Phisix: Massive Global Credit Easing Policies Means Short Term Profit Taking

Economic weakness of China and of high oil prices, which supposedly threatens global economic growth, has been attributed by media as the cause for this week’s anemic performance by global stock markets[1].

The Perils of Relying on Media’s Availability Heuristics

It’s has been the intuitive inclination of media to oversimplify the causation process in the narration of events. In reality, such oversimplification represents the available bias or availability heuristic—judgment based on what we can remember, rather than complete data[2] or the fallacy of attributing current events to most recent market actions—than about the real forces driving the market’s action.

And applying heuristics to market analysis can lead one astray, and thus, amplifies the odds of erroneous decision making. One of Warren Buffett’s most precious investment advice has been

Risk comes from not knowing what you're doing.

This applies to sloppy thinking based on heuristics.

Financial markets rarely moves in a straight line.

If they do, then markets must be experiencing an episode of extreme stress, symptomatic of the ventilation of acute systemic imbalances on the marketplace. They appear in the form of a blowoff phase (climax) of a bubble cycle or of hyperinflation in motion.

Yes, stock markets soar to the firmament during episodes of hyperinflation. Although whatever gains seen is largely illusory as the local currency, enduring hyperinflation, depreciates so much faster than the nominal price gains in stock market values.

Zimbabwe which suffered from hyperinflation just a few years back saw its stock markets zoom[3], so as with the German stock market[4] during the horrific days of the Weimar hyperinflation.

Here, the role of stock markets shifts from intermediaries of capital to a monetary lightning rod. Of course, this cannot be explained by the orthodoxy of earnings or corporate fundamentals, since the public’s flight to safety motives has been driven by the desire to protect one’s wealth through ownership of real assets.

As one would note, stock markets becomes the fiduciary alternative to money under such conditions.

Yet in a normal bullmarket (or boom phase of a credit driven bubble cycle), intermittent profit taking sessions should be expected. This is where profit taking sellers of financial securities overwhelm the buyers that result to countertrend price actions. Nevertheless, financial markets tend to move in a general direction (uptrend, consolidation or downtrend) for a given period of time, despite interim countercylical fluctuations.

The pulsating surge of key global equity benchmarks suggests that this week’s retracement represents more of a profit taking process than signs of anxiety, where the losses (left window) have hardly dented on the enormous nominal local currency gains posted by the bellwethers of major economies since the start of the year (right window).

The US S&P 500 posted its second weekly loss in 12 weeks into 2012, while the Germany’s Dax, Japan’s Nikkei and the Philippine Phisix had 3 non-consecutive weekly losses. So far this translates to 1 week loss for every 3 weeks of gains for the latter 3 and 1 loss for every 5 weeks of gain for the S&P. Of course past performance is no guarantee for future outcomes.

In addition our ASEAN neighbors, Indonesia and Malaysia whom has largely missed the recent bullrun seems to defy last week’s profit taking mode. Instead they have posted modest gains, which in essence, incrementally closes on the gap between the region’s leaders the Philippines and Thailand and the laggards.

Moreover, Thailand has finally caught up with the Phisix.

So if we are seeing a rotational process among sectors and in the PSE and issues within specific sectors, then we seem to see the same process at work in global equity benchmarks.

The rotation in relative performances has been symptomatic of an inflationary boom.

As for media’s narrative, one week does not a trend make.

Huge Credit Easing Policies Means Profit Taking Will Be Short Term

If we examine the chart patterns of US equities, they seem to imply that this week’s profit taking mode might be extended.

And this could coincide with a breakdown of the ascending wedge pattern of the S&P 500 below.

Aside from the S&P, the Dow Jones Industrials and the Nasdaq chart patterns seem to tell the same tale.

What makes charts occasionally credible is that many believers can make such patterns a self-fulfilling process over the short run. And perhaps they can be augmented or complimented by trades based on algorithm or computer programs, which buy or sell triggers have been programmed to activate based on specific data points derived from chart patterns and or their corresponding indicators.

Yet any such breakdown could see some support at the 1,350 area. From Friday’s close, a downside move to this level will translate to about 3.3% retracement.

Yet chart patterns of the Philippine Phisix reveals of a subtle difference compared to the US benchmarks.

The Phisix seems to be partly in a symmetrical triangle—fundamentally this is a trend neutral pattern, which either signals continuity or a reversal[5]. Yet the recent double bottom pattern breakout also seems to suggest of a fresh upside trend at work. The implication is that any correction may be short term and shallow.

The Phisix and the S&P has had loose correlations from the last quarter of 2010 until late last year, where there had been numerous accounts of divergent actions between the two bourses. As a reminder, divergence does not represent decoupling.

Their correlations seemed to have tightened only from last October, where the combined actions of major central banks have forcibly led to major short coverings, as well as, yield chasing arbitrages that has painted an aura of ‘recovery’ as evidenced by resurgent global markets.

Another important reminder is that it is a misguided notion to assume that the current financial market developments have entirely been about ‘liquidity’.

