Phisix Record 8,000: Market Confidence or Publicity Campaign to Project Confidence?

Nations, like individuals, cannot become desperate gamblers with impunity. Punishment is sure to overtake them sooner or later.—Charles Mackay, The South Sea Bubble, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds

In this issue:

Phisix Record 8,000: Market Confidence or Publicity Campaign to Project Confidence?

-Record Stocks as Symptoms of Monetary Abuse: The Venezuela and Argentina Model

-Record Stocks NOT EQUAL to G-R-O-W-T-H: Japan and China

-Record Stocks NOT EQUAL to G-R-O-W-T-H: US, Europe and ex-China and Japan Asia

-Phisix Record 8,000: Market Confidence or Publicity Campaign to Project Confidence?

-What the Philippine President’s Dream of Phisix 10,000 Means

-Dismal Rebound in February Philippine OFW Remittances

Phisix Record 8,000: Market Confidence or Publicity Campaign to Project Confidence?

I will open this outlook with this splendid quote from nineteenth century Scottish poet and author Charles Mackay from his epic book, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds[1]

IN READING THE HISTORY OF NATIONS, we find that, like individuals, they have their whims and their peculiarities; their seasons of excitement and recklessness, when they care not what they do. We find that whole communities suddenly fix their minds upon one object, and go mad in its pursuit; that millions of people become simultaneously impressed with one delusion, and run after it, till their attention is caught by some new folly more captivating than the first…

Some delusions, though notorious to all the world, have subsisted for ages, flourishing as widely among civilised and polished nations as among the early barbarians with whom they originated,—that of duelling, for instance, and the belief in omens and divination of the future, which seem to defy the progress of knowledge to eradicate them entirely from the popular mind. Money, again, has often been a cause of the delusion of multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper. To trace the history of the most prominent of these delusions is the object of the present pages. Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.

Record Stocks as Symptoms of Monetary Abuse: The Venezuela and Argentina Model

Has stocks markets been about economic growth?

Let me frame this question under contemporary popular wisdom, has record stocks really been about booming economies?

The above equity benchmarks are from the Latin American nations of Venezuela and Argentina whose stocks have been racing to record highs since 2013.

Year to date as of Friday’s close, local currency returns for these indices have been at 39.45% and 38.94% respectively. In 2014, the same bourses returned a spectacular 41.01% and 59.14% while in 2013 returns have been at a shocking nosebleed 480.48% for the IBVC and a breathtaking but less stellar 88.87% for the Merval!!!

Yet a short glimpse of their respective statistical (annual) economic growth data suggests of mediocre performance for Venezuela and lethargic activities for Argentina. 

But economic numbers don’t represent food on the table. The reality has been that basic supplies appear as being rationed in Venezuela. As aptly described by the New York Times last January: “the situation has grown so dire that the government has sent troops to patrol huge lines snaking for blocks. Some states have barred people from waiting outside stores overnight, and government officials are posted near entrances, ready to arrest shoppers who cheat the rationing system.”

In Venezuela, tourists have been even asked to bring their own toilet papers due to the near absence of supplies! It has been a little less desperate for the Argentine economy, but goods shortages exists nonetheless. And such scarcity of supply has been highlighted by the recent sensational shortages of tampons!

If the economies of both nations has been in dire straits, so why has their respective stocks been racing to record highs?

A concise answer has been that because of the lack of access to credit, the governments of both countries has been relying on the monetary printing press to finance political economic spending, the result of which has been massive devaluation of their currencies and HYPERINFLATION!

And given the rigorous clampdown on capital and currency flows by their governments, and since residents of both countries have sought safety of their savings from devaluation and from the severe loss of purchasing power, equities—which signify as titles to capital goods—have served as refuge from monetary abuse. Said differently, the store of value function of currencies of both countries has shifted to stocks!

Venezuela and Argentina represents the extreme episodes of stocks functioning as shock absorbers from monetary debasement.

But the buck doesn’t stop here.

Record Stocks NOT EQUAL to G-R-O-W-T-H: Japan and China

Venezuela and Argentina’s symptoms seem as being replicated everywhere but at a tempered basis that comes in different shades or form.

In the case of Japan, milestone high stocks have been diverging from the statistical economy. Japan’s economy has been laboring to climb out of an economic rut or particularly intermittent recessions.

But the Japanese government thinks that they have found an elixir to her economic predicament. They believe that stock market boom and destruction of a currency translates to economic salvation.

So they have mandated the Bank of Japan to devalue her currency, the yen, by  expanding the her balance sheets by buying enormous amounts of bonds and stocks since 2013. And the government has extended and expanded the same program in November 2014. Japan’s largest pension fund, the Government Pension Investment Fund (GPIF) has likewise been enlisted to the stock market buying program.

Unfortunately the result has been devastatingly opposite to what has been intended: stocks continue to diverge with the real economy as resident (individual and institutional) money continues to gush out of the nation.

Aside from the BoJ and GPIF, foreign money has largely been responsible for driving Japan’s stocks to record levels.

Chinese stocks have also frantically been skyrocketing as the statistical economy has been dramatically slowing.

Chinese property prices continue to fall in March but at a much subdued pace. However, China’s new built houses as of February crashed to its lowest level or by 6.1% year on year!

Broad indicators reveal that the Chinese economy’s downtrend appears to be accelerating. The continuing downshift includes fixed asset investments, retail sales and industrial production which has all contributed to the statistical economic growth of 7%, the slowest since 2009.

The Lombard Street Research (LRC) counters that real economic growth in China has CONTRACTED in 1Q 2015 Q-on-Q where the Chinese economy endured a ‘historic collapse’.

From Breibart (bold mine)[2]: Lombard Street Research (LSR) has reported that China’s “real” (after-inflation) GDP actually fell -0.2% for the quarter ending March 2015. Despite the official government claim of +1.3 percent growth for the quarter and +7 percent annualized growth. China’s quarterly performance was the worst showing since the Global Financial Crisis as, “real” domestic demand suffered a historic collapse. LSR’s Diana Choyleva has been the best Western economist at untangling China’s less-than-authentic economic statistics. She reveals that after peaking in 2014 at +2 percent on real domestic demand growth, China has collapsed by over 4 percent and to a -2.1 percent. Choyleva says this is the first negative performance observed since LSR began recasting China’s quarterly economic reports in 2004.

Trouble in the real economy has been more than a slowdown, as credit risks mounts.

Aside from the recent missed interest rate payment by Cloud Live Technology, another company, power-transformer maker Baoding Tianwei Group Co. expressed doubts whether it can make interest payments on April 21, signaling risks of another potential default.

Yet despite the economic fragilities, the Chinese government continues to force feed credit into system. The Chinese government appears to either be buying time from a bubble bust or hoping that blowing new bubbles may cure problems caused by previous bubbles.

Chinese loan growth beat expectations in March even as money supply growth continues to ebb. Those loans appear as being rechanneled into the frenzied bidding of stocks. Even funds from China’s shadow banks have reportedly been increasingly used for wanton stock market speculation.

Worst, despite recent imposition of regulatory controls, margin debt used to finance stock market speculation has reportedly more than doubled the US counterpart.

