Phisix: Holiday Abridged Sessions Unlikely an Obstacle to the Year End Rally

Methodological Individualism Applied to Holiday Shortened Trading Sessions

Trading sessions will be limited to just three days in the coming week as two days have been declared as public holidays by the Philippine government in the tradition of paying homage to the dead.

Since not everyone practices the tradition, others have used such occasion for leisure and travel.

Yet such extended holidays are likely to divert the attention of market participants on how and what to do during the mandated respite from work.

When markets are on a vacation mode, I expect trading activities to slowdown which may be reflected on Peso volume (excluding block and special block sales).

But lethargic trading does not necessarily reduce volatility.

For the past two years, holiday abbreviated weeks with three day trading sessions have posted substantial over 1% moves

*Aug 29 and 30 in 2011, Eidul Fitr and National Heroes Day[1]

**August 20 2012 Ninoy Aquino Day (Replaced to Monday)[2]

The same goes with All Saint’s Day week celebrations since 2007.

The natural intuition for the mainstream would be to impute from the above facts statistical correlations and or to seek out patterns from which to project into the future.

For instance, it would be easy to deduce of the dominance of negative returns by simple observation and the employment of heuristics without examining the operating conditions which had led to such outcomes

Let’s say, the -1.43% from November of 2011 came amidst the oversold bounce from the flash September market meltdown, as most likely an offshoot to the US Federal Reserve chairman Ben Bernanke’s jilting of market’s expectations of QE 3.0[3]

The other instances have shown to be responses to what seems as short term overbought conditions (in April and August 2012 marked by blue arrows) following new highs.

Thus, losses from Holiday shortened week have most likely accounted for profit taking.

Nonetheless the losses from the above incidentally marked the interim bottoms which eventually led to milestone highs.

Or how about the negative output during November’s of 2007 and 2008? The unfolding bear market cycle during the said period can serve as convenient explanation.

Today, considering that the Phisix has just been marginally off the record highs, along with the ASEAN peers, this means that price volatility can go in either direction.

On the downside, profit taking, possibly to fund vacations, leisure or traditional activities, could partly explain why the proclivity for negative returns.

On the upside, aggressive participants may take advantage of any new information that could eclipse such profit taking activities that may push the market higher.

In essence, there are no linear and clear cut answers to such short term events

What this implies is that even if the week’s results should turn out negative, this may not be suggests of an inflection point as the general market trend remains on the upside. This is unless of course, exogenous tail risk events may rattle the highly interconnected and intercorrelated global markets and gets transmitted to the ASEAN equity markets and to the Phisix.

The bottom line is that it would signify a serious mistake to perceive history as mechanically repeating itself for the simple reason that history is a complex phenomenon.

History as factual episodes represents heterogeneously embedded unique circumstances as consequence to “multiple causes” where “none of the factors are in constant relationship with the others” [Rothbard 1976[4]].

This also means that historical facts, according to the great Austrian Professor Ludwig von Mises[5], “cannot be used as building material for the construction of theories and the prediction of future events. Every historical experience is open to various interpretations, and is in fact interpreted in different ways”.

This also implies that while history can give us some clues, it is the understanding of science of human actions which is most important.

Again Professor Mises from the same material[6]

The subject matter of all historical sciences is the past. They cannot teach us anything which would be valid for all human actions, that is, for the future too. The study of history makes a man wise and judicious. But it does not by itself provide any knowledge and skill which could be utilized for handling concrete tasks.

Author Samuel Langhorne Clemens popularly known as Mark Twain[7] nailed it when said ‘history does not repeat itself, but it does rhyme’.

Financial Markets Are Now About Bernanke Put

Some have expressed alarm over the recent downside volatility seen in the overseas markets.

It’s all about framing, I’d say.

This week’s retracements (blue bar) seem to be in response to last week’s gains (red bars). While the degree of price changes has been different from last week to the other week, the scale of volatility has been evident. Heightened volatility from market distortions brought about by interventionism has been the crux of the current market environment.

Yet for some, declining US markets serves as a reason for concern.

The S&P 500, which I use as a key benchmark for the US markets, have lost 1.48% this week. Add to such loss the current level of the S&P 500, which represents nearly 4% loss from the most recent or September peak, we have a short term bear market story.

But there is the other view; year-to-date the major US benchmark has still been robustly up 12.27%. This remarkable advance by the US markets as exemplified by the S&P 500 has lubricated the outperformance of the Philippine Phisix and Thai’s SET and an animated global equity markets.

There are also those who claim that declining earnings will drive US markets lower.

But this concern seems valid when markets operated on merely the platform of the barrage of promises by the FED.

Expectations of the FED’s coming steroids provided the shot in the arm that produced a risk ON environment despite material signs of disconnect with the real economy or in terms of declining earnings and of the weakening of the economy[8].

Since promises are subject to diminishing returns, they are unsustainable. Rising markets based on empty talks simply increased the sensitivity to enormous downside risks or that this represents a recipe for a market crash.

