Phisix: The Correction Phase Cometh

I believe that the Phisix has entered a temporary corrective phase, or a pause from the bullmarket.

I wrote last week[1]

given the recent dramatic record run up, we should expect natural profit taking process to follow. And perhaps such profit taking will take cue from weakening commodity prices (CRB) and stock markets abroad led by the S&P 500 (SPX). This is likely to be a temporary event, or another episode where steroid propped financial market clamors to be fed with more steroids of inflationism.

Perhaps the weekend elections in the Eurozone could also spice things up.

I have been pointing out from the start of the year that the bullrun of the local stock market may last until the first semester of this year[2] from which we may encounter renewed volatility.

In March I said[3]

the raft of credit easing measures announced last month will likely push equity market higher perhaps until the first semester or somewhere at near the end of these programs. Of course there will be sporadic shallow short term corrections amidst the current surge.

However, the next downside volatility will only serve as pretext for more injections until the market will upend such policies most likely through intensified price inflation.

The reason for pointing this out is to dispel the misimpression that I only see the market as moving in one direction—UP.

It just so happened that last week’s correction came sooner and deeper than expected.

For Every (Mini) Boom, a (Mini) Bust

And the recent re-emergence of the downside volatilities which again has likely been prompted by overbought conditions seems to have taken cue from the external environment.

Emerging markets around the world or not limited to Asia have mostly been slammed. Major Asian bourses have been battered as well.

In a relative sense, in general, Asia has endured substantially more losses than the US or Europe.

And it is ironic that crisis afflicted Portugal, Italy and Spain posted marginal gains this week. Meanwhile Greece equities collapsed, the ASE general crumbled by 11.3% this week and down 10% for the year.

Meanwhile the losses of the Phisix seem understated.

Instead of the usual rotation, or the process of alternating winners and losers, this week, the broader market breadth sharply deteriorated.

In just one week, overall positive market sentiment seemed to have been reversed. Declining issues reasserted dominance with manifest forcefulness.

The scale of last week’s dramatic recoil has almost mirrored the fierce downside move of September-October of 2011, where the Phisix lost 18% from the August peak.

Of course current conditions are different from the 2011. But the point of the above is to show the perspective from the big picture and not just to absorb the frames presented.

Technically speaking the Phisix has yet to breach the 50-day moving averages. This could be seen yet as a positive sign.

In addition, the seeming resiliency of the Phisix means that while most of the broad market losses have been concentrated on the implosion of many “miniature” bubbles seen in second and third tier issues, the heavyweights has been less affected.

Of the 13 issues with 3% and above free market capitalization float that constitutes 70.38% of the Phisix basket as of Friday’s close, 3 defied the last week’s carnage, while 5 issues fell more than the decline of the Phisix. The Phisix dropped 2.63% which reduced year to date gains to 17.93%

It is just apt to remind everyone that Newton's third law of motion[4] “To every action there is always an equal and opposite reaction" has some validity in the stock markets.

The lesson being that during occurrences of market euphoria, where powerful speculative activities or price chasing dynamics results to many high flying issues, a reversal of which would result to prices falling more swiftly and more intensely almost as they have ascended.

Prices fall faster than they rise because of the behavioral principle of loss aversion[5], where fear is a stronger motivator than the pleasure of gain.

That’s why I don’t recommend chasing prices.

Asset price inflation is followed by asset price deflation: minor boom bust cycles within major boom bust cycles.

Except for the mining issues, the previously biggest winners (Property and finance) have basically been last week’s largest losers. Because the losses of the holder sector have been limited the mother units of top performers have taken the top spot in terms of returns on a year to date basis.

The swift and dramatic reversal of the market’s sentiment haunted the high flying mining peripheries first, which then rippled across to the heavyweights, the contagion effect has visibly been seen in the breakdown of the mining index.

Commodity Prices as Stethoscope

Importantly, adverse developments at the world commodity markets may have influenced the recent crash of the local mining sector.

Yet such decline have not been limited to gold or oil but dispersed throughout the entire commodity spectrum.

And instead of earlier divergences[6] where global financial assets has seen price inflation amidst a backdrop of declining commodity prices, recently, divergences seem to have transformed into a convergence—where both commodity prices and financial securities have been evincing signs of lethargy.

This serves as further proof that assets have been highly correlated and that markets have been severely distorted or “broken”[7] where the pricing mechanism have been manipulated to reflect on the preferred pricing levels by politicians.

Thus today’s investing environment has been transformed into a grand casino operating on the principle of a “Risk On or Risk Off” environment.

From the technical viewpoint, commodity markets seem to highlight the ongoing corrosion of price trends. Both the broad commodity index the Reuters/Jefferies (CRB) and the main US oil benchmark the West Texas Intermediate Crude (WTIC) seem to be signaling a bearish head and shoulder pattern. The WTIC has already broken down while the CRB has yet to breakdown.

Though I am not a believer in patterns, the numerous momentum players can make such patterns as self-fulfilling over the short term.

That’s why this week will be crucial for the CRB, where a successful breakdown of which may be portentous to global stock markets, the Phisix as well.

We should remember that oil markets hardly exhibits “real economics” or free market based demand and supply. Oil markets, as I have repeatedly pointing out, have been highly politicized[8].

The welfare states of many of the major producers, particularly OPEC economies or even non-OPEC such as Russia[9] greatly depends lofty oil prices, perhaps about $85 and above. Even President Obama’s green energy projects have been anchored on high oil prices.

This means that if oil prices breaks below their welfare threshold for a prolonged period, then this would incite popular uprising and the eventual collapse of the current political order.

And this is why oil producing governments have been limiting private sector’s access to oil reserves[10]. Yet the capacity by these governments to bring oil to the surface has been constrained by government budget, which has been mostly spent on welfare (yes to buy off their political privileges from their constituents), and the lack of technology.

The implication of the above is that these governments will probably try to restrict production, seek the war option[11] (e.g. urge the US to militarily take on Iran), inflate their economies to pay for their welfare system or influence major central banks and politicians of major economies to resort to more inflationism.

I might add that given the current political arrangement, it may not be farfetched to deduce that many, if not most US politicians from both parties, have been bankrolled by these oil producing client states.

Add to these, falling oil prices jeopardizes President’s Obama’s green projects.

Thus contemporary political institutions significantly dependent on revenues from resources (resource curse) rather than from trade would represent a vested interest group that would lobby to seek for bailouts in the form of inflation or through bank rescues.

