In A Bernanke Market, Comparisons With The 80s Are Like Apples And Oranges

This is another example why I wouldn't be listening to Wall Street.

The Bloomberg chart of the day tries to simplistically associate today's market rally with 1980s.

According to Bloomberg, ``The CHART OF THE DAY compares the Standard & Poor’s 500 Index’s advance since March 9, when the benchmark fell to its lowest level in 12 years, with its recovery from a two-year low set on Aug. 12, 1982. The S&P 500 rose 15 percent for all of 1982 and moved higher every year for the rest of the decade.

``“Investor sentiment today is quite similar” to what prevailed 27 years ago, James W. Paulsen, chief investment strategist at Wells Capital Management, said yesterday in an interview.

``“There’s nothing but doubt” about the economy’s ability to recover from its slump even as consumer and business confidence, retail sales, exports and other indicators point to a rebound, not depression, Paulsen said. The S&P 500 reached its August 1982 low during the second U.S. recession in three years."

But the financial and economic environment 1980s is entirely different than today.

In the past debt levels had not been as disproportionate as today relative to GDP.

Another, globalization and "Reaganomics" has taken off in the 80s. Today, the "Obamanomics" or the growing role of government/s in the economy via a slew of new regulations and welfare programs funded by higher taxes will curb globalization trends and politicize vital sectors of the national economic system which will reduce productivity and returns.

More, the 80s had analog cellphones in contrast to today where internet and digital phones rule.

So it would seem like an apples-to-oranges comparison or simply clustering illusions- a cognitive bias of looking for patterns where non exist.

Importantly, much of today's rally has evidently been liquidity driven as shown by chart above from the WSJ article.

As former hedge fund manager Andy Kessler rightly observes,

``At the end of the day, only one thing has worked -- flooding the market with dollars. By buying U.S. Treasuries and mortgages to increase the monetary base by $1 trillion, Fed Chairman Ben Bernanke didn't put money directly into the stock market but he didn't have to. With nowhere else to go, except maybe commodities, inflows into the stock market have been on a tear. Stock and bond funds saw net inflows of close to $150 billion since January. The dollars he cranked out didn't go into the hard economy, but instead into tradable assets. In other words, Ben Bernanke has been the market."

China In A Bubble, ASEAN Next Leg Up?

``The margin of safety is the central concept of investment. A true margin of safety is one that can be demonstrated by figures, by persuasive reasoning and by reference to a body of actual experience". Benjamin Graham

Recently I stumbled upon some quants predicting (ZeroHedge) a crash in China’s stock markets over the next few days.

Although there have been many doing so, what attracted my attention is that they had the temerity to quantify the period for the said event-particularly, July 17 to July 27.

This group seems to have a good track record of predicting events, in contrast to most of their genre (whom were caught with the recent market meltdown), albeit mostly way TOO early based on their site.

I have no idea whether these will occur or not, but I won’t bet on their side.

Although based on Figure 4 by US global Investors, China is clearly operating in bubble territory.

Figure 4: US Global Investors: Monetary Expansion in China

As caveat, bubbles normally take time to reach a climax. For instance, the US real estate bubble ballooned from 2002-2006, while global stock markets inflated from 2003-2007. True, today’s China bubble could risk being pricked hastily or abruptly, but in my view, this may seem too early.

It’s because normal bubble cycles need sustained massive infusions (we seem to be seeing the first phase) and the vast concentrations or clustering of resource misallocations that could either become huge enough to be extremely sensitive to interest rate hikes or would require continued exponential amplification of credit to maintain present price levels or a pyramiding dynamics…until the structure in itself can’t be sustained (usually interest rates from market or policy induced does the trick).

I doubt if we have reached that point.

Besides, I think that the risks seem more tilted towards government debt bubbles as global governments appear predisposed to activating money printing solutions at any signs of renewed weakness or distress in their respective domestic economies.

Remember, the present environment, for the officialdom, is construed as signs of policy based accomplishments, hence, more of the same treatment will likely be applied but at higher dosages, if asset (stock) markets fall.

Unfortunately, such policies seem to direct people into speculating more than investing.

Global policymakers, as we have reiteratively been asserting, appear to target the stock markets as the preferred signaling channel to communicate “recovery” to the public.

Figure 5: US Global Funds: Strong Loan Growth in China

And global central banks appear willing to inflate more by maintaining loose money policies to encourage bank lending growth, rather than to tighten in order to support sentiment (albeit mostly speculative) or the “animal spirits”.

In the case of China (see figure 5), the surge in loan growth appears to have triggered some alarm bells in the officialdom, as the People’s Bank of China (PBoC) had reportedly been mulling to “switch to more direct lending controls” to temper growth and where recent sales of Chinese Treasury bills saw the government accepting higher rates (Forbes). Given ample evidences of sustained economic growth, it is believed that China would begin to increase interest rates by 2010 (Bloomberg).

