Phisix Amidst the Global Pandemic of Bubbles

7 consecutive weeks on the upside and 12.2% returns local currency returns. Make that 13.2% in US dollar returns. Absolutely fantastic.

Will the Phisix Go Vertical?

What you see depends on where you stand. Reference point matters.

Last week, I exhibited the chart of the Phisix in a transition to a parabolic phase.

From the longer term perspective or from the trough of post Lehman bankruptcy in March of 2009, the nearly four year chart reveals of the three stages of acceleration, represented by the steepening angle or slope of the evolving trend lines.

At the current rate of growth, the Phisix could go vertical.

I am NOT saying it will, but we simply can’t rule out such possibility.

The local benchmark yielded about 7.4% last January. At 7% a month, the Phisix at 10,000 will be reached in about 8 months. As of Friday’s close, February’s gains have accrued to about 4.4%, with 9 trading sessions to go for the month. Will February deliver another 7%?

And a Phisix 10,000 by the yearend translates to 72% returns for 2013. Of course, this would represent another fulfilment of my decade long prediction.

Again the narrative above signifies an extrapolation of the current trend into the future. Yet past performance should not be relied on as an airtight measure of the future.

Nevertheless, the intensifying boom can be seen as partly playing into the “regression to the mean” trade.

I wrote at the start of the year[1],

Average returns from 1985 to 2012 or over 27 years is about 26% based on the annual nominal local currency. The first cycle (1985-1996) generated 50% nominal returns yearly. This cycle (2003-2012) has yielded only 23.61%, still distant from the 27 year average or from the post martial law first cycle.

This is NOT to suggest that the Phisix will need to repeat the returns of the first cycle boom, whose environment has been immensely distinct from today’s cycle. The Philippines then emerged from economic stagnation, high inflation, a debt moratorium and from the clutches of the two decades of dictatorship.

But if the 27-year average should come into play, then this means that the Phisix will need to deliver far greater returns than 2012, particularly 47.45% for 2013, just to reach the mean. This assumes that the Phisix boom ends next year, which I doubt.

47% gains would translate to Phisix 8,500. This makes 10,000 not far off the radar screen.

BSP Data Reveals of the Deepening Credit Driven Mania

The real reason behind the possibility of the reinforcement of the current boom has been the evolving manic phase in the local financial markets and major parts of the real economy in response to incumbent domestic social policies, as well as, to the influences of the external equivalent.

Mania, in my definition, is the phase of the bubble cycle characterized by the acceleration of the yield chasing phenomenon, which have been rationalized by vogue themes or by popular but flawed perception of reality, enabled and facilitated by credit expansion.

Last week, I wrote[2],

Bubble cycles are not just about irrational pricing of securities, but rather bubble cycles represent the market process in response to social policies where irrationalities are fueled or shaped by credit expansion accompanied or supported by faddish themes.

The fundamental risk that underlies the cycle of manias, panic and crashes is that of the massive build-up of debt founded on malinvestments and speculative excesses that becomes a systemic issue that eventually has to unravel.

The Philippine central bank, the Bangko Sentral ng Pilipinas (BSP), recently released its loans outstanding data from the banking sector for 2012. This gave me the opportunity to do a back search on the previous years[3] from which I used to construct the chart below. 

On the surface, over the past 7 years the compounded average credit growth for the overall economy or for “Production by Economic Activity” has been at about 7.7%. 

This would seem just about normal and or in harmony with the statistical economic growth data. Nothing to see here move along.

But as they say, the devil is in the details.

Over the last 3 years, bank loan data reveals that “Aquinonomics” has been about the inflation of a) Financial Intermediation[4] (blue bar)--which represents the banking, non-bank financials (pension and provident funds), insurance and Auxiliary activities—b) Real Estate, renting and other Business Activities (maroon bar)—which covers property, ownership dwelling and rents, and lastly c) wholesale and retail trade[5] (green bar).

Notice that rate of growth for these industries have spiked to the 25% levels and above in 2012. 

I would suspect that the astounding loan growth in financial intermediation may have partly been channeled to the stock market. Thus the growth rate of this sector would seem like good proxy or bellwether for net margin debt in the stock market.

Also the stupendous growth of the wholesale and retail trade sector reinforces my concerns over the increasing risks of a shopping mall bubble[6].

