Will Frothy Bond Markets Drive the Phisix Higher?

The Philippine equity benchmark, the Phisix seems to be knocking on the gateway of another milestone high, as I noted two weeks back[1],

One must be reminded that bubbles come in stages. So far the Philippines seem to be at a benign phase of the bubble cycle.

Again bubbles will principally be manifested on capital intensive sectors (like real estate, mining, manufacturing) and possibly, but not necessarily, through the stock markets.

This means that for as long as the US does not fall into a recession or a crisis, ASEAN outperformance, fueled by a banking credit boom and foreign fund flows operating on a carry trade dynamic or interest rate and currency arbitrages (capital flight I might add), should be expected to continue.

And again I will maintain that ASEAN’s record breaking streak may be sustained at least until the end of the year 2012.

Friday’s substantial decline in the US stock markets may put a start-of-the-week dampener on the current momentum. However this seems unlikely a hurdle to the Bernanke-Draghi inspired Christmas or year-end rally particularly for the record setting ASEAN bourses as shown above [Philippine Phisix PCOMP orange, Indonesia JCI green, Thailand SET yellow, Malaysia FMKLCI red].

Emerging Market Bonds Outperform Equities

The price actions of the bonds of emerging market should give us a clue.

The zooming pace of the JP Morgan USD Emerging Market Bond Fund (EMB) appears to be accelerating.

In the bond fund, the Philippines and Indonesia have been among the major components of with 6.81% and 6.56% share of the pie in the total portfolio[2]. This implies that the ASEAN bond markets have been outperforming their respective equity peers.

A further clue can be seen in what appears as emerging bond markets (EMB) eclipsing the gains of emerging equity (EEM)[3] counterparts.

As caveat, the country based distribution of weightings of the bond and equity indices have been different. This means that we can’t entirely depend on its accuracy when making a comparison.

Nevertheless, for local bond currency market, the huge jump in the share distribution of the real estate (18% in June vis-à-vis 13% December 2011) and infrastructure-based industries (from insignificant to 6%) gives further evidence of the business cycle in progress.

As per the largest issuers by sector, banks and financials remain the largest but have lost 3% of the share of the pie. This is followed by the rapidly growing real estate sector and holding companies.

And for the share of the ownership of investors by type, based on % of local currency denominated government bonds issued, banks and financial institutions have been the largest, albeit on a steady marginal decline in terms of trend over the past 7 years.

Other major investors, according to the Asian Development Bond includes[4]

1) BTr-managed funds which account for Bond Sinking Fund (BSF) Securities Stabilization Fund (SSF), and the Special Guaranty Fund (SGF),

2) contractual savings and tax-exempt institutions (TEIs) which represent government pension and insurance funds (e.g., Government Service Insurance System [GSIS], Social Security System [SSS], and Philippine Health Insurance Corp. [PHIC]), private insurance companies, and tax exempt funds and corporations

3) custodians which are BSP-accredited securities custodians for investor-clients and lastly

4) other government entities such as government-owned and -controlled corporations (GOCCs), and various corporate and individual investors.

The apparent boom in emerging market bond markets may have been partly reflected on the sectoral returns in the equity markets.

The financial sector, property and holding companies—which have been heavy on both—have returned a whopping 42.54%, 40.95% and 33.32% respectively; on a year-to-date basis (see light maroon bars).

Except for the service sector, the nearly broad based weekly gains (dark maroon bars) for the rest of industry compounded on the outsized year-to-date returns (see light maroon bars).

Bonds are Less Risky or a Bubble?

The positive flows into the bond markets have not been limited to Asia, this has apparently been true even in the US, where fund flows have mostly been concentrated on fixed income related investments such as ETFs and “hybrid” balance funds with income orientation as retail investor flee equity markets[5].

Yet the idea that bonds are relatively “less risky” represents charade bestowed upon by global central bank’s tsunami of monetary inflation and financial and banking regulations that have biased towards incentivizing financial and bank institutions to hold bonds[6].

For instance, Japan’s central bank, the Bank of Japan (BoJ) recently warned the banking and financial industry of their high sensitivity to interest rate risks; where for every 1% increase of interest rates, large banks and regional banks could suffer losses of ¥ 3.7 trillion and ¥3.0 trillion respectively[7]

But the supreme irony has been that the BoJ themselves have been responsible for putting at risks the domestic banking system through their pronounced policy of supposedly fighting deflation through inflationism via asset purchases. The BoJ’s balance sheet[8] now accounts for about 30% of the IMF’s estimated economic growth rate.