Hence we see the odds seem likely for a correction from severely overbought levels than from a prospect of a crash as foreseen by the quants.

However, Chinese policymakers, like their US counterparts seem to be increasingly in a bind. An early tightening (increase rates or bank reserves) or if the market sees the need for higher rates, could set off renewed volatility hence, the likelihood for both the governments to press for asset friendly bubble blowing policies.

Figure 6: Russia’s RTSI: A Probable Path For China’s SSEC

Nonetheless, in figure 6, China’s (black) trajectory could probably follow Russia (black red), where the latter saw its stock benchmark fell by 80% during the recent crisis and rebounded by 129% and has corrected by 29% at its most recent trough and appears to be on a path to recovery.

Since March of this year, China’s Shanghai Index has shown no pause from its winning streak- a valid cause of concern.

For the meantime, financial systems that have been less leveraged than their counterparts in the developed countries seem likely to absorb more of the inflationary policies adopted by their national governments and or transmitted by the US Federal Reserve.

Last week, perhaps due to this, several Asian bellwethers either broke their resistance levels or are adrift at these levels attempting for a breakout see figure 7.

Figure 7: Stockcharts.com: ASEAN Bourses

So far only Malaysia (MYDOW) has successfully cleared the hurdle while Singapore (STI), Korea (KOSPI) and Indonesia (IDDOW) are almost over the threshold point.

Meanwhile other bourses such as Taiwan, Hong Kong and Pakistan are likewise approaching their respective resistance levels with a probable test to break these barriers soon. Next week perhaps?

From where we stand, momentum appears to tell us that the next leg could likely be up for most of Asian bourses mostly led by ASEAN bellwethers.

And this should include the Philippine Phisix.

Example Of Chart Pattern Failure

As we always say chart patterns can’t be relied upon for that pivotal decision, most especially the short term ones.


The May-July S&P 500 Head and Shoulders pattern (blue curves) which had been used by the bears to call for a market crash appears to have been invalidated.

However, there is another longer term reverse Head and Shoulders (red curves) from which a break off the 950 neckline level would suggest of a vital upward thrust. Technically a break from the 950 should lead towards the 1,234 target. I doubt this to occur unless governments inflate extensively anew (second round stimulus?).

I have no opinion on where the US markets will be headed over the short or medium term. Although given the inflationary tendencies of the US government, it may seem that the recent lows could have likely served as the bottom or the floor, unless proven otherwise. But we're not saying its gonna be a bull market too.

Remember, inflation as a component of US equity returns, [see last week’s Worth Doing: Inflation Analytics Over Traditional Fundamentalism!] are likely to grow at a much faster clip than dividends or real capital returns.

And the US government has been practically inflating to support asset (stock and real estate) prices.

Meralco’s Run Reflects On The Philippine Political Economy

``When the government, along with the pay-for-favors thieves in Congress and special interest power players, nationalizes and runs a business, decisions will always be made with political considerations/favors being first up on the agenda. Decisions will never be made on the basis of profit-and-loss and winning and retaining satisfied customers… Governments are not in the business of profit-and-loss; they are in the business of steal-and-spend.” Karen De Coster Politicians Act Surprised by Lack of "Business Criteria" for Decisions at New Government Motors

For those fixated with “prices driven by fundamentals”, they ought to explain to us in fundamental lingo why the sudden outperformance of Meralco, a Philippine electric utility company whose legislated monopoly covers the franchise of the national capital region of Metro Manila.

Meralco surged 23.45% over the week and is up by about 200% year to date. Of course, I’d like to congratulate those whom have been presently profiting from the recent activities.

To consider, given Friday’s close at Php 179 per share, this puts Meralco’s Price Earnings Multiple to high 68 (based on PSE calculations) or 32 (based on technistock). Price to Book is now 3.74 (technistock) and 3.73 (PSE) while dividend yield is .56% (technistock) and .3% (PSE). [Yes, as you probably noticed, financial fundamentals also come in diverse interpretation depending on the institution.]

Meralco hasn’t been driven by foreign investors as modest foreign selling has been accounted for during the past 4 weeks.

Has Meralco stuck gold as to merit its present price levels? Or has Metro Manila consumers suddenly been bequeathed with a windfall as to boost its electric consumption, thereby translating to bigger top line and also fatter bottom line?

The obvious answer is no.

If there has been a precipitate boom in electricity consumption then activities that underpin electricity usage such as TV programming could likewise be booming too and should be reflected in share prices of TV stations as GMA-7 or ABS CBN . Unfortunately both TV stations have been consolidating alongside the major indices [see figure 5]

Figure 5: PSE: Meralco and Sectoral Indices

Meralco (light green) which falls under the category of Commercial industrial (pink) both of which has seen outperformances relative to other sectoral indices [in pecking order] such as the Mining (green), All Index (Maroon), Holding (red), Properties (Blue) market laggards in Service (gray) and Bank (Black candle) index.

