On Feasibility Studies: Research Quality Is Subjective And Not Commoditized

``Irrationality as a real economic attribute is not only the pith of behavioral finance; it is the next frontier for all market research.”-Woody Dorsey

At a recent social function, a colleague opined that some professors at post-graduate universities ‘moonlight’ by selling feasibility studies through consultancy services. Yet these feasibility studies were adduced to have been consigned to the students, from which the professors consolidate, package and deliver to clients as their own. The negative connotation is that professors monetize on these by “using” their students to do their work. Hence, the conclusion was, instead of contracting consultancy services from such professors, it would be better off simply hiring students to conduct such feasibility requirements at much cheaper rate.

Nonetheless while there are merits to the allegation of delegating some work to students (which I say would be mostly be data gathering), the hasty generalization is that feasibility studies are homogeneous or monolithic. Unfortunately, they are not.

Feasibility studies, while constituting basic components, are highly subjective and greatly dependent on the reference points, data set or data coverage, methodology, interpretation and importantly the author’s biases.

This may somewhat be seen analogous to market reports, where similar data sets would induce different interpretations which ultimately arrives at different conclusions for these observers. That because researchers, like anybody else, have different marginal utilities or set of values or priorities.

For instance, while conventional market reports focuses mainly on micro (e.g. PE ratio, national GDP) or macro fundamentals (e.g. current account balances) or technical charting theme, my methodology would flow from the monetary and behavioral aspects, to inflation dynamics to prospective political directions. Hence my conclusions or projections are frequently seen as unorthodox or “contrarian”.

The point is, research quality is highly subjective and variable and can’t be “commoditized” or seen as a “one-size-fits-all” template.

Applied to business strategies, contracting “cheap” feasibility studies would only amplify business risk. This isn’t your school requirement, where you rush to C.M. Recto to ‘buy’ a stereotyped report (a road in Manila reputed for “outsourcing or for hire school reports researchers” and “fake” legal documents), and where the stake is only choice between “passing” or “failing” grade; business strategies involve long term capital allocation, where wrong decision/s from haphazard analysis subjects investors to financial losses.

Herding Behavior and Awkward Dancing

Paul Kedrosky calls this video Contagious Behavior and Bad Dancing.

I would say that this is a manifestation of the cognitive bias called the Bandwagon effect or the Herd Behavior where "individuals in a group can act together without planned direction" plus really bad or awkward dancing.

WHO's Pandemic Alert On Swine Flu: Real Pandemic Threat Or Other Unspecified Motives?

The Swine Flu has officially been declared by the WHO as a pandemic.
This from the Economist, ``THE World Health Organisation raised the threat level for swine flu on Thursday June 11th to pandemic status, the highest possible. It is the first influenza pandemic since 1968, when Hong Kong flu killed 1m people. Almost 28,000 cases of swine flu and 141 deaths have been confirmed in 74 countries since the A(H1N1) virus was first identified in Mexico in late March. In Australia alone, the number of people infected has jumped from around 500 to 1,200 in one week. However, in a new paper published in Nature on Thursday, researchers suggest that the strain had probably been in existence for months before it was isolated, highlighting the need for good surveillance."

I'm no health expert, but I remain a skeptic.

The figures are telling; 141 out of 28,000 cases translates to a .5% fatality rate. The 1918 pandemic had a case fatality (CF) ratio of 3-6% according to wikipedia.org.

Moreover, 28,000 cases in 3 months against a world population of 6.7 billion doesn't seem to project anywhere near the same degree of impact relative to the 1918 case.

Then, some 25 million people had reportedly been killed during the first 25 weeks of the outbreak according to wikipedia.org.

Of the world population of approximately 1.6 billion, estimated fatalities for the 2 year lifespan of the pandemic reached a third or about 500 million-again from wikipedia.org.

Under the same rate, we would now have tens of millions of infected people and casualties that would run in the hundreds of thousands if not in millions.

Of course, one may argue that- this is what the pandemic alert is for-to prevent the spread of the disease and fatalities!

But where should the line be drawn between the use of "fear" from pandemics (or as an excuse) for expanded government control of our lives and the real menace of swine flu as pandemic? Or how do we know if the pandemic alert is genuinely about disease prevention or about some implicit interests being foisted on us by government/s? How do we know if this isn't about propping up sales of pharmaceuticals, some of which are said to be partly owned by certain politicos or a thrust to impose global taxes or other concerns outside of the pandemic issue?

