Sequel To Asian Financial Crisis?, Costly Bailouts and Bernanke Buys Time

``So the lesson we can take away from all this is to respect what the market tells us, listen to it and ignore the nonsense in the news. More recent incongruous market action should be respected because it may be indicating something important.”-George Kleinman, Commodity Trends, What I Learned This Year Trading Commodities

 

Since I read voluminous reports, articles and research papers daily, I get the privilege of having to access a diversity of opinions and insights of which ranges from the extreme ends of optimism and pessimism. Thus, I realized that my personal biases have been frequently challenged or tempered by the influences of contrasting outlooks. Instead of having extreme convictions which are usually swayed by emotions my views have been redirected to the moderation.

 

Over the years we have pointed on the perils of systemic overleveraging via the US housing bubble and how it poses as a challenge to the global market and the economies. Now that it has become a reality and whose dynamics has been providing us with a suspense thriller, I have been arguing today that the “US is not the Philippines and vice versa” such that while there are transmission linkages that could impact the local economy via trade, labor and financing, there are domestic factors to reckon with that could help cushion on the negative effects from the present systemic deleveraging seen in developed economies.

 

Besides, if I had to take the view of the extreme pessimist, I would have to move to the countryside, stockpile upon years of food (aside from raising them by ourselves) and medicine, accumulate precious metals, and load up on ammunition, energize our homes with solar panels and erect my “mini” fortress in anticipation of the holocaust. Think medieval times applied to present circumstances. That is what the extremes see. Great Depression, a world at war, grand anarchy, massive famine and hunger, breakdown of the financial and monetary system and the society’s division of labor and etc.-arising out of the sudden arrival of “peak oil” or from the ravages of a global economic depression.

 

However, I learned from the Austrian School of Economics that people are rational beings which when confronted with even similar circumstances react distinctly as we discussed last week in Global Recession: Reading From Individual Actions Than From The Collective. Because of such divergence in the actions of individuals there is the tendency that the perceived outcome could be different from what many analysts expect.

 

If it were as simple for people to react in a “common” manner, as seen via the lens of “omniscient” experts, perhaps in the model of the “Gaussian curve”, then our problems would be easily solved. Governments through these experts can simply legislate away on how we should act. But the reality is that we are not robots, our rationalities cannot legislated, and governments only react to circumstances brought upon by the compounded actions of the marketplace. Why do you think we have this “deleveraging” problem in the first place?

 

Not wanting to stop the boom which the US authorities fostered (negative real rates, current account deficits, Fannie and Freddie Mac’s privileged status-which impelled them to take upon greater risk in their portfolios and prompted for a model from which was assimilated by private label mortgages, former Federal Reserve Chair Greenspan’s promotion of ARM, tight regulation in the banking system which led to creation of the “shadow banking system”, etc.) in the first place, now the same authorities have been applying cushion to the impact of an unwinding market dynamic emanating from a grand malinvestment edifice. Yet, if circumstances have been as predictable and politicians react accordingly, we wouldn’t be in these shoes today.

 

Sequel To Asian Financial Crisis? Not So Fast!

 

Even from the Philippine perspective we see the same unpredictability. Because of the interconnectedness brought upon by globalization trends, we have been saying that perhaps the Philippine economy will probably experience slower growth because of the adverse development abroad which are likely to negatively impact our “external linkages”. None of this has happened yet. Export growth trends (up 8.3% in June) and (remittances up 30% in June) have remained vigorous. Maybe it will be a matter of lagged effects.

 

It has been the same with our bullishness of the Peso relative to the US dollar. Where fundamentals favor many ex-US dollar currencies, especially relative to Asia, the sheer vigor in the momentum of the US dollar’s ACROSS THE BOARD advances have spawned many “rationalizations” from “high inflation” to “relative economic growth” to “shrinking liquidity due to current account improvement” and now to Fannie and Freddie Mac inspired risk of a currency crisis. Much of them I believe as unfounded.

 

Look at the following horrid news items:

 

This from the Bloomberg (emphasis mine),

 

Asia Currencies to Fall 12% on Capital Flight, ABN Amro Says

 

``There is more downside to Asian currencies from a reflow of capital out of Asia,'' Irene Cheung, a Singapore-based strategist at ABN Amro Bank, said in a phone interview. ``The decline could accelerate in the next two months because banks in the U.S. and Europe are pulling out. They are short of cash and need to recapitalize toward year-end.''….

 

``As much as $1 trillion flowed into Asia since 2001, of which two-fifths went to China, slightly more than a third to Korea and the rest went mostly to India and Taiwan, according to ABN's estimate.

 

Or this Korea’s Chosun.com (highlight mine)

 

``The main reason behind Monday’s panic was the September crisis rumor, which refused to go away despite government efforts to calm jitters.Stoking them was a scenario where W8 trillion (US$1=W1,118) worth of foreign investment in bonds maturing in September would exit the Korean market at once, further undermining the won and leading to a string of bankruptcies in financial institutions.”

