Quote of the Day: The Hemingway Law of Motion: Gradually, then Suddenly

Ernest Hemingway's 1926 novel The Sun Also Rises, which is available various places around the web like here, includes the following snippet of dialogue:

"How did you go bankrupt?" Bill asked.
"Two ways," Mike said. "Gradually and then suddenly."

Many economists will recognize this as a version of an apercu offered a number of times over the years by the prominent macroeconomist Rudiger Dornbusch, who liked to say (for example, in this interview about Mexico's economic crisis in the 1990s):

"The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought."

What I am dubbing the Hemingway Law of Motion clearly has wide applicability. It's when the creaking of your back porch doesn't matter much, until the day you put a foot through the floor. It's when the cracks and rust on the bridge don't seem to matter, until the day the bridge goes down. It's the concern that you can see signs that the risk of a financial crisis or a stock market run, but little action is taken until the crisis is upon us. It's the concern that the costs and risks of climate change may look quite reasonable, until something large and perhaps irreversible happens all at once. 

The Hemingway Law of Motion is simultaneously a useful reminder in some cases and a rhetorical trick in other cases. It's a useful reminder that the world often isn't smooth and linear. Instead, the world full of tipping points and thresholds. When warning signs exist, they may not steadily rise to a predictably timed crescendo. Instead, those who interpret the warning signs correctly and take action will often look like alarmists, because if they act in time, the negative event never actually materializes--and so was it really necessary for them to make such a fuss in the first place?

The excerpt above including a quote from Mr. Rudiger Dornbusch is from the Conversable Economist blogger, editor, author and lecturer Timothy Taylor.

My version of this: drip, drip, drip then a flood or a slomo downhill before a collapse.

Has SNB’s actions functioned as the Causa Proxima for the Return of Global Financial Volatility?

More on Swiss National Bank’s pulling the plug on the franc-euro cap which I posted Thursday.

SNB’s governor Thomas Jordan on the discontinuation of the franc euro policy:

Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated substantially against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB has concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.

The Wall Street Journal Real Times Economic Blog provides a list of foreign exchange brokers which suffered heavy losses from the SNB’s actions.

-FXCM Inc., the biggest retail foreign-exchange broker in the U.S. and Asia, said in a statement that because of unprecedented volatility in the euro against the Swiss franc, clients’ losses left them owing it about $225 million and that it was trying to shore up its capital. 

-In the U.K., retail broker Alpari Ltd. entered insolvency after racking up losses amid the currency turmoil following the SNB’s decision. 

-Global Brokers NZ Ltd., which is registered in New Zealand, said it would close its doors as it could no longer meet regulatory minimum-capitalization requirements of 1 million New Zealand dollars ($782,500). The firm is connected to online currency trading websites Cashback Forex, Forex Razor and Excel Markets and appears to be owned by entities in the British Virgin Islands. 

-Japan’s Finance Ministry was checking on trading firms Friday after industry sources said the country’s army of mom-and-pop foreign exchange traders suffered big losses.

Oh by the way, Swiss stocks which collapsed 8.97% on Thursday, had a follow on 5.96% meltdown on Friday. For two days the SMI has lost 14.93%! 

Stock market crashes and sharp financial volatility have become real time events!

The Swiss equity bellwether has apparently diverged from many other European stocks where the latter has rallied strongly. Last week’s stock market bids have largely been anchored on next week’s highly anticipated full scale QE from the ECB.

Nonetheless here are some interesting commentaries from various experts.

Austrian economist Patrick Barron at the Mises Canada Blog says that Switzerland has implicitly abandoned the European Monetary Union (bold mine)

Oh. You didn’t know that Switzerland was part of the European Monetary Union? You thought that the Swiss used their own currency, the Swiss franc? In a definitional sense only, you are correct. Within its monopolized currency area, the political boundaries of Switzerland, the Swiss franc is legal tender. But for approximately three years the Swiss National Bank has maintained a Swiss franc to euro ratio of 1.2 francs per euro. The usual suspects, exporters, were the driving political force behind the SNB’s policy. They feared fewer sales to eurozone countries should the franc cost more in euro terms. This policy made the European Central Bank (ECB) the determinant of monetary policy in Switzerland and relegated the Swiss National Bank to the mechanical role of currency board. When the Swiss franc started to appreciate against the euro, meaning that buyers were willing to accept fewer than 1.2 francs per euro, the Swiss National Bank printed francs and bought euros. Over the last three years as demand for Swiss francs from euro holders increased, the SNB’s balance sheet exploded with new euro reserves. However, as the world now knows, in a surprise move the SNB abandoned its currency peg policy. Today the franc exchanges approximately one for one with the euro, meaning that the franc has appreciated by approximately twenty percent against the euro.

As far as I know the SNB has made no official announcement of the reason for its surprise move. I suspect that the Swiss people had made themselves heard that they feared inflation from the ECB’s imminent quantitative easing policy.  The Swiss gold referendum on November 30 would have required their central bank to hold a fixed percent of reserves in the form of gold. It was defeated only after the major political parties and the SNB amounted a concerted anti-referendum blitz. Still in control of their own currency, it was a relatively simple matter for Switzerland, in effect,  to veto the ECB’s proposed policy by abandoning the currency peg. This shows the rest of Europe that at least one nation does not fear returning to full control of its currency nor does it fear the consequences of a temporary drop in exports. (The drop will be temporary, because Swiss import prices will fall and eurozone users will be awash with depreciated euros and willing to pay more for the Swiss franc.)

The lesson is clear. If Switzerland can retake control of its money, so can any eurozone nation. The process may take longer, as the country reissues is own currency and re-denominates its bank accounts in local currency terms, but it can be done. Already there are reports that the Danish central bank is contemplating abandoning its currency peg of approximately 7.5 krone per euro.  If the sky does not fall on Switzerland and Denmark, other nations may follow. Does anyone know how to say deutsche mark?

To visualize on the explosion of euro reserves on the SNB’s balance sheets, as of November 2014, the SNB's balance sheet has swelled to 540 billion CHF and now accounts for 80% of GDP (chart from Danske).  

Austrian economist Frank Hollenbeck at the Mises Institute notes that the surprise SNB action has been intended to shield Swiss political economy from ECB’s forthcoming irresponsible actions (emphasis added)

In theory, the Swiss could have held the floor. To keep your currency from appreciating, all you need to do is print, print print. Of course, this printing is not without consequences. With this bold move, the Swiss have crossed the Rubicon. They cannot go back. They have in dicated to speculators there is a pain threshold, or monetary expansion, that the Swiss are not willing to bear. Any attempt to set a new floor would set up a one way bet for speculators.

By pegging your currency to that of a bigger neighbor, you are essentially letting your neighbor determine your monetary policy. Dubai fixed its currency, the dirham, to the dollar and imported the US’s excessive monetary policy which led to the same real estate bubble in Dubai as the bubble in the US. In other words, by fixing your currency, you have to follow your bigger neighbor’s irresponsible monetary policy.

With the increasing likelihood that the European Central Bank would violate the Maastricht treaty and purchase sovereign debt, the Swiss finally decided they had had enough. The talk now is that the ECB will purchase over a trillion euros worth of bonds. To keep the peg, the Swiss would have had to increase the money supply by the same percentage, which would have been irresponsible monetary policy for such a small country.

By letting the peg go, Switzerland did the right thing. It should now concentrate on eliminating most EU debt from its balance sheet. There is an EU storm brewing, and Switzerland will no longer be one of the innocent bystanders.

In an interview, American entrepreneur and financial commentator Peter Schiff said that the SNB has been the first central bank to "surrender" or to back away from them global ‘currency war’. 

The transcript of the interview from LewRockwell.com (bold mine)

“First of all, it’s not just the euro that collapsed. The US dollar collapsed almost as much. I think it was the right thing to do. I think it was a mistake for the Swiss to have adopted that peg in the first place. In fact, by abandoning the peg, they’re admitting it was a mistake, because now the Swiss franc has appreciated anyway, which was something the peg was designed to prevent. Now the Swiss National Bank has tens of billions of francs worth of losses on a 500 billion plus cash of euros and dollars that they’ve accumulated to defend that ridiculous peg. Of course, had they not ended it, the losses would have mounted. If Europe launches QE, they could have lost hundreds of billions of francs…

“Central bankers rarely admit their mistakes. What’s changed? It’s not necessary because it didn’t work. It was never necessary. They probably have a much greater supply now of euros and dollars on their balance sheet than they bargained for. The prospect of having to back up the toboggans and fill them full of euros was very daunting. So they abandoned this peg, thankfully for the Swiss… Swiss people are going to benefit. Look at the drop of oil prices in terms of Swiss francs. Prices are going to come down and the Swiss are going to be that much more prosperous because of a stronger franc…

“I think that is a mistake. I don’t think they need negative interest rates. I think that is taking some of the luster off of the franc. It would be even stronger had they not done that. But a strong currency is not a bad thing. A weak currency is a bad thing. Switzerland should take pride in the strength of its currency. Now they have to deal with the losses by trying to prevent it from rising. Of course, there have been some economic mistakes made in Switzerland and elsewhere, because of this monetary policy, that now have to be corrected. Unfortunately, these were needless mistakes that didn’t have to be made. I think a lot of people are now jumping to the conclusion that Europe is going to do a big QE program, and that’s why the Swiss are backing away. Without the Swiss, I think it makes it that much more difficult for Europe to do QE. So maybe they’re not going to be able to do it, because they no longer have the Swiss to support their currency. Maybe they’ll do some more substantive economic reforms instead. That would be a positive for Europe. I think that it could mean the US is the last central bank standing with QE, because I think we’re going to be doing QE4…

“I think that you’re going to see a complete breakdown in the confidence that people have for central banking over the next several years. The Swiss were saying, ‘Over my dead body. We will defend this peg to eternity.’ Then they went around and they didn’t do it. Of course, that’s generally what central banks do. They have to deny, deny, right up until the point where they do what they were denying they were going to do. I think you have a lot of confidence and trust and faith in central bankers. I think that bubble in central bank confidence is going to burst, is going to be shattered. Particularly when it comes to the confidence people have in the Federal Reserve and in Janet Yellen, because they’ve been talking about how great the US economy is. To anyone who has been payingattention to the statistics, this mirage of a recovery, this illusion is fading fast. I think instead of the promised recovery that Janet Yellen has been talking about, we’re going to have a relapse to recession. Instead of rate hikes, we’re going to have QE4. That’s going to be the end of their credibility…

We see the same concerns even in the mainstream. 