From Bloomberg[3]: Securities firms’ outstanding loans to investors for stock purchases were a record 1.64 trillion yuan ($264 billion) as of April 10, up 50 percent in less than three months, despite bans imposed by the CSRC in January and April on lending to new clients by four Chinese brokerages…China’s margin finance now stands at about double the amount outstanding on the New York Stock Exchange, after adjusting for the relative size of the two markets.

The serial record breaking Chinese stock market benchmark has already surpassed the Japan contemporary in terms of market capitalization.

At the close of Friday’s trading session for Chinese stocks, Chinese regulators once again say that they will tighten margin trade as exchanges announced expanding shorting facilities.

From the Wall Street Journal[4] (bold mine): The CSRC warned small investors, who have been big drivers of the rally, not to borrow money or sell property to buy stocks, ratcheting up its rhetoric about the market. Mainland investors opened stock-trading accounts at the fastest pace ever in the week ended April 10, and margin account balances reached a record 1.16 trillion yuan ($187 billion) as of Thursday, according to the Shanghai Stock Exchange. The regulator banned a type of financing called umbrella trusts that provided cash for margin trading, the practice of borrowing against the value of common shares held at a brokerage, and placed limits on margin trading for highly risky small stocks that trade over the counter, rather than on exchanges. The regulator said customer accounts needed to be better classified, potentially a warning that limits will be placed on the type of trading permitted for small investors. The exchanges issued rules that would make it easier for investors to short, or bet against, stocks. To short a stock, an investor borrows shares and sells them, hoping the price will fall and so let them repay with cheaper shares. It has been difficult to short stocks in China even as valuations soared because it has been virtually impossible to borrow shares. The exchanges said they would push for an increase in the supply of shares available for lending and increase the number of stocks whose shares can be borrowed.

This seems like another superficial or political staged attempt to curb or control the stock market bubble that has been going berserk.

The Shanghai index pole-vaulted 6.27% last week.

With Chinese stock market futures as indicated by China A50 futures suffering a 5.97% loss Friday, Chinese stocks may be headed for a sharp selloff in Monday’s opening.

And it has not just been about stocks, Chinese junk bonds have been enjoying a record run.

From Bloomberg[5] (bold mine): Investors in Chinese junk bonds are taking the biggest gamble in at least a decade. Leverage for speculative-grade Chinese companies is at its highest since at least 2004, whether measured by earnings relative to interest expense or total debt to a measure of cash-flow, according to data compiled by Bloomberg using a Bank of America Merrill Lynch index. Borrowers have also piled on the most debt relative to their assets since 2007. The deterioration in credit quality coincides with the slowest annual growth since 1990 for Asia’s biggest economy, and helps explain why Fitch Ratings Ltd. predicts defaults will climb. That’s bad timing for bond investors who swallowed a record $209.2 billion of Chinese-company notes denominated in either dollars, euros or yen last year, Bloomberg data show.

As one can see for Japan and China, record stocks have been a function of monetary abuse.

Record Stocks NOT EQUAL to G-R-O-W-T-H: US, Europe and ex-China and Japan Asia

You think it is different for the US or for Europe? Well think again.

Record US stocks has been about growth? Hardly

The US Federal Reserve of Atlanta, one of the twelve regional Federal Reserve banks, has a NOWcasting or real time forecasts of the US statistical economy.

Here is what they see for the 1Q 2015 as of this writing: The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2015 was 0.1 percent on April 16, down from 0.2 percent on April 14. The decline came after Wednesday morning's industrial production release from the Federal Reserve Board

Record stocks on a .1% G-R-O-W-T-H??!!

Additionally, whatever growth that had been posted in the recent past has been below the 3.24% average. Yet again record stocks.

More.

Factset, a company that provides financial information, recently noted that for 1Q 2014 negative earning guidance has dominated earnings announcements. Importantly, they note that stock markets have been rewarding companies posting negative earnings announcement more than those with positive earnings[6]!

Even more. Record US stocks comes as bankruptcies climb to its fastest level since 2010.

From Reuters[7] (bold mine): The number of bankruptcies among publicly traded U.S. companies has climbed to the highest first-quarter level for five years, according to a Reuters analysis of data from research firm bankruptcompanynews.com. Plunging prices of crude oil and other commodities is one of the major reasons for the increased filings, and bankruptcy experts said a more aggressive stance by lenders may also be hurting some companies. While U.S. stocks have climbed to near record levels and the jobless rate has fallen to a six-year low, 26 publicly traded U.S. corporations filed for bankruptcy in the first three months of 2015. The number doubled from 11 in the first quarter of last year and was the highest since 27 in the first quarter of 2010, which was in the immediate aftermath of the financial crisis. In addition, many of the bankruptcies were large. Six companies had reported at least a billion dollars in assets when they filed in the first quarter of this year, the most in the first quarter of any year since 2009. The $34 billion in assets held by the 26 companies is the second highest for a first quarter in the past decade. The highest was the $102 billion held by the public companies that filed in the first quarter of 2009 when the crisis was at its worst.

Yet it has been pretty bizarre for Fed officials and Wall Street to quibble over a measly proposed quarter of a percent (.25%) rate hike, which goes to show how hooked on credit the entire economy and financial markets has been founded on.

As for Europe, this earnings chart indicates why Europe’s turbocharged stocks have hardly been about growth!

Record or near record stocks has become a dominant feature even in ex-Japan and China Asia. Yet if one looks at their respective economic G-R-O-W-T-H trends since 2011, they have MOSTLY been on a decline: Australia, South Korea, Taiwan, Singapore, Hong Kong, Indonesia and Thailand. Only India, Vietnam and New Zealand appear to beat the region’s dominant trend.

On the other hand, what the establishment has mostly ignored has been the relationship of debt with record stocks…that is with the exception of a few…

For instance, German Finance Minister Wolfgang Schaeuble expressed concerns last week that that “high debt levels remain a source of concern for the global economy”, where the Chinese economy has been "built on debt".

Moreover, research company MSCI recently warned against global property bubbles (bold mine): “Fears of a renewed global property bubble are rising as prices and yields hit records last seen before the financial crisis” as “the pricing of real estate around the world had become ‘increasingly aggressive’….The main factor behind the pricing is “exceptionally low” bond yields, which made property much more appealing to investors in relative terms, Mr Hobbs said, citing “frenzied buying”.

In sum, record stocks (as well as record property prices and bonds) have mostly been about unbridled and rampaging speculative activities financed by credit that has been pillared on zero (or negative) bound rates, QEs and other monetary easing tools than they have been about G-R-O-W-T-H.

Reasoning from price changes will be detrimental for one’s portfolio.

Phisix Record 8,000: Market Confidence or Publicity Campaign to Project Confidence?

This bring us to the Philippines where popular wisdom has been to tie record stocks with to confidence from economic G-R-O-W-T-H

The following represents the hazards of rationalizing from price changes, or the recency bias or serial position bias or ticker tape mentality.

The Philippine president graced the opening ceremony at the PSE last Tuesday where officials of the Philippine Stock Exchange cajoled to the honored guest[8]. (bold mine)

In his welcome remarks during the event, PSE Chairman Jose T. Pardo said, "At the 8,000 point level, the index is giving returns just this year of already more than 10 percent. It is interesting to note that the unprecedented ascent to 8,000 comes with other remarkable market indicators."

