Inflation: Myths And Beneficiaries

``Inflation is socially disruptive in that the management of fiat money — as all today's currencies are — causes great hardships. Unemployment is a direct consequence of the constantly recurring recessions. Persistent rising costs impoverish many as the standard of living of unfortunate groups erodes. Because the pain and suffering that comes from monetary debasement is never evenly distributed, certain segments of society can actually benefit. Ron Paul Challenge to America: A Current Assessment of Our Republic

It is commonly thought that consumer goods and services inflation is bad for EVERYONE. While inflation represents as stealth tax and is bad for the society from a generalized perspective, on a relative basis some groups benefits from inflation more than the others.

To quote Ludwig von Mises Institute President Lew Rockwell (highlight mine), ``For most people, it is seen the way primitive societies might see the onset of a disease. It is something that sweeps through to cause every kind of wreckage. The damage is obvious enough, but the source is not. Everyone blames everyone else, and no solution seems to work. But once you understand economics, you begin to see that the value of the money is more directly related to its quantity, and that only one institution possesses the power to create money out of thin air without limit: the government-connected central bank.”

So when you see people on the streets scream for price controls, in the understanding that “inflation” is caused by anything BUT the government themselves. They mistakenly believe that government can control the economic laws of demand and supply by intervening in the markets.

And you have politicians pretending to address “inflation” with even more interventionist “inflationary” actions, from Ludwig von Mises in Economic Freedom and Interventionism (emphasis mine), ``To avoid being blamed for the nefarious consequences of inflation, the government and its henchmen resort to a semantic trick. They try to change the meaning of the terms. They call "inflation" the inevitable consequence of inflation, namely, the rise in prices. They are anxious to relegate into oblivion the fact that this rise is produced by an increase in the amount of money and money substitutes. They never mention this increase. They put the responsibility for the rising cost of living on business. This is a classical case of the thief crying "catch the thief." The government, which produced the inflation by multiplying the supply of money, incriminates the manufacturers and merchants and glories in the role of being a champion of low prices.”

Therefore, inflation is fundamentally ALL ABOUT GOVERNMENT, whether it is caused by monetary expansion (Milton Friedman-“always and everywhere a monetary phenomenon”) or government spending (Dr. John Hussman- “government spending expansion, regardless of the form, will tend to raise the marginal utility of goods and services while lowering the marginal utility of government liabilities…but as long as a government appropriates goods and services to itself in return for pieces of paper that compete as stores of value and means of exchange in the portfolios of investors, you'll get inflation”).

Under a free market environment, marginal utility-satisfaction of consumers from consuming one or more unit of goods or services (investopedia.com)-imbalances via supply constraints or unfulfilled demands or generally “relative prices” are usually temporary and resolved by market forces, through the natural adjustments in production and consumption guided by market prices.

Thus, the prolonged nature of imbalances or the popular known “inflation” are nonetheless caused by distortions on the public’s marginal utility by government instituted policies, spending and or money expansion.

Remember, the MISMATCH OF INCENTIVES that guides government actions (preservation of political power or non-economic motives) and the general public (economics) reinforces the inflationary dynamics within a society.

A very lucid example is the biofuel subsidies in the US which have been meant to promote agri based (corn) feedstock biofuel as alternative energy source in order to reduce dependency of fossil fuel.

The subsidies had been political in nature, i.e. promoted agri industries (and its corresponding voters and political financiers) at the same time aimed to reduce the political power of unfriendly oil exporting nations by reducing revenues via lower US imports, but this came at the expense of public as an unintended outcome, i.e. through higher world food prices due to reduced acreage for food. The Guardian reports that a soon to be released study from the World Bank discloses the impact of such subsidies to as much as 75% of price hikes in food! Yeah, government knows what is best right?

Today’s monetary architecture has the de facto US dollar “paper” standard system as the ultimate source and transmitter of world inflation, especially punctuated under today’s globalized or more integrated financial landscape compounded by cumulative effects of currency pegs/US dollar links or monetary structure by many countries aside from the disparate policies (fiscal and monetary) of each nation.

While globalization has its benefits (see recent post Globalization Highlights From Past To Present), it has equally carried over some of the imperfections.

So who benefits from inflation?

Primarily the government. Political pressures from the public for government to intervene in the marketplace mean further empowerment of governments (of course the politicians and the bureaucracy).

This means more government spending or roots for added inflation in the future. Example, because of the Rice crisis, the Philippine agricultural department is asking for an additional/supplemental budget of Php 15 billion (US$337 million) allegedly “to help farmers and consumers” (inq7.net). More long term distortions in the marketplace, yet more potential loopholes for corruption for the purpose of short term mitigation.

Second, the affiliates of government or economic agents that deals directly with the government. The Banking industry, for instance, as primary agents for the fractional reserve banking system has been a recipient of “privileged deals” from the US Federal Government at the expense of US taxpayers. Think the Fed engineered JP Morgan’s takeover of Bear Stearns.

Or how about today’s Fannie Mae and Freddie Mac (F&F) episode; the recent rescue of the GSEs highlights the chain of special “political” connections by the Federal government-banking-mortgage industry.

Figure 2: US Global: World Holdings of US Long Term Agency Debt

From RGE Monitor’s Nouriel Roubini (hat tip: Craig McCarty), ``The existence of GSEs and the implicit subsidy that they provide to the housing sector and mortgage market is a major part of the overall U.S. subsidization of housing capital that will eventually lead to the bankruptcy of the U.S. economy. For the last 70 years investment in housing – the most unproductive form of accumulation of capital – has been heavily subsidized in 100 different ways in the U.S.: tax benefits, tax-deductibility of interest on mortgages, use of the FHA, massive role of Fannie and Freddie, role of the Federal Home Loan Bank system, and a host of other legislative and regulatory measures. The reality is that the U.S. has invested too much – especially in the last eight years – in building its stock of wasteful housing capital (whose effect on the productivity of labor is zero) and has not invested enough in the accumulation of productive physical capital (equipment, machinery, etc.) that leads to an increase in the productivity of labor and increases long run economic growth. This financial crisis is a crisis of accumulation of too much debt – by the household sector, the government and the country – to finance the accumulation of the most useless and unproductive form of capital, housing, that provides only housing services to consumers and has zippo effect on the productivity of labor. So enough of subsidizing the accumulation of even bigger MacMansions through the tax system and the GSEs.” (emphasis mine)

Not to mention that Freddie Mac and Fannie Mae (F&F) officials spent $170 billion during the last decade in lobbying to the US Congress to maintain such privileges. Corruption-free First World Economies? You must be joking.

