble

Moody’s upgrade has been justified as the Philippines representing “Asia’s Rising Star”. Glenn Levine Moody’s analyst responsible for the publication of the upgrade was quoted by FinanceAsia.com as “Investors are bullish on the Philippines, and so are we”[5].

So has “appeal to the popular” replaced economic analysis as basis for upgrades? Or is it that Moody’s simply wants to jump on the bandwagon like everyone else?

Another article says that the other reasons for Moody’s bullishness have been due to construction and business process outsourcing sectors and domestic demand[6].

However the upgrade on the Philippines didn’t come with enough scrutiny, again FinanceAsia quotes the Moody’s analyst

“A stock market bubble would affect relatively few, but the Philippines’ real estate market is a concern, since housing investment is more widespread,” says Levine. “The scant available data on the Philippines’ real estate, alongside anecdotal evidence, suggest that prices and construction may be rising ahead of fundamentals. This bears watching.”

The above represents the changes of loans from the banking sector to the supply side and the demand side. Data from BSP.

Since 2010 financials, real estate and trade, which accounts for more than 40% of total banking loans, have been running past 20% and rapidly increasing. I didn’t include construction loans despite its monstrous jump 57% year on year jump last February due to time constraints.

Does the analyst from Moody’s know how much of the 20% increase year-to-date increase in the Phisix, aside from last year’s 32% returns, has been based on borrowed money from banks? From the above statement they are clueless.

Yet lending in financial intermediaries has jumped by over 30% in 2011-2012 and 27% this February (year on year).

So if a lot of money loaned from the banks has been channelled into the stock market, then despite the stock market’s small penetration level, a stock market hit will also extrapolate to a hit on loans and the banking system and other creditors. Thailand, may not be the Philippines, but the recent increase imposed by regulators in collateral requirements for margin trades jolted the SET[7], whom at the start of the year had been running neck to neck with the Phisix.

What’s the point? Thailand’s booming stock market has likewise been founded on a credit boom.

So, to conclude that the impact will be “relatively few” seems groundless and signifies a reckless conclusion.

On the demand side, household credit has risen to the mid-teen levels or more than double the statistical growth of the local economy.

This represents the robust domestic demand?

People have been confusing credit intoxication with productivity. Credit does not, in most occasions, translate to productive growth.

Yet ironically, the mainstream can’t seem to fathom the difference between statistical growth and real growth. Statistical GDP numbers has been computed based on the growth rate pumped up by such underlying credit growth.

This means that the statistical growth has been much puffed up. Without the credit boom statistical GDP will reflect on significantly lower numbers.

I have not enough data for BPOs to make any comments.

Are credit bubbles sustainable?

Bank credit growth has been running amuck, close to 30% (year on year; blue line, left window) and nearly 20% (4 quarter rolling GDP, red line)! This is according to the chart from the latest IMF 2013 ARTICLE IV CONSULTATION[8].

Domestic credit to the private sector as percentage of the GDP has spiked to 50.4% by the end of 2012 according to the BSP chief (right window). I previously quoted his speech on my last comment on this[9], now the same figure has been splashed over at media[10]. In 2011 the data was only at 31.78%. This means that in 2012, debt as % to GDP rocketed by 18.62%!

And given the rate of acceleration, which will be compounded by all these upgrades, we can expect that, regardless of the price levels of the Phisix (10,000 or not) at the end of the year, domestic debt to the private sector in % will likely balloon to anywhere around 60-70% or even more!

The BSP chief has the public routine of comparing Philippine debt levels with that of our regional peers. According to him, local debt levels are “low” given the 100%+ levels of our neighbors.

But again this really represents the fallacious apples to oranges comparison. Political money authorities feel like having attained a state of celestial bliss. This time is different. This is the new order.

In their chronicles of global financial crises over the eight centuries, Harvard Professor’s Carmen Reinhart and Kenneth Rogoff in their book points out, that debt intolerance or the “extreme duress” of debt levels which “involves a vicious cycle of loss of confidence, spiralling interest rates on external government debt and political resistance to paying foreign creditors”[11], have had “very different thresholds for various individual countries”.

