Austrian Business Cycle and September Market Crashes

September has been the slowest month for the stock markets.

In fact, the September October window has had the most number of incidences of Stock market crashes.

Chart above from Investopedia.com

Austrian economist Bob Wenzel sees the link between stock market crashes and the Austrian Business Cycle,

Austrian business cycle theory holds that the boom-bust business cycle is the result of central bankers printing money and distorting the consumption-savings ratio in favor of savings and the bust occurs when the printing stops and the economy adjusts itself back in favor of a more consumer leaning consumption-savings ratio, which sees more money head into the consumption sector.

When a central bank stops printing money, September may act as something of a catalyst to push the consumer-savings ratio in favor of consumption more rapidly, since September is likely a very heavy consumption spending month. Consumers spend money in September for new school clothes for kids. The colder months begin to approach, so winter clothes are bought. More televisions are likely bought because of the colder weather, as more people spend time inside. Thus, there is more consumption and liquidation of savings (including stock ownership and withdrawals from banks) in September to fund the increased consumer spending.

October actually seems to be the month when stock market crashes occur most often (Think October 1929 and October 1987), as opposed to September. This may be a continuation of the problems started in September. Stocks go down and consumers have spent money that previously would have propped up the stock market. Further, October stock market liquidations also occur late in the month as people start thinking about Christmas shopping and less money is added to the stock market.

Bernanke Jilts Markets on Steroids, Suffers Violent Withdrawal Symptoms

Despite my current circumstances, I felt the compulsion to offer a reaction on today’s market meltdown.

Here is what I recently wrote,

I would certainly watch the US Federal Reserve’s announcement and the ensuing market response.

If team Bernake will commence on a third series of QE (dependent on the size) or a cut in the interest rate on excess reserves (IOER), I would be aggressively bullish with the equity markets, not because of conventional fundamentals, but because massive doses of money injections will have to flow somewhere. Equity markets—particulary in Asia and the commodity markets will likely be major beneficiaries.

As a caveat, with markets being sustained by policy steroids, expect sharp volatilities in both directions.

Obviously the market’s response on team Bernanke’s failure to deliver on what had been expected has apparently been violent.

The Philippine Phisix (chart from technistock.net), as well as ASEAN equity markets, has basically suffered the same degree of bloodbath relative to her developed economy equity market peers

This reaction from a market participant captures the underlying sentiment. From a Bloomberg article

“This is not likely to provide any significant stimulus,” said Jason Schenker, president of Prestige Economics LLC in Austin, Texas. “The market really needed a boost of confidence. There is no confidence from this.”

So what did the Mr. Bernanke deliver?

Again from the same article at Bloomberg

The Federal Reserve will replace $400 billion of short-term debt in its portfolio with longer- term Treasuries in an effort to reduce borrowing costs further and counter rising risks of a recession.

The central bank will buy securities with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less, the Federal Open Market Committee said today in Washington after a two-day meeting. The action “should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the FOMC said.

Chairman Ben S. Bernanke expanded use of unconventional monetary tools for a second straight meeting after job gains stalled and the government lowered its estimate of second- quarter growth. Yields on 30-year Treasuries fell below 3 percent for the first time since 2009 and U.S. stocks had their biggest drop in a month on the Fed’s plan, dubbed “Operation Twist” after a similar Fed action in 1961.

The twist, as earlier stated, has been telegraphed. What was not expected has been the non-appearance of Bernanke’s QE which resulted to today’s convulsions.

The ‘twist’ which essentially attempts to flatten the yield curve basically reduces the banking system’s profitability from the borrow short and lend long (maturity transformation) platform that has partly catalyzed these selloffs.

From the Wall Street Journal

But for bankers, who are already struggling with low interest rates on loans and tepid loan demand, the twist option could further dent already-weakened profits. That is because lower long-term interest rates would result in contracting net interest margins for banks—essentially, the profit margin in the lending business—at a time when their revenue is growing slowly, if at all. Banks would earn less on loans and investments, and might end up making fewer loans as well.

"Ouch" is how one executive at a big retail bank described the prospect of Operation Twist. (Bankers typically don't publicly comment on Fed policy given the central bank's role as a bank regulator.)

Austrian Economist Bob Wenzel says that Operation Twist represents a failed experiment…

So how did the original Operation Twist turn out? Three Federal Reserve economists in 2004 completed a study which, in part, examined the 1960's Operation Twist. Their conclusion (My bold):

“A second well-known historical episode involving the attempted manipulation of the term structure was so-called Operation Twist. Launched in early 1961 by the incoming Kennedy Administration, Operation Twist was intended to raise short-term rates (thereby promoting capital inflows and supporting the dollar) while lowering, or at least not raising, long-term rates. (Modigliani and Sutch 1966).... The two main actions of Operation Twist were the use of Federal Reserve open market operations and Treasury debt management operations.. Operation Twist is widely viewed today as having been a failure, largely due to classic work by Modigliani and Sutch.”

