Warren Buffett: Do as I say, Not as I Do: No Bubble, but Berkshire Hathaway’s Cash Hoard Soars

At a CNN interview, US President Obama crony Warren Buffett denies a bubble in US stocks: Buffett said stocks "might be a little on the high side now, but they've not gone into bubble territory."

Yet he further stated that:  "I don't find cheap stocks to buy either," he said, adding after follow-up questions that there were "very little" and "very few" bargains out there right now.

For Mr. Buffett, the framing of bubble in the context of portfolio management matters. 

In Berkshire’s 2014 annual report, Mr. Buffett wrote: (bold mine)

There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined investing as “the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.”

The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities – Treasuries, for example – whose values have been tied to American currency. That was also true in the preceding half-century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century. 

Stock prices will always be far more volatile than cash-equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments – far riskier investments – than widely-diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk. Though this pedagogic assumption makes for easy teaching, it is dead wrong: Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray. 

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing-power terms) than leaving funds in cash-equivalents. That is relevant to certain investors – say, investment banks – whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits. 

For the great majority of investors, however, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities

Yet action speak louder than words.

Berkshire Cash and Cash Equivalents since 1995

Berkshire cash at US$ 60.98 billion or 17% of market cap as of yesterday (based on Yahoo Finance).

The cash holdings of Mr. Buffett’s flagship Berkshire Hathaway has been skyrocketing.

From an annualized basis, Berkshire’s biggest gain in cash equivalent has been in 2014. Yet since 2008, Berkshire has been stockpiling cash reserves.

And the crux has been, Berkshire has done little to use those cash hoard!

While it may be true that “a multi-decade horizon, quotational declines are unimportant”, buying at a elevated prices will have an impact on portfolio returns even at the long run. 

And what Mr. Buffett didn’t say has been that most of Berkshire’s holdings has been from long term positions, rather than from current investments.

It’s true that Berkshire Hathaway recently bought $560 million in the automotive sector through Axalta Coating System, a 145-year old seller of coatings for cars, SUV’s and commercial vehicles, but this hardly signifies a dent on the $60 billion stash.

At least Mr. Buffett has been candid to admit that he is just human and has been subject to miscalculations and losses.

In the same annual report he shares the sad experience of Berkshire’s position with Tesco.

Attentive readers will notice that Tesco, which last year appeared in the list of our largest common stock investments, is now absent. An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.

At the end of 2012 we owned 415 million shares of Tesco, then and now the leading food retailer in the U.K. and an important grocer in other countries as well. Our cost for this investment was $2.3 billion, and the market value was a similar amount.

In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)

During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.

We sold Tesco shares throughout the year and are now out of the position. (The company, we should mention, has hired new management, and we wish them well.) Our after-tax loss from this investment was $444 million, about 1/5 of 1% of Berkshire’s net worth. In the past 50 years, we have only once realized an investment loss that at the time of sale cost us 2% of our net worth. Twice, we experienced 1% losses. All three of these losses occurred in the 1974-1975 period, when we sold stocks that were very cheap in order to buy others we believed to be even cheaper

Finally, yet some very useful advise from the annual report (bold italics mine)

If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement. (The S&P 500 was then below 700; now it is about 2,100.) If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).

Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary fees to managers and advisors, and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. Indeed, borrowed money has no place in the investor’s tool kit: Anything can happen anytime in markets. And no advisor, economist, or TV commentator – and definitely not Charlie nor I – can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

The commission of the investment sins listed above is not limited to “the little guy.” Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades. A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool’s game

Well, the above insight brings us back to Mr. Buffett’s old adage: 'You want to be greedy when others are fearful. You want to be fearful when others are greedy. It's that simple.'

So there you have it, for Mr. Buffett the term "bubble" seems as a political sensitive word. So he fudges this by framing the market over the long term versus the short term. 

Updated to add: Of course uttering the word 'bubble' may just deflate Mr. Buffett's glory, prestige and esteem, as the investing public would refrain from pushing up Berkshire Hathaway or assets held by Berkshire.

Yet in his 2014 annual report Mr. Buffett made lots of caveats in citing "borrowing has no place in the investor's tool kit" when US non-financial companies has been in a borrowing splurge, that makes markets susceptible to "anything can happen anytime in the markets".

