The Importance of Peripheral Vision

``Entrepreneurial profit and loss emanate from the dedication of factors of production to definite projects. Stock exchange speculation and analogous transactions outside the securities market determine on whom the incidence of these profits and losses shall fall. A tendency prevails to make a sharp distinction between such purely speculative ventures and genuinely sound investment. The distinction is one of degree only. There is no such thing as a nonspeculative investment. In a changing economy action always involves speculation. Investments may be good or bad, but they are always speculative. A radical change in conditions may render bad even investments commonly considered perfectly safe.”-Ludwig von Mises

ASEAN Markets Ablaze!

Here is an update of the seemingly majestic performances of ASEAN bourses (see Figure 1).

Figure 1: Bloomberg: ASEAN Bourses On Fire!

Of course, the reason why we should take the BIG PICTURE into perspective is primarily to avoid getting mired with the FALSE impression that domestic politics has been the DRIVER of these dynamics.

As one would note from the above, despite the tremendous showing of the Philippine Phisix (yellow trend line), which has been up over 17% on a year-to-date basis (as of Friday’s close), the fact is the local benchmark TRAILS the fiery actions of Thailand’s SETI (red line) and the Indonesia’s JCI (green line), up nearly 22% and 23% over the same period respectively.

Incidentally, the turbocharged Thailand’s SETI has already caught up and surpassed Indonesia’s JCI based on a one year basis and has been closing in fast even based on the year-to-date as reference point.

Now Asia markets have been uneven in terms of performances. What I am saying is that the inflationary milieu hasn’t lifted all boats similarly, and this simply validates the theory that inflationism has relative effects on almost everything, whether applied to financial assets, commodities to consumer goods or services. This also disproves the fictitious Keynesian construct of neutrality of money and of the obsessive fixation on aggregatism.

Yet the ASEAN bourses, while stirring hot, would seem only a shadow to the spitfire actions of South Asian bourses, particularly, Sri Lanka and Bangladesh up 64% and 49% respectively. Outside South Asia, Mongolia seems to be another bourse ablaze and has been likewise up 65% as of Friday’s close.

In other words, the trajectory of impact from global inflationism has been conspicuous in the markets (financial and non-financial) of the periphery nations. And I also would infer that these effects have been amplified by globalization.

The China Influence

Although China has been getting most of the news, such as having to successfully overtake Japan as the second largest economy in the world[1], the kernel of important actions again are in the peripheral markets but somewhat related to China.

Despite an up week, both of China’s bourses have been significantly down on a year to date basis (see figure 2).

Figure 2: stockcharts.com: China, Emerging Market Bonds and the Baltic Dry Index

One must NOT forget that the actions in China’s stock markets have been repeatedly tampered by with government interventions since late last year. This has been aimed at preventing a homegrown policy induced bubble from inflating into an unwieldy monster, and thus the material underperformance of China’s stock market indices.

And most of financial markets of developed Asia seem to either track the actions of China (e.g. Australia) or the market motions of the West (e.g. Singapore, Hong Kong and Japan).

Nevertheless following a steep decline last quarter, the Shanghai index (SSEC) seems to be manifesting of a rebound.

We can’t say if the momentum will persist until she successfully breaks out of the 2,700 level. A successful breach would possibly suggest that the Shanghai index will attempt for the threshold level of 3,000-3,150.

And China’s stock market actions appear to synchronize with the actions of the copper market (COPPER-the window below the Shanghai Index).

While we are NOT suggesting that China’s stock market has influences on the copper market, what both of these markets seem to say is that they could be responding to the current crop of policies being effected by the Chinese government.

The ongoing slowdown in China’s economy appears to reduce China’s government’s interest to tighten the monetary landscape, and thus, the prospects of lesser government intervention could be giving China’s stockmarkets a boost, especially in the light of the still generally loose credit environment.

Whereas the rebound in the copper market, while possibly partially influenced by these developments, could also be exhibiting signs of “inflationary pressures”. Monetary easing for China could extrapolate to more “speculative” flows from, or “reservation demand”[2] for, commodity buyers. As previously pointed out[3], the commodity price inflation appears to be rotating or diffusing into the “soft” or agriculture based commodities.

Debunking Selective Perception

Another thing that I’d like to point out, which the bears have been pounding on in the recent past, has been the Baltic Dry Index (BDI).

The recent collapse of BDI had been used to prognosticate a market collapse from what we see as fictitious “deflation” in a world of fiat money and central banking. And like US monetary aggregates, such as the M2 which we earlier discussed[4], these indicators have now tilted against them hence the apparent reticence or the deliberate omission of this indicator in current “deflation” discussions.

The selective use of the perma bears of these indicators to prove their case has gradually and repeatedly been falsified. Now to turn the tables, we use these indicators to disprove them.

They never seem to run out of materials to throw in, after the earlier “death cross” and the ERCI leading indicator, whose effects remain to be seen, now they point to the Hindenburg Omen[5] as a reason to take flight.

While September-October tend to be the seasonally weakest month for the stockmarket—where most crashes tend to occur—the dynamics for a crash doesn’t seem to be in place.

Not with the Federal Reserve already embarking on to replace the maturing mortgage bonds with fresh Treasury purchases[6] and certainly not with interest rates at zero bound for an extended period for key developed OECD economies.

Selective use of data for interpretation apparently disregards other things that matter more. For instance, the underlying ‘mixed’ actions (albeit mostly bullilsh) for emerging markets stocks doesn’t seem to be congruent with the actions in emerging bonds which has been exploding (JEMDX)!