Compounded annual growth rate for the 6 year period (2007-2012) for wholesale and retail trade is at 16.83%, financial intermediation 10.86%, and real estate 16.099%. However, a caveat with CAGRs is that such metric doesn’t accurately capture the inflection points or the major turns in trend dynamics. When people begin to lever up to chase for yields, CAGRs will then only manifest on such changes ex-post.

As a side note, I didn’t include the 2005-2006 data for two reasons: one categorization of financials has been lumped together with real estate, and second, household credit has been excluded. The BSP has still way much room to improve in showing to the public the necessary economic and financial information. 

Yet the cumulative loans by the booming trio, the financial intermediaries-property-retail sector, accounts for 44.32% share of the total loans issued by the banking sector on “production on economic activity” in 2012.

Independently, the share of real estate sector loans represents 18.82%, wholesale and retail trade 15.78% and financial intermediation 9.73%.

Manufacturing has the largest share at 19.42%. But one fundamental thing that makes me think that manufacturing hasn’t been a bubble is the lack of popular appeal.

Of course unlike the more concentrated property sector, manufacturing even according to national statistics has been more diversified[7]. And due to this bias and to time constraints I haven’t been able to include this in my recent calculations.

The widening disparity between the rapid growth in the abovementioned supply side sectors bankrolled by credit have likewise been reflected on the growth rate on consumer loans.

Since 2009, total household consumption credit (blue bars) has grown from 9.12% to 16.12%. 

The growth in auto loans has been in decline from a peak of 30.62% over the same period, but still at significant levels of 18.62%. Credit card, which accounts for 57% of the consumer loans, rose from single digits to a modest 12% in 2012.

The “other” category which accounts for 10% share of the consumer loans, that are likely about personal and salary loans[8] have likewise been on a sharp upswing.

I am confused with the BSP’s statistics, though.

The publicized tables on household consumption don’t include residential real estate loans. However in a first semester 2011 publication[9], residential loans have accounted for the biggest portion of consumer loans (left window). I suspect that residential real estate loans may have been incorporated as part of the supply side segment of the Real Estate classification.

Consumer spending will be determined mainly by productivity growth, by savings, and or by debt acquisition. The lopsided rate of credit growth responsible for the rapid expansion of the financial-property-shopping industries has been conspicuously disproportionate with consumption growth even seen through the lens of consumer loans (right window).

Eventually such imbalances will be vented on the marketplace. 

Don’t Underestimate the Risks from a Surge of Systemic Credit

Domestic credit provided by the banking sector as share of GDP was last reported at 51.84% according to tradingeconomics.com[10] based on World Bank’s published report in 2012.

Banking sector credit was over 80% of GDP at the onset of the Asian Financial crisis. While such data may seem distant from the pinnacle of the boom, it pays not to underestimate the possible scaling up of the pace of loan that can occur during a mania

So far, bank loans have been “bottoming out” and have only began to show marginal improvements by going above the “mean”.

And given the recent substantial rate of increase of overall banking loans relative to statistical economic growth, I expect such figures to increase to around 60% in 2012. 

During onset of the last mania in 1993 where the Phisix returned 154% in local currency terms, the share of banking loans relative to the GDP was even less than today’s level! But bank loans skyrocketed (red ellipse) as the boom progressed through the year and the succeeding years until Asian crisis.

It’s simply the same strain of crowd feeding frenzy that should be expected if loose monetary conditions remain in place. And while I am not sure when exactly this should happen, I suspect that this sooner rather than later, perhaps this year or next. Again all this will depend on feedback mechanism between social policies and the marketplace.

The boom in financial-property sector can also be seen in the other credit markets particularly corporate bonds.

While the Philippine bond market growth has been modest in 2012 and mostly directed towards government securities, by the third quarter of the same year, corporate bonds mainly from banking-financials, real estate and holding companies had been the top issuers, according to the Asian Bond Monitor[11]. And most of the corporate bond issuers have been publicly listed companies. 

This only means that many publicly listed companies have diversified in gaining access to credit through the bond markets.

Such boom continues to resonate in the Phisix.

The recent leader, the mining sector had been bogged down by another environmental headline hugging controversy of an unfortunate landslide that claimed 5 lives of workers[12] sent heavyweight Semirara [PSE:SCC] into funk, which significantly weighed on the index. So price rotation meant a shift in attention back to the finance-property companies.

