Politicking Weighs On Phisix, Inflation Problems Have Been Policy Induced

``For far too long, we have accepted the idea that government can and should take care of us. But that is not what a free society is all about. When government gives us something, it does two bad things. First it takes it from someone else; second, it causes dependency on government. A wealthy country can do this for long periods of time, but eventually the process collapses. Freedom is always sacrificed and eventually the victims rebel. As needs grow, the producers are unable or unwilling to provide the goods the government demands. Wealth then hides or escapes, going underground or overseas, prompting even more government intrusion to stop the exodus from the system. This only compounds the problem.” Congressman Ron Paul Challenge to America: A Current Assessment of Our Republic

The Phisix has been bedraggled by administration led politicking which has led to its recent rout (down 3.1% over the week). Yet, the efforts by the mainstream media have been to affix the culpability to inflation which recently rose to a 9 year high. This mindless penchant to attribute false causes has been misleading the public compounded by blabbermouth experts.

Attribution To Inflation Woes Don’t Add UP!

As we argued in my recent post, Phisix Breakdown: Politics Not Inflation Related, goods and services inflation means the loss of purchasing power by the domestic currency to mostly fuel and food (which is what the news report says). Alternatively, this means that rising fuel and food prices have been getting a far larger share of expenses out of household or business budgets from which comes at the expense of non-fuel and non-food items. In short, spending on food and fuel crowds out other items. This is called relative price adjustments.

So in the perspective of relative prices applied to the equity markets, share prices of energy issues should benefit from the expectations of rising share of fuel expenditures and so with food related firms at the expense of other issues if “inflation” is the concern. Relative to the performance of energy companies, except for Petron Corporation, which amazingly soared by 17.65%, the rest of issues slumped such as Aboitiz Power (-3.57% w-o-w), Aboitiz Equity Ventures (-1.39%), PNOC EDC (-5.36%), First Gen (-1.43%), First Philippine Holdings (-3.03%) and Meralco (-4.07%)! So the so called inflation woes don’t add up.

Yet, inflation figures reported in the news reckon of past performance-particularly of last May. This means markets acting as a forward discounting mechanism should have discounted the past and read into the future.

If in the past (say last month or in May which read on the April figures) the market believes food and fuel inflation will continue to impact spending patterns in the future (which is today) then share prices of these issues would have likewise adjusted. This means at this point, shares of energy and food issues should be on an uptrend. But this isn’t the case.

And when the same deduction will be applied tomorrow or if once again the energy group is extrapolated to reflect on the continuing adjustments of consumption patterns then they should be expected to trend higher. This means prospective higher prices for energy issues!

But have we been seeing such dynamics? The reality is energy issues have either been consolidating (AEV, PCOR, AP and FGEN) or seem headed for the sewer (Meralco, FPH and EDC). Again, this inflation themed anguish doesn’t rhyme at all.

So why have energy issues (or the Phisix in general) been collapsing in the face of spending pattern adjustments arising from higher costs of fuel and food?

Because foreigners have been selling the Phisix! This week, foreign money has sold the most (Php 1.273 billion) since end of April. Coincidentally, the bulk or 68% of the foreign selling came at the time when the joint foreign chamber of commerce was being excoriated by our sanctimonious politicians.

A foreign chamber of commerce is a business organization representative of foreign owned enterprises in the Philippines. The benefits or costs accrued by their companies are transmitted to their countries which may induce or reduce incentives for future capital investments locally. Hence, any negative projection imparted by our leaders or by our political economy will negatively impact our image which may lead to foreign capital efflux aside from inhibiting future capital investments-our future jobs and taxes. So it becomes a paradox to brag about our “sovereignty”, especially under today’s “globalization” or increasing trends of cooperation and integration, when we can’t produce for ourselves enough capital to make enough jobs for our countrymen.

Besides, if as a foreigner you are invested in the country, having come to the realization that your equity ownership is at risk from political intervention, will you not sell and pull out? The answer is pretty obvious. Hence, the political risk arising from the administration’s continued assault on the private sector has been impairing the country’s attractiveness as a business destination. In effect, we have been shooting ourselves in the foot anew. We just hope and pray that sanity will be restored to our leadership.

Finally, the cause and effect between inflation and equities doesn’t necessarily have a linear correlation as we have always argued. To see an example, let us base it on recent global events-Kenya’s massive rise in its inflation data was equally met with a strong response in its stock market as shown in my post Kenya’s Mixed Message: Soaring Inflation Rates and Rising Stock Market.

Of course, Kenya is unlike Zimbabwe whose currency has practically collapsed down 84% since May and whose inflation rates is said to have vaulted to 1.8 MILLION PERCENT in May (Reuters). Of course, Zimbabwe’s hyperinflationary refuge has been its stock markets where its industrial index is up 261.15% in just ONE week while its mining index is also up 379.23% in just THREE days (allafrica.com)! In these we find that equity investments can become the corollary store of value when trust over a currency loses its foundation.

Yet, if there is any little trace of inflation based positioning in our domestic markets, well Figure 3 tells it best…

Figure 3 PSE data: Philippine Mining Index Diverges From the Phisix!

The Philippine Mining index (red line) has greatly outperformed the Phisix up 2.68% amidst the harrowing decline of the Phisix (black candle) over the week.

If inflation is defined as a loss of purchasing power against hard assets then naturally, resource based issues are likely to outperform under a massively devaluing currency reserve standard of the world, the US dollar.

Besides, since the Mining industry is the administration’s baby, (hopefully they won’t change minds), it is likely that there will be continued rotation towards such resource based sectors.

Figure 4 stockcharts.com: Resource based Assets Survive the US onslaught

And it’s not just here.