The stock market bullish fund manager David R. Kotok chairman of Cumberland Advisors Chairman suddenly seems skittish: (bold mine)

Markets can handle good news, and they can handle bad news. Markets have trouble, however, with uncertainty. The pressure on stock markets and the volatility that has spiked due to the SNB’s move are the results of rising uncertainty about the foreign-currency-denominated debt and abrupt changes in central bank policy.

The Swiss have punched new holes in their cheese. They have boiled their chocolate so that it smells bad. They committed to a course, reversed themselves, and have now lost their credibility. This is the second governor of the Swiss central bank who has suffered a loss of credibility. The first one had to resign because a member of his household was allegedly trading a foreign currency position against the euro peg. The second governor has derailed billions in loans and pressured his citizens through his unexpected policy change.

When one central bank loses its credibility, all central banks suffer. The burdens on the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England, and others have now intensified.

Finally, chief advisor to Allianz and economic commentator and author Mohamed El Erian, writing at the Financial Times says that the SNB’s actions looks like signs of widening cracks on the central bank induced low volatility environment: (bold added)

The implications of this historic policy turnround extend well beyond a period of bumpy economic and financial adjustment for Switzerland itself. They risk destabilising some other countries and decision-making in the neighbouring eurozone will become even more complicated and contentious.

Confirming the historical lesson that large currency moves tend to break things, they also highlight the extent to which central banks, operating in a world of growing economic and policy divergence, are struggling to maintain the paradigm of low market volatility that is central to their efforts to generate higher economic growth…

Following the abrupt removal of the currency peg, Switzerland is now looking at a period of bumpy economic and financial adjustment. Being a relatively “open economy”, in which trade and tourism play an important role, Swiss companies face a considerable competitiveness challenge ahead. The country will also have to deal with issues of currency mismatches, as well as having to battle larger, externally-induced deflationary forces.

But the implications extend far beyond Switzerland. Countries with Swiss franc denominated liabilities, such as Hungary, now have to deal with a major adverse valuation shock.

More importantly in terms of global systemic effects, politicians in the core economies within the eurozone — including Germany, Austria, Finland and the Netherlands — will see the SNB’s move as a reaffirmation of the dangers of substituting financial engineering for real economic reform. As such, they will be less willing to accommodate the hyperactivism of the ECB. And while this is unlikely to stop the ECB from doing more, it may increase the legal, reputational and unity risks it takes in doing so. 

Then there are the consequences for a global economy which, in the absence of a comprehensive policy response in the advanced world, has ended up overly reliant on central bank interventions. Given that their tools cannot reach directly and sufficiently at what holds back growth and jobs, these central banks have been forced to use the partial channel of financial asset prices to influence real economic outcomes.

To this end, central banks have sought to repress market volatility as a means of encouraging risk taking that would then boost asset prices and thus encourage greater household consumption (via the wealth effect) and corporate investment (via animal spirits). 

The SNB’s decision is further evidence that central banks are finding it harder to implement a policy of volatility repression that already was being challenged by the growing divergence in policy prospects between the eurozone and the US.

The ECB better deliver the highly expected "bazooka" next week because if not market volatility may return with a vengeance.

Yet has last week’s action by the SNB functioned as the causa proxima* for the return of global financial market volatility as the Swiss franc carry trade unravels that may lead to the breakdown of the euro and of bursting of the central banking confidence bubble?

*Causa Promixa is what historian Charles Kindleberger calls as "some incident that saps the confidence of the system" in Manias, Panics and Crashes p 104

SNB Abandons Swiss Franc Euro cap, Swiss Stock Market Crashes

In a world of central planning, all it takes to destabilize the markets is for authorities to succumb to their caprices.

The Swiss central bank, the Swiss National Bank, suddenly decides to end the 1.2 franc per euro cap.

From the Bloomberg:

The Swiss National Bank unexpectedly scrapped its three-year policy of capping the Swiss franc against the euro in a u-turn that may change the perception of a century-old institution known for reliability.

In a surprise statement that sent shockwaves through equities and currency markets, the central bank ended its cap of 1.20 franc per euro and reduced the interest rate on sight deposits, deepening a cut announced less than a month ago.

The shift marks an attempt by the SNB to reinforce its defenses of the economy before government bond purchases by the European Central Bank that could crumple the franc cap. The franc surged after the announcement, Swiss stocks including UBS AG tumbled and the chief executive of watchmaker Swatch Group AG said the policy shift would hurt exports. SNB President Thomas Jordan defended the move, saying surprise was necessary.

It’s pandemonium on Swiss financial markets as the EUR/CHF collapse.

Yields of 10 year Swiss bond collapses.

Just look at that bond yield collapse (bond rallies)! Yields of 7 year Swiss bonds turn negative! (all charts above from investing.com)

Swiss stocks, as of this writing, have crashed 10%!

As been repeatedly stated here, crashes have become real time events.

Speculations are rife that SNB actions have signified as hints to a massive ECB QE that may come next week. And has most likely been the reason for the massive swing from losses to substantial gains for other European Stocks.

(charts above from Bloomberg)

Gold has so far soared 2%. US stocks have been wildly fluctuating from losses to gains back to losses.

Curiously just last Monday the SNB said that they would maintain the franc-euro cap.

From Reuters (hat tip Zero Hedge)

The Swiss National Bank's cap on the franc at 1.20 per euro will remain its key monetary policy tool, the central bank's vice-chairman said in a television interview broadcast on Monday.

"We took stock of the situation less than a month ago, we looked again at all the parameters and we are convinced that the minimum exchange rate must remain the cornerstone of our monetary policy," Jean-Pierre Danthine told RTS.

The above is an exhibit of how financial markets have become almost entirely dependent on central bank policies.

And yet the outcome of centralization is a black swan event. So far this has been a Swiss financial markets affair. How this will affect trades and investments embedded on the franc-euro cap outside Switzerland remains to be seen.

We truly live in interesting times.

The French Government Uses Free Speech as Pretext to Suppress Free Speech

At the Ron Paul Institute, Daniel McAdams comments that the French government has used the Charlie Hebdo incident as a convenient excuse to crack down on Free speech (“After Free Speech Rally, France Cracks Down on Free Speech”)

Well that didn't take long. Just three days after the French government hosted dozens of foreign leaders in a "unity rally" to defend free speech in the wake of last week's shooting at the Charlie Hebdo magazine, France has begun arresting its citizens for actually exercising free speech.

According to news reports, more than 50 French citizens were arrested today and charged with offensive speech — the same kind of speech that was the trademark of of the Charlie Hebdo publication. 

None of those arrested were charged with links to terrorism or any real crime. Instead, they are facing up to seven years in prison for making statements the French authorities claim are supportive of the shootings or are anti-Semitic.

New directives from the French Justice Ministry provided the legal basis for arresting those deemed "supportive" of the attacks or who express anti-Semitic or racist sentiment. Anti-Muslim sentiment was not included in the government's new arrest orders, despite a dramatic spike in actual attacks on French Muslims since the shootings. The justice ministry claimed the new anti-speech measures were necessary to protect freedom of expression.

Among those arrested is controversial French comedian Dieudonné M’bala M’bala, charged with being "an apologist for terrorism" and facing jail time over a Facebook post making fun of Sunday's "unity rally." Exercising free speech by making fun of the French government as it celebrates free speech is apparently a crime.

The French government has long banned Dieudonné's comedy performances over his controversial jokes, even as French authorities celebrate Charlie Hebdo's controversial jokes.

Those arrested for exercising free speech in France will be charged under "special measures" put into place after the shooting, which provide for immediate sentencing of the accused. Some 130,000 military and security forces have been deployed on the streets of France and ordered to keep a particular eye on incidents that could bring violence against the police.

Unreported in the US, Charlie Hebdo has long ties with the French Communist Party and after the shooting has moved its headquarters to the offices of Libération, a French newspaper with roots in the Communist Party-inspired unrest of May, 1968. One of most famous Charlie Hebdo cartoonists,Stéphane Charbonnier ("Charb"), was a long-time member of the French Communist Party. Currently the newspaper is considered "left wing" and is controlled by Edouard de Rothschild of the international banking family, which should provide some additional fodder for the conspiracy-minded.

