Monday, January 07, 2013

What to Expect in 2013

Wishing everyone a Happy, Healthy and a Prosperous New Year!!!

[I would like to thank my youngest son for helping me transcribe quotes from the book]

2013 has started with a bang!

Global markets have greeted the New Year with a bullish rampage to score fantastic gains over the week (see left window).

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Following the joint ‘unlimited’ easing by the US Federal Reserve and the European Central Bank (ECB), whom has similarly been supported by the Bank of Japan (BoJ), global equity markets have become turbocharged.

This basically validated my main thesis last September, where I wrote[1],
I believe that the interim response from the FED-ECB policies, designed to prop up financial assets, will likely provide strong support to the global stock markets including the Philippine Phisix perhaps until the yearend, at least.

The mining index, which has underperformed all sectors, will likely expunge its year to date losses at least by the yearend.

The mining index will likely retake command of the leadership in 2013 as it has outperformed biyearly since 2007.
This week’s fiery opening has essentially signified a carryover from last year’s final quarter blitzkrieg (right window), a thrust which may last until the first quarter.

While the gist of my expectations for the local stock market has been mostly fulfilled, the domestic mining index sector failed to come through. Nonetheless, I still hold on to the premise that an inflationary boom will spur a rotation as it has done so for the past 8 years.

This is not based on the blind belief of repetition of patterns, but rather from the economic reasoning based on the relative transmission effects of credit and monetary expansion or the Cantillion Effects[2] as manifested in changes in relative prices.

In other words, all the money being created to “promote demand” will have to flow somewhere. And somewhere means that this will be manifested via relative pricing of equity securities, especially pronounced for an underdeveloped domestic equity market like the Philippines.

Such dynamic has become apparent in global financial markets, the same dynamic has also become evident within the Philippine Stock Exchange.

The Monkey Business Illusion and Mainstream Wisdom

Before I proceed I urge you to take this test on attention or cognitive science called the Monkey Business Illusion:


The test originally called the Invisible Gorilla[3] designed by Professors Christopher Chabris and Daniel Simons shows of people’s selective attention or inattentional blindness[4], where the limitations of people’s ability to focus leads to perceptual blindness.

In the video, people are asked to count on the number of ball passes made by team members wearing white shirts.

The stimuli to focus on the above instruction has led many observers to miss out on the appearance of the gorilla, the reduction of the number of black shirt team members and the change of color of the curtains. Half of the participants have missed the gorilla alone according to Professor Simons. [Have you been you part of those who missed one of the above? I didn’t miss the gorilla, but I overlooked the curtains]

Aside from inattentional blindness, the point is that the framing of the stimuli impels many if not most people to focus on the plausible, or what gives ‘cognitive ease’ or ‘coherent pattern of activated ideas’[5]

What has this got to do with the financial markets?

Many attribute the current financial market boom to economic performance. That’s how the mainstream experts and media frames or narrates it, especially the Philippine variety.

But if all these collective booms indeed reflected on economic performances, then why does it require global policymakers to—not only to massively cut interest rates—but to complement these credit easing measures with central bank’s balance sheet expansions?

More than half of the central banks[6] all over the world cut interest rates in 2012

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Add to these the balance sheet expansions of central banks of developed economies[7]. This implies that these economies represent 95% of the $98.4 trillion bond markets from which governments share are about 45%[8]. In short, why does central banks need to support the bond markets if the world economy has been truly resilient?

If for instance, the Philippines has “solid economic growth, relatively stable exchange rate, responsive banking system that is able to withstand external shocks”, according to a Bangko Sentral ng Pilipinas (BSP) official[9], then why resort aggressive rate cutting?

What explains the parallel universe or the blatant disconnect or divergences between surging stock markets and sluggish economic growth[10] for the rest of the world in 2012?

What further explains the seemingly tight correlation[11] between the world’s top performing stock markets of 2012 and the aggressiveness in interest rate cuts by their respective national central banks? Sheer coincidence?

In short, like the invisible gorilla, many people would prefer to rely on the spoon feeding of superficial and loosely correlated ideas (stimulus) or what behavioral psychologists call as “the illusions of understanding” rather than to examine on their veracity or the soundness of their suppositions.

In a world of uncertainty, the illusion of understanding provides comfort for people in search for cognitive ease and coherence.

Dr. Kahneman explains[12]
The illusion that one has understood the past feeds the further illusion that once can predict and control the future. These illusions are comforting. They reduce the anxiety that we would experience if we allowed ourselves to fully acknowledge the uncertainties of existence. We all have a need for the reassuring message that actions have appropriate consequences, and that success will be reward wisdom and courage.
In the same context, people who insist on “contractionary forces” have been misled by the consistency bias or the error of remembering past environment and behavior as supposed to resemble today.

Money does not exist in a vacuum.

While consumer price inflation may not be apparent yet, what has been conspicuous has been a global asset boom. In short, monetary expansion has led to a global asset boom or global asset inflation.

In the recap of wold markets, Doug Noland in his Credit Bubble Bulletin[13] captures it best:
Various recent headlines support my “right tail” analysis:  “Record-setting Year for Corporate Debt;”  “Record Year for Junk Bonds;” “Mortgage Bonds Soar on Fed’s Refinance Push;”  “[Corporate] Sales Approaching $4 Trillion in Stimulus Repast; “A Banner Year For Riskiest Debt;” “Fourth-Quarter M&A Surge Spurs Optimism..;” “Leveraged Loan Volume: $456bn in 2012, Thanks to Torrid Fourth-Quarter Market.”
The fact of the matter is, in restating Newton’s third law of motion, for every episode of inflation, there will be an equal and opposite dimension of deflation. This is known as the business cycle or bubble cycles.

