More Bubble Signs: Jay Z raps the Warhol, Korea’s Invisible Tower

When the art markets become mainstream and appear priced to perfection then they could be indications of escalating overconfidence and or a culmination of a mania phase of the bubble cycle

Could rapper Jay Z rapping about Warhol, Basquiat and Art Basel signal an art bubble? Market guru James Grant thinks so.

From the CNBC:

Market guru James Grant quotes Jay Z's "Picasso Baby" in his latest Grant's Interest Rate Observer, arguing that prices in the contemporary art market may not be justified by long-term value. While well-hyped artists like Jeff Koons, Damien Hirst and Jean-Michel Basquiat are fetching eight-digit prices, it's unclear whether their work will withstand the test of time, art critics and museums.

It's hard to tell, for instance, whether one of Koons' famous pieces, "New Hoover"—four vacuum cleaners in an acrylic case —will be valued as a work of genius or "just another vacuum cleaner," Grant said.

"Modern art is valued in terms of modern money," he wrote. The Fed's low-interest-rate policies have driven the wealthy increasingly to collectibles of all kinds, including art, cars and jewels. "Miniature interest rates have reduced the opportunity cost of investing in any kind of nonyielding asset."

And while Koons and Basquiat are hot now, they might end up like the English portraits of the early 19th century, whose frenzied boom was followed by a spectacular bust. Prices never recovered.

The zero bound rates or free money chasing of asset markets has apparently percolated into the art markets. 

But the property sector has been ground zero for asset bubbles (aside from the stock markets).

 

Mushrooming signature skyscrapers almost everywhere (see previous post here here and here) appear as intensifying signs of an inflating bubble. One symptom: the skyscraper curse or monuments of grandeurs

From the Business Insider

The world will soon have its first "invisible" skyscraper.

There's no construction date yet for the planned 1,476-foot tower, called Tower Infinity. But its architects have just been granted a construction permit to begin building outside of Seoul, South Korea near Incheon International Airport.

The visionaries behind the project, GDS Architects, will make the tower appear "invisible" using an LED facade system with optical cameras to display what's directly behind the building. When turned on, the "reflective skin" of the building will give the illusion that Tower Infinity is blending in with the skyline.

The building's projections may also be used for broadcasting special events, or for advertising purposes, according to GDS Architects.

The tower itself has an impressive profile, with a main spire flanked on either side by two separate building wings. Tower Infinity will be used primarily for entertainment and leisure purposes, and is set to include a 4D theater, restaurants, a water park, landscaped gardens, and the third-highest observation deck in the world.

The actions of the bond vigilantes will determine whether these markets are bubbles or not.  My guess is on the affirmative

Boom Bust Cycles: The Skyscraper Curse in Emerging Markets (and the Philippines)

The New York Times associates the skyscraper curse in Emerging Markets with the prospects of bursting bubbles.

In a city where skyscrapers sprout like weeds, none grew as high as the Sapphire tower in Istanbul.

Today, it stands as a symbol of how far the mighty may fall.

Like a vast majority of new buildings that have blanketed the Istanbul hills in recent years, the Sapphire — at 856 feet it is the tallest in Turkey and among the loftiest in Europe — was built on the back of cheap loans, in dollars, that have flooded Turkey and other fast-growing markets like Brazil, India and South Korea. The money began to flow when the Federal Reserve and other major central banks cut interest rates to the bone in 2009 and cranked up the printing presses in a bid to spur recovery in the United States and other advanced industrial nations.

But now, with expectations mounting that the Federal Reserve, led by its departing chairman Ben S. Bernanke, may soon begin to tighten its monetary spigot, Istanbul’s skyline could well be a harbinger of an emerging-market bust brought on by unpaid loans, weakening currencies, and, eventually, the possible failure of developers and banks.

The artificial boom spurred by easy money had mainly been boosting egos and the ambitions of politicians and more importantly inflates the wallets of the politically connected… (bold mine)

Goldman Sachs is forecasting a dollar-lira rate of 2.2, representing a 15 percent mini-devaluation from the current level of 1.95. “The Turkish economic miracle was built on liquidity and a massive appreciation of the Turkish lira,” said Atilla Yesilada, an economist at Global Source partners in Istanbul, who has lived through Turkey’s previous financial crashes in 1994 and 2001.

These loans — many of them relatively short term — also highlight a recurring characteristic of the emerging-market growth boom: the powerful nexus between ambitious governments eager to promote high-profile investments and politically connected business groups ready to take on such projects.

The Sapphire tower in Turkey is a perfect example in this regard.

The 54-floor tower, which received a ceremonial baptism from Prime Minister Erdogan when it opened in early 2011, is the signature property of the Kiler Group, one of the many construction-themed conglomerates that have achieved extraordinary success since Mr. Erdogan came to power in 2003. Like Mr. Erdogan, whose family comes from the northern Black Sea region, these businessmen hail from Turkey’s conservative Islamist provinces.