Since 2008, political actions have included the widespread alteration of the rules of the game (such as changes in accounting rules[6], easing of collateral requirements[7], indiscriminate changes in the rights of private ownership to sovereign debt[8], arbitrary determination of credit event conditions for derivatives contracts[9]), direct and indirect bailouts, guaranteeing access to credit, implicit and explicit guarantees on assets, manipulation of the yield curve, interest rate payment on excess reserves, market making, buyer of last resort, lender of last resort, and etc..., has not only been about liquidity (liquefying of illiquid assets) but about arbitrary interventions in various forms and degree. In short, today’s financial markets have massively been in violation of various forms property rights of the private sector to the benefit of the banking system and the welfare state.

The mass politicization of the markets has been distorting price signals and has been misdirecting the allocation of resources. The piper in the fullness of time will be paid.

And given that the gist of the current tidal wave of major central asset purchasing programs have only been announced and put into action last month (such as ECB’s LRTO[10]), the effects of these massive cash infusions, compounded by the policy trends to adapt a negative rate regimes for many major emerging markets will likely put a floor on any recent corrections.

Thus it is unclear if the adverse signal emitted by these chart patterns, possibly signifying an extension of the corrective phase, will play out. And even if it does, any correction will likely be shallow.

Market Internals Reveal Profit Taking and Rotational Process

Yet market internals of the Phisix still exhibits some positive signs despite this week’s hefty correction.

True, decliners led advancers, but the spread between them has not deteriorated in a panic stricken scale as the previous sell-offs.

Moreover, of the 12 Phisix heavyweights representing 67% of the free float market cap last Friday, 3 posted gains and provided cushion to the index, specifically, Alliance Global [PSE:AGI], SM Investments [PSE: SM] and Bank of the Philippine Islands [PSE: BPI].

Meanwhile all the rest of the biggest caps posted losses led by SM Prime Holdings [PSE: SMPH], Philippine Long Distance Telephone [PSE:TEL], market leader Ayala Land [PSE:ALI] and Banco de Oro [PSE: BDO], all of which weighed on the index.

The decline as seen by the Phisix biggest market caps have equally been mirrored on the sectoral performance.

Again, we note that the mining index appears to have regained some appeal as many of the majors fell.

Finally foreign trades posted hefty net selling this week amidst a largely unchanged Peso.

But this came on the heels of the completion of the sale Alaska Milk Corporation[11] [PSE:AMC] from the seller, the Uytengsu family to the new owners the Dutch dairy giant Royal Friesland Campina for Php 12.86 billion.

My puzzle is that the buyer was a foreign group but the seller was a local group yet during the date of execution of the AMC trade, net foreign trade showed net selling almost to the tune of the AMC transaction.

Perhaps the foreign group incorporated a local company to execute the transaction, while the selling group, the Uytengsus’ equity ownership had been divested through a holding company incorporated abroad.

This could be another example of the inaccuracy of statistics which fails to capture the real developments behind each transaction.

The Political Imperative to Inflate the System

Bottom line: It is really very difficult to predict short term moves.

Nevertheless my basic premise still holds, the recent actions of major central banks combined with negative interest rate policy regime by the Philippine central bank, the BSP, as well as other emerging markets, will impact stock markets over the 3-6 months window as it has done before[12]. Most likely, we may see renewed selling pressures as these steroids come to a close.

Manipulating the financial markets including the stock markets has been part of the Bernanke’s doctrine[13] to save the banking system and indirectly to finance the welfare state. And the Bernanke creed seems to have been imbued as the de facto global policy handbook for central bankers.

And hawkish overtones[14] by some members of the US Federal Reserve or the ECB[15] may change as quickly, as so required by political exigency, especially when faced with the reemergence of selling pressures.

It would take a really big and nasty surprise and an equally static or passive or non response by central bankers to such event for the markets to feel pressure again.

And the only thing that may demobilize central bankers will be massive price inflation. As for politics, the arcane world of central banking has so far eluded the scrutiny of the benighted public.

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[1] Businessweek.com Mounting global growth concerns push markets lower, March 23, 2012 Associated Press

[2] Changingminds.org Availability Heuristic

[3] Koning John Paul Zimbabwe: Best Performing Stock Market in 2007? April 10, 2007 Mises.org

[4] Nowandfutures.com Germany, during the Weimar Republic & the hyperinflation

[5] Incrediblecharts.com Triangles and Wedges

[6] Wikipedia.org Effect on subprime crisis and Emergency Economic Stabilization Act of 2008 Mark to Market Accounting

[7] The Euro Crisis Amidst the Cheer, Could the LTRO Be Storing Up Problems for Later?, February 29, 2012 Wall Street Journal Blog

[8] Kotok David R. Moral Hazard-CAC Cumber.com, February 23, 2012

[9] Reuters.com Deeper Greek losses 'unlikely' to trigger CDS -ISDA, October 27, 2011

[10] Weekly Focus, Concerns about fragile global recovery March 23, 2012 Danske Research

[11] Business.inquirer.net Uytengsus complete sale of Alaska Milk stake March 21, 2012

[12] Zero Hedge, Operation Twist Is Coming To An End: A Preview Of The Market Response March 19, 2012

[13] See US Stock Markets and Animal Spirits Targeted Policies, July 21, 2010

[14] Bloomberg.com Fed’s Bullard Sees Price Threat From G-7 Delaying Tighter Policy, March 23, 2012

[15] Bloomberg.com Asmussen Says ECB Must Start to Prepare Exit, Die Zeit Reports, March 21, 2012

Gold’s near $100 Price Drop Hardly has been about Bernanke’s Stimulus Statement

Media attributes the slump in gold prices to the US Federal Reserve chair Ben Bernanke’s statement last night.

