Mohamed El-Erian: My Money Has Mostly Been Into Cash as Central Banks Pump Asset Prices

Former PIMCO co-founder and now chief economic adviser at the Allianz Mohamed El-Erian, in a recent interview says why his portfolio has been mostly in cash.

Selected excerpts from OCGregister (hat tip Bloomberg) [bold mine]

Q. Why write a book on central banks?

A. This is a historic period in which central banks are the only game in town when it comes to policy. But central banks do not have the tools to deliver what the global economy needs. We need more potent reinvigorated growth models.

The West fell in love with the wrong growth models 10 years ago. It fell in love with finance as an enabler of prosperity. The whole society fell in love with leverage and credit as a way of prospering. We were entitled to accumulate debt! People bought homes they could not afford. Governments borrowed money that they could not pay back.

Regulators believed that finance was so sophisticated that you could lessen regulations on it. This romance with the wrong growth model fell apart in 2007 and 2008...

Q. Where is your money? Stocks? Treasuries? Bonds?

A. It is mostly concentrated in cash. That’s not great, given that it gets eaten up by inflation. But I think most asset prices have been pushed by central banks to very elevated levels.

Q. So we’re nearing a bubble?

A. Go back to central banks. Central banks look at growth, at employment, at wages. They are too low. They don’t have the instruments they need, but they feel obliged to do something. So they artificially lift asset prices by maintaining zero interest rates and by using their balance sheet to buy assets.

Why? Because they hope that they will trigger what’s called the wealth effect. That you will open your 401k, see it has gone up in price, and you’ll spend. And that companies will see their shares are going up and they will be more willing to invest. But there is a massive gap right now between asset prices and fundamentals.

It's interesting to see how changes has been happening at the margins to the point that risks appears to be seeping into mainstream awareness.

Ludwig von Mises: The Peculiar and Unique Position of Economics

In celebration of this year's Holy week, residents of the Philippines will be having a long weekend.

So before I sign out for the week, here is a recommended read on the importance of economics and its effects to society and politics as articulated by the great Austrian economist Ludwig von Mises excerpted from Human Action (1949), chapter 37, "The Nondescript Character of Economics."

From the Mises Institute: (bold mine)

The Singularity of Economics

What assigns economics its peculiar and unique position in the orbit both of pure knowledge and of the practical utilization of knowledge is the fact that its particular theorems are not open to any verification or falsification on the ground of experience. Of course, a measure suggested by sound economic reasoning results in producing the effects aimed at, and a measure suggested by faulty economic reasoning fails to produce the ends sought. But such experience is always still historical experience, i.e., the experience of complex phenomena. It can never, as has been pointed out, prove or disprove any particular theorem. The application of spurious economic theorems results in undesired consequences. But these effects never have that undisputable power of conviction which the experimental facts in the field of the natural sciences provide. The ultimate yardstick of an economic theorem's correctness or incorrectness is solely reason unaided by experience.

The ominous import of this state of affairs is that it prevents the naïve mind from recognizing the reality of the things economics deals with. "Real" is, in the eyes of man, all that he cannot alter and to whose existence he must adjust his actions if he wants to attain his ends. The cognizance of reality is a sad experience. It teaches the limits on the satisfaction of one's wishes. Only reluctantly does man resign himself to the insight that there are things, viz., the whole complex of all causal relations between events, which wishful thinking cannot alter. Yet sense experience speaks an easily perceptible language. There is no use arguing about experiments. The reality of experimentally established facts cannot be contested.

But in the field of praxeological knowledge neither success nor failure speaks a distinct language audible to everybody. The experience derived exclusively from complex phenomena does not bar escape into interpretations based on wishful thinking. The naïve man's propensity to ascribe omnipotence to his thoughts, however confused and contradictory, is never manifestly and unambiguously falsified by experience. The economist can never refute the economic cranks and quacks in the way in which the doctor refutes the medicine man and the charlatan. History speaks only to those people who know how to interpret it on the ground of correct theories.

Economics and Public Opinion

The significance of this fundamental epistemological difference becomes clear if we realize that the practical utilization of the teachings of economics presupposes their endorsement by public opinion. In the market economy the realization of technological innovations does not require anything more than the cognizance of their reasonableness by one or a few enlightened spirits. No dullness and clumsiness on the part of the masses can stop the pioneers of improvement. There is no need for them to win the approval of inert people beforehand. They are free to embark upon their projects even if everyone else laughs at them. Later, when the new, better, and cheaper products appear on the market, these scoffers will scramble for them. However dull a man may be, he knows how to tell the difference between a cheaper shoe and a more expensive one, and to appreciate the usefulness of new products.

But it is different in the field of social organization and economic policies. Here the best theories are useless if not supported by public opinion. They cannot work if not accepted by a majority of the people. Whatever the system of government may be, there cannot be any question of ruling a nation lastingly on the ground of doctrines at variance with public opinion. In the end the philosophy of the majority prevails. In the long run there cannot be any such thing as an unpopular system of government. The difference between democracy and despotism does not affect the final outcome. It refers only to the method by which the adjustment of the system of government to the ideology held by public opinion is brought about. Unpopular autocrats can only be dethroned by revolutionary upheavals, while unpopular democratic rulers are peacefully ousted in the next election.

The supremacy of public opinion determines not only the singular role that economics occupies in the complex of thought and knowledge. It determines the whole process of human history. 

The customary discussions concerning the role the individual plays in history miss the point. Everything that is thought, done and accomplished is a performance of individuals. New ideas and innovations are always an achievement of uncommon men. But these great men cannot succeed in adjusting social conditions to their plans if they do not convince public opinion.

The flowering of human society depends on two factors: the intellectual power of outstanding men to conceive sound social and economic theories, and the ability of these or other men to make these ideologies palatable to the majority.

Quote of the Day: Hayek: Inflation is the Most Important Single Factor for the Loss of Freedom via Government Expansion

There are two points which cannot be stressed enough: first, it seems certain that we shall not stop the drift toward more and more state control unless we stop the inflationary trend; and, second, any continued rise in prices is dangerous because, once we begin to rely on its stimulating effect, we shall be committed to a course that will leave us no choice but that between more inflation, on the one hand, and paying for our mistake by a recession or depression, on the other. Even a very moderate degree of inflation is dangerous because it ties the hands of those responsible for policy by creating a situation in which, every time a problem arises, a little more inflation seems the only easy way out.

