``Time is what matters most. Just as time is the friend of the great business and the enemy of the not-so great business, so to time, like volatility, makes friends with the long-term investor and antagonizes the short-term one.” –Josh Wolfe Timeless Space & the Mismeasure of Risk
Post Holy week of 2008, we noted of an article by a high profile domestic analyst in a business broadsheet satirically provoking local stock market participants to “panic” so as to “end” the anguish of the present bear market.
The article appeared to be a “reverse psychology”, as we wrote in In A Crisis, Be Aware Of The Danger But Recognize The Opportunity, ``which was meant to do otherwise, it signifies pretty much of a deeply entrenched state of denial-the inability to accept the persistence of the present conditions. This seems to reflect signs of impatience and deepening frustration from a supposed market expert. As German-Swiss author poet Hermann Hesse in his novel Steppenwolf wrote, ``All interpretation, all psychology, all attempts to make things comprehensible, require the medium of theories, mythologies and lies."
Instead we suggested that prudent investors ought to understand the global credit-equity cycle, which appears to be of more impact to our equity market more than simply reading too much of sentiment as a potential indicator of the direction of our market.
Let us see why…
Figure 1: stockcharts.com: World Equity Markets Have Basically Tracked US Financials
Figure 1 courtesy of stockcharts.com depicts of the Dow Jones World Index (main window), whose peak seems to resemble the local Phisix (not shown), has been winding down since the US General Financial Services (lowest pane) has broken down in July of 2007. In short, global equity markets have been heavily correlated with the performance of US financial stocks and apparently have signified as a drag.
However, in contrast to the Dow Jones World index, which remains above its recent low, the local benchmark the Phisix has severely underperformed by successively carving out new lows despite this week’s technical rally.
Will Global Financial Markets Survive High Oil Prices?
In addition, we hear many of today’s pains pinned on oil prices. However, such causality seems specious. The same chart shows oil prices (pane below main window-$WTIC) and global equities have not been strongly associated. On the contrary, the recent rally of oil prices coincided with the rebound of global equity markets.
When oil prices pinnacled at nearly $140, global equity markets were already rolling over concomitantly alongside with the US financials. Thus, the pain from high oil prices is clearly a subordinate source of concern relative to the headwinds from the US financials.
On a positive note, $135 oil today also translates to strong demand from emerging countries, which is a peculiarity or an unprecedented characteristic given today's environment see Figure 2.
Figure 2: British Petroleum: World Oil Consumption: Signs of Decoupling?
British Petroleum notes that ``world consumption rose by about 1 million barrels in 2007, just below the 10 year average. OECD consumption declined nearly 400,000 barrels per day. China accounted fro the largest increment to consumption even though growth rate was below average. Consumption in oil exporting regions was robust.” (BP)
Essentially with oil at $135, the outperformance of emerging markets relative to advanced economies in terms of oil consumption could also be seen as another sign of "decoupling".
Yes, China surprisingly raised energy prices this week-18% diesel, 16% gasoline (NYT) and electricity prices nearly 5%-which means easing of subsidies to alleviate the growing incidences of crippling shortages arising from losses of petrol refineries, whom have been curbing production, aside from the prospects of power failure (as the Olympic season nears), as power companies have become reluctant to operate oil fired power stations for the lack of revenues to cover oil costs. Anyway, despite such increases, refined crude oil prices are still about 30% BELOW world market prices!
Of course while we may expect price increases to somewhat dampen demand for energy usage (it is expected to hurt mostly countries that don’t use subsidies), this won’t be enough to curtail overall demand as evidenced by some countries who recently undertook measures to lift subsidies as Indonesia-recently hiked oil prices last May (Reuters), saw vehicle sales 24.4% year on year but 1.8% down from April (automotive world).
Besides, the market have learned how to adjust to the recent high oil price landscape by introducing fuel efficient yet affordable motor vehicles, as shown in Figure3.
Figure 3: Economist: Where low-cost car sales are set to grow
From the Economist, ``WITH one eye on emerging markets and another on fuel restrictions more carmakers are entering the low-cost car market. Renault, which already manufactures the €7,600 ($12,000) Logan, recently announced a venture with Nissan and an Indian carmaker, Bajaj Auto, to develop a car that will compete with Tata's Nano, which goes on sale in India in October for a tiny $2,400. Sales of basic and small low-cost cars are predicted to leap by nearly 4m cars a year to 17.7m by 2012, according to Roland Berger, a consultancy. Growth is set to be highest in the emerging economies of Asia and Eastern Europe, but sales in America, home of the big gas-guzzler, will also grow by an average of 8.7% a year.”
Figure 4: Economist: Falling US Light Truck Sales
So yes, while SUVs and Hummers (figure 4) are on the decline in the US, we don’t see the same with China which has a black market for Hummers and some growing variants-Beijing Auto’s Trojan and Dongfeng Auto’s HanMa (Financial Times).
The world has survived high oil prices. And is likely to get over high oil prices provided the world can adapt to the changes brought forth in time.
In fact, as seen in above, it is not high oil prices per se that has been contributing to the angst of the financial markets and the real economy, but the rate of change of oil prices, given that oil has doubled year on year. But then again the world markets seem to be finding ways and means to adjust to a given environment.
The point is that high oil prices reflect the reality of distortive government policies on one hand, and the seismic shift in the sphere of global economic progress on the other.
