Phisix in the Shadow of Greed and Fear

Strange times are these in which we live when old and young are taught in falsehood's school. And the one man who dares to tell the truth is called at once a lunatic and fool. -- Plato

Up, up and away!

The Philippine Phisix only posted a marginal .24% gain this week. But on a weekly basis the local benchmark soared to an all-time high.

Such marginal gain reflects on this week’s sharp volatility, specifically the difference between the spike during the two post-election trading sessions and the subsequent profit taking at the close of the week which ended up with a residual net gain.

Year-to-date the Phisix has returned a fantastic 25.24% as of Friday’s close. We are fast closing in on the 32.95% annual return of 2012. Yet there are 7 months until the end of the year.

At the current rate of return of about 5% gain per month, if sustained, would translate to a 10,000 Phisix by the end of the year or at the first quarter of 2014.

The steepening of the ascending slope suggests of the deepening convictions of the bulls of the trend’s sustainability. Such convictions have now been strengthened by even more price increases.

But this seems to have morphed into more than just a reflexive feedback loop between expectations (shaped by prices) and outcomes (influenced by expectations); some people in social media have already been exuding an aura of invincibility by hectoring on very rare bearish international reports.

As I have said before[1], markets have hardly been pricing about “cheap” or “expensive” but about electrically charged emotions: Greed and Fear.

Sectoral returns have been demonstrating such dynamic.

Bulls have been swamping into popular investment themes, while the bears have frantically been smashing down what seems as ‘politically incorrect’ issues.

Bull markets tend to lift all, if not most issues, but apparently not this time.

Also, the annual rotational pattern has been broken. Instead of an alternating leadership as during the past 6-7 years, the mining sector has gone completely in the opposite direction of the general markets.

The decline in the mining issues has not been proportional. Some issues fell of the cliff where losses account for an astounding 50-70% from their recent zenith. 

Such dramatic selloffs and declines already exhibit a state of depression with hardly any “corporate fundamentals” to account for. Others have been down by 20-30%. I may add that the biggest losers have been those with operations within the Benguet area, so I am wondering whether domestic politics may have been aggravated the dour sentiment which has been partly imported.

So, on the one hand we see intensive yield chasing phenomenon. On the other, we see panic. Greed and Fear.

But what should concern serious participants is not the “fear”, but the dominant “greed” as manifested by a ballooning mania.

And I wouldn’t exactly characterize “greed” in the conventional sense, but rather greed in the context of expansive risk appetite as consequences from various social policies.

The public has been motivated to speculate from easy money policies and from implied guarantees on the financial market, thus the market has responded in such rampant and destabilizing manner.

When we tax something we get less of it, but when we subsidies something we get more of it. So this applies to stock markets too: Current policies subsidize or reward “greed”, and at the same time, punish “prudence”.

Even the Jaime Caruana, the chief of the Bank of International Settlements, or the central bank of all central banks, have come to recognize and warn about this[2].

Global Equity Markets Melt-UP

Year-to-date, major global benchmarks have seen a return of a RISK ON environment as the levitation of equity markets has been accelerating. 

The above table doesn’t give justice to the overall representation of the other bourses. This is due to the distortions from the magnified gains by Japan’s Nikkei which diminishes what should have revealed as outsized gains for developed economies and ASEAN equities

In the behavioral science field, this is called the perceptual contrast effect[3], where people’s judgement are shaped by perceptions framed from relative immediate or visible comparisons

Nonetheless, gains of major developed economies and ASEAN nations have been mounting while the BRICs seem to be recovering except for Brazil.

In observing price trends, the melt up in equity markets have become global.

The US major benchmark, the Dow Jones Industrials, as well as, Germany’s DAX index has shown upside acceleration. 

As of Friday’s close, the Dow Industrials has been up 17.2% year-to-date while the German DAX has been up 10.32%. In 2012, the Dow yielded gains of 6% while the DAX 29%.

As I have recently pointed out[4], the surge in the DAX comes in contrast with Germany’s struggling economy. Germany managed to eke out a .1% growth during the first quarter of the year. Whereas the overall direction of growth since 2011 has been on a downtrend, yet the German DAX seems on a melt up mode.

This Isn’t Your Daddy and Grand Daddy’s Market

The most striking parallel universe phenomenon would be in France.

French financial markets will tell you of a booming economy: 

The equity bellwether the CAC 40 has racked up gains of 9.89% year-to-date and was up 15.23% in 2012. Interest rates as measured by the French government 10 year yields[5] have been drifting at multi-year lows (see lower window).

So OECD France has a booming bond and the stock markets almost similar to the emerging market Philippines.

Ah, but France is not the Philippines. Ironically the French economy slipped into a recession in the first quarter of this year. For most of 2012, France has also been in periodical recessions. Yet the market booms. France was even downgraded by Moody’s last November[6]. But the stock and bond markets have ignored them. And this is why the French equity market seems in melt up mode even as the stagnating economy seems to intensify.

And given that the French economy has been hocked to the eyeballs with debt, as debt-to-gdp has been ballooning[7] since 2009, one would expect that the extended recessions would have amplified credit and market risks that should have roiled the financial markets.

But no, this time is different.

Bad news is good news. More signs of economic troubles translate to more prospects of accommodation from central banks. The more the bad news, the better for the financial markets.

In addition, central banks policies appear to have jaded the market’s perception of risks. French interest rates have gone down partly because of Japan government’s aggressive pursuit[8] of doubling her monetary base via “Abenomics”, where Japanese insurance and banking firms sought higher yields[9] (if not safehaven) from French bonds as shown above.