The “too big to fail” rational has likewise been used as justification to shore up the ailing GSEs. This from CBS Marketwatch, ``[Treasury Secretary] Paulson said the global reach of Fannie and Freddie necessitated unprecedented action.” (highlight ours) Figure 2 from US Global funds shows of the extent of foreign ownership of Agency (F&F) Bonds.

Again this lends credence to our view that the US government’s continues to rely heavily on foreign financing and trade to buttress their economy even under today’s depressed post-bubble conditions. The problem is sustainability.

As CFA’s Brad Setser warns, ``The costs of a system that channeled huge sums of emerging market savings into the US real estate market — contributing to a bubble in US housing that is now collapsing, at a significant cost to all involved (private market players who bet that housing would only go up, the US government, and emerging market governments who bet on the dollar) and now a surge in inflation in the emerging world — are now quite apparent. It has produced a massive misallocation of resources on a global scale…And it now seems that this game will break down on the US end before it breaks on the emerging market end. The Agencies will run out of equity before central banks lose their willingness to buy Agency paper.” So will deflationary pressures in the US financial system cause a run in the US dollar?

The third beneficiary will be debtors over creditors. Creditors will be paid with depreciated currency. The public’s incentive will be to save less and consume more and consume today by borrowing more. In effect, inflation is a redistributive process of transferring real wealth from creditors to debtors. And once inflation begins to bite, people will call on government demanding compensation, aid and safety nets as we are seeing today.

Of course, the biggest beneficiary of inflation should be the biggest debtor, to quote Austrian economist Hans Senhholz in 2005, ``The biggest debtor also is the biggest inflation profiteer. With some eight trillion dollars in debt [$9,521,842,618,777.96 as of July 20, 2008 from brillig.com-mine], the Federal Government is by far the biggest winner. In fact, it gains not only from debt depreciation, which at just three percent amounts to some $240 billion every year, but also from Federal Reserve money and credit creation that enables the U.S. Treasury to suffer annual budget deficits of some $500 billion a year.”

In addition, liabilities from Medicare, Medicaid and Social Security and other welfare promises add up to $59 trillion (wikipedia.org) or $85.6 trillion (Federal Bank of Dallas President Richard Fisher).

Whereas foreign ownership of US debts have swelled over the years, this from wikipedia.org (emphasis mine), ``The US debt in the hands of foreign governments is 25% of the total, virtually double the 1988 figure of 13%. Despite the declining willingness of foreign investors to continue investing in US-dollar–denominated instruments as the US Dollar has fallen in 2007, the U.S. Treasury statistics indicate that, at the end of 2006, foreigners held 44% of federal debt held by the public. About 66% of that 44% was held by the central banks of other countries, in particular the central banks of Japan and China.”

So the likely path for the US government, as the biggest debtor, is to inflate its way out of its debts. And this we believe is functional seen via the transmission mechanism of currency pegs and US dollar links which aims to transmit stimulative policies to emerging markets see Reverse Coupling, Inflation From The Core and Current Account Deficits.

The fourth beneficiary are the industries that benefit from cross price elasticity of demand (about.com), ``the rate of response of quantity demanded of one good, due to a price change of another good. If two goods are substitutes, we should expect to see consumers purchase more of one good when the price of its substitute increases. Similarly if the two goods are complements, we should see a price rise in one good cause the demand for both goods to fall.” In short, substitution dynamics on the demand side arising from prices changes.

For instance, under high oil prices scenario, the tendency is for people to go for fuel efficient cars or bicycles or use more of public transportation as the preferred mode for transit.

This means that sales of big SUVs could be expected to decline (as it has been in the US) while smaller fuel efficient car industry sales, bicycle industry sales or public transportation revenues can be expected to rise.

But a caveat here, mainstream media suggests that the Philippines have met the threshold level of pain from energy prices enough to tilt the balance of car sales.

Look at this seemingly biased headline, “Soaring oil prices pull down June car sales”

From abs-cbnnews.com, ``Series of surges in fuel prices in the country have made their mark on automobile sales as car buyers shift from gas-guzzling and full-sized sport utility vehicles to economical and dual-purpose automobiles, the Chamber of Automotive and Manufacturers of the Philippines, Inc. and the Truck Manufacturers Association said in their joint report.

``The sales report showed that vehicle sales sustained their strength in the first-half of the year despite rising fuel prices, carrying a growth of 13.6 percent with 54,257 units sold to 61,654 units during the same period of 2007. But sales beginning in the month of June 2008 dwindled compared to the month of May, its second monthly decline for the year.

``June 2008 sales accounted to 10,772 units, 1.2 percent lower than the 10,900 sold in May. Sales, however, were still up 10.6 percent compared to the same month last year, which had 9,737 vehicles.”

Why biased? The article seems to give weight to the outcome from the reference point of month-to-month sales rather than from the year-on-year or from first half of the year sales in making such conclusions.

In other words, the article’s headline wants to reinforce the popular view that rising oil prices are having a big NEGATIVE impact on car sales, which is obviously NOT the case!

In nominal terms, June sales compared to May was 128 units lower compared to the 1,035 cars sold more relative to June of 2007. Common sense tells us that 1035 is almost 7 times greater than 128. To add, over the first semester, car sales had been up 7,397 units or an average of 10,275 units per month compared to last year’s 9,043 units per month!

So while the rate of change may be indeed by marginally decelerating, it isn’t enough to justify on the generalization that car sales were being NEGATIVELY impacted by rising oil prices!

But relative to cross price elasticity we see a confirmation of this phenomenon, `` shift from gas-guzzling and full-sized sport utility vehicles to economical and dual-purpose automobiles.”

And it goes the same way with the Philippine economy.

News accounts portray the Philippines in a helpless quagmire given the phenomenon of rising food and fuel prices. For me, such perspectives are politically designed-they are meant to either encourage government intervention or portray the incumbent as inept.

But if we examine the structural composition of the Philippine economy (as previously discussed in A Prospective Boom in Philippine Agriculture!) where agriculture accounts for about 36% of employment, 25% of exports and 16% of GDP, operating under a huge 13 million hectares (Food and Fertilizer Technology Center or agnet.org), booming agricultural prices (a.k.a. inflation) should translate to booming income for the rural farmers (ceteris paribus or all things being equal)!

Stated differently, while food prices are expected to hurt the urban poor, rural folks could be expected to benefit from rising food or agri prices.

Anyway as discussed in Politicking Weighs On Phisix, Inflation Problems Have Been Policy Induced with an accompanying chart from ADB’s Hyun H. Son, while the Poor’s expenditures for food accounts for nearly 50% of income, fuel related expenditures account for about 4% (2.5% for nonpoor), which extrapolates that food prices are having much greater impact to inflation figures more than oil prices.