The economists go on to state that the size of Operation Twist was relatively small, possibly too small to determine if such an operation could be successful if carried out at on a larger scale. That experiment is now being conducted on the economy of the United States with the $400 billion Operation Twist announced today. How big was the original Operation Twist? $8.8 billion.

The three Fed economists, who seem to concur that the first Operation Twist was a failure, are sure going to get an experiment on the United States economy on a much grander scale to see if this time it will work different than it did the first time. So who are these three lucky Fed economists who are now going to be able to witness Operation Twist on a grander scale? Vincent R. Reinhart, Brian P. Sack and BEN S. BERNANKE.

So part of the market’s virulent reaction signifies a revolt on Bernanke’s experimental policy. This is an example of how interventionist measures prompts for heightened uncertainties.

The Fed also promised to support mortgage markets by keeping the interest low. Again from the same Bloomberg article,

The central bank said today it will also reinvest maturing housing debt into mortgage-backed securities instead of Treasuries “to help support conditions in mortgage markets.”

Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates tumbled the most in more than two years relative to Treasuries. The average rate on a typical 30-year fixed loan fell to a record low 4.09 percent last week.

So why has Bernanke failed to live up with the expectations for more QE?

Like in the Eurozone, there has been mounting opposition to Bernanke’s inflationist bailout policies as seen by a divided FOMC… (same Bloomberg article)

The FOMC vote was 7-3. Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota and Charles Plosser of the Philadelphia Fed voted against the FOMC decision for a second consecutive meeting. They “did not support additional policy accommodation at this time,” the Fed statement said today.

…and from some Republicans who mostly recently who made public representations against further QEs.

Republican lawmakers including Boehner and Senate Minority Leader Mitch McConnell urged Bernanke in a letter this week to refrain from additional monetary easing to avoid “further harm” to the economy.

This is aside from political pressures applied by his predecessor, Paul Volker

In my view, Chairman Ben Bernanke could be:

-trying to lay the blame of policy restraints at the foot of his opponents in the recognition that markets would behave viciously from a stimulus dependent ‘withdrawal syndrome’, or

-that his penchant for grand experiments made him deliberately withhold QE to see how the markets would respond to his innovative ‘delusion of grandeur’ measures.

By withdrawal, I don’t mean a reduction of the Fed’s balance sheet, which the Fed aims to maintain (which probably would incrementally expand on a less evident scale) but from further specifically targeted asset purchases. The ‘twist’ essentially sterilizes the operation which means no money supply growth.

Today’s brutal reaction in global financial markets essentially validates my view that the contemporaneous market has been built on boom bust policies such that NOT even gold prices has been spared.

The tight correlations in the collapsing prices of equities and commodities as well as the rising dollar (falling global currencies) are manifestations of a bust process at work.

The primary issue here is that in absence of government’s backing via assorted stimulus, mostly via monetary injections, artificially established price structures from government stimulus or from credit expansion unravels.

Only when the tide goes out, to paraphrase Warren Buffett, do we know who has been swimming naked.

Or as Austrian economist George Reisman writes,

A fundamental fact is that our present monetary system is characterized both by irredeemable paper money, i.e., fiat money, and by credit expansion. There is no limit to the quantity of fiat money that can be created. This is the foundation for potentially limitless inflation and the ultimate destruction of the paper money, when the point is reached that it loses value so fast that no one will accept it any longer. The fact that our monetary system is also characterized by credit expansion is what creates the potential for massive deflation — for deflation to the point of wiping out the far greater part of the money supply, which in the conditions of the last centuries has been brought into existence through the mechanism of credit expansion

Japan's Minister Calls for More Inflationism to Stem Global Market Crash

Here we go again. Crashing markets has prompted policymakers to make “assurances” to the public.

From Bloomberg, (bold emphasis mine)

The G-7 needs “very close cooperation in coming weeks,” Japanese Finance Minister Yoshihiko Noda said in Tokyo, where the Topix index fell to a two-year low. Hong Kong financial official K.C. Chan urged investors to “stay calm” and not be “spooked by the market,” as the Hang Seng index slumped 2.4 percent. In Beijing, Vice President Xi Jinping said his nation will avoid an economic hard landing.

Plunging equity markets are crushing consumer and business confidence, worsening the outlook for a global economy already hampered by the debt burdens of developed nations. Speculation that European banks may have insufficient capital and signs of weakness in the U.S. economy are helping to drive a stock rout that returned to Asia today…

It’s sad to see how logic works for politicians. Investors don’t get spooked by the markets. Instead, investors sell the markets down for certain reasons, particularly the unresolved problems or uncertainty from the continuing debt crisis that plagues the Eurozone and the US. Such frenetic selling has been vented on the markets. The effects are not the cause.

So what steps will they assure investors?

Again from the same article, (bold emphasis mine)

Asked how policy makers should respond to market turmoil, Noda referred reporters to an Aug. 8 pledge by G-7 finance ministers and central bank governors to “take all necessary measures to support financial stability and growth.” He didn’t specify any likely next step.