The reason I highlighted Meralco movements in March is to show that Meralco and the energy sector has led the general market’s rebound. Today’s sizzling performance could portent for a replay sometime in the near future.

Going back to the issue of fundamentals, the electric utility company projects a flat growth for 2009! So the present market activity is hardly about positive change in the traditional fundamental aspect.

And the only “fundamental” driver appears to be the transitioning of the ownership structure of the prized utility company.

In a word…POLITICS!!!

Meralco’s Possible Role In The Presidential Elections

The formerly Lopez dominated Meralco, whom has been associated with the political opposition, has been subjected to political harassment by the incumbent administration since last year.

The corporate struggle has drawn in an apparent ally of the administration in Danding Cojuangco owned San Miguel Corporation [SMC], who in a dramatic fashion overhauled its business model almost overnight by selling its beer business and has swiftly bought into Petron and Meralco, as previously discussed in Has San Miguel's Shifting Business Model Been Linked To The Philippine Presidential Elections? Lessons and San Miguel’s Shifting Business Model: Risks and Opportunity Costs.

The struggle over the company’s leadership seems to have diminished when a white knight in the Manny V. Pangilinan controlled Philippine Long Distance Telephone , the largest publicly listed company in the Philippines, came to the rescue of the Lopezes as discussed in King Kong Versus Godzilla at the PSE; Where Politics Trumps Markets and in Has Meralco’s Takeover Been A Good Sign?

Today, the acquisition process has apparently been unfinished, as PLDT through subsidiaries Metro Pacific [MPI] and Pilipino Telephone [PLTL] are said to be adding to the its holdings by acquiring through the open markets (Reuters).

Of course, we can’t discount that the other party SMC could also be behind the same activities in order to improve on their shareholdings for a potential showdown into next year’s annual stockholders meeting over management control.

In my view all of this is tied to the 2010 presidential elections.

The first scenario could be that the 2010 elections will possibly see an administration planted Trojan horse among the field of opposition candidates who will contend with the administration bet.

The winner of the 2010 elections will likely be covertly affiliated with either MVP’s TEL or Danding Cojuangco’s San Miguel Corp.

Here, depending on whose side the assuming President will be, the “opposing camps” will possibly sell their shares in blocks to the other party, where the Lopez camp could be eased out.

Or the other scenario could be that Meralco could be used as a vehicle to fund or finance an affiliate candidate of the new Meralco owners in next year’s election.

Joe Studwell in his book Asian Godfather: Money and Power in Hong Kong and Southeast Asia aptly describes how the ASEAN political economy operates,

``Centralized governments that under-regulate competition (in the sense of failing to ensure its presence) and over-regulate market access (through restrictive licensing and non-competitive tendering) guarantee that merchant capitalists-or asset trader, to use a more pejorative term-will rise to the top by arbitraging economic inefficiencies created by politicians. The trend is reinforced in South-east Asia by the widespread presence of what could be called as ‘manipulated democracy’, either in the guise of predetermined winner democracy (Singapore, Malaysia, Suharto’s Indonesia) or else in the scenario where business interest gain so close a control of the political system that they are unaffected by the changes of government that do occur (as in Thailand and the Philippines). In both instances politicians spend huge sums to maintain a grip on power that has some semblance of legitimacy. This can only be financed by through direct political ownership of big business or more usually, contributions from nominally independent big business that is beholden to politicians. Whichever, the mechanism creates a not entirely unhappy dependence of elites between politicians and tycoons.” (bold highlights mine)

At the end of the day Meralco will ultimately serve as a trophy for the winner of the political crony capitalist football.

As you can see, the nations’ political structure shapes the local economy. Hence, it would be a reductionist fallacy to presume markets operate evenly everywhere or that traditional fundamental metrics apply straightforwardly to disparately constructed political economy. Again operating reality and mainstream expectations don’t match.

Again Joe Studwell describes how wealth is generated in Southeast Asia and the function of the tycoon class to the economy,

``The tycoon class served its political purpose, and generated enormous personal wealth, but did little to promote overall economic growth. Instead growth came from a combination of small scale entrepreneurs, many concentrated in and around manufacturing, and a policy of renting out the local labour force to efficient multinational exporters.” (bold highlights mine)

In other words, it would be overly simplistic and imprudent to simply assess a security or a publicly listed company based on financial fundamentals without taking into consideration the security/company’s position in the nation’s political economic structure or even the political class behind the issue or the industry.

That’s because politicians and the domestic elite group have the laws and institutions behind their interests from where economic rent can be generated for the advancement of their personal wealth.