The Swiss National Bank (SNB) may have also been a party[10] to subsidizing the French government through accumulation of French bonds. 

Or it could be that French institutions with international exposure could have been downsizing partly by selling their holdings abroad from which they repatriate to buy French bonds for reserve requirements purposes.

Charles Gave of the Gavekal Research opines[11]

France has a large financial sector, with huge international positions. Some entities may be selling international holdings which demand large reserve requirements. The proceeds are then brought back in France to buy French government bonds—against which there are no reserve requirements.

As I earlier said, current developments reveal that there hardly has been anything fundamental in the traditional or conventional understanding from which current markets operate on.

This isn’t your granddaddy or your daddy’s financial markets.

Or take a look at three national benchmarks above.

All of them are apparently in a melt-up mode. Year-to-date the chart at the left has yielded 45.63%, the center 29.45% and the right 61.92% as of Friday’s close.

The melt-up for these three bellwethers has a common denominator: they have been spiked by strong monetary forces.

Argentina’s Merval[12] (center) and Venezuela’s Caracas[13] (right) have both been enduring hyperinflation but in different phases[14], their stock markets are proving to be partial safehavens. On the left is Japan’s Nikkei[15]. Japan’s Nikkei 225 has skyrocketed from the government’s plan to double her monetary base which is really is in the direction of Argentina and Venezuela except that Japan policies are in an embryonic phase.

Thus the conventional and popular wisdom where today’s market has been one about growth, or fundamentals or political salvation will be proven wrong in the fullness of time.

Again this isn’t your granddaddy or your daddy’s financial markets.

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[1] See Phisix 7,000: Why Asia’s Rising Star is a Symptom of Mania April 29, 2013

[2] See BIS Official: Loose Central Bank Policies Looking Increasingly Dangerous May 17, 2013

[3] ChangingMinds.org Perceptual Contrast Effect

[4] See Parallel Universe: Booming German and French Stocks as Economies Stagnate May 15, 2013

[5] Bloomberg.com France Govt Oats Btan 10 Yr Oat

[6] Guardian.co.uk Moody's downgrades France's credit rating to AA1 November 20, 2012

[7] Tradingeconomics.com FRANCE GOVERNMENT DEBT TO GDP

[8] Zero Hedge We Found The 'Other' Greater Fool May 13, 2013

[9] Businessinsider.com European Government Borrowing Costs Are Plunging — And It's All Thanks To Japan April 8, 2013

[10] Wall Street Journal Button-Down Central Bank Bets It All January 8, 2013

[11] Zero Hedge Charles Gave: "Get Out Of Banks, Get Out Of France - Get Out Of The Euro" May 16, 2013

[12] Bloomberg.com Buenos Aires Stock Exchange Merval Index

[13] Bloomberg.com Caracas Stock Exchange Stock Market Index

[14] See Inflation and Price Controls: Latin America Edition April 19, 2013

[15] Bloomberg.com Nikkei 225

Global Equity Markets: Signs of Distribution and Japan’s Capital Flight

Global equity markets appear to showing signs of exhaustion.

Possible Signs of Distribution?

This week’s pronounced weakness (top window) in major equity benchmarks has essentially pared down year-to-date gains (lower window).

Even US markets, which has been under the US Federal Reserve’s $85 billion a month steroids since September 2012[1], appear to be exhibiting signs of divergence. 

While the Dow Jones Industrial Averages (INDU) posted only a marginal decline (-.09%) this week, there seems to be a broadening of losses seen across many important indices.

The S&P 500 fell 1.01%, the small cap Russell 2000 ($RUT) plunged 2.97%, the Dow Transports ($TRAN) plummeted 3.5% while 10 year US treasuries rallied, as yields fell. Yields of the 10 year US government bonds broke down from its recent uptrend.

The weakness in global equity markets have likewise been reflected on the commodity markets (upper window[2]). Stock market benchmarks of major commodity producers such as Brazil (EWZ) Canada (EWC) and Russia (RSX) have wobbled along with struggling commodity prices (top window[3]).

Such narrowing of gains and the broadening of losses can be seen as signs of distribution. They may indicate interim weakness.

So far, most of the ASEAN majors have remained resilient.

Except for Thailand, declines in the Philippine Phisix (-1.76%) and Indonesia’s JCE (-.3%) has been modest relative to their emerging market peers. Year-to-date, returns on the Phisix and the JCE remains at double digits, particularly 15.73% and 14.12% respectively.

Thailand’s SET has been hounded by sharp volatility following the assault on stock market investors by Thai authorities through the tightening of collateral requirements on credit margins. Even with this week’s 4.58% loss in Thailand’s SET, the Thai benchmark remains up 7% year to date.

Meanwhile the region’s laggard, the Malaysian KLSE has almost erased her annual losses with this week’s 1% weekly advance. The Prime Minister of Malaysia dissolved the parliament last April 3[4], which means that a general election will be held soon or no later than June 27 2013[5]. While politics may temporarily influence Malaysia’s markets, it will be the bubble cycle which will remain as the key driver.

The jury is out whether the diffusion of losses in global equity-commodity markets will persist and if these will begin to impact on ASEAN majors and or if developments in Thailand will also have an influence on the region’s performance.

Thailand’s equity markets will have to undergo the process of resolving the psychological conflict inflicted by Thai’s authorities.

As I wrote a few weeks back[6],

Market participants will then assess if SET officials will continue to foist uncertainty through more ‘tightening’ interventions, or if the authorities will allow markets to function. If the former, then Thai’s equity markets would have more downside bias going forward. If the latter, then Thai’s mania may catch a second wind.