Since most people see only the visible, the mushrooming grandiose projects have broadly been misinterpreted as signs of prosperity by the public and by experts who mistakes interpreting statistics as economics.

But all these have been an illusion, as the great leader of Austrian school of economics Ludwig von Mises warned,

Credit expansion cannot increase the supply of real goods. It merely brings about a rearrangement. It diverts capital investment away from the course prescribed by the state of economic wealth and market conditions. It causes production to pursue paths which it would not follow unless the economy were to acquire an increase in material goods. As a result, the upswing lacks a solid base. It is not real prosperity. It is illusory prosperity. It did not develop from an increase in economic wealth. Rather, it arose because the credit expansion created the illusion of such an increase. Sooner or later it must become apparent that this economic situation is built on sand.

Well, Turkey’s case where central bank easy money policies redistributes wealth in favor of the cronies and the political class are really subsidies that comes at the expense of society. This has been no different than the Philippines. 

The Philippines has its own race to build the tallest skyscraper version which is seen by the mainstream as signs of “this time is different” boom.

Here are the 10 top ten list of tallest completed buildings in the Philippines as compiled by Wikipedia.org

I wrote about the ASEAN skyscraper curse which may herald a regional crisis here.

The ongoing tightening of money, via the bond vigilantes has hardly been due to the Fed’s tapering, but about the unsustainability of the current debt financed bubbles. The continuity of the global bond market rout will expose on the fragilities brought about by massive capital misallocations that would lead to a systemic bust.  

And as anticipated, Emerging markets have been showing the way.

Has the Skyscraper Curse Hit China?

The Skyscraper Index introduced by Dresdner Kleinwort Wasserstein research director Andrew Lawrence has been a reliable but a not perfect leading indicator of business cycles. 

Skyscraper booms tend to highlight the peak of a business cycle, as I discussed in 2009, or tends to rise on “the eve of economic downturns” according to Wikipedia.org.

The peak of the Skyscraper cycles has frequently signaled the advent of recessions, the Wikipedia.org elaborates, “where investment in skyscrapers peaks when cyclical growth is exhausted and the economy is ready for recession”

Has the Skyscraper curse become a reality in China?

The construction of the world’s tallest building in China has reportedly been suspended.

According the Dubai Chronicle: (bold mine)

In May, the Dubai Chronicle reported that China is planning to challenge Dubai’s Burj Khalifa’s status as world’s tallest building. The Asian country is preparing to build a skyscraper which is even taller than Burj Khalifa’s 2,716 feet. The building, called Sky City, was initially planned for completion by the end of the year. However, the date is now pushed forward, slowing down the mega project.

Only a couple of months ago, China’s Sky City project was said to be ready by end of 2013. The developers behind the ambitious project were confident in their prognosis even though the construction works on the tower had not even begun. According to them, the 2,739-feet Sky City would take only half a year to complete due to its unique construction process.

But despite the forecasts, Sky City’s completion is now delayed to April 2014. There is no specific information on why the project is taking so long, given that it is enjoying the great support of the Chinese government.

In addition, this is not the first time in which Sky City’s opening is being delayed. Originally, the project was supposed to be ready at the beginning of 2013. However, the construction work started last week.

The cost of the record-aiming building has also been changed. In May, Sky City was expected to consume only $625 million. Now, its construction is estimated at over $855 million.

Skyscraper manias have always been accompanied by overconfidence, similar to the stock market.

Next, the cost overrun has simply been a manifestation of the inadequate savings in sustaining of such grandiose project. As the great Austrian economist Ludwig von Mises explained:

The whole entrepreneurial class is, as it were, in the position of a master builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master builder's fault was not overinvestment, but an inappropriate employment of the means at his disposal.

The “lack of material needed” has been expressed by higher input prices as the construction-real industry earlier bid up on input prices, enabled and facilitated by cheap interest rates, thus resulting to the ballooning cost of the project.

The Zero Hedge has an illustration of the Sky City…

…and of China’s simmering skyscraper mania.

Unraveling of malinvestments are presently being manifested through cash squeezes which has been ventilated via higher interest rates.

Austrian economist Professor Mark Thornton, who expanded the study on the Skyscraper Index to cover the Austrian Business Cycle, notes that,

Higher interest rates discourage the building of taller buildings and of construction in general because capital is scarcer and land is less in demand and available at lower prices.

And the weakness in the Chinese economy seem to be intensifying. This would further expose on the massive misallocations of capital that would further translate to even higher interest rates or higher costs of capital.

A fresh Bloomberg article reports that China’s manufacturing index “weakened further in July, signaling the worst of the nation’s slowdown has yet to be reached, according to a preliminary survey of purchasing managers”

And its not just in the economy, current social policies may help prick the runaway property bubble.