Reports also suggest that the BoJ may even add to their monetary easing efforts[9] on October 30^th

Noticeably Japan’s outward investment flows, which are at near record levels[10], have supplanted China, despite the streak of failures where the batting average of outward FDIs have been unfavorable and the losses have been substantial.

About 26 trillion yen ($330 billion) have accounted for the lost market value from the 10 biggest overseas purchases by Japanese companies from 2000 to a year ago. Apparently the batting success average of Japan’s outward Foreign Direct Investments has been 1: 5 or 20%, where two posted gains while eight companies suffered losses during the said period.

And of the two winners, one is from Kirin Holdings whose acquisition of 48% of San Miguel Brewery [PSE:SMB] in 2009 has tripled in value[11].

I have been pointing out here that beyond the mainstream’s false notion of Japan’s deflation bogeyman, monetary policies, policy or regulatory (regime) uncertainties, interest rate risks and credit risks have all compounded to haunt Japan’s increasingly crony based political economy, prompting resident investors to take larger and unnecessary risks abroad for either survival or to seek out higher returns[12].

Going back to the fund flows in the US, ironically, despite the sustained outflows in the equity markets and last Friday’s slump, the US major bellwether the S&P 500 ended the week marginally on the positive note (dark violet bars).

Yet major global equity markets, led by the S&P 500, have mostly been significantly up on a year-to-date basis (light violet bars).

This fantastic but unsustainable run in the bond markets, which has exhibited symptoms of bubble dynamics, will unlikely persist.

We can either expect a shift out of bonds and into the stock markets or that the bond markets could be the trigger to the coming crisis.

In my view, the former is likely to happen first perhaps before the latter. To also add that triggers to crisis could come from exogenous forces.

Central Bank Actions Rule the Day

So far, steroids from central banks aimed at supporting the asset markets will continue to distort market price signals. And this time I am not alone saying this.

This recent commentary from Financial Times[13] seems highly relevant to the current state of affairs (bold emphasis mine)

Much of the blame for this tends to be attributed to the fact that markets now move to a drumbeat of statements from politicians and central bankers, such as the head of the US Federal Reserve. “All 500 S&P companies have the same chairman and his name is Ben Bernanke,” says Jurrien Timmer of the Fidelity Global Strategies Fund.

It is also true that securities within markets, as well as far-flung debt and equity markets have been trading more “in sync” with each other: the willingness of investors to take on risk being a common factor behind price moves.

The conditions of a parallel universe—where markets have become seemingly detached to economic reality—which I have been pounding on the table since, has even been recognized by the chief executive Mohamed El-Erian of PIMCO one of the largest fixed income firms.

At the Financial Times Mr. El-Erian writes[14] (bold mine)

Essentially, the Fed is inserting a sizeable policy wedge between market values and underlying fundamentals. And investors in virtually every market segment – including bonds, commodities, equities, foreign exchange and volatility – have benefited handsomely. In the process, many asset prices have been taken close to what would normally be regarded as bubble territory, with some already there. 

Central bank action, both real and perceived, rules the investment day, and will continue to do so for now. This is also the case in Europe.

And if central bank actions have truly become the rule for the investment world, then to what degree of relevance does traditional or conventional knowledge apply on pricing and valuing stock markets in the current setting?

Another commentary from the Lex Column of the Financial Times nails it[15],

Perhaps the most horrifying thing about the current combination of sales deceleration, margin contraction and high valuations is that it might not even be a sell signal.  The central banks of the US and Europe may well keep investors trapped in risky assets indefinitely. Those who look at the fundamentals and flee to cash had better be patient.

In reality market participants are being sucked into the vortex of speculative mania, which means another round of intensive build-up of misallocated resources or malinvestments and a future bust. We are in a boom phase of a bubble cycle.

FED policies have begun to diffuse into the US property markets which have shown significant broad based recovery[16]: particularly in existing home sales, housing starts, new home sales, building permits, builder confidence, to even a decline in shadow inventories, and signs of the inflection point of real estate loans at ALL commercial banks.

The assumption that FED policies have been successful would signify as presumptive or short sightedness or even blind belief of the capabilities of bureaucrats.

People forget that costs are not benefits. What seems as a boom today will ultimately end in tears. And bubbles, which have been growing in scale and frequency, once pricked will lead to massive capital destruction that would take years to recover especially when interventions delay them and or even make them worse.

General destruction of wealth and wealth generating activities can never be a benefit even from the Pareto optimal perspective. 