Unfortunately policymakers have been attempting to prevent market from clearing, which is why the intensifying recourse on activist monetary policies.

The Psychological Impact of the Inflationary Boom

It is important to point out that inflationary boom materially affects people’s psychology and their corresponding actions.

From the behavioral finance perspective, people’s seduction to the inflationary boom can be imputed to the some of the following cognitive biases:

Outcome bias. Where people judge past decisions based on the outcome and not based on the quality or soundness of the action which led to such outcome. The Outcome bias, writes Nobel laureate Professor Daniel Kahneman, “leads observers to assess the quality of a decision not by whether the process was sound but by whether its outcome was good or bad”[14].

Halo Effect. The outcome bias prompts people to bear overall impressions or generalized conclusions or the Halo Effect. Professor Kahneman describes such cognitive bias as the “tendency to like (or dislike) everything about a person—including things you have not observed”[15]. Thus, if you like the president’s politics, Prof Kahneman analogizes, then the likehood is that you would also his voice and appearance.

Applied to the recent boom, whether one relates to the economy or politics, the current quasi-euphoric environment has been viewed by the public as having been hunky dory or as having been sanitized of risks and or that every political act by the current administration seems like King Midas.

Regression to the mean. Extraordinary may transform to mediocre performance and vice versa. Because it has been intuitive or innate for people to search for casual explanations, the idea of luck determining outcome has instinctively been rejected.

Again Dr. Kahneman[16] 
When our attention is called to an event, associative memory will look for its cause-more precisely; activation will automatically spread to any cause that is already stored in memory. Casual explanations will be evoked when regression is detected, but they will be wrong because the truth is that regression to the mean has an explanation but does not have a cause.
Feedback. I have always stated that everyone’s a genius in a bullmarket. That’s because intuitive experience mostly based on false causation, tends to get reinforced by the policy induced distorted pricing mechanism.

In George Soros’ reflexivity theory[17], the current stage of the boom bust cycle encapsulates the transition of the boom phase, specifically from the growing conviction resulting in the widening divergence between reality and expectations, and the flawed perception which eventually leads to the climax—all reinforced by the manipulated price mechanism. 

Substitution. Pressed for the rigors of theory or empirics to prove one’s ingrained belief, the public impulse has been to resort to “generating intuitive opinion on complex matters”. In short, people substitute hard questions with related but easier to answer question based on heuristics. This is how non-sequitor arguments are triggered and employed.

Again Dr. Kahneman explains[18],
When called upon to judge probability, people judge something else and believed that they have judged probability
Affect Heuristics. The feedback mechanism between prices and intuitive experience leads to the strengthening of convictions.

For instance in the deepening of a bullmarket, contrarian opinion will increasingly be rejected and treated as heresy. People will increasingly rely on group behavior for confirmation of their beliefs

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Affect heuristic essentially deals with the emotional attitude of people when their beliefs are confronted with the tradeoff between cost and benefits.

Again Dr. Kahneman[19],
If you dislike any of these things, you probably believe that the risks are high and its benefits negligible.
As markets segue into periods of excessiveness, people’s biases will increasingly be driven by their risk taking appetite. Pollyannas will markedly overestimate on the benefits of stock market investing while distinctly underestimate the risks.

The bottom line is that the inflationary boom compounds on the many psychological errors of the public that aggravates volatility, escalates risk taking activities, i.e. what the public reads as “greed”, and sadly, eventual losses (bust).

But for the meantime, the public’s desire to placate the brain’s dopamine “pleasure chemical” neurotransmitter[20] via an orgy of speculations has made the inflationary policies quite popular.

To quote the great Austrian economist Ludwig von Mises[21], (bold mine)
The boom produces impoverishment. But still more disastrous are its moral ravages. It makes people despondent and dispirited. The more optimistic they were under the illusory prosperity of the boom, the greater is their despair and their feeling of frustration. The individual is always ready to ascribe his good luck to his own efficiency and to take it as a well-deserved reward for his talent, application, and probity. But reverses of fortune he always charges to other people, and most of all to the absurdity of social and political institutions. He does not blame the authorities for having fostered the boom. He reviles them for the inevitable collapse. In the opinion of the public, more inflation and more credit expansion are the only remedy [p. 577] against the evils which inflation and credit expansion have brought about
Key Factors for 2013 

Pattern seekers should be concerned that the Phisix bullmarket may have reached a potential stage of maturity—the aging of the bubble.

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The previous secular bullmarket cycle evolved around 11-12 years. Today’s bullmarket is about 10 years old. If the past will make a replay, then the Phisix must be or will likely enter a blow-off phase soon.

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From the regression to mean, we are hardly seeing the same phenomenon as the 1986-1996 cycle.

Average returns from 1985 to 2012 or over 27 years is about 26% based on the annual nominal local currency. The first cycle (1985-1996) generated 50% nominal returns yearly. This cycle (2003-2012) has yielded only 23.61%, still distant from the 27 year average or from the post martial law first cycle.

This is NOT to suggest that the Phisix will need to repeat the returns of the first cycle boom, whose environment has been immensely distinct from today’s cycle. The Philippines then emerged from economic stagnation, high inflation, a debt moratorium[22] and from the clutches of the two decades of dictatorship.

But if the 27-year average should come into play, then this means that the Phisix will need to deliver far greater returns than 2012, particularly 47.45% for 2013, just to reach the mean. This assumes that the Phisix boom ends next year, which I doubt.

