Profit From Short Term Dividend Plays

"The margin of safety is the central concept of investment. A true margin of safety is one that can be demonstrated by figures, by persuasive reasoning and by reference to a body of actual experience". Ben Graham

The Phisix’s 3.34% decline this week contravened the surge in global equity markets. This was fundamentally a function of the collapse in the prices of Meralco (-26.59%) and from Philippine Long Distance Telephone (-6.33%). Combined, the free floated adjusted market cap comprised about 40% of the entire index last week, and from this Friday’s close, this has now declined to about 37%.

Meralco’s unraveled its formative bubble the way we hoped it would [see Beware Of The Brewing Meralco Bubble!], and has spared the Phisix of the menace of a full blown bubble.

Meanwhile, PLDT’s decline was basically a function of the company’s dividend ex-date, where share prices adjusted to its dividend yields.

The Case For Dividend Plays

And dividend yields in today’s environment presents us with short term opportunities to dabble with in an increasingly “cash hostile, risk friendly” environment.

So instead of technical or chart reasons to go into the market, I will provide you with fundamental reasons.

Since it is the annual stockholder season, this likewise implies of the “dividend” season.

And corporate financial statements, especially by the heavyweight market cap issues or the “blue chips”, usually reflect on the conditions of the domestic economy.

Despite the unmatched deterioration in the economy as manifested in many of the corporate fundamentals by major public listed companies, even in the face of a steep decline in share prices, many companies will probably retain their previous scale of dividend payouts, which implies select companies with very impressive yields of more than 10%.

In short, depressed share prices with unchanged dividends will likely bring about outsized dividend yields! And this may prompt for a short bout of “yield chasing” by market participants after they are declared by the respective company.

Of course, the optimistic frame here is “unchanged”, because for the mainstream, a global recession prompted downshifting of the domestic economy should also account for a downside adjustment in most of the financial statements of the publicly listed firms.

While we agree that the economy could further weaken as a belated effect from the collapse of global trade last year and or in response to big increases in unemployment levels overseas, we are doubtful if the crash in share prices last year will equally be reflected on the performance of the corporate world.

Besides, our short term dividend play doesn’t consider the future but is a bet on last year’s performance.

On the other hand, what if instead of reduced dividends, a company, because of its strong showing last year in spite of the morose outlook, decides to hike its payout? We’ll make a guess; we get a catalyst for a short term run.

Nevertheless, if we are right about the Phisix drifting in a seeming “bottom formation” phase of the market cycle, then dividends can thereby represent as a “margin of safety” against risks of future price declines-because dividends represent as a value added factor for stock investments-can partially offset cyclical paper losses.

So from a short term perspective dividends can operate as a catalyst for a “short-term” run, and from a medium-long term horizon, dividends can be a cushion against further price decline pressures-our margin of safety-operating under today’s presumptive bottom phase.

Yet unlike the conventional market agents who react only after a dividend has been declared, the key to the game is in the anticipation of dividends. Of course, having a network of insiders could help a big deal.

So if we go by the premise of the short term “play” basis, we should start by looking at the company’s previous payout record and by vetting on its most recent financial statements, as we attempt to establish the speculative premise of whether the company will retain or even raise dividends. From here, we buy the target company before it announces its dividends.

And when the company announces and if they fall in line with our expectations, then we can expect the share prices to possibly surge in order to reflect mostly the rate of dividends which should adjust accordingly on the ex-date.

The dividend play means that we can “advance” the dividend by taking profit prior to the ex-date or as the price target reflective of the dividend level is met or wait for the dividend payout and hope for additional capital gains from the general market’s momentum swings.

The Risks And Recent Examples

Of course, one problem here would be the “timing” of the announcement of the payout. An early entry may reduce or if, fortunate enough, expand the scope of gains (see below examples of PLTL and PSE).

Another problem could be based upon wrong assumptions where the scale of the payout won’t occur.

Faced with such risk factors, however, if our assessment of today’s overall risk environment is anywhere accurate, then even wrong residual risk specific assumptions are less likely to equate to a disastrous portfolio.

For the many reasons cited above, the present environment, at worst may accommodate for a gracious exit with very minimal losses or even a breakeven. At best, if fortuitous enough, our exit might be accompanied by moderate capital gains.

In other words, the dividend play offers a far greater magnitude of gains than the degree of possible expected losses, basically from the premise of the margin of safety based on huge yields.

Over the past weeks, we have seen some of these dynamics at play. Here are some examples…

Figure 4: PLDT: Dividend dynamics

PLDT made its declaration of P 60/ share (special) and P 70/ share (regular) dividend last March 3^rd for a combined P 130/share. At the close of March 2^nd the company’s share price was at Php 2,175 or equivalent to a dividend yield of 6%.

The day from the announcement (blue arrow), the PSE’s largest company’s share prices rose to Php 2,310 basically manifesting the yield of the dividend. And on the ex-date (red arrow), share prices retreated beyond the price level. This sharp decline, however, appears to account for as an overreaction, as in the case of the PSE (below).

Figure 5: PLTL: Same Dividend Dynamics

Pilipino Telephone basically had the same dynamics with its parent PLDT.

The company declared a .52 cents dividend last March 2^nd where its share prices closed at Php 6.8 (blue arrow) or a yield of 7.6%. But share prices even rose beyond the rate of dividend yield but eventually fell back (even below the level from which the announcement was made) on the ex-date (red arrow).

But unlike PLDT, the company surged on 8.8% on Friday for reasons beyond the dividend play. PLTL’s experience shows that dividends can even compliment capital gains under today’s environment.

Figure 6: Philippine Stock Exchange: Dividend Play

As a last example, we see also the same dynamics with the Philippine Stock Exchange .

The non-banking monopoly finance company announced its dividend on February 25^th, which consisted of Php 3.65/share (special) and Php 4.35 (regular) or a total of Php 8/share. The share price on the day of the announcement (blue arrow) was at Php 129 for an equivalent 6.2% dividend yield.