 

Or this from UK Timesonline.co.uk

``Heavy investment by the Korean Government in Fannie, Freddie and other US-related agency bonds has left a potentially huge liquidity problem - perhaps $50 billion (£27.4 billion) - in the foreign reserve portfolio. Some believe that Seoul might have no ammunition left to prevent a significant flight from the won. Fruitless currency intervention by South Korea - increasingly desperate-looking verbal and financial measures to fight the market trend - cost about $20 billion in July alone.”

 

I don’t know why the seeming emphasis on the South Korean won’s 3.3% decline (see figure 1) when the Australian dollar and the New Zealand dollar even took heavier blows, down 5.08% and 4.46% respectively. Although I suspect that the latter two can be easily attributed to sharp decline in commodity prices.

Figure 1: yahoo.com: The Skyrocketing US dollar-Korean Won

 

Except for the Chinese remimbi (down .04%) and the Japanese yen (up 1.14%), based on Bloomberg’s data, ALL Asian currencies took it to the chin with the biggest casualties including the once mighty Singapore Dollar (down 1.43%). The Peso was down nearly 2% to 46.82 to a US dollar. Such dramatic cascading actions in the currency markets have led to creepy claims of market disaster.

 

Patching up all these we understand that stuffed with outsized holdings of US Fannie and Freddie Mac papers have basically rendered South Korea’s central bank as illiquid. Faced with maturing bonds in the face of a central bank liquidity crunch aggravated by current account deficit and portfolio liquidations from the deleveraging US and European institutions translates to a currency run. Thus, the currency crisis of South Korea and the rest of Asia!

 

Run for your lives…Its Asian crisis all over again! Or is it?

 

Of course we understand too that the global credit crunch has adversely impacted many companies that rely on global trade like Daewoo Shipping, some of whose international customers have withdrawn due to the lack of access to credit, aside from the anticipation of slowing business due to economic growth deceleration. And state owned Korean institutions, the Korea Development Bank and Korea Asset Management Corp, which controls 50.4% (Bloomberg, Hat Tip Craig McCarty) have reportedly been selling their stake in the company, possibly reinforcing the view of the state’s liquidity predicament.

 

But wait, what seems grossly inconsistent is that if South Korea’s central banks are truly in liquidity crunch, the same institutions cited above have played separate roles in NEGOTIATING TO ACQUIRE stakes at the beleaguered US financial institutions of the LEHMAN Brothers and Merrill Lynch!

 

So what could also be seen as selling by state owned Korean financial institutions of Daewoo shipping could also be interpreted not as raising liquidity for financing obligations but as an arbitrage, buying US assets! If the latter view is correct then, where’s the currency crisis?

 

Horror Stories Deserve A Second Look

 

Of course we can’t deny that with heightened incidences of liquidations from hedge funds on every asset class would “hurt” somewhat ex-US currencies due to a gush of outflows.

 

But to assume that MOST of the money which had flowed into Asia WILL EQUALLY stampede out seems one dimensional if not downrightridiculous or absurd. Such assumption ignores the fact that Asia has also been a source of liquidity growth and not just in the US.

 

Proof?  This from India’s Daily News Analysis (emphasis mine), ``Wealth is growing at much faster rates among the rest of the world.Households in Asia, the Pacific Rim excluding Japan and Latin America saw the greatest growth, with wealth rising 14%. That growth was fuelled by manufacturing in Asia and commodities in Latin America and the Middle East, as well as more currency and political stability.”

 

Besides, such analysis ignores that the fact that Asia has been impacted by trade and financial linkages and have NOT been the source of the financial disaster. In short there is a stark difference between structural and cyclical factors.

 

Another proof?

 

While, many OECD economies have been undergoing the paroxysm of deleveraging which essentially raises the cost of capital aside from the paucity of access to capital seen via contracting bank lending, figure 2 shows how the Philippine Banking system continues to experience robust growth!

Figure 2: ATR Kim Eng: Philippine Banking System Continues to Expand!

 

This from ATR Kim Eng (Hat Tip: Ton Garriz), ``The growth in outstanding loans of commercial banks accelerated to 18.1% Y/Y in June from 15.8% in May. The trend is consistent with the numbers reported separately by banks in their Q2 financial results. Credit expansion was driven by wholesale and retail trade (+38.5%), electricity, gas and water (+43.8%), and transportation, storage and communications (+57%). The growth in loans to the manufacturing sector grew at a slower pace of 7% although an improvement from 5.2% in the previous month. Manufacturing accounts for the 22% of total loans, the largest among categories. Auto loans also reversed course, growing 15.3% in June from a 6.9% contraction in the previous month.”

 

So aside from growth seen in the general industry we are seeing also credit growth in the consumer segment as seen in Auto Loans. This also suggests that sales of cars despite “high” oil prices can be expected to remain firm.