France and Europe chokes under the noxious cloud of hypocrisy.

Judge Andrew Napolitano at the LewRockwell.com sees the same (bold mine)

The French government has prohibited speech it considers to be hateful and even made it criminal. When the predecessor magazine to Charlie Hebdo once mocked the death of Charles de Gaulle, the French government shut it down — permanently.

The theory of anti-hate speech laws is that hate speech often leads to violence, and violence demands police and thus the expenditure of public resources, and so the government can make it illegal to spout hatred in order to conserve its resources. This attitude presumes, as Wilson did when he prosecuted folks for publicly singing German songs during World War I, that the government is the origin of free speech and can lawfully limit the speech it hates and fears. It also presumes that all ideas are equal, and none is worthy of hatred.

When the massacres occurred last week in Paris, all three of the murderers knew that the police would be unarmed and so would be their victims. It was as if they were shooting fish in a barrel. Why is that? The answer lies in the same mentality that believes it can eradicate hate by regulating speech. That mentality demands that government have a monopoly on violence, even violence against evil.

So, to those who embrace this dreadful theory, the great loss in Paris last week was not human life, which is a gift from God; it was free speech, which is a gift from the state. Hence the French government, which seems not to care about innocent life, instead of addressing these massacres as crimes against innocent people, proclaimed the massacres crimes against the freedom of speech. Would the French government have reacted similarly if the murderers had killed workers at an ammunition factory, instead of at a satirical magazine?

And how hypocritical was it of the French government to claim it defends free speech! In France, you can go to jail if you publicly express hatred for a group whose members may be defined generally by characteristics of birth, such as gender, age, race, place of origin or religion.

You can also go to jail for using speech to defy the government. This past weekend, millions of folks in France wore buttons and headbands that proclaimed in French: “I am Charlie Hebdo.” Those whose buttons proclaimed “I am not Charlie Hebdo” were asked by the police to remove them. Those who wore buttons that proclaimed, either satirically or hatefully, “I am Kouachi” were arrested. Arrested for speech at a march in support of free speech? Yes.

What’s going on here? What’s going on in France, and what might be the future in America, is the government defending the speech with which it agrees and punishing the speech with which it disagrees. What’s going on is the assault by some in radical Islam not on speech, but on vulnerable innocents in their everyday lives in order to intimidate their governments. What’s going on is the deployment of 90,000 French troops to catch and kill three murderers because the government does not trust the local police to use guns to keep the streets safe or private persons to use guns to defend their own lives.

Meanwhile former Assistant Secretary of the US Treasury and former associate editor of the Wall Street Journal Paul Craig Roberts deems that the unfortunate Charlie Hebdo incident was instead a false flag

The Two Faces of Japan’s November Machinery Order Report

The mainstream sees the November Japanese Machinery Order report as  “positive”

For instance, this CNBC headline says “Japan November core machinery orders rise 1.3% on month” (bold mine)

Japan's core machinery orders rose a smaller-than-expected 1.3 percent in November from the previous month, government data showed on Thursday, suggesting capital expenditure among manufacturers could weaken.

The rise in core orders, which exclude those of ships and electric power utilities, compared with a 5.0 percent rise forecast by economists in a Reuters poll. It followed a 6.4 percent decline in October, the Cabinet Office data showed.

Compared with a year earlier, core orders, a highly volatile data series regarded as an indicator of capital spending in the coming six to nine months, fell 14.6 percent, against the median estimate of a 5.8 percent annual decline. The Cabinet Office lowered its assessment of machinery orders, saying the recovery is showing signs of stalling.

Japan’s Machinery Order based on Tradingeconomics.com charts

On the other hand the Zero Hedge reports a big slump on the same report: (bold original)

So much for that short-lived hope-fest that Abenomics was not a total and utter disaster. Japan Machinery Orders (excluding -rather ironically- volatile orders) plunged 14.6% Year-over-Year in November (missing expectations of a 6.3% drop) for the biggest fall since Nov 2009

What’s the difference? The framing.

Both looks at the same report but the point of emphasis differs. 

The mainstream sees the ‘positive’ the month on month change. On the other hand, the Zero hedge accentuates on the ‘negative’ or the year on year change.

What you see depends on where you stand.

But observe that in the mainstream report above, the 14.6% plunge in core orders was also reported, except that this has been buried in the third paragraph 

Yet here is the official data and report from Japan’s Cabinet  office: (bold mine)

-The total value of machinery orders received by 280 manufacturers operating in Japan decreased by 10.4% in November from the previous month on a seasonally adjusted basis.

-Private-sector machinery orders, excluding volatile ones for ships and those from electric power companies, increased a seasonally adjusted by 1.3% in November.

Notice of the omission of the total value of machinery orders? 

Yet Japan’s Cabinet office illustrated the collapsing total value of machinery orders, as well as, the private sector segment of the machinery orders statistics.

Now which of the two sources of information looks more like propaganda: the mainstream or the contrarian?

Philippine Bonds: Marginal Improvements for the Week, Deflation Signs in the Construction Industry!

It will be a truncated work week due to the Pope’s visit to the Philippines.

The Philippine bond markets closed the week with marginal improvements.

This comes in the light of the recent $ 2 billion fund raising by the Philippine government in the international bond markets as discussed last weekend.

Given the new funds injected, signs of liquidity strains should have materially eased.

Well it hasn’t. Maybe in the coming weeks but so far the pace of improvements hasn’t been substantial.

For now, only yields of 3 month bills have markedly eased. But it remains at June 2013 levels. Yields of 6 months and 1 year has moderated marginally.

Interestingly, not only has the inversion between yields the 5 year and 4 year deepened, the 5 year has also inverted with its 3 year treasury counterpart!!!

In short, 3 year yields have closed the week higher than 5 year. Why???

Overall, a glimpse at the spreads between 10 and 20 year vis-à-vis the shorter maturities, namely 6 months, 1 year and 2 years have hardly made any significant change this week.

Yet if we compare the effects of the latest borrowing by neighbor Indonesia which also raised $ 4 billion last week, the rally in Philippine bonds at the long end has been dwarfed by the Indonesian counterpart whether seen in both the yields of 10 or 20 year bonds (charts from investing.com)

All these are based on today’s actions.

The rally in Indonesian bonds is the scale of what I initially expected to happen here.

So everything hunky dory for Philippine bonds eh?

I have said this weekend that deflation has landed on Philippine shores as seen via crashing M3, negative CPI, the flattening of the yield curve and the spike in CDS.

Well to add to this, here is a more striking development: wholesale prices of construction materials in December has CONTRACTED!

Let me quote the National Statistics Office: (bold mine)

Compared to a year ago level, the Construction Materials Wholesale Price Index (CMWPI) in the National Capital Region (NCR) posted a negative rate of 0.1 percent in December. Last month it was recorded at 0.8 percent and in December 2013, 2.4 percent. The downtrend was due to 14.9 percent decline in fuels and lubricants index. Slower annual increments were also noted in the indices of cement at 2.3 percent and tileworks, 2.7 percent. The rest of the commodity groups either had higher annual mark-ups or retained their last month’s rates with the indices of asphalt and machinery and equipment rental still registering a zero growth...

On a monthly basis, the wholesale prices of selected construction materials in NCR further went down by 0.8 percent in December. This was attributed to the decreases registered in the indices of fuels and lubricants at -7.0 percent and cement, -0.2 percent. Higher monthly growths were, however, seen in the indices of hardware and reinforcing steel at 0.2 percent; plywood, 0.5 percent; plumbing fixtures and accessories, 0.6 percent; and PVC pipes, 0.1 percent. Movements in the other commodity groups either remained at their last month’s rates or had a zero growth. A series of price rollbacks was observed in gasoline, diesel and fuel oil during the month. Likewise, prices of cement were on the downtrend. On the other hand, higher prices were noticed in plywood, steel bars, PVC pipes, plumbing fixtures and accessories like faucet, kitchen sink and angle valves.

One can partly impute to construction deflation to crashing oil prices, but the declining prices of cement, machinery and equipment rentals and the others have likely been more about demand. 

In addition, rising prices of plumbing fixtures and other accessories could be about the falling peso, rather than demand based increases.

So why the collapse in construction material prices? Has there been a deluge of imports or production by domestic supply which has not been met by demand? Or has this been an essentially demand slowdown problem?

If this has been a manifestation of diminished demand, then this should be portentous for statistical GDP for the 4Q. 

Just to remind you of the contribution of construction industry on 3Q 2014 statistical GDP

From the expenditure side, based on NSCB data, construction grew 12.3% in 3Q 2014 year on year. Construction accounted for 9% of 3Q GDP.

From the industry side, construction expanded 11.94% in 3Q 2014 with the share of the industry to overall GDP at 5.83%.

The 5.3% 3Q GDP owes largely to construction and finance activities as discussed here.

From the expenditure perspective, if statistical CPI on a month-on-month basis, which has SHRANK for two successive months, could most likely be indicative of decreased consumption activities by domestic households (compounded by falling oil prices), if exports hardly picked up and where its gains has been offset by import growth (X-M) and if the above signifies a manifestation of a slowdown in construction, then where will 4Q statistical GDP come from?

