Phisix: Too Much of Horror Movies

``In the sky, there is no distinction of east and west; people create distinctions out of their own minds and then believe them to be true." – Buddha

Local investors have been spooked by either inflation figures or elevated oil prices or both. The Phisix lost another 3.94% over the week to increase its year to date losses of 34.58%. From the Phisix peak in October 2007, the present bear market has accrued losses of about 39%.

Despite the net foreign selling this week, which was mostly due to the special block sales of San Miguel shares, board transactions reveal of a marginal net foreign buying. Again the rather slightly bearish bias to neutral outlook by foreign participants indicates of the locals at the driver’s seat.

The recent activities suggest that local participants continues indiscriminately sell the market in the assumption that the apocalypse is around the corner. This is a peculiarity though; retail investors hardly seem to know how to absorb losses which makes us suspect the ongoing selling pressures could possibly come from redemptions from indirect participants (e.g. bank UITFs, or Index funds or mutual funds).

Well we have been arguing that inflationary environments does not equate to financial Armageddon, there are industries that have been seen to benefit from the present environment see figure 7.

Figure 7 PIMCO: Winners and Losers

Pimco’s Mark Kiesel says that their company remains weighted in certain sectors (highlight mine), ``The energy, materials and metals and mining sectors remain areas we continue to favor in our credit selection process. In the case of energy, fundamentals tend to improve as price levels rise because higher inflationary periods typically result in strong top-line revenue growth for energy companies where demand is relatively inelastic. The industrialization of the emerging markets has led to significantly stronger demand growth for energy and put pressure on already tight resource supplies. Not surprisingly, gross margins for energy companies have expanded over the past several years as revenue has grown faster than costs.”

Why? See figure 7 again courtesy of PIMCO…

Figure 8: PIMCO: Who Has Pricing Power?

So inelastic demand, commodity pricing pass through, revenues growing faster than rising costs makes the aforementioned industries attractive.

Why have the local participants been selling? Because they’ve watched too much of horror movies.

Politicking Weighs On Phisix, Inflation Problems Have Been Policy Induced

``For far too long, we have accepted the idea that government can and should take care of us. But that is not what a free society is all about. When government gives us something, it does two bad things. First it takes it from someone else; second, it causes dependency on government. A wealthy country can do this for long periods of time, but eventually the process collapses. Freedom is always sacrificed and eventually the victims rebel. As needs grow, the producers are unable or unwilling to provide the goods the government demands. Wealth then hides or escapes, going underground or overseas, prompting even more government intrusion to stop the exodus from the system. This only compounds the problem.” Congressman Ron Paul Challenge to America: A Current Assessment of Our Republic

The Phisix has been bedraggled by administration led politicking which has led to its recent rout (down 3.1% over the week). Yet, the efforts by the mainstream media have been to affix the culpability to inflation which recently rose to a 9 year high. This mindless penchant to attribute false causes has been misleading the public compounded by blabbermouth experts.

Attribution To Inflation Woes Don’t Add UP!

As we argued in my recent post, Phisix Breakdown: Politics Not Inflation Related, goods and services inflation means the loss of purchasing power by the domestic currency to mostly fuel and food (which is what the news report says). Alternatively, this means that rising fuel and food prices have been getting a far larger share of expenses out of household or business budgets from which comes at the expense of non-fuel and non-food items. In short, spending on food and fuel crowds out other items. This is called relative price adjustments.

So in the perspective of relative prices applied to the equity markets, share prices of energy issues should benefit from the expectations of rising share of fuel expenditures and so with food related firms at the expense of other issues if “inflation” is the concern. Relative to the performance of energy companies, except for Petron Corporation, which amazingly soared by 17.65%, the rest of issues slumped such as Aboitiz Power (-3.57% w-o-w), Aboitiz Equity Ventures (-1.39%), PNOC EDC (-5.36%), First Gen (-1.43%), First Philippine Holdings (-3.03%) and Meralco (-4.07%)! So the so called inflation woes don’t add up.

Yet, inflation figures reported in the news reckon of past performance-particularly of last May. This means markets acting as a forward discounting mechanism should have discounted the past and read into the future.