If Thailand’s authorities will continue to intervene and prevent the mania phase from taking hold in the stock markets, then sentiment will only shift to the more fragmented, more loosely controlled and localized property markets

Capital Flight Will Help Inflate Asset Bubbles

The recent weakness in US equities may have been a function of 1^st quarter diminishment of US money supply aggregate M2[7] (red ellipse left window). Actions of the US equity markets have been tightly linked to, or rather, caused by the Fed’s monetary expansion[8]. The recent reacceleration of M2 may suggest that any weakness may be temporary.

In addition, the inaugural action of newly installed chief of the Bank of Japan (BoJ) Haruhiko Kuroda has been to advance Prime Minister Shinzo Abe’s aggressive “Abenomics” policies. Mr. Kuroda’s mimics his European counterpart, Mario Draghi, to “do whatever it takes” to allegedly stop deflation for Japan.

Mr. Kuroda’s “shock and awe” opening salvo will be channeled through a grand experiment of doubling of the monetary base in 2 years[9] by aggressive asset purchases by the Bank of Japan mostly through bonds[10]. Such aggressive policy is likely to stoke a massive yen carry trade, or a euphemism for capital flight.

The initial impact of a vastly lower yen has been an asset boom; surging stock markets (The Nikkei was up 3.51% for the week, 23.46% for the year), and soaring bonds.

Rising bonds or lower yields or interest rates will induce more borrowing for the Japanese government. This will in the near term, fuel more asset bubbles.

However rapid diminution of the yen (-3.51% w-o-w, 11.11% y-t-d) will also mean that aside from asset bubbles, resident Japanese will likely seek shelter through foreign currencies in order to preserve their savings, thus, such policies entails greater risks of capital flight.

So instead of promoting investments and economic competitiveness, currency devaluation will lead to distortions in economic calculation, increased uncertainty, lesser investments and a lower standard of living.

I have been anticipating this move from the BoJ. A year ago, I said that ASEAN and the Philippines will likely become beneficiaries of BoJ’s inflationism[11]

The foremost reason why many Japanese may invest in the Philippines under the cover of “the least problematic” technically represents euphemism for capital fleeing Japan because of devaluation policies—capital flight!

Capital flight will be masqueraded with technical terminologies of portfolio flows and Foreign Direct Investments (FDIs)

Now even the billionaire trader-investor George Soros shares my view. In a recent TV interview, the Bloomberg quotes Mr. Soros warning of a potential stampede out of the yen[12],

“What Japan is doing is actually quite dangerous because they’re doing it after 25 years of just simply accumulating deficits and not getting the economy going,” Soros said in an interview with CNBC in Hong Kong today. “If the yen starts to fall, which it has done, and people in Japan realize that it’s liable to continue and want to put their money abroad, then the fall may become like an avalanche.”

And it appears that incipient signs of ‘capital flight’ may have emerged.

The perspicacious analyst and fund manager Doug Noland writing at the Credit Bubble Bulletin may have spotted what seems as incipient adverse reactions from the yen’s devaluation[13].

And Japan’s move to follow the Fed down the path of 24/7 monetary inflation is a key facet of the “global government finance Bubble” more generally. Japanese institutions were said to be major buyers of European bonds this week. French 10-year yields dropped 24 bps Thursday and Friday to a record low 1.75%. French yields were down about 50 bps in five weeks. Spain’s 10-year yields were down 32 bps points this week to 4.73%, and Italian yields sank 39 bps to 4.37%. Ten-year Treasury yields were down 12 bps in two sessions to end the week 14 bps lower at 1.71%. No Bubble?

One has to realize that every crises dynamics begins from the periphery to the core. If the Japan’s capital flight dynamics will intensify overtime, then a debt or currency crisis will befall on Japan, sooner rather than later. Such a crisis will slam the region hard.

And if the account where Japanese institutions have been major buyers of Euro bonds have indeed been accurate, then this would seem like the proverbial jump from the frying pan into the fire…a sign of desperation.

Seeking refuge via euro debts represents a dicey proposition.

I recently showed how the Spanish government has essentially employed Ponzi finance to survive their welfare state[14]. Aside from raiding of pension accounts, which signifies as a key source of the people’s savings, profits from trading arbitrages by the Spain’s government have become a key source of funding welfare obligations. Thus, central bank policies are likely to concentrate on propping up asset prices in order to sustain these political objectives or risks bankrupting the welfare state.

And any sign of trouble that would undermine asset markets will prompt for central banks to intervene.

The extended economic stagnation or recessions in the Eurozone as evidenced by record high unemployment[15] has prompted the markets to speculate that ECB’s Mario Draghi may consider further lowering of interest rates[16].

The growing desperation by governments to seize private sector savings directly—via unsecured deposits in Cyprus[17]—or indirectly—via Kuroda’s ‘Abenomics’ or aggressive inflationism extrapolates that faith on the current fiat based money and banking system will erode overtime.

Financial repression will only hasten the structural economic entropy borne out of the incumbent political system.

The Japanese government has been using the same Keynesian snake oil over and over again and yet has been expecting different results.

They aggressively cut interest rates between 1991-1995 and pursued zero bound rates ever since. They implemented 10 fiscal stimulus packages costing more than 100 trillion yen in taxpayer money, none of which have lifted Japan’s economy from the rut. Japan’s government switched to quantitative easing in 2001.

In August 2008, Japan’s government made another 11.5 trillion in stimulus, which consisted nearly of 1.8 trillion of spending and 10 trillion of loans and credit guarantees. In 2009 the BoJ embarked on new asset purchase program covering corporate bonds, commercial paper, exchange-traded funds (ETFs), and real estate investment trusts (REITs). From December 2008 through August 2011, the BoJ’s 134.8 trillion yen purchases of government and corporate securities failed to impact “inflation expectations” according to an IMF paper authored by Raphael Lam.

