The Philippine Peso And The Phisix: With A Little Help From Our Neighbors

``Any currency is both a means of payment and a store of value. So when you try to determine what it's worth, you have to consider both what it can buy in terms of goods, and what it can earn if you hold it as an asset. An exchange rate is just the price of a currency. So a given foreign currency might be quoted as so many dollars per unit ($/FC).”-Dr. John Hussman

The Philippine equity benchmark fell 2.64% for the first time in 5 weeks following a massive 17% rally during the previous four. The much needed correction came amidst regional sluggishness and importantly drifted “independently” from the pendulum swings of the US markets.

Of course technical factors have weighed in on last week’s activities as the Phisix had been in overbought conditions following four furious weeks of rallies. So the recent actions could have somewhat diminished the profit selling pressures.

Fundamentally, some suggested that the ongoing military action in Mindanao has helped depressed sentiment, we don’t share that view.

While the military action in Mindanao is inflationary and won’t help the cause of the Philippine Peso as discussed in Toynbee’s Generational War Cycle: In Mindanao or In Georgia/South Ossetia?, because war spending will add pressures on our fiscal balance sheets and cause undue burden to the Peso, which fell anew by .75% to 45.65 to a US dollar, the operation has been largely isolated. But then again this war-related Peso loss shouldn’t be seen from the prospects of the Philippine currency alone. The US dollar is itself very much belabored from the strains from its financial markets and the economy.

Nonetheless what needs to be shown is that the present actions in the currency front seem to reflect regional actions as shown in Figure 7.Figure 7: finance.yahoo.com: Malaysian Ringgit and Taiwan Dollar

Including the Chinese Yuan, the US dollar has risen against Asian currencies. On the left is the Malaysian Ringgit and on the right is the Taiwan Dollar. My intent is to show the representativeness of the region’s currency activities from both the Southeast and East Asian economies. Even in South Asia, India and Pakistan have shown similar US dollar rally patterns.

Again a lot of this has been predicated on the US dollar as safehaven status over the prospects of a severe slowdown as tackled above. Others insist that it is about economic growth which should eventually be shown as unfounded especially when compared to the region’s potentials. For us, it’s been either a scare story that has been peddled in the financial markets or a “momentum trade” that has largely been bought into by financial institutions.

The odd thing is that the supposed impact from the scare stories have not yet caused a meltdown where it is due but instead impelled some volatility in external markets.

While the momentum trade is a function of a cognitive bias called survivorship bias- people tend to look at the “winners” or survivors and pile into them and ignore the rest, thereby skewing any analysis.

The important point to address is that relative to the equity markets, it is hard to see an immediate transition to an advance phase from the present “bottom” phase of the Phisix without some signs that part of the region could be improving.

In short, it is going to be difficult, but not improbable, to have the Phisix transition into a bullmarket or advance phase alone see figure 8.

Figure 8: Bloomberg: Select Asian Equities: The Phisix Seems Not Alone!

All of Asian markets have suffered from the recent bear market cycle (measured from 20% fall from the peak). But as shown in figure 8, while 3 national bellwethers (China-green, Phisix-dark orange, Vietnam blue) turned lower almost synchronically (but Vietnam fell first!), Indonesia (yellow) has had a “asynchronous” or lagged impact.

Noticeably too, based on a one year period, the performance (or returns) of Indonesia could be assessed as only slightly negative compared to the Phisix, China or Vietnam. Such disparities give us further room to question the validity of the religion like “recoupling” dogma.

The most important and encouraging observation now is that following the most recent crash, Vietnam (blue) appears to have hurdled its first bump-where it broke its previous resistance-and can be construed as in an upward momentum.

Meanwhile, the Phisix, which turned lower almost at the same time with China last October, appears to have followed pace of Vietnam (albeit belatedly) but has yet to breakout from its recent high.

Of course, bear markets can always lead to false dawns. But as we pointed out, the Phisix is likely to be in a bottom considering the cyclical nature of the recent decline. Besides, a global contagion is most likely to force a consolidation than see a outright collapse unless those “end tails” become a reality as discussed last week.

We don’t know much about Vietnam except for the fact that market seems to signal either previous excessive selling or a prospective economic recovery.

According to Deyi Tan and Chetan Ahya of Morgan Stanley, ``The aggressive tightening undertaken by the State Bank of Vietnam (SBV), hiking the base rate from 8.75% in May to 14% in June, has had an effect on Vietnam’s macro environment. Coupled with declining commodity prices and administrative measures, indicators are showing signs of cooling off. This has increased the markets’ hopes for a meaningful cut in banks’ lending rates over the next 3-4 months.”

So the tapering off of inflation expectations aside from a slowdown in economic growth seems to be shaping expectations for a possible monetary easing and could be instrumental in boosting Vietnam’s market or the Ho Chi Minh Index from the recent nadir.

But such prospective policy actions could be limited since Vietnam still is in negative real rates and risks stoking future headline inflation.

For now we will observe if the Phisix-Vietnam tandem will be successful in their distinct attempts to move higher and if they can help influence other regional bellwethers such as Indonesia or Thailand. With a little nudge from our neighbors we might get the much needed momentum into moving forward.

Olympic Medal Count Based on Select Economic Measures

Interesting site from Youcalc.