 

Additional information from the Inquirer.net,

 

``Consumer-related loans, which made up of about 8.0 percent of total bank lending, climbed 22 percent in June against a revised 19.9 percent in May, the central bank data showed. Consumption loan growth came mostly from credit card receivables which grew 27.3 percent in June, the central bank said.”

 

So the credit contraction or a liquidity crunch hasn’t infringed (yet. Though I don’t expect it to impact us materially) on the premises of the Philippine economy. Also all these suggest that the Philippine economy remains vibrant.

 

And the financial markets except the Peso have been bearing us out.

 

While Korean bonds have fallen (rising yields) reflecting the anxiety of deficit-global deleveraging process, Philippine bonds continue to rallymarkedly (falling yields).

 

This implies two possible developments, one, “lower” expectations of future consumer price inflation and two, diminished symptoms of “liquidity” crunch or contagion from the world’s develeraging process.

 

As we have written in many times during the past, market internals of the Phisix have shown decreasing depth of foreign selling. This has recently supported the Phisix’s “divergence” from most of the global markets, see figure 3.

Figure 3: PSE: Once Again, Diminishing Foreign outflows

 

As you can see, the foreign selling since the credit crunch unraveled last year has been the dominant theme in the Phisix. But once again the scale of selling activities (exhibited by the red arrow) seems to be diminishing and NOT increasing in contrast to the gloom and doom citations by freaked out analysts!

 

And yes, while the markets may not agree with me yet on the Peso which I believe reflects mainly a function of the unwinding short US dollar Carry trade, the deleveraging process, government intervention and momentum, this perhaps could last longer than my expectations.

 

Besides as we pointed in our July 20 issue Philippine Peso: Technical Pattern, BSP Actions and Diminished Inflation Points To A Rally, previous patterns have shown the Peso to correct by 45-50% before resuming its upward path which means the Peso could go over 47 before appreciating.

 

And if falling Asian currencies have been associated with the illiquidity from Asian central bank portfolio holdings of Fannie and Freddie Mac securities then the latest proposed emergency actions by the US Treasury (which is set to be announced before Asian markets open on Monday) suggest that “implicit guarantees will become explicit” as the US nationalizes the two behemoth widely owned mortgage institutions.

 

This from Bloomberg, ``The Treasury plans to put Fannie and Freddie into a so- called conservatorship and pump capital into the companies, House Financial Services Committee Chairman Barney Frank said in an interview yesterday. The government would make periodic capital injections by buying convertible preferred shares or warrants, according to a person briefed on the plan. Paulson is seeking to end a crisis of confidence in the companies sparked by concern the companies didn't have enough capital to weather the biggest housing slump since the Great Depression.”

 

US Dollar Weighed By Heavy Cost of Bailout, Bernanke Buying Time

 

It’s simply amazing how we can be bullish the US dollar when the US government will be throwing so much money to salvage its financial system from a complete meltdown at a heavy cost to its taxpayers.

 

Don A. Rich in Mises.org wrote about the estimated full cost to taxpayers in rescuing Fannie and Freddie Mac alone, ``the real cost of the bailouts will easily exceed $1.3 trillion. In fact, the real cost is likely to range between $1.3 trillion to $1.6 trillion, and is not unlikely to reach $2.5 trillion.”

 

In perspective, US $1.3 trillion is almost equivalent to 10% of the US GDP! That’s for the GSEs alone, how about the others (FDIC and the rising bank foreclosures)?

 

Furthermore, just look at these comments from the news wires:

 

The Bloomberg quotes PIMCOs top honcho and bond market wizard Bill Gross (highlight mine),

 

``Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,'' Gross said. ``If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.''

 

Former Federal Reserve Chairman Paul Volker says of the same thing (Bloomberg)

 

``This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down,'' Volcker said today at a banking conference in Calgary. ``Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation.''

 

No, the US dollar’s rally can’t be about economic growth or earlier recovery relative to its peers. The remaining pillar that keeps the US economy afloat has been exports, if the actions in the international financial markets are any indications, as seen in collapsing commodity prices and falling equity values in the BRIC zone (except India!), these suggest that US exports will likewise founder perhaps ushering its economy to a full blown recession perhaps from here going forward.

 

It can’t be about compression of liquidity out of the improvement in the US current account deficits too, if US exports fall in tandem with imports then the deficit standings will remain the same. Besides, the strength of the US exports implies the strength of the global economy; meaning in order for the US economy to keep from falling into a recession it needs a stronger global economy. So relativity-wise, the US can’t outgrow the world economy, especially against emerging markets which has supplied most of its financing requirements.

 

Yet any supposed improvement in the current account deficits will likely be offset by a sharp widening of fiscal deficits where government spending can’t be curbed at the same rate as the slowdown in tax revenues. And these deficits entail the need for foreign capital to plug or fill such yawning gap.

 

It can’t be about the rush to secure US dollars to pay off debt as deflation proponents argue. The liquidity crunch has been mainly a US and partly a Europe phenomenon. Besides, liquidity hasn’t been a monopoly of the US dollar and its financial system.

