Sectoral Performance In US, China And The Philippines

``[Asia is] a very different dynamic compared with the rest of the world. Most banking systems in Asia are flush with liquidity as they have a surplus of deposits over lending. So if [corporates] have in the past financed in the international bond markets, when it comes to refinancing they can turn to the local market alternatives because plenty of banks are still willing to lend”- Jason Rogers, a credit analyst at Barclays Capital Asia-Pacific corporate bonds surge

In bubble cycles, the object of a speculative bubble, after a bust, normally takes years to recover.

To cite a few, the Philippine Phisix following the 1997 Asian Crisis episode hasn’t fully recovered even 12 years after, Japan’s Nikkei 225 and its property sector remains in doldrums following the bust in 1990 (that’s 19 years!), and the technology centered dot,com bust during the new millennium in the US has left the Nasdaq miles away from its peak, 9 years ago.

The recent bubble cycle phenomenon evolved around the US real estate sector which had been funded by the financial industry. In short, these two sectors-financials and real estate accounted for as the epicenter of the bubble cycle crisis. So given the nature of bubble cycles, I originally expected the same dynamics to unfold.

The fundamental reason for this is due to the market clearing process or the process of liquidating clusters of malinvestments acquired during the bubble.

And since bubble blowing or the “boom” phase is a process underpinned by policies that is cultured by the markets over time, the liquidation or the “bust” phase likewise employs the same time consuming process but in reverse.

But I guess this dynamic doesn’t seem to be the case today or put differently, this time looks different.

Why?

Because US money managers have largely been overweighting the financial sector, see Figure 5.

Figure 5: Bespoke Invest: Institutional Sector Weightings

According to Bespoke Invest, ``money managers collectively have 18.5% of their long portfolios in the Financial sector, which is the highest weighting for any sector. Technology ranks second at 16.8%, followed by Health Care (12.9%), Energy (12%), and Industrials (10.3%).

``The second chart compares these weightings with the sector weightings of the S&P 500. As shown, institutions are overweight the Financial sector the most and underweight Consumer Staples the most.”

Obviously, the enormous backstop provided for by the US government to the US financial sector has circumvented the natural process of liquidations from fully occurring.

Hence, the intriguing outperformance led by the money managers piling into a sector under the government “umbrella” to seek profits or “economic rent”.

Yet, despite such outperformance, government intrusion to the industry will likely result to more systemic distortions.

To quote Professor Mario Rizzo in a recent paper ``These are agents whose discretionary behavior, insulated from the normal discipline of profit and loss, can significantly affect the course of economic effects. Thus, discretionary behavior on the part of monetary authorities (the Fed), fiscal policy makers (Congress or the Executive), or even in some cases private monopolists, can increase uncertainty faced by most economic agents (“small players”). They will have to pay more attention to trying to guess the perhaps idiosyncratic behavior of the big players. Economic variables will become contaminated with big-player influence. It will become more difficult to extract knowledge of fundamentals from actual market prices.”

Again, pricing signals are becoming less efficient due to government intervention (more difficult to extract knowledge of fundamentals from actual market prices) and is likely to heighten systemic risks (can increase uncertainty faced by most economic agents) arising from the asymmetric behavior of the industry participants shaped by regulators (insulated from the normal discipline of profit and loss).

In combination with the toxic assets stacked in the bank balance sheets, I would remain a skeptic over US financials.

Interesting Parallels In China And The US, Possible Opportunities

It is interesting to see how some parallels can be gleaned from the institutional interest in US stocks and in China’s recent sectoral performance.

While Financials, Materials, Consumer Cyclicals, Energy and Industrial outperformed the S & P 500, in China, Energy, Materials, Financials, Technology and Industrials constituted the top 5 during the latest run on a year to date basis, see figure 6.

Figure 6: Bespoke Invest: China’s Sectoral Performance

In other words, except for Consumer Cyclicals in the US and Technology sector in China, there seems to be some common interests from respective domestic investors-energy, materials, financials and industrials.

In the Philippines, the top 3 sectors have been Mining and Oil, Industrial (energy) and holding companies, whereas financials and services (telecoms) have been laggards.

Except for the financials, basically we see the same pattern playing out.

More interesting insights from Bespoke Invest, ``Sector performance in China paints an interesting picture. In typical selloffs, sectors that lead the rally see the steepest declines, while laggards in the rally tend to outperform. In this selloff, however, this trend is much less evident. The chart below shows the average performance of Chinese stocks by sector during the rally and since the peak on 8/4. While Energy led the rally and has seen the sharpest decline, in other sectors the relationship has been much less evident. For example, Utilities and Telecom Services were in the bottom four in terms of performance during the rally, but during the decline they have also been among the weakest sectors with the second and third worst performance.” (emphasis added)

Given the degree of corrections, it appears that China’s financials are on the way to outperform but could still play second fiddle to Energy.

So while I would remain a skeptic over US financials, it’s a different story for China and for Asia.

