Jessica Hagy's Indexed On The Regret Theory

Jessica Hagy makes a great diagram illustrating the Regret Theory in her Wish you had, or wish you hadn’t? post.

Regret theory as defined by investopedia.com is ``A theory that says people anticipate regret if they make a wrong choice, and take this anticipation into consideration when making decisions. Fear of regret can play a large role in dissuading or motivating someone to do something."

How does this apply to investing? Dr. John Hussman has a befitting explanation,

``Anytime you discover you are taking too much risk, realize in advance that you will experience some level of regret as you correct it, if you sell your first portion and the market advances, you'll regret having sold anything. If you sell your first portion and the market continues to decline, you'll regret that you didn't sell everything. The way to keep from being "paralyzed" in the financial markets is to realize in advance that gradually changing an investment position will always involve regret. It is better to "lock in" an acceptable level of regret than to risk an unacceptable loss."

Nassim Taleb: Monetary Policy Is Out of Control

Monetary Policy is out of control says Black Swan author Nassim Taleb in an interview at CNBC.

Some noteworthy quotes

-Don’t be fooled by complex system, you can have a positive number, but that doesn’t mean anything. System is very fragile, your talking about something that is deleveraging

-You may have a temporary relief but you still are in a world that is breaking, and that world should break…gonna break.

-Whatever is fragile in complex system breaks, in other words, you took at nature, nature breaks anything that is too big, not to create interdependency just to reach equilibrium.

-We’re in a middle of a crash

-If I am going to forecast something I know its going to get worst not better.

-If things start breaking as you can see it, they break much harder than they build themselves

-Monkey on our back is debt.

-Instead of deflating debt they are thinking of inflating assets, actually they even don’t know what they are doing. They’re doing lot of contradictory things.

-Hyperinflation is a mechanism that’s very vicious. Because all you need is for people to think there’s gonna be inflation to start hoarding. So it’s a perceptional mechanism and TIPS won’t save you from that. If you have TIPS, TIPs pays you nominal inflation but expectations can go wild.

-My statement is not that we are going to have hyperinflation, my statement is that Monetary policy is out of control.

-What makes me very pessimistic in not seeing any leadership or awareness on parts of government on what has to be done, which is deleverage $40-to-$70 trillion

-Those who basing themselves on past history, don’t know anything about history, because we are in an environment that doesn’t resemble the past at all.

Global Financial Industry: More Upside Ahead?

Bloomberg's David Wilson presents a UBS study showing sustained bullishness for the global financial industry.

We quote Mr. Wilson, (all bold emphasis mine)

``Financial stocks are poised to keep rising worldwide after posting this quarter’s best performance, according to Jeffrey Palma, a global strategist at UBS AG.

``The industry stands to benefit from “a much improved backdrop,” Palma wrote yesterday in a report. He recommended that investors increase their percentage of assets in financials to a “modest overweight” relative to benchmark indexes. They had been “neutral.”

chart from Bloomberg

``As the CHART OF THE DAY shows, financials are headed for the second quarter’s biggest gain among the 10 main industry groups in the MSCI World Index. They last set the pace in the second quarter of 2003, according to data compiled by Bloomberg. The chart has the MSCI World Financial Index's quarterly rankings and percentage moves during the past six years, including this quarter’s gain through yesterday.

``Relatively steep yield curves globally will help financial companies lift earnings, Palma wrote. The gap between yields on two-year and 10-year U.S. Treasury notes reached 2.76 percentage points, a record, on May 27. Falling loan-loss provisions and rising asset values, including share prices, may also lead to higher profits, the report said.

``There is still room for profitability to recover” even if the industry’s return on equity stays well below its 16 percent in 2007, Palma wrote. He favors banks in Australia, Canada and emerging markets.

``Financials amount to 20 percent of the MSCI World Index’s value, more than any other industry group, according to data compiled by Bloomberg."

My Comment:

All financials aren't cut from the same cloth. My impression is that the financials in the bubble bust afflicted economies (such as in the US or UK) may seem like landmines that could be triggered by a wrong move. Such risk remains until the issue of toxic assets in the industry's balance sheets are resolved.