Figure 4: PIMCO: World Real Policy Rates Remain Negative!

 

Figure 4 from Pimco demonstrates that the world remains essentially “accommodative”.

 

My interpretation is that by keeping the US Fed policy rates down, Chairman Bernanke aims to transmit its inflationary policies via dollar links and currency pegs to Emerging Economies in order for latter to recover earlier-if not to remain vibrant-in order to buoy (via exports) and finance (plug deficits) the US economy, aside from inflating away the relative values of foreign owned US financial liabilities. (Korea’s plan to buy into Lehman and or Merrill Lynch exhibits such patterns).

 

You see the probable strategy employed by the global central banks led by Chairman Bernanke’s US Federal reserve seems to be to buy enough time for the world to recover and eventually write off all the losses in the affected financial sectors (once enough capital has been raised and when markets stabilize) similar to what the US Federal Reserve did in the early 1980s when every major American bank was technically bankrupt.

 

This apropos excerpt from one of our favorite analyst John Maudlin (underscore mine),

 

``They had made massive loans all over Latin America because the loans were so profitable. And everyone knows that governments pay their loans. Where was the risk? This stuff was rated AAA. Except that the borrowers decided they could not afford to make the payments and defaulted on the loans. Argentina, Brazil and all the rest put the US banking system in jeopardy of grinding to a halt. The amount of the loans exceeded the required capitalization of the US banks.

 

``Not all that different from today, expect the problem is defaulting US homeowners. So what did they do then? The Fed allowed the banks to carry the Latin American loans at face value rather than at market value. Over the course of the next six years, the banks increased their capital ratios by a combination of earnings and selling stock. Then when they were adequately capitalized, one by one they wrote off their Latin American loans, beginning with Citibank in 1986.”

 

Conclusion

 

The important thing to differentiate from our standpoint to that of horror stories is that the world is much integrated, more sophisticated and collaborative or more flexible as to diffuse these shocks to perhaps minimize stress levels. That’s why I try to always keep my mind open than simply fall for emotionally stirred hypes.

 

Applied to the investing world, such scenario translates to the same theme: gradual accumulation of EM and Asian assets and/or currencies as the opportunities arise, because the world likely to grow or recover in support of the US economy and not the other way around.

Phisix: Enduring A Global Meltdown, Surviving September

``Whenever you see a successful business, someone once made a courageous decision.”-Peter Drucker

 

In spite of the jitters of a market meltdown, the Phisix alongside Vietnam’s Ho Chi Minh Stock Exchange (+1.4%) and Bangladesh’s Dhaka Stock Exchange (+1.36%) astoundingly outperformed most of the “collapsing” Asian markets. The Philippine benchmark accounted for a positive 1.36% advance over the week. This came in spite of the massive selloffs in the US markets which lost about 3% last Thursday and whose decline reverberated across globe. The Phisix fell by only 1% last Friday to reduce gains acquired early during the week.

 

By the way, among the 7 markets we monitor as possibly forming a bottom as discussed last week in Stock Markets As Indicators Of Recession, 2 are definitely out of the list as Taiwan and Thailand broke support levels while Australia remains in critical support levels. However we will have to add Bangladesh’s Dhaka Stock Exchange whose short term improving technical performance (whose market I glossed over last week) may be a part of team of outliers. Incidentally, New Zealand and India suffered slight losses, down by only .51% and .55% respectively.

 

In the past when the US markets tumbled our Phisix either fell by a proportionate degree or lost greatly more than the decline in US markets. But we have been seeing signposts of growing dissociation. The last time the US benchmarks tumbled by 3% in June 26^th as measured by Dow Jones Industrials, the Phisix lost only 2.2%. Thursday’s hefty 3% loss for the Dow Jones Industrials translated to only 1% loss in the Phisix. So far the Phisix has been behaving against the “recoupling” crowd.

 

Besides one notable action seen in the market internals of the Phisix has been that the greatly reduced degree of losses have been backed by SHARPLY reduced volume as shown in Figure 5.

Figure 5: PSE: Reduced Peso Volume Equals Diminishing Selling Pressures!

 

The bullmarket of 2005 to 2006 haven’t been accompanied by large volumes, which means much of the ascent was “unnoticed”. Peso volume improved only during late 2006 until mid 2007 (green line). As the credit crisis unraveled Peso volume has dramatically fallen along with the recent bear market (red line).

 

Note: it is common to see falling volume in a bear market, as buyers go on a strike. However, a differentiation is that when the scale of market declines substantially eases accompanied by volumes drying up significantly-signifies as diminished degree of selling pressure.

 

Lately we have had two occasions where the market’s Peso volume shriveled to a little over Php 1.1 billion on 2-3 points of decline. The last time the Phisix did the same activity was in September of 2006 which eerily seems to reveal of a similar pattern as today’s; except that the difference is that today’s action seems to be the enlarged version of the 2006 episode as shown in see figure 6.