Nonetheless if we follow Dennis Gartman’s 7^th rule of his 22 trading rules, ``Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds... they shall carry us higher than shall lesser ones”, then this would imply that energy, materials and financials could be the best performing sectors over the coming years and could be the most conducive place to be in to achieve ALPHA.

That’s also because China has aggressively been bidding up global resource and energy stocks, for reasons we cited in China's Strategic Resource Accumulation Continues.

Finally, this brings up a possible “window of opportunity” arbitrage for the Philippine markets. Since the local financials have severely lagged the recent rally and IF the same US-China patterns would play out sometime in the future, then positioning on financials on market weakness looks likely a feasible trade.

In addition, the underperformance of the telecom sector which has patently diverged with technology issues has piqued my interest and could be a point of discussion for another day.

Food Crisis Watch: Sugar On Fire- Writing On The Wall?

Sugar prices have been on fire.

According to the Economist, ``THE price of sugar is higher than at any point in 27 years, having risen much more than prices of other food in recent months. The cause appears to be a huge drop in sugar production in India, the world's second-largest producer. In the 2007-08 season India's output was 28.6m tonnes of sugar, but this year production is estimated to fall to 16m tonnes. Indian farmers planted less sugarcane last year after sugar prices fell, partly in response to a ban on exports. A weak monsoon also threatens this year's production. Indians are also the biggest consumers of the sweet stuff: in 2008, they used 24.3m tonnes, nearly 15% of global demand. A decline in Indian production means that it will import more, driving up international prices. India's government has lifted its export ban, but production is unlikely to meet demand before 2011."

So the unintended effects from government policies to curb exports and weather appears to be the "seen" culprit.

But as you would probably notice, the Economist food price index have likewise been creeping higher but at a much subdued clip relative to sugar prices.

I would add that sugar's accelerated price movement came about as stock markets globally surged. This implies of some correlation-loose monetary environment plus fiscal policies may have likely been principal factors too.

Nonetheless here is Jim Roger's take on sugar.(emphasis added)

``Sugar –even though it is at a 28 year highs, you would probably know it is down 70% from its all time high. So sugar is still very depressed on any kind of historic basis and I suspect it will go higher. The last time we had a bull market in sugar in 70s, if you would remember there was no biofuel - that is a huge new element of demand now and most of Asia was not involved in the sugar market in any big way back in the 70s. But now Asia is prospering and there are 3 billion people trying to have a better life and most people when they get more prosperous, use more sweets. So you have big elements of demand in sugar now that you did not have in the last bull market. I wouldn’t sell sugar, I don’t know if it is going to go up in the next week or the next month but I am certainly expecting sugar to go much higher during the course of the bull market over the next several years.

It won't be just sugar though...

Jim Rogers anew, ``food inventories are at the lowest they have been in decades – not lowest in months or years but in decades. There is a very good chance that we are going very serious explosions in the price of food because we may have no food at any price if we continue to have weather problems. Yes you are having some monsoon problems in India but the rest of the world still hasn’t had bad weather. If we start having serious weather problems around the world as we have had many times in history, the price of food is going to skyrocket because there are no inventories and there is no productive capacity."

Ergo, The price spike in sugar could be the proverbial "shot across the bow".

As we noted in Chart: Global Food Price Inflation

``Many factors that gives rise to these disparities, aside from monetary and fiscal policies (taxes, tariffs, subsidies, etc...), there are considerations of the conditions of infrastructure, capital structure, logistics/distribution, markets, arable lands, water, soil fertility, technology, productivity, economic structure and etc.

``Our concern is given the present "benign state of inflation", some developing countries have already been experiencing high food prices, what more if inflation gets a deeper traction globally? Could this be an ominous sign of food crisis perhaps?"

Onion News Network: Wipe Out National Debt Through A Staged Coup

From the Onion News Network (Hat tip: Investment Postcards)

U.S. Government Stages Fake Coup To Wipe Out National Debt

Mark Mobius: Expect Market Volatility, But Capitalize On The Opportunity

From Franklin Templeton's July Emerging Markets Review

Feature of the Month: Q&A on Emerging Markets with Mark Mobius, Executive Chairman, Templeton Asset Management Ltd. (red highlights mine)

Is the recent rally in emerging market equities sustainable?

Although we are optimistic about the markets’ upside potential, it is important to realize that volatility is still with us and will be with us for a while. This means that there will be down markets as well as up markets. We therefore must pay attention to valuations and long-term earnings growth prospects in order to avoid buying or holding expensive stocks as a result of dramatic price rises that we have seen. Current valuations are below the five-year high valuations and thus are not excessive.

Emerging market equity funds resumed net inflows, recording a record $26.5 billion of investment in the 2nd quarter. Do you think emerging markets will continue to attract inflows?

