The Asymmetric Odds Of Short Term Trading

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

My comment:

What the article didn't say?

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

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

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

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

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

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

What's next, tax human fart?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

All charts from Gallup.

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

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

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

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

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

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

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

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

To aptly quote Jeff Jacoby at the Boston.com,

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

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

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

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

So, caveat emptor.

GATA: Gold Suppression Scheme Nears End

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

Watch the video and read parts of the transcript here

Some noteworthy excerpts from the interview,

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

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

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

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

US Federal Reserve Study: Currency Crashes Can Be Good!

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Interesting Chart from Bloomberg's Chartoftheday:

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

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

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

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

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

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

Protectionism: Clear and Present Danger

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

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

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

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

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

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

Beer, Consumer Choice and Free Society: The American Model

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

Video from Reason TV,

Quoted from Reason TV

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

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

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

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

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

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

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

Hat Tip Mark Perry

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Beware Of The Brewing Meralco Bubble!

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

Meralco is in a SEMINAL bubble.

The Case For A Brewing Bubble

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

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

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

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

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

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

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

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

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

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

Figure 6: Moneyweek.com: Stages of A Bubble

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

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

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

King Kong Versus Godzilla

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

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

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

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

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

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

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

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

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

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

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

The Psychology of Bubbles

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Conclusion

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

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

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

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

Unfortunately markets don’t operate on hope.

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

“Before me things create were none, save things

Eternal, and eternal I endure.

All hope abandon ye who enter here."

Therefore my advice, caveat emptor.

Phisix: Braving The Global Storm So Far

``Most financial professionals have strongly concluded that recent market action has completely disproved the decoupling theory that I have espoused. This is premature. It will take some time for the rest of the world to realize that what has been decoupled from the economic train is the caboose, not the engine”-Peter Schiff, The Price of Popularity

For the fourth consecutive week, the US equity markets have suffered its second episode of meltdown throes, where major US bellwethers have lost over 20%. True, many parts of the world have tracked the developments in the US, especially among industrialized economies. But unlike the first episode during the last quarter of 2008, where collapsing markets were ‘synchronized’, this time pockets of divergences have apparently emerged.

The Philippine Phisix, for instance, seems to have been shrugging off the turbulence, as the major bellwether accrued a 2.56% weekly advance amidst a raging four week squall to tally a marginal 2.53% year-to- date gain.

We have asserted that last year’s rout in the global market and the Phisix had been principally tied to the global debt deflation phenomenon called as the “forcible selling” or forced liquidations as described earlier than merely domestic “economy” related.

Nonetheless even as the world has been facing relentless pressure on the besieged US banking sector, which is further exacerbated by the banking crisis in developed Europe, locked in by the economic crisis in Emerging Europe, the appearance of diminishing degree of deleveraging based NET foreign liquidations seem to be partially gaining momentum in the Philippine Stock Exchange, see figure 2.

Figure 2: PSE: % Share of NET Foreign Trade

The red ellipse shows of the sharp drop in the share of foreign trade to total trade.

For the past four weeks, most of the sudden reduction of foreign trade is largely due to the expanded speculations over Meralco , a Manila based utility firm which maintains a legal stranglehold on electricity distribution over the National Capital Region (NCR).

Moreover, based on several market internal indicators as the advance-decline spread, see figure 3, we can take note of the improving breadth of the trading activities in the Philippine Stock Exchange (PSE) despite the violent gyrations in the overseas equity market.

Figure 3: PSE: Improving Advance-Decline Spread

In contrast to most of 2008, where the advance-decline spread hardly saw any material improvement, the collapse in late October of last year until the recent days have manifested a sizeable progress in the advance-decline spread as displayed by the red arrow.

Combined with the narrowing of foreign trade even before the Meralco sizzle, the improvement in the market breadth plus the 5 months of sideways trading makes it appear that the Phisix (see figure 4) has been drifting along a Bottoming phase of the market cycle.

Figure 4: Three Divergences: S&P 500, Phisix, Meralco

The Phisix, in green, is on a 5 month consolidation while the US S&P, light orange, has been on a steep plunge!!

But our guarded optimism has been partially substituted with alarm; the fantastic price actions in Meralco (black candle), where on the positive side has been providing the PSE with a semblance of “market leadership”, and risks being negated by a negative side, a formative bubble that risks overturning the recent improvements!

Global Economies and Markets: From Debt Deflation To Creative Destruction?

``Yet “revolutions” every generation, as was recommended by Thomas Jefferson, are not the solution. We know that “revolution” is not achievement and the new dawn. It results from senile decay, from the bankruptcy of ideas and institutions, from a failure of self-renewal. The only way in which an institution – whether a government, a university, a business, a labor union, an army – can maintain continuity is by building systematic, organized innovation into its very structure. Institutions, systems, policies, eventually outlive themselves, as do products, processes, and services. They do it when they accomplish their objectives, and they do it when they fail to accomplish their objectives. Innovation and entrepreneurship are thus needed in society as much as in the economy, in public service institutions as much as in business. The modern organization must be a destabilizer; it must be organized for innovation.-Peter Drucker, Modern Organization Must Be a Destabilizer

The mainstream has argued sternly about the “myth of decoupling”, when the term decoupling has been a palpable misnomer.