Don’t forget one of the beneficiaries of US Federal Reserve bailout in 2009, was ironically, the Libyan government headed by then ally turned enemy Muamar Gaddafi[12]

So from this supply side perspective we understand that the policy direction of current governments will be through more inflationism. [On the demand side, money printing has enabled the welfare state to grow]

China’s Weakening Consumption Demand?

The listless state of commodity prices may be driven by two important forces;

One is consumption demand.

If the sluggishness in commodity prices has been representative of consumption demand, then the likely source for such weakness could emanate from China.

Soft economic data on export and import data for April (right window[13]) and a seeming rolling over of China’s equity markets (left window) seem to support this angle.

While many analysts read this to be an anomaly, such as ‘calendar effect’, I don’t. I would prefer to wait and watch.

I have been saying that China could be the global markets next black swan[14] whose economic slowdown has been highlighted by growing signs of the political fissures.

And that’s why I believe that the Scarborough Shoal territorial claim dispute has either been a squid tactic meant to divert the public’s attention from real economic conditions or a yeoman’s undercover sales job for the US and China’s military industrial complex[15] or both.

And given China’s Keynesian policies of permanent quasi booms, then it should be expected that a commensurably huge bust will be in the offing. Evidences of malinvestments have already been present; 64 million empty apartments, ghost cities and vacant shopping malls[16] which have been considerably financed by China’s version of the $1.7 trillion shadow financing system[17].

The question for the coming bust is a WHEN rather than an IF. And this depends on the China’s state of real savings

At present, the $64 trillion question is to what degree will China’s government’s conduct the bailout? If China still has substantial real savings then her government may be able to kick the proverbial can down the road.

As Austrian economist Dr. Frank Shostak explains[18],

For a while, the government's package can appear to be working; this is because there is still enough real savings to support both profitable and unprofitable activities. If, however, savings and capital are shrinking, nothing is going to help, and the real economy will follow up with further declines.

That’s why I am largely neutral on China’s financial markets.

In the commodity sphere, China has become the proverbial gorilla in the room as the largest, if not a significant, consumer of many commodities (see upper window)

As IMF’s Shaun K. Roache writes[19],

China is a large consumer of a broad range of primary commodities. As a percent of global production, China’s consumption during 2010 accounted for about 20 percent of nonrenewable energy resources, 23 percent of major agricultural crops, and 40 percent of base metals. These market shares have increased sharply since 2000, mainly reflecting China’s rapid economic growth. History has shown that as countries become richer, their commodity consumption rises at an increasing rate before eventually stabilizing at much higher levels.

Further, commodity prices seem to be correlated with the actions of China’s equity bellwether the Shanghai index (lower window[20]).

Yet the correlation can go both ways, either China’s or the commodity markets could lead. The Shanghai index [SSEC] may recover (perhaps boosted by a major move from Chinese authorities) and this may provide a lift to commodity prices, otherwise a continuing and deepening slowdown of China’s economy could pose as a drag to the commodity markets which will diffuse into the SSEC.

On the other hand, a major boost from a major central bank could power commodities higher, and this may help buoy China’s markets higher.

Or Indecisive Central Bankers?

Weak commodity prices may have also been symptomatic of asset liquidations, perhaps evidenced by JP Morgan’s $2 billion trading losses in credit derivatives[21].

This may be indicative that commodity prices along with financial asset prices could be factoring in less than aggressive interventions from major central banks.

And this may have been underscored by the ECB’s reluctance to intervene[22], perhaps until political impasse at several EU nations will have been resolved.

Sunday’s elections in Greece has failed to “put together a government[23]” from which contending parties, divided between pro- or anti- bailout camps, have reportedly been haggling to form a coalition to avert national elections. Such national elections have been seen as increasing the risks of a Greece exit from the EU.

Ironically, the EU officials appear to be openly talking about a Greek exit[24], perhaps to condition the public of its eventuality.

The same is true for France where the parliamentary elections in June will either solidify the dominance of the socialists[25] or may open the nexus for the extreme (fascist) right to acquire and expand power[26].

Thus until the political leadership of these nations have been established, the ECB will likely to adapt a wait and see stance.

And except for the Bank of Japan (BoJ) whom has continued to expand her balance sheet[27], the Bank of England (BoE) as well, has officially declared a halt[28] on their asset purchasing program, which I say is temporary.

Meanwhile, US Federal Reserve through their chairman Mr. Ben Bernanke continues to dither or give mixed signals on the prospects of more quantitative easing measures[29]. True monetary conditions in the US remains easy, as seen by the renewed pickup of growth in M2, but this could be offset by perceptions about inadequate support.

The current Operation Twist has also been slated to expire next month or on June[30].

And if history will rhyme, then the past two incidences where the Fed technically concluded market intervention programs led to sharp downside volatilities, as shown in the republished chart[31].

My hunch is that the current market pressures could most likely be exhibiting parallel symptoms of market’s apprehension over the lack of further steroids.

[As a reminder, I am vehemently against inflationism, but as an investor, we have to be realists and play by the cards we are dealt with]

Conclusion and Recommendations

The current weakness in commodity prices, which has partly been transmitted to the global stock markets, could represent a deepening China’s economic slowdown (bust has not yet been established) or the factoring in by financial markets of the withholding of the provision of more support to the financial markets, by central bankers, via direct interventions of asset purchases or even both.

And any further weakness in commodity prices will likely filter into the asset markets.

As an aside, I know much of the mainstream will say that weak commodity markets should be a positive aspect because these lowers input costs and improves profits. In reality, what they mean is that “low consumer price inflation” will justify more interventions from major central bankers.

And this has been exactly the message I have been saying, see my March note

“the next downside volatility will only serve as pretext for more injections”

The general idea is that markets have been prone to boom bust cycles or the inflation cycle[32] or volatility as a result of government and central bank policies that keeps markets dependent on “on and off” steroid boosters.

My guess is that China’s markets will be addressed politically in the same way too.

And it would seem that periods of greater market volatility and the ensuing fear will leave market participants begging for more interventions and inflationism.

For the Phisix, the current resiliency by the heavy caps has been a noteworthy auspicious development. Yet we should not discount the likelihood of a contagion from any adverse exogenous events.

My inclination is that based on the above evidences and in the understanding that NO TREND GOES IN A STRAIGHT LINE, the Phisix will likely undergo a correction or profit taking phase.