In general, we expect inflows to continue, however, there could also be some volatility. We cannot expect to see net inflows every month or every week, but in general the trend should be positive. In the first seven months of 2009, net inflows (using weekly data from www.emergingportfolio.com) totaled US$34.5 billion. This is more than 85% of the approximate US$40 billion in outflows in 2008.

What are the reasons?

A return of confidence in emerging markets, the desire for higher returns, an increase in investor risk appetite, the search for undervalued companies and most importantly, attractive valuations in emerging market companies drove the inflows.

Within the emerging markets universe, where do you see the most attractive opportunities at this juncture?

Since it’s usually possible to find at least a few bargains in most markets, all emerging market regions are looking exciting. Currently, our largest exposures are to Brazil, Russia, China, India and South Africa. In terms of sectors, commodity stocks also look good because some of them have declined significantly below their intrinsic worth and we expect the global demand for commodities to continue its long-term growth. Consumer stocks are also favored. With rising per capita income and strong demand for consumer and other goods, the earnings growth outlook for these stocks is positive.

The World Bank recently said that reduced capital inflows from exports, remittances and foreign direct investment means “increasingly grave economic prospects” for developing nations. Do you share the view and is it something to worry about?

The World Bank is normally "behind the curve" when it comes to economic projections. Economists tend to look through the rear view mirror and not ahead. While reduced capital inflows from exports, remittances and foreign direct investment could have a negative impact on emerging markets, we can expect to see increased inflows resulting from consumer and infrastructure spending growth compensate for this. This could allow markets to record positive economic growth. This is especially the case in markets such as China and India.

Are you still optimistic about Asia ex-Japan? Which markets are you most positive about?

Yes, Asia is the largest emerging market region in the world. Asian countries are also growing relatively fast. They include countries like China and India with very large populations whose per capita income is growing, and capital markets in those countries are undergoing rapid development. Economic growth remains relatively high, per capita incomes have been rising, valuations remain attractive and reforms continue, thus improving the region’s business and investment environment. Our largest exposures are to China, India, South Korea and Thailand.

What are your views on the BRICs bloc? Is it a good investment proposition?

Yes, we remain optimistic about the long-term future of the BRIC markets. The BRIC countries are among the fastest growing economies in the world. Moreover, foreign exchange reserves in all four countries remain high. The four markets together account for more than 40% of the world population. Domestic demand growth also remains robust. China and India continue to register significant positive GDP growth rates in spite of the global slowdown China continues to take great strides towards becoming a major global player. The Chinese economy is expected to grow about 8% in 2009 and its foreign reserves have surpassed US$2 trillion. Moreover, Brazil and Russia are resource rich countries and although commodity prices have declined from their peak, the longer trend for commodity prices is up and these countries will benefit from global demand for oil, steel, aluminum, pulp, and other commodities.

Commodity prices have rebounded strongly and this has augured well for emerging markets. What are your views on commodities going forward?

The outlook for commodities remains positive. Strong demand from emerging markets coupled a more inelastic supply could lead to higher prices in the future. In general, we expect commodity prices to maintain a long-term uptrend. However, this will not be without corrections along the way. A number of emerging markets are major suppliers of various commodities as well as big consumers. For example, Brazil is one of the world's largest suppliers of iron ore, Russia is the largest supplier of natural gas, and so forth. Also, since emerging markets have the most people in the world the potential demand for commodities in those countries is also great. It is no surprise therefore that interest in such commodities is important..

I'd like to add that Dr. Mobius recently reemphasized the volatility factor.

According to Bloomberg (bold highlights mine), “When you have these rapid increases, almost without correction, you will definitely have a correction at some point, so we can expect a lot of volatility,” Mobius, the executive chairman of Templeton Asset Management Ltd., said in an interview in Kuala Lumpur today. “Increases of 70 percent can be followed by decreases of 20 to 30 percent.”

The so-called correction “can happen anytime, probably this year,” Mobius said. “It may not be all at once, you may not see a decrease of 20 percent suddenly, it could be 10 percent here, and a rise of 5 percent then another 10 percent, you’ll see this kind of volatility in the markets.” He added that he was referring to shares “globally.”

Nonetheless he would use the correction to add positions...

Again from Bloomberg, ``The biggest risk for global stocks is the increase in initial share sales and bond issues, Mobius said today. Investors will be “selling to take up new stocks, that will impact the prices,” he said. Mobius, who oversees about $25 billion, on July 29 said he plans to double Templeton Asset Management’s emerging-market assets within two years."

Since he doesn't think its a bubble...

Again from Bloomberg, “I don’t think it’s a bubble” because “you don’t have the irrational exuberance so to speak that you would normally find in a bubble activity,” Mobius said. The government’s policies to rein in bank lending are a “good thing,” he said.

Nassim Taleb: We Are Probably Worst Off Than Before

Interesting discussion between Nassim Taleb and Nouriel Roubini on Ben Bernanke at the CNBC.