The major US benchmarks fell by about 3% last Friday, as the US dollar crumbled, to which some have associated the market’s reaction to the surprising stance by European Central Bank Jean Claude Trichet indicating the possibility of raising interest rates in July.

This unexpected declaration by Mr. Trichet allegedly prompted for a forced massive short covering across the Euro and commodities-particularly the oil benchmark which jumped by 8% the biggest increase since oil futures started trading in 1983 (NYT), aside from liquidation sales in the broad equity for margin calls. On the other hand, commodity related international stocks fell at a much subdued clip while mining and oil bellwethers in the US jumped (see figure 4)!

The Dow Jones Latin American Index (main window) slipped by 1.9% but still trades at near its recent highs, while the Dow Jones US mining index (pane below main window) shot to fresh record heights amidst the market turmoil.

Meanwhile, the Dow Jones Oil and Gas Services (middle pane) similarly leapt, as the Dow Jones Gold index (lowest pane) pivoted higher following the recent doldrums which has basically reflected the price action of gold.

As you would observe, except for the US Gold mining index which we think would follow suit higher, all three indices have been moving to the upside despite the increased volatility in the main US markets of late. This is “inflation” at its finest. In short, the loose correlation with the general market makes commodity based investments very attractive diversifiers.

Politically Induced Policy Measures Assures Of Prolonged Inflation Pains

All these market signals indicates too that the commodity and the “goods and services” inflation pressures being generated by the massive imbalances imposed upon by collective governments in skewing the global marketplace will continue to persist and risks even exacerbating. It is unhealthy to discount the possibility of a US dollar crisis.

In fact, our local politicos and the administration’s actions will likely compound on their dilemma with a slew of unintended consequences arising from their growing hostility towards the market instead of utilizing them for efficient allocation.

To give you an example the recent land conversion ban of agricultural properties ensures of the rising values of real estate which will likewise be reflected on rising rental prices as the supply of non-agricultural properties gets restricted in the face of growing urbanization and expanding population growth.

Figure 5: ADB’s Hyon H Son: Has Inflation Hurt the Poor?

As shown in Figure 5 courtesy of Hyon H. Son of ADB, rental comprises the largest of the non food expenditures for the Philippine poor and also for the non-poor.

So essentially, our government is simply shifting from one form of “popular” burden to another form of “unpopular” burden which eventually will get us slammed overtime anyway. Of course, the trick here is to understand how to cash in from the opportunities presented by the government’s populist impulsive driven policy gaffes.

Government’s Time For Self Introspection

And like all trends, commodities and good and services inflation doesn’t move in a straight line.

And as we also expected, inflationary pressures abroad has filtered to the domestic scene and will continue to do so until perhaps a global stagflationary recession occurs or a policy induced slowdown (tightening) by key Central Banks or nations collectively drop policy distorting measures (quite an impossibility).

Yes, another fulfilled expectations too is our (Bangko Sentral ng Pilipinas) BSP’s tepid response to rising “inflation” by increasing its headline borrowing and lending rates by a measly 25 basis points.

The unfortunate part is that increasing policy rates will do little good because-ONE, our inflation is basically imported, as University of Columbia’s Joseph Stiglitz recently wrote against inflation targeting, ``Inflation in these countries is, for the most part, imported . Raising interest rates won’t have much impact on the international price of grains or fuel. Indeed, given the size of the US economy, a slowdown there might conceivably have a far bigger effect on global prices than a slowdown in any developing country, which suggests that, from a global perspective, US interest rates, not those in developing countries, should be raised” and-SECOND, raising rates on baby steps doesn’t remove the accommodativeness of the Philippine monetary landscape.

Come to think of it even after raising rates, the margin of our inflation index has been growing wider compared to 1) the country’s economic growth rate or 2) the nominal rates set by the central bank or 3) the yields of our treasury bills, which means like many other central banks around the world, the BSP seems to be fostering an “inflation friendly” negative real rate environment, again another policy induced problem.

Of course not to mention that March money supply growth rate is nearly double or 9.6% of the recent economic growth clip-another prospective contributor to domestic inflation.

So essentially the problem with our government is that they have been looking for scapegoats at the wrong places and have been caviling on the private sector’s contribution to our economic woes, when in fact, it is time for them to do some self-introspection.

Faltering Phisix Issues, Firming Broader Market

``Successful speculation requires staying on top of changes in industries and companies that either create new industries or improve on existing industries. The majority of your profits will come from these two … The shrewdest traders throughout history all adapted the skill of reactionary change, as the market constantly presents new and different opportunities.” -Bernard Baruch (1870-1965), Financer, Speculator Statesman and Presidential Adviser

In a typical bear market, broad market issues are expected to fall faster than Phisix heavyweights, but recently a peculiarity emerged; Phisix issues seem to be falling faster than the broad market.

Figure 6: PSE: Advance Minus Decline Spread: Narrowing Volatility Over the Broadmarket

Figure 6 from the PSE data reveals that the daily advancing issues - declining issues spread from June 1, 2007 until Friday’s close, suggests that the downside volatility coming from certain issues are NOT being shared by the rest of the market or by the broader market as seen by the narrowing range of advance decline spread (see arrows).

The largest series of frenzied selling pressures occurred in July and in October of 2007 where the spread has reached nearly 150 issues. After which, there had been a sporadic bout of sharp selling episode seen in January and in March but at much lower incidence and degree compared to the initial burst.

Whereas last week, despite the steep decline of the Phisix (-3.1%), the spread has only gone beyond 50 issues!

This means the selling breadth has been narrowing and has been undergoing selective and not a broad market phenomenon. In other words, the concentration of mass based selling has eased considerably.

This should be seen as a POSITIVE factor as most issues appear to be holding ground even amidst a weakening Phisix.