The property sector now has widened its lead, as the financial sector closes the gap with mines. One possible additional interim blackeye will likely be from the recent drop of precious metal prices which I think is in a shakeout mode.

Myth of Money Flows in the PSE, Redux; Financial Investing is an Art

I recently heard people talk about how money has been flowing into domestic stocks.

In truth, there is no money flows into stocks. For every buyer of a particular security is an equivalent counterparty—a seller of the same security. The transaction or exchange only means that money shifts from the buyer to the seller of a specific security. There is no money flows.

This applies whether we reckon about board transactions, odd lots or about IPOs, secondary offerings or other forms financial securities.

I previously dwelt with this in length[13]

So when people speak of foreign money “flowing” into stocks, what they are really saying is a change in the composition of ownership. For instance when foreigners (whether individual or institution) buy, they buy from selling locals (individual or institution).

What drives prices up or down are people’s subjective valuation of specific securities. Rising prices means buyers are more aggressive. Falling prices means sellers are more forceful. Unchanged prices mean that neither buyer nor seller have been dominant, or that prices are momentarily at relative equilibrium levels.

In terms of foreign participation, any buying or selling of foreigners at the Philippine Stock Exchange will not necessarily correspond to an assumed relative corresponding rise or fall in securities as many people think.

Simply said, the presence foreign buyers don’t necessarily extrapolate to higher prices. This would depend on the valuation of every participant, whether the foreigner acts for himself or in behalf of a fiduciary fund from which his/her valuations and preferences would translate into action.

If the foreigner is aggressive then he/she may bid up prices. But again since people’s valuations differ, the scale of establishing parameters for each action varies individually.

A foreign participant can also be conservative, who may rather patiently accumulate, than bid up prices.

If an investment fund is managed by a team, then the team’s priorities, that prompts for subsequent actions, will be set according to agreement/s from the value scales of team members or from the team leader.

Such examples deal with the misimpression that the presence of foreigners imply mechanically positive for the markets or of the implicit inferiority complex where we see foreign participants as having superior force in shaping prices.

The bottom line is that every individual whether foreign or local will have their own technique or preferred means of dealing with the financial markets which are based on their subjective valuations, preferences and opinions that gets translated via actions (buy, sell or wait).

In other words, people, not nationalities, acting on individual priorities establish prices.

And this is also why financial investing is an art more than it is a science.

Global Pandemic of Bubbles

I have wanted to show you this last week but was comprised by time and space.

The general idea which I wanted to impart is that today has immensely been different than the era which culminated with a crisis represented by the 2008 Lehman bankruptcy. 

First, political authorities were reactive to the bubble bust then. Today, political authorities can be considered as having been pro-active, pre-emptive or activists, such that any incipient signs of sap in economic strength has led political authorities to utilize increasingly powerful shock therapy responses. 

However, drastic policies which results to short term equally commanding market response only dissipates over the long run. Such dynamic can be described as the Risk ON Risk OFF volatility.

Second, during the last crisis, emerging markets (China and ASEAN) and similarly developed economies as Canada, Australia or New Zealand filled some of the slack left by economies slammed hard by the crisis.

Today, what I call as the “periphery” nations appear to be enduring the same malaise or risks of fragility from the bubble pathology, even as the hangover from the crisis lingers

In short bubble cycles have become a global pandemic.

Canada, having been known to have withstood previous economic dislocations, may not seem invincible at all. Home prices in Canada may have reached bubble proportions[14]. And this has been undergirded by Bank of Canada’s (BoC) stealth balance sheet expansion which according to Zero Hedge[15] has grown by 21% year on year—the most since 2009 through 46% growth in purchases of Canadian government bonds.

And it’s not just Canada. Another commodity currency may be in trouble.

Australian banks may be in the process of seguing into a bubble bust which the BCA Research[16] euphemistically calls as “deleveraging”. The Canadian research outfit discerns that the unsustainable growth in household liabilities in both countries will impair their respective banking system soon.

My point is that there are limits to the powerful potion or shock therapy, which are seen as elixirs, applied by central banks. And once the bursting bubbles ripples and overwhelms significant parts of the world, parading or shooting policy bazookas will not guarantee the revival of the risk ON risk OFF environment.