Mr. Taleb avoids directly confronting Mr. Roubini, but runs an argument against policies undertaken by Bernanke from which Mr. Roubini supports. Nevertheless, Mr. Taleb in pun notes that Mr. Roubini's weakness is that "he likes Bernanke too much".

Here is Henry Blodget's summary of the interview:

-We're all in denial
-We're replacing private debt with public debt.
-We're not dealing with the cancer in our banking system.
-We're not making the structural changes we need to make.
-We're not being aggressive enough about restructuring debt (debt for equity swaps).
-Bernanke is a wimpy Greenspan sycophant
-Obama's rewarding the fools who got us here (Summers, Bernanke, Geithner)
The banksters are taking over again

Marc Faber: A Period Of Recovering Dollar And A Correction In Asset Markets

Marc Faber interviewed at CNBC with Nouriel Roubini

Some excerpts from Dr. Faber:

A period of recovering dollar and a correction in asset markets.

Because strong dollar means global liquidity is tightening

US least cyclical economy.

Emerging markets are more cyclical…they are like warrants on the US economy

In a scenario where growth will be disappointing…emerging markets are kind of vulnerable. They also became the favorite investment destination by momentum players

The worse the global economy, the more stocks could go up because the world’s central bankers have become nothing more than money printers.

They’re dangerous to the health of the global economy.

They created the Nasdaq bubble, the housing bubble, and now they want to create another bubble to bail them out.

Total breakdown of the system is ahead of us and it will devastate the global economy.

For the central bankers of this world and in particular Mr. Greenspan and Mr. Bernanke, the market mechanism is alright as long as prices go up, except for crude oil. That they object. But when it goes down that they feel they have to intervene.

Myths From Subprime Mortgage Crisis

Here is a noteworthy article by Yuliya Demyanyk of the Federal Reserve of Cleveland debunking popular explanations of the recent subprime mortgage crisis.

Ms. Demyanyk's intro: (bold highlights mine)

``On close inspection many of the most popular explanations for the subprime crisis turn out to be myths. Empirical research shows that the causes of the subprime mortgage crisis and its magnitude were more complicated than mortgage interest rate resets, declining underwriting standards, or declining home values. Nor were its causes unlike other crises of the past. The subprime crisis was building for years before showing any signs and was fed by lending, securitization, leveraging, and housing booms."

Most of the misconceptions had been aggravating circumstances read as causal effects, logical fallacies or outright cognitive biases at work.

The ten myths:

Myth 1: Subprime mortgages went only to borrowers with impaired credit

Myth 2: Subprime mortgages promoted homeownership

Myth 3: Declines in home values caused the subprime crisis in the United States

Myth 4: Declines in mortgage underwriting standards triggered the subprime crisis

Myth 5: Subprime mortgages failed because people used homes as ATMs

Myth 6: Subprime mortgages failed because of mortgage rate resets

Myth 7: Subprime borrowers with hybrid mortgages were offered (low) “teaser rates”

Myth 8: The subprime mortgage crisis in the United States was totally unexpected

Myth 9: The subprime mortgage crisis in the United States is unique in its origins

Myth 10: The subprime mortgage market was too small to cause big problems

Read her insightful revelations here.

My favorite quote from Yuliya Demyanyk's striking comments (oddly from a quasi government agency): From myth 2.(bold highlights mine)

``The availability of subprime mortgages in the United States did not facilitate increased homeownership. Between 2000 and 2006, approximately one million borrowers took subprime mortgages to finance the purchase of their first home. These subprime loans did contribute to an increased level of homeownership in the country—at the time of mortgage origination. Unfortunately, many homebuyers with subprime loans defaulted within a couple of years of origination. The number of such defaults outweighs the number of first-time homebuyers with subprime mortgages.

``Given that there were more defaults among all (not just first-time) homebuyers with subprime loans than there were first-time homebuyers with subprime loans, it is impossible to conclude that subprime mortgages promoted homeownership."

In short, inflationary "boom bust" policies has not only failed to achieve its goals, it has led to the sharp deterioration of the society's standard of living!!!

The Squabble For National Artist Awards Reeks Of Political Ignominy

This just a glaring example of how pathetic and crass Philippine politics is.

Recently another domestic controversy erupted over the choice of National Artist awardees.

The Political Process

The awards had supposedly been meant to be ``given to a Filipino who has been given the highest recognition for having made significant contributions to the development of Philippine arts,” according to the Inquirer. (emphasis added)

Who determines the winner? ``The selection committee is composed of representatives from the CCP and the National Commission for Culture and the Arts” says the Inquirer.

And what was the object of the controversy?

According to Manila Times’ Rome Jorge ``The recent inclusion by President Gloria Arroyo of four nominees who did not go through the painstaking selection process (as well as her omission of one candidate who did) has provoked public outrage as well as condemnation by the country’s most esteemed artists, many of them National Artists themselves.” (emphasis added)

So the CCP, NCCA and the eventually President selects the awardees.

