Graphic of the Day: When History Repeats….

This striking chart demonstrates why there have been patterns of similarities in history…

Writes Simon Black at the Sovereign Man (bold mine)

But it’s not just debt burdens that are problematic. ‘Rich’ countries in the West are also rapidly debasing their currencies, spawning tomes of regulatory impediments, restricting the freedoms of their citizens, aggressively expanding the powers of the state, and engaging in absurd military folly from Libya to the South China Sea.

Once again, this is not the first time history has seen such conditions. In our own lifetimes, we’ve seen the collapse of the Soviet Empire, the tragi-comical hyperinflation in Zimbabwe, and the unraveling of Argentina’s millennial crisis. Plus we can study what happened when empires from the past collapsed.

The conditions are nearly identical. Is our civilization so different that we are immune to the consequences?

Probably not. And the cycle that has befallen so many great powers before us– decline, collapse, turmoil, and reset– will likely happen in our time too.

But it’s not the end of the world. Not by a long shot.  It’s a complete reshuffling of the deck. A brand new game with brand new rules. And the old way of doing things (like printing money backed by nothing) will be resigned to history’s waste bin.

One of the things that we see frequently in history is that this transition occurs gradually, then very rapidly.

Think about the Soviet Union, which you may recall. One day, they were the greatest threat to the planet. The next day, the wall came down. It happened so quickly. It’s like what Hemingway said about bankruptcy– it happens slowly at first, then all at once.

Unfortunately we don’t know where we are along this path. And we won’t know until we’re over the cliff on the way down. Everything will feel normal until then.

The repetition of crises had been the outcome of the short term obsession of attaining political goals mostly through economic and political repression.

Thus it is equally nonsense to assert debt by itself creates all these troubles.

For instance this self-contradictory claim by populist analyst John Mauldin…

As an aside, it makes no difference how the debt was accumulated. The black holes of debt in Greece and in Argentina had completely different origins from those of Spain or Sweden or Canada (the latter two in the early '90s). The Spanish problem did not originate because of too much government spending; it developed because of a housing bubble of epic proportions. 17% of the working population was employed in the housing industry when it collapsed.

…who earlier admits that

Debt (leverage) can be a very good thing when used properly.

The reality is that debt can be distinguished through productive and consumptive activities where debts from consumption (welfare, government spending) and malinvestments (for instance convergence of interest rates and moral hazard from policies in the euro which brought about a bubble) have all been a result of interventionism or emanates from political policies that leads to business cycles or bubbles.

In a paper submitted to the classical liberal organization, the Mont Pelerin Society, which recently held a meeting in Prague, Terry College of Business University economics professor George Selgin gives a terse but insightful dynamic of the Euro crisis, (bold mine) 

Philip Bagus (2012) explains the particular course by which Greece was able to take the European Monetary Union hostage. Banks throughout the Eurozone, he says, bought Greek bonds in part because they knew that either the ECB or other Eurozone central banks would accept the collateral for loans. Thus a Greek default threatened, first, to do severe damage to Europe’s commercial banks, and then to damage the ECB insofar as it found itself holding Greek bonds taken as collateral for loans to troubled European banks.

In short, in a monetary union sovereign governments, like certain banks in single-nation central banking arrangements, can make themselves “too big to fail,” or rather “too big to default.” As Pedro Schwartz (2004, p. 136-9) noted some years before the Greek crisis: “[I]t is clear that the EU will not let any member state go bankrupt. The market therefore is sure that rogue states will be baled [sic] out, and so are the rogue states themselves. This moral hazard would increase the risk margin on a member state’s public debt and if pushed too could lead to an Argentinian sort of disaster.

Indeed, the moral hazard problem as it confronts a monetary union is all the worse precisely because sovereign governments, unlike commercial banks, can default without failing, that is, without ceasing to be going concerns. This ability makes their ransom demands all the more effective, by making the implied threats more credible. A commercial bank that tries to threaten a national central bank using the prospect of its own failure is like a suicide bomber, whereas a nation that tries to threaten a monetary union is more like a conventional kidnapper, who threatens to harm his innocent victim rather than himself.

Next, it is not debt alone, but rather attempts at the preservation of the status quo which has been founded on unsustainable political-economic premises through political and financial repression which makes conditions all the worst.

This means that the popularity of absolving culpability of those responsible for them, the “inattentiveness” to genuine conditions and or the cognitive fallacy of selective perception out of political bias or economic ideology signifies as principal reasons of the recurrence of patterns in history. 