Based on the said yield, the PSE should have climbed up to around to Php 137 per share. But it zoomed all the way to Php 147 a day prior to the ex-date.

While the share prices collapsed on the ex-date (similar to PLDT, red arrow), it quickly bounced back and was last traded at Php 138/share. This implies dividend plus capital gains from the original Php 129 level.

Finally, it is important point out that despite the sharp losses in share prices and a gloomy environment, two of the three issues mentioned above gave out special dividends, namely PSE and PLDT. In addition, while the overall dividends from the PSE (Php 10 per share adjusted on the 100% stock dividend) and TEL (Php 194- but may offer more at the second half of 2009) have been lower from last year, PLTL raised its dividend from .48 to .52 cents per share. Moreover, these issues dealt with less than 10% dividend yields.

Since it is the start of the dividend season, some issues seem as great opportunities from which we may be able to profit from based on this unorthodox tactical approach. If you are interested you can check with your broker if not you can write me by email (benson_te@gmail.com). But, except for clients, this won’t come for free.

Why An Increasingly Asset Friendly Environment Should Benefit The Phisix

``There is only one cure for terminal paralysis: you absolutely must have a battle plan for reinvestment and stick to it.”- Jeremy Grantham Reinvesting When Terrified

The risk environment seems to be tilting towards an increasingly cash hostile-asset friendly environment from which the local stock market would likely benefit from.

Here are six reasons why:

1. Extremely Depressed Mainstream Sentiment.

After a 55% drop in the Phisix from its peak in October of 2008, the public still sees the equity market as highly “risky” in the “traditional” economic sense (more below).

You can just see this overwhelming dire sentiment in news headlines or TV news shows or from the viewpoints of media’s favorite talking heads. This runs starkly opposite to the dominant sentiment when the Philippine benchmark was at 3,800 when there was a cheery consensus (except for us).

In other words, overtly depressed mainstream sentiment (or sentiment extremities) conveys of nascent signs of a possible inflection point.

2. Creative Destruction

After a staggering $50 trillion loss of global financial assets from which one fifth or $9.6 trillion has been ascribed by the Asian Development Bank to Asia (msnbc.com), a recognition of global recession and the collapse in global trade, investment and financing or deglobalization, such colossal downsizing of financial assets and the massive retrenchment in the global macroeconomic structure, for us, signifies as “creative destruction” which may have reached a near culmination of the process in many parts of the world. Possibly with the exception of the US and parts of Europe.

3. Perspective Shift from the Macro to Micro environment

Despite the latest globalization trends, since the world isn’t “entirely” integrated, where much of the external linkages have been only from the aspects of labor (remittances), trade, finance and investments, the significant market attention on the macroeconomic framework during this adverse adjustment period is likely to shift weight towards to the micro landscape [see Fruits From Creative Destruction: An Asian and Emerging Market Decoupling?], thereby possibly leading to more signs of “divergences” or “decoupling”.

4. Policy Incentives Are Directed Towards Aggressive Risk Taking

Of course, we have to admit that the healing process from today’s major drastic economic shakeup will translate to a time consuming effort or that resource or capital reallocation essentially takes quite a time.

But this doesn’t mean markets can’t progress especially when global policymakers have been working feverishly to impel incentives favorable to risk taking.

One, global central bankers have been squeezing down interest rates nearly to zero…

From Morgan Stanley’s Joachim Fels and Manoj Pradhan (bold highlights mine) ``. Within the G10, official interest rates are virtually zero in the US (0-0.25%) and Japan (0.1%) and just 0.5% in the UK, Canada and Switzerland.

``In the euro area, the refi rate still stands at 1.5% after last week’s cut, but the effective overnight interest rate (EONIA) between banks trades close to the 0.5% floor set by the ECB’s deposit rate. Thus, the GDP-weighted G10 policy rate now has a zero handle. The weighted G10 policy rate is likely to drop further as we expect more rate cuts in the euro area, Japan, Australia, New Zealand, Sweden, Norway and Switzerland in the next few days, weeks or months.”

Next, they’ve also been monetizing debt or printing money…

Again from Fels and Pradhan ``several major central banks including the Fed, the ECB, the Bank of Japan and the Bank of England are engaged in various forms of quantitative easing, which has led to an explosion of excess reserves held by banks with these central banks. The explosion of bank reserves has pumped up the monetary base – consisting of cash in circulation plus bank reserves held at the central bank – in these four countries, as we have illustrated. In the US, the monetary base has more than doubled over the past year, while it is up by 40% in the euro area and 30% in the UK over the same period. The monetary base is also called ‘high-powered’ money, because our fractional reserve banking system allows banks to create many times the dollar amount of deposits from the monetary base through lending to, or acquiring assets from, non-banks.”

It is not much different here in the Philippines see figure 1.

Figure 1: Danske Emerging Market Briefer: Philippine Negative Interest Rates

At least in terms of the interest rate regime, the Philippine overnight borrowing rate has been fixed presently below the (CPI) inflation level by the Bangko Sentral ng Pilipinas (BSP), which makes the domestic interest rate environment essentially negative- net losses for savings compels the public to stretch for yields, which makes the marketplace conducive for speculation.

Furthermore, since the Philippine economy has negligible exposure to leverage, where the underlying risks from the evolving crisis has so far been “marginal” and limited to the external nexus, policies have been mainly directed at the interest rate and fiscal “safety nets”. In other words, no Quantitative Easing required, which should be a strong case for the Peso.

Table 1: IMF: Distribution Share of Global Stimulus Package

Finally global governments have been applying huge-but according to IMF and other ‘Keynesian’ economists-inadequate-doses of fiscal stimulus programs (see table 1) in an attempt to offset growing slack in the global economy.

Figure 2: Ivyglobal: Size of Global Bond Market

With over 75% of the global debt markets, see figure 2, held by the overleveraged economies in the US and Europe, this means that these coordinated measures appears to have been also targeted at “reducing the real debt levels” mostly held by the private sector.

