For Many Greeks, Taxes have been seen as Theft…

…and thus massive tax avoidance and the huge informal economy.

The Wall Street Journal explains: (bold mine)

Of all the challenges Greece has faced in recent years, prodding its citizens to pay their taxes has been one of the most difficult.

At the end of 2014, Greeks owed their government about €76 billion ($86 billion) in unpaid taxes accrued over decades, though mostly since 2009. The government says most of that has been lost to insolvency and only €9 billion can be recovered.

Billions more in taxes are owed on never-reported revenue from Greece’s vast underground economy, which was estimated before the crisis to equal more than a quarter of the country’s gross domestic product.

The International Monetary Fund and Greece’s other creditors have argued for years that the country’s debt crisis could be largely resolved if the government just cracked down on tax evasion. Tax debts in Greece equal about 90% of annual tax revenue, the highest shortfall among industrialized nations, according to the Organization for Economic Cooperation and Development.

Greece’s new government, scrambling to secure more short-term funding, agreed on Tuesday to make tax collection a top priority on a long list of measures. Yet previous governments have made similar promises, only to fall short.

Tax rates in Greece are broadly in line with those elsewhere in Europe. But Greeks have a widespread aversion to paying what they owe the state, an attitude often blamed on cultural and historical forces.

During the country’s centuries long occupation by the Ottomans, avoiding taxes was a sign of patriotism. Today, that distrust is focused on the government, which many Greeks see as corrupt, inefficient and unreliable.

“Greeks consider taxes as theft,” said Aristides Hatzis, an associate professor of law and economics at the University of Athens. “Normally taxes are considered the price you have to pay for a just state, but this is not accepted by the Greek mentality.”

The above article manifests of rich political economic insights.

 

One, the typical approach by political agents in addressing economic disorders has mainly been to focus on superficiality or the immediacy—in particular “could be largely resolved if the government just cracked down on tax evasion”. 

Political solutions that fail to understand the incentives guiding the average Greeks has been the reason why tax policies continue to falter.

Two, just to be sure that non-payment of taxes hasn’t been the reason why Greeks have been struggling…

Nominal government spending based on tradingeconomics.com and Eurostat data

The above represents Greek’s government spending relative to GDP

Greece’s government debt relative to GDP (tradingeconomics and Eurostat)

Greece and Europe’s welfare state in % of GDP based on OECD data

As one can see in the above, the controversial “austerity” exists only in the mindset of the statist occult. The Greek government continues to spend at a rate more than the statistical economy and thus the ballooning debt which consequently translates to heightened economic burden on the Greek society.

Three, Greece’s (and the Eurozone’s) boom bust cycle have only exposed on the chink in the armor of Greece’s big government.

The dilemma facing Greece today exemplifies the paragon of radical changes in fiscal conditions when the bust phase of the boom cycle emerges.

This can be seen from the article: (bold mine) 

The reason isn’t just political, but economic. The country’s depression has already pushed many small businesses to the brink of collapse. Forcing them to pay more in taxes would put even more out of business—and more Greeks out of work.

“The Greek economy would collapse if the government were to force these people to pay taxes,” one senior government official said.

So the above data shows why many Greeks see their government as “corrupt, inefficient and unreliable” for them to “consider taxes as theft”

It doesn’t require a libertarian of the Rothbardian persuasion to see how taxes are theft. 

All it takes is for one to see with two eyes the real nature of how governments operates. This has been best described in the article as “corrupt, inefficient and unreliable”. 

Nonetheless here is the dean of Austrian Economics, the great Murray N. Rothbard on taxes. (For A New Liberty, The Libertarian Manifesto, p.30 )

Take, for example, the institution of taxation, which statists have claimed is in some sense really “voluntary.” Anyone who truly believes in the “voluntary” nature of taxation is invited to refuse to pay taxes and to see what then happens to him. If we analyze taxation, we find that, among all the persons and institutions in society, only the government acquires its revenues through coercive violence. Everyone else in society acquires income either through voluntary gift (lodge, charitable society, chess club) or through the sale of goods or services voluntarily purchased by consumers. If anyone but the government proceeded to “tax,” this would clearly be considered coercion and thinly disguised banditry. Yet the mystical trappings of “sovereignty” have so veiled the process that only libertarians are prepared to call taxation what it is: legalized and organized theft on a grand scale.

For the Greeks, the logical solution would seem as to dramatically pare down government spending and taxes or real austerity. These should ease tax burdens on the entrepreneurs or the productive agents that would allow them to channel resources to productive means. This should entail real economic growth.

In doing so, the informal economy should flourish and grow for the latter to integrate with the formal economy voluntarily.

But it’s not just taxes, there is the exigency to incentivize entrepreneurial activities via liberalization from excessive politicization of economic activities, specifically regulations, mandates, controls and all other politically erected anti-competition obstacles favoring entrenched interests. 

Importantly, the Greeks should embrace sound money by preventing the government from tinkering with interest rates, and the currency via the central bank and allow real competition in both the currency and the banking system.

Of course, given the size of the debt burden, debt that had benefited politicians and cronies of the past, such debt has to be defaulted on. Creditors who took the risk in financing the previous government excesses should pay their dues.

But of course, parasites would not want to end their privileges so this will hardly be the route taken. 

Politicians will continue to sell free lunch politics in order to get elected and stay the course. 

So after winning on such populist platform, the Tsipras government’s sellout to the Troika and the Eurogroup reinforces this dynamic

But since Greek’s problem has been about economics, the solution will always be about economics. Yet political solutions that fails to address the real (and not statistical) economic issues will have inevitable economic consequences.

I am reminded by this gem from author and professor Thomas Sowell:

The first lesson of economics is scarcity: There is never enough of anything to satisfy all those who want it. The first lesson of politics is to disregard the first lesson of economics.

Yet my ideal solution is the Rothbard solution; end organized theft.

Phisix: Profit Taking now is a Taboo

I have repeatedly been pointing out here that given the recent sharp run up, the Phisix have been exhibiting signs of ‘exhaustion’ where normal profit taking should take hold. But apparently corrections now appear to be a taboo. Index managers see any downside as intolerable. The Philippine benchmark has now been engineered to move in a single direction! And this applies to everyday activities!

For the day, following a strong start, the Phisix found itself succumbing to profit taking thus has been in the red through most of the session. That’s until the pre-run off period where again the ‘marking the close’ not only virtually reversed the day’s losses but importantly, set another fresh high record session for the domestic benchmark!(charts from technistock.net and colfinancial.com)

Again the modus remains the same. The pump revolves around 3-5 biggest market caps whose weights add up to about 20% of the Phisix basket. 

Those significant last minute major pumps can be seen in three sectors, service, property and finance. The holding sector also contributed but to a lesser degree compared to the above.

These are the top 20 most active issues of the day based on the table from the PSE. Some of the above have been subjects of the closing session pump.

Peso volume was only about Php 7.6 billion but the special block sales from AC (Php 7.5 billion) and SM (Php 1.6 billion) bloated the day’s volume to Php 17.234 billion.

As evidence of the profit taking mode, aside from sluggish (ex-special block sales) peso volume  decliners led advancers by about 20 issues. Even the top 20 traded issues reveal of 9 decliners relative to 8 advancers and 3 unchanged.