If in the past (say last month or in May which read on the April figures) the market believes food and fuel inflation will continue to impact spending patterns in the future (which is today) then share prices of these issues would have likewise adjusted. This means at this point, shares of energy and food issues should be on an uptrend. But this isn’t the case.

And when the same deduction will be applied tomorrow or if once again the energy group is extrapolated to reflect on the continuing adjustments of consumption patterns then they should be expected to trend higher. This means prospective higher prices for energy issues!

But have we been seeing such dynamics? The reality is energy issues have either been consolidating (AEV, PCOR, AP and FGEN) or seem headed for the sewer (Meralco, FPH and EDC). Again, this inflation themed anguish doesn’t rhyme at all.

So why have energy issues (or the Phisix in general) been collapsing in the face of spending pattern adjustments arising from higher costs of fuel and food?

Because foreigners have been selling the Phisix! This week, foreign money has sold the most (Php 1.273 billion) since end of April. Coincidentally, the bulk or 68% of the foreign selling came at the time when the joint foreign chamber of commerce was being excoriated by our sanctimonious politicians.

A foreign chamber of commerce is a business organization representative of foreign owned enterprises in the Philippines. The benefits or costs accrued by their companies are transmitted to their countries which may induce or reduce incentives for future capital investments locally. Hence, any negative projection imparted by our leaders or by our political economy will negatively impact our image which may lead to foreign capital efflux aside from inhibiting future capital investments-our future jobs and taxes. So it becomes a paradox to brag about our “sovereignty”, especially under today’s “globalization” or increasing trends of cooperation and integration, when we can’t produce for ourselves enough capital to make enough jobs for our countrymen.

Besides, if as a foreigner you are invested in the country, having come to the realization that your equity ownership is at risk from political intervention, will you not sell and pull out? The answer is pretty obvious. Hence, the political risk arising from the administration’s continued assault on the private sector has been impairing the country’s attractiveness as a business destination. In effect, we have been shooting ourselves in the foot anew. We just hope and pray that sanity will be restored to our leadership.

Finally, the cause and effect between inflation and equities doesn’t necessarily have a linear correlation as we have always argued. To see an example, let us base it on recent global events-Kenya’s massive rise in its inflation data was equally met with a strong response in its stock market as shown in my post Kenya’s Mixed Message: Soaring Inflation Rates and Rising Stock Market.

Of course, Kenya is unlike Zimbabwe whose currency has practically collapsed down 84% since May and whose inflation rates is said to have vaulted to 1.8 MILLION PERCENT in May (Reuters). Of course, Zimbabwe’s hyperinflationary refuge has been its stock markets where its industrial index is up 261.15% in just ONE week while its mining index is also up 379.23% in just THREE days (allafrica.com)! In these we find that equity investments can become the corollary store of value when trust over a currency loses its foundation.

Yet, if there is any little trace of inflation based positioning in our domestic markets, well Figure 3 tells it best…

Figure 3 PSE data: Philippine Mining Index Diverges From the Phisix!

The Philippine Mining index (red line) has greatly outperformed the Phisix up 2.68% amidst the harrowing decline of the Phisix (black candle) over the week.

If inflation is defined as a loss of purchasing power against hard assets then naturally, resource based issues are likely to outperform under a massively devaluing currency reserve standard of the world, the US dollar.

Besides, since the Mining industry is the administration’s baby, (hopefully they won’t change minds), it is likely that there will be continued rotation towards such resource based sectors.

Figure 4 stockcharts.com: Resource based Assets Survive the US onslaught

And it’s not just here.

The major US benchmarks fell by about 3% last Friday, as the US dollar crumbled, to which some have associated the market’s reaction to the surprising stance by European Central Bank Jean Claude Trichet indicating the possibility of raising interest rates in July.

This unexpected declaration by Mr. Trichet allegedly prompted for a forced massive short covering across the Euro and commodities-particularly the oil benchmark which jumped by 8% the biggest increase since oil futures started trading in 1983 (NYT), aside from liquidation sales in the broad equity for margin calls. On the other hand, commodity related international stocks fell at a much subdued clip while mining and oil bellwethers in the US jumped (see figure 4)!

The Dow Jones Latin American Index (main window) slipped by 1.9% but still trades at near its recent highs, while the Dow Jones US mining index (pane below main window) shot to fresh record heights amidst the market turmoil.