But I am not dependent on patterns, nor do I rely on numerical averages. In addition, this bullmarket cycle will be determined not by media and mainstream pontificating on political self-righteousness, but from the feedback loop of policymaking and the market’s response on them.

As I have written in my New Year’s edition on 2011 and 2012[23], the same dynamics that shaped the markets then will remain in play for this year:
1. Monetary authorities of developed economies will fight to sustain low interest rates.

2. More Inflationism: Bailouts and QEs To Continue

3. Effects of Divergent Monetary Policies

4. The Globalization Factor
I may add a fifth variable: other forms of financial repression via regulatory controls: capital controls, price controls, border controls, and bank-capital regulations.

Let me repeat: the direction of the Phisix and the Peso will ultimately be determined by the direction of domestic interest rates which will likewise reflect on global trends.

Global central banks have been tweaking the interest rate channel in order to subsidize the unsustainable record levels of government debts, recapitalize and bridge-finance the embattled and highly fragile banking industry, and subordinately, to rekindle a credit fueled boom.

Yet interest rates will ultimately be determined by market forces influenced from one or a combination of the following factors as I wrote one year back[24]: the balance of demand and supply of credit, inflation expectations, perceptions of credit quality and of the scarcity or availability of capital.

For the moment, most of the monetary expansion has been absorbed by financial markets which will likely remain so until at least the first quarter of 2013.

While most central banks, including the BSP, foresees prolonged era of low interest rates, such prospects are mere guesswork.

Authorities understand that there has barely been any penalty for miscalculations, for policy mistakes and or for portraying an environment favorable to the incumbent political masters.

Moreover, crises have provided ripe opportunities for governments to exercise more control over society: the former Obama’s Chief of Staff Rahm Emmanuel (today’s Mayor of Chicago) famous quote resonates “This crisis provides the opportunity for us to do things that you could not do before."[25]

In short, authorities have been motivated or incented to produce social policies that have popular short-term effects at the expense of the future, because such policies provide intertemporal benefits to the political class: A boom projects an aura of political success that generates votes, while a crisis provides an opportunity for expanding social controls using social justice as pretext. Said differently, for many a boom makes one feel good for the taxes one pays, a bust will mean more taxes, whether you like it or not.

The knee jerk nostrums of implementing the Babel of regulations and controls has only fostered more unintended consequences and has provided benefits to those with political connections.

Two examples, one Basel Accord and the US Dodd Frank

From the Bloomberg[26],
The first Basel agreement on global banking regulation, adopted in 1988, was 30 pages long and relied on simple arithmetic. The latest update, known as Basel III, runs to 509 pages and includes 78 calculus equations…

The Securities Industry and Financial Markets Association, another lobbying group, estimates that regulators will end up writing 29,000 pages of directives once Dodd-Frank is completely in place.
Complexity of rules translates to more lobbying, more revolving door relationships, more corruption, regulatory arbitrage and other unethical relationships (sex power and moolah), which works in favor of those firms who can afford such political horse trading, while at the same time works at the expense of small companies who can’t play the insider’s game.

The recent controversial US Fiscal cliff deal is an example of a supposed crisis in the making that ended up with economic concessions for the politically connected[27] and essentially pushed back any reforms on government spending. This means more political struggles ahead (as the debt ceiling debate nears) and equally more interventions by the US Federal Reserve as insurance against default.

This validates my recent view of the US fiscal cliff[28],
Nonetheless any deal reached by the two houses of Congress will likely be cosmetically in favor of increasing taxes, as against farcical spending cuts where the latter will likely be premised on growth rates rather than real cuts.

Three, watch the actions of FED which will increasingly become President Obama’s major instrument for obtaining statistical economic growth, as well as, the actions of the Fed’s major collaborator, the ECB. Both of whom will likely aggressively employ balance sheet expansions that may get reflected on gold and other commodity prices.
This, despite the blarney as revealed by the FOMC minutes of the supposed dissension by growing number of FED board members of the bond buybacks for 2013. This, for me, serves as another Poker bluff[29] by the Fed.

And since there will hardly be any genuine reforms to encourage the growth of the business environment, which serves as the real source of real wealth, global and local political authorities increasingly have been resorting to central banking activism to conceal on their policy shortcomings. 

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For instance despite the seeming newfound tranquillity in the Euro area and in Japan, all these have represented mirages as consequence of government and central banking prestidigitation. Example, Spain’s stealth use of her Social Security Reserve Fund[30] as buyer of Spanish government bonds may have helped in bringing down sovereign yield.

Dr. Ed Yardeni rightly notes of the magic wand from ECB’s Mario Draghi in the collapsing yield[31]:
These extraordinary declines weren't triggered by any improvement in the sorry state of state finances in the euro zone. Rather, they started when ECB President Mario Draghi declared in late July of last year that he would do “whatever it takes” to defend the euro, including buying the sovereign notes of euro zone governments. So far, the ECB hasn’t had to do much to back up Draghi’s declaration. His willingness to implement unlimited “outright monetary transactions” (OMT) has worked wonders.

Draghi’s fairy dust also stopped the massive capital outflows out of Spain and Italy into Germany, as evidenced by the flattening of TARGET2 balances since last summer. Among the best-performing stock markets last year were the ones in the euro zone: Greece (33.4%), Germany (29.2), Ireland (17.1), and France (15.2).
Eventually, the current boom will get out of hand, which will be manifested through rising interest rates, which the mainstream vernacular will call “economic overheating” or may be upset by micro political-economic factors, such as the resurfacing of the solvency or credit quality issues of crisis stricken nations as the above.

Governments then will reattempt to force down rates, using downside volatility to justify such actions.