It looks as if a big negative surprise for 4Q statistical GDP is in store for the high growth one way street looking consensus. We will know by January 29th.

So what has today’s orgasmic bidding spree to push the Phisix beyond 7,500 all about? The Philippine economy has reached a state of utopia where risks have all vanished?

US Stock Markets: Wild Intraday Pendulum Swings

Remember the fantastic volatility in December marked by 2 round trips which led to a 6.5% intraday swing in the Phisix? Such astounding bout of volatility has been replicated in the US last night

The tale of two roundtrips.

The Dow Jones Industrial opened the session strongly, as shown in the above chart from Google Finance. It reached a zenith of 274 points (+1.5%), then gave up all those gains towards midday.

By the afternoon, the Dow was down 136 points (-.77%).

From the intraday high to the lows was a swing of 410 points!!!  And from the lowest point, the main US bellwether crept up by 109 points to end the day off by only 27 points.

The sum of the nearly two round trips was an stunning 793 points or a 4.4% pendulum swing!

It’s not just the Dow, all key equity benchmarks as shown above from stockcharts.com experienced similar sharp gyrations.

Such sharp bouts of volatilities are hardly about stability, but about deepening tensions between the bears and the bulls. Sharp volatility as these usually surface during inflection points.

Ron Paul: Lessons from Paris

Former US congressman and libertarian Ron Paul explains that the latest terror events in Paris partly represented a blowback from foreign policies.

From the Ron Paul Institute  (bold mine)

After the tragic shooting at a provocative magazine in Paris last week, I pointed out that given the foreign policy positions of France we must consider blowback as a factor. Those who do not understand blowback made the ridiculous claim that I was excusing the attack or even blaming the victims. Not at all, as I abhor the initiation of force. The police blaming victims when they search for the motive of a criminal.

The mainstream media immediately decided that the shooting was an attack on free speech. Many in the US preferred this version of “they hate us because we are free,” which is the claim that President Bush made after 9/11. They expressed solidarity with the French and vowed to fight for free speech. But have these people not noticed that the First Amendment is routinely violated by the US government? President Obama has used the Espionage Act more than all previous administrations combined to silence and imprison whistleblowers. Where are the protests? Where are protesters demanding the release of John Kiriakou, who blew the whistle on the CIA use of waterboarding and other torture? The whistleblower went to prison while the torturers will not be prosecuted. No protests.

If Islamic extremism is on the rise, the US and French governments are at least partly to blame. The two Paris shooters had reportedly spent the summer in Syria fighting with the rebels seeking to overthrow Syrian President Assad. They were also said to have recruited young French Muslims to go to Syria and fight Assad. But France and the United States have spent nearly four years training and equipping foreign fighters to infiltrate Syria and overthrow Assad! In other words, when it comes to Syria, the two Paris killers were on “our” side. They may have even used French or US weapons while fighting in Syria.

Beginning with Afghanistan in the 1980s, the US and its allies have deliberately radicalized Muslim fighters in the hopes they would strictly fight those they are told to fight. We learned on 9/11 that sometimes they come back to fight us. The French learned the same thing last week. Will they make better decisions knowing the blowback from such risky foreign policy? It is unlikely because they refuse to consider blowback. They prefer to believe the fantasy that they attack us because they hate our freedoms, or that they cannot stand our free speech.

Perhaps one way to make us all more safe is for the US and its allies to stop supporting these extremists.

Another lesson from the attack is that the surveillance state that has arisen since 9/11 is very good at following, listening to, and harassing the rest of us but is not very good at stopping terrorists. We have learned that the two suspected attackers had long been under the watch of US and French intelligence services. They had reportedly been placed on the US no-fly list and at least one of them had actually been convicted in 2008 of trying to travel to Iraq to fight against the US occupation. According to CNN, the two suspects traveled to Yemen in 2011 to train with al-Qaeda. So they were individuals known to have direct terrorist associations. How many red flags is it necessary to set off before action is taken? How long did US and French intelligence know about them and do nothing, and why?

Foreign policy actions have consequences. The aggressive foreign policies of the United States and its allies in the Middle East have radicalized thousands and have made us less safe. Blowback is real whether some want to recognize it or not. There are no guarantees of security, but only a policy of non-intervention can reduce the risk of another attack.

Who will be the Victim of Propaganda: The Conformist or the Critical Thinker?

I have been accused of relying on a website that allegedly peddles "propaganda". 

First, what is propaganda? Based on Dictionary.com’s definition, propaganda has been about “information, ideas, or rumors deliberately spread widely to help or harm a person, group, movement, institution, nation, etc.” 

In short, propaganda essentially is deliberate disinformation or bluntly a lie. So I am, in effect, a believer of lies.

Yet the consensus thinking has revolved around the following themes:

-Debts are free lunches or have no limits or consequences to an individual or to a business entity, to the markets or to the government or to the political economy. 

-Stocks markets are a one way street

The money question is: are these about reality?

Isn’t economics about the law of scarcity?

So which is propaganda? Information that defies economic logic and reality or information designed to sell to the public what they want to hear—confirmation bias?

Let me further spell the difference between a conformist and an independent thinker

A conformist relies on information that conforms with one’s biases. Such person thinks along with the crowd. They are likely to reject information that goes to the contrary regardless of the validity of the reasoning. Crowd information or wisdom is like gospel truth for them.

On the other hand, a critical thinker attempts to distinguish between reality and quackery. Such person, who thinks out-of-the-box, is likely interested with the validity of reasoning or theories rather than finding comfort with the crowd.

So who will likely be a victim of propaganda, the critical thinker or the conformist?

Cracks in Singapore’s Credit and Housing Bubble?

Interestingly, mainstream media seems worried over signs of Singapore’s deflating housing markets.

Last year I posted here that Singapore’s central bank the Monetary Authority of Singapore warned of a domestic debt bubble.

Apparently the diffusing property slowdown appears to be raising anxiety over potential escalation of credit risks

From Yahoo.com (bold mine)

Local rates have already started ticking up. Sibor, or the Singapore interbank offered rate, used as the basis for setting mortgage and other loans, climbed around 15 basis points in early January, to its highest since April 2010 after years of stability, Maybank (Kuala Lumpur Stock Exchange: MBBM-MY)-Kim Eng noted in a report this week.

The bank estimates a one percentage-point rise in Sibor increases monthly mortgage payments by 12 percent, under certain conditions. It expects Sibor will rise to 1.0 percent by the end of this year and 2.0 percent by the end of 2016, compared with 0.46 percent at end-2014.

While the rate is still relatively low -- the three-month Singapore-dollar Sibor was at 0.639 percent Thursday -- analysts expect it could continue to push higher. They lay the rise at the feet of U.S. dollar strength against the Singapore dollar (Exchange:SGD=) spurring fund outflows from the city-state, a situation unlikely to reverse anytime soon. Once the U.S. Federal Reserve begins a rate hike cycle, Sibor is likely to push even higher, they said…

Whether most households can handle a big bump in mortgage payments will be a key policy test. Singapore's central bank, the Monetary Authority of Singapore (MAS), introduced a total debt servicing ratio (TDSR) in mid-2013 to help contain property prices and limit how much debt households could take on.

Here is the USD-SGD

The USD-Singapore trades at 2010 highs

Yet the debt numbers:

Consumers' debt is still growing, rising 5.6 percent on-year in the third quarter, although that's down from an average 9.2 percent over the past five years, the MAS said.

Housing loans accounted for around 74 percent of household liabilities in 2014's third quarter, the data show.

More signs of the emergence of deflation…

Despite a lot of handwringing forecasts for property price declines of as much as 20 percent, official data show private residential prices fell just 4 percent in 2014, although the number of transactions fell around 50 percent in the year-to-November. But analysts generally expect property price declines to continue this year.

Other cracks have begun to show in the property market, such as indications some buyers may have found ways to skirt the TDSR to get approval for larger mortgages. This week, local bank UOB(Singapore Exchange: UOBH-SG) filed a 181 million Singapore dollar (around $136 million) lawsuit against a unit of Indonesian company Lippo Group and some individuals, claiming a conspiracy to obtain inflated mortgages for 38 units at a luxury development on tony Sentosa island. All but one of those 38 loans have defaulted. Lippo has reportedly denied involvement in a conspiracy…

However, lower property prices will limit financially troubled households' ability to sell their homes as a means of exiting debt.

Another worry is the around 3 percent of credit card holders with unsecured debt greater than their annual incomes, although the MAS plans policies this year to prevent these people from getting further credit.

After the credit fueled boom, the legacy will always be the problem of debt, debt and debt…

This reports says Singapore’s banks are vulnerable to a housing deflation. From Nikkei Asia (bold mine) 

The slow-down in Singapore's property market has reduced high-end condominium prices and raised concerns that major local banks could be vulnerable to a surge in non-performing housing loans.

According to Singapore's Urban Redevelopment Authority, the price of private residential properties dropped 4% in 2014. Maybank Kim Eng notes that loan defaults have concentrated mostly among luxury homes which are more popular with foreign investors, particularly those located near Orchard Road, Singapore's retail hub, and Sentosa Island, a vacation destination with sandy beaches and resort hotels.