As we have previously argued it is not high oil prices per se but the accelerated rate of change of oil prices that is having an impact on consumer sentiment or psychology. But overall, food is the most sensitive of all variables.

This also means that the “food inflation” menace looks likely a temporary phenomenon given the sudden shocks arising from the severe policy impelled distortions (e.g. trade prohibitions and subsidies) in the marketplace, as high “food” prices will lead to rising investment expenditures either from the government itself (e.g. nearly $1 billion in subsidies for fertilizer, rehabilitation of irrigation systems and post harvest facilities and high yielding rice varieties) or from the private sector (e.g. San Miguel-Kuok $1 billion venture) to the agricultural industry.

So from the standpoint of the incentives of political survival through government action to economic feasibility projects by the private sector all direction points towards massive investments in the agricultural industry, which should translate to higher supply in the future or lower statistical inflation data.

As aptly quoted by India’s Economic Times, ``"In virtually every country, there’s a recognition that they’ve got to increase investments in agriculture," said Robert Zeigler, director general of the Philippines-based International Rice Research Institute, which helped launch the green revolution.”

Thus while inflation is generally bad for the society because it robs the currency of its purchasing power which effectively depresses economic activities, some sectors actually benefits from the adjustments under such environment.

Hence, investing under such scenario should be selective. The notion that “inflation” is bad for all investments is a cockamamie.

Philippine Economy: World Financial Markets Allude To Diminishing Risks of Inflation

``Inflation is like sin; every government denounces it and every government practices it."- Frederick Leith-Ross, famous authority on international finance

We have been pounding on the table for the Bangko Sentral ng Pilipinas (BSP) to raise interest rates because of the external inflationary impact to the local economy (academic vernacular-cost push inflation), and true enough our BSP responded by raising 50 basis points to its policy rates to 5.75% but still way below the rate of inflation to suggest that Philippine monetary environment remains accommodative.

As we have argued in Has The Underperformance of Philippine Markets Been Due To Policy Credibility?, ``It would be a better option for the BSP to raise interest rates and reduce the negative real rates environment if they aim to defend the Peso and contain the consumer goods and services inflation pressures. But if the BSP is concerned about the impact to economic growth from higher interest rates, the market is doing it anyway for them through higher yields in domestic treasuries and from rising consumer prices. By closing the real rates gap at least they can’t be held solely responsible for “bad” policymaking.”

Domestic sovereign yields in local currency and have climbed enough to render a policy reaction or response from our BSP in spite of the IMF’s prodding. As we learned from Nassim Taleb of the Black Swan fame, policymakers are always reactive agents.

While the BSP continues to expect higher “inflation” over the rest of the year, it is likely that consumer price and goods inflation, which does NOT move in a straight line, has already peaked for this cycle.

Why?

Figure 3 stockcharts.com: Inflation Pressures Likely To Ebb

One, the decline of oil prices seems representative of a global growth slowdown as shown in Figure 3.

WTIC oil prices fell by 11% over the week below the $130 threshold crossing over the 50 day Moving Averages, which suggests that Oil is in a CORRECTIVE MODE which may last sometime.

Remember correction mode is a different animal from a Bubble bust; it is my belief that unless governments liberalize or open the oil industry by allowing increased private sector access to geological areas for exploration, or unless technology induced revolution via alternative energy that should gain the required economies of scale or unless innovative radical drilling equipments or rigs for non-conventional oil wells are introduced, oil supply will remain under pressure from declining major wells in spite of softening demand and thus put a floor on oil prices.

According to teachitworld.com ``Oil production is decreasing in 54 of the world’s top 60 oil-producing nations, including Britain (North Sea output, which peaked in 1999, has now plunged by more than half). The overall amount discovered has been falling for 40 years; easily reached oil fields are being depleted; untapped reserves are often small and hard to exploit. Many experts expect non-Opec production to peak around 2010; outside the cartel, the best hope is said to lie under the Arctic – but reserves are thought to be relatively limited, and conditions are horribly hostile.”

History has its lessons. In 2006 oil prices fell by 40% or from $80 to $50 (blue arrow) yet nearly tripled to hit $147.9 per barrel last July 11^th, from the trough of two years ago.

Two, it’s not only oil but apparently most of the commodity spectrum. The broad decline in commodity sector has likewise been reflected in the CRB index (lowest pane), while the softening of Dr. Industrial metals as shown by $GYX (pane below main window) seem indicative of slowing demand from emerging economies.

In consonance, the steep fall in WTIC Crude relative to the European benchmark Brent Crude (down only 5%) possibly signifying more economic weakness in the US. But it also suggests that Europe appears to be also losing strength.

Even the precious metal sector (above pane) has been shown in sympathy to its brethren.

Figure 4: ino.com: Softening Rice Prices

Three, with rice prices failing to breach the 50 day moving averages as shown in Figure 4, downside pressure in Rice prices means reduced “food” inflation for the Philippines or in most of the emerging world.

The infirmities in the Baltic dry Index also seems to chime in to the same tune.

Figure 5: Northern Trust: China Slows Down!

Most importantly, China’s moderating economic growth at 10.1% during the last quarter based on year to year comparison or even from first half growth of 10.4% in 2008 relative to 11.9% in 2007 (Forbes) appears to validate such thesis.

Figure 5 from Northern Trust shows of the rapidly falling rate of change in China’s real GDP aside from moderating consumer price index or “inflation”.

The declining phase in China’s economic growth suggests of a respite in resource intensive consumption, having been a major consumer of world commodities. It also suggests of a possible reprieve in rising export prices, having been the world’s second largest exporter.

It also confirms the deceleration in world trade, as one of the largest pillars of world trade and perhaps with reduced exports but with sustained outperformance of domestic demand, this should possibly translate to a slowdown in the accumulation of foreign exchange surpluses (unless speculative or hot money continues to pour in).

But if the Chinese economy decelerates further then China’s thrust to tighten might give way to policy directives towards growth (or easing bias) which may subside market expectations for the appreciation of the remimbi. This would suggest that the streak of hot money influxes could ebb.

All these adds up to a global economic slowdown which we believe has been reflected in global stock prices and should translate to lower inflation figures to the Philippine or world economy.

In the next few months, if global stock markets remain in a lackluster mode, while consumer goods “inflation” slows then the oversimplified singular causality linearly flawed inference of “high inflation equals high interest rates equals lower stock prices” will perhaps fade much like the Peso driven remittance argument of the past.

Thus the slackening the world economies are likely to magnify the downside risks of financial assets in economies that had experienced securitization backed housing boom bust cycles.