Ironically too, the weakest link appears to be issues held most by foreigners or Phisix composite issues.

Figure 7: stockcharts.com: PLDT A Drag to the Phisix?

A prime example would be Philippine Long Distance Telephone (PLDT).

The (Philippine Stock Exchange) PSE’s largest listed company is likewise listed in NYSE under PHI symbol is shown sizably underperforming the Phisix in Figure 7.

PLDT commands about 26.5% of the Phisix free float adjusted market cap index, which means a single fluctuation from the largest telecom company is enough to jolt the Phisix towards its direction. Unfortunately, where from 2003 PLDT led the Phisix to its recent high and even cushioned the market during the recent decline until February 2008, today, PLDT appears to have reversed its role and signify as a drag to the Phisix.

Said differently, the recent fall of the Phisix has been greatly influenced by the declining telecom giant. Could our officials be responsible for this too (see Why Forcible “Free Texting” Will Only Lead To Increased Poverty)?

Friday’s formidable decline in the US markets took a heavy toll on PLDT down by 7.23%. We don’t know if US markets will recover on Monday, as the PSE is on a holiday, but certainly some of PLDT’s decline in NYSE will likely be felt as the Phisix opens on Tuesday. This probably means that both the Phisix and PLDT could break from its recent low (support levels) and possibly carve out a new low near or at the new support levels of 2,400 and 2,600 respectively before bouncing back. Over the short term yes, some selling pressure remains but this should be seen as an opportunity than stampeding out of fear itself.

Again given the improving market breadth, this new low could represent mostly a knee jerk reaction towards the recent politicking aggravated by the adverse reactions in the US markets. If our leaders simply bark with no accompanying bites, then our market will learn how to discount these and eventually recover. However, if talks will come with attendant action, then portfolio rebalancing is thus required or rotating to issues less likely held by foreign money or less sensitive to political intervention.

Remember, under inflationary-negative real rates environment, holding cash or money market instruments or bonds are likely to present as a losing proposition considering that inflation rates are far more pernicious (concealed taxes) and punitive for savers. Your cash purchasing power loses value overtime! Aside, interest income recovers only a segment of your cash holdings.

The next likely option is to invest directly on tangible assets or equity issues with tangible assets or to invest in other forex reserve rich and current account surplus currencies or equities.

Kenya’s Mixed Message: Soaring Inflation Rates and Rising Stock Market

Mainstream media tell us that “rising inflation” (goods and services) and stock markets don’t mix well. Our usual retort is it depends…

Just last week Kenya’s benchmark, the Nairobi Stock Exchange rocketed 5.83%...

Kenya's NSE 3 year chart Courtesy of Bloomberg

According to Indexmundi.com, Kenya’s annual historical and estimated inflation rate…

But just as its stock market surged, Kenya’s inflation rates reportedly likewise escalated beyond estimates:

Annual inflation rates spiraled 31.5% (reuters Africa) in May on the account of soaring food prices 44% (FT.com)!

Since we have sparse idea behind Kenya’s market dynamics we suspect this to be perhaps to be related to its oil exports or tea prices.

You see, Kenya’s main exports are tea, horticultural products, coffee, petroleum products, fish and cement (indexmundi.com).

Although it registered crude oil production of a measly 9,627 barrels a day in 2006, of which exports accounted for 7,377 barrels a day in 2006 according to the Energy Information Administration.

It could be that since Africa is a hotbed for the next generation of oil and gas exploration, the sprightly stock market activities could be oil related or if not due to soaring TEA prices. Of course all of these are just conjectures on my part.

The point being: Rising “goods and services” inflation DOES NOT ALWAYS EQUAL to slumping equities.

Phisix Breakdown: Politics Not Inflation Related

Philippine “Inflation” surged to its highest level in 9 years and got blamed for the Phisix breakdown. Nonsense.

First, the Phisix had been falling even prior to such news. In fact it has dropped in 6 out of the last 7 sessions. On the other hand, the Phisix rallied prior to the strings of losses even as “inflation” reached an “unexpected” (for our authorities) high. So inflation is nothing but an excuse.

Two, the biggest damage today were seen in Lopez owned companies…Benpres (-8.91%), First Philippine Holdings (-7.35%) and Meralco (-4.1%), all of which had borne the brunt of the selling pressures since the wrangling over the Meralco management emerged.

Phisix black candle, BPC blue, Meralco red and First Philippine Holdings green

True, the broadmarket fell but what needs to be understood is that this is more of a contagion related than inflation instigated carnage.

Third, as a matter of irony inflation means loss of purchasing power relative to high food and energy cost. Thus why has energy related investments plunged?

When government harangues or puts the blame on the market for any particular reason with threats to “intervene” by restraining property ownership rights for pretentious social purposes, then it is natural to expect market participants to flee from the market out of the fear of loss of equity ownership from its socialistic tendencies.

The blame should be on politics and not inflation.

World Bank’s Doing Business in the Philippines 2008

Some important highlights from the World Bank’s Doing Business in the Philippines 2008

Best equity returns belong to countries with the most number of positive reforms.

Since many emerging markets have likewise been undertaking reforms, the competition to attract investments should be a continuing dynamic. Increasing competitiveness means constant in-depth reforms relative to our competitors. Tentativeness or lackluster actions translate to a decline in relative performance or our attractiveness as a place for viable investments decreases.

Aside from the national levels, reforms can also start with the local (LGU) levels.

The table above shows of the best performing “Doing Business” categories in the Philippines. At the right side of the table is the equivalent ranking based on global standards. This shows that there is much room for needed improvements.

For our leaders and prospective leaders this should be a great starting point for a meaningful governance agenda.

Good luck to them.