And if one looks at Mr. Buffett's Berkshire’s Hathaway cash stash, they seemed positioned for a coming fat pitch…

So do as I say, not as I do.

Mohamed El-Erian: My Money Has Mostly Been Into Cash as Central Banks Pump Asset Prices

Former PIMCO co-founder and now chief economic adviser at the Allianz Mohamed El-Erian, in a recent interview says why his portfolio has been mostly in cash.

Selected excerpts from OCGregister (hat tip Bloomberg) [bold mine]

Q. Why write a book on central banks?

A. This is a historic period in which central banks are the only game in town when it comes to policy. But central banks do not have the tools to deliver what the global economy needs. We need more potent reinvigorated growth models.

The West fell in love with the wrong growth models 10 years ago. It fell in love with finance as an enabler of prosperity. The whole society fell in love with leverage and credit as a way of prospering. We were entitled to accumulate debt! People bought homes they could not afford. Governments borrowed money that they could not pay back.

Regulators believed that finance was so sophisticated that you could lessen regulations on it. This romance with the wrong growth model fell apart in 2007 and 2008...

Q. Where is your money? Stocks? Treasuries? Bonds?

A. It is mostly concentrated in cash. That’s not great, given that it gets eaten up by inflation. But I think most asset prices have been pushed by central banks to very elevated levels.

Q. So we’re nearing a bubble?

A. Go back to central banks. Central banks look at growth, at employment, at wages. They are too low. They don’t have the instruments they need, but they feel obliged to do something. So they artificially lift asset prices by maintaining zero interest rates and by using their balance sheet to buy assets.

Why? Because they hope that they will trigger what’s called the wealth effect. That you will open your 401k, see it has gone up in price, and you’ll spend. And that companies will see their shares are going up and they will be more willing to invest. But there is a massive gap right now between asset prices and fundamentals.

It's interesting to see how changes has been happening at the margins to the point that risks appears to be seeping into mainstream awareness.

Ludwig von Mises: The Peculiar and Unique Position of Economics

In celebration of this year's Holy week, residents of the Philippines will be having a long weekend.

So before I sign out for the week, here is a recommended read on the importance of economics and its effects to society and politics as articulated by the great Austrian economist Ludwig von Mises excerpted from Human Action (1949), chapter 37, "The Nondescript Character of Economics."

From the Mises Institute: (bold mine)

The Singularity of Economics

What assigns economics its peculiar and unique position in the orbit both of pure knowledge and of the practical utilization of knowledge is the fact that its particular theorems are not open to any verification or falsification on the ground of experience. Of course, a measure suggested by sound economic reasoning results in producing the effects aimed at, and a measure suggested by faulty economic reasoning fails to produce the ends sought. But such experience is always still historical experience, i.e., the experience of complex phenomena. It can never, as has been pointed out, prove or disprove any particular theorem. The application of spurious economic theorems results in undesired consequences. But these effects never have that undisputable power of conviction which the experimental facts in the field of the natural sciences provide. The ultimate yardstick of an economic theorem's correctness or incorrectness is solely reason unaided by experience.

The ominous import of this state of affairs is that it prevents the naïve mind from recognizing the reality of the things economics deals with. "Real" is, in the eyes of man, all that he cannot alter and to whose existence he must adjust his actions if he wants to attain his ends. The cognizance of reality is a sad experience. It teaches the limits on the satisfaction of one's wishes. Only reluctantly does man resign himself to the insight that there are things, viz., the whole complex of all causal relations between events, which wishful thinking cannot alter. Yet sense experience speaks an easily perceptible language. There is no use arguing about experiments. The reality of experimentally established facts cannot be contested.

But in the field of praxeological knowledge neither success nor failure speaks a distinct language audible to everybody. The experience derived exclusively from complex phenomena does not bar escape into interpretations based on wishful thinking. The naïve man's propensity to ascribe omnipotence to his thoughts, however confused and contradictory, is never manifestly and unambiguously falsified by experience. The economist can never refute the economic cranks and quacks in the way in which the doctor refutes the medicine man and the charlatan. History speaks only to those people who know how to interpret it on the ground of correct theories.