In what seems as another attempt by the Chinese government to curtail such property bubbles, a 5 year ban has been imposed on construction of new government buildings.

From another fresh Bloomberg report:

China banned government and Communist Party agencies from constructing new buildings for five years and told them to suspend projects that have already won approval as the country seeks to cut wasteful spending.

The ban includes construction for purposes of training, meetings and accommodation, the government said in a statement on its website yesterday, calling for resources to be spent instead on developing the economy and improving public welfare. All localities should report the implementation of the new rules by Sept. 30, according to the statement.

The suspension of the construction of the world’s tallest building, intermittent cash squeezes, the reappearance of the bond vigilantes, tanking stock markets, signs of intensifying weakness of the economy, declining yuan-US Dollar (see above)  and the Chinese government’s policy path to break the runaway property bubble seem to reinforce the Skyscraper curse. 

And a severe downturn may lead to a "period of instability" says a state researcher. 

Oh, don't forget, ASEAN has her own Skyscraper mania. 

Ignore these signs at your own peril.

Does China’s Dubai Project Flop Signify as Signs of the Skyscraper Curse?

More signs of the China’s imploding property bubble. 

From the AFP (including above photo)

It was billed as China's Dubai: a cluster of sail-shaped skyscrapers on a man-made island surrounded by tropical sea, the epitome of an unprecedented property boom that transformed skylines across the country.

But prices on Phoenix Island, off the palm-tree lined streets of the resort city of Sanya, have plummeted in recent months, exposing the hidden fragilities of China's growing but sometimes unbalanced economy.

A "seven star" hotel is under construction on the wave-lapped oval, which the provincial tourism authority proclaims as a "fierce competitor" for the title of "eighth wonder of the modern world".

But the island stands quiet aside from a few orange-jacketed cleaning staff, with undisturbed seaside swimming pools reflecting rows of pristine white towers, and a row of Porsches one of the few signs of habitation.

Chinese manufacturers once snapped up its luxury apartments, but with profits falling as a result of the global downturn many owners need to offload properties urgently and raise cash to repay business loans, estate agents said.

Now apartments on Phoenix Island which reached the dizzying heights of 150,000 yuan per square metre ($2,200 per square foot) in 2010 are on offer for just 70,000 yuan, said Sun Zhe, a local estate agent.

Majestic, grand or ostentatious real estate projects usually highlight the peak of business or bubble cycles. Such has been called as the “Skyscraper curse” as I pointed out in 2009. The rest of Asia, including ASEAN has also been exhibiting the same symptoms

The Skyscraper curse or Skyscraper syndrome, notes Austrian economics Professor Mark Thornton signifies as the “salient marker of the twentieth-century’s business cycle; the reoccurring pattern of entrepreneurial error that takes place in the boom phase that is later revealed during the bust phase.”

It is unclear if China’s Dubai episode has merely been a localized problem.

Instead I would see this as signs of the bursting of her internal bubbles occurring at the periphery which may be in the process of spreading to the core, as explained this weekend.

So far, recent government interventions such as stealth fiscal stimulus and monetary easing has only deferred on the day of reckoning or managed to kick the can down the road.

Yet despite such political actions, China’s retail sales reported rose at the smallest pace in 4 years, and February posted a slump in manufacturing.

Again as noted this weekend, last week China moved to withdraw some of the recent fund injections, as well as, imposed new restrictions on property sales, that may have rattled China’s stock market aside from global commodity markets.

It remains to be seen if China’s political authorities would have the gumption to allow markets to clear that would come with significant economic anguish that may translate to heightened socio-political risks for the incumbent leaders.

My bet is that once the slowdown will become evident anew, policymakers will be quick to reverse on any tightening recently made and flood the system with money. Such has been the du jour policy convention.

The Secret of Aquinomics: Bubble Economic Policies

In a self-congratulatory claim to the outperformance of the Asia’s 7.1% statistical Philippine economic growth, the administration has even coined “Aquinomics” to such alleged accomplishment.

The Inquirer notes

Finance Secretary Cesar Purisima said confidence in the way the government was being run had encouraged more people to do business in the country.

“The growth rate shows that the economics of good governance, or ‘Aquinomics’ works,” Purisima said in a statement.

But what is exactly the Aquinomics or the recipe to the newfound success?

Robust domestic consumption and higher government spending have helped cushion the economy from the worst of the global slowdown, while manageable inflation has allowed authorities to keep interest rates conducive to growth.

So “Aquinomics” seems all about boosting domestic consumption and higher government spending.

Let us examine both. 

First higher government spending.

The government is slated to spend next year, a record 400 billion pesos (US $ 9.8 billion) or about 4.4% of Philippine GDP (2011)

Think of it this way, if all it takes is for the government to spend in order to boost the economy, then why limit spending? Perhaps the government should spend 100% or more of the economy.