Moreover we’d like to add that the steep yield curve has definitely had diversified or distinctive impact on the asset markets (see Figure 3) as we have repeatedly been pointing out[7].

Figure 3: Asian Development Bank[8]: Yield Spread Between 2 year and 10 year bonds

We can still say that the US and Europe has very steep yield curves (as of August 13-green bar) despite recent signs of flattening.

Moreover, outside these crisis affected economies, where the effects of the yield curve could be muted due to balance sheet constrains on the respective domestic banking system, in crisis free Asia, the Philippines still has the steepest yield curve.

What this seem to imply is that Philippine banks will likely take advantage of the maturity transformation[9] (converting short term liabilities to long term assets) in a system which has relatively higher savings, less systemic leverage and unimpaired banking system. In short, credit growth is likely to explode here.

And I would discern that many of the new credit issued could be finding its way into the domestic asset markets including the domestic stock market.

And I would also suspect the same dynamics in operation in other ASEAN economies which has fuelled her recent outperformance.

And one can’t ignore the influences of the divergences of monetary policies between developed economies and emerging markets, where the expectations in the changes of policies seem to induce international capital in favour of emerging markets.

For many, the temptation to get into the bandwagon would seem irresistible. And as the region’s stock market continues to flourish, short term momentum trades would be appear to very lucrative.

In addition, these shifts appear to hallmark the seeds of the bubble.

---

[1] See The Power of Slow Change: The China-Emerging Market Story

[2] See Financialization of Commodities: Boon Or Bane?, May 31, 2010

[3] See Breakfast Inflation, August 5, 2010

[4] See Why Deflationists Are Most Likely Wrong Again, August 15, 2010

[5] Kahn Michael, Taking Stock of a Scary Market Signal, Barrons, August 18, 2010

[6] Bloomberg.com Fed Buys $3.609 Billion of Notes to Keep Yields Low, August, 19, 2010

[7] See What Has Pavlov’s Dogs And Posttraumatic Stress Got To Do With The Current Market Weakness?, February 1, 2010

[8] Asian Bonds Online, Weekly Debt Highlights, August 16 2010

[9] Wikipedia.org, Financial intermediary

How To Go About The Different Phases of The Bullmarket Cycle

``I’m hopeful that the answer is obvious: the market reflects vastly more information than the individuals. Yet we persist in listening to individuals in order to explain the markets. Executives point to analyst reports or discussions in the media to try to understand what’s going on with their stock. The media find an esteemed strategist to explain yesterday’s market move. Don’t ask the ants, ask the colony. The market is the best source for understanding expectations.” Michael J. Mauboussin

I’d like to point out that NOT all bullmarkets are the alike.

Bullmarkets come in different phases which effectively translate to different approaches in the management of portfolios under such evolving circumstances.

Thus it would be a darned big mistake to treat bullmarkets like a one-size-fits-all or a “whack a mole”[1] game- where everytime a mole randomly pops out of the hole, one takes a whack at them with a mallet in the hope to score a point.

Unlike the whac-a-mole, the goal isn’t about scoring points. In the financial markets, the goal is about maximizing profits—unless there are more important sublime goals that supersedes the profit motive such as thrill-seeking or ego tripping (i.e. the desire to brag about the ability to “time the market”—which bluntly speaking is based MOSTLY on luck).

Nevertheless it always pays to first to identify the phases of the bullmarket before deciding on how to approach deal with it.

To borrow the bubble cycle as defined by market savant George Soros, we can note of the following phases[2]:

-the unrecognized trend,

-the beginning of the self-reinforcing process,

-the successful test

-the growing conviction, resulting in a widening divergence between reality and expectations,

-the flaw in the perceptions

-the climax

-the self reinforcing process in the opposite direction

Bubble cycles reveals of these recognizable patterns from the hindsight view (see figure 4).

Figure 4: Stages of The Boom Bust cycle

But unfolding bubbles can be identified real-time by the prevailing market actions, the psychology that undergirds market action, as well as economic data on credit dynamics. Remember, booms are always lubricated by credit—a sine qua non of all bubble cycles.

And this has been NO stranger to us.

For instance, the Philippine Phisix has had minor boom-bust cycles within the secular bullmarket cycle of 1986-1997 (right window).

One would note of the Soros boom tests in the two marked red ellipses which closely resembled the typical boom bust paradigm (left window).

In 1994-1997, the climax or the “massive flaw of perception” had been highlighted by the prominent label of “Tiger Economies”[3] (new paradigm) on the ASEAN-4, which of course, turned out to be a massive flop.

As a side note, let me tell you that the Philippines won’t be anywhere near a Tiger Economy UNTIL we learn to adapt and embrace economic freedom as a way of life. Boom bust cycles will not substitute for real growth from free trade. Instead what these policy induced actions will bring about is a false sense of prosperity and security which eventually will be unravelled.

Yet, if we read or watch media, and assume that the people imbues what media says as gospel of truths, then the prospects of a “Tiger Economy” remains an ever elusive dream. As corollary to this, the belief in the salvation by the political leadership who is assumed to take the role as economic messiah is a sign of either ignorance or immaturity or dogmatic espousal of superstition as truth.

Going back on how to read market cycles, the point I wish to make is that one should be cognizant of the operational phases of the market cycle, and adapt on the actions that befit the underlying circumstances.

At present, I would say that the Phisix has been transitioning from the “successful test” towards the “growing conviction” phase.

Figure 5: PSE Sectoral Groups: Industry Sector Rotation and Tidal Flows

And this phase will be characterized by sporadic explosive moves on select issues. But these activities will be rotated among specific issues or among issues within sectors.

