Despite all the assurances to the contrary, all bubbles pop because they are based in human emotions. We attempt to rationalize them by invoking the real world, but the reality is speculative manias are manifestations of human emotions and the feedback of running in a herd of social animals—Charles Hugh Smith
In this issue
Two Critical Factors Behind the Changes in the PSEi 30 Membership (DMC & UBP "In"; MEG & RLC "Out")
I. Selection Rules Designed to Inflate Bubbles, Moat for the Elites
II. Trading Opportunities from Changes in the PSEi 30
III. Real Estate Industry Woes Reflect the Exit of Megaworld and Robinsons Land
Two Critical Factors Behind the Changes in the PSEi 30 Membership (DMC & UBP "In"; MEG & RLC "Out")
Marginal changes in the composition of the PSEi 30 take effect this week. Two factors—the bubble psychology and the predicaments of the real estate industry—may have driven it.
Philippine Stock Exchange, January 27: DMCI Holdings, Inc. (DMC) and Union Bank of the Philippines (UBP) will be included in the PSE index (PSEi) starting February 6, 2023. Both companies will be replacing Megaworld Corporation (MEG) and Robinsons Land Corporation (RLC) based on the January to December 2022 index review of the Philippine Stock Exchange (PSE). DMC and UBP have been PSEi constituents in the past and rejoining the main index after a year and a half and 14 years, respectively. To be considered for inclusion in the PSEi, a listed company should be among the top companies in terms of liquidity and market capitalization. It should also have a free float level of at least 20 percent of its outstanding shares. Relevant financial criteria as well as eligibility for early inclusion are also considered by the PSE in the index review.
The recomposition of the index embodies a theme that underlies mainstream perception.
I. Selection Rules Designed to Inflate Bubbles, Moat for the Elites
The first concern is the selection criteria of the Philippine Stock Exchange (PSE) in the changes in the PSEi 30 membership. (all bold mine)
3.2.1. The rules for additions and removals during the semi-annual review are designed to provide stability in the selection of constituents of the PSE indices and at the same time to ensure that the indices are representative of the market by including and/or excluding those companies which have risen or fallen significantly.
3.2.2. A company shall be inserted in the PSEi if it rises to the 25th position and above by full market capitalization. It shall replace the company that ranks the lowest in terms of full market capitalization.
3.2.3. A company shall be deleted in the PSEi if it falls to the 36 th position and below by full market capitalization. It shall be replaced by the company with the highest market capitalization from the list of companies that passed the public float and liquidity eligibility requirements.
Aside from the free float and liquidity requirements, the PSE gives paramount importance to the full market capitalization of a candidate firm, which extrapolates to the preference for relatively high price performance for its inclusion in the elite benchmark. Full market cap equals share price multiplied by the outstanding shares.
Liquidity is also related to market capitalization due to the survivorship bias (or the penchant for including winners only). Momentum and the trend-following crowd usually magnify the trading value or volume and activities (daily trade, number of issues traded).
Simply put, the better the price performance, the higher the possibility of more liquidity or participation (value and transactions).
Yet, the outperformance of share prices may not necessarily in reflection of the fundamentals; it may be a product of speculative excess.
In any event, instead of membership distribution representative of the economy, the fixation on price performance has skewed the composition of the PSEi 30 mainly to companies owned by the top-hierarchy elites.
Hence, the % weight of the top 5 issues has cornered almost half of the total market cap (in free float and full market cap). They even surpassed the halfway mark in 2020. (Figure 1 top and middle windows)
The imbalance exhibits uneven returns and other financial measures, institutional bias, and asymmetric valuations (the premium paid for) favoring these firms. For instance, the Price Earnings Ratio (PER as of 2021 eps) echoes the power law distribution in the free float market cap share of the PSEi 30. (Figure 1, lowest chart)
The ramifications of the selection rules—all 30 companies of the elite bellwether, the PSEi 30—are owned by the Philippines' wealthiest families that belong to the Forbes top 20 richest. A significant number of the 288 listed firms in the PSE are owned by Forbes' 50 wealthiest families.