Either trapped by their own policy signalling measures, or in the realization that failed expectations could bring chaos and relive the September 2011 flash meltdown, the FED and the ECB HAD to deliver.

And they DID. Both will be flooding the world with money to the preliminary tune of $2 trillion.

Add to this that this fact that it will not just be the FED-ECB but other major central banks as well. The Bank of Japan (BoJ) just joined the bandwagon with additional stimulus[9] while the Bank of England (BoE) has once again signaled its intent to expand her balance sheet further[10].

And most importantly, the US Fed Chairman Ben Bernanke made explicit that QE Forever/QEternity has been meant to sustain asset prices[11].

Many seem to forget that it is central bank actions that really matters since the market’s price mechanism has been skewered by their repeated interventionism.

Today’s risk environment has dramatically shattered conventional thinking. In a recent “Bagehot” lecture at the Buttonwood in New York City, PIMCO’s chief Mohamed El-Erian poignantly remarked[12]

What we are ultimately talking about is an “unusually uncertain” distribution of potential baseline outcomes, as well as unusually shaped tails. This inevitably undermines the robustness of lots of conventional wisdom, as well as a range of historical contracts and entitlements. It also challenges the agility of institutions in both the public and private sectors.

If corporate earnings have hardly been a factor in driving up market prices, then why should corporate earnings become a factor in marking down prices?

Earnings have recently become a matter of concern only after central bank’s rescue mechanism has been put in place. What this really shows is of the market dynamic of “buy the rumor sell on news”.

And given the reality of the slated expansion of money supply from central banks via asset purchases, this will also mean that sales revenues of enterprises will rise faster than the costs of business, where the latter has been incurred during the time prior to additional money infusions.

This implies that inflation creates the illusion of greater ‘corporate profits or earnings’, where the more the inflation, the greater the profit margins.

As financial analyst Kel Kelly explains[13] 

Another way of looking at it is that, with more money being created through time, the amount of revenues is always greater than the amount of costs, since most costs are incurred when there is less money existing. Thus, because of inflation, the total monetary value of business costs in a given time frame is smaller than the total monetary value of the corresponding business revenues. Were there no inflation, costs would more closely equal revenues, even if their recognition were delayed…

Since business sales revenues increase before business costs, with every round of new money printed, business profit margins stay widened; they also increase in line with an increased rate of inflation. This is one reason why countries with high rates of inflation have such high rates of profit. During bad economic times, when the government has quit printing money at a high rate, profits shrink, and during times of deflation, sales revenues fall faster than do costs.

This profit mirage from monetary inflation represents the ephemeral boom phase of business cycle.

Also as previously noted, the seeming recovery in the US real estate sector[14] will likely to be used as pretext to boost stock prices.

So far, the Dow Jones US Real Estate ($DJUSRE) and the iShares Real estate (IYR) along with Regional Bank Index (KRE) and the Philadelphia Bank Index (BKX) have all backed off from the recent highs. Although there has been little signs of any material deterioration,

Finally given the explicit goal by the FED to support asset prices via the “Wealth Effect” or Portfolio Balance Channel[15], any adjustments to the newly instituted QE Forever policies will likely be in accordance to the conditions of the financial markets.

In short, the Bernanke Put is in motion: conditions of the financial markets will dictate on the FED’s actions.

This also implies of the policy of redistributing resources from main street into the financial sector.

And any attendant tail risks will likely come from rising consumer prices (inflation risk) or the escalation of political squabbles e.g. the risks of growing secession movements in Europe[16] (political risks) or the recognition of insolvency of crisis afflicted nations or the lack of capital (credit risks), all of which will be manifested through interest rate channel.

How Interest Rate Regimes Affect Asian Stock Markets

Current easing policies by developed economies have translated into a boom through most of Asia.

That’s because most of Asia has mimicked their developed economy counterparts but from a lesser aggressive stance.

In the region, interest rate regimes can be categorized as[17]

-rate cuts in 2012: These include China, South Korea, Singapore, Thailand, Philippines, India, Pakistan and Australia

-previous rate changes prior to 2012, but remains on hold through 2012: These includes New Zealand who cut in 2011, Taiwan increased in 2010 until July 2011, Vietnam raised rates in 2010 until early 2011, Indonesia cut rates from last quarter of 2011 until January 2012 and Malaysia increased rates in mid 2011.

-increased rates in 2012: Bangladesh, Sri Lanka, Mongolia 

The relationship between interest rates and equity market performance has been striking.

Countries who cut rates in 2012 mostly outperformed: Pakistan, India, Philippines and Thailand. For those whose rates were unchanged, e.g. Malaysia, Indonesia and Taiwan, the benchmark equity performance has largely been the median.

The losers or the laggards are economies that have been raising rates: Bangladesh, Sri Lanka and Mongolia.