A past example of joint action is the intervention that temporarily weakened Japan’s currency after the nation’s March earthquake. Major developed nations are hampered in further stimulating their economies because of their debt burdens, and have limited or no room for interest-rate cuts after reductions that countered the financial crisis of 2008.

Their proclivity is to implement the very same set of actions that has created this problem in the first place, where more inflationism translates to greater volatility via the boom bust cycles.

It isn’t that governments don’t learn, rather governments prefer to adapt actions that have short term beneficial effects but with long term untoward costs. It’s a vicious cycle.

Record Gold Prices and Bond Spreads Point to Stagflation

Amidst last night’s second chapter of this year’s global stock market rout, GOLD prices has spiked anew to record highs breaking above the $1,800 level (or added $1,000 in just 10 days!!!).

I have been repeatedly (nauseously) saying here that gold’s rise has been in the account of greatly increased expectations of more inflationary actions by the central bankers.

The US bond markets appear to be echoing gold’s actions.

This from Bloomberg’s Chart of the Day, (bold emphasis mine)

The Federal Reserve’s unprecedented pledge to hold interest rates at a record low risks creating an inflationary surge once the economy starts to accelerate, Treasury bond trading shows.

The CHART OF THE DAY tracks the difference between yields on the 30-year Treasury bond and its Treasury Inflation Protected Securities counterpart and the same comparison for two-year notes. The lower panel shows that the gap between those so-called breakeven rates reached the widest since December this week, as the Fed’s commitment to hold down borrowing costs, announced after an Aug. 9 meeting, intensified concern inflation would accelerate.

“Because the Fed maintained fund rates at exceptionally low levels, that’s causing inflationary expectations to pick up,” said Hiroki Shimazu, senior market economist in Tokyo at SMBC Nikko Securities Inc. “In the long-term, there are much bigger problems for the U.S. economy. This is one of the warning signs.”

The spread between yields on two-year notes and so-called TIPS, which gauges trader expectations for consumer prices over the life of the debt, narrowed to 0.95 percentage point on Aug. 16. When using 30-year bonds and same-maturity TIPS, the figure jumps to 2.61 percentage points. The difference between the measures was 1.66 percentage points, the highest this year.

The establishment's commentary misleads the public when they attribute the cause and effect relationship of inflation to economic growth.

The fact is inflation arises from money printing or expansion of fiduciary media, and can accelerate even when the economy is in the doldrums such as in the stagflation era of the 70s (shown below- US consumer prices on a year annual % change trended up even during 3 recessions).

Or for a more extreme example, Zimbabwe’s hyperinflation episode which came amidst an economic depression (falling GDP, very high unemployment)

Bottom line: Gold and current bond spreads currently point to risks of stagflation

Global Equity Meltdown: Political Actions to Save Global Banks

“However, hanging onto money is highly risky in a time of monetary inflation. The security-seeker does not understand this. Keynesian economists do not understand this. Politicians do not understand this. The result of inflationary central bank policies is the production of uncertainty in excess of what the public wants to accept. But the public does not understand Mises' theory of the business cycle. Voters do not demand a halt to the increase in money. It would not matter if they did. Central bankers do not answer to voters. They also do not answer to politicians. "Monetary policy is too important to be left to politicians," the paid propagandists called economists assure us. The politicians believe this. Until the crisis of 2008, so did voters.” Professor Gary North

Local headlines blare “Global stocks gyrate wildly; sell-off resumes in markets”[1]

To chronicle this week’s action through the lens of the US Dow Jones Industrial Average (INDU), we see that on Monday August 8th, the major US bellwether fell 635 points or 5.5%. On Tuesday, the INDU rose 430 points or 4%. On Wednesday, it fell 520 points 4.6%. On Thursday, it rose 423 points or 3.9%. The week closed with the Dow Jones Industrials up by 126.71 points or 1.13% on Friday.

All these wild swings accrued to a weekly modest loss of 1.53% by the Dow Jones Industrials.

Some ideologically blinded commentators argue that these had been about aggregate demand. So logic tell us that aggregate demand collapsed on Monday, jumps higher on Tuesday, tanked again on Wednesday, then gets reinvigorated on Thursday and Friday? Makes sense no?

How about fear? Fear on Monday, greed on Tuesday, fear on Wednesday, and greed on Thursday and Friday? Do you find this train of logic convincing? I find this patently absurd.

Confidence doesn’t emerge out of random. Instead, people react to changes in the environment and the marketplace. Their actions are purposeful and seen in the context of incentives (beneficial for them).

And that’s why many who belong to the camp of econometrics based reality gets wildly confused about the current developments where they try in futility to fit only parts of reality into their rigid theories.

And part of the realities that go against their beliefs are jettisoned as unreal.

So by the close of the week, these people end up scratching their heads, to quip “weird markets”.

Weird for them, but definitely not for me.