See past articles:
Swine Flu: Mostly A Media Fuss
Swine Flu: The Politics of Fear and Control
Swine Flu: The Black Swan That Wasn’t

Soaring Oil Prices Isn't Just Relative To The US Dollar, But On Most Currencies!

Oil prices as benchmarked by the West Texas Intermediate Crude (WTIC) recently hit $73 per barrel where many analysts attributed oil's climb to the US dollar.

Having checked on the WTIC compared with different currencies we realized that this had only been partially accurate-oil has been surging across major currencies!

Against the Euro

Against the Aussie Dollar

Against the Japanese Yen

Against the Canadian Dollar (loonie)

Against the Swiss Franc

and even Against the South African Rand!

Decoupling in Oil Markets: The Centre of Gravity in Energy Markets Has Shifted To Emerging Markets

Mr. Tony Hayward, chief executive of BP made a dramatic revelation about the evolving energy industry published at the Telegraph last week.

He said that the "centre of gravity" of the energy markets had permanently shifted towards emerging markets.

We quote Mr. Hayward (emphasis added), ``But one event went almost unnoticed. 2008 was the year when the centre of gravity in the energy market tilted sharply and permanently towards the emerging nations of the world. For the first time ever, non-OECD energy consumption outstripped that of the OECD nations.

``This really is a decisive moment. People have been predicting such fundamental shift, with its implications for the world economy and geopolitics, for some time. Now it has happened."

Yet, ironically, many so called experts stubbornly insist that the world can't decouple.

chart from BP Statistical Review on World Oil consumption

Adds Mr. Hayward, ``As has been the case for several years, China again led the way in incremental energy consumption in 2008, accounting for three-quarters of the extra growth, and India took second place.

``Both countries rely heavily on coal for power generation. China in particular has extensive coal reserves and this means that coal remains the fastest-growing fuel, as it has for six consecutive years.

``The shift in energy consumption towards the non-OECD is not a temporary phenomenon. On the contrary, I believe it will increase still further over time. It is a trend which will continue to affect prices and raise questions about the sustainability of economic growth, energy security and climate change."

Chart from McKinsey Quarterly/Reserach Recap

Well it isn't just Mr. Hayward or BP saying so, research institute McKinsey Quarterly observes the same dynamics in motion too.

Mckinsey Quarterly's Interactive chart depicting of the World Energy Demand (I placed it under a severe downturn scenario).
Also Mckinsey Quarterly's Interactive chart on World oil consumption (I also placed it under a severe downturn scenario)

From McKinsey, “More than 90 percent of this demand expansion will come from developing regions, with China, India, and the Middle East leading the way. Five sectors within China—residential and commercial buildings, steel, petrochemicals, and light vehicles—will account for more than 25 percent of global energy demand growth. India’s light-vehicle, residential-buildings, and steel sectors and the Middle East’s light-vehicle and petrochemicals sectors will be other notable contributors to the growing demand for energy.” (bold highlight mine)

So Emerging Market demand, restricted supplies, inflationary policies and limited geographical access adds up to $200 oil or more as we wrote in $200 Per Barrel Oil ,Here We Come!

Philippine Politics: "Con Ass" Much Ado About Nothing?

I have not been following the controversy over the so called Constitutional Assembly (Con-Ass) or an attempt by adherents of the present administration to railroad a modification on the Philippine constitution purportedly for extending the tenure of incumbent officials.

It's because my interpretation of the furor has been more of a "noise" than of a genuine concern.

From an intuitive layman's point of view I would require answers to these questions:

1. Is there a legal basis to amend the Philippine constitution with only one house of the bicameral legislative branch in support of such action?

2. Assuming there is, since any amendment would require a people's referendum or plebiscite, would there be a legal framework for a CON ASS referendum to supersede next year's scheduled national elections?

3. And would there be enough resources and time earmarked to do so?

In my view, a NO answer to any of these 3 questions would likely torpedo these efforts to advance the CON ASS agenda.

Notwithstanding, considering the unpopularity of the present administration, legal hurdles can be utilized by the political opposition to derail such agenda. This would essentially constrict the window for a referendum, in lieu of or prior to next year's national elections.

In short, such actions doesn't look feasible even from the start.

Then why does it seem that the administration has been adamant to play this card?

We offer two guesses here:

One, it could be a diversionary tactic to lure the political opposition into concentrating their efforts over such useless issue while the administration, behind their backs, works to strengthen its logistics and networks in preparation for the upcoming national election.