The Philippine central bank, the Bangko Sentral ng Piliipinas (BSP) appears to have succumbed to pressures from the external agents during the recent IMF-World Bank annual gathering by raising interest rates for the fourth time this year last week[18].

The BSP announced through Mr. Amando Tetangco that such measures were meant to “help ward off risks associated with weaker external demand by encouraging investment and consumption.”[19]

Consumption does not emerge from a vacuum. Consumption would need to be satisfied through exchange via division of labor that arises out of production.

This means production has to come from capital good investments which are financed by capital or through savings, and not from printing of money or digital creation of money.

As a reminder all economic growth stems from savings. According to the great Professor von Mises[20],

At the outset of every step forward on the road to a more plentiful existence is saving--the provisionment of products that makes it possible to prolong the average period of time elapsing between the beginning of the production process and its turning out of a product ready for use and consumption. The products accumulated for this purpose are either intermediary stages in the technological process, i.e. tools and half-finished products, or goods ready for consumption that make it possible for man to substitute, without suffering want during the waiting period, a more time-absorbing process for another absorbing a shorter time. These goods are called capital goods. Thus, saving and the resulting accumulation of capital goods are at the beginning of every attempt to improve the material conditions of man; they are the foundation of human civilization. Without saving and capital accumulation there could not be any striving toward non-material end

Inflationism, thus, only dilutes the purchasing power (even Lenin and Keynes recognized this[21]), as well as, creates economic imbalances that promote bubbles and social instability.

The BSP further admits that there has been increasing risks of price inflation through “impending electricity rate increases and rising global prices for some grains could upset the inflation outlook” but recklessly assumes that “subdued global demand should temper the overall picture by easing price pressures on oil imports”

But price inflation has been creeping upward[22] in spite of “subdued global demand” and falling Philippine exports[23]. Perhaps local monetary officials have yet to discover that there exists an economic phenomenon called stagflation—high price inflation, high unemployment and economic stagnation[24]--which dominated the 1970-80s

Nonetheless with diminishing recession risks from the US despite the recent corrections in the equity markets, explicit policy support from global central bankers led by FED-ECB on the financial markets, the still “benign” domestic price inflation, the deepening domestic negative real rates regime and the recently established momentum from the breakout, we should expect domestic financial markets (the Phisix, the Peso) to outperform at least until the year end unless external shocks will derail the above dynamics

We should also expect that sluggish commodity prices in the environment of near coordinated monetary easing implemented by almost every major economy to make an eventual rally, not entirely because of ‘consumption demand recovery’ but because of reservation demand[25] or the “demand to hold stock” or “hoard” out of anticipation of higher prices or greater use of the good or more exchange opportunities of the good for other goods.

Applied to the local stock market, stocks will rise barely because of conventional wisdom of earnings or economic growth, but because of the growing urgency to chase for yields, to gamble and to punt which all represent as products of the policy regime of negative real rates. And proof of such progression has been the growing incidences of miniature bubbles[26].

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[1] PublicHoliday.org Philippines 2011 Holidays Calendar

[2] PublicHoliday.org Philippines Holidays 2012 Calendar

[3] See Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms, September 22, 2011

[4] Murray N. Rothbard Praxeology: The Methodology of Austrian Economics Mises.org

[5] Ludwig von Mises 1. Praxeology and History Chapter II. The Epistemological Problems of the Sciences of Human Action, Human Action Mises.org

[6]Mises, Ibid

[7] Wikipedia.org Mark Twain

[8] See ECB-China Stimulus: Has the Risk ON Environment Returned? September 10, 2012

[9] see Bank of Japan Adds More Stimulus October 27, 2012

[10] Bloomberg.com King Says BOE Is Ready to Add to QE If U.K. Recovery Fades October 24, 2012

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

[12] Mohamed El-Erian Mohamed El-Erian's Bagehot Lecture From Buttonwood Minyanville.com October 24, 2012

[13] Kel Kelly How the Stock Market and Economy Really Work September 1, 2012 Mises.org

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

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

[16] Atlantic Sentinel Secessionist Movements Threaten Foundation of Europe, October 17, 2012

[17] Asian Bonds Online Asia Bond Monitor September 2012

[18] ABS-CBNNEWS.com BSP ready to ease policy rates anew – Tetangco October 14, 2012

[19] Inquirer.net Philippines trims key interest rates again October 25, 2012

[20] Ludwig von Mises 2. Capital Goods and Capital XV. THE MARKET Human Action

[21] See IMF’s Christine Lagarde Inflationist Delusions October 20, 2012

[22] Danske Bank Brighter global outlook but every rose has it thorns, Emerging Market Briefer October 15, 2012

[23] See I Told You So Moment: Philippine Exports Hit in August October 12, 2012

[24] Wikipedia.org Stagflation

[25] See Are Surging Oil Prices Symptoms of a Crack-up Boom? February 24, 2012

[26] See Will Frothy Bond Markets Drive the Phisix Higher? October 22, 2012

The Major Risk from Currency Union Breakups: Hyperinflation

At the Peterson Institute for International Economics, Mr. Anders Aslund has an interesting paper on the historical aftermaths of the dissolution of currency unions.