Noteworthy Quotes and Top life tips from favorite iconoclast Nassim Nicolas Taleb

Mr. Nassim Nicolas Taleb is the author of best selling books must read investment books as Fooled by Randomness: The Hidden Role of Chance and the Black Swan: The Impact of the Highly Improbable.

Short background:

-Mr. Taleb charges about $60,000 per speaking engagement and does about 30 presentations a year to ``to bankers, economists, traders, even to Nasa, the US Fire Administration and the Department of Homeland Security” according to Timesonline’s Bryan Appleyard.

-He recently got $4million as advance payment for his next much awaited book.

-Earned $35-$40 MILLION on a huge Black Swan event-on the biggest stockmarket crash in modern history-Black Monday, October 19,1987.

Some of Mr. Taleb’s noteworthy quote in the Mr. Appleyard’s Timesonline article...

“Scientists don’t know what they are talking about when they talk about religion. Religion has nothing to do with belief, and I don’t believe it has any negative impact on people’s lives outside of intolerance. Why do I go to church? It’s like asking, why did you marry that woman? You make up reasons, but it’s probably just smell. I love the smell of candles. It’s an aesthetic thing.”

“Complex systems don’t allow for slack and everybody protects that system. The banking system doesn’t have that slack. In a normal ecology, banks go bankrupt every day. But in a complex system there is a tendency to cluster around powerful units. Every bank becomes the same bank so they can all go bust together.”

“Governments and policy makers don’t understand the world in which we live, so if somebody is going to destroy the world, it is the Bank of England saving Northern Rock. The biggest danger to human society comes from civil servants in an environment like this. In their attempt to control the ecology, they don’t understand that the link between action and consequences can be more vicious. Civil servants say they need to make forecasts, but it’s totally irresponsible to make people rely on you without telling them you’re incompetent.”

“Let’s be human the way we are human. Homo sum – I am a man. Don’t accept any Olympian view of man and you will do better in society.”

Finally, Taleb’s Top life tips…

1 Scepticism is effortful and costly. It is better to be sceptical about matters of large consequences, and be imperfect, foolish and human in the small and the aesthetic.

2 Go to parties. You can’t even start to know what you may find on the envelope of serendipity. If you suffer from agoraphobia, send colleagues.

3 It’s not a good idea to take a forecast from someone wearing a tie. If possible, tease people who take themselves and their knowledge too seriously.

4 Wear your best for your execution and stand dignified. Your last recourse against randomness is how you act — if you can’t control outcomes, you can control the elegance of your behaviour. You will always have the last word.

5 Don’t disturb complicated systems that have been around for a very long time. We don’t understand their logic. Don’t pollute the planet. Leave it the way we found it, regardless of scientific ‘evidence’.

6 Learn to fail with pride — and do so fast and cleanly. Maximise trial and error — by mastering the error part.

7 Avoid losers. If you hear someone use the words ‘impossible’, ‘never’, ‘too difficult’ too often, drop him or her from your social network. Never take ‘no’ for an answer (conversely, take most ‘yeses’ as ‘most probably’).

8 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.

9 Hard work will get you a professorship or a BMW. You need both work and luck for a Booker, a Nobel or a private jet.

10 Answer e-mails from junior people before more senior ones. Junior people have further to go and tend to remember who slighted them.

Why Forcible “Free Texting” Will Only Lead To Increased Poverty

``Congress, devoutly promise that all their actions are based on good intentions. But it doesn't matter: bad ideas regarding the nature and role of government breed bad results and suffering occurs nevertheless. Twisted logic, Machiavellian justifications, excuse making, and short-run benefits can never justify the removal of one iota of liberty from any one person if we intend to live in a free society.” US Congressman Ron Paul, The Economics of a Free Society

People always ask why the Philippines remain “poor”? Our reply has been “because of the lack of respect of markets, the dearth of economic common sense, the dependency culture, political hubris and the incessant pandering by authorities to buy public opinion through government intervention”.

``The problem is not that supply and demand is such a complex explanation. The problem is that supply and demand is not an emotionally satisfying explanation. For that, you need melodrama, heroes and villains”, wrote Thomas Sowell. And melodrama is what has prompted for the recent “Free Text” ruction, where in essence this is all about PRICE CONTROL.

Because of the huge profits accrued, domestic telecoms companies have been portrayed by some public officials as “villains” for not providing text messaging services for free. The assumption is that telecom companies have undeservingly been making huge profits at the “expense” of consumers (the “victims”) something analogous to taxation. Thus, the soi-disant “heroes” threatens to impose redistributive “justice” by compelling these “greedy” firms to make good free text messages as part of “social” service….or else!!!

The Survivorship Bias and Earnings Cycles

English novelist George Orwell once wrote, ``Power-worship blurs political judgment because it leads, almost unavoidably, to the belief that present trends will continue. Whoever is winning at the moment will always seem to be invincible.”

Thus before passing any generalization it would be best to examine the facts behind the issues.

For starters, the telecoms industry is a capital intensive industry; it requires Billions of Pesos in capital investments for its infrastructure rollout to be able to operate.

Yet the public or our so called “heroes” DO NOT SEE or REALIZE that the huge sums of investments DO NOT automatically GUARANTEE profits. This is why it is called as RISK CAPITAL. Nobody puts at risk his or her capital without the attendant expectations of profits or return on investments (ROI). If a venture goes wrong, investors LOSE equity, on the other hand, if they are right they deservingly REAP profits. So there is ALWAYS a TRADEOFF.

In the same way, even if the domestic telecom industry have been earning today, this DOES NOT GUARANTEE that they will NOT LOSE tomorrow or sometime in the future. Risk taking endeavor is always an ONGOING DYNAMIC because the challenge is the future. Yesterday’s performance may or may not be the same for tomorrow. The past has been perfected, but the future still needs to be ascertained.

