The Philippine SEC’s Phantasm of “Trading Gangs”

Below is an example of Hayek's Fatal Conceit applied to the Philippines

From the Business Mirror,

The Securities and Exchange Commission (SEC) is studying new surveillance initiatives that may see the establishment of a special division to monitor online chatter targeting so-called trading gangs, SEC Commissioner Juanita Cueto said on Thursday.

Trading gangs, according to Cueto are loosely defined as short-term trader syndicates who have both the resources and numbers to drive market prices and volumes.

She added that the trading rings that “play” the market are nothing new in the country or even abroad, but she noted that their influence had been growing in recent years, aided by the anonymity offered by the Internet and the influx of new and relatively inexperienced investors who may fall prey to these groups.

“They have pseudo names on the Internet. The scary part is they buy and sell in unison. Some of their analyses are inaccurate and can hurt issuers,” Cueto told the BusinessMirror. “It is a concern of legitimate brokers and issuers.”

She said the surveillance measures could involve closer scrutiny of Internet-based stock-market forums.

Some people cheer at this development WITHOUT an inkling of understanding HOW the SEC will be able to define and enforce surveillance of the so called "short term trader syndicates" that “have both the resources and numbers to drive market prices and volumes” from so-called trading gangs.

At what criterion will groups of people (syndicates) who shares “beliefs” in certain stocks, even in the short term, whom they are or could be exposed to, culpable of “driving” market prices and volumes? What if the stocks they promote indeed goes up? 

If a prediction fails, does this mechanically imply fraud?

In bear markets, does allegations of “pump and dump” proliferate or even exist at all?

Importantly what delineates “belief” and “analysis” from the intent to “defraud” through manipulation?

So the implication is that such regulations will be arbitrarily defined or established according to the whims of the political masters.

People who espouse political intrusions have a strange mystic adulation for the supposed omniscience of authorities and of the platonic ethics of regulators.

Yet if this logic holds true, then markets DO NOT need to exist at all.

Áll such ruckus essentially boils down to the definition of prices and values.

Who determines what appropriate prices and values are? The SEC? From what basis?

For starters, market prices are ALWAYS subjectively determined

To quote the great Ludwig von Mises,

It is ultimately always the subjective value judgments of individuals that determine the formation of prices. Catallactics in conceiving the pricing process necessarily reverts to the fundamental category of action, the preference given to a over b. In view of popular errors it is expedient to emphasize that catallactics deals with the real prices as they are paid in definite transactions and not with imaginary prices. The concept of final prices is merely a mental tool for the grasp of a particular problem, the emergence of entrepreneurial profit and loss.

Prices, which are subjective expressions of people’s value scales and time preferences, are principally used for economic calculations from where trades (of all kinds including stock markets) emerge, again Professor Mises

In the market society there are money prices. Economic calculation is calculation in terms of money prices. The various quantities of goods and services enter into this calculation with the amount of money for which they are bought and sold on the market or for which they could prospectively be bought and sold. It is a fictitious assumption that an isolated self-sufficient individual or the general manager of a socialist system, i.e., a system in which there is no market for means of production, could calculate. There is no way which could lead one from the money computation of a market economy to any kind of computation in a nonmarket system.

So if prices are subjectively determined, how then does the "gods" of the SEC know each and every individuals order of priorities?

And at what levels are prices to be considered “fair”?

Again Professor Mises,

The concept of a "just" or "fair" price is devoid of any scientific meaning; it is a disguise for wishes, a striving for a state of affairs different from reality. Market prices are entirely determined by the value judgments of men as they really act.

So supposed fraud will be substituted for propaganda and the curtailment of civil liberties.

This comment by a market practitioner from the same article “It could be really hard to prove wrongdoing this way,” is half correct, but has been obscured by the misleading reference of “noting how identities can be masked online”.

“Anonymity” does not automatically make stock promotions unethical. What makes unethical is the deliberate act to defraud or bamboozle people, e.g. a breach of contract or deprivation of property rights, which based on the above seems very difficult to prove.

This would be analogical to say that advertising is a fraud.

