``No two economies are ever alike in details. The composition of the industries changes. The expectations of people change. The government changes. The international linkages and governments change. The monetary systems vary. The skills and composition of the labor force change. The technology changes. The knowledge changes. The goods being produced and consumed change. The institutions change. Need I go on? No one understands an economy, and no one can understand a business cycle in an economy. I mean really understand it. Sure, there is a broad understanding. There is a grasp of certain features. We are not bereft of knowledge. But we do not know the details. We do not understand the linkages or what goes through people’s minds and affects their behavior. All the models we use, including the Austrian models, are more or less broad-brush affairs.”-Michael S. Rozeff Fiscal and Monetary Policy Annoy Me
As of Friday’s close, the Philippine Phisix passed the 2,500 Rubicon.
And by doing so the Philippine benchmark has recovered some 48% of its losses from the 2007 pinnacle and is now about 52% away from a full recovery, see Figure 1.
Figure 1: Phisix: On A Halfway Mark To A Complete Recovery
To attain the present levels, the Phisix has tallied a blazing 6 consecutive weeks of gains.
The Predicament of Mechanical Chart Reading
A mechanical chart practitioner, without the understanding of the underlying fundamental dynamics, would have seen resistance after resistance being broken, and as consequence, would either have been left behind watching in ‘shock and awe’ and immersed in ‘regrets’ (constantly muttering “I should have…” or “I could have…”) or have been frantically chasing after adrenalin infused stock prices.
True, technically speaking, the run in the Phisix have been overextended but the hallmarks of major trends can translate to serial bouts of trend overreach.
Moreover, historical actions can’t serve as precise guide simply because the underlying circumstances between the points of comparison could be distinct; where possible incidences of parallelism would depend on the degrees of circumstantial similarities.
Minyanville’s James Kostohryz, an investment banker, hits the nail in the head in his Anatomy of a Losing Trade, ``There's no such thing as a market being “overdue” for a correction. This is pure nonsense. There's no reason why a market has to behave in a fashion that one is comfortable with. Past experiences are only relevant to the extent that current circumstances are analogous. In this case, they weren't. So leaning on past experience was a mistake.”
The lesson is that mechanical chart reading signifies as oversimplification of reading and analyzing markets which is an inferior way to generate outsized returns.
Market-Real Economy Divergences Underscore Reflexivity Theory At Work
Yes, markets can go anywhere over the interim. This means that profit taking could surface or that a countertrend cycle can emerge.
And markets could use divergences in current events relative to markets to justify such actions.
Figure 2: NSCB: Philippine GDP At The Edge of Recession
Take for instance the descending trend of economic growth as shown in Figure 2. 1st quarter Philippine GDP growth surprised to the downside with a substantial slowdown (NSCB).
However this hasn’t been the case. On the contrary, the Phisix got fired up to account for a remarkable 5.83% gain week on week and for a cumulative 35.02% advance year to date!
Of course we expect the mainstream to read this as an “inflection point” so as to “rationalize” current market actions. And this is what we have been expecting for sometime.
Although, it would be a paradox to note that the Phisix had been stabilizing in the first quarter even as the economy had been undergoing a belated precipitate decline in economic activities, the operating fundamental dynamics underscores the reflexivity theory at work.
As we wrote in The Growing Validity Of The Reflexivity Theory: More PTSD And Periphery, ``In short, the reflexivity theory -from fact to perception and now perception to facts-seems to be succeeding at recalibrating the market’s mood.” Rationalizations of market actions (perceptions) to the real economy may indeed translate to a turnaround (prospective fact).
We see the same divergent mechanisms or reflexivity theory operating even in our regional contemporaries.
Except for Indonesia whose economic growth clip over the same period has marginally slowed but remains substantially up at 4.4% (guardian.co.uk), Thailand and Malaysia recorded negative growth and could be in the threshold of a recession.
Yet, Indonesia’s bellwether the JKSE has on a year-to-date basis displayed the bulls’ overwhelming dominance to account for 54% of gains, while Thailand’s SETI has tabbed 34% and Malaysia’s KLSE 23%.