And thus, according to former Mises Institute President and now Senior Editor of Laissez Faire Books[18],

For more than two decades, the Japanese central bank and government have emptied the Keynesian tool chest looking for anything that would slay the deflation dragon. Reading the hysterics of the financial press and Japanese central bankers, one would think prices are plunging. Or that borrowers cannot repay loans and the economy is not just at a standstill, but in a tailspin. Tokyo must be one big soup line.

So what the mainstream reads as a coming miracle will lead to the opposite.

Yet the pressing problem for the marketplace today is that all these cumulative disruptive actions will translate to distressing intensification of market volatilities that will be manifested through capital flight and through yield chasing dynamics.

While price inflation has substantially been offset by productive activities of globalization and innovation, boom bust cycles will reduce productivity, increase systemic fragility to crises and promote social upheaval through revolutions or wars. In addition loss of productivity means greater sensitivity to price inflation.

Exploding prices of the “virtual or digital currency”, the bitcoin looks like a testament to the growing capital flight-yield chasing phenomenon at work[19].

Yet more predatory financial repression policies will mean more capital flight and yield chasing.

Unless external shocks—possibly such as the potential deterioration of geopolitical US-North Korea standoff into a full-scale military engagement—any slowdown for the Phisix will likely be limited and shallow, as the manic phase or the credit fuelled yield chasing process induced by domestic policies (artificially low interest rates and policy rates on special deposit accounts[20]) will likely be compounded by capital flight from developed nations as Japan. 

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[1] US Federal Reserve Press Release September 13, 2012

[2] Danske Bank Weekly Focus ECB to dig further in the toolbox, April 5, 2013

[3] John Murphy Weak Commodities Hurt Producers stockcharts.com Blog April 6, 2013

[4] Guardian.co.uk Malaysia heads for general election April 3, 2013

[5] Wikipedia.org Malaysian general election, 2013

[6] See Thailand’s Officials Flexes Muscles on Domestic Stock Market Bubbles March 25, 2013

[7] St. Louis Federal Reserve U.S. Financial Data M2

[8] Center for Financial Stability FED POLICY DRIVES EQUITIES: CFS MONEY SUPPLY STATISTICS March 20, 2013

[9] See Video: Kyle Bass on Kuroda’s Doubling of Monetary Base; Japan’s Debt Trap, April 5, 2013

[10] See BoJ’s Kuroda’s Opening Salvo: 7 trillion yen ($74 billion) of Bond Purchases a Month April 4, 2013

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

[12] Bloomberg.com Japan’s New Stimulus May Trigger Yen Avalanche, Soros Says April 5, 2013

[13] Doug Noland Kuroda Leapfrogs Bernanke Credit Bubble Bulletin April 5, PrudentBear.com

[14] See Spanish Government’s Ponzi Financing Scheme April 5, 2013

[15] Bloomberg.com Euro-Area Unemployment Rises to Record 12% Amid Slump April 2, 2013

[16] Wall Street Journal Europe's Banker Hints at Rate Cuts

[17] See Cyprus: The Mouse that Roared March 25, 2013

[18] Douglas French Japan’s Bold Move of Nothing April 6, 2013 Laissez Faire Club

[19] Bitcoin charts

[20] See Phisix and the BSP: This Time is Different? March 17, 2013

Bear Market in Commodities Isn’t Bullish for Stocks

The Bloomberg reports that commodities have entered a bear market, (bold emphasis mine)

Commodities tumbled into a bear market as U.S. reports on manufacturing, jobless claims and home sales signaled a faltering economy after the Federal Reserve refrained from announcing another round of stimulus.

The Standard & Poor’s GSCI Spot Index of 24 raw materials fell 2.8 percent to settle at 559 at 3:56 p.m. New York time. The gauge has dropped 22 percent from this year’s highest close of 715.52 on Feb. 24, entering a bear market. Earlier, the measure touched 558.14, the lowest since November 2010. Metals and energy led today’s slump.

Manufacturing in the Philadelphia region contracted in June at the fastest pace in almost a year. Existing U.S. home sales fell more than forecast by analysts, and jobless claims topped estimates. Yesterday, the Fed, led by Chairman Ben S. Bernanke, reduced its 2012 forecast for economic growth, and policy makers decided against a third round of debt purchases.

“We got nothing significant from Bernanke, and data continues to paint a horrible picture,” said Steve Mathews, the chief investment officer of Flintlock Capital Asset Management LLC in New York, which manages $105 million of assets. “We have to wait until the next Bernanke event to know if the Fed will indeed do something to perk the economy.”

The GSCI index surged 92 percent from the end of December 2008 to June 2011 as the Fed kept borrowing costs at a record low and bought $2.3 trillion of debt in two rounds of so-called quantitative easing.

Let me put the the news into the proper perspective. Slackening economic developments in the US only aggravates the already existing weak conditions around the world.

As pointed out earlier, China’s markets continue to tumble on fresh accounts of sluggish manufacturing. This in spite of the recent tepid inflationist policies in ‘support’ of China’s economy (it’s really not the economy but the cronies).

Bear market in commodity prices (GTX) has more been consistent with actions of China’s Shanghai index (SSEC) than the US S&P 500 (SPX).

Add to the mix the Euro crisis, dwindling growth of emerging markets and most importantly, the seemingly irresolute or halfhearted central bankers, such as the US Federal Reserve’s miserly extension of Operation Twist, who may be tacitly wishing for a crash to justify their interventions, you’ve got a recipe for a reversal in expectations.