Meanwhile, the Dow Jones Oil and Gas Services (middle pane) similarly leapt, as the Dow Jones Gold index (lowest pane) pivoted higher following the recent doldrums which has basically reflected the price action of gold.

As you would observe, except for the US Gold mining index which we think would follow suit higher, all three indices have been moving to the upside despite the increased volatility in the main US markets of late. This is “inflation” at its finest. In short, the loose correlation with the general market makes commodity based investments very attractive diversifiers.

Politically Induced Policy Measures Assures Of Prolonged Inflation Pains

All these market signals indicates too that the commodity and the “goods and services” inflation pressures being generated by the massive imbalances imposed upon by collective governments in skewing the global marketplace will continue to persist and risks even exacerbating. It is unhealthy to discount the possibility of a US dollar crisis.

In fact, our local politicos and the administration’s actions will likely compound on their dilemma with a slew of unintended consequences arising from their growing hostility towards the market instead of utilizing them for efficient allocation.

To give you an example the recent land conversion ban of agricultural properties ensures of the rising values of real estate which will likewise be reflected on rising rental prices as the supply of non-agricultural properties gets restricted in the face of growing urbanization and expanding population growth.

Figure 5: ADB’s Hyon H Son: Has Inflation Hurt the Poor?

As shown in Figure 5 courtesy of Hyon H. Son of ADB, rental comprises the largest of the non food expenditures for the Philippine poor and also for the non-poor.

So essentially, our government is simply shifting from one form of “popular” burden to another form of “unpopular” burden which eventually will get us slammed overtime anyway. Of course, the trick here is to understand how to cash in from the opportunities presented by the government’s populist impulsive driven policy gaffes.

Government’s Time For Self Introspection

And like all trends, commodities and good and services inflation doesn’t move in a straight line.

And as we also expected, inflationary pressures abroad has filtered to the domestic scene and will continue to do so until perhaps a global stagflationary recession occurs or a policy induced slowdown (tightening) by key Central Banks or nations collectively drop policy distorting measures (quite an impossibility).

Yes, another fulfilled expectations too is our (Bangko Sentral ng Pilipinas) BSP’s tepid response to rising “inflation” by increasing its headline borrowing and lending rates by a measly 25 basis points.

The unfortunate part is that increasing policy rates will do little good because-ONE, our inflation is basically imported, as University of Columbia’s Joseph Stiglitz recently wrote against inflation targeting, ``Inflation in these countries is, for the most part, imported . Raising interest rates won’t have much impact on the international price of grains or fuel. Indeed, given the size of the US economy, a slowdown there might conceivably have a far bigger effect on global prices than a slowdown in any developing country, which suggests that, from a global perspective, US interest rates, not those in developing countries, should be raised” and-SECOND, raising rates on baby steps doesn’t remove the accommodativeness of the Philippine monetary landscape.

Come to think of it even after raising rates, the margin of our inflation index has been growing wider compared to 1) the country’s economic growth rate or 2) the nominal rates set by the central bank or 3) the yields of our treasury bills, which means like many other central banks around the world, the BSP seems to be fostering an “inflation friendly” negative real rate environment, again another policy induced problem.

Of course not to mention that March money supply growth rate is nearly double or 9.6% of the recent economic growth clip-another prospective contributor to domestic inflation.

So essentially the problem with our government is that they have been looking for scapegoats at the wrong places and have been caviling on the private sector’s contribution to our economic woes, when in fact, it is time for them to do some self-introspection.

Foreign Money on Domestic Mining Industry

Why we think foreign money has been flowing into Mining stocks and why we think they will continue to pump them up…

Here are some clues.

First clue: benchmark indices of several key commodity countries are at record highs.

Courtesy of Bloomberg: Brazil’s Bovespa

Courtesy of Bloomberg: Canada’s S&P/TSX

Courtesy of Bloomberg: Russia’s Russian Traded Index

Second clue: global mining indices likewise are on the ramp!

Courtesy of Stockcharts.com: Dow Jones US mining

Courtesy of Stockcharts.com: S&P Metals and Mining Index

Courtesy of Stockcharts.com: S&P Global Mining Index

Third clue: Best and Dominant Performers during the Past 3 months (as of Friday’s close)

Courtesy of Big charts.com

Convinced?