Mr. Pardo cited the brisk trading activity in the first quarter of 2015 which soared by 40 percent from the same period a year ago. He also mentioned that in the first three months of the year, total market capitalization of listed firms rose by 18 percent to P14.98 trillion from the same period in 2014 and that foreign funds registered a net buying of P48.87 billion in the January to March period, a 182 percent increase year-on-year. There was also an increase in local investor participation as they accounted for 53 percent of trading activity in the first quarter of the year.

"This can only mean one thing, confidence in the economy under your leadership, Mr. President", Mr. Pardo stated.

Last week’s 2.2% correction came with a net foreign trade of NEGATIVE Php 5.71 billion, the largest since October 2014.

If record Phisix 8,000 has allegedly been about ‘confidence’ partly predicated on foreign trade, then the above indicates an OOPS moment!!!

With the above and this week’s correction, has confidence on G-R-O-W-T-H been reversed? Or will this be explained or justified away by sidestepping the selling activities as mere profit taking? So rising stocks equals G-R-O-W-T-H but falling stocks equals denial?

The problem with rationalization has always been the inconsistency of the logic presented.

And here is what the PSE officials forgot to say…

…that record stocks has been engineered by index managers. 

Massaging or manipulating the index via “marking the close”, which represents a violation of the SEC Securities Regulation Code, has been used with blatant regularity and has apparently been condoned by the authorities.

And to add to last week’s discussion[9] of the growing concentration of trade activities, here are more facts about record Phisix 8,000.

On market cap distribution

As of the close of April 17, the market cap weighting of the top 15 issues of the Phisix constitutes a staggering 79.57% of the domestic bellwether!

Meanwhile, the 10 best performers as measured by year to date gains (as of last week) has an accrued market cap share of an astounding 55.23%!

So movements of the 10 best performers or the top 15 biggest market caps determine the direction of the Phisix!

On Peso volume distribution

Peso volume trades of the 30 members of the Phisix basket relative to total volume (Phisix issues+ non-Phisix issues+ special block sales + odd lot) on a daily basis have been climbing since February. They have now ranged from over 60% to 80% of total volume.

Yet if adjusted for major special block sales to include Friday’s Php 26 billion Meralco special block sales, the volume from Phisix trade expands to the range of 65% to 95%. The above doesn’t even include minor special block sales. Firms from the Phisix basket constitute a large majority of special block sales even from the perspective of minor block sales

So this translates to a massive gravitation of trading activities towards Phisix companies.

And it has been more than just the entire Phisix.

Aside from valuations, gains and market cap weightings, like a centripetal force, trading activities has been converging into the top 15 biggest firms.

The same top 15 issues have increasingly been taking the bulk of the daily peso trade volume based on gross basis (left) especially if adjusted for major block sales (right).

Additionally, with the top 15 garnering the market’s attention and or signifying the index managers’ maneuvering, the 10 outperformers from the 15 biggest market caps have also been absorbing an increasingly significant share of the daily peso volume trades (left). This has been magnified by the special block sales (right)!

So since record Phisix 8,000 has been a function of an increasing concentration in terms of trading, price setting, valuations and performance activities towards the biggest market cap issues, in particular, the 10 best performers, it can be construed that record Phisix 8,000 has hardly accounted for as a genuine product of market confidence, but rather about stealth publicity measures to “project” market confidence that has been engineered from rampant market manipulations.

What the Philippine President’s Dream of Phisix 10,000 Means

Yet the Philippine president hopes to see 10,000 Phisix at the end of his term.

Given the appalling or revolting degree of current overvaluations even at 8,000, what the president proposes will be a transmogrification of the Philippine stock exchange into a destructive hub of casino speculators.

What he seems to also be suggesting is for stock market’s basic function as channel to intermediate savings into investments, enabled and facilitated by price discovery predicated on the discounting dynamics of finance, to be totally obliterated or dismantled!

He appears to also implicitly promulgate that—since soaring stocks will extrapolate to a redistribution of resources in favor of the beneficiaries, particularly the elites, many of whom has already been basking in glory to be included in the roster of the world’s richest, all coming at the expense of the average citizens—inequality must be promoted!

Of course, Phisix 10,000 can be achieved. All he has to do is to mimic the monetary policy aspects of Japan’s Abenomics. He can instruct the Bangko Sentral ng Pilipinas and public pension funds to emerge from the shadows and to openly buy stocks.

Yet this will crash the peso and send price inflation to the skies, while at the same time inflating the already inflated balance sheets of the many companies particularly the publicly listed ones.

So instead of positively contributing to the economy, Phisix 10,000 will lead to a total collapse of the real economy!

Of course, the other way to do it is for market manipulators to stay their course. But where will the index managers get their funding to sustain present activities?

I am reminded of the fateful BW bubble that turned into a scandal. BW’s preposterous 52x run climaxed with the visit of Macau’s casino mogul Stanley Ho to the PSE. This eventually was followed by the stock’s monumental collapse back to its origins!

Dismal Rebound in February Philippine OFW Remittances

Low or zero growth even in the government’s own statistical accounts has now been reckoned as taboo and has even been subject to implied censorship!

In the perspective of remittance statistics, in the past where rate of growth falls in line with government projections, the BSP headlines will ostensibly indicate of the N% of the increase, or be accompanied by acclaims such as “Sustain Robust Growth” or “Continue to Rise”.

But with recent accounts of low growth, the BSP headlines will just denote of, or frame remittance data as having “reach” X levels. This seems designed to sanitize the unpopular event or to put a positive spin on the below expectation numbers.

Yet, framing aside, the reality has been February’s remittance growth rates continue to disappoint.

The BSP on personal remittances[10]: Personal remittances from overseas Filipinos (OFs) amounted to US$2.1 billion in February 2015, an increase of 4.0 percent compared to the same period in 2014. As a result, remittance inflows for the first two months of the year reached US$4.1 billion, posting a year-on-year growth of 2.1 percent, Bangko Sentral ng Pilipinas Officer-in-Charge Nestor A. Espenilla, Jr. announced today.  For the period January-February 2015, personal remittances from land-based workers with work contracts of one year or more, and migrants’ transfers totaled US$3.1 billion. Meanwhile those from sea-based and land-based workers with work contracts of less than one year aggregated US$1.0 billion.

The BSP on cash remittances (bold added): Cash remittances from OFs coursed through banks summed up to US$1.9 billion in February 2015, higher by 4.2 percent than the level posted a year ago. This brought cash remittances for the first two months of 2015 to US$3.7 billion, representing a 2.4 percent increase relative to the year-ago level. In particular, cash remittances from land-based and sea-based workers rose to US$2.8 billion and US$0.9 billion, respectively.  The bulk of cash remittances came from the United States, Saudi Arabia, the United Arab Emirates, the United Kingdom, Singapore, Japan, Hong Kong, and Canada.  The slowdown in growth in recent months could be due to base effect as remittances last year were relatively high given higher transfers from overseas Filipinos that were intended for the rehabilitation and rebuilding efforts in Eastern Visayas due to the damage caused by Typhoon Yolanda.

This month’s numbers marks the third in four months of dismal or below expectations growth figures.

February 2015 remittance growth rates have sunk below 2009 levels, or have been worse than 2009, or accounts for as the lowest growth rate since 2002!

Key questions:

One, should ‘base effects’ of low growth in February data—allegedly due to the previous ‘high growth’ in response to Typhoon Yolanda according to the BSP—occur immediately or a year after the event?