Among the three largest Singaporean banks, United Overseas Bank (UOB) is the most exposed on Sentosa. The report indicated UOB's non-performing housing loan volume has risen 61.4% since the end of 2013…

Other vulnerable banks…

Despite this case, Maybank Kim Eng concluded that among the three largest Singaporean banks, Oversea-Chinese Banking Corp. (OCBC) is most at risk in the event of a meltdown in the housing market, followed by UOB. DBS Group is least at risk.

Although OCBC's exposure to the luxury properties most favoured by foreigners is lower, the bank lent more heavily overall to property buyers than its competitors from mid 2009 to 2012 when prices in Singapore were breaking records and "speculation was high."

Here are several questions: what happens when Singapore’s housing and debt deflation intensifies? Will Singapore’s problems be isolated to the property sector and to the city state? Will there be no contagion via trade and financial linkages with the region or the world?

How about Singapore’s stocks? Will housing-debt deflation be vented on stocks?

So far Singapore’s stocks appear to be ignoring such risks.   

Phisix at Record 7,400: Be Fearful When Others Are Greedy

True heroism is remarkably sober, very undramatic. It is not the urge to surpass all others at whatever cost, but the urge to serve others, at whatever cost. –Arthur Ashe (1943-1993)

In this issue

Phisix at Record 7,400: Be Fearful When Others Are Greedy

-Phisix at Record 7,400 Defies the BSP Chief’s Warnings

-Despite the $ 2 billion Bond Offering, Strains in Bond Markets Remain

-Deflationary Forces Have Landed: Crashing M3, Negative CPI, Spike in CDS, Falling Peso

-Record Phisix 7,400 on Record Index Pump!

-Record Phisix as Domestic Casino Stocks Crash!

-Phisix 7,400: Déjà vu 1997?

-2015: Real Time Crashes Will Spread and Intensify

Phisix at Record 7,400: Be Fearful When Others Are Greedy

The Philippine Stock Exchange celebrates the New Year with a run to a record high.

Phisix at Record 7,400 Defies the BSP Chief’s Warnings

In August of 2014, the Philippine central bank, Bangko Sentral ng Pilipinas Governor Amando Tetangco Jr. issued an Alan Greenspan like “irrational exuberance” warning in a speech. Then, I quoted him[1]:

What can you control? Certainly your risk appetite. Controlling this when greed gets the better of you is very difficult. So in a period of low volatility such as what we have been experiencing, practice the discipline of setting limits. This discipline will not only help you to avoid the pitfalls of “chasing the market”.

In a follow up speech in October, the BSP chief elaborated on this[2]:

While we have not seen broad-based asset mis-valuations, the BSP remains cognizant that keeping rates low for too long could result in mis-appreciation of risks in certain segments of the market, including the real estate sector and the stock market as markets search for yield.

“Mis-appreciation of risks” from the “pitfalls of chasing the market” simply entails overvaluation from excessive speculation. And the primary target for flagrant speculation has been specified as the “real estate sector and the stock market”

Mr. Tetangco’s commented on how this euphoria can unravel

Right now because of excess liquidity in the system, the industry doesn’t seem to mind much that real interest rates are negative. But ladies and gentlemen, when the tide turns, those projects that you may have “approved” based on a specific expected value may not provide you the “return” you anticipated. With this in mind, our policy actions have been aimed at helping you manage your own risk appetites.

Let me first point to the paradox, contradictions or the cognitive dissonance in the statements.

Of course, since real interest rates represents an invisible subsidy (transfer) to borrowers, specifically to the real estate and ancillary sectors, these sectors love the free lunches served to them on a silver platter as they gorge on debt, rationalized on statistical G-R-O-W-T-H which has actually been shouldered or paid for by the currency holders.

And by stating that “keeping rates low for too long could result in mis-appreciation of risks” which has prompted for “the pitfalls of chasing the market” in “the real estate sector and the stock market” the BSP unintentionally had been caught in a contradiction.

Why has there been a low interest rate regime low in the first place? Hasn’t this been because of the BSP’s actions?

In 2009, the BSP embraced the US Federal Reserve zero bound policy. The BSP chief then promulgated that “Maintaining an expansionary monetary policy stance to the extent that the inflation outlook allows, could support market confidence and assure households and businesses that risks to macro-stability are being addressed decisively”[3].

In short, the yield chasing mania from incumbent easy money regime signified by “a period of low volatility” has been a product of “keeping rates low for too long” policies.

But the BSP pins the blame on market participants even as the former recognizes that the latter has only been responding to the central bank’s policies.

Yet even with an implicit attribution that their policies have been the cause to chasing the markets, the BSP offers their position as market saviors “our policy actions have been aimed at helping you manage your own risk appetites.”

Well, Phisix at 7,400 apparently has not been a sign that the BSP has been helping the public manage their risk appetitive. To the contrary Phisix 7,400 have been representative of the intensifying “mis-appreciation of risks”

And considering that bank credit expansion continues to swell at a blazing rate of 18.6% in November, perhaps much of the newly issued money has been funneled towards “chasing the markets”.

But interestingly, the BSP chief’s pointed of how things can go haywire from his October spiel: “when the tide turns, those projects that you may have “approved” based on a specific expected value may not provide you the “return” you anticipated.”

What’s the difference between the essence of the BSP chief’s comments and the following quote?

The whole entrepreneurial class is, as it were, in the position of a master builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master builder's fault was not overinvestment, but an inappropriate employment of the means at his disposal.

The BSP chief’s warnings simply reverberate on what the great Austrian economist Ludwig von Mises calls as malinvestments[4].

Unfeasible projects that had been made feasible via interest rate subsidies eventually discover that there is no such thing as a free lunch: the mismatch between the structure of investments and production activities with that of the supply of capital goods will lead to what the BSP chief says as “projects that you may have “approved” based on a specific expected value may not provide you the “return” you anticipated”—or with reference to the gem of a Warren Buffett axiom from the 2001 Berkshire annual report, “After all, you only find out who is swimming naked when the tide goes out”.

Despite the $ 2 billion Bond Offering, Strains in Bond Markets Remain

The Philippine bond markets have already been expressing signs of these.

Even as Philippine stock markets levitated from last December’s shakeout which incensed bulls that inspired this ‘managed’ run-up, Philippine bonds massively sold off going into the close of the year to materially flatten the yield curve.

And instead of being a seasonal variable, the December selloff in the domestic bond markets accounted for an ongoing trend since 2011. This can be seen via the 2011-13 December yield spreads of the 10 year and 20 year minus 1 and 2 year and 3 months and 6 months

I noted that a rally was to be expected considering that the Philippine government would be offering dollar based bonds at the year’s start. The tightly controlled bond markets had to express “confidence” to attract financiers. So it was. This week, the Philippine government raised $2 billion bonds in the international debt market at 3.95% from the initial offering coupon rate of 4.25% which means privileged access to credit from “real interest rates are negative” around the world.

See what a stock market boom (plus yield fixing by banking-government cabal and Moody’s upgrade) can give to the government? 

I expected a major rally. The rally did come, but for now, such has hardly has been ‘major’. 

Short term yields (1 year and below) slid but remains above or at June 2013 taper tantrum highs. Yields of 4 and 5 year treasuries have inverted again! (although a minor inversion)

Yield spreads widened only for 20 year minus 6 months and 1 year but remained steady for the rest. 10 year minus 2 year has even flattened amidst the rally.

As I recently noted[5]:

Instead of an anomaly, the flattening of the yield curve is an indication of the business cycle in progress.

It has been a sign of monetary produced imbalances that has prompted credit markets to arbitrage on the asset liability mismatches via the spread differentials—whose windows have now been closing. It has been a sign of how credit expansion has engendered massive pricing distortions in the economy that has been demonstrated by inflationary pressures which have now been reflected on the bond markets. And it has also been a sign that such credit expansion fueled boom has been backed by a lack of savings.

From an academic viewpoint, Austrian economists Philipp Bagus and David Howden notes of the significance of flattening yield curve as an expression of the business cycle[6].

Lacking adequate savings for the terms of the projects, these malinvestments must be liquidated. But when exactly will the recession set in? Two cases may be distinguished. In the first, the disturbance directly affects productive ventures. In the second case, financial intermediates first enter distress and only later affect productive enterprises. 

In the first case, companies finance additional long-term investments with short-term loans. This is the case of Crusoe getting a short-term loan from Friday. Once savers fail to roll over the short-term loans and commence consuming, the company is illiquid (assuming other savers also curtail their lending activities). It cannot continue its operations to complete the project. More projects were undertaken than could be completed with the finally available savings. Projects are liquidated and the term structure of investments readapts itself to the term structure of savings.