And yet, the irony is that both parties (CCP and NCCA) in the screening committee are said to be politically colored but under opposing camps. Again from Mr. Jorge, ``More than just legacies of opposing regimes, the CCP and NCCA represent two divergent viewpoints on what Philippine arts ought to be. Their latest battleground is the National Artist Award—itself a relic of political manipulation of the arts.” (emphasis added)

The Apolitical Fantasy

Haven’t two quasi political parties along with a political President imply that POLITICS AND NOT OBJECTIVITY been the ultimate parameter for the reckoning?

How does one measure the “contribution to the development of the Philippine arts”? Because the CCP says so? Because the NCCA says so? Or because the President says so? Or because of a unanimous decision?

Isn’t art subject to the eyes of the beholder?

How can these so called representatives constitute as the national voice of the Filipinos when their aesthetic artistic palates or tastes are different from the rest of the society? Do their political positions or expertise entitle them to account for vox populi vox dei?

The reality is that politics and arts are two distinct animals.

Hence it is of no question to us, that since politics has been the principal determinant of the awards, there will always be “aggrieved” parties who think that they deserve such politically bestowed privileges but had been “manipulated” out of the race.

Ironically, the belief that the awards must be kept apolitical, but is in truth sustained and decided for by political forces, is thus nothing but another unalloyed fantasy.

Manny Pacquiao’s Lessons

In the field of sports, Manny Pacquiao does NOT need to be recognized by any political party/ies in order to be hailed a “National sportsman”.

His accomplishments have NOT just been breaking boxing world records, but most importantly his feat has been recognized by the MARKETPLACE.

That’s why he has been paid millions in currencies for appearances, for endorsements and advertisements and for the matches where he engages in.

As proof of the market’s generosity, even members of his family gets a share of the limelight by reportedly having their own ads or as guests in several TV programs, etc.!!!

In short, the market has accorded Mr. Pacquiao with the prestige of an international boxing legend more than just a national celebrity- award or no award from politicos.

In addition, he doesn’t require any blessings from politicos to become part of boxing history.

To the contrary, because of his overwhelming success, politicians have been all over him to generate political advertisement by mere association!

Thus, the accolade he receives transcends politics and subjectivism because his performance buttressed by the market has elevated him to such preeminent pedestal.

One may argue that Mr. Pacquiao maybe an extreme case, but nevertheless, you can’t achieve “significant contributions to the development of the arts” without the patronage of the public.

Ultimately, it is the artists’ contributions to the public that determines the level of “significance” to the society-a sine qua non! Even an art teacher would need pupils to ascertain his/her efficacy where success would mean higher wages or other perquisites.

Abolish The Farcical Awards

This brings us back to the issue of arts; if politics and not the markets determine the legacy of the so called “national artists” then the whole process is nothing but a sham.

Instead of advancing and fostering the cause of art, the inherent political process in the determination of the beneficiaries of the National Artist awards would only nurture political partisanship, factions, envy and rancor thereby defeating the very objective of its existence, as manifested by the recent disgraceful controversy.

Hence, given the above circumstances, the best option would be to abolish it.

Local Currencies Are Back In Fashion In The US

In the US, local currencies have been making a comeback- after its last appearance during the Great Depression.

They come in many names: In North Carolina Plenty, it is the Plenty. In Detroit, the Cheer. In Arizona, it is the Mesa Bucks and in Massachusetts, the Berkshare.

Read the rest from the LA Times here

China's Strategic Resource Accumulation Continues

China's insatiable appetite for strategic resource accumulations runs unabated.

The latest buyout activities as reported by the Wall Street Journal (all bold emphasis mine)

``China National Petroleum Corp. and Cnooc Ltd. have proposed paying at least $17 billion for all of Repsol YPF SA's stake in YPF, its Argentine unit, two people close to the talks said.

``The potential deal, which could be the biggest overseas investment by China, highlights the country's growing thirst for energy resources globally and its willingness to offer big money for access. It also underlines the ambition of CNPC to build its presence in South America and elsewhere.

``A deal would be another example of how Chinese companies are now working together to buy foreign energy assets after years of working alone.

``But the potential acquisition faces significant hurdles. A deal could be politically sensitive in Argentina, where YPF is the country's leader in both upstream operations -- the exploration for and production of oil -- and downstream operations involving oil refining and marketing...

``China's resource majors have snapped up foreign oil and other assets recently, as the country seeks to lock in energy supplies.

``China Petrochemical Corp., the Chinese state-owned oil company known as Sinopec, in June acquired Switzerland-based oil explorer Addax Petroleum Corp. for $7.2 billion. In April, CNPC purchased Kazakh oil producer MangistauMunaiGas jointly with Kazakhstan's state-owned KazMunaiGas for $3.3 billion.

``China's state energy companies are also showing more teamwork in chasing foreign deals than previously. This year Sinopec and Cnooc have together struck deals for oil and natural-gas assets in Angola and the Caribbean. In July they agreed to buy jointly a 20% stake held by U.S. oil producer Marathon Oil Corp. in an oil block off Angola for $1.3 billion.