It shows of the Olympic medal standings seen from the perspective of economics based on either:

1. per Trillion $ GDP
2. Per million inhabitants
3. Per country

Click on the link for updates

Global Warming Debate: Oops…WMO says First Half of 2008-COOLEST in 5 Years!

From yahoo-Reuters (highlight mine),

``The first half of 2008 was the coolest for at least five years, the World Meteorological Organisation (WMO) said on Wednesday.

``The whole year will almost certainly be cooler than recent years, although temperatures remain above the historical average.

``Global temperatures vary annually according to natural cycles. For example, they are driven by shifting ocean currents, and dips do not undermine the case that man-made greenhouse gas emissions are causing long-term global warming, climate scientists say.

``Chillier weather this year is partly because of a global weather pattern called La Nina that follows a periodic warming effect called El Nino.

"We can expect with high probability this year will be cooler than the previous five years," said Omar Baddour, responsible for climate data and monitoring at the WMO.

"Definitely the La Nina should have had an effect, how much we cannot say."

Read the rest here.

My comment:

Yeah sure…if La Nina’s impact to global warming/cooling seems unclear even to the experts, how can we be confident that those advocating for a “man-caused” global warming climate can be said with certainty?

Yet, if mathematical models or the basis for the climate gloom and doom, have not predicted with efficiency the markets (1987 stock market crash-portfolio insurance programs and today’s quant "strategies") or even economic trends or aggregate human (social) behavior…why should I entrust the same to “professionals” whom are likewise susceptible to “cognitive biases” which may/can be influenced by ideology (socialism in green robes) or by power politics or by money (e.g. grants on research funds)?

As Dr. Patrick Moore, Co-founder of Greenpeace, Chairman and Chief Scientist of Greenspirit Strategies Ltd. in Vancouver, Canada recently said (highlight mine),

``Environmentalism has turned into anti-globalisation and anti-industry. Activists have abandoned science in favour of sensationalism. Their zero-tolerance, fear-mongering campaigns would ultimately prevent a cure for Vitamin A deficiency blindness, increase pesticide use, increase heart disease, deplete wild salmon stocks, raise the cost and reduce the safety of health care, raise construction costs, deprive developing nations of clean electricity, stop renewable wind energy, block a solution to global warming, and contribute to deforestation. How sick is that?”

Already too much of our mundane problems have been due to the unintended effects of "self-righteous- omnipotent-elixirs" based politics or by so-called populist political correctness.

Eventually delusions will be envisaged with harsh reality.

Sports Globalization: NBA Goes Emerging Markets!

Last January, the widely followed US National Basketball Association (NBA) formed its overseas arm, NBA China, to expand its basketball league to cover at China.

This from NBA, ``Five strategic partners will invest $253 million to acquire 11% of the company in preferred equity. The strategic partners are an elite group of exceptionally prominent and successful entities: ESPN, a division of The Walt Disney Company, Bank of China Group Investment, Legend Holdings Limited, Li Ka Shing Foundation and China Merchants Investments.”

We further read that the NBA plans to develop teams of professional players from about 10 cities in the coming years and help install more than 800,000 basketball goals throughout China, making the popular game even more accessible!

It doesn’t end here. NBA now plans to stretch its exposure to India!

From Steve Kyler of hoopsworld.com (highlight mine), ``[NBA Commissioner] David Stern also dropped hints that China may be the first stop of the NBA in Asia, but said he and his staff did meet with officials from India, where the NBA recently held a Basketball Without Borders stop. Stern pointed to India as an area where the NBA sees tremendous interest in basketball, and is open to exploring opportunities for the NBA to help develop the game in India. Europe may be stealing a few middle tier NBA players, but it seems the NBA is more focused on exploiting the billion fan markets of Asia.”

The Moral of NBA’s actions: FOLLOW the MONEY!

Study Says Happiness Comes From Freedom

Happiness is not mainly about wealth, it is about the freedom to make choices, that’s according to a study by Inglehart, Foa, Peterson and Welzel at the World Values Survey.

World Values Survey: Economic development leads to a shift in survival strategies

This from Robert Foa at the Financial Times (highlight mine)

``How is it that the world is getting happier? In the words of Thucydides, the secret of happiness is freedom. In each survey respondents were also asked to rate their sense of free choice in life…

``The world in which we live today is unquestionably a free one. For the first time in history, most of the world is governed democratically, the rights of women and minorities are widely acknowledged, and people, ideas and investment can cross borders. Since the study began in 1981, dozens of middle-income countries have democratised, relieving many from fear of repression: every country making a transition from authoritarian rule to democracy shows a rising sense of free choice…

World Values Survey: Socioeconomic change, growing freedom, and rising happiness: The human development path.

Implications?

Again from Mr. Roa,

``First, that the expansion of political and social freedoms over the past quarter of a century is vindicated. The open world in which we live is a fundamentally happier one. This may not surprise those who have argued in favour of a liberal global order. It will undoubtedly cause puzzlement and consternation among those who yearn for the false certainties of an earlier era.

``Second, the results may engender caution towards attempts to engineer happiness through public policy. The happy countries include social democracies such as Sweden and Denmark, and more laisser faire economies such as Australia and the US. What they have in common are not their policies but institutions: democracy, rule of law and social tolerance. People are largely capable of engineering their own happiness when given the means to do so.