So to rephrase, despite the repeated promulgated goals by global governments to induce “normalization” of credit flows by various ways to replace lost ‘demand’ mostly via government spending, the combined actions of lowering of interest rates, coordinated “various forms of quantitative easing” and massive infusion of fiscal stimulus can also be construed as inflating away debt levels.

What does this imply?

The gradual metastasizing of the risk environment from one characterized by economic recession to one where global currency values are being deliberately debased seems to be intensifying. This increases the opportunity costs of holding cash. And the effects are likely to be felt first in parts of the global asset markets. But there isn’t going to be a revival of the securitization-financial structured-shadow finance markets, the source of the bubble bust though.

5. Signs of Improving Trends in the Marketplace.

We may have begun to witness signs of selective recovery in several asset markets.

There has been significant progress in the technical pictures of primary commodity markets such as oil, copper, gold and the Reuters-CRB index or in the general commodity markets. Importantly the advances in the commodity markets have equally been reflected on Baltic Dry index, a cargo freight weighted index, and several key credit markets.

Moreover, there was an explosive upside action in most of the global equity markets last week.

Figure 3 stockcharts.com: Oversold Bounce

While this huge bounce appears to have been mainly a function of severely oversold conditions, see figure 3, it is important to note that Emerging markets (EEM), at the topmost window, have led the bounce earlier relative to major markets in Asia (DJP2-ex-Japan), European (Stoxx 50) and the US S&P 500.

From the technical perspective since the US S&P 500 have widely departed from its 50-day moving averages, hence, like an overextended rubber, snapped back vigorously.

We are skeptical yet of the US and key European markets as having hit the milestone “bottom”. Material progress in the technical picture, which requires some additional time to reveal on its maturity, plus signs of some economic improvement could serve as key indicators for a turnaround. Besides, the mayhem in the financial sector hasn’t been resolved. But for now, these markets appear to be working off overstretched conditions.

Nonetheless, the oversold bounce, which could probably last 1-2 months, could likely help boost general market sentiment even temporarily. And the progress in general sentiment could function as the necessary fulcrum for an extended and substantial improvement of the technical picture of the relative outperformers, mostly found among Emerging Market bourses, enough to cushion them into the next possible wave of decline.

For instance, the Philippine Phisix, which appears to be in a bottoming process, could be jolted out of its consolidation phase and segue into the early stage of the advance phase of its market cycle.

It could possibly do a Taiwan, whose key bellwether the Taiex index, a surprising outperformer, which appears to have broken out of the consolidation phase on the back of a fantastic 3-week run, even prior to last week’s general recovery in the global equity markets. The Taiex is up by about 17% from its lows last November and is up 6.6% over the year with the gist of gains coming from last week’s 5.24% romp.

6. Phisix: Learning From Market Cycles

In our July 2008 edition, the Phisix: Learning From the Lessons of Financial History, we identified the scalability of the typical bear market cycle for the Philippines.

Since the activities of today’s domestic bear market cycle reflects on principally the global contagion effects from last October deleveraging or “forcible selling” process more than economically prompted, we seem to have accurately read the dynamics where an easing of foreign based deleveraging motion will cease to hemorrhage asset values in the Philippine markets.

And indeed as the share of foreign trade has contracted and where net foreign selling has materially diminished, [see Phisix: Braving The Global Storm So Far], the Phisix appears to have been in consolidation or appears to have been reinforcing this bottom formation dynamics for about 5 months now.

Besides, with the Phisix having to touch losses of 55% late last year, it is has nearly reached its conventional bear market range of retracement of 60-66%. To consider, this bear market hasn’t been “internally” (domestic or regional) generated but instead from contamination overseas. Hence, its recovery will likely be fortified on signs of the more participation from the region’s bourses and from signs of improvements in the national economies in the region.

Together with some developments in the corporate world, the windows for risk taking either for the long term or for the short-term outlook seem to have opened. It is time to take advantage of it by nibbling on the market either by trading or taking long positions or both.

The Asymmetric Odds Of Short Term Trading

``We gamble because we are willing to accept the large probability of a small loss in the hope that the small probability of scoring a large gain will work in our favor, for most people, in any case, gambling is more entertainment than risk.”- Peter Bernstein, Against the Gods, [p.203]

In contrast to the conventional sell side analysts, normally I do not encourage short term trades. That’s because short term trades are not only risky, they also induce relative portfolio underperformance, by reinforcing our cognitive biases or by whetting our gambling ticks. In other words, they promote recklessness than discipline.

As investing guru and author Seth Karman wrote in the Margin of Safety, ``There are no winners in the short-term, relative performance derby. Attempting to outperform the market in the short-term is futile... The effort only distracts a money manager from finding and acting on sound long-term opportunities... As a result, the clients experience mediocre performance... Only brokers benefit from the high level of activity."

While the expected odds may seem like a median risk-reward distribution (50%-50%) for the typical market participants, the truth is short term trades have asymmetric odds or where the payouts aren’t equal.

For instance, short term trades in a maturing bullmarket will likely promote overtrading, where the frequency of gains leads to overconfidence and to constant churning of trades, regardless of the risk environment. The primary basis of trades are usually from charts (where past performance is assumed to deliver the same results) or market rumors.

But as the market reverses, the feckless market punters gets shocked into paralysis, and helplessly watch the cumulative “frequent” gains on their portfolio more than wiped out or expunged by the sheer horrifying magnitude of bear market losses.

This, in behavioral finance, we understand as the Prospect Theory, or where ``we tend to value a gain that is certain more than a gain that is less than certain, even when the expected value of each is the same. The opposite is even more true for losses: we will clutch at straws to avoid a certain loss, even if it means taking even greater risks.” (changingminds.org)

The proclivity for the mortal market participants or even many so-called institutional experts is to read or project interim trends into the future, where short term trends are construed as the “expected value”. For example, in the environment of rising markets, repeated gains from overtrading almost always extrapolate as vulnerability transforming into insuperability, risks are then read as risk free, luck is perceived as expertise and overconfidence morphs into hubris. The essence is that people take more bets than is warranted by the environment.