But I am certain that such policy bazookas will be boldly and loosely used as they are today.

So I’d stick by the hedges against such repercussions.

Black Swans Around the Corner, Conclusion

For the Philippine markets, I expect the Phisix as well as local assets, bonds and the Peso to remain strong until at least the end of the first quarter. But we should expect a much needed short term reprieve to occur anytime soon.

After the first quarter, again the fate of the Phisix will be shaped by the expected direction of interest rates which mostly will be determined by domestic factors but will also be sensitive to external influences. This will depend, of course, on the feedback loop or the ping pong relationship between social policies and market responses.

Yet we are seeing more and more signs of the transition towards a credit fueled mania. If the current pace of expansion of systemic debt intensifies, then we shouldn’t discount that the hunt for yield may lead to a blowoff phase for the Phisix or for other Philippine asset markets.

In short, I wouldn’t rule out a Phisix 10,000 soon, in as much as I wouldn’t rule out a 10% correction.

But I don’t expect an inflection point to a bear market yet, perhaps not in 2013.

I also expect the hunt for yield to also generate interests from foreign investors mostly in response to the coordinated easing policies.

These intensifying yield chasing phenomenon are really about capital flight and equally natural responses to social policies that have been designed to undermine short sellers, to depreciate the purchasing power of respective national currencies, to manipulate short term booms in order to support the largely insolvent political institutions, as well as, to coax and force the public through the moral hazard “Central Banking Puts” ala the Bernanke Put and via negative real interest rates, into speculative orgies in order to support the asset markets which underpins the balance sheets of the politically privileged banking system, who are financiers of the government.

Nevertheless in the Philippine Stock Exchange, there are no money flows as buyers and sellers balance out each trade. Individuals, not nationalities, determine prices.

As we are seeing signs of bubbles in the Philippines, China and in Thailand, we are also seeing signs of bubbles in Canada and Australia. The consequence of the global pandemic of bursting bubbles will probably not be what the consensus or the mainstream expects. Since systemic fragility has only been heightening through aggressive risk taking, which has been bolstered by equally aggressive policy responses, one cannot discount huge market dislocations to abruptly occur. Black Swans are just around the corner.

Finally my advice for readers, especially to the tyros, is to avoid chasing prices.

Instead, since price level rotations has been a natural phenomenon in an inflationary boom, a less risky proposition is to position into issues that haven’t significantly moved up and hope that the rising tide eventually lifts all boats.

Of course, there is NO guarantee for anything. Many choices we make could end up as the exception rather than the rule. We live in a world where we think we can predict the effects of passing meteors/asteroids when really can’t[17].

---

[1] See What to Expect in 2013 January 7, 2013

[2] See Phisix and Global Asset Markets: More Signs of Mania, February 11, 2013

[3] Bangko Sentral ng Pilipinas LOANS OUTSTANDING OF UNIVERSAL AND COMMERCIAL BANKS (monthly) 2012, 2011, 2009-2010, 2008-2009, 2007-2008, 2006, 2005

[4] National Statistics Coordination Board Glossary Financing, Insurance, Real Estate and Business Services

[5] National Statistics Coordination Board Glossary Wholesale and Retail Trade

[6] See Philippine Economy’s Achilles Heels: Shopping Mall Bubble (Redux) January 13, 2013

[7] National Statistics Coordination Board Glossary Manufacturing

[8] Bangko Sentral ng Pilipinas, Bank Lending Standards Eased Slightly for Firms and Households in Q4 2012, February 8, 2013

[9] Bangko Sentral ng Piilpinas Status Report on the Philippine Financial System First Semester 2011 Philippine Banking System

[10] Tradingeconomics.com DOMESTIC CREDIT PROVIDED BY BANKING SECTOR (% OF GDP) IN PHILIPPINES The Domestic credit provided by banking sector (% of GDP) in Philippines was last reported at 51.84 in 2011, according to a World Bank report published in 2012. Domestic credit provided by the banking sector includes all credit to various sectors on a gross basis, with the exception of credit to the central government, which is net. The banking sector includes monetary authorities and deposit money banks, as well as other banking institutions where data are available (including institutions that do not accept transferable deposits but do incur such liabilities as time and savings deposits). Examples of other banking institutions are savings and mortgage loan institutions and building and loan associations.