This means you can’t buy simply because of “cheap” PE ratios, because PE multiples won’t be enough to bring about economic windfall to the privileged class, it would take monopolies, laws that circumvent competition, political privileges (e.g. licensing), tariffs and other forms of implicit government support to attain these.

And it is of no question for me why some market participants’ position (including my mentor) have been based on “jockeys” or on “political affiliates” than from financial fundamentals.

At the end of the day, it seems hardly about markets but about political trends, networks and the underlying policies.

Nonetheless, inflationary policies still is the major force which drives the local equity market.

Risk Of Food Crisis Creeping Back?

In a recent article Whatever happened to the food crisis?, The Economist drudges anew over the enigma of conflicting developments: rising food prices in a recessionary environment.

Nonetheless like us they see the risks of a food crisis creeping back.

(bold emphasis mine)

``If this was happening during a boom, it might be understandable. But recession would normally dampen down price rises. So what explains the return of food-price inflation? And does it mean that the so-called world food crisis is returning?

``There are two clusters of explanation: cyclical factors—features of the farm cycle and world economy that fluctuate from season to season—and secular, long-term factors. Cyclical influences include re-stocking: cereal stocks were run down as prices spiked and need to be replenished. In 2006 and 2007, stocks fell below 450m tonnes, about 20% of consumption; now they are back up over 520m, or 23%. That is one source of new demand. Another comes from ethanol. As oil prices rise, ethanol starts to be competitive again (as a rule of thumb, ethanol is profitable when petrol costs $3 a gallon in America, a level it has just reached in California). The fall in the dollar and in freight rates has also kept the local-currency costs of importing a tonne of cereals lower than dollar-denominated world prices. This has encouraged many countries to buy more.

``Lastly, it is possible that the widespread hunger brought about by soaring prices—the FAO says a billion people will go hungry this year—may have reached a peak and the poor may be back in the market for grain again. This may sound unlikely, as traditionally poor consumers have had little influence over world food prices, but economic growth has continued in the largest emerging markets (notably China and India) and governments in much of the developing world have been expanding aid programmes for the poor, such as conditional cash-transfer schemes. That may be boosting demand; it would explain why prices of grain, which everyone eats, have been rising this year while prices of meat—the food of the rich and aspiring middle classes—have continued to fall."


My comment: So cyclical factors of restocking, rising oil prices (transmitted via the ethanol channel) and low prices could have contributed to a demand boost, although the Economist admits that government programs-such as aid expenditures could have also been key variables.

And as we have long mentioned inflationary policies impact prices relatively. It affects sectors that are the primary beneficiaries of government programs- in this case, aid spending which could have resulted to the disparities between meat and grain price trends.

However, sustained government fiscal spending is likely to cause a diffusion of increases consumer which means that even meat prices will likely increase over time.

The Economist adds some important secular trend dynamics,

``But the world food crisis of 2007-08 showed that food prices are not influenced solely, or even mainly, by cyclical factors. They soared in large part because of slow, irreversible trends: population growth; urbanisation; shifting appetites from grain to meat in developing countries. There is no sign that these trends are abating."

Finally, the Economist imputes regulatory and political obstacles as substantially distorting the marketplace.

``The failure of farmers in poor countries to respond to price signals does not mean they are deaf to them. Rather the signals they get are often scrambled or muted. Farmers were frequently not paid the full world price for their crops, because governments were determined to keep local prices low in order to relieve hard-pressed consumers. Some governments also banned food exports.

``Even in rich countries, farmers are responding to many things other than food markets. Take oil prices, for example: these (and government subsidies) determine how much maize is planted for ethanol. That in turn influences how much land is planted to soyabeans, which for American farmers are interchangeable with maize. Growers are also responding to the flow of investment capital into farming as a result of the global financial meltdown. Food is recession-resistant, and farming has been one of the sectors least affected by the worldwide slump. The FAO’s Abdolreza Abbassian argues that increasing links between farming and other parts of the economy are making it more difficult for farmers to calculate in advance the profitability of any one crop, so the area they plant is tending to fluctuate more sharply from year to year. Farming—as the past two years have clearly demonstrated—is becoming a more volatile business, both in terms of price and area planted."

``On the face of things, markets last year were adjusting exactly as economic theory predicts they should: prices rose, drawing investment into farms; supplies then rose sharply, pushing prices down. But that was not the whole story. The price fluctuations of 2007-09 suggested that uncertainty in the world of agriculture was deepening under the influence both of oil prices and capital flows. The fact that prices are still well above their 2006 average, even in a recession, suggests that the spike of 2008 did not signal a mere bubble—but rather, a genuine mismatch of supply and demand. And this year’s price increase suggests that there is a long way to go before that underlying mismatch is eventually addressed. “I don’t see that anything has fundamentally changed,” says Mr Abbassian. “That means we cannot go back to where we were in 2007.”