To which government providing “truth” in advertising is likewise delusional, Professor Ludwig von Mises writes,

But whoever is ready to grant to the government this power would be inconsistent if he objected to the demand to submit the statements of churches and sects to the same examination. Freedom is indivisible. As soon as one starts to restrict it, one enters upon a decline on which it is difficult to stop. If one assigns to the government the task of making truth prevail in the advertising of perfumes and toothpaste, one cannot contest it the right to look after truth in the more important matters of religion, philosophy, and social ideology.

And government interventions DO NOT make transactions ethical too, on the contrary, they make them worst.

Bruce L Benson in “The Enterprise of Law: Justice Without the State” writes, (bold emphasis mine) 

When government becomes involved in the enterprise of law, both the rules of conduct and the institutions for enforcement are likely to change. The primary functions of governments are to act as a mechanism to take wealth from some and transfer it to others, and to discriminate among groups on the basis of their relative power in order to determine who gains and who loses.

Yes most people don’t seem to realize that in an inflationary boom, the guiding incentives provided by manipulation of interest rates promote rampant gambling and irresponsible actions which are always blamed on market actors.

From the great Henry Hazlitt

Inflation, to sum up, is the increase in the volume of money and bank credit in relation to the volume of goods. It is harmful because it depreciates the value of the monetary unit, raises everybody's cost of living, imposes what is in effect a tax on the poorest (without exemptions) at as high a rate as the tax on the richest, wipes out the value of past savings, discourages future savings, redistributes wealth and income wantonly, encourages and rewards speculation and gambling at the expense of thrift and work, undermines confidence in the justice of a free enterprise system, and corrupts public and private morals.

Non-Austrian Charles Kindleberger author of Mania’s Panics and Crashes also notes how swindles emerge during bubble cycles. (Previously I quoted him here)

Commercial and financial crisis are intimately bound up with transactions that overstep the confines of law and morality shadowy though these confines be. The propensities to swindle and be swindled run parallel to the propensity to speculate during a boom. Crash and panic, with their motto of sauve qui peut induce still more to cheat in order to save themselves. And the signal for panic is often the revelation of some swindle, theft embezzlement or fraud

And as proof, I cited instances of Ponzi schemes in the US has had meaningful correlations with the FED’s credit easing policies.

When political gods determine winners and losers, contrary to popular brainwashed expectations, the outcome is not one of optimism. According to author, philosopher and individualist Ayn Rand on her classic novel Atlas Shrugged,

Money is the barometer of a society's virtue. When you see that trading is done, not by consent, but by compulsion--when you see that in order to produce, you need to obtain permission from men who produce nothing--when you see that money is flowing to those who deal, not in goods, but in favors--when you see that men get richer by graft and by pull than by work, and your laws don't protect you against them, but protect them against you--when you see corruption being rewarded and honesty becoming a self-sacrifice--you may know that your society is doomed. Money is so noble a medium that is does not compete with guns and it does not make terms with brutality. It will not permit a country to survive as half-property, half-loot.

Such interventionism also leads to a suppression of freedom of expression.

Nonetheless, sorry to say but regulations will not solve or protect people form their silliness or foolishness, their reckless behavior and the entitlement mentality which most likely has been a result of existing policies…instead these would only do worse.

And in contrast, as I previously noted, successful investing requires Self discipline.

“Pump and Dump” Policies Pumps Up Miniature and Grand Bubbles

A friend recently called to say that there have been numerous accounts of “miniature bubbles” in the local markets. Others claim that these have been brought about by unscrupulous people engaged in “pump and dump”.

In reality as I have been pointing out, miniature bubbles are symptoms of the ultimate bubble blower—central bank policies. Central bank policies distort people’s incentives towards money. Savings, investment and consumption patterns will have all been skewered. Where negative real rates punish savers, naturally people whose savings are being diminished through the erosion of purchasing power will seek higher yield, and thus, redeploy their savings into other activities which may include more consumption activities, speculation or high risk investments and or take up more debt to fund these activities. Even private sector Ponzi schemes has been flourishing under today’s environment[1]

In essence policies that tamper with money motivates the public to value short term over the long term.