We have not had space to touch on the various ways in which the efforts of individuals to protect themselves against inflation, such as sliding-scale contracts, not only tend to make the process self-accelerating but also increase the rate of inflation necessary to maintain its stimulating effect. Let us simply note, then: that inflation makes it more and more impossible for people of moderate means to provide for their old age themselves; that it discourages saving and encourages running into debt; and that, by destroying the middle class, it creates that dangerous gap between the completely propertyless and the wealthy that is so characteristic of societies which have gone through prolonged inflations and which is the source of so much tension in those societies. Perhaps even more ominous is the wider psychological effect, the spreading among the population at large of that disregard of long-range views and exclusive concern with immediate advantages which already dominate public policy.

It is no accident that inflationary policies are generally advocated by those who want more government control-though, unfortunately, not by them alone. The increased dependence of the individual upon government which inflation produces and the demand for more government action to which this leads may for the socialist be an argument in its favor. Those who wish to preserve freedom should recognize, however, that inflation is probably the most important single factor in that vicious circle wherein one kind of government action makes more and more government control necessary. For this reason, all those who wish to stop the drift toward increasing government control should concentrate their efforts on monetary policy. There is perhaps nothing more disheartening than the fact that there are still so many intelligent and informed people who in most other respects will defend freedom and yet are induced by the immediate benefits of an expansionist policy to support what, in the long run, must destroy the foundations of a free society.

(bold and italics mine)

All I have been saying captured in three paragraph from the great Austrian economist Nobel Prize winner Friedrich August von Hayek in Chapter 21 The Monetary Framework, The Constitution of Liberty p 338-339 via Libertarianismo.org

That last statement from 3rd paragraph resonates…

Wow. Federal Reserve of Atlanta’s Estimates of 1Q 2015 US GDP now at ZERO Growth!

The US Federal Reserve of Atlanta has a segment called GDPNow which attempts to estimate US GDP on a real time basis or prior to its official release.

The official description by the Atlanta Fed on GDPNow:

The growth rate of real gross domestic product (GDP) is a key indicator of economic activity, but the official estimate is released with a delay. Our new GDPNow forecasting model provides a "nowcast" of the official estimate prior to its release. Recent forecasts for the GDPNow model are available here. More extensive numerical details—including underlying source data, forecasts, and model parameters—are available as a separate spreadsheet.

Their latest forecast (bold mine) 

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2015 was 0.0 percent on April 1, down from 0.2 percent on March 30. Following this morning's construction spending release from the U.S. Census Bureau, the nowcast for real residential investment growth increased from -1.1 percent to 1.8 percent. This was more than offset by declines in the nowcasts for real nonresidential structures investment growth (-19.3 percent to -22.5 percent) and real state and local government spending growth (0.3 percent to -0.8 percent).

Record stocks as GDP growth sinks to ZERO! 

Truly Awesome!

US Stock Market Bubble: In 1Q 2015, Firms with Bad Earnings Have Been Rewarded More than those with Good Earnings

The US Treasury’s Office of Financial Research appears to be right, US stocks has been plagued by overvaluation and overleverage which has amplified the risks of financial instability.

Here’s more, the reason why overvaluation exists has been because companies with bad or negative performance has been rewarded by the markets more than companies with positive performance.

From Factset’s 1Q Report on the S&P (bold mine)

-For Q1 2015, 85 companies in the S&P 500 have issued negative EPS guidance and 16 companies have issued positive EPS guidance. If 16 is the final number of companies issuing positive EPS guidance for the quarter, it will mark the lowest number since Q1 2006.

-Companies are providing EPS estimates for Q1 that are 9.2% below analyst expectations on average. This percentage is slightly below the 5-year average of -11.3%.

-The market is not punishing companies that have issued negative EPS guidance for Q1 on average. Companies that have issued negative EPS guidance for Q1 have seen an average increase in price of 1.7%, which is well above the 5-year average price change (-0.9%). This is the highest average price increase for companies issuing negative EPS guidance for a quarter since Q2 2009.

-For the current fiscal year, 179 companies have issued negative EPS guidance and 61 companies have issued positive EPS guidance.

The Factset notes on “Highest Average Price Increase for Companies Issuing Negative EPS Guidance Since 2009”

To date, the market is not punishing companies that have issued negative EPS guidance for Q1, while it is rewarding companies that have issued positive EPS guidance for Q1 at only average levels. 

The 85 companies that have issued negative EPS guidance for Q1 2015 have seen an average increase in price of 1.7% from two days before the guidance was issued through two days after the guidance was issued. This percentage is well above the 5-year average price decrease of 0.9% during this same window for companies issuing negative EPS guidance.

In fact, this quarter marks the largest average price increase for companies issuing negative EPS guidance for a quarter since Q2 2009 (+4.3%) Overall, 50 of the 85 companies that have issued negative EPS guidance recorded an increase in price during this time frame. Of these 50 companies, 6 recorded a double-digit price increase.

The 16 companies that have issued positive EPS guidance for Q1 2015 have seen an average increase in price of 2.8% from two days before the guidance was issued through two days after the guidance was issued. This percentage is just slightly above the 5-year average price increase of 2.6% during this same window for companies issuing positive EPS guidance. Overall, 13 of the 16 companies that issued positive EPS guidance during the quarter saw an increase in price during this time frame. None of these companies recorded a double-digit price increase.

Like the Philippines, US stocks has reached a point where valuations or risks hardly matters at all and where price discovery has been almost entirely been broken.

The Slippery Slope of Deposit Confiscation: Australian Edition

In the  recent  G-20 meeting, deposit confiscation (bailIns) had been included as part of the multipartite political agenda. Yet unknown to most, this serves as handwriting to the wall for the formal banking system.

Here is what I wrote then: (bold mine)

In short, the formalization of the G20 accord on the downgrade of bank deposits implies, the greater risks of bank runs.  Yet the institutionalization of bail INs will not likely to be limited to G20s but should spread even on Emerging-Frontier markets.

Governments around the world have been in a state of panic. They are desperately manipulating stock markets in the hope that these may produce “wealth effect”, a miracle intended to save their skin or the  status quo (the welfare-warfare, banking system and central bank troika), as well as, camouflage current economic weakness and or kick the debt time bomb down the road.

Yet the same political institutions recognize that inflating stocks are unsustainable. So during this current low volatile tranquil phase, they have been implementing foundations for massive wealth confiscation.

What better way to confiscate than do it directly. Yet the more the confiscations, the greater risks of runs on banks and on money.