While the Economist alludes to capital flows as another variable in passing, it didn't dwell on the influence of global monetary policies -where zero bound interest rates and a loosened credit policy environment have sparked credit booms in emerging markets as China and may have added further pressures on the demand side.

At the end of the day, the growing risks of a food crisis all boils down to extensive government intervention that has deadened market price signals, and severely distorted the balance of supply and demand.

Aside, this could also possibly signify a flight to commodities or the crack up boom phase of our Mises moment.

Global Stock Market Performance Update: Rotational Effects and Tight Correlations

Another fantastic chart from Bespoke Invest giving us an update on the recent turn of events.

According to Bespoke (bold highlight mine),``Bloomberg's World Index made a rally high on June 2nd. Below we highlight the stock market performance for 83 countries since June 2nd and year to date. Since the 2nd, 14 countries have seen stock prices continue to rise, while the other 69 have seen prices fall. Lebanon, Kenya, Sri Lanka, and Mauritius are the only countries with double-digit percentage gains. The biggest country to show gains during a time when global stocks have struggled is China. China's Shanghai Composite has rallied 6.18%. The other three BRIC countries have not fared as well. India is down 3.7%, Brazil is down 7.82%, and Russia is down a whopping 21%. Russia has been the second worst performing country during the recent downturn.

``Looking at G-7 countries, Japan has held up the best since June 2nd with a decline of 1.59%. The US has been the second best at -5.21%, followed by the UK, Canada, France, Germany, and then Italy."

My comment:

If global markets have been driven by liquidity or monetary forces or inflation dynamics then it is quite obvious that there will be rotational effects and secondly, for the early movers some tight correlation, as global liquidity transmission interlinks divergent markets.

Notice that most of the today's (from June 2nd) topnotch performers (e.g. Kenya, Bangladesh, Latvia, Slovakia, Oman, Morroco, Bostwana et. al.) have had sluggish year to date gains or had earlier underperformed.

Additionally, the decline of the BRICs (except China) have been in parallel with the decline of the front running EM leaders, as well as, having tracked OECD market performance in terms of price direction over the interim.

Russia's hefty decline exhibits overheating. The Russian benchmark is still the 5th best year to date performer IN SPITE of the recent (21%) downturn. It trails Peru, Sri Lanka, China and India.

This implies of an ongoing rotation, where previous laggards are now ahead, while former leaders appear to undergo a hiatus.

Next, despite the recent correction, Emerging Markets continue to outperform developed economies, albeit at different rates-again an obvious impact from inflation dynamics-as that of being relative.

Inflation or Deflation? The Global Perspective

The following chart from Bespoke is quite revealing. It shows of the present inflation rates around the world.

We quote Bespoke (underscore mine), ``For those interested, below we highlight a big bar chart showing the most recent inflation rates for 77 countries. The average unweighted inflation rate for all of the countries is 4.11%. Fifty-nine countries are currently seeing prices rise versus a year ago, 14 are seeing prices decline, and 4 are flat. Venezuela has the highest inflation rate at 27.7%, followed by Kenya, Iran, Ukraine, Pakistan, Guatemala, and Russia. Ireland is seeing the most deflation with a year over year decline in prices of 4.7%. China has the third biggest decline in prices at -1.4%, while the US is right behind at -1.3%. Whether or not you use this chart to make any investment decisions, it does provide a good look at where each country stands in regards to price movements."

Our observations: one in four countries have been experiencing inflation in the face of the crisis.The average inflation rate is 4%.

Nonetheless, Two things clearly standout:

One, inflation is relative. Common policy programs aimed to address national problems which have been structurally idiosyncratic apparently results to different levels of inflation.

Two, for those arguing about global deflation, these chart appears to strongly refute such an argument.

To add further, consider that the present climate has yet been operating under a "benign" phase of the inflation, what more if inflation secures a strong foothold in countries impacted by debt deflation??!!!

As Edward Chancellor of GMO aptly wrote in the Financial Times, ``There is no question that a determined central bank can get rid of deflation. It is simply a question of printing enough money. Economists have another term to describe the monetisation of government debt. The history of “seigniorage” goes back to the debasement of the coinage under the Roman emperors. Seigniorage is really a tax on holders of money and government debt which is paid via inflation. When carried to excess, it leads to hyperinflation."

You've got a serious inflation crisis ahead!

Global Stock Markets: Finally A Reprieve, Ivory Tower Syndrome And Ipse-Dixitism

``Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one” -Charles Mackay, Extraordinary Popular Delusions and the Madness of Crowds

Finally after 6 weeks consecutive weeks and a dazzling 21.64% of gains, the Philippine benchmark, the Phisix, finally succumbed to a hefty 7.72% “profit taking” streak over the week.