Furthermore they state that “the worst the history, the less the capacity to tolerate debt”[12].

In the past, the Philippines fell into a recession or a crisis when debt levels reached 51.59% in 1983 and 62.2% in the pre-Asian crisis of 1997. While the level of debt intolerance may increase, expectations of 100% levels similar to our peers signifies as sheer fantasy.

A famous quote from Karl Marx in his book the Eighteenth Brumaire of Louis Napoleon[13] "History repeats ... first as tragedy, then as farce" seems very applicable today.

And given the dramatic deluge of debt, confidence can evaporate with a snap of a finger, where “rising star” may became a wayward meteor, especially when creditors become increasingly sceptical of the debtor’s ability to settle on their liabilities

In short, while I expect the mania may go on through the year, anytime the Philippines reaches or even surpasses the 1997 debt levels then she will become increasingly fragile or vulnerable to a recession or a crisis that may be triggered internally or externally.

BSP Officials on Bubbles: Yes and No

This week other BSP officials have offered mixed signals.

Some reportedly acknowledged the existence of bubbles, but like Thai authorities, deny of their risks, since they presume to have the tools to rein them.

But Deputy Governor Nestor Espenilla issued the strongest statement on bubbles so far, as quoted by Bloomberg[14]

“Our source of concern is the rapid growth of credit,” Espenilla said in his office on April 24. “The central bank is very mindful of seeing the foundation of an asset bubble that can burst and create dislocations in the economy.

Now we are talking.

A major market participant mentioned in the same article seems in a state of denial

“Demand is still growing,” Henry Sy Jr., chief executive officer of SM Development Corp. (SMDC), said in an April 24 interview. “But there’s danger in some areas because good days don’t last forever.”

But the Bloomberg reports that the SM group plans to invest up to 71 billion pesos on expansion up until 2015. Such magnitude of spending doesn’t seem to suggest that “good days don’t last forever”, because these implies of an investment payoff from 2015 and beyond!

Yet demand continues to grow, because of the acceleration of the credit boom.

And it gets more interesting. From the same article

“There could be some surplus in the upper end of the market,” central bank Deputy Governor Diwa Guinigundo told reporters yesterday. “On the more significant parts of the market like the low-cost, socialized and medium-cost, there are no signs of a bubble formation.”

Some very noteworthy aspects from the comment.

The good Deputy Governor Diwa Guinigundo resorts to the fallacy of substitution and composition. The allusion to areas supposedly unaffected by bubbles or the absence of bubbles doesn’t validate or invalidate the presence of bubbles elsewhere. Such represents an ambiguous statement designed to evade the question or that the good governor has poor grasp of bubbles.

Bubbles are concentrated on capital intensive popular themes that reflect on the cluster of entrepreneurial errors as incentivized by policies.

As the great dean of the Austrian school of economics, Murray N. Rothbard explained[15].

But the regular, systematic distortion that invariably ends in a cluster of business errors and depression—characteristic phenomena of the "business cycle"—can only flow from intervention of the banking system in the market

Yet Mr. Guinigundo seems to echo US Federal Reserve Chairman Ben Bernanke, who denied of a housing bubble and of the 2007 crisis until it blew up on the face of the US Federal Reserve

In a 2010 speech, Mr. Bernanke admitted to his failure to act on a national housing bubble[16].

Although the house price bubble appears obvious in retrospect--all bubbles appear obvious in retrospect--in its earlier stages, economists differed considerably about whether the increase in house prices was sustainable; or, if it was a bubble, whether the bubble was national or confined to a few local markets.

Also it would signify as an obvious mistake to presume bubbles as merely a “upper higher end of the market” phenomenon. 

Shopping malls[17] and the casino industry, whom are part of the property sector, have been acquiring substantial amounts of banking loans in support their rapid growth. The rate of which has gone far beyond the growth rates of their respective demand side of the markets, particularly domestic consumers and regional bettors, respectively.

In other words, property projects for different classes of customers that have not been limited to the upper scale.

Shopping malls have catered largely to the general local population depending on the malls, whereas the coming casino complex has likely been targeted at regional or foreign clienteles.