The recovering US real estate industry is being buttressed by the improving state of credit as seen by the annual % change in consumer loans and commercial industrial loans at ALL commercial banks. (Source St. Louis Fed)

Yet once the colossal excess reserves by depositary institutions held at the US Federal Reserve flows into the system, the US and the rest of the world will be faced with the risks of price inflation.

And price inflation or the market’s recognition of the unsustainability of the fiscal positions of US will likely serve as the proverbial the pin that would perforate and end the inflating bubble.

For now, the US asset bubble will likely be sustained.

Miniature Stock Bubble: Alcorn Petroleum

At the local markets, as pointed out last week, inflationary booms titillates the gambling ticks and speculative adrenalin of many participants. Punters and tyros will be seduced to the allure of easy money based on dramatic price surges, and eventually, fall prey to gruesome price collapses.

And the imprudent and those bearing the entitlement mentality will pass the blame on ‘manipulation’ or ‘fraud’ to the markets and call for regulations without accounting for the incentives brought about by bubble policies on people’s behavior.

Let me quote anew the great libertarian economist, journalist Henry Hazlitt[17]

Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals.

More regulations will not solve the behavioral imbalances caused and rewarded by antecedent immoral policies.

Over the past two weeks Alcorn Petroleum [PSE: APM] has skyrocketed to close on Friday by an eye-popping 600+%!

The company officially disclosed that they “cannot confirm” the rumored backdoor listing by allegedly the other “retailing” businesses owned by the same of owners, although the firm “appointed a financial adviser” to submit recommendations[18]. If the rumor involved different parties then such denial would seem sensible as negotiations involve the risks of transaction failure. But in this case, the parties supposedly are the same owners.

The company also referred the excessive price fluctuations or movements to a possible “oil exploration play”. Alcorn Petroleum has a 9.32% participating interests at the Service Contract 51- covering the East Visayas Basin.

Yet since the other partners in the same service contract[19] have had mixed performance this week, particularly, Trans Asia (+5.79%) [PSE: TA] and PetroEnergy [PSE: PERC] (-.84%) one can hardly impute an oil exploration play to the astronomical price surge of APM.

Whatever the reasons behind the price spike, prudence dictates that such huge series of price surges characterizes bubble dynamics which overtime typically ends up with huge frustrations for those left holding the proverbial bag.

Property giant Century Property Group [PSE: CPG], which got listed through the backdoor from the buyout of East Asia Power Resources in August[20] of last year, had seen a similar stratospheric surge as many jumped in on the rumored backdoor play.

However when the rumor became fact, CPG retrenched most of its accrued bottom-to-peak gains. As of Friday, CPG’s prices have been down about 62% from its zenith closing price.

Today’s bullmarket, and partly CPG’s financial heft, have essentially provided support to her current price levels. 

CPG’s tale is unlike the sordid experience of another stock bubble in 2000, which again involved another backdoor listing play, particularly Philweb [PSE: WEB] through formerly listed South Seas Oil[21]. Not to mention the BW Resources scandal in 1999.

In the backdrop of a bear market and upon the realization of the deal, WEB virtually gave back all its 1,000++% gains or returned whence it came from. And many punters who took part in the play had about a decade or more to recoup part of their losses (that’s for those who can’t accept their mistakes).

WEB’s experience seems to parallel the Thailand episode during the Asian Crisis as previously discussed[22]. Bubbles take time to heal whether seen from a macro or micro level.

The bottom line is to apply the Duck Test[23] for suspected stock bubbles: if it walks like duck, swims like a duck and quacks like a duck, it must be a duck.

These are the issues to avoid and to ignore.

This wisdom quote from author C Joybell C should apply to stock picking as well

Choose your battles wisely. After all, life isn't measured by how many times you stood up to fight. It's not winning battles that makes you happy, but it's how many times you turned away and chose to look into a better direction. Life is too short to spend it on warring. Fight only the most, most, most important ones, let the rest go.

