``The true prophet is not he who predicts the future, but he who reads history and reveals the present.”-Eric Hoffer, 1902-1983, American social writer
So far so good.
My suspicion that the Phisix could have probably entered into a bottoming phase encountered its first acid test and appears to have passed with flying colors. In the face of pervasive gloom and doom, the Phisix cautiously bounced back by 2% this week for the first week in five.
Interpretation of Initial Impact and Arguments For A Phisix Bottom Redux
Of course the market’s reaction can be interpreted in two ways;
one- a short term interim technical bounce amidst a persistent medium term bear market or
second- an interim bounce which paves way for a seminal bottom under the perspective of its long term underlying trend. Remember market cycles involves process transitions and is not merely event-driven as incredibly suggested by some “experts”, therefore, the Phisix would have to pass repeated tests in order to reconfirm the validity of the ongoing restoration of confidence process.
We have premised the potential turnaround on a confluence of factors which involves the following:
1. Market volatility.
The recent gains of the Phisix (2.8 times) have not been steep and sharp enough as to merit a similar scale of descent. As an example, in 1986-1987 the Phisix climbed by about 10 TIMES which was correspondingly met by a nasty 50% correction. Similarly as mentioned last week, Saudi’s Tadawul and China’s Shanghai bourses flew by over 5 times in TWO to THREE years and has met by the same degree of volatility on its corrective phase, 65% and 50% respectively. Paraphrasing Newton’s Law, Every action has an almost equivalent and opposite degree of reaction.
2. Bubble cycle.
Every asset classes in today’s paper money driven world have been driven by varying stages of massive credit and monetary expansion. Based on public participation we have not seen evidence of such euphoria or investor irrationality.
Next, our asset markets have not reached extensively rich valuations levels. Lastly, the country’s macro or micro indicators have not signified signs of excessive leverage.
3. Encompassing Negative Sentiment.
Since market activities are driven by the investing or speculating public making decisions for whatsoever reasons- they involve psychology. Thus, market cycles are primarily underpinned by the psychological cycle.
Given today’s dire headlines from the domestic front (rice crisis, government threat of a utility takeover, etc.) to overseas (US recession, world economic slowdown, continuing credit crisis, surging “inflation” in food and energy, etc.), the degree of risk aversion has somewhat reached overshoot levels. Yet actions in the marketplace do not reflect or have not been congruent to the same degree of anxiety as shown in Figure 1.
Figure 1: stockcharts.com: PSE The Outlier!
As global markets have remained as closely correlated as in the past, most of these benchmarks imply that the underlying national indices under such rubric have rebounded since March of this year (vertical line).
The Dow Jones World Market at the top pane, the Dow Jones Asia Ex-Japan Index (below center window) and the iShares Emerging Markets (lowest pane) have recovered substantial losses since October.
Whether this recovery represents a “dead cat’s bounce” or a “bear market” rally is arguable and predicated on the caller’s bias. But the point is the Phisix (at center window) has missed the “gravy train”! Or…so it seems?
But compared to the past rallies which manifested of sharp V-shaped bounces, this time we are seeing some signs of consolidation (circle).
A prolonged consolidation or a gradual ascent should exhibit the recovery’s resilience, but again bottoming as a function of an evolving process within a cycle will mean repeated tests where investor patience and grit amidst prevailing fear should eventually be rewarded.
Yes, we were delighted to see that even as the US markets lost meaningful grounds last Wednesday (by about 2%), the Phisix “diverged” by recording moderate gains Thursday.
We have noted in the past that for the Phisix to reestablish strong indications of a recovery, (see Phisix: Pummeled On Foreign Downgrades, Still In Search Of A Bottom) durability in the form of less sensitivity to external variables should be seen as a guide, aside from progressive technical action, of which both signs seems to have been manifested this week.
Monday should be another test day since the US markets ended the week with moderate losses. Since Mondays are traditionally the weakest day of the week, the Phisix could be subject to some selling pressure following the weakness in the US markets. But for as long as the Phisix keeps the pace of its losses to within the range of losses in the US markets, we should remain in a consolidation phase with a recovery bias.
Dead Calm Waters Reveals Attribution Bias
One must be reminded that betting on future outcomes requires the understanding of risk and reward tradeoffs.