Casino Bubble Redux

One of the four grand casino projects by the incumbent regime has reportedly obtained 14 billion pesos of debt from 3 banks for expansion. Three more grand casinos have been slated to open within 3 years[18].

Melco Crown (Philippines) Resorts Corp has reportedly raised $377 billion from follow on IPO offering[19]. My guess is that the next phase of fund raising will be on debt, whether from bonds or banking loans, perhaps similar to the path of the newly opened Solaire Manila which is owned and controlled by Enrique Razon led Bloombery Resorts [PSE BLOOM].

These marquee casinos are essentially competing with the regional casinos for the regions bettors rather than dependent on local peers. So the fate of these companies are essentially anchored or leveraged on regional growth.

Mainstream observers also say that such elaborate projects should help the tourism industry seems largely misunderstood. Many foreign based high rollers hardly go around the country as regular tourists. Their itinerary consists of the sojourn between casino and the airports. So while the casino, select hotels, and allied services and the airports benefits, they are hardly considered tourism in the conventional context.

Nevertheless, as discussed before, the gaming industry is said to grow at 28% CAGR from 2012-2018, when the average regional growth will be about the growth rate of the Philippines.

Yet these casinos appear to be political “pet” projects. These companies will operate on the government owned 8 hectare property envisioned as a Las Vegas entertainment complex known Entertainment City[20] and under the auspices or supervision of the Philippine Gaming and Amusement Board (PAGCOR)[21].

This also means that to obtain such privileges one has to be considered favorably within the circles of the incumbent political elite. And this is why one of the four major license holder whom is a Japanese mogul had been accused of bribery because such license had been acquired during the previous administration[22].

But political “pet” projects are unlikely good bets. They barely exists to serve customers. Instead these politically privileged agents use government “licensing” as economic moats from competition in order to extract financial rent, which they share with government directly and indirectly.

If the successes of political pet projects are to be measured, US President Barack Obama green energy “pet” projects could be used as paradigm. Obama’s green energy embodies a roster of failures[23]. Recently another supposed hybrid electric car company that got $200 million from the US government has been on the verge of bankruptcy[24].

I know, green energy projects are not casinos and Philippine politics haven’t been the same as American politics. But the hoopla of supposed gains where according to a study quoted by Finance Asia[25] “gaming revenues to more than double to $3.2 billion in 2015 from an estimated $1.4 billion in 2012, and reach $4.1 billion by 2016 as the supply increases” conspicuously ignores the risks from a severe regional economic slowdown, or a bursting bubble.

Such studies, which the political class relies on, overlook why global central banks need to keep interest rates at zero bound, and why central banks of developed economies need to expand balance sheets.

Nonetheless these big 4 casino operators will likely get bailed out once financial conditions turn against their expectations, which seems as why such aggressive risk taking behavior. 

 

Early Signs of the Periphery to the Core?

Of course the most important kernel of wisdom from Mr. Guinigundo’s quip looks like a revelation of what I call “periphery to the core” dynamics developing in the property sector.

He notes that there are “some surplus in the upper end of the market” without explaining the ramifications.

Well, allow me.

Surpluses may lead to cash flow problems for highly leveraged firms that may prompt for foreclosures.

If the incidences of surpluses multiply, then this could put to risk the entire bubble structure.

An overleveraged sector amplifies the risks of insolvencies that would undermine creditors, particularly the banking system which has been the source of much of the financing as shown above[26].

Bond creditors will also get hurt. And the impairment of assets of the banking industry would mean a general tightening of credit conditions.

Such contraction in bank assets would also translate to debt deflation or a bubble bust which also implies the race to liquidate or to raise cash, capital or margin calls at depressed price levels.

Thank you for the clues, Deputy Governor Mr. Guinigundo.

For shopping malls, the “periphery to the core” would start from the mall areas with the least traffic and from marginal malls or arcades.

Surpluses amidst a boom which implies high rents, high cost of operations such as wages, electricity and other inputs prices, would place pressure on profits of retail tenants competing for consumers with limited purchasing capacity.