Economics and Public Opinion

The significance of this fundamental epistemological difference becomes clear if we realize that the practical utilization of the teachings of economics presupposes their endorsement by public opinion. In the market economy the realization of technological innovations does not require anything more than the cognizance of their reasonableness by one or a few enlightened spirits. No dullness and clumsiness on the part of the masses can stop the pioneers of improvement. There is no need for them to win the approval of inert people beforehand. They are free to embark upon their projects even if everyone else laughs at them. Later, when the new, better, and cheaper products appear on the market, these scoffers will scramble for them. However dull a man may be, he knows how to tell the difference between a cheaper shoe and a more expensive one, and to appreciate the usefulness of new products.

But it is different in the field of social organization and economic policies. Here the best theories are useless if not supported by public opinion. They cannot work if not accepted by a majority of the people. Whatever the system of government may be, there cannot be any question of ruling a nation lastingly on the ground of doctrines at variance with public opinion. In the end the philosophy of the majority prevails. In the long run there cannot be any such thing as an unpopular system of government. The difference between democracy and despotism does not affect the final outcome. It refers only to the method by which the adjustment of the system of government to the ideology held by public opinion is brought about. Unpopular autocrats can only be dethroned by revolutionary upheavals, while unpopular democratic rulers are peacefully ousted in the next election.

The supremacy of public opinion determines not only the singular role that economics occupies in the complex of thought and knowledge. It determines the whole process of human history. 

The customary discussions concerning the role the individual plays in history miss the point. Everything that is thought, done and accomplished is a performance of individuals. New ideas and innovations are always an achievement of uncommon men. But these great men cannot succeed in adjusting social conditions to their plans if they do not convince public opinion.

The flowering of human society depends on two factors: the intellectual power of outstanding men to conceive sound social and economic theories, and the ability of these or other men to make these ideologies palatable to the majority.

Quote of the Day: Hayek: Inflation is the Most Important Single Factor for the Loss of Freedom via Government Expansion

There are two points which cannot be stressed enough: first, it seems certain that we shall not stop the drift toward more and more state control unless we stop the inflationary trend; and, second, any continued rise in prices is dangerous because, once we begin to rely on its stimulating effect, we shall be committed to a course that will leave us no choice but that between more inflation, on the one hand, and paying for our mistake by a recession or depression, on the other. Even a very moderate degree of inflation is dangerous because it ties the hands of those responsible for policy by creating a situation in which, every time a problem arises, a little more inflation seems the only easy way out.

We have not had space to touch on the various ways in which the efforts of individuals to protect themselves against inflation, such as sliding-scale contracts, not only tend to make the process self-accelerating but also increase the rate of inflation necessary to maintain its stimulating effect. Let us simply note, then: that inflation makes it more and more impossible for people of moderate means to provide for their old age themselves; that it discourages saving and encourages running into debt; and that, by destroying the middle class, it creates that dangerous gap between the completely propertyless and the wealthy that is so characteristic of societies which have gone through prolonged inflations and which is the source of so much tension in those societies. Perhaps even more ominous is the wider psychological effect, the spreading among the population at large of that disregard of long-range views and exclusive concern with immediate advantages which already dominate public policy.

It is no accident that inflationary policies are generally advocated by those who want more government control-though, unfortunately, not by them alone. The increased dependence of the individual upon government which inflation produces and the demand for more government action to which this leads may for the socialist be an argument in its favor. Those who wish to preserve freedom should recognize, however, that inflation is probably the most important single factor in that vicious circle wherein one kind of government action makes more and more government control necessary. For this reason, all those who wish to stop the drift toward increasing government control should concentrate their efforts on monetary policy. There is perhaps nothing more disheartening than the fact that there are still so many intelligent and informed people who in most other respects will defend freedom and yet are induced by the immediate benefits of an expansionist policy to support what, in the long run, must destroy the foundations of a free society.

(bold and italics mine)

All I have been saying captured in three paragraph from the great Austrian economist Nobel Prize winner Friedrich August von Hayek in Chapter 21 The Monetary Framework, The Constitution of Liberty p 338-339 via Libertarianismo.org

That last statement from 3rd paragraph resonates…

Wow. Federal Reserve of Atlanta’s Estimates of 1Q 2015 US GDP now at ZERO Growth!