A reversal in expectations will mean bad news IS bad news.

Let me repeat what I have been warning about and what I said yesterday,

If GLOBAL political agents will continue to withhold steroids from the steroid-starved or stimulus-addicted financial markets, expectations will likely reverse soon.

And that reversal could be swift, deep and dramatically violent.

“We got nothing significant from Bernanke” are signs of growing demand for REAL actions and increasing frustrations with current set of political actions. The allure of promises appears to be fading.

This also implies of the possible inflection of market’s expectations on mere pledges and guarantees.

So seen from both the dimensions of consumption or from monetary inflation, a bear market in commodities cannot be bullish on (steroid dependent) global equities (including the Phisix).

Be very careful out there.

Navigating Today’s Market Volatility: A Bird at Hand is Worth Two in the Bush

Current developments appear to have validated my projections. While I really don’t do short term predictions, I must admit to be lucky on this call.

I will be working from my outlook and recommendations of last week

Here is what I wrote[1],

And any further weakness in commodity prices will likely filter into the asset markets…

For the Phisix, the current resiliency by the heavy caps has been a noteworthy auspicious development. Yet we should not discount the likelihood of a contagion from any adverse exogenous events.

My inclination is that based on the above evidences and in the understanding that NO TREND GOES IN A STRAIGHT LINE, the Phisix will likely undergo a correction or profit taking phase.

This retrenchment, perhaps 5-10% from the peak or a low of 4,800, should be seen as healthy and normal. Should this be realized then the local benchmark will likely drift rangebound.

Of course external developments will play a big role in either confirming or falsifying this.

The retrenchment turned out exactly as described last week, albeit too fast and too soon.

The accelerating decline of the broad based commodity market, as measured by the CRB (behind), apparently dragged the Phisix substantially lower (candle).

The local benchmark slumped by a ghastly 5.4% in just one week! And the Phisix has lost about 8% from the peak and is just over 1.6% away from the 4,800 level. Year to date the Phisix is still up 11.61% as of Friday’s close.

It must be noted that the CRB has been on a downtrend since May of 2010. But following the temporary rebound which peaked this March, the rate of the recent decline has somewhat paralleled the intensity of the selloff in September-October 2011, in scale but not in timeframe.

The commodity rout then coincided with the short term massacre of global equities.

The seeming effect of today’s commodity slump appears to resonate with that of 2011, global stock markets have been clobbered.

It should be noted that factors driving the volatility of 2011 and today’s market stress has been different. And a further question is how long would this thrashing last?

In perspective, the decline of the Phisix signifies a worldwide dynamic that covers developed markets, the BRIC and the emerging markets.

Last week’s carnage has been no different with our ASEAN contemporaries.

Aside from the Phisix which posted the largest loss for the week, Indonesia’s JCI (green), Thailand’s SET (yellow) and Malaysia’s FBMKLSI (red) likewise hemorrhaged down by over 3% this week.

More from last week’s letter

Yet I am LESS inclined to believe that a new high for the Phisix will be reached soon. Such should be until major central bankers will have announced their renewed support for the markets or if there have been conspicuous signs that they have been operating behind the curtains…

So far, the fact is, that the damage seen in the market internals will have to be remedied first…

The good part is that the much of the selloff has been locally driven which unfortunately has affected many momentum participants. Yet foreign buying remains net positive in spite of the carnage and may have provided cushion to the heavyweights…

Finally in the expectation of the possibility of the non-participation of central banks until June or after, this means greater volatility ahead in both directions.

In fact, the damage to the general market seems to have intensified.

Previously, the concentration of the losses had mainly been in mid-tier and peripheral issues. Last week, seller’s wrath encompassed the Phisix major heavyweights.

Volatility has indeed been seen in both directions.

Except for Thursday bounce which reduced the overall impairment of this week’s market breadth as shown above, the broad corrosion of internal market activities over the past 2 weeks has practically chimed with the ferocity of losses endured by the major benchmark the Phisix.

Despite the drubbing, sectoral rotation seems to have been evident last week as the distribution of losses rotated.

The major loser from last week’s funk, the Mining index was this week’s least injured.

On the other hand, last week’s second outperformer the Holding index, suffered most.

Foreign sentiment seemed to have also soured.

This week, foreign activities showed modest NET selling, which may have likewise been reflected on the local currency the peso, which lost 1.6% this week.

For almost every instance where the Phisix (red) encounters major downturn, the Peso fumbles along with it (green oval).

Yet this should not been as isolated to the local currency, but seen as a REGIONAL dynamic.

The year to date chart of the Bloomberg JP Morgan Asian dollar index[2] has exhibited the same degree of pressure as the peso

On the other hand, the US dollar has once again served as the lightning rod during market shocks.

My concluding statement of last week…

Investors may raise their cash balance during rallies and buy on every episodes of panic. And in the event that any one of the major central banks declares the next steroid (the size should matter), then our strategy shifts to buy high, sell higher.

All the evidences provided above suggest that for any material recovery to occur, market internals would have to settle or immensely improve from the current conditions.

Also while there will surely be intermittent rallies emanating from vastly oversold conditions, the path of least resistance for local equities, for the moment, seems tilted to the downside until proven otherwise. I am not sure if the 4,800 level will hold.

From this point of view, to improve on what I earlier wrote, while investors may raise cash balance during rallies, buying should be done lightly on select episodes of panic.

Again such position should be maintained until we see stability in the actions of the Phisix, which must be accompanied by an improvement of market internals.

Of course, since the Phisix has been externally influenced, any improvements must be compatible with developments abroad.