When we talk of a “bottom” we don’t even go near to the suggestion of a mystical formula or some alternative forms of voodoo rituality applied to the financial sphere but one where we distinguish the odds of the probability of incurring more losses against that of the odds of the prospective gains. In simple words, the bet of a bottom means the understanding that the room for further loss is significantly less than for future gains. But this, in contrast to the expectations of market punters, happens OVERTIME and requires PATIENCE.
I might like to add that the negative sentiment have truly reached extremes seen in the ground levels. In a recent social function which I regularly attend, where early this year participants seem agog over the market despite the decline (the assumption is that the market’s decline was short and shallow), today almost everyone seem to shun the topic of the stock market, which for me appears to uncannily resemble the investing atmosphere in 2002, a great window for grabbing outsized returns.
Nonetheless, I gathered that losses for some have been staggering enough to dismiss the existence of the stock market. And some have even fostered acerbity towards the financial intermediary agents (bankers, stock brokers and analysts).
Of course I might be accused of reading the sentiment of a group into the whole (fallacy of composition) but as we previously pointed out market internals, as seen by declining daily trades, have depicted the same picture where speculative froth engaged by mostly retail market participants have substantially ebbed. Since speculators have been caught in long positions due to their inability to accept losses or have been immobilized, trading activities have been restrained.
The lesson here is one of the Attribution Bias, where people tend to take credit on successful endeavors to inherent skills but deny responsibility for failures by imputing situational variables either by “randomness” or by the influences of others to their decision making.
Thus, when the market is buoyant everyone seems to know of the “whys” and the “whats” and the “who-drives-what” in the marketplace, and conversely when the market is dreary, the atmosphere seems like dead calm waters.
Negative Real Interest Rates and Emerging Market Bubbles
4. Negative Real Interest Rates.
Mainstream analysts or experts impute stock market investing to micro or macro events, some deal with the technical aspects. As a contrarian, we see the market as mainly the alternative function of money: a medium of exchange, a unit of account (means for economic calculation) and a store of value.
Not everything can be explained by micro or macro factors. Yet mainstream analysis insists on such lockstep correlation. We beg to differ.
Policies administered by government/s have manifested significant impact to asset prices. That is the reason for the phenomenon of bubbles. Investor irrationality is only an aggravating circumstance to a bubble in formation, because this cannot thrive without the principle of leverage (margin trades or credit expansion).
Following years of monetary accommodation and extensive growth of credit intermediaries of all sorts-derivatives to margin trades to alphabet soup of securitization, the implosion of the housing bubble in the US and other Anglo Saxon Economies has left central banks apprehensive of the negative economic growth impact from declining asset prices. As such, monetary authorities have mostly left policy rates lower than instituted “inflation” benchmarks hence negative real rates. Aside, they have been conducting massive liquidity bridging operations and applying fiscal subsidies in support of consumers suffering from the string of recent losses. We have explained most of these in Has Inflationary Policies of Global Central Banks Boosted World Equity Markets?
In addition, monetary pegs and mercantilist trading structures of key emerging markets have apparently resulted to a globalized mechanism for transmission of inflationary activities whose effects are now ostensibly rechanneled from Wall Street securities into commodities and emerging markets.
This insightful excerpt from Prudent Bear’s Doug Noland in his Credit Bubble Bulletin (highlights mine),
``prevailing inflationary pressures are global in nature. Wall Street finance is the source fueling the boom, and it’s running outside the Fed’s control. American asset inflation and resulting wealth effects are minimal, while price effects for food, energy, and commodities are extreme. In contrast to previous inflationary booms, while some selected groups benefit, the vast majority of people today recognize they are being hurt by rising prices. This hurt comes concurrently with atypical housing price declines. Today’s price effects pummel already weakened consumer sentiment, as opposed to previous effects that tended (through asset inflation) to bolster confidence. Furthermore, current inflationary forces are destabilizing and even destructive to many businesses, while playing havoc with the fiscal standing of federal, state and municipal governments.