Short Credit-Short Equity In The Face of Global Monetary Inflation
Next, as we further commented, the pang of the recent bear market here and abroad looks likely one which tracks the cyclical credit-equity cycle. As we earlier quoted Citibank’s Mark King’s credit-equity cycle, it looks likely that we have segued into the fourth phase, where…
``Phase 4: Short credit, Short equity
``This is the classic bear market, when equity and credit prices re-couple and fall together. It is usually associated with falling profits and worsening balance sheets. Concerns about insolvency plague the credit market, while broad profit concerns plague the equity market. A defensive strategy is most appropriate - cash and government bonds are the best performing asset classes.”
Going back to figure 1 shows that LIBOR rates have remained high signifying continuing stress in the credit markets.
The London Interbank Offered Rate (wikipedia.org) is a daily reference rate based on the interest rates at which banks offer to lend unsecured funds to other banks in the London wholesale money market (or interbank market). To quote David Kotok of Cumberland Advisors, ``LIBOR is perhaps the most important interest rate in the world, in US dollar terms. It’s the pricing reference for probably $150 trillion. Trillion with a T. That number includes lots of derivatives.”
While falling credit and falling equities seem to be the classic bear market which we envisage today, we are faced with an environment where rising goods and services inflation makes the classic defensive strategy (cash and bonds) as an unlikely viable option.
Why? Because the inflation phenomenon has been transformed into a global affair. To aptly quote Doug Noland, in his Credit Bubble Bulletin (emphasis mine),
``First, there is the massive flow of dollar liquidity inundating the world. Despite huge dollar devaluation, a major Credit crisis, and economic downturn, our system is on track for yet another year of $700bn plus Current Account Deficits (and this doesn’t include the massive speculative outflows to participate in the global inflation). Global economies, especially booming Asia, are awash in dollar liquidity to use to bid up the prices of oil and other strategic resources.
``Second, today’s massive dollar flows have increasingly gravitating to speculative endeavors (hedge funds, sovereign wealth funds, commodities speculation, etc.) – each year ballooning the “global pool of speculative finance” that by its very nature chases rising prices (“liquidity loves inflation”).
``Third, the confluence of the flood of global liquidity and unfettered domestic Credit systems has exerted its greatest stimulatory effect upon the highly populated countries of China, India, and Asia generally. This, then, has created a historic inflationary bias throughout the energy, food and commodities complexes.-Doug Noland Good Inflation?
Figure 5: Brad Setser: US Exports More Financial Assets
Proof? Figure 5 courtesy of the Brad Setser of the Council of Foreign Relations shows that the US exports TWICE more Financial Assets than its exports of goods and services.
To quote the meticulous Brad Setser, ``No one has argued that the main benefit of globalization is that it allows America’s bankers to sell US debt – and increasingly shares of American companies – to governments in the emerging world. But that is a fairly accurate description of current trade and financial flows.”
This is the epitome of the US dollar standard- the US sells promises to pay (sovereign debt or treasuries/agencies) in exchange for goods and services, aside from selling equity ownership in the US to foreigners (mostly emerging markets).
Thus, the ongoing wealth transfer and inflationary pass through from the US to world which has begun to boomerang back to the US.
Local Investors Gripped By Panic! Bottom Ahoy?
Well going back to the local analyst who called for the domestic participants to panic, the Philippine stock market appears to be accommodating his wishes.
Market internals suggests, despite the rally in the Phisix last week, of panic stricken activities led by local mostly retail investors.
Let us look at some of the evidences:
Figure 6: PSE: Net Foreign Trade
Figure 6 accounts for the year to date representation of net foreign trade. The chart shows that despite the most recent burst of foreign selling largely brought upon by the intense politicking amidst a drab global equity market sentiment, the intensity of foreign selling seems to have been thawing (red arrow) compared to the earlier bouts of liquidation.
In fact, for this week, foreign trade accounted for a marginal net buying of Php 152 million. But, this came amidst a negative net foreign trade breadth or the number of companies with positive foreign trade minus number of companies with negative foreign trade.
For the Phisix to bottom, foreign trade needs to revert to both a positive net Peso value and positive market breadth. We anticipate improvements on the said variables as the BSP raises interest rates in the face of high goods and services inflation, provided the politicking will abate.
However, market breadth persisted to decline despite the modest rally posted by the Phisix this week.
Figure 7: PSE data: Deteriorating Advance-Decline Spread
As can be seen in Figure 7, market breadth has turned deeply negative, but this has been smaller compared again to the earlier bouts of selling seen last January or March.
A bottoming phase would likely show lesser degree (smaller incidences of declining companies) and intensity (smaller number of declining companies during down days) of negative market breadth coupled with stability or improvement in the technical picture.
Figure 8: PSE: Collapsing Average Peso Trade Amidst Rising No. of Trades
And the kicker, as shown in Figure 8, is the surging number of trades (violet) amidst a materially diminishing Peso volume per trade (maroon).
During the earlier bouts of selling (since the second round of credit driven fears emerged in October 2007), the number of trades had been declining as the Phisix headed lower. This basically reflected a retreat of buyers.
However during the past two months we can see a reversal of this pattern, the Phisix persisted towards its downdraft but the number of trades amplified. This apparently reflects FEAR.
In addition, the latest episode of selling shows that the average Peso volume per trade has dramatically weakened. Again the lower volume plus heightened trading activity could possibly indicate fear among small accounts or retail investors!
Usually, the inflection point of any cycle is marked by a shift in ownership. In a bullmarket cycle, the strong hands give way to the weak hands who pushes the market to its maturity or until the pivotal turning point. On the other hand, we should expect the same but an antipodal ownership shift in a bearmarket, where weak hands are expected to give way to the strong hands.
So for our analyst whose wishes appear to have come in full circle, perhaps this could be indicative of the nearing culmination of the bearmarket.