``Third, the link from free choice to rising happiness suggests that the appropriate benchmark of development is not income per capita, but individual freedoms and capabilities. This is the human development perspective associated with Amartya Sen, the Nobel laureate. While income and well-being are closely correlated at early stages of development, once the threat of starvation recedes, social and political freedom appears to be as important.”

If the study is anywhere near accurate what it means for us is- we can’t be "free" unless we can decide what is best for ourselves- financially, economically socially and politically.

Olympics: Trend of Breaking Records Accelerates! What drives them?

From the Economist,

``TUMBLING world records are part of the Olympic experience, but just how much have swimmers or runners improved over the past 100 years? In Beijing, new records have been set in the most glamorous events in athletics and swimming—the men's 100m sprint and freestyle. Jamaica's Usain Bolt cruised to victory, taking his own 100m sprint world record down by three-hundredths of a second to 9.69 seconds. In the century or so since official records began, the quickest time has fallen by just under a second—a 9% improvement. But in the pool, Australia's Eamon Sullivan covered 100m in the heats (although he lost in the final) in a world-fastest time of 47.05 seconds, 19 seconds (and 28%) quicker than the record-holder of 1905."

Courtesy of the Economist

With these trends here are some questions we’d like to know…

-Has demographics or world population growth been a significant contributor to these developments?

Courtesy of Franklin Institute Science Museum

Or more people equals better odds for outperformance?

-or has rapid and sweeping advances in technology or “sports science” (sports gears, equipments, arenas-e.g. pool design, scientific training etc…) been the major driver?

Example, this from the New York Times (underscore mine), ``As swimming becomes more popular, it attracts better athletes, who often stay in the sport for more than one Olympics and have access to increasingly sophisticated sports science. Swimmers who once concentrated mostly on endurance now spend up to 50 percent of their training on refining the technical aspects of kicking, pulling, breathing and body position, said Genadijus Sokolovas, director of sports science for USA Swimming….

``American swimmers here are accompanied by four sports-science experts. Each race is videotaped. Immediately after a race, each swimmer has an ear pricked to test for lactic-acid levels. After a warm-down swim, video analysis is made immediately available to monitor stroke counts, distance per stroke, split times, and the biomechanics of takeoffs and turns.

Another example (HT: Forbes’ Josh Wolfe) Phil Mickelson’s Congressional testimony on the importance of Math and Science (emphasis mine)``I use math and science every day, and it's not just adding yardages to the pin. I actually practice based on statistics. I use course management based on numbers. For instance, I know that my margin of error is plus or minus 5 or 6 percent. So if I have a 200 yard shot, 6 percent of that is going to be 32 yards off line - that's going to be my margin of error. And there's even more science involved in equipment I use. Launch angles, spin rate, loft, deflection, initial velocity, the transfer of energy. I continually work with companies like Callaway and some of the most technical design processes to optimize the performance of my clubs.”

“I use statistics to maximize my practice. I do a drill with 3-foot putts. And I can make 100% of them. But at 4 feet, it's 88%, at 5 feet 78%, and at 6 feet, it's only 65%. So while I may not be wasting my time trying to add 20 yards to my drives, what I really need to do is hit my chip shots within 3 feet of the hole. That's the best way to lower my score."

-or has the global political economic dimensions of Olympics (globalization’s role-e.g. training abroad or migration trends; investment or financing of participants a function of markets or of government?; type of government and or social acceptability etc..) played a major role?

Philippine Peso Wilts Under The Unwinding Short US Dollar Carry Trade!

``The world is changing and how we measure that change economically and financially is clearly a challenge and an opportunity. We have seen a re-weighting of risk around the world, but the world itself is being economically re-rated and so we need an index that allows investors to take advantage of these changes. Indian companies will obviously have a place in The Global Dow as will companies from other emerging countries where we have seen an unprecedented economic emancipation over the past two decades.” Rupert Murdoch, owner Dow Jones, on the Global Dow plan, in Mumbai, India.

So what ails the Philippine Peso?

After a fierce rally following the Philippine central Bank the (Bangko Sentral ng Pilipinas) BSP’s move to raise policy interest rates to quell “inflation”, the Philippine currency made a 180° turn and dived. The Peso lost 2.19% over the week to 45.13 to a US dollar see figure 1, Asia’s second biggest loser after India’s Rupee.

Figure 1: Yahoo.com: USDollar/Philippine Peso: Ailing Peso?

Local mainstream media ascribes the recent activities on several factors as foreign portfolio outflows “on jitters over rising inflation”, “heightened concerns over global economic growth”, “lower commodity prices”, “hedge against potential recovery in oil prices” and “low levels of liquidity” in the financial markets.

There seems to be some confusion about “rising inflation” and “lower commodity prices” (which is which? Isn’t rising inflation supposed to be represented by higher commodity prices?), aside from concerns about global economic growth as a causal factor to Peso’s steep loss (how does slower “global” economic growth translate to lower Peso?).

So from previous concerns over “inflation” to now “global economic growth”, media and the local experts appear to be lost on what truly is driving the Peso’s decline.

The Inflation Bogey Revealed

While it is true that foreign portfolio continued to account for outflows that have weighed on the Peso, we doubt if the premise is indeed ALL about “inflation”.

Proof? See Figure 2.

Figure 2: AsianBondsonline.com: What Inflation? Where?