Ah, but the problem is who pays for the spending? This means that the government would have to tax, borrow or inflate its way to fund the spending.

I have no qualms about the progress of the Philippine government’s paring down of public debt. 

But if one would look at where the real “progress” lies, it looks as if Aquino government has done marginal comparable or relative to what had been "accomplished" by the much maligned past administration. 

Government debt to GDP has been trimmed from 71.4% in 2004 to 44% in 2010. This means that the incumbent administration has whittled down debt to 40% or by only 4 percentage points as against 27 percentage points by the past administration.[This is not to defend the past administration, but to show the facts]

Taking away the populist politics or political color from the above statistics, the current administration has simply been piggybacking on the “achievements” of the past administration.  Without the substantial reduction of debt, ‘Aquinomics’ would not have the leeway or leverage it has today to undertake "record" spending programs. 

Of course, part of that supposed financial success by the previous administration has been to increase VAT from 10% to 12% in 2006 which came at the expense of the consumers. 

And there is always the question of how government spending helps. How does government spending translate to increased productivity, if such would only transfer resources from productive to consumption activities which extrapolates to a reduction of revenues to a society (or the crowding out effect)?

As the great classical liberal Jean Baptiste Say known for the eponymous Say’s Law elaborated in A Treatise in Political Economy (p.471)

The privation resulting from taxation, whether voluntary or compulsory, affects the tax-payer in his quality of producer, whenever it operates to curtail his profits; that is to say, his income or revenue; and affects him in his character of consumer, whenever it increases his expenditure, by raising the prices of products.

And, since an increase of expenditure is precisely the same thing as a diminution of revenue, whatever is taken by taxation may be said to be so much deducted from the revenues of the community.

Yes government infrastructure (public works) spending signifies as consumption activities—they are not built for the purposes of generating revenues.

Moreover, there is the dubious assumption that central planners know exactly or with precision, the demands of the marketplace. This is aside from the actual implementation of projects which usually leads to cost overruns or “overcharging”.

And there will always be the concerns over the ethics of political privileges in the distribution of political projects, such as corruption, cronyism and etc…

The other aspect of the Aquinomics is consumption driven economy.

How does the government attain the desired consumption outside government spending and the informal economy (the latter of which I have been saying has been the undeclared key pillar of real economic growth)? 

As I previously pointed out, the Philippines has been the most aggressive in Asia in adapting easy money policies

The result of which is easily one which I have been predicting.  

As I previously wrote,

Thus the environment of low leverage and prolonged stagnation in property values is likely to get a structural facelift from policy inducements, such as suppressed interest rates which are likely to trigger an inflation fuelled boom by generating massive misdirection of resources-or malinvestments.

Of course many would argue on a myriad of tangential or superficial reasons: economic growth, rising middle class, urbanization and etc... But these would mainly signify as mainstream drivels, as media and the experts will seek to rationalize market action on anything that would seem fashionable.

The effects of Aquinomics, from the same Inquirer article,

Among industries, construction posted its highest growth in at least six quarters, jumping 24.3 percent from a year earlier as Metro Manila enjoys the best property boom in two decades

And such boom has been powered by an expansion of credit, as the Oxford Business Group notes, (bold mine)

According to a report released at the end of September by Bangko Sentral ng Pilipinas (BSP), the central bank, lending to the real estate sector hit an all-time high in June. Banks’ exposure to the sector reached P561.6bn ($13.55bn) at the end of the second quarter, up 18.9% on 2011 and 4.4% higher than the end of the first quarter in 2012.

The BSP said the country’s 38 universal and commercial banks accounted for P434bn ($10.47bn), or 77.3%, of overall exposure, while 71 thrift banks accounted for the remaining 22.7%, worth P127.6bn ($3.08bn). Thrift banks are institutions offering basic banking services, focusing on deposits and mortgage financing, which play an important role in the Philippines’ banking system.

The lion’s share of exposure, some 97.3%, or P546.5bn ($13.18bn), consists of real estate loans, with the remaining 2.7% (P1.2bn, $28.94m) accounted for by securities issued by property companies. These segments grew 4.3% and 8.4%, respectively, during the second quarter of 2012.

The P22.3bn ($537.89m) of new loans issued in the second quarter was split between P11.9bn ($287.04m) of residential lending and P10.4bn ($250.85m) in the commercial segment. Investment in real estate securities included P12.1bn ($291.86m) in debt and P3bn ($72.36m) in equity.

This has not only translated to a credit induced bubble in the real economy but likewise in a boom in the stock market led by the property-finance and holding companies (latter has been due to the former two). Financials are intertwined with the property sector where the former, as pointed out above, provides the chief source of financing to the ballooning property boom.

Again validating my prediction, when the property sector has underperformed last year.

The upcoming rebound would not only close the underperformance gap but would also power this sector as one of the best performers.

