Phisix: The Philippine Presidential Honeymoon Cycle Is On

``Most of Southeast Asia is held back by corrupt relationships between politicians and businessmen. This results in too many monopolies and cartels, and a corporate sector that enriches a few powerful families at the expense of the overall economy. Under Marcos, crony capitalism plumbed new depths of larceny and incompetence. Still, the situation was bad in the Philippines even before then. This perhaps reflects two things. First, the key business families are also the key political families, rather than their associates, and so are even closer to the heart of government. Second, its history as a Spanish colony means its systems are closer to those of Latin America than the rest of Asia, which was mostly colonised by Britain, France and the Netherlands. So it shares many of that region’s governance problems.”- Cris Sholto Heaton Should you invest in the Philippines?

So how will the present turn of events impact Philippine markets?

Here is how the Wall Street Journal sees the effect of the Euro’s bailout on Asia[1], (bold highlights mine)

``While Asian markets welcomed the €750 billion ($955 billion) bailout plan, economists and analysts warned that the rescue package could end up bringing even more capital to Asian markets...

``Loose monetary policy in Europe and the U.S. has already helped to inflate assets prices in Asia, especially for emerging-market bonds and real estate. The European Union proposal telegraphs that easy money will continue for the time being. The Federal Reserve reinstalled currency-swap lines that will also make dollars more easily accessible to funding markets around the globe.

``Recent data confirm that Asia's economies are moving strongly despite the turmoil in Europe, and are at risk of inflation grabbing hold.

Why should foreign money come to us?

Aside from the tremendous liquidity, Asia’s finances are generally better positioned relative to developed economies (see figure 6)

Figure 6: Money Week Asia[2]: Why the eurozone crisis won't rattle Asia

In relative terms, Asia has higher savings, current account surpluses, low systemic private sector debt, lower national debt as % of GDP and better fiscal position.

I think the most important factor driving Asia today is the inclination towards more openness to trade and investment with the world today. This is aside from deepening trends towards regional integration.

Moreover, the other notable impact of the trade openness is the economies of scale from Asia’s huge population.

However, economic development and financial markets can disconnect as it did in 2008.

So I am not as confident of a decoupling until we see more elaborate evidences from this.

Nevertheless since markets as unlikely to crater from our perspective, the other potential impact could likely come from the optimism brought about by a Presidential honeymoon cycle.

As we noted in the past[3], the Presidential elections in the Philippines tend to coincide with the troughs in the interest rate cycle in the US.

This we think has fuelled the optimism that led to previous Presidential honeymoon cycles (see figure 6). And we seem to be in exactly the same position as before.

Figure 7 Phisix: The Phisix’s Presidential Honeymoon Cycle

The outperformance of the Phisix relative to global markets of late could already be a sign of liquidity driven Presidential honeymoon cycle.

But one week does not a trend a make.

Therefore we will have to observe how our markets will react to external pressures.

Nevertheless the odds appear to be greater for the domestic honeymoon cycle to playout as it has, possibly this time with a stronger impact.

However it’s mainly not because of the election winner, although the buoyant sentiment will indeed contribute, but it’s going to be because of the unprecedented scale of liquidity, given the current conditions.

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[1] Wall Street Journal, Asia Fears Flood of Capital Risks More Overheating

[2] Money Week Asia Why the eurozone crisis won't rattle Asia

[3] See Why The Presidential Elections Will Have Little Impact On Philippine Markets

Evidence of Liquidity Boom: "The Market Loves Trash"

As we've been saying all along the global markets have been liquidity driven more than "fundamentally" driven.

This phenomenon seems evident including in the US, where small cap stocks have outperformed the big cap stocks.



From the Wall Street Journal, (Thanks to Bespoke for the pointer) [bold emphasis mine]

``After a brief swoon in January and early February, the riskier end of the stock market is back in favor.

``That includes small stocks, stocks badly hurt by the financial crisis and those most dependent on global economic growth. Safer stocks, including those that offer steady dividends, are out.

``That wasn't the case between Jan. 19 and Feb. 8, when the Dow Jones Industrial Average fell 8% amid fears that the global recovery could stall.

``Since then, the Dow is up 7%. And in most cases, investors are turning to the same stocks that led the market higher in last year's big rally.

"It seems like the lower-quality, smaller-sized names are taking the lead," says Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "We are getting a junk dominance again."

``By a variety of measures, lower-quality stocks are out-gaining higher-quality stocks, says Paul Hickey, co-founder of Bespoke Investment Group in Harrison, N.Y.

"In the words of Oscar the Grouch," says Mr. Hickey, "the market 'loves trash.' "

``He has ranked the quality of stocks in the Standard & Poor's 500-stock index based on their market size, price/earnings ratio and credit rating. He even sorted them based on which get the most attention from short sellers, the bearish investors who bet that stocks will decline by borrowing the stocks and selling them.