Yet such inflationism will likely spillover serially to price inflation, where the feedback loop of fighting inflation with more inflation leads to greater price inflation, or eventually market turbulence based on stagflation.

Here, the more governments rely on central banks to financial their requirements via debt monetization, the greater the risks of price inflation[32].

Expect Greater Volatility in 2013

For 2013, I expect the current global financial market boom to persist until at least the first quarter. The same dynamic should apply for the Philippine Phisix and the Peso.

Everything else after will depend on the direction of interest rates which will signify as manifestations of the market’s response to social policies and vice versa.

In short, expect markets to be fluid and highly, if not wildly, volatile. So far volatility has been on the upside.

For the Phsix, if domestic interest rates continue to remain low, perhaps we may see a blowoff phase (Phisix 8,000-8,500???) by the yearend.

Such boom may be compounded by the acceleration of capital flight into ASEAN from developed economies whose central banks have been massively expanding their balance sheets such as Japan whose outflows to Emerging Markets have been ballooning[33].

In addition, the regional and local stock market boom may likely be accompanied by the intensification of the credit financed bubble in the property sector in the real economy mostly bankrolled by the banking system.

On the other hand, if interest rates begin to marginally rise, then the Phisix may underperform or fall below consensus expectations via meagre (single digit) or even negative returns.

Nonetheless, for as long as the inflationary boom remains, I also expect a rotation towards last year’s laggards: the mining sector and possibly the service industry.

Finally it would be naïve to see lagging gold prices as underperforming. This would tantamount to the ticker tape mentality.

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Despite falling short of my expectations, gold prices which I suspect has recently been subjected to politically orchestrated attacks have risen for the 12th straight year in 2012[34] in US dollar.

Although, so far, with the exception of gold, no trend has moved in a straight line, so it would be natural for gold to undergo a year of negative returns.

Nonetheless all these will also depend on the actions of monetary authorities.

In the fullness of time, markets eventually exposes on the façade erected by politically instituted controls.

I will close this week’s outlook with another noteworthy quote from the great Professor von Mises[35],
The masses, the hosts of common men, do not conceive any ideas, sound or unsound. They only choose between the ideologies developed by the intellectual leaders of mankind. But their choice is final and determines the course of events. If they prefer bad doctrines, nothing can prevent disaster.
For as long as the public continues to genuflect on the altar of politics, crises are inevitable.





[3] Christopher Chabris and Daniel Simons Invisible Gorilla Invisiblegorilla.com


[5] Daniel Kahneman, Thinking, Fast and Slow Farrar Straus and Giroux p. 104

[6] Central Bank News Global Monetary Policy Rate Index Interest Rates



[9] Malaya Business Insight BSP to keep rates low January 4, 2013



[12] Kahneman, Op. cit., p.204-205

[13] Doug Noland 2012 In Review December 28, 2012 Credit Bubble Bulletin PrudentBear.com

[14] Kahneman, Op. cit., p.203

[15] Ibid. p.82

[16] Ibid. p.182

[17] George Soros, Reflexivity in the Stock Market, The Alchemy of Finance p.58 John Wiley & Sons

[18] Kahneman, Op. cit., p.98

[19] Ibid. p.103




[23] See What To Expect in 2012, January 9, 2012


[25] Wall Street Journal In Crisis, Opportunity for Obama November 21, 2008





[30] Wall Street Journal Spain Drains Fund Backing Pensions, January 13, 2013

[31] Ed Yardeni Europe, January 3, 2013



[34] James Turk Gold rises for the 12th consecutive year January 2, 2013 Goldmoney.com

Saturday, January 05, 2013

Video: How the Pricing System Works

Duke University Prof. Michael C. Munger, in the following video from LearnLiberty.org, explains how the price system works


To quote the great Austrian economist Friedrich von Hayek
We must look at the price system as such a mechanism for communicating information if we want to understand its real function — a function which, of course, it fulfils less perfectly as prices grow more rigid. (Even when quoted prices have become quite rigid, however, the forces which would operate through changes in price still operate to a considerable extent through changes in the other terms of the contract.) The most significant fact about this system is the economy of knowledge with which it operates, or how little the individual participants need to know in order to be able to take the right action. In abbreviated form, by a kind of symbol, only the most essential information is passed on and passed on only to those concerned. It is more than a metaphor to describe the price system as a kind of machinery for registering change, or a system of telecommunications which enables individual producers to watch merely the movement of a few pointers, as an engineer might watch the hands of a few dials, in order to adjust their activities to changes of which they may never know more than is reflected in the price movement.

More Signs of Japan’s Capital Flight

I propounded in March of 2012 that the Bank of Japan’s inflationist policies will prompt for capital flight via carry trades, which will be disguised as FDI’s and portfolio flows into ASEAN and the Philippines:
The foremost reason why many Japanese may invest in the Philippines under the cover of “the least problematic” technically represents euphemism for capital fleeing Japan because of devaluation policies—capital flight!…

Japan’s investments in ASEAN do not seem to be country specific, but more of a regional dynamic. Or that the Japanese probably hedge their ASEAN exposure by spreading their investments throughout the region.
Signs of such capital flows I have noted here in July 2012

But the yen carry trade may not just be limited to ASEAN but to the emerging market space.

A report from Reuters partly affirms my prognosis: (bold mine) 
JP Morgan analysts calculate that EM-dedicated Japanese investment trusts, known as toshin, have seen inflows of $7 billion ever since the U.S. Fed announced its plan to embark on open-ended $40-billion-a-month money printing.  That’s taken their assets under management to $67 billion. And in the week ended Jan 2, Japanese flows to emerging markets amounted to $234 million, they reckon. This should pick up once the yen debasement really gets going — many are expecting a 100 yen per dollar exchange rate by end-2013  (it’s currently at 88).