``Chinese oil companies have also signed oil-for-loans agreements with Russia and Brazil.

``But not all of China's efforts have been successful. In June, a $19.5 billion bid by Aluminum Corp. of China, or Chinalco, to raise its stake in Anglo-Australian mining-giant Rio Tinto collapsed amid shareholder and political concerns. An earlier, successful deal by Chinalco, in which it paid $14 billion for an initial 9% stake in Rio in February 2008, is China's largest foreign investment in the resources sector.

Read the rest here

My take.

China's aggressive resource accumulation has the following implications:

1. Economic-it has been amassing resources for its industrialization and rapidly progressing middle class.

2. Political-it has been using their immense foreign reserves as leverage to expand its geopolitical influence overseas, which could have some possible bearing on its desire to become a military and economic powerhouse.

This could be manifested by its thrust to elevate the yuan as an eligible international reserve currency and as possible candidate to the replacement of the embattled US dollar.

3. Security-it has been insuring itself from US government's policy to debase the US dollar.

Moreover, by expanding access to resources coupled with a build up in military and commercial logistics and expanding her sphere of global political influence, all these could also be interpreted as an insurance policy against future military conflict.

The apparent transition of the geopolitical order from unipolar to a multipolar framework cannot be guaranteed as orderly and peaceful.

Paper Money On Path To Return To Intrinsic Value - ZERO

Voltaire (1694-1778) once said, ``Paper money eventually returns to its intrinsic value ---- zero."

No matter how you look at it...

From Price levels...

source (Robert Sahr, Oregon State, HT: Jeff Tucker)

Or inversely translated into the currency's purchasing power...

(Source AIER)

Paper money based on the US dollar system is indeed headed towards ZERO

Source AIER

As Thomas Paine(1737–1809) an English pamphleteer, revolutionary, radical, and classical liberal once wrote, ``Paper money is like dram-drinking, it relieves for a moment by deceitful sensation, but gradually diminishes the natural heat, and leaves the body worse than it found it. Were not this the case, and could money be made of paper at pleasure, every sovereign in Europe would be as rich as he pleased. But the truth is, that it is a bubble and the attempt vanity. Nature has provided the proper materials for money: gold and silver, and any attempt of ours to rival her is ridiculous…."

Crack-Up Boom Spreads To Asia And The Philippines

``But the administration does not want to stop inflation. It does not want to endanger its popularity with the voters by collecting, through taxation, all it wants to spend. It prefers to mislead the people by resorting to the seemingly non-onerous method of increasing the supply of money and credit. Yet, whatever system of financing may be adopted, whether taxation, borrowing, or inflation, the full incidence of the government's expenditures must fall upon the public. With inflation as well as with taxation, it is the citizens who must foot the total bill. The distinguishing mark of inflation, when considered as a method of filling the vaults of the Treasury, is that it distributes the burden in a most unfair way, overcharging those who are least able to bear it.”-Ludwig von Mises The Truth About Inflation

I received 4 text messages and 2 telephone calls anew this week from different banking institutions offering me loans. This seems like a defining activity since the start of the year. I don’t recall of such persistency to promote access to credit even prior to the Asian Crisis in 1997.

Yet I assume that this could be a national dynamic. Nonetheless, I can’t help but associate the actions in the Phisix to such anecdotal evidence.

Obviously, the domestic banking system which functions as the primary source of funding, has only been responding to regulatory policies.

While we don’t have available national data yet as proof for our assumption, a prolonged accommodative monetary environment will imply further space for mass speculation and a greater degree of consumption growth-that is likely to be reflected on our economic statistics.

And this seems to be the case for Asia, see Figure 1.

Figure 1: Danske Weekly: Recovery Gets More Visible

As Danske’s Fleming Nielsen wrote in his Weekly Focus, ``June’s economic data confirmed that Asia is experiencing a pronounced upswing, with strong industrial production numbers across the board. Countries such as South Korea and Thailand, which were hit exceptionally hard by the global financial crisis, are seeing industrial production recover to pre-crisis levels at a surprising clip. There are also signs throughout Asia that domestic demand is picking up – especially private consumption, with rising retail and car sales in the past couple of months.” (emphasis added)

For us, aside from the government policies, such intense reaction has been a manifestation of the “anomalous” collapse in the last quarter of 2008, which had been due to the seizure in the US banking system which rippled globally- a shock we called as Posttraumatic Stress Disorder (PTSD) [see What Posttraumatic Stress Disorder (PTSD) Have To Do With Today’s Financial Crisis].

Apparently the current actions in the financial markets and economic stats have strongly been validating our views.

Moreover, we see other national and regional quirks posing as significant influences that can electrify the pricing of regional financial assets.

As discussed in Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble, ``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.”