Well Sovereign Man’s Simon Black identifies Australia as one of the would be pioneers to such path… (bold original, italics mine)

Several months ago, the government of Australia proposed to tax bank deposits up to $250,000 at a rate of 0.05% (5 basis points).

Their idea was for the money to be invested in a rainy day Financial Stabilization Fund to insure against in the unlikely event of a banking crisis… or all-out collapse.

And as of this morning, it looks like the levy might just pass and become law in Australia. All parties support the idea. Which means that Australia might just have a tax on bank deposits starting January 1, 2016.

To be clear, the proposal seems to plan on taxing the banks based on the amount of deposits they’re holding—but it’s pretty obvious this will be passed on to consumers in the form of lower interest rates.

Let’s look at what this means:

1. Taxes on bank deposits are generally the same as negative interest rates. Australia is a rare exception.

Interest rates on bank deposits in most developed nations are practically zero… if not already negative.

So charging a tax above and beyond this would clearly push rates (further) into negative territory.

I have, for example, a small bank account in the United States that pays me about .03% interest (three basis points). If the government imposes a tax of 5bp on interest of 3bp, I’m left with negative interest.

Australia (along with New Zealand) is a rare exception since interest rates are actually positive. You can get 2-3% on a savings account. So a 5bp tax still results in positive interest.

2. Taxes always start small… then increase over time.

Of course, the proposal on the table right now is a 5bp tax. There’s nothing that says this can’t increase to 50bp over time.

When the United States government first imposed the modern federal income tax a century ago, the top tax rate was just 7%. These days that would qualify the US as a tax haven.

Over time, tax rates rose to as high as 92%. Tax rates can (and do) rise. And once they’re passed, they’re almost never abolished.

3. Taxes are rarely used for their stated purpose

Politicians create and raise taxes all the time for special purposes. And again, over time, they are often diverted away from those purposes.

In 1936 after a devastating flood in Johnstown, Pennsylvania, the state government passed a ‘temporary’ 10% tax on all alcohol sold in the state in order to help pay for disaster relief.

Six years later the work was complete. But the tax is still on the books (now at 18%), with all the revenue going to whatever the state lawmakers want to blow it on.

FICA is another great example. Though payroll taxes in the US were initially established to fund Social Security and Medicare, the federal government steals this revenue every year to haplessly try and plug budget deficits.

So a tax to build a financial stabilization fund might sound comforting in theory… but will all the revenue actually be allocated for that purpose? Doubtful.

4. If this can happen in Australia, is anyone foolish enough to think it can’t happen in the US or Europe?

Australia has a sound and sturdy banking system.

Banks in Australia are actually, you know, solvent. Capital ratios and liquidity rates are solid. Australia’s is a well-capitalized banking system—far more than in the US and Europe.

The numbers tell a very clear story. Banking systems across Europe in particular have had to be routinely bailed out over the past few years—Slovenia, Spain, Greece, Cyprus, etc.

In the United States it is perhaps even more absurd. Based on their own numbers, US banks are highly illiquid, still gambling away customer funds in trendy investment fads that will likely suffer an epic meltdown.

Backing up this little scam is the FDIC, which itself is pitifully undercapitalized to support any significant problem in the banking system.

Backing up the FDIC is the US federal government, which is already drowning in more than $60 trillion in liabilities (based on the most recent GAO report).

And supplying crack to the crack head is the US Federal Reserve, America’s central bank.

With net capital just 1.26% of total assets, the Fed is so pitifully capitalized they make Lehman Brothers look like Berkshire Hathaway.

So if the government of Australia is concerned that their well-capitalized banking system needs a safety net and wants to tax deposits for such purpose, how in the world can we possibly expect the US and Europe, with all of their banking system risk, won’t do the same?

One thing leads to another.

When the next global crisis appears (very soon), domestic currency confiscation will likely spread to foreign currency deposits. The buck won’t stop here. As part of the manifold means to capture resources, capital controls will be imposed, trade controls, price and wage controls will most likely be  also implemented. 

Government’s use of monetary inflation or the inflation tax will intensify. 

Proof? In Ireland, Irish politicians has proposed of the nationalization of money creation. They want to bar banks of this role and shift money creation to solely the domain of the central bank

From Telegraph (bold mine)

Iceland's government is considering a revolutionary monetary proposal - removing the power of commercial banks to create money and handing it to the central bank.

The proposal, which would be a turnaround in the history of modern finance, was part of a report written by a lawmaker from the ruling centrist Progress Party, Frosti Sigurjonsson, entitled "A better monetary system for Iceland".

"The findings will be an important contribution to the upcoming discussion, here and elsewhere, on money creation and monetary policy," Prime Minister Sigmundur David Gunnlaugsson said.

The report, commissioned by the premier, is aimed at putting an end to a monetary system in place through a slew of financial crises, including the latest one in 2008.

According to a study by four central bankers, the country has had "over 20 instances of financial crises of different types" since 1875, with "six serious multiple financial crisis episodes occurring every 15 years on average".

Mr Sigurjonsson said the problem each time arose from ballooning credit during a strong economic cycle.

So instead of dealing with the incentives that whets on the appetite of the banking system to expand credit, politicians see knee jerk reactions as solutions. 

Yet by monopolizing credit allocation, this will lead to even more politicization of  distribution of credit. And because governments via central bank will pander to populist short term oriented political agenda, this heightens the risks of, or eventually paves way to, hyperinflation. 

Going back to negative rates, yet the opportunity cost of negative rates will be the cost of storage of currency/banknotes. This means that if negative rates will go deeper, at a certain point, people will look at cash/banknotes (in safety boxes? or in pillow mattresses?) as a more feasible alternative to bank deposits. 

So the likely unintended consequence will be intensified “debt deflation” as more people horde cash. And instead of global economies experiencing a renaissance, the opposite will occur, capital consumption will intensify, thus economies will falter if not collapse, thereby leading to massive debt defaults.

Stashing cash may increase security risks as robbery and theft. This will raise the cost of holding cash. So the public will be immersed in a conundrum: the devil or the deep blue sea; Submit to government confiscation or to heightened security risks of holding cash. This points at how inflationism destabilizes society

Although, some entrepreneurs may see this as commercial opportunities. They may offer large scale storage/safety box facilities with stringent security. I am hopeful that there will be private sector alternatives even if it means black market substitutes.

But governments will always attempt to employ a dragnet on the resources of her constituency by imposing controls. Example, the French government has been en route to outlaw or impose increase restrictions on cash holdings.