Political Actions to Save the Global Banking System

Yet if there has been any one dynamic that has been proven to be the MAJOR driving force in the financial markets over the week, this has been about POLITICS, as I have been pointing out repeatedly since 2008[2].

I am sorry to say that this has not been about aggregate demand, fear premium, corporate profits, conventional economics or mechanical chart reading, but about human action in the context of global policymakers intending to save the cartelized system of the ‘too big to fail’ banks, central banks and the welfare state.

As I pointed out last week[3],

Important: The US has been downgraded by the major credit rating agency S&P after the market closed last Friday, so there could be an extended volatility on the global marketplace at the start of the week. This largely depends if such actions has already been discounted. The first thing on Monday is to watch Japan’s response.

The S&P’s downgrade tsunami reached the shores of global markets on Monday, where the US markets crashed by 5.5%.

It is very important to point out that the market backlash from the downgrade did NOT reflect on real downgrade fears, where US interest rates across the yield curve should have spiked, but to the contrary, interest rates fell to record lows[4]!

And as also correctly pointed out last week, the US Federal Reserve’s FOMC meeting, which was held last Tuesday, introduced new measures aimed at containing prevailing market distresses.

The FOMC pledged to:

-extend zero bound rates until mid-2013, amidst growing dissension among the governors,

-maintain balance sheets by reinvesting principal payments of maturing securities,

and importantly, keep an open option to reengage in asset purchases[5].

Some have argued that the Fed’s policies has essentially been a stealth QE, as the steep yield curve from these will incentivize mortgage holders to refinance. And this would spur the Fed to reinvest the proceeds.

According to David Schawel[6],

A surge of refinancing will reduce the size of the Fed’s MBS holdings and allow them to re-invest the proceeds further out the curve

The Fed’s announcement on Tuesday, basically coincided or may have been coordinated with the European Central Bank’s purchases of Italian and Spanish bonds or ECB’s version of Quantitative Easing. The combined actions resulted to an equally sharp 4% bounce by the Dow Jones Industrials.

Mr. Bernanke has essentially implemented the first, “explicit guidance” on Fed’s policy rates, among the 3 measures he indicated last July 12th[7].

The resumption of QE and a possible reduction of the quarter percentage of interest rates paid to bank reserves by the US Federal Reserve signify as the two options on the table.

My guess is that the gradualist pace of implementation has been highly dependent on the actions of the financial markets.

I would further suspect that given the huge ECB’s equivalent of Quantitative Easing or buying of distressed bonds of Italy and Spain, aside Ireland and Portugal, estimated at US $ 1.2 trillion[8], team Bernanke perhaps desires that financial markets digest on these before sinking in another set of QEs.

And to consider that US M2 money supply[9] has been exploding, which already represents a deluge of money circulating in the US economy, thus, the seeming tentativeness to proceed with more aggressive actions.

Wednesday saw market jitters rear its ugly head, as rumors circulated that France would follow the US as the next nation to be downgraded[10]. The US markets cratered by 4.6% anew.

On Thursday, following an earlier probe launched by the US Senate on the S&P for its downgrade on the US[11], the US SEC likewise opened an investigation to a possible insider trading charge against the S&P[12].

Obviously both actions had been meant to harass the politically embattled credit rating agency. The possible result of which was that the S&P joined Fitch and Moody’s to affirm France’s credit ratings[13].

To add, 4 Euro nations[14], namely Italy, Belgium, France and Spain has joined South Korea, Turkey and Greece[15] to ban short sales. A ban forces short sellers to cover their positions whose buying temporarily drives the markets higher.

These accrued interventions once again boosted global markets anew which saw the INDU or the Dow Industrials soar by 3.9%.

Friday’s gains in global markets may have been a continuation or the carryover effects of these measures.

Unless one has been totally blind to all these evidences, these amalgamated measures can be seen as putting a floor on global stock markets, which essentially upholds the Bernanke doctrine[16], which likewise underpins part of the assets held by the cartelized banking system and sector’s publicly listed equities exposed to the market’s jurisdiction.

Thus, like 2008, we are witnessing a second round of massive redistribution of resources from taxpayers to the politically endowed banking class.

Gold as the Main Refuge

AS financial markets experienced these temblors, gold prices skyrocketed to fresh record levels at over $1,800, but eventually fell back to close at $1,747 on Friday, for a gain of $83 over the week or nearly 5%.

From the astronomical highs, gold fell dramatically as implied interventions had been also extended to the gold futures markets. Similar to the recent wave of commodity interventions, the CME steeply raised the credit margins of gold futures[17].

We have to understand that gold (coins or bullions) have NOT been used for payments and settlements in everyday transactions. So gold cannot be seen as fungible to legal tender imposed fiat cash (for now), even if some banks now accept gold as collateral.[18]

In an environment of recession or deleveraging—where loans are called in and where there will be a surge of defaults and an onrush of asset liquidations to pay off liabilities or margin calls, fiduciary media (circulating credit) will contract, prices will adjust downwards to reflect on the new capital structure and people will seek to increase cash balances in the face of uncertainty—CASH and not gold is king. Such dynamic was highly evident in 2008 (before the preliminary QEs).

