This is the fundamental problem with relying on macro-accounting tautologies; people often bring in causal arguments from economic theories without realizing they are doing so. Robert P. Murphy
The Philippine Phisix posted a blistering start for 2012, which also seems as a lucky initiation for me. That’s because the performance of the local composite benchmark has been realizing what I have been saying especially last December where I pounded the table on the likelihood of this occurrence.
Even better, the Philippine Phisix closed the week to take on the second spot as the best performer[1], based on nominal local currency, among global equity benchmarks (of 78 nations).
Where we had been told by an establishment analyst in a conference that the Phisix will NOT break into NEW highs unless the Euro crisis will get resolved, I argued otherwise.
As I wrote last December[2],
And even more, any hiatus from the perceived worsening of the EU crisis, which will likely be treated with the band-aid approach most likely emanating from massive ECB purchases and possibly from the US Federal Reserve, will likely lead to ASEAN bourses outperforming the region or the world.
This means that contra mechanical chartists and consistently wrong mainstream deflationists, my bet is for the Phisix to breach the August highs perhaps sometime within the first quarter of 2012. Again, all these are conditional or subject to the premise where global central banks will continue to unleash waves and waves of inflationism. Otherwise all bets are off.
Of course the other point is that charts patterns, as I previously noted, will not fulfill its gloomy portent which again validated my projections.
Charting theory says that long term patterns should have a stronger effect[3] than the short term, yet the 15 month bearish head and shoulder (blue arcs) has clearly been neutralized by the shorter 5 month reverse head and shoulder (red arcs).
In short, the limits of using chart patterns as an investing guide can clearly be observed in the above.
Breaking Out Amidst the Euro Crisis; Refuting Some Euro Crisis Bunk
The Phisix breakout DOES NOT come amidst the resolution of the Euro crisis.
Instead, as I have been repeatedly pointing out, aggressive ECB intervention will work to defer the impact of the crisis and give the pretext for the bulls and for the yield chasers to push up the markets.
Again as from the same article I wrote,
If global central bankers will inflate massively, far more than the market’s expectations from the adverse effects of the crisis then the answer should be a conditional “yes”.
This exactly is what has been happening as provided by the charts from Danske Bank[4],[5].
So far yields of Spain and Italy has positively responded to such ‘back door’ intervention[6] by the ECB, as debt auctions were reportedly oversubscribed as Euro banks took advantage of subsidized cheap loans from the ECB to acquire sovereign debt of Italy and Spain. Essentially the subsidized rates give EU banks breathing room to earn from the yield spreads and at the same time helps to finance government funding requirements.
Also, the above debunks the mainstream claims that Eurozone policy operates on a quasi “gold standard”. We won’t see monetary inflationism of such magnitude being conducted on a gold standard as this would result to capital flight or a massive outflow of gold reserves.
Writes Joseph Salerno[7],
Briefly, according to the Currency School, if commercial banks were permitted to issue bank notes via lending or investment operations in excess of the gold deposited with them this would increase the money supply and precipitate an inflationary boom. The resulting increase in domestic money prices and incomes would eventually cause a balance-of-payments deficit financed by an outflow of gold. This external drain of their gold reserves and the impending threat of internal drains due to domestic bank runs would then induce the banks to sharply restrict their loans and investments, resulting in a severe contraction of their uncovered notes or “fiduciary media” and a decline in the domestic money supply accompanied by economy-wide depression.
Also this refutes the masquerade about the alleged deleterious effects of austerity. There has hardly been a meaningful austerity (reduction of government expenditures or debt) taking place whether in Europe or the US.
This certainly has not the case in the US, where government debt has been replacing the deleveraging process being experienced by the private sector components as shown in the chart from PIMCO[8]
What has been happening instead in the Eurozone has been a transfer of resources mainly from the welfare state and the real economy into the highly politically privileged and protected banking sector and even to the arms or weapons industry (!), where the latter seems to be part of a quid pro quo agreement[9] with crisis affected PIIGS in return for bailouts.
And it is also absurd or simply false to claim that a dysfunctional banking system will aggravate current economic conditions in the Eurozone, which are premised on faulty assumptions that credit only drives growth.
Fact is, like Japan’s experience in the 1990s, as the bust phase deepened, credit supply flowed from the impaired banking system to the non-banking sector[10].
