China: Despite Present Bubble, Financial Markets Remain Bullish over the Long Term

``The rise of China -- and of Asia -- will, over the next decades, bring about a substantial reordering of the international system. The center of gravity of world affairs is shifting from the Atlantic, where it was lodged for the past three centuries, to the Pacific. The most rapidly developing countries are in Asia, with a growing means to vindicate their perception of the national interest.”-Henry Kissinger, a former secretary of state, chairman of Kissinger Associates

LAST week we pointed out that aside from the overbought conditions seen in the US markets, which has been providing the leadership for global equities, one potential trigger for a correction was the continued spike in US Treasury yields.

A spike in yields could be interpreted as “tightening” of liquidity in the financial marketplace, which again does not bode well for the equities in general.

However, this comes in the face of persistent chitchat by domestic mainstream analysts of China’s market bubble as having a major influence on Asian markets, including that of the Phisix.

As we have argued last week or even in late February where the first “Shanghai Surprise” transpired, we believe that China’s market has manifested little signs of interdependence with Asian markets due to major fundamental reasons such as having a closed capital account, heavily regulated financial markets and extremely limited exposures by foreign investors as well as domestic investors.

Figure 1: stockcharts.com: Phisix-China: What correlation?

We noted that even as China’s markets fell apart, investors of the Phisix and most Asian markets went into a buying spree last week. And in contrast, this week as the tremors in the US markets were equally felt elsewhere, China’s markets took steps to recover from the recent shakeout, as shown in Figure 1.

The blue arrow tells us that Emerging markets (upper window), Asian markets ex-Japan (lower window) and the Phisix (center window) simultaneously in a corrective downdraft even as China’s Shanghai market appear to have convalesced. From which we ask: How germane the correlation of China’s Shanghai index and the Phisix?

Said differently, while we saw China as having initially been used as “scapegoat” for the much needed “profit-taking” from the overheated markets at the end of February (have we not been saying so as early as last quarter of 2006?), the global equity markets today appear to have discounted the relevance of Shanghai’s activities. So aside from fundamental reasons we initially broached, we can now see a stark price disconnect. Again, it seems that our views have once again been validated.

Yet local mainstream analysts find causality in presumed patterns that has never happened or has misinterpreted “coincidental” events as having cause and effect links. In behavioral finance/economics such is part of the “Cognitive bias” (human perception of reality) which is in particular is called as the Clustering Illusion or “seeing patterns where none existed”.

Yes, we think that China’s market today has exhibited signs of extreme froth or “bubble-like” conditions and envisages the risks of either having pronounced gyrations or of an implosion anytime. Yet, there is also a big chance that it could even go higher before its reckoning period, as discussed last week.

However over the long term (10+ years), we infer that since China has been cognizant of the importance of fostering a market-based economy for the nation’s wealth creation, it has acted gradually by rehabilitating its financial markets (enactment of property laws, expanding into more complex or sophisticated markets as the financial futures and gold market, has expanded supplies by amending the “non tradable shares”, gradual opening of its capital markets through the QDII and QFII programs) to reflect on allocation by price efficiency.

And those incremental steps to deregulate and adopt new market mechanisms are likely to provide a floor to any interim volatility. In other words, as China’s economy grows, the contribution of its financial markets in providing and intermediating capital becomes an imperative, as it veers away from its traditional form of financing, i.e. through banks, hence all these cumulative steps to amend the present system. These should support China’s asset prices over the long term.

Likewise we believe that as China’s markets opens, deepens and matures the likelihood is that our Phisix over the long term will increasingly cultivate deeper interrelations with them as well as with other major Asian financial markets (Singapore, Japan and Hong Kong).

This should be a lesson for us, since financing requires market based valuations and liquidity in channeling savings into investments. Finance without adequately functioning markets leads to the same inefficiencies of the past.

Bond Markets Rout; Signs of Rising Inflation? Bullish on Philippine Agriculture

``Whether through asceticism, ideology, religion, advertising or other means, whether consciously or not, the elites in all societies manage desire-the starting point of wealth creation. Obviously, just pumping up the desire level-or for that matter, extolling greed, which is different from either wealth or desire-won’t necessarily make anyone rich. Cultures that promote desire and pursue wealth do not necessarily attain it. On the other hand, cultures that preach the virtues of poverty usually get precisely what they pray for.”-Alvin and Heidi Toffler, Revolutionary Wealth

Now going back to the world markets, the world bond market tells us of some risks to be concerned of.

US coupon rates jumped across the yield curve as global bonds got crushed. This has been occurring as global Central Banks has been on an interest rate hiking mode; where New Zealand and the Euro zone were the latest to raise rates this week.

Figure 2: US Treasuries and emerging market yield spikes!

The inflationary policies adopted by global central banks have now started to permeate into consumer price indices. In the same sphere, we see government intervention (in forms of subsidies) in the energy markets have likewise contributed heavily to the law of unintended consequences; raising steeply corn prices that triggered the tortilla crisis in Mexico and the spiraling pork prices in China!

Legal mandate and subsidies on corn as feedstock to the biofuel programs have led to a sizable shift in demand for corn (in competition to its traditional uses; food, animal feed, sweeteners), aside from the reallocation of acreage into corn plantation at the expense of crops. This has likewise prompted price increases in other products, such as soybeans, cotton etc.

According to McKinsey Quarterly’s article Betting on BioFuel, ``From 2003 to 2006, the percentage of the total US corn harvest used to produce biofuels rose to 16 percent, from 12 percent. But now that the federal government has adopted a goal of 35 billion gallons of alternative fuels a year by 2017, the use of domestic corn-based bioethanol to meet even half of this target would require 40 percent (emphasis mine) of that year’s expected harvest. Not surprisingly, the cost of corn has soared: average wholesale prices rose from $1.90 a bushel in 2005 to $2.41 in 2006, and corn has regularly surpassed $4 a bushel on the spot market since late 2006.”

``Other unintended consequences of greater demand could bring a consumer backlash like the one that broke out in Mexico when tortilla prices skyrocketed because of bioethanol-related corn shortages. Environmental concerns were also raised after last autumn’s burning of Indonesian forestland to make space for palm oil crops that were linked to increasing demand for biodiesel. The environmental impact of other aspects of biofuel production, including the widespread cultivation of fast-growing jatropha (a plant that produces a toxic vegetable oil), are unknown.”