``Revolving around booming Wall Street finance, previous inflationary booms naturally fueled surges in securities issuance and speculation. These Bubble Effects worked as powerful magnets in attracting foreign financial institutions, foreign-sourced speculators, and cheap foreign-sourced borrowings (i.e. yen borrowings financing higher-yielding U.S. securities) that all worked in concert to “recycle” our Current Account Deficits (“Bubble dollars”) directly back to our securities markets.
``In contrast, today inflationary forces largely bypass U.S. securities to play global energy, commodities, and hard assets. Foreign financial institutions are fleeing the U.S. risk intermediation business, while “Bubble dollars” are chiefly recycled back into Treasury and agency securities (where they now have minimal effect on U.S. home and asset prices). Meanwhile, the massive global pool of speculative finance is today focused on energy, commodities and the “emerging” economies.”
In short, what you are witnessing today is an ongoing massive shift in the inflation bias or bubble progression on a global scale from securities to commodities and to emerging economies.
Figure 2: stockcharts.com: Soaring Commodities and Latam Bourses!
Look at today’s commodity and commodity affiliated markets (see figure 2): Oil at an ALL time high $126 per barrel! The CRB Index is also at a Fresh record high! And commodity heavy benchmark of Latin American bourses (Dow Jones Latin America) also on record!
A world of negative real rates is likely to buttress such powerful dynamic. What you will likely have is a phenomenon of funds chasing winners which should spillover to a broader spectrum of commodity associated assets (yes we are seeing signs of the emergence of Ponzi financing in commodities), hence the bandwagon effect in motion!
While the impact of such inflation bias will always be unequally distributed between producers, sellers and buyers of commodities as discussed in my previous blog, Inflation Data Brings Philippines Into Deeper Negative Real Rates; NOT A Likely Cause of Today’s Decline, the Philippine economy as an erstwhile major commodity exporter is a strong contender to be a beneficiary from the globalized inflation machinery.
Figure 3: PSE subindices: Recent Recovery Primarily Driven By the Mining Sector
Incipient signs of such rotation have already surfaced.
While the Phisix remain depressed down 23.25% year to date as of Friday’s close, the mining index (equally down 16.5%. y-t-d) has seemingly bottomed since March and has gradually been in consolidation and now seen moving higher-see figure 3 (Japanese Candlestick). This comes after a 6% jump this week, mostly from Atlas Consolidated which has soared by 25%! You don’t normally see a 25% run over a week from an index heavyweight (second largest weighting in the mining index at 16% after Philex) especially in a BEAR market! This only strengthens our case that the Phisix will likely recover soon.
And given that both the above technical picture plus the developments in the world market strengthened by a negative real rate environment, it is likely that the mining and oil sector will lead the Phisix’s recovery over the coming sessions.
All other indices in the chart are underwater on a year-to-date basis, this includes Banking (blue) down 19.75%, Commercial Industrial (violet) 20.59%, Property (red) 29.95%, Holding (green) 27.62% and Services (orange) 19.82%.
Moreover, investors will always find justification for an investment theme. Economic growth supported by capital investments over a dominant asset class is likely to become a feedback loop in a self reinforcing bubble cycle.
Figure 4 GMO: “They have the growth. We don’t. What’s to discuss?”
As the sagacious fund manager Jeremy Grantham of GMO (Jeremy Grantham, Richard Mayo and Eyk Van Otterloo) recently argued in his outlook, historically bubbles would need a strong underlying fundamental case from which the bubble is anchors upon.
In terms of emerging markets as shown in Figure 4 it is likely to be found in the consistent outperformance of economic growth. In the poignant words of Mr. Grantham, ``They have the growth. We don’t. What’s to discuss?”
Like us, Mr. Grantham believes that the next bubble will be on emerging markets. Quoting at length Mr. Grantham (all highlights mine),
``For one, emerging will increasingly be seen on a country-by-country basis. Nevertheless, the second wave of let’s-look-like-Yale money from state plans is still in its early stages and looking to invest overwhelmingly in emerging market funds, not in the specific country funds of the Yales and Princetons.
``For another caveat, the GDP growth rate of a country does not in the very long term necessarily determine how much money a country’s stock market will make. Long-term market return may depend more on profit margins. But investors believe GDP growth really matters, and Japan went to 65x earnings despite average or lower corporate profit margins.