Today’s bullmarket should come with a lot of opportunities without having to expose oneself to enormous risk. And all it takes is emotional intelligence[24] and self-discipline[25]

---

[1] See Phisix-ASEAN Bellwethers at Fresh Record Highs, October 8, 2012

[2] iShares.com J.P. Morgan USD Emerging Markets Bond Fund us.iShares.com

[3] iShares.com MSCI Emerging Markets Index Fund us.iShares.com

[4] ADB, Asia Bond Monitor, Asianbondsonline.org September 2012

[5] Zero Hedge R(osenberg) & B(ernstein): Two Ex-Merrill Colleagues, Two Opposing Outlooks, One Permabull Rebuttal, October 19, 2012

[6] See How Capital Regulations Contributed to the Current Crisis December 5, 2011

[7] Wall Street Journal Japanese Banks Face Huge Rate Rise Risk, Warns BOJ, October 19, 2012

[8] Pedro Da Costa Central bank balance sheets: Battle of the bulge Reuters Blog April 12, 2012

[9] Asahi Shimbun BOJ mulls further monetary easing, October 18, 2012

[10] Zero Hedge Forget China; Japan Is 'Taking Over' The World Again October 15, 2012

[11] Bloomberg.com Softbank’s Son Seeks to Skirt Cross-Border Failure History, October 17, 2012

[12] See Will Japan’s Investments Drive the Phisix to the 10,000 levels? March 19, 2012

[13] Dan McCrum End to ‘alpha’ spells trouble for fund managers Financial Times September 10, 2012

[14] Mohamed El Erian Beware the ‘central bank put’ bubble Financial Times, October 10, 2012

[15] Dave Glen Markets Remain Bid Despite Weakish Fundamentals September 18, 2012

[16] See US Federal Reserve Policies Re-Inflate US Property Bubble October 20, 2012

[17] Henry Hazlitt What You Should Know About Inflation p.18 Mises.org

[18] Alcorn Petroleum Re: Comment on Inquirer.net News Article PSE.com.ph October 16, 2012

[19] Business Inquirer.net Drillers settle dispute on farm-in deal August 10, 2012

[20]Business Inquirer.net Century Properties sets backdoor listing on Philippine Stock Exchange, August 18, 2012

[21] Newsflash.org BOI OKAYS REGISTRATION OF PHILWEB AS NEW I.T. FIRM January 29, 2001

[22] See FED-ECB’s Nuclear Policies: Risk ON is Back! September 17, 2012

[23] Wikipedia.org Duck test

[24] See Applying Emotional Intelligence to the Boom Bust Cycle August 21, 2011

[25] See Self-Discipline and Understanding Market Drivers as Key to Risk Management April 2, 2012

Brain Damage and Better Investment Decisions

Jason Zweig in his latest article at the Wall Street Journal cites a study which suggests that people with brain damage are likely to make superior investment decisions than normal people…

With computerized traders that "hold" stocks for only a few seconds at a time and markets that can swing wildly in a matter of moments, long-term investing seems to be on the verge of extinction.

Perhaps this is inevitable. It turns out that short-term thinking is deeply embedded in the workings of the human brain. New research suggests that in order to avoid trading your accounts to death, you must counteract some of the very tendencies that make Homo sapiens the most intelligent of all species.

In a study published last month in the Journal of Neuroscience, researchers from California Institute of Technology, New York University and the University of Iowa looked at how people use past rewards to predict future payoffs.

Directly behind your forehead is a region of the brain known as the frontopolar cortex. Much larger in humans than in other primates, this area is critical to such advanced mental functions as memory, exploring new environments and making decisions about the future.

In the new study, the researchers wanted to see how the frontopolar cortex contributes to predicting rewards. So they compared people with damage to the frontopolar cortex against two control groups of healthy people and those with injuries elsewhere in the brain (but not the frontopolar cortex)….

When confronted with the unpredictable, however, the frontopolar cortex refuses to admit defeat. It draws on all your computational abilities to search for patterns in random data.

In the absence of real patterns, it will detect illusory ones. And it will prompt you to act on them.

No wonder so many investors find it hard to muster the willpower to buy and hold a handful of investments for years at a time.

But if "buy and hold is dead," as growing numbers of investors argue, it isn't clear what else is alive. In the lousy markets of the past decade, various alternatives such as "tactical asset allocation" (or market timing), mathematical risk-reduction techniques and even plain old intuition haven't worked out all that well, either.

Most of the folks who say buy and hold is dead don't talk much about their long-term returns. Instead, they stress how they have done recently, a tactic that for many potential clients has the same irresistible appeal as the last couple of pulls on a slot machine.

The solution to short-term thinking isn't to bash yourself in the forehead with a hammer, of course. But you can use your brainpower to your advantage.

Every investing decision you make should be the result of a deliberate process.

The implication that it would take brain damage to make for a better investor would seem downright preposterous (the same goes with the theory of high IQs)

Pseudo scientific studies like the above disparages the individual’s distinctive capacity to deal with the ever changing circumstances we are faced with.