Thus, it would signify a ridiculous self-contradictory argument to suggest that record gold prices has been manifesting risks of ‘deflation’.

Instead, what has been happening, as shown by the recent spate of interventions, is that for every banking problem that surfaces, global central bankers apply bailouts by massive inflationism accompanied by sporadic price controls on specific markets.

Alternatively, this means that record gold prices do not suggest of a fear premium of a deflationary environment, but instead, a possible fear premium from the prospects of a highly inflationary, one given the current actions of central banks.

This panic-manic feedback loop or in the analogy of Dr. Jeckll and Mr. Hyde’s “split personality” which characterizes the global markets of last week has been materially different from the 2007-2008 US mortgage crises.

Not only has there been a divergence in market response across different financial markets geographically (e.g. like ASEAN-Phisix), the flight to safety mode has been starkly different.

The US dollar (USD) has failed to live up to its “safehaven” status, which apparently has shifted to not only gold but the Japanese Yen (XJY) and the gold backed Swiss Franc (XSF).

It’s important to point out that the franc’s most recent decline has been due to second wave of massive $55 billion of interventions by the SNB during the week. The SNB has exposed a total of SFr120 billion ($165 billion!) over the past two weeks[19]. The pivotal question is where will $165 billion dollars go to?

Bottom line:

This time is certainly different when compared to 2008 (but not to history where authorities had been predisposed to resort to inflation as a political solution). While there has been a significant revival of global market distress, market actions have varied in many aspects, as well as in the flight to safety assets.

This implies that in learning from the 2008 episode, global policymakers have assimilated a more activist stance which ultimately leads to different market outcomes. Past performance does not guarantee future results.

The current market environment can’t be explained by conventional thinking for the simple reason that markets are being weighed and propped up by the actions of political players for a political purpose, i.e. saving the Global Banks and the preservation of the status quo of the incumbent political system.

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[1] Inquirer.net Global stocks gyrate wildly; sell-off resumes in markets, August 12, 2011

[2] See Stock Market Investing: Will Reading Political Tea Leaves Be A Better Gauge?, November 30, 2008

[3] See Global Market Crash Points to QE 3.0, August 7, 2011

[4] See Has the S&P’s Downgrade been the cause of the US Stock Market’s Crash?, August 9, 2011

[5] See US Federal Reserve Goes For Subtle QE August 10,2011

[6] Schawel, David Stealth QE3 Is Upon Us, How Ben Did It, And What It Means Business Insider, August 9, 2011

[7] See Ben Bernanke Hints at QE 3.0, July 13, 2011

[8] Bloomberg, ECB Bond Buying May Reach $1.2 Trillion in Creeping Union Germany Opposes, August 8, 2011

[9] FRED, St. Louis Federal Reserve, M2 Money Stock (M2) M2 includes a broader set of financial assets held principally by households. M2 consists of M1 plus: (1) savings deposits (which include money market deposit accounts, or MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs). Seasonally adjusted M2 is computed by summing savings deposits, small-denomination time deposits, and retail MMMFs, each seasonally adjusted separately, and adding this result to seasonally adjusted M1.

[10] The Hindu, Fears of France downgrade trigger massive sell-off in Europe, August 11, 2011

[11] Bloomberg.com U.S. Senate Panel Collecting Information for Possible S&P Probe, August 9, 2011

[12] Wall Street Journal Blog SEC Asking About Insider Trading at S&P: Report, August 12, 2011

[13] Bloomberg.com French AAA Rating Affirmed by Standard & Poor’s, Moody’s Amid Market Rout, August 11, 2011

[14] USA Today 4 European nations ban short-selling of stocks, August 11, 2011, see War against Short Selling: France, Spain, Italy, Belgium Ban Short Sales, August 12, 2011

[15] Business insider 2008 REPLAY: Europe Moves To Ban Short Selling As Crisis Spreads, August 11, 2011, also see War Against Market Prices: South Korea Imposes Ban on Short Sales, August 12, 2011

[16] See US Stock Markets and Animal Spirits Targeted Policies, July 10, 2010

[17] See War on Gold: CME Raises Credit Margins on Gold Futures, August 11, 2011

[18] See Two Ways to Interpret Gold’s Acceptance as Collateral to the Global Financial Community, May 27, 2011

[19] Swissinfo.ch Last ditch defence of franc intensifies, August 10, 2011

The Remarkable Phisix-ASEAN Resiliency Amidst the Global Financial Storm

“Keynesians tend to assume that government spending has a big positive effect on economic growth. Others disagree. But if the impact of increasing government spending is large, then the impact of removing it is also. So policy makers better be sure that the boom is around the corner. And all these are just short-run considerations. Here's the real dirty secret of Keynesian policies: They are sure to have a negative effect in the fullness of time.” Kevin Hassett

So how has the global markets affected ASEAN benchmarks and Philippine Phisix during last week’s furor?