First Test of the Phisix Bottom Thesis: Passed With Flying Colors!

``The true prophet is not he who predicts the future, but he who reads history and reveals the present.”-Eric Hoffer, 1902-1983, American social writer

So far so good.

My suspicion that the Phisix could have probably entered into a bottoming phase encountered its first acid test and appears to have passed with flying colors. In the face of pervasive gloom and doom, the Phisix cautiously bounced back by 2% this week for the first week in five.

Interpretation of Initial Impact and Arguments For A Phisix Bottom Redux

Of course the market’s reaction can be interpreted in two ways;

one- a short term interim technical bounce amidst a persistent medium term bear market or

second- an interim bounce which paves way for a seminal bottom under the perspective of its long term underlying trend. Remember market cycles involves process transitions and is not merely event-driven as incredibly suggested by some “experts”, therefore, the Phisix would have to pass repeated tests in order to reconfirm the validity of the ongoing restoration of confidence process.

We have premised the potential turnaround on a confluence of factors which involves the following:

1. Market volatility.

The recent gains of the Phisix (2.8 times) have not been steep and sharp enough as to merit a similar scale of descent. As an example, in 1986-1987 the Phisix climbed by about 10 TIMES which was correspondingly met by a nasty 50% correction. Similarly as mentioned last week, Saudi’s Tadawul and China’s Shanghai bourses flew by over 5 times in TWO to THREE years and has met by the same degree of volatility on its corrective phase, 65% and 50% respectively. Paraphrasing Newton’s Law, Every action has an almost equivalent and opposite degree of reaction.

2. Bubble cycle.

Every asset classes in today’s paper money driven world have been driven by varying stages of massive credit and monetary expansion. Based on public participation we have not seen evidence of such euphoria or investor irrationality.

Next, our asset markets have not reached extensively rich valuations levels. Lastly, the country’s macro or micro indicators have not signified signs of excessive leverage.

3. Encompassing Negative Sentiment.

Since market activities are driven by the investing or speculating public making decisions for whatsoever reasons- they involve psychology. Thus, market cycles are primarily underpinned by the psychological cycle.

Given today’s dire headlines from the domestic front (rice crisis, government threat of a utility takeover, etc.) to overseas (US recession, world economic slowdown, continuing credit crisis, surging “inflation” in food and energy, etc.), the degree of risk aversion has somewhat reached overshoot levels. Yet actions in the marketplace do not reflect or have not been congruent to the same degree of anxiety as shown in Figure 1.

Figure 1: stockcharts.com: PSE The Outlier!

As global markets have remained as closely correlated as in the past, most of these benchmarks imply that the underlying national indices under such rubric have rebounded since March of this year (vertical line).

The Dow Jones World Market at the top pane, the Dow Jones Asia Ex-Japan Index (below center window) and the iShares Emerging Markets (lowest pane) have recovered substantial losses since October.

Whether this recovery represents a “dead cat’s bounce” or a “bear market” rally is arguable and predicated on the caller’s bias. But the point is the Phisix (at center window) has missed the “gravy train”! Or…so it seems?

But compared to the past rallies which manifested of sharp V-shaped bounces, this time we are seeing some signs of consolidation (circle).

A prolonged consolidation or a gradual ascent should exhibit the recovery’s resilience, but again bottoming as a function of an evolving process within a cycle will mean repeated tests where investor patience and grit amidst prevailing fear should eventually be rewarded.

Yes, we were delighted to see that even as the US markets lost meaningful grounds last Wednesday (by about 2%), the Phisix “diverged” by recording moderate gains Thursday.

We have noted in the past that for the Phisix to reestablish strong indications of a recovery, (see Phisix: Pummeled On Foreign Downgrades, Still In Search Of A Bottom) durability in the form of less sensitivity to external variables should be seen as a guide, aside from progressive technical action, of which both signs seems to have been manifested this week.

Monday should be another test day since the US markets ended the week with moderate losses. Since Mondays are traditionally the weakest day of the week, the Phisix could be subject to some selling pressure following the weakness in the US markets. But for as long as the Phisix keeps the pace of its losses to within the range of losses in the US markets, we should remain in a consolidation phase with a recovery bias.