Unfortunately people and those in power simply don’t understand this. They are skewed to only see the profits and NOT the ACCOMPANYING RISKS (called survivorship bias-the fallacy of seeing winners only), hence makes a bigoted issue out of these.

It is not always cloud 9 for the industry.

Figure 1 Ed Yardeni.com: S&P Telecom P/E Ratio

As an example, figure 1 courtesy of Yardeni.com shows of the Price-Earnings Ratio of the US S&P 500 Telecommunication sector. As you can see, the PE ratio peaked in 2000 and collapsed by more than half as the dot.com bust unraveled. This shows of how investors paid exuberantly for share prices of telecom issues in 1998-2000 in the EXPECTATIONS of the continuity of astronomic earnings growth seen in the recent past (early 90s). When reality sunk in, where expectations did not match with real earnings, prices retrenched. Until now or eight years from the pinnacle, the price earnings ratio of the US telecom companies remains depressed!

So huge profits are a permanent fixture for the industry? Think again.

Remember, earnings growth in any industry undergoes cyclicality. For instance, the wireless segment of the telecom sector, the biggest earnings revenue contributor today, is likewise subject to the innovation cycle (innovation, growth, shakeout, maturity and end phase).

As the cycle segues from rapid growth (today) to the maturity phase, the explosive pace of growth will eventually slowdown to match or track the pace of the country’s economic growth or GDP. It can only manage to sustain such extraordinary levels of growth if it is able to introduce more revolutionary innovative products which consumers will patronize. But then again, that is a risk which the industry has to bear with by spending largely for its research and development.

Telecom’s Success Formula: Competition

Another, the telecom industry operates under a deregulated environment. This means that industry firms would have to STIFFLY COMPETE among each other to be able to attract enough subscribers in order to recoup on their investments and eventually earn from it.

And how do they do that? By offering BEST POSSIBLE SERVICES at the MOST AFFORDABLE PRICES.

As the “Text capital” of the world, we are said to have been privileged with the lowest “texting” rates in the region. From the Philippine Star, `` [Globe Telecom senior vice president Rodolfo Salalima] Salalima also emphasized that the Philippines has the lowest text messaging rates in the region. Because of the various promotional campaigns being offered by local telcos, particularly unlimited texting, text-messaging rates in the country have gone down to as low as 13 to 14 centavos per message.

``This rate, he stressed, is extremely low when compared to India’s 61 centavos per text message, Malaysia’s 67 centavos, Indonesian Extelcomindos’ P1.18 per message, China’s P1.55 per text, and Hong Kong CSL’s P15.91 per message.”

Meanwhile, the penetration levels for domestic mobile have reached 51% or some 46 million in early 2007(marketreserach.com), which means more than half of the population is now connected.

Yes, the success to spread connectivity in the country today is principally due to intense competition, which has immensely LOWERED prices and thus added subscriber volume or by expanding coverage.

Economics 101 tells us that if you want more of anything you simply lower the cost and if you want less of anything you increase the cost. But as a caveat this important insight from Mr. Jeff Bezo, Amazon.com’s CEO, ``Lowering prices is easy. Being able to afford to lower prices is hard", which alternately means lowering prices has its limits. You can afford to lower prices enough to keep some profits to ensure the survivability of the company.

And this has not been an isolated or a Philippine only phenomenon but a global one as shown in Figure2.

Figure 2: ITU: Global Mobile Industry has been Powered by Competition

Where monopoly once dominated the telecom industry today competition has taken over. Because of competition which brought upon affordable pricing worldwide, in 2007 mobile the penetration level have exploded to around 49% or some 3.3 billion subscribers (news.com.au).

Enormous Capital Investments Need Huge Earnings

It does not end here.

Because the industry is technology laden, this means that it would require CONTINUOUS ACCESS to risk capital in order to EXPAND CAPACITY (think nationwide coverage, reduction of dead spots, reduced time lags from message sending to receiving, international roaming et. al.), UPDATE/UPGRADE TECHONOLOGY (think Multi-media messaging, 3G) or to INNOVATE (think WIMAX, IPTV) its infrastructure or to even CUSTOMIZE PRICING (think unlimited texting or calls) for the very same purpose of attaining viability of the project by offering QUALITY and EFFICIENT SERVICES at AFFORDABLE PRICES to attract MORE subscribers and earn profits from it. As earlier mentioned it has to also spend for considerable investments on RESEARCH and DEVELOPMENT.

Not only that…billions of Pesos of existing infrastructure is similarly subject to OBSOLESCENCE RISK-where the risk to infrastructure or extant technology becomes obsolete or outmoded!

Figure 3 Ray Kurzweil: Moore’s Law

Figure 3 from futurist Ray Kurzweil shows of how technology propelled innovation have accelerated exponentially or the “S” Curve. This means that technology based companies like those in the telecoms will have to be nimble enough to adapt to the swift advances in technology or lose subscribers and money.

In short, HUGE PROFITS are thereby REQUIRED for the UPKEEP of the capital intensive system of the telecom industry to ensure its survival. Nonetheless, what needs to be further stressed is that such profits are never guaranteed and is never static since it breathes upon the patronage of fickle consumers! Consumers like voters can easily change preferences for whatever reasons.

Consumer Sovereignty and Patriotism as Refuge of Scoundrels

When consumers subscribe to a company’s service (post paid or pre paid), this is because of the perceived satisfaction or utility derived from the services offered. They are done VOLUNTARILY and NOT BY FIAT. Consumers always have the option to terminate or transfer to other firms offering similar generic services (or more) because they see it fit according to their interests. This is called consumer sovereignty. It is unlike taxation which derives revenues by FIAT or decree. By the same token it means that earning by risk taking and earning by coercion are TWO different animals.