Figure 6: stockcharts.com: Phisix 2006 Redux? Divergences to Continue?

 

When the Phisix reached its second bottom in September 2006 the Peso volume shrank by same degree (gold arrow in Figure 5), the following months saw the Phisix sprint by over 40%.

 

This is not to suggest that the Phisix will do the same sprint given the global conditions but we can’t write off a material improvement in the Phisix once we survive the seasonal weakness of September, which may imply that we can have a yearend rally barring any shocks.

 

Moreover, the red vertical line shows how the Phisix appears to have departed from its peers, neighbors and the US market. And if such a trend gets reinforced in the coming sessions, local investors, who appear to be driving the Philippine Stock Exchange, might get confident enough to invest more of their sidelined money. Remember, the local participants constitute less than 1% of the population, which means there is much room for participation improvement.

 

As an aside, the prospect of a vastly improving Phisix might yet in itself reverse those foreign fund flows by attracting money from international investors looking for yields enough to offset the forcible liquidation dynamic. For example, the “Mrs. Watanabes” or the housewife currency trader who could be representative of some segment of Japanese savers with a war chest of US $5.04 trillion (New York Times) could be one of our prospective momentum investors.

 

Remember too, that the Philippines is still in a negative real rate environment (statistical “inflation” rate is higher than policy rates, bond yields or economic growth rates) which is why we think that credit growth has been expanding aside from the improvement in the Phisix in the face of slowing “inflation”.

Besides, if US housing will probably bottom by 2010 as shown in Figure 7.

Figure 7: Wall Street Journal: Housing Bottom Still A Year Away

 

Markets, functioning as forward discounting mechanism, usually prices in 6-9 months ahead of the event, suggest that most of the world markets will probably hit the bottom by the first semester of 2009, which gives further boost to our hypothesis that 2010 will see the Phisix take off under the Philippine Presidential cycle.

 

Overall our general message is not for us to run away and hide but to take opportunities to earn from possible seasonal trends aside from positioning for the eventual recovery of global markets possibly in 2009.

Based on Odds, Smokers Die Earlier

Bad news for smokers (I guess this is NOT NEW news at all). A study says probability of death is higher for smokers as shown in the chart below from New York Times…

From the New York Times ``New risk charts in a paper published in The Journal of the National Cancer Institute provide a broader perspective than most of the risk calculators on the Internet, because they cover the risks for 10 different causes of death, and for all causes combined, while differentiating by age and between smokers, nonsmokers and former smokers.”

``At first glance, it may appear that smokers and nonsmokers die of heart disease at the same rate, but a 35-year-old male smoker is seven times as likely to die of heart disease as a nonsmoker the same age. The numbers begin to converge as some smokers survive the more common smokers’ diseases, and by age 75, their rate of death from heart disease is almost the same as nonsmokers’.”

So if a smoker does hurdle the said risks diseases by age 75, death rate is almost the same as nonsmokers. So if you can’t help get rid of the habit maybe eating watercress can get you through to the age were smokers and non smokers have level chances of dying.

Decoupling in Cyberspace? Internet Traffic Begins to Bypass the US!

The following article by New York Times' John Markoff accounts of a monumental watershed development in the world's cyber traffic. This is a compelling read. Here are some excerpts...

``The era of the American Internet is ending.

``Invented by American computer scientists during the 1970s, the Internet has been embraced around the globe. During the network’s first three decades, most Internet traffic flowed through the United States. In many cases, data sent between two locations within a given country also passed through the United States.

``Engineers who help run the Internet said that it would have been impossible for the United States to maintain its hegemony over the long run because of the very nature of the Internet; it has no central point of control.

``And now, the balance of power is shifting. Data is increasingly flowing around the United States, which may have intelligence — and conceivably military — consequences...

``Ms. Claffy said that the shift away from the United States was not limited to developing countries. The Japanese “are on a rampage to build out across India and China so they have alternative routes and so they don’t have to route through the U.S.”

``Andrew M. Odlyzko, a professor at the University of Minnesota who tracks the growth of the global Internet, added, “We discovered the Internet, but we couldn’t keep it a secret.” While the United States carried 70 percent of the world’s Internet traffic a decade ago, he estimates that portion has fallen to about 25 percent.

``Internet technologists say that the global data network that was once a competitive advantage for the United States is now increasingly outside the control of American companies. They decided not to invest in lower-cost optical fiber lines, which have rapidly become a commodity business...

Important Lessons:

1. Government intrusions have been driving away internet traffic from the US.

2. The snowballing realization of the significance of the Internet to the economic sphere has prompted for diversification of internet providers.

3. Developing countries have been pouring massive capital to the industry more than the US

4. The growing diffusion of world internet usage world wide could be seen in the prism of "one of many indicators that the world is becoming a more level playing field both economically and politically." In short, decoupling!