Mr. Aslund opens with a refutation of the Nirvana fallacy of the Keynesian prescription on the currency devaluation elixir. Here Mr. Aslund rebuts Nouriel Roubini. (all bold highlights mine)

While beneficial in some cases, devaluation is by no means necessary for crisis resolution. About half the countries in the world have pegged or fixed exchange rates. During the East Asian crisis in 1998, Hong Kong held its own with a fixed exchange rate, thanks to a highly flexible labor market. The cure for the South European dilemma is available in the European Union. In the last three decades, several EU members have addressed severe financial crises by undertaking serious fiscal austerity and reforms of labor markets, thus enhancing their competitiveness, notably Denmark in 1982, Holland in the late 1980s, Sweden and Finland in the early 1990s, all the ten post communist members in the early 1990s, and Germany in the early 2000s. Remember that as late as 1999, the Economist referred to Germany as “the sick man of the euro.”

More recently, the three Baltic countries, Estonia, Latvia, and Lithuania, as well as Bulgaria have all repeated this feat (Åslund 2010, Åslund and Dombrovskis 2011). Among these many crisis countries, only Sweden and Finland devalued, showing that devaluation was not a necessary part of the solution. The peripheral European countries suffer in various proportions from poor fiscal discipline, overly regulated markets, especially labor markets, a busted bank and real estate bubble, and poor education, which have led to declining competitiveness and low growth. All these ailments can be cured by means other than devaluation.

Mr. Aslund on the currency union dissolution during the gold standard eon.

It was rather easy to dissolve a currency zone under the gold standard when countries maintained separate central banks and payments systems. Two prominent examples are the Latin Monetary Union and the Scandinavian Monetary Union. The Latin Monetary Union was formed first with France, Belgium, Italy, and Switzerland and later included Spain, Greece, Romania, Bulgaria, Serbia, and Venezuela. It lasted from 1865 to 1927. It failed because of misaligned exchange rates, the abandonment of the gold standard, and the debasement by some central banks of the currency. The similar Scandinavian Monetary Union among Sweden, Denmark, and Norway existed from 1873 until 1914. It was easily dissolved when Sweden abandoned the gold standard. These two currency zones were hardly real, because they did not involve a common central bank or a centralized payments system. They amounted to little but pegs to the gold standard. Therefore, they are not very relevant to the EMU.

“Abandonment of gold standard” simply suggests that some members of these defunct unions wantonly engaged in inflationism which were most likely made in breach of the union’s pact that had led to their dissolution.

Mr Aslund tersely describes on one account of “successful” post gold standard breakup…

Europe offers one recent example of a successful breakup of a currency zone. The split of Czechoslovakia into two countries was peacefully agreed upon in 1992 to occur on January 1, 1993. The original intention was to divide the currency on June 1, 1993. However, an immediate run on the currency led to a separation of the Czech and Slovak korunas in mid-February, and the Slovak koruna was devalued moderately in relation to the Czech koruna. Thanks to this early division of the currencies, monetary stability was maintained in both countries, although inflation rose somewhat and minor trade disruption occurred (Nuti 1996; Åslund 2002, 203). This currency union was real, but thanks to the limited financial depth just after the end of communism, dissolution was far easier than will be the case in the future. In particular, no financial instruments were available with which investors could speculate against the Slovak koruna

It seems unclear why the Czech and Slovak experience had been the least worse or had the least disruption compared to the others.

Yet considering that inflation is a monetary phenomenon with political objectives, “limited financial depth” seems unlikely a significant factor the “success”. Instead it may have been that political authorities of the Czech and Slovak experience, aside from the “early division of currencies” which may have given a transitional time window, may have likely implemented some form of monetary discipline which lessened the impact.

Mr Aslund finds that the the incumbent European Union seems more relevant with three recent accounts of currency disintegration which had cataclysmic results.

The situation of the EMU is very different from these three cases. It has no external norm, such as the gold standard, and it is a real currency union with a common payments mechanism and central bank. The payments mechanism is centralized to the ECB and would fall asunder if the EMU broke up because of the large uncleared balances that have been accumulated. The more countries that are involved in a monetary union, the messier a disruption is likely to be.

The EMU, with its 17 members, is a very complex currency union. When things fall apart, clearly defined policymaking institutions are vital, but the absence of any legislation about an EMU breakup lies at the heart of the problem in the euro area. It is bound to make the mess all the greater. Finally, the proven incompetence and slowness of the European policymakers in crisis resolution will complicate matters further.

The three other European examples of breakups in the last century are of the Habsburg Empire, the Soviet Union, and Yugoslavia. They are ominous indeed. All three ended in major disasters, each with hyperinflation in several countries. In the Habsburg Empire, Austria and Hungary faced hyperinflation.