Although I do share the enthusiasm for emerging markets and Asian financials, primarily on the steepening yield curve dynamics as previously discussed in Steepening Global Yield Curve Reflects Thriving Bubble Cycle, which should augment profitability, enhance lending and induce more risk taking.

However, cyclical weakness could be in the short term horizon given the bearish head and shoulders formation as seen below.

chart from stockcharts.com

But for as long as the dynamics of liquidity and wide spreads across yield curve persists, we should use this dips as buying windows.

In essence it is all a matter of time horizon, possibly short term weakness with strenght going into the medium to the longer term.

The Parallels Of The Philippine Con Ass And The Honduran Political Crisis

In a recent post on Philippine politics, particularly, the brouhaha over the CON ASS we wrote, ``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.’ [See Philippine Politics: "Con Ass" Much Ado About Nothing?]

Well, the ongoing political crisis in Honduras could be interpreted as a seeming parallel to the local Con Ass situation. Basically, it's about an attempt by the incumbent political leader to extend his stay in power.

Honduran President Jose Manual Zelaya wanted to force a referendum on his people to approve a new constitution to achieve this goal.

Sounds familiar?

This from Cato’s Juan Hidalgo,

``Zelaya, a close ally of Hugo Chávez, is barred from pursuing a second term in the general elections in November.

``Unfortunately for Zelaya, he doesn’t have the backing of his own party, much less any other major political group. So he has moved unilaterally to call for a referendum on the need for a new constitution. The vote, which is scheduled for this Sunday, has been declared illegal by the Supreme Court and the Electoral Tribunal, and condemned by the Honduran Congress and attorney general (whose office is not part of the cabinet in Honduras).

``Despite the widespread institutional opposition to his plans, Zelaya is pushing for the vote. On Wednesday he ordered the Honduran armed forces to start distributing the ballots and other electoral materials throughout the country. The army chief, complying with the Supreme Court ruling, refused to obey the order. Zelaya sacked him, which prompted the resignation of all other leading army officers and the defense minister.”

``The attorney general is asking Congress to impeach Zelaya for violating the institutional order and abusing his powers. Last night, the Congress discussed removing Zelaya from his office. The president is defiant and has accused the Congress of attempting a coup.``The attorney general is asking Congress to impeach Zelaya for violating the institutional order and abusing his powers. Last night, the Congress discussed removing Zelaya from his office. The president is defiant and has accused the Congress of attempting a coup.”

But events unfolded quite hastily out of desperation.

It didn’t take long for the Honduras military to mount a coup and successfully oust President Zelaya which sent him into exile in Costa Rica (CNN Blog).

The Honduran Congress swiftly responded by legally stripping Pres. Zelaya of the Presidency and appointed a provisional president in Roberto Micheletti (CNN Blog)

Meanwhile Zelaya’s ally Venezuela’s Hugo Chavez has threatened to intervene militarily-by invasion (guardian).

As of this writing, the Honduran political crisis still remains unresolved.

As in the earlier post, I think PGMA understands that the Honduran Crisis could be the most probable outcome if her followers insist to let her remain in office.

Given her unpopularity, its almost a no win probability for her if she adamantly opts for this route. And this is why I think, the Con Ass controversy, seems more of a diversionary tactic than an outright attempt to grab power.

Nonetheless all these reeks of what Lord Acton once warned of, ``Power corrupts; absolute power corrupts absolutely”

INO's Adam Hewison on Gold: Energy Fields Signaling The Next Big Move

INO.com's Adam Hewison explains the technical aspects -energy fields and reverse head and shoulders-as the signaling gold's big move.

Pls click on the image below..

Documentary On The Risks of US Hyperinflation

The National Inflation Association presents an interesting three part documentary on the risks of Hyperinflation in the US, called the Hyperinflation Nation. I might, with a possible spillover or contagion effects to the world.

The interesting part for me are the accounts or footages of the wrong analysis by US Federal Chairman Ben Bernanke on the housing crisis, and its impact to the markets and the economy.