ADB’s Asianbondsonline depicts of the Philippine Peso denominated sovereign instruments in 2 year (green line) and 10 year (red line) yields. As the chart shows, the sharp drop in the yields last month seems to be validating our arguments that inflation concerns have been abating as discussed in Philippine Economy: World Financial Markets Allude To Diminishing Risks of Inflation.

With LOWER food prices, which is our MAIN concern (over 45% of our Consumer Price Index basket is in food while energy is just about 3%), manifested by sharply falling broad based commodity prices, via moderating “global and local” demand compounded with supply side responses from market forces and from policy directives emanating from political pressures (subsidies, interest rate hikes, added investments and etc.), the falling yields reflected in Philippine debt papers have equally signified diminishing inflation risk over the interim.

Since government “inflation” figures represent past data, this accounts as a LAGGING indicator. So when you read of Philippine inflation rates nearing a 17 year high in July at 12.2% (xinhua.net), we should expect these figures to drop significantly in the coming months. In short, consumer goods and services inflation has peaked!

So from this angle, inflation as a risk variable hasn’t been the MAIN impetus for the Peso’s decline.

Slowing Global Economic Growth Weighs On The Peso? Not Likely

Now if the argument swings to one of global growth, economic data doesn’t seem to support such a premise either.

One must be reminded that the currency values are ALWAYS priced in pairs. That’s why currency markets function as a zero sum game because when one wins, the other loses.

This means that the conventional measure of the Philippine Peso is relative to the US dollar, since the US dollar represent as the de facto world currency reserve. This also means that if we allude to the world economic growth’s impact on the Philippines, then we must also account for how the same factors will affect the US.

Let us see how the downturn abroad has impacted the Philippine Economy…

According to the latest remittance trends, June’s money flows from overseas foreign workers set a NEW record in the face of a SLOWING global economy! (Yeah…“decoupling is a myth”??!!)

This from Bloomberg (highlight mine),

``Remittances from Philippine citizens working overseas rose at the fastest pace in 14 months in June as more people found jobs as nurses, seamen and engineers abroad.

``Money sent back to the Philippines jumped 30 percent from a year earlier to $1.5 billion, the highest since records began in 1989, the central bank said in a statement in Manila today. Remittances grew 15.6 percent in May.

``The number of Filipinos who got jobs overseas rose 33.5 percent to 640,401 in the first six months of the year, the central bank said today…

``Slowing global growth may limit jobs abroad as companies lay off workers and freeze expansion, reducing the amount of money expatriates can send home in the coming months. Half of the Philippines' remittances come from the U.S., where tumbling home prices, mounting job losses and credit restraints are threatening growth.

``Funds sent home by the more than 8 million Filipinos living abroad climbed 17.2 percent to $8.2 billion in the first half of 2008 from a year earlier.”

Remember, remittances account for about 10% of the local economy and have SUPPORTED consumption patterns in the Philippines. The fact that 3 of the 10 largest malls in the world are in the Philippines (see our blog post A Nation Of Shoppers??!!) could be seen as partly being propped up by these fund flows from our migrant workers. Thus as far as labor and financial links are concerned, the global economic slowdown hasn’t been reflected YET in these accounts.

Although it is true that the risks of a negative impact to remittances from a slowing global economy may have a lagging effect, as in the case of Mexico which reported a slight decline during the 2^nd quarter and the first semester of 2008 (Wall Street Journal), these would actually depend on the sectors from which our OFWs are exposed to.

According to the BSP, ``Filipino workers continue to be in strong demand overseas due to the diversity and quality of skills they offer. The conduct of bilateral talks with host countries also continues to open up new employment opportunities abroad for Filipinos.” (emphasis mine)

Much to our knowledge, health (caregivers and nurses) and science based industries (engineers) aside from education (teachers) could be seen as defensive sectors that are least likely to be affected by the ongoing economic and financial slump in the US, thus the seeming resilience.

Aside, as the BSP has noted, bilateral agreements has effectively widened the opportunities for more of our labor/manpower exports.

Paradoxically, it appears that the so-called “Peso-driven-remittance” premise formerly touted by media and our experts has vanished altogether! Why? Just because the Peso is down and seems not to be supported by the remittance flows doesn’t mean this has no contribution. This goes to show how media and the highly paid institutional “experts” frequently resort to specious analysis based on AVAILABLE Bias.

Might as well abide by Nassim Taleb (author of the Black Swan) advise, ``Don’t read newspapers for the news (just for the gossip and, of course, profiles of authors). The best filter to know if the news matters is if you hear it in cafes, restaurants... or (again) parties.”

Going back to the local economy, if we look at the performances of publicly listed companies, we hardly notice any significant slowdown. Yes while earnings fell (from a jump in input costs or “inflation” and from mark down on equity investments), revenues from business operations jumped!

This from ABS-CBN (emphasis mine), ``Companies whose shares are listed on the local bourse saw their total earnings fell in the first quarter of the year due to rising inflation and lower trading gains, a new study by the Philippine Stock Exchange (PSE) showed.

``According to PSE data, the combined profits of listed firms amounted to P66.68 billion in the first three months, a 4.3-percent decrease over the previous year's P69.67 billion. The same study showed that their combined revenues expanded by 10.4 percent to P589.71 billion from P534.05 billion a year ago.