Again as we have long forecasted, we remain bullish on the domestic agriculture industry in spite of its downtrodden state, primarily because of its prolonged era of underinvestment in the light of the dramatic wealth induced demand growth in emerging countries equally matched by the multifaceted supply constraints from rapidly developing emerging market economies (such as demographic and urbanization trends, rising incidences of desertification, industrialization, chronic water supply shortages), the weakening US dollar and now, the effectual distortions emanating from government interventions in the marketplace due to energy and climate change requirements.

As shown in Figure 2, bond prices have accelerated their descent in the US (upper window), as well as in emerging markets (lower window), as 10-year treasuries yields nearly topped its 2006 high (center window).

In the US, Chief Economist Paul Kasriel of Northern Trust believes that rising consumer price inflation, or New Zealand’s policy actions or inflation expectations have NOT been responsible for the present activities in the bond market.

Instead he argues that perhaps the recent bond market rout could have been an outcome from a spate of market activities which included hedging out of growing mortgage prepayment risks, Mr. Kasriel says (emphasis mine),

``When bond yields started creeping up a few weeks ago, mortgage portfolio prepayment risk started creeping down. This meant that the massive amount of mortgages in portfolios needed fewer non-callable Treasuries as duration maintainers. I am not saying that something perceived to be fundamental by bond investors has not changed. But what Lahart is saying is that the massive duration hedging required by mortgage portfolios acts as a supercharger to fundamentally-induced changes in yields. Remember 1994?”

This means that that rising rates has prompted for higher mortgage rates, which likewise increased the risks of fewer prepayments. And with high inventories of mortgages, mortgage investors could have either sold mortgages or hedged their portfolio by selling US treasuries, as expectations for rate cuts have diminished.

And another possible unseen reason could have emanated from declining interests with US treasury purchases by foreign investors, adds Mr. Kasriel (emphasis/highlight mine)…

Figure 3: Northern Trust: Less Purchases from the Foreign Official Holdings

``I will, however, add one fundamental factor that may have played a smaller role in this week’s bond market selloff – foreign official holdings of U.S. Treasury and Agency securities. As the chart (Figure 3) shows, in the week ended Wednesday, June 6, there was a relatively large $12.5 billion reduction in these custody holdings.”

Our take is that if this is an emerging trend where foreign central banks have shown lesser appetite to prop up US assets then the likelihood that the rally seen in the US dollar recently could merely serve as a blip.

So Far It’s NOT about the Carry Trade!

``The potential of the carry trade as a source of future exchange rate volatility has brought back memories of October 1998 when the yen collapsed against the dollar as hedge funds unwound carry trades in response to the Russian financial crisis.”-Peter Garnham and David Pilling, Financial Times

Well, some have argued that the recent plunge in US and global stocks have been due to the unwinding of the carry trade.

Figure 4: stockcharts.com: Rising US dollar; Falling Yen and Swiss franc

Figure 4 tells us that the so-called CARRY Trade has NOT been much of a factor in the recent selloff YET, as both funding currencies of the Japanese Yen (upper window) and the Swiss Franc (lower window), has contrary to expectations, continued to encounter marked declines amidst rising volatility.

Instead we see a rallying US dollar traded weighted index and a return to a positive yield slope in our midst. (Yes the Philippine Peso declined abruptly by 1.28% to Php 46.67 alongside with most of the region’s currencies, aside from an equivalent tremblor in the region’s bond markets).

The Carry trade assumes borrowing or shorting low yielding currencies and utilizing the proceeds to invest in higher yielding currency/assets. However if the costs of these currencies rises, there could be pressures to sell the invested assets and payback the loans or buyback the shorted currency, where such offsetting transactions would result to across the board selling pressures in the traditional high risk asset market classes like the emerging market assets, commodities and corporate junk bonds. We have not seen this happen yet.

In other words, if one were to speculate on whether today’s shakeout has impaired the system of leverage from which the global markets operate on, then the depiction of insouciance by the Yen and Franc as funding currencies to such levered transactions shows that either these Carry trades have produced insignificant bearing in last week’s activities or has not reached its stress level enough to trigger the purported systemic risks.

Considering the actions of the tape here and abroad, what we are in essence witnessing is a simple return to cash, from regular profit-taking activities, instead of a market bedlam as some bears suggest, of course, until prove otherwise.

Let me quote Chris Gaffney, Vice President of the EverBank World Markets, ``Eventually this cash will need to be put back to work, or will be used to pay off the loans which many of these investors have used to create the explosion of liquidity we have seen over the past few years. As I have said in the past, many loans are denominated in the lowest yielding currencies, the Japanese Yen and the Swiss Franc. If / when investors finally decide to pay back these loans, they will need to buy both of these currencies and the 'carry trade' will be reversed. As I mentioned above, I think blaming a reversal of the carry trade for the move in currencies overnight just doesn't make sense (emphasis mine). But, at the same time, I do believe we have seen the first step in a reversal of this trade.”

Commodities Drop on Inflation Concern, How unseemly?

``Gold has worked down from Alexander’s time…When something holds good for two thousand years I do not believe it can be because of prejudice or mistaken theory”- Bernard M.Baruch 1875-1965, American financer, stock market speculator, statesman and Presidential adviser

The plunge in bond prices, which has affected global equities have likewise prompted severe selling in the commodities market such as key bellwethers as Gold (down 3.83%), Silver (down 4.99%), Copper (down 4.25%), Crude Oil WTIC (down .49%) and Brent crude (down .68%) and the CRB Commodity Spot Index (down 1.38%).

Mainstream news accounted that rising interest rates would curtail demand for these items. We think such arguments as cockamamie.

Figure 5: Economagic: Rising Interest Rates, Falling US Dollar have been bullish for Commodities (particularly Precious Metals)

If inflation concerns had been a key factor in the recent selloff in the bond markets, as media portrays them to be, then we should have seen rising metal prices. Instead metal prices fell significantly, perhaps impelled by cross market leverages, where losses in margin accounts in one market have compelled collateral selling on the other.

In Figure 5, over the long stretch, we see a strong correlation of the US-dollar, Fed fund rates and precious metal prices where each time the US dollar falls (green line), despite rising interest rates (red line) we see precious metals (blue line) move higher (1977, 1985, 1993). Of course such correlation has not been in lockstep but the odds are given the same inflationary dynamics, history should rhyme.

We doubt if we are to likely see a furtherance of this phenomenon.

Inflationary Bias and NOT Events Drive the Markets

``All professions are conspiracies against the laity." George Bernard Shaw

MAINSTREAM media and their clique of experts has it all figure out; first it was the elections a.k.a “peace dividends” that spurred the Phisix breakout following the culmination of the national elections. Then last week’s one day selloff was no more than from local political developments and to some extent influenced by China’s tremors (again!). And finally, Friday’s FRESH milestone RECORD high had to be from no other than better-than-expected Economic Growth Data. If only markets worked as simple as media projects them to be….