Two, it could also be a trial balloon to gauge on the "winnability" of PGMA's "anointed" bets via her popularity going into next year's election.

It is political season in the Philippines hence most sensationalist events disseminated by media, including the Halili Kho scandal, are likely to be instruments for political agenda.

As I responded to a colleague at a recent social function:

We must remember, in politics, those in power will always work or attempt to preserve their political privileges, while those in the periphery will always work or attempt to usurp such privileges. Such is the vicious cycle of politics.

Why? Because political privileges are usually products of an interventionist welfare state. Where, to quote Richard Eberling, ``The political process is the mechanism that these individuals and groups use to get that money via regulation, protections, and redistribution."

Politics is hardly about social "weal" or the "people" as much as it has been bruited about, it's mostly about privileges.

India's Surging Markets Lures Companies From The Government and The Private Sector To Raise Financing

Surging financial markets in India have lined up companies from the private sector and government to raise financing.

From the trough, India's BSE 30 is up about 84% and is 26% shy from its 2008 peak.

The Indian rupee has also rallied furiously since the simultaneous trough in the stock and currency markets.

According to the Wall Street Journal, ``So far this year, issues of new shares have been scarce. But with the Bombay Stock Exchange's benchmark index at a 10-month high, many companies have plans to raise capital to bolster balance sheets and fund growth, bankers say.

``The new government's budget, scheduled for release in early July, also could usher in new sales of stakes in public companies. The frenzy may be welcome news to investors looking to ride a rapid rise in India's stock market over the past few months...

``Data provider Thomson Reuters expects $50 billion of new shares to be issued in India this year. So far, there has been just $1 billion.

The newly elected government is also in a rush to join the financing bandwagon.

Again from the same article, ``On the IPO front, state-owned hydro-power outfit NHPC Ltd. and oil-exploration company Oil India Ltd. are expected to issue shares. On Monday, Rahul Khullar, the outgoing top bureaucrat in the department in charge of state company disinvestment, said the government is likely to sell stakes in NHPC and Oil India by September, followed by six to seven other companies before March 31, 2010.

``The government's budget could offer further divestment plans amid the need to stimulate the economy without severely worsening the fiscal deficit.

``Air India, India's national airline, and state-run telecommunications company Bharat Sanchar Nigam Ltd., or BSNL, are likely to sell some shares, market watchers say."

The phenomenal activities in India are likely to be replicated in major Emerging Markets and in Asia.

Search Trends Reveal Growing Concerns Over Hyperinflation

During the last quarter of 2008, the near collapse of the US banking system prompted by some accounts of institutional or electronic bank runs paved way for the predominant concern of deflation.

The one year search trend in Google Trends reflected this (see below). Now with surging stock markets and turbocharged commodity prices, the pendulum has apparently shifted from deflation to the other extreme end-hyperinflation.

Deflation searches have been on a decline while searches for hyperinflation has been on the rise (see below).

As of this writing, deflation still dominates with 6.58 million articles against 2.5 million for hyperinflation. Meanwhile, inflation has 67.5 million articles while stagflation has 735,000 articles.

So there seems less interest on the middleground.

The point is we seem to be at the crux of a trend transition where public concerns appear to weigh on hyperinflation.

Power Curves Applied To Economy, Markets And Nature

This is an interesting study from The McKinsey Quarterly which dwells with power curves in "Power Curves": What Natural And Economic Disaster Have In Common

The power curve or the power law according to wikipedia.org,``A power law is a special kind of mathematical relationship between two quantities. If one quantity is the frequency of an event, the relationship is a power-law distribution, and the frequencies decrease very slowly as the size of the event increases. For instance, an earthquake twice as large is four times as rare. If this pattern holds for earthquakes of all sizes, then the distribution is said to "scale". Power laws also describe other kinds of relationships, such as the metabolic rate of a species and its body mass (called Kleiber's law), and the size of a city and the number of patents it produces. What this relationship means is that there is no typical size in the conventional sense. Power laws are found throughout the natural and manmade worlds, and are an active area of scientific research.

McKinsey suggests that the laws of nature can be applied to economies or marketplace, ``Scientists, sometimes in cooperation with economists, are taking the lead in a young field that applies complexity theory to economic research, rejecting the traditional view of the economy as a fully transparent, rational system striving toward equilibrium. The geophysics professor and earthquake authority Didier Sornette, for example, leads the Financial Crisis Observatory, in Zurich, which uses concepts and mathematical models that draw on complexity theory and statistical physics to understand financial bubbles and economic crises.