Thus heightened price volatilities which are deemed as “pump and dump” or as “miniature bubbles” represent as symptoms rather than the cause. People will look for excuses to push up prices or speculate for the simple reason that policies have egged them to do so.

The easy money climate lures the vulnerable public to go for momentum and chase prices using any available tools (charts, corporate fundamentals or even tips[2] and rumors) to do so. And this is why pump and dumps happen.

Large price swings make some people think that stock market operators are culpable for such swing. But this would be mistaking trees for the forests. Absent easy money policies, bubbles and pump and dumps hardly has been a feature. Had there been mini bubbles or pump and dumps during the bear market of 2007-2008? No, because inflated assets were all deflating in response or as contagion to the real estate-banking crisis abroad.

Broken Markets

And as earlier pointed out[3], the US today has not been different, junk bonds or high yielding debt has been booming.

Writes the Buttonwood (Philipp Coggan) of the Economist[4]

Of course, the broader point is that investors are being pushed into these high-yielding assets because of the policy of the Fed (and most developed world central banks) of keeping interest rates close to zero. Similar reasoning drove the enthusiasm for structured products that financed the subprime boom.

Zero bound rates have prompted for yield chasing actions, here or in the US.

The mainstream finally comes to admit what I have been saying all along—that markets have been vastly distorted where one cannot use “fundamentals” in the traditional and conventional sense to evaluate investments.

The excessive price volatility in today’s markets does not match with the fluctuations of conventional metrics of financial ratios. Today’s price volatility has been incongruent with trends of corporate fundamentals. And thus as I earlier pointed out[5], anyone who believed in “fundamentals” would have sold as early as March.

Considering the huge jump in prices from the start of the year, we should be around at near the peak of 2007. So anyone who believes in this stuff ought to be shorting or selling the market. I won’t.

The left window from the chart above as I earlier posted last March has a time series that ended November of 2011. The right chart from DBS represents a more updated one albeit was updated until last March. Considering that the Phisix has now been drifting at over 5,150 which means valuations continues to climb higher away from these charts, the Phisix has become “priciest” stock market in Asia.

Yet leaning on earnings or conventional fundamental metrics, like the Heisenberg uncertainty principle, becomes a permanently moving target which is impossible to pin down, especially punctuated under today’s easy market climate.

Will I sell on the account of earnings/fundamentals? My answer is still no. Not until interest rates climb in response to consumer price inflation, or through heightened demand for credit, or questions over credit quality of government papers or the scarcity of capital becomes apparent[6]. Nominal interest rates are not a one-size-fits-all thing, and there are many measures (like real interest rates, CDS, yield curve et.al.) to gauge if the monetary environment has begun to tighten for one reason or another. This also should come in the condition that the hands of central bankers have also been shackled and would be unable to respond forcefully as they have been doing today.

For now central banks around will continue to find ways and means to push more easing measures in support of the asset markets which was highlighted by last week’s additional stimulus by the Bank of Japan (BoJ)[7]

The following excerpt from the mainstream loudly resonates on what I have been saying.

From the Financial Times[8],

Markets are broken. Accepted investment wisdom has been overturned and the basic tenets of value and diversification no longer work. The financial crisis put the market into a volatile “risk on, risk off” – or Roro – mode for which there is no cure.

For many investors, this has made stockpicking seemingly an impossible task. Markets once responded to their fundamentals. Now, disparate assets have a much greater tendency to move together, individual characteristics lost. Trusted strategies such as relative value and currency carry trades are nearly useless, overwhelmed by daily market-wide volatility.

“Assets now behave as either risky assets or safe havens, and their own fundamentals are secondary,” writes HSBC strategist Stacy Williams in a recent note. “In a world where most asset classes are synchronised, it becomes very difficult to achieve diversification. It also means that since most individual assets are dominated by a common price component, it becomes increasingly futile to invest in them based on their usual fundamentals.”

Though asset classes had been moving in closer correlation since the start of the financial crisis in 2007, the Roro trend became most apparent after the collapse of Lehman Brothers a year later. The uncertainty helped turn investing bimodal, where every price has been contaminated by systemic risk. Everything became a bet on whether we were closer to a global recovery or to deeper crisis.