Additionally, today’s number of trades fell below 50,000. This means less churning activities compared to the average bristling pace of 50-60k a day from December 2014 onwards.

Since February, the advance decline spread seems to favor decliners (10 days against 7 days for advancers), hence emitting signals for ‘correction’.

But again correction has now become a taboo.

Yet this reveals of the lamentable quality of record highs.

US Fed Chief Janet Yellen’s Irrational Exuberance Warnings 2015 Edition

In July 2014, in reporting to both houses of the US Congress, US Federal Reserve chairwoman Ms. Janet Yellen mimicked Alan Greenspan’s "irrational exuberance" warning in 1996, with an admonition that some segments of the equity markets have been “substantially overstretched”.

Given that stocks have reached record upon record highs after this appearance, this only means the markets has been ignoring or fighting the FED. 

Another way to see this is that the FED has “lost control” over the asset bubbles.

Yet in the same appearance before the US congress, yesterday, Ms. Yellen reiterates her irrational exuberance warning for 2015.

From Ms. Yellen’s Monetary Policy Report to the US Congress dated February 24

From page 22 (bold and italics mine)

Over the second half of 2014 and early 2015, broad measures of U.S. equity prices increased further, on balance, but stock prices for the energy sector declined substantially, reflecting the sharp drops in oil prices (figure 32). Although increased concerns about the foreign economic outlook seemed to weigh on risk sentiment, the generally positive tone of U.S. economic data releases as well as declining longer-term interest rates appeared to provide support for equity prices. Overall equity valuations by some conventional measures are somewhat higher than their historical average levels, and valuation metrics in some sectors continue to appear stretched relative to historical norms. Implied volatility for the S&P 500 index, as calculated from options prices, increased moderately, on net, from low levels over the summer.

From page 24

The financial vulnerabilities in the U.S. financial system overall have remained moderate since the previous Monetary Policy Report. In the past few years, capital and liquidity positions in the banking sector have continued to improve, net wholesale shortterm funding in the financial sector has decreased substantially, and aggregate leverage of the private nonfinancial sector has not picked up. However, valuation pressures are notable in some asset markets, although they have eased a little on balance. Leverage at lower-rated nonfinancial firms has become more pronounced. Recent developments in Greece have rekindled concerns about the country defaulting and exiting the euro system. 

With regard to asset valuations, price-to-earnings and price-to-sales ratios are somewhat elevated, suggesting some valuation pressures. However, estimates of the equity premium remain relatively wide, as the long-run expected return on equity exceeds the low real Treasury yield by a notable margin, suggesting that investors still expect somewhat higher-than-average compensation relative to historical standards for bearing the additional risk associated with holding equities. Risk spreads for corporate bonds have widened over recent months, especially for speculative-grade firms, in part because of concerns about the credit quality of energy-related firms, though yields remain near historical lows, reflecting low term premiums. Residential real estate valuations appear within historical norms, with recent data pointing to some cooling of house price gains in regions that recently experienced rapid price appreciation. However, valuation pressures in the commercial real estate market may have increased in recent quarters as prices have risen relative to rents, and underwriting standards in securitizations have weakened somewhat, though debt growth remains moderate

The private nonfinancial sector credit-to-GDP ratio has declined to roughly its level in the mid-2000s. At lower-rated and unrated nonfinancial businesses, however, leverage has continued to increase with the rapid growth in high-yield bond issuance and leveraged loans in recent years. The underwriting quality of leveraged loans arranged or held by banking institutions in 2014:Q4 appears to have improved slightly, perhaps in response to the stepped up enforcement of the leveraged lending guidance. However, new deals continue to show signs of weak underwriting terms and heightened leverage that are close to levels preceding the financial crisis.

As a result of steady improvements in capital and liquidity positions since the financial crisis, U.S. banking firms, in aggregate, appear to be better positioned to absorb potential shocks—such as those related to litigation, falling oil prices, and financial contagion originating abroad—and to meet strengthening credit demand. The sharp decline in oil prices, if sustained, may lead to credit strains for some banks with concentrated exposures to the energy sector, but at banks that are more diversified, potential losses are likely to be offset by the positive effects of lower oil prices on the broader economy. Thirty-one large bank holding companies (BHCs) are currently undergoing their annual stress tests, the results of which are scheduled to be released in March.

Leverage in the nonbank financial sector appears, on balance, to be at moderate levels. New securitizations, which contribute to financial sector leverage, have been boosted by issuance of commercial mortgage-backed securities (CMBS) and collateralized loan obligations (CLOs), which remained robust amid continued reports of relatively accommodative underwriting standards for the underlying assets. That said, the risk retention rules finalized in October, which require issuers to retain at least 5 percent of any securitizations issued, have the potential to affect market activity, especially in the private-label residential mortgage-backed securities, non-agency CMBS, and CLO sectors.

Reliance on wholesale short-term funding by nonbank financial institutions has declined significantly in recent years and is low by historical standards. However, prime money market funds with a fixed net asset value remain vulnerable to investor runs if there is a fall in the market value of their assets. Furthermore, the growth of bond mutual funds and exchange-traded funds (ETFs) in recent years means that these funds now hold a much higher fraction of the available stock of relatively less liquid assets—such as high yield corporate debt, bank loans, and international debt—than they did before the financial crisis. As mutual funds and ETFs may appear to offer greater liquidity than the markets in which they transact, their growth heightens the potential for a forced sale in the underlying markets if some event were to trigger large volumes of redemptions.

Again we see authorities dishing out warnings after warnings on asset bubbles albeit on a sanitized basis—there is a growth in the risk environment but the economy is strong yada yada yada…

And for me, current imbalances have been so apparent that it can't be ignored anymore. And these warnings seem more about escape outlets, so that when the real thing occurs, authorities will jump in defense: I saw and warned about it...so it is not my fault—a veneer.

And speaking of former Fed chief Alan Greenspan. At one of the latest investment conference, Alan Greenspan had a dire outlook for the markets.

Here is Mac Slavo on Alan Greenspan’s gloomy predictions (bold and italics original)

Greenspan recently joined veteran resource analyst Brien Lundin at the New Orleans Investment Conference to share some of his thoughts. According to Lundin, the former Fed chairman made it clear that the central bank is facing a serious problem and one that will have significant ramifications in the future.

We asked him where he thought the gold price will be in five years and he said “measurably higher.”

In private conversation I asked him about the outstanding debts… and that the debt load in the U.S. had gotten so great that there has to be some monetary depreciation. Specially he said that the era of quantitative easing and zero-interest rate policies by the Fed… we really cannot exit this without some significant market event… By that I interpret it being either a stock market crash or a prolonged recession, which would then engender another round of monetary reflation by the Fed.

He thinks something big is going to happen that we can’t get out of this era of money printing without some repercussions – and pretty severe ones – that gold will benefit from. 

Record stocks in the face of record imbalances and record warnings from authorities

While Asia Central Bankers Need to Go Easy on Rate Cuts, They will Cut Rates Anyway

Frederic Neumann co-head of HSBC’s Asian economic research counsels Asian monetary authorities to go slow with interest rate cuts. Writing at the Nikkei Asia “Asia needs to go easy on rate cuts”, he provides three reasons: (bold mine)

The trouble is, it will prove only mildly effective and, in some cases, possibly counterproductive. That interest rate cuts help to ease the debt servicing burden of indebted consumers and companies is not in doubt. But, in most economies, it seems unlikely they will exert a lift through their second, more potent channel: faster credit growth. Take India. State banks, which dominate the financial system, are saddled with non-performing loans. Many large companies, too, are stuck with too much debt. Rate cuts alone, therefore, may not boost spending. Thailand, Malaysia and South Korea face similar challenges.