Yugoslavia experienced hyperinflation twice. In the former Soviet Union, 10 out of 15 republics had hyperinflation. The combined output falls were horrendous, though poorly documented because of the chaos. Officially, the average output fall in the former Soviet Union was 52 percent, and in the Baltics it amounted to 42 percent (Åslund 2007, 60).

According to the World Bank, in 2010, 5 out of 12 post-Soviet countries—Ukraine, Moldova, Georgia, Kyrgyzstan, and Tajikistan—had still not reached their 1990 GDP per capita levels in purchasing power parities. Similarly, out of seven Yugoslav successor states, at least Serbia and Montenegro, and probably Kosovo and Bosnia-Herzegovina, had not exceeded their 1990 GDP per capita levels in purchasing power parities two decades later (World Bank 2011).

Arguably, Austria and Hungary did not recover from their hyperinflations in the early 1920s until the mid-1950s. Thus the historical record is that half the countries in a currency zone that breaks up experience hyperinflation and do not reach their prior GDP per capita as measured in purchasing power parities until about a quarter of a century later, which is far more than the lost decade in Latin America in the 1980s.

The causes of these large output falls were multiple: systemic change, competitive monetary emission leading to hyperinflation, collapse of the payments system, defaults, exclusion from international finance, trade disruption, and wars. Such a combination of disasters is characteristic of the collapse of monetary unions.

Why hyperinflation poses as the greatest risk for the disintegration of the fiat money based currency unions?

A common reflex to these cases is to say that it was a long time ago, that things are very diferent now, and that other factors matter. First of all, it was not all that long ago. Two of these economic disasters occurred only two decades ago. Second, hyperinflation was probably the most harmful economic factor, and it is part and parcel of the collapse of a currency zone, regardless of the time period. About half of the hyperinflations in world history occurred in connection with the breakup of these three currency zones. The cause was competitive credit emission by competing central banks before the breakup. Third, monetary indiscipline and war are closely connected. The best illustration is Slovenia versus Yugoslavia. In the first half of 1991, the National Bank of Yugoslavia started excessive monetary emission to the benefit of Serbia. On June 25, 1991, Slovenia declared full sovereignty not least to defend its finances. Two days later, the Yugoslav armed forces attacked Slovenia (Pleskovic and Sachs 1994, 198). Fortunately, that war did not last long and Slovenia could exit Yugoslavia and proved successful both politically and economically

Again since inflationism essentially represents monetary means to attain political ends, previous accounts of hyperinflation in post currency union dissolution may have been a result of policy miscalculations from political leaders trying to attain the illusory positive effects from devaluation.

Or most importantly or which I think is the more relevant is that in absence of access to local and foreign savings through banking or financial markets, political authorities in pursuit of their survival have resorted to massive money printing operations.

Also since hyperinflation means the destruction of division of labor or free trade, one major consequences have been to seek political survival through plunder, thus the attendant war. Inflationism, according to great Ludwig von Mises has been “the most important economic element in this war ideology”.

Looking at history has always been deterministic. We look at the past in the account of how narrators describes the connections of the facts in them. But we must not forget of the importance of theory in examining these facts.

As Austrian economist Hans Hermann Hoppe explains,

There must also be a realm of theory — theory that is empirically meaningful — which is categorically different from the only idea of theory empiricism admits to having existence. There must also be a priori theories, and the relationship between theory and history then must be different and more complicated than empiricism would have us believe.

I concur that hyperinflation could likely be the outcome for many European countries once a breakup of the Eurozone becomes a reality. This will not happen because history will merely repeat itself, but because the preferred recourse by politicians has been to resort to inflationism. Theory and history have only meshed to exhibit the likelihood of such path dependent political actions.

How Reliable is the S&P’s ‘Death Cross’ Pattern?

Mechanical chartists say that with the recent stock market collapse, the technical picture of the US S&P 500 have been irreparably deteriorated such that prospects of a decline is vastly greater (which has been rationalized on a forthcoming recession) than from a recovery. The basis of the forecast: the Death Cross or ‘A crossover resulting from a security's long-term moving average breaking above its short-term moving average or support level[1]’.

First of all, I’ve seen this picture and the same call before.

In July of last year, the S&P also experienced a similar death cross. Many articles emphasized on the imminence of a crash[2] that never materialized.

Secondly, I think applying statistics to past performances to generate “feasible” odds on a bet based on the ‘death cross’ represents as sloppy thinking

To wit, betting based on a ‘death cross’ signifies a gambler’s fallacy or fallacy committed when a person assumes that a departure from what occurs on average or in the long term will be corrected in the short term[3].

A coin toss will always have a 50-50 head-tail probability distribution. If the random coin toss exercise would initially result to string of ‘heads’ outcome, the eventual result of this repeated exercise would still result to a 50-50 outcome or a zero average, as shown by the chart below.