While it may be true that many people have the tendency to fall for cognitive biases, in reality all of people’s actions are driven by incentives

Incentives are shaped by the dynamic admixture of many factors—including genes and the environment, peer pressure and social status, educational background, culture, religion, technology and even to social policies such as zero bound rates—in relation to changes to the environment, social relations and the economy (even if some of their actions can be read as cognitive biases or heuristics—pattern seeking behavior).

This applies to short-term thinking.

Deliberate process is more about containing the urge for the dopamine to govern one’s action, or importantly, managing emotions through emotional intelligence (EI) to attain self-discipline.

Superior investing decisions can be attained even if you have a normal brain.

Quote of the Day: David versus Goliath: Why Underdogs Win

Famed author Malcolm Galdwell talked about his new book “David and Goliath” and has been quoted by the Business Insider (bold original)

The crux of Gladwell's argument is that "underdogs win all the time, more than we continue to think," he told Thompson. "Traits that we consider to be disadvantages aren't disadvantages at all. ... As a society, we depend on damaged people far more than we realize. ... They're capable of things the rest of us can't do [because] they look at things in different ways."

Gladwell says that through his research he found that "'Goliath' only wins 66 percent of the time — which is first of all astonishing — so 34 percent of time someone who is one-tenth the size of his opponent wins. That blew my mind."

Underdogs who win refuse to compete by the same standards as their opponent; instead they use an entirely different strategy that exploits their stronger opponent's weaknesses. In business, this is essentially the judo strategy, or a way of disruptive innovation.

In the field of investment, I would add that underdogs are commonly known as the “contrarians” and are likely to have much greater odds of winning than the mainstream because of their ability to think independently and think 'outside the box' by going against the crowd and by challenging the conventional thinking or wisdom.

Will the Phisix Divergence Last?

My source of livelihood has almost entirely been from the local stock market, particularly investing, as I am hardly or rarely a short term trader.

Thus, objective and thorough investigations, assessments and analysis have been IMPERATIVE on me. And as part of my investing philosophy, I try to avoid getting married to a position, in as much as assuming the HIGH RISK role of becoming a stock market CHEERLEADER.

Losing money means my family will starve and this is why I cannot afford to lose money. Therefore such punctilious efforts, on my part, to deal with risks represent what have been known as stakeholder’s problem—where my incentives to attain relevant knowledge are prompted by the degree of my stakes in the financial marketplace. Since I depend on the markets thus I have to know the possible risks attendant to my positions.

And this outlook which I share with you, has not only been based on my battle hardened experience, but also from my candid evaluations of the conditions of the risk environment.

I am not here for an egotistical trip as many have been wont to.

Separating Signals from Noise

I have long been an adherent to the wisdom of the legendary trader Jesse Livermore. I have repeatedly been posting one of my favorite Mr. Livemore’s aphorisms here (bold emphasis mine)

I began to realize that the big money must necessarily be in the big swing. Whatever might seem to give a big swing its initial impulse, the fact is that its continuance is not the result of manipulation by pools or artifice by financiers, but depends on underlying conditions. And no matter who opposes it, the swing must inevitably run as far and as fast and as long as the impelling forces determine.

Simply said, profits are to be made based on underlying conditions which drives the general trend, and importantly, serves as the critical source of big swings.

And this is why I give heavy emphasis at the unfolding events based on the big picture. Unlike most practitioners, I am hardly swayed by vacillations from ticker tape activities.

Yet, ticker tape activities and the big picture frequently represent the noise and signal problem

Nassim Nicolas Taleb in his forthcoming book wonderfully explains the psychological impact from noise and signal[1]

we are not made to understand the point, so we overreact emotionally to noise. The best solution is to only look at very large changes in data or conditions, never small ones.

Just as we are not likely to mistake a bear for a stone (but likely to mistake a stone for a bear), it is almost impossible for someone rational with a clear, uninfected mind, one who is not drowning in data, to mistake a vital signal, one that matters for his survival, for noise. Significant signals have a way to reach you. In the tonsillectomies, the best filter would have been to only consider the children who are very ill, those with periodically recurring throat inflammation.

There was even more noise coming from the media and its glorification of the anecdote. Thanks to it, we are living more and more in virtual reality, separated from the real world, a little bit more every day, while realizing it less and less. Consider that every day, 6,200 persons die in the United States, many of preventable causes. But the media only reports the most anecdotal and sensational cases (hurricanes, freak incidents, small plane crashes) giving us a more and more distorted map of real risks. In an ancestral environment, the anecdote, the “interesting” is information; no longer today. Likewise, by presenting us with explanations and theories the media induces an illusion of understanding the world.