Translation: When company balance sheets have been hocked to the eyeballs with debt, borrowing will about debt rollovers rather than capex. And that's if there will be borrowings at all. You can lead the horse to the water, but you cannot make it drink.

The second point is that rate cuts, to the extent that they spur lending, may fuel growing imbalances that could ultimately push economies deeper into a disinflationary, if not deflationary, trap. Leverage in Thailand, for example, is already high, especially among consumers. Cutting interest rates could provide a temporary boost to spending, but at the cost of driving debt ratios even higher. In Australia, too, further easing will add fuel to the booming housing market without curing the underlying problem: a deflating mining investment boom. China also comes to mind, with blanket easing doing little to correct imbalances.

Translation: When company balance sheets have been hocked to the eyeballs with debt, borrowing will about debt rollovers rather than capex. More companies will resort to Hyman Minsky’s Ponzi financing. With insufficient cash flows for debt servicing, companies become heavily reliant on using debt to service existing debt. Asset sales function as a compliment. In short, Ponzi finance=Debt IN debt OUT + asset sales. And this is why the need to spike asset values as they provide bridge financing for debt.

Unfortunately as Mr. Neumann rightly points out, increasing use of Ponzi finance signifies heightens the risk of ‘debt’ deflationary trap.

Third: Easing monetary policy exposes countries to greater financial volatility down the road. The Fed, of course, may raise rates only gradually in the coming years. But the dollar looks set to strengthen further. In itself, this may not be enough to drive capital out of the region. Still, if local central banks overplay their hand and ease too aggressively, especially with no improved growth prospects to show for it, investor jitters might return. The "taper tantrum" of 2013, when investors dumped risky assets, was a painful reminder of the vulnerability of emerging markets when the Fed starts to move. Indonesia, especially, looks exposed.

Translation: In a financial and economic landscape where asset sales become complimentary to debt IN debt OUT, today’s asset market pump have likely been about the use of inflation in asset markets to generate cash flows to service debt.

And because asset market inflation are unsustainable this leads to “greater financial volatility”. 

In addition, a general use of Ponzi financing can become a systemic issue. 

From Wikipedia (bold mine): If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.

So even mainstream can see what I am seeing.

While the advise to monetary authorities of the diminished use of zero bound rates has been commendable, I doubt if such will be heeded.

Reasons?

Political agenda will dictate on monetary policies. Incumbent political leaders would not want to see volatilities happen during their tenure, so they are likely to pressure monetary authorities to resort to actions that will kick the can down the road. Here is an example, Turkish central bank yielded to the Prime Minister’s repeated demand for interest rate cuts. The Turkish  central bank trimmed 25 basis points for both overnight lending and borrowing rates yesterday

In short, authorities are likely to be concerned with short term developments. And political agenda will most likely revolve around popularity ratings and or the next election—or simply preserving or expanding political power.

Next, there is the social desirability bias factor. Monetary authorities won’t also want to be seen as “responsible” for a volatile environment. They don’t like to be subject to public lynching from market volatilities.

Third, there is the appeal to majority and path dependency. Since every central banker has been doing it and have long been doing it, they think that they might as well do it and blame external factors for any untoward outcomes. Again the cuts of central banks of Turkey and the record low rates by Israel two days back brings a tally of 21 nations on an easing path in 2015. 25 actions if we consider the multiple actions by some countries (Romania and Denmark) as I noted last weekend.

Asian central bankers are likely to embrace the “sound banker” escape hatchet as propagated by their political economic icon—JM Keynes: 

A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.

So expect more rate cuts ahead.

As a side note: Indonesia "vulnerable"? Hasn't Indonesian stocks been at record upon record highs? Has record highs not been about a risk free environment? Of course, opposite record high stocks have been a milestone high USD-Indonesian rupiah.

15 year High Nikkei , 4Q GDP 2014 Recovery: Survey says 81% of Japanese asks “Where’s the Recovery?”

Since February 18th, Japan’s equity bellwether the Nikkei 225 has been drifting at a 15 year high. Additionally the Japanese government recently released data that the economy has been pulled out of the recession in the 4Q.

Yet the man on the street remains puzzled of the so-called recovery. A poll conducted last weekend says that 81% of the average Japanese who participated in the survey have been wondering where the headline recovery has taken hold?

From Nikkei Asia

The recovery in Japan's economy has yet to reach the public, according to Nikkei Inc.'s latest opinion poll, with 81% of respondents saying they have not sensed any tangible improvement.

Merely 13% said that the economic recovery has been felt in their daily lives. The weekend survey was conducted jointly with TV Tokyo.

Preliminary figures for the October-December quarter point to the Japanese economy having expanded for the first time since last April's consumption tax hike.

"The economy is expected to recover on the strength of private-sector demand," says Akira Amari, minister of state for economic and fiscal policy.

Support for the cabinet of Prime Minister Shinzo Abe edged 1 point lower from the January poll to 50%, while those expressing disapproval climbed 1 point to 34%. Among the cabinet supporters, 73% said that an improvement in the economy has not been felt, with 23% indicating that they have sensed a recovery. For those dissatisfied with the cabinet, the percentages came to 96% and 3%.

If the survey has been accurate, then such divergence would be an example of the difference between statistical economy and real economic performance.

It’s also an example of the ongoing parallel universe—surging stocks in the light of a struggling and stagnating real economy

Japan’s stock market penetration level tells us that only about 20% of Japanese households have been invested in stocks according the 2014 Fact Book by Japanese Securities Dealers Association as of 2013

As a share of financial assets, equities represented only 9.4% of the household balance sheet according to the BOJ’s fund flows based on the 3Q 2014 report.

And if one accounts for the latest activities, it appears that Japanese households have been NET SELLERS of equity securities consistently during the past 3 years (2012-14), again based on data from Japanese Security Dealers Association.

The implication is that Japanese households have hardly been beneficiaries of the latest stock market run. This reveals that based on demonstrated preference or actions by market participants, Japanese households have hardly been positive about Abenomics.

Instead because of the deliberate attempt to crash the Japanese currency, the yen, as part of the Abenomics three arrows, Japanese households have been in a capital flight as seen by the jump in the holdings of outward investments in securities and investment trusts according to the BoJ as of the 3Q. 

These outflows or capital flight seem to affirm my predictions way back in 2012-13

So the biggest beneficiaries of the 15 year high Nikkei have mostly been foreigners, followed by domestic investment trusts and financial institutions. And this has been why Abenomics seems to be having a field day with international cheerleaders.

Abenomics’ attempt to push stocks to record upon record levels has only widened the disparities between financial assets and real economic performance. And such divergences has been revealed by the street survey.

Thus, whatever recovery that will be seen in the future will mostly be about statistics and hardly about progress in the real economy

Price distortions from sustained currency debasement will continue to have an adverse impact on the domestic entrepreneurs' economic calculation thereby filtering to the process of economic coordination or allocation of resources. Redistribution via inflationism won’t create economic value added but instead increases the misallocation of resources which results to the erosion of productivity and capital consumption.