Typhoon Yolanda occurred in first week of November 2013. November and December remittances soared, but since, remittance trend has been on a steady decline. However the recent downshift appears to have sharply intensified. These are base effects?

Has the BSP been reasoning from price changes?

Two, has the decline in remittances been instead a function of diminishing returns (see chart above lower pane)?

Three: If the much touted OFW remittances growth rate remains muted or subdued, then where will demand come from?

Yet how will high expectations of consumer based statistical economic G-R-O-W-T-H be met? More importantly, how will this be financed? Will income (wages, dividends, earnings, profits, rents and interests) from BPOs, construction, shopping malls, hotel and casinos offset the decline in remittance growth rates? Or will credit growth recover and zoom?

[As a side note, following a landmark spike in 1 month Philippine treasury bills last Thursday, index managers—who may be reading me—came back to contain recent bouts of volatility in the short term spectrum, Friday. We’ll see how this goes.]

What will be the effect of diminishing growth of remittances to the supply side? The supply side has been in a frantic race to build shopping malls, housing, condos, hotels and allied industries, so where will these industries get their customers? What happens if expectations won’t be met?

Unlike establishment analysis, where demand seems to just pop out of statistics, demand will only emanate from income or savings or borrowing. OFW remittances mostly account for as wages earned from employment. And OFW employers depend on economic activities of their  respective locality.

Since remittances and BPOs depend on global political economic developments, which represent most of their sources of income, how then will a sustained downshift in global economic conditions (or even a prospective crisis) impact these economic agents? Or have these agents acquired superhuman or divine powers to become ‘immune’ to external economic developments? The consensus seem to assume such conclusion for them to project fantastically high economic growth rates.

Expectations that will eventually crash into reality like share prices of the infamous Enron—previously billed as the “seventh largest company in the world”.

---

[1] Charles Mackay Preface to the First Edition, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, Library of Economics and Liberty

[2] Breibart.com REPORT: ‘REAL’ CHINA GDP SHRINKS AS DEMAND COLLAPSES April 16, 2015

[3] Bloomberg.com China Walks $264 Billion Tightrope as Margin Debt Powers Stocks April 13, 2015

[4] Wall Street Journal China Raises Red Flag on Its Stock Markets April 17, 2015

[5] Bloomberg.com China Junk Bonds Pose Most Risk Since ’04 on Credit-Quality Dips April 14, 2015

[6] See US Stock Market Bubble: In 1Q 2015, Firms with Bad Earnings Have Been Rewarded More than those with Good Earnings April 2, 2015

[7] Reuters.com U.S. public companies seek bankruptcy at fastest first-quarter rate since 2010 April 14, 2015

[8] PSE.com PSE cites President Aquino's leadership for market’s ascent to 8,000 April 14, 2015

[9] See Phisix 8,100: A Story of 10 of the 15 Biggest Market Cap Heavyweights and the Combustion of the Global Risk ON Moment April 12, 2015

[10] Bangko Sentral ng Pilipinas, January-February 2015 Personal Remittances Reach US$4.1 Billion April 15,2015

Phisix: The Speculative Mania Galore In Full Throttle!

The opinion of ten thousand men is of no value if none of them know anything about the subject. –Marcus Aurelius Antoninus Augustus (121-180) Roman emperor (161-180)

In this issue:

Phisix: The Speculative Mania Galore In Full Throttle!

-Thank You, Errors.

-Deeply Held Convictions are Signs of Major Market Inflection Points

-The Speculative Mania Galore In Full Throttle!

-Philippine Asset Valuations: When The Tide Goes Out, Who Will Be Caught Swimming Naked?

-Has the BSP been worried over the Unwinding of Carry Trades?

-Domestic Sources of Risk, Redux

-Cracks in Asia’s Casino Bubble

-A Note on 10,000 Phisix and Back to the Future

Phisix: The Speculative Mania Galore In Full Throttle!

One of the most unforgettable life changing moments of my stock market career was during the Phisix nadir of 2002.

Thank You, Errors.

2002 marked my third return to the stock market, this time as a serious occupation. My previous two engagements had merely been part time experiments, one of which tragically ended with my fingers burned via dabbling with margin trade where I swore off the stock markets. It took my mentor, my golfing buddy, who had been a former president of a foreign stock market brokerage, to convince me back.

In my return one of the first tasks was to revive dormant accounts where I had to call on the clients assigned to me. In process of doing so, I encountered what turned out to be a gem of a lesson.

In one of my client calls, after introducing myself as the new account manager, the client suddenly unleashed a barrage of invectives at me, called me names and denounced me for being part of the alleged cabal or “syndicate” of manipulators whom had short changed retail investors like him. My previous experience at handling objections as salesman helped me through this turbulent conversation. But having been initially shocked at the adverse reception, I had mostly listened at his virtual virulent monologue for about a few minutes or so until he hanged up.

This was a defining moment for me for two reasons.

One, as a ‘novice’, where most of my understanding of stocks have initially been grounded on technical analysis, but thanks to my mentor’s books, I gained some knowledge about how stock market cycles operate; the client’s overzealous reaction reinforced my gut feel or my intuition that the market’s bottom has been reached. Such psychological revulsion, for me, signaled a major reversal or inflection point that would usher in a bull market.

I became wildly bullish on the Phisix, particularly on telecoms and the mining industry. Yet since nearly everyone I spoke with practically refused to engage, as they didn’t immediately share my optimism, the feeling of solitariness hardly dampened my enthusiasm. Nevertheless, eventually I had been proven right, or might I say, the rest is history.

The lesson here is that today’s bullmarket has been a product of the early skepticism. Applied in the opposite context, the coming full bear market will be an offspring of today’s euphoria. As the legendary contrarian investor Sir John Templeton once counseled, “Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.”

Second and the more important point have been for me to come understand why the retail client responded in such heated or impassioned manner. Obviously the client agonized from the losses which emerged out of a ‘buy high’ position most likely executed during the pre-Asian crisis boom. And more, it could be possible that his ‘trading’ portfolio had been transformed into a ‘long only investor’. 

Since it took 6 years for the completion of the bear market cycle or for the Phisix to finally hit a bottom, this means he excruciatingly watched the evisceration of his portfolio as market values collapsed overtime.

Why did he incur such loses? He was obviously seduced by the fad during those boom days, possibly abetted by his previous account manager.

Nonetheless his experience can be seen in the light of the paradigm of another legendary investor, Jesse Livermore’s guidance[1] against people who think with the eyes. [bold mine]

But the average man doesn’t wish to be told that it is a bull or bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He doesn’t even wish to have to think. It is too much bother to have to count the money that he picks up from the ground.

And because the client couldn’t take to own up or admit to his mistakes, particularly for falling into the groupthink trap, he sought an outlet to vent his frustrations which he saw in me. His actions depicted the capitulation phase for the bulls.

The second lesson from this unfortunate but fruitful encounter has been my epiphany. Over the years, I labored to deepen my understanding of the practical applications of economics, especially when applied to finance, the tradeoff between risk and reward. I also learned of the ethics of the principal agent problem—the potential conflict of interest issues between the varying roles of financial market participants. So it became imperative for me to present the objective side of risk-reward balance.

From both the aspects of finance and ethics emerged my theme: prudent investing.