Periphery to the core would mean initially fast turnover from retail tenants on stalls of lesser traffic areas and of marginal malls. Then the length of vacancy extends and the number of vacancy spreads.

Leveraged malls and arcades thus will suffer from the same vicious cycle of cash flow problems and eventual insolvencies that will impair creditors and will spread to many sectors of the economy.

Why has the Philippine Bond Yield Curve been Flattening?

The slope of the Philippine yield curve has dramatically been flattening (red arrow) since the start of the year. This week (red line) the 10 year revealed of a strong move. This compares with the previous week (green) or end of March (blue). Also see table on the right from Asianbondsonline.com[27]

This has been in stark contrast with our neighbors whose curves have registered marginal changes.

Rates from the longer end of the curve, particularly the 10 year bonds, have materially declined, which has been down by 137.5 bps year-to-date as of Thursday.

Why are investors stampeding into the Peso based government 10 year bonds? Are they discounting price inflation amidst the so-called ‘Rising Star of Asia’ boom?

Has this been merely yield chasing? Particularly by foreigners? Or has this been an anomaly? Why lock into 2.775% for 10 years, if so-called boom could lead to the risks of inflation or “ overheating” pressures?

Yet if such slope flattening continues, where the short end begins to rise while the longer end continues to fall then we may segue into an inverted yield curve: a harbinger of recession as a liquidity squeeze from malinvestment gets reflected on diametric moves of coupon yields across the maturity curve.

Moreover, flattening of the slope will theoretically reduce the banking system’s net interest margins[28].

Although today’s banking system has been more sophisticated since they don’t rely on net interest income alone.

But the Philippine banking’s income statement shows that as of June 2012 net interest income is at 122.543 billion pesos relative to 73.876 billion pesos of non interest income according to BSP data[29]. So the banking system will have to rely on non-loan markets, otherwise there will be pressure on profits.

Developments in the Philippine bond markets appear to be a conundrum to the Rising Star of Asia meme. 

 

The “Controlled Deficits” Travesty

Another supposed bullish reason with Moody’s on the Philippines is the so-called “controlling fiscal deficits”.

One would wonder, if the Philippines has indeed been booming, why the tremendous pressure to raise taxes on the public?

Why does the Aquino regime resort to an implicit class warfare campaign of “ostracization” against the Chinese community[30] and on Forbes billionaires over taxes[31]?

Current fiscal conditions offers as some clues.

Cash operation on National government continues to operate on deficits, where expenditures have been more than revenues, as shown by the 2012 BSP Annual Report[32], since the advent of the Aquino presidency.

The same changes in deficits can be seen in % year-on-year and as % of GDP changes from the IMF’s paper.

Since 2009, tax revenues has been blossoming alright, but this represents less than 10% y-o-y growth, which should reflect on economic performance, or that tax revenues fluctates from about 4-8% GDP. But the government’s spending at 20% y-o-y, 8-12% of GDP has ballooned by even more!

Some controlling deficits eh?

The reason statistical debt-to-gdp or deficit-to-gdp ratio continues to exhibit signs of resilience has been mainly because of accounting treatment. Statistical gdp, which has been bolstered by a credit boom, has reduced the increases of government liabilities.

Moreover, government expenditures have been growing in a straight line (green arrow). But taxes mainly depend on, and are entirely sensitive to economic performance. So the revenue side of the government’s accounting book are variable while the expenditure side are at a fixed trend growth. Such asymmetry is a recipe for instability.

Should an economic slowdown occur, or worst, if a recession happens, those deficits will balloon as tax revenues collapse. Thus “controlled deficits” are really a charade.

While one can argue about from collection efficiencies, taxes essentially crowds out productive investments, so I would counter that tax collection inefficiencies are a good thing or adds to economic efficiency. As the great Ludwig von Mises would say “Capitalism breathes through those loopholes.[33]”

The US crisis of 2007-2008 was felt only in 2009, where a massive decline in tax revenue led to a jump in fiscal deficits. This transpired even when the Philippines didn’t fall into a recession.