Additionally Abenomics seem as in trouble. A reported rift between PM Shinzo Abe and BoJ Kuroda may be brewing.

From another NIkkei Asia report: (bold mine)

It is hard to say what, exactly, is going on between Prime Minister Shinzo Abe and Bank of Japan Gov. Haruhiko Kuroda, but one thing is clear: The once rock-solid relationship between the nation's leader and its central banker is starting to crack.

Signs of this strain were evident during a Feb. 12 meeting of the Council on Economic and Fiscal Policy.

Kuroda, in an unusual move, requested permission to speak and offered straightforward advice for the prime minister, according to a person informed about the matter. The BOJ governor stressed that interest rates could soar in the future if the fiscal credibility of the government is called into doubt.

But the minutes of the meeting, released five days later, included little of what Kuroda actually said. Only vague phrases such as "We need to have serious discussions [on fiscal rehabilitation]" were left in the document.

The report speculates that the split may have been due to the differences in views of tax policies. I am not here to speculate on this

Nonetheless, such development seems to coincide with the latest spike by the Japanese Government Bonds across the curve.

From a record low of .207% January 19 2015, yield of the 10 year JGB soared to .45% on February 16 as shown by the chart above from investing.com

I have noted this weekend that BoJ’s assurances of more easing may have temporarily quashed the JGB rebellion. Thus the yield has recently backed off.

Yet more signs of fissures between the two political leaders, the principal architects of Abenomics, could possibly mean a revival of the JGB rebellion.

And if this happens big trouble looms, not just in the financial markets but in the real economy, and more importantly, raises risks of Japan’s precarious fiscal conditions as well. Japan's outstanding national debt has reached 1,029 trillion yen ($8.62 trillion) as of 2014 according to the Asahi Shimbun

And such trouble will have transmission links abroad.

Record stocks stares at the face of record imbalances.

Quote of the Day: Accounting Magics

Back then, just as today, few people really understood it. And those who did were often clever enough to find loopholes in the system to hide their fraud. Especially banks.

There are some really stunning (and sometimes hilarious) examples of early banks who learned how to cook their books and misstate their capital using Pacioli’s system.

Curiously very little has changed. Banks still use accounting tricks to hide their true condition.

Bloomberg showcased one such technique last year, exposing the way that many US banks are rebooking their assets from “available for sale (AFS)” to the “held-to-maturity (HTM)” designation.

This is a very subtle move that means nothing to most people.

But to banks, it’s a highly effective way of concealing losses they’ve suffered in their investment portfolios.

Banks ordinarily buy bonds and other securities with the purpose of generating a return on that money until they have to, you know, give it back to their depositors.

That’s why they’re called “available for sale,” because the bank has to sell these assets to pay their depositors back.

But here’s the problem– many of these investments have either lost money, or they soon will be. And banks don’t want to disclose those losses.

So instead, they simply redesignate assets as HTM.

It’s like saying “I don’t care that these bonds aren’t worth as much money as when I bought them because I intend to hold them forever.”

Thing is, this simply isn’t true. Banks don’t have the luxury of holding some government bond for the next 30-years.

This is money they might have to repay their customers tomorrow, which makes the entire charade intellectually dishonest.

That doesn’t stop them.

JP Morgan alone boosted its HTM mortgage bonds from less than $10 million to nearly $17 billion (1700x higher) in just one year. This is a huge shift.

Nearly every big bank is doing this, and is doing it deliberately. This is no accident. And there’s only one reason to do it—to use accounting minutia to conceal losses.

But the accounting tricks don’t stop there. And in many cases they’re fueled by the government.

One recent example is how federal regulators created a new ‘rule’ which allows banks to consciously reduce the risk-weighting they assigns their assets.

The Federal Financial Institution Examination Council recently told banks that, “if a particular asset . . . has features that could place it in more than one risk category, it is assigned to the category that has the lowest risk weight.” 

This gives banks extraordinary latitude to underreport the risk levels of their investments. 

Bankers can now arbitrarily decide that a risky asset ‘has features’ of a lower risk asset, and thus they can completely misrepresent their investments. 

Bottom line, it’s becoming extremely difficult to have confidence in western banks’ financial health.

They employ every trick in the book to overstate their capital ratios and understate their risk levels.

This, backed by a central bank that is borderline insolvent and a federal government that is entirely insolvent.

It certainly begs the question—is it really worth keeping 100% of your savings in this system?

(bold mine)

This is from Simon Black from his website the Sovereign Man.

Such statistical charade can be epitomized by the recent experience of Hong listed Kaisa Group. As I wrote last weekend:

The camouflaging of debt reminds me of the Kaisa Group, a property and shopping mall developer in China but whose shares are listed in Hong Kong.

The once “fundamentally” strong company suddenly surprised the market when they announced of their inability to pay interest rates on foreign denominated loans. So the Chinese government worked behind the scenes to find a buyer to bailout the beleaguered company.

Last week, the company’s debt suddenly DOUBLED. Since the company didn’t disclose why the debt has swelled, media has been speculating on its possible causes. They point out that “home buyers may have unwittingly turned into lenders” where advance proceeds and deposits were converted into debts. They also attributed the possibility of debt from trade credit (credit to suppliers and contractors) and from legal actions, or even from off balance sheet debts.

The obvious lesson is that credit booms have always masked the disease. It’s when the loans have been called in, when the proverbial Pandora’s Box gets to be opened.

Beware of those embellished statistics.

Phisix 7,800: Record Stocks, Incredible Misperceptions

Recall that, according to the Oxford English Dictionary, a factoid is "an item of unreliable information that is reported and repeated so often that it becomes accepted as fact." The famous "Dr. Fox Lecture," which was presented at the University of Southern California's Medical School, illustrates just how so-called "experts" can effectively work and influence a crowd. The lecture was presented by Dr. Myron Fox --an advertised heavyweight -- to an academic audience in 1970. The response to Dr. Fox's lecture was unanimously favorable. Little did the audience know that "Dr. Fox" was an actor who had been cloaked with an impressive fake curriculum vitae and trained to deliver a nonsensical lecture filled with contradictory statements, double-talk and non-sequiturs. Like it or not, when the big guns sound off, they are heard. Beware. –Professor Steve Hanke

In this issue

Phisix 7,800: Record Stocks, Incredible Misperceptions

-Peso Volume’s Divergent Stories: The Contrast Effect and Penetration Levels

-Peso Volume’s Divergent Stories: Special Block Sales, and Signs of Exhaustion

-Phisix 7,800: G-R-O-W-T-H Misperceptions: 2014 Price Earning Ratios

-Shopping Mall Vacancies: The Rental Rates Factor

-Shopping Mall Vacancies: Truck Ban and Port Congestion

-Phisix 7,800: Philippine Bonds Just Sold Off

-Global Record Stocks, Record Warnings from Authorities Too

Phisix 7,800: Record Stocks, Incredible Misperceptions

Once again, record upon record.

This marks the ninth consecutive weekly gains for the domestic benchmark which has already topped the 2013 streak of eight weeks.