``The findings were based on the unaudited financial statements of 221 listed companies received by the PSE as of June 11.”

Of course past performance doesn’t imply the same prospective outcome, but the point is if the largest companies in the Philippines have been seeing strength in the revenue context, then a material slowdown (or even a recession) isn’t likely to be in the cards. So the world may go into a recession alright but we are unlikely to join the bandwagon.

Besides, except for the trade linkages seen via the export and export related manufacturing channels, which supposedly accounts for as the most sensitive or the weakest link to a global slowdown (ironically exports grew 8.3% in June year on year, and 4% from January to June over the same period last year), the rest of the other industries should remain resilient.

As evidence, we can get some clues from the latest export figures (Inquirer.net)…

``Exports of clothing and accessories, the second-biggest export item after electronics in June, were down 7.6 percent year-on-year at $172.33 million.”

``Other top exports in June were petroleum (down 1.0 percent at $138.71 million), cathodes of refined copper (up 97 percent at $122.16 million), and coconut oil (up 105 percent at $116.97 million).

So there…a downturn in global consumer spending is reflected through the decline in clothing and accessories exports. Meanwhile, agriculture (coconut oil) and mining and related (refined copper) industries should continue to experience robust growth. As reminder, agriculture accounts for a substantial-over one third of the Philippine employment profile.

Not only that…the ongoing economic slack in the OECD economies have been prompting more firms to consider the outsourcing avenue as a way of cost cutting.

In the US, investment banks suffering from the housing and mortgage backed securitization meltdown is seen accelerating the outsourcing of jobs or in the vernacular- “knowledge process outsourcing,” “off-shoring” or “high-value outsourcing-to emerging markets.

This from the New York Times (underscore mine),

``Cost-cutting in New York and London has already been brutal thus far this year, and there is more to come in the next few months. New York City financial firms expect to hand out some $18 billion less in pay and benefits this year than 2007, the largest one-year drop ever. Over all, United States banks will cut 200,000 employees by 2009, the banking consultancy Celent said in April.

``The work these bankers were doing is not necessarily going away, though. Instead, jobs are popping up in places like India and Eastern Europe, often where healthier local markets exist.

``In addition to moving some lower-level banking and research positions to support bankers and analysts in New York and London, firms are shipping some of their top bankers from those cities to faster-growing developing markets to handle clients there…

``After research, the next wave may include more sophisticated jobs like the creation of derivative products, quantitative trading models and even sales jobs from the trading floors.

``Proponents of the change say Wall Street’s wary embrace of the activity may signal the beginning of a profound shift in the way investment banks are structured, with everyone but the top deal makers, client representatives and the bank management permanently relocated to cheaper locales like India, the Philippines and Eastern Europe.”

We don’t like to sound like engaging in a schadenfraude but the article message is crystal clear-someone’s loss is somebody’s gain; very much like the tradeoff between the Peso and the US dollar.

So, in addition to the milestone remittance volume in June and the prospects of a lower “inflation”, plus a calibrated upswing in the rest of the other industries economic growth figures to the upside (Government expects the country to grow by 5.7% for the year (inquirer.net))!!!

Figure 3: San Francisco Federal Reserve: World Real Economic Growth and US Real GDP

So under the context of economic growth, we don’t expect the US to OUTPERFORM emerging markets including the Philippines, as shown in Figure 3 from the San Francisco Federal Reserve even under a very OPTIMISTIC scenario of a NO-recession economic recovery in the US (right pane), an outlook which seems as questionable for us.

Besides, even under a moderation in economic growth it is unlikely that emerging markets will undergo the same penance as those in the debt to the eyeballs OECD economies. Even during the Dot.com bust of 2000-2002, emerging markets contributed 75% to the world economic growth as seen on the left pane. Lately, the emerging countries or developing countries accounted for almost 70% of world real GDP and should remain as an important driver going forward.

Thus, the recent fall by the Peso isn’t also supported by the slow economic growth thesis.

The Unraveling Short US Dollar Carry Trade!

So if it is not inflation and it is not slowing global economic growth then what is?

The recent strength of the US dollar hasn’t been a Philippine Peso only phenomenon. It has been a broad based rally seen in Asia (except Indonesia) including the redoubtable Singapore or for much of the world as shown in Figure 3 as measured by the US dollar “trade weighted” Index.

Figure 4: stockcharts.com: US dollar rally

As shown in Figure 4 the US dollar (main window) has massively rallied against its major trading partners (except the Canadian Loonie) which apparently coincided with the collapse of commodity prices, CRB Index (pane below main window), Gold (pane below CRB) and Oil prices (lowest pane).

While others have imputed these to “deflationary” pressures which may be partly responsible for the recent events, but has been inconsistent with the activities seen in the equity markets, we think that today’s volatile actions in the currency market signify the rotating process of “deleveraging”.

Perma bears cheerfully claim that the breakdown of commodities signifies a collapse in EM demand-which we think is unproven yet- and not evident in the Philippines anyway.

While others may call it the “global margin call” we call it the unwinding “short US dollar carry trade”.

Said differently, the US dollar has almost functioned as a ONE WAY BET or one huge crowded trade where international investors have massively “borrowed” against (because of relative lower rates) or “shorted” the US dollar (in expectations of a lower US dollar because of the years of continued decline) to buy commodities or emerging market assets or ex-US currencies in the hunt for added yields.