The Philippine property sector as I earlier predicted will see a boom phase] (again barring any exogenous shocks). Real estate or property booms have traditionally functioned as the centrifugal force from a monetary induced bubble cycle. This has been very evident in China. And likewise became the ground zero for the US mortgage-banking crisis.

Of course, such property boom has been a regional dynamic (ASIA and ASEAN), not limited to the Philippines. Hong Kong has even a parking lot bubble. Grand and elaborate signature projects have hallmarked what seems as a Skyscraper curse in the region

Finally, the credit boom has been giving this administration the political capital facelift it needs for the coming elections. 

Nevertheless credit bubble policies will give an interim economic superficial boost but would come with wretched macroeconomic side effect in the fullness of time.

And as I previously wrote such bubble policies are addictive especially to the incumbent political agents, 

All these talks about curtailing bubbles again represents authorities superficially dealing with symptoms. In reality, they are pretentious actions. They are intended to paint the imagery of the politics of “do something” in the assumption that they “know” or fully comprehend the situation.

Really?

Bubbles serve to bloat statistical economic growth. This gives media mileage and approval ratings for the incumbent authority. They also enrich the political as well as the politically favored economic class whom are usually the first recipients of easy money policies.

So why they should political authorities curb a bubble? Should they kill the goose that lays their golden eggs?

This reminds me of the great dean of the Austrian school economics who warned.

Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance, by repeated doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop, either because the banks are getting into a shaky condition or because the public begins to balk at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, then the piper must be paid, and the inevitable readjustments liquidate the unsound over-investments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production.

But all has not been bad news though. 

I do hope that they would indeed adapt real reforms on easing “the cost of doing business” which should have been the primary thrust. Add to this the “tapping of the country’s record foreign reserves to pay its foreign debts”.

But I am troubled to say that both seems more about rhetoric than forthcoming actions. 

Remember massive government spending means more debt or higher taxes or higher consumer prices in the future. And credit upgrades only add to this incentive to borrow rather than to institute real reforms.

All these suggest that the new economic paradigm or "Aquinomics" has been anchored on increasing debt levels whether from government (via public works) or the private sector (via asset price bubbles and malinvestments). 

In my view Aquinomics hardly differs or seems parallel to typical Keynesian bubble policies. 

This chart which exhibits the stages of bubble chart also demonstrates the attendant the bubble mentality.

Guess in what phase of the bubble cycle has the “new paradigm” been associated with?

**economic charts above from tradingeconomics.com

Why Current Market Conditions Warrants a Defensive Stance

Here is what I wrote last week[1],

Also the Phisix is likely to surf on the global ‘EU Summit honeymoon’ sentiment, as well as on the momentum from an imminent RECORD breakout.

Whether this breakaway run will be sustainable remains unclear as global markets will remain volatile on both directions.

Indeed the jubilation from the EU Summit combined with momentum powered the major local equity benchmark, the Phisix, to a fresh record high.

Of course this breakaway run will be subject to the question of sustainability given the recent developments abroad.

Nevertheless after 3 successive weeks of advances which racked up 8.53% in returns, it would be normal to see some profit taking.

Nonetheless today’s exemplary standings have more stories to tell.

The ASEAN Standout

From my radar screen of 70+ international equity benchmarks, the Phisix only ranks fourth among the best performers based on a year-to-date returns.

But the Phisix is the ONLY bellwether among the elite contenders that has been trading at record highs.

Except for Venezuela which has been drifting close to the recently etched milestone highs established last May, it is only Thailand that comes close to having a superb feat.

All the rest are still way off from their apogees set during the last 3-5 years

I do not count Venezuela’s stock market as a real contender for the simple reason that the outperformance of the Venezuelan stock market could be a reaction to the amplified risks of hyperinflation.

Due to a combination of price controls and massive imports by the government, Venezuela’s inflation rate has been down reportedly to 21.3% last June[2]. But this is likely to be temporary and designed for the reelection of President Chavez this October

Combined with falling oil prices and massively expanding government expenditures, the Venezuelan government will likely run out of hard currency or of foreign exchange which may force them to ramp up on the printing presses for financing.

Stock markets have been functioned as safehaven during episodes of hyperinflation as people jettison currency for real assets. A good example is the recent bout of horrific hyperinflation[3] endured by Zimbabwe which culminated in 2008[4].

Surging stocks amidst hyperinflation has barely been about real (investment) returns but about people trying to preserve savings through acquisition of claims on real assets (insurance against monetary disorder).

And going back to the top 11, Thailand’s stock market as measured by the major bellwether the Stock Exchange of Thailand (SET) is second only to the Phisix to demonstrate remarkable gains.

While the SET is at a milestone multi-year high, the Thai bellwether is still about 30% off from the 1994 pre-Asian crisis record.