BSP Policies To Add To Inflation Woes
Going back to the Philippines, the substantial decline in growth has extrapolated to a hefty drop in inflation which has prompted the Philippine central bank the Bangko Sentral ng Pilipinas (BSP) to cut rates to a 17 year low, see Figure 3.
Figure 3 Reuters: Philippine Inflation
The Consumer Price Inflation has basically fallen below Bangko Sentral ng Pilipinas (BSP) policy interest rates.
I don’t know how accurate this inflation gauge is, but to my observation, commercial rice prices in our location have remained at the price levels near the peak of the inflation cycle and haven’t manifested any meaningful deviation as accounted for by the published official statistical account. Rice is a key component in the inflation index (see chart here).
Nonetheless, the steep fall in the domestic inflation index appears analogues to the Posttraumatic Stress Disorder (PTSD) impact on global trade last year. It most likely reflects on a lagged impact of the global financial and economic shock from the seizure in the US banking system on the real Philippine economy, which is likely to be a temporary phenomenon, especially that prices of commodities have returned with a vengeance.
Yet like all central bankers who believes they can control the economy “to avert recession” by adjusting knobs through monetary tools, our BSP has joined its global peers to impose Zero bound policy rates and has declared the possibility of more rate cuts. And in doing so, have revved up the business cycle which has been premised on the unsustainable highly flawed economic ideology of borrowing, speculating and spending policies to boost the economy.
As you will observe, policymakers everywhere are innately reactive than proactive. Current market prices have been signaling a return of inflation yet the focus by policymakers have been on past data. Commensurately, the policy response is to address the past concerns. Unfortunately, such responses would result to short term gains but with lasting damage far greater than any interim benefits.
Hence, Philippine policies have been contributing to the global “super” inflation dynamics.
While it had been a delight to read that our honored BSP Governor Amando Tetangco quote one of our inspirational economic icons in his speech at the Australian-New Zealand Chamber of Commerce Philippines Annual General Membership Meeting, Makati-City last 14 April 2009, where he said, ``Frederic Bastiat, a 19th century French economic journalist, once said, “there is only one difference between a bad economist and a good economist: the bad economist confines himself to the visible effect; the good economist takes into account the effects that can be seen and those effects that must be foreseen”, disappointingly the venerable Governor doesn’t seem to be practicing what he had preached. And quoting Mr. Bastiat looks more like an ornament to spice up a talk.
Policies Shape People’s Incentives, Foreign Funds Flows Recovering
Policies shape people’s incentives.
The low interest rate regime has begun to show signs of gaining traction. This has spurred a boom in domestic banking credit in April (BSP) and equally a hefty liquidity expansion as reflected by the domestic M3 which grew by 13.7% in April (BSP).
Of course while bank loans to industries may presuppose usage, we can’t say if the loans had actually been used as so designated. Possibly some of these could have been diverted to the stock market.
Figure 4: PSE: Percentage Share of Foreign Trade: Local Participants Dominates!
The present boom in the Philippine Stock Exchange (PSE) has been mostly due to local participants, see figure 4. This is in contrast to the previous cycle 2003-2007 where foreigners functioned as the market’s driver.
The share of foreign trade has hardly gone beyond the 50% threshold as exhibited by the black horizontal line, since the start of the year.
This local buying phenomenon has been a primary feature in the present epiphany of stock markets in Emerging Markets and in Asia.
To quote the high profile contrarian analyst from CLSA Mr. Chris Wood whose interview can be seen here, ``What is being positive there in the rally began in Asia in October-November last year, is that we've seen growing local investor participation in Asian market, so the people who bought earlier in this rally since late last year weren't foreign fund managers but local investors throughout the region. That growing local investor participation is a long term positive.” (bold highlight mine)
For us, it is likely that high savings rate combined with loose monetary policies to induce speculation, fiscal stimulus applied, largely unblemished banking system, and low systemic leverage that has impelled a bidding war in the stock markets and commodity markets.