The Growing Inflationary Bias Of Asia’s Markets

For the longest time we had been advocating that in a world of central banking and virtual free lunch money polices, bubble cycles emanating from these are likely to be imbued more by Asia and emerging markets since developed economies have debts that have been “hocked to their eyeballs”.

Doug Noland in his Credit Bubble Bulletin says the same, `` The most robust inflationary biases are today domiciled in China, Asia and the emerging markets generally. The debased dollar has provided China and the “developing” world Credit systems unprecedented capacity to inflate (expand Credit/financial claims without fear of spurring a run on their currencies). Asian and emerging markets are outperforming, exacerbating speculative flows. Things that the “developing” world needs (energy/commodities) and wants (gold, silver, sugar, etc.) should demonstrate increasingly strong inflationary pressures. Their overflow of dollars provides them, for now, the power to buy whatever they desire.”

And the transmission mechanism from US Federal Reserve policies into global assets have nowhere been more explicit see figure 2.

Figure 2: Stockcharts.com: US dollar Index’s Inverse Correlation

As we pointed out in Asia Sows The Seeds Of The Business Cycle, a breakdown in the US dollar index (USD) seem likely to propel a reacceleration of the asset bidding wars.

The USD indeed broke down last week which likewise brought many global stock market benchmarks to new post crisis highs (the Philippine Phisix nearly touched the 2,900 level). However, Friday’s announcement of the US unemployment data, which showed a modicum of progress, may have incited a USD short covering.

The fun part is identifying the apparently synchronized inverse correlation of oil (WTIC), Emerging Market stocks (EEM) and Asia ex-Japan (DJP2) where the crucial inflection point has been vividly demarcated in March (see the red horizontal line).

So those arguing on the basis of the traditional fundamentalist metrics seem to be looking at the wrong picture. Inflation appears to be increasingly the principal moving force behind the motions of the progressively interconnected global financial asset markets.

The Global Crack-Up Boom

Where financial markets once functioned as signals for economic transitions, it would now appear that financial markets have become the essence of global economies, where the real economy have been subordinated to paper shuffling activities.

What was once a feature dominated by the West, seem likely to get assimilated rapidly by the East as government policies appear to be directed at either juicing up or controlling the “animal spirits”.

Nonetheless today these dynamics have been “globalized”.

Proof?

We pointed out last week (see The Inflation Cycle Accelerates; Asia As Chief Beneficiary) how China has been dithering over the explosive rise of its stock and property markets wherein policymakers signaled intentions to rein the markets by restricting flow of credit. However, the violent response in the stock market compelled a retraction from authorities.

This week we see more of the same.

Publicly listed state owned China Construction Bank President Zhang Jianguo reportedly resolved to materially prune its credit expansion. According to Bloomberg ``the nation’s second-largest bank will cut new lending by about 70 percent in the second half to avert a surge in bad debt.”

The result had been the same, after a reaching a new high, China’s Shanghai Index crumbled over the last 3 sessions to end the week down 4.4%.

In the US, the path to serfdom continues, the Federal Trade Commission has issued new rules to ``crack down on fraud and manipulation that can drive up prices at the pump.” (Bloomberg) Oil prices which had been on a tear mostly reflecting on the US dollar’s earlier breakdown, had been tempered anew by the realized regulatory actions (more than just threats), aside from the sharp rally in the US dollar.

Still the WTIC rose by over 2% the week.

In the UK, the Bank of England (BoE) surprised the markets when it announced additional quantitative easing measures. This means that the central bank will be issuing ‘money from thin air’ to acquire domestic sovereign instruments (Gilt) as well as “high” quality corporate debt (Marketwatch). While directly such policies are aimed at propping up the financial system, implicitly it further implies support to financial asset prices. The British pound fell .21% over the week.

In anticipation of prospective inflation, Australia will be resurrecting issuance of inflation indexed bonds as a hedge. According to Bloomberg, ``Australia will sell its first inflation-indexed bonds in six years as record stimulus spending worldwide prompts speculation price increases will resume once the global recession ends…

``Asia-Pacific governments including Australia, Japan and Thailand had signaled they may sell inflation-linked bonds as improving economies threaten to boost the price of goods and services. Australia, which considered scrapping its bond market in 2003, boosted its debt outstanding by 67 percent to A$101.1 billion ($85 billion) in the year ended June 30, about 10 percent of its gross domestic product.”

The significance:

One, when government and financial claims grow more than real output or available economic resources the outcome is materially higher prices.

Two, governments are in a predicament, while they want to see sustained elevated or high financial asset prices, to give the impression of economic growth and to further unleash “animal spirits” or expand risk appetite, the demand from excessive money has also diffused into scarce economic resources which has compelled them to impose price controls [as previously discussed in The Inflation Cycle Accelerates; Asia As Chief Beneficiary].

Price controls will only cause arbitrages into markets that are more open, it would also reduce market pricing efficiency by distorting them and enhance shortages which would fuel more volatility.