Our client’s bitter episode or his failures can serve as our learning experience. As my favorite iconoclast Nassim Taleb writes about the importance of decentralized distribution of errors[2], “In a system, the sacrifices of some units—fragile units, that is, or people—are often necessary for the well-being of others units or the whole. The fragility of every startup is necessary for the economy to be antifragile, and that’s what makes, among other things, entrepreneurship works: the fragility of individual entrepreneurs and their necessarily high failure rate.” In a market economy, learning from failures should help make us become stronger.

Deeply Held Convictions are Signs of Major Market Inflection Points

Yet it’s been a totally diametrical scenario between 2002 and 2014.

In 2002, psychological revulsion governed people’s sentiment of the stock market. Today the very entrenched populist notion has been that Philippine stock markets have been predestined to reach nirvana!

And part of the signs of such euphoric conviction can be gleaned from a recent rebuke I received from an industry participant chieftain who implied of the supremacy of social acceptance or popularity in terms of conducting economic analysis or even presumably stock market investing.

Interesting objection. But the logical assumption that the crowd or the popular is always right means that panics, crashes and recessions would not exist even in the dictionary and that we should be in utopia today. But how true is this?

A better frame is that the crowd is always right during major trends, but crowd is always wrong during major inflection points.

Yet such assumptions are disturbing signs for a few reasons.

First, to argue the primacy of the popular fails to appreciate the role of diversity of opinions that leads to market actions.

Stock market transactions are basically a consummation of buy and sell orders from different entities of a specific issue based on an agreed price and volume. This means that the matching of transaction orders for both the buy side and the sell side depends on the diverse-opposing opinions or preferences of the buyer and the seller. Thus a failure to appreciate diversity redounds to a failure to grasp the basic principles of stock market operations. Such is instead a manifestation of a ONE WAY trade mindset.

Second, this seems as more signs where political correctness has pervaded into the domestic stock market. Is it now politically taboo to question the sustainability of stock market boom? Has it been immoral to provide competing or alternative insights for investors protect themselves from the mainstream’s uniformity or even possibly from widespread disinformation?

Third, social acceptance as “priority” means to forsake economic calculation, risk-reward assessment and critical thinking. For the individual to submit to the popular assumes the impeccability, infallibility and the inviolability of the crowd’s concept of reality.

Abandoning economic calculation also means allocation of money or resources based on where the crowd is, or to chase momentum. Yet here is the erstwhile value investor Warren Buffett’s take on momentum trades: (bold mine)

For some reason, people take their cues from price action rather than from values. What doesn't work is when you start doing things that you don't understand or because they worked last week for somebody else. The dumbest reason in the world to buy a stock is because it's going up.

Let me repeat: The DUMBEST reason in the world to buy a stock is because it’s going up.

Yet the advocacy of groupthink reminds me of the mainstream’s adaption of their economic deity John Maynard Keynes’ sound banker approach “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.” (bold mine)

In other words, the mainstream provides leadership to the crowd during the boom, but absconds under the skirt of the crowd to elude responsibility when all things fail.

Do you now see why the opprobrium vented by the dejected client who bought into the voguish days of the pre Asian crisis boom? His “ruination” was almost entirely due to being blindsided by the risks facing him. And this has substantially been due to the systematic brainwashing of the supposed reality of the permanence of credit inflated booms peddled by the mainstream and their favorite experts who in truth have been oriented as “not one who foresees danger and avoids it”. In short, this serves as example of the principal-agent problem or the Wolf of Wall Street Philippine edition.

Fourth, such views represent a deepening conviction about the sustainability of today’s presumed “risk free or low risk” conditions—again a ONE way manic trade.

Unfortunately, the perception of “risk free” or “low risks” are instead flagrant symptoms of “overconfidence” articulated in the ambiance of recklessness and hubris.

Notice the sentimental and psychological character of the climax of every boom in the above chart: They have been dominated by “I am smart” and the “new paradigm” mindset.

In other words, to suggest of the omnipotence of social acceptance or of the popular in terms of economic analysis or stock market investing seems representative of what the investing legend Sir John Templeton has warned of as the four most dangerous words of investing…“This Time is Different” 

And what has been the common denominator of all financial-economic crises through history?

Let us hear it again from Harvard’s Carmen Reinhart and Kenneth Rogoff[3]: (bold mine)

The essence of the this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crisis is something that happens to other people in other countries at other times; crises do not happen here and now to us. We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply. The current boom, unlike the many previous booms that preceded catastrophic collapses (even in our country), is built on sound fundamentals, structural reforms, technological innovation, and good policy. Or so the story goes…

Investing guru George Soros in his Reflexivity theory says that market tops can be identified by “the flaw of perception” that leads to “THE climax”.

Objections catering to the appeal to the popular or the appeal to the majority (Argumentum ad populum) in defense of the bubble signify “overconfidence to the max”. This would seem to confirm of THE climax phase of the boom.

The bottom line: The zeitgeist of every major inflection points can be seen by the degree of the ardent defense of the status quo.

The Speculative Mania Galore In Full Throttle!

And speaking of the deepening populist—one way—crowded trade…

Folks, lo and behold…

...the spectacle of the UNLEASHED EXPLOSION of speculative orgy!

In the Phisix daily quotation there are two data which I use to gauge sentiment. These are the number of trades and number of issues traded daily which I average for each week. These figures have been largely ignored by the mainstream. Yet what is garbage for them is treasure for me.

The number of trades represents the completed transactions of the day. The number of issues traded covers the issues from all the transactions of the day. The latter is limited to the number of issues listed (344 as of 2012).

Hardly anyone noticed that as the Phisix attempted to breach the 6,900, the recent explosion of trade churning which involves equally a broader breadth of the markets—set a remarkable milestone. Trade churning has not just broken out. They have not only topped the June 2013 highs when the Phisix was at 7,400, trade churning has blasted to the upside by about 25% from June last year. 

Trade churning can mean the inclusion of more participants and or simply increased participation from existing participants. The former is less likely a scenario. Despite the raging bullmarket, new Brokerage accounts grew by only 22% from 2007 (430,631) to 2012 (525,850)[4]. Any increases today may be stronger but they will likely be marginal. This means current participants have increased their trading activities where they see only sustained increases for Philippine equity asset prices—again a ONE direction trade.

The Phisix posted its first week down following 7 weeks of the relentless climb. It’s really been a pseudo correction. While the broader market was slightly down for the week, which was responsible for the decline in the index, the HIGH PER and PBV stocks continued with its unwavering march forward. As one would note in the right window, high flying property index was slightly off or almost unchanged. While consumer stocks in the industrial sector held off a broad based decline by pulling the index up.

Peso trading volume has spiked over this week in support of the record run by speculators (left window). Notice that despite the recent jump, the average daily peso volume for the week has still been way below the June 2013 highs.

Yet this week’s crescendoing frenzied speculation in the face of the pseudo correction means that locals sold the “blue chips” but the selling pressure has been negated or cushioned by foreign buying. Foreign buying even pushed popular high PE/PBV stocks higher. Thus the paltry decline of the Phisix or the pseudo correction. Both locals and foreigners have been conditioned to see a one way trade.

Meanwhile proceeds of the sales by locals on their blue chip holdings have been used to churn second-third tier issues. In short, locals rotated into the more ‘speculative’ and illiquid issues that paved way for the spectacular record trade churning run supported by the record breaking broader market activities.