It is obvious that the failure to understand the dynamics of the industry is by itself a manifestation of grand myopia. Thus, the projection of the “immorality” of profits is totally unwarranted, unjustified and unfair.

Yet while pretending to serve for the best interest of the populace or consumers, this propaganda or threat to intervene via price controls actually seems more of a camouflage for punishing them.

The threats to compel free text messaging signify irresponsible statements which are wantonly absurd and have far reaching dire unintended consequences. The unfortunate part of government intervention is- “they make the rules, we the nation suffer from it”.

What possibly happens when such policies gets implemented?

Since text messaging for the telecom industry today is a MAJOR profit center, it will shift to a COST CENTER or at worst transform into a SUNK COST.

Stated differently, the telecom industry’s incentives will be overhauled overnight. Companies will either (at best) marginalize on improving on the cost center subject to subsidies from HIGHER PRICES of other services (higher toll fee for wireless, landline, data and other services) or look for other sources of revenue center (maybe via a shift towards content subscription) or (at worst and most likely path) totally ABANDON the text services altogether.

In the private sector, a nonprofit cost center can only exist when it indirectly contributes to other sources of revenues. (Think GOOGLE-it provides free search engine as a come on in order to generate significant traffic volume from which attracts advertisers-the company’s main revenue source). However, if the cost to maintain the cost center exceeds the profit potential from its major sources of revenues then it bleeds the overall operation of the company which leads to imminent closure.

Plainly said, the revenues lost from text messaging will now be recovered in the form of HIGHER prices of OTHER services. If they are not able to do so, you can kiss text messaging goodbye.

Think of it, who in the right mind would spend tens of millions or billions of capital to upgrade the network if it is non-revenue generating anyway or if it does not compliment to revenue generation?

Remember, this is NOT a government bureaucracy which can afford to subsidize one sector. In the market, revenues are derived from VOLUNTARY exchanges. In government, revenues are derived from seignorage (money issuance) or taxation-which comes out of compulsion as a subject of the state. In short, taxation is predatory-people don’t have the LEGAL option to say NO to taxes, except by tax evasion or smuggling which is punishable by law.

Put differently, in the market, people have the power to say NO to poor services by voting with their money. In government, people are NOT empowered with the same privilege. Instead we will have to bear with the inadequacy of public services because it is imposed by edict.

So applied to price controls, the choice would be having jerrybuilt or substandard services (think severely delayed text messages which may take hours, days, weeks to receive-if at all) or none at all! Besides, anything free could mean an exponential rise in usage which may vastly exceed the network capacity (systems overload) of telecom firms and thus heighten risks of a network system crash!

Moreover, because of reduced earnings, companies in the embryonic stage or with razor thin margins will simply vanish due to insolvencies.

All these combined, you can be guaranteed of even more HIGHER rates for the other residual services from the remaining service providers!

As Ludwig von Mises wrote, ``If the government fixes a maximum price for certain commodities below the level which the unhampered market would have determined for them and makes it illegal to sell at the potential market price, production involves a loss for the marginal producers. Those producing with the highest costs go out of the business and employ their production facilities for the production of other commodities, not affected by price ceilings. The government's interference with the price of a commodity restricts the supply available for consumption. This outcome is contrary to the intentions which motivated the price ceiling. The government wanted to make it easier for people to obtain the article concerned. But its intervention results in shrinking of the supply produced and offered for sale.”

Because reduced supply from policy initiated incentives equals higher prices, price controls do more harm than what is intended.

At the end of the day, the road to hell is paved with noble intentions. Free text messaging equals no text messaging and or higher cost of other communication services.

On the other hand, the only more viable way to bring down prices is to liberalize the industry or open it to MORE competition as shown above.

Aside, our authorities have another option of reducing prices: REDUCE TAXES but with CORRESPONDING DEDUCTION IN SOCIAL SPENDING. Our glib talking politicians should not only vent on the industry but should look at their own bureaucracy as a source of savings. They should consider giving back to the people their wasteful and inefficacious boondoggles in the form of pork barrel!

Nationalization Next?

So once interventionism creeps in, what’s to stop the government from going further?

The next step would probably be to put a cap or ceiling on prices of the other sources of revenue sources. This should translate to humongous losses and lead to industrywide foreclosures.

In the same manner if the government compels companies to operate free text services by bleeding them dry, the industry would simply allow itself to be taken over.

Hence, government completes the transition by effectively “nationalizing” the industry.

By nationalization, government would need tons of capital from which would come from taxpayer funding. Remember, the lifeblood of this industry requires recycling of huge capital. The assumption that government can manage the monopoly profitably is wishful thinking given its horrible track record and its LACK of resources.

As a political entity, the cosmetically rehabilitated state owned company will only be an endemic source for political appointments which will be hobbled with incompetence, abuse, corruption and other forms of capital allocation inefficiencies. It will be another potential cow to milk at the expense of consumers.

If the company will offer mobile services (at subsidized rates) under subsidies from the national government, losses accumulated will be charged to the unfortunate productive taxpayers, whom will bear the brunt of higher taxes and or higher costs of living.

If they should charge for services, given the monopoly and inherent inefficiencies, whatever services will be paid for will be at VASTLY greater prices than what it is today even at the face of dysfunctional or shoddy quality of services.

Thus, your free text becomes both a DIRECT and INDIRECT tax to consumers!

In a world where technology has helped improved the lives of people by increasing communications, connectivity, interaction and business transactions and trades by lowering costs, price controls and unnecessary intrusions by government will undo these progress. We are likely to materially slowdown, if not regress.

Ultimately all these should lead to immense lost productivity, loss of competitiveness, loss of investments, capital flight, loss of jobs, higher taxes, higher cost of living, lower the standard of living, a more intensified corruption and worst of all increased poverty.