Some suggest that the next derivative pop via Credit Default Swap (CDS) would occur in Asia. We doubt this, considering the low exposure of CDS relative to US (45%) or Europe (27%) throughout the region (cumulative is 23%), with Japan accounting for about 55% of the region’s CDS, according to the Bank of International Settlements.

Although the slowing inflation backdrop will likely imply that governments, especially those exposed to the recent bust, are likely to undertake stepped up inflationary activities in the hope to “normalize” the financial system.

This in effects will breed the seeds for the next bout of inflation surges.

BSP’s Actions Should Reflect Sound Money Policies, Philippine Banks Can Afford Tightening

``The whole policy . . . must be looked upon as a case of price-fixing by which the rate of interest . . . was kept artificially lower through an unsound use of government control over banking policy. The results were speculation, inflation of prices, and eventual disillusionment and loss to investors and to large numbers of other citizens.”-Frank A. Fetter Modern Economic Problems, The Century Company

For us, the BSP should continue to raise its policy rates even if the statistical inflation index diminishes in the near term.

Raising interest rates to positive real levels will relieve policymakers of the blame of unbecoming conduct and inducing an inflationary regime, aside from reducing imported inflationary pressures via currency appreciation.

Besides, we believe that the banking sector and the Philippine economy are resilient enough to withstand further tightening.

The pervasiveness of the informal economy stresses the point that LIQUIDITY is the more important variable, since informal financing has made the sector inured to high interest rates or “5-6” microlending schemes as discussed in Phisix: In The Eyes of Asia’s Bond Market, Deflation Phantom, Hedge Against Inflation.

Next is ACCESS TO FINANCING. As testament to the low penetration level of the banking sector, according to BSP chief Amando Tetangco Jr., ``Rural banks alone cover around 80% of the total municipalities in the Philippines with nearly 730 banks and over 2,000 branches nationwide.”

But of course, with the composition of investment patterns that are likely to shift towards resource or commodity oriented industries in the rural areas, the growth of rural banks according to our BSP chief has been ``faring equally or even better than its universal, commercial and thrift bank counterparts while remaining true to its core mission of serving the needs of the countryside.” And this trend is likely to get better.

Another, mainstream bank financing growth has improved modestly but has been concentrated to mostly consumer lending. The Philippine Daily Inquirer quotes BSP Deputy Governor for bank supervision BSP Deputy Governor for bank supervision Nestor Espenilla Jr. ``Loans to the corporate sector haven’t been growing too much. What’s driving growth is consumer loan and basically this mirrors the vibrance of the consumer sector of the economy. This has something to do with the [overseas Filipino] remittance story,” he said."

In short, the expanded rural income will probably be helped by remittances and will continue to find financial intermediation support from the banking sector, most especially from the rural areas.

Finally, in consideration of overall bank intermediation, this statement from the IMF ``Despite substantial progress in reducing NPAs, they remain large and depress bank profits. Bank lending remains low, well below funds raised in the capital market in 2007, as banks are willing to lend to only their best clients. The credit reporting system is poor, only 5½ percent of adults are currently covered, and an inefficient bankruptcy code extends recovery time to 5¾ years and reduces recovery rates to 4¼ percent.”

In other words, bank lending remains highly conservative, given the shortcomings of credit reporting or bankruptcy code as the IMF cites which indicates need for administrative reforms.

Moreover, the anguish from the Asian Financial crisis probably remains impressed on our bankers, hence the functioning hindrance in the access to credit.

These are some other banking highlights from researchandmarkets.com, which suggests of the vitality of our banking sector (highlight ours)

- Deposit mobilization is concentrated with universal and commercial banks, which account for the majority of the Philippine banking industry deposit.

- Financial Intermediation was the largest shareholder of the loan disbursal by banks during 2004-2007.

- Bancassurance will account for 65% of the total sales of insurance products by 2011.

- Increasing at a CAGR of 69.78%, microfinancing in the Philippines is expected to reach 56.5 Billion Pesos.

- Increasing mobile penetration will expand the mobile banking user base to more than 11 Million by 2011.

With reference to the Philippine Stock Exchange, some suggested that increasing rates will reduce the public’s incentive to invest in the stock exchange.

This premise will probably hold true if local participants dominate the trading activities. The fact is that only a scant segment of the Philippine society of approximately 1% has invested in the PSE directly and indirectly, which means that foreigners are likely to remain as main navigators of the Phisix. And our guess is appreciating currencies, controlled “inflation”, and improving balance sheets are more of an attraction once the financial chaos in the system settles than simply rising interest rates.

Bottom line: Interest rates are not the only variable that will determine capital flows. The BSP can afford to raise rates by responsibly closing the gap of the real interest rates and at the same time addressing regulatory reform issues, while the Philippine banking system given the present economic conditions can afford to withstand such tightening measures.

Philippine Peso: Technical Pattern, BSP Actions and Diminished Inflation Points To A Rally

``In a free economy the principal cause of a cumulative deficit in a country's international payments is to be found in inflation . . . In a country whose currency is not convertible into gold, inflation leads to its continuous devaluation in terms of foreign currencies.”- Michael A. Heilperin, International Monetary Economics

With the hazard from “food and fuel inflation” likely to diminish, there is a strong likelihood that the Peso could rally following its latest string of precipitate decline.

Figure 6: DBS Bank: Peso’s habitual 45-47% retracements

Of course, the BSP’s unexpected 50 basis points hike provoked a furious rally in the Philippine Peso up 2.45% over the week.

But nonetheless we would like to emphasize that a rallying Peso might not reflect equal strength into other the Philippine asset classes YET, unless foreign sentiment reverses.

I have seen similar patterns abroad with currency strongly firming up, such as some CEE (Central and Eastern Europe) nations or Norway, as central banks raise rates to positive levels but equity markets continue to falter.

Most of the weaknesses in these financial markets (including the Philippines) could be traced to decelerating global economic growth and the ongoing international credit crisis than from “inflation” (which has admittedly aggravated the circumstances than have caused it).

However, I maintain the view that perhaps we are in the 8^th to the 9^th inning of the cyclical decline or nearing the bottoming phase for the Phisix, barring any major shocks.

Stripping away the fundamental argument, DBS bank believes that the Peso has a habit of correcting 45%-47% before resuming on its major trend.

Quoting DBS Bank, ``Historically, USD/PHP is known to retrace about 45% of large moves, like it did in 1997/98 and 2000/01. Like these two episodes, the PHP is currently confronting an uncertain global economy. Assuming that the same 45% retracement takes place, USD/PHP could extend its rise to 47 before entering into a broad consolidation, possibly between 41 and 47. If export competitiveness becomes a priority with the government, the consolidation range could be narrow at 45-47 instead.”