So issues or sectors that may seem to have been in dormancy or has materially lagged will likewise see rejuvenated price movements overtime, while current market leaders may stall or temporarily underperform. Remember the axiom—no trend moves in a straight line, this should always apply. Otherwise those that manages to move in temporary defiance of this, would eventually pay a steep price later (Remember the BW scandal?). Hence, every action has its corresponding consequence.

And as the major benchmark continues to rise; the price levels of almost ALL issues will likewise keep in pace but differ in terms of degree, the timing and the time-motion of each price actions. But eventually, the cumulative actions would produce a net effect of having the “rising tide lifts all boats” phenomenon.

This has long been our Machlup-Livermore model.

For instance, today’s top performing sectors used to be last year’s laggard and vice versa (see figure 5).

During the last quarter of last year, the mining industry (black candle) and the service sectors (light orange) led the Phisix (red circle), and all the rest (red-banking, blue-holding, green-commercial Industrial and maroon-property) performed dismally.

And up to this point, last year’s top performers have essentially traded places with last year’s laggards, where the latter have taken much of the today’s limelight. Remember the proclivity of the crowd is to read today’s action as linear, hence while crowd may be right in major trends they are always wrong during turning points. And this applies both to specific issues and general activities on the marketplace.

And one of the latest spectacular moves has been in the property sector (maroon) which has likewise been among laggards going into July (the property sector was the third worst performer then).

But last week appears to be payback time for key property issues, as the property benchmark spectacularly skyrocketed by over 8% to nearly take the top spot which it now shares with the leaders.

And I’d venture a guess that based on the relative impact of inflation on stock market prices, today’s laggards will be doing a redux of last year’s actions soon.

To be blunt, the rotational effects will buoy the service sector and the mining industry. And a glimpse at the chart seems to show that such phenomenon may have already commenced!

Let me add that as the growing conviction phase deepens (I would presume that a break above the 2007 high should underscore this), the frequency of rotational explosive moves will increase.

Thus, trying to “time the market” will only result to missed opportunities, the chasing of higher prices and an increasing risk exposure to one’s portfolio.

Bottom line: We shouldn’t essentially “time” the market per se as the mainstream would define it, instead we should identify, read, analyse and act according to the whereabouts of the bubble cycle.

In other words, any “timing” must focus on the possibility of the emergence or rising risks of a major inflection point, in accordance to the stages of a bubble cycle. Meanwhile, all the rest of the one’s subsequent actions should be focused on the virtues of “waiting” and some “rebalancing”.

---

[1] Wikipedia.org, Whac-A-Mole

[2] Soros George, The Alchemy of Finance p.58

[3] Wikipedia.org Tiger Cub Economies

Global Policy Divergences Favors A Rising Peso

``Governments remain today, as much as when Hayek spoke these words, under the sway of political ideologies that insist it is the duty of the state to regulate the market in the service of powerful special-interest groups, to redistribute wealth, and to secure “safety nets” under most aspects of everyday life. The budgets and deficits of many EU countries, and the fiscal crisis they have now gotten themselves into demonstrate this beyond any doubt.” Richard M. Ebeling

I’d like to bring about a small point on the Peso and the Phisix.

In contrast anew to domestic mainstream analysis, the Peso has been proceeding in accordance to our projection. The Peso should continue to appreciate (anywhere in the range of 43 to 44+ to a US dollar by the yearend) as the Phisix surges.

The Peso’s rise will reflect on many factors, but mostly on excess US dollar liquidity and divergences of monetary policies.

Not only has the Peso risen despite the recent lagging actions[1] relative to our neighbors, which I had suspected had been part of the political efforts to embellish of the image the new President during his first State of the Nation Address (SONA). As a political group the Peso has now become sensitive to the demands of OFWs. Hence, I suspect the constant involvement by the Bangko Sentral ng Pilipinas (BSP) or the Philippine central bank to stem any meaningful appreciation.

Notice too that the Peso immediately rallied fervently just right after the SONA. This only furthers my impression that our new President has been soooo obsessed with image preservation or maintaining high popularity ratings, therefore would resort to populist measures at the expense of the public. Sorry to say, but a majority of the people are economically unlearned to absorb such truths.

But unless the BSP would take the risk of severely undermining the Peso in order to match the inflationary policies implemented by the US authorities, efforts to keep the Peso from rising will only serve as temporary patches. But again unknown to the public, all interventions has attendant costs, and will be paid for by the public either through a lowered purchasing power (higher consumer prices) or higher taxes in the future.

Nevertheless as the US continues to manipulate her bond markets for the purpose of allegedly staving off deflation, such actions accentuate the increasingly gaping policy divergences between Asia and the US.

And foreign currency reserve rich China, perhaps anticipating such predicament, appears to join us in becoming more bullish with the austerity conscious Euro[2], and likewise parts of Asia, such as Japan and South Korea[3] where she had embarked on selling US dollar ‘bonds’ for Euro and the Asian ‘bond’ assets.

And the greater the policy divergences, the higher the allure to arbitrage against the US dollar for higher yielding assets (a.k.a. carry trade) like the Peso.

And as we have previously argued[4], the influx of foreign money will not only intensify the price actions in the Phisix (see Figure 6), it will also be reflected on other domestic assets as real estate, bonds (already happening) and hopefully into more investments.

Nevertheless all these will be vented on the price of the Philippine Peso.

Figure 6: Peso and Net Foreign Trade in the Phisix

We have previously pointed out (left window-Peso at the upper pane and foreign trade at the lower pane) that surging foreign interest in the Phisix coincided with a higher Peso.