Of course, for media and mainstream, it would prominently be the “high” economic growth story which we won’t disagree with.
Figure 5: PSE: Improving Foreign Trade
Notably, foreign trade on the account of the falling US dollar index has also been improving see figure 5. For most of the year, foreign trade has largely been a net selling.
I excluded from the chart the April 30 foreign trade data which incorporates the special block sale of San Miguel Brewery to Kirin, because it skews the chart by making little visibility to current market action. Nevertheless, the red line manifests the reemergence of foreign buying activities but has remained minor to local activities.
And this hasn’t been an insulated event. Fund flows to emerging markets have begun to pick up steam.
According to this report from Bloomberg (bold highlight mine), ``Emerging-market equity funds received $3.79 billion in net inflows for the week ended June 3, led by investments in Asia excluding Japan, EPFR Global said.
``Funds that invest in Asian stocks excluding Japan added $1.54 billion, the most in dollar terms, while global emerging- market equity funds attracted $1.07 billion, the Cambridge, Massachusetts-based research company said in a report dated yesterday. Latin America stock funds drew inflows of almost $1 billion, while funds investing in Europe, the Middle East and Africa gained $230 million.
``Emerging-market stock funds have taken in $26.1 billion of net inflows this year, following 13 straight weeks of gains.”
So renewed interests from foreign investors on emerging markets are likely to even propel stock prices to higher levels! We should see the same dynamics reinforced locally. This time it will probably be foreigners chasing stock prices.
The Peso Riddle
For me one of the current major puzzles has been the underperformance of the Philippine Peso, in spite of the spirited rally of the Phisix and in the face of the sagging US dollar.
While the Peso has been marginally up from the start of the year, it has underperformed most of its contemporaries.
My conjecture is that foreign portfolio flows could have had considerable influence to this and my suspicion is that since foreigners had been basically net sellers the Peso hasn’t responded positively.
However, if foreign flows into the Philippine Stock Exchange continue to improve then we might see a sizeable move in favor of the Peso.
The other possible factor is government intervention.
Officials could be intervening in the currency exchange markets so as to “contain” appreciation of the Philippine Peso relative to the US dollar.
Lately some accounts of such intrusions have been observed in the region, according to the Wall Street Journal, ``central banks in South Korea, Thailand, Taiwan, Singapore and India are believed to have sold their currencies”.
So considering the economic ideological underpinnings by our officials, there is a good chance that government involvement to support “OFWs” which has been a popular cause, and exporters could have been a factor for the Peso’s inferior performance.
Conclusion
The flagrant disconnect between markets and the real economy has reached Philippine shores, where monetary forces seem to be the overwhelming driver of the rejuvenated Phisix.
While the Philippine economy has been less sensitive to exogenous bubble bursting woes abroad, local policies have now been contributing to the collective global efforts to “reflate” economies. And mounting evidence shows that markets have been increasingly responding to these policies.
The positive signs from current market actions are likely to have some influence to the real economy, which essentially validates the reflexivity theory. Although, present policies will likely fillip speculative spirits instead of promoting real investments.
Moreover, the resumption of the bear market in the US dollar has now widened the portal for foreign money flows into emerging market financial markets. As the initial thrust over the past months had been due to local money, foreign money could now function as the secondary engine to sustain the upswing in the domestic financial markets. This dynamic could also tilt the fate of the Peso which could have been hampered by previous accounts of net foreign selling or by government intervention in the currency markets.
With monetary forces clearly at the driver’s seat, the Phisix could be on its way to a full recovery and could even prompt for our target of Phisix 10,000 (perhaps sooner than later).
The unfortunate part is that we are clearly in an embryonic phase of the next bubble, thanks to policies that cater to economics of abundance in a world of scarcity.
And unlike the 2003-2007 cycle, which saw the Phisix as a victim of contagion, if present internal policies and external transmission persists to inflate the bubble, then the bubble dynamics will become structural for the Phisix and the Philippine economy.