"No matter how you look at it, so-called low-quality stocks in the S&P 500 have outperformed high-quality stocks" since Feb. 8, Mr. Hickey says.

``The 50 smallest S&P stocks have risen 13%, compared with a gain of 9% for the 50 largest stocks. Companies whose bonds are rated as junk have risen more than those with investment-grade ratings. The 50 stocks with the highest prices, compared with analysts' expectations for their 2010 profits, are up 16%. Those with the lowest price-to-earnings ratios are up 10%. The most heavily shorted are up 15%. The least-shorted are up 7%."

My comment:

Essentially the outperformance of small stocks appear to be driven by momentum, as punters pile in on the winners in the expectations of continued strength.

As we previously pointed in Are Stock Market Prices Driven By Earnings or Inflation?, a refresher on some of the valuable insights of Fritz Machlup on the stock market.

-A continual rise of stock prices cannot be explained by improved conditions of production or by increased voluntary savings, but only by an inflationary credit supply.

-Extensive and lasting stock speculation by the general public thrives only on abundant credit.

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.

Monetary Forces Gaining The Upper Hand Equals The "Bailout Bubble"?

It's been our repeated assertion that monetary forces have been dominating the financial markets and this has been generating some spillover effects to the real economy from which the mainstream labels as "greenshoots".

An article from the Wall Street Journal seems to recognize this phenomenon, which they brand as the "BAILOUT Bubble".

chart from the WSJ

Quoting the WSJ, (bold emphasis mine)

``But governments around the world are pumping money into the economy at a frenetic pace. 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. Some investors have begun speaking of a "bailout bubble" being created in certain markets, and about a "melt-up" in demand fueled by the growing supply of money."

``"All that money that was printed had to go somewhere," says Joachim Fels, co-head of global economics at Morgan Stanley. "It has been pushing up commodity prices and stock prices, starting in emerging markets and then pushing over into developed markets."

``The U.S. government alone has allocated $11.4 trillion to direct and indirect stimulus in the past two years, of which about $2.4 trillion has been spent, according to an estimate by Daniel Clifton, head of policy research at New York's Strategas Research Partners. Most of the money has been pushed out in the past year.

``The money is gushing from direct grants, central-bank lending, tax breaks, guarantees and other items. China has announced plans for $600 billion in direct stimulus spending; Russia, $290 billion; Britain, $147 billion; and Japan, $155 billion, according to Strategas. Those countries and others are spending trillions more indirectly.

``"It is quite easily the biggest combined fiscal stimulus the world has ever seen in modern times," says Jim O'Neill, chief economist at Goldman Sachs. "That liquidity will impact anything that is sensitive to it, ranging from short-term fixed-income securities through stock prices through property prices and into people's personal wealth."

We might add that government direct spending (e.g. infrastructure and etc.), federally insured mortgages, and Federal Reserve purchases of US treasuries and mortgage bonds from overseas investors and central banks as possible alternative channels from which bailout money has been reallocating of risk.

Dr. John Hussman recently wrote taking a different approach, he says, ``the proper way to think of all of these bailouts and stock issues is not that new purchasing power is being created, but that ownership of existing assets and liabilities has changed in a way that reallocates risk from the private sector to the government. There is not a bunch of money "looking for a home." The overall effect of the bailouts has been to put Treasury securities and temporary bank reserves in the hands of the financial companies, in return for preferred stock and temporary repos of commercial mortgage backed securities. Let those corporate securities fail however, and that's when we have a real money creation problem, because the government will have created liabilities that it cannot buy back in using the assets it took in when it created them. That's a huge risk here."

Nevertheless, the WSJ article goes on to say that this isn't likely going to end well.

``The growing liquidity also is creating serious policy challenges. Senior economists, including Federal Reserve Chairman Ben Bernanke in congressional testimony on June 3, have begun warning that the government can't keep piling up debt at current rates without creating severe financial problems.

``In coming years, officials will need to raise taxes, cut spending, or both to mop up the ocean of liquidity they have created. That process could weigh on growth and stifle the market boom...

``If the government fails to mop up the money, the consequence could be even worse: inflation and a collapsing dollar."

``Past liquidity-driven booms haven't ended well. In 1998, the Federal Reserve injected cash into the economy to rescue teetering bond markets. The unintended outcome: Technology stocks soared and then cratered. After the government turned on the spigot in 2001 to stave off deflation, residential real estate surged and then collapsed."

So whether this is about money flows or reallocation of risks or stages of inflationary cycle (the latter view is where I lean on), the end game isn't going to be anywhere tranquil.

Policymakers are only deceiving themselves to believe that surges in stocks and commodities signify as "recovery" or "signs of stabilization". They perhaps know deep down inside that a "policy of bailouts will only increase their number", which means persistent expanded inflation to keep prices at present levels. And their supporters, nonetheless, advocate this.

Yet all these are unsustainable.