This retrenchment, perhaps 5-10% from the peak or a low of 4,800, should be seen as healthy and normal. Should this be realized then the local benchmark will likely drift rangebound.

Of course external developments will play a big role in either confirming or falsifying this.

Yet I am LESS inclined to believe that a new high for the Phisix will be reached soon. Such should be until major central bankers will have announced their renewed support for the markets or if there have been conspicuous signs that they have been operating behind the curtains.

Should I be wrong and the local (and global) markets continue to tread higher without support from major central bankers, unless this would be backed by a strong surge of lending from the banking system particularly in the US, Europe or China, then we should even be more cautious, as any rally would likely lose steam from the current environment, again, without steroids.

The outlier risk from this would even be a crash, as Dr. Marc Faber suggests[33] during the second half of the year.

So far, the fact is, that the damage seen in the market internals will have to be remedied first.

The good part is that the much of the selloff has been locally driven which unfortunately has affected many momentum participants. Yet foreign buying remains net positive in spite of the carnage and may have provided cushion to the heavyweights.

Well this chapter should serve as part of our continued learning process.

Finally in the expectation of the possibility of the non-participation of central banks until June or after, this means greater volatility ahead in both directions.

Investors may raise their cash balance during rallies and buy on every episodes of panic. And in the event that any one of the major central banks declares the next steroid (the size should matter), then our strategy shifts to buy high, sell higher.

---

[1] See Bubble Signs at the PSE: Raising Capital Through Pre-selling Model, May 7, 2012

[2] See An Inflationary Boom Powered Phisix Bullmarket January 22, 2012

[3] See Global Stock Markets: Will the Recent Rise in Interest Rates Pop the Bubble? March 18, 2012

[4] Wikipedia.org Newton's third law

[5] Wikipedia.org Loss aversion

[6] See Are Falling Gold Mining Stocks Signaling Deflation? April 25, 2012

[7] See “Pump and Dump” Policies Pumps Up Miniature and Grand Bubbles Aprl 30,

[8] See Are Surging Oil Prices Symptoms of a Crack-up Boom?, February 24, 2012

[9] See The Geopolitics of Oil and Russia’s Knowledge Economy March 13, 2012

[10] See Peak Oil Represents Government Failure, February 10, 2011

[11] See Saber Rattling over Iran is only Part of the Big Oil Price Story January 25, 2012

[12] See US Federal Reserve Lent To (or Bailed Out?) Libya’s Qaddafi in 2009, April 5, 2011

[13] Danske Research China: Slowing imports & exports due to calendar effects? , May 10, 2012

[14] See Signs of China’s Snowballing Political Crisis: Six Arrested over Coup Rumors, April 1, 2011

[15] See The Scarborough Shoal Standoff Has Not Been About Oil, April 16, 2012

[16] See China’s Tiger by the Tail, April 13, 2012

[17] See China’s Bubble Cycle: Shadow Financing at $1.7 Trillion, June 28, 2011

[18] Shostak, Frank The Rescue Package Will Delay Recovery, September 29, 2008 Mises.org

[19] Roache Shaun K. China's Impact on World Commodity Markets, IMF Working Paper, May 2012

[20] Holmes Frank Looking to China to Fire Up its Economy, May 11, 2011

[21] Tavakoli Janet Jamie Dimon's SNAFU: JPMorgan's Other Derivatives' Losses Huffington Post, May 12, 2012

[22] Reuters India, ECB fends off pressure to take crisis action May 8, 2012

[23] Reuters.com Greek president makes last push to avert elections, May 12, 2012

[24] Thestar.com Greek euro-exit talk seeps into public as officials air doubts, May 9, 2012

[25] Bloomberg.com French Favor Socialists, Allies in June Parliamentary Elections, May 11, 2012

[26] See Will French Politics Swing from Socialism to Fascism? May 12, 2012

[27] See Bank of Japan Adds More Stimulus, April 27, 2012

[28] See Bank of England Halts QE for Now, May 10, 2012

[29] Wall Street Journal Bernanke Expresses Fiscal Concerns To Senate Democrats, May 10, 2012

[30] Federal Open Market Committee Federal Reserve issues FOMC statement, US Federal Reserve September 21, 2011

[31] See Central Bankers Whets Wall Street’s Fetish For Inflationism, March 12, 2012

[32] See Chart of the Day: The Inflation Cycle, April 5, 2012

[33] See Dr. Marc Faber Warns of 1987 Crash if No QE 3.0 May 11, 2011

Quote of the Day: The Value of Superfluous Fluff

Some economists like to believe (although this belief has blessedly faded in the recent decades) that economics is an edifice built on the rocks of mathematical theory and statistical empiricism, and everything else is superfluous fluff. McCloskey (1983) thoroughly strafed that conceit, pointing out in “The Rhetoric of Economics” that the research and analysis of economists is built on uncertain and subjective judgments, and often uses, among its rhetorical tools, analogy and metaphor, appeals to authority and to commonsense intuition, and the use of “toy models” counterbalanced with the choice of supposedly illustrative real-world episodes.

Economic arguments rooted purely in mathematical formalism or statistical analyses are superb at specifying the steps leading to the particular conclusion. However, cynical economists (but I repeat myself) know that a model can be built to illustrate any desired conclusion, and that if the data are tortured for long enough, they will confess to anything. Persuasiveness requires a multidimensional argument that reaches beyond formalism. As McCloskey (1983) wrote: “There is no good reason to to make ‘scientific’ as opposed to plausible statements.”

That’s from economist Timothy Taylor on the issue of editing economists (hat tip Professor David Henderson).

Phony and manipulated “tortured” models function as standard instruments used to justify social controls through public policies. Think anthropomorphic global warming, Keynesian stimulus, mercantilism and etc…

Will French Politics Swing from Socialism to Fascism?

Far right Marine Le Pen’s strong showing at the recent Presidential runoff in France may have opened the door for politics of the extreme right.

Writes historian Eric Margolis at the Lewrockwell.com

Talk about déjà vu. Such a sweeping change would return France to its pre-war political landscape, when hard Left and hard Right were locked in bitter confrontation. Marine Le Pen could well emerge as the angry voice of many Europeans – a prospect that causes shudders across conservative-ruled Europe.

She could also prove the nemesis of the European Union. Le Pen has vowed to oppose austerity pacts, quit the Euro, restore the franc, and follow economic mercantilism. Her anti-EU, anti-free trade policies are attracting many people across Europe and even in Russia.