The US Federal Reserve of Atlanta has a segment called GDPNow which attempts to estimate US GDP on a real time basis or prior to its official release.

The official description by the Atlanta Fed on GDPNow:

The growth rate of real gross domestic product (GDP) is a key indicator of economic activity, but the official estimate is released with a delay. Our new GDPNow forecasting model provides a "nowcast" of the official estimate prior to its release. Recent forecasts for the GDPNow model are available here. More extensive numerical details—including underlying source data, forecasts, and model parameters—are available as a separate spreadsheet.

Their latest forecast (bold mine) 

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2015 was 0.0 percent on April 1, down from 0.2 percent on March 30. Following this morning's construction spending release from the U.S. Census Bureau, the nowcast for real residential investment growth increased from -1.1 percent to 1.8 percent. This was more than offset by declines in the nowcasts for real nonresidential structures investment growth (-19.3 percent to -22.5 percent) and real state and local government spending growth (0.3 percent to -0.8 percent).

Record stocks as GDP growth sinks to ZERO! 

Truly Awesome!

US Stock Market Bubble: In 1Q 2015, Firms with Bad Earnings Have Been Rewarded More than those with Good Earnings

The US Treasury’s Office of Financial Research appears to be right, US stocks has been plagued by overvaluation and overleverage which has amplified the risks of financial instability.

Here’s more, the reason why overvaluation exists has been because companies with bad or negative performance has been rewarded by the markets more than companies with positive performance.

From Factset’s 1Q Report on the S&P (bold mine)

-For Q1 2015, 85 companies in the S&P 500 have issued negative EPS guidance and 16 companies have issued positive EPS guidance. If 16 is the final number of companies issuing positive EPS guidance for the quarter, it will mark the lowest number since Q1 2006.

-Companies are providing EPS estimates for Q1 that are 9.2% below analyst expectations on average. This percentage is slightly below the 5-year average of -11.3%.

-The market is not punishing companies that have issued negative EPS guidance for Q1 on average. Companies that have issued negative EPS guidance for Q1 have seen an average increase in price of 1.7%, which is well above the 5-year average price change (-0.9%). This is the highest average price increase for companies issuing negative EPS guidance for a quarter since Q2 2009.

-For the current fiscal year, 179 companies have issued negative EPS guidance and 61 companies have issued positive EPS guidance.

The Factset notes on “Highest Average Price Increase for Companies Issuing Negative EPS Guidance Since 2009”

To date, the market is not punishing companies that have issued negative EPS guidance for Q1, while it is rewarding companies that have issued positive EPS guidance for Q1 at only average levels. 

The 85 companies that have issued negative EPS guidance for Q1 2015 have seen an average increase in price of 1.7% from two days before the guidance was issued through two days after the guidance was issued. This percentage is well above the 5-year average price decrease of 0.9% during this same window for companies issuing negative EPS guidance.

In fact, this quarter marks the largest average price increase for companies issuing negative EPS guidance for a quarter since Q2 2009 (+4.3%) Overall, 50 of the 85 companies that have issued negative EPS guidance recorded an increase in price during this time frame. Of these 50 companies, 6 recorded a double-digit price increase.

The 16 companies that have issued positive EPS guidance for Q1 2015 have seen an average increase in price of 2.8% from two days before the guidance was issued through two days after the guidance was issued. This percentage is just slightly above the 5-year average price increase of 2.6% during this same window for companies issuing positive EPS guidance. Overall, 13 of the 16 companies that issued positive EPS guidance during the quarter saw an increase in price during this time frame. None of these companies recorded a double-digit price increase.

Like the Philippines, US stocks has reached a point where valuations or risks hardly matters at all and where price discovery has been almost entirely been broken.

The Slippery Slope of Deposit Confiscation: Australian Edition

In the  recent  G-20 meeting, deposit confiscation (bailIns) had been included as part of the multipartite political agenda. Yet unknown to most, this serves as handwriting to the wall for the formal banking system.