``Sornette aims to predict extreme outcomes in complex systems. Many other scientists in the field of complexity theory argue that earthquakes, forest fires, power blackouts, and the like are extremely difficult or even impossible to foresee because they are the products of many interdependent “agents” and cascades of events in inherently unstable systems that generate large variations. One symptom of such a system’s behavior is that the frequency and magnitude of outcomes can be described by a mathematical relationship called a “power law,” characterized by a short “head” of frequently occurring small events, dropping off to a long “tail” of increasingly rare but much larger ones...

``If, for instance, you plot the frequency of banking crises around the world from 1970 to 2007, as well as their magnitude as measured by four-year losses of GDP for each affected country, you get a typical power curve pattern, with a short head of almost 70 crises, each with accumulated losses of less than 15 percent of GDP, quickly falling off to a long tail of very few—but massive—crises . While the most extreme cases involve smaller, less developed countries, the same distribution also applies to more developed ones—and with much larger absolute values for GDP loss. Earthquakes, forest fires, and blackouts yield a similar power curve pattern—for instance, from 1993 to 1995, Southern California registered 7,000 tremors at 2.0–2.5 on the Richter scale, falling off to the 1994 Northridge earthquake, at the end of the tail, with a magnitude of 6.7. The curve highlights a key property of the power law: extremely large outcomes are more likely than they are in a normal, bell-shaped distribution, which implies a relatively even spread of values around a mean (in other words, shorter and thinner tails)."

The power law applied to the industrial production...

``These examples indicate that power law patterns, with their small, frequent outcomes mixed with rare, hard-to-predict extreme ones, exist in many aspects of the economy. This suggests that the economy, like other complex systems characterized by power law behavior, is inherently unstable and prone to occasional huge failures. Intriguing stuff, but how can corporate strategists, economists, and policy makers use it? This is still a young field of research, and the study of power law patterns may be part of the answer, but it isn’t too early to consider and discuss potential implications."

Read the rest here

Jim Grant On Federal Reserve Policies, Federal Reserve Audit, and Gold

Jim Grant at CNBC.com deals with Federal Reserve policies, the possibility of the Federal Audit and its repercussions and gold.

The interesting part comes from Mr. Grant's reaction to Congressman Ron Paul's initiative to have the Federal Reserve audited.

This from lewrockwell.com ``The Federal Reserve's balance sheet is so out of whack that the central bank would be shut down if subjected to a conventional audit, Jim Grant, editor of Grant's Interest Rate Observer, told CNBC.

``With $45 billion in capital and $2.1 trillion in assets, the central bank would not withstand the scrutiny normally afforded other institutions, Grant said in a live interview."

``If the Fed examiners were set upon the Fed's own documents – unlabeled documents – to pass judgment on the Fed's capacity to survive the difficulties it faces in credit, it would shut this institution down," he said. "The Fed is undercapitalized in a way that Citicorp is undercapitalized."(bold highlights mine)

Ouch!

Barry Ritholtz: How to Fix Financial Television

Prolific blogger Barry Ritholtz in one of his latest post "How to Fix Financial Television" submits a wish list of how media should conduct their TV programs when discussing financial affairs (some of this seem applicable to the Philippine equivalent).

Except for number 3, all bold highlights mine. We quote Mr. Ritholz...

1. Stop Yelling. Stop interrupting. Stop Talking Over Each Other: This is not Jerry Springer, its serious business. People’s retirement and investments are at stake. Please treat it that way.

2. Bring us People We Don’t Have Access to. What various FinTV channels do really well is when they bring us long, thoughtful interviews with the likes of Warren Buffett, WIlliam Ackman, David Einhorn, and others. People we wouldn’t ordinarily have access to. Example: This morning, CNBC had on James Rickard. More of this please.

3. S - L - O - W D - O - W - N

4. Risk: All traders must appreciate the potential downside of trades. So too, must FinTV. Explain stop losses. Understand Risk/Reward. Recognize there are periods when Buy & Hold is a jumbo loser.

5. Lose the Octobox. Fire whoever came up with the Decabox. ‘Nuff said.

6. Separate the Signal from the Noise. Understand that most of the day-to-day action is simply noise. Look at a long term chart, you can barely see 9187 or 9/11. If those major events get lost in the long term trend, what does the intraday jags, kinks and reversals mean? Very little. Recognize that not every data release, slice of news, or rumor is at all significant. Stop treating them as if they were.