By way of the recent market actions, this phenomenon seems to be taking place again and seems to build up pressures incrementally prior to a massive move (right window).

Of course, the caveat will be expectations of a reduction in liquidity (risk aversion) in the marketplace.

But given the prospects of a slowdown which has given rise to mainstream’s heightened need for more political actions, we can expect policymakers to go about unleashing a new wave of liquidity as had been in the Lehman episode of 2008 or during the Greece spurred Euro crisis of 2010.

At the end of the day, for policymakers it’s all about economic ideology, path dependency and adherence to superstitions cloaked with mathematical formalism.

But of course, all these won’t repeal the natural laws of economics.

---

[1] See The Philippine Peso’s Lagging Performance July 18, 2010

[2] Bloomberg.com China Favors Euro to Dollar as Bernanke Shifts Course, August 16, 2010

[3] Bloomberg.com China Doubles Korea Bond Holdings as U.S. Debt Sold, August 18, 2010

[4] See Buy The Peso And The Phisix On Prospects Of A Euro Rally, June 14, 2010

Why Bernanke’s Inflationary Policies Will Hurt Americans

The short answer...because Americans have taken over the financing of her own liabilities!

New York Times’ Floyd Norris writes,

NEARLY a decade ago, when budget deficits ballooned in the United States, it was widely said that Washington — like Blanche DuBois in “A Streetcar Named Desire” — “depended on the kindness of strangers.” In Washington’s case, foreigners — mostly foreign governments — stepped in to buy most of the new Treasury securities being issued.

Budget deficits have ballooned again, but the story is different this time. Americans are buying most of the new Treasuries being issued. Foreign governments, whose purchases were once critical, were net sellers of Treasury securities in the first half of 2010, according to figures released this week.

Well, the US government’s policy to inflate simply means robbing her citizens of her purchasing power.

In a choice of policy actions, it’s almost always short term or goals of immediacy over the long term consequences that matters for policymakers. Who cares about tomorrow? In the long run we’re all dead as their favorite icon used to say.

Yet once the bond bubble implodes, this is going to hurt Americans badly.

Can Government Prevent Disasters?

I am disheartened by the news of the recent bus tragedy in Benguet whereby some 41 people died when the Bus fell into the ravine.

Yet we hear some sectors intuitively propose government to intervene, in the assumption that government can indeed forestall disaster. Again “romancing the government” without examining the cost benefit tradeoffs.

Here is why I think government can’t help in preventing disasters, (even if you install a communist government)

1. Government officials don’t know and can’t tell the future.

2. Government officials don’t know and can’t tell ALL the ongoing changes in the environment.

3. Government officials don’t know and can’t tell ALL the spontaneous actions of tens of millions of people.

4. Government officials don’t know and can’t tell ALL the conditions of the vehicles that people use.

5. Government officials don’t know and can’t tell ALL the impact of the interactions of the people, the vehicles and the environment.

In short, it will ALWAYS BE A KNOWLEDGE problem.

So unless, someone can enlighten me on the supposed omniscience of government, from such premises, no matter what the government does, they won’t be able to prevent disasters.

At worst, they could enhance it.

How?

First, every government intervention entails a bureaucracy.

Two, every bureaucracy comes with financing charged to taxpayers. So if the government plans to reduce accidents by having people NOT to travel by imposing onerous taxes, then this would be the way to go. That’s because people will be too poor to travel. Yet quality of life can be associated with impact of disasters (Think Haiti)

Three every regulations will benefit one group at the expense of the other.

A great example of this would be the Philippine Maritime industry.

Out of the world’s 176 worst maritime disaster, the Philippines owns 6 of them and has the inglorious status of having the worst, the MV Dona Paz.

Well, it’s NOT that the maritime industry has been lacking regulation. The fact is the opposite the industry have SATED with regulations.

As I previously wrote,

It is a peculiar development why despite the repeated accidents by the same shipping company, consumers continue to patronize such private entity. The answer is the lack of choice.

None in the media has brought out the fact that the domestic shipping industry is a very tightly regulated industry.

Imagine, aside from 5 agencies that directly supervise the industry; namely, Maritime Industry Authority, Philippine Ports Authority, Bureau of Customs Bangko Sentral ng Pilipinas and the Philippine Shippers Bureau, there are another twenty six (26) other agencies directly or indirectly regulate the inter-island freight shipping industry (NEDA’s Philippine Institute for Development Studies). Incredible red tape!

THIRTY ONE Agencies regulating the Shipping Industry yet the repeat disasters?! Why?

Because the bureaucratic red tape has served as a substantial barrier from competition to the benefit of the incumbent industry players.

And when consumers have been left with no choice, they will be forced to patronize even when the services offered are inferior or when their lives are put to risk. Ergo, the repeat disasters.

Another, there is such a thing called “regulatory capture”. It’s when the interests of the industry have “captured” the regulators, or when regulators and the protected industry dance the proverbial tango.

In many instances, regulators find their career outside public service in the industry which they once regulated. In short, the interest of the regulators tends to align with the interest of the regulated for personal motives such as career or otherwise. (As I said regulators are HUMAN Beings and look after their personal interest FIRST). Thus, by keeping chummy they open the doors for laxity in supervision and risk of disasters.

Four, regulators are obsessed with rules and NOT with pleasing the consumers. Yet rules don’t and won’t incorporate everything that is known for the benefit of society. The fundamental premise of which anew is the Knowledge problem and of the interest of diverse groups involved in shaping the laws.