At present, the lion’s share of Japanese toshin holdings — over $40 billion of it — are in hard currency emerging debt, JP Morgan says (see graphic).


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But if developed central banks’ seemingly endless money-printing starts to significantly inflate emerging currencies again, local currency debt is likely to become more attractive.
BoJ's policies will inflate bubbles not just EM currencies and debts denominated in EM local currencies but in their respective stock markets, as well.
 
I’ll post an update of Japan’s capital flight into ASEAN once I get the updated data.

Quote of the Day: Central Banking Heroics Produced a Parallel Universe in 2012

Central banks proved, once again, the world’s hero.  Heightened fears that global central banks had largely expended their bullets were supplanted with childlike enthusiasm that they essentially retain unlimited ammunition.  And with traditional inflationary pressures well contained throughout much of the world, the view held that there was essentially little risk associated with extraordinary monetary stimulus.  Whether it was Europe, the U.S. or Japan, the risk vs. reward equation was viewed as strongly supporting aggressive central bank reflationary measures.  Along the way, global risk markets decoupled from fundamentals.  A critical facet of the “right tail” scenario unfolded before our eyes:  the historic Bubble strengthened and broadened – global risk market prices inflated and risk premiums deflated - even as the economic backdrop turned increasingly problematic.

The U.S. economy and corporate profits disappointed in 2012, while stock prices posted the strongest gains since the policy-induced rally of 2009.  The German economy disappointed, although slightly positive GDP equated with a 29% gain in the DAX equities index.  The French economy badly disappointed, so the CAC40 was limited to just a 14.6% advance.  The Italian economy faltered, yet stocks were up almost 8%.  Spain was a near disaster; stocks fell a mere 5%.  

The big divergence between fundamentals and stock prices was not limited to the U.S. and Europe.  India’s growth slowed sharply, while the Sensex Index gained about 26%.  The South Korean economy disappointed, although stocks almost posted double-digit gains.  Eastern European economies nearly fell prey to the European crisis, although most equities markets posted big advances for the year.  In Latin America, Brazil’s economy slowed markedly, although stocks gained 7%.  Argentina became a bigger mess, yet stocks were up 15%.  The resilient Mexican economy spurred a 17% advance in the Bolsa Index.

It is well worth noting the 2012 dynamic where growth slowed in the face of ongoing Credit excesses.  In this regard, Brazil and India were notable among major economies demonstrating late-cycle Credit dynamics.  In the “old days,” the confluence of rampant Credit expansion and waning economic expansion would have provoked destabilizing capital flight – and a rather abrupt end to booms.  But the new world paradigm is one of unlimited “quantitative easing” and currency devaluation from the world’s major economies.  This global Bubble Dynamic sees unleashed central banks promoting unleashed “developing world” Credit systems.  
This is from last week’s Credit Bubble Bulletin outlook by fund manager and outstanding financial analyst Doug Noland at the PrudentBear.com

Friday, January 04, 2013

Quote of the Day: How the Individual Becomes Part of the Crowd

A human group transforms itself into a crowd when it suddenly responds to a suggestion rather than to reasoning, to an image rather than to an idea, to an affirmation rather than to proof, to the repetition of a phrase rather than to arguments, to prestige rather than to competence
This quote is from classical liberal French journalist, author and philosopher Jean-François Revel (1924-2006)

Bob Farrell’s 10 Timeless Investing Guides

When in investing in the financial markets, particularly in the stock markets, there are times which necessitates contrarian positioning and their are occasions which require crowd following.

Retired wall street veteran and stock market guru Bob Farrell in his 10 “Market Rules to Remember” lays out when we should assume on such positions: (bold mine)
1. Markets tend to return to the mean over time
2. Excesses in one direction will lead to an opposite excess in the other direction
3. There are no new eras — excesses are never permanent
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
5. The public buys the most at the top and the least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend
9. When all the experts and forecasts agree — something else is going to happen
10. Bull markets are more fun than bear markets.
Explanations of the above can be found in Stockcharts.com, Investment Postcards and Marketwatch.com 



Poker Bluffing FOMC: Probable Stop in Bond Buying

Here we go again. Authorities of the US Federal Reserve in an implicit pabulum about “exit strategy”.

From Yahoo news:
The Federal Reserve will keep buying bonds indefinitely to try to keep long-term borrowing costs low. It's just not clear how long indefinitely will be.

Minutes of the Fed's last policy meeting show that officials were divided about when to halt the purchases.

Some of the 12 voting members thought the bond purchases would be needed through 2013. Others felt they should be slowed or stopped altogether before year's end. This group worries that the bond buying is keeping rates so low for so long that it could ignite inflation or encourage speculative buying of risky assets.

The Fed last month ended up approving open-ended purchases of $85 billion a month in Treasurys and mortgage bonds to replace an expiring bond-purchase plan and maintain its level of purchases.

The minutes covered the Fed's Dec. 11-12 meeting. In a statement after the meeting, the Fed said it planned to keep a key interest rate at a record low even after unemployment falls close to a normal level — which it said might take three more years…

The minutes showed that "several" Fed policymakers thought the bond buying should probably stop well before 2013 ends.
They babbled about “exit strategy” in 2010. They tattled of withholding QE 3.0 in 2011.
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At the end of the day: the US Federal Reserve ended up with the opposite: escalation of their balance sheet via increasing asset purchases (chart from Cleveland Federal Reserve).

That’s why I call them the Poker Bluffing Fed.