From Bloomberg,

Gold futures fell as much as $100 to below $1,700 an ounce on signs that that the Federal Reserve will refrain from offering more monetary stimulus to bolster the U.S. economy.

In testimony before Congress today, Fed Chairman Ben S. Bernanke gave no signal that the central bank will take new steps to boost liquidity. The dollar rose as much as 0.8 percent against a basket of major currencies, eroding the appeal of the precious metal as an alternative investment. Yesterday, gold reached $1,792.70, a three-month high, even as coin sales by the U.S. mint slumped in February

I am not persuaded that the the reaction in the gold market has entirely been about “refrain from offering more money stimulus”, this seems more like the available bias or post hoc fallacy

That’s because the sell-off seems to have been limited to gold and silver prices. Oil prices seems to have shrugged off the stimulus issue (No, oil prices has hardly been about Iran). The US stock markets too which closed modestly lower has hardly reflected on the the scale of gold’s collapse.

Any concerns over ‘stimulus’ which extrapolates to 'liquidity' would bring about an across the board selling pressure similar to September of 2011

While Mr. Bernanke’s statement may have served as aggravating circumstance, I’d say that either profit taking (yes gold market looked for an excuse and found one in Bernanke) or some unseen developments over the past 24 hours may have led to a crash in gold’s prices.

Nevertheless this is likely to be a temporary episode which means gold prices will recover...soon.

Another important issue to bring up is how mainstream now associates policy stimulus to gold prices. When the public gets to realize that money debasement (inflationist) policies have been the principal cause of price inflation in the asset markets which eventually diffuses into the real economy, the political heat against central banking or central banking policies will intensify.

So far central banks can still afford to hide underneath the cover of esoteric econometrics which the public does not comprehend--a tenuous cover which will eventually be unmasked.

End the Fed, abolish central banking.

Paul Krugman’s Rationalization of Record Gold Prices

Here is Paul Krugman's take on today's record gold prices (quote from the Business Insider) [bold emphasis mine]

The logic, if you think about it, is pretty intuitive: with lower interest rates, it makes more sense to hoard gold now and push its actual use further into the future, which means higher prices in the short run and the near future.

But suppose this is the right story, or at least a good part of the story, of gold prices. If so, just about everything you read about what gold prices mean is wrong.

For this is essentially a “real” story about gold, in which the price has risen because expected returns on other investments have fallen; it is not, repeat not, a story about inflation expectations. Not only are surging gold prices not a sign of severe inflation just around the corner, they’re actually the result of a persistently depressed economy stuck in a liquidity trap — an economy that basically faces the threat of Japanese-style deflation, not Weimar-style inflation. So people who bought gold because they believed that inflation was around the corner were right for the wrong reasons.

My comments

This is an example of a biased ex-post analysis wherein facts are fitted into a theory or model.

First of all, Mr. Krugman assumes a causal linkage between gold prices and interest rates without telling us why gold became the preferred choice of investors among the many possible ‘other investment’ alternatives.

Gold’s prices has just simply been assumed as fait accompli.

Second, it isn’t just gold that’s been rising but the precious metals group and most of the commodity sphere. His model has been silent on this.

The S&P GSCI Energy Index (GSCI), Dow Jones-UBS Agriculture sub index (DJAAG) and Dow Jones-UBS Industrial Metals (DJAIN) are all in an uptrend (yeah blame emerging markets!)

Third, Mr. Krugman does not explain why this relationship did not hold true in the 90s where interest rates had been in a secular decline along with the bear market of gold prices.

Neither does he explain how this model worked when gold prices soared along with ascendant interest rates during the stagflation decade of 1970-1980s

Lastly if Mr. Krugman’s analysis is right, then why hasn’t he predicted today’s record gold prices?

The Osama Bin Laden Available Bias

The history of war is the history of powerful individuals willing to sacrifice thousands upon thousands of other people’s lives for personal gains.-Michael Rivero

Correlation isn’t causation. This applies to the implied impact of Osama Bin Laden’s assasination to the financial markets.

People are so used to connecting current events with actions of market prices from which they impute cause and effect linkages. Such available bias leads people to miscalculate on what has truly been driving markets.

Why should Bin Laden’s death lead to falling markets? Because of fears of retaliation? Retaliation by whom?

Alarmism is no more than part of the political propaganda for increased social control.

Osama Bin Laden’s Al Qaeda represents a small faction whose capability is no more than to launch sporadic urban guerilla tactics with limited effect.

As Eric Margolis writes[1],

The specter of al-Qaida provided a handy pretext to invade Afghanistan to secure strategic territory next to Central Asian oil, keep China out of that region, and double spending on arms. The invasion of oil-rich Iraq was also justified by patently false White House claims Saddam Hussein was in cahoots with Osama bin Laden over 9/11.

Al-Qaida "affiliates" in North Africa, Arabia, and south Asia are simply small groups of local militants who have taken the al-Qaida brand name without having any organic or communications links to the remnants of the core al-Qaida in Pakistan. They are more a dangerous nuisance than a deadly threat.