Yet the best annual performers masks or are framed to exclude the position of the others. This shows why the use of statistics can tricky and can be tailored to fit a predetermined conclusion.

Indonesia and Malaysia may have posted moderate year-to-date returns relative to the Phisix, up only 6.1% and 5.87% respectively, but Malaysia, like Philippines, trades at record HIGHs.

Meanwhile Indonesia trades a few percentages or (3.5%) off the recent record.

So ALL four major ASEAN bourses are AT or NEAR landmark highs but so far the Phisix leads the pack.

Outside the region, I have not encountered any national stock markets that have come close to beating their 3-5 year highs.

Growing Detachment between Stock Markets and Real Events

It is obvious that any economic or financial gains would be used as political advertisement.

For instance the recent S&P upgrade of the Philippine credit rating have been painted as a puffery of good governance. The fact is that whatever gains seen in the Philippines has been a regional dynamic. They are in reality symptoms of the boom phase of the business cycle that has mainly been driven by the domestic monetary policies through the negative real rate regime and supplemented by external monetary policies which has induced a search for yield dynamic from foreign investors in response to international easing policies. This ‘search-for-yield’ can also be interpreted as capital flight.

The current market conditions of the Phisix fit the inflationary boom scenario described by the late Austrian economist Fritz Machlup[5]

If, however, we inquire into the causes of the inflow of speculative capital from abroad which is so much objected to, we shall often find that it was the boom tendencies that were already present on the stock exchange which attracted the foreign funds. La hausse amene la hausse. The beginnings of the speculative boom originated in a flow of money from domestic sources. And as it is extremely difficult domestic to conceive of a sudden epidemic of saving, we are once again driven back to credit expansion by the banks. It is the "domestic" creation of credit which usually produces that sentiment on the stock exchange and that movement of stock prices, which act as an by foreign invitation to foreign funds.

The occasions when the short-term foreign funds flowing onto the stock exchange are to be regarded with real mistrust are when these funds owe their boom is existence to a credit inflation abroad. In this case foreign they bring the foreign “business cycle germ” into the home country

Yet the much ballyhooed upgrade has been based on superficial measures. They have most likely been influenced by surging prices in the asset markets (reflexivity theory), by political Public Relations campaign, particularly the phony war against corruption (where corruption is misleadingly portrayed as a function of ethical virtuosity rather than from real cause: arbitrary statutes and regulations[6]) and could even possibly be related to dwindling stock of “safe assets” for the global banking system than from real changes or market based economic reforms as I explained earlier[7]

What the credit upgrade does is to give license to the Philippine government to lavish on public expenditures. This would only promote crony capitalism, (yes guess which parties will be awarded with the proposed $16 billion of public work spending?) and that rewarding debt would work to the detriment of the economy over the long run through the adverse effects of the crowding out phenomenon[8], higher taxes and the serial blowing of the bubble cycles.

Grandiose skyscrapers (or the Skyscraper Index) have exhibited uncanny accuracy as harbingers of the bust phase of financial bubbles.

And believe it or not, 9 of the 10 of the world’s tallest building will rise in Asia and have been slated for completion from 2015 onwards—with China having four, South Korea three and one apiece for Indonesia (3^rd largest) and Malaysia[9].

So if the skyscraper index remains a functional indicator of financial excesses then we could or we may see a regional financial crisis anytime during the time window of 2015-2017.

Yet given the extreme fluidity of current conditions, such bubble conditions may be delayed or hastened depending on the direction of external and domestic social policies mostly channeled through monetary policies, particularly the complicit war by central bankers against interest rates (or the euthanasia of the rentier).

From the prescient admonitions of the great Ludwig von Mises[10]

Public opinion is prone to see in interest nothing but a merely institutional obstacle to the expansion of production. It does not realize that the discount of future goods as against present goods is a necessary and eternal category of human action and cannot be abolished by bank manipulation. In the eyes of cranks and demagogues, interest is a product of the sinister machinations of rugged exploiters. The age-old disapprobation of interest has been fully revived by modern interventionism. It clings to the dogma that it is one of the foremost duties of good government to lower the rate of interest as far as possible or to abolish it altogether. All present-day governments are fanatically committed to an easy money policy.

Of course, I see the soaring Phisix as effects of the bubbles parlayed as symptoms of Panglossian complacency (based on the belief that the Phisix or the region will decouple) or if not Pavlov’s classic mental conditioning (of the strongly held belief that central bankers will successfully bailout financial markets) or as effects of “jockeyed” markets.

As for the latter, aggressive buying in a landscape where global political authorities have been exhibiting anxieties over global economic conditions simply does not match with the current state of exuberance.

To give some examples.

The Bloomberg quotes IMF’s Christine Lagarde’s diagnosis of the world economy[11]

“Over the past few months, the outlook has regrettably become more worrisome,” Lagarde said. “Many indicators of economic activity -- investment, employment, manufacturing -- have deteriorated. And not just in Europe or the United States.”