Here is what I wrote then: (bold mine)

In short, the formalization of the G20 accord on the downgrade of bank deposits implies, the greater risks of bank runs.  Yet the institutionalization of bail INs will not likely to be limited to G20s but should spread even on Emerging-Frontier markets.

Governments around the world have been in a state of panic. They are desperately manipulating stock markets in the hope that these may produce “wealth effect”, a miracle intended to save their skin or the  status quo (the welfare-warfare, banking system and central bank troika), as well as, camouflage current economic weakness and or kick the debt time bomb down the road.

Yet the same political institutions recognize that inflating stocks are unsustainable. So during this current low volatile tranquil phase, they have been implementing foundations for massive wealth confiscation.

What better way to confiscate than do it directly. Yet the more the confiscations, the greater risks of runs on banks and on money.

Well Sovereign Man’s Simon Black identifies Australia as one of the would be pioneers to such path… (bold original, italics mine)

Several months ago, the government of Australia proposed to tax bank deposits up to $250,000 at a rate of 0.05% (5 basis points).

Their idea was for the money to be invested in a rainy day Financial Stabilization Fund to insure against in the unlikely event of a banking crisis… or all-out collapse.

And as of this morning, it looks like the levy might just pass and become law in Australia. All parties support the idea. Which means that Australia might just have a tax on bank deposits starting January 1, 2016.

To be clear, the proposal seems to plan on taxing the banks based on the amount of deposits they’re holding—but it’s pretty obvious this will be passed on to consumers in the form of lower interest rates.

Let’s look at what this means:

1. Taxes on bank deposits are generally the same as negative interest rates. Australia is a rare exception.

Interest rates on bank deposits in most developed nations are practically zero… if not already negative.

So charging a tax above and beyond this would clearly push rates (further) into negative territory.

I have, for example, a small bank account in the United States that pays me about .03% interest (three basis points). If the government imposes a tax of 5bp on interest of 3bp, I’m left with negative interest.

Australia (along with New Zealand) is a rare exception since interest rates are actually positive. You can get 2-3% on a savings account. So a 5bp tax still results in positive interest.

2. Taxes always start small… then increase over time.

Of course, the proposal on the table right now is a 5bp tax. There’s nothing that says this can’t increase to 50bp over time.

When the United States government first imposed the modern federal income tax a century ago, the top tax rate was just 7%. These days that would qualify the US as a tax haven.

Over time, tax rates rose to as high as 92%. Tax rates can (and do) rise. And once they’re passed, they’re almost never abolished.

3. Taxes are rarely used for their stated purpose

Politicians create and raise taxes all the time for special purposes. And again, over time, they are often diverted away from those purposes.

In 1936 after a devastating flood in Johnstown, Pennsylvania, the state government passed a ‘temporary’ 10% tax on all alcohol sold in the state in order to help pay for disaster relief.

Six years later the work was complete. But the tax is still on the books (now at 18%), with all the revenue going to whatever the state lawmakers want to blow it on.

FICA is another great example. Though payroll taxes in the US were initially established to fund Social Security and Medicare, the federal government steals this revenue every year to haplessly try and plug budget deficits.

So a tax to build a financial stabilization fund might sound comforting in theory… but will all the revenue actually be allocated for that purpose? Doubtful.

4. If this can happen in Australia, is anyone foolish enough to think it can’t happen in the US or Europe?

Australia has a sound and sturdy banking system.

Banks in Australia are actually, you know, solvent. Capital ratios and liquidity rates are solid. Australia’s is a well-capitalized banking system—far more than in the US and Europe.

The numbers tell a very clear story. Banking systems across Europe in particular have had to be routinely bailed out over the past few years—Slovenia, Spain, Greece, Cyprus, etc.

In the United States it is perhaps even more absurd. Based on their own numbers, US banks are highly illiquid, still gambling away customer funds in trendy investment fads that will likely suffer an epic meltdown.

Backing up this little scam is the FDIC, which itself is pitifully undercapitalized to support any significant problem in the banking system.

Backing up the FDIC is the US federal government, which is already drowning in more than $60 trillion in liabilities (based on the most recent GAO report).

And supplying crack to the crack head is the US Federal Reserve, America’s central bank.

With net capital just 1.26% of total assets, the Fed is so pitifully capitalized they make Lehman Brothers look like Berkshire Hathaway.