Fortunately, Francois Holland could prove a counter-balance to the ascendant Right. He is a moderate, cautious centrist politician given to pragmatism rather than ideology. His popularity and image of geniality and caring about people will help him withstand the forces of both Left and Right trying to pull him in different directions.

Even so, Marine Le Pen and her aggressive rightists are likely to become an ever-increasing threat to the French Republic as economic conditions worsen. It seems only a matter of time before fascism rears its head again in Spain, Italy, and Portugal. Greece is already on the way. Failure to implement austerity plans will bring economic convulsions and with them the bully boys in black

Mr. Francois Holland's victory has been negative enough for domestic entrepreneurs. Many of whom have reportedly been looking for refuge overseas from the prospects of punitive tax increases, if not from asset forfeitures, by the incoming socialist government, whom has openly declared war against the wealthy.

Yet if the prognosis of Mr. Margolis becomes a reality, then the rise of fascism (based on economic nationalism or mercantilism) elevates the risk of regional war.

As the great Ludwig von Mises once admonished,

What generates war is the economic philosophy almost universally espoused today by governments and political parties. As this philosophy sees it, there prevail within the unhampered market economy irreconcilable conflicts between the interests of various nations. Free trade harms a nation; it brings about impoverishment. It is the duty of government to prevent the evils of free trade by trade barriers. We may, for the sake of argument, disregard the fact that protectionism also hurts the interests of the nations which resort to it. But there can be no doubt that protectionism aims at damaging the interests of foreign peoples and really does damage them. It is an illusion to assume that those injured will tolerate other nations' protectionism if they believe that they are strong enough to brush it away by the use of arms. The philosophy of protectionism is a philosophy of war. The wars of our age are not at variance with popular economic doctrines; they are, on the contrary, the inescapable result of a consistent application of these doctrines.

The current trend of French politics seems locked into a wretched choice between the proverbial devil and the deep blue sea. Beautiful France may not be as beautiful as she is today in the future.

Democracy, as the great libertarian H.L. Mencken said, is the theory that the common people know what they want, and deserve to get it good and hard.

Quote of the Day: Under ZIRP, Corporate Balance Sheets DO NOT Matter

What, however, people do not know is that under ZIRP, when every basis point of debt return over 0% is praised, and an epic scramble ensues among hedge for any yielding paper no matter how worthless, the balance sheets of companies just do not matter. In other words, for companies that have massive leverage, high interest rates, negative cash flow, which all were corporate death knells as recently as 2008, the capitalization structure is completely irrelevant.

(bold highlights original)

That’s from the anonymous Tyler Durden at the Zero Hedge, discussing the boom in high yield debt. The unprecedented or uncharted scale of interventionism and inflationism has been massively distorting the way asset markets are being valued. The result has been magnified volatility and boom bust episodes.

More on US Exodus: Facebook co-founder Gives up US citizenship

Wow. Wealthy Americans giving up on their citizenship seems to be snowballing.

Now we’ve got a high profile case; one of Facebook’s founders has reportedly renounced his citizenship before the company’s IPO.

From Bloomberg,

Eduardo Saverin, the billionaire co- founder of Facebook Inc. (FB), renounced his U.S. citizenship before an initial public offering that values the social network at as much as $96 billion, a move that may reduce his tax bill.

Facebook plans to raise as much as $11.8 billion through the IPO, the biggest in history for an Internet company. Saverin’s stake is about 4 percent, according to the website Who Owns Facebook. At the high end of the IPO valuation, that would be worth about $3.84 billion. His holdings aren’t listed in Facebook’s regulatory filings.

Saverin, 30, joins a growing number of people giving up U.S. citizenship, a move that can trim their tax liabilities in that country. The Brazilian-born resident of Singapore is one of several people who helped Mark Zuckerberg start Facebook in a Harvard University dorm and stand to reap billions of dollars after the world’s largest social network holds its IPO.

“Eduardo recently found it more practical to become a resident of Singapore since he plans to live there for an indefinite period of time,” said Tom Goodman, a spokesman for Saverin, in an e-mailed statement.

Saverin’s name is on a list of people who chose to renounce citizenship as of April 30, published by the Internal Revenue Service. Saverin renounced his U.S. citizenship “around September” of last year, according to his spokesman.

Singapore doesn’t have a capital gains tax. It does tax income earned in that nation, as well as “certain foreign- sourced income,” according to a government website on tax policies there.

Exit Tax

Saverin won’t escape all U.S. taxes. Americans who give up their citizenship owe what is effectively an exit tax on the capital gains from their stock holdings, even if they don’t sell the shares, said Reuven S. Avi-Yonah, director of the international tax program at the University of Michigan’s law school. For tax purposes, the IRS treats the stock as if it has been sold.

Renouncing your citizenship well in advance of an IPO is “a very smart idea,” from a tax standpoint, said Avi-Yonah. “Once it’s public you can’t fool around with the value.”

The tax bill from Facebook’s IPO, I believe, could be just one issue seen by the media.

Future taxes and civil liberties, I think, could be of the more important unnoticed concern.

Of course, America’s loss, in the case of Mr Saverin, should likely benefit Singapore, which is another sign of wealth convergence or productive capital moving to Asia and emerging markets. Another wow, the billionaire is only 30 years old (signs of how technology has been reshaping industries).

Unless the political trend towards repressiveness in the US reverses, there will be more cases of exiting wealthy Americans.

And speaking of taxes, globalization and the information age seems to have conspired to create opportunities for technology companies to use legal loopholes to arbitrage away taxes through overseas corporate vehicles.

From the New York Times

The growing digital economy presents a conundrum for lawmakers overseeing corporate taxation: although technology is now one of the nation’s largest and most valued industries, many tech companies are among the least taxed, according to government and corporate data. Over the last two years, the 71 technology companies in the Standard & Poor’s 500-stock index — including Apple, Google, Yahoo and Dell — reported paying worldwide cash taxes at a rate that, on average, was a third less than other S.& P. companies’. (Cash taxes may include payments for multiple years.)

Even among tech companies, Apple’s rates are low. And while the company has remade industries, ignited economic growth and delighted customers, it has also devised corporate strategies that take advantage of gaps in the tax code, according to former executives who helped create those strategies.