Behold the speculative mania galore in full throttle!

Philippine Asset Valuations: When The Tide Goes Out, Who Will Be Caught Swimming Naked?

It’s been an incredulous sight to see domestic ‘blue chips’ priced at the valuation levels of US technology and small cap stocks which has similarly been sold on ‘growth’! Yet the growth story represents a mere mainstream populist canard.

Let us take for example, company XYZ with a PE ratio of 40 and an expected forward earnings growth rate of 15%. By the end of the year, if the company does live up to expectations, at current prices the PE ratio falls to the lower 30s. But the stockmarket huckster will say that 15% will be sustained (in perpetuity) so encourages everyone to buy. So the stock goes up by 15%. The 15% stock price increase will offset the 15% earnings growth. Essentially “growth” becomes a pretext for unbounded multiple expansion via sky high prices. Risk vanishes! This TIME is DIFFERENT! Yet this is another example of the one way trade. Yet the assumptions I make here is that the growth projections will be accurate. They are not. Inflated revenues, earnings and asset values will TANK when the BSP pulls back on the 30+% money supply growth rate.

And given the composite members of Phisix represents the largest companies spread over different industries—a perpetual over the GDP growth rates are mathematically impossible because there are natural limits to profit growths[5], such as competition, the law of compounding, inflationism and more.

Bubbles have become so evident almost everywhere. The fabled growth story of US small caps has even caught the eye of US Federal Reserve chairwoman Janet Yellen. From the CBS[6]: “But the big surprise from Yellen was her comment that small-cap stocks were showing pockets of possible overvaluation.” (bold mine)

The Zero Hedge[7] points to a speech by German Finance Minister Wolfgang Schaeuble in Munich last week where the Mr. Schaeuble remarked that “Financial markets have almost 'Excessive Confidence'” and “Market liquidity points to new bubbles” (bold mine)

Mr. Richard Fisher Dallas Federal Reserve President in a recent speech[8] tacitly admits to how FED policies have influenced bubbles, “The answer is an admission of reality: We juiced the trading and risk markets so extensively that they became somewhat addicted to our accommodation of their needs. You may remember the “taper tantrum” market operators threw last spring when we broached the idea of temperance. It went over about as big as would saying you wanted to ban Hurricanes and other happy-making libations here in New Orleans! (bold mine)

As you can see, bubbles have risen to levels where authorities can’t hide them anymore. Instead of denying them, what they are doing today has been to downplay their risks.

In the local setting, basking in the glory of inflationary boom, authorities deny them and proclaim that they are in control of the situation. The BSP chief, Amando Tetangco, offers their guarantees From the Strait Times[9]: “Our policy will continue to be geared towards ensuring that inflows do not generate financial stability concerns”

Yet the charming part about such rhetorical assurance is that they signal the authority’s control over current conditions. But without specifying the details, the BSP’s opaque communications only leaves us in the dark as to what their true parameters for identifying “financial stability” risks, if there is ever one at all. Yet does 30,40,50,60+ PE ratios and PBV values of 4,5,6,7,8+ have not been “signs of financial stability concerns? The ultimate question is where does the BSP draw the line demarcating normative financial conditions relative to financial excesses? And what are consequent actions need to be done?

And why confine or restrict burden of financial stability concerns to only “inflows”? Are foreigners the only source of financial stability concerns? What about the locals?

The fact that the BSP refuses to act on her self-imposed 20% banking loan cap on the property and property related sector which in May of 2013[10] (exactly a year ago) was already at the 20 percent threshold (20.68%) reinforces my suspicion that they have been reluctant to pull a brake on what seems as mounting financial excesses.

If the Philippine economy has truly been strong as they claim, then why have they been dithering at withdrawing excess liquidity or tightening money in order to ensure financial stability? Why use the reserve requirements tool when modern central banking suggests that the BSP provides the required reserves on banks rather than the banking system limiting their loans via reserve mandates[11] which means using reserve requirements have been symbolical rather than real?

Why spend countless money in managing (implied price controls) of the peso and bond levels? Why not raise interest rates or enforce banking caps on property loans (which obviously will raise rates)? Has the government and their vested interest groups been so very deeply addicted to this negative real rate stimulus that they can’t wean from it? Are they afraid that a monetary retreat would expose who, to borrow from Mr. Warren Buffett has been “swimming naked when the tide goes out”?

Has the BSP been worried over the Unwinding of Carry Trades?

The BSP chief rightly mentions the concerns over “inflows”. Does he know something that the public doesn’t?

Magicians perform by having their hands move faster than the eyes (now aided with technology). Where the attention of their audiences has been fixated on what the performer intends them to see rather than what the magician moves behind the scenes to produce the desired magical effect.

The same applies to the many type of social activities, particularly in politics, policymaking or even in the markets.

People see domestic markets rising so they assume something extraordinary from such actions. Their beliefs (endowment bias) are magnified by news about statistical economic data or positive developments as credit rating upgrades.

Yet they seem ignorant of the fact that this hasn’t just been a Philippine only phenomenon.

In fact for 2014, the biggest equity gainers thus far have been last year’s most troubled emerging market economies.

I might add that civil war torn and a potential tinderbox for World War III, Ukraine’s stocks (PFTS index) have been one of the world’s best performers up by 32.47% year-to-date as of Friday’s close. Amazingly the bankrupt Ukraine has inflated two stock market bubbles from 2005-2012, all of which returned to earth. Now could be the third bubble. If a new Ukraine government decides to nationalize everything, then goodbye investments.

Joyce Poon of the Hong Kong based Research outfit, Gavekal Dragonomics makes a riveting observation[12] of the current Emerging Market rallies “The defining feature of the current run-up in emerging markets is that the greater the sell-off a country suffered last year, the stronger the rally it has enjoyed this year.” (bold mine)

The Gavekal team observed further that inflation pressures will extrapolate to national central banks of emerging markets as taking the easing option off the table, while most forward looking indicators, “especially in Asia, are signaling no prospect of any decisive upturn in the growth outlook”. With growth expected to underperform, this leaves the current rallies in emerging assets a function of “the search for carry”. 

In short, as credit markets led by the US balloon to record levels, part of this credit expansion has been channelled through carry trades. And such carry trades has found their way to pump up on emerging market assets, currencies, bonds and stocks. Emerging markets have already substantial exposure to carry trades as I pointed out last February[13].

The problem is once that volatility returns for any reason at all, these juicing up of emerging market assets may suddenly reverse.

And this is what perhaps bothers the BSP chief more for them to cite “inflows” as possible sources of “financial stability concerns”.

But the BSP chief ignores the fact that “sudden stops” can be a function not only of exogenous factors but also endogenous forces. A simple loss of confidence for any matter, like the escalation of the territorial dispute with China that may lead to Vietnam type of anti-Chinese and anti-Asian riots* can serve as trigger.

*As per CNN[14] “the arson was indiscriminate, with Korean-, Taiwanese- and Japanese-owned properties also torched by the angry mob.”

As a side note: it would represent arrant foolishness for anyone to brush aside the risks of the escalation from the region’s territorial dispute. The Vietnam riots shows how nationalism based domestic political frictions can cause economic disruptions that may not only lead to economic slowdown and a reduction—or even subsequent withdrawal—of investments but to outright protectionism, that exacerbates the chances of a realization of military conflict.