But as the market goes into a funk, the characteristics of the previous bullmarket as conceit, skills and the apparent risklessness reverses; denial, fear, desperation, despondency and the perception of a perpetually risky environment predominate. Some others will even “double down” to “avoid a certain loss” or “loss aversion”.

This innate tendency for the public to read into the market’s short term horizon signifies as the frequency of an outcome. People tend to tunnel on small but repeated occurrences than to look for probable magnitude of an outcome in a trade opportunity.

In general, the inherent shortcomings of short term trades are mainly due to the overemphasis on the frequency more than the magnitude of an outcome.

Environmental Politics Dottiness: Taxing Cow Farts! Human Farts Next?

The "Green" theme has evolved from science to patent religious zealotry or wanton absurdity...

Take this news from the timesonline.com "What do cars and cows have in common? No, not horns"

Excerpts from the article with all bold highlights mine...

``Proposals to tax the flatulence of cows and other livestock have been denounced by farming groups in the Irish Republic and Denmark.

``A cow tax of €13 per animal has been mooted in Ireland, while Denmark is discussing a levy as high as €80 per cow to offset the potential penalties each country faces from European Union legislation aimed at combating global warming."

``The proposed levies are opposed vigorously by farming groups. The Irish Farmers' Association said that the cattle industry would move to South America to avoid EU taxes.

``Livestock contribute 18 per cent of the greenhouse gases believed to cause global warming, according to the UN Food and Agriculture Organisation. The Danish Tax Commission estimates that a cow will emit four tonnes of methane a year in burps and flatulence, compared with 2.7 tonnes of carbon dioxide for an average car.

``Agriculture, transport and housing are not included in the EU's Emissions Trading Scheme (ETS), which enables industrial companies to buy and sell permits to emit carbon dioxide. Instead, EU member states are obliged to cut the emissions from non-ETS sectors by 10 per cent overall by 2020.

``While Romania and Bulgaria will be allowed to increase emissions, Ireland and Denmark are each faced with cuts of 20 per cent in farming sector emissions.

``The cow tax proposals would raise funds to buy allowances from other member states or to invest in technology that might reduce emissions. Denmark is believed to be further advanced with housing for pigs that captures and stores methane emitted from the animals. The gas can be used as a fuel for power generation."

My comment:

What the article didn't say?

If you want more of a 'thing' you reduce its costs, if you want less of the same 'thing' you raise its cost.

Alternatively, by taxing livestock farming which means raising the cost of meat production, governments in essence wants people to reduce meat intake...unless of course you are willing to pay for it with higher prices.

On the other hand, a shift in production and consumption patterns due to such taxes, essentially leads to higher prices across the board for food items, i.e. production of livestock will be reduced or moved overseas (causing shortages of supplies), while demand will likely shift to non-meat products (raising the cost of seafoods,vegetables and etc.).

The other unseen cost is that the demand substitution as a consequence to such obtuseness will equally strain environments, i.e. overfishing, overcropping etc... will translate to other unintended consequences (drought, desertification, fish depletion, pollution, etc.).

In a choice between human and environment, these taxes are skewed towards preserving environment than people. How sensible can this be?

In short, governments have implicitly been promoting HUNGER out of the ridiculous notion that cow farts have been causing greenhouse gases.

What's next, tax human fart?

Has San Miguel's Shifting Business Model Been Linked To The Philippine Presidential Elections? Lessons

In San Miguel’s Shifting Business Model: Risks and Opportunity Costs, we opined that San Miguel's drastic "overnight" overhaul of its business model could have possibly been partly motivated by tactical political developments than just strategic financial or economic goals.

Here is what I wrote, `` the company’s chairman Eduardo Cojuangco Jr., who is founder of the National People’s Coalition and has ran against Fidel V Ramos for the 1992 presidency but lost, could possibly have politically associated strings to these acquisitions with the 2010 elections only a year away."

And this from today's headlines at the Inquirer.net...

``Defense Secretary Gilbert Teodoro could be the “dark horse” in the ruling Lakas-CMD party’s short list of presidential aspirants, Senate Majority Leader Juan Miguel Zubiri said Thursday.

``The other day, Teodoro, a member of the Nationalist People’s Coalition (NPC) founded by his uncle, San Miguel Corp. chair Eduardo “Danding” Cojuangco, announced that he would run for president in 2010.

Including the fracas over the management control of Meralco, [see Beware Of The Brewing Meralco Bubble!], these actions appear to reinforce the connections of the corporate makeover to the corporate takeover to the political spectrum or the 2010 Philippine presidential elections.

What seems apparent is the solidifying alliance of the PGMA- San Miguel's Danding Cojuangco and possibly Imelda Marcos, wife of ex-President Ferdinand Marcos in preparation for 2010.

But this seems not limited to politics but likewise in the economic arena as the collaboration appears to work on securing economic rent from government imposed monopolies or heavily regulated industries.

Of course we maintain the previously risks enumerated from the San Miguel's business reconfiguration.

Nonetheless all these goes to show how the Philippine political economy functions- operating under the Keynesian framework, political elites battle for control over government ordained economic and political privileges.

And of course the only way to secure such bounty is to assume command of the Philippine government, with the affiliates or political constituents gaining control of the said institutions- we describe this as our "crony capitalist" paradigm.

Hence, the moral is that the belief in "virtuous" leadership to emancipate the Philippines from poverty bondage seems like an eternal fantasy-an impossible dream which almost everyone seem to fail to grasp.

The dismantling of the Keynesian political economic structures and a broader adaptation of economic freedom is required more than just an "honest" bureaucracy, whose underlying incentive is driven primarily by politics than by virtuous.

Polls: Signs of Increasing Skepticism on Global Warming in the US?

This from Gallup's latest article "Increased Number Think Global Warming Is Exaggerated"

All charts from Gallup.