And since investments are about managing economic opportunities, then there would be time for profit, and there would also be time for wealth preservation.

Until we see marked progress in price trends, market internals and actions in overseas markets, for now, a bird at hand seems better than two in the bush.

Said differently, an overweight on cash position seems to be the most prudent option in negotiating with today’s tumultuous road.

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[1] See Phisix: The Correction Phase Cometh, May 14, 2012

[2] Bloomberg.com Bloomberg JP Morgan Asia Dollar Index Chart

Global Equity Market’s Inflationary Boom: Divergent Returns On Convergent Actions

Since I’ve already lain out my expectations and projections[1], and with little changes in the global political and economic landscape; all that is required is to simply monitor how my stated themes have been playing out.

Global Markets Still on a Bullish Juggernaut, Expect Profit Taking Anytime

The blazing start for the year 2012 for global equity markets continues.

So far, this has been a “free-for-all” environment for global equity markets as stock markets from developed to emerging to frontier markets seem to be furiously galloping for the top spot.

Argentina and the Philippines, whom were the early leaders[2] have fallen back and have been surpassed by newcomers Turkey, Vietnam, Greece and Venezuela. The latter have joined the recent leaders of the pack, particularly Egypt, Germany, Russia, India, Austria and Peru.

And six weeks into the year, based on nominal local currency returns, the gains have been an eye-popping 15% and more for the frontrunners!

While the local bellwether the Phisix racked up a fantastic 9.41% such advances has not been enough to keep in pace with the current pack of leaders. But this is understandable, the Phisix and ASEAN markets are trading at record highs or near record highs, whereas most of the leaders are coming off from the recent lows.

And another noteworthy observation is that the credit easing operations by the European Central Bank (ECB) at the Eurozone has led Greece and Germany and other European bellwether to outperform. But again, while the region has posted gains in general, the scale of advances has been variable. Again this seems to underscore the relative effects of monetary inflation.

For instance, Greece’s outperformance may be due to the market’s factoring in of the bailout deal[3]. For Germany, in spite of the ephemeral stabilizing effect brought by the ECB’s Long Term Refinancing Operations (LTRO) to the financial markets, investors have reportedly been stuck with placements to German bunds[4] due to lingering uncertainty over the success of the current bailout measures. My guess is that aside from the bund, part of the money from LTRO operations have percolated into Germany’s equities.

Local currency gains can be misleading too. While Venezuela posted 13.73% returns y-t-d, statistical inflation rate has been about or nearly double the returns (see chart[5]) which implies of negative real returns on equity investments.

This also infers that Venezuela’s stock market has mostly been reflecting on the state of their currency’s (Bolivar) chronic disorder, an outgrowth of socialist policies gone haywire, which of course can hardly be explained by either earnings or economic growth.

Going back to the global equity market backdrop, of the 71 bourses I track only 14% are in the red. Most of the issues that are NOT on my screen are from Middle East and North Africa (MENA) and from Central Asia, if time permits I will eventually include these benchmarks.

In Asia, aside from Vietnam, India and the Philippines, the other top gainers have been Hong Kong, Taiwan, Korea and Thailand where gains have ranged from 8-13% over the same period.

Among major ASEAN bourses, there has been a widening gap between the outperformers Philippines-Thailand and this year’s laggards Indonesia-Malaysia. The latter pair has registered measly gains of just over 2%. Such divergence would seem anomalous considering their previous tight correlations of the four bourses.

Yet if such tight correlations should continue, then we should expect either the latter pair to do some sizable catching up or for the former pair to retrace. Otherwise, current actions may signal a departure from the previous relationship.

Meanwhile, Vietnam’s recent surge can be traced to central bank policies too. Interest rates on local currency loans had been cut by 2%[6] which constitutes part of the series of cuts recently made by the Vietcombank. This is aside from recently granted subsidized rates for politically preferred industries made by state owned Bank for Investment and Development of Viet Nam (BIDV)

The big picture matters.

Looking at chart actions should give us a better handle on the current situation.

One does NOT need to rely on technical indicators to see how overbought global markets have been, given that price actions for the FTSE World (FAW), the US S&P 500 (SPX), Europe’s Stoxx 50 (Stox50) and Asia’s Dow Jones Asia Pacific Index (P1DOW) have risen nearly at an angle of 45 degrees with hardly any breathing spell.

The US equity markets, represented by the S&P, appears to have assumed the role of the du jour leader for global equity markets and now trades at the resistance levels (blue horizontal line).

On the other hand, the contemporary benchmarks of the Europe and of Asia remains way below their respective resistance levels.

Notice too how tightly correlated the major global markets have been when based on the seeming symmetry in the undulations of each of the chart actions above.

The point that requires emphasis is that while nominal gains accrued have been relatively diverse, price movements seems have been synchronized. These actions essentially serves as manifestations of the relative effects of inflation which magnifies on the inflationary boom being experienced by global equity markets and the ‘globalization’ of stock market price actions.

Divergent returns on convergent actions primed by a highly inflationary backdrop.

The supercharged and largely overbought global markets have yet to encounter a cyclical countertrend or a natural profit taking cycle.

So while the inflationary push on financial assets may continue over the interim, we should expect profit taking to take place anytime. And global markets will likely embrace any negative developments as an excuse to justify such actions.

However, any profit taking will likely be characterized by short term impact at a modest scale.

More Confirmation Signs of Phisix’s Inflationary Boom

Manifestations of the inflationary boom in global markets seem to be equally evident in the local Philippine Stock Exchange.

My hunch for a boom on capital intensive or capital goods industries (as seen in the property sector and energy sector, aside from the mining sector), as well as, in the banking and financial sector, as funding intermediaries, seem to come to fruition.