ASEAN’s Gradual Discounting of Global Equity Market Meltdown

Except for Monday and Tuesday, where the bears launched a ‘blitzkrieg’ that has resulted to two day cumulative loss of 6.3%, broken down to 2.3% and 4% respectively, the diminishing marginal (time) value of information has stunningly prompted for an exceptional performance by the Phisix and the ASEAN region.

Astonishingly, the Phisix has managed to shrug off or IGNORE the 6% loss by the US last Thursday and went on to even close marginally higher[1]!

The recovery during the last three sessions of the week accrued to a net loss of 2.61% by the Phisix, still significant but the figures hardly reveal everything.

The actions of the Phisix basically have been identical with most of our neighbors.

Except for Indonesia (JCI) which saw a measly .79% decline for the week and while the Phisix (-2.61%) and the Thailand’s SET (-2.86%) fell by more than the US, the latter two still posted positive returns on a year to date basis, respectively 2.87% and 2.84%. Only Malaysia which fell by 2.67% over the week, has been down by 2.3% on a year to date.

Yet there are some noteworthy developments here and in the region:

1. Again Indonesia, Thailand, and the Philippines remain on the positive territory, despite the global meltdown. Only Malaysia among the ASEAN tag team has been on the negative.

2. Regional volatility appears to be decreasing even as global markets continue to roil.

If such trend should persist then convergence in the performance of ASEAN bourses could deepen or could reflect on higher correlations of emerging Asian equities.

The statistical correlations may seem ambiguous, but from the above charts courtesy of the ADB[2] we can see how least correlated we are with US equities in relative terms.

Among ASEAN bourses only Malaysia has had above half a percent of correlations (left window). Indonesia (.38) has the least correlation followed tightly by the Thailand (.39) and the Philippines (.4).

So well into 2011 the correlations have tightened among ASEAN bourses which have also been reflected on the right window (emerging Asia-emerging Asia correlations, green line). Whereas correlations of emerging Asia with the US has clearly departed or has significantly diminished, where previous correlations .62 in 2009 has recently been only .46.

The implication is that global or US investors who seek to diversify away from high correlations performance with US assets may likely consider Emerging Asia or the ASEAN region as an alternative.

This is why the recent US downgrade is unlikely a net negative for Phisix or the ASEAN region as global diversification play could be a looming reality.

And this could also be why regional policymakers appear to be “bracing” for a possible onslaught of foreign capital flows[3].

3. Domestic participants appear to be learning how to discount events abroad.

In the Phisix, the seeming resiliency from the recent global market rout has primarily been an affair dominated by domestic participants.

Net daily Foreign trade (averaged on a weekly basis) exhibits net outflows last week (left window). Nonetheless, total outflows have yet to reach the May levels, in spite of this week’s dramatic volatility. This has likewise been reflected on the Philippine Peso which was nudged lower (.14%) to close at 42.64 to a US dollar this week.

The share of foreign investors to total trade has spectacularly declined as domestic investors has taken over or dominated (right window) trading activities. Local investors accounted for about 65% of this week’s trade.

I think the current trend of local bullishness can be buttressed by recent empirical evidence. Philippine bank lending in June has reportedly been strongly expanding[4]. Although official statistics say that most of the loan growth has been directed to ‘production activities’ led by power (62.3%) and financial intermediation (31.9%), I would surmise that many of these loans may have been redirected to the Phisix.

The Bangladesh stock market crash should be a noteworthy example to keep in mind where were substantial amount of bank loans had been rechanneled to the stock market. And when the government imposed tightening measures (both monetary and administrative), the Dhaka Stock Index collapsed[5]by about 40% in January of this year. Since, the Dhaka has hardly made a significant headway in recovering.

Nevertheless the Philippines maintains the steepest yield curve in Asia, which should even boost the appetite of banks to lend. This should serve as an impetus for the boom phase of the domestic business cycle which the Phisix seems to be part of the transition.

Importantly, policy rates remain very accommodative with only two marginal increases in the BSP’s policy rates as of June 2011. Meanwhile Indonesia’s rates are at record low (no wonder the outperformance).

Phisix and Market Internal Divergence

3. Market internals despite this week’s drastic swings has not been entirely negative.

Daily traded issues averaged on a weekly basis (left window) seem to validate the remarkable actions by local investors as this sentiment indicator continues to climb.

The advance decline spread computed on a weekly basis reveals of the same developments; lopsided lead by declining issues during the early selloff has partly been offset by the asymmetric difference by the advancing issues during days where the Phisix rebounded.

Proof of this week’s astounding resilience is that the early devastation from global market carnage hasn’t reached the intensity of the 1^st quarter storm marked by the Arab Spring-Japan triple whammy calamity selloffs.

In essence, the losses of the Phisix may have overestimated the actual actions in the general market or the Philippine Stock Exchange.

Said differently, the Phisix reflected on foreign outflows (selling of Phisix heavyweights) in contrast to the general market which manifested a much buoyant of local investors, an apparent divergence!