In the US, while Global Warming adherents remain a significant majority, although recent signs suggests of declining interests by the public over such concerns.

There seems to be a mounting sentiment over "exaggerated" accounts of global warming.

And most of the shift in sentiment seem to emanate from the middle age to the elderly or from the age group of 30-65 or older. In other words, signs of skepticism have grown in most age groups except for the youth.

In addition, relative to other environmental issues, global warming seems to be losing ground in terms of priority.

According to Gallup, "the solitary drop in concern this year about global warming, among the eight specific environmental issues Gallup tested, suggests that something unique may be happening with the issue."(bold highlight mine)

Yet, the article can't seem to ascertain the reasons behind the sagging trend, "It is not clear whether the troubled economy has drawn attention away from the global warming message or whether other factors are at work. It will be important to see whether the 2009 findings hold up in next year's update of the annual environmental survey."

No problem. Experts realizing this have been quick to work on the arrest of the ebbing flow of interests with recent environmental disclosures by claiming sea levels have been rising twice as fast than originally thought of.

Unknown to most the issue of global warming is MORE than just about science or environment but mostly about political ideology (socialism) and dogmatism, money (funding grants, business or economic or financial interest groups & etc..), political power and control (limit civil liberties, suppression of economic growth). Thus some vested interest groups have been fighting strenuously to assert control by influencing public sentiment.

To aptly quote Jeff Jacoby at the Boston.com,

``There is no shame in conceding that science still has a long way to go before it fully understands the immense complexity of the Earth's ever-changing climate(s). It would be shameful not to concede it. The climate models on which so much global-warming alarmism rests "do not begin to describe the real world that we live in," says Freeman Dyson, the eminent physicist and futurist. "The real world is muddy and messy and full of things that we do not yet understand."

``But for many people, the science of climate change is not nearly as important as the religion of climate change. When Al Gore insisted yet again at a conference last Thursday that there can be no debate about global warming, he was speaking not with the authority of a man of science, but with the closed-minded dogmatism of a religious zealot. Dogma and zealotry have their virtues, no doubt. But if we want to understand where global warming has gone, those aren't the tools we need."

Remember failed math models [see earlier post How Math Models Can Lead To Disaster] played a big role for the mess that brought into this financial crisis.

And importantly math models have essentially less variables to deal with than nature itself.

So, caveat emptor.

GATA: Gold Suppression Scheme Nears End

Russian Media (Russian Today) interviews Adrian Douglas, financial analyst and the director of the Gold Anti-Trust Action Committee on the supposed gold suppression scheme.

Watch the video and read parts of the transcript here

Some noteworthy excerpts from the interview,

``The whole mechanism for this has been described in a paper by Lawrence Summers, who was ex-Secretary of the Treasury, but when he was professor of the economics of Harvard University he wrote a paper called "The Gibson paradox and the gold standard". In that research he explains how in a freely traded gold market the real interest rates and the gold price should move in inverse relationship to each other. In other words, if trust rates are low, the gold price should be high and visa versa.

``What we've seen through the 90s and most of this decade is that we've had a low gold price and low interest rates. So, the conclusion we made was that the gold market is not freely traded and it has been suppressed..

``Yes, the Western central banks, with the leaders of federal reserves and governments, have investigated this scheme of suppressing the gold price. And this is what is at the core of the strong dollar policy. If you can suppress the gold price and not make it a free market then you can have low interest rates and a low gold price.

``The low gold price essentially switches off the alarm in the financial system. What the purpose of the strong dollar was so that the US Government could issue lots of dollars without the alarm bells going off. The benefit for the US has been to live beyond their means. They managed to import goods from foreign countries and they have paid for them essentially with overvalued treasure debt. And they have even been so successful they have convinced other central banks that US treasure debt is a reserve asset. Now central banks around the world are sitting on trillions of dollars of treasure debt as a reserve asset which has a huge counterparty risk now of the American government – they will not repay it."

US Federal Reserve Study: Currency Crashes Can Be Good!

The Federal Reserve recently came out with an interesting discussion paper which attempts to discredit the commonly held view that Currency Crashes are economically devastating.

In Currency Crashes in Industrial Countries: Much Ado About Nothing? Fed economist Joseph E. Gagnon concludes that crashes can be occasionally good ...

``Currency crashes in industrial countries have always been associated with at least one of the following causal factors:

-Inflationary macroeconomic policies that put upward pressure on all prices, including the price of foreign currency. (my comment-printing money)

-Weak aggregate demand and rising unemployment that encourage policymakers to stimulate growth through expansionary monetary policy, including devaluation in the case of a fixed exchange rate. (my comment printing money again)

-Large capital outflows or current account deficits that run into financing difficulties. In some cases, these deficits may reflect either of the above forces (my comment printing money again), but they may also reflect exogenous shifts in the terms of trade or in financial market sentiment (my comment-currency run due to previous money printing or too much debt absorption held in foreign currency-currency mismatch).

``The consequences of currency crashes depend critically on the causes. Poor outcomes have occurred only after inflationary currency crashes. The responses of macroeconomic policymakers after inflationary currency crashes had important implications for GDP growth. Tighter policies to fight inflation generally reduced GDP in the short run. (my comment-recession)

``When authorities did not fight inflation, GDP growth generally held up in the near term." (my comment-let inflation rip...).

``Bond yields usually rose and real equity prices usually fell during and immediately after inflationary currency crashes."

``Non-inflationary currency crashes uniformly had good outcomes: GDP growth was average to above average, bond yields fell, and real equity prices rose."(my comment-yehey printing money solves the society's ills).

Could this study serve as a fundamental justification or a trial balloon of the US Federal Reserve's possible policy direction-which is to go for a massive US dollar devaluation (crash)?

As Axel Merk of Merk Funds recently wrote, ``There is one area we are in agreement with Fed Chairman Bernanke: those countries that devalue their currency may recover more quickly from a depression. Rather naturally so: if the purchasing power of your savings is slashed, you have a great incentive to work again."