[11] Asianbondsonline.org Asian Bond Monitor November 2012

[12] Philstar.com Bodies of 5 Semirara workers located February 16,2013

[13] See The Myth Of Money Flows Into The Stock Markets April 3, 2009

[14] Mark Perry Does Canada have an unsustainable housing bubble and is it headed for a major 30% price correction like the US? Carpe Diem AEI, January 30, 2013

[15] Zero Hedge, Mark Carney Leaves Canada With 'Stealth QE' Rising At Fastest Pace Since 2009 January 28, 2013

[16] BCA Research Fixed Income Strategy: Relative Value In Dollar Bloc Financials February 5, 2013

[17] See Chart of the Day: Odds of Death February 15, 2013

The Myth Of Money Flows Into The Stock Markets

``To understand reality is not the same as to know about outward events. It is to perceive the essential nature of things. The best‐informed man is not necessarily the wisest. Indeed there is a danger that precisely in the multiplicity of his knowledge he will lose sight of what is essential. But on the other hand, knowledge of an apparently trivial detail quite often makes it possible to see into the depth of things. And so the wise man will seek to acquire the best possible knowledge about events, but always without becoming dependent upon this knowledge. To recognize the significant in the factual is wisdom.” Dietrich Bonhoeffer (1906-1945) German Lutheran Pastor

I recently picked up a short remark on the cyberspace about how the most recent febrile punts from “Meralco” could have caused a “rotation” in the general markets. The idea is that those who profited from the recent upside volatility in Meralco may have buoyed the general market by using profits earned from recent trades to shift into other issues.

This seems similar to the conventional thinking where occasions of huge IPOs or other security offerings (e.g. preferred shares, bonds) in the domestic financial system are deemed as having to adversely “suck the liquidity out” of the Philippine Stock Exchange.

The general idea for both assertions is that money flows “in” and “out” of the Philippine Stock Exchange .

The fact is that money DOES NOT flow in or out of the stock market.

Why?

On any given trading day unless a publicly listed company issues new or additional securities, shares available to the market are fixed.

This means that a transaction occurs only when buyers and sellers agrees to voluntarily exchange cash for a specified security at a particular price.

Let’s say Pedro has Php 100 in cash and agrees to buy Juan’s ownership of publicly listed XYZ company shares for Php 10 a share. The transaction would prompt for a shift in ownership: Pedro’s cash will be credited to Juan’s account while Juan’s XYZ shares will be transferred to Pedro’s account.

In short, in contrast to conventional thinking there is no money flows.

The price directions in the exchange merely reflect on the aggressiveness of the buyers in bidding up the price level of a security (hence, higher prices) or of the assertiveness of sellers in selling down a security at certain price levels (hence lower prices).

As we recently wrote at A Primer On Stock Markets-Why It Isn’t Generally A Gambling Casino, ``Yet prices are always set on the margins. What you read on the stock market section in the newspapers account for as prices determined by marginal investors, where daily traded volume represent only a fraction of total shares outstanding or market capitalization, and not the majority owners.”

As in the case of Meralco, there had been buyers and sellers at recently low prices as much as there had equally been buyers and sellers at the recent high prices. Thereby the suggested “rotation” from punts signifies as “rationalization”-probably holds true for some but not all (fallacy of composition)-than of reality.

In addition, the “sucking out of liquidity” from a monster $800 million record bond offering of San Miguel Brewery , which was reportedly oversubscribed by 16 times, to exclusively the domestic market hasn’t drained liquidity from the PSE, the fact is that despite the resurgence of broadmarket NET foreign selling, the Phisix is up by about 15% from the close of the SMB bond offering last March 16^th.

The SMB offering only suggests that there is a vast pool of non-equity market liquidity sloshing in the domestic financial system.

Importantly, the recent recovery in the Phisix likewise extrapolates to local liquidity substituting for the net foreign selling which has been accounted for in the market since the credit crisis erupted in 2007.

Figure 1: PSE: NET Foreign Selling (above), Transition from Foreign Dominance to Local Dominance

Figure 1 from the PSE gives an abbreviated view of the ongoing dynamics in the local exchange.