With amplified recession risks coming from a global economic growth slowdown, Anglo Saxon economies are likely to commit more of their taxpayer’s money into patching up the gaping holes into their respective financial markets which extrapolates to more balance sheet expansions or fiscal degradations (a.k.a. inflationary activities). So aside from the probability of reduced “domestic” inflation, compounded by the prospects of further BSP actions, a strengthening Peso could be in the offing.

As for market timing or the practice of financial astrology, we are most of time too early.

Globalization Highlights From Past To Present

The historical contribution of Globalization to world economy, from the Economist,

``GLOBALISATION, as historians of the subject like to point out, has been around for a long time. Industrialisation and technological changes—such as the invention of the steam ship, which produced cheaper means of migrating and trading between continents—spurred one period of globalisation in the 19th century. In similar fashion new inventions—jet aircraft, the internet—helped to encourage later periods of it. In a new World Trade Report published this week, the WTO compared three broad periods, looking at global growth in GDP, in population and in the trade of goods. Migration rates are shown only for four countries of the “New” world.

courtesy of the Economist

Present Trends as Indicated by the WTO 2008 World Trade Report

Accelerating world economic growth…

Rising Per Capita…

And broad based Poverty Alleviation…

This from WTO (highlight mine)…

“International trade is integral to the process of globalization. Over many years, governments in most countries have increasingly opened their economies to international trade, whether through the multilateral trading system, increased regional cooperation or as part of domestic reform programmes. Trade and globalization more generally have brought enormous benefits to many countries and citizens. Trade has allowed nations to benefit from specialization and economies to produce at a more efficient scale. It has raised productivity, supported the spread of knowledge and new technologies, and enriched the range of choices available to consumers. But deeper integration into the world economy has not always proved popular, nor have the benefits of trade and globalization necessarily reached all sections of society.”

Unfortunately globalization trends, despite its tremendous advantages, are highly unappreciated or unpopular simply because it is imperfect. But much of these has been borne out of the market distorting policies.

The message is the world needs more trade than relying too much from government.

Does The Violence In Pakistan’s Stock Market Signify Signs of Panic?

Some people have taken the recent stock market plunge to the political realm.

From Bloomberg (highlight mine), ``Pakistan's main stock exchange received police and paramilitary protection after investors stoned the building in protest at collapsing share values.

``I have lost my life savings in the last 15 days and no one in the government or regulators came to help us,'' said Imran Inayat, an investor who was part of the protest.

This is the common problem with retail participants: most of them don’t understand the risks involved in the financial markets. They jump in when market momentum keeps moving up (because mostly of the misleading notion of “keeping up with the Joneses” and the prospects of "perpetual short term gains") but when slammed with losses they demand regulators to “save them”.

In short, privatize profits but socialize losses from reckless activities.

Courtesy of Bloomberg: Pakistan’s Karachi 100

Seen from the long term, the returns for long term investors hasn't been all that bad; Pakistan’s Karachi 100 has been up by over 300% since 2004 and has lost nearly 35% from its peak.

It's just a matter of overconfidence turned into frustrations especially for retail punts.

In addition, government intervention only complicates the situation…

Again from Bloomberg,

``Regulators this week eased curbs on trading, removing a 1 percent limit on price declines that led trading volumes to fall to the lowest in a decade. Shares have slumped 29 percent this year, ending a rally that had pushed the key index more than 14- fold higher since 2001.

``There has been some level of mismanagement by the authorities,'' said Habib-ur-Rehman, who manages the equivalent of 6.5 billion rupees ($90 million) in Pakistani stocks and bonds at Atlas Asset Management Ltd. in Karachi. ``This may be due to their misperception that they can prevent the market from falling. Investors have to learn to bear losses as they do gains.''

You can watch the video from Javo.tv (hat tip: Charleston Voice)
...

...

The point is-in the psychological cycle of markets, this indicates of a transition to the cycle of desperation and panic which eventually culminates with capitulation or depression...or your market bottom.

Perhaps the Pakistanis are nearly there.

Sir John Templeton's Legacy: 8 Precious Investment Tips

John Christy of Forbes had been fortunate enough to get the last words of wisdom from our investing icon Sir John Templeton who just recently passed away last July 8. Rest In Peace, Sir John, you will be missed.

Anyway here is our departed guru’s legacy to the world as enumerated by Forbes Mr. Cristy (all green highlights mine)…

1. All investing is global. Templeton became famous in America for promoting the idea of global diversification, but he didn't invent the concept. After studying law as a Rhodes Scholar at Oxford, Templeton embarked on a whirlwind journey that took him to 35 countries in seven months. In his travels, Templeton simply noticed that there were far too many opportunities outside the U.S. to ignore. And that was back in the 1930s. To this day, academics and financial advisers use fancy equations and pie-charts to justify the case for international investing. For Templeton, it was always just common sense.

2. Always take a contrarian approach ... "People are always asking me where the outlook is good, but that's the wrong question," Templeton explained to Forbes in 1995. "The right question is: 'Where is the outlook most miserable?' " This is Templeton's famous "principle of maximum pessimism." It runs counter to almost every other big decision we make in life: choosing a company to work for, a neighborhood to live in or a person to marry. But that's what makes investing so difficult and the reward for successfully betting against the crowd so compelling.

3. ... But make sure the fundamentals are intact. Identifying out of fashion sectors or countries is merely a starting point. The corollary to the principle of maximum pessimism is that the underlying, long-run fundamentals must be sound. Pessimism once ran high at Bear Stearns, and for good reason.

4. Let valuation be your guide. Many "sophisticated" international investors insist on divvying up the world into a catalogue of developed, emerging and frontier markets, based on Morgan Stanley (nyse: MS - news - people ) Capital International's classification system. But Templeton had already made a killing in Japanese stocks in the 1960s before MSCI even existed. Was Japan developed or emerging back then? It didn't matter. Its stock market traded at four times earnings and the Japanese economy was growing like gangbusters.

5. Don't be afraid of big bets. At one point in the 1960s, Templeton held more than 60% of the Templeton Growth Fund's assets in Japan, an allocation that would get a manager fired on the spot at most mutual fund houses today. That's an extreme example, but investors shouldn't be afraid of bold bets whenever their research uncovers a big opportunity. Besides, Templeton wasn't a big fan of investment committees anyhow: "I am not aware of any mutual fund that was run by a committee that ever had a superior record, except accidentally."