Dead Calm Waters Reveals Attribution Bias

One must be reminded that betting on future outcomes requires the understanding of risk and reward tradeoffs.

When we talk of a “bottom” we don’t even go near to the suggestion of a mystical formula or some alternative forms of voodoo rituality applied to the financial sphere but one where we distinguish the odds of the probability of incurring more losses against that of the odds of the prospective gains. In simple words, the bet of a bottom means the understanding that the room for further loss is significantly less than for future gains. But this, in contrast to the expectations of market punters, happens OVERTIME and requires PATIENCE.

I might like to add that the negative sentiment have truly reached extremes seen in the ground levels. In a recent social function which I regularly attend, where early this year participants seem agog over the market despite the decline (the assumption is that the market’s decline was short and shallow), today almost everyone seem to shun the topic of the stock market, which for me appears to uncannily resemble the investing atmosphere in 2002, a great window for grabbing outsized returns.

Nonetheless, I gathered that losses for some have been staggering enough to dismiss the existence of the stock market. And some have even fostered acerbity towards the financial intermediary agents (bankers, stock brokers and analysts).

Of course I might be accused of reading the sentiment of a group into the whole (fallacy of composition) but as we previously pointed out market internals, as seen by declining daily trades, have depicted the same picture where speculative froth engaged by mostly retail market participants have substantially ebbed. Since speculators have been caught in long positions due to their inability to accept losses or have been immobilized, trading activities have been restrained.

The lesson here is one of the Attribution Bias, where people tend to take credit on successful endeavors to inherent skills but deny responsibility for failures by imputing situational variables either by “randomness” or by the influences of others to their decision making.

Thus, when the market is buoyant everyone seems to know of the “whys” and the “whats” and the “who-drives-what” in the marketplace, and conversely when the market is dreary, the atmosphere seems like dead calm waters.

Negative Real Interest Rates and Emerging Market Bubbles

4. Negative Real Interest Rates.

Mainstream analysts or experts impute stock market investing to micro or macro events, some deal with the technical aspects. As a contrarian, we see the market as mainly the alternative function of money: a medium of exchange, a unit of account (means for economic calculation) and a store of value.

Not everything can be explained by micro or macro factors. Yet mainstream analysis insists on such lockstep correlation. We beg to differ.

Policies administered by government/s have manifested significant impact to asset prices. That is the reason for the phenomenon of bubbles. Investor irrationality is only an aggravating circumstance to a bubble in formation, because this cannot thrive without the principle of leverage (margin trades or credit expansion).

Following years of monetary accommodation and extensive growth of credit intermediaries of all sorts-derivatives to margin trades to alphabet soup of securitization, the implosion of the housing bubble in the US and other Anglo Saxon Economies has left central banks apprehensive of the negative economic growth impact from declining asset prices. As such, monetary authorities have mostly left policy rates lower than instituted “inflation” benchmarks hence negative real rates. Aside, they have been conducting massive liquidity bridging operations and applying fiscal subsidies in support of consumers suffering from the string of recent losses. We have explained most of these in Has Inflationary Policies of Global Central Banks Boosted World Equity Markets?

In addition, monetary pegs and mercantilist trading structures of key emerging markets have apparently resulted to a globalized mechanism for transmission of inflationary activities whose effects are now ostensibly rechanneled from Wall Street securities into commodities and emerging markets.

This insightful excerpt from Prudent Bear’s Doug Noland in his Credit Bubble Bulletin (highlights mine),

``prevailing inflationary pressures are global in nature. Wall Street finance is the source fueling the boom, and it’s running outside the Fed’s control. American asset inflation and resulting wealth effects are minimal, while price effects for food, energy, and commodities are extreme. In contrast to previous inflationary booms, while some selected groups benefit, the vast majority of people today recognize they are being hurt by rising prices. This hurt comes concurrently with atypical housing price declines. Today’s price effects pummel already weakened consumer sentiment, as opposed to previous effects that tended (through asset inflation) to bolster confidence. Furthermore, current inflationary forces are destabilizing and even destructive to many businesses, while playing havoc with the fiscal standing of federal, state and municipal governments.