Osama bin Laden may well and truly be dead. He predicted long ago he would die a martyr in a gunfight with US forces. Bin Laden has been more or less retired for the past 8-10 years, spending his time and energies in staying alive with a $25 million price on his head. He had almost become irrelevant.

As I earlier pointed out[2] Bin Laden’s political capital has sharply been eroding as shown in the chart above from the Economist. This underscores Bin Laden’s irrelevance.

I suspect that Bin Laden was disposed of, largely because of political expediency: President Obama’s popularity ratings have plummeted to record lows and whose chances for reelection have been rapidly shrinking. Thus, the need for a massive boost from which Bin Laden’s death provided as the fodder (which it temporarily did!).

While the general public sees Bin Laden as a mortal enemy, behind scenes Bin Laden looks more like a friend of the US military industrial complex, the huge bureaucratic tentacles of homeland defense which emerged post 9/11 and US politicians. The hunt for Bin Laden was estimated at about the $3 trillion (about 15% of national debt) that has sucked up much of resources at the expense of the economy[3].

So Bin Laden looked more like a political stooge donned as a villain for the public to lash at, but covertly have been providing benefits and profits for the political operators, her network of defense contractors and the bureaucracy.

As earlier pointed out if the report is true that Bin Laden lived in the compound, where he was killed, for 5-6 years, then either this represents a massive intelligence failure for the US government or that the US knew all along and tolerated Bin Laden’s presence.

Thus the eroding political capital base of Bin Laden meant that he was expendable and that Bin Laden would represent as the sacrificial lamb to advance the political interests of President Obama. Besides, a new substitute of Bin Laden has emerged: Libya’s Muammar Gaddafi.

So whether Bin Laden was a political stooge or not, the point is that Bin Laden’s assassination will have little impact on the markets.

As one would note in the above charts, the cratering silver prices prompted for subsequent weaknesses in S&P 500, and Emerging Markets benchmarks while the US dollar belatedly rallied. While some may argue that the sharp moves in the US dollar (obversely a dramatic fall in the Euro) may be attributed to chatters about Greece leaving the Eurozone which has been denied[4] and also on the news of the Portugal bailout[5], I see the US dollar rally-Euro decline as a natural response from overextended positions.

So one has to be careful in reading the sequences of events from which to establish causation relationships.

As a final note, it would also be oversimplistic to view the demise of Bin Laden as a ‘victory’ for the US government. After all it had been Bin Laden’s strategy to engage in a “war of attrition” aimed at bankrupting his superpower opponents...a path which the US seems headed for.

As Ezra Klein of Washington Post aptly writes[6],

For one thing, superpowers fall because their economies crumble, not because they’re beaten on the battlefield. For another, superpowers are so allergic to losing that they’ll bankrupt themselves trying to conquer a mass of rocks and sand. This was bin Laden’s plan for the United States, too.

“He has compared the United States to the Soviet Union on numerous occasions — and these comparisons have been explicitly economic,” Gartenstein-Ross argued in a Foreign Policy article. “For example, in October 2004 bin Laden said that just as the Arab fighters and Afghan mujaheddin had destroyed Russia economically, al Qaeda was now doing the same to the United States, ‘continuing this policy in bleeding America to the point of bankruptcy.’ ”

For bin Laden, in other words, success was not to be measured in body counts. It was to be measured in deficits, in borrowing costs, in investments we weren’t able to make in our country’s continued economic strength. And by those measures, bin Laden landed a lot of blows.

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[1] Margolis Eric Why bin Laden’s Ghost Is Smiling, May 3, 2011 LewRockwell.com

[2] See Osama bin Laden’s Death: Propaganda, Diminishing Political Capital and Re-election, May 04 2011

[3] Fernholz, Tim and Tankersle Jim, The cost of bin Laden: $3 trillion over 15 years, May 5, 2011, National Journal

[4] Bloomberg.com EU Finance Chiefs See More Help for Greece, Reject Euro Exit (1), May 7, 2011

[5] Monstersandcritics.com EU, IMF confirm 78 billion for Portugal aid package, May 5, 2011

[6] Klein Ezra Osama bin Laden didn’t win, but he was ‘enormously successful’, May 3, 2011, Washington Post

Global Markets And The Phisix: New Year Rally Begins

"Real knowledge is to know the extent of one's ignorance." – Confucius

Here is my guess.

The current correction mode has culminated and that ASEAN equity markets could likely be headed higher going into the first quarter of 2011. In short, the next leg of the New Year rally could be here (See figure 1).

We have earlier asserted that the recent correction phase had simply been a function of profit taking[1] of which many have refused to accept.

Using current events as basis for discerning the cause and effect link to the actions in the marketplace, many mainstream opinion makers contrived unfounded ‘negative or adverse’ conclusions. We further pointed out that most of these rationalizations actually constituted cognitive biases.

Some permabears have even used the recent setbacks to declare a major reversal of the present upbeat trend. Apparently, gloomy predictions based on personal biases have turned out consistently wrong.

Figure 1: Second Wind of ASEAN Equity Markets?