So instead of looking for the welfare of their clients or the consumers, industry providers will be forced to pay attention FIRST to comply with the web of laws.

And the cost of compliance is the obverse side of disaster, industry players tend to stick by the standards (regulations) and ignore the cost of a potential disaster from a black swan or a random event.

Remember life is dynamic, new technology, environmental changes and evolving consumer patterns among others contribute to “randomness”. Even new laws contribute to changes in people’s behaviour, which add to randomness or life’s complexities.

At the end of the day, if an accident from a black swan event happens, then the industry players can go scotch free since they are outside the ambit of government imposed standards.

Of course, unless consumers are deemed to be so dumb, then always the excuse for government intervention.

But in contrast to this, consumers can always be empowered to render discipline on the providers, if given the chance.

That is if they allow competition to determine their cost-benefit tradeoffs relative to the price, quality and safety of the product they use or consume.

It’s funny and an irony how we tend to TRUST the people to make the “right” choices about the leadership in elections, yet degrade their capabilities when they account to choose for their own self-interest which they have a direct stakeholding, when dealing with personal needs and wants. It’s a reasoning gone backwards.

Another, outside regulations and the consumers, the other source of discipline are tort laws. If the judicial system will be facilitative into rendering judicious resolution and indemnity to the aggrieved parties, then obviously no business interests would in the right mind NOT to seek the interest of the consumers because they will and can be sued out of existence.

In short, you don’t need more government intervention, what you need is more competition and judicious facilitation of tort laws.

___
Update:

I’d like to thank Nonoy Oplas for his most valued input (see comment section).

Nevertheless, let me clarify that the Jeepney industry can’t be classified as an open competition but a regulated competition. As an analogy, if you have (x number of) pets in a cage and throw food into it, your pets will “compete” for the food you throw. There is “competition” but the competition is limited by your actions (as pet owner), or in the case of the Jeepney, the government.

Jeepneys are essentially covered by a slew of regulations, these includes franchise restrictions, territorial coverage, allowable fees to charge (public tolls), vehicle type and engine specifications, road use, traffic regulations—the latter, of which are vacillatingly implemented, and perhaps many more (this would need to be researched and a topic for another day).

Thus, I wouldn’t generalize that discourteousness of many Jeepney drivers as a result of “competition” but from a combination of many of these regulations which has skewed the behaviour of drivers towards “incivility”.

One shouldn’t forget the uneven application and occasional boorish behaviour of the implementing officers and notwithstanding the “palakasan” attitude as a result of political dependence could also be contributing factors. So there are many many many factors influencing the Jeepney industry.

Since buses have “higher barriers to entry”, one might say they seem more professional in competition. But I have my reservations. This needs more research before making any conclusions. Some like Victory Liner which has been a favourite of mine seem to respond to “competition”.

The transport sector is more a regulated competition than a free market competition. Hence, the beneficial effects from competition may NOT be apparent, since they are suppressed.

Of course, in agreement with Nonoy's suggestion, open competition, the abolishment of government agencies, facilitation of the tort laws, and the rule of law should matter most. One can use the this experiment as example.

Cartoon of the Day: Tax on Education

The following enlightening caricature from Heritage Foundation underscores how taxes impact the cost of education.

I just hope that there would be a Philippine version for this.

The Power Of Slow Change: The Rise Of Asian Consumers (Beer Drinkers)

China’s and the emerging market story can be seen in many aspects.

And part of these story that we seem to be seeing is the empowerment of Asian Consumers as signified by the surge in beer economics.

This from the Economist,

CHINA'S remarkable growth is as apparent in beer consumption as it is in more formal economic indicators. In the space of a couple of decades the country has gone from barely touching a drop to become the world's biggest beer market, a considerable distance ahead of America. And beer drinking in China is growing fast, by nearly 10% a year according to Credit Suisse's World Map of Beer. This might seem like good news for the four big firms that dominate global brewing. Between them ABI, SABMiller, Carlsberg and Heineken have nearly half the world market. But unlike America and other hugely profitable mature markets where beer drinking has levelled off or is in decline, China's drinkers provide slender profits. Still it remains a market with huge potential, though foreign brewers must now be rather tired of hearing that.

Trends like this are easy spot once you open your mind, but for many these changes would seem hard to grasp.

Nevertheless there are many possible ramifications here: some that come to my mind is that they provide windows of opportunity for investments, they give an insight on how many people in Asia are spending their money (cultural shift), they also reveal changes in trends that also have geopolitical and domestic political and economic implications and etc...

Interesting.

Has The Welfare State Peaked?

As Economist Herb Stein used to say, “If something cannot go on forever, it will stop.”

The welfare state which basically picks from one pocket and gives it to another is an unsustainable program. It works for as long as there are enough pockets to pick on to give to others.

Yet could we be seeing the peak of the welfare state?

This from the New York Times, (all bold highlights mine)

For years, Denmark was held out as a model to countries with high unemployment and as a progressive touchstone to liberals in the United States. The Danes, despite their lavish social welfare state, managed to keep joblessness remarkably low.

But now Denmark, which allows employers to hire and fire at will while relying on an elaborate system of training, subsidies for those between jobs and aggressive measures to press the unemployed into available openings, is facing its own strains. As a result, it is beginning to tighten up.

Struggling to keep its budget under control after the financial crisis, the government in June cut into its benefits system, the world’s most generous, by limiting unemployment payments to two years instead of four. Having found that recipients either get work right away or take any job as their checks run out, officials are also redoubling longstanding efforts to move Danes more quickly out of the safety net.

The New York Times, being a liberal in the conventional sense, ends up defending the welfare programs. However, the lesson seems quite clear.