In Italy today, organized crime groups or the Mafia has taken over credit provision in many parts of their economy and was even reported as having assumed the “number 1 bank”[11]. So we seem to be seeing the same dynamics of having non-bank sectors taking over.
And this certainly has NOT been true with the US, where despite falling business loans, the US recession cycle ended in 2009. Credit conditions only bottomed out during the late 2010 way after the US economy have convalesced. Today, improving commercial and industrial loans seem to augmenting the current momentum fuelled by an inflationary boom.
Yet the mainstream gives us false choices premised on accounting tautologies premised on “400 years of accounting understanding”[12].
Try applying this to the stateless Somalia (or failed state as per media’s lingo) to see if such appeal to math and aggregates has been valid. Since there is no state (ergo government spending) such statistics becomes irrelevant. [Perhaps this could be the likely reason Somalia has been excluded in many statistics]
Yet the false dilemma being presented is that Europe’s policy option has been limited to a choice from the following: private sector leverage or public sector leverage or adjusting trade balances. The focus on accounting leads to a solution that requires MORE government intervention by acquiring MORE debt or by inflationism.
The fact is, what prompts for massive trade deficits and deficiencies in trade competitiveness has been brought about by the capital consumption effects of government spending and the boom bust cycles. Political, legal, bureaucratic and regulatory risks also contributes to the business environment uncertainties which put a shackle on entrepreneurship that drives competitiveness.
And proof to this assertion is that despite cheaper wages compared to their developed counterparts, as previously pointed out[13], the crisis affected PIIGS has been least competitive in terms of labor efficiency mainly due to bureaucratic and regulatory impediments. Most of the PIIGS rank nearly (except for Ireland) at the bottom relative to their counterparts in terms of Doing Business.
As for consumption effects of government spending let me quote the great Murray Rothbard[14], [italics original]
All government expenditure for resources is a form of consumption expenditure, in the sense that the money is spent on various items because the government officials so decree. The purchases may therefore be called the consumption expenditure of government officials. It is true that the officials do not consume the product directly, but their wish has altered the production pattern to make these goods, and therefore they may be called its “consumers.”
And boom bust policies likewise alters time preferences of consumers and producers that encourages consumption and misdirection of investments
Writes Professor Robert P. Murphy[15]
The low interest rates of the boom period mislead entrepreneurs into borrowing too much, but they also mislead consumers into borrowing too much and saving too little. This is physically possible because resources that otherwise would have gone into replenishing the capital structure are instead devoted to new projects or additional consumption goods.
Also the great Ludwig von Mises[16]
The essence of the credit-expansion boom is not overinvestment, but investment in wrong lines, i.e., malinvestment. The entrepreneurs employ the available supply of r + p1 + p2 as if they were in a position to employ a supply of r + p1 + p2 + p3 + p4. They embark upon an expansion of investment on a scale for which the capital goods available do not suffice. Their projects are unrealizable on account of the insufficient supply of capital goods. They must fail sooner or later. The unavoidable end of the credit expansion makes the faults committed visible. There are plants which cannot be utilized because the plants needed for the production of the complementary factories of production are lacking; plants the products of which cannot be sold because the consumers are more intent upon purchasing other goods which, however, are not produced in sufficient quantities; plants the construction of which cannot be continued and finished because it has become obvious that they will not pay.
In other words, what the mainstream cannot see as the principal cause of a society’s orientation towards consumption, hence the trade deficits, are government interventionism and the welfare state. The crisis affected Euro economies look as great examples of these policy induced imbalances.
And even worse is the reverential awe towards statistics as an accurate measure of the functioning economy, particularly via the GDP. Little do many understand that such spending biased statistics has been designed towards looking at the economy from the Keynesian perspective, and which in corollary, would lead to Keynesian policy prescriptions.
The fact is the GDP is a highly flawed metric.
Professor Bryan Caplan explains[17],
Gross Domestic Product is staunchly atheoretical. If someone spends money on X, X is GDP - even if "someone" is Congress, and X="a bridge to nowhere."
There are exceptions; most notably, the stats supposedly exclude "intermediate goods" to avoid double counting. I say "supposedly" because the list of "intermediate goods" is so inconsistent. Insofar as police protection and the military protect firms from harm, aren't the police and military intermediate goods? But despite these tensions, a big part of the philosophy of GDP is to eschew philosophical arguments about what's "really productive."