In the second case, companies finance their long-term projects with long-term loans via a financial intermediary. This financial intermediary borrows short and grants long-term loans. The upper-turning point of the cycle comes as a credit crunch when it is revealed that the amount of savings at that point in time is insufficient to cover all of the in-progress investments. There will be no immediate financial problems for the production companies when the rollover stops, as they are financed by long-term loans. The financial intermediaries will absorb the brunt of the pain as they will no longer be able to repay their short-term debts, as their savings are locked-up in long-term loans. The bust in this case will reverberate backward from the financial sector to the productive sector. As financial intermediaries go bankrupt, interest rates will increase, especially at the long end of the yield curve, lacking the previous high-degree of maturity mismatching driving them lower. Short-term rates will also increase due to a scramble for funds by entrepreneurs who try to complete their projects. This will place a strain on those production companies that did not secure longer-term funding, or rule out new investment projects that were previously viable under the lower interest rates. Committed investments will not be renewed at the higher rates

Importantly, if stock markets are about credit and liquidity, and its corollary, ‘confidence’, then the flattening of the yield curve means indications of diminishing liquidity conditions. So record stocks come in the face of declining liquidity extrapolates to heightened risks!

Deflationary Forces Have Landed: Crashing M3, Negative CPI, Spike in CDS, Falling Peso

I noted above the BSP reported November bank credit expansion at a blistering rate 18.6%. This comes in the light of collapsing money supply growth rate last pegged at 9% in November.

Let me quote the BSP on this[7]: Preliminary data show that domestic liquidity (M3) grew by 9.0 percent year-on-year in November to reach P7.3 trillion. M3 growth decelerated from the 15.4-percent expansion recorded in October. On a month-on-month seasonally-adjusted basis, M3 contracted by 1.2 percent. Money supply continued to increase due largely to the sustained demand for credit. (bold mine)

Claims on the private sector and secondarily claims on other financial institutions account for about 73% of November M3.

Did you notice? Money supply on a month-on-month basis has CONTRACTED. So the Philippines now have been experiencing seminal episodes of DEFLATION in monetary terms!

The yield curve and the money supply growth rates seem as in a chorus to suggest of ongoing liquidity strains!

And notice further of the collapse in statistical consumer price inflation from the above data as of November (data from NSCB)

The BSP reported December CPI at 2.7% (bold mine)[8]: Year-on-year headline inflation for the whole year of 2014 averaged 4.1 percent, within the Government’s inflation target range of 4.0 percent ± 1.0 percentage point for the year. This was the sixth consecutive year that the average inflation rate has been within the government target. Inflation in December eased further to 2.7 percent from 3.7 percent in November, and was likewise within the BSP’s forecast range of 2.4-3.2 percent for the month.  Similarly, core inflation—which excludes certain food and energy items to better capture underlying price pressures—slowed down to 2.3 percent in December from 2.7 percent in the previous month. On a month-on-month seasonally-adjusted basis, inflation was unchanged at -0.1 percent in December.

Although there seems to be a discrepancy between the reported -.01% (BSP) and tradingeconomics data (perhaps owing to seasonality adjustments; see left window), the statistical fact is that Philippine consumer price inflation has SHRANK for two successive months!

Monetary deflation has ushered in CPI deflation that appears to have been ventilated at the bond markets through higher short term yields and a significant flattening of the yield curve!

Folks, forces of deflation appear to have landed on Philippine shores!

While CPI deflation may have partly been influenced by crashing oil and commodity prices abroad, the strains on household spending activities has already been evident as shown by the declining growth rates since the 3Q of 2013 through 3Q of 2014 based on the 3Q statistical GDP as I previously pointed out.

The supply side can’t be said to be overproducing, industrial production while up in November over the previous months has been below 2013 levels both in growth rates and in nominal terms based on data from National Statistics Office. Nor has this been the case for imports. While imports has supposedly grown 7.5% in October, based on nominal terms October imports have been down compared to each of the three months of the 3Q 2014.

As a side note, exports reportedly leapt 19.2% in November following a paltry 2.5% growth in October based on NSO data. But a glimpse of nominal levels indicates that there have been only marginal changes on a monthly basis based on October and November, from tradingeconomics data. Said differently, based on US dollar quotes, both October and November export performance has been materially lower than the monthly performance during the past 5 months.

In short, the decline in statistical CPI has largely been a function of eroding consumer demand.

Whatever happened to the vaunted Philippine consumer boom story whose capacity to consume has been perceived by the consensus as interminable?

The New York Times recently featured a slideshow of the “death spiral” of US shopping malls. The growth imbalances between the supply side relative to demand that had led to the sorry fate of US “dead malls” serve as a blueprint for the Philippine equivalent.

Together with casinos and other property related projects, this serves as a wonderful example of the blatant mismatch between the structure of investments and production activities with that of the supply of capital goods

And once demand continues to fall, these imbalances will be exposed as excess capacity, financial losses and magnified credit risks.

Yet the irony has been that the huge leap in bank credit growth rates hasn’t translated to money circulation in the economic stream suggests that current loan growth has been about debt rollover (Debt IN Debt OUT) than of capital expenditures.

And notice too that despite the $2 billion international issuance at lower coupon rates, the price to insure Philippine debt via Credit Default Swaps (based on Deutsche Bank data) has hardly improved from the recent spike (see right window).

What this implies is that underneath all those rose colored glasses statistics and record stock markets, credit risks have been on the rise!

The falling peso should add to the current pressures. The peso closed down .5% to Php 44.95 this week. The falling peso simply means more peso for every dollar imports which should affect CPI through prices of imported goods and services. Importantly, this also means more pesos for every US dollar based debt.

Unless hedged, domestic companies exposed to the “short dollar” loan portfolio would need more peso based growth to offset bigger dollar requirements for debt service. The Wall Street Journal estimates that Philippine firms have borrowed $12.16 billion since 2008. While this signifies a drop in the bucket for the $ 4 trillion emerging market US dollar loan portfolio to non-banks out of the overall $9 trillion exposure, a major seizure in one of the major borrowers (say Brazil or China) can ripple across the world as falling dominoes via an emerging market “margin call”.

The central bank of central banks or the Bank for International Settlements via Hyun Song Shin have warned on this as previously noted[9].

Yet the current statistical monetary and CPI data and actions in the bond markets pose as a significant challenge to 4Q 2014 statistical GDP. The current developments are likely to serve as more negative surprises for the consensus sporting a one way G-R-O-W-T-H mindset where RISK have been priced out of existence. Of course the caveat is that since government makes the data they can show anything.

Bottom line: There has been a widening divergence developing in the Philippine financial system and the economy.

Forces of deflation (bubble bust) have emerged. Such has been revealed by cratering money supply growth rate, crashing CPI, pressures on the bond via elevated short term yields and tightening yield spreads and a surge in Credit Default Swaps (CDS) in the face of ballooning credit growth rates. The falling peso adds to the pressure in the real economy via CPI inflation and credit risks from external liabilities.

All these adverse forces have been occurring in the face of record highs stock markets.

Also Phisix 7,400 essentially defies the warnings made by the BSP chief. Given that the BSP has stopped tightening, perhaps out of political pressures from the natural beneficiaries of the boom has been the government, the banking system and their clients (bubble sectors and the stock market), Phisix 7,400 signifies how the BSP has lost control over the mania.

So the BSP has been trapped from their own policies.

Record Phisix 7,400 on Record Index Pump!

The next question is how has the Phisix reached the record highs?

My answer is simple. It has been massaged to the current levels.

Managing the index has been coursed through three ways. 

One, index managers go into a maniacal bidding spree of select grotesquely overpriced securities as global stock markets suffered from a meltdown.

The likely intent has been to reduce the possibility of bearish sentiment from developing. The other possible objective is to depict to the world how Philippine stocks have developed invincibility to become immune from any contagion. Corrections have become impermissible. Philippine stocks can only go up. Valuations hardly matters.

The operations begin after a few minutes from the opening bell. Big declines at the open are either totally erased or reversed to show gains by the closing bell. This has been the case in 3 instances October 16 2014 and December 15 2014 and last Tuesday January 6 2015 since the rally that began in early 2014.

Last Monday, when US-European markets convulsed, panic buying operations went into action even as most of Asia had suffered significant losses. The Phisix ended up unchanged at the close.

Such all-day operations have used only during global market pressures.

The second way has been what I call the ‘afternoon delight pump’. Morning sessions are usually left for the markets to determine their levels. After the lunch recess, index managers go to work, they frantically push up prices of 3-4 issues with a combined market cap of 20% until the session’s close.

The third way has been “marking the close” or the manic pumping of key index issues at the last minute prior to the pre-run off period. By the way, marking the close is considered a violation of the Philippine Security Exchange Commission’s Security Regulations Code. But for as long as violations benefit the establishment, who cares?

The “afternoon delight” pump and the “marking the close” has usually been used as combination and has become a regular feature since the start of 2014, although its frequency has increased during the last quarter of 2014. This reveals of the desperation to attain 7,400. Why?

During the first attempt at 7,400 in 2013, these index massaging has been rare.

But today, index managers have become increasingly frantic. They have most likely been infuriated by the recent reemergence of downside volatility particularly when domestic casino stocks came under the limelight of global contagion.

In one occasion particularly 18th of December, the Phisix encountered a startling wild rollercoaster ride session marked by two round trips—an early sharp 1.6% upside at the open that had been more than erased. By the lunch recess, the Phisix was stunningly down 1.2%. After lunch, the fantastic afternoon pumping scheme basically eviscerated the 1.2% intraday loss. The closing was even grander, a whopping 92.5% of the day’s .91% gains attained by marking the close!

Overall, the Phisix gyrated by an astounding 6.5% intraday—from gains to losses and back to gains mostly based on index massaging! This could mark a record of sorts.