Makes you wonder how the public or even the administration continues to put their unwavering faith in him, even with such a terrible track record. In addition, Mr. Bernanke of late has been yearning to consolidate even more power under him.

Further the documentary shows how hyperinflation emerged in Zimbabwe, Weimar Germany and Yugoslavia; not consumer spending as the mainstream has repeatedly argued but from excessive and unrestrained government spending.

Video includes terse commentaries by Dr. Marc Faber, Jim Rogers, Peter Schiff and Dr. Ron Paul.


Here is is part 1

Here is is part 2

Here is is part 3

PSE: The Handicaps Of A One Directional Reward Based Platform

``A free market has to and does coordinate current and future production against future unknown demands, supplies, and shocks; and it has to and does find ways to alleviate the negative effects of shocks. People generally accomplish this by planning, forecasting, conservative practices, saving, hedging, insuring, and diversifying. There are countless ways, each tailored to particular circumstances. When a man has a backup trade, he is hedging against being laid off in his main occupation. When a family saves, it is hedging against loss of income. When family members help one another in hard times, they are insuring each other. When a business is conservative in obtaining credit and expanding, it is hedging against possible stringent business conditions. When a person diversifies investments, he is hedging against loss in one part of the portfolio. When a business controls inventories, it is managing the risk of shocks to the business.”- Michael S. Rozeff, Destination Collapse

Over at a recent huddle, a good friend asked me “how does one maintain discipline if it is an extended bear market?” The underlying concern was that the temptation or the urge to “catch the falling knife” or to “scalp (day trades)” had been quite strong given the nearly 2 years of drought in profit opportunities.

I would believe that such sentiment fundamentally embodies the unappreciated circumstance that inhibits the progress of our capital markets.

The principal problem with the Philippine Stock Exchange (PSE) is that the sustainability of the equity market industry is almost entirely dependent on a UNIDIRECTIONAL trend- that’s because people and the industry generally make money only when the Phisix goes up or is in a bullmarket!

True, “short” or the securities borrowing and lending facilities lending have been recently introduced. But apparently unfamiliar to the public or to the authorities or regulators is that any regulatory framework operates on economic dimensions : It’s always about the tradeoffs between costs and benefits.

If brokers don’t implement these, for reasons of perceived cost outweighing perceived benefits, primarily due to the compliance albatross, then effectively the program is rendered inoperative. Even if it seems noteworthy in paper, what good is a new trading platform if it can’t be used at all?

Unforeseen Consequences

Nonetheless a one dimensional reward based market has these unforeseen consequences:

1. Deprives market participants to earn

Obviously since markets operate on secular cyclical trends, then the industry or the public profits only from a bullmarket and suffers from a period of agony of “deprivation” once the bearmarket reign.

In Biblical analogy, the PSE is reduced to FAT and LEAN years with basically nothing in between. This, sadly to say, reflects on the primitive state of our financial markets.

2. Limits Liquidity

Industry participants whine of the lack of liquidity or volume. But this is exactly why hardly volume hardly progresses:

In a bullmarket, the volume of trade improves because the public churn trades profitably. In contrast, in a bearmarket, buyers have essentially been confined to a “catching a falling knife” position, where loses from wrong market “timing” or “expectations” would compel a mostly “long” position, thereby containing incidences of trades which effectively shrivels volume.

And reduced liquidity diminishes the incentives for private companies to get publicly listed, increases the market’s risk profile and exaggerates volatility.

3. Restrains growth potential of the industry

Moreover, major industry participants, particularly, brokers, mutual funds or Unit Investor Trust Funds (UITFs) would be reluctant to invest for expansion under the recognition of operational handicaps of a unidirectional reward based market, hence, the growth rate mediocrity of the Philippine capital markets.

Figure 1: ADB Bond Monitor 1^st Quarter 2009: Year on Year Performance

The chart above (which shows the year on year changes) also shows state of the Philippine equity markets in terms of market capitalization calculated in US dollars, which has severely lagged the region.

4. Handicapped Financial Industry Is Transmitted To Suboptimal Economic Growth

Another underappreciated dimension is that a unidirectional reward based market has an economic wide impact.