In short if your currency is worth less than what was, one will be forced to double work efforts.

But with too much debt in the system, devaluation seems to be Ben Bernanke's nuclear option. Could he be telegraphing his moves?

Does Higher Bonds Returns Relative to Stocks Presage The Rise of Socialism?

Interesting Chart from Bloomberg's Chartoftheday:

The chart shows the returns of 30-year US treasury bonds snatching the lead from the stock market index of developed countries.

From Bloomberg (bold highlight mine), ``Buying 30-year Treasuries is returning more than stocks for the first time since Jimmy Carter was president.

``For three decades, owning equities in developed countries earned more than “on-the-run” 30-year government bonds. The advantage reversed after $36 trillion was erased from equity markets since October 2007 amid the first simultaneous recessions in the U.S., Europe and Japan since World War II"

Could this be the trend of the future? If so we are reminded of Peter Bernstein's latest admonition at the Financial Times ,

``If the long-run expected return on bonds in the future were higher than the expected return on equities, the capitalist system would grind to a halt, because the reward system would be completely out of whack with the risks involved. After all, from the end of 1949 to the end of 2000, the S&P 500 provided a total annual return of 13.1 per cent, while long Treasuries could grind out only 5.8 per cent a year." (bold highlight mine)

By Mr. Bernstein's insight, could this imply that global governments will be embracing socialism or totalitarianism as well? If it does, my guess is that these may lead to more national bankruptcies or a collapse in the monetary system.

Protectionism: Clear and Present Danger

In a crisis or a recession, populists demands from growing "nationalism" increases the odds for governments to embrace protectionist policies out of political exigency, regardless of the geopolitical or macroeconomic consequences.

And since the outbreak of the crisis, the world has gradually lurched towards this high risk direction led by the US.

This from the IMF's latest report Swimming against the tide How Developing Countries are coping with the Global Crisis,

``Protectionism remains a serious threat in the current environment. Many countries are contemplating, or have already implemented, increased protection, which may be difficult to reverse and will slow the recovery. Since the beginning of the financial crisis, roughly 78 trade measures have been proposed or implemented, of which 66 involved trade restrictions. Of these,47 measures were actually implemented, including by 17 of the G20. In addition, anti-dumping claims and actions increased 20 percent in 2008 relative to 2007; and 55 percent in the second half of 2008 relative to the first half of 2008. (italics mine)

``Agricultural subsidies, not counted in these numbers, have increased automatically with the recent fall in commodity prices. In addition to changes in tariffs, nontariff barriers, such as licensing requirements and tighter application of product standards, are also being introduced. Governments are also taking measures to support specific industries through potentially trade distorting measures, including by increasing subsidies as part of fiscal stimulus packages. While government financial support packages do not necessarily distort trade, public intervention targeted at specific export-oriented industries or competing import industries are akin to protectionism and run the risk of starting a subsidy race among nations. In addition, there is a risk that governments providing “bailouts” to domestic banks may exert pressure on those banks to use those resources within their countries rather than to provide trade finance that would go to foreign countries."

Unfortunately economic ignorance will only aggravate the situation. As Ludwig von Mises warned, ``People favor discrimination and privileges because they do not realize that they themselves are consumers and as such must foot the bill. In the case of protectionism, for example, they believe that only the foreigners against whom the import duties discriminate are hurt. It is true the foreigners are hurt, but not they alone: the consumers who must pay higher prices suffer with them."

Beer, Consumer Choice and Free Society: The American Model

A striking quote for Beer- "Beer is proof that God loves us and wants us to be happy"-Benjamin Franklin

Video from Reason TV,

Quoted from Reason TV

``In 1920, the National Prohibition Act destroyed the beer industry in the United States, putting some 1,500 breweries out of business. When the "noble experiment" was repealed in 1933, beer lovers rejoiced, and the beer industry staggered back to its feet. The industry had lost much of its diversity, however, and the emergence of national brands in the 1950s and 1960s led to industry consolidation and fewer choices for American beer drinkers. By 1980, there were less than 50 breweries in the U.S.

``By the 1980s, American beer had an international reputation as weak and watery as a case of Hamm's. Most breweries only produced American-style lagers, a light and inexpensive style of beer typically made with rice or corn adjuncts in addition to barley, hops, yeast and water.

``What American beer lovers didn’t know at the time was that a revolution was imminent. In 1979, a clerical error in the 21st Amendment was corrected, and for the first time in nearly 50 years it became legal to brew small batches of beer at home. Home brewers who had little interest in cutting costs or making beer with mass appeal began brewing big, flavorful beers in a wide range of styles. Many of these home brewers decided to turn their passion into small businesses, and microbreweries began popping up all over the country.

``Today, although mainstream beers still dominate the market, more than 14,00 breweries in the U.S. produce more styles of beer than anywhere else in the world, and American beers routinely dominate international beer competitions.

``So the next time you’re at your favorite brewpub, hold your glass up high and celebrate the American beer revolution."

Lesson: Industry liberalization promotes competition, which provides consumers with the best choices at the most reasonable prices, and societal satisfaction.

Unfortunately for the Philippines, the microbrewery industry is still at an infancy...I only know of two.

Hat Tip Mark Perry

Has the Reverse Invisible Hand Been Responsible For The Dismal Performance of US Equity markets?

The US markets is on a milestone…a milestone low.

And Chart of the Day tells us ``The Dow is currently down 53.4% since peaking in October 2007. To put the magnitude of the current correction in perspective, today's chart illustrates the 15 worst corrections of the Dow since its inception in 1896. As today's chart illustrates, the current Dow correction already ranks as the second worst on record. Only the correction that began in 1929 was worse.”

While we often resist the temptation to attribute market movements to politics, this observation from Bespoke seems worthy to contemplate on.