Yeah, cower in fear because the big bad bear is back in picture! But is it?

Figure 1: Global Profit Taking

Anyone looking for a simplified answer should get this…we aren’t alone. See Figure 1

While the domestic losses may have the biggest in Asia, perhaps exacerbated by the uncertainties over the political front or just plain momentum-sentiment based panic, the carnage in the region had been nearly equally as steep. For instance, Vietnam, Thailand, Indonesia, Hong Kong and India suffered losses anywhere in the range of 5%-7%. That has been the rule.

The chart shows how the Dow Jones World, Asia Ex-Japan and Emerging Markets simultaneously turning down.

And again, China has again been the exception with both indices (Shanghai and Shenzhen) gaining nearly an astounding 5%.

But it isn’t China alone this time, the recently concluded longstanding Tamil insurgency problem in Sri Lanka appears to have brought about a stockmarket honeymoon.

The Colombo Index has spiked by nearly 9% this week, and is the first of among Asian markets to have reached the pre-crisis levels and is just off by about 20% from the 2007 high see Figure 2.

Figure 2: Bloomberg: Sri Lanka’s Colombo: Honeymoon

And I am predisposed to think that Asian bourses will follow suit.

Additionally, I’d like to point out that the Sri Lankan Colombo index has defied the tide because of an extraordinary development.

Going further, the scale of the recent losses has extended throughout most of Europe and to the Americas. Nevertheless, it has been a mixed showing for the Middle East and African region.

G-8 Communiqué As Catalyst?

So what has spurred this so-called global profit taking?

Technically speaking, under normal circumstances, no trend goes in a straight line.

Empirically, we have been witnessing excess volatility from a massive liquidity driven environment.

Fundamentally, I am predisposed to view this event, the G-8 meeting in Italy last weekend where leaders spoke about plans (actually blarneys) to unwind rescue program-as having been the main catalyst.

This from the Wall Street Journal (bold highlights mine), ``World financial leaders are starting to examine how they will unwind their emergency spending packages and bank rescues as signs emerge that the economic crisis may have hit bottom.

``Finance ministers from the Group of Eight leading countries on Saturday asked the International Monetary Fund to research strategies to slim budget deficits and reduce government presence in the financial sector, but in a way that wouldn't reignite the crisis.”

Three observations from these meaty statements:

One, governments have engaged in massive scale of emergency programs without the benefit of studying the possible unintended effects of such programs.

Two, along with this is the NO contingent or NO exit plans.

Gadzooks! Governments have been operating on mere BLIND FAITH on the feasibility of mainstream economic models!

And lastly, asking the IMF to “research strategies to slim budget deficits” is downright and strikingly preposterous! It resonates of the addiction by governments on boondoggles (spending binges) without considering the financing or all other aspects for that matter.

Commonsense says that you either need to cut spending or raise revenues! How complex or difficult could that be? And you don’t need the IMF for that. Qué Horror! Maybe the G8 leaders need to bankroll me for a lot cheaper price.

Markets, acting apparently on cue, shuddered from the thought of such exit plans! This goes to show how increasingly dependent our financial markets have become to money printing dynamics.

The Ivory Tower Syndrome?

Yet for some, commonsensical thinking or basic economic reasoning isn’t the preferred view.

Ironically commonsensical thinking has been perceived as tantamount to the Ivory Tower Syndrome.

The comments of Professor James K. Galbraith of the Lyndon B. Johnson School of Public Affairs at the University of Texas relates to its definition, ``I don’t detect any change at all. [Academic economists are] like an ostrich with its head in the sand.”

Experts afflicted with the Ivory Tower Syndrome simply means losing touch with reality.

It’s because these experts mostly live in a theoretical world filled with quant or econometric models, with virtually no hands-on exposure at risking their own money. Nonetheless they survive under the stipend of institutions and by NOT getting their hands dirty. In other words, perspectives of Ivory Tower analysts are most likely to be unrealizable, if not delusional and unworthy to be heeded.

As the global financial markets endured from a meltdown during the last quarter of 2008, we pointed out that some significant signs, such as the emergence of barter trade (which signified as an impasse on trade finance more than an economic problem) and an appearance of a bottoming market in China, defied the “realistic” consensus view that the world would fall apart.

At the heat of the panic we even declared a buy! [see October 12, 2008 The Bullish Case: It’s Blood On The Streets!].

Then, except for a few experts as Warren Buffett, Jeremy Grantham and John Hussman whose outlook we explicitly covered, other prominent value investors joined the contrarian bandwagon as Steve Leuthold, Anthony Bolton, Vanguard’s John Bogle and Rob Arnott we mentioned in The Rise of Value Investors Amidst A Prevailing Fear and Loss Environment. All of these elite savants, along with my humble perspective, challenged the interpretation of reality by the consensus as the imminence of deflationary depression!!!