When central banks intervened (as we pointed out in Global Markets: The End Of The World? Or Overestimating Global Consequences?) to put a floor on the US dollar, the entire short US dollar short phenomenon unraveled spectacularly!

The attendant margin calls from the US dollar carry spurred forced liquidations in the positions of the commodity trade or in emerging markets or even among the currencies of the major trading partners of the US which had morphed into a dysfunctional rout. Hence, the almost synchronous inverse actions of the US dollar relative to commodities and the rapid disorderly panic stricken selloffs involving many currencies including the Philippine Peso!

This has not been a new phenomenon. About a year earlier, the advent of the credit crisis resulted to a wallop in global equity assets as many financial institutions who were caught in the subprime mortgage shakeout were compelled to raise capital via forcible liquidations. Most of these were vented in the global equity markets including the Philippine Stock Exchange.

We are seeing it happen today again, but this time involving ex-US assets. Hence the rotating disorder of delevaraging from a system that greatly relies on leveraging.

In May of 2006, the Gavekal Team wrote about the parallelism of a short US dollar phenomenon which had contributed to the imbalances or bubble formation that became what is known as the Asian Crisis (emphasis ours)…

``We had an echo of this very same phenomenon in Asia in the period 1995 to 2000. In 1995, everyone was convinced that the THB, MYR, KRW were massively undervalued and due a large revaluation. Everyone borrowed US$ (since rates were cheaper than local rates) to finance local projects (usually real estate). As money continued to plow in, returns on capital weakened. Soon the returns on capital moved below its cost and Asian currencies were forced to devalue. Asian banks, and the OECD banks that had lent to them, found themselves de facto “short the US$”. As Asia repaid its US$ borrowing in the period 1997-2000, the US$ rose higher than anyone expected (including ourselves) and central bank reserves barely grew (despite large current account deficits).”

Deleveraging and Probable Policy Goals Behind Interventions

The process of forcible liquidations almost always involves indiscriminate selling regardless of the fundamentals of an asset. This is because the antecedent of deleveraging is overleveraging which constitutes inflation, excessive speculation and reckless risk taking.

And deleveraging of overvalued or overextended markets means raising capital to fund margin deficits by closing out positions which usually is directed at the most liquid or most profitable positions. Hence deleveraging is commonly seen within a universe of a specified asset class. In today’s case: currencies and commodities.

Even gold, which traditionally functioned as hedge against volatility, inflation or financial or economic distress, became a downright victim to the latest market carnage.

An added view is our suspicion of the coordinated Central Bank-government efforts to prop the US dollar to force down commodity prices so as to reflect a peak in “inflation”, thereby relieving them of the political pressures from the responsibilities of policy errors (e.g. Biofuel subsidies).

Also we suspect that the same political forces could be conditioning markets for further policy easing measures (more rate cuts) in view of the still recalcitrant gridlock in the credit markets whose adverse impact has begun to spread into the real economy.

Finally in understanding of the guiding principles of US Federal Reserve Chairman Ben Bernanke policymaking, it is likely that such actions could have been designed to bolster or cushion equity markets especially under the seasonal conditions of August to October which have been prone to “crashes”!

In 2000, Chairman Ben Bernanke wrote a treatise entitled “A Crash Course for Central Bankers” which we quote Mr. Bernanke…

``There’s no denying that a collapse in stock prices today would pose serious macroeconomic challenges for the United States. Consumer spending would slow, and the U.S. economy would become less of a magnet for foreign investors. Economic growth, which in any case has recently been at unsustainable levels, would decline somewhat. History proves, however, that a smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse.”

Figure 5: BBC US Market Crashes Through Ages

Figure 5 which we featured almost at the same time last year (see A “Normal” Correction in the FACE of Massive Government Interventions? No Can Do!) exhibits the worst crashes and bear markets in the US.

Given the cognizance of the unfolding weaknesses in the economy, US markets could be deemed as sensitive or vulnerable to a stock market crash, hence Mr. Bernanke alongside with other central banks could be attempting to create conditions that could avoid a similar situational risk.

Conclusion

In finale, we don’t share the mainstream view that the Philippine Peso’s recent downside jolt emanates from either the popular premises of being “inflation” impacted or as corollary to a global economic slowdown, both of which seems to have inadequate evidences and rests on tenuous logic in support such claims.

Much of the inter-market activities reflect on the process of deleveraging from an overextended-ONE way bet market (US DOLLAR) that has led to unruly forcible liquidations involving cross volatilities in the currency and commodity markets.

We suspect that political entities have had a hand in the present market actions were aimed at mitigating the political cost owing to adverse impacts of policy errors or US policymakers could be conditioning global financial markets for further policy easing measures (more rate cuts) or that alleged market intervention had been designed to bolster or cushion equity markets especially under the seasonal conditions of August to October which have been prone to “crashes”!

We further suspect that the unfounded serial bouts of forced selling should also translate to opportunities similar to that seen in the Phisix-that the Philippine Peso should rebound after the smoke from the battle clears.