So if the government of Australia is concerned that their well-capitalized banking system needs a safety net and wants to tax deposits for such purpose, how in the world can we possibly expect the US and Europe, with all of their banking system risk, won’t do the same?

One thing leads to another.

When the next global crisis appears (very soon), domestic currency confiscation will likely spread to foreign currency deposits. The buck won’t stop here. As part of the manifold means to capture resources, capital controls will be imposed, trade controls, price and wage controls will most likely be  also implemented. 

Government’s use of monetary inflation or the inflation tax will intensify. 

Proof? In Ireland, Irish politicians has proposed of the nationalization of money creation. They want to bar banks of this role and shift money creation to solely the domain of the central bank

From Telegraph (bold mine)

Iceland's government is considering a revolutionary monetary proposal - removing the power of commercial banks to create money and handing it to the central bank.

The proposal, which would be a turnaround in the history of modern finance, was part of a report written by a lawmaker from the ruling centrist Progress Party, Frosti Sigurjonsson, entitled "A better monetary system for Iceland".

"The findings will be an important contribution to the upcoming discussion, here and elsewhere, on money creation and monetary policy," Prime Minister Sigmundur David Gunnlaugsson said.

The report, commissioned by the premier, is aimed at putting an end to a monetary system in place through a slew of financial crises, including the latest one in 2008.

According to a study by four central bankers, the country has had "over 20 instances of financial crises of different types" since 1875, with "six serious multiple financial crisis episodes occurring every 15 years on average".

Mr Sigurjonsson said the problem each time arose from ballooning credit during a strong economic cycle.

So instead of dealing with the incentives that whets on the appetite of the banking system to expand credit, politicians see knee jerk reactions as solutions. 

Yet by monopolizing credit allocation, this will lead to even more politicization of  distribution of credit. And because governments via central bank will pander to populist short term oriented political agenda, this heightens the risks of, or eventually paves way to, hyperinflation. 

Going back to negative rates, yet the opportunity cost of negative rates will be the cost of storage of currency/banknotes. This means that if negative rates will go deeper, at a certain point, people will look at cash/banknotes (in safety boxes? or in pillow mattresses?) as a more feasible alternative to bank deposits. 

So the likely unintended consequence will be intensified “debt deflation” as more people horde cash. And instead of global economies experiencing a renaissance, the opposite will occur, capital consumption will intensify, thus economies will falter if not collapse, thereby leading to massive debt defaults.

Stashing cash may increase security risks as robbery and theft. This will raise the cost of holding cash. So the public will be immersed in a conundrum: the devil or the deep blue sea; Submit to government confiscation or to heightened security risks of holding cash. This points at how inflationism destabilizes society

Although, some entrepreneurs may see this as commercial opportunities. They may offer large scale storage/safety box facilities with stringent security. I am hopeful that there will be private sector alternatives even if it means black market substitutes.

But governments will always attempt to employ a dragnet on the resources of her constituency by imposing controls. Example, the French government has been en route to outlaw or impose increase restrictions on cash holdings.

From Reuters: From September onwards, people who live in France will not be allowed to make payments of more than 1,000 euros ($1,060) in cash, down from 3,000 now. The cap for foreign visitors, left higher for reasons that include facilitating tourism, will be cut to 10,000 euros from 15,000.

So while stock markets have been running records, behind the scenes, perhaps in anticipation of violent adjustments from the current unsustainable arrangements, governments have been working 24/7 on the legal, political, technical platforms towards direct confiscation of people’s resources.

Humor of the Day: Dilbert on the Employable Economist's Economic Babble

(hat tip Zero Hedge/Source Dilbert)

This 'dropping-of-economic-terminologies-equals-economics' strip is so relevant...

Ah, the told-to-say economic view economist...

...can also be a fortuitous economist...

Phisix Record 8,000: Happy April Fool’s Day!

The PSE celebrates today’s 24th record high session and 10.5% gain for the year. 

From their press release

Our stock market managed to close higher despite the decline in major Asian indices. This resilience has been evident as local economic and corporate developments continue to positively influence investor sentiment

(table from Bloomberg)

Well, what you see depends on where you stand.