While for most people, the stock market is seen as a gambling casino or as some form of legal embellishment, for us, the stock market functions as a fundamental pillar to national development. And to reprise its importance, from our A Primer On Stock Markets-Why It Isn’t Generally A Gambling Casino:

-The stock market is a vital part of the process from which we coordinate production. Ideally stock prices should reflect the productivity of business firm aside from market’s discernment of the entrepreneurial judgments concerning future productivity.

-It competes with the banking sector in determining the degree of mobilization of savings into investment. From a national scale this becomes a formidable channel for economic advancement in terms of efficiency of capital deployment.

-Unknown to many, stock markets often function as forward indicators, such that they have been known to predict upcoming recessions or prospective recoveries. Thus, movements in the financial and stock markets can give a clue to the transitioning business environment, which should help management or businessmen, in allocating resources or in applying their business strategies going forward.

-It operates as alternative avenues for fund raising (public listing), intermediation (using shares as collateral for borrowing-lending) or liquidity generation (buying or selling a company).

-Because the markets operate as an organized platform of exchange, the ease from a market’s liquidity allows companies to save on transaction costs: search cost (matching buyers and sellers), contracting costs (cost of negotiation) and coordination cost (meshing securities of different industries into a single platform), which frees up capital for other usage.

-Allows wider public participation in the ownership of major companies, which expands the concept of private property ownership.

-Allows some individuals to save from taxation (e.g. inheritance taxes)

-Because stock markets function as repository of collateral or store of value, it can serve as protection or safehaven against hyperinflation or a severe form of a loss of purchasing power of a currency.

Hence in a unidirectional reward based market the following factors have been compromised:

-market pricing efficiency (reduced liquidity amplifies volatility and structurally raises risk premium or the hurdle rate),

-the optimum channeling of savings into investment or capital deployment (which translates to lesser investment opportunities and suboptimal returns),

-access to alternative financing (extrapolates to high cost of financing, which implies low public listings),

-investment opportunities that allows for a wider public participation or the “trickle down effect” (limited income growth opportunities for the public),

-the lowering of transactional costs (reduces the incentives for attracting wholesale or bulk institutional investments and requires higher hurdle rate) and

-hedging and other opportunity costs as seen from any sophisticated and deep markets (increases risk profile or premium, and heightens volatility)

From which all of these translates to lost opportunities for national wealth generation.

5. Emits Wrong Impressions and Reduces Role of Specialization

A unidirectional rewards based market exacerbated by Principal Agent problem reinforces the public’s perspective of the simplistic functionality of stock markets.

Information derived from commission based Sell Side institutions accentuates on the short term orientation of market exposure to most retail investors. And this also applies to some institutional accounts as well.

Where markets are seen as operating in a short term framework, the degree of risk taking appetite would be intensified by cyclical extremities. Again this magnifies volatility, increases perception of risk from the international institutional standpoint and diminishes the requirement or the need for division of labor or the role of specialization for domestic industry participants.

Who would want to invest in mutual funds, or UITFs or broker discretionary accounts, when the impression portrayed is -what the so-called experts can do is available to anyone? Who cares about risk, when mainstream literature almost always expounds on momentum, preened in the fundamental or technical charting garb?

To respond to such objections local sell side institutions would then expound on emphasizing on their capability to trade short term fluctuations-which is nothing more than a hokum operating on the graces of lady luck!

It’s is of no wonder why losses suffered by retail investors during bearmarkets, in many occasion, leads to abhorrence and complete desertion of the markets. This is mainly due to the wrong expectations inculcated from misleading foundations of how markets operate and the lack of alternative instruments to protect market participants from market losses during cyclical transitions.

6. Distorts Incentives

Some discretionary accounts operating under a bearmarket would prefer to withdraw proceeds than leave them with industry fund managers.

In my mind’s eye, the perception is that cash would be better off under the clients’ management since there would be no alternative options to put these at work in the capital markets. Hence, these risks skewing the incentives for managers to long the client’s account, despite the realities of an unfolding bearmarket cycle, than to lose handle.