Apple, for instance, was among the first tech companies to designate overseas salespeople in high-tax countries in a manner that allowed them to sell on behalf of low-tax subsidiaries on other continents, sidestepping income taxes, according to former executives. Apple was a pioneer of an accounting technique known as the “Double Irish With a Dutch Sandwich,” which reduces taxes by routing profits through Irish subsidiaries and the Netherlands and then to the Caribbean. Today, that tactic is used by hundreds of other corporations — some of which directly imitated Apple’s methods, say accountants at those companies.

So class warfare politicians appear to be increasingly caught in the bind of economic reality. Raise taxes, capital flees.

Graphic: Endowment Effect

Another gem from my favorite cartoonist Ms. Jessica Hagy of Indexed, who creatively turns complex ideas into simple graphics.

Ms Hagy calls the chart below as “What would you grab if the house was on fire?”

I would say that this is a precise depiction or representation of the endowment effect bias (from changingminds.org)

When I own something, I will tend to value it more highly. If I have to sell it, I will probably want to ask more than it is really worth.

Dr. Marc Faber Warns of 1987 Crash if No QE 3.0

From Bloomberg,

U.S. stocks may plunge in the second half of the year “like in 1987” if the Standard & Poor’s 500 Index (SPX) climbs without further stimulus from the Federal Reserve, said Marc Faber, whose prediction of a February selloff in global equities never materialized.

“I think the market will have difficulties to move up strongly unless we have a massive QE3,” Faber, who manages $300 million at Marc Faber Ltd., told Betty Liu on Bloomberg Television’s “In the Loop” from Zurich today, referring to a third round of large-scale asset purchases by the Fed. “If it moves and makes a high above 1,422, the second half of the year could witness a crash, like in 1987.”

The Dow Jones Industrial Average plunged 23 percent on Oct. 19, 1987 in the biggest crash since 1914, triggering losses in stock-market values around the world. The Standard & Poor’s 500 Index plummeted 20 percent. The Dow still closed 2.3 percent higher in 1987, and the S&P 500 advanced 2 percent.
“If the market makes a new high, it will be a new high with very few stocks pushing up and the majority of stocks having already rolled over,” Faber said. “The earnings outlook is not particularly good because most economies in the world are slowing down.”

Profit Growth

More than 69 percent of companies the S&P 500 that reported results since April 10 have exceeded analysts’ forecasts for per-share earnings, according to data compiled by Bloomberg. Profits are due to increase 3.9 percent in the second quarter and 6 percent the following period, estimates compiled by Bloomberg show.

Faber said a third round of quantitative easing would “definitely occur” if the S&P 500 dropped another 100 to 150 points. If it bounces back to 1,400, he said, the Fed will probably wait to see how the economy develops.

see Bloomberg's interview of Dr. Marc Faber below

Media has the innate tendency of reducing investment gurus into astrologers or soothsayers by soliciting predictions over the short term. And investing gurus eager to gain media limelight fall into their trap. And this is why Dr. Faber’s warnings comes with a Bloomberg notice about his latest failed predictions, which has been punctuated by "whose prediction of a February selloff in global equities never materialized."

Dr. Faber, who introduced me to the Austrian school of economics through his writings, is simply stating that if a tsunami of central banking money has been responsible for the buoyant state of markets, then a withdrawal of which should mean lower asset prices. In short, the state of the financial markets heavily, if not almost totally, relies on the actions of central bankers.

Yet since we can’t entirely predict the timing and the degree of central bank interventions, or if they intervene at all, we should expect markets to be highly sensitive to excessive volatility.

And aside from money printing, the risk of high volatility has been amplified by many other interventions on the marketplace (via various bank and financial market regulations). And heightened volatility could translate to a crash. And don’t forget a crash could be used to justify QE 3.0.

As to whether the Fed’s QE 3.0 will come before or after a substantial market move is also beyond our knowledge, since this will depend on the actions of political authorities. I have to admit I can’t read the minds of central bankers.

Yet QE 3.0 may come yet in the form of actions of other central bankers, e.g. ECB’s LTRO and or SMP.

What I know is that inflationism has been seen by the mainstream and by the incumbent political authorities as very crucial for the survival of the current forms of political institutions. This is why I, or perhaps Dr. Faber, sees the probability for more central bank interventions over the marketplace. This is because the cost of non-intervention would be a substantial reduction of the political control over society from vastly impaired political institutions.

It must be noted that Austrian economics is basically an explanatory science, where given a set of actions we see the consequence being such or such. The idea of reducing logical deduction into some form of predictive science is wizardry.

In short, while I don't predict a crash I would not rule out this option. Especially not in a highly distorted and politicized markets

Video: How Occupational Licensing Hurts the Economy

This video from the Institute for Justice shows how occupational licensing, or restrictive employment regulations, represents a form of labor protectionism that hurts the consumers, investors and job seekers, or as a whole, the economy. Yet the beneficiaries are the small number of privileged license holders and the government of course.

While the video has been focused on occupational licensing in the US, labor market interventions has universal relevance. In short, this applies to the Philippines too.

David Stockman: The US Federal Reserve is Destroying the Capital Markets

David Stockman, former Republican U.S. Congressman and director of the Office of Management and Budget, founding partner of Heartland Industrial Partners and the author of The Triumph of Politics: Why Reagan's Revolution Failed and the soon-to-be released The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy in an interview at the Gold Report has this biting message. [bold emphasis mine]

The Fed is destroying the capital market by pegging and manipulating the price of money and debt capital. Interest rates signal nothing anymore because they are zero. The yield curve signals nothing anymore because it is totally manipulated by the Fed. The very idea of "Operation Twist" is an abomination.

Capital markets are at the heart of capitalism and they are not working. Savers are being crushed when we desperately need savings. The federal government is borrowing when it is broke. Wall Street is arbitraging the Fed's monetary policy by borrowing overnight money at 10 basis points and investing it in 10-year treasuries at a yield of 200 basis points, capturing the profit and laughing all the way to the bank. The Fed has become a captive of the traders and robots on Wall Street…

I think the likely catalyst is a breakdown of the U.S. government bond market. It is the heart of the fixed income market and, therefore, the world's financial market.

Because of Fed management and interest-rate pegging, the market is artificially medicated. All of the rates and spreads are unreal. The yield curve is not market driven. Supply and demand for savings and investment, future inflation risk discounts by investors – none of these free market forces matter. The price of money is dictated by the Fed, and Wall Street merely attempts to front-run its next move.