On reflection, though, the standard approach is anything but agnostic. Official stats tacitly make an extreme assumption: waste does not exist. Astrology counts, even though astrologers can't predict the future. Every penny of health care counts - regardless of its efficacy. The whole defense budget counts - even if it's provoking war rather than deterring it. Indeed, if two countries' militaries mutually annihilate, both countries count the cost as a benefit.
So the mainstream case has immensely been pockmarked by half-truths and by reading effects as the cause, all dedicated to the promotion of the status quo whose policies paradoxically constitutes the roots of the current crisis.
And more ironically is that their prescribed policies seem to signify as political insanity—doing the same actions and expecting different results—or as similar to engaging the mythical beast Lernaean Hydra[18] which Greek legendary hero Hercules fought as part of his second labor[19], where for each head that had been cut off from the hydra, two grows in replacement.
The crux of the matter is that current interventionist policies being applied by EU authorities have been contrived at bolstering asset prices in order to keep the balance sheets of the banking sector afloat, and in tandem, to ensure access to financing for the unsustainable welfare state.
So essentially, the tight interdependence of the banking sector and governments can be analogized as two drunks trying to prop each other up by consuming more alcohol which is continually being provided by the bartender (the ECB abetted by the FED).
And this has not been limited to the Eurozone. Mr. Ben Bernanke, the chairman of the US Federal Reserve, has reportedly been itching for QE 3.0, but this time, the Bernanke led FED appears to have changed tactic to focus on providing support to the mortgage industry[20] which may reduce political opposition than from the previous QE which concentrated on acquiring US treasuries.
Analyst and portfolio manager Doug Noland thinks the FED will make a go on a mortgage based QE3.0[21],
Fed is quite worried about Europe, global de-risking/de-leveraging, and the strengthened dollar. Especially if the euro faces additional selling pressure, the Fed will talk – and at some point implement- additional quantitative ease in hopes of dampening dollar bullish sentiment. With more Treasury purchases posing significant political risk, they’re cleverly building a case for buying MBS.
And I would add that since the mandated debt ceiling by the US congress has already been breached[22], there seems to be a big likelihood for another accord to hike the debt ceiling levels, of course after some vaudeville opposition acts.
This means that we should expect the US Federal Reserve to actively but perhaps indirectly facilitate the financing of these liabilities possibly through the banking system in exchange for the Fed’s buying of mortgages.
So the ECB and the FED will work to overcome political obstacles by resorting to legal loopholes. They who make the rules, break it.
The bottom line is that we will likely see intensification of central bank actions in 2012. Although I share the view that such conditions are unsustainable and represent as boom bust cycles, it is unclear that any unwinding will happen anytime soon.
As explained last week[23], interest rates will most likely determine the popping of this bubble where interest rates may be driven by any of the following dynamics, changes in: 1) inflation expectations 2) state of demand for credit relative to supply 3) perception of credit quality and or 4) of the scarcity/availability of capital.
And as interest rate levels remain benign, this should mean more upside for global equity markets including the Phisix perhaps until the end of the first quarter. It would be best to assess issues periodically and see how politicians respond to market developments.
The Permanence of Change Represents the Endgame
I might add that it is utter poppycock to talk about any grand finale or Mayan type Armageddon—usually heard from mainstream jeremiads—as outcomes for the current imbalances.
In reality, the ultimate outcome we should expect is the permanence of change.
For instance, the collision of the forces of decentralization with forces of the relics of the industrial era via 20th century political institutions, legal framework and current top-down policies and mindset will likely intensify and may increase social tensions that may lead to some upheavals. Because of the many entrenched groups, profound changes will not be seamless. But eventually people will adapt.
As for inflationism, these have signified as boom bust CYCLES throughout the ages, with the worst consequence leading to death and the eventual birth, or if not, drastic reforms of the monetary system or through defaults. But again people learn to live or move on.
We must realize that in over 200 years, despite 2 major world wars and the grand but botched wretched experiments of communism, aside from pandemics[24] (e.g. Swine Flu) which resulted to massive losses of human lives and large swath of property destructions, world living standards has remarkably spiked[25].