ANY SENSIBLE market observer knows that the rudimentary function of the financial markets is the extrapolation of future outlooks by discounting them to the present. On the contrary, we are then made to believe that markets (or any germane social subjects be it economics, politics, etc…) operate on a backward process; the public prices securities as a matter of historical actions, particularly event based impelled actions. Why would anyone buy on a financial instrument based on the past? Unless, of course, we presuppose that such activities will CONTINUE way into the future. The 64 billion pesos question is WILL THEY?

In the CONTEXT of media, this makes us a “seer” or a “soothsayer” for “accurately” predicting the developments in the Philippine financial markets, so far. Albeit we don’t like to rent up a table space at the malls, spread out tarot cards and make use of astrology to inject events to spruce up on our forecasts, lest be accused of dislodging Madam Auring, whose role in the society’s division of labor we respect.

Our humble outlook is that we premise our views based on the most probable drivers of the markets rather jumble on supposed causalities or correlation which in the first place was less likely a factor after all.

For instance, we have been saying all along that the Phisix has been on an uptrend or advancing cycle primarily because of the inflationary-driven syndrome diffusing allover the world’s financial markets.

The so-called “Liquidity” factor is no other than the unprecedented scale of money and debt creation and intermediation that has filtered into almost every corner of the world markets or even among diverse asset classes.

Figure 1: Economagic: US Exploding Financial Sector debt

Aside from the Global Foreign Exchange Reserves held by Central banks as we previously discussed, in the US alone the credit owed by its Financial Sector has exploded massively to the upside in support of today’s buoyant global financial markets as shown in Figure 1.

Yet who among the laity would accept such abstract premise? Unfortunately because it is our natural tendency to look for simplified explanation for events we are inclined to dismiss such relevance and account for what is “sensational” rather than what really matters.

Philippine Elections Determined by The Contrast Principle!

``A democracy cannot exist as a permanent form of government. It can only exist until the voters discover they can vote themselves largesse from the public treasury. From that moment on, the majority always votes for the candidates promising them the most benefits from the public treasury, with the result that a democracy always collapses over a loss of fiscal responsibility, always followed by a dictatorship. The average of the world's great civilizations before they decline has been 200 years. These nations have progressed in this sequence: From bondage to spiritual faith; from spiritual faith to great courage; from courage to liberty; from liberty to abundance; from abundance to selfishness; from selfishness to complacency; from complacency to apathy; from apathy to dependency; from dependency back again to bondage."- Alexander Fraser Tytler in "The Decline and Fall of the Athenian Republic" 1776."

In similar application, let me digress and turn to politics. The recently concluded elections prompted some political “experts” to generalize that since “popularity” had NOT been much of a factor in the recent outcome, the present electoral exercise reflected a graduation into a “matured” or “educated” vote (I almost fell out of my seat laughing at such incredulous statement; obviously the universality of such statement reflects on the political bias of the analyst/commentator).

Also in another TV interview, a program host asked a beauty contestant “what the world should NOT know about the Philippines?”, and her answer was “corruption”. And the host responded something like ``that’s special”. Duh? What’s so special about it when the electorate itself had bought into the “corruption” and “cheating” theme?

As Franklin Pierce Adams (1881-1960) American Journalist wrote, ``Elections are won by men and women chiefly because most people vote against somebody rather than for somebody.” And Mr. Adams’ aphorism echoes loudly in today’s vote; it was a vote AGAINST somebody rather than for somebody (-ies).

Does a vote on political butterflies, acerbic “glitzy” rhetoric and major contending platform-“less” parties signify or even QUALIFY as “matured” or “educated” vote? Moreover, while today’s vote was a resounding political statement aimed at NO less than the administration or particularly at PGMA herself, the winning party was nonetheless ostensibly supported by an erstwhile leader deposed by the very same “corruption” charges leveled against him from which today’s battle front was drawn, our question is…has not the public shown a poor sense of history if not memory?

Has this also not shown again of the vicious cycles of “personality based” politics, where officials are voted upon into office NOT by platforms or ideologies represented but on faddish labels as “corruption”? Yet, has any of the candidates from the complete roster (from ALL camps) specified on how they will curb corruption without merely resorting to “motherhood” statements? Nonetheless too, does the public truly comprehend on what corruption stands for?

Again all these signify manifestations of the public’s widespread practice of cognitive bias particularly on the CONTRAST PRINCIPLE or the distinction between things and not absolute measures. According to changingminds.org (emphasis mine), ``When we make judgments, evaluating how good a dress or person is, we don't make absolute judgments. The way we judge pretty much anything is in comparison with something else. When we say someone is smart or talkative, we actually mean they are smarter or more talkative than other people. (Note the '-er' at the end of the adjective and the 'more' -- these are sure signs of contrastive words).”

A vote against someone rather than for someone obviously depicts that we chose NOT because of the quality but out of the perceived “outrage” from the impassioned belief of an allegedly “atrocity” committed or out of deep sympathy with the “victims” of such alleged infraction. Aside of course, from the shortage of choices offered, hence the very essence of the “contrast principle” vividly at work in the Philippine elections. It’s like having to choose the best movie from an entry of all grade B movies.

Yet even if there had been limited available alternative choices (three “genuine” independents), they had been discarded as unwinnables. Again such dynamics of unprincipled voting hardly qualifies as “educated” or “matured” voting.

Well to remind our readers, the socio-political history of the Philippines has been plagued by endemic corruption, simply because politicians have perennially been the source of our economic livelihood (where tinges of our semi-feudal structural political state of affairs, or even mindsets, has yet to be outgrown as evidenced by continued existence of dynasties, which is seen accelerating even in the national level- just look at the Senate), and not from attendant efficiencies offered by competition from the free markets. Our mantra has always been “everybody-wants-to-get-rich-but-nobody-wants-to-risk” syndrome or the DEPENDENCY culture.

To quote the Austrian school of economics and leading free market advocate Ludwig Von Mises, ``Corruption is a regular effect of interventionism”. Nonetheless the outgrowth of our systemic malaise has repeatedly been from too much of our politicians and their cadres playing “God” in determining the fate of the economy and the country.

In free market economies, politicians take a backseat as the culture of enterprise rules. In other words, lesser government equals lesser degree of corruption. Yet, we never learn and always insist on “personality based politics” based on the welfare state mentality.