As long as the hedge fund traders and fast-money boys believe the Fed can keep everything pegged, we may limp along. The minute they lose confidence, they will unwind their trades.

On the margin, nobody owns the Treasury bond; you rent it. Trillions of treasury paper is funded on repo: You buy $100 million (M) in Treasuries and immediately put them up as collateral for overnight borrowings of $98M. Traders can capture the spread as long as the price of the bond is stable or rising, as it has been for the last year or two. If the bond drops 2%, the spread has been wiped out.

If that happens, the massive repo structures – that is, debt owned by still more debt – will start to unwind and create a panic in the Treasury market. People will realize the emperor is naked.

Read the rest here.

Many people believe that the numerous incidences of irregularities seen in financial markets emanate from unscrupulous behavior by some market agents, little has been understood that central bank policies, together policies that cater to crony capitalism, have been incentivizing or fostering such behavioral anomalies.

And importantly, the nature of capital markets have been intensely distorted to the point where conventional wisdom of its mechanics has nearly been rendered obsolete.

Either we face up to such evolving realities or suffer from our recalcitrance to adjust when the day of reckoning arrives.

Has the Underwear Bomber Hoax been Designed to Justify Naked Airport Security Checks?

I recently pointed out that the expose on the underwear bomber terrorist hoax has likely been driven by an undeclared political incentive,

Visible ‘terrorism’ effects, as illustrated above, can be manufactured for political reasons—example to justify the existence and or the expansion of government bureaucracies (such as US Homeland Security) or to promote interests of the military industrial complex or both.

Paul Craig Roberts, former Assistant Secretary of the US Treasury and former associate editor of the Wall Street Journal, writing at the lewrockwell.com proposes this source of motivation,

But the real significance of this latest hoax is to introduce into the fearful American public the idea of an undetectable underwear bomb.

What does this bring to mind? Anyone of my generation or any science fiction aficionado immediately thinks of Robert Heinlein’s The Puppet Masters.

Written in 1951 but set in our time, Earth is invaded by small creatures that attach to the human body and take over the person. The humans become the puppets of their masters. Large areas of America succumb to the invaders before the morons in Washington understand that the invasion is real and not a conspiracy theory.

On clothed humans, the creatures cannot be detected, and the edict goes out that anyone clothed is a suspect. Everyone must go about naked. Women are not even allowed to carry purses in their hand, because the creature can be in the purse attached to the woman’s hand.

Obviously, if the CIA, the news sources, and Dianne Feinstein’s briefers are correct that defeated al-Qaeda has come up with an “undetectable” bomb, we will have to pass through airport security naked.

In short, create a scenario to justify the TSA’s lust for naked security checks (perhaps this porno entertainment for them).

Could be.

Nonetheless the current trend of airport security checks has been dehumanizing and symptomatic of the expanding rule of tyranny.

Video: 10 years after, Ron Paul was Right

In a 5 minute 2002 speech at the US Congress, congressman Ron Paul made a challenge for the public to track the accuracy of his litany of predictions. (hat tip Bob Wenzel)

At the close of this speech Mr. Paul said,

"I have no timetable for these predictions, but just in case, keep them around and look at them in 5-10 years. Let's hope and pray that I'm wrong on all accounts. If so, I will be very pleased."

Unfortunately, after 10 years, most of the events which he had hoped that would NOT happen became stunningly true.

Bank of England Halts QE for Now

From Bloomberg

Bank of England officials halted stimulus expansion after seven months of bond purchases as the threat of inflation trumped concerns about an economy that’s succumbed to a double-dip recession.

The nine-member Monetary Policy Committee led by Governor Mervyn King today held its quantitative easing target at 325 billion pounds ($524 billion), ending a second round of stimulus, a move forecast by 43 out of 51 economists in a Bloomberg News survey. Officials also left their benchmark interest rate at a record low of 0.5 percent. The pound erased its decline against the dollar.

With inflation on course to exceed Bank of England forecasts and the economy struggling to recover, policy makers have been divided on how to resolve the dilemma. Today’s decision signals price-growth worries are mounting even as the U.K. struggles with government budget cuts, high unemployment and threats from Europe’s debt crisis.

The double dip recession serves as evidence that the Bank of England’s (BoE) quantitative easing (QE) measures has failed to meet the goal of “stimulating” the economy.

Worst, the aftereffect has been a significant loss of purchasing power for the average Briton.

True, statistical consumer price inflation (CPI) has been lower compared to last year, but remains elevated relative to the 2009-10, as well as the average inflation rate from 1989 until 2010 of 2.72% [according to tradingeconomics.com, the source of most of the charts on this post].

So the recessionary environment along with elevated inflation rates…

…plus high unemployment rates represents an accrued symptom which characterized the 1970-1980s economic landscape known as stagflation (Wikipedia.org). In short, UK has been suffering from benign stagflation.

Also, since this BoE policy has been widely anticipated by the consensus, it does appear that today’s policy decision may have partly influenced the present weaknesses seen in the global commodity markets, as well as, in the world stock markets.

Of course, I have my doubts on the current stance of the BoE. I don’t think that they have totally abandoned the inflationist doctrine. I think that this has been more of a temporary lull.

That’s because if UK’s finance markets should endure more downside volatility, then this would have an adverse transmission effect to the balance sheets of UK’s banking system.

As this study from the BoE shows, since the introduction of the QE, prices of bonds and equity (via the FTSE all share) had been energized or the QE has provided pivotal support to their asset markets.

Yet BoE’s QEs have only added to the general indebtedness of the UK’s economy.

And like the Euro counterparts there has been no genuine “austerity” in the UK.

So unless there will be greater savings from the average British to finance government borrowing or foreign buyers step up the plate, then the BoE will have their hands full in trying to smooth out the management of government debt and the balance sheets of UK’s banking system overtime. Oh, essentially the same dilemma haunts the US and the Eurozone.

Quote of the Day: A Foolish Thing is a Foolish Thing

The following quote seems profoundly relevant especially to politics and media, and has likewise noticeable influence on the financial markets or even in social networking media such as Facebook.

If fifty* million people say a foolish thing, it is still a foolish thing.

That’s from Anatole France, French author and winner of the Nobel Prize in Literature (1921), as quoted in Listening and Speaking : A Guide to Effective Oral Communication (1954) by Ralph G. Nichols and Thomas R. Lewis, p. 74 (Wikiquote.org)

*the common attribution has been “If a million people”…

Video: How America Chooses the President (Electoral College System)

The Economist has a video explaining how Americans elect their President.