Internal Market Conditions Supports The Phisix’s Breakaway Run
As I wrote in my last major article on the stock market for 2011[26]
Any sustained rally in the Phisix which may come during the yearend or during the first quarter of 2012 will likely translate to a broad market rally.
The 2012 rally has largely been supported by substantial advances in market internals.
The weekly averaged advance decline-spread has decisively swung to the side of the bulls.
Average daily trades have also sprung higher. This means more participation (possibly from neophytes) or more churning from existing participants or both. The spike in the trading activities exhibits snowballing confidence.
This is where the recent breakout seems amiss though, while average daily volume has improved this has not been as extensive as the intensity of the breakout would suggest.
Finally foreigners appear to be more bullish as net foreign buying averaged on a weekly basis has been on the upside.
As I used to point out, once foreigners become bullish their tendency is to push up major Phisix components or the heavyweights (largest market caps which are most liquid). The consequence is to amplify the gains of the Phisix.
Such bullishness may have filtered into the Philippine Peso, which almost in line with the Phisix was unchanged in 2011, but eked out .8% gain for this week. The Peso was at 44.11 last week compared to this week’s close at 43.75 per US dollar.
Given the strong move by the Phisix which seems to have significantly outraced our neighbors, there is a possibility that interim profit taking would be the order of the coming sessions. Yet even if profit taking mode occurs, the likelihood would be rotational activities—where previous winners may take a recess while the laggards gain the market’s attention—than a broad based decline.
However in a bullmarket, overbought conditions usually may extend.
Overall, since the market is likely to move higher overtime, the short term bias is likely to reflect on a positive sentiment despite interim volatilities.
And for as long as markets remain politicized and highly dependent on actions of policymakers, our task is to monitor their activities and assess and project the possible impacts from such actions on the markets.
[1] See Global Equity Markets: Philippine Phisix Grabs Second Spot, January 14 2012
[2] See Can the Phisix rise Amidst the Euro Crisis? December 4, 2011
[3] Learntechnicaltrading.com Buying signals using trend lines
[4] Danske Bank FX Top Trades 2012 December 14, 2011
[5] Danske Bank Weekly Focus, January 13, 2012
[6] Reuters.com UPDATE 3-Yields fall sharply at Spanish, Italian debt sales, January 12, 2012
[7] Salerno Joseph T. Money and Gold in the 1920s and 1930s: An Austrian View, thefreemanonline.org
[8] Gross William H. Towards the Paranormal, January 2012
[9] See Greece Bailout: The Military Industry as Beneficiaries, January 12, 2012
[10] See Japan’s Lost Decade Wasn’t Due To Deflation But Stagnation From Massive Interventionism, July 6, 2010
[11] Reuters.com Mafia now "Italy's No.1 bank" as crisis bites: report, January 10, 2012
[12] Mauldin John The End of Europe? January 14, 2012 Goldseek.com
[13] See Euro Debt Crisis: The Confidence Fairy Tale and Devaluation Delusion, November 28. 2011
[14] Rothbard Murray N. 1. Introduction: Government Revenues and Expenditures Man, Economy & State Mises.org
[15] Murphy Robert P. Correcting Quiggin on Austrian Business-Cycle Theory, Mises.org
[16] Mises Ludwig von 6. The Gross Market Rate of Interest as Affected by Inflation and Credit Expansion, XX. INTEREST, CREDIT EXPANSION, AND THE TRADE CYCLE, Human Action Mises.org
[17] Caplan Bryan Real Real GDP, Library of Economics and Liberty, January 14, 2012
[18] Wikipedia.org Lernaean Hydra
[19] Wikipedia.org Labours of Hercules
[20] Bloomberg.com, Bernanke Doubles Down on Fed Mortgage Bet, January 11, 2012
[21] Noland Doug, The Year Of The Central Bank Credit Bubble Bulletin January 13, 2012 Prudent Bear.com
[22] See US Debt Ceiling Breached, President Obama to Seek Increase, January 12, 2012
[23] See What To Expect in 2012, January 9, 2012
[24] CNN.com Deadliest pandemics of the 20th century April 27, 2009
[25] See BBC’s Hans Rosling: 200 Years of Remarkable Progress and a Converging World, December 3, 2010
[26] See Phisix: Primed for an Upside Surprise, December 11, 2011