From then, the index managers never looked back. Last week’s global stock market meltdown, as mentioned above, the Phisix was cushioned by the January 6th index massaging operations. When global stock markets strongly recoiled from losses due to the Fed Evans who said that tightening soon would be catastrophic and the ECB’s jawboning, such rally provided tailwinds to the domestic mania. Thus, the Phisix at 7,400.

Peso volume speaks loudly of the quality of the record high.

In May 15^th 2013, when the Phisix first reached 7,403, Peso volume was at a marvelous Php 21.4 billion. In the September 2014 chapter, peso volume was at a measly Php 9.5 billion as I showed here.

Friday January 9th edition posted a better than September feat at Php 11.2 billion, but still almost a half way shy of the 2013 failed attempt.

The weekly averaged daily peso volume (left) reveals of the relatively low volume ramp to record highs. What has distinguished 2014 from 2013 has been the delirious rate of turnovers (right) which has been about 35% higher today.

Stock market pumping means to acquire specific equity securities at higher than the market rates. Marking the close is a wonderful example.

Yet the increasing frequency of the stock market pump means that these index managers have been heavily accumulating equity positions at record high levels.

Looking at the charts of the 30 Phisix composite members, 15 or half have closed above 2013 highs. 2 are at 2013 highs while the rest or 13 are below their respective 2013 watermark levels. So the record high hasn’t reflected a broad based run.

Curiously of the half that has been above the 2013 levels, some have soared in a parabolic or near vertical fashion. Wow. Total Mania.

And of course with PE ratios at 30, 40, 50 and PBV at 4,5,6,7 this has NOT been about G-R-O-W-T-H, but the incantations of G-R-O-W-T-H to justify mindless bidding up of mispriced securities.

When stock market returns outpace earnings or book value growth, the result is price multiple expansions. This is why current levels of PE ratios are at 30, 40, 50 and PBVs are at 4,5,6,7. This is NOT about G-R-O-W-T-H but about high roller gambling which relies on the greater fool theory or of fools buying overpriced securities in the hope to pass on to an even greater fool at even higher prices—all in the name of G-R-O-W-T-H!

Going back to the index massaging, this only implies that in order to generate a bandwagon effect, index managers have mostly been piling on the most popular issues.

So in order to finance the next series of managing or to reload, they would need to sell at least at breakeven levels. So has the furious rate of turnovers been symptoms of the manipulation of index rather than of retail speculation gone berserk?

Otherwise, index managers have been stashing boatloads of overvalued securities such that a market crash would expose on their balance sheet problems (whether they are private or public firms). This explains the intolerance for any correction. So the continuous pump to keep façade of their balance sheets.

Yet what more if such heavy accumulation of key popular index stocks at record prices has been financed through credit? Perhaps another reason why stocks can’t be allowed to go down.

Record Phisix as Domestic Casino Stocks Crash!

This week’s record run has mostly been bannered by the holdings and property sector. The financial sector even posted losses for the week. Why the loss in the financial sector? Have these been about the emergent recognition of the effect of tightening spreads on bank balance sheets?

Interestingly, domestic casino stocks have been in serious trouble—crashing in the face of record Phisix 7,400!

Large integrated resorts have mainly been about shopping malls and hotels with casinos as come-ons or attractions. Yet the heavily leverage casino stocks translates to magnified credit risks to lenders. As I have previously explained, there are about Php 45-50 billion of debt that are at risks if Chinese gamblers don’t appear soon enough and or if the domestic economy fumbles and or if domestic political and financial elites will hardly patronize them to profitability.

Considering that about 3 of 10 residents are “banked”, then this means that leverage circulates among a small segment of banked people and institutions. Let me add that the reason the Philippines has low gearing ratio per capita is because of the mostly unbanked population. But if we should measure gearing in terms of the population of only banked entities, the leverage levels should soar.

In short, casino stocks are just part of the concentration risks from systemic overleverage which obviously the record Phisix 7,400 chooses to ignore.

Phisix 7,400: Déjà vu 1997?

I am not a fan of pattern seeking in charts, if patterns serve as a standalone metric. But I consider patterns, if they account for the whereabouts of the business cycle especially when backed by fundamentals.

Today’s record Phisix (top) which has been part of the 2013-2014 volatility seems like a miniature replica of the 1994-1997 topping process.

The remarkable rally of 1993 which delivered an astonishing 154% returns peaked in early 1994. What followed was an exceptional periods of volatility. From 1994-1995 there had been three accounts where the Phisix fell by about 20% but rallied back. This I call as bear market strikes.

By the end of 1995, the bulls eventually regained the upper hand and pushed the Phisix back to marginally top the 1994 highs by February of 2007 before the Asian crisis collapse.

The current episode had the Phisix climax in May of 2013. The bull run had been disrupted by the Bernanke taper talk and by the volatility from BoJ’s QE 1.0. What followed next was three occasions where the Phisix had attempted a touchdown on bear market levels.

Nonetheless the bulls recovered momentum from the start of 2014 mainly due to the index managers through today’s record high. The Phisix returned 22.76% in 2014. This week’s record run has generated 2.38%.

Aside from chart patterns of 1997 and today, there are many other similarities.

-Current stock market valuations have already topped the 1995-96 levels.

-Credit to GDP has mostly like substantially eclipsed the 1997 highs of 62.2%.

As I wrote last July[10]

In a speech last year, the BSP chief cited the credit to GDP at 50.4% as of Q4 2012. Allow me a back of the envelop calculation using current data to establish 2013 debt levels.

The average BSP’s measure of the banking system loan growth in 2013 has been at 13.5%. The average annualized growth per quarter in 2012 has been at 7.225%. So this implies a credit-to-gdp ratio now at around 56.7%

Such level outstrips the 1984 high at 51.59%. This is the same period or in particular in 1983, where the Philippines faced a balance of payment crisis and an eventual inflationary recession in 1984 which I previously discussed here, chart from Wikipedia.org. Notice high inflation, high interest rates (T-bills). Rings a bell? (I know the bulls will assert we can’t have a balance of payment crisis because of foreign reserves! But shouting foreign reserves! foreign reserves! foreign reserves! are not free passes to bubbles)

Current credit-to-gdp levels have also surpassed the 1996 high at 54.85% and have been just shy away from the 1996 high of 62.22% in 1997. If the pace of current credit growth is sustained through the year at current economic growth levels, the 1997 acme will be easily reached or exceeded by the yearend.

At any rate, the Philippines economy has now reached critical levels—where if the past will rhyme—points to severe economic turbulence ahead.

The average banking system loans to the productive economy rates growth rates for the past 11 months has been at 18.53%. Let me wear the hat of the mainstream to assume that statistical GDP for 2014 will be optimistically at 6%. This extrapolates to a net credit growth of 12.53%. If my 2013 estimates at 54.85% has been anywhere accurate, then 2014’s credit to gdp ratio would total 67.38%! Yet if the statistical GDP falls below 6%, the larger the gains of net credit growth, the higher credit to gdp ratio!

-In 1997, Japan raised sales taxes and suffered a recession. Japan raised sales taxes in April 2014 and has been in a recession. If Japan’s recession deepens then there will likely be a feedback transmission to her trading partners and vice versa.

-ASEAN nations have been acquiring more debt than the pre-1997 days.

As example, syndicated loans from M&A are at record levels. From Nikkei Asia[11] (bold mine): The volume of syndicated loans in Southeast Asia was at its largest ever in 2014 with Singapore leading the pack, according to a report by a financial research firm Dealogic. As merger-and-acquisition activity rises in Southeast Asia, more companies are using syndicated loans for funding.  Loans hit a record high of $119.5 billion in the region, up from $86.6 billion the previous year. The number of syndicated loan deals totaled 247, compared to 294 in 2013. Singapore is the largest generator of syndicated loans in the region. The city-state's volume expanded 71% to $60.5 billion in 2014, recording the largest year-on-year increase in Southeast Asia. Indonesia and Malaysia followed, with $21.4 billion and $18.3 billion of syndicated loans in 2014, respectively

I have noted in September of the S&P warning of top ASEAN firms whose growth has increasingly relied on debt.

As a refresher, from theNationMultiMedia.com[12]: "Asean companies are increasingly using debt to finance growth and are likely to continue doing that over the next two years," said Standard & Poor’s credit analyst Xavier Jean. Standard & Poor’s estimates that internal cash flows and cash balances could fund only about half of almost US$300 billion Asean’s largest companies spent on expansion and acquisitions between 2008 and the first quarter of 2014. At the same time, these companies issued about $150 billion of additional debt to bridge the gap. The result of ongoing investment by Asean companies has weakened their credit profiles since 2011, when growth in revenues and cash flows started to wane.

-Indonesia’s currency the rupiah has already exceeded the 1997 lows or the USD rupiah topped 1997 highs at 12,600.

Like the Philippines, the Indonesian government successfully raised $4 billion in the international bond markets last week according to a report from Bloomberg. But unlike the Philippines, the Indonesian government had to pay for higher rates: 5.95% for 10 year and 6.85% for 30 years compared to the previous 5.684% and 6.85%, respectively.

The $ 4 billion signifies a parcel of the targeted $ 29.2 billion financing requirements for 2015 to be raised at domestic and international markets. The Indonesian government reportedly failed to meet its financing requirement last November but generated a warmer reception last week.