This block excerpt from philosopher George Santayana gives as some useful lessons; from REASON IN COMMON SENSE Volume 1) [bold mine]

Progress, far from consisting in change, depends on retentiveness. When change is absolute there remains no being to improve and no direction is set for possible improvement: and when experience is not retained, as among savages, infancy is perpetual. Those who cannot remember the past are condemned to repeat it. 

In the first stage of life the mind is frivolous and easily distracted; it misses progress by failing in consecutiveness and persistence. This is the condition of children and barbarians, in whom instinct has learned nothing from experience. In a second stage men are docile to events, plastic to new habits and suggestions, yet able to graft them on original instincts, which they thus bring to fuller satisfaction. This is the plane of manhood and true progress. Last comes a stage when retentiveness is exhausted and all that happens is at once forgotten; a vain, because unpractical, repetition of the past takes the place of plasticity and fertile readaptation. In a moving world readaptation is the price of longevity. The hard shell, far from protecting the vital principle, condemns it to die down slowly and be gradually chilled; immortality in such a case must have been secured earlier, by giving birth to a generation plastic to the contemporary world and able to retain its lessons. Thus old age is as forgetful as youth, and more incorrigible; it displays the same inattentiveness to conditions; its memory becomes self-repeating and degenerates into an instinctive reaction, like a bird's chirp.

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.

---

[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

World Cup Indicator: Boon Or Bane?

Will the World Cup games, which opened yesterday, portend of a bullish or bearish markets for the coming months?

Frank Holmes of US Global Investors argues that this should be bullish, especially from the perspective of the host country, i.e. South Africa...


So as with mint.com...

Pls click here to redirect link to mint's site to see a crispier image.

But Bespoke Invest sees the historical correlation as "negative"....

According to Bespoke, "both the US and world markets have averaged declines over both periods throughout history. The S&P 500 has averaged a decline of 1.65% during all 18 prior World Cups, and a decline of 0.37% in the three months following. The MSCI World Index, which we only have back to the 1970 World Cup, has averaged a decline of 1.25% during and 4.34% over the following three months. Historically the market has averaged gains over one- and three-month periods, so indices have definitely underperformed during World Cups. Most fans of the sport would take a couple months of declines in the market if it meant their country would win, however."

To my mind, historical patterns are not reliable measures in assessing market prospects because they can be positive and negative depending on the prevailing market and economic conditions then.

Instead, these indicators appeal to people who are only looking for patterns either to confirm their biases or to rationalize market actions.

Besides, major sporting events as the World Cup or the Olympics can only give a temporary boost to the economy. But on a larger picture such events could entail greater costs from the crowding out effect from inefficient government spending relative to private sector investments. In short, gains can be "exaggerated".

As Leander Schaerlaeckens at the ESPN writes, (bold highlights mine)

``People who are excited about hosting a World Cup, write Szymanski and Simon Kuper in "Soccernomics," "are merely expressing in extreme form a conventional belief: that hosting a big sports event can make a place rich."

``In truth, write the authors, while World Cups don't produce much monetary gain, they have been shown in several studies to be good for general happiness among the hosting population and a country's self-esteem. Thabo Mbeki, South Africa's president until September 2008, declared in a speech that the tournament would be "sending ripples of confidence from the Cape to Cairo." It doesn't look bad for a politician looking to get re-elected, either.

"FIFA and the Olympics all enjoy monopoly standings," Baade said. "And that permits them to foist enormous economic cost on those that compete for mega-events like the World Cup. They're in a position to expropriate public funds. The argument is made that we're going to bring in so many non-native spendthrifts that that will offset the expense of stadiums, but there's very little evidence to support that."

``Chances are that like many predecessors South Africa will eventually discover that hosting the World Cup was a poor choice, at least from a financial viewpoint. But by then, FIFA will have moved on to flattering some other country into believing it should pour the money it doesn't have into hosting another glorious edition of the World Cup."

As always, the temporal 'self-esteem' gains are skewed mostly towards grandstanding politicians. And at the end of the day, if revenues expected are not fulfilled, then the carrying costs of the 'country's self-esteem' will eventually be borne by the taxpayers.

In the Philippines, this is called the fiesta mentality.

Seeing Patterns Where None Exist

Below are good examples of a cognitive bias known as Clustering Illusions or seeing patterns where none exist.

Such presentations depends usually on the underlying biases of the commentators or analysts.

For example "bears" would use today's markets in comparison with that of the Great Depression of the 30s as shown below...