Here, as expected governments are bent to deal with the symptoms than the cause. The superficial nature of policy actions enhances nurturing the bubble cycle.

Three, bubble affected economies will likely prompt for more borrowing (see figure 3) and more money issuance activities as signified by Bank of England’s QE or Secretary Tim Geithner’s request to the US Congress to expand debt limit to $12.1 trillion (HT: Craig McCarty).

As Doug Noland aptly observed of the inflationary pyramid being erected (from the same article), ``The deeply maladjusted U.S. “Bubble” economy requires $2.5 Trillion or so of net new Credit creation to stem systemic (Credit and economic Bubble) implosion. Only “government” (Treasury, agency debt, GSE MBS) debt can, today, fill the gigantic void created with the bursting of the Wall Street/mortgage finance Bubble. The private sector Credit system is severely impaired, and there is as well the reality that the market largely lost trust (loss of “moneyness”) in Wall Street obligations (private-label MBS, CDO, ABS, auction-rate securities, etc.). The $2.0 Trillion of U.S. “government” Credit creation coupled with the Trillion-plus expansion of Federal Reserve Credit over the past year has stabilized U.S. financial and economic systems.” (emphasis added)

Figure 3: Bloomberg Chart of the Day: Addiction To Debt

The above chart shows that in the US it now takes about $4 dollars of debt to generate $1 of economic output (left window), while debt to GDP ratio has soared to 372%, which is clearly unsustainable.

Yet the policy direction is assuredly headed towards engaging in more borrowing and issuance of paper or digital money. Recently the US extended $2 billion “cash for clunkers” program which incentivize people to replace old cars with new ones supported by government subsidies (Bloomberg) is another example of debt addiction.

As Ludwig von Mises warned, ``But the boom cannot continue indefinitely. There are two alternatives. Either the banks continue the credit expansion without restriction and thus cause constantly mounting price increases and an ever-growing orgy of speculation, which, as in all other cases of unlimited inflation, ends in a ‘crack-up boom’ and in a collapse of the money and credit system. Or the banks stop before this point is reached, voluntarily renounce further credit expansion and thus bring about the crisis." (emphasis added)

The end result would likely be a nasty choice between that of market compelled deflation or hyperinflation.

The institutional bank run in the US that triggered the 2008 meltdown (in financial markets and global trade) was a classic example of the near “collapse of the credit system”.

In short, what is unsustainable won’t last. Artificial measures will only aggravate the imbalances.

In sum, all these account for the phenomenon known as the “crack-up boom” applied on a globalized scale.

Hence a bubble based boom equals a prospective bubble bust and another crisis down the road. So relish the fun while it lasts.

Interim Pause, The Bubble Blowing Dynamics At Least Until The 2010 Elections

Friday’s torrid bounce in the US dollar index could signify as a worthwhile pause for the vastly overheated Asian-Emerging Market stock markets (see figure 4)

Figure 4: US Global Investor: Asia Technically Overbought

According to US Global Investors, ``For the first time since mid-1999, stocks in emerging Asia are trading at more than 35 percent premium to the 200-day simple moving average, an overbought condition which historically has resulted in sizable corrections in the following months.”

So if this should hold true, then a correction would likely be in the range of 10-20%.

Nonetheless we can expect any material decline would likely be met by anxious officials who would hastily act to restore boom conditions.

Remember, in today’s era where policies are skewed towards favoring paper shuffling activities and where the financial sector acts as the principal growth engine of the economy, rising prices are construed as the norm (for statistical purposes) regardless of the substance of the growth. So lofty prices in financial assets will likely be the undeclared policy thrust.

Nevertheless in a bull market hiatus, which is likely a function of profit taking than policy reversals, declines are less likely to move in tidal fashion, as some stocks may generate speculative attention because the marketplace would continually seek for yields in response to the loose monetary environment.

And applied to the Philippine Phisix, foreign buying, which has largely been absent for most of the first semester of the year, appears to have returned. For three successive weeks, we have seen a net buying from foreign funds in both nominal terms and in the broader market.

So the recent approach towards the 2,900 level could be interpreted as the bidding up of Philippine stocks compounded by foreign buying as we had been expecting. In Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble, we said, ``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.”

Nonetheless, foreigners entering the local market appear to have been responding to the decline of the US dollar index.

If the US dollar is expected to fall further especially against Asian currencies then such dynamics are likely to be sustained. This would function as an important support to key components of the Phisix which also means a cushion from any major correction.

Figure 5: PSE: Share of Foreign Trade

Yet, despite this foreign trade improvement, the shape of today’s rally has departed from the 2003-2007 paradigm, where this time, local investors have powered the market as shown in Figure 6. Foreign trade from the start of the year have seen only occasional bouts where it gone beyond the 50% level which characterized the previous run.

At the end of the day, domestic policymakers will also want to see such trend persist going into the local national election season, as this would boost the odds of reducing the negative rating of the incumbent President PGMA thereby improve the chances for her appointee during the national election derby.