From Reuters: From September onwards, people who live in France will not be allowed to make payments of more than 1,000 euros ($1,060) in cash, down from 3,000 now. The cap for foreign visitors, left higher for reasons that include facilitating tourism, will be cut to 10,000 euros from 15,000.

So while stock markets have been running records, behind the scenes, perhaps in anticipation of violent adjustments from the current unsustainable arrangements, governments have been working 24/7 on the legal, political, technical platforms towards direct confiscation of people’s resources.

Humor of the Day: Dilbert on the Employable Economist's Economic Babble

(hat tip Zero Hedge/Source Dilbert)

This 'dropping-of-economic-terminologies-equals-economics' strip is so relevant...

Ah, the told-to-say economic view economist...

...can also be a fortuitous economist...

Phisix Record 8,000: Happy April Fool’s Day!

The PSE celebrates today’s 24th record high session and 10.5% gain for the year. 

From their press release

Our stock market managed to close higher despite the decline in major Asian indices. This resilience has been evident as local economic and corporate developments continue to positively influence investor sentiment

(table from Bloomberg)

Well, what you see depends on where you stand.

Asian equities was mixed today.

Benchmarks of Japan, Taiwan, South Korea, Australia, Indonesia and Vietnam closed down.

On the other hand, Hong Kong, China, India, Thailand, Pakistan and the Philippines have been up today.

So the reference to Asian indices really depends on which has been the basis of the claim.

Nonetheless, the general idea from the press release has been to paint--that not only has the Phisix outperformed the region--but that local developments imply that the Phisix will ‘decouple’ and will be immune from external developments!

In short, this time is different!!!

Yet let see how today record runs equates to “positively influence investor sentiment” (charts from Colfinancial.com)

We see the same operations to manage the index at work again. This session features another 'afternoon delight' pump marked by wild panic buying and price pushing which ultimately culminated with a “marking the close” to ensure Phisix 8,000 would be just a breath away!

It has been a five sector last minute price fixing: Four sectors exhibited a pump, while the service sector a dump (not in chart)…

The rush to 8,000 comes with only Php 7.72 billion. 

Curiously why the seeming desperation if this has truly been about "economic and corporate developments"?

Today’s actions essentially piggybacks on yesterday’s performance (aside from Monday's shocking actions)… 

In contrast to today, the market started strong yesterday. But the session saw a profit taking trend from the strong start going through the pre-runoff period. 

However, for the index managers, correction has not been permissible. 8,000  has to be met soon…so again the incredible last minute pump!

Index managers have become so desperate to reach Phisix 8,000 soonest!

And the same modus had been used for the closing of yesterdays’ session.

In terms of sectoral activities, another price fixing pump on big ticket issues representing four indices essentially offset some of the infirmities from the strong opening of the day.

Add to this Monday’s fabulous pump and dump which surely has been one for the books!

Market manipulation appears to be the major driving force behind the record Phisix. It's being implemented daily.

Yet the PSE lauds rising security prices in the assumption that such has been about “local economic and corporate developments”. 

But they never seem to give a thought that spectacular overvaluation, manic yield chasing and the rigging or massaging of markets has already underwritten the boom’s demise as discussed last weekend.

Said differently, record 8,000 has not just been about yield-momentum chasing hysteria that has been taking hold in the marketplace, but that the domestic stock market seems as being rigged right under the noses of the PSE! And instead of ensuring the healthy function of the markets to reflect on price discovery, PSE officials cheer on such impropriety and the transmogrification of the equity markets into a loaded casino! 

Let me quote again Warren Buffett’s mentor Benjamin Graham and David Dodd’s warning on why this new-era theory is fated to end in tears. 

From Graham-Dodd’s classic Security Analysis (bold mine)

The notion that the desirability of a common stock was entirely independent of its price seems incredibly absurd. Yet the new-era theory led directly to this thesis. If a public-utility stock was selling at 35 times its maximum recorded earnings, instead of 10 times its average earnings, which was the preboom standard, the conclusion to be drawn was not that the stock was now too high but merely that the standard of value had been raised. Instead ofjudging the market price by established standards of value, the new era based its standards of value upon the market price. Hence all upper limits disappeared, not only upon the price at which a stock could sell but even upon the price at which it would deserve to sell. This fantastic reasoning actually led to the purchase at $100 per share of common stocks earning $2.50 per share. The identical reasoning would support the purchase of these same shares at $200, at $1,000, or at any conceivable price. 

An alluring corollary of this principle was that making money in the stock market was now the easiest thing in the world. It was only necessary to buy “good” stocks, regardless of price, and then to let nature take her upward course. The results of such a doctrine could not fail to be tragic. Countless people asked themselves, “Why work for a living when a fortune can be made in Wall Street without working?” The ensuing migration from business into the financial district resembled the famous gold rush to the Klondike, except that gold was brought to Wall Street instead of taken from it

To repeat with emphasis:

The results of such a doctrine could not fail to be tragic.

Phisix Record 8,000: Happy April Fool’s day!

South Korea’s Collapsing Merchandise Trade

I’m supposed to be on a vacation, but there have simply been too many very interesting developments some of which I feel I must share.

Well one of these has been that Korean merchandise trade has virtually been collapsing.

Today, the Korean government reported a 4.2% drop in year on year March exports (chart from investing.com)

This marks a back to back decline with a seeming acceleration in the rate of the downtrend.

Considering that China, US Japan, Hong Kong and Singapore make up her 5 major export trade partners, aside from possible issues on competitiveness, the alternative and or complimentary explanation for the sluggish exports has been deepening languid performance of economic activities of her trading partners.

Korea’s plummeting exports has been occurring in the face of a sustained battering of her currency the won as shown in the USD-Krw above from google finance

So currency weakness has hardly done anything to improve on Korean exports.

March import data brings about even more bad news.

Korean imports have basically been collapsing. Since late 2014, the rate of decline has been intensifying. 2015 has been dominated by double digit declines!

The import cascade seems like a symptom of the weakening of Korea’s internal demand.

Although consumption spending has been creeping up while retail sales jumped in February following a drop in January 2015, the gist of these spending activities has been financed through household credit.

Considering that merchandise trade (exports and imports) constitute a big segment of her economy (82.4% 2010-2014 World Bank), the above slump signifies a coming squall to her statistical GDP. 