5. Expanding global competition helps drive the spread of internet usage.

Global Recession: Reading From Individual Actions Than From The Collective

``Here’s the truth: voters naively think (or hope) that one man has the right answers in the right plan. It's not possible. Presidential policies are way too simple in a world way too complex to be prescriptive with any certainty in their consequences. Stuff happens. I believe the only thing a single man can do before an audience is this: get their attention; move them to action. Influence. Change their psychology. Make them positive, make them hopeful, inspired, make them motivated. Make them act. We don't have to agree with the words of history's greatest orators, but we can't deny they moved people. Mostly for the better (Cicero (before senate in Rome), Jesus (Sermon on the Mount), Patrick Henry (liberty or death), Lincoln (Gettysburg + Inaugural Address), FDR (fear speech) Churchill, Kennedy (Ask not and Moonshot), MLK (I have a dream), Reagan, even—Al Gore created an entire movement, with a slide-deck). Make no mistake: history is littered with corrupted power, jingoistic rhetoric, misguided promises and words wielded with malicious intent from galvanizing speakers (Hitler, Stalin, Castro, Chavez) who took a broken people and raised their spirits and moved them to action--and to atrocities--in the completely wrong direction.”-Josh Wolfe, Words Matter

***

Recession has been the de rigueur word in the web sphere. The more the clarion the call for a global recession, the more public’s attention seems to have been drawn to this. The debate has apparently shifted from one of the probability of occurrence to one of severity and duration of the “established” event.

While it is true that what seem to ail the world today have been imbalances that have been fostered throughout the years, it isn’t clear how these “malinvestments” should result to cataclysm on a global scale.

The worst part is that the penance from the sins of one clique is seen as similar penitential discipline to the others whom have not committed the same iniquities. Thus, because of connectivity or “recoupling” we are told, we ought to prepare for Armageddon.

We learned from the Austrian school that because people are rational and thinking individuals guided by reasons to our every action, the diversity of the individual’s marginal utility or our “values” may generate different responses to even similar circumstances that we are faced with. Seen from the real world perspective, where circumstances are distinct for everybody, the responses from individuals are even more complex and disaggregated than can be comprehended by “articulate self-righteous” aggregate looking Keynesian assimilating experts.

As Jim Fedako of the Mises.org recently wrote, ``the concept of the individual must never be lost amid the ideal of the collective — the belief that the members of the collective (the nation in this instance) are faceless automatons dedicated to serving the whole.”

Such divergences can be seen even from governments themselves.

Many have argued that deteriorating conditions in the external trade and financial linkages would lead to central banks’ conventional response of cutting policy interest rates. During the last crisis, European central bankers followed the steps of the US Federal Reserves; faced with a recession in 2001 the US Fed slashed policy rates to 1% while the European Central Bank cut similar rates to 2%. Recently, as the US Fed cut an aggregate 325 basis points on the advent of the credit crisis, the Europeans refused to follow. And many have been puzzled by the ECB’s persistent recalcitrance.

In June, Wolfgang Munchao (at the Financial Times) sees this in the light of evolving geo-political economic dynamics (highlight mine),

``This suggests that in terms of global monetary policy, we are in the middle of a shift from a unipolar to a bipolar world. In the past, the Fed’s policy alone used to determine the global monetary policy stance – via the dollar, the global anchor currency. Through long periods of loose monetary policies, including lengthy episodes of negative real interest rates, the Fed contributed directly to the rise in global inflation. I am not referring to the recent commodity price increases but to the trend rise in inflation we have been observing for some time.

``European inflation has also risen as part of this global trend. If the ECB follows the course Mr Trichet appears to have set out, there is now a real possibility that the eurozone, and perhaps some other regions in the world as well, could decouple from this US-led trend. This is what I mean by policy decoupling.”

While the ECB might belatedly respond to the lowering of interest rates considering rapidity of declines in economic conditions, this isn’t at all certain. The Bloomberg quotes European Central Bank council member Axel Weber as saying in an interview in that ``there's no scope for interest-rate cuts and the bank may even need to raise borrowing costs again once the economy emerges from its slump.”

All this goes to show that the decoupling recoupling debate is nothing but abstractionism that won’t attain absoluteness simply because nations interact with each other and at same time retain distinctiveness in terms of domestic activities. In the same manner arguments which leads to a global meltdown based on such premises should also be seen with skepticism.

Look at how the world has defied such conviction, e.g. one year into the US-Euro credit crisis impelled global economic slowdown, Germany’s exports continue to account for positive growth whereas the country’s economic slowdown has been due to slowing domestic demand (Wall Street Journal). In other words, Germany’s present weakness has been in the account not because of external linkages but from domestic strains allegedly from “high consumer prices” and not the externally presumed cause-and-effect factors.

Or look at Japan’s recent exports see figure 1.

Figure 1: Danske Bank: Asia leads Japan’s exports

The conventional analyses have focused on deteriorating export markets of US and Europe as one of the reasons for marking down Japan. But just recently China has emerged as Japan’s top export destination (IHT). The Dankse chart shows how the growth clip of Asian exports (blue) have remained resilient (or rangebound) in spite of the sharp volatilities in the US (red) and the European market (apple green).