The chart manifests of the prevalent net foreign selling since last quarter of the 2008 and the shifting regime of trading ascendancy which was previously controlled by foreign investors (grey line) to presently local investors (maroon line) seen at the lower pane entitled ‘Total Value Traded By Investor Type’.

The other vital point to consider is that the transactions in the PSE represents for as a continuing flux of the character of ownership than one of technical “money flows”. As cited above, one of the current tangible alterations in the ownership has been that of local money replacing foreign money.

Fundamentally, it would rather be irrelevant if the issue of ownership transfers will be just from speculators to market punters or scalpers whom are looking to profit from minor price fluctuations.

But it would be materially relevant if the conveyance reflects a shift from major stockholders to a wider spectrum of public shareholder ownership because a larger breadth of public participation should entail a broader cognizance of the basic functions of capital markets.

And since capital markets operate as non-banking alternative option to raise, access, avail or price in or value investment capital, it has an economically vital function of channeling society’s savings into productive investments.

Moreover, when we argue about the low penetration rates of domestic investors in the local equity markets, which according to the PSE is estimated at less than half of 1% of the population even at the peak of the market, we are thinking along the premise of concentrated degree of ownership or of the limited float on the supply side (of listed companies) and or the lack of widespread market participation from the local public savers on the demand side. Of course, here the PSE looks at only direct investments, but glosses over the indirect investments through Unit Investment Trust Funds and mutual funds-where we estimate market exposure increases to somewhere at 1%.

The point is that these glaring deficiencies essentially reflect on the severe underdeveloped nature of the local equity markets.

And these are further compounded by the dearth of sophisticated instruments to hedge on “naked” positions, the “gambling” or overtrading culture disseminated as “education” by conventional brokers and the high cost structures from regulatory compliance that serve as material barriers to entice additional listing from privately owned unlisted enterprises into tradeable or investable publicly listed financial instruments.

Market Ignorance and Political Serfdom

Let me add that it doesn’t help or do justice to the public or to society to induce “trading” assimilation programs because it “tunnels” vulnerable neophytes to believe that the stockmarket is merely a gaming platform to play with, based on a very narrow time frame expectations regardless of prevailing risk conditions.

Ironically, what is the use to study the risk reward nature of markets (or even to obtain course certificates as Chartered Financial Analyst-CFA) if only markets operate in the analogy of games played in the casino or the racetrack?

People who get burned from wrong expectations tend to shy away from a bad experience. It is out of such adverse outcome that the “casino” imprint gets etched into mainstream psyche. And worst, a tarnished image has viral (word of mouth) repercussions. So short term gain always come at the expense of long term losses (in the form of monetary loss and mental anguish) which equally poses as a considerable obstacle to economic development.

On the philosophical aspect, the paucity of exposure to the capital markets is one substantial reason for the “overdependence” of Filipinos to the government as the ever elusive elixir for societal ills.

The problem is that government as the solution has served as perpetual illusion. The problem isn’t due to the “bad” attitudes by the Filipinos, as repeatedly floated in emails, but attitudes fostered by an entitlement and welfare privileged class or the “dependency culture” which is a common trait to a society highly dependent on government.

Yet the eternal search for virtuousness can’t be reconciled with political realities, where each incidence of hope from a new beginning eventually turns out as a mass frustration.

Mr. Robert LeFevre in his The Nature of Man and His Government tells us why, ``Government is a tool. The nature of the tool is that of a weapon…government, designed for protection, always ends up by attacking the very persons it was intended to protect…Government begins by protecting some against others and ends up protecting itself against everyone."

Notwithstanding, we Filipinos have not yet to realize that entrepreneurship and its quintessential feature of risk taking serve as fundamental conditions for economic and financial progress.

The Law Of Demand And Supply Applied To Equities

Going back on how the law of demand-and-supply of equities impact pricing, two charts from Northern Trust reveals of the basic laws of economics at work in the recent collapse of the US equity markets…

Figure 2: Northern Trust: How Demand and Supply Impacts Stock Prices During the Recent Crisis

Last year’s meltdown came in conjunction with a record amount of net equity issuance which totaled $986 billion during the fourth quarter of last year, or at a seasonally-adjusted annual rate or equivalent to 6.9% to nominal GDP.

And who was doing the record issuance?