Asian equities was mixed today.

Benchmarks of Japan, Taiwan, South Korea, Australia, Indonesia and Vietnam closed down.

On the other hand, Hong Kong, China, India, Thailand, Pakistan and the Philippines have been up today.

So the reference to Asian indices really depends on which has been the basis of the claim.

Nonetheless, the general idea from the press release has been to paint--that not only has the Phisix outperformed the region--but that local developments imply that the Phisix will ‘decouple’ and will be immune from external developments!

In short, this time is different!!!

Yet let see how today record runs equates to “positively influence investor sentiment” (charts from Colfinancial.com)

We see the same operations to manage the index at work again. This session features another 'afternoon delight' pump marked by wild panic buying and price pushing which ultimately culminated with a “marking the close” to ensure Phisix 8,000 would be just a breath away!

It has been a five sector last minute price fixing: Four sectors exhibited a pump, while the service sector a dump (not in chart)…

The rush to 8,000 comes with only Php 7.72 billion. 

Curiously why the seeming desperation if this has truly been about "economic and corporate developments"?

Today’s actions essentially piggybacks on yesterday’s performance (aside from Monday's shocking actions)… 

In contrast to today, the market started strong yesterday. But the session saw a profit taking trend from the strong start going through the pre-runoff period. 

However, for the index managers, correction has not been permissible. 8,000  has to be met soon…so again the incredible last minute pump!

Index managers have become so desperate to reach Phisix 8,000 soonest!

And the same modus had been used for the closing of yesterdays’ session.

In terms of sectoral activities, another price fixing pump on big ticket issues representing four indices essentially offset some of the infirmities from the strong opening of the day.

Add to this Monday’s fabulous pump and dump which surely has been one for the books!

Market manipulation appears to be the major driving force behind the record Phisix. It's being implemented daily.

Yet the PSE lauds rising security prices in the assumption that such has been about “local economic and corporate developments”. 

But they never seem to give a thought that spectacular overvaluation, manic yield chasing and the rigging or massaging of markets has already underwritten the boom’s demise as discussed last weekend.

Said differently, record 8,000 has not just been about yield-momentum chasing hysteria that has been taking hold in the marketplace, but that the domestic stock market seems as being rigged right under the noses of the PSE! And instead of ensuring the healthy function of the markets to reflect on price discovery, PSE officials cheer on such impropriety and the transmogrification of the equity markets into a loaded casino! 

Let me quote again Warren Buffett’s mentor Benjamin Graham and David Dodd’s warning on why this new-era theory is fated to end in tears. 

From Graham-Dodd’s classic Security Analysis (bold mine)

The notion that the desirability of a common stock was entirely independent of its price seems incredibly absurd. Yet the new-era theory led directly to this thesis. If a public-utility stock was selling at 35 times its maximum recorded earnings, instead of 10 times its average earnings, which was the preboom standard, the conclusion to be drawn was not that the stock was now too high but merely that the standard of value had been raised. Instead ofjudging the market price by established standards of value, the new era based its standards of value upon the market price. Hence all upper limits disappeared, not only upon the price at which a stock could sell but even upon the price at which it would deserve to sell. This fantastic reasoning actually led to the purchase at $100 per share of common stocks earning $2.50 per share. The identical reasoning would support the purchase of these same shares at $200, at $1,000, or at any conceivable price. 

An alluring corollary of this principle was that making money in the stock market was now the easiest thing in the world. It was only necessary to buy “good” stocks, regardless of price, and then to let nature take her upward course. The results of such a doctrine could not fail to be tragic. Countless people asked themselves, “Why work for a living when a fortune can be made in Wall Street without working?” The ensuing migration from business into the financial district resembled the famous gold rush to the Klondike, except that gold was brought to Wall Street instead of taken from it

To repeat with emphasis:

The results of such a doctrine could not fail to be tragic.

Phisix Record 8,000: Happy April Fool’s day!

South Korea’s Collapsing Merchandise Trade

I’m supposed to be on a vacation, but there have simply been too many very interesting developments some of which I feel I must share.

Well one of these has been that Korean merchandise trade has virtually been collapsing.