7. Fact Check: An awful lot of things on air get stated with authority and confidence. Much of them are little more than junk or pop myths. Why is it that the more dubious a proposition is, the greater the confidence the speaker seems to muster? Consider fact checking as much of the statements that are made on air as possible, and making frequent corrections.

8. Accountability is important: I am astounded at some of the money losing hacks that are various shows again and again. These are the “articulate incompetants” to use Bennett Goodspeed’’s phrase. Why not keep track of the records of guests — and let the viewers know how their past few calls have been. Are they Perma-bulls or bears? Are their stock picks awful? Are they reliable money makers? If not, let us know. (Of course, the better question is, if not, why even have them on?)

9. Bring Back Louis Rukeyser: Not the man, but rather, his style. Wall $treet Week — Rukeyser hosted it from 1970 to 2005 — was plain-spoken, thoughtful and accessible. Quiet, contemplative, discussions, with intelligent market participants, revealing helpful information. The investing public would appreciateagain. something of that sort —

10. Sound FX: What is with all the bizarre sound effects every time a screen changes? Its financial news, not a video game. Kill ‘em.

11. Embed your video (on your own website or YouTube) instead of using WMP. At long last, thank you.

12. Investigative Pieces: David Faber seems to have a monopoly on deep, long thoughtful analyses. Be they on Wal-Mart, the credit crisis, whatever, his long format work is a highlight of CNBC. More of these, please.

13. Most stock picks are losers. That’s normal, but the audience does not realize this. A big part of the challenge is informing the viewer that finding the biog winners is a low probability, high outcome event. As in a baseball, a 350 hitter is a star. Explain this to your audience.

14. Stop the Bull/Bear Debate: This is a vast over-simplification of the market, and often does not serve the audience well. There are nuances and variables that get lost when you reduce everything to black and white.

15. Partisanship: Leave your personal politics at home. Viewers don’t care what most of you think.

16. Respect the Audience: We are adults. Treat us that way.

Great stuff, Barry.

I'd like to add, for the Philippine setup -stop projecting markets as some sort of a "game" similar to horse racing. It is one reason why locals have a poor understanding of the markets.

10 World's Largest Energy Renewable Projects

Interesting trivia on the world's largest renewable energy projects from Scientific American.

According to Sciam, ``Today, renewable energy sources generate 12 percent of electricity in the U.S. But wind, wave, sunshine and others represent more than 93 percent of the energy the country could be producing, according to the Energy Information Administration of the U.S. Department of Energy."

The list includes wind, geothermal, biomass, tidal or wave power, hydroelectric, solar and landfill gas...

Here are two samples of the renewable energy landmarks.


World's Biggest Offshore Wind Farm Lynn and Inner Dowsing Wind Farm Near Skegness, Lincolnshire, England

World's Largest Photovoltaic Power Plant Olmedilla Photovoltaic Park in Olmedilla de Alarcón, Spain

For the complete list and details, Pls click here

Peter Bernstein on Risk and Risk Managment

McKinsey Quarterly presents Peter Bernstein [my apologies I erroneously placed Richard Bernstein earlier]

``The celebrated author of Against the Gods: The Remarkable Story of Risk explores the history of risk and how it works in real-world markets and in our lives.

``Risk doesn’t mean danger—it just means not knowing what the future holds. That insight resides at the core of risk management for companies, whether in managing the potential downside of an investment or putting a value on the option of waiting when making irreversible decisions. In this video Peter L. Bernstein also explains why in the real world the most sophisticated mathematical models can sometimes fail."

Peter Bernstein in this video deals with Risk, Risk Control and Management, Options and Option pricing, and mathematical models that can't input world dynamics.

"It's how you deal with it when it happens"

Update: Learned today June 10th, that risk guru Peter Bernstein has recently passed away at age 90 (Bloomberg). Sad to lose such an inspirational icon, he will surely be missed.

WSJ Economic Scenarios: Just, Right, Too Cold or Too Hot

Here is a quaint chart from Wall Street Journal depicting on the possible scenarios for the US economy and its financial markets

Here are some excerpts from the article...

Just Right

``Hefty government stimulus -- easy Federal Reserve monetary policy and $787 billion in government spending, tax breaks and other perks -- encourages consumers to spend and businesses to hire. This bolsters economic growth, keeps a lid on unemployment and finally ends the pain in the housing market.