Politics Likely A Factor-“Flexing Political Muscles”

The incumbent President is an economist, so we are inclined to believe that she is very much aware of the negative repercussions from the derring-do actions of her subordinates, unless she is a closet hammer and sickle bearing ideologue (which so far enough hasn’t been the case).

That said, it is likely that the administration could be seen as “flexing its political muscle” as a demonstration of strength that it is still a power to reckon with even as her tenure approaches the twilight (or the projection that the administration is not in a lame duck state). This is especially directed to whom she perceives as her political opponents. (Yes some of the supporters of her adversaries are stalwarts from the industry).

Yet political maneuverings will do us no good by signaling to investors of the country’s vacillation to sanctify contracts and or uphold private ownership rights. Moreover, it is this kind of interventionist culture that inhibits a market economy from flourishing, aside from the perpetuation of the state of corruption.

As the illustrious economist Milton Friedman once said, ``There is no such thing as a FREE Lunch! To paraphrase, ``There is no such thing as a workable forced free texting!

As a final thought and disclaimer, my perception of the industry is one where it has been cherry picked or where the “low hanging fruits” have already been harvested. The rapid growth phase seems likely to transit into a mature phase which should grow in line with the economy over the coming years. Thus the performance of the telecom sector should reflect the growth of the Phisix than massively outperform as in the past, in my view. As a market participant who aims for “growth” and unpopular “value”, the industry has not been much of a priority, which means I DON’T OWN any telecom issues as of this writing.

Phisix: Plagued By Domestic Politics

``The interventionist doctrinaires and their followers explain all these undesired consequences [of government intervention] as the unavoidable features of capitalism. As they see it, it is precisely these disasters that clearly demonstrate the necessity of intensifying interventionism. The failures of the interventionist policies do not in the least impair the popularity of the implied doctrine. They are so interpreted as to strengthen, not to lessen, the prestige of these teachings. As a vicious economic theory cannot be simply refuted by historical experience, the interventionist propagandists have been able to go on in spite of all the havoc they have spread."-Ludwig von Mises, Human Action

One of the risks we mentioned in today’s marketplace, aside from external recessionary environment, is domestic political risk.

Considering that foreign money has not been much of a driver of late, the Phisix has been subjected to mainly domestic sentiment, which has gyrated from the flux of events dominated by politics as the inopportune MERALCO affair.

Political Grandstanding Amidst Global Inflation

While external markets have mainly recovered from the other week’s selloff (see figure 4), the Phisix closed .77% lower over the week weighed by the seeming “tightening of the noose” by government officials on the marketplace as seen in the sordid Meralco imbroglio aside from the “free texting” and Banking industry’s forex deals.

Figure 4: stockcharts.com: Phisix versus the World

As we have repeatedly noted, the rising prices of consumer goods and services have spurred officials to do “something” in the face of public pressure if not as a deflection from controversial issues surrounding the administration. Essentially officials have vented the blame on public utilities for such dilemma.

Our public officials have not been forthright though; in an interview over an international business network we even hear the chief of our central bank claim that “inflation pressures” arose from “supply shocks”. This isn’t exactly the picture.

Like the rice crisis, these supposed “shocks” have been exacerbated by knee jerk political reactions (e.g. restriction of exports by surplus food producers or panic buying from the Philippines abroad) than the genuine causality. To date, since the rice crisis emerged, there has been no indication of a rice crisis for the commercial rice, but in the past-on NFA or government subsidized rice level. What was featured as a nationwide crisis in media was certainly true for some areas but not all.

Figure 5 ino.com: July Rough Rice

Of course, since many governments have now regained their composures and tempered their trading curbs aside from supply side responses to high prices in terms of more harvests (Bloomberg), rice prices have moderated (see figure 5)—for now.

With a sharp correction in major commodity prices this week, it is likely that goods and services inflation will probably have a “reprieve” in the coming weeks or months. But it is highly unlikely that these inflationary trends will meaningfully subside given the penchant for governments to “socialize” under the present landscape.

However, the fact is every part of the world today has been experiencing “goods and services” inflation, even among developed countries suffering from a credit squeeze due to the recent housing industry bubble bust. This means that goods and services inflation has basically been IMPORTED and not simply due to a domestic/global “supply” shock. Rising demand from emerging markets as China and India represents similarly a “demand” shock.

What policymakers have eluded to say is that monetary (monetary pegs, negative interest rates, bridge liquidity provisions for the credit affected financial sectors in the developed worlds, currency debasement or “competitive devaluation” programs in emerging markets) and fiscal policies (subsidies, high taxes and tariffs, trading curbs, non-transparency, nationalization, et. al.) have severely distorted the functions of price discovery, price transparency, pricing efficiency as allocators of resources in the marketplace, pushed a tsunami of money into the financial system, which has been finding a refuge at hard assets, where others superficially interpret as “market fundamentalism”, a.k.a. speculation.

Yet because most people don’t understand what is truly going on, for simplification purposes, somebody or some entity would have to take the blame.

This means that the first line of assault would be on the public utility providers, where “profits” are scrutinized and condemned as “unjust” and contributing to “inequality” and “poverty” thus requiring redistribution. Bolivia is an example of this recent movement, as it recently nationalized energy and telecom companies. Could we be smelling the same pattern here?

The popular notion is, if you squeeze public utility operators of profits or “nationalize” them, prices of basic services will go down. Baloney. Yes, this will happen over the short period of time. You can party for as long as the booze will last, but not when it gets depleted.

The basics is that the government can only afford to “subsidize” for as long as the revenues it gets is enough to compensate for this, which is the same as saying picking from taxpaying (productive) Pedro and doling out to non-taxpaying (non-productive) Juan. The problem is that the source of looting is limited while the demand for financing is unlimited.