And the understanding of events (and risks) on the part of members of the press is so retrospective that they would put the security checks after the plane ride, or what the ancients call post bellum auxilium, send troops after the battle. Owing to domain dependence, we forget the need to check our map of the world against reality. So we are living in a more and more fragile world, while thinking it is more and more understandable.

The bottom line is that many people get confused when working to separate the proverbial wheat from the chaff or when filtering signal from noise. People with lesser stakeholdings are likely to emphasize on the noise which usually signify as “an illusion of understanding the world” and or embrace steeply biased (but unworkable and highly flawed) theories.

The Dopamine Fetish

I would also add that part of the psychological-neuroscience aspect in dealing with markets has been about dopamine neurons.

People’s dopamine neurons, or brain chemicals, gets fired up when rewards attained are GREATER than expected. In contrast, REGRETS are symptoms of depressed dopamine neurons. Thus short term thinking and short term trading have MOSTLY been about the fetish for dopamine trips.

A study on neuroscience suggests that dopamine flows are pervasive during early stages of a ballooning bubble, reflecting desire for profit. However as the bubble peaks, dopamine flows tend to culminate in a cessation just before the market burst[2]

Monetary policies by central banks also whet or induce dopamine powered speculative behaviors[3].

The lesson here is that we should manage our dopamine flows rather than allowing dopamine neurons to dominate the risk-reward tradeoffs that confront our investing decisions. This is basically about Emotional Intelligence (EI)

Let me further add that the technical construct of the Philippine Stock Exchange has been skewed to inculcate upon the public of the upside bias for issues listed on the markets, as well as, the component index.

The rational for this seems to be part of the political designs to exhibit economic booms.

Take shorting. While shorting has been legalized, rigorous procedural and regulatory compliance requirements have made shorting impractical. So we have a facility that has hardly been used.

And since market participants only earn from an UPSIDE price move, thus logically, the dominant entrenched PSYCHOLOGICAL bias would be for the public to yearn for the stock market to go only in one direction—UP.

Next, complimenting the psychological and physiological aspect, monetary policies have also been rewarding speculative activities at the expense of savings and production.

So intensifying speculative activities extrapolates to the herd effect in motion.

Where the basic function of the stock market has been about the cost of buying future income stream relative to insecurities (risk and uncertainty), such functionality has been negated or substituted by rationalizations for price chasing momentum.

Writes Kevin Dowd, Martin Hutchinson, and Gordon Kerr at Cato Forum for monetary policies[4],

Low interest rate policies not only set off a malinvestment cycle but also generate destabilizing asset price bubbles, a key feature of which is the way the policy rewards the bulls in the market (those who gamble on the boom continuing) at the expense of the sober minded bears who keep focused on the fundamentals, instead of allowing the market to reward the latter for their prudence and punish the former for their recklessness. Such intervention destabilizes markets by encouraging herd behavior and discouraging the contrarianism on which market stability ultimately depends. A case in point is the Fed’s low interest rate policy in the late 1990s: this not only stoked the tech boom but was maintained for so long that it wiped out most of the bears, who were proven right but (thanks to the Fed) too late, and whose continued activities would have softened the subsequent crash. The same is happening now but in many more markets (financials, general stocks, Treasuries, junk bonds, and commodities) and on a much grander scale. Such intervention embodies an arbitrariness that is wrong in principle and injects a huge amount of unnecessary uncertainty into the market.

In essence, the inflationary boom psychology has been distorting economic reasoning.

Add to this the leash effects of bailout policies.

The bottom line is that inflation fueled bull markets have become a religion to many.

And advises to undertake prudent positions—based on appraising the risk environment that may adversely affect one’s portfolio—has been seen as sacrilege.

Short Selling Not Recommendable; Contagion Risks

I also do NOT recommend shorting in the Philippines for the following reasons

-the cost to undertake shorts positions have been enormous relative to prospective gains (if a short position is required the best is to do it from overseas)

-a full blown BEAR market for the Philippines has NOT been yet established, although the RISKS from such scenario seem to be STRENGHTENING.