When emotions dictate on the choices made, such hardly qualifies as rational choice but more of our impulsive nature, which reminds of us the invaluable words of American writer Dale Carnegie (1888-1955), ``When dealing with people, remember you are not dealing with creatures of logic, but creatures of emotion."

As they say, ``The more things change, the more they remain the same.”

Has Politics Influenced on the Movements of Local Markets?

``Men can always be blind to a thing, so long as it is big enough." G. K. Chesterton

Now going back to the markets, even as the Phisix turned sizzling hot for the week up 3.07% or 18.94% year-to-date, we have not been the star performers among the region as Thailand (+4.84%), Bangladesh (+4.36%) and South Korea (+4.52%) easily bested us.

Even Japan’s stock markets surged remarkably, an issue which we had previously discussed, as evidenced by a surge in the Nikkei 225 (+2.73%) alongside its broadweighted Topix (+3.05%).

Thailand’s market breezed through amidst a political setback, where Thailand’s military junta appointed judges of the Supreme Court recently ordered the disbandment of its ousted leader Mr. Thaksin Shinawatra’s political party, the Thai Rak Thai (TRT), Thailand’s main political party. According to the Economist, this was a blow or a “step away” from “democracy”.

Well, Thailand’s stock market appears not to have shared the same pessimism as with the Economist, as its key benchmark rose beyond its December highs, when their government tinkered with the botched “capital controls” to stem their rising currency which resulted to a massive investor stampede out of the Thai’s market.

This should be a lesson to mainstream analysts or to the average investors who always attempt to link events to the markets. While “undemocratic” activities could have resulted to additional woes to the market, instead, running against conventional thinking, the market went into a melt-up phase.

Why? Because we think that in a world of globalization or the intensification of financial markets integration, where a click of the mouse determines capital movements across the borders, markets have shown to increase correlations in an inflationary setting as more money chasing for bigger returns appear to prompt on more “risks” taking appetite wherever and whenever.

And larger risks appetites attempt to ignore developments in the political arena of an emerging market unless it involves the framework of capital flows.

Or perhaps it is in the context that the US dollar poses much more risks compared to the domestic political instability of an emerging market economy, hence the continued flow to non-US dollar assets as portrayed in Figure 2.

Figure 2: Barry Ritholtz: US Dollar Heads Overseas

Another favorite analyst of mine Barry Ritholtz quotes the Wall Street Journal, ``As U.S. investors chase profits overseas, there may be an unintended consequence closer to home: pressure on the American dollar."

Is it a wonder why our own asset classes regardless of the “corruption” and “cheating” charges on its leader continues to absorb heavy torrents of foreign money?

Yes, as the Phisix set new record it was evidently foreign driven; Php 4.67 billion worth of NET inflows, with record spread from foreign money inflows based on companies bought or sold by foreign money.

Eventually a lot of people are gonna pay for a misread or for assuming all such risks, question is who pays, will it be ex-US dollar investors (those who have been bullish with unorthodox “emerging” markets as the Philippines) or US dollar bulls or local politically obsessed public (whom have been indoctrinated to personality based politics)?

Could China’s Bubble Last Longer than Expected?

``The art of central banking is too important to be left to bankers.”-William Pesek, Bloomberg Analyst

And for those insisting that China’s global markets have set the pace for Asia’s market, this we have argued against previously on our February 26 to March 2 edition (see The Blame is on China’s “Shanghai Surprise”, But....); we believe that China’s basically closed capital account and very limited markets to both foreign investors as well as to domestic retail investors (in spite of the blow off numbers) will have less impact to global markets than the rest of the playing field with relatively open capital flows structure.

According to Bloomberg’s Scott Lanman and Simon Kennedy (emphasis mine), ``Total stock holdings in China account for just 25 percent of domestic wealth, and in Asia only Indonesia has a smaller market capitalization than China's 60 percent of GDP….China has capped foreign investment at an aggregate $10 billion in the yuan-denominated ``A'' shares, less than the market value of about 700 U.S.-listed companies.”

This week, China’s stock markets fell the most as its Shanghai index slumped by 4.28% while its Shenzhen index cratered by 8.62% in the face of Asian soaring markets.

If China’s market supposedly LED most of Asia then the recent tremors instigated anew by the government repeated attempts to rein in the parabolic or near vertical run should have caused an equivalent selloff elsewhere, however except for a few seemingly unrelated but insignificant degree of declines in Sri Lanka (-1.32%), Vietnam (-1.12%) and New Zealand (-.2), such China-led premise has ben proven to be a fallacy.

Is it the end of the run for China? We don’t think so. While we share former FED Chief Alan Greenspan or Hong Kong magnate Li Ka Shing’s concerns that China could be due for “dramatic contractions”, we doubt if this would be the end of the bubble.

First and foremost, we do agree that China’s market is in a bubble; when maids quit their jobs (10% of maids in Shanghai!!...according to a Bloomberg report) to do stocks it is definitely signs of a bubble.

However, we don’t think bubbles end soon enough, simply because markets can ever remain so irrational against anyone’s expectation, including Mr. Greenspan or Mr. Li Ka Shing.

Another is that government’s repeated attempt to quash the bubble seems to only intensify buying actions. Each decline has been seen as rather a buying opportunity than the end of the streak. Our view is that bubbles usually collapse by their very own weight.

Most importantly, China’s bubbles are symptomatic of the global inflationary syndrome we have been talking about. Excess US dollars or revenues from exports and investments have to be redeemed by printing local “Yuan/remembi” currency. But since China’s bond markets are yet underdeveloped, “sterilization” or open market operations by the government to absorb surplus money by way of sale of domestic bonds have been inadequate; hence surplus liquidity has permeated its way into China’s stock market.

In addition, the country’s closed capital account and heavily regulated markets have limited the options of the nation’s capability to allocate into other forms of investments. Unless China decides to opt out of symbiotic recycling its excess forex reserves into US treasuries vis-à-vis export revenues, we are likely to see a continuity of this phenomenon of liquidity boosted stock markets in China.

In the future, contrary to most expectations, it is even possible that the US dollar could gain against the China’s currency as the real rate of money supply growth has been more than that of the US.

Finally bubbles don’t usually end with 400% gains from the bottom even at a very short time span. We have previously seen the gains of the Nikkei and of US treasuries as much as we have seen the past the full cycle of the Phisix.

Figure 3: Bloomberg: Saudi’s Tadawul Index

In figure 3, as I have previously shown you, Saudi’s Tadawul Index raced from 2,400 to a zenith of 20,350 in a period of about three years or for about 7.5 times return before imploding.