Here is the intro

THE electoral college is a relic of the 18th century that gives disproportionate weight to voters in smaller states and focuses attention on a dozen "swing" ones. Our videographic, below, explains more.

Ron Paul: Federal Reserve System is the Epitome of Crony Capitalism

Here is the gist of US congressman Ron Paul’s courageous talk before the Committee on Financial Services, Subcommittee on Domestic Monetary Policy & Technology, United States House of Representatives, May 8, 2012 (From Lew Rockwell)

Much confusion exists over what the Federal Reserve System actually is. Some people claim that is a secret cabal of elite bankers, while others claim that it is part of the federal government. In reality it is a bit of both. The Federal Reserve Board is a government agency, while the Federal Reserve Banks are privately-run government-chartered institutions, and monetary policy decisions are made by the Federal Open Market Committee, which has members from both the Board and the Reserve Banks.

The Federal Reserve System is the epitome of crony capitalism. It exemplifies the collusion between big government and big business to profit at the expense of the taxpayers. The Fed's bailout of large banks during the financial crisis propped up poorly-run corporations that should have gone under, giving them an advantage that no other business in the United States would have received. The bailouts continue today, as banks maintain $1.5 trillion worth of excess reserves at the Fed, reserves which were created through the Fed's purchase of worthless securities from banks. The trillions of dollars that the Fed has injected into the system have the goal of forcing down interest rates. But the Fed fails to realize that interest rates are a price, the price of money and credit, and that forcing interest rates down will only create an even bigger bubble and an enormous economic depression when this entire house of cards comes falling down.

The Federal Reserve is statutorily required to focus on three aims when engaged in monetary policy: full employment, stables prices, and moderate long-term interest rates. In practice, only the first two have received any attention, the so-called "dual mandate." Some reformers have called for the full employment mandate to be repealed, in order to allow the Fed to focus solely on stable prices. But these critics ignore the fact that stable prices are not a desirable goal. After all, with increasing productivity and technological innovation, the natural trend for most goods is for prices to decrease. By calling for the prices of goods to remain stable, the Fed would have to inflate the money supply in order to counteract this trend towards price declines, pumping new money into the system and creating economic distortions. This is exactly what happened during the 1920s, as the Fed's monetary pumping was masked by rising productivity. The result was stable prices, but the malinvestment caused by the Fed's loose monetary policy became evident by 1929. There is no reason to expect that focusing on stable prices today would have a dissimilar outcome.

Other reformers have called for changes to the composition of the Federal Open Market Committee, the body which sets the Fed's monetary policy objectives. On Constitutional grounds, the FOMC is undoubtedly problematic, as government appointees and the heads of the private Federal Reserve Banks work together to set monetary policy objectives that directly impact the strength of the dollar. While all of the members of the FOMC ought to be confirmed by the Senate, debates about the size of the FOMC or whether Reserve Bank Presidents should make up a majority of the members or whether they should even serve at all are largely a sideshow. While the only dissent to monetary policy decisions in recent years has come from Reserve Bank Presidents, there is no reason to think that expanding the FOMC to include more Reserve Bank Presidents would lead to any greater dissent or to any substantive changes to the conduct of monetary policy.

Another proposal for reform is for outright nationalization of the Fed or its functions. No longer would the Fed create money; that function would be taken up by the Treasury, issuing as much money as it sees fit. No longer would the Treasury issue debt to cover fiscal deficits, it would just issue new money to cover budget shortfalls. If what the Fed does now is bad, allowing the Treasury to print and issue money at will would be even worse. These types of proposals hearken back to the days of the first greenbacks, which the U.S. government began issuing in 1863. A pure fiat paper currency, unbacked by silver or gold, the greenbacks were widely reviled. Only once the greenbacks were made redeemable in gold were they accepted by the American people. The current system of Federal Reserve Notes is even worse than the greenback era in that there is no hope that they will ever be redeemable for gold or silver. The only limiting factor is that the Federal Reserve System only creates new money when purchasing assets, normally debt securities. Allowing the federal government to print money without at least a nominal check on the amount issued would inevitably lead to a Weimar-like hyperinflation.

So what then is the solution? The Fed maintains that a paper standard can be adequately managed without causing malinvestment, inflation, or other economic distortions. If the Fed were omniscient and knew the wishes, desires, and future actions of all Americans, this might be possible. But the Fed cannot possibly aggregate or act on the information necessary to engage in monetary policy. The actions of hundreds of millions of individuals, all seeking to better their position in life, acting purposefully towards that aim, cannot possibly be compiled into aggregates or calculated through mathematical equations or econometric models. Neither a single person, nor the members and staff of the FOMC, nor millions of people with millions of computers working in a new Goskomtsen will ever be able to accumulate, analyze, and act upon the information required to create a centrally planned monetary system. Centrally planned fiat paper standards such as the one currently in place in this country are doomed to failure.

This brings us to the question of the gold standard. The era of the classical gold standard was undoubtedly one of the greatest eras in human history. For a period of several decades in the late 19^th century, largely uninterrupted by war, the West made enormous advances. Economic productivity increased, art and culture flourished, and living standards rose so that even the poorest citizens lived a life their forebears could have only dreamed of.

But the problem with the gold standard is that it was run by the government, which exercised a monopoly over monetary affairs. The temptation to suspend gold redemption, so often resorted to by governments throughout history, reared its head again with the outbreak of World War I. Once the tie to gold was severed and fiscal restraint thrown to the wind, undoing the damage would have required great fiscal austerity on the part of governments. Emancipated from the shackles of the gold standard, the Western world proceeded to set up a gold-exchange standard which lasted not even a decade before the easy money policies it enabled led to the Great Depression. While returning to the gold standard would certainly be far better than maintaining the current fiat paper system, as long as the government retains the power to go off gold we may end up repeating the same mistakes that occurred from 1934 to 1971 as the government went first off the gold coin standard and finally off the gold bullion exchange standard.

The only viable solution for monetary stability is to get government out of the money business permanently. The way to bring this about is through currency competition: allowing parallel currencies to circulate without any one currency receiving any special recognition or favor from the government. Fiat paper monetary standards throughout history have always collapsed due to their inflationary nature, and our current fiat paper standard will be no different. The Federal Reserve is currently sowing the seeds of its own destruction through its loose and reckless monetary policy. The day of reckoning may still be many years in the future, but given the lack of understanding on the part of the Federal Reserve's decision makers, it is quickly coming upon us.