In other words, because the operational arrangements of the fund industry could be impaired by the lack of instruments to employ idle funds in a market which only profits from one direction, fund managers could be motivated to take on more risks than required. Again, the Principal Agent Problem at work here.

From my standpoint, bearmarkets can be classified into two strains: structural or contagion based/cyclical. Both of which requires different investment approaches.

The latter of which is one that can be longed or endured with, since the national economy has no major fundamental impairment (mostly clustering errors from malinvestments from bubble policies) and could be expected to recover and to profit from a reversal of the cycle in the fullness of time. The 2007-2008 financial crises serves as lucid example of this scenario applied to the Philippine setting.

Nonetheless, the former requires total exodus regardless of the conditions of the portfolio when such a cycle emerges. That’s because bubble afflicted markets or industries can vaporize issues regardless of its previous stature. Think AIG, Bear Stearns, Lehman Brothers, General Motors and Chyrsler.

In short, there are no blue chips in an unwinding bubble afflicted industry! The idea that paper losses are merely paper losses without liquidations consummating the transaction is false.

So the analytical approach of the analyst or fund manager ultimately distinguishes between portfolio salvation and damnation, and matters more than what the public normally expects of them.

7. Cognitive Biases Also Shaped In One Direction

Again since markets are basically psychologically driven, participants are thereby influenced by cognitive biases or the reflexivity theory.

Analysts or experts as well as the general public, here, are predisposed towards a bullish bias simply because the current operating environment rewards participants only when the markets move in a sustained upward trajectory.

And we see the same dynamics applied to politics, market participants audibly cheer upon policies that temporarily boost market prices at the expense of the future simply because the public’s general expectation is predisposed towards the short term expectations.

And it is the same reason why many participants, like my good friend, despite the understanding of key market tenets, have been tempted to defy such guidelines to engage in ‘catching a falling knife’ trades- out of the psychology directed by the reward incentives provided for by the present operational market mechanism.

And such a bias doesn’t elude me entirely.

Conclusion and Recommendations

And so what could be done?

For PSE authorities:

We suggest that the “ease of use” principle founded on a sound legal framework, or the proverbial horse before the cart, as the main thrust to introduce market reforms.

New market platforms depend on the functionality or utility more than mere technical legal vernaculars which risks of high compliance costs or choking regulatory requirements that could render reforms inapplicable.

Remember, all regulations operate on latent economic dimensions. Fundamentally, success of any market platform will depend on the cost-benefit tradeoffs and not on intricate legalese.

Moreover, it would be more convenient and pragmatic to rush market reforms to include expanded local investor access to markets as Exchange Traded Funds, basic derivatives (such as options-put or call) and commodity spot and futures markets (I’d say currency markets as secondary) to enable local investors:

-the ability to hedge on or minimize risks by diversification or by utilizing hedge instruments,

-to increase capital efficiency allocation, and

-to utilize moderate leverage to augment returns

Markets that profits from the upside or the downside or sideways complimented with the ability to minimize risks by hedging or diversification will likely attract a larger and more diversified base of capital and deepen the local financial markets that should translate to value added economic growth.

For market participants:

We can only operate under the platform from which the PSE operates on, this means identifying and positioning based on cyclical or secular trends.

Next, for sophisticated investors is to tap the same aforementioned hedge instruments such as ETFs (an inventory list here), basic derivatives or commodity markets overseas. [For a related article see my previous outlook see Should Filipinos Invest Abroad?]

Finally, choose wisely on your investment analyst for guidance or for managing your funds. Avoid from selecting opinions which merely confirms your biases and from embracing viewpoints that merely deduce present price signals as basis for prospective market action. Market analysis should be objective and dispassionate where risk must always be weighed against prospective gains.

In short, avoid the bias traps.

The Asian-Emerging Market Momentous Historical Bubble?

``When a long-term trend loses momentum, short-term volatility tends to rise, it is easy to see why that should be so: the trend-following crowd is disoriented.”- George Soros

Excess volatility is the name of today’s game.

Global equity markets have been in a wild rollercoaster ride of late.