Today, from its pinnacle to a low of 7,050, Saudi’s Tadawul is off by about 65% from its high.

In Bear market cycles, values lose about 80% to 90% from its peak before finding a bottom. In the dimension of Saudi Tadawul this translates to a probable bottom at around the 4,000-5,000 area. Although if present consolidation would be able to base form for a longer timeframe, say one year, possibly this area could also mark as a bottom. But it is too early to make a call.

Our aim is to show how a full market cycle unravels.

Figure 4: Bloomberg: China’s Shenzhen Index

Similarly in Figure 4 China’s Shenzhen index has zoomed from about 230 up to a recent high of 1,290 for an equivalent return of 4.6 times in a very rapid two years frame.

While such vertical action can lead to extremely wild swings, given the secular performances of the other asset classes, this tell us that Shenzhen Index could reach somewhere 1,800 to 2,000 for its “a blow off top” which follows the “dramatic correction” which our gurus are looking for (back to 500???).

Of course, the financial markets do not operate on the spectrum of rocket science; hence we work on guess estimates and probabilities.

Over at the Phisix, the momentum has clearly favored the bulls for the moment. The gains which we have previously defined as a “rising tide lifts all boats” have been punctuated as advancers run roughshod on the decliners. We had two days where bulls were all too dominant with 111-6 on Thursday and 90-25 on Friday.

Risk Watch: US Treasury Yields Spikes!

``A page of history is worth a volume of logic.” Oliver Wendell Holmes

However, looking at risks equation we note that technical variables could be indicative of a short term overbought signal for the US markets.

Given that the US markets have provided leadership in today’s global markets, any pause in the US markets are likely to influence global markets (including the Phisix). This will all depend on the degree of the pause or correction.

And so goes with the US dollar, which at the present seems wavering onto its future directions. A stronger US dollar could weigh in on ex-US dollar capital flows.

Further, the jump in US Treasury yields to close in on its July 2006 at 5.2% likewise renders us of some risks to monitor. US Treasury yields climbed 9.5 basis points to 4.956% over the week.

As you know global central banks particularly that of the OECD have been in a rate hiking or tightening mode on mostly inflation (consumer prices) concerns. The present increase in US treasuries in the face of a weakening GDP (first quarter GDP .6% below consensus estimate), is a potential harbinger of rising rates, as shown in Figure 5. And rising rates in the light of an economic slowdown imperils the stock market momentum by signaling declining liquidity.

Figure 5: Economagic: US Interest rates and the S & P 500

The Fed Rates (red line) have frequently “tailed” the actions of the US 10 year treasuries (blue line).

Further, notice that the stock market boom seen in the US, as represented by the benchmark S & P 500 (green line), has been inversely correlated to the declining interest rates by both the US 10 year yields and the Fed rates from 1980 up to the present. Prior to the 1980, as interest rates spiked markets consolidated.

In other words, the long term picture tells us that if rising interest will be the long term feature of then US markets then, returns are unlikely to be as good as is today.

Mr. David Kotok of the Cumberland Advisors says (emphasis mine)``four central banks now control the policy rates for 95% of the world’s international bonds and nearly all of its international commerce and financial markets. It is good to know the rules under which each of them operates.” The four banks include the Bank of England and Japan, the Fed and the ECB.

In short, the effects of interest rate movements would have different impacts on each distinct markets.

We will be watching.

Profiting from Markets by Understanding How Cycles Determine Trends

``I know you won’t believe me, but the highest form of Human Excellence is to question oneself and others.” Socrates

ON the average, investors think the markets are a function of random events, hence gets easily swayed by ticker based actions. It is such reason why the common man’s interpretation of the financial markets are as gambling havens, simply because they mostly assimilate a gambler’s fallacy mindset or ``the tendency to assume that individual random events are influenced by previous random events”-wikipedia.org.

For instance after a series of coin tosses, where 5 heads appear in a row, what do you think would be the next outcome?

Trend followers would bet that the next throw would still result to a head (due to its streak), while contrarians would bet on a tail (premised on the “running out of luck” or “law of averages”).

But the fact is since the coin tosses are a 50/50 odds proposition, the next outcome is independent of the results of the previous throws. Therefore, both bets were based on flawed grounds.

However, unlike a coin toss financial markets do not basically operate on random. Instead they operate on cycles. As Warren Buffett’s mentor Ben Graham once said, ``In the market is a voting machine but in the long run it is a weighing machine.” Yes, there may be instances where short-term randomness will dictate on markets, but as a weighing machine the likelihood is it follows a general secular trend.

Figure 3: Chartrus.com: Japan’s Nikkei 225 suggests of an incipient bull market

We love to look at the long term macro perspective and for bull markets cycles, long term returns are usually awesome, for instance in Japan the 20-year bullmarket lifted the Nikkei 225 from about the 2,000 level in 1970 until 40,000 or a return of 20 times!

Yet following the Nikkei Bubble bust, the next 14 years saw the Japanese benchmark on a general downtrend until 2003 or a loss of 80% from its peak. Today the Nikkei has broken out of its long term declining trend, has shown signs of convalescence and is apparently on an upward dynamic.

So the secular trend for the Nikkei 225 could most likely be on an advancing phase and such is why we have been bullish on Japanese Equities since 2003 despite its recent underperformance.

We believe that the market clearing phase has sloughed off enough malinvestments to merit renewed revaluations of the Japan’s asset markets.

Further, we also believe that the Japanese are likely to adopt to the globalization dynamics with necessary reforms, such as further liberalization of its markets and unwinding of its opaque web of keiretsu crossholdings, plus a shift to shareholder responsiveness while increasing economic ties with its neighbors are additional boosters.

In addition, we also think that Japan’s demographic challenges will allow its government to adopt policies which will increase migration flows and outsourcing trends. Lastly, we think that increasing rates for the world’s largest creditor nation will help repatriate resident funds invested overseas and bolster Japan’s financial asset markets as well as for the region.

This is in sharp contrast to the long term trends that one can see in the US interest rates markets, where the US 10 year rates appear to be forming a bottom and could possibly segueing into higher rates as shown in figure 4.

Figure 4: Economagic: 10-year Treasury Constant Maturity: shows of advancing rates

As I have shown this in the past, the US interest rates have depicted some 20-year cyclical patterns. US 10 year coupon rates advanced from 1953-1981 (28 years) and fell from 1981-2003 (22 years). The chart shows that if the cyclicality holds then future rates are likely to move higher than lower.

What could be the potential instigators?