Peso Volume’s Divergent Stories: The Contrast Effect and Penetration Levels

Following Friday’s record close, a jubilant Philippine Stock Exchange issues this press release[1]

Today's record close is the fourteenth for the PSEi since the start of the year.

"Trading activity may be muted because of the Lunar New Year break in other countries but it has obviously not kept the index from gaining. We are pleased that alongside the record highs, we have seen the market’s daily average turnover almost double to Php11.70 billion from the same period last year. We hope that this level of activity will be sustained, and hopefully even improve in the coming months," PSE President and CEO Hans B. Sicat said.

The PSEi has gained 8.2 percent year-to-date

Let us put the volume into perspective

Year	iPsei level	Gross Peso volume	days	Average Peso daily
2013	6,648.69	325,390,399,657	36	9,038,622,212.7
2014	6,352.76	215,222,266,509	35	6,149,209,614.53
2015	7,825.39	362,927,017,220	32	11,341,469,288

Perhaps I may have miscounted or there could have been changes in data, which I have not seen, but based on the PSE daily quotes, my tabulations for the daily activities year to February 20th have been the above.

It’s always important to look at the basis of comparisons, because different reference points can altogether reveal of divergent stories.

It’s true that based on 2014 figures the numbers have almost doubled. But it must be known that the Phisix was then at 6,352 compared to record 7,825 today or a 23% variance. February 2014 signified as the early stage of recovery from the losses incurred during May 2013s taper tantrum which brought the Phisix down to touch bear market levels. So the doubling of volume can be seen from the perspective of bear market recovery relative to record highs, hence the near doubling. This seems like an apple to orange comparison.

Yet if we base this on a similar upside pace or trend, in particular the path towards the first 7,400 which was over the same period in 2013, the gains would have been narrower. In February 20 2013, the Phisix was at 6,648.69 so the difference between then and today in terms of index was 17.7%, and in terms of volume 25.5%. If I base it on the above PSE press release, the change in terms of volume increases to 29%.

So seen from a different prism in the context of parallel momentum towards record levels, gains are still significant in 2015 but not as magnified when based on 2014.

What you see depends on where you stand.

But it is not just about nominal numbers. There is always the qualitative component.

These are the figures of stock market accounts as per the PSE: 430,631 in 2007, 525,850 in 2012 and 585,562 in 2013.

The numbers tell us that in between the two record high of Phisix 2007 (October 3,873) and 2013 (May 7,392.2) or a 90.8% asset inflation, direct participation rates through stock market accounts, grew by only 36%. With a population approximated to have reached 100 million, stock market accounts at 600,000 would mean just .6% of people trading stocks directly.

Part of those accounts have been institutions. Yet I hardly think that indirect participation by the public—via mutual funds or UITF or other managed funds—would substantially enhance on the penetration level. Even at optimistically 2-3%, this would mean 2 to 3 million people with exposure to stocks or even to bonds

Unlike the Chinese stock market boom which has been a magnet for a throng of retail participants, the Philippine record high as of 2013 has been mostly about a few retail and institutional accounts pumping and pushing the markets. Even at 7,800, I doubt if this dynamic has materially changed.

So volume growth means heavier exposure on stocks by a limited segment of society. Likewise this “doubling up” at record levels could have been funded by credit and by leverage from carry trades.

These are risks behind those flowery numbers which the PSE refuses to look at, or if they have, refrains from divulging.

So all such feel good “pat on the back” has mostly been about symbolism. Like politics, Phisix 7,800 has been about showbiz—form over substance.

The penetration level of the stock market along with bank and or insurance accounts reveals of the state of the Philippine financial markets or what the mainstream calls as “financial inclusion”—access to financial services. But the supposed shortcoming, the dearth of financial inclusion, can also be seen as a blessing—adverse developments that will occur on the domestic financial markets will largely be limited to the few lemmings.

Peso Volume’s Divergent Stories: Special Block Sales, and Signs of Exhaustion

Yet there is another factor: a significant contribution to the current volume has been special block sales.

Special block sales have contributed to 19% to the total volume from the start of the year through February 20th this 2015 as compared with 2.8% and 12.1% in 2014 and 2013 respectively. Special block sales are equity based deals by publicly listed firms that have been conducted through the PSE.

The rate of special block sales reflects on the market’s sentiment. As the market’s rise, debt and or equity instruments of many firms, especially the popular ones, may be transformed into “currencies”. The perception of increased liquidity or “moneyness”—brought about by inflated equity prices which create a perception of confidence—means that firms can easily tap funding from the markets or conduct deals (e.g. M&A, LBOs) in exchange for equity or debt deals collateralized by equity. 

From the start of the year, major special block sales (based on 1 billion pesos up) has been from CMT (now FNI), ALI, FGEN, JGS, GTCAP, ISM and MPI.

In the case of raising money, such deals would signify as SUBSIDIES and a TRANSFER of risks on a wholesale basis from publicly listed firms to the public—channeled through sell side institutions.

Think of it when the market sinks, who will bear the risk of 40+ PERs or paying more than 40 years for current earning levels?

These companies would have likely paid out money raised from the public as dividends and or as executive bonuses. Yet the dividends paid will hardly offset capital losses from deflated equity values held by the equity owners.

So it would be natural for these companies to champion the status quo (asset inflation) and or even possibly partake to the recent recourse to “index management” mostly through “marking the close”. That’s because aside from the banks, and the government, these firms have been major beneficiaries of the stealth wealth transfer enabled and facilitated by zero bound-financial repression policies.

Anent marking the close, the Phisix had three last week even when there had only been 4 trading days; two were minor accounts of “pump”, the bigger one was a reverse or a “dump”.

Despite the PSE babble on record territory, here is another unstated development. 

While it is true that volume year to date has doubled relative to last year, this week’s average daily volume at Php 6.86 billion has halved when compared from last week or from all the weekly average daily volumes during the previous 5 weeks! The collapse in the average daily volume has partially mirrored the daily trades (averaged weekly).

Two things. Last week posted trivial accounts of special block sales. So without amplified effect from major special block sales, volume becomes smaller.

Next, the decline in peso volume comes after record after record run. This means even while market breadth has shown marginal improvements the bulls have been losing steam.

As for market breadth, advancers marginally led decliners 362 to 348 in a truncated trading week due to the Chinese New Year. In addition, advancers equaled decliners in the context of weekly activities.

In short, the present state of the markets has been showing signs of exhaustion or exhibiting signs for a correction.

But the index managers would have none of this. The pump and push vaudeville must go on.

And this is what the PSE hopes to be “sustained”.

Phisix 7,800: G-R-O-W-T-H Misperceptions: 2014 Price Earning Ratios

This has what Phisix 7,800 and 8.23% year to date gains has done so far.

From an industry basis, the gains have been skewed towards the holding sector with the property sector gaining ground. For the week, the activities in the industrial sector appears to have slowed but has been at pace with the property sector year to date. 

Though still posting positive returns, the financial sector, service and mining have underperformed the benchmark.

What can be discerned from the above has been the seeming rotation occurring among the three leading sectors, the industrials, the holding and property.

Gains are being concentrated to a few leaders representing these sectors.

Broken down into the member issues within the Phisix basket, the divergences has become more apparent.