``At the same time, the massive structural problems facing the economy, including burdensome debt on consumer and government balance sheets, keep just enough of a brake on growth to keep inflation in check.

``Under this scenario, corporate profits and economic growth limp their way back to recovery through the second half of the year, setting up a stronger 2010. Stocks rise, though perhaps not by much. The consensus view among many strategists is that the broad Standard & Poor's 500-stock index will stagger its way to somewhere between 1000 and 1100 by the end of the year, a 17% gain from Friday's close.

Too Hot

``Under the too-hot scenario, surging asset prices trigger worries about inflation, hurting the dollar and causing the interest rate on government debt to rise. That might force the Fed to buy more Treasurys to keep interest rates low -- yields move in the opposite direction of prices -- fueling more worries about higher inflation and a devalued dollar.

Too Cold

``This pessimistic scenario is a recipe for retesting the stock market's March lows. In the longer run, it could also lead to deflation, in which prices tumble as consumers keep delaying purchases. Deflation can be long-lasting and have a chilling effect on stock markets."

Here is how I see it

Just Right is a fantasy premised on the efficacy of the Obama administrations' magical powers to successfully subvert the laws of scarcity and heal the economy.

Too Cold (or deflation)-a scenario where the US is insulated from the world and or that money has no impact on real economic activity.

Too Hot (or inflation)- a scenario presupposing the reemergence of inflation.

Our take: hot, too hot and possibly boiling hot!

Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble

``No two economies are ever alike in details. The composition of the industries changes. The expectations of people change. The government changes. The international linkages and governments change. The monetary systems vary. The skills and composition of the labor force change. The technology changes. The knowledge changes. The goods being produced and consumed change. The institutions change. Need I go on? No one understands an economy, and no one can understand a business cycle in an economy. I mean really understand it. Sure, there is a broad understanding. There is a grasp of certain features. We are not bereft of knowledge. But we do not know the details. We do not understand the linkages or what goes through people’s minds and affects their behavior. All the models we use, including the Austrian models, are more or less broad-brush affairs.”-Michael S. Rozeff Fiscal and Monetary Policy Annoy Me

As of Friday’s close, the Philippine Phisix passed the 2,500 Rubicon.

And by doing so the Philippine benchmark has recovered some 48% of its losses from the 2007 pinnacle and is now about 52% away from a full recovery, see Figure 1.

Figure 1: Phisix: On A Halfway Mark To A Complete Recovery

To attain the present levels, the Phisix has tallied a blazing 6 consecutive weeks of gains.

The Predicament of Mechanical Chart Reading

A mechanical chart practitioner, without the understanding of the underlying fundamental dynamics, would have seen resistance after resistance being broken, and as consequence, would either have been left behind watching in ‘shock and awe’ and immersed in ‘regrets’ (constantly muttering “I should have…” or “I could have…”) or have been frantically chasing after adrenalin infused stock prices.

True, technically speaking, the run in the Phisix have been overextended but the hallmarks of major trends can translate to serial bouts of trend overreach.

Moreover, historical actions can’t serve as precise guide simply because the underlying circumstances between the points of comparison could be distinct; where possible incidences of parallelism would depend on the degrees of circumstantial similarities.

Minyanville’s James Kostohryz, an investment banker, hits the nail in the head in his Anatomy of a Losing Trade, ``There's no such thing as a market being “overdue” for a correction. This is pure nonsense. There's no reason why a market has to behave in a fashion that one is comfortable with. Past experiences are only relevant to the extent that current circumstances are analogous. In this case, they weren't. So leaning on past experience was a mistake.”

The lesson is that mechanical chart reading signifies as oversimplification of reading and analyzing markets which is an inferior way to generate outsized returns.

Market-Real Economy Divergences Underscore Reflexivity Theory At Work

Yes, markets can go anywhere over the interim. This means that profit taking could surface or that a countertrend cycle can emerge.

And markets could use divergences in current events relative to markets to justify such actions.

Figure 2: NSCB: Philippine GDP At The Edge of Recession

Take for instance the descending trend of economic growth as shown in Figure 2. 1^st quarter Philippine GDP growth surprised to the downside with a substantial slowdown (NSCB).

However this hasn’t been the case. On the contrary, the Phisix got fired up to account for a remarkable 5.83% gain week on week and for a cumulative 35.02% advance year to date!

Of course we expect the mainstream to read this as an “inflection point” so as to “rationalize” current market actions. And this is what we have been expecting for sometime.