Asia’s or Oil Exporting countries’ “reserve currency decoupling” of their “surpluses” from recycling into the US dollar/or US dollar assets, as evidenced by the recent moves by Kuwait to unpeg its currency from the US dollar.

Another is China’s fiery baptism into the emerging realm of Sovereign Wealth Funds by acquiring 9.9% or $3 billion stake of US private equity firm, Black Stone Group or possibly recent surges in the prices of food prices or agricultural products as a result of a global boom and aggravated by market distortions imposed by government policies promoting agricultural feedstock to produce biofuel.

Even Japan’s potential repatriation of resident investments overseas could likewise serve as a trigger.

The other major factor, the underfunded state welfare programs confronted by the present demographic trends could further raise inflationary pressures which eventually translate to higher interest rates.

Of course, one may argue that fears of deflationary bust from an overleveraged US financial economy would prompt the FED to drastically cut rates, but that would essentially be like throwing gasoline into the fire.

Or that a global deflationary depression could lead US treasuries (lower rates) into a new bull market as some analyst suggests. While we see such as a probable risk factor one cannot discount, I think that an implosion of the overleveraged US credit system in today highly “globalized” world has a potential to cause some serious delinkages or financial decoupling from US assets.

As I see it, the world is getting to be increasingly less and less US-centric as enumerated in my “History is not a closed book” series. Today we are seeing intensifying signs of US dollar “currency reserve decoupling”. In the future, the likelihood is that the “economic decoupling” thesis could gain more traction.

Further signs; Asia has fielded more candidates for the CFA or financial analysts exams than that from the US or UK or Canada as reported by the Financial Times. More writings on the wall?

Overall, prudent investors are concerned with long term trends while looking at potential risks that could upend such trends.

And while trends could be influence by some short-term randomness or gyrations they are likely to be dictated by cycles over the long term. And by cycles we can incorporate the business and economic cycles, by considering the Juglar cycle (7-11 years), Kitchin cycles (40 months or 3-4 years), the Kondratieff long wave cycle (50-60 years), and simply the financial markets cycle.

Jesse Livermore was Right, A Rising Tide Lifts Most Boats!

``Democracy, Communism, and Modern Portfolio Theory all rest on the same claptrap - that The People are geniuses and saints. All the theories agree - there is no higher source of wisdom, virtue, or pricing than the will of the heaving masses. If the voters want to do something foolish, who can tell them not to?” –Bill Bonner, Daily Reckoning

WE face arduous challenges in trying to communicate our long term views relative to the short-term expectations of the public.

As we have described in numerous times, the average investor have the natural inclinations to look for simplified explanations on the market’s action rather than understanding the underlying structural dynamics beneath its moves.

While we attempt to identify present trends as part of the long term cycle, the average investor desires to be told of media-hugging sensationalized activities as drivers of the markets or prices of securities.

The legendary trader Jesse Livermore had been absolutely right; the average investors don’t want to know whether it is a bull or bear market, they only want to be told of what they want or need to hear. And media alongside with mainstream analysis feeds on these popular “ad hoc” explanations, which are mainly “event” prompted.

Because sound scrutiny does not appeal, intuition based rationalization becomes the fundamental basis for decision making. It is of no wonder why most investors are bound to lose when the market cycle turns, as it has always been. Again the invaluable words of Mr. Livermore, ``The stock market never really changes that much. What happened before will happen again and again and again."

For instance, we persistently hear of arguments that our local markets are MICRO fundamental driven. Said differently, securities are believed to be priced according to its corporate fundamentals, i.e. cash flows, sales, earnings, dividends, enterprise value and etc.

And because it is supposedly micro fundamentally driven, the implied assumption is that the success in stock selection becomes a function of ability or talent. This reminds us of the behavioral finance school which identifies the common follies of investors called as the “cognitive biases” or in this case, specifically the attribution bias or the tendency to attribute success to one’s skills and failures to randomness.

We have long argued that aside from being macro or globalization propelled, because of the juvenile state of our stock market, the Philippine Stock Exchange have been mostly impelled by momentum trades by local investors over the broad market rather than valuation based investing; hence, the “rising tide lifts all boats” dynamics have even been more pronounced. In matured or developed markets, I would wholeheartedly agree that fundamental drivers are important contributors to the market’s direction, but not locally.

Why? The lack of local investor breadth has been one elemental foible. Yet where local investors have been actively engaged, they have been mostly guided by momentum driven or voguish explications from sell side analysts, whose economic interests are far divergent from the investor’s goals. To our experience, this lack of sophistication and comprehension of the financial market dynamics applies to even local institutions.

Second, there is also the issue of the paucity of publicly listed companies and the lack of more sophisticated trading instruments. The universe of publicly listed companies in the PSE is only about 260, which is far below our neighbors with Vietnam fast catching up on us with 109 listed companies from 30 companies at the start of 2006.

Figure 1: Number of Issues traded shows a “Rising Tide Lifts All Boats”

As shown in Figure 1, the booming Phisix translates to the rising incidences of number of issues traded. The accelerating trend of issues traded from a limited bandwidth depicts of the diffusion of issues gaining the attention from investors as the market advances.

In addition, where the stock market functions as claims on future cash flows, we see some issues frenetically being bidded up, whose fundamentals are backed by nothing but “stories”.

On some accounts, if one realizes the supposed actualization of cash flows from the purported plans, they would probably occur (if they materialize at all) at the peak of the market’s cycle. And astonishingly yet, these issues have greatly outperformed the market by a mile!

Evidently, the investing public has become less discriminatory and more daring with regards to imbuing risk appetite. This simply shows how the gullible public would ACT on justifying their actions using any pretext to eagerly join the bullish bandwagon.

Another, over the broader market, from the start of the year, the Phisix has gained by 15.4% as of Friday’s close. Nevertheless, advancing issues outnumber declining issues by a daily average of 59 relative to 52, respectively.

Lastly, sliced and diced based on the sectoral index performance, as shown in Figure 2, we prominently see the arguments in favor of a “Rising Tide lifts all Boats” dynamics.

Figure 2: PSE sectoral Performance: “Rising Tide Lifts All Boats”

The Manulife and Sunlife weighted All index (violet line), the Commercial Industrial (Pink line), Holdings (Red), Property (Blue), Services (Orange) and the Mining Index (Green line) are seen in conjunction headed higher, as the Phisix breaks into a new high.

Two important notes, since Manulife (unchanged year to date) and Sunlife (+2.2%) has barely budged from the start of the year, the rising trend of the “All” index markedly exhibits of a broad market advance.