Eight of the top 15 biggest market cap has outperformed as against only six of the next half of member composite of domestic bellwether. So 14 of the 30 have borne the yoke of the Phisix at 7,800.

Evidently those pump and push mostly on the top 15, which has signified a carryover from last year, not only has been the reason behind Phisix 7,800, but has also levitated PER ratios of most of the PSE issues to absurd levels.

Based on the PSE’s February 18th PERs; for the top 15 biggest market cap Phisix companies, 9 of the 15 have PERs at 20 and above. This compares to 6 for the latter half. Overall, 15 or HALF of the entire Phisix have been trading at phantasmagoric levels!

Early this year an insurance bigwig was quoted as saying that the Phisix traded historically at 14 to 15.

But what has not been said is that because insurance policies have to be sold, and are best marketed on a backdrop of inflated returns, risks have been dismissed to justify higher valuations for the Phisix.

Such concealment of risks comes in the light of inflation of corporate earnings, the statistical economy and the government fiscal balance all of which has been pillared by credit inflation on mostly the private sector. This sidelining of risks accompanied by the expected projection of G-R-O-W-T-H in a linear trajectory becomes the foundations that rationalize the PERs of 18 to 20.

In short, what the consensus has suggested has been that structural changes in the economy would now accommodate earnings deviations from historical accounts by 20-33% (based on PER of 15). Wow!

This reminds me of the common denominator of all crises through time: This Time is Different. Again Harvard’s Carmen Reinhart and Kenneth Rogoff on their chronicle of 2 centuries of crisis: The essence of the this-time-is-different syndrome is simple. It is rooted in the firmly held belief that financial crises are things that happen to other people in other countries at other times; crises do not happen to us, here and now. We are doing things better, we are smarter, we have learned from past mistakes. The old rules of valuation no longer apply. The current boom, unlike the many booms that preceded catastrophic collapses in the past (even in our country), is built on sound fundamentals, structural reforms, technological innovation, and good policy. Or so the story goes

Yet if we apply the historical PE of 14 to 15 to the present basket, excluding BLOOM which has a negative PER, only THREE issues trades at or below historical levels!

Alternatively put, this means that 86% of the index members have valuations that have been ridiculously overstretched based on historical averages!

Moreover, even if we grant the consensus their idea of 18-20 PERs, the PER at 20s have been considerably breached!

Of course, the index is calculated based on the distribution of weights from the changes on market capitalization as reflected by the share prices of its composite members. 

As of December 2014, the Phisix closed at 7,230.57, based on BSP data the December PER has been pegged at 21.46 (left table). This entails a 22.49% (21.46/17.52) jump from December 2013 PER at 17.52. The 22.49% PER growth reflects on the 22.76% nominal peso returns of the Phisix in 2014.

Year	December close	PER December	EPS	EPS Growth
2014	7,230.57	21.46	336.93	.22%
2013	5,889.83	17.52	336.18	3.9%
2012	5,812.73	17.97	323.47

Now here is where things get more interesting.

If we apply the BSP’s PERs to the Phisix levels at the close of December for the year 2012-14 we get their corresponding EPS and the EPS growth rates.

In 2013, the Phisix eked out a 1.33% nominal gain yet eps grew by 3.9%. In 2014, eps grew by ONLY .22% yet the Phisix soared by 22.76%! That’s .22% or ONE FIFTH of ONE PERCENT! This shows how this has hardly been a story of earnings G-R-O-W-T-H but about a story of plain multiple expansions from rampant speculation. And the numbers hardly supports the supposed departures by EPS growth from historical accounts.

Remember the consensus sold the idea that earnings growth for 2014 will be about 6% and 16% for 2015. But with .22% growth, the 22.76% pump means that earnings G-R-O-W-T-H in 2014 have been entirely a mirage!

Philippine stocks have been pulling away from reality and this will be reflected on sustained multiple expansions!

Yet there is no stopping the misperceptions as seen by record upon record stocks.

Such wild and unbridled speculations have all been founded on the Pavlovian conditioned stimulus (classical conditioning) from the utterances by media and establishment of G-R-O-W-T-H that has been positively reinforced by operant conditioning through a feedback loop mechanism of rising prices and the bandwagon effect.

December’s PE levels signify as the second highest for the year 2014 and the fifth ranked if we include the trek to 7,400 of March, April and May of 2013. How much more if we apply the current year to date 8.23%? Has current earnings outgrown the rate of price growth? If not, has the Phisix now traded at the range of 22 PER levels? Has it exceeded the April 2013 22.1 level? To what extent will markets continue to accommodate frenetic punts?

Or has the domestic stock market’s price discovery function as discounting mechanism been totally been broken?

Again the composite equity yardstick represents a distribution of weightings, thus the 21.46 PER have been representative of PERs of half of the issues with 20 and over (outperformers; 9 from the top 15 and 6 from the next 15) as against the other half (underperformers) with PERs below 20. The latter offsets the increases of the former.

In short, the Phisix PER of 21.46 masks or sanitizes the imbalances behind the outlandish mispricings especially seen in the most popular issues. Ten or one third of the Phisix issues have PERs at 30 and above!

Perhaps history could be irrelevant. But what if it is not? What if this time is NOT different? Current PERs 21.46 have vastly exceeded the 1995 and 1996 PER levels as I have shown before (see right table). Then, the outcome hasn’t been positive. Market participants saw their portfolio eventually slaughtered.

So when the PSE regales the public that record stocks will be sustained based on (italics mine)…“we expect corporate profits and dividend stories to continue to lift the market[2]”…they are right, the entire saga of brazen speculation has been based on tall tales.

The Phisix PE ratio tells it all.

Finally I’d be very concern about buyside institutions selling products heavily based on expectations of beyond historical average returns. Those rose colored glasses may be a function of endowment effect—people value things highly because they own them. If the portfolio of buyside institutions have been largely weighted on such expectations, and if such expectations fail to take hold, a big mismatch in the asset—liability could result to a lot of pain for the clients.

Shopping Mall Vacancies: The Rental Rates Factor

Because I have been anticipating (since 2013) that the Philippines will import what has been happening to the US and China, I have been periodically visiting malls. The current material changes in the malls have prompted for my observations of last two weeks.

Personally, I love shopping malls. It’s where I see a lot of people interact with the markets at different levels. It’s also where I see competition bring about positive changes in quality and services, and where innovations take place, as well as, gives hints on the preferences of consumers. It’s also a great place to try out diverse gastronomes. Importantly it’s also a place where I can make long walks…safely and under a cold environment.

But as an investor and an analyst, it’s just sad for me to see how resources are being misdirected due to the tampering of interest rates by the central bank. The distortion of interest rates has resulted to a cluster of entrepreneurial errors, in specific, the ongoing overbuilding and overcapacity dynamic in the sector.

Yet shopping malls have become a catechism for many, particularly the participants of the relentless pump and push of asset prices, whereby any criticism has been viewed as impiety thus will be subject to denial or vehemently objected upon without dealing with the basics.

The dilemma has been simple and elementary: what needs to be shown is the balance between the demand and supply side. Said differently, income has to grow faster or at least match the growth rate of credit and supply side.

This has not been what government data has been showing us. To the contrary as I have been pointing out the race to build malls financed by debt, not only by the major operators and developers, but even by small players reveals why excess supply will take hold. The supply side have been burgeoning at a rate faster than income. Worst, they have been financed by credit.