Incidentally and ironically archrivals Ron Paul and Fed Chair Ben Bernanke had a face to face breakfast meeting the following day.

Here’s the Wall Street Journal Blog reporting on what transpired.

Still, Wednesday’s breakfast brought together two figures who publicly agree on very little. A longtime critic of paper currency and fan of the gold standard, Mr. Paul’s fiery Fed-bashing has enthused his campaign trail supporters, who often start rallies with loud chants of “end the Fed!”

Mr. Bernanke, meanwhile, dedicated a significant chunk of his first lecture at George Washington University in March to enumerating the flaws associated with a system in which the dollar is valued at a fixed price per unit of gold.

So did Wednesday’s meeting overturn any deep-set beliefs?

“He’s for the gold standard now,” joked Mr. Paul.

End the Fed. End Central Banking. End the politicization of money.

The Unraveling of Europe’s Wonderland

Dr. Ed Yardeni at his blog, has a superb and eloquent piece on the problems besetting the Eurozone which he calls as Europe’s wonderland (bold emphasis mine)

The Europeans have had the best governments money can buy. Their elected leaders have provided them with all sorts of wonderful social welfare benefits. Many Europeans are employed by their governments to provide those benefits to their needy fellow citizens. Those who cannot find a job, or are too depressed to look for one, are provided with extremely generous unemployment benefits. Retirement benefits are great, and early retirement is the norm. Life has been very good in Europe.

Of course, that all costs lots of money. That’s why income tax rates are so high in Europe. On top of those rates, Europeans pay significant value-added taxes on the goods and services they buy. Yet there has been an ever-widening gap between government spending and revenues. That’s partly because Europeans have responded to their exorbitant tax rates with widespread tax avoidance.

The spending of European governments has ranged between 40% and 60% of GDP for many years. The revenues collected by these governments have ranged between 30% and 50% of GDP. The resulting deficits have led to rapidly rising ratios of government debt to GDP.

Attempts to bring back some fiscal sanity, led by Germany’s Chancellor Angela Merkel, are now widely caricatured as fiscal “austerity.” In my opinion, the only way to fix Europe is to slash government spending, reduce tax rates, enforce tax collection, and deregulate labor markets. Instead, enraged European voters are rising up against austerity and voting for the status quo. They haven’t indicated who they expect will pay the bills. However, they must be counting on either the Germans to pick up the tab or the ECB to implement more rounds of the LTRO.

European politicians who signed on to the “fiscal pact” promoted by Germany late last year are losing their jobs. Those favoring a “growth pact” are winning support, though they have no specific plan yet and certainly no way to finance it once it is specified. Also gaining support are various left- and right-wing fringe groups that tend to promote anarchy as the most effective way of overthrowing the established order and replacing it with their disorder.

Europe is at risk of devolving from an economic and monetary union into a disunion of failed states. The Greeks are unable to form a coalition government after the two major parties lost significant support to fringe parties over the weekend. They may need to have another round of elections. The remote chance of Radical Left leader Alexis Tsipras forming a coalition faded on Tuesday when New Democracy leader Antonis Samaras promptly rejected his demand to scrap Greece’s bailout plan, warning such a move would drive Greece out of the euro: "Mr. Tsipras asked me to put my signature to the destruction of Greece. I will not do this. The country cannot afford to play with fire."

(According to Greek mythology, Prometheus stole fire from Zeus and gave it to mortals. Zeus then punished him for his crime by having him bound to a rock while a great big eagle ate his liver every day only to have it grow back to be eaten again the next day. During the Greek War of Independence, Prometheus became a figure of hope and inspiration for Greek revolutionaries.)

The above is simply commonsense economics which shows that we can NOT spend ourselves to prosperity or that there is NO such thing as a free lunch.

This implies that reversion to the mean would be the natural order from previous overspending that produced high levels of debt. And the logical and commonsensical solution to such predicament would either be to raise revenues by making the economy more competitive or to reduce government spending, or more optimally, having to apply both approaches. The ECB can only kick the can and even worsen the scale of the imbalances.

Unfortunately many people live in dreams. Politicians and their academic and institutional backers pander to such utopianism by imposing the same policies that got them there. They do this by whipping up public’s sentiment by peddling half truths to the gullible and uninformed. A good example is media’s baloney over so-called “austerity” which in reality has been a gross perversion of semantics. Mr. Yardeni’s chart above reinforces my earlier assertions.

Yet Sweden’s anti-Keynesianism policies should serve as a wonderful counterexample where commonsense economics--economic freedom, genuine austerity and tax cuts--have been driving real growth.

Politicians and (parasitical) voters would like to make permanent a life of abundance, by living off someone else’s labors. Unfortunately the reality says that we are bounded by the laws of scarcity, and people’s efforts are constrained by such limits.

Thus when the proverbial rubber meets the road, delusions over Europe’s desired perpetual state of wonderland has been in the process of being unmasked.

Reality, says Libertarian author Robert Ringer, isn't the way you wish things to be, nor the way they appear to be, but the way they actually are.

Pirate Island: More Dreams of a Government Free Community

Dreams of getting government off their backs are being put into reality through chartered cities, free cities, seasteading and now the Pirate Island.

From the register.co.uk (hat tip Bob Wenzel)

Over 100 international tech companies have registered their interest in the floating geek city, Blueseed, which will be launched next year in international waters outside of Silicon Valley.

The visa-free, start-up friendly concept launched late last year aims to create a fully commercial technology incubator where global entrepreneurs can live and work in close proximity to the Valley, accessing VC dosh and talent as required.

A new research report released by Blueseed reveals that the bulk of registered demand germinated from the US at 20.3%, Indian start-ups rank second at 10.5% and Australians third at 6%.

The research found that international start-ups nominated living and working in an “awesome” start-up- and technology- oriented space; proximity to Silicon Valley's investors and an alternative to having to get US work visas for company founders or employees as the key reasons for getting on board.

The Blueseed model budgets for around 1,000 live-in entrepreneurs on deck with costs ranging US$1,200 to $3,000 per month, per person for living quarters and office space.

It is most likely that Blueseed will revamp a decommissioned luxury cruise liner which the founders estimate would cost between $10 -$25 million to fit out.