6. Don't rush into positions. Templeton was an investor, not a trader. But even for patient investors, it can be frustrating to watch a cheap stock get even cheaper before the rest of the crowd catches on. Bottom fishers in financial stocks today know this all too well. In 1988, Templeton gave Forbes readers an important piece of advice that is especially relevant today: Always put your new investment ideas on a watch list, or take a small position before rushing in. If it's a truly great bargain, there's no need to hurry.

7. Get away from the crowd. "Outstanding performance cannot come from someone who is always part of the herd." While Templeton meant this in the sense of being a contrarian, he physically distanced himself, too. One of his early investment partnerships, Templeton, Dubbrow & Vance, was in the heart of Manhattan at Rockefeller Center, but Templeton spent the latter part of his career in the Bahamas, where he moved in the 1960s. Avoiding U.S. taxes was the big reason, but Templeton frequently cited the distance from Wall Street's noise as an advantage to his decision-making. And this was in the days before Bloomberg terminals, BlackBerrys and CNBC.

8. Don't worry about the direction of the market. In a 1978 Forbes cover story, Templeton summed it up this way: "I never ask if the market is going to go up or down because I don't know, and besides it doesn't matter. I search nation after nation for stocks, asking: 'Where is the one that is lowest-priced in relation to what I believe it is worth?' Forty years of experience have taught me you can make money without ever knowing which way the market is going."

The 13 Worst Email Scams To Avoid

Avoid falling for email based scams says Mr. Mark Nestmann, Privacy Expert & President of The Nestmann Group, in an article published at the Sovereign Society.

Each of the scam has a similar pattern. Mr. Nestmann advices, ``All these scams start with you sending them money. When you don't receive the promised funds, you'll be told "difficulties have arisen." To resolve the difficulties, you must send — you guessed it — more money.”

The Dirty 13 Scams…

1. Jackpot Scam. You've just won the jackpot or the lottery that you never entered, but to get your full winnings, you must first pay various fees.

2. Inheritance Scam. You've inherited a large sum of money from a mystery relative or some other person. To claim your inheritance, you must first pay taxes and fees.

3. Murdered Politician Scam. The widow or child of a dead politician in a third-world country contacts you for assistance. The politician stashed away a few million dollars in a foreign bank account, but the widow/child can't get to it without your help. You'll get a percentage of it if you help retrieve the funds, but first you must send money to a "lawyer."

4. Company Representative Scam. A foreign company wants your help to process payments from its customers. They want to use your bank account to process checks, money orders, credit card payments, etc. But first, you must pay a fee.

5. Government Contract Scam. Someone who has supposedly won a lucrative contract with a government in Africa contacts you for assistance. If you help him bribe the appropriate officials to finalize the contract, you'll receive a portion of the proceeds.

6. Dying Widow/Wealthy Merchant Scam. A wealthy widow or wealthy merchant has terminal cancer and wants your assistance in funding their favorite charity. You'll get a portion of the inheritance, but first, you must send money to a lawyer.

7. Rich Investor Scam. A wealthy investor wants to invest millions in your business. But first, you must send money to a lawyer to draw up a contract.

8. Loan Scam. You've been awarded a loan on very favorable terms, but first, you must send money to pay various fees or taxes.

9. Oversized Check Scam. A foreign person wants to buy merchandise you advertised on e-Bay or elsewhere, but mistakenly draws up a cashier's check for a larger amount. He asks you to wire the balance to a "shipping agent" before sending the payment.

10. Recover from a Scam Scam. The FBI, IRS, or other law enforcement agency contacts you by email and asks for your assistance in recovering money from advance fee fraudsters. First, however, you must send them money. (Law enforcement agencies never do this, but this doesn't stop scammers from impersonating them.)

11. Credit Card Scam. You've won a credit card with a million-dollar credit limit. But first, you have to pay a few thousand dollars as an "activation fee."

12. Job or Immigration Scam. You've just been awarded a lucrative employment contract or visa to an EU country. But first, you need to send money to a fake immigration official or lawyer.

13. Lonely Hearts Scam. A beautiful woman you meet online wants you to marry her. She wants to come visit you in the United States (or wherever you live). But first, you must send her money for an airline ticket.

Food Crisis: The Economist Suggests Eating “Bugs” To Solve World Hunger.

A proposed radical solution for world hunger and environmental preservation: Eat Bugs! (Yuck!)

This from Green.view of the Economist, ``The world is getting hungrier. After years of falling food prices, eating is suddenly getting expensive. With price-tags now rising some 75%, the World Bank estimates that the soaring cost of food will push 100m people into poverty. What with rising fertiliser prices, increasing concerns about deforestation and unreliable rains brought on by climate change, how will we find new sources of nourishment?

``Scientists at the National Autonomous University of Mexico have an answer: entomophagy, or dining on insects. They claim the practice is common in some 113 countries. Better yet, bugs provide more nutrients than beef or fish, gram for gram.

Courtesy of the Economist

``Meat provides just under one fifth of the energy and one third of the protein humans consume. But its production uses up a hugely disproportionate share of agricultural resources. Feed crops gobble up some 70% of agricultural land, while a quarter of the world’s land is devoted to grazing. Brazil’s burgeoning livestock industry is responsible for huge swathes of deforestation in the Amazon.

``As developing countries get richer meat’s ecological footprint is set to get even bigger. The Food and Agriculture Organisation (FAO) at the United Nations considers livestock “one of the top two or three most significant contributors to the most serious environmental problems, at every scale from local to global.” It predicts that the world’s demand for meat will nearly double by 2050.

``Eating insects does far less damage. For one thing, the habit could help to protect crops. Some 30 years ago the Thai government, struggling to contain a plague of locusts with pesticides, began encouraging its citizens to collect and eat the insects. Officials even distributed recipes for cooking them. Locusts were not commonly eaten at the time, but they have since become popular. Today some farmers plant corn just to attract them. Stir-frying other menaces could help reduce the use of pesticides.

Read the entire article here.

Phisix: Learning From the Lessons of Financial History

``Here’s the thing: When you get diversity breakdowns in markets, you get bubbles and crashes. When you get diversity breakdowns in societies, it’s ideologically similar. As Scott Page has shown, diversity (markets, ideas, ecologies) is a key to stability and growth.”-Josh Wolfe, Forbes Nanotech

In loving memory of my uncle Marciano U. Te (January 2, 1926-July 7, 2008)

``“The mistakes of a sanguine manager are far more to be dreaded than the theft of a dishonest manager," wrote Walter Bagehot. The best protection against excessively sanguine beliefs is the study of financial history, with its many examples of how easy it is to be plausible, but wrong, both as financial actors and as policy makers. Perhaps we need a required course in the recurring bubbles, busts, foibles and disasters of financial history for anyone to qualify as a government financial official. I have the same recommendation for management development in every financial firm.” Thus wrote veteran banker Alex Pollock, a resident fellow of the American Enterprise Institute, in advocating that the lessons from Financial History represents as the paramount guide into shaping of regulations-where history manifests of a slew of policy actions in reaction to market developments and their unintended backlashes-or for financial actors when divining portfolio strategies.