A dear friend recently gave a valuable input.

In the case of EDSA Shang mall, the increase in vacancies, he posits, may have possibly been due to a ‘surge’ in rental rates.

Let us go to basics. Unless they are from the public sector, most of the mall tenants are profit and loss enterprises.

An increase in rental rates would mean that tenants will either have to depend on improvements on growth rates in retail sales or make sufficient upside price adjustments to offset changes in rental overhead cost in order to maintain profits.

Apparently, in the case of EDSA Shang, the same tenants most probably saw that the growth trend in retail sales or price adjustments required will not justify the rental rate increases, thereby the string of closures.

This means that problem once again stems from both demand and supply. Insufficient demand, prompted by growing discrepancy between the industry’s supply and demand balance, along with a recent slowdown in consumer demand, has exposed on the mall tenant’s sensitivity to higher operating costs.

Therefore, the issue of rental rates reinforces the dynamics of imbalances from overbuilding financed by overborrowing.

It’s also been a clash of expectations. While mall operators seem to expect sustained strong retail demand for them to demand higher rental rates, real time commercial activities on the store level has indicated that this has not been the case. So the conflict of expectations has prompted for the closures.

Yet such incongruity of expectations—where developers see retail trends as a one way street as against dynamic non-linear changes in store level activities—has been the reason for the system’s massive capacity buildup.

In addition, if a surge in rental rates has been mainly the case, then EDSA Shang’s plight should have been isolated. There would have been a flight of EDSA Shang tenants to other malls, or malls within the area would have absorbed most of EDSA Shang’s tenants. In short, EDSA Shang’s loss would have been the gain of the others.

But evidently this has hardly been the case as store vacancies have swelled even at the neighboring malls, but at a rate lesser than EDSA Shang’s.

Nonetheless, increases in rental rates may partly explain the yawning gap between the vacancy rates of EDSA Shang (my estimates at 10%+) with that of neighboring malls (my estimates 1-3+%).

Also the rental factor could have partly influenced the store closing incidences IF lease contracts of EDSA Shang with tenants have the same expiry dates. Remember most of these vacancies seem to have happened in a short time window of December 2014 and January 2015. This is unless tenants paid penalties for early termination.

Nevertheless if the rental factor has been true, then this would dovetail with the law of demand: “as the price of a product increases, quantity demanded falls”—which should affirm my warnings in 2013[3] that property inflation or property bubbles are destructive to the real economy: (bold mine)

Property bubbles will hurt both productive sectors and the consumers. Property bubbles increases input costs which reduces profits thereby rendering losses to marginal players but simultaneously rewarding the big players, thus property bubbles discourage small and medium scale entrepreneurship. Property bubbles can be seen as an insidious form of protectionism in favor of the politically privileged elites.

Property bubbles also reduces the disposable income of marginal fixed income earners who will have to pay more for rent and likewise reduces the affordability of housing for the general populace.

Unless there will be a meaningful jump in investment, which should filter into as income growth, the retrenchment in retail activities seen in 4Q GDP will hardly help to improve household income-spending conditions going forward. Of course growth of OFW remittances will be a factor too, but it won’t match the scale of growth from internal investments.

Shopping Mall Vacancies: Truck Ban and Port Congestion

How about the Truck ban and the recent port congestion?

I raised the issue of the city of Manila’s “truck ban” as a being a factor blamed by media on spiking inflation in July 2014. Reports suggest that easing of port congestion has occurred during the last quarter of 2014.

Both the truck ban and port congestion implies of supply side obstacles. It also hints of temporary dislocations.

For clues, let us revert back to the government’s data. This is data from the National Statistical Coordination Board. Anyone can go to the site and plot the growth rates on the spread sheet and do their interpretation.

Let us focus first on wholesale trade (green line). Wholesale trading activities seem to suggest of seasonal factors. For the past two years, there has been strong growth in Q1 which peaked at Q2 while Q3 seems to be in a hiatus. In the meantime, 4Q performance of 2013 and 2014 seems to have diverged.

Nevertheless, growth rates for the entire 2014 has been higher than 2013. Annual change according to the NSCB has been at 7.5% (2000 constant prices) 2013-14 as against 3.4% in 2012-13. That’s more than double the growth rates! That’s a lot of supplies.

Let us now input the truck ban and port congestion. My report on the truck ban was during early 3Q. So the port congestion may have partly influenced the decline in 3Q which adds to the seasonality factor.

But remember wholesale growth rates in 2014 have surpassed 2013 levels except for Q1. So this hardly exhibits of signs of supplyside shortages.

In addition, if we add to the picture trends of retail growth, then stark divergence emerges. Retail activities have been slowing from its zenith in Q4 2013. As I have been pointing out, Q4 2013 posted a 33% collapse in growth rates from 6.1% 3Q to 4.1%. The implication is that wholesalers have been building inventories more than consumers can absorb through retail outlets.

Now the port congestion easing during the 4Q may have led to a spike in wholesale growth rates, but ironically this comes as retail activities plummeted. I earlier suspected this to be channel stuffing which remains a possible factor.

So given the huge 2Q 2014 growth rates PLUS growth rates above 2013 levels during the 3Q for the wholesale sector, a supply driven retail slump doesn’t seem logically coherent.

Yet the antipodal activities between the wholesale and retail looks ominous to future activities. If retail activities don’t recover soon or continues to stagnate, then there will be lesser inventory accumulation activities from both manufacturing and from importations. This means a slowdown in the real formal economy.

Of course, this is unless those government statistics have been largely inaccurate.

So while government may pad G-R-O-W-T-H statistics via public spending, the real economy will diverge.

I also explained earlier that unsold perishable goods will lead to losses. This eventually will also apply for existing nonperishable items as well. The question is how has these inventories been funded? If they have been funded by debt, then losses will incur and this will lead to credit problems.

The trade industry has been one of the biggest sponges of debt. The trade industry’s share of loans from the banking system has been at 15.77% in 2012, 15.82% in 2013 and 16.03% in 2014.

Growth trends of the trade industry have been shown sharply growing from 2013 to August 2014 (see right chart). However 4Q growth rates have tumbled along with retail activities.

So even if the BSP comes up with all florid statistics about those low NPLs of the banking system (universal-commercial and thrift) has been, economic reasoning tell us that those statistics may not reflect on actual or on developing conditions.

The growing imbalances between retail and wholesale suggest that losses may have already been emerging. Loans that have financed either one of them will lead to debt problems.

And I would suppose that many of the numbers have been camouflaged via accounting magic.

Phisix 7,800: Philippine Bonds Just Sold Off

Government statistics and market manipulation may hide progressing entropy, but somehow somewhere cracks will appear.

The fissures have become apparent in the bond markets which continue to tell of a different story from record stocks.

The Philippine bond markets sold off last week. This happened to most of the maturities with the exception of the 3 months and 20 year.

The 4 and 5 year inversion has been rectified. They have become normal. There have been previous attempts to correct the inversion. The former attempt has been to push down yields, apparently this failed. This week, the 5 year yields vaulted and had been sold off the most.

This week’s almost broad based sell off has incited for a mix signal. Because 10 year yields climbed higher than the 1 and 2 year counterparts, their corresponding spreads have widened. But all the rest continues to narrow.