I argued of a potential ASEAN Alpha play at the end of July[6], here is what I wrote,

So it is unclear whether ASEAN and the Phisix would function as an alternative haven, which if such trend continues or deepens, could lead to a ‘decoupling’ dynamic, or will eventually converge with the rest. The latter means that either global equity markets could recover soon—from the aftermath of the Greece (or PIIGS) bailout and the imminent ratification of the raising the US debt ceiling—or that if the declines become sustained or magnified, the ASEAN region eventually tumbles along with them. My bet is on the former.

Therefore, I would caution any interpretation of the current skewness of global equity market actions to imply ‘decoupling’. As I have been saying, the decoupling thesis can only be validated during a crisis.

In the meantime, we can read such divergent signals (between ASEAN and the World) as motions in response to diversified impact from geopolitical turbulence.

For this week, the function of the Phisix (or ASEAN) as alternative haven has been demonstrably true for the domestic participants but unsubstantiated by foreigners fund flows.

My divergence theory seems as gradually being validated by the marketplace!

Again let me remind you, that divergence only thrives in a global scenario that doesn’t signify a real crisis or a recession, most likely from a global liquidity drain. For if the imminence of an overseas recession should emerge, we have yet to see how the local and regional markets would react.

Remember this is no 2008! This time the activist approach by the conventional ‘modern’ central bankers has been paving way for different outcomes on different markets.

Gold as Refuge, Also Played Being Out via Domestic Mining Issues

4. As Gold, the Japanese yen, and the Swiss franc has functioned as the du jour flight to safety assets during the current market distress, we seem to be witnessing the same phenomenon taking hold even in the local equity markets where gold mining issues have taken the center stage!

Whether from year to date (below window) or from last week’s amplified volatility, the market psychology of domestic investors on mining issues have ostensibly turned from the fringe to the mainstream.

One would note that in the sectoral charts above, Tuesday’s carnage only dented the mining sector (violent) which again found footing or used this decline as leverage to recoil higher. All the rest of Phisix (green) sectors, namely bank (blue), Commercial Industrial (grey), Holding (red), Services (light green) and Property (black candle), went in the direction of the mining sector but has been hobbled by the steep losses.

All I can say is that since the Philippines have NO physical markets for gold in terms of spot or futures or even Exchange Traded Funds (ETF), mining issues could have likely served as a proxy or representative asset.

That’s why in the face of the current market inconstancy or turbulence, despite the hefty gains, I would recommend a partial shift of asset exposures to gold mines as hedge. This is not a momentum play but rather a possible flight to safety move as we seem to be seeing here and abroad.

Conclusion

Mimicking the US Federal Reserve, my closing will be a reprise of my statement from last week[7] but with some alterations, enclose by brackets [ ]

The Phisix and the ASEAN-4 bourses have not been unscathed by the brutal global equity market meltdown.

However, excluding Friday’s [Monday and Tuesday’s] emotionally charged fallout and despite the weak performances of developed economy bourses during the week, the Phisix and ASEAN bourses has managed to keep afloat and has even demonstrated significant signs of relative strength, signs that could attract more divergent market activities in a non recessionary setting.

As global policymakers continue to engage in a whack-a-mole approach to the acute problems facing the developed economies’ banking-welfare based government system, the path dependent solution, as demonstrated during this tumultuous week, has been the age old ways of printing money and selective price controls.

The same foreseeable actions can be expected over the coming days, more patchwork with unintended consequences overtime.

And the outcome to the marketplace should be variable as the current conditions reveal.

Lastly, downgrades for Asia and possibly for Europe which may have a short term effect on Asian assets should actually be a plus for the region over the long run. This is not only from the possible diversification move but also from real capital flows.

That is if we adapt relatively sounder money approach and embrace economic freedom.

However if we continue to act in concert with global policy trends then we could expect these downgrades to eventually export boom bust cycles anew to Asia.

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[1] See Philippine Phisix: What An Incredible Turnaround! (Global Equity Markets Update), August 11, 2011

[2] Asian Development Bank Asia Capital Markets Monitor August 2011

[3] Bloomberg.com Asia braces for capital flows as currencies rise, gulfnews.com August 9, 2011

[4] BSP.gov.ph Bank Lending Continues to Accelerate in June, August 10, 2011

[5] See Bangladesh Stock Market Crash: Evidence of Inflation Driven Markets, January 11, 2011

[6] See The Phisix-ASEAN Alpha Play, July 31, 2011

[7] See Phisix-ASEAN Outperformance Despite Global Meltdown, August 7, 2011

Philippine Phisix: What An Incredible Turnaround! (Global Equity Markets Update)

Amazing, the Philippine Phisix simply shrugged off the US-European market rout yesterday.

Chart from technistock.net

The actions of the market can’t be argued as having been boosted from US Federal Reserve assurances as alleged by some, for the following reasons:

One, the Phisix opened down only less than 2% (81.47 points). This represents evidence that even with heightened uncertainty overseas, investors put an immediate floor on the Phisix from the opening bell.