As I previously wrote[7],

I am predisposed towards what Austrian economics calls as the higher order stages of production or the capital goods industries, which are likely the beneficiaries of the business cycle, specifically, mining, property-construction and energy, as well as financials whom are likely to serve as funding intermediaries for these projects.

Also, market leadership seem to be rotating away from the former leader the mining sector. The levelling of gains through the broader market appears to be reinforcing the bi-annual outperformance of the mines as I previously noted[8].

Yet index watching may not tell of the entire story too.

The gains of the holding index, which placed third, have likely been due to exposure by the mother companies of Ayala Corporation and SM Investments to their sizzling hot subsidiaries in the property and or the financial sector, while the rest of the holding sector has lagged.

Also while price actions of the mining titans seem to have faltered which has led to the retracement of the mining index, the market’s attention has palpably shifted to the peripheral issues.

To cite some examples of mining component issues on a year-to-date basis, Manila Mining has been up 26.67%, Nickel Asia 17.6%, NiHao Mineral Resources 136% (!!!), Geograce Philippines 67.9% (!!), Apex Mining 37.5% (!), Omico Corporation 15.2%, Oriental Peninsula Resources 48.6% (!!) and oil issues Oriental Petroleum A 31.25% (!) and The Philodrill Corporation 45.45% (!!).

In short, the market’s attention for the mining issues remains intact except that the focus has shifted from the core to the periphery.

Going back to the internal market activities of the PSE, for 2012, through the week ending February 10^th, the Phisix has corrected only once in 6 weeks.

Since the last correction, which was about two weeks ago, the local benchmark has been in consolidation.

So even as the bulls appear to be in a temporary lull, the daily Peso volume traded (averaged on a weekly basis) which has meaningfully improved, appears to have peaked.

In the meantime, advance-decline spread (averaged weekly) seems to be narrowing, following a lopsided surge which has favored the bulls.

Also for the first time this year, foreign trade posted a net selling last week.

I would see these as potential signs of a coming profit taking mode.

But there is an important caveat. In a bullmarket, overbought conditions can remain extended for a certain period of time. Therefore predicting short term moves can be tricky.

Although we can’t discount and should expect a normal countercyclical trend or a correction anytime, any profit-taking shouldn’t be seen as an end to the current momentum, as these would again, likely signify a short-term event with a modest impact (unless external factors will sharply deteriorate)

Besides, as recently exhibited by the market’s internal dynamics, corrections may imply a decline of the benchmark heavyweights but not necessarily reflecting the motions of the overall markets.

To the contrary, the rotational dynamic may likely continue; whether the market’s attention will shift in distributing gains among sectors or among issues within a particular sector.

At the end of the day, easy money policies in the Philippines and abroad will likely lend support to the cause of the bulls.

Inflationary Boom in the Real Economy

I’d further add that the inflationary boom can be seen in in the real economy as systemic credit growth has surged remarkably where the rate of growth of commercial bank lending in the Philippines has doubled in 2011 from 2010.

According to the Manila Bulletin[9]

The total outstanding loans of commercial banks went up by 19.3 percent at the end of 2011, higher than 2010 growth of 8.9 percent and reflecting a robust growth in the real sector.

Growth in commercial loans was across the board. All posted double digit growth led by mining/quarrying loans (60.1%), wholesale and retail trade (57.8%), electricity/gas/water (54.2%), real estate/rending/business services loans (25.2%), construction (22.3%) and financial intermediation (16.8%).

Statistical categorization can’t be relied on though. As in the latest Bangladesh experience[10], many loans labeled as ‘industrial’ were rechanneled to other undertaking, particularly to the stock market. The monetary tightening by the government put an end to yield chasing activities which prompted for last year’s crash that even spawned a political turmoil.

The next very crucial point is policy induced negative real rates seem to be driving the public to take on more credit driven activities. What the mainstream and the media sees as ‘healthy developments’ are in reality nascent indications of malinvestments and the implicit promotion of consumption activities.

As German economist and honorary professor Thorsten Polleit[11] explains (italics original)

The artificial lowering of the market interest rate induces additional investment. At the same time, savings decline and consumption increases. As a result, the economy starts living beyond its means. The boom is inflationary: all that has increased is the amount of money, not the supply of the means of production, such as labor and land.

The boom is economically unsustainable, because the policy-induced deviation of the market interest rate from the neutral interest rate causes malinvestment. Firms embark upon capital-intensive investment projects, and production becomes more time consuming, or roundabout.

The lengthening of the production structure implies a rise in the production of capital goods at the expense of consumer goods. The artificially suppressed market interest rate thus induces firms to engage in a kind of production that does not correspond to actual demand. As soon as this is revealed, the money-driven boom turns into bust.

Again piecing up the pieces together, we are seeing more evidence of an inflationary boom or the Austrian business cycle or the boom bust cycle at work which has been influencing the actions in the financial markets, as well as, in real economic activities.

Expect More Monetary Inflation Ahead

Central banks of developed economies have continued to telegraph aggressive expansions of their balance sheets directly or indirectly.

The Bank of England (BoE) announced a £50 billion increase[12] of their bond purchases over the next 3 months.

The European Central Banks will be offering the second tranche of their Long Term Refinancing Operation (LTRO) by the end of February[13] where ECB President Mario Draghi urged banks to avail of this facility.

The ECB may be adapting more eligible form of collateral to accommodate more banks in the upcoming LTRO.

