Why Blowoff Episodes Reveals That The Boom Is The Disease!

Vainglorious ‘experts’ and many market ‘knowledgeable’ people have frequently resorted to rationalizing price actions with historical ‘fundamentals’. They try to “reason from price changes” as one popular monetary economist puts it.  

So when they see skyrocketing share prices, they associate this with (delusional) prosperity. They tend to see things or numbers selectively by eschewing all the negatives and embracing all the positives which they attribute to such price actions.  

And when offered the prospects of a crash, the frequent excuse is to ask “what will drive it?” Because prices are up and fundamentals look (selectively) rosy, they would automatically deny the probability of such an outcome.  

Experts of such quality are afflicted by the recency bias. They look at the ticker tape or headline news which they extrapolate into the future. They hardly have theories to back them up except to rely on statistics (past data) to constitute their presuppositions of the economy.  

Yet markets function as a discounting mechanism. Because they are a discounting mechanism, markets tend to reflect on fundamentals way ahead or even before they become apparent.  

Take a few examples.  

The Phisix peaked in February 1997, a few months before the Asian Crisis surfaced into the open (July 1997).  

The Phisix responded to the Great Recession months ahead before early 2008, when people began suspecting that the US had fallen into a deep economic downturn. To repeat the Phisix crashed in August 2007. Rallied back to recover all the losses, only to crash again in October.  

The National Bureau of Economic Research (NBER) belatedly dated the US Great Recession in December 2007.  

It’s easy to make explanations ex-post. That’s because hindsight is 20/20.  

Yet what explains the two crashes in the Phisix in 2015 and January 2016?  

Following the run to April’s 8,127.48 record, the Phisix began to wilt in prices and in the context of internal actions. I have been pounding on this at my prudent investor weekly outlook.  

When the China’s yuan depreciated in August, this proved to be a secondary order effect or the event risk trigger (aggravating circumstance) which further escalated on the already debilitating Phisix.  

The Phisix hardly recovered from the August debacle and weakened further through December.  It broke 7,000 by the year end to close at 6,952. By January 2016, the downside actions accelerated. This again climaxed with the yuan’s second significant weakening. The Phisix dropped to 6,084. Then came the G-7’s implicit Shanghai Accord plus the BSP’s silent stimulus which arrested the decline.  

In gist, developing conditions at the PSE caused its vulnerability. Hence, weak conditions made it ripe the for two crash events to transpire which external events exposed (via China’s yuan depreciation).  

At present, if there is anything the market has repeatedly been signaling, it has been that the gamut of hysteric or panic buying or the mania phase has only been masking an internal degradation process. The BOOM itself signifies the disease!  

That’s because the credit based artificial boom has been erected on unsound foundations. And from tenuous grounds, such temporary boom will eventually be fated to a reversion to the mean. Or the markets will clear.  

All the financial and economic imbalances and maladjustments from economic distortions brought about by the political tinkering with money prices through interest rates will have to readjust to conform with economic reality. Borrowing from the future will entail of future and present costs. There is no free lunch.  

Signs of the costs of imbalances have already existed: Faltering growth in tax revenues, downside pressures on the top line and earnings of PSE firms, manufacturing stagnation, export recession, jobless boom, soaring education prices, and incipient signs of strains even at the heart of the boom—real estate. Agriculture has been also down (partly from politically induced economic distortion and partly from weather).  

Don’t forget people employed in the manufacturing, agriculture and exports account for a big segment of the population. They comprise about 40% of the work force. So weak output in these industries should translate to lower spending and less jobs.  

Add to this the race to build capacity by the key engine of the Philippine economy—the bubble sectors—which implies the likelihood of lesser investments when surpluses vent itself through corporate profits.  

And all these have occurred, despite the government’s smokescreen of inflating the GDP numbers. In short, real economic indicators have been moving against survey based aggregated statistics.  

What has the repeated crashes (majors: May 2013, August 2015 and January 2016; minors: October and December 2014) have been telegraphing to us?  

The answer: Whatever boom in the Philippine economy, it has been finding itself mired into an increasingly fragile state!  

Just think of what the supposed boom did to politics. Has it not been due to a perceived popular ‘protest vote’ that the new administration was elected from? Why would 16.6 million people see themselves as expressive of dissatisfaction and dissent when GDP continues to scintillate at elevated levels?  