Of course, we don’t deny that present developments may lead to the belated reactions in both Japan and Germany relative to external links as the downshift from global economic growth spreads, but the lesson is clear: If governments-organizations controlled by a few individuals-can’t get their act to be as predictable for the gloom-and-doom advocates, how much more when we deal with markets.

Stock Markets As Indicators Of Recession

``The media loves a recession, because it means no slow news days for a while. Every utterance from the Fed is a headline, weekly columns write themselves (just pick two recession cliches from your cliche file and rub ‘em together), and "man in the street" interviews will always yield some nice emotional sound bites.”- John Carlton, How to Survive Excessive Recession Hand Wringing

Financial markets function as forward discounting mechanisms and could thereby serve as leading indicator for impending recessions.

According to renowned Wharton economist Jeremy Siegel in Stocks for the Long Run, since 1948, 10 recessions in the US were preceded by a stock market decline with a lead time of 0 to 13 months or an average of 5.7 months. (It should be noted that ten stock market declines of greater than 10% in the DJIA were not followed by a recession)-[source wikipedia.org].

Figure 2: Economagic: S & P 500 and US Recessions

Figure 2 from Economagic validates the view of Mr. Siegel that the stock markets have historically accounted for as strong lead indicators of previous economic storms. The recessions of 1970, 1974, 1981, 1991 and the latest dot.com bust all shows of falling stock markets values (based on the S & P 500 closing prices) prior to the formal recession (shaded areas).

Moreover, since official declarations are backdated-for instance the National Bureau of Economic Research (NBER), a private non-profit organization that officially reckons of the US business cycle, in 2001 declared the US entered into a recession in March but was broadcasted only in November 2001 (BBC)-the markets have already reflected upon the gist of the downside adjustments.

The S&P 500 accounted for nearly ¾ of the losses of the entire cycle in terms of scale (peak-trough) and had been at more than 50% of the duration of the time cycle of the bear market, when the pronouncement of a recession was made.

The point is, by the time of the official recession was recognized by the NBER, the likelihood is that the markets have already reflected the meat of the losses or is in the last inning of the bear market.

Of course, we’d like to point out that ALL recessions are different in terms of underlying causes, operating conditions and effects or impacts to markets or the economy such that we can’t interpret wholly past conditions as reflective of the future. Doing so would render one guilty of simplistic thinking.

Derivatives and structured finance or the so-called "shadow banking system", technology enabled real time capital flows, "Mrs Watanabe" and the US$ 3 trillion+ per day currency trades, South-South trading, 37 years of off-Brettonwoods “gold” standard, global transmission effects by currency pegs and dollar links, globalization of trade, labor and finance, emergence of sovereign wealth funds, massive growth of current account imbalances, emerging market vendor financing of current account deficit developed economies (or nondemocratic countries financing democratic nations), offshoring/outsourcing, WIKInomics, telecommutations, hybrid electric cars, climate change, nanotechnology, biotechnololgy and etc....account for only SOME of the variables that were NOT SEEN or were NOT AS SIGNIFICANT in the PAST as it is today that will continue to revolutionize or sizably impact present conditions going forward-in terms of economic, social, cultural, financial, political, environmental and scientific spectrums.

What we can do is to simply look at these circumstances and integrate past lessons into examining the potential distributive outcomes. Assuming a replay of past conditions under the present landscape signifies as haphazard analysis or thinking at best.

Recession: The Denmark and New Zealand Experience

From the recent global slowdown we can take glimpse of how some equity markets have responded to official recessions.

So far among developing economies only Denmark (EU Business) and New Zealand (BBC) have been official casualties to the economic downdraft or has encountered an economic growth recession in a technical sense (two quarters of negative economic growth), see figure 3.

Of course, Japan, UK and some economies under the Eurozone have been widely anticipated to fall into the daisy chain category of economic recessions in the coming quarters. Such expectations have allegedly resulted to a swift change of tide as seen in the furious rally of the US dollar index.

Figure 3: Denmark’s KFX Index (left) and New Zealand’s NZ50 (right)

Although Denmark officially acknowledged a recession last July (blue arrow)-having covered two quarters from October 2007 to June 2008 (see vertical blue lines)-we can note that from the peak-trough, the KFX has lost 23% and is now down about 18% from its former highs.

What seems to be noteworthy is that the labor market seems to be tight in spite of the recession. According to Steen Bocian chief economist of Dankse Bank (highlight mine), ``For now then, low unemployment is tempering the bleakest portents for the Danish economy. However, it is important to remember that the economy has just emerged from a long period of strong economic growth which has exerted immense pressure on the labour market. Labour shortages are therefore still a big concern for many businesses, making them reluctant to let people they worked hard to recruit go, even if order books are beginning to dry up.