ASEAN equity markets have been Christmas carolling since the 2008 nadir, as the major benchmarks appear to undulate in synchronicity, namely Indonesia’s JCI (yellow), Philippine Phisix (orange), Thailand’s SET (green) and Malaysia’s KSI (red).

And this hasn’t been limited to ASEAN markets, but to almost every major bellwether worldwide (see figure 2).

Figure 2: Global Equity Markets Rebounding

The world markets as seen by the Dow Jones World index (DJW), the Emerging Market index (EEM), Asian-Pacific market (P1-DOW includes ASEAN) and even the crisis affected Eurozone (STOX50) in what looks like a rejuvenation.

And the rally in risk assets has not also been limited to equities but likewise over to a broad range of commodities. (see figure 3)

Figure 3: Commodity Bull Run (stockcharts.com)

Agricultural commodities, represented by Powershares Global Agricultural ETF (PAGG), along with the precious metal group (DJGSP Dow Jones Precious Metals Index), the Industrial metal sector (DJAIN-Dow Jones-UBS Industrial Metals Index) and the Energy Sector (DJAEN-Dow Jones-UBS Energy Index) appears to have caught fire.

The Bond Markets Scream Inflation!

And it does not stop here.

Earlier, the divergence between falling bond yields and rising commodity prices/rising equity prices had been used by deflation exponents to justify of the supposed risks of a debt deflation bust which we have refuted in ad nauseam.

We have argued that bond markets were actively manipulated which means they had been relatively more distorted, while most of the other financial markets were less manipulated. Eventually, market forces will prove mightier than the visible hand of interventionism.

And the tide appears to have turned vastly in my favour (see figure 4).

Figure 4: Rising Bond Yields Amidst QE 2.0

In the US, yields of the longer end sovereign bonds or the US Treasury Notes as seen by the (TNX) 10 year yield and (UST30) 30 year yield have risen markedly amidst the efforts by US Federal Reserve to artificially suppress interest rates via QE 2.0. And rising yields has emerged in spite of the recent rally in the US dollar (USD) contravening the 2008 crash scenario from which many deflationists have anchored their outlook on.

Yet the steepening of the yield curve implies of an accelerating diffusion of inflation expectations from present cumulative policies of major developed economies.

Importantly, inflation protected securities as seen by the iShares Barclays TIPS Bond Fund (TIP) seems to be rising for most this year, which appears to reinforce this inflation cycle.

And rising interest rates presuppose one of the following drivers: increased demand for credit, concerns over credit quality, emerging scarcity of capital or the deepening inflation expectations.

And in looking at the big picture, the cumulative market actions point to the latter as the having the most of the influential factor in driving up interest rates, although demand for credit (even in the US see figure 5) and concerns over credit standings appear to also have some substance.

Figure 5: US Consumer Spends! (Chart from Danske Bank and St. Louis Federal Reserve)

As a consequence of debt deleveraging, mainstream perma bears have perpetually been pounding on the table over the death of US consumers. Yet US consumption has been expanding right after the deflation shock of 2008 (based on month to month changes-left window), even as consumer loans had faltered (right window). Now that consumer loans have exploded to the upside, this should serve as a tailwind for continued growth.

What the mainstream fails to comprehend is that credit, based on unproductive consumptive spending, does not drive growth, savings does. In addition, people respond to prices, which are not captured by model based aggregatism and thus the deflation shock of 2008 appears to have created buying windows which served as a floor.

Stocks Over Bonds

Nevertheless, lady luck seems to smile at me for having to accurately pinpoint on the timely reversal or the seeming inflection point in the US Treasury bond markets.

The excessively negative sentiment exuded by retail participants in the middle of this year prompted for a stampede out of the equity markets, and conversely, a dash for US treasuries. This appears to be the tipping point since the consensus outlook had been predicated on a ‘deflation outcome’. When a flaw in perception[2] (false reality) gets fused with populist actions then the most likely outcome is a trend reversal.

And as I wrote last August[3],

Retail investors are usually called the OPPOSITE of smart money.

That’s because they signify as the extreme of the crowd actions-the HERD.

They usually account for as the frenetic buyers during the euphoric top and panicky sellers during market depressions.

Thus, massive moves by retail investors could likely herald signs of INFLECTION points.

In this case, US retail investors have reportedly been FLEEING stocks and BUYING bonds. I’d suggest that, like always, they are wrong and betting against them (in stocks) would likely be a profitable exercise.

Nevertheless the pristine trend away from bonds and into equities appears to be gaining momentum (see figure 5).

Figure 5: US Global Funds/Weldon Financial: Stocks Over Bonds

As US Global Fund’s John Derrick observes[4],

You can see that the stock breakout over the past several months has finally broken the downward trend. This is a very bullish signal for stocks as money rotates out of Treasuries and back into equities.

For the nth time, none of these actions points to another deflation shock, which has been continually alleged by mainstream perma bears.

Overall, considering that with a few days left before the end of the year, it would be safe to say that my predictions that inflation would pose as a key theme for 2010[5] has been corroborated by the marketplace.

And we should expect such theme to continue and deepen throughout 2011. Central banks of developed economies will continue to remain accommodative and rollout direct and indirect rescue packages to their respective banking, whether it is in Europe, the US, UK or in Japan or elsewhere.