In the globalization heyday of yesteryears, which means the integration of finance, trade, investment and labor, “convergence” was obviously the natural outcome. Thus, global markets and economies had been mostly coordinated or harmonized as the bubble blossomed.

But when the US originated global credit bubble imploded, this globalization platform have effectually been reduced, as world trade is expected to decline by more than 2% (usatoday.com), and capital flows around the world is also expected to crater- world Foreign Direct Investment (FDI) is expected to slump by 21% (Dailystar.net) and capital flows to Emerging Economies is likewise expected to tumble to $165 billion from $466 billion according to the Institute of International Finance (Marketwatch.com).

In addition, ongoing debt deflation in major economies have been reversing capital flows, as major financial institutions vie to meet capital requirements hence repatriate capital from liquidated overseas investments.

And as we previously argued, the recent surge of the US dollar’s price against most of the world’s currencies has been a function of dollar shortage in the system, the BIS recently issued a report which essentially validates our view [see The US dollar's Vitality Stems From Debt Deflation Prompted US Dollar Shortage]

Worst, the rising protectionist sentiment seen in many diverse forms are being resurrected and may further add to negatively impact trade and financial flows [as discussed in Will Deglobalization Lead To Decoupling?].

Hence, the natural incipient impact from deglobalization was also a synchronous meltdown seen late last year.

Now a new trend seems to be evolving.

In contrast to the macroeconomic perspective, whose penchant is to view the world in terms of aggregates and who seem to believe that people behave like automatons and tend to think alike, we think that people respond differently to the circumstances, hence may lead to diverse reactions. In short, people act based on purposeful behavior or incentives.

The carnage in October of 2008 instigated by the institutional run or “electronic run” in the US banking system seems to have posed as a severe mental shock known as the Posttraumatic Stress Disorder (PTSD) to the world economic activities and the financial markets. In some accounts, such mental discord has been labeled as the “After Lehman” syndrome [see our latest post, Global Posttraumatic Stress Disorder (PTSD): The After Lehman Syndrome].

And as the world fell in into a transient suspended animation from such anxiety disorder, the consequent spillover to the real economy have been transmitted through a deep retrenchment of the credit driven demand and the subsequent sharp downside adjustments in the global supply chain, which reflected on the abrupt dismantling of the production structure built around the bubble global paradigm.

This means that the compression of the supply chain had been equally manifested in the mass closure of relative excess capacities, the efforts to reduce existing surplus inventories and the reduction of labor and or rationalization of wages. Likewise, expected valuations in on diverse asset markets during the bubble days are being intensely reappraised, as the once euphoria outlook seems to have transmogrified into a depression mentality.

In short, as explained in Fruits From Creative Destruction: An Asian and Emerging Market Decoupling?, the world’s financial markets and economies appear to be undergoing ‘creative destruction’, where the speculative excesses from the bubble structure is being undone by market forces, despite government’s exhaustive travails to futilely sustain them.

As Friedrich Hayek once wrote, ``The thing which is most needed to secure healthy conditions is the most speedy and complete adaptation possible of the structure of production. If the proportion as determined by the voluntary decisions of individuals is distorted by the creation of artificial demand resources [are] again led into a wrong direction and a definite and lasting adjustment is again postponed. The only way permanently to 'mobilise' all available resources is, therefore to leave it to time to effect a permanent cure by the slow process of adapting the structure of production.” (bold highlight mine)

Signs of Positive Impact From Creative Destruction?

However, considering the scale and depth of collapse, much of these precipitate changes may have been overdone. Yet, combined with the idiosyncrasies of the political, capital and production structure of each nation, signs of creative destruction may have started to reinforce signs of “divergence dynamics”- in a world where globalization trends have apparently been on a descent.

Proof? See figure 1.

Figure 1: Danske Bank Weekly: Last In, First Out

China appears to be leading the way out of the global economic morass, as industrial (manufacturing) activity, credit growth and car sales appear to be markedly recovering even as the US remains in doldrums.

According to Steen Bocian Chief Economist of Danske, ``China was one of the last countries to be dragged into the global financial crisis, and now looks set to be one of the first to come out the other side.”

And it's not only China but other East Asian countries as well.

And this development seems congruent to what we wrote in July of 2008 in Phisix: Learning From the Lessons of Financial History,

``This I think is what the global financial market has thus far priced in, aside from the ongoing delevaraging process that has fomented the forcible selling of most liquid asset classes by institutions caught in the web of illiquidity stasis.

``And if Asia is not a bubble then the likelihood is that the bear market arising from the present contagion conditions as mentioned above could be likewise be cyclical and temporary in nature. If our analysis is correct then we should see the rendition of the same patterns even amongst our neighbors.”

While much of Asia’s equity markets hasn’t been lifted by these developments yet, but instead dragged by dreary global sentiments, China’s Shanghai index remains as the world’s market leader up 5.29% for the week and up 20.4% over the year.