From Bespoke Invest (bold highlights mine), ``While Washington has lauded the $787 spending bill as the medicine that will help bring the economy out of the recession that President Obama 'inherited,' the market is taking a different view. Consider this -- since the spending bill was passed by Congress on February 13th, the S&P 500 has lost over $1.8 trillion in market cap, which is over twice the size of the plan signed into law! The question for economists now is whether or not the positive multiplier effect associated with the spending bill will be enough to offset the negative multiplier effect from the proportionately bigger decline in the value of US equities in the pension funds, IRAs, 401k's, and investment accounts of Americans.”

Is this merely a coincidence? Or is the market signaling disapproval on government's action? The market losses have apparently been greater than the stimulus packages drawn up by the US government.

More from Bespoke, ``As shown in the chart above, during the first few weeks of President Obama's Administration, the Dow was rangebound with a slight negative bias. It wasn't until the stimulus bill was signed and the budget unveiled that the bottom fell out of the market. Since Inauguration Day, the Dow has declined 1,686 points (20.4%). Of those 1,686 points, 1,253 have come since the passage of the stimulus plan. While there are certainly plenty of other issues weighing on the market, it's hard to argue that the "stimulus" and budget proposal haven't had a negative impact. While the Bush Administration was criticized by investors for lacking clarity in its policies regarding the economy, Wall Street clearly is not comfortable with the actual clarity coming out of Washington today.

``With a 20.37% decline since Inauguration Day, the Dow's performance during President Obama's Presidency already ranks as the third worst among US Presidents since 1900.”

We saw a media jester convey a message in a show that markets don’t accurately reflect on people’s sentiment. That’s plain hogwash. People can say something but do the opposite. On the other hand, we suggest that markets reflect on actual votes-in terms of money in or out of their wallets. It signifies something like “people voting with their feet”.

Besides the US markets have nearly half of its populace exposed to the financial markets.

ICI estimates that some 52.5 million, or 45.0 percent, of households in the United States owned mutual funds.And the biggest share as shown above is in the ownership of stocks.

And likewise the US census estimates that 50.3% of households had exposure in stocks in 2005.

With the torrent of bailouts and or stimulus money thrown to rescue several companies in a funk, the Nasdaq OMX has created last January 5, “The Government Relief Index” meant “to measure the performance of the 21 stocks that received at least $1 billion in emergency government funding, is down a whopping 58 percent.” (US Global Investors)

This perhaps could be seen as another sign where markets appear to be refusing the endorsement of the hodgepodge of government sponsored programs which in essence marks a reversal of the invisible hand.

Which brings to fore a fitting quote from Peter L.P. Simpson posted at the Mises Blog,

``There is, one might even suppose, a reverse invisible hand at work. The free market is said to produce order and success as the unintended result of many producers and sellers and buyers independently pursuing their goals. So the controlled market seems to produce chaos and failure as the unintended result of many voters and politicians and bureaucrats independently pursuing their goals. Unlike the invisible hand of the free market, the reverse invisible hand is not benevolent. It is malign. It is the chief cause of economic booms and busts and of the accompanying delirium and distress where outrageous profits jostle alongside outrageous losses.” (bold highlight mine)

Beware Of The Brewing Meralco Bubble!

``As government has destroyed one business opportunity after another, perhaps we should not be surprised that investment money has left domestic production and was diverted to financial markets. Investors want a return, and government agents and the political classes seem determined to destroy free markets — and the opportunities they present for economic growth.”-William L. Anderson, One Cheer for Paul Krugman, or Why the Bubble Economy?

Meralco is in a SEMINAL bubble.

The Case For A Brewing Bubble

The Lopez owned utility firm skyrocketed 40% last week and is 111% up on a year to date basis.

Meralco’s free floated market capitalization share to the Phisix index has leapt to 5.48% as of Friday’s close from less than 1% share late last year and has catapulted to the FOURTH spot among the top weighted issues, following PLDT 34.15%, Bank of the Philippine Island 7.17% and Ayala Corp 5.52%. Previously Meralco wasn’t even in the top 12!

Meralco’s outperformance seen in its soaring share prices coupled with the languid performances of the price values of the traditional heavyweights- such as BPI, AC, Metrobank , SM Investments , SM Primeholdings have expanded MER’s influence on the Phisix.

This means that a sharp reversal of MER’s share price trend would risks placing unnecessary onus on the Philippine benchmark. And this could unduly influence the overall market especially if it unwinds under today’s melancholic global atmosphere.

Moreover, MER’s weekly traded volume in PESO has accounted for a cumulative 53.3% of the entire trade, 48.55% of the trades at the close of February 27^th and 32.37% on the close of February 20^th. Previously Meralco had less than 5% share of total trades.

We recall that the last time we saw bubbles with nearly the same magnitude was in BW Resources (1998-1999) and Philweb (2000) days see figure 5.

Figure 5: Philweb (red), BW Resources (blue) Bubble and Phisix (black) Bear Market

If memory serves me right, the controversial BW Resources (blue line) corralled about 70% of the entire market’s PESO traded volume during its zenith, and in fact, fleetingly displaced San Miguel Corp as the largest listed company based on market cap in the Phisix then.

Incidentally, both bubbles- BW Resources which today is listed under a new management Sun Trust Realty (of the Megaworld group) and Philweb (red line)- occurred during the bear market of 1998-2002.

Although one may argue that the scale of price increases may not be similar YET, where BW (approx 5,000%) and Philweb (estimated 1,200%), whereas MER’s prices has only increased by about 200% (based on June 2008 trough), the common feature of ANY bubble is the transition from a MANIC phase to a BLOW OFF phase characterized by parabolic movements in the underlying share price trend (see figure 6).

Figure 6: Moneyweek.com: Stages of A Bubble

Meralco seems to be in a manic phase. And we hope to see some temperance rather than a progression to the Blow off phase.

As you would notice in the previous chart, both BW and the Philweb boom-bust cycles have the same dynamics as the typical vicious bubble cycle above. To add, in both times the bubbles went bust, the overall markets suffered dearly.