Two, Japan’s Nikkei is still down more than 1% as of this writing. This hardly means Fed assurance factor.

Three, except for Indonesia which is down about 1%, Malaysia and Thailand are slightly lower. In other words, today's action is another validation of the ASEAN divergence process at work.

Fourth, the mining issues spearheaded this magnificent intraday recovery.

The mining index surged by 4.2% and carried the weight of the Phisix rebound!

Nevertheless, the big picture tells us that the Fed’s (stealth QE) and the ECB’s QE may have been interpreted by the world markets as an antidote with insufficient potency to overwhelm the prevailing negative factors

Second, the Eurozone’s crisis continues to affect global markets

And that’s why Ben Bernanke came out last night swinging at the notion that dissensions from within the ranks of the US Federal Reserve board of governors would stop him from declaring another round of overt Quantitative Easing.

We will see.

In my view, I believe that despite today's superb performance by the Phisix, caution is highly warranted until we see:

-concrete or definitive actions by the US Federal Reserve. Again, stealth QE by the Fed and the ECB’s overt QE has been essentially eclipsed or overpowered by the banking-PIIGS meltdown in Eurozone.

-signs of stability in global equity markets (where large swings or gyration dissipates), even if most of the world markets continue to decline.

Though yes, $1,800 gold appears to be lending support to the Phisix as I have been arguing here.

Just to show how the Phisix-ASEAN seems to metaphorically defy gravity, this great year to date chart is from the Bespoke Invest is telling.

As of yesterday, of 78 nations monitored by Bespoke Invest, there are only 10 gainers so far.

Two of them hails from ASEAN, particularly Thailand and Indonesia. The Philippines (12^th) and Malaysia (14^th) are still ranked in the top 20 of the world's best performers despite marginal losses.

The US is ranked 19^th in spite of the series of recent blood bath.

If you look at the overall performance, one would note that global equities have mostly been in the sea of red, with more countries joining the ranks of bear market losses (20% or more) rather than of the gainers’ column.

Such broadening losses should be seen as a source of caution, nevertheless, cautious optimism.

Global Debt Crisis: Rotation from Global Equities ($7.8 trillion losses) to Bonds ($132 billion gains)

The global debt crisis experienced another rotation: Global equity markets posted whopping losses estimated at $7.8 trillion as bonds gained $132 billion.

From Bloomberg, (bold emphasis mine)

The worldwide retreat from stocks and commodities following Standard & Poor’s unprecedented cut of the U.S. AAA credit rating has driven the value of the global bond market to a record high.

The market value of Bank of America Merrill Lynch’s Global Broad Market Index has increased $132.4 billion since the end of July to $42.1 trillion, the most in data going back to 1996. The index, containing more than 19,000 bonds sold by governments, banks and the world’s biggest companies, returned 1.09 percent this month as yesterday’s stock rout wiped out about $2.5 trillion in global equity values, extending total losses since July 26 to $7.8 trillion.

While S&P said the credit worthiness of the U.S. was diminished when it cut the rating to AA+ on Aug. 5, Treasuries have surged. The yield on the benchmark 10-year note dropped today to as low as 2.27 percent, the least since January 2009. Investors are seeking the safest assets amid growing concern that debt crises in the U.S. and Europe and a manufacturing growth slowdown in the world’s two biggest economies may cause the global recovery to falter.

Point is: there always will be a bullmarket somewhere. This functional rotation should also take into the context the actions of gold, the Japanese Yen and the Swiss franc whom have, like bonds, has served as ‘flight to safety’ assets.

Nevertheless, this puts into perspective the negative correlation of bonds and stocks.

Minyanville’s Howard Simons observed of this widening bond-equity correlation in June and wrote,

Interestingly enough a rolling three-month correlation of returns between the two indices shows we are at a level normally visited only during a bear market. As the bonds’ returns are rising and stocks’ have been falling, we must conclude the debt claim on corporate cash has become quite expensive while the equity claim has become cheaper. Who is the starry-eyed cheerleader now?

The present state of affairs can be restated as bond investors over-paying for the perception of safety and stock investors underpaying for a dollar of dividend income. Viewed on this basis, stock investors remain chastened while bond investors are eager participants in a bubble driven by excess financial liquidity.

I add my two cents

Asset correlations changes over time. Negative correlations between bond and equities become pronounced during sharply volatile markets (today-the equity markets).

I guess this correlation should apply with other assets such as gold too. This should give us windows to trade developing correlations or correlation trade.

Next, Mr. Simons’ observations resonates more today than in June where stocks have been heavily oversold while bonds have been sharply overbought.

Finally, if this has truly been about a debt crisis, then both bonds and equities should have been equally in a downturn. Bond vigilantes would have haunted debts of nations whose paying capability has been put to question.

Such dissonant actions tell me that financial markets are either confused (distorted by heavy interventions) or has not been telling us the entire story.