It should be a reminder that in every cyclical transition there will always be a change in market leadership and perhaps, China could be assuming such a role, if the recovery will be sustained.

Economic Restructuring Will Restore Global Growth

Nevertheless, it would be a misguided collectivist notion to think that China would even attempt to save the world. China will only act to protect its political, financial or economic self-interest. And any spillover will mostly be coincidental than intended, except perhaps for extraordinary circumstances which is exigent to their self-interest.

Take this report from Chinastakes.com, ``Chinalco’s $19.5 billion capital injection into Rio Tinto, so far the largest foreign investment of any Chinese enterprise, is believed to signal China’s holding’s transition into strategic resources. Officials and leaders of state-owned enterprises also suggest the government inject some of the reserve into state-owned enterprises to help them invest overseas or establish funds for overseas acquisition.”

Ironically, common sense tell us, where everyone wants to be saved, the world is simply too enormous and too complex to be saved with restricted resources.

And the harsh reality is that world will have to undergo an economic restructuring than continue to survive on a farcical political economic landscape dependent on sustained bubble blowing.

Otherwise what may seem like a temporary recovery may even lead to a malevolent nightmare, as Joseph Schumpeter in the The Economics of Recovery Program observed, ``"Depressions are not simply evils, which we might attempt to suppress but-perhaps undesirable-forms of something which has to be done, namely, adjustment to previous economic change. Most of what would be effective in remedying a depression would be equally effective in preventing this adjustment. This is especially true of inflation, which would, if pushed far enough, undoubtedly turn depression into the sham prosperity so familiar from European post war experience, but which, if it be carried to that point, would, in the end, lead to a collapse worse than the one called in to remedy.”

Global Posttraumatic Stress Disorder (PTSD): The After Lehman Syndrome

We opined that the collapse in world economic and market activities in the last quarter of 2008, which was principally an outgrowth of the seizure in the US banking system, engendered a psychological "shock and awe" trauma for the world.

Similar to infamous 9/11 tragedy, such anxiety disorders overwhelmed the public's psychological defenses, wherein the subsequent reaction have been to dramatically undertake massive adjustments in the ecosystem as fear governed. [See discussed in "What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis."]

This is what I think the world is presently enduring.

And we seem to have found clues to support our thesis. Mr. Andrew Foster, Chief Investing Officer of Matthews Asia/Matthews International capital noted of a "Before Lehman and After Lehman" stigma, in his recent sojourn in 4 Asian countries.

This is his observation (all bold highlights mine)...

``I would venture to guess that many of the managers I met on my trip would have struggled to recognize the name “Lehman” prior to last September, and very few could claim to have suffered directly as result of Lehman’s collapse (e.g. exposure as a creditor or an investor). Yet what was interesting about the phrase was the universal way that these managers were using “Lehman” as a means to explain (or excuse) the frustrating downturn in the performance of their companies. For me, this highlighted the external nature of the current crisis: these managers were not coping with changing technologies, heightening competition or demand destruction; rather, a strange and unseen external shock had suddenly crippled the outlook for their businesses. It was as if all the managers were struggling simultaneously to understand the nature of this invisible shock, and had picked up the same newspaper on the same day, read the same headline, and said to themselves, “Oh, that’s what it is.”

``One illustration of this comes to mind: a newspaper company in Delhi that I visited publishes two editions, one in English and the other in Hindi. The former was seeing ad revenues decline by roughly a 20% annual clip, presumably because gloomy headlines in the English-language press were reverberating around the world, robbing confidence, and with it, economic prospects. Meanwhile, the Hindi version was seeing growth of nearly 30% in its ad rates. This growth may not be sustained; the global shock may come to roost in the Hindi segment as well. I asked management about this anomaly. They had asked the same question of some of their customers, to which the somewhat ironic reply was, “What recession?” Apparently the dour headlines had yet to penetrate those parts of India."...

Here is the clincher...

Again from Mr. Foster...

``But interestingly, most are simply frozen in stasis, paralyzed by a sort of uncertainty about what the future might hold. People everywhere are struggling to cope with what the headlines mean for them. While the shock Lehman precipitated was severe, the uncertainty—even fear—it generated has been more widely felt."

Like us, Mr. Foster believes that time will heal such mental stresses...

Again from Mr. Foster, ``Yet it is my experience that with time and stability fear tends to pass. And here is a possible silver lining: when the present fear does pass, many of these Asian companies might find that the fundamentals they once enjoyed (save perhaps easy access to financing) have not deteriorated to the same extent as they have elsewhere in the world, especially here in the United States. "B.L. / A.L." will undoubtedly be scorched in investors' memories permanently. Yet with a bit of luck, it will become more of a catch phrase rather than destiny itself."

So I'd be wary of any analysis, which omits the context of human psychology to deal with anxiety disorders such as the PTSD, and utilize the "After Lehman syndrome" to project into the future.

Cartoon of the Day: Correlation-Causation Dilemma

Source xlcd.com