And all these will be vented on the marketplace and will transition into boom-bust cycles as it has always been or a crack-up boom which implies a flight from money towards assets.

For now, this would look like a great opportunity to reenter the equity markets.

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[1] See Tumult In Global Markets: It Is Just Profit Taking, November 14, 2010

[2] George Soros’ description of the sequence of a bubble cycle. See How To Go About The Different Phases of The Bullmarket Cycle August 23, 2010

[3] See US Markets: What Small Investors Fleeing Stocks Means, August 23, 2010

[4] Derrick, John Investors Warm Up to Equities, Cool Down on Bonds US Global Funds

[5] See Following The Money Trail: Inflation A Key Theme For 2010, November 9, 2009.

Markets Make Opinion

On a year to date basis, Figure 1 demonstrates how Asian equity markets have been performing.

Figure 1: Asian Equity Markets: Divergent Actions (stock charts.com)

And based on the big picture, as we have earlier argued[1], Asian equity markets appear to be in a profit taking mode rather than suffering from a major reversal.

And what media says about the supposed causal linkages does not match with the actions of the equity which appears to give credence to my case.

First of all, the market leaders, the major bellwethers of Philippines (light green), Thailand (light blue) and Indonesia (fushia) has been retrenching way ahead of the Ireland crisis or China’s struggle with inflation or the North Korea incident.

Second, the South Korean bellwether the KOSPI appear to be either peaking out or transitioning towards a consolidation phase even amidst the recent unfortunate military encounter with her communist neighbour (see red arrow).

Considering the heightened degree of risks from an escalation to an all out conflagration, the KOSPI lost only 2% over the week. In other words, the Korean markets have not been jolted in as much as the news coverage had portrayed it, given the ‘surprise’ factor from the shelling of South Korea’s Yeonpyeong Island. Another way to say it is that the event risk form the Yeonpyeong incident seems to have been largely discounted (based on last week’s actions).

Third, Taiwan (violet) and Japan’s (orange) markets seem to be jaded to these adverse current events as their respective markets continue to tread higher.

So overall, the stark divergences in the performances of Asian equity markets refute arguments attributing most of the current infirmities in the region’s equity markets to recent events. This is what is known as the available bias.

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[1] See Tumult In Global Markets: It Is Just Profit Taking, November 14,2010

Tumult In Global Markets: It Is Just Profit Taking

``Experience is a dear school, but fools learn in no other”-Benjamin Franklin

It is very interesting to observe how the volatility in the marketplace can intensively sway the emotions of participants. Apparently, this is the reflexivity theory—the feedback loop mechanism between prices and expectations—at work.

On the one hand, there are those whose crowd driven sanguine expectations seems to have been dramatically fazed by an abrupt alteration in the actions of market prices, where the intuitive reaction is to frantically grope for explanations whether valid or not.

Nonetheless such instinctive reactions are understandable because it signifies our brain’s defensive mechanisms as seen through its pattern seeking nature, a trait inherited from our hunter gatherer ancestors for survival purposes, mostly in the avoidance to become a meal for stalking predators in the wildlife.

For this camp, the newly instilled fear variable has been construed as the next major trend.

On the other hand, there are those whose longstanding desire for a dreary outcome. They cheerfully gloat over the recent actions that would seem to have their perspectives momentarily validated.

Permabears, whom have lamentably misread the entire run, sees one day or one week of action as some sort of vindication. This pathetic view can be read as the proverbial “broken clock is right twice a day”.

This camp claims that the recent paroxysms in the marketplace would signify as a major inflection point.

I’d say that both views are likely misguided.

The Market Is Simply Looking For A Reason To Correct

It’s not that I have been pounding on the table saying that the global markets, including the Philippine Phisix, have largely been overextended[1] and that profit-taking activities should be expected anytime.

Albeit, considering that the global financial market’s frenzied upside momentum, the unprecedented application of monetary policies and its probable effects on the marketplace, and where overextensions are common fares on major trends (bull or bear), crystal-balling short term trends can be fuzzy[2].

Besides it isn’t our role to tunnel in on the possible whereabouts of short term directions of the markets, a practise which I would call as financial astrology, to borrow Benoit Mandelbroit’s terminology.

Yet in vetting on the general conditions of the global marketplace in order to make our forecasts, we should look at the big picture.

Figure 1: Global Markets: Correction Not An Inflection Point

What is said as a ‘crowded trade’ is where the consensus has taken a position that leaves little room for expansion for the prevailing price trends. And in the paucity of further participation of ‘greater fools’, profit taking which starts as a trickle gradates into an avalanche, or the account of high volatility.

In looking at the charts of Gold (left upper window), the Dow Jones World Index (right upper window) and the Euro (left lower window) one would observe that the crowded trade phenomenon under current market conditions may have been in place since the run up began mainly from August.

I say ‘may’ because this will always be subjectively interpreted.

And for those who use the charts as guide, the intensifying degree of overextension have been evident from the departure or from the widening chasm of price actions from that of the moving averages, particularly the 50-day moving averages (blue lines).