Boosting shares doesn't only inflate the value of their assets; as collateral, higher share prices increase their borrowing capacity, and as currency, higher share prices increase their capacity to finance M&A and other deals.
And with a shallow pool of reserves, the PSE recycles the participation to marginal contenders, also "reserve" firms of the elites. (Hence, the return of EMI, DMC and SCC and etc.)
That is to say, the selection rules appear to be a moat for the elite-owned and controlled firms.
Importantly, because the PSE chases price performance intended to bolster the index, it keeps a blind eye on the seeming misconduct by some participants to "game" the index, which effectively politicizes the stock market.
Intense index pumps, primarily through "marking the close," have recently intensified. (Figure 2, topmost row of intraday charts from technistock.net)
While there have also been "dumps," generally, it is the "pumps" that have dominated the price-fixing of the index.
Above all, instead of capitalizing on the potential of the financial or capital markets to attain efficiency in the economic allocation and pricing of capital, the stock market has become a tool for the "trickle-down" policies of political authorities.
Despite increasing participation rates reflecting partly demographic conditions, the result has been a decline in the trading volume resonant of the entropy in bank liquidity. (Figure 2, middle row)
That is, bubble-blowing policies result in an invisible redistribution favoring the elites, which fuels rising inequality (and malinvestments).
Thanks to the BSP's "trickle-down" policies channeled through the PSE, banks, real estate, and credit markets, the Philippines has one of the widest world wealth gaps in the world, according to the World Bank.
Finally, the underlying precept or dogma for all this is that instead of productivity, it is credit-financed asset bubbles that create wealth!
II. Trading Opportunities from Changes in the PSEi 30
In any case, the flaws in the price-chasing component of membership selection policies could provide potential profitable arbitrage "opportunities".
Companies that are replaced or booted out are those whose share prices have underperformed or stagnated. By contrast, share prices of recently included companies have outperformed.
That "price tops" serve as entry points for new members, while "exit spots" become bottoms for the replaced parties should be unsurprising to perspicacious observers.
The above charts of Semirara, DMC, ACEN & CNVRG, MONDE, and EMI showcase possible trade "opportunities" in the face of seemingly defective/partisan selection priorities and preferences in the construction of the PSEi 30. (Figure 3 lowest window and Figure 4)
The Wall Street axiom, "Past performance does not guarantee future results," has clearly been demonstrated in these charts.
III. Real Estate Industry Woes Reflect the Exit of Megaworld and Robinsons Land
The axed real estate firms, MEG and RLC, from the PSEi 30 signify the next issue.
Figure 4
On the same plane, the underperformance of the % market cap share of three of the four largest real estate firms (ALI, MEG, and RLC) represented not just their erosion but also the performance of the industry's GDP.
Next, the property index has also underperformed the PSEi 30.
The declining price charts and underperforming market cap share must have been the reason behind the eviction of MEG and RLC. (Figure 4, second to the lowest windows)
Third, worryingly, since 2015, the sector's pie of the national GDP has been declining, but the % share of the industry's (supply-side) loans relative to the total universal and commercial banking loans has been adrift near its highest level. (Figure 4, lowest chart)
And because the sector has been the banking industry's biggest borrower, a slowdown heightens the risks of systemic contagion.
The poor performance of their share prices has resonated with real-world conditions.
But SMPH has been the most intriguing. Its share price trend has been defiant, even when fundamentals have been essentially the same as its peers. The firm has been building up significant leverage too.
My guess is that given the heft of its free float market cap weight and premium PER, it may be a favorite of "index managers."
Does the exit of the two property firms signify a "bottom" in their share prices?
Or will the PSE's decision be proven right?
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references
Philippine Stock Exchange, Policy on Index Management, p.9 June 2021, pse.com.ph