Northern Trust Chief Economist Mr. Paul Kasriel makes as an astute observation, ``it was the financial system, desperate for new capital to replace a huge amount of old “depreciated” capital, that was doing all the issuing. At a seasonally-adjusted annual rate, financial institutions were net issuers of equity to the tune of $1.4 trillion in the last year’s fourth quarter while nonfinancial corporations were net “retirers” of $450 billion of equity.

``At the same time the financial institutions were issuing record absolute and relative amounts of new equity, I think it is safe to say that investors’ demand for financial institutions’ equities was somewhat inhibited…”

So as the US financial institutions had been undertaking intense balance sheet deleveraging by selling off liquid assets worldwide to raise capital, which further crimped on general market sentiment and which similarly contained demand interests for equity assets, we also saw financial institutions flooding the equity markets with new issuance or simply supply overwhelmed demand which prompted for a meltdown.

Mr. Kasriel rightly concludes, ``In sum, there is no mystery as to why the broad U.S. stock indexes took a dive in the fourth quarter of last year. It simply was a matter of an increase in supply accompanied a decrease in demand.”

The equity demand supply dynamics in the US hasn’t been the case in the Philippine equity markets as the latter has suffered mainly from the contagion impacts, as the exposure to “toxic” assets had been inconsequential that didn’t require equity issuance to plug losses.

The Myth Of Cash On The Sidelines

To further expand the thought about the misguided “money flows” in and out of the stockmarket, this should include the misimpressions about sitting “cash on the sidelines” as potential drivers of the market.

Dr. John Hussman rightly and eloquently argues (bold highlight mine), ``savings equals investment, and new savings can finance new investment. But what investors often point to and call “cash on the sidelines” is really saving that has already been deployed and used either to offset the dissavings of government or to finance investments made by other companies. Once those savings have been spent, you can't, in aggregate, use the IOUs (in the form of money market securities) to do it again.

``In other words, the amount of cash that investors hold “on the sidelines” is determined by the amount of borrowing that has occurred in the form of money market securities like T-bills and commercial paper. It's a lapse of proper thinking to believe that investors, as a group, can move their “cash on the sidelines” into the stock market, or that companies, taken together, can turn their “cash on the sidelines” into new investment and capital spending.”

Technically speaking, money invested in corporate or government bonds account for as money having been already spent and thus a shift into the equity markets does not account for as “money flows” into “new” capital investment.

So what is commonly perceived as drivers for equity prices in terms of “cash in the sidelines” isn’t accurate. Equity prices again are driven by the aggressiveness of either buyer or seller in the marketplace.

Other than that the exercise of paper shuffling, the switching of assets simply can be construed as realignment or rebalancing of portfolio holdings.

Applied to the Philippines, this implies that a genuine measure of money flow into the equity market should translate to savings financing a new equity issuance in the form of an IPO, which generally flourishes during boom days or is pro-cyclical [see The Prudent Way To Profit From IPOs!], and or secondary listings which are meant to finance fresh projects or company expansions.

Summary and Conclusion

The point of this article is to refute the fallacious mainstream notion that daily transactions signify as some mystic form of money flowing in and out of the equity markets.

Money flows into the equity markets only occur when savings are utilized to finance new capital spending projects by virtue of new corporate equity issuances in the form of IPO or secondary listing.

Instead, the directions of equity prices are driven by the aggressiveness of buyer or seller, where daily transactions only reflect on the dynamics of changing of ownership of mostly marginal investors.

In addition, the fundamental laws of demand and supply applied to equity distribution have been shown to have a material impact on its price values. Thus it is important not only to look at the elements encompassing macro or micro environment dynamics and its impact to earnings or to the national economy but likewise on the variables that may directly influence the demand and supply allocation of equities.

Finally the population penetration level of equity investors can be reflective of the nature of a society’s understanding of how capitalism works. The small diffusion of domestic public investors seems highly correlated to the statist biases of the local populace. Since the capital markets function as an important conduit of capital accumulation through the development of the country’s production structure, the corollary of the underdevelopment of the capital markets is manifested by the nation’s suboptimal economic growth.

Hence, until the local population can materially increase their comprehension over how markets fundamentally work or how their savings can be recycled into productive investments, the local markets will remain underutilized and underinvested if the misperception that markets are simply “games” to dabble with remains.

We hope that our industry colleagues will authentically “educate” the public that sets aside short term gains in exchange for long term economic progress.