Focusing On The Future: the Phisix and the Philippine Presidential Cycle

``The typical US investor tends to have about 80 percent of equities in the US. The world of tomorrow suggests a much greater exposure overseas. In general, you should consider holding a third of your equities in the US, a third in industrial countries outside the US and a third in emerging markets.”-Mohamed El-Erian, When Markets Collide: Investment Strategies for the Age of Global Economic Change, co-CEO of bond-investing giant Pimco

Self development author Robert Ringer cites the work of the late Alvin Toffler in the landmark book, the Future Shock, where Mr. Ringer wrote, ``Toffler believed that at any given time in history, about 90 percent of the population thinks in terms of the past, 7-8 percent have their heads in the present, and 2-3 percent are focused on the future.” (highlight mine)

Applied to the markets, since only 2-3% think in terms of the future while 97% are merely trend followers or momentum players then getting “ahead of the curve” translates to focusing on the possible outcomes in terms of the future and positioning ahead.

Getting Ahead of the Curve: Focus On The Longer Horizon

Thus to be able to acquire such an edge we need to understand how to use information. Josh Wolfe of the Nanotech section of the Forbes magazine tells us of the three sources that we need to focus on:

From Mr. Wolfe (underscore mine),

``Remember this: there are three sources of edge for you as an investor: informational, analytical or behavioral. Having an informational edge—a legal one at that—is very hard today because bits of information are distributed (via bits of optically propelled 0s and 1s) faster and wider than ever before. If the world is flat then information spreads across it (through Cisco routers) with nary a ripple (like Crisco on a pan). And sad but true: those lacking assets connecting them to info (logins, laptops, and lit fiber) lack assets connecting them to investors. You need basic infrastructure for basic trade and e- infrastructure for ETrade.

``Now “analytical” edge is more valuable than informational edge because fewer have it. Scarcity has value. You and I can get the same information but I can analyze it differently, attributing different meaning and weight the duration or magnitude of information or expectations differently. Maybe I can analyze it better. But more investors and more funds means more efficiency and less edge. And many market players competing to surgically excise (and analyze) truth from information means you get paid less to be a “surgeon” in the stock market ER.

``Know this: the best way to have analytical edge is to have a longer time horizon than the rest of the market. If the market discounts intrinsic values to the quarter, having a variant perception a year out can help you find undervalued stocks. My friends at Fund-of-Funds say so. Yet, shockingly: they do as they do not as they say. They manage their hedge fund managers to the month (with monthly reporting)—the unintended consequence? Their hedge fund managers shorten their own time horizon to manage against redemptions and fund withdrawals—inadvertently eroding away their edge. But alas, lamenting “short-termism” seems to be the only long-term rant that stays the course.

``Thus behavioral edge is the one remaining true source of edge. Edge can come from understanding social psychology, the madness (or wisdom) of crowds and individual cognitive and behavioral biases. If you guessed “none” instead of “nine” you thought appropriately more like a sociologist than a mathematician.

In essence, Mr. Wolfe suggests to us to have access to the right information by having the appropriate infrastructure, to know how to process such information by adequately analyzing them in the context of the big picture and to understand social psychology and the cognitive or behavioral biases to take advantage of market sentiment.

The Phisix And The Philippine Presidential Cycle

For instance 2 years from now the Philippines will undergo another national political exercise known as the Presidential elections.

While much of the public have been speculating on who will be running under what party, we are interested to know how the Phisix responds to the election of a NEW president as shown in Figure 6.

Figure 6: Presidential HONEYMOON

The blue arrows in Figure 6 demonstrate of how the Phisix responded during the last 3 Presidential election years which spanned over the past 22 years or since 1986. All of them have been positive.

In 1992, when Fidel V. Ramos assumed the presidency under the bull market cycle of 1986-1997, the Phisix soared from about 1,100 to 3,200 in 1994 (about 190%). Of course this didn’t happen in a straight line. 1992 had a mid year correction but the HONEYMOON prompted bullmarket was jumpstarted anew when the New Year ushered in.

1998 was a baptism of fire for Joseph Ejercito Estrada, having been elected to the presidency a year after the Asian Financial Crisis imploded. The Phisix responded with a late but fierce HONEYMOON-Technical oversold bounce which resulted to a gain of about 127%. Unfortunately, because the bounce signified as a countercyle amidst a secular downtrend, the advances were momentary and lasted only NINE months.

The controversial reelection of the incumbent president Gloria Macapagal Arroyo came amidst the backdrop of a booming global equity markets. The Phisix jumped from around 1,430 in April to 2,130 in February 2005 for a 48% gain in less than one year to reflect the GMA HONEYMOON.

However, 2005 saw the US dollar stage a massive rally amidst another political controversy which hounded the presidency-the Hello Garci Scandal, thus the Phisix traded sideways for most of the year until the last quarter.

By 2010 Global Markets Could Be In A Recovery Phase

Of course, we should mull over on whether the external environment would be supportive of such HONEYMOON. On whether the banking crisis in the US would have been on a mend or if it could still be undergoing adjustment pangs as shown in Figure 7.

Figure 7: PIMCO Emerging Markets: Average Crisis Durations

According to Michael Gomez, Executive Vice President of leading global investment management company PIMCO in a recent article, ``Unfortunately for the U.S., the fallout is usually both lengthy and costly: historical evidence suggests that banking crises in developed countries take, on average, between four and five years to resolve. As Yogi so famously said, “It ain’t over ‘til it’s over.””