Even from a standpoint of misperception, popular politics REINFORCES symptoms of economic contortions. Think of just what 10 months of 30%+++ of money supply growth in 2013-2014 did to the purchasing power of the average citizenry. Had I not warned that this would create popular discontent?  

Essentially, the popular ‘protest vote’ not only represented a backlash against, and the supposed repudiation of the outgoing administration’s policies, it most likely have been a sign that the Philippine bubble has been pricked!  

Yes it may be true that some of the discontent has been on social burdens as traffic, crime, drugs and etc., but which of them have been isolated from the economy or from economics?  

As a side note, think about all the surveys conducted by the government (particularly by the BSP) stating how satisfied consumers had been, prior to the elections. Also think about the privately done poll, which came up with the bizarre, risible and outrageous findings that a-third of the population had actually thought that the Philippines had attained developed economy status. The self-identified ‘protest vote’ essentially demolished all these as nothing more than a myth, if not propaganda. This represents another noteworthy example of demonstrated or revealed preference or people expressing themselves through actions rather through words.  

Yet by rationalizing popular politics as an extension of the previous boom, the establishment has been fighting wildly and furiously to camouflage the bubble from bursting through the deepening of the manic phenomenon at the domestic financial markets!  

Let us do some follow the money trail or examine how the vertical run may have been financed.

Falling credit growth has coincided with the recent decline of the PSEi seen both from a quarterly (upper window) and from the monthly basis (middle window). 

Because the PSEi fell to 6,084, and when compared to the trek towards 8,127 over the same period in 2015, the first quarter of 2016 posted huge losses in terms of relative or comparative growth (upper window). 

But because some unknown entity forcibly steepened, on what has been a sustained trend of flattening to inverting yield curve, banking credit growth did a magnificent turnaround and significantly ballooned in 1Q 2016! 

So bank credit growth soared as the PSEi recovered. 

YET three factors may have forced the unseen intervenor to act or deploy a silent stimulus: 

1. The masquerade of falling price levels (as measured by the government) which has inflated GDP is unsustainable. The government’s statistical artifices will be exposed if prices will not recover. And prices can only recover through the bank credit channel. 

Since GDP is about money based spending and since bank credit growth accounted for more than 70% of money supply growth, then this means that the core segment of GDP has accrued from bank credit growth. In short, bank credit growth is the quintessence of GDP performance. 

So the target of reversing the decline in credit growth trend may have been intended to boost statistical GDP. 

2. Election spending. There is no such thing as a free lunch. Election campaigns and vote buying will need to be financed. 

And banks did most of it! This can be seen in the growth of the money via M1, which consists of currency in circulation (or currency outside depository corporations) and peso demand deposits (BSP), have only been accelerating since 4Q 2015. And this intensified further in the first four months of 2016! (lowest window) 

So bank credit growth may have been targeted directly or indirectly to fund election spending. 

Question: how will these resources, which were directed through unproductive means, be repaid? 

3. Sustained crash of the PSEi. 

The surge in bank lending growth seems to have powered the recent run at the PSE! 

Aside from the 1Q 2016’s 16.12% surge in overall bank lending, at 18.5%, banking loans to the financial sector in April nearly doubled in terms of growth rate when compared to March’s 10.59% and tripled to that of February’s 6.33% and January’s 5.25%! 

As the PSEi moved higher so did bank loans to the financial sector! 

Yet how much of those vertical ‘panic buying’ moves have been bank financed? 

What happens to such loan portfolios when the ultra-expensive equity prices unravel? 

So the surge in bank credit growth may have been intended to indirectly bailout entities and institutions that have been heavily exposed to the stock markets. 

If true, then what even happens more if financial institutions suffer from credit problems? More bailouts? And if true, then such bailouts simply strengthen indications of existing or incumbent problems unseen by the public. 

So up to what point before more of such invisible stimulus will be forced out into the open? 

Yet government’s own measures of prices have already been signaling dangers ahead.  While April’s CPI was at 1.1%, the government’s measure of retail price index soared to 1.6% a high almost at the April 2015 level at 1.8%. Sustained substantial increases in credit growth will likely distill into CPI too. 

Again higher economy (goods and services) prices will smite the already strained consumer spending or the pesos’ purchasing power! Think of what this will do to people (mostly employees) involved to sectors (agriculture, export and manufacturing) already suffering from an economic stagnation? 

