Given the mostly pat in the back themes, I stopped reading on the BSP chief speeches published at the BSP’s website. This is with the exception when his speeches get published at the Bank for International Settlements.
YET in a speech held at the FMAP 2016 Awards and Fellowship Night in July 21 the BSP Governor Amando M. Tetangco said (bold mine, quote in whole so as not to taint his message to subjective interpretations. My analysis comes after)
The second issue I wish to cover is this – the asset management business has systemic implications.
Consider the two basic types of agency agreements 1) the passively managed funds, performance of which mirrors or closely tracks that of a specific benchmark, and 2) the actively managed or specialist funds, which are not linked to a specific benchmark. There are positives to this dichotomy. Actively managed funds have the advantage of potentially higher yields while passive funds provide lower costs. The downside however is that shifting towards higher-yield but-illiquid exposures exacerbates the vulnerability of financial consumers towards market risk, while the ease of passive funds also nurtures “herding” behaviour as well as correlated market movements.
These notions are confirmed by empirical work at the BIS, among others, that have shown that “asset managers in EME asset markets tend to behave in a correlated manner and that investment flows to asset managers and asset prices amplify each other’s fluctuations”.
This is why my second message for the industry is this: Do not be oblivious to financial stability issues.
Ladies and gentlemen, we “live” in an industry where “change” is literally a minute by minute phenomenon (i.e., not only in financial rates and prices but also in market sentiment). But there are also those tail risks, the “Black Swan” risk, as popularized by Taleb. Moving from “the elephant in the room”, Wucker recently talks of the “grey rhino” s the highly probable high impact but neglected threat.
I am not sure how swans, elephants and rhinos come together, but I am certain that we do not want any of what they represent to come true. We can look towards regulation to manage market conduct within acceptable norms, but, in the end, it will have to be the market practitioners who need to be committed to upholding the standards
The Phisix closed at 8,102 when Mr Tetangco made the above speech.
Asset correlation hasn’t been a new issue. I raised this way back in September 2014 (Phisix: ASEAN Currencies Dive as the BIS, IMF, OECD Warns About Bubbles!) where the deepening correlation from yield chasing has occurred due to the uniformity or near uniformity by actions of fund managers of asset under management (AUM) mainly prompted by leverage.
In fact, negative interest or policy rates have spurred a global bond panic buying spree which has filtered into the Philippines as I noted last week.
Another sign of such phenomenon has been the uncanny twin or similar price actions between the Phisix and Indonesia’s JKSE.
But the fact has been that foreigners have been LESS of a critical force in driving the recent manic vertigo bidding binge of the PSEi or the Phisix.
Even the BSP’s data on foreign portfolio flows show of a massive underperformance of foreign participation on Philippine stocks relative to previous record highs.
The share of foreign trade to total trade has even turned lower even as the Phisix raced to 8,100. This has been in sharp contrast to previous milestone highs in May 2013 and April 2015.
I believe that the BSP chief recognizes this as well.
And this brings to crux of what he was talking about.
The BSP chief has used external justifications to warn of local market participants of the growing risks from the present vertical pumps!
This was not the first time though. He did this TWICE in 2014!
Particularly in August 2014: Phisix: As Mania Rages, BSP Chief Warns on “Complacency” and “Chasing the Market”!! (August 24, 2014)
So in a period of low volatility such as what we have been experiencing, practice the discipline of setting limits. This discipline will not only help you to avoid the pitfalls of “chasing the market”. More importantly, this discipline will help you take advantage of the obvious opportunities, as well as unearth those that are hidden. Discipline set during the sober low volatility period will guide you when you are confronted with factors that are not within your control, especially during a frenzied high volatility period
And he repeated in October 2014 Phisix: 7,400 is not the Technical Hurdle, the BSP Governor Is (October 6, 2014)
To help manage the financial stability risks of the over-all low interest rate environment. While we have not seen broad-based asset mis-valuations, the BSP remains cognizant that keeping rates low for too long could result in mis-appreciation of risks in certain segments of the market, including the real estate sector and the stock market as markets search for yield. So far, coupled with changes in reportorial requirements and macroprudential measures, the monetary policy actions appear to have achieved some success in moderating the buildup of “irrational exuberance” in certain market segments.;
Because the Phisix was then trading at 7,400, when he made the two irrational exuberance speeches in 2014, the BSP chief may be accused of missing out the April 10 2015 acme of 8,127.48
But in contrast to the chief honcho of the PSE, the BSP chief turned out to be rather prescient. After a short tryst to paradise, the Phisix collapsed to 6,084 in January 21, 2016
Well folks, he just repeated on the sounding of the alarm bells! After the verbal carousel, the BSP chief's theme boiled down to a single poignant message...
Do not be oblivious to financial stability issues.
Stunning bluntness!!!!!!
But the BSP chief seems to have forgotten on the essence of his very own 2014 warning where “keeping rates low for too long could result in mis-appreciation of risks”.
Sorry sir, it’s not a ‘could’ but rather keeping rates low for too long WILL result in mis-appreciation of risks.
And it has mainly not been foreigners responsible for the wild price chasing but the locals. That’s because “keeping rates low for too long” has only been fueling credit expansion that has been used for “chasing the market”.
All that is needed is to connect the logic of the given variables: interest rates, credit, prices and valuations.
So this only means that the BSP chief seems to have been caught in a severe cognitive dissonance—perhaps he sincerely does not think that the Philippines is vulnerable to financial instability from within (due to endowment bias or because current environment represents his and the monetary board’s policies) but ironically admitted that financial instability can occur from external forces.
Yet this represents a self-contradictory logic. It is the structural conditions of finance that makes it either robust or fragile, and not perceptions. External (or internal events) can serve as only triggers that will either expose on the system’s fragility or validate on its resilience.
Or he may be playing with the political correctness rhetoric (keeps the real conditions to himself but signals on such risks—using politically expedient factors—to exculpate himself from the event of a financial instability)
Aside from warning on financial instability, yet more importantly, he lectured the fund management industry with “it will have to be the market practitioners who need to be committed to upholding the standards”
Amazing self righteousness.
While this looks virtuous from the surface, as it chastises the industry for present recklessness (which is music to my ears), the BSP does not seem to appreciate that the industry have only been responding to his and the monetary board’s trickle down negative real rates policy regime.
Or since such agents have been oriented or programmed to act to benefit from the BSP policies, then they will continue to act in a similar direction for as long as the subsidies exist.
Or what does he expect his underlings to do? Voluntarily stop using the incentives that the BSP continues to provide?
So instead of implicit blarneys about self-discipline, actions are required. The BSP chief needs to reverse the present easy money policies. Only by then will his privileged agents respond and be disciplined accordingly.
Nevertheless the awesome bottom line: The BSP chief’s warning on financial instability risks represents another sign that history is in the making, right here right now!