And attempting to “time” bubbles by the ordinary market participants may only lead to more tears and mental anguish.

King Kong Versus Godzilla

Another common feature of the localized bubble is the “takeover” component which rationalizes the market action.

In BW Resources series, it was the hyped tale of a supposed (but aborted) buy-in of the Macao’s gambling magnate Mr. Stanley Ho.

On the other hand, the surge in Philweb share prices came about over the company’s successful takeover of the Cabarrus owned South Seas Oil and Minerals (formerly SSO), which likewise partially piggybacked on the peaking sentiment of the US dot.com boom.

Of course, one may further argue that Meralco is a cash flow rich utility vastly different from “third tier issues”. But NO economic or corporate fundamentals justify such exuberance except for the same “takeover” story.

The apparent action in Meralco has been allegedly due to corporate maneuverings by rival groups in contest for the management prize.

According to the grapevine, the Lopez camp, which is the incumbent managers with substantial ownership of Meralco is allegedly being aided by PLDTs Manny Pangilanan (with speculations of access to the Indonesia’s Salim group), while at the same time reportedly seeking other allies (Henry Sy?), to fortify its position in the utility company by acquiring shares in the market, against a possible hostile takeover attempt by PGMA ally in San Miguel Corp.

If this floated story is anywhere near correct, then MER, which is a regulation instituted monopoly, whose prized possession is being bitterly contested by politically privileged groups signify an engagement between “crony capitalists” representative of the opposite side of the political fence.

It’s like a King Kong versus Godzilla movie, where one monster eventually wins but the rest of the city is devastated.

This means that joining the bandwagon risks a disaster for most of the ordinary market participant. Why? Since it is a high profile corporate struggle, the flow of information is largely asymmetric. Movements of share prices tend to favor insiders and their affiliates who seem to be “gaming” the issue.

Yet even insiders can’t be assured of their newfound paper wealth. If we learn by history, in the BW case, allegedly some insiders or even the BW owner Dante Tan, reportedly lost a fortune in the pointless exercise to buttress a deflating bubble.

In addition, such maneuvers will obviously come to an end, possibly on one or a combination of the following reasons: 1) share price will be high enough to dissuade anyone of the contending parties from further pursuing their agenda, 2) budgets of one of the opposing camps have been drained, 3) political goal accomplished-alliance confirmed and management role retained or successful takeover and or 4) lastly, basic economics-high prices will eventually lure more sellers than buyers.

The Psychology of Bubbles

It is disheartening to see a bubble-like activity emerge anew in an environment resembling a bear market, even when the overall domestic market seems to be on the mend. If history were to rhyme and the MER saga transforms into a full blown bubble which eventually goes bust, then this could extrapolate to additional selling pressures on the local markets anew.

Nonetheless, the vulnerability of the public to get hooked to a bubble is understandable; in a somber environment like today, there is an added desire to squeeze some earnings from momentum driven trades.

Besides, the dearth of trading opportunities in a bear market which have been handicapped by the lack of accessible “short” facilities may have increased participants desire to speculate.

Moreover, negative real interest rates account for as a big incentive to chase yields. When your savings account yields lower returns than the inflation rate, then the temptation to gamble or the appetite to speculate is whetted.

Perhaps these are some of the reasons why a localized bubble coincides with a bear market here.

But unknown to most participants, bubbles operate similar to getting finagled by a Ponzi scheme like the recent Bernard Madoff or Robert Allen Stanford case or the US real estate-securitization cycle.

Such fraudulent conducts or unsustainable trends require exponential acceleration of fresh flow of money from new entrants, whom are seduced with records or appearances of sustainability of past performances-persistent high yields or strong capital returns-even when the underlying business model is questionable or flawed or even non-existent.

In short, most people buy on emotions and not on rationality.

Yet, the more the entrenched the trend, such as the dot.com or US Real Estate, or the more “socially” known people are involved, the greater the attraction to join the bandwagon, such as the Bernard Madoff case.

This is a cognitive bias which humankind in general won’t overcome-the Herd mentality- simply because it is hardwired into our genes. Our ancestors didn’t have the privilege of rationalizing and used intuitions or mental short cuts rather than risks becoming the next meal for carnivorous predators such as tigers and or lions.

But we don’t live in primordial times anymore. We have advanced and will continually do so but our instincts remain.

Worst of all, having a PhD or even an army of highly decorated or awarded professionals does not guarantee protection from fraud. Again as in the Bernard Madoff case, it had among its victims Banks, Insurance companies or hedge funds [see Madoff Ponzi Scam and Boom-Bust cycles].

Yet this world appears to be more fixated with academic and professional credentials whose rich “quantified” trainings or experiences haven’t reduced their ability to read through risks. Thus, the perpetual cycle.

Actually, it is the process ability from emotional intelligence that distinguishes plain academic or technical expertise from being streetsmart or market smart.

Conclusion

The present price actions in Meralco appear headed towards a full blown bubble.

We hope to see the issue make a gradual ascent instead. Moreover we hope that the positive sentiment from its recent activities spillovers to the general market which should reinforce the case of a general market turnaround thereby strengthening the case for MER’s sustained long term uptrend. For a boom to be sustained this requires a recovery in the general market sentiment, especially for the largely underdeveloped liquidity and sentiment sensitive Philippine equity markets.

On the other hand, a bursting bubble, which implies a decline in a similar degree to the preceding upside momentum, will only dampen sentiment as losses are likely to be swift and severe.

In learning from the lessons of history we understand that a bubble bust risks undermining the progress in the local market. This happens even if the bubble is a residual specific risk or is based on a particular company, mainly because the bubble has commanded a substantial share of the market’s attention. Thus, a bubble works like a temptress-they are seductive but fatal.

Unfortunately markets don’t operate on hope.

Applied to the analogy of Dante Alighieri’s who wrote in his classic "Divine Comedy"…

“Before me things create were none, save things

Eternal, and eternal I endure.

All hope abandon ye who enter here."

Therefore my advice, caveat emptor.