As the illustrious mathematician Benoit Mandelbroit wrote[4],

If you repeat a random experiment often enough, the average of the outcomes will converge towards an expected value. With a coin, heads and tails have equal odds. With a die, the side with one spot will come up about a sixth of the time

Applied to the death cross, we see the same probability 50-50, because each event from where the ‘death cross’ appears entails different conditions (finance, market, politics, social, cultural, even time and spatial differences and etc), as earlier argued[5]. It would signify a sheer folly to oversimplify the cause and effect order and speciously apply odds to it.

Proof?

One would hear proponents bluster over the success of the death cross in 2000 and 2007. Obviously the hindsight bias can be very alluring but deceptive. The causal relationship which made the ‘death cross’ seemingly effective in 2000 and 2007 for the US S&P 500 had been mostly due to the boom bust cycles which culminated to a full blown recession or a crisis during the stated periods.

The death cross was last seen in July of last year (green circle above window), but why didn’t it work? The answer, because the death cross had been pulverized by Bernanke’s QE 2.0 (see green circle chart below). When Mr. Bernanke announced QE 2.0, the ‘death cross’ transmogrified into a ‘golden’ cross!!! This shows how human action is greater than historical determinism or chart patterns.

Many mistakenly think that chart patterns has an inherently built in success formula which is magically infallible, as said above, they are not.

Third, not all market crashes has been due to recessions.

The above illustrates the crash of 1962 (upper window) and 1987 (lower window)[6]. This is obviously unrelated to the death cross, however the point is to illustrate that not every stock crash is related to economic activities. The recent crash may or may not overture a recession.

Bottom line: The prospective actions of US Federal Reserve’s Ben Bernanke and European Central Bank’s Jean-Claude Trichet represents as the major forces that determines the success or failure of the death cross (and not statistics nor the pattern in itself). If they force enough inflation, then markets will reverse regardless of what today’s chart patterns indicate. Otherwise, the death cross could confirm the pattern. Yet given the ideological leanings and path dependency of regulators or policymakers, the desire to seek the preservation of the status quo and the protection of the banking class, I think the former is likely the outcome than the latter.

And another thing, we humans are predisposed to look for patterns even when non-exist, that’s a result of our legacy or inheritance from hunter gatherer ancestors’ genes whom looked for patterns in the environment for survival or risked being eaten alive by predators. This behavioural tendency is called clustering illusion[7]. A cognitive bias which we should keep in mind and avoid in this modern world.

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[1] Investopedia.com Death Cross

[2] The Economic Collapse Blog, The Death Cross: Another Sign That We Are On The Verge Of A Recession?, July 5, 2010

[3] Nizkor.org Fallacy: Gambler's Fallacy

[4] Mandelbrot, Benoit B The (mis) Behaviour of Markets, Profile Books p.32

[5] See The Causal Realist Perspective to the Phsix-Peso Bullish Momentum, July 10, 2011

[6] About.com Stock Market History

[7] Wikipedia.org Clustering illusion

Confirmation of the Phisix Breakout!

The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time, and still retain the ability to function. — F. Scott Fitzgerald

The landmark breakout by the Philippine composite benchmark, the Phisix, has been confirmed!

It’s certainly not just that the local benchmark has treaded on fresh nominal record highs, importantly, we should expect momentum to continue if not accelerate.

Attempting to time the markets under these conditions will likely leave market participants with opportunity losses and remorse (regret theory), as broad market actions will likely be defined by sharp upside swings.

Again this phenomenon has not been isolated to the Phisix but can be seen as a regional dynamic.

While major ASEAN equity markets crawled away from the losses at the start of the year, the high octane rebound appears have been a recent phenomenon which only commenced last June.

Ironically, these has been happening on a post QE 2.0 environment (but with QE 3.0 officially on the table[1]), and despite various global market interventions, that initially had jolted global financial markets.

The milestone performance by the domestic bellwether [Phisix: PCOMP, red-orange line] seems coy compared to the breathtaking bullish renditions by Indonesia [JCI: orange line] and Thailand [SET: green line].[chart courtesy of Bloomberg]

Malaysia [KLCI: red line], whom earlier took a temporary lead has, over the interim, deviated from the group and appears to be weakening. This divergence could be a temporary phenomenon.

Nonetheless, all four ASEAN bellwethers have posted advances on a year-to-date basis. And notably, the gains by ASEAN ex-Malaysia appear to be progressing swiftly.

Breakout Confirms the Long Term Direction

The most important message from such this monumental breakout is the apparent continuing confirmation of my long held view of the evolving boom-bust cycle of the Phisix[2].

Patterns don’t play out because of fate or destiny, as some mechanical chartists seem to suggest, instead patterns play out because of real underlying forces that drive them. People’s choices and NOT patterns ultimately determine market actions or cycles.

We should never confuse patterns or historical experience with deterministic action in the way natural science behaves.