In essence, Korea’s economy has increasingly become dependent on leveraging. And such debt buildup has likewise become a drag to her economic activities, as this seems as being transmitted via the consumers, while simultaneously increasing her risk profile in the context of interest rate, currency and credit.

Korean mainstream press seems worried of the rapid buildup of household debt. From the Korean Times (March 31) [bold mine]

At the end of February, household loans reached an accumulated 522 trillion won after climbing 3.9 trillion won in the first two months, and a combined 66 trillion won in the 2012-2014 period, according to data from the Financial Supervisory Service (FSS).

Escalating worries of possible non-performing loans (NPLs), more than 70 percent of the accumulated household loans were mortgages in the two-month period, Cho said citing FSS data.

So aside from the recent unexpected rate cut two weeks ago, the Finance Ministry launched a bailout program called “relief loans” but was apparently met with skepticism

From the same article (bold mine)

Korea's household debt is on track to rise further after jumping nearly 4 trillion won ($3.6 billion) in the January-February period; while the "Relief Loans" designed to restructure this debt will not be of much help, experts said Tuesday.

"The 40 trillion won Relief Loans are aimed at helping a small portion of households convert their existing mortgages into fixed, low-rate ones, and also allowing them to pay principal and interest together on a monthly basis," Cho Young-moo, an economist at LG Economic Research Institute, said Tuesday.

He said installment payments of principal and interest will help families lower their overall debt over time, but the conversion program is not likely to reduce the country's entire household debt.

The law of demand says that the lower the cost of an activity, the more people will do of it. So by lowering cost of credit (via policy rates) and by providing subsidies or bailouts, one can expect credit activities to expand and aggravate on the existing impairments on Korea’s private sector balance sheets…until these collapses under its own weight.

A further bad news has been that the HSBC manufacturing PMI has posted 49.2 this March implying a contraction in manufacturing activities. The March survey supports the developing slack in Korea’s internal and external economic activities.

And given the apparent deterioration in her economy and the policy choice to subsidies internal debt at the expense of the currency, many South Koreans have been looking overseas to chase for yields.

The other option has been to chase yields in domestic stocks regardless of the intensification of her risk profile. 

So we have another parallel universe, rising stocks amidst a deepening of economic stagnation.

In McKinsey Global Institute's recent report “Debt and (not much) deleveraging”, they note of the burdensome effects of debt to economic activities:

High debt levels, whether in the public or private sector, have historically placed a drag on growth and raised the risk of financial crises that spark deep economic recessions

It’s not just about empirics, rather this has been based on economic axiom. Here is my version:

Debt represents the intertemporal distribution of spending activities. Borrowing money to spend simply means the frontloading of spending. The cost of debt financed spending today is spending in the future. Debt will have to be repaid at the expense of future spending. Of course there are productive and non-productive debts. But policies of financial repression via zero bound rates tend to promote non-productive ‘speculative’ and consumption debts.

As I have been saying here, there are multiple tinderboxes to trigger a global economic storm. 

South Korea has been just as vulnerable as the many others.  Yet signs of deterioration has been spreading everywhere.

Tick Tock. Tic Tock.

Phisix: Today’s Incredible 8,000 Pump…and Dump!

Today’s activities as described by the PSE: 

Despite the pullback at the end of the session, breaking the 8,000 mark is an indication of the confidence level that investors have on the market. This conviction is supported by the prevailing positive sentiment in local developments as well as in the region as seen by gains in most Asian bourses 

With today's .27% gain, the PSE goes on to tout the 22nd record breaking streak and the cumulative 9.3% gains for the year. 

Well, do the following charts reveal that today’s activities has been about 'confidence'? (all charts from colfinancial) 

The Phisix

By sectors 

Finance 

Industrials

Holdings 

Property 

Service 

What has the above images shown? 

The Phisix was sharply up from the opening bell and drifted at the 8,000 levels for MOST of the day and THROUGH the closing minutes! At the pre-runoff period, the index managers decided to take profits off the table and executed a MASSIVE COORDINATED DUMP of big ticket issues across the above sectors, leaving the hapless greater fools holding the bag! 

About an astounding 80% of today's gains going toward the pre-runoff period had been erased!

In context, today's drama has been about a massive early Pump…then a fantastic "marking the close" dump! 

Truly awesome! 

Pump and Dump as defined by Investopedia.com (bold mine) 

A scheme that attempts to boost the price of a stock through recommendations based on false, misleading or greatly exaggerated statements. The perpetrators of this scheme, who already have an established position in the company's stock, sell their positions after the hype has led to a higher share price. 

Considering that today’s activities has shown net foreign buying of a hefty Php 2 billion, then dumpers must be from the locals.

Perhaps the index managers have been merely reloading their ammos for another day.

But the above images hardly reveals that this has been about 'confidence', but rather of a market that has incredibly been RIGGED!!! The stock markets has been transformed into a loaded casino! And the PSE blindly cheers on it!

And another thing…if one can’t back up rationalizing current activities then use external activities to support a claim. 

Oh by the way, the peso closed down at 44.8…hardly a sign of confidence. 

When Graham-Dodd’s ominous words of the new era theory (as explained last night)—“The results of such a doctrine could not fail to be tragic”—becomes a reality, I wonder what THE rationalization will be?

But here is a guess; the Keynes’ sound banker rule will come into play: “A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him” 

Nice.

Phisix 20th Record Close: Facts and Fantasy

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. - Friedrich Nietzsche

In this issue:

Phisix 20th Record Close: Facts and Fantasy

-Record Phisix 7,800: Rigging of the Index has now become a Daily Affair

-Record Phisix is as Symptom of Inequitable Transfers; Poverty Surges in 2014!

-Priced In USD, the Phisix Still Has to Beat 2013 Highs

-Contagion Risks; More on Why Basel Standards are Flawed

-The Different Hats of the BSP Chief

-Record Phisix 7,800: Benjamin Graham and David Dodd’s View of Overvalued PERs

-US Treasury’s OFR Warns on US Stocks! BOE Sounds Financial Instability Alarm as Four Central Banks Cut Rates!

Phisix 20th Record Close: Facts and Fantasy

20th record close. Amazing.

The Philippine Stock Exchange crows and rationalizes feat to[1]: The country's benchmark index closed ahead of its Asian counterparts as investors anticipate positive earnings results from more companies for the full year 2014. Investor confidence in our listed companies continues to sustain the upward trajectory of our market

There are many more things that meets the eye than what has been countenanced.

Record Phisix 7,800: Rigging of the Index has now become a Daily Affair

Every single session over the past week has been become handiwork of index managers! 