Second, the mining index has as previously identified broken above its crucial resistance levels (another bullseye for us!).

While it is true that several market cap heavyweights are key components to these disparate indices, there have been rotations within each benchmark to offset the stalled activities of the others.

In effect, Mr. Livermore was quite accurate with his assertions that the inclinations of a cyclical market is for broad market moves. Let me repeat, issues may not move simultaneously (except on parabolic stages) but may undergo rotation by the sector or by the units within the sector.

Of course, there have been some exceptions to the rule, where some issues continue to lag. However these exceptions could be construed as symptoms of greenness or immaturity of the advancing phase of our secular bull market which represents a very bullish long term signal.

Again all these evidences contravene the arguments that our markets have been micro “valuation based” boosted but rather lends credence to our contention that global inflationary bias has psychologically pushed investors into bidding up asset prices of emerging markets, as in the PSE, with a “reflexivity loop” of the “prevailing bias” of the markets influencing economic fundamentals.

Another Bullseye! The Phisix Weaves Into A New Frontier.

``Elections are won by men and women chiefly because most people vote against somebody rather than for somebody.”-Franklin Pierce Adams (1881-1960) American Journalist

SO it’s all splashed over the headlines; the Phisix has finally joined its peers (global bourses) to set a fresh milestone high!

Yet, against the conventional wisdom where elections have been thought of as a menace to the markets, we unequivocally asserted that given the today’s credit-driven inflationary environment, political exercises would have minimal consequences to our financial markets.

The Election Drivel

In our January 22 to 28 edition article, Financial Globalization and Not Elections Will Determine the Path of the Phisix we said,

``Unless political developments would have an impact on the capital flow framework as that of Venezuela or Thailand, they are unlikely to MATERIALLY affect the capital flow dynamics on our financial asset markets today. Hence, under such premises, the political election like in the past will most likely be discounted.”

And no matter how media in cahoots with mainstream analysts portrays markets as being event-driven, the fact is that trends, and not events (unless it comes on a complete surprise or shall we say “shocks”) largely determine the market’s activities.

Take for instance the assertion that the markets “cheered” the elections or that “peace dividends” have equally caused the market’s elation.

Figure 1: stockcharts.com: Phisix on a CHEER mode since March!

THE week prior to the election proper, the Phisix had already climbed by 2.6% which essentially confirmed our “election spending” theory.

Here we conjectured that the lagging performance of the Philippine benchmark, which had been be traced to local selling, could have been a direct or indirect result of campaign fund raising via the stock market. Hence, if such activities have indeed weighed on the markets, in spite of discordant behavior of the other Philippine asset classes, i.e. firming Peso and the rallying bonds, aside from the buoyant asset classes of our neighbors of the US markets, the Philippine Stock Exchange (PSE) would recover at the eve of the campaign raising. AND IT DID SO!

If we take a gander at Figure 1, the Phisix is limned on an upside “cheering” mode even PRIOR to the elections. POST-elections simply AMPLIFIED such trend with a breakout gap from February’s high on Tuesday (the Day AFTER), and carved a fresh record at the week’s close.

To quote Sherlock Holmes in the crime novel “The Hound of the Baskervilles” ``The world is full of obvious things which nobody by any chance ever observes."

Furthermore, we argued that in a declining trend of the US dollar, foreign money would likely buttress our markets.

Over the past TWO weeks, where the Phisix climbed by an amazing 5.2%, foreign money flows heavily streamed into Philippine equity assets accounting for Php 5.224 billion or about 11% of the aggregate turnover. Moreover, the scale of influx was seen over the broadmarket, which essentially confirms our outlook that the fate of the US dollar has been a key pillar to global money flows.

As we have said before, media loves sensationalism because it has to sell what the public wants. Such is the reason too why market actions are explained away simplistically, where our “experts” join in to add “authority” on the subject matter even if premised on tenuous grounds. This is because, as mathematician author Nassim Taleb says, ``We favor the visible, the embedded, the personal, the narrated, the tangible. We scorn the abstract.”

Because market actions are oversimplified, what would have been the explanation if the markets fell after elections? “Disappointed by election results”, perhaps?

Now, if one considers the elections as the MAIN driver of our financial markets, would an opposition dominated Senate be favorable to the nation’s present political environment? Could it not translate to even more political tumult and instability rather than harmony? Or could it be indicative of an aggravated gridlock, where legislative activities would grind to halt? (I know; they appear to function more as a body of inquisition rather than of legislation, which provides its members ample room for political “showmanship”….or perhaps a public “spectacle”. Yet the public loves it.)

In other words, looking at the political dimension alone hardly suffices for the present bullish theme…IF politics had been the SOLE DRIVER. However, in reality it isn’t. Markets comprise of multitudinal dimensions and variables, therefore, in absence of any meaningful enlightenment, our “experts” speedily arrive at flaky justifications such as the “peace dividend” bunk.

In the same manner, we can see how politicians undeservingly seize the present developments as propaganda opportunities to snare credit.

Figure 2: Stockcharts.com: World Equity Markets on A Bull run!

Where the international financial markets have shown intensifying correlation due to increasing dynamics of financial markets integration, according to Standard & Poors (emphasis mine), ``Based on monthly returns over the past five years, the S&P 500 and the MSCI-EAFE, which tracks developed markets, registered a correlation of 0.85. (A perfect correlation is 1.0.) Similarly, the MSCI-EM index, which represents emerging markets, sported a 0.78 correlation with the "500." Mid and small-cap U.S. stocks also had correlations of at least 0.77 with developed and emerging markets, as well as larger U.S. blue chips”, a 77% to 78% correlation can hardly be assessed as “insular”, it would be downright misleading to impute the domestic market’s record breaking run to “micro” activities, as shown in figure 2.

The chart shows how the world markets have been performing synchronically through the Dow Jones World Index ($DJW-Main window), iShares MSCI Emerging Markets Index (EEM-above window), JP Morgan Fleming Asia Equity (JPAIX-upper below pane) and the Fidelity Southeast Asian Fund (FSEAX-bottom pane) which all have been in a winning streak!

So while indeed several administrative reforms helped boosted the fundamental outlook for the Philippine asset class, it would be inappropriate to read through this as its main driver, since an ocean of liquidity has bolstered global asset classes of diverse nature and in different geographical zones. One must remember that foreign money flows represents a majority of our trades in the Phisix or even in other asset classes.

China’s Financial Liberalization + Global Excess Reserves =Phisix 10,000?