With the yields of 6 months and 1 year yield continuing with its upside moves and now nearing the December highs, this only shows of how short term funding pressures remains—or has been seething underneath.

Remember the domestic sovereign bond markets are held by a select few, particularly the banking system and their clients and the government. So the sustained flattening of the yield curve defies whatever rosy picture that has been peddled by the establishment and by government sycophants. The establishment and the consensus can deny, manage the indices or suppress information. What their action does will be is to buy time. But this won’t prevent reality from happening.

Developments on the domestic bond market reveals of innate tension progressing, tensions that appears to building from within the banking system.

Has this been the reason why banks have been underperforming of late?

The camouflaging of debt reminds me of the Kaisa Group, a property and shopping mall developer in China but whose shares are listed in Hong Kong.

The once “fundamentally” strong company suddenly surprised the market when they announced of their inability to pay interest rates on foreign denominated loans. So the Chinese government worked behind the scenes to find a buyer to bailout the beleaguered company.

Last week, the company’s debt suddenly DOUBLED. Since the company didn’t disclose why the debt has swelled, media has been speculating on its possible causes. They point out that “home buyers may have unwittingly turned into lenders” where advance proceeds and deposits were converted into debts. They also attributed the possibility of debt from trade credit (credit to suppliers and contractors) and from legal actions, or even from off balance sheet debts.

The obvious lesson is that credit booms have always masked the disease. It’s when the loans have been called in, when the proverbial Pandora’s Box gets to be opened.

And inflation (asset boom) has always been followed by deflation (asset bust).

Global Record Stocks, Record Warnings from Authorities Too

Stocks have been rampaging around the world. This comes in the light of many central banks working feverishly to slash interest rates. The general idea is that rate cuts will augment aggregate demand and forestall what the mainstream sees as deflation risk. That’s the headline story.

In terms of nationality there have been some 19 central banks that have eased this year. In terms of overall activities there have been 23 easing measures. This includes four from Denmark and 2 from Romania. Even neighboring Indonesia has jumped into the bandwagon to “unexpectedly” cut rates last week. 

I have yet to know how many have increased rates. But obviously with majors like China, Japan, Europe, on the side rate cuts, much of the world has been desperately trying to prop up domestic conditions.

Given that global debt has been estimated to have reached 286% of the global gdp according to McKinsey Quarterly, the reality has been that all these easing have been meant to buy time from a debt bubble bust.

The alleged deflation risk peddled by the mainstream has been euphemisms about governments and their allies going broke.

So the rush to ease has spawned a spate of negative yield debt instruments. Savers and creditors now pay debtors to borrow money. Credit risk has been buried alive. Economic forces have been mangled beyond recognition. It’s all about borrow borrow borrow to buy buy buy stocks and bonds and borrow borrow borrow to spend spend spend.

As of last week of January, about 16% of global government bonds have yielded negative. Those QEs have led to Wall Streets of the world to front run the government on bonds. And negative rates have further whetted appetite for blind yield chasing which has sent stocks to the firmament.

I have recently noted of a seeming rebellion against Japan Government Bonds via a recent spike in yields. I asked[4]: Will the BoJ accommodate the desire for more easing? Or will this herald an inflection point for BoJ’s subsidy to the Japanese government and their private sector allies?

Last week I got an answer. From Business Times Singapore: Bank of Japan Governor Haruhiko Kuroda has helped calm expectations for price swings in government debt by leaving open the possibility of more monetary stimulus.[5]

So with the BoJ’s assuage, JGB rebellion has been temporarily quashed.

Interestingly China’s head of State Administration of Foreign Exchange (SAFE), the institution responsible for forex reserve management shockingly admitted that China’s conditions resembled the Asian Crisis.

Let me quote the Bloomberg[6]: (bold mine) China is increasingly finding itself in a situation similar to the 1998 Asian financial crisis with emerging markets under pressure from capital outflows as the dollar strengthens, Guan Tao, head of the State Administration of Foreign Exchange’s international payment department, said at a forum in Beijing on Feb. 14. There will be uncertainties this year while the nation remains attractive to long-term capital, SAFE said in a report Sunday.

With China’s debt levels reaching 282% of their inflated GDP as of 2Q 2014 according to the McKinsey Quarterly, it is of no doubt why an official would make such remark.

Authorities around the world have been steadily issuing sanitized warnings or escape clauses on the possibility of a crisis.

It’s also interesting to learn that the financial engineering of debt securities via slicing and dicing of Collateral Loan Obligation (CLOs) has been mimicked in China and the adaption of which has been spreading fast.

From the Financial Times[7]: (bold mine) Call it déjà vu with Chinese characteristics: collateralised loan obligations, the sliced and diced loan bundles that helped tip the world into financial crisis in 2008, are surging in China. While CLOs fell into disrepute in the US and Europe after the crisis, China is promoting issuance of asset-backed securities as a means of weaning investors away from riskier shadow bank products while also ensuring enough credit flows to the slowing economy. Issuers appear to be heeding the message. Following years of delays and false starts, CLOs are now the fastest growing asset class in China’s financial system, with issuance of asset-backed securities up more than tenfold to Rmb326bn last year. A senior China Banking Regulatory Commission official predicted last month that China’s CLO market would “grow by leaps and bounds” this year, adding that Rmb90tn in outstanding bank loans could theoretically be eligible for securitisation.

In the US, the latest Fed minutes reveal of dithering by the monetary officials to raise rates. Part of this has been due to mentions of foreign or exogenous based risks.

But also ensconced within the minutes has been another “irrational exuberance” warning sounded out by the FED (bold mine)[8]: However, the staff report noted valuation pressures in some asset markets. Such pressures were most notable in corporate debt markets, despite some easing in recent months. In addition, valuation pressures appear to be building in the CRE sector, as indicated by rising prices and the easing in lending standards on CRE loans. Finally, the increased role of bond and loan mutual funds, in conjunction with other factors, may have increased the risk that liquidity pressures could emerge in related markets if investor appetite for such assets wanes. The effects on the largest banking firms of the sharp decline in oil prices and developments in foreign exchange markets appeared limited, although other institutions with more concentrated exposures could face strains if oil prices remain at current levels for a prolonged period.

As you can see record stocks comes about with record warnings from authorities too.

For now those rate cuts/easing/negative yields may have positive influence on stocks. But since we live in a world of scarcity, the deformation from such policies will hit a natural limit.

I foresee the rate cut mania to likewise hit the Philippine shores.

---

[1] Philippine Stock Exchange PSE index rallies anew to a fresh all-time high February 20, 2015

[2] Philippine Stock Exchange PSEi closes above 7,800 February 18, 2015

[3] See Cracks in the Philippine Property Bubble? October 7, 2015

[4] See Clash of the Titans: Phisix 7,700 in the Face of a Steep Flattening of the Bond Yield Curve! February 15, 2015

[5] The Business Times Singapore Kuroda keeping options open helps calm bond market February 20, 2015

[6] Bloomberg.com Offshore Yuan Declines Most in Three Weeks on Outflow Concern February 16, 2015

[7] Financial Times Sliced and diced loans take off in China February 19, 2015

[8] FOMC Minutes of the Federal Open Market Committee January 27–28, 2015 FederalReserve.gov