``Revolving around booming Wall Street finance, previous inflationary booms naturally fueled surges in securities issuance and speculation. These Bubble Effects worked as powerful magnets in attracting foreign financial institutions, foreign-sourced speculators, and cheap foreign-sourced borrowings (i.e. yen borrowings financing higher-yielding U.S. securities) that all worked in concert to “recycle” our Current Account Deficits (“Bubble dollars”) directly back to our securities markets.

``In contrast, today inflationary forces largely bypass U.S. securities to play global energy, commodities, and hard assets. Foreign financial institutions are fleeing the U.S. risk intermediation business, while “Bubble dollars” are chiefly recycled back into Treasury and agency securities (where they now have minimal effect on U.S. home and asset prices). Meanwhile, the massive global pool of speculative finance is today focused on energy, commodities and the “emerging” economies.”

In short, what you are witnessing today is an ongoing massive shift in the inflation bias or bubble progression on a global scale from securities to commodities and to emerging economies.

Figure 2: stockcharts.com: Soaring Commodities and Latam Bourses!

Look at today’s commodity and commodity affiliated markets (see figure 2): Oil at an ALL time high $126 per barrel! The CRB Index is also at a Fresh record high! And commodity heavy benchmark of Latin American bourses (Dow Jones Latin America) also on record!

A world of negative real rates is likely to buttress such powerful dynamic. What you will likely have is a phenomenon of funds chasing winners which should spillover to a broader spectrum of commodity associated assets (yes we are seeing signs of the emergence of Ponzi financing in commodities), hence the bandwagon effect in motion!

While the impact of such inflation bias will always be unequally distributed between producers, sellers and buyers of commodities as discussed in my previous blog, Inflation Data Brings Philippines Into Deeper Negative Real Rates; NOT A Likely Cause of Today’s Decline, the Philippine economy as an erstwhile major commodity exporter is a strong contender to be a beneficiary from the globalized inflation machinery.

Figure 3: PSE subindices: Recent Recovery Primarily Driven By the Mining Sector

Incipient signs of such rotation have already surfaced.

While the Phisix remain depressed down 23.25% year to date as of Friday’s close, the mining index (equally down 16.5%. y-t-d) has seemingly bottomed since March and has gradually been in consolidation and now seen moving higher-see figure 3 (Japanese Candlestick). This comes after a 6% jump this week, mostly from Atlas Consolidated which has soared by 25%! You don’t normally see a 25% run over a week from an index heavyweight (second largest weighting in the mining index at 16% after Philex) especially in a BEAR market! This only strengthens our case that the Phisix will likely recover soon.

And given that both the above technical picture plus the developments in the world market strengthened by a negative real rate environment, it is likely that the mining and oil sector will lead the Phisix’s recovery over the coming sessions.

All other indices in the chart are underwater on a year-to-date basis, this includes Banking (blue) down 19.75%, Commercial Industrial (violet) 20.59%, Property (red) 29.95%, Holding (green) 27.62% and Services (orange) 19.82%.

Moreover, investors will always find justification for an investment theme. Economic growth supported by capital investments over a dominant asset class is likely to become a feedback loop in a self reinforcing bubble cycle.

Figure 4 GMO: “They have the growth. We don’t. What’s to discuss?”

As the sagacious fund manager Jeremy Grantham of GMO (Jeremy Grantham, Richard Mayo and Eyk Van Otterloo) recently argued in his outlook, historically bubbles would need a strong underlying fundamental case from which the bubble is anchors upon.

In terms of emerging markets as shown in Figure 4 it is likely to be found in the consistent outperformance of economic growth. In the poignant words of Mr. Grantham, ``They have the growth. We don’t. What’s to discuss?”

Like us, Mr. Grantham believes that the next bubble will be on emerging markets. Quoting at length Mr. Grantham (all highlights mine),

``For one, emerging will increasingly be seen on a country-by-country basis. Nevertheless, the second wave of let’s-look-like-Yale money from state plans is still in its early stages and looking to invest overwhelmingly in emerging market funds, not in the specific country funds of the Yales and Princetons.

``For another caveat, the GDP growth rate of a country does not in the very long term necessarily determine how much money a country’s stock market will make. Long-term market return may depend more on profit margins. But investors believe GDP growth really matters, and Japan went to 65x earnings despite average or lower corporate profit margins.