Figure 3: Economist: Asian Hoarders

And speaking of global liquidity, Figure 3 from the Economist depicts of the foreign exchange reserves rich countries which come mostly from Asia and other emerging markets and has signified improvements on their respective economic and financial outlook. In my view, the massive surpluses are indicative of an inflationary boom.

According to Bloomberg analyst Andy Mukherjee (emphasis mine), ``The bloated and growing Asian foreign-exchange reserves are being increasingly financed by an expansion in the monetary base. Base-money growth in China was 21 percent in 2006, double the annual average of 2004 and 2005. It was about 20 percent in Korea in 2006, six times the average in the preceding two years, according to a World Bank report last month.

``Unmistakably, Asia is contributing -- along with petrodollars and Japanese carry trades -- to a surfeit of global liquidity and a mispricing of risk....Standard & Poor's, which raised the credit rating on eight out of 34 emerging-market sovereigns and lowered its assessment on just one in the 12 months through August 2006, is talking about the need to redefine the ``emerging market'' label, and in certain cases, even eliminate it.”

Yes, these excess savings are likely to provide a floor for risk asset classes, where according to Morgan Stanley’s Stephen Jen (emphasis mine), ``This ‘real’ liquidity arises from a mismatch between world savings and investment rates. World capex has surprisingly been too low to absorb all available savings. Annually, there are some US$800 billion worth of ‘excess savings’ from oil exporters and Asian exporters to chase after assets.”

Another buoyant development likely to boost the global equity asset markets could be the recent liberalization actions undertaken by China to allow its residents to invest overseas via the qualified domestic institutional investors (QDII), which is meant to ``allow for an 'orderly outflow of funds' from the mainland and ease pressure on the yuan to appreciate, Hong Kong Monetary Authority chief executive Joseph Yam said.”

While at the onset the estimated QDII licenses covering 18 commercial banks have an aggregate quota of only around US $14 billion, where 50% or about $7 billion would be allowed to invest overseas, this should translate to a minimal impact over the interim.

However, looking at the bigger picture, this reflects a very important breakthrough as the enormous amount of Chinese savings has far reaching potential impact once totally deregulated, according to JP Morgan (emphasis mine), ``the Chinese savings pool of RMB36 trillion (more than US$4.6 trillion) has proven to be too big for the domestic stock market (market cap only RMB 15 trillion, with RMB 6 trillion floatation). EM/Asia stands to benefit the most as Chinese investors would want to have a natural hedge against renminbi appreciation, and Asian currencies are likely to appreciate over the long run along with renminbi to provide the hedge.”

So there you have US$800 million of excess “public” savings plus a potential US $2.3 trillion from Chinese resident investors that could be invested in today’s rapidly integrating world financial markets whose equity market cap according to the World Federation of Exchanges, is about $50.623 trillion end of 2006. And the noteworthy part of it is that a substantial share of these could be invested within the region (Asia’s market cap of US$11.838 trillion or 23% of the world).

Just imagine even if a fraction of the said amount would be invested in the Phisix, such would drive the Philippine benchmark to parabolic heights!

Aside from technical developments in the US markets, these efforts by China to liberalize have possibly led to the “capitulation” of one of my bear favorite analyst Richard Russell. CBS Marketwatch analyst, Mark Hulbert quotes the Dow Theorist practitioner Mr. Russell (emphasis mine), ``We saw something that is extremely rare [on April 20 and April 25], in fact I can't remember ever having seen this before. What I'm referring to is that on those two dates all three Dow Jones Averages, and -- closed at simultaneous historic highs. To me, a fellow steeped in Dow Theory for over half a century, this was like a clap of thunder... My take on the situation is that the stock market (and the Dow Theory) told us that an unprecedented world boom lies ahead."

Short Term Risks: Overheated Markets and a US dollar bounce?

Yes, despite the exuberant outlook, risks abound. Aside from the factors of excessive leverages and speculation, structural imbalances, asymmetric carry trades and untested novel financial instruments, short term risks include an overheated global equity markets following its recent sizzling hot streak. In addition, a potential rebound or rollover of the US Dollar (represented by its trade weighted index) from its recent lows could heighten volatility, as shown in figure 4.

Figure 4: BCA Research: US dollar Poised for a Rebound

Notes the widely followed independent research outfit BCA Research (emphasis mine), ``The U.S. dollar has moved into oversold territory, and according to our capitulation index a bounce is likely. Furthermore, speculators are short the currency and sentiment has been declining for the past 18 months - both measures are often good contrarian indicators. However, the bigger question for the dollar is whether there are fundamental reasons for currency strength. Currently, the global macro backdrop still supports a soft dollar. The U.S. remains the weak link in an otherwise solid global economy and further growth redistribution (via an adjustment in the currency) is likely needed. Still, any signs of improvement in the U.S. housing market as the year progresses would result in an unwinding Fed rate cut expectations and provide support for the currency. Bottom line: Betting on the dollar can be justified purely on technical grounds, but improvements in the U.S. housing picture would add momentum.”

Finally, the breakout from its 10 year range by the Phisix signifies our bullmarket is in a PRIMARY TREND, which places my Phisix 10,000 at a very attainable target.

Most of the questions I receive today allude to what issues are likely to move during this bullmarket phase of the cycle.

Over the past two weeks as the Phisix gained by over 5%, where advancing issues dominated the market with 548 against 432 decliners and 505 unchanged issues, local investors appear to be dithering as foreign money went into a shopping spree.

Because in bullmarkets it is a general rule that ALL stocks go up, previous heavyweight laggards as San Miguel and SM Investments substituted the previous heavy cap favorites in PLDT and the Ayala Group in pushing the Philippine benchmark to its recent record highs. This clearly shows that past performance does not equate to future actions, as the favorites underperformed against the former laggards.

Yet, the average investors can hardly grasp that in a bullish cycle, stocks either go into a rotation or move up simultaneously especially at cyclical peaks. The public believes that micro forces drive the local market when evidences tell us that the present cyclical advance is hardly a “micro” thing.

I’d like to repeat a very important message (which I have practiced) from Jesse Livermore, in his investing classic, Reminiscences of a Stock Operator (emphasis mine), ``I never hesitate to tell a man that I am bullish or bearish. But I do not tell people to buy or sell any particular stock. In a bear market all stocks go down and in a bull market they go up...I speak in a general sense. But the average man doesn’t wish to be told that it is a bull or bear market. What he desires is to be told specifically which particular stock to buy or sell. He wants to get something for nothing. He does not wish to work. He does not even wish to have to think. It is too much bother to have to count the money that he picks up from the ground.”

Believe me, it is a basic rule which works.