Curiously the Indonesian government has been tapping foreign currency loans as her currency continues to struggle.

Nevertheless like the Philippines, Indonesian stocks have been drifting at record highs in the face of emerging financing strains.

Anyway unless one has used heavy leverage to bet on the stock market or has been part of the institutions that has become totally addicted to perpetually rising asset prices, the break of 7,400 has really been meaningless to any prudent investor.

The past secular tops show that record highs have hardly been accompanied by lasting or sustainable upside moves.

For instance, the nominal gains from the February 3 1997 high over the previous Jan 6 1994 highs has only been 4.68%. If we apply this to the 7,400 would translate 7,746.

During my dad’s stock market cycle, the secular high of January 1979 from its previous high in 1969 was 10.14%. This equates to 8,150 in current terms.

The recent Lehman contagion saw the Phisix rally above the July 5, 2007 highs by only 2.168% in October 2007. In today’s equivalent, this would represent 7,540.

Yet all these tops preceded a collapse.

This implies that at 7,400 the risk reward balance has been heavily tilted towards risk. Betting on a 10% gain in the face of a potential loss of at least 50% will signify a gamble than investments.

Fund manager Dr John Hussman has a pertinent rule for today’s market participants. He calls this the “Exit Rule for Bubbles” or the assumption that “you only get out if you panic before everyone else does” (bold mine): you have to decide whether to look like an idiot before the crash or an idiot after it.[13]

It’s really not just about social desirability bias; one can be seen being an idiot but preserve capital, but the other can be both an idiot and at the same time lose money!

2015: Real Time Crashes Will Spread and Intensify

At the start of 2014 I wrote of potential black swans[14]:

The potential trigger for a black swan event for 2014 may come from various sources, in no pecking order; China, ASEAN, the US, EU (France and the PIGs), Japan and other emerging markets (India, Brazil, Turkey, South Africa). Possibly a trigger will enough to provoke a domino effect.

The black swans have arrived. Crashes have become real time events. But so far they appear as fragmented series of events than a global systemic issue. 2015 will most likely see the spreading and acceleration of this process.

Oil and commodities have been collapsing. Macau’s casino stocks have also been in a tailspin. Casino stocks in Singapore and even the US have also been on a meltdown. US gambling stocks have diverged from her record peers. So applies with US energy stocks which has also been cracking.

Interestingly the common denominator of oil, commodities and casinos has been China.

While Chinese stocks have been melting UP partly on the government’s massaging of the stock markets via the price controlled IPOs and by stimulus, the real economy has been lumbering. Just last week, a Hong Kong listed Shenzhen based property and shopping mall (!) developer, Kaisa Group Holdings Ltd, missed interest payments that could herald the first overseas bond default.

This bombshell from Wall Street Journal[15] (bold added): A default, if confirmed, would be the more shocking because it was so unexpected, investors say. Kaisa was seen as in good financial shape, with a healthy portfolio of commercial and residential projects, strong sales and solid cash flow that had made its bonds popular with investors. Kaisa’s net profit in the first half of 2014—the latest figures available—rose 30% versus the previous year to 1.33 billion yuan ($214 million), with revenue of 6.79 billion yuan. As of June 30, the 16-year-old company, which is listed on the Hong Kong exchange, had cash of 9.38 billion yuan versus short-term debt of 6 billion yuan.

Healthy portfolio, strong sales, solid cash flow and rising net profits all vanished in the face of a missed payment on interest from a $500 million of debt. As I have been saying here, when debt deflation (bubble bust) comes knocking, the illusions of strength from a credit boom can evaporate in an instant. What you see isn’t what really is. To quote the sage of Omaha Warren Buffett again, you only find out who is swimming naked when the tide goes out.

As a refresher, despite so-called statistical growth of the Chinese economy, the government has undertaken many forms of stimulus. As I recently wrote[16],

The drastically slowing highly levered Chinese real (and not statistical) economy has compelled the People’s Bank of China (PBoC) to do a series of easing measures.  As I recently pointed out the Chinese government has launched “targeted easing” last June, has resorted to selective bailouts of firms which almost defaulted last July, imposed price controls on stock market IPOs last August, injected $125 billion over the last two months.

The much ballyhooed China-Hong Kong connect also went onstream November 17 where the Chinese government also liberalized fund flows on IPOs conducted overseas to ensure money overseas can be repatriated with ease.

The Chinese government via the PBoC has also refrained from sterilizing funds injected to system.

Add to this recent action that allows banks to lend more from their deposits.

Recently the Chinese government announced they would be “accelerating 300 infrastructure projects valued at 7 trillion yuan ($1.1 trillion)”, although the Chinese government denies that this represents new stimulus. Whether this has been about fast tracking of projects in the pipeline or stealth injection of new projects, it’s all about frontloading of spending today. 

Yet the rudimentary problems would be the funding and implementation of government sponsored spending. Will these be funded by more debt? In the same way soaring stocks have been energized by an explosion of margin debt? Debt problems to be solved by acquiring more debts?

How will all these projects be implemented in the wake of the so-called anti-corruption campaign?

Nonetheless collapsing oil prices along with a strong US dollar has prompted for Middle East stocks to suffer from a series of sharp volatility dominated by crashes.

Many emerging market currencies have been under tremendous currency strains, stock markets of emerging market economies as Russia, Brazil, Nigeria and more have suddenly fallen into in bear markets.

In Southeast Asia, while stock markets of Philippines and Indonesia are at record highs, Thailand SET has been under pressure, punctuated by an intraday 9% collapse last December 15th, which it mostly recovered during the session. The Malaysian ringgit and Malaysian (KLSE) stocks have been seriously weakening. The USD-MYR has reached 2008 levels! Vietnam’s stocks recently landed on the door steps of the bear market before bouncing back to recover some of the recent losses.

In Europe, Greece’s stocks and bonds appear to be in a freefall from domestic politics.

Stock markets of developed nations have also began to exhibit increasing signs of stress only to be repeatedly rescued by promises of support by their respective central banks.

Yet Bank for International Settlement warned on this during their Quarterly review last December, from Claudio Borio, Head of the Monetary and Economic Department:

Once again, on the heels of the turbulence, major central banks made soothing statements, suggesting that they might delay normalisation in light of evolving macroeconomic conditions. Recent events, if anything, have highlighted once more the degree to which markets are relying on central banks: the markets' buoyancy hinges on central banks' every word and deed

Increasing pressures on risk assets can’t qualify as black swans anymore. That’s because the element of surprise has been taken away.

The central bank of central banks, the Bank for International Settlements (BIS), the IMF and the OECD has jumped on the bandwagon to sternly warn of risks of a global financial crisis. Many other central banks has also joined the warning chorus but in different degrees most of them sanitized.

Admiringly, the BIS have been the most persistent. They have used every opportunity of late to air concerns of the debt financed mania griping financial markets everywhere.

Markets are a process. The periphery to core that I have been warning about has been spreading. The spreading process will likely intensify in 2015. If the developed markets succumb to forces of asset deflation, the periphery would fall harder. The feedback loop will accelerate.

Like in Middle East or Casino stocks, record highs suddenly transmogrified into bear markets.

Greed will metastasize into fear.

The Phisix bear market in 2007-8 came as a contagion even without systemic problems. Today internal imbalances as revealed by inchoate signs of deflation will mean not just a financial asset meltdown but economic turmoil as well.

My all time favorite quote from the Sage of Omaha has become very relevant:

I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful."

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[1] See Phisix: As Mania Rages, BSP Chief Warns on “Complacency” and “Chasing the Market”!! August 24, 2014

[2] See Phisix: 7,400 is not the Technical Hurdle, the BSP Governor Is October 6, 2014

[3] See Phisix: In 2009, the BSP Engineered a Crucial Pivot to a Bubble Economy April 14, 2014

[4] Ludwig von Mises Malinvestment, Not Overinvestment, Causes Booms May 24 2010

[5] See Philippine Bonds Close the Year with a Rally; Flattening Yield Curve as Business Cycle Indicator December 29, 2014

[6] Philipp Bagus and David Howden The Term Structure of Savings, the Yield Curve, and Maturity Mismatching The Quarterly Journal of Austrian Economics 2010

[7] Bangko Sentral ng Pilipinas Domestic Liquidity Growth Decelerates in November December 29, 2014

[8] Bangko Sentral ng Pilipinas 2014 Average Inflation Within Government Target January 6, 2015

[9] See Phisix: The October Syndrome is Back! Philippine Casinos as the Causa Proxima? December 15, 2014

[10] See Phisix Breaks 6,900 as Inflation Risk Becomes a HOT Political Issue! July 6, 2014

[11] Nikkei Asia M&A activity has Southeast Asia lending record amounts January 5, 2015

[12] theNationMultiMedia.com Asean companies' growth hinges on rising debt and credit availability September 11, 2014

[13] John P Hussman Losing Velocity: QE and the Massive Speculative Carry Trade November 3, 2014 Hussman Funds

[14] See Phisix: Will a Black Swan Event Occur in 2014? January 13, 2014

[15] Wall Street Journal Chinese Developer Appears to Default January 8, 2015

[16] See Phisix: Tremors Rock Philippine Casino Stocks, Malaysian Financial Markets December 8 2014