While US and European markets continue to sag following last week’s sharp decline, many of key Asian markets rallied hard recovering substantial segments of losses from the previous week.

So we seem to be witnessing another round of divergences at play, see figure 2.

Figure 2: stockcharts.com: Asia and EM stocks OUTPERFORM anew

The Dow Jones Asian Index which includes Japan appears to be testing for a new high, along with the less robust Emerging Market index (EEM) and the US S&P 500 (SPX). The weakest link seems to be European Stocks (STOXX).

Momentous Historical Bubble, Elixir Trade Model

The same friend, who commented earlier about the temptations of falling captive to gravity pulled “knives” in a bearmarket, likewise remarked of his friend who earlier paid for a series of monthly subscriptions to a local analyst, who is on the business of issuing regular technical charting outlook.

His friend came to realize that chart reading can be variable, vacillating and couldn’t be relied on, and hence, after a few months desisted from extending this “privilege”.

It’s simply amazing how people can be so captivated or bedazzled by the allure of short horizon Holy Grail type of market approaches, such that they have been shelling out substantial amounts to pay for guidance that dwell mostly on momentum driven or support-resistance trades or simply confirming biases of market participants through the technical picture. It seems like an incredible business model, I might add.

Yes, although this has been an opportunity cost for me in terms of the newsletter business paradigm, nonetheless, we’d rather stick by our principles to deal with prudent investing.

So aside from illustrating the possible dynamics of how the retail market works and how the some local subscription model business had profited immensely from the need for elixir based trades, the point of this article is to prove that today’s market can truly confound mechanical technicians or even macroeconomic fundamentalists.

Why is this so?

To put on our Ivory Tower thinking cap, we quote Prof. Steve Horwitz in The Microeconomic Foundations of Macroeconomic Disorder: An Austrian Perspective on the Great Recession of 2008, ``The Austrian approach to macroeconomics can already be seen as being fundamentally microeconomic. What matters for growth is the degree to which microeconomic intertemporal coordination is achieved by producers using price signals, especially the interest rate, to coordinate their production plans with the preferences of consumers. However, this coordination process can be undermined through economy-wide events that might well be called “macroeconomic.” In particular, the very universality of money that makes possible the coordination that characterizes the market process can also be the source of severe discoordination. If there is something wrong with money, the fact that it touches everything in the economy will ensure that systemic “macroeconomic” problems will result. When money is in excess or deficient supply, interest rates lose their connection to people’s underlying time preferences and individual prices become less accurate reflectors of the underlying variables of tastes, technology, and resources. Monetary disequilibria undermine the communicative functions of prices and interest rates and hamper the learning processes that comprise the market.” (emphasis added)

In short, too much of monetary inflation distorts the function of price signals which essentially increases speculative activities, massively misallocates capital away from consumer preferences and engenders excessive market volatility.

And if we go by the market savant George Soros’ perspective of the market, ``Many momentous historical developments occur without the participants fully realizing what is happening.”

Incidentally we’ll be quoting much of George Soros’ market wisdom for this article.

And such “momentous historical development” could essentially be a seminal formation of the next bubble, in Asia and in Emerging Markets, see figure 3.

Figure 3 US Global Investors: Excess Liquidity Drives Up Asian Markets

According to the US Global Funds, ``U.S. Federal Reserve’s reluctance to withdraw from quantitative easing programs should bode well for Asian asset prices going forward. The past 25 years suggest that when money supply expansion outpaced GDP growth in the U.S., excess liquidity would typically drive equity prices higher the following two years in emerging Asia.” (bold emphasis added)

Oops, let me repeat… “excess liquidity would typically drive equity prices higher the following two years in emerging Asia”!!!

We are hardly into the first year of liquidity driven boom, which subsequently means more upside ahead.