``So, it is probably only a matter of time before we see a rise in unemployment. Nevertheless, there is a lot of evidence to suggest that such a move may be slow in coming and unlikely to result in especially high joblessness. Anyway, rising unemployment is not necessarily a bad thing for the Danish economy in the current climate. It may sound strange to say that the economy could benefit from having more people out of work, and of course this could not stand as an end in itself. But there is no doubt that pressure on the labour market remains intense, and unemployment is well below the structural level . i.e. one compatible with stable wage and price formation in the slightly longer term.”

It is indeed peculiar to hear an economist say that “high unemployment will be good for an economy” which is frequently blamed on “inflation” when monetary policies should be more of the culprit but nonetheless the low of levels of unemployment should extrapolate to a floor to the downside momentum of the Danish economy.

The chart itself seems to croon of the same tune; the KFX appears to be exhibiting signs of a bullish “double bottom”! So the likelihood is that Denmark’s travails could be short term in nature.

On the other hand, New Zealand which also was officially declared to be in a technical recession early August (blue arrow), covering the first semester of the year (blue vertical lines), has seen its major benchmark down on a peak to trough basis of nearly 30% to presently 22% following its recent rebound.

While it would be too early to conclude if New Zealand is in the path to a confirmed inflection point, what can be noted is that based on the technical picture the NZ50 appears to be attempting for a breakout from its bear phase of the stock market cycle. The seeming “breach” from the downside channel of the NZ50, once confirmed, should demarcate such transition.

Some Asian Bellwethers Attempt To Form A Bottom

The New Zealand’s primary benchmark the NZ50 is one of the 7 Asian bourses which seem to be working towards a formative “bottom” cycle as seen in Figure4.

Figure 4: stockcharts.com: Asian Bourses Attempting To Bottom

Aside from the Phisix and Vietnam where we previously discussed in The Philippine Peso And The Phisix: With A Little Help From Our Neighbors, and New Zealand; India’s BSE (upper left window) seems to mimic the NZ50’s motion, while the Taiwan’s Taiex (upper right window), Australia’s All Ordinaries (lower left window) and Thailand’s SET (lower right window) seem to be in a tight consolidation-typical characteristics of market bottoms; albeit this is too premature to conclude since it would need to manifest more prolonged period of rangebound movement or gradual ascension).

Nevertheless as a matter of market timing and the seasonality of trends, September usually has been a critical period for the global stock market as shown in Figure 5, although as reminder, seasonal trends aren’t infallible indicators.

Figure 5: chartoftheday.com: September’s Seasonal Weakness

The US Dow Jones Industrials have tended to be weakest during September which if seasonal trends should persist, increases the odds of volatility this month considering the already frail economic environment.

And this is where it gets interesting; if Asian equity markets manage to withstand the turbulence abroad, then the chances for the “bottoming” process are likely to get enhanced going into the yearend. This implies that if the present “divergences” will be sustained from the expected infirmities in the US markets, then Asian markets could probably see a much amplified rally by the end of the year to highlight the establishment of the bottom cycle.

And going back to the current recessions of New Zealand and Denmark, the intensity and durations of such adjustments also matters. The recession’s longevity would likely be determined by the cyclicality or secularity of the present market trends relative to the domestic economic cycle. This suggests that if, for instance, Denmark’s recession had been based on economic growth ‘overheating’ than from systemic excessive overleveraging to deleveraging adjustments, then the present recession could be ‘short and shallow’ instead of an extended one. Hence the market actions should equally reflect such momentary shortcomings than a brutish bear.

Conclusion and Recommendation

Recessions are the official affirmations of the public’s expectation of statistical negative economic growth. Where the stock market signifies as a strong leading indicator, a declaration of official recession could be construed similar to the reverse analogy of “buy on rumor, sell on news”…or simply “sell the rumor, buy the news”.

So far among developed economies, only Denmark and New Zealand has entered its fold while some others have been expected to follow.

In addition, the durability and duration of a recession depends on the degree of structural or external influences on the economic and the market cycle. Read from the stock market’s perspective, in most instances, the official declaration of a recession usually marks of the last leg of the bear market cycle especially if the market’s deterioration was earlier prompted by cyclical forces. Structural led bear markets tend to extend losses overtime and in terms of depth.

Recession will probably be a problem for some Asian economies as Japan. However, interpreted from the stock market’s action, many Asian markets have been currently attempting to form a bottom which probably means that the contagion impact from the US credit crunch could be peaking unless proven otherwise. Going into the usually volatile month of September, such critical “bottom-forming” exercise could be confirmed or debunked.

If Asian markets manage to hold its standings or its present gains into September, then based on seasonal factors there is a good chance for the markets to rally going into the yearend. A rally that fortifies the technical picture seen above compounded with broader participation could formally establish the region’s transition towards the market’s “bottom” cycle and an upcoming recovery.

In the same plane, any weaknesses seen in the market this month could be seen as an opportunity to accumulate.

At the end of the day, stock markets are likely to be driven by monetary growth and credit creation, technological advances, economic and productivity growth.