A ‘probable end’ to bond buying translates to higher interest rates.

This will mean more than just ideology, this entails how the Fed authorities views the world and their path dependent ways of implementing policies (solving problems) in accordance to such purview: particularly demand based management, the wealth effect and the portfolio balance channel.

Of course, higher interest rates will likely ruffle or pummel financial markets severely which monetary authorities have been so sensitive to protect. 

These include the stock markets which has been Fed Chair Ben Bernanke’s once held basic creed for ‘smart’ central banking, and the bond markets where the US government—as well as global governments—and key US and international financial institutions have substantial exposures, if not deep dependency, on credit easing policies.

Just to give a few examples:


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The opaque derivatives markets have been mostly anchored on interest rate based derivative contracts whose maturity has been shortening.

Interest rate contracts have become increasingly short-term in recent years. Notional amounts of contracts with maturities of more than five years fell by 9% in the first half of 2012 to $117 trillion, or 24% of total interest rate contracts. By contrast, the volume of contracts with a maturity of up to one year went up by 4% to $207 trillion, or 42% of the total. In the mid- and late 2000s, longer-term contracts accounted for up to 35% of all interest rate contracts.
Higher interest rates would likely increase the counterparty and default risks for the humongous derivatives market.

The recovering US real estate market has also been latched to recent low interest and credit easing policies by the US Federal Reserve


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Given that the Fed holds substantial mortgage securities and where the Government Sponsored Enterprises (GSEs) account for 99.5% of the mortgage market, a possible rise in interest rate will likely undermine their portfolio holdings (of the Fed and the GSEs) at the taxpayer’s expense (chart from Freddie Mac)

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Also, given that the US Federal Reserve has financed practically 61% of US treasury debt in 2011, a desistance of support by the US Federal Reserve on US treasury debt enhances the risks of a debt default by the US government. 

US Treasury securities held by the FED has been programmed to grow through the recently implemented QE 4.0 (chart from the St. Louis Federal Reserve)


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Likewise, given that publicly held debt by the US will continue to expand, higher interest rates possibly means amplified credit and rollover risks for the US government. (charts from the Heritage Foundation)

Of course foreign currency swaps, the marked difference between total bank deposits and loans in the US banking system, devaluation as an official policy, and many other factors have become dependent on the backings and credit easing policies of the US Federal Reserve.

Thus the (possible histrionic) dissension among FED authorities may be interpreted as the following possibilities:

-trial balloon to see how financial market responds (yes commodities down, but stock markets losses were marginal so far),

-spur of the moment sentiment by Fed authorities that will easily shift once downside volatility resurfaces

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-an attempt to manage or control “inflation expectations” via indirectly targeting commodity prices. Gold prices bore the brunt while the US dollar rallied from yesterday’s announcement. This could also be part of the surreptitious design to suppress gold prices

Yes current policies are unsustainable. But FED authorities are unlikely to tergiversate on the direction of policymaking which has been adapted by almost every central banker around the world since 2008.

To repeat, authorities of developed economies whom has embarked on credit easing policies via ZIRP and balance sheet expansions account for 95% of the USD 98.4 trillion global bond markets, where 45% of the share of the bond markets are government bonds.

The bottom line is that current credit easing policies have been deeply intertwined or embedded with the interests of the status quo or particularly the political-economic cartel of the welfare-warfare state, crony banks and central banking.

Authorities of the FED will most likely evade the responsibility from the financial market bloodbath or meltdown that may ensue once interest rate substantially rises.  And like Pontius Pilate, they will likely be washing their hands and leave tightening to the marketplace.

Thursday, January 03, 2013

Unintended Consequences from the French Financial Tax Experiment

Desperate governments scrounging for money via more taxes and regulations (financial repression) have been getting an unexpected pushback from the marketplace.

From Businessinsider.com (bold original)
One suggestion that has gained popularity in the post-crisis regulatory debate is a tax on financial transactions.

Proponents suggest that the tax would raise revenues for governments (at a time when such revenues are badly needed) and curb the excessive speculation that contributed to the global financial crisis.

In August 2012, France became the first eurozone nation in the wake of the financial crisis to implement such a tax, and so far, it's been a total failure.

In an article for Risk.net, Hannah Collins explains that in France, the tax – which amounts to 0.2 percent on transactions involving buying or selling of shares of stock – is actually just shifting investors out of equities and into even riskier, more opaque products like derivatives and derivatives-based ETFs:

Investors who own French shares are selling them and taking positions on them through derivatives instruments such as contracts for difference, structured products and ETFs, according to a Paris-based lawyer. "Most structured transactions remain outside the tax," he says. "It is due only if you have actually purchased the shares."

In other words, instead of curbing excessive speculation, the tax is simply forcing those speculative activities into darker, less-regulated corners of the market.
People’s incentives to act are also shaped by social policies.

Instead of moving in accordance to the intended goals set by politicians, the financial markets resort to regulatory arbitrage—finding legal loopholes from the new legislation from which to operate on.

And the incentive to reduce transaction costs by eluding the Financial Transaction tax would likely extrapolate to the nurturing of shadow derivatives-banking system where in this case has been signified as driving “investors out of equities and into even riskier, more opaque products like derivatives and derivatives-based ETFs”.

In short, politicians create or spawn their own Frankensteins.

The Fiscal Cliff Deal and Crony Capitalism

Yesterday’s bipartisan last minute “Fiscal Cliff deal” exhibits or signifies an example of the unjust and immoral distribution of political-economic privileges (which favors those with political connections or the political class)

From ABCNews.go.com (hat tip Zero hedge)
The “fiscal cliff” compromise has been heralded as a saving grace for middle class taxpayers, their families and the unemployed.