As former chancellor of West Germany Ludwig Wilhelm Erhard wrote to remind us, (bold emphasis mine)

Just as a people cannot consume more than it has first produced, so the individual cannot gain more real security than we, the whole people, have gained as a result of our efforts. This basic truth cannot be concealed by attempts to veil it with collective schemes. It is for just these well-intentioned ventures that a high price has to be paid. Efforts to free the individual from too much state influence and too much dependence on the state are thus brought to naught; the tie with collectivism becomes stronger. The apparent security, granted to the individual by the state or by any other group, has to be bought dearly. Whoever wants protection of this kind must first pay in cash.

At the end of the day, the basic laws of economics prevails.

Austerity Equals Deflation? Not In The Eurozone

If you read mainstream analysis, their mantra seems to be ‘austerity equates to deflation’. (Because B follows A, B is the cause of A-post hoc analysis)

Yet when applied to the Eurozone, this seems NOT to be happening.

This from the New York Times, (bold highlights mine)

Higher energy prices drove inflation in the euro area to an annual rate of 1.7 percent in July, the highest level in 20 months but still within the range considered acceptable by the European Central Bank.

Excluding energy prices, inflation increased by 1.1 percent in July when compared with the previous year. That was up from 0.9 percent in June, Eurostat, the European Union’s statistics office, said Monday.

The rise in overall prices, from a rate of 1.4 percent in June, was not considered alarming by economists, who generally expect price pressures to remain in check as growth slows in most of Europe.

“We need to see convincing signs of an upturn in domestic demand, and we’re not seeing that just yet,” said Nick Matthews, an economist at Royal Bank of Scotland. “Underlying domestic price pressures are still quite contained.”

But the European Central Bank could have problems finding a monetary policy that is right for all 16 euro area members if prices continued to rise in some countries while holding stable or even falling in others.

This chart from Tradingeconomics.com

Additional observations:

1. The above development goes to show that inflation is always relative. Some areas experience more and some experience less. In short, money is never neutral.

2. If inflation has been rising in spite of weak domestic demand as alleged by the expert quoted, then obviously it isn’t domestic demand that is the root of inflation. So the expert failing to account for the recent rise likewise fails to look at genuine drivers or the bigger picture.

3. One should note that the inflation dynamics in the Eurozone doesn’t suggest that this is a one time event or random walk, but seemingly a momentum trend on an upswing.

4. This also shows why listening to the ideas of the mainstream seems to be like placing a noose around one’s neck.

The Power of Slow Change: The China-Emerging Market Story

We learned yesterday that China has surpassed Japan as the second largest economy in the world.

But this isn’t much news to us since, as an example of the power of slow change, China has been creeping towards economic outperformance in many areas such as banking (see our 2009 post A Tectonic Shift In The Global Banking Industry!) to finally catch up with OECD nations.

Nevertheless this has been a dead giveaway—as manifested in the markets for a long time. All that is needed is to open one’s eyes to see this coming.

China’s stock market performance today isn’t at all sterling. It’s been in consolidation after the boom bust cycle of 2008.

Chart from Bloomberg

Year to date China is way down about 19%.

However over the past years, China’s gains have basically outclassed the OECD economies, even if her stock market has stagnated. Of course, most of the world followed a similar boom bust dynamic, including the Philippines.

Yet, Bespoke Invest has a great presentation of this massive paradigm shift.

Bespoke writes,

Japan's stock market capitalization is currently 7.97% of world market cap. China ranks second at 6.89%. Five years ago, Japan accounted for 10.34% of world market cap, while China accounted for just 1.10%. Back in 2005, China ranked just 17th in terms of market cap, behind countries like Saudi Arabia, Spain, Switzerland, South Korea, Taiwan, India, and the Netherlands. Now with the world's second biggest economy and third biggest stock market, it's hard to classify China as an emerging market, but it is indeed still emerging in terms of growth.

The context has to be seen in the light NOT confined to China, as the gains have been made mostly by Asia and emerging market economies.

Instead, what you are seeing is a paradigm shift of growth mostly away from developed economies to emerging markets.

No, this isn’t about cheap labor.

This is about a menagerie of factors as demographics, savings, debt burdens, urbanization and etc... all founded upon the foundations of deepening of free trade, economic freedom and globalization.

So the China-powered emerging market growth story seen in the stock market and economic performances merely epitomizes this power of slow change.

Unless there would be structural political-economic factors that would reverse engineer globalization, I won’t dare bet against this paradigm shift.

Quote of the Day: The Power Of Slow Change

Seth Godin, my favorite marketing guru, recommends that we need to watch the power of slow change,

``Cultural shifts create long terms evolutionary changes. Cultural shifts, changes in habits, technologies that slowly obsolete a product or a system are the ones that change our lives. Watch for shifts in systems and processes and expectations. That's what makes change, not big events.”

Take Facebook.

Facebook only emerged barely 6 years ago, now it has over 500 million active users. It’s a slow, but massive change.

In the same context these changes will certainly affect almost every aspect in people’s lives, i.e. people’s way of conducting commerce, personal relationships and even laws and regulatory regimes.

The point is people who value the conditions of the present without putting into perspective the underlying paradigm shifts in the system will underestimate change. They will be left behind the curve.

I am not like them, are you?