Here is an example. From the Wall Street Journal[15]: “Foxconn—the world's biggest electronics contract manufacturer, whose official name is Hon Hai Precision Industry Co.--said Friday it would halt production at its Vietnam units through Monday "for safety reasons." The plants of the Taiwanese company, a major supplier to Apple Inc., haven't been attacked by protesters.”

If these riots continue or even spread not only to affected countries but to the region then expect more suspension of operations and investments, and eventually withdrawals. And if the Vietnamese government and other Emerging Asian government counter with capital flow restrictions then one can expect a regulatory tit-for-tat. Protectionism rises. Trade grinds to a halt. Asia’s supply chain network crumbles.

The Philippines has no riots yet. But from street protests, which could be inflamed further by politicians and media, riots will not be far away.

And to add to the observation of Gavekal, even the mainstream news network, the Financial Times, in carrying the analysis of HSBC points to the increasing vulnerability of Emerging Asia’s growth model as she becomes deeply reliant on debt to produce statistical “growth”, or simply the diminishing returns of debt, which the HSBC calls “credit intensity”.

Asia is addicted to debt bannered the Financial Times[16]. How? “From Credit levels have risen sharply since 2008 in Hong Kong, Singapore, Thailand and Malaysia, while already high levels of household debt in South Korea and Taiwan have tracked even higher. During times of accelerating growth, that might not be a cause for concern. But now much of Asia is faltering. Credit intensity – the amount of borrowing needed to generate a unit of output – has surged, while productivity growth has tumbled. The debt train appears to be fast running out of track just as the world prepares for higher interest rates.” (bold mine)

The chart from the right window resonates with the Philippine statistical growth version that has increasingly been relying on the bubble industries.

So stock markets have been rising along with debt levels as growth underperforms while productivity lags. All these come at the heels of the prospects of higher interest rates. This IS sustainable?

To believe that domestic or external markets are rising because of “sound fundamentals” can be analogous to the belief that Peter Pan and fantasyland have been more than a cartoon, merchandise stuffs and fun rides.

Domestic Sources of Risk, Redux

This brings us to the potential internally sourced risks

Funny but the 30+% money growth rate which has been consistent for the past 9 months IS also sustainable? Economic theory tells us that price inflation comes in stages[17]. The first stage is when prices hardly rise in the proportion of the rate of money creation. This is because the public sees inflation as a temporary dynamic, thus the increase in social demand for money. In this phase, prices even fall. This is the longest phase of the inflation cycle.

The second stage of inflation is when prices rise in proportion to the rate of money creation. This means if the banking system prints 30+%, consistently for a long period, eventually real price inflation will rise to match the 30+% levels even if manipulated statistics don’t say so.

This has been true with Argentina. As I have recently shown[18], Argentina’s government has been inflating 25-30+% a year for the past four years. Prior to the January sharp interest rate increases, Argentina’s implied inflation has reached about 25% before dropping to 16% after the interest rate hikes and now back to 21% today. Official rates say only 10%. As reminder, Argentina’s government has been inflating because they lack of access to international credit, thus in order to finance her deficit spending programs, the government has been the fountain of money creation growth.

And this is what differentiates the Philippines and Argentina. Unlike Argentina, because of the illusions from a credit financed supply side boom, the Philippine has wider access to cheap credit. The Philippine government recently got a fresh credit rating upgrade from the S&P. 

Inflated revenues and profits from the boom has financed government spending while at the same time financial repression policy of negative real rates has kept cost of public borrowing in check—all such invisible transfers have been financed by peso holders.

This means that instead of the government responsible for money creation as in Argentina, the Philippines’ banking system has been the key source of money creation. Based on BSP’s data about 68% of M3 has been banking claims on the private sector[19]. This is the source of the delusions of transformative growth touted by the mainstream.

So even if the BSP claims that the banking system sufficiently capitalized[20], whose Tier 1 capital have been all based on inflated asset valuations and retained earnings, the rate of banking loan growth ventilated through money supply growth figures shows that these forces are incompatible. Why? Simple: Growing debt loads means greater sensitivity to interest rate risks. Yet fast expanding debt means that the infusion of money streams will affect the real economy through the price channel which subsequently impacts economic coordination and production process. This means higher inflation rates. Yet rising price inflation will extrapolate to higher interest rates, which will be compounded by the fall in the peso. So once we reach a critical tipping point where inflation rates will influence interest rates enough to adversely affect ‘demand’ (top line figures) and debt serviceability of listed and unlisted companies we will see constriction of profits that will be followed by retrenchment and liquidations.

And it is not just interest rate and inflation, growing debt size or levels alone can represent a threat. Yet who are the borrowers of the banking system and why are they borrowing? The borrowers have been mostly the bubble sectors: real estate, construction, hotel (casino) and restaurant, wholesale and retail trade (shopping malls) and financial intermediaries. Based on BSP data these industries constitute about 50% or half of overall banking loans to the formal economic industry. The same industries are borrowing mainly to finance their capital expansion. But what if they current rate of expansions lead to overcapacity or what if supply growth exceeds demand growth? What if these industries collectively miscalculate on demand?

Where will the borrowers get the wherewithal to fund these liabilities? Will these companies employ the debt version of Russian roulette of imbuing more debt to finance existing debt? If so, then a surge of adaption of Ponzi financing will translate to even greater systemic risks.

Essentially four factors say that current conditions are not sustainable: 1) Growing debt levels, 2) excessive money supply rate growth as manifestation of debt levels, 3) overcapacity financed by debt and 4) escalating inflation-interest rate risks.

Mind you, these factors are NOT isolated but instead they are interrelated or deeply entwined. Yet all these are symptoms of the policy of generating something from nothing—bubbles.

Think of it, if the bubble bursts, do you think these accrued excess capacities (malls, hotels and high rise) can be immediately converted into manufacturing centers? The answer is no. They account for as sunk costs. They will have to massively re-priced lower for new investors to find high value uses for these idle properties.

As example, just look at how US shopping malls are being demolished. Here is a list of demolished malls and this list will expand[21].

This only means that the belief in the longevity or even perpetuity of government manipulated booms are a mirage, as the great Austrian economist Ludwig von Mises warned[22], (bold mine)

Public opinion is utterly wrong in its appraisal of the phases of the trade cycle. The artificial boom is not prosperity, but the deceptive appearance of good business. Its illusions lead people astray and cause malinvestment and the consumption of unreal apparent gains which amount to virtual consumption of capital. The depression is the necessary process of readjusting the structure of business activities to the real state of the market data, i.e., the supply of capital goods and the valuations of the public. The depression is thus the first step on the return to normal conditions, the beginning of recovery and the foundation of real prosperity based on the solid production of goods and not on the sands of credit expansion.

Cracks in Asia’s Casino Bubble

And to compound on the pressures on the Philippine bubbles has been the current bear markets of Macau based “blue chip” casinos[23], particularly MGM China Holdings Galaxy Entertainment Group, Sands China Ltd., Wynn Macau, Melco Crown Entertainment and SJM Holdings owner of the Grand Lisboa 

Media reports 5 reasons for the ongoing Macau casino bearmarket 1) Chinese government crackdown on illegal fund transfers and potential restrictions on the mobility of Chinese gamblers. 2) Overcapacity 3) Chinese government clampdown on corruption 4) Overvalued stocks. 5) Slowing Chinese economic growth

Two favorite excerpts from article.