But buried in the fine print of the 150-page deal are also some lesser-known New Year’s gifts to some of Washington’s favorite industries.
So what industries are these?

From the same article (bold original)
$430 million for Hollywood through “special expensing rules” to encourage TV and film production in the United States.  Producers can expense up to $15 million of costs for their projects.

$331 million for railroads by allowing short-line and regional operators to claim a tax credit up to 50 percent of the cost to maintain tracks that they own or lease.

$222 million for Puerto Rico and the Virgin Islands through returned excise taxes collected by the federal government on rum produced in the islands and imported to the mainland.

$70 million for NASCAR by extending a “7-year cost recovery period for certain motorsports racing track facilities.”

$59 million for algae growers through tax credits to encourage production of “cellulosic biofuel” at up to $1.01 per gallon.

$4 million for electric motorcycle makers by expanding an existing green-energy tax credit for buyers of plug-in vehicles to include electric motorbikes.
Unnamed in Washington’s favorite industries is Warren Buffett’s Burlington Northern Santa Fe who will be one of the major beneficiaries (perhaps compensation for being Obama's mouthpiece).

Add to the above:
Wind farms, motorsports tracks, global banks and other businesses won revived tax breaks in a $75.3 billion package included in a last-minute budget deal Congress passed yesterday… (Bloomberg)
Political power blocks, special interest groups and pet projects of politicians accounts for as the main beneficiaries of the latest fiscal deal.

The above hardly has been about "unregulated capitalism", but about cronyism via state capitalism or participatory fascism

As Professor Thomas DiLorenzo at the Mises Institute aptly described
It is a system of crony capitalism financed by a central bank, government borrowing, and pervasive taxation. It is a system that is of plutocratic elites, for plutocratic elites, and by plutocratic elites (to paraphrase Abraham Lincoln, the true founding father of this system). The massive welfare state is merely used to buy enough votes to maintain the “legitimacy” of the system.

Vatican’s Scapegoating Capitalism

The easiest way of blaming social evils has been to bash capitalism. 

A good example has been the recent New Year homily by the Catholic Pope Benedict XVI who condemned “unregulated capitalism” for sowing “hotbeds of tension and conflict caused by growing instances of inequality between rich and poor” due to "the prevalence of a selfish and individualistic mindset which also finds expression in an unregulated financial capitalism” (BBC)

In the eyes of the Pope, the world operates on unregulated or unfettered individualism. 

In reality, the world is being suffocated by mounting regulations that has essentially been shifting the balance of social power from the markets to politicians.

Proof?

In 2012, in the US 29,000 laws came into existence in the state laws with more coming.

From CNBC.com
In 2013 in Illinois, motorcyclists will be able to "proceed through a red light if the light fails to change." In Kentucky, releasing feral or wild hogs into the wild will be prohibited. And in Florida, swamp buggies will not legally be considered motor vehicles.

On Jan. 1, as crowds of people toast to a new year, more than 400 news laws across the country will take effect — and possibly improve life for some.

"The laws that state governments deal with are really the laws that impact people on a daily basis," said Jon Kuhl, a spokesmanfor the National Conference of State Legislatures, which tracks the bills. "Whether amending or updating laws or enacting brand new legislation, it was an active year."

In addition to the new laws of 2013, more than 29,000 laws were passed by state legislatures this year, Kuhl said. Many dealt with healthcare, education, gay rights, child safety and the Internet.
And that’s aside from Federal laws. (MSNBC estimates the above at 40,000 laws including federal)

Another fact is that US tax code has ballooned from 400 to 72,000 words.

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As Voxxi notes (chart theirs)
We have more professional tax preparers in the United States than law enforcement officers (765,000) and professional firefighters (310,400) combined.

But we need them. Consider this: in  1913, we had 400 pages of federal tax code in law. Today, its more than 72,000 pages.

Fear of being audited has led to this boost in tax preparers.
In short lobbying, tax avoidance, corruption and other means to influence political institutions to acquire favorable treatment becomes the commonplace operations.
 
And the above is just a segment of the overall political picture.

In other words, the Pope got his perverted idea of social malfeasance backward. Either the Pope has been misinformed or has not been forthright.

The Pope only needs to see how government debt levels in developed countries has been skyrocketing and how central banks have been bailing out the the privileged bankers. This has hardly been a function of individual-market based greed but of greed by those in power and their cohorts.

What the Pope and the Vatican seem to really rebuke hasn't been unregulated capitalism but state capitalism, corporatism or cronyism.

Yet in truth, individuals are not innately evil. It is mainly political power that debauches morality.

As the great John Emerich Edward Dalberg-Acton, 1st Baron Acton, popularly known as Lord Acton [Online Library of Liberty] pointed out
I cannot accept your canon that we are to judge Pope and King unlike other men, with a favourable presumption that they did no wrong. If there is any presumption it is the other way, against the holders of power, increasing as the power increases. Historic responsibility has to make up for the want of legal responsibility. Power tends to corrupt, and absolute power corrupts absolutely. Great men are almost always bad men, even when they exercise influence and not authority, still more when you superadd the tendency or the certainty of corruption by authority. There is no worse heresy than that the office sanctifies the holder of it.
I am inclined to think that institutions like the Catholic church have used capitalism as convenient scapegoats when they are underfire, i.e. to deflect on the raging controversies, such as charges of institutional corruption and sexual abuse  which like the Australian Catholic Church admits and apologized.

Is it not that the Bible warned that “He that is without sin among you, let him first cast a stone”? (John 8:7)

Does this not apply to the Vatican too?