In other words, rampant violation of the SEC regulation code has hallmarked the record Phisix. (charts courtesy of colfinancial)

Let me further add of the remarkable accounts of “marking the closes” of last Tuesday (March 24) and Thursday (March 26). 

Last Tuesday (left), profit taking mode dominated the entire session. The Phisix traded at a range of about .4 to .5% lower than the previous day’s close. That’s of course until the last minute, where a three sector pump virtually erased two-third of the index’s loss of the day!

And following a sharp decline in the US markets Wednesday, most of Asia carried over the sentiment last Thursday. 

Yet similar to the previous three accounts of global selloffs, particularly, January 6, 2015, December 15, and October 16, 2014, index managers went into operations early in the morning to engage in what I call as “panic buying”. The panic buying amidst the selloff pushed the Phisix into positive territory (right). The index managers ensured that the day ended with oomph: The Phisix posted a .44% gain even as the entire Asia was almost in the red!

The objective appears to have been designed to show the Phisix as becoming independent or decoupled from the world! Phisix as superman!

The peculiar thing is that Phisix has just 6.5% above 7,400 yet manipulations have become so increasingly flagrant.

You see corrections have become impermissible. Charts are being deliberately drawn. This has been more than just a sign of hysteria, the rigging of the Philippine stock markets have become shamelessly and notoriously regular or routine.

The Phisix can’t stand on market forces alone without being rigged? The record Phisix needs false legs from unseen faces as props? Why?

And this is what constitutes record Phisix? A record which PSE officials pat on their backs?

Record Phisix is as Symptom of Inequitable Transfers; Poverty Surges in 2014!

The PSE doesn’t say that how such improprieties have been brazenly operating under their noses. And neither have there been any seeming attempt to address these infractions.

Of course, given that record Phisix benefits the establishment, I would expect that the PSE to just look elsewhere or keep a blind eye on current developments, and instead, rationalize current events to other seemingly plausible factors so as camouflage such unscrupulous actions taking place. And this is what has been happening.

For one, record Phisix which is a product of financial repression paints a popular notion that this has been about G-R-O-W-T-H.

Doing so enables and facilitates the government’s easy access to credit—directly (lowers bond yields, high demand for local currency and foreign currency government bonds) and indirectly (foreign capital flows, perceived lesser risks, credit upgrades, increased taxes from bubble sectors and etc…).

And because financial repression generates a credit fueled boom for both the government and for the formal sector with access to credit, the boom not only spawns instant gratifications for these sectors, but such translates to high popularity ratings for the administration. Popularity ratings thus pave way for government actions or government pet projects in the name of public welfare via infrastructure (PPPs), welfare or defense projects.

Second, since financial repression embodies an invisible transfer of resources from the public to the government indirectly channeled through institutions owned by the politically connected financial elites, the latter institutions has become secondary major beneficiaries.

Such boom has allowed these politically privileged institutions to absorb resources and likewise transfer risks from their undertakings to the public.

For instance, 30 companies has corralled 89% of the Php 675.2 billion local currency corporate bond markets as of 4Q 2014 (4Q ADB Bond Monitor) where a vast majority of them, whether listed or not (most have been listed), are owned or controlled by the elites. Think of the numerous hapless and gullible depositors whom have extended financing to these companies with measly returns* at the cost of potential credit risks!

*Measly returns could even be exaggerated. That’s because many of the recent coupons issued hardly offers any real returns—I mean real inflation and NOT statistical inflation adjusted returns.

Yet a lot these bond financing has been coursed through financial intermediaries owned by the elites. Go to a bank and ask for long term deposits, you will most likely be offered with bonds from their clients or their affiliated institutions.

All these benefits that accrue the elites have been owed to negative real rates–zero bound –financial repression policies.

Yet the same elites have graced the flamboyant list of world’s wealthiest where most of their wealth has been derived from equity ownership.

And since the same sectors have been in control over media, the onslaught campaign in support of the credit financed mania

So here is simple anecdote of how the modus works. Project a boom (with the help of media and supply side). Let the public manically bid up on ridiculously overvalued assets (real estate and stocks, previously bonds) financed by credit due to negative real rates. Let asset managers create a sustained imagery of the boom through manipulation of the various indices and markets. Then companies of the elites absorb the public’s resources in exchange for rates that hardly covers real inflation rates while at the same time shifting the burden of risk to the public (via issuance of bonds and preferred shares, listing of secondary IPOs and etc. at free lunch rates or prices). 

The elites then send their money overseas, perhaps to hedge their holdings, thus the seeming capital flight from local residents in 2014.

The elites then reward themselves with titles to the prestigious list of the global elite class.

Thus record Phisix has been a symptom of such inequitable transfers. Yet today, such symptoms are being conducted desperately through market manipulation.

And speaking of inequitable transfers, I have written in the past how inflationism has signified an economic drag to the underprivileged. This has been expressed via self-rated poverty sentiment which has ballooned as money supply growth zoomed to 30%+ in 2014[2].

The so-called “transformational boom” has been prompting for an UPWARD trending self-diagnosed poverty. The implication from the above chart is that a large segment of the Philippine society has been paying the price for the benefit of a few. It would be misguided to say these groups have been “excluded” from growth, because it is precisely their resources that have been funneled to subsidize industries from financial repression policies or facilitated through the “continuing process of inflation”.

Yet the much ballyhooed boom in 2014 has paradoxically led to a rise in poverty!

Writing at the Inquirer, pollster Mahar Mangahas of the Social Weather Station (SSS) confirmed what I suspected[3]. (bold mine)

The rise of poverty last year reminds us yet again that growth in the Gross National Product, of itself, does NOT improve the lot of the poor. The so-called “growth elasticity of poverty”—see “Naive projection of poverty (Opinion, 1/24/2015)—that the World Bank read into the 2013 fall of poverty failed to operate in 2014.

Yes, there was growth in 2014S1 in the money incomes of the lower classes, said Dr. Balisacan, but it was overpowered by the inflation of prices of things the poor need. The inflation facing the poor is stronger than average inflation. In particular, the price of rice is needlessly high, because of the import monopoly of the National Food Authority. This monopoly should be abolished.

It’s nice to see Mr. Mangahas punctuate his message with an all caps “the Gross National Product, of itself, does NOT improve the lot of the poor”. 

GNP and GDP are nothing but accounting identities or tautologies. They hardly represent the real economy. This especially has been amplified for the Philippines which has a large informal sector. The growth stories have been accounted for by the major beneficiaries of invisible redistribution.