From Google charts

Whereas the "bulls" would use the 1970s as a counterexample.

chart from Businessinsider

But the fact is that there is little in common between the 1930s and today (e.g. gold standard versus today's fiat money, deposit insurance, prohibitions in Intestate banking or the McFadden Act & etc...) or between 1970s and today (e.g. China still a communist economy than a mixed economy, globalization, high inflation versus today's "suppressed" inflation) to suggest of a similar dynamic that could accrue to the same outcomes for the markets.

Essentially, this signifies as a logical fallacy known as cum hoc ergo propter hoc or that "correlation does not imply causation".

Importantly, aside from having different operating conditions, political actions (interventionism) during those days had been different in type and in degree, such that the distortions in the economic and financial system greatly varied.

So essentially whatever directions shapes the future will likely be due to "chance" more than actual "analogies" relative to the above examples.

Anyway, I found this "tight" correlation between copper/gold-S&P 500 chart to be quite interesting.

From Trader's Narrative

Although my suspicion is that the correlation between the two could likely be "new" in the sense that the decades of 1980s-2000s saw "opposing" directions between commodities, which had been in a grueling bear market, and the performance of the US stock market, which had boomed in those salad days or during the "great moderation".

Nevertheless, the point of the chart is to show of the bearish disposition of the current market actions, by an analyst who can be described as a perma bear, David Rosenberg.

But again, as earlier pointed out, for every example would be a counter-example. It all depends on the bias of the writers.

China’s Bailout Package; Shanghai Index At Possible Bottom?

``Financial success depends on the ability to anticipate prevailing expectations and not real world events.” -George Soros, Alchemy of Finance

When bad news comes, it pours.

China hasn’t been unscathed by the recent turn of events.

There have been increasing signs of impacts related to the contagion from the global financial crisis, even if its capital markets have been heavily regulated or its linkages to foreign markets or economies have been limited.

Reports like the “slowest industrial growth in seven years” (Bloomberg), “a sharp fall in manufacturing survey” by CLSA indicative of a prospective recession (Bloomberg), “the narrowing profit margins” and concerns over the “rising incidences of bad loans from overseas investment” (Bloomberg) or from declining financial markets, or decelerating export growth (Bloomberg) amidst a record trade surplus are just a few examples. Yet, despite the seemingly downcast message, the statistical figures still remain positive albeit ostensibly slowing.

Some strident perma bears have launched the offensive to downscale China’s economic growth forecast to 5-6% to reflect a hard landing, apparently to chime with their deflationary bias.

Figure 5: Economist: Breakdown of China’s GDP

For starters, despite being popularly known for its export prowess, figure 5 from the Economist exhibits that net exports (exports-imports) account for about 3% of its GDP.

Arthur Kroeber at Dragonomics estimates that about 21% China’s manufacturing value is exported, while manufacturing accounts for only a third of GDP value and investment, of which only 7% of China’s investments are directly linked to export production.

Meanwhile the largest chunk of China’s GDP has been in investments which is estimated at 40% (the Economist) or 30% (Dragonomics-GaveKal) of the economy where over half of these are into infrastructure [30.8% of total construction investments (source: Dragonomics-Gavekal)] and property [24% of total construction investments].

Figure 6: Guinness Atkinson: Declining China Property Growth

Reflating China.

Faced with deteriorating signs of health in the global economy, despite a still vigorous export growth clip (emerging markets have offset declines in the US), emerging signs of strains in manufacturing, slumping stock markets and worst, declining real estate values as shown in Figure 6, aside the declining rate of investments in real estate (xinhua.net), instinctively, China’s recent response have been to launch a massive stimulus of $568 billion (Bloomberg) or equivalent to around 14% of its GDP in dollar terms (Economist).

Edmund Harriss of Guinness Atkinson lists latest policy measures undertaken by Chinese government prior to its massive $586 stimulus package namely, Tax rebates for exporters, Three interest rate cuts, Two cuts in the required reserve ratio, An injection of $4.4 billion into the banking system to ensure liquidity, An increase in bank lending quotas for smaller and medium-sized businesses, Lowering of the mandatory mortgage down-payment from 30% to 20%, Cut property transaction taxes and lowered mortgage rates, Municipal governments have launched a series of additional property supporting measures specific to their local markets.

In addition, the latest stimulus is said to cover (source Danske Bank):

-Construction of more affordable low-rent housing.

-Increasing investment in rural infrastructure (mainly road and power grids).