Quote of the Day: Price controls Create a Population of Liars

Economists are trained in theory, statistics, modeling, and other skills. Historians are trained in the careful scrutiny and interpretation of historical sources. Neither economists nor historians, unfortunately, are trained to use common sense in their work. Postwar proponents of the reimposition of price controls have often pointed to the success of such controls during the war. Yet, despite thousands of employees and an army of volunteer monitors associated with the Office of Price Administration and despite the U.S. Attorney General’s prosecutory zeal in hauling alleged violators into court, the government’s price-control efforts during World War II failed to stem the tide of rising prices set in motion by the huge contemporary increases in the money stock.

Price controls, at most, only create a population of liars. True prices continue to do what the existing economic conditions cause them to do. No one can control the amount of precipitation by passing a law against reporting more than a stipulated amount of rain and snow.
This is from Austrian economist Robert Higgs at the Independent Institute on the evils of Price Controls

Tuesday, January 01, 2013

Quote of the Day: To Achieve Liberty, Envy and Intolerance have to be Overcome

To achieve liberty and peace, two powerful human emotions have to be overcome. Number one is "envy" which leads to hate and class warfare. Number two is "intolerance" which leads to bigoted and judgmental policies. These emotions must be replaced with a much better understanding of love, compassion, tolerance, and free market economics. Freedom, when understood, brings people together. When tried, freedom is popular.

The problem we have faced over the years has been that economic interventionists are swayed by envy, whereas social interventionists are swayed by intolerance of habits and lifestyles. The misunderstanding that tolerance is an endorsement of certain activities, motivates many to legislate moral standards which should only be set by individuals making their own choices. Both sides use force to deal with these misplaced emotions. Both are authoritarians. Neither endorses voluntarism. Both views ought to be rejected.

I have come to one firm conviction after these many years of trying to figure out "the plain truth of things." The best chance for achieving peace and prosperity, for the maximum number of people world-wide, is to pursue the cause of LIBERTY.

If you find this to be a worthwhile message, spread it throughout the land.
This excerpt is from the stirring farewell speech by Ron Paul at the US Congress

Monday, December 31, 2012

Happy 2013!

Wishing you the best of 2013!!!

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(updated to add: I would like to thank my daughter for the image above)

Live life. Love Liberty. Love life.

Quote of the Day: The Illusions of Pundits

People who spend their time, earn their living, studying a particular topic produce poorer predictions than dart-throwing monkeys who would have distributed their choices evenly over the options. Even in the region they knew best, experts were not significantly better than non-specialists.

Those who know more forecast very slightly better than those who know less. But those with the most knowledge are often less reliable. The reason is that the person who acquires more knowledge develops an enhanced illusion of her skill and becomes unrealistically overconfident. “We reach the point of diminishing marginal predictive returns for knowledge disconcertingly quick,” Tetlock writes. (Philip E. Tetlock, University of Pennsylvania in 2005 book Expert Political Judgment: How Good is It? How Can We Know?—Prudent Investor) “In this age of academic hyperspecialization, there is no reason for supposing that contributors to top journals—distinguished political scientists, area study specialists, economists, and so on—are better than journalists or attentive readers of the The New York Times in ‘reading’ emerging situations”. The more famous of the forecaster, Tetlock discovered, the more flamboyant the forecasts. “Experts in demand,” he writes, “were more confident than their colleagues who eked out existences far from the limelight.”
The above quote is from 2002 Nobel laureate psychologist and professor Daniel Kahneman in his insightful book Thinking, Fast and Slow p.219

There are many reasons not to trust pundits, aside from overconfidence, which essentially oversimplifies human action.

I believe that the substantial chunk of “expert errors” emerge from the influences of conflict-of-interest relations, particularly the principal-agent problem, where “experts” tend to promote the interests of employers, sponsors, donors, grant providers and or even political agents (perhaps through implicit ambition to be part of the political institution) whom are sources of the self-interests of such pundits.

Forecasting inaccuracies may also be linked to the rigid application of ideology and or on the overreliance on math models (scientism).

Add to this the desperate desire by “experts” to attain social acceptance via social signaling.  Such would include making extreme (media attracting) projections or providing the veneer of expertise on what truly is about populism—forecasting based on what is popular, or as I previously wrote 
For many, thus, expertise signify more as social signaling (posturing or seeking social acceptance) and or “telling people what they want to hear” but predicated on certain technically based paradigms which produces an aura of supposed superiority rather than representative of the true domain knowledge.
Dr. Kahneman suggests that to determine “true expertise” from merely displays of the “illusions of validity”, one should identify conditions where pundits have excelled in “an environment that is sufficiently regular to be predictable” and from their having “to learn these regularities through prolonged practice” (p 240). In short, in an unpredictable world, expert opinion should be less trusted.

However by simply associating expertise with “regularity” and “prolonged practice” seems to contradict logically his earlier critique of pattern seeking behavior (which is about the human psychological propensity to seek regularity or constancy through patterns while at the same time underestimating the role of randomness). The nuance will be on the marginal efforts applied by practitioners via  “prolonged practice” in dealing with such regularities. 

The point is despite being able to minimize the influences of “expert or non-expert” intuition on decision making that may result to lesser degree of judgmental errors, behavioral economics/finance will not lead to omniscience or come close to solving the knowledge problem: a complex society will always be subject to irregularities and unpredictability from the dynamic and intricate feedback mechanism of human action and of environmental changes. Dr. Kahneman acknowledges this: "Errors of prediction are inevitable, because the world is unpredictable" (p. 220)

Nevertheless the best way to acquire “expertise” is primarily through investing in oneself