The key question now is “Can a country’s productive sector permanently sustain a non productive sector?” The obvious answer is no. Eventually the country which undertakes heavy socialization or welfare programs will pay for the political mountebank when it enters into a financial crisis or sees its standard of living decline.

That’s why politics is always about short term convenience at the expense of the long term pain. The fundamental problem is that the public is easily directed away from the true causes.

A Snippet on Meralco’s Controversies

Energy issues have been taking the brunt with monopoly distributor Meralco down 3.91% over the week (down 25% from the week ending May 2^nd), aside from First Philippine Holdings (14% w-o-w) and Petron (10.53%-it’s a wonder if foreign investors are now anticipating a political spillover to this issue).

Fortunately enough, the strong performances in Friday ended the week positive for telecom issues and banking issues (led by Banco De Oro up 7.45% and Union Bank up 11.11%-could some prospective deals be brewing between them?).

As for Meralco we have not scrutinized on the nitty-gritty of the ongoing controversy but have construed the recent developments as possibly emanating from the following motivations:

One, a political retribution or a ruse to engage a vocal supporter of a well entrenched political adversary or

Two, an attempt to sidetrack the controversies surrounding the recent government scandals by redirecting the public attention to “goods and services” inflation by effectively focusing on utility providers as culprits, or

Three, a possible economic opportunity for certain interests group to wrest the management in order to benefit from the ongoing changes under the Electric Power Industry Reform Act (EPIRA) in the power sector. As a distribution monopoly, grabbing hold of this strategic network by any of the power producers ensures of a captive market.

Lastly, a combination of any of the three.

What are the major points of contention we can observe of in the corporate dispute:

-Take or Pay provision, a derivative of the 1993 Electric Power Crisis Act of the Ramos Regime which is the source of the wrangling over the charging of system losses.

-Royalty taxes and VAT charges

-alleged conflict of interest from cross ownership

So essentially you have a technical LEGAL spat over a government monopoly franchise operating under an intensely regulated industry.

Since the Lopezes have not been cordial or in good graces with the administration, the present environment of rising good and services inflation makes them susceptible targets for politicking.

But of course, other tangential concerns have brought upon by left leaning groups as;

-Subsidies
-market abuses from operators
-regulatory capture or regulators overwhelmed by those regulated
-corruption
-high rates required to sell Napocor assets
-“high prices breed inefficiency”

…our unsolicited comments;

-subsidies-see above
-market abuses (because of the monopoly), corruption and regulatory capture (the latter two are intertwined-regulators get controlled because they can be bought) are principally offshoots to overregulation. They represent the symptoms and not the cause.
-high prices in itself do not “breed” inefficiency but reflects on demand and supply even if they have been contorted with misaligned or skewed policies (e.g. high taxes) or lousy management. Simply said, high prices are the result of accrued inefficiencies. High prices DO NOT create, breed or foster inefficiencies; policies do. You put the horse before cart, and not the other way around.
-high rates needed to sell NPC assets accounts for a slippery slope argument. Investors invest because of the attractiveness of returns relative to risks not because of high prices. High prices do not guarantee returns. It’s the net margins or the ROI that counts!

Yes while a new management maybe able to trim down rates to achieve so called “efficiency” (which is highly doubtful), the fact that our problems is basically one of “imported inflation” ensures that over the long term energy prices will continue to rise unless:

One- demand destruction overtakes the global economy via ‘stagflation’ or

Two- alternative energy or unconventional energy sources will be able to generate sufficient economies of scale to overhaul the energy dynamics of the global transport and energy consumption infrastructure.

Three-policies will be undertaken to remove excess liquidity in the global financial system (meaning a policy induced recession)

Next, for the local energy sector, I’d like to give the EPIRA a chance to be fully implemented compared to a centralized energy policy since 1972 (Presidential Decree 40 - “Establishing Basic Policies For The Electric Power Industry”), where Napocor’s unwieldy P 600 billion debt should be enough lesson for us.

Risks of Owning Public Utilities

Figure 6: PSE: Industrials Taking the Heat

Of course, the major risk of owning “sensitive” public utilities today is that political powers will probably use them as scapegoats to pass populist policies which should be detrimental to the industry or to the society. The least is to harass them for publicity purposes as we might be probably witnessing today.

Figure 6 shows how the PSE Industrials have been buffeted by political volatility (aside from the recent bearmarket pressures) and is seen in a continued downdraft, where Meralco (26% of the Index) and other energy and public utilities are benchmarked. Overall the Industrials have been a sizeable drag to the “recovering” Phisix.

Besides, the risks of nationalization or instituting price caps or government takeover are enough reasons to dissuade foreign investors from owning these issues, even if it were just mere rhetoric. The problem is that it could be seen as an attempted assault on private ownership rights which tarnishes our credibility and takes sometime to restore.

Of course we don’t discount that there is a possibility that all these could also signify tactical moves of a facelift poop and scoop operation where investors flee from anxiety while giving entry opportunities for those fostering such scenario.

But on the contrary, we also understand that a declining Phisix isn’t a good reflection for the administration (especially if world markets begin to markedly advance) which habitually likes to take credit or bask in the glory of its past successes.

This means that if the Phisix will lag the world because of continued politicking, the meddling into these industries might suddenly or surprisingly fade! But this is being hopeful.

Important Disclosure:

This is not to say that you should own or not own public utilities shares. Instead, this is to evaluate on the risks of owning public utility shares given today’s “inflation” driven politicized environment. It represents risks or opportunities to gain from such risks. This is a market critically dependent on the path of government action.

Besides, not all of the public utilities share the same or equal measure of risks.

Writer owns shares of First Gen (FGEN).