Mr Mangahas even goes on to say that inadequacies of statistics and surveys extrapolates that “the new official poverty rates are understatements.” (italics mine)

Wow. And I thought I was alone.

Yet sustained manipulation of the Phisix will NOT expunge the evils of invisible political transfers. 

Nevertheless regardless of its iniquities such dynamic isn’t sustainable. And manipulation of the index has simply been signs of desperation to perpetuate a flawed system.

Priced In USD, the Phisix Still Has to Beat 2013 Highs

There is another thing that the Philippine Stock Exchange didn’t say.

True, in peso terms the Phisix have been at a record.

But since about 15% of the domestic equity market has been held by foreigners, this means foreigners will look at the Phisix in US dollar terms.

In the context of the Phisix in US dollars, record highs have yet to be established.

The above chart represents a reconstruction of the closing prices of the Phisix, calculated based on the USD-peso exchange rate since mid 2012

Let us measure today’s record high with the 2013 high

The previous record by the Phisix in May 15, 2013 was at the closing prices of 7,392.2.

Then the equivalent USD-Php exchange rate was at Php 41.2. So dividing the Phisix with the exchange rate would give us a USD Phisix at 179.42.

Friday’s (May 27th) record close was at 7,877.96. The US Peso exchange rate of that day was at 44.76; hence, this gives us a US dollar calculated Phisix at 176.00.

If we juxtapose the records of May 2013 179.42 and Friday May 27 at 176 and compute for their variances, then we get a difference of 1.9%. This means that the US dollar Phisix has gap of 1.9% to fill—in order to equal the May 2013 highs.

And the only way for the 1.9% gap to get bridged is for the Phisix to rise faster than the falling peso or the peso stops fumbling.

Contagion Risks; More on Why Basel Standards are Flawed

Yet a stronger peso doesn’t seem to be a likely path.

In a recent speech[4], the Bangko Sentral ng Pilipinas Chief Amando Tetangco Jr. AGAIN reiterates the same 3 risk factors in his previous deflation spiel as risk to the current environment, particularly “1) the uneven global economic growth;  (2) the uncertainty of the oil price path and the ambiguity of the underlying drivers of the oil price decline; and (3) the resulting divergence in monetary policy stance among major advanced economies”, and how these would influences the domestic markets and the economy

In the last year and a half, these factors have manifested themselves in the movement of global capital into US assets (away from core Europe and emerging markets), an appreciating trend in the US dollar and a decline in global long-term interest rates.  The rebalancing in global portfolios, as funds search for better yields, has surfaced in our domestic financial markets as volatility in the peso/dollar exchange rate, and in the local bond and equity markets.

Going forward, should the uneven global growth scenario persist, we may see this translate into more pronounced changes in trade patterns.

Contra the mainstream belief that the Philippines can decouple, it appears that the BSP chief understands that there will be transmission mechanisms that will likely lead to linkages in terms of financial asset and economic performance.

Let me cite an example the latest IMF report on Indonesia’s risk[5].(bold mine)

Corporate sector performance is showing signs of strain on the back of slowing economic growth and rising funding costs. Overall profitability and debt servicing capacity of listed companies in Indonesia have weakened. On the former, the return on assets fell slightly to 14.7 percent in the first three quarters of 2014, still high relative to international peers. On the latter, the share of companies with income insufficient to cover interest expenses increased to 21 percent in 2013, while the share of debt of these companies jumped to 30 percent—in excess of its peak in 2008. Stress appears more concentrated in the resources sector as a result of sluggish mining activities and falling commodity prices.

Pockets of vulnerabilities exist owing to rising corporate indebtedness, increasing concentrated leverage and corporate insolvency, and unhedged foreign currency debt. 

· Corporate debt has increased rapidly in recent years, reaching 34 percent of GDP as of end September 2014 (latest figures available) compared to 23 percent at end 2010, in part spurred by easy financial conditions in the aftermath of the global financial crisis. About 45 percent of the increase in corporate debt was financed by borrowings from abroad. Corporate external debt was US$118 billion (around 15 percent of GDP) at end September 2014—up by US$66 billion since end 2010, although about 60 percent of this increase was either FDI-related (i.e., financed by parent or affiliated entities) or incurred by state-owned enterprises (SOEs). The greater reliance on external funding could also pose a refinancing risk, possibly exacerbated by major corporate distress, with about US$10 billion of bond and syndicated loans maturing in 2015.

· Concentrated leverage at highly indebted companies has also increased, coupled with rising corporate insolvency. Companies that were already highly indebted became even more indebted over the past few years, despite only a marginal increase in system-wide average leverage ratios. This concentration is seen in the aggregate debt-to-assets ratio of listed companies (weighted by individual companies’ outstanding debt), which has increased substantially to a level near its peak in 2009. In addition, the share of listed companies with negative equity has risen sharply, indicating potential for more widespread corporate defaults.

· Exposure to foreign exchange (FX) risk is not negligible. About half of corporate debt is denominated in foreign currency. Although around 70 percent of non-SOE foreign currency debt is estimated to have been incurred by companies with FDI-related funding and/or with FX cash flows, some companies are still subject to FX risk.1 A large rupiah depreciation could significantly undermine balance sheets of companies with inadequate hedging of their FX exposure, with market reports also suggesting that most hedging now in place will knock out at specific levels of the exchange rate

Yet despite the substantial buildup in Indonesia’s credit risk profile, ironically the IMF still expresses confidence that their banking sector will remain resilient “given strong capital buffers”.

I don’t share that confidence.

That’s the USD-Indonesian ringgit. 

The ringgit has been taking it to the chin and now has crashed to record levels. Question now is: To what extent will the current ‘capital buffers’ hold in the prospect of a sustained US dollar juggernaut vis-à-vis the ringgit??? Where is the breaking point for the system to snap?

If Indonesia’s system wilts and eventually cracks how will this affect the entire region? Do the big bosses of the BSP and their hordes of economists know?

In the above speech by the BSP chief he notes that Basel 3 serves as the Philippine banking system’s regulatory “primary safety net” but this hasn’t been the only standard.

Curiously the BSP chief generalizes that “the quality of loans has been improving, with NPLs continuing to fall”.

Really?

Does the above exhibit the validity of the above claim where the banking system’s “quality of loans has been improving”? 