So while markets can go anywhere over the interim, and that infirmities may follow the recent strength due to numerous variables: such as technical corrective patterns in the US [see INO's Adam Hewison On The S&P 500: Market Tenor Has Changed, Emphasis On The Negative-this is assuming the Phisix will track the US] or in the Phisix itself, seasonality weakness (July to September statistically is the weakest quarter for stocks), volatility brought about by next wave of US mortgage resets [see US Financial Crisis: It Ain’t Over Until The Fat Lady Sings!] and plain vanilla momentum- the sheer might of the combined stimulus package from Emerging Markets, (see figure 4) aside from those applied in OECD economies, could translate to an awesome impact for the markets in Asia and the Emerging markets to behold.

Figure 4: Deutsche Bank: EM-Anti Crisis Measures

The Philippines relative to other Emerging Market contemporaries seems hardly one of the most lavish spenders for government stimulus. Think about it, if deficit spending equates to weak currencies as discussed last week in Philippine Peso: Interesting Times Indeed, then it follows that China, Russia, Hong Kong, Brazil, South Africa, Vietnam, Thailand would all have weak currencies relative to the US dollar due to their larger deficit spending. Unfortunately this hasn’t been the case.

Nonetheless, ``Asian and Latin American banks, notes the Deutsche Bank, “seem to have learnt from their past crisis episodes. In general, they have restricted foreign-currency exposures and funded credit expansion with domestic deposits. Thus, most banking systems have suffered from tighter liquidity conditions but only a few have needed recapitalisation (Korea, India and Hong Kong). On the fiscal side, government packages seek to neutralise the effect of shrinking domestic demand as well as supporting local companies unable to roll over their foreign debt obligations.” (emphasis added)

As we have long been saying, an unimpaired banking system in the region and in Emerging markets coupled with substantial savings has the potential to take up the credit slack from the bubble bust plagued OECD economies to shore up domestic demand. And this alone is a massive force to reckon with.

Another empirical example, just this week, it’s like I received numerous calls or text messages from different banks on daily basis, offering me bank loans mostly based on the unused portion of my credit cards. I’d assume that this applies to their entire customer base.

As the Deutsche Bank concludes, ``The crisis is not over yet and we do not rule out additional bumps in the road. However, it is fair to state that in a more globalised world characterised by stronger linkages among economies, emerging markets are proving to be better prepared to face external shocks than in the past.”

Well “proving to be better prepared to face external shocks than in the past”, can be interpreted in a relative sense and applicable only when compared today against the recent past.

But if the bubble cycle is brewing from within, then such conclusion won’t hold when the bubble pops.

Inflation Analytics Over Technical And Fundamental Approach

Remember in a highly globalized world, the transmission mechanism from inflationary policies could be very substantial and has far reaching consequences.

And that is why in spite of the most recent global meltdown, out of the 77 countries monitored by Bespoke Investments [see our earlier article Inflation or Deflation? The Global Perspective], 59 nations experienced consumer price inflation against 14 nations that saw consumer price declines (consumer price deflation) while 4 nations saw flat CPI rates. This translates to a ratio of 4:1 in favor of inflation with an average inflation rate at 4%! And that includes the peak of the meltdown!

For all the claptrap about the global deflation bogeyman, this should have disproved such an assertion.

Figure 5: Danske Weekly Focus: The tide is turning

And the credit boom appears to be filtering into the real economy as Industrial production in key Asian regions has sharply picked up, shown in Figure 5.

Nonetheless, aside from disoriented chart technicians, we also have conflicting predictions from multilateral agencies.

The readjusted outlooks saw the World Bank projecting a downgrade, whereas the IMF has raised its forecasts for world economic growth. On the other hand, OECD has joined IMF to forecast a modest increase in global growth.

2 out of 3 doesn’t mean that the majority is right.

Nonetheless, to put this anew in the context of George Soros’ reflexivity, `` The greater the uncertainty, the more people are influenced by the market trends; and the greater the influence of trend following speculation, the more uncertain the situation becomes.”

So yes, more reflexive actions are unfolding in the marketplace. As the market prices continue to move higher, the public will likely interpret market performance as indicative of the real economy.

Again from Mr. Soros, ``People are groping to anticipate the future with the help of whatever guideposts they can establish. The outcome tends to diverge from expectations, leading to constantly changing expectations and constantly changing outcomes. The process is reflexive.”