As the great Ludwig von Mises reminded us[3], (bold emphasis mine)

The experience with which the sciences of human action have to deal is always an experience of complex phenomena. No laboratory experiments can be performed with regard to human action. We are never in a position to observe the change in one element only, all other conditions of the event remaining unchanged. Historical experience as an experience of complex phenomena does not provide us with facts in the sense in which the natural sciences employ this term to signify isolated events tested in experiments. The information conveyed by historical experience cannot be used as building material for the construction of theories and the prediction of future events. Every historical experience is open to various interpretations, and is in fact interpreted in different ways.

The Philippines experienced its first modern bubble cycle which progressed during 1985-2003, an 18 year cycle. This cycle surfaced after the Philippines had been liberated from a tyrannical rule which had suppressed the local market and the economy.

The first bubble cycle saw the Phisix advance from around 150 to around 3,100 for a whopping gain of 19x. The advance had not been linear, though. Two bear markets interspersed the advance phase. These bear markets (orange and green ellipses) were both triggered by failed coup d'états.

Yet the advances coincided with then President Cory Aquino’s administration’s US $12 billion worth of bailouts of several politically connected banks that caused the old central bank to fold from the strain[4].

A topping process developed in 1994-1997, as Japan’s busted bubble redirected a gush of Japanese capital into ASEAN economies[5]. The regional or ASEAN inflation boom eventually unraveled and became known as the Asian Crisis[6].

The ensuing 6 year bear market accounted for as the market clearing process for the region and for the Philippines, part of which had been aggravated by a global recession[7] triggered by the US dot.com bubble bust[8].

Today, the Phisix has been playing out a seminal cycle.

The 2007-2008 bear market in the Phisix had been due to exogenous factors—a contagion from the US mortgage crisis. Yet the latest bear market resembles the earlier or first coup bear market of 1987 (orange ellipse).

This week’s breakout only confirms my long time claim that the recent bear market served as normative countercyclical phase representative of any major trends.

And that’s why I’ve been repeatedly saying that the Phisix will, in the fullness of time, reach 10,000.

It’s a long term trend that seems underway even for our neighbors.

With the conspicuous breakout for the Indonesia, Malaysia and the Philippines (as shown by the charts from chartrus.com), only Thailand, the hub of the Asian Crisis, has yet to reach all time highs.

My crystal ball does not have the surreal or metaphysical sophistication that would allow me to predict the exactitudes, or simply stated, “I can’t say when”. I am no Madame Auring.

All I know is that for as long as the primary forces which drives the Phisix or ASEAN markets—particularly the internal or domestic monetary policies and transmission mechanism from external monetary policies—both of which signify as bubble policies, globalization (which implies further development of the capital markets of ASEAN or of most of Asia) and the global wealth transfer (West-East) or convergence dynamics—remains intact, this advance phase should continue.

In my view, it would take an endogenous or a regional bust similar to 1997, or a reversal of one of these primary factors—through the materialization any of these ‘fat tail’ events: outbreak of global protectionism or a US dollar collapse that risks global hyperinflation or a war that involves the region or a deflationary banking collapse where central banks would not intervene or the adaption of a gold standard—that risks terminating this inflationary boom cycle.

In short, patterns are hardly ever conclusive or that they don’t play out because they have or need to. Since market actions are not historically determined, the realization of patterns would be conditional to the material similarities in the feedback mechanisms or stimulus response dynamics which operated then and which operates today.

If there is a single major nexus between then and today that could influence the fulfillment of said patterns, it is the path dependent nature of governments to inflate the system designed to safeguard the banking system and to preserve the cartelized tripartite patron-client relationship of the welfare state, banking political class and central bankers. The consequences of their actions have perennially led to business (bubble) cycles.

As to whether there will be another countercyclical trend [another provisional bear market] or that the Phisix might advance unobstructed is beyond my ken. Albeit if there will be a clear and present danger that risks another major crisis, I think this could emanate from China[9], instead of the the Eurozone or the US in contrast to mainstream’s expectation.

So far while there have been signs of strains[10] in China, they have not reached a point where I would need to increase demand for cash balances for myself and for my clients.

As far as the current signals from which price trends seem to have been telling us, the upside leg of this advance phase may not only continue, but would likely strengthen.

Breakout Confirmed by the Peso and Market Internals

The Philippine Peso has conjointly broken out of their resistance levels along with Phisix. I told you so.

The tandem’s working relationship has been pretty much solid and dependable. The correlation may not be perfect since the Peso’s action has been distorted by the sporadic interventions by the Bangko Sentral ng Pilipinas (BSP) nonetheless the causation has been strong. Both have been reacting to the relative demand for the Peso assets. The Peso has been driven more by the state of capital flux[11].

Also the Peso can be seen as pursuing less inflationary policies than the US dollar, but a lot more inflationary than the Swiss franc[12].

The simultaneous breakouts can be viewed positively.

Yet the pendulum of the market internals has swung decidedly in favor of the bulls.