Or how about the “45-minute salvo” fired by 3 central banks last Thursday as acts of desperation?

From another Bloomberg article[12]

Global central banks went on the offensive against the faltering world economy, cutting interest rates and increasing bond buying as a round of international stimulus gathers pace.

In a 45-minute span, the European Central Bank and People’s Bank of China cut their benchmark borrowing costs, while the Bank of England raised the size of its asset-purchase program. Two weeks ago, the Federal Reserve expanded a program lengthening the maturity of bonds it holds and Chairman Ben S. Bernanke indicated more measures will be taken if needed.

Many major global equity markets sagged following the news of the 45 minute interval coordinated easing from 3 major central banks.

The most curious response I saw came from China.

The Shanghai index remained wobbly and even traded on the negative for almost two thirds of Friday’s session which appeared to have discounted the interest rate cuts. The above chart from Bloomberg shows of the intraday actions. It took the last minute for the Shanghai index to surge, which according to news reports had been led by the property sector[13].

That last minute adrenalin shot may not persist as China’s Premier Wen Jiabao immediately shot down the notion of the lifting property controls in a comment today[14].

This is yet another example of the confounding stance by China’s political authorities.

The weaknesses in global markets following the reported near simultaneous interventions in the bourses of major economies could be deemed as “buy the rumor, sell on news” or of reality check relative to hope based expectations.

As I wrote a few weeks back[15],

One, if central bankers FAIL to deliver in accordance to market’s expectations, then we will likely see another huge bout of downside volatility in global equity markets….

On the other hand, if markets may be temporarily satisfied with REAL actions of central banks (e.g. $1 trillion bailout) then we should see a minor or a slight “sell on news”. But this should be seen as opportunities to RE-ENTER the markets incrementally.

Considering that the Phisix has soared since, I don’t see today as a providing a buying window, unless global central bankers would bring on their vaunted bazookas or until there will be meaningful improvements in the global economic arena

When financial markets flows into the opposite direction from the economy sans support from central bankers then the risks of a crash becomes a factor to reckon with.

One thing that could be justify divergences or decoupling is the possibility of intensified capital flight. While there are little signs of these affecting ASEAN markets yet, as explained last week, Denmark’s case seems like a relevant model.

Denmark’s bond markets which earlier have exhibited negative yields have now been reinforced by Denmark’s central bank policy of negative interest rates. Capital flight from the Eurozone to Denmark has prompted for an outperformance of Denmark’s equity markets[16] and has been on my top 11 list.

However the same capital flight phenomenon has not boosted the Switzerland’s Swiss Market’s Index in the same degree as Denmark. So we need to observe this further.

Outside More Central Bank Intervention, Expect Downside Pressures

Current conditions could be ripe for a significant retrenchment for global equity markets based on ‘fundamentals’.

Nearly 80% of the world’s industrial activities have been contracting[17].

Compared to 2007-2008 which had the US property bust as the epicenter, today’s slowdown has been coming from different directions, particularly, the Euro area and the BRICs.

Even in the US, both the industrial activities[18] and non-industrial activities[19] have been exhibiting considerable signs of weakening.

These may not signal yet the imminence of recession, but the risk of recession grows if both domestic and international conditions deteriorate further.

And the global economic slowdown has shown incipient signs of filtering into US corporate profits[20].

While the distribution of revenues from S&P 500 member companies has marginally been tilted towards US, nonetheless revenues from abroad still accounts for a substantial 45% share[21].

This means that slowing global economic growth will pose as material drag to current “fundamentals”.

So in the absence of further interventions by central banks or when steroid dependent markets have been left to their own devices, broad based downturns on the world economy would hurt profits and will get reflected on the stock prices.

The alternative view is that since global weakness has been coming from different directions interventions will require global coordination similar to the 45 minutes salvo.

In addition, “liquidity” conditions in emerging markets have reportedly been faltering.

This essentially reflects on the ongoing monetary tightening or increasing manifestations of bubble bust conditions in major economies as the Eurozone and the BRICs to Emerging Markets.

The transmission mechanism of which can be seen through the deterioration in trade balances which has been exacerbated by falling commodity prices, declining foreign reserve accumulation as some EM authorities have used excess reserves to support their domestic currency and a slowdown in capital inflows (which even may risk a reversal, if current conditions worsen)[22].

I would further point out that easing through interest rate policies will have miniscule effects to economies laden with debt.

Demand for credit will be limited as hock to the eyeball indebted individuals, households or corporations will be working to pay off existing liabilities. Further, impaired credit ratings diminish access to debt. Also supply of credit will be limited as institutions whose balance sheets have been compromised by problematic assets will work on building up capital reserves. Also, slowing of economic conditions will also hamper debt activities.