-Boosting investment in transportation (railway, airports and upgrade of urban power grids).

-Increase spending on healthcare and education.

-Improve environmental protection by investing in sewage, rubbish treatment and energy conservation.

-Extending reform in VAT reform to all industries (cut corporate taxation by CNY120bn).

-Income support by increasing agricultural subsidies and subsidies to low income urbane residents.

Some observations:

1) China’s bailout package reflects the general trend of global governments to concertedly ease monetary policies and use government coffers to pump prime the economy.

2) It is unclear how much of the total package represents new spending. Many of them were previously announced but have been currently incorporated probably aimed at gaining media or political mileage or having some impact on the financial markets.

3) It would appear that the main thrust of the stimulus would be to cushion the impact of the decline in investments which account for the biggest share in China’s GDP.

4) The spending measures will definitely benefit certain sectors or nations. But there will be lingering questions on the overall efficacy of such programmes or its possible unintended consequence.

5) Some have made comparisons to an almost similar policy stimulus program instituted during the Asian Crisis which managed to keep growth rates at nearly 8% in 1998-1999 (indexmundi.com). Although, China today is much bigger in size compared to the 90s, in as much as the extent of the external shock threatening China.

6) While the program is said be implemented within a two year window (Economist), such policy measures will take time before any material impact can be felt or assessed.

7) There is always the question of financing. It’s been said that the national government will account for 25% of the package, with unspecified amount to be shouldered by the local governments and the rest by so-called “social investments” (Northern Trust). The ambiguities from the sources of financing have led some to speculate on the risks that China could sell US treasuries at a time when the US is in dire need of funding for its fiscal programs. And selling US assets (mostly treasuries or agencies) could be detrimental to the already sensitive and volatile markets.

This doesn’t seem likely though. China has a national savings rate of 51.2% last year (San Francisco Chronicle) which could be channeled instead to fund such government expenditures than propping up of losing private investments in the property sector (as the US has done). Besides, roiling the already volatile markets could have undesired effects financially, economically or even politically.

Anticipating Prevailing Expectations: Shanghai Composite At Bottom?

How does this affect China’s markets or of Asia?

Well China has thrown various tools as mentioned above even prior to the latest stimulus program. It didn’t stop the major benchmarks from the hemorrhage. But this doesn’t mean the past will be the same.

Our idea is to look at history first.

Figure 7 chartrus.com: 17 year chart of China’s Shanghai Composite

China’s1993-1995 bear market manifested a peak to trough loss of 73%, while the 2001-2005 version lost some 56%.

Of course the conditions of those years are starkly different than from today. Although from the standpoint of bear market losses- from which the Shanghai index peaked from October of 2007 (6,036.28) to its recent November lows (1719.77)- have registered a loss of nearly 72%, almost at the same depth as the bear market trough of the 90s.

In my view, this means that the market (barring a great depression) is likely near or at the bottom with or without the stimulus.

Although the stimulus could possibly work as a psychological booster. See figure 8.

Figure 8: stockcharts.com: US markets-China/Japan/Asian Markets Diverging?

This has been the same dynamics going on in the US markets. Many have been hoping for government actions to successfully prop up its domestic market, but to no avail.

Last week the US benchmarks attempted to test the October 10 lows and fleetingly passed. But maybe we might see a repeat of the test next week as the recent gains haven’t been successfully safeguarded.

Once again this takes us to the edge of our seats as to whether the US markets makes a pivotal decision point of either establishing a bottom or a new low.

However, as figure 8 shows, China’s Shanghai Composite (SSEC) seem to be “diverging” alongside with other Asian markets as the Nikkei or Asia ex-Japan. As US markets seem testing the lows, Asian markets appear to be holding ground.

Likewise, the SSEC seems to have been boosted by the National Bailout program. But as we have earlier mentioned the SSEC have been treading in historical bottom pattern which makes the 1,719 area a strong support level.

As we have long mentioned, it has been a longstanding bias of mine that the Asian markets are likely to recover first considering the impact from the present crisis have been one emanating from the periphery than from the epicenter.

Put differently, Asian markets have borne the brunt of the contagion than as source of the crisis. Fundamentally speaking, many factors favor a recovery in the Asian markets (less debt or leverage in both internal and external liabilities, sizeable currency reserves, demographic advantage, growing middle class, significantly improving productivity, rising income and etc.).

But one or two weeks doesn’t a trend make.

So we will have to stay in the sidelines and watch for further confirmations.