-global regulators have periodically been intervening. The degree of intervention mostly through bailout policies comes with such INTENSITY such that these can TORCH shorts on short notice. A good example has been Europe’s LTRO which singed Euro shorts at the start of the year[5]

-global regulators have innate biases against short sellers. They have done so lately through direct market interventions, such as drastic imposition of shorting bans which forces short covering to investors at a loss. A great example has been the shorting bans on Europe stock markets in mid-2011[6] in the political belief that speculations, and NOT insolvency, have been the fundamental problem that besets the Eurozone. Yet in spite of the bans, European stock markets continue to bleed PROFUSELY. This represents a vivid example of the “illusion of understanding the world” by political agents who always try to shift what has truly been their mistake to the markets.

Lastly I do NOT wish or DESIRE for a bear market.

Because of the limitations to take on hedge positions, bear markets or even phases of consolidation with a downside bias or volatility translates to income drought for me or most market participants (see the structural bull market bias above)

While I am an optimist who believes that the Phisix will reach 10,000 sometime in the future, I am also a REALIST who understands that external forces have a HUGE influence to actions of the local stock markets and that NO trend goes in a straight line.

In suggesting of the countercyclical trend amidst a secular trend I wrote in March[7],

I am not certain whether we will see a repeat of the discontinuities similar to the 1986-1997 bull market cycle or will suffer more than the past cycle before reaching my goal or if the Phisix will proceed to double. What needs to be monitored are drivers of the current trends and the whereabouts of the present boom cycle based on internal and external dynamics.

In short, the PHISIX, despite the secular trend, is VULNERABLE to a CONTAGION risk.

Could this week’s Phisix Divergence Represent an Anomaly?

The local benchmarket, the Phisix, majestically bucked the global stock market carnage last week.

As one would note, the Phisix has not only outperformed the region, the local benchmark basically defied gravity.

China and Malaysia joined the Phisix, as outliers, with hefty gains amidst a sea of red.

Yet such divergences have given the dopamine to Pollyanna trippers the ammunition to declare “bottom” for the market.

I have yet to be convinced.

The gist of the weekly gains or 52% of the Phisix came from Thursday’s activities.

Ironically, the sizable gains occurred in the backdrop of staggering US and global markets.

Media and experts has alluded to reports of sturdy domestic economic growth[8], the hints of a possible upgrade[9] by US rating agency Moody’s on the credit standing of the Philippines and the closure of milestone impeachment trial[10] with a conviction of the accused which favors the administration as reasons for this.

I beg to differ.

I raised this concern on this last Thursday[11]. The Phisix went down to as low as 67 points at the early session, dragged by the selloffs in the US and Europe. But suddenly, aggressive and systematic buying of heavyweights (blue chips) throughout the day pushed the Phisix to close at almost at the peak (76.81) at 73 points. The pendulum swing from loss to gain represented an astounding 2.8%!!!

Buyers seem to have, ironically, been resolutely aggressive to push up prices in an environment of MOSTLY falling stock market prices globally, perhaps in the assumption that local stocks will soon experience a strong surge.

Or is it?

The weekly performance of the heavy cap issues reveals that gains of the Phisix were mostly seen through Ayala Corp (AC), JG Summit (JGS), Banco De Oro (BDO), Metrobank (MBT), SM Investments (SM), International Container (ICT), PLDT (TEL) and Bank of the Philippine Islands (BPI).

The logical part for any buyers under such scenario would be to make use of the dour sentiment to take advantage of price declines to bargain hunt. Yet these have not been the case.

Let me lay out my suspicions.

I do not think that these has been due to general market sentiment, although pushing up the PHISIX index succeeded to give a boost to the general market sentiment.

Thursday closed with a mixed showing between advancers and decliners with the latter having a slight edge. On a weekly basis advancers took a slight lead over decliners showing modest improvement in the market breadth or sentiment.

Second my naughty thoughts suggests that Thursday actions was likely executed to create an impression of economic ‘confidence’. I am not so sure why though. Perhaps to squelch demand for signing waivers for top officials.

Buyers suddenly became price insensitive. The likelihood is that non-market entities may have been responsible for aggressively pushing up Big Caps. I would suspect that these may have been government institutions such as the SSS, GSIS or others.

While it is true that Thursday a net foreign buying, the bulk of these buying can be traced to cross trades at DM Consunji.

Besides, net foreign buying data may not reveal of the real extent of activities that took place. Foreign buying can represent overseas based subsidiaries or branches of locally owned corporate vehicles or tycoons, as well as, foreign based politically allied corporations.

Of course I may be wrong and that there may have been special factors driving up the Phisix.

But if my suspicions are valid then such interventions are likely to produce short term effects.