On overcapacity. “The companies are spending billions of dollars to expand facilities that cater to tourists in the city of about 600,000 people, the only place in China where casinos are allowed.”

The above shows how Macau’s gambling market has been totally dependent on the Mainland. Yet the boom has encouraged capacity expansions amidst a China economic slowdown. This is an example of gross miscalculation emanating mostly from the distortions of price signals and from overconfidence.

Yet compounding on Macau’s casino woes has been political uncertainties from the Mainland. The focus will swing to how these expansions have been financed. If they have been financed by debt then falling revenues in the wake of large debt burden will amplify the profit margin squeeze. Such would likely to raise their respective credit risks. 

So from Macau’s casinos we find that problems can emanate from both directions: internal and external.

Next On overvaluation. “Even after this year's declines, casino operators aren't cheap, according to Pruksa Iamthongthong, who helps oversee $US541 billion at Aberdeen Asset Management and said she doesn't hold any Macau gambling stocks. Wynn Macau trades at 19 times reported earnings, versus 10 times for the Hang Seng Index. MGM China has a multiple of 17, compared with 25 for Sands China, 23 for Galaxy and SJM's 15.”

Remember mainstream media always attempts to oversimplify or rationalize the current market actions. For instance, in the above quote, media doesn’t explain why despite overvaluations, Macau casino stocks boomed before they cracked.

And a further more important note look at the comment of the analyst where he says “casino operators aren't cheap”. 15-25 PERs for him are not considered cheap. How would he reckon with Philippine blue chips with PERs of 30,40,50,60?

The current boom in the domestic hotel industry has been primed by a race to build casinos. These casinos have been intended to compete and to grab a pie of the regional markets as I pointed out last year[24]. If Chinese gamblers comprise the key markets to the Asian casino industry then a sustained slowdown in China and political uncertainties will affect demand for the regional casinos including the Philippines.

Will domestic gamblers be sufficient to sustain the rampant buildup of casinos? If not, then Macau’s overcapacity will apply to the Philippine casinos. Boom goes bust.

A Note on 10,000 Phisix and Back to the Future

And despite all my bearish outlooks, most of you think that I have abandoned my Phisix 10,000 forecast. Sorry but No I haven’t.

I hold a long term view for the markets. Unlike the mainstream, I don’t see events to “just happen”. Instead I see markets as a process or I read markets based on business or stock market cycles.

At the depth of 2009, the Phisix was at about 1,700. That was when I was also screaming a buy. Exactly one year ago, the Phisix posted a record high at 7,400. That was when like today I was already skeptical of the sustainability of the boom.

From 2009-2013 the Phisix returned 3.35x.

Even if the Phisix should fall to 2,500 or 3,000, the same rate of return will mean over 10k+ Phisix. The rally can be driven by three factors, real economic reforms (low probability), another boom bust cycle (high probability) or Argentina-Venezuela like deficit spending monetization (medium probability) 

But the Phisix will have to fall into a bear market first to cleanse its system from all the cumulative excesses or the government will have to launch a massive bailout and/or takeover from the banking system the role of money creator.

For investors that would mean to navigate today’s treacherous high risk waters by avoiding substantial nominal losses, real (inflation adjusted) losses and opportunity costs. I previously pointed out that despite two booms and one bust, and the stagflation of the 1970-80s, anybody invested in the Philippine equities from 1970 until 2012 would have posted a NEGATIVE return[25].

So the best way to maximize profit with lesser risks will be to understand how cycles work and to surf them. This would better than to trade based on the fear of being missed out that prompts for a frenzied chasing of the unsustainable crowded trade pillared on perilously flaky fundamentals.

All these may take years unfold but that’s the way domestic financial markets—under the current political environment—works.

And I will probably be calling for a buy when I see the same scenario in the 2002 where the mainstream capitulates from their ONE way trade mentality with stark revulsion to the markets.

To heed one of the most precious or best advices from Warren Buffet:

Be fearful when others are greedy, and be greedy when others are fearful

or

Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well.

My encounter with a dispirited client in 2002 will be what I expect to see in the future. 

This means we are headed back to the future.

A relevant quote from the 1989 movie Back to the Future II

Marty McFly (Michael J. Fox): Okay. Okay! Relax, Doc! It's me! It's Marty!

Doc Brown (Christopher Lloyd): No! It can't be! I just sent you back to the future.

Marty: I know. You did send me back to the future, but I'm back. I'm back from the future.

Doc: Great Scott! [faints]

---

[1] Edwin Lefèvre Reminiscences of a Stock Operator Chapter 7, Austrocycle.net

[2] Nassim Nicolas Taleb Antifragile: Things That Gain from Disorder (Incerto) p 65 Random House

[3] Carmen Reinhart and Kenneth Rogoff From Financial Crash to Debt Crisis Harvard University

[4] See Phisix: Will the Fed’s Spiking of the Punchbowl Party Be Sustainable? September 23, 2013

[5] See Phisix: The Stock Market Mania Deepens March 10, 201

[6] CBSNews.com Janet Yellen's surprising warning about small caps May 7, 2014

[7] Zero Hedge German Finance Minister Admits To "New Bubbles" & "Excessive Confidence" May 13, 2013

[8] Richard W. Fisher Comments on Tailored Regulation and Forward Guidance Remarks before the Louisiana Bankers Association 114th Annual Convention and Expo New Orleans, Louisiana · May 9, 2014 Dallas Federal Reserve

[9] Strait Times.com Manila central bank says ready to guard against financial excesses May 13, 2014

[10] Bangko Sentral ng Pilipinas BSP Releases Results of Expanded Real Estate Exposure Monitoring, May 10, 2013

[11] See Showbiz S&P Upgrade & BSP Actions Sends Phisix and the Peso into a Frenzied Blow off Top May 12, 2014

[12] Joyce Poon Gavekal Dragonomics Outside the Box: EM Carry Trade Looks Vulnerable MauldinEconomics.com May 15, 2014

[13] See Emerging Market $2 trillion Carry Trade: The Pig in the Python February 24, 2014

[14] CNN.com Protestors torch factories in southern Vietnam as China protests escalate May 15, 2014

[15] Wall Street Journal Foreign Firms Regroup After Vietnam Riots, May 16, 2016

[16] Financial Times Asia: Addicted to debt May 12, 2014

[17] See Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy April 14, 2014

[18] See Phisix Melts Up as Money Supply Growth Sizzles for the Eight Month April 7, 2014

[19] See Phisix Mania Rages As Money Supply Sizzles for the 9th Month! May 5, 2014

[20] Bangko Sentral ng Pilipinas U/KBs Remain Well-Capitalized Against Risks May 14, 2014

[21] See Hard Lessons from the US Shopping Mall Bust February 10, 2014

[22] Ludwig von Mises The Economic Consequences of Cheap Money September 10, 2012 Mises.org

[23] See Has Macau’s Casino Bubble Been Pricked? May 15, 2014

[24] See The Philippine Casino Bubble April 11, 2014

[25] see Phisix: The Convergence Trade in the Eyes of a Prospective Foreign Investor November 11, 2013