The UNwisdom Of The Crowd

``What I must do is all that concerns me, not what the people think. This rule, equally arduous in actual and in intellectual life, may serve for the whole distinction between greatness and meanness. It is the harder because you will always find those who think they know what is your duty better than you know it. It is easy in the world to live after the world's opinion; it is easy in solitude to live after our own; but the great man is he who in the midst of the crowd keeps with perfect sweetness the independence of solitude.” Ralph Waldo Emerson, Self Reliance

The Follies of Groupthink

Groupthink is when people substitute the opinion of the consensus or the group for their own. It is a product of group cohesion, which leads to a deterioration of “mental efficiency, reality testing, and moral judgment”[1] or particularly the erosion of critical thinking.

This thought process also sacrifices independence, uniqueness, toleration of alternative perspectives and independent thinking in pursuit of group cohesiveness, mostly with the aim to reduce group conflict or maintain balance.

By casting off critical thinking, groupthink leads to hasty, irrational decisions and actions that could be harmful. Think fraternity violence.

If based on social psychologist Irving Janis’ 1970s study on groupthink, the eight symptoms are[2]: (bold emphasis and italics mine)

1. Illusion of invulnerability –Creates excessive optimism that encourages taking extreme risks.

2. Collective rationalization – Members discount warnings and do not reconsider their assumptions.

3. Belief in inherent morality – Members believe in the rightness of their cause and therefore ignore the ethical or moral consequences of their decisions.

4. Stereotyped views of out-groups – Negative views of “enemy” make effective responses to conflict seem unnecessary.

5. Direct pressure on dissenters – Members are under pressure not to express arguments against any of the group’s views.

6. Self-censorship – Doubts and deviations from the perceived group consensus are not expressed.

7. Illusion of unanimity – The majority view and judgments are assumed to be unanimous.

8. Self-appointed ‘mindguards’ – Members protect the group and the leader from information that is problematic or contradictory to the group’s cohesiveness, view, and/or decisions.

In other words, Groupthink embodies the psychological properties that characterize most religious, political and economic forms of social zealotry.

Applied to investing, groupthink represents as the wisdom of the crowd at the extreme levels or near the inflection point of any major trend.

The Wisdom Of The Crowds

In analysing social aspects of life, crowd psychology always operate as very critical factors in determining the sentiment and the possible path of people’s action. This means that crowd psychology does not represent random walk, but as collective sentiment brought about by the crowd’s reaction to the fluid circumstances they are faced with.

Whether vetting on the outcome of national elections, observing the behaviour of horse racing enthusiasts or examining the behaviour the financial markets or the real economy, we run a common ground of crowd psychology in different stages.

The crowd psychology comprises as form of social signalling.

Since people are intrinsically social animals, we always have the frequent sublime need to commune as group, and such is the reason why society has ultimately flourished over the centuries, even amidst the destructive impulses likewise inherent in men to dominate and to plunder (that has led to wars).

Ever since the eons of our prehistoric ancestors, as hunters, our progenitors operated on groups (tribes) to seek protection from among each other, to have a greater chance of attaining the goal of a successful hunt, and importantly, to achieve posterity via gene reproduction purposes.

Conforming to these social patterns is how man’s actions have mostly been directed.

As example “Keeping up with the Jones’” is a common catchphrase that signifies attempts by the individual to emulate an elevated social status in terms material possessions.

The crowd psychology also represents a form of tradition.

For instance the perpetuation of various forms of superstitions, such as in politics, are part of the tradition based crowd psychology.

As English philosopher and liberal political theorist Herbert Spencer once wrote[3],

“The great political superstition of the past was the divine right of kings. The great political superstition of the present is the divine right of parliaments. The oil of anointing seems unawares to have dripped from the head of the one on to the heads of the many, and given sacredness to them also and to their decrees.” (emphasis added)

Applied to politics, the crowd psychology hardly distinguishes between functioning reality and the romanticized expectations of government as supermen.

Traditionalism also finds its way deeply rooted into culture, economics, religion and others aspects of social life.

Of course traditionalism via the crowd psychology can also be used as an escape mechanism.

In Henry Kaufman’s Memoirs, he writes[4],

``Most predictions fall within a rather narrow range that does not deviate from consensus views in the financial community. In large measure, this reflects an all-too-human propensity to minimize risk and avoid isolation. There is, after all, comfort in running with the crowd. Doing so makes it impossible to be singled out for being wrong, and allows one to avoid envy or resentment that often inflicts those who are right more often than not.” (emphasis added)

In other words, traditionalism, or applied conventionally, could be used as an advantage to secure social acceptance.

As in the case above, it can be used to as pretext to elude responsibility. And conversely, as ploy to generate ‘networking’ effects.

A good example of this is from Prof Angelo Codevilla[5], who aptly he describes how the American ruling class have used traditionalism (conventionalism) to secure their current position.

``Today's ruling class, from Boston to San Diego, was formed by an educational system that exposed them to the same ideas and gave them remarkably uniform guidance, as well as tastes and habits. These amount to a social canon of judgments about good and evil, complete with secular sacred history, sins (against minorities and the environment), and saints. Using the right words and avoiding the wrong ones when referring to such matters -- speaking the "in" language -- serves as a badge of identity. Regardless of what business or profession they are in, their road up included government channels and government money because, as government has grown, its boundary with the rest of American life has become indistinct.” (emphasis added)

In short, to be sociologically “IN” means to assimilate conventional ‘uniform’ behavior, de facto ethics and morality as normative.

Importantly, crowd psychology is a form of social expression.

Political elections are the strongest demonstrations of crowd expression.

And so with market bubbles, as James Surowiecki writes[6],

``Bubbles and crashes are textbook examples of collective decision making gone wrong. In a bubble, all of the conditions that make groups intelligent -- independence, diversity, private judgement--disappear.” (emphasis added)

Crowd psychology isn’t always wrong though.