Although, it would be a paradox to note that the Phisix had been stabilizing in the first quarter even as the economy had been undergoing a belated precipitate decline in economic activities, the operating fundamental dynamics underscores the reflexivity theory at work.

As we wrote in The Growing Validity Of The Reflexivity Theory: More PTSD And Periphery, ``In short, the reflexivity theory -from fact to perception and now perception to facts-seems to be succeeding at recalibrating the market’s mood.” Rationalizations of market actions (perceptions) to the real economy may indeed translate to a turnaround (prospective fact).

We see the same divergent mechanisms or reflexivity theory operating even in our regional contemporaries.

Except for Indonesia whose economic growth clip over the same period has marginally slowed but remains substantially up at 4.4% (guardian.co.uk), Thailand and Malaysia recorded negative growth and could be in the threshold of a recession.

Yet, Indonesia’s bellwether the JKSE has on a year-to-date basis displayed the bulls’ overwhelming dominance to account for 54% of gains, while Thailand’s SETI has tabbed 34% and Malaysia’s KLSE 23%.

BSP Policies To Add To Inflation Woes

Going back to the Philippines, the substantial decline in growth has extrapolated to a hefty drop in inflation which has prompted the Philippine central bank the Bangko Sentral ng Pilipinas (BSP) to cut rates to a 17 year low, see Figure 3.

Figure 3 Reuters: Philippine Inflation

The Consumer Price Inflation has basically fallen below Bangko Sentral ng Pilipinas (BSP) policy interest rates.

I don’t know how accurate this inflation gauge is, but to my observation, commercial rice prices in our location have remained at the price levels near the peak of the inflation cycle and haven’t manifested any meaningful deviation as accounted for by the published official statistical account. Rice is a key component in the inflation index (see chart here).

Nonetheless, the steep fall in the domestic inflation index appears analogues to the Posttraumatic Stress Disorder (PTSD) impact on global trade last year. It most likely reflects on a lagged impact of the global financial and economic shock from the seizure in the US banking system on the real Philippine economy, which is likely to be a temporary phenomenon, especially that prices of commodities have returned with a vengeance.

Yet like all central bankers who believes they can control the economy “to avert recession” by adjusting knobs through monetary tools, our BSP has joined its global peers to impose Zero bound policy rates and has declared the possibility of more rate cuts. And in doing so, have revved up the business cycle which has been premised on the unsustainable highly flawed economic ideology of borrowing, speculating and spending policies to boost the economy.

As you will observe, policymakers everywhere are innately reactive than proactive. Current market prices have been signaling a return of inflation yet the focus by policymakers have been on past data. Commensurately, the policy response is to address the past concerns. Unfortunately, such responses would result to short term gains but with lasting damage far greater than any interim benefits.

Hence, Philippine policies have been contributing to the global “super” inflation dynamics.

While it had been a delight to read that our honored BSP Governor Amando Tetangco quote one of our inspirational economic icons in his speech at the Australian-New Zealand Chamber of Commerce Philippines Annual General Membership Meeting, Makati-City last 14 April 2009, where he said, ``Frederic Bastiat, a 19th century French economic journalist, once said, “there is only one difference between a bad economist and a good economist: the bad economist confines himself to the visible effect; the good economist takes into account the effects that can be seen and those effects that must be foreseen”, disappointingly the venerable Governor doesn’t seem to be practicing what he had preached. And quoting Mr. Bastiat looks more like an ornament to spice up a talk.

Policies Shape People’s Incentives, Foreign Funds Flows Recovering

Policies shape people’s incentives.

The low interest rate regime has begun to show signs of gaining traction. This has spurred a boom in domestic banking credit in April (BSP) and equally a hefty liquidity expansion as reflected by the domestic M3 which grew by 13.7% in April (BSP).

Of course while bank loans to industries may presuppose usage, we can’t say if the loans had actually been used as so designated. Possibly some of these could have been diverted to the stock market.

Figure 4: PSE: Percentage Share of Foreign Trade: Local Participants Dominates!

The present boom in the Philippine Stock Exchange (PSE) has been mostly due to local participants, see figure 4. This is in contrast to the previous cycle 2003-2007 where foreigners functioned as the market’s driver.

The share of foreign trade has hardly gone beyond the 50% threshold as exhibited by the black horizontal line, since the start of the year.

This local buying phenomenon has been a primary feature in the present epiphany of stock markets in Emerging Markets and in Asia.