This means that unless global central banks pull out another rabbit out of a hat trick of aggressive ‘delaying the day of reckoning’ interventions through money printing, money conditions will tighten, as the malinvestments from previously inflated activities will have to undergo price adjustments that would need re-coordination in the transfer of resources from non-productive to productive activities.

So debt acquired during the bubble heydays will have to be dealt with eventually through the laws of economics.

Aside from the ECB, all eyes will be on the US Federal Reserve FOMC’s meeting on July 31 to August 1, 2012[23]

It would be interesting to see how the Phisix and ASEAN bourses will react in the face of a more pronounced slowdown in the US

Stay Defensive

The principal reason why the Philippines and her ASEAN neighbors have been more receptive towards negative real rates policies is that these economies has been excised of leverage as a result of the Asian crisis as shown in the above chart[24].

But this does not mean that the Philippine and ASEAN economies will be immune from a global economic slowdown. Again the exceptionalism and resiliency of ASEAN markets will be tested with a US economic slowdown.

Again since negative real rates rewards debt and speculation, today’s low debt era may easily transform low debt ASEAN economies into speculative and consumption activities based on debt similar to conditions which plagues developed economies today.

That’s the nature of bubble cycles.

For now, unless the US Federal Reserve (and or the European Central Bank) brings out the BAZOOKA soon, expect the Phisix, ASEAN and global markets to retrench.

At record and near record highs for the Phisix and ASEAN markets, retracements should be seen as normal countercyclical process.

But since events have been so fluid, we cannot discount the risks of a global recession emanating from continuing political stalemate, dithering over monetary policies and from policy errors. Recessions can turn bullmarkets into bear markets.

Oppositely, powerful responses from central bankers may alter the risk scenario for the benefit of the bulls for another short period.

And this is why excessive volatility in both directions will continue to characterize the financial marketplace.

Yet if the Phisix continues to soar, alone or along with ASEAN, despite all the mounting risks, and without support by the FED and or by the ECB, and if they are not driven by capital flight, the tail risks of downside volatility may become magnified.

The current conditions of financial markets can be analogized to navigating in treacherous waters where one’s survival depends on skillful handling of the steep ebbs and flows of the tides, and of course guided too by lady luck. Yet chance according to Louis Pasteur favors the prepared mind.

So still, I would advise that prudence will remain a better part of valor in terms of portfolio management

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[1] See Why has the Phisix Shined? July 2, 2012

[2] Businessweek/Bloomberg Venezuela Inflation Slows for Seventh Month on Import Surge, July 3, 2012

[3] See Zimbabwe's Hyperinflation February 25, 2009

[4] See Zimbabwe In The Aftermath Of Hyperinflation: Free Markets November 16, 2009

[5] Machlup Fritz A Digression On International Speculation Chapter 10, The Stock Market, Credit And Capital Formation William Hodge And Company, Limited p.163 Mises.org

[6] See Doug Casey On Corruption: Laws Create Corruption And Corruption Engenders Laws February 10, 2011

[7] See S&P’s Philippine Upgrade: There's More than Meets the Eye July 5, 2012

[8] Wikipedia.org Crowding out (economics)

[9] See Does the Skyscrapers Curse Signal a coming Asian Crisis?, July 6, 2012

[10] Mises Ludwig von 8. The Monetary or Circulation Credit Theory of the Trade Cycle XX. INTEREST, CREDIT EXPANSION, AND THE TRADE CYCLE Human Action Mises.org

[11] Bloomberg.com Lagarde Says IMF To Cut Growth Outlook As Global Economy Weakens, July 5, 2011

[12] Bloomberg.com, Central Banks Deliver 45-Minute Salvo As Growth Weakens, July 5, 2012

[13] Reuters.com China bank shares pull down Hong Kong HSI, property lifts Shanghai, July 6, 2012

[14] See China’s Property Controls: Mistaking Forest for Trees July 8, 2012

[15] See Dealing with Today’s Uncertainty: Patience is the Better Part of Valor June 17, 2012

[16] See Denmark Cuts Interest Rates to Negative, July 4, 2012

[17] Zero Hedge 80% Of The World's Industrial Activity Is Now Contracting July 5, 2012

[18] Yardeni.com US Manufacturing Purchasing Managers Index July 3, 2012

[19] Wall Street Journal Blog Vital Signs: Slowing in Nonmanufacturing, July 6, 2012

[20] Wall Street Journal Blog, Number of the Week: Rest of World Pulls Down U.S. Profits June30, 2012

[21] Businessinsider.com CHART: A Breakdown Of Where S&P 500 Companies Get Overseas Business, June 27, 2012

[22] See Emerging Market “Liquidity” Conditions Deteriorate July 5, 2012

[23] US Federal Reserve Meeting calendars, statements, and minutes (2007-2013)

[24] Zero Hedge, Asia's Downside Risk And The Three Big Hopes June 21, 2012