``But the third caveat is the most serious; this emerging bubble can easily be postponed or even stopped before it really begins by the current financial problems and the slowing growth rates of the developed world that are likely to follow.
``My own view is that our credit problems will impact and interrupt the recently sustained outperformance of emerging in the intermediate term, say, the next 3 years, even as the acceptance of this emerging bubble case grows. Such interruptions may be quite violent but, despite them, at the next low point for the U.S. market the emerging markets are quite likely to do no worse and in the recovery they will go to a very large premium. And if, just if, the U.S. gets very lucky indeed and muddles through without serious market and economic problems, then the emerging bubble will of course occur more quickly and smoothly.”
Phisix: Political and External Risk Variables
So yes, allied with the views of Mr. Grantham as we have previously mentioned, the Phisix is envisaged by two major risk factors; one is domestic political risk and the other is the transmission factors of the external risk environment.
Political risk could be associated with the risk of destabilizing markets through populist policies such as overextending subsidies to reverse the gains or improvements of the country’s fiscal position and balance sheet, combined with threats to the sanctity of private property ownership via “nationalization” or management “take over”.
So when we read of canards repeatedly circulating in the emails of “why the Philippines is poor?” we understand that it is the fundamental aspect of principally NOT having ENOUGH capital investments in the country and NOT because of lack of “moral” leadership why the Philippines is “poor” (yea ironically the Philippines is “poor” but home to 3 of the 10 world’s largest malls and growing!).
It is because of the lack of appreciation of the markets through property ownership and the enforcement of contracts, the lack of savings, a dearth of platform or infrastructure for establishing pricing efficiency, the lack of competitive environment, a politically dependent society or culture and importantly the high costs of political intervention and bureaucracy.
Remember the popular personality based politics theme of corruption represents a symptom and NOT the disease. Corruption basically is an offshoot to suffocating network of bloated bureaucracy as a result of overregulation and inordinately high taxation due to huge liabilities accrued from failed policies and deep dependence on political gratuity (a.k.a. pork barrel).
Economics 101 tells us that the more you want of something you LOWER the costs, in contrast, the less you want of something you INCREASE the cost. If you want to lessen the incidences of corruption you increase the cost of committing corruption. If corruption is an offshoot to overregulation then streamlining of laws, reduced bureaucracy and lower taxation should be encouraged aside from strictly enforcing laws.
In addition it is NOT governments that drive the wealth of economies or responsible for the upgrading of the standard of living of societies, otherwise communism (Stalin’s USSR, Mao’s China, Kim’s North Korea, Castro’s Cuba) would have succeeded; it is the people!
If governments empower its people to conduct trade openly with LESS political intervention thereby strengthening the division of labor within its economy then it reduces the country’s risk premium, lowers the hurdle rate, reduces the cost of doing business and thus becomes competitively attractive for capital investments.
Governance permissive of a market economy or an entrepreneurship culture and less dependence on the political leadership is the common denominator of successful economies. Because it is a governing policy to limit government’s intervention then the issue of “moral” becomes moot.
But when you see the leadership use its coercive power of its legally clothed leviathan to conduct political harassment or render vindictive actuations on presumed political opponents in the name of public services then it raises questions among potential investors about the sacredness of equity ownership.
This in itself increases the cost or barriers of doing business. Hence capital would seek a hefty premium in terms of higher rate of return or yields for it to consider deploying them into the country. The higher the costs the lower rate of investments.
These incessant political interventions is the reason why the Philippines will remain politically and economically disadvantaged and will thus depend on the global or regional cycle for its upliftment than from intrinsic factors such as the popularly demanded (but largely ineffective) “government driven” initiatives instead of the unpopular market oriented reforms. To quote Ludwig von Mises, ``The effect of its interference is that people are prevented from using their knowledge and abilities, their labor and their material means of production in the way in which they would earn the highest returns and satisfy their needs as much as possible. Such interference makes people poorer and less satisfied.”
As for external risk variables, the country is faced with the same macro risks as the others, a sharp US recession, a steep global economic slowdown, accelerating inflationary policies which could fuel the intensity of the present bubbles and or goods and services inflation, geopolitical risks of public upheavals (triggered by food crisis) or potential military conflicts (over resources), a US dollar crash, global depression and other fat tails.