``But the third caveat is the most serious; this emerging bubble can easily be postponed or even stopped before it really begins by the current financial problems and the slowing growth rates of the developed world that are likely to follow.

``My own view is that our credit problems will impact and interrupt the recently sustained outperformance of emerging in the intermediate term, say, the next 3 years, even as the acceptance of this emerging bubble case grows. Such interruptions may be quite violent but, despite them, at the next low point for the U.S. market the emerging markets are quite likely to do no worse and in the recovery they will go to a very large premium. And if, just if, the U.S. gets very lucky indeed and muddles through without serious market and economic problems, then the emerging bubble will of course occur more quickly and smoothly.”

Phisix: Political and External Risk Variables

So yes, allied with the views of Mr. Grantham as we have previously mentioned, the Phisix is envisaged by two major risk factors; one is domestic political risk and the other is the transmission factors of the external risk environment.

Political risk could be associated with the risk of destabilizing markets through populist policies such as overextending subsidies to reverse the gains or improvements of the country’s fiscal position and balance sheet, combined with threats to the sanctity of private property ownership via “nationalization” or management “take over”.

So when we read of canards repeatedly circulating in the emails of “why the Philippines is poor?” we understand that it is the fundamental aspect of principally NOT having ENOUGH capital investments in the country and NOT because of lack of “moral” leadership why the Philippines is “poor” (yea ironically the Philippines is “poor” but home to 3 of the 10 world’s largest malls and growing!).

It is because of the lack of appreciation of the markets through property ownership and the enforcement of contracts, the lack of savings, a dearth of platform or infrastructure for establishing pricing efficiency, the lack of competitive environment, a politically dependent society or culture and importantly the high costs of political intervention and bureaucracy.

Remember the popular personality based politics theme of corruption represents a symptom and NOT the disease. Corruption basically is an offshoot to suffocating network of bloated bureaucracy as a result of overregulation and inordinately high taxation due to huge liabilities accrued from failed policies and deep dependence on political gratuity (a.k.a. pork barrel).

Economics 101 tells us that the more you want of something you LOWER the costs, in contrast, the less you want of something you INCREASE the cost. If you want to lessen the incidences of corruption you increase the cost of committing corruption. If corruption is an offshoot to overregulation then streamlining of laws, reduced bureaucracy and lower taxation should be encouraged aside from strictly enforcing laws.

In addition it is NOT governments that drive the wealth of economies or responsible for the upgrading of the standard of living of societies, otherwise communism (Stalin’s USSR, Mao’s China, Kim’s North Korea, Castro’s Cuba) would have succeeded; it is the people!

If governments empower its people to conduct trade openly with LESS political intervention thereby strengthening the division of labor within its economy then it reduces the country’s risk premium, lowers the hurdle rate, reduces the cost of doing business and thus becomes competitively attractive for capital investments.

Governance permissive of a market economy or an entrepreneurship culture and less dependence on the political leadership is the common denominator of successful economies. Because it is a governing policy to limit government’s intervention then the issue of “moral” becomes moot.

But when you see the leadership use its coercive power of its legally clothed leviathan to conduct political harassment or render vindictive actuations on presumed political opponents in the name of public services then it raises questions among potential investors about the sacredness of equity ownership.

This in itself increases the cost or barriers of doing business. Hence capital would seek a hefty premium in terms of higher rate of return or yields for it to consider deploying them into the country. The higher the costs the lower rate of investments.

These incessant political interventions is the reason why the Philippines will remain politically and economically disadvantaged and will thus depend on the global or regional cycle for its upliftment than from intrinsic factors such as the popularly demanded (but largely ineffective) “government driven” initiatives instead of the unpopular market oriented reforms. To quote Ludwig von Mises, ``The effect of its interference is that people are prevented from using their knowledge and abilities, their labor and their material means of production in the way in which they would earn the highest returns and satisfy their needs as much as possible. Such interference makes people poorer and less satisfied.”

As for external risk variables, the country is faced with the same macro risks as the others, a sharp US recession, a steep global economic slowdown, accelerating inflationary policies which could fuel the intensity of the present bubbles and or goods and services inflation, geopolitical risks of public upheavals (triggered by food crisis) or potential military conflicts (over resources), a US dollar crash, global depression and other fat tails.