Further, we even found evidences of a bottom in commodities last November 2, 2008, see More Compelling Evidence For An Inflection Point in Commodities!.

Moreover, as signs of improvements got reinforced, we repeatedly pounded on the table that stock markets and commodity markets will eventually be driven by government printing presses around the world, which has collectively been operating on 24/7 basis.

And instead of getting tied with economic gobbledygook, we focused on the inflation dynamics which in our view should give us a better glimpse of the market’s direction [see November 30, 2008, Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?]

This means that, in contrast again to the consensus, whom has opted to fixate on mainly the economic template, our fundamental area of concern has been to scrutinize on the actions of global political leaders and central bankers with its possible ramifications or impact on the markets and the economy.

Simply stated, we DIDN’T DEAL with esoteric mathematical models or flamboyant statistical artifacts seemingly aimed to mostly impress gullible audiences as employed by most mainstream analysts with their highly flawed models, we simply dealt with plain vanilla economic reasoning.

As Gerard Jackson in Economic commentators still clueless about the recession so aptly put, ``Unfortunately there are no mathematical relationships in economics. This means that economics is qualitative and not quantitive, despite the obvious importance of statistics.”

The point of this rant is not to accept or deny the pejorative imputation of Ivory Tower analyst, since that would be subjective. People can just say anything about anybody, true or untrue. It’s all a matter of consistency or inconsistency between the allegation and the performance.

Importantly, the perception of reality has always been a preconception out of individual biases. Alternatively, this means ``People believe what they need to believe, when they need to believe it”, a favorite quote of mine excerpted from Bill Bonner of the Daily Reckoning fame. Otherwise, this is also known as the confirmation bias-or the proclivity to look for or interpret data which confirms to inherent beliefs.

Ipse Dixit: Fundamental Driven Markets

In the present circumstances what seems to be the predilection of the mainstream?

Since the markets have shown signs of “life”, many have extrapolated current price levels as an attribution to “fundamental” driven market-economy dynamics.

In other words, the George Soros’ reflexivity theory seems to be getting even more entrenched- many now insist that fundamentals matter more than liquidity. Why? Because prices say so!!!

Funny, but 9 months ago or even at the start of the year, we haven’t heard arguments of such genre. Now market actions appear to calcify on the biases of many market observers.

Let us put it this way, since we believe that this episode has been tightly driven by the interlinkages of global liquidity channels, then it is likely that stock market and commodity market performance will be reflective of the state of inflation absorption as well as the degree of monetary inflation across the global economic and financial system.

In other words, inflation is always relative. As Henry Hazlitt in What You Should Know About Inflation [p.130] wrote, ``Inflation never affects everybody simultaneously and equally. It begins at a specific point, with a specific group. When the government puts more money into circulation, it may do so by paying defense contractors, or by increasing subsidies to farmers or social security benefits to special groups. The incomes of those who receive this money go up first. Those who begin spending the money first buy at the old level of prices. But their additional buying begins to force up prices. Those whose money incomes have not been raised are forced to pay higher prices than before; the purchasing power of their incomes has been reduced. Eventually, through the play of economic forces, their own money-incomes may be increased. But if these incomes are increased either less or later than the average prices of what they buy, they will never fully make up the loss they suffered from the inflation.”

Applied to the current setting, I would deduce that that the stock market and commodity markets have been the secondary recipients of global government spending, central bank lending, direct grants and US Federal Reserve purchases of US sovereigns and mortgage bonds. This has prompted some corners to baptize a moniker for this phenomenon as the bailout bubble, as earlier discussed in Monetary Forces Gaining The Upper Hand Equals The "Bailout Bubble"?.

Whereas circulation credit or bank lending from emerging markets or in Asia or in parts of the US (such as federally insured mortgages) or elsewhere could account for as primary or also secondary channels. The Wall Street Journal gives as this clue, ``Because businesses can't put trillions of new dollars to work in such a short time, the money is finding its way into financial markets.” (bold emphasis mine)

Since markets always operate on the basis of expectations, then a synchronic decline in global markets suggest of four possible causes, outside the technical and sentiment based considerations:

One, markets could probably be discounting a peak in government sponsored programs. Given the addiction of governments as shown by the G-8 news, this isn’t the likely route. Governments have been relishing both the spending spree and the apparent initial favorable effects on the markets.

Two, markets could also be factoring in a culmination in bank lending thru policy induced tightening or a by an aggregate private institutional policy curbs.

This isn’t likely so too. Since the US Federal Reserve has been providing leadership and guidance to global central bankers’ action, then its policy rates could serve as bellwether to the interest rate policy direction of other major central banks see figure 3.