And higher prices will affect business input while having little power to pass cost increases to the consuming public. Yet a recipe for more profit squeeze! 

So the secret stimulus may have spiked the PSEi, GDP and elections, but the drawback has also surfaced.  There is no free lunch. 

If the secret stimulus will prevail, then the risk is that there will be another outbreak of inflation (very soon). This again will force the BSP to tighten monetary conditions. But doing so, will only lead to the same outcome as we had seen in the recent past but at a worst degree. Remember the difference has been that leverage today has been larger than that of 2013-14 and that the real economy has been a lot weaker (despite the government numbers). 

And if the secret stimulus program will cease, then the recent boom will once again deflate. And again, Remember the difference has been that leverage today has been larger than that of 2013-14 and that the real economy has been a lot weaker (despite the government numbers). 

Such the Keynesian monetary parlor tricks have reached its climax.

Infographics: Life and Times During the Great Depression

The Visual Capitalist on the life had been during the Great Depression. 

Note: The Great Depression was preceded by an economic boom fueled by a credit bubble. The boom's epoch was popularly known as the "Roaring Twenties". Of course, generally, there won't be a bust (recession, depression or crisis) without an antecedent credit driven boom. 

The Money Project is an ongoing collaboration between Visual Capitalist and Texas Precious Metals that seeks to use intuitive visualizations to explore the origins, nature, and use of money.

The economy of the United States was destroyed almost overnight.

More than 5,000 banks collapsed, and there were 12 million people out of work in America as factories, banks, and other shops closed.

Many reasons have been supplied by the different economic camps for the cause of the Great Depression, which we reviewed in the first part of this series.

Regardless of the causes, the combination of deflationary pressures and a collapsing economy created one of the most desperate and miserable eras of American history. The resulting aftermath was so bad, that almost every future Central Bank policy would be designed primarily to combat such deflation.

The Deflationary Spiral

After the stock crash, money and consumer confidence was hard to find. Instead of spending money on new things, people hoarded their cash.

Fewer dollars spent meant more drops in demand and prices, which led to defaults, bankruptcies, and layoffs.

As a result of this spiral, the prices for many food items in the U.S. fell by nearly 50% from their pre-WW1 levels.

The price of butter went from pre-crisis levels of $0.21 to $0.13 per pound in 1932. Wool had a drop from $0.24 to $0.10 per pound, and most other goods followed the same price trajectory.

The Effects

Here’s how “real value” is affected in a deflationary environment:

Money

Real value increases: cash is king and gains in real value.

Assets (stocks, real estate)

Real value decreases as prices fall.

Debt

Debtors owe more in real terms

Interest Rates

Real interest rates (nominal rates minus inflation) can rise as inflation is negative, causing unwanted tightening.

From Bad to Worse

The Great Depression lasted from 1929 to 1939, which was unprecedented in length for modern history. To this day, economists disagree on why the Depression lasted so long. Here’s some of their explanations:

The New Deal was not enough

Looking back on The Great Depression, John Maynard Keynes believed that monetary policy could only go so far. The Central Bank could not ultimately push banks to lend, and therefore demand had to be created through fiscal policy. Keynes advocated massive deficit spending to offset markets’ failure to recover.

Keynesians such as Paul Krugman believe that Franklin D. Roosevelt’s economic policies through The New Deal were too cautious.

“You can’t push on a string.” – Keynes

The New Deal made things worse

Some economists believe the New Deal had a negative net effect on the recovery.

The National Recovery Administration (NRA) is a primary subject of this criticism. Established in 1933, the goal of the NRA was to lift wages. To do this, it got industry leaders to meet and establish minimum prices and wages for workers.

Cole and Ohanian claim that this essentially created cartels that destroyed economic competition. They calculate that this, along with the aftermath of these policies, accounted for 60% of the weak recovery.

Lastly, one other charge leveled at Roosevelt by his critics is that the sprawling policies from the New Deal ultimately created uncertainty for business leaders, leading to less investment. This lengthened the recovery.

“[The] abandonment of [Roosevelt’s] policies coincided with the strong economic recovery of the 1940s.” – Cole and Ohanian

The Federal Reserve didn’t do enough

Milton Friedman claimed that the Federal Reserve made the wrong policy decision, which extended the length of the Depression.