Today, the Korean government reported a 4.2% drop in year on year March exports (chart from investing.com)

This marks a back to back decline with a seeming acceleration in the rate of the downtrend.

Considering that China, US Japan, Hong Kong and Singapore make up her 5 major export trade partners, aside from possible issues on competitiveness, the alternative and or complimentary explanation for the sluggish exports has been deepening languid performance of economic activities of her trading partners.

Korea’s plummeting exports has been occurring in the face of a sustained battering of her currency the won as shown in the USD-Krw above from google finance

So currency weakness has hardly done anything to improve on Korean exports.

March import data brings about even more bad news.

Korean imports have basically been collapsing. Since late 2014, the rate of decline has been intensifying. 2015 has been dominated by double digit declines!

The import cascade seems like a symptom of the weakening of Korea’s internal demand.

Although consumption spending has been creeping up while retail sales jumped in February following a drop in January 2015, the gist of these spending activities has been financed through household credit.

Considering that merchandise trade (exports and imports) constitute a big segment of her economy (82.4% 2010-2014 World Bank), the above slump signifies a coming squall to her statistical GDP. 

In essence, Korea’s economy has increasingly become dependent on leveraging. And such debt buildup has likewise become a drag to her economic activities, as this seems as being transmitted via the consumers, while simultaneously increasing her risk profile in the context of interest rate, currency and credit.

Korean mainstream press seems worried of the rapid buildup of household debt. From the Korean Times (March 31) [bold mine]

At the end of February, household loans reached an accumulated 522 trillion won after climbing 3.9 trillion won in the first two months, and a combined 66 trillion won in the 2012-2014 period, according to data from the Financial Supervisory Service (FSS).

Escalating worries of possible non-performing loans (NPLs), more than 70 percent of the accumulated household loans were mortgages in the two-month period, Cho said citing FSS data.

So aside from the recent unexpected rate cut two weeks ago, the Finance Ministry launched a bailout program called “relief loans” but was apparently met with skepticism

From the same article (bold mine)

Korea's household debt is on track to rise further after jumping nearly 4 trillion won ($3.6 billion) in the January-February period; while the "Relief Loans" designed to restructure this debt will not be of much help, experts said Tuesday.

"The 40 trillion won Relief Loans are aimed at helping a small portion of households convert their existing mortgages into fixed, low-rate ones, and also allowing them to pay principal and interest together on a monthly basis," Cho Young-moo, an economist at LG Economic Research Institute, said Tuesday.

He said installment payments of principal and interest will help families lower their overall debt over time, but the conversion program is not likely to reduce the country's entire household debt.

The law of demand says that the lower the cost of an activity, the more people will do of it. So by lowering cost of credit (via policy rates) and by providing subsidies or bailouts, one can expect credit activities to expand and aggravate on the existing impairments on Korea’s private sector balance sheets…until these collapses under its own weight.

A further bad news has been that the HSBC manufacturing PMI has posted 49.2 this March implying a contraction in manufacturing activities. The March survey supports the developing slack in Korea’s internal and external economic activities.

And given the apparent deterioration in her economy and the policy choice to subsidies internal debt at the expense of the currency, many South Koreans have been looking overseas to chase for yields.

The other option has been to chase yields in domestic stocks regardless of the intensification of her risk profile. 

So we have another parallel universe, rising stocks amidst a deepening of economic stagnation.

In McKinsey Global Institute's recent report “Debt and (not much) deleveraging”, they note of the burdensome effects of debt to economic activities:

High debt levels, whether in the public or private sector, have historically placed a drag on growth and raised the risk of financial crises that spark deep economic recessions

It’s not just about empirics, rather this has been based on economic axiom. Here is my version:

Debt represents the intertemporal distribution of spending activities. Borrowing money to spend simply means the frontloading of spending. The cost of debt financed spending today is spending in the future. Debt will have to be repaid at the expense of future spending. Of course there are productive and non-productive debts. But policies of financial repression via zero bound rates tend to promote non-productive ‘speculative’ and consumption debts.

As I have been saying here, there are multiple tinderboxes to trigger a global economic storm. 

South Korea has been just as vulnerable as the many others.  Yet signs of deterioration has been spreading everywhere.

Tick Tock. Tic Tock.