So what recommendations do they offer for the public to deal with the state of “broken markets? They have three. One is to pick a position from the boom or the bust scenario, second is to chase momentum and third is to hedge positions through index futures.

I would like to emphasize on the second option, not because this is my preferred approach but because of its relevance to the conditions of the local markets, from the same article,

Another option is to seek out an investment strategy that still works. Momentum investing – in effect, buying the winners and selling the losers – is a method that HSBC analysts highlight as having been largely impervious to the risk trade. To chase a trend aims to harvest small but systematic mispricing of assets, and there is no reason to suppose these anomalies would disappear in bimodal markets, the broker argues. (In this context, the growth of high-frequency trading since the start of the crisis is unlikely to be coincidental.)

This simply means that the mainstream will largely be chasing momentum, by targeting frequency over magnitude through “harvest small but systematic mispricing of assets”. So in essence, high risk speculative activities or gambling (a.k.a “miniature bubbles” and “pump and dump”) has been recognized as the common or standardized feature of the current market place. So history will rhyme and a bust will be around the corner.

I would rather “time” the bubble cycle rather than go chasing prices. And this is why it is imperative for any serious investors to understand the bubble process or the boom bust cycle.

Stock Market is about Human Action

Finally financial markets signify a social phenomenon. There is a popular aphorism from former President John F. Kennedy, who said in the aftermath of the failed Bay of Pigs Invasion[9], which seems relevant to the financial markets,

Victory has a thousand fathers; defeat is an orphan.

Winning issues and or market tops tend to attract substantial participants as a function of easy money (get rich quick mentality), keeping up with the Joneses (bandwagon effect) or survivorship bias (focus on survivors or winners at the expense of the others) or social signaling (desire for greater social acceptance, elevated social status and or ego trips).

On the other hand market bottoms results to the opposite: depression, avoidance, isolation and animus behaviour for those caught by the crash.

Most people don’t realize that emotional intelligence or self discipline is key to surviving the market’s volatility, not math models or charts or any Holy Grail or Greek formulas. And this comes from the desire to attain self discipline than from advices of other people.

Yet self discipline is earned and acquired through knowledge and through the whetting of one’s skills based on these accrued knowledge. Alternatively, self discipline cannot be not given or inherited. And that’s why I vehemently opposed the suggestion by a popular religious personality, who had investments on a mutual fund, to get housemaids to invest in the stock market[10].

The incentive to acquire the desired knowledge and skills varies from individual to individual because they are largely driven by the degree of stakeholdings or the stakeholder’s dilemma or stakeholder’s problem[11].

Today’s information age has democratized access to information. What can be given are information relevant to attaining knowledge and skills. What can NOT be given is the knowledge that dovetails to one’s personality for the prudent management of one’s portfolio. Like entrepreneurship this involves a self-discovery process.

And most importantly, what can NOT be given are the attendant actions to fulfill the individual’s objectives.

Stock market investing is about people and their actions. That’s why this is a social phenomenon. No more, no less.

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[1] See After 5,000: What’s Next for the Phisix?, March 5, 2012

[2] See New Record Highs for the Philippine Phisix; How to Deal with Tips February 20, 2012

[3] See Self-Discipline and Understanding Market Drivers as Key to Risk Management, April 12, 2012

[4] Buttonwood Hooked on junk, April 27, 2012, The Economist

[5] See Earnings Drive Stock Prices? International Container Terminal and Ayala Land, March 6, 2012

[6] See Global Equity Market’s Inflationary Boom: Divergent Returns On Convergent Actions, February 13, 2002

[7] See Bank of Japan Adds More Stimulus, April 17, 2012

[8] Financial Times ‘Roro’ reduces trading to bets on black or red April 20, 2012

[9] Quotationspage.com Quotation Details John F. Kennedy, "A Thousand Days," by Arthur M. Schlesinger Jr [1965]., p289. Comment made by JFK in the aftermath of the failed Bay of Pigs invasion, 1961.

[10] See Should Your Housemaid Invest In The Stock Market? September 5, 2010

[11] See Knowledge Acquisition: The Importance of Information Sourcing and Quality, March 6, 2011