In financial markets crowd psychology can be depicted by trends. Major trends, for instance, are emblematic of the direction of the dominance of crowd behaviour.

As Shawn Andrew of Ricercar Fund observed[7],

“The CROWD is always wrong at market turning points but often times right once a trend sets in. The reason many market fighters go broke is they believe the CROWD is always wrong. There is nothing further from the truth. Unless volatility is extremely low or very high one should think twice before betting against the CROWD.” (all caps original)

The fact of the matter is that it is groupthink or the excessiveness of the crowd to impetuously gravitate towards the collective opinion as the assumed gospel of truth that creates such instability.

Of course, this can only happen when underlying incentives are set to condition people’s mind. Such conditions, in terms of financial markets, include government policies as interest rate manipulation, inflationism, tax policies, the picking winners or losers and etc...

Lessons From The Crowd

So what are the lessons we should learn?

Crowd psychology is a very essential variable in determining social trends (political, economic, and financial trends)

In financial markets, the flow with the crowd is useful for as long as they reflect on the general trend, and for as long as conditions are yet distant from reaching groupthink status.

Groupthink fallacy is the surrender of one’s opinion for the collective. This accounts for as a loss of critical thinking and is reflective of emotional impulses in the decision making of the crowd. When groupthink becomes the dominant mindset of the crowd, an ensuing volatile episode can be expected to occur applied to both markets and politics (bubble implosion or political upheaval).

Though crowd-following is useful, doing what the crowd does isn’t. This prominent quote from a movie character Alan Ashley-Pitt in Quigley Down Under, says it all[8]

"The man who follows the crowd will usually get no further than the crowd. The man who walks alone is likely to find himself in places no one has ever been."

That’s because thinking with the crowd exposes one to deep vulnerability, since crowd psychology hardly represents what the reality is. This is especially pertinent to the markets or even to politics.

Gustave Le Bon[9] spared no sympathy on the crowd’s unintelligence, he wrote,

``This very fact that crowds possess in common ordinary qualities explains why they can never accomplish acts demanding a high degree of intelligence. The decisions affecting matters of general interest come to by an assembly of men of distinction, but specialists in different walks of life, are not sensibly superior to the decisions that would be adopted by a gathering of imbeciles. The truth is, they can only bring to bear in common on the work in hand those mediocre qualities which are the birthright of every average individual. In crowds it is stupidity and not mother-wit that is accumulated.” (emphasis added)

And it’s not just Mr. Le Bon, but likewise one of the world’s richest and most successful investor, Mr. Warren Buffett, the sage of Omaha, subtlety admonishes people from using crowd psychology as justification to trade or invest[10],

"A great IQ is not needed to do well as an investor, what is needed is the ability to detach yourself from the crowd."

Why? Because what matters is independent ‘critical’ thinking! This ability, in my opinion, is to get within the ambit of what is consistently effective or what works and what doesn’t.

Author James Surowiecki sees non-correlation and diversity of knowledge as important variables to independent thinking, he writes[11]

``Independence is important to intelligent decision making for two reasons. First, it keeps the mistakes that people make from becoming correlated. Errors in individual judgement won't wreck the group's collective judgement as long as those errors aren't systematically pointing in the same direction. One of the quickest ways to make people's judgements systematically biased is to make them dependent on each other for information. Second, independent individuals are more likely to have a new information rather than the same old data everyone is already familiar with. The smartest groups, then, are made up of people with diverse perspectives who are able to stay independent of each other. Independence doesn't imply rationality or impartiality though. You can be biased and irrational, but as long as you're independent, you won't make the group any dumber.”

Since groupthink extinguishes personal opinion for the collective then the variability of information becomes eroded and homogenized and thus expanding the potential errors of the consensus in their assessment and their succeeding courses of action. Thus, independent thinking not only maintains the diversity of opinion and information, but should likewise be representative of more “efficient” markets.

Nevertheless, the groupthink phases of crowd psychology should be taken advantage of by people in the know.

THUS, people who think for themselves, who are not afraid to get socially ostracized and or lose ‘temporal’ acceptance via conformity or signalling, or are prepared to go against conventionalism/traditionalism are the people who are likely to work through with right actions derived from pertinent independent analysis.

If there is one single market today which resonates actions of a bubble matched by groupthink psychology it is the US treasury markets.

The 10 year treasury whose bond yields are near the 3 decade long lows (left window), which I flipped to demonstrate the degree of the bubble action (red upside trend at the right window) is currently matched by the humdrum of daily fervid incantations of mainstream opinion makers and their followers, pumped up by from the insights of policymakers, of the mythical “deflation”.

As a caveat, let me repeat “mythical”, in the world of central banking, deflation would only exist once policymakers abandon to use of the printing press and accept the dominance of market forces.

This isn’t happening.

---

[1] Psysr.org, What is Group Think

[2] Ibid

[3] Spencer, Herbert, The Great Political Superstition (1884)

[4] Random Roving Blogspot, Running With The Crowd

[5] Codevilla Angelo M. Codevilla America's Ruling Class -- And the Perils of Revolution, Spectator.org

[6] Surowiecki, James The Wisdom of The Crowd (p 244) bloggiaim.com

[7] Andrew, Shawn; Jeffrey Hirsch Stock Trader’s Almanac 2010

[8] Iwise.com, Alan Ashley-Pitt

[9] Le Bon, Gustave Le Bon The Crowd p. 17

[10] MoneyCentral MSN.com 12 steps to being a 'Zen millionaire'

[11] Surowiecki, James loc sit