The most common problem we observe is that the public loves to adhere to simplified understanding of a complex problem, usually sourced from mainstream news, and apply nostrums as solutions. Whether it is the rice crisis, stratospheric oil or energy prices, or Phisix bear market it is basically all the same, we find a culprit, pin the blame on them without examining in depth why all these came about and worst, proffer solutions that are usually knee jerk responses bereft of historical morals which usually gets us mired into more trouble in the future.

Understanding the Phisix Bear Market

The Phisix, like most of the major equity benchmarks in the world including the US, is in a technical bear market, down by nearly 40% (37% to be exact based on Friday’s close). Since mainstream media is so fixated with oil and food, thus accordingly our market is likewise allegedly bogged by such issues.

We hardly hear any voice including from our so-called high profile experts in dealing with other pertinent issues: the continuing gridlock in the global credit market, the worsening economic slowdown in major developed worlds as a result of the deflating housing bubbles and attendant signs of contracting liquidity or monetary tightening in the global marketplace which has now become discriminate.

Of course, we do not share with depression advocates the view that the world is headed for Armageddon or that global financial “decoupling” is a fiction. As we mentioned, shrinking liquidity has made investment destinations become rather choosy or discriminate and our observation of Africa (see Recoupling and Inflation Doesn’t Explain Everything…) as benefiting from the present environment has been corroborated by the Economist magazine (emphasis ours),

``At the start of this year, some 15 sub-Saharan African countries had stockmarkets, listing some 500 companies with tradable shares and a combined market capitalisation–excluding relatively mighty South Africa's–of $100 billion, according to a report from Goldman Sachs, “Africa Rising”. Since then, these markets have mostly soared ever higher, even as shares everywhere else have plunged to earth. The best performing stockmarket among this impressive bunch is Ghana's, up by one-third so far this year.”

If this isn’t “decoupling” then I don’t know what this is suppose to represent.

Is it not a wonder why Africa seems immune to the same problem we or the world have been suffering from? Is it not the Philippines an “economically” better positioned compared to these states? So what’s the difference?

Honestly speaking, we don’t have an answer to everything although we do have some suspicions (prolonged years of underinvestment, prevailing commodity resource boom, probable portfolio rotations and China’s growing role in financing Africa’s infrastructure investments).

But there is one thing we can be sure of; if the premises cited by our financial experts do not seem to be applicable to African states, whom are supposedly in a far inferior position relative to us (based from the standpoint of economic statistics) or to most of our neighbors, then the likelihood is that the same conventional justifications used at our end stands from tenuous grounds.

Financial History And The Phases of Bear Markets

Figure 1: Phisix: History Shows 4 Bear Market Cycles

This brings us to financial history.

Financial markets are basically characterized by market trends borne out of the transitions of overinvestment-underinvestment cycles or commonly known as the Boom-Bust cycles.

Bear markets functioning as the other major market trend (other one being the Bullmarket) may constitute as either primary/structural/secular or secondary/cyclical/countertrend.

Primary-secular-structural bear market usually signifies the unwinding of previous excesses built up within the marketplace- as seen by massive overvaluation, speculative excesses (proliferation of margin trading) and “this time is different” euphoric attitudes- financed by too much debt or leverage in the banking system and or capital markets to the point of massive asset-liabilities mismatches which likewise reflects on major imbalances within an economy.

It may also represent fatalistic or defeatist government policies; remember the 5 cardinal sins-protectionism (nationalism, capital controls), regulatory overkill (high cost from added bureaucracy), monetary policy mistakes (bubble forming policies as negative real rates), excess taxation or war (political instability).

Overall, structural or secular bear markets reflect internal or endogenous adjustments as a result from these malinvestments or bungled policies.

On the other hand secondary-cyclical-countertrends are simply trends that correct temporarily against a major trend. Remember since no trend goes in a straight line major trends are likewise confronted with major corrections, and this could be triggered by many superficial factors.

The Phisix has not been a stranger to bear markets. In the past twenty two years we have seen four bear markets which equally reflect both cyclical and secular or structural (see figure 1) phases.

The Cyclical Phases (as measured by peak to trough)

Following EDSA I, the Phisix soared by TEN times before:

1. August 1987 to October 1988- the Phisix lost about 45% and consolidated for 13 months before recovering and resuming another attempt to the upside. The trigger for the bear market in 1987 – ex-Col. Honasan’s August 28^th Black Friday’s botched coup d'état against erstwhile President Cory Aquino.

2. November 1989 to October 1990- the Phisix lost about 62% in about 11 months before convalescing. The trigger for the bear market of 1989 -November 30^th Makati coup again by ex-Col. Honasan.

The aftermath to the last cyclical bear market saw the Phisix soar by over 5 times to its 1997 high of 3,447.

As you can see, political upheavals such as the past aborted coup attempts could serve as triggers to bear markets.

The Structural/Secular Phase (as measured by peak to trough)

Figure 2: IMF: Asia: A Perspective on the Subprime Crisis

Figure 2 from IMF’s Khor Hoe Ee and Kee Rui Xiong reveals of the similarity between today’s subprime debacle in the US and the 1997 Asian experience.

Abundant liquidity, massive capital inflows, overcapacity from overinvestments, loose credit standards, soaring assets fueled by leverage, inordinate foreign currency debts, conflicting interests from participants (agency problem) and moral hazard among others have been enumerated as main contributors to these pair of boom bust cycles.

In the Philippine financial markets, the angst from the fundamental adjustments of the 1997 crisis was mainly expressed via massive price revaluations as the sharp depreciation of the Peso, the collapse in real estate prices and the initial collapse of the Phisix.

Again what must be remembered was that even if the bubble popping contagion was seen from a regional perspective, the imbalances brought about by the above factors was seen in the construct of the domestic economy and in the local financial markets. In short, the bubble was internally generated as much as it reflected the region’s activities.

This leads us back to figure 1, the secular bear market of the Phisix…

3. February 1997 to October 1998-the Phisix lost 66% in about 20 months. But following the election of President Joseph Estrada, the cyclical Presidential honeymoon period led to the Phisix rebound of 120%. This could be interpreted as the cyclical bullmarket within the secular bear market.