Between 1929 and 1933, the monetary supply dipped 27%, which decreased aggregate demand and then prices. The Fed’s failure was in not realizing what was happening and not taking corrective action.

“The contraction is…a tragic testimonial to the importance of monetary forces…[D]ifferent and feasible actions by the monetary authorities could have prevented the decline in the stock of money… [This] would have reduced the contraction’s severity and almost as certainly its duration.” – Milton Friedman (and co-author Anna Schwartz)

The Federal Reserve shouldn’t have done anything

Austrian economists believe that the Fed and government both made policy choices that slowed the recovery. For starters, most agree with Friedman that the Fed’s policy choices at the start of the Depression led to deflation.

They also point to the premature tightening that occurred in 1936 and 1937 as a policy failure. During those two years, the Fed not only hiked interest rates, but it also doubled bank-reserve requirements. These policies coincided with Roosevelt’s tax hikes, and a recession occurred within the Depression from 1937 to 1938.

Critics of these policies say that this delayed the recovery by years.

“I agree with Milton Friedman that once the Crash had occurred, the Federal Reserve System pursued a silly deflationary policy. I am not only against inflation but I am also against deflation. So, once again, a badly programmed monetary policy prolonged the depression.” – Friedrich Hayek

Personal Stories from The Great Depression

“One evening when we went down to check on the bank, there were hundreds of people out front yelling and crying and fighting and beating on the locked doors and windows. They had fires built in the street to keep warm and there were people milling around all over the downtown.” – Vane Scott, Ohio

“A friend I worked with said in the Depression he rode the rails and stopped to eat vegetables out of a garden. The owner said he would shoot him if he didn’t stop. My friend said ‘go ahead,’ as he was that hungry. ” – James Randolph, Ohio

“When neighbors couldn’t get a loan from the bank, they’d come to Dad. He sold farm machinery. He never put his money in a bank. He stored it in a strongbox in the fruit cellar, under the apples. He’d loan the neighbors what they needed and they paid him back when they could. If there was a month—especially the winter months—when they couldn’t pay, they’d slaughter a cow or a pig and give him a portion. In the summer it was vegetables: corn, peas, whatever they had growing.” – Gladys Hoffman, New York

“I thought the Depression was going to go on forever. For six or seven years, it didn’t look as though things were getting better. The people in Washington DC said they were, but ask the man on the road? He was hungry and his clothes were ragged and he didn’t have a job. He didn’t think things were picking up.” – Arvel “Sunshine” Pearson, Arkansas

Conclusion

After the 1937-38 Recession, the United States economy began to recover.

The focus of the American public would eventually shift away from the Great Depression, as events in Europe unfolded after Germany’s invasion of Poland in 1939.

For the Austrian account of the Great Depression read Murray N Rothbard's America's Great Depression

Courtesy of: The Money Project

Infographics: Keynesian Economics 101

If one should wonder why the scourge of boom busts cycles and its attendant crises (economic, financial, currency and debt), as well as accounts of hyperinflation, continually afflicts society, then look no further than to the economic dogma that has provided justification for their existence.

The Austrian Insider (hat tip Mises Blog and Zero Hedge) on the 4 Simple Lessons of Keynesian economics

Since Keynesian economics has reined supreme among mainstream economists for decades, you might want to know some of the basics. If this is confusing to you though, don’t worry about it! There are people in charge who have it all under control.

The great Austrian economist F.A. Hayek on Keynesian economics (from page 349 of Hayek’s The Trend of Economic Thinking, which is Vol. 3 in The Collected Works of F.A. Hayek hat tip Cafe Hayek) [bold added]

It is characteristic of much of recent economics that by ever new arguments it has tried to vindicate those very prejudices which are so attractive because the maxims that follow from them are so pleasant or convenient: spending is a good thing, and saving is bad; waste benefits and economy harms the mass of the people; money will do more good in the hands of the government than in those of the people; it is the duty of government to see that everybody gets what he deserves; and so on.)