According to the Danske Research[14],

The ECB has approved proposals relevant for acceptance of additional credit claims as collateral in the credit operations put forward by seven central banks, namely Central Bank of Ireland, Banco de España, Banque de France, Banca d’Italia, Central Bank of Cyprus, Oesterreichische Nationalbank and Banco de Portugal (see national central banks for further details). The other national central banks are working on preparing similar proposals for temporary approval of credit claims as collateral. The broadening of the collateral base can potentially increase the usage of the second LTRO substantially compared with the first one.

Draghi refrained from giving any estimate on the expected usage of the upcoming threeyear LTRO. It was clear that Draghi was comfortable about the substantial market relief following the introduction of the three-year LTRO. We expect banks to take around EUR300-600bn at the 3Y LTRO. According to Reuters, forecasts now range from EUR75bn to EUR800bn and there is still talk of EUR1tr. We expect banks to take around EUR300-600bn

LTRO’s serve not only as free money, but as opportunities for the banking system to offload toxic assets to the ECB. The banking system will oblige on Draghi’s call.

Next politicians have been pressuring the Bank of Japan (BoJ) to ease further or face a revision of the BoJ law[15] in order to “give the government more room to intervene in monetary policy”. This is an example of the sham in the so-called central banking independence.

Central banks are politically influenced directly or indirectly. The BoJ will be stepping on the QE gas pedal. Yet, if Japan’s government manages to remold on the BoJ law which gives Japanese politicians the space to intervene directly, then the yen will be faced with greater risk of hyperinflation.

Acting chairman of the Swiss National Bank, Thomas Jordan, also vowed to continue with currency intervention[16] through quantitative easing if deemed required by the technocracy.

Moreover, a purported $26 billion foreclosure deal[17] by the US government with various states and the 5 biggest banks appear to be parcel to US Federal Reserve chairman Ben Bernanke’s repeated pronouncements of QE 3.0 targeting mortgages[18] which could serve as a backdoor bailout of the privileged “too big to fail” banks[19].

Around the world this week, three central banks slashed rates (Belarus and Indonesia[20] as well as Vietnam). This further adds to the negative real rates environment that should be supportive of the asset markets.

Commodity prices have risen but returns have varied. Gold has led the recovery followed by the industrial metals (DJAIN) and the energy index (GJX). Agriculture prices have trailed (GKX). Nonetheless, world food prices have reportedly reached the highest level in 11 months[21].

With commodity prices not as responsive relative to gains of financial asset markets, this will be seen by central bankers as windows of opportunities for the deployment of more credit easing programs.

So any correction must be seen as an opportunity to accumulate as all these money printing will have to flow somewhere.

Finally while I have been emphasizing that interest rates will serve as a major gauge on monetary conditions, interest rates won’t be a one-size-fits all solution in predicting cyclical inflection points.

As I have pointed out in the past[22],

interest rates will most likely determine the popping of this bubble where interest rates may be driven by any of the following dynamics, changes in: 1) inflation expectations 2) state of demand for credit relative to supply 3) perception of credit quality and or 4) of the scarcity/availability of capital.

Plainly put, different circumstances will influence interest rate prices distinctly. This also means varying impacts on the financial markets. Thus identifying the cause of interest rate conditions will matter. The yield curve will matter. Actions in several credit markets (CDS, TED Spread, Libor-OIS) will matter. The correlations with other interconnected markets will also serve as other pivotal factors.

Since markets represent human actions, they are a complex dynamic. Thus aggregate based analysis or heuristics paraded as economic reasoning can be fatal.

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[1] See What To Expect in 2012, January 9, 2012

[2] See Global Equity Markets: Philippine Phisix Grabs Second Spot, January 14, 2012

[3] Reuters.com Greece set to agree bailout as Germany demands action, February 12, 2012

[4] Bloomberg.com ECB Cash Fails to Wean Investors Off German Debt: Euro Credit, February 10, 2012

[5] Tradingeconomics.com Venezuela Inflation Rate

[6] Vietnamnews.com Banks flirt with low interest rates February 11, 2011

[7] See Phisix-ASEAN Equities: Awaiting for the Confirmation of the Bullmarket, November 13, 2012

[8] See Graphic of the PSE’s Sectoral Performance: Mining Sector and the Rotational Process, July 10, 2011

[9] Manila Bulletin Loans Grow 19.3% In 2011 February 9, 2011 mb.com.ph

[10] See Bangladesh Stock Market Crash: Evidence of Inflation Driven Market, January 11, 2011

[11] Polleit, Thorsten The Cure (Low Interest Rates) Is the Disease, April 5, 2011, Mises.org

[12] See Bank of England Adds 50 billion Pounds to Asset Buying Program (QE), February 9, 2012

[13] Reuters.co Euribor rates fall after ECB urges banks to tap LTRO, February 10, 2012

[14] Danske Research Flash Comment ECB meeting: looking intensively at credit tightening risk, February 9, 2012

[15] Reuters.com BOJ may consider action next week as political pressure mounts, February 10, 2012

[16] Financial Times Jordan vow to continue SNB intervention, February 2, 2012

[17] New York Times, States Negotiate $26 Billion Agreement for Homeowners, February 8, 2012

[18] Bloomberg.com Bernanke Doubles Down on Fed Bet Defied by Recession: Mortgages, January 20, 2012 Businessweek.com

[19] Newsmax.com David Stockman: Obama Mortgage Refinance Plan is 'Crony Socialism' February 8, 2012

[20] Centralbanknews.info Monetary Policy Week in Review - 11 February 2012, February 10, 2012

[21] See Inflation Watch: World Food Prices Jump Most in 11 Months February 9, 2011

[22] See I Told You Moment: Philippine Phisix At Historic Highs! January 15, 2012