If we are to base the present crisis from the inflection point of the US real estate sector, then the reckoning period for the advent of the crisis could be pegged at February of 2007, see Figure 8.

Figure 8: stockcharts.com: US Real Estate Led Crisis

The NYSE Real Estate index (main window) turned nearly a quarter before the Dow Jones Financials (top minor pane), Banking Index (mid minor pane) and the Mortgage Finance Index (lowest pane).

So if it should take the average crisis in the US to be settled in a timeframe of four to five years, then 2010 would already mark the late phase of the crisis which could translate to a bottoming or consolidation of the US equity markets. At best, it could also start to exhibit some signs of recovery!

Another, if it takes 3.7 years for all countries to resolve the present crisis and 3.3 years for emerging markets based on the PIMCO studies of banking crisis, then it also means that most of the world economies would also be on the process of a recovery by 2010!

This posits for a possibility of strong kick during the presidential honeymoon phase, which also means that 2009 could translate to a springboard for a powerful presidential honeymoon cycle momentum in 2010.

Overall, the prospects of a recovery in the Phisix looks likely a sooner than a later proposition.

Crash and Meltdown Alerts

However, as a word of caution these three months are likely to reflect the most vulnerable months of global equity markets. Some institutions like the Royal Bank of Scotland and Morgan Stanley have issued crash or meltdown alerts last June.

It is not for us to agree or not with such dire outlooks. We have spilled so much ink on these horror stories. While I don’t share the outlook, it can happen. The important thing is to observe HOW OUR PHISIX WILL REACT if these events do occur and not to run to the hills to seek refuge.

At the interim, if the PRESENT DIVERGENCES in the Phisix-US/global markets CONTINUE TO MAKE A SIGNIFICANT HEADWAY even amidst the prospects of a “perfect storm” then investors could possibly start to price in with confidence the belief that we could depart from the rest of the global markets affected by the debt bubble bust stigma.

The best is to see the Phisix consolidate with an upside bias on a gradual scale regardless of what happens elsewhere. A sharp upside climb risk a volatile and deep decline that could wipe out all gains accrued. A good example would be President Estrada’s honeymoon.

Thus, we should see a meaningful yearend rally to mark the transition from the bottom towards a recovery probably from mid October thereafter-assuming no major crashes to impact us. Then 2009 should see a marked improvement from 2008.

On the worst outlook, a global crash could possibly bring our call for this bottom phase to a test.

Global Recession watch: Japan and Euroland Economic Growth Turns Negative!

Japan suffers from slowing exports and rising consumer prices.

Courtesy of Danske Bank

From the Economist, ``According to data released by the government's Cabinet Office on August 13th, seasonally adjusted real GDP contracted by 0.6% quarter on quarter in the three months to June. As the new data also revise down first-quarter growth, from 1% to 0.8%, the economy's performance in the second quarter looks especially weak. In annualised terms, GDP contracted by 2.4% in the quarter to June. Japanese national-accounts data are revised frequently, so the picture may change as further data releases come out later in the year…

``This reflects the increasing impact on Japan of the various headwinds from the global economy—including weakening demand in export markets, high oil and food prices, and the continuing fallout from the US sub-prime crisis…

And it is the same for the Eurozone…

Courtesy of the Economist

From the Economist, ``Europe is struggling to stay above water. Figures released on Thursday August 14th showed that the euro-area economy shrank at an annualised rate of 0.8% in the second quarter, the first such reverse since 2001. Nor are things likely to improve soon. A closely watched survey of purchasing managers in manufacturing and services slumped in July to its lowest level since 2001. Business confidence has turned down sharply in all of the three biggest economies in the euro area: Germany, France and Italy…

``The economy’s downward lurch puts the ECB in an awkward spot. It raised its main interest rate to 4.25% on July 3rd to show that it was serious about controlling inflation, which is well above its target ceiling of 2%. The rate-setters’ fear was that inflation would persist if firms and households used today’s rate as a benchmark for future wages and prices. They are right to worry. In Italy and Spain, wage growth is picking up even as unemployment rises, because of contract clauses allowing workers to be compensated for higher-than-expected inflation.”

Courtesy of stockcharts.com

With the Europe’s Stoxx 50 and Japan’s Nikkei down 27% and 28% as of August 15th, the markets may have already factored in or reflected the GIST of these downside adjustments, in my view.

In the context of Japan’s Nikkei, this observation of Darrel Whitten of Japaninvestors.com should articulate today’s development (highlight mine),

``Excluding the current recession, the 12 prior cycles included recessions that lasted an average of 13~14 months. This implies that Japan’s recession could linger into 2010. Moreover, as the Nikkei 225 has bottomed on average some seven months ahead of these recessions, a bottom in the Nikkei 225 probably won’t be confirmed until Q2 of 2009 or later.

``The good news however is that the Nikkei 225 has already discounted the bulk of the unfolding recession, as it already fell some 29% from a February 2007 high, and is now only about 6% away from what has historically been a post-recession trough (i.e., a 30% peak-to-trough correction). Of course, the previous three pre-recession bear markets involved peak-to-trough corrections of 40%~50%, but this was within the context of the Heisei secular deflation bear market, which we do not believe applies in this case.”

…unless of course, if the deflation conditions in the US and parts of the Europe gorges on the world economy and markets, a scenario we don’t think is likely.