Figure 2: Bloomberg: ASEAN Hotshots Likewise In A Corrective mode

And the same market motions seem to affect the ASEAN bourses, which of late has assumed the role as one of the world’s market leaders[3] or as one of the best performers. ASEAN benchmarks, last week, almost reacted synchronically with most emerging markets or with developed economy bourses. Decoupling, anyone?

The Philippines Phisix, which grabbed the top spot among ASEAN contemporaries, fell the most (6.26%) this week among all Asian bourses.

The last time the Phisix had a major one week slump at a near similar (but worst) degree was in the week that ended June 19, 2009. Like today, in tandem with our neighbours and global activities, the Phisix then lost 7.7% (see figure 2 blue ellipse: Thailand SET-red, Indonesia’s JKSE-yellow, Malaysia’s KLSE-green, Phisix-orange). Of course what followed was not a collapse but a febrile upside spiral from where the Phisix has not looked back.

So from the hindsight view, everything seems perfectly clear, the overheating or the overextensions, applied in current terms, may have peaked and thus has prompted for the market’s current ‘reversion to the mean’. Yet such regression should not imply a major trend reversal as it is likely to be a short term process.

And thus the current spasms seen in the marketplace is likely to account for mostly a normative profit-taking dynamic than from either a fear based regression or as a major inflection point.

I would thus carryover on my earlier advice[4],

I am not a seer who can give you the exactitudes of the potential retrenchment. Anyone who claims to do so would be a pretender. But anywhere from 5-15% from the recent highs should be reckoned as normal.

Yet, one cannot discount the potentials of a swift recovery following the corrective process. This is why trying to “market timing”, in this “growing conviction” phase of the bullmarket, could be a costly mistake.

Reflexivity and The Available Bias

The reflexive price-expectation-real events theory simply states that price actions may influence expectations which eventually reflect on real events. Consequently, developments in real events may also tend to reinforce such expectations through the pricing channel, hence the feedback loop.

Since this theory operates on a long term dimension, it plays out to account for as the shifting psychological or mental stages of a typical bubble cycle.

In other words, it would take sustained intensive price actions or major trends to trigger major psychological motions that eventually pan out as real events.

A simple illustration is that if the current market downside drift would be sustained, then the public may interpret the formative trend as an adverse development in the real world. Subsequently, people’s actions will be reflected on the economic sphere via a recession or another crisis. Hence, the price actions emanating from evolving negative events get to be reinforced in the stock markets-via a reversion to a bear market.

Unfortunately, there appears to be a problem in applying this theory in today setting; the reason is that the opinions from the marketplace seem to be tentative over what constitutes as the real cause and effect.

In short, the public’s pattern seeking character refuses to accept the profit taking countercyclical actions of the markets, and instead, looks for current events from which to pin the blame on or associate the causality nexus.

Again we understand this as the available bias.

Available Bias: China’s Battle With Inflation

There have been two dominant factors from which the mainstream has latched the recent stress in the global markets on (see figure 3): one is China’s war with inflation and the other is the political tumult over Ireland.

Figure 3: Available Bias: Ireland Debt Crisis and China’s Tightening (charts from Danske Bank[5])

Friday’s 5.2% dive in China’s Shanghai Composite Index has been ascribed to the unexpected surge in inflation data[6] that has prompted Chinese authorities to reportedly raise bank requirements[7] to stanch credit flows coupled with rumors over more interest rate increases.

The selloff percolated to the commodity markets and rippled through emerging markets which laid ground to the rationalization of the supposed contagion effects from a potential curtailment of global economic growth on a tightening monetary environment in China.

It’s funny how the mainstream repeatedly argues over a myriad of fundamental issues supposedly affecting the markets when all it seems to take is the prospects of a credit squeeze to bring about a fit in the markets. This only proves our case that global stock markets have been mainly driven by inflationism (artificially suppressed rates and the printing of money).

China has been no stranger to such interventionism where the stock markets have been repeatedly buffeted by her government’s struggle, over the past year, to contain the so-called inner demons or a progressing bubble cycle (see figure 4).

Figure 4: Shanghai Composite: Another Government Instigated Drubbing (from stockcharts.com)

If I am not mistaken these interventions were interspersed from sometime mid 2009 until the 1^st quarter of 2010. The net result over the past year has been a consolidation phase in the Shanghai Composite Index (SSEC) albeit a negative 8.9% return on a year to date basis.

Nonetheless, China isn’t likely to resort only to monetary tools but also through the currency mechanism. China would likely allow her currency to appreciate as part of the mix in her ongoing battle against bubble cycles.

And on the consumption based model, the appreciating the yuan is likely to spur internal demand that would further increase demands for commodities and trade flows with emerging markets. But this would be too simplistic, if not myopic.

Yet even if this is partly valid, then this only shows that the sell-off had been exaggerated which will likely be self corrected over the coming sessions.

The currency factor will not, by itself, likely do the trick, for the simple reason that the manifold parts of any economy have different costs sensitivity and that the distribution of costs for corporations are likewise varied in terms of ownership (private or state owned or mixed), per industry or per geographic boundaries and many other factors.

While the currency factor will partly help in the adjustment towards the acquisition of higher value added industries, a transition towards more convertibility of the yuan would allow international trade to be facilitated by China, instead of relying solely on the US dollar. Of course this could also function as one possible solution to China’s concern over the US Federal Reserve’s QE 2.0[8].