To quote the high profile contrarian analyst from CLSA Mr. Chris Wood whose interview can be seen here, ``What is being positive there in the rally began in Asia in October-November last year, is that we've seen growing local investor participation in Asian market, so the people who bought earlier in this rally since late last year weren't foreign fund managers but local investors throughout the region. That growing local investor participation is a long term positive.” (bold highlight mine)

For us, it is likely that high savings rate combined with loose monetary policies to induce speculation, fiscal stimulus applied, largely unblemished banking system, and low systemic leverage that has impelled a bidding war in the stock markets and commodity markets.

Of course, for media and mainstream, it would prominently be the “high” economic growth story which we won’t disagree with.

Figure 5: PSE: Improving Foreign Trade

Notably, foreign trade on the account of the falling US dollar index has also been improving see figure 5. For most of the year, foreign trade has largely been a net selling.

I excluded from the chart the April 30 foreign trade data which incorporates the special block sale of San Miguel Brewery to Kirin, because it skews the chart by making little visibility to current market action. Nevertheless, the red line manifests the reemergence of foreign buying activities but has remained minor to local activities.

And this hasn’t been an insulated event. Fund flows to emerging markets have begun to pick up steam.

According to this report from Bloomberg (bold highlight mine), ``Emerging-market equity funds received $3.79 billion in net inflows for the week ended June 3, led by investments in Asia excluding Japan, EPFR Global said.

``Funds that invest in Asian stocks excluding Japan added $1.54 billion, the most in dollar terms, while global emerging- market equity funds attracted $1.07 billion, the Cambridge, Massachusetts-based research company said in a report dated yesterday. Latin America stock funds drew inflows of almost $1 billion, while funds investing in Europe, the Middle East and Africa gained $230 million.

``Emerging-market stock funds have taken in $26.1 billion of net inflows this year, following 13 straight weeks of gains.”

So renewed interests from foreign investors on emerging markets are likely to even propel stock prices to higher levels! We should see the same dynamics reinforced locally. This time it will probably be foreigners chasing stock prices.

The Peso Riddle

For me one of the current major puzzles has been the underperformance of the Philippine Peso, in spite of the spirited rally of the Phisix and in the face of the sagging US dollar.

While the Peso has been marginally up from the start of the year, it has underperformed most of its contemporaries.

My conjecture is that foreign portfolio flows could have had considerable influence to this and my suspicion is that since foreigners had been basically net sellers the Peso hasn’t responded positively.

However, if foreign flows into the Philippine Stock Exchange continue to improve then we might see a sizeable move in favor of the Peso.

The other possible factor is government intervention.

Officials could be intervening in the currency exchange markets so as to “contain” appreciation of the Philippine Peso relative to the US dollar.

Lately some accounts of such intrusions have been observed in the region, according to the Wall Street Journal, ``central banks in South Korea, Thailand, Taiwan, Singapore and India are believed to have sold their currencies”.

So considering the economic ideological underpinnings by our officials, there is a good chance that government involvement to support “OFWs” which has been a popular cause, and exporters could have been a factor for the Peso’s inferior performance.

Conclusion

The flagrant disconnect between markets and the real economy has reached Philippine shores, where monetary forces seem to be the overwhelming driver of the rejuvenated Phisix.

While the Philippine economy has been less sensitive to exogenous bubble bursting woes abroad, local policies have now been contributing to the collective global efforts to “reflate” economies. And mounting evidence shows that markets have been increasingly responding to these policies.

The positive signs from current market actions are likely to have some influence to the real economy, which essentially validates the reflexivity theory. Although, present policies will likely fillip speculative spirits instead of promoting real investments.

Moreover, the resumption of the bear market in the US dollar has now widened the portal for foreign money flows into emerging market financial markets. As the initial thrust over the past months had been due to local money, foreign money could now function as the secondary engine to sustain the upswing in the domestic financial markets. This dynamic could also tilt the fate of the Peso which could have been hampered by previous accounts of net foreign selling or by government intervention in the currency markets.

With monetary forces clearly at the driver’s seat, the Phisix could be on its way to a full recovery and could even prompt for our target of Phisix 10,000 (perhaps sooner than later).

The unfortunate part is that we are clearly in an embryonic phase of the next bubble, thanks to policies that cater to economics of abundance in a world of scarcity.

And unlike the 2003-2007 cycle, which saw the Phisix as a victim of contagion, if present internal policies and external transmission persists to inflate the bubble, then the bubble dynamics will become structural for the Phisix and the Philippine economy.