Figure 3: St. Louis Fed: Fed Fund Rates futures

We note that while the Fed rates futures have indeed seen a marginal increase to the upper band of the official Fed Rates, it hasn’t succeeded in breaking out yet.

Three, a combination of both.

Fourth, false negative or also a trial balloon. Here the market may have misread the government actions or communications on the threats to unwind or reverse emergency programs, where the official G-8 communiqué may have been unintentional or intentional, possibly targeted at testing markets response.

While I am not certain on the true state of the markets now, the G-8 pronouncements most probably embodies the fourth variable.

Governments given their ideological underpinnings and the present conditions are unlikely to further discomfit the markets. So any further weaknesses by the stock markets are likely to prompt for “dovish” or market friendly communications from the officialdom.

This brings us back to the revitalized arguments of the ‘fundamentalist’, if markets have been moving based on fundamental factors and not from liquidity transmission channels, then why is it then that global markets continue to act almost uniformly? Why are correlations high among regional markets (except for China and Sri Lanka) or even relative to global markets?

The reaction seen in the global markets hasn’t been seen only on Phisix component issues but also in the internal market actions as seen in the market breadth and in the sectoral performance, of the Philippine Stock Exchange (PSE) see figure 4.

Figure 4: PSE: Sectoral Performance, Fundamentals, Where?

The Banking index (black candle), Service (Gray), Commercial Industrial (pink), Holdings (red), property (blue), All index (maroon) and mining (green) have all been down.

The most recent carnage has almost been in the scale of the climax of the October-November 2008 rout, where advance-decline balance has almost been 1:4 ratio!

Further deterioration of market internals at the same rate as last week would translate to the same tsunami that would sink all ships afloat!

So fundamentals, where?

Focus On Issues That Matter

People are unarguably entitled to their perception of reality. If anybody wants to believe in the “reality” of Santa Claus or Peter Pan and tinkerbell or Superman or a living Elvis, no one will stop them.

Although we are open to exchanges of ideas in the same way markets operate on the exchanges of goods or services based on voluntarism and the availability and expected informational changes, my preference for cerebral stimuli are based on merits and show proofs or evidences and not on Ipse-dixitism or an unsupported assertion.

That’s because to operate on hunches or base intuition is likely to be a very risky endeavor where cognitive biases can function as fatal traps. And this applies not only to the investment sphere but to real life non-investment decision making.

A misdiagnosis that leads to a wrong cure risks worsening of the conditions of a patient possibly by complications. In investments, the same misdiagnosis could translate to heavy losses.

And that’s why we try to avoid dealing with gossip or trivia based market actions. Sensationalism, which connects to the majority, only reinforces cognitive biases. And what usually are deemed as popular issues or causes are frequently flawed or even illusory. For instance, politicians sell free stuffs-health, education, jobs, including bailouts and etc. especially during election seasons. In a world of scarcity, there is no such thing as free lunch. Another, some people equate stocks to horse racing, hence, they get what they deserve.

And by the omission of the sensational, it doesn’t matter if our viewpoints aren’t popular. What matters for us is survivability and feasibility.

Conclusion

Despite the harrowing performance of the Phisix or of global stock markets, which may have been prompted for by market’s realization that the good party days may be cut short perhaps based on the conveyed communication by the G-8 meeting or possibly due to overextended or overheated winning streak, it is highly likely that these setbacks could be temporary.

Governments sensing the latest streak of triumphs aren’t likely to upset the present gains, in spite of pressures applied by certain quarters. The present environment has been ideal for the governments as they benefit from both their spendthrift ways and an ephemeral favorable market condition which illuminates on the vainglories of the fictitious centrally based solutions to national economic problems. Maybe Murphy’s Law applies here: If it ain’t broken, don’t fix it.

If today’s markets have been responding to the expectations of culminating inflationary actions then governments will most likely change tones and revert to dovish themes while simultaneously re-inflating the system. That’s our bet.

Besides mainstream experts adhering to the predominant ideology would constantly use technical jingoism of “output gaps” and “idle resources” to rationalize or justify further money printing activities through-quantitative easing, deficit spending, Zero bound policies, negative real interest rates and etc.

So I’d go against the technical outlook which is in present emitting signals in conflict with the probable effects from government policies. Stock markets could go lower or consolidate but won’t probably retest the old lows.

Finally, what appeals to people is what they like or want to hear, read or see premised on their underlying biases.

Biases are inherent to human nature, as it had been hardwired to us by our ancestors. It has been programmed into our genes. Although, the best way to manage bias is by keeping an open mind.

After all, in the markets, it isn’t about being “right” in terms of convictions, it is essentially about being profitable by adopting the “right” flexible mindset and discipline.

So from our end, if the Ivory Tower syndrome equates to survivability, feasibility and performance, then it’s no shame to be labeled as one.

Unfortunately, the idiom, which means to lose touch with reality, would lose its relevance.