Thus more liberal trade and investment policies must compliment in the prospective adjustments in the yuan in order to have more impact.

Fixating on the currency elixir on the premise of “ceteris paribus” constants is all being out of touch with reality, applying models notwithstanding.

Available Bias: Political Kerfuffle Over Ireland

The second factor in the latest market stress, as shown in figure 3, is being imputed to the re-emergence of credit quality concerns over the periphery nations in the Euro zone, particularly that of Ireland which seems to be spreading to the other crisis stricken PIIGs.

As part of the crisis resolution mechanism, reports say that Germany’s Chancellor Angela Merkel is requiring investors to take write-offs in sovereign rescues[9]. And on this account Germany has been pressing Ireland to seek aid from multilateral institutions such as the IMF and the EU commission in transition. A route so far downplayed by the government of Ireland.

And apparently the Merkel position has clashed with that of European Central Bank Jean Claude Trichet who said that having investors to suffer from losses under present conditions would ‘undermine confidence’.

To add, the ECB’s modest purchase of government bonds[10] have reportedly not helped in allaying concerns over such political impasse. Another way to see it is that the ECB could be using the markets as leverage to extract concessions in behalf of several interest groups.

This makes the debt problems over at the PIIGS a politically motivated one.

Of course in the understanding of the ethos of politicians, should the stalemate go out of hand, we should expect hardline positions to reach for a compromise or adapt a pacifist approach unless these politicians would be willing to put to risks the Euro’s survival.

So far what is being portrayed as an infectious credit crisis, similar to the Greek episode early this year, has been largely isolated as major credit market indicators appear to be unruffled yet by the political kerfuffle in the Eurozone (see figure 6).

Figure 6: Credit Markets Still Unaffected By The Ireland

There are hardly any signs of bedlam over at the credit markets if we measure the diversified corporate cash indices in the US (left window) and or the 3m LIBOR OIS spread (right window), both measured in the US (red line) and the Euro (blue line). The 3M LIBOR OIS spread is the interest rate at which banks borrow unsecured funds from other banks in the London wholesale money market for a period of 3 months[11] and is a widely watched barometer of distress in money markets.

In fact, these credit indicators have hardly manifested any signs of contagion, even if we are to take the Greece episode early this year as a yardstick.

Figure 6: PIGS Equities Not In Unison With Credit Markets (chart from Bloomberg)

In addition, considering the record spreads between the debts of Eurozone’s periphery with that of Germany, one should expect such strains to be vented hard on their respective equity markets.

Yet despite being significantly down on a year to date basis, equity markets appears to have been little affected, as shown by Ireland’s Irish Overall Index (green) Portugal’s PSI General Index (orange) Greece’s Athens Composite Share (yellow) and Spain’s MA Madrid Index (red), all of which seem to be in a consolidation phase.

One may observe that Spain and Portugal’s benchmark seem to be trending down of late, that’s because they have been moving higher from the 2^nd quarter, this, in contrast, to Greece and Ireland whose equity markets seem to be base forming.

Thus in summing up all these, I conclude that a potential major inflection point on the global equity markets emanating from the so-called contagion risks from the aftershocks in the PIIGS credit markets as largely unfounded.

One can add signs of resurfacing of some of the debt woes of Dubai[12], yet evidence suggests that today’s market actions is no more than an exercise of profit taking finding excuse in current events.

As a final note, I’d like to further emphasize that the Fed’s QE 2.0 seems to be failing in its mission to lower interest rates as US treasury yields have turned higher in spite of the recent market pressures (go back to figure 1 bottom right window). Of course, another way to look at it is that they seem to be succeeding in firing up inflation.

Moreover, the rally in the US dollar, despite the so-called return of risk aversion, likewise seems tepid.

So there seem little signs of a repetition of 2008 as many permabears have envisioned.

Overall the current market turbulence signifies as plain vanilla profit taking unless prices would be powerful enough to alter expectations that eventually would be reflected on real events.

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[1] See An Overextended Phisix, Keynesians On Retreat And Interest Rate Sensitive Bubbles, October 25, 2010

[2] See Should We Chart Read Market Actions From QE 2.0?, November 7, 2010

[3] See Global Equity Markets Update: Peripheral Markets On Fire, Philippines Grabs Lead In ASEAN, November 4, 2010

[4] See Political Spin On The Philippine Economy And An Overextended Phisix, October 10, 2010

[5] Danske Bank, Focus turns from QE to debt crisis, Weekly Focus, November 12, 2010 p.1

[6] New York Times, China’s Inflation Rose to 4.4% in October, November 10, 2010

[7] Wall Street Journal, PBOC To Raise Major Bank's Reserve Ratio By Extra 50 BPs – Sources, November 11, 2012

[8] Businessweek/Bloomberg China Says Fed Stimulus Risks Hurting Global Recovery, November 5, 2010

[9] Bloomberg.com Germany Said to Press Ireland to Seek European Aid, November 14, 2010

[10] Danske Bank loc cit p.4

[11] St. Louis Federal Reserve The LIBOR-OIS Spread as a Summary Indicator, 2008

[12] Businessweek/Bloomberg Dubai ruler's firm talks with banks over debt load, November 11, 2010