This historic breakout has been backed by a hefty surge in volume (weekly volume; left window) which translates to more participation by the public and the pronounced aggressiveness by the buyers.

Foreign inflows, for the week, remained substantial but constituted only about 35% of total trades. This implies positive sentiment for both local and foreign participants.

Based on the average daily traded issues (computed on a weekly basis), the public’s trading interest reached nearly 80% of the 244 issues listed. This means that third tier formerly illiquid and dormant securities have been getting some attention and liquidity. Such spillover dynamics signals broad market bullishness.

It is rare to ever see such strongly linked or convergence of signals as this.

Except for the holding sector, every sector in the Philippine Stock Exchange posted gains.

This time the financial and the property sector tailed the overheated Mining sector both of which has contributed substantially to the advances of the Phisix.

Yet given the sharp pullback by the mining sector over the past two sessions (about 6% from the 2-day high), despite the weekly reported gains, the overstretched mining sector could enter a temporary corrective-consolidation phase.

The mining sector has been up by a remarkable 15 of the last 17 weeks. This week’s advances marked the 5^th consecutive week which has elevated the sizzling hot year-to-date returns to an eye-popping 61.45% as of Friday’s close.

While the strong breakout and the bullish tailwind could mean that the Phisix could rise further, we can’t discount profit taking sessions.

And part of this phenomenon could highlight a rotation away from the mining sector and into the other laggards, perhaps to the finance[13] and the property[14] sector as the next major beneficiaries of the percolating inflation driven boom as previously discussed.

A Journey of a Thousand Miles by Single Steps

Greece received second round bailout package 159 billion euros ($229 billion) which has been larger “shock and awe” than expected by the public.

As the Danske Bank reports[15], (bold emphasis mine)

In particular, the elements of the second rescue package for Greece: EUR109bn in official funds, a EUR12.6bn debt buy-back programme, a lowering of interest rates to 3.5%, a lengthening of the maturity on future loans to Greece to a minimum of 15 years and up to 30 years with a 10 year grace period, as well as a lengthening of the maturity on existing loans.

Burden sharing with the IMF will proceed in line with standard practice (1/3 from the IMF).

The increased flexibility of the EFSF could result in more active intervention in the secondary market. The EFSF now takes on this role, which was previously played by the ECB, but will still be supported by ECB analysis.

Such announcement appears to have lifted the global equity market’s sentiment. That’s because we have another QE in place, but this time based on the Eurozone’s rescue, which has been hardly about Greece, but of the Euro (and US) banking system.

And if global equity markets continue to recover from the recent PIIGS crisis shakeout, where the direction of global equity markets may converge, then this should further intensify the bullish proclivities at the Philippine Stock Exchange or ASEAN bourses as foreign capital seek for higher returns or as safehaven on assets of currencies that have been less tainted by inflationists policies.

Under current circumstances it would be best to use pullbacks as buying windows and to refrain from “timing the markets”.

The gist of any relative outperformance portfolio gains or Alpha[16]--return in excess of the compensation for the risk borne—frequently comes from the magnitude of returns[17] and not from frequency of marginal returns which contemporary sell side analysts design their literatures for their clients or how we are traditionally taught even by academia. (I had to challenge my son’s professor on this)

Yet before we think of the Phisix at 10,000, we will need to see the local bellwether transcend the psychological threshold at 5,000, perhaps by the end of the year.

This journey of a thousand steps, to paraphrase Confucius, will be attained through a series of single steps.

Again, profit from political folly.

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[1] See Ben Bernanke on QE 3.0: Not Now, But An Open Option, July 15, 2011

[2] See The Phisix And The Boom Bust Cycle, January 10, 2011

[3] Mises, Ludwig von Praxeology and History Chapter II. The Epistemological Problems of the Sciences of Human Action Chapter 2, Section 1 Human Action, Mises.org

[4] See Philippine Banking System: “Most Heavily Fortified Bastion of Privilege and Profit”, June 20, 2011

[5] See Capital Flows, Financial Liberalization and Bubble Cycles, July 22, 2011

[6] Wikipedia.org 1997 Asian financial crisis

[7] Wikipedia.org Early 2000s recession

[8] Wikipedia.org Dot-com bubble

[9]See Mark Twain and China’s Yuan, June 25, 2011

[10] See China’s Bubble Cycle: Shadow Financing at $1.7 Trillion June 28, 2011

[11] See I Told You So Moment: The Phisix At Milestone Highs, July 17, 2011

[12] See Is the Swiss Franc Better than Gold?, July 21, 2011

[13] See A Bullish Financial Sector Equals A Bullish Phisix? May 22, 2011

[14] See Expect a Rebound from the Lagging Philippine Property Sector, July 17, 2011

[15] Danske Bank EU summit delivers bold measures, July 22, 2011

[16] Wikipedia Alpha (investment)

[17] See Investing Guru Joel Greenblatt: Focus on the Long Term, July 9, 2011