So not only do we speak of excess liquidity, but of excess liquidity translated into a secular weak dollar trend see Figure 6.

Figure 6: US Global Investors: Inverse Correlation Weak US Dollar, Strong Asian Markets vice versa

The weak dollar has had a strong inverse correlation with the performance of Asian stock markets, where a strong US dollar trend translates to weak equity markets and weak US dollar equals strong Asian markets trends.

With the US dollar trade weighted index expected to suffer from a secular decline as a consequence to its massive deficit spending, the continuity of these correlation suggests of the persistence of a revitalized or reenergized Asian markets.

Moreover, the prospective weaknesses in the respective bubble bust scourged economies combined with the appearances of the “right” and “effective” remedy measures ensures that present policy directions will be sustained.

Proof?

The ECB recently announced that it will be lending a historic €442 billion ($621 billion) over the next 12 months to backstop liquidity within the region.

The US Federal Reserves’ FOMC meeting recently announced that it would be extending most of its liquidity facility programs specifically, the Board of Governors approved an extension to 1 February 2010 of the following: Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), Commercial Paper Funding Facility (CPFF), Primary Dealer Credit Facility (PDCF) Term Securities Lending Facility (TSLF).

The expiration date for the Term Asset-Backed Securities Loan Facility (TALF) remains set at December 31, 2009. The Term Auction Facility (TAF) does not have a fixed expiration date. In addition, the temporary reciprocal currency arrangements (swap lines) between the Federal Reserve and other central banks have been extended to February 1. (Danske Bank)

The Swiss National Bank conducted a series of intervention in the currency markets last week to keep the Franc from rising amidst a deflationary environment and shrinking economic growth (WSJ).

And this hasn’t been confined to the Swiss Franc, market chatters speculated on possible government interventions in the currency market in the Kiwi (New Zealand Dollar), the Loonie (Canadian Dollar) and the Aussie (Australian Dollar). (Bloomberg)

Moreover, the issuance of the new Won 50,000 banknotes in South Korea, after 35 years (the largest had been Won 10,000), further fueled speculations that the South Korean government could be expecting higher inflation from current policies undertaken (Financial Times).

As you can see, global governments have been conducting mercantilist “race to bottom” policies for their respective currencies to maintain their “export” latitude.

And as Steve Horwitz, echoing the Austrian school perspective, says that, ``If there is something wrong with money, the fact that it touches everything in the economy will ensure that systemic “macroeconomic” problems will result.”

And the continuation of these developments will only compound on the growing risks of a global inflation crisis.

So in my view, globally coordinated policy based programs to ensure excess liquidity through zero bound rates, quantitative easing and intensive stimulus fiscal spending programs, which has been manifested in the steepening of the global yield curve [see Steepening Global Yield Curve Reflects Thriving Bubble Cycle], a floundering US dollar, currency interventions or the implicit currency war, the reflexive market action which has been diffusing into the real economy and rising risk appetites based on credit boom outside the bubble plagued economies- all conspire to pose as more powerful or potent forces to deal with than simply technical or seasonal factors over the next “two years” at least.

Since market timing isn’t likely to be anyone’s expertise especially in the context of short term trades, we’d rather focus on the major trend as defined by George Soros.

The Boom Bust Cycle Of George Soros

This brings us to the boom bust stage cycle as defined by George Soros which we last mentioned in 2006:

1) The unrecognized trend,

2) The beginning of a self-reinforcing process,

3) The successful test,

4) The growing conviction, resulting in a widening divergence between reality and expectations,

5) The flaw in perceptions,

6) The climax and finally

7) A self-reinforcing process in the opposite direction.

In my assessment, present developments are highly indicative of the transition from 1) the unrecognized trend-as manifested by the substantial skepticism over the present market cycle and 2) the beginning of a self-reinforcing process.

In other words, the bubble cycle has much to accomplish yet.

Since this article has been a George Soros quotefest, the last statement belongs to Mr. Soros, ``Economic history is a never-ending series of episodes based on falsehood and lies, not truths. It represents the path to big money. The object is to recognize the trend whose premise is false, ride that trend, and step off before it is discredited"