4. July 1999 to November 2001- the Phisix lost 62% in about 28 months for the culmination of the secular bear market cycle. Oddly, the Phisix appear to trace the developments in the US markets or when the Nasdaq dot.com bubble imploded in 2000, for a huge chunk of this cycle.

From the above we learned that it is very important to distinguish between the basic compositions of market trends. Why? Because, the torment from a secular bear market relative to the cyclical bear market is far worse in terms of depth (longer duration for adjustments) and scale (larger degree of losses). Thus you can make your portfolio adjustments to reflect on the risks involved once you can categorize which part of the cycle we are into.

In general, the internal market configurations and domestic economic structural dynamics determine the adjustments reflected in the financial markets from which demarcates the cyclicality or secularity of a given trend.

Alternatively, this means that if today’s problems emanates from exogenous factors then unless it becomes severe enough to fundamentally alter the present economic and financial landscape, we should expect the present bear market to represent the cyclical nature of today’s underlying market trends.

No Bubble: A Reprise!

Have we been in a structural bubble? No, as we scrupulously argued in Phisix: No Bubble! Time for Greed Amidst Fear.

Figure 3: IMF: Improving Balance Sheets and No Property Bubble

Even IMF’s Khor Hoe Ee and Kee Rui Xiong argues in their piece that balance sheets of corporate debt levels have been markedly improving in Asia, aside from modest property appreciation seen relative to the advances in Europe and the US see figure 3.

But there are always exist some form of risks most likely coming from a contagion, quoting Mr. Khor and Mr. Kee (highlight mine),

``Even so, Asian policymakers must watch for remaining risks from the subprime crisis that could pose problems for Asia. These include what a Standard & Poor's report called a possible "triple whammy" on banks: more subprime-related losses, an adverse impact on Asian financial markets that affects banks, and an adverse impact on Asian economies that affects banks.

``But to date, such impacts seem muted. Asian banks are engaged in traditional bank lending and are not heavily exposed to the more sophisticated types of financial products that have hurt financial sectors in many industrial countries. However, a decline in the real economy as a result of economic declines in the United States and Europe could cause a significant deterioration in the quality of bank loans.”

Since the banking system has been the foremost conduit for the financing of most the Asian economies, all eyes should now focus on how banks will adjust to the ensuing downdraft in the economic growth of developed countries or from the junctures of rising “inflation”.

This I think is what the global financial market has thus far priced in, aside from the ongoing delevaraging process that has fomented the forcible selling of most liquid asset classes by institutions caught in the web of illiquidity stasis.

And if Asia is not a bubble then the likelihood is that the bear market arising from the present contagion conditions as mentioned above could be likewise be cyclical and temporary in nature. If our analysis is correct then we should see the rendition of the same patterns even amongst our neighbors.

Vietnam climbed about EIGHT times from late 2003 and has corrected 66% over the past 8 months. Today, the much ballyhooed “next China” seems to be healing (but needs further confirmation) and is up 20% from its most recent lows.

India likewise soared nearly FIVE times over the past four years and is down nearly 40% from the peak and could see still some selling pressures. Whereas China’s Shanghai index skyrocketed 4.5 times since only 2005 (or a bullmarket of about 2 years old!) and has surrendered 57% of those gains (based from its recent peak prices).

Meanwhile, our neighbor Indonesia has climbed about 4.5 times also since 2003 and has contracted by 32% during the first panic in August of 2007, but interestingly remains above this level. The JKSE is also presently above its April lows (-23% from peak) and is today down by about 20%.

On the other hand, our Phisix has trailed all of them up by only 280% from June 2003 to October 2007 and has touched the 40% threshold of losses just the other week.

Another, in a structural bear market practically all issues are supposedly headed for the gutters, but this isn’t the case today. In fact some issues have been trading within their 2007 highs: namely, Pilipino Telephone (PLTL), Petron Corp (PCOR) and Oriental Petroleum (OPM), or at near historical highs Manila Water (MWC), Philodrill (OV) and Semirara Corp (SCC).

Again these are empirical evidences that today’s bear market is cyclical in nature.

The point of this exercise is to show you the following:

1. Relativity of the performance of the previous upside and the present downturn matters. Market trends are generally determined by the longer term trends and are usually impeded by intermittent secondary or cyclical-counter trends.

2. Experts usually use existing headline information to account for present market actions but whose analysis can be shown NOT TO BE CONSISTENT with the broader market picture or if taken from a macro perspective. To quote self development author Robert Ringer, ``A false perception of reality leads to false premises, which in turn leads to false assumptions, which in turn leads to false conclusions, which, ultimately, leads to negative results…Which is why it’s incumbent upon you to become adept at distinguishing between reality and illusion. A false perception of reality — regardless of the cause — automatically leads to failure. An accurate perception of reality doesn’t guarantee success, but it’s an excellent first step in the right direction.”

3. Since people by nature are hurt by the prospects of pain more than the delight from future gains-this accounts for a cognitive bias called LOSS AVERSION- thus, losses tend to be fast and furious, even during cyclical markets due to the impulsive nature of investors.

4. If the recent losses signify cyclicality and not structural impairments then the gist of the losses appear to have been priced in for many of Asian markets (Barring any massive shocks from external channels, e.g. stock market crash in the US or UK). This is not to imply that they can’t go lower. What we mean is that the scale of losses will probably be much lesser from this point on or the degree of losses could be in the process of culminating.

5. The cyclicality, tendency to overshoot, false premises and relative performance combines to reinforce the likelihood of a faster than expected recovery.

6. Finally we are not in the practice of financial voodooism to suggest when exactly the turning point will be. From our perspective, using the lessons of the financial history, we should use the present crisis as an opportunity to grab worthwhile investment themes which are likely to be selective given the present character of heightened risk aversion.

To quote PIMCO’s co CEO Mohamed El-Erian (emphasis mine),

``Today's markets are particularly tricky as they provide the duality of both great opportunity and enormous risk. And in contrast to recent years, investors will not be able to appeal to a few macro themes; be they bullish ("the great moderation" and "goldilocks") or bearish ("debt exhaustion" and the collapse of structured finance). Instead of the phase of highly correlated market moves, up and then down, we will witness the gradual assertion of fundamental differentiation between market segments and for instruments in the capital structures…

``This volatile cocktail also speaks to the other side of the duality: the existence of big opportunities. The toxic mix is causing markets to throw the baby out with the bath water. There is now a littering of high quality assets whose prices are divorced from their underlying quality. Rather than reflect fundamentals that will eventually assert themselves, these valuations have fallen victim to the seemingly endless disruption in the financing of highly leveraged owners that have no choice but to continually dispose of assets in a disorderly fashion.”