Why Keynesian economics have popular with politicians and why it signifies as societal disease. From Austrian economist Peter Boettke (bold added)  

Keynesianism is not a panacea because Keynesianism has dominated public policy making for half a century and has left us in such a state of public debt. Keynesianism broke the old time fiscal religion of balanced budgets and fiscal responsibility, and changed not only attitudes of economists and policy makers, but also eroded whatever institutional constraints existed on public spending that had existed. Keynesianism cannot work to solve our current problems because Keynesianism is responsible for our current problems. Keynesianism provided an illusion of short term prosperity, but the reality of long term stagnation. Of course, the revealing of the illusion can be put off, as I have pointed out before, if there is the discovery of new opportunities for gains from trade, and/or gains from innovation.

But the governmental habit of spending is still there and the bill has to be paid as some point. Keynesianism is a disease on the body politic because it caters to the natural propensity of politicians to focus on short run, and to concentrate benefits and disperse costs.

Charts: US Stocks and The Greater Fool Theory; No Weekend Stock Market Commentary

I’m taking this week off from my weekly stock market outlook.

In gratitude to my readers, I will leave something for you to ponder on this weekend: Important charts depicting what seems as the greater fool theory in motion at the US stock markets. Remember, what happens to the US will most likely have a domino effect to the world.

Greater fool theory—buying assets in the hope that greater fools will buy the same assets at a much higher price—or as per Wikipedia.org—”a situation where the price of an object is not being driven by intrinsic values, but by expectations that irrational bidders for limited assets or commodities, will set the price”

Bullishness in investor sentiment has now reached extreme levels (Zero Hedge). The sustained upside movement has only strengthened the convictions of the bulls and the fools, luring more and more of them into a bidding spree.

Yet this appear to be signs of a ‘crowded trade’ where everybody’s "all in" and everyone's expecting higher prices from more fools buying at higher prices (endowment bias). 

Question is but what if there are lesser number of fools to sell to?

Who could be the fools?

Record US stocks have been driven mostly by retail/household punters (in billion of dollars).

Household buying of US stocks have also reached milestone highs, drifting slightly above the 2000 and 2007 levels (Yardeni.com).

The last 2 times US households furiously stampeded into the stock markets, bear markets followed (see pink rectangles). Remember the crash from the dot.com bubble bust and the US housing mortgage bubble bust? Again household buying has reached "peak" levels of 2000 and 2007.

Question is could the Bernanke-Yellen policies have transformed stocks into a “permanently high plateau” (to borrow from the late economist Irving Fisher)? 

Will this time be different?

What has financed such bidding frenzy from the bulls and the fools? The short answer is DEBT.

Record US stocks have now coincided with record margin debt.

Margin ‘real inflation-adjusted’ debt has currently surpassed the 2000 levels but has been slightly off the 2007 record highs.

Margin debt including free cash accounts and credit balances in margin accounts or Credit Balance as the sum of Free Credit Cash Accounts and Credit Balances in Margin Accounts minus Margin Debt  as per Doug Short, which are also at record levels, reveals how punters have increasingly used leveraged to push up stocks to record territory. 

It's more than just margin debt and investor credit. 

Systemic leverage in order to chase yields have been intensifying and broadening, from bond issuance to finance stock buybacks, near record consumer and industrial loans, stratospheric unprecedented levels for commercial real estate lending and more.

What have the bulls and the fools been buying?

Record stocks comes amidst declining EPS (Business Insider)…

…as well as record negative over positive eps announcements (Zero Hedge).

All these means that the fools have been chasing multiples rather than eps growth with escalating debt.

Will the current bonanza via a “don’t worry be happy” trade remain in favor of the stock market bulls and the fools?

Perhaps. Depending on how many more fools can be seduced into the frenzied pile up. Mania phases can have an extended period of euphoria. Manias signify the "peak" of the bubble cycles where convictions have been the strongest.

Nevertheless the farther the height of the serial increases, the bigger the accumulation of risk via more debt, the greater the fall.

Based on the “log periodic” pattern designed by economist Didier Sornette where bubbles reflect on “a widening gap between the increasingly extrapolative expectations of market participants and the prospective returns that can be estimated through present-value relationships linking prices and likely cash flows” current momentum indicates of an accelerating odds of a text-book stock market crash, according to fund manager John Hussman

Well such risks will be discarded and the ignored by the bulls and their fools because stock markets, for them, have been perceived as a one way street: "up, up, up and away!"—courtesy of the Greenspan-Bernanke-Yellen Put, which some believe have worked as an elixir.

At the end of the day, let us see who will be holding the proverbial bag.