As example the Bank of Japan’s (BoJ) $13.3 billion[12] interventions DID bring down the Yen for about a month. However the Yen has been regaining lost grounds since. This effectively has neutered tax payer financed interventions. In short $13.3 billion down the drain.

Another question that begs to be asked is WHY the PHSIX alone?

While Malaysia did post hefty weekly gains next to the Phisix, the Malaysia’s benchmark (FBMKLCI:IND, green) has almost missed out the recent bull market. On the other hand, Thailand (SET:IND, orange) and Indonesia (JCI:IND, red) which shared or alternated the lead with the Phisix, since last year, has wilted significantly.

Yet it can be observed that ASEAN’s stock markets have been nearly been moving in nearly synchronous fashion UNTIL the peak in May of this year.

This only means that last week’s gains by the Phisix either represents an ANOMALY or that the Phisix LEADS Asia.

My bet is on the former.

The Decoupling Myth

I have been saying that current environment have been dominated by POLITICAL uncertainty which for the Philippines and ASEAN represents a CONTAGION risk.

If global markets stock markets have been pricing in a bust or the unwinding of malinvestments which is being transmitted to the global economies, then it would dangerous, if not reckless, to presume immunity or “decoupling” where trade and investment linkages of ASEAN economies have been deepening relative to the world.

ASEAN economies have largely been exposed to developments abroad through merchandise trade (exports and imports).

The Philippines merchandise trade represents over 50% of GDP, while Malaysia and Thailand are over 100%.

This means any meaningful economic slowdown in the region or in the world will negatively impact economic growth.

Add to this the potential slowdown effect on remittances and supply chain networks.

The deepening of financial globalization also means the integration of emerging Asia’s capital markets[13] with the world (left chart) and with intra-region (right pane).

In short, the false notion of DECOUPLING will likely melt in the face of a global recession or when a full blown financial crisis, if such phenomenon transpires.

Let me be clear, the conditional term is an IF, while global economies have indeed been slowing down, a global recession or worldwide contagion from euro’s financial crisis has yet to become evident in Asia.

Of course a decoupling COULD happen if there should be massive inflation or even hyperinflation from any of these major economies. However, under the current circumstances this is unlikely to happen.

This means that for those in the belief that the Philippines can decouple from the world, the following chart should be a helpful reminder…

2007-2008 signifies as the contagion based bear market.

Neither has there been an economic recession during the said period nor did earnings fall materially. But the Phisix entered a full blown BEAR Market and lost about 50% peak-to-trough as a result of an exogenously driven financial crisis in 2007-2008.

Of course 2008 is different from today. In fact, today has been worst compared to the 2008 crisis. In 2008 the crisis was limited to the banking, property and mortgage industry. Today the crisis dynamics has shifted to envelop banks AND sovereigns. Not to mention that world wide government debts have surged[14] and that US fiscal deficits have skyrocketed (at $1.327 trillion or 8.2 times larger than 2007[15]).

Yet for those who should insist on decoupling, then I wish you the best of luck.

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[1] Taleb Nassim Nicolas Noise and Signal — Nassim Taleb Farnam Street, May 29, 2012

[2] ChangingMinds.org The Neuroscience of Financial Bubbles

[3] See How US Federal Reserve Policies Stimulates the Public’s Speculative Behavior, May 8, 2012

[4] Dowd Kevin, Hutchinson Martin, and Kerr Gordon The Coming Fiat Money Cataclysm

and the Case for Gold

[5] Marketwatch.com Euro hits 3-month high on LTRO hopes, February 24, 2012

[6] Wall Street Journal, Europe Short Bans Extended, August 26, 2011

[7] See Phisix: The Journey Of A Thousand Miles Begins With A Single Step, March 12, 2012

[8] ABS-CBNnews.com.ph PH eco grows 6.4% in Q1; highest in ASEAN, May 31, 2012

[9] Businessmirror.com.ph Moody’s raises PHL to ‘positive’ May 29, 2012

[10] See The Lessons and Validity of Public Choice Theory Applied to the Chief Justice’s Corona Impeachment, May 29, 2012

[11] See Phisix: Very Impressive Day or Month End Close for May 2012, May 31, 2012

[12] Bloomberg.com Japan Adopts Stealth Intervention As Yen Gains Threaten Exporter Earnings February 7, 2012

[13] ADB ONLINE Asia Capital Markets Monitor August 2011

[14] Zero Hedge, Presenting Dave Rosenberg's Complete Chartporn, June 1, 2012

[15] Weiss Martin Lehman-Type Megashock Looming, Money and Markets May 21, 2012