Yet given that government spending continues to swell, now at far more than the 2009 levels, any regression of tax revenues to the 2009 levels would amplify deficits. The 2009 event is a clue to what will happen in the future…but magnified.

Moody’s will be exposed for another flawed call.

Moody’s and the false acclaim of political ascendancy along with all the rest are symptoms of the credit bubble in full motion.

As the great Ludwig von Mises warned[34],

All governments, however, are firmly resolved not to relinquish inflation and credit expansion. They have all sold their souls to the devil of easy money. It is a great comfort to every administra­tion to be able to make its citizens happy by spending. For public opinion will then attribute the resulting boom to its current rulers. The inevitable slump will occur later and burden their successors. It is the typical policy of après nous le déluge. Lord Keynes, the champion of this policy, says: "In the long run we are all dead." But unfortunately nearly all of us outlive the short run. We are destined to spend decades paying for the easy money orgy of a few years.

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[1] See Fitch Credit Upgrade: Phisix Mania Phase in Full Throttle March 28, 2013

[2] Bloomberg.com Philippine Stock Trading Drops as Valuations Surge to Record April 24, 2013

[3] See Are Stock Market Prices Driven By Earnings or Inflation? January 25, 2009

[4] See Parallel Universe: Record US Stock Markets and Falling Estimates of Corporate Earnings April 25, 2013

[5] FinanceAsia.com Bullish on the Philippines April 25, 2013

[6] GMANews Online Moody's Analytics says PHL is 'Asia's rising star' April 24, 2013

[7] See Thailand’s Officials Flexes Muscles on Domestic Stock Market Bubbles March 25, 2013

[8] IMF Country Report Philippines 2013 ARTICLE IV CONSULTATION p.25 IMF.org

[9] See Phisix and the BSP: This Time is Different? March 17, 2013

[10] Inquirer.net SDA amount remains huge; BSP considers more rate cuts March 21, 2013

[11] Carmen M. Reinhart and Kenneth S. Rogoff, This Time is Different Eight Centuries of Financial Folly, Princeton University Press p.21

[12] Reinhart and Rogoff Op. cit p.25

[13] Wikipedia.org The Eighteenth Brumaire of Louis Napoleon

[14] Bloomberg.com Philippines Ready to Act on Property Loan Surge: Southeast Asia April 26, 2013

[15] Murray N. Rothbard The Positive Theory of the Cycle Business Cycle Theory Mises.org

[16] Ben S. Bernanke Monetary Policy and the Housing Bubble At the Annual Meeting of the American Economic Association, Atlanta, Georgia January 3, 2010

[17] see Philippine Economy’s Achilles Heels: Shopping Mall Bubble (Redux) January 13, 2013

[18] see The Philippine Casino Bubble April 11, 2013

[19] Inquirer.net Gaming firm MCP raises $377M from equity placement deal April 25, 2013

[20] Wikipedia.org Entertainment City

[21] Wikipedia.org Philippine Amusement and Gaming Corporation

[22] Bloomberg.com Kazuo Okada Under Criminal Investigation, U.S. Says April 10, 2013

[23] See US President Obama’s Green Energy List of Failures October 26, 012

[24] Judicialwatch.com Another Obama Green Project Folds after Getting Millions from Taxpayers April 24, 2013

[25] Finance Asia Melco Crown Philippines prices follow-on at the top April 24, 2013

[26] IMF Country Report Philippines Op cit p.19

[27] Asian Bonds Online Philippines ADB

[28] Federal Deposit Insurance Corporation What the Yield Curve Does (and Doesn’t) Tell Us February 22,2006

[29] BSP.gov Income Statement and Key Ratios Philippine Banking System

[30] Rappler.com 'Filipino-Chinese tax evaders will be prosecuted', March 25, 2013

[31] Editorial Inquirer.net BIR’s misleading list April 22, 2013

[32] BSP.gov Annual Report Volume I 2012

[33] Murray N. Rothbard Long Live the Loophole December 13 2012

[34] Ludwig von Mises Section 6 Monetary Planning Chapter 11 THE DELUSIONS OF WORLD PLANNING Omnipotent Government p 252