Based on SMC’s full year 2014 Investor’s presentation, long term debt bulged by Php 32 billion to Php 483 billion while profits grew by only 28.1 billion!

SMC supposedly declares itself to be a profitable company, but debt continues to massively mount despite recent major asset sales (e.g. Meralco and PAL), why? Whatever happened to the proceeds of the asset sales? These have been spent on corporate expansions, rather than paying down debt? Why? Yet are these expansions guaranteed to deliver the much needed cash flows to eventually bring down these huuuuggggeeee debt levels?

Or has it been that profits have merely represented intracompany juggling of accounting numbers? Or has it been that stories have to be made to bewitch the public to sustain what has been SMC’s core method of financing: borrowing IN borrowing OUT or what the late Minsky calls the Ponzi finance?

In term of relative proportions, do you how big Php 483 billion is? It’s not just a number.

Well based on BSP data, as of December 2014, the Philippine banking system’s total resources has been calculated at Php 11.159 trillion. This means SMC’s 2014 debt has been equivalent to around 4.3% of the entire banking system!

As caveat, of course, not all of SMC debt has been from domestic banks (some are from bonds and some are foreign banks and financial institutions). Also the above data covers long term debt and hardly the short term ones which are also sizeable.

So what happens if Indonesia’s financial conditions shatters? Will capital flight be limited to Indonesia or will it spill over to the region and to the Philippines? If the latter, how will these affect the heavily levered domestic companies like San Miguel?

Again do the big bosses of the BSP and their hordes of economists know? Or is SMC the local equivalent of the US too big to fail or Systemically important financial institution where the BSP has already covert rescue plans for them?

Meanwhile NPLs as previously noted[6] hardly ever serve as leading indicators but at best are coincident indicators.

Non Performing Loans (NPLs) are coincident if not lagging indicators. NPLs are low because the current boom continues.NPLs become reliable indicators, when asset quality deteriorates or when the credit boom is in the process of reversing itself into a bust. Again they are coincident if not lagging indicators.

The mainstream would like to believe that there is some magical potion or formula on how to control credit with statistical variables even when the main policy itself PROMOTES credit.

This would be another version of cognitive dissonance applied to policy

In a recent interview[7], former Bank of Japan governor Masaaki Shirakawa questions the current reliance on bank capital standards in controlling of financial stability risk. (bold and italics mine)

The current assessment of financial stability risk that I often hear is that – because of the improved capitalization and increased liquidity buffers of financial institutions – there is no imminent threat. If I stress “imminent,” I do not disagree with this view.

But, at the same time, we have to recognize that financial crises over the past 20 years or so have taken on a different form every time. We cannot grasp the system’s vulnerability just by looking at average data. What is important is the distribution of positions and the correlation of risk factors. In this regard, we have to be attentive to the fact that we have been through a very long period of low interest rates. And, while I cannot specify the exact form of positions that could threaten financial stability, it is natural to think that various forms of potentially risky positions that we do not see clearly could be accumulating. Also, we have to be attentive to the behavioral changes in the government that these financial conditions could bring about…

Shirakawa-san further advocates on the priority of controlling monetary policy that promotes debt than from implementing macroprudential policies…

Following the global financial crisis, there were many measures introduced in the area of regulation and supervision to make finance safer. Most of these measures are desirable. But, it is not enough to have a certain liquidity or capital buffer for a given amount of debt. What is more important is to avoid too much debt itself. And, we have to discuss this issue more seriously.

In this regard, we need some rethinking of the conduct of monetary policy. We have to wonder whether the current regime of monetary policy has a bias toward the creation of too much debt. For instance, if monetary policy is overly focused on price stability in the short term without paying due attention to the stability of the financial system, it may lead to excess debt creation by giving the sense that accommodative policy will extend into the future. Also, if central banks have too strong a preference for low volatility, providing insurance against a fall in asset prices, then this may lead to excess debt creation. Of course, macroprudential policy is important, but I don’t think it will be effective without a corresponding monetary policy adjustment.

Again obsession to statistical metrics hardly serves as guarantee to the soundness of a financial system. Statistics is not economics.

Instead a system that depends on the politicized distribution of credit via central banking fiat standard will always be vulnerable to boom-bust cycles or to hyperinflation.

Finally, has the strong dollar begun to exert its adverse influence to the stock markets of our neighbors?

If so, to what extent will the Phisix be shielded? Will the Phisix be subjected to the BSP’s observation that “The rebalancing in global portfolios, as funds search for better yields, has surfaced in our domestic financial markets as volatility in the peso/dollar exchange rate, and in the local bond and equity markets”

Can the index managers prevent a potential contagion?

Interesting.

The Different Hats of the BSP Chief

While the BSP chief omitted the word 'deflation' in his most recent speech, he structures his arguments from the basis which he previously argued of deflation risks. This implies of his continued deflation mindset.

In addition, the BSP chief appears to be engaged in serious cognitive dissonance.

First, in his lecture to journalists on how they should write about economics, he emphasized on the authorities’ ‘knowledge problem’, in particular how authorities are faced with the variability and fluidity of events for them to react. This striking commentary is an example: “There are no absolutes in dealing with these issues. There are many ifs and buts. And, a number of factors and variables, including concerns related to technology and geopolitics, would need to be considered. Friends, there is no crystal ball for these things.”[8]

I have even been smitten by his quote: “Economic numbers rarely tell the complete story when taken at face value. Therefore, a responsible journalist who seeks to offer readers a fuller appreciation of the information will examine the figures within a broader context or against an array of other relevant indicators.”

Yet in the recent speech he attempts to show the opposite, how BSP actions have been “proactive, preemptive and prudent”. In short, he shifts from the knowledge problem to the pretense of knowledge.

So different audiences, different hats, anything that panders to the audience hence the clashing messages.

Second, the proclivity to see the world in the context of deflation risks has so far prompted the BSP’s monetary board to maintain policy rates last week. This aligns with the BSP’s lowering inflation forecasts to 2.2% in 2015 while ironically projecting growth rates of 7-8%.

Given that “rebalancing in global portfolios” has already “surfaced in our domestic financial markets” that may “translate into more pronounced changes in trade patterns” how the heck can one project 7-8% growth rates if the above external conditions will be realized and transplanted to domestic conditions? How will say a sustained firming of the US dollar influence domestic interest rates which translate to borrowing or credit conditions, capital flows, trade and production process? Does he or the entire BSP know? Or has the BSP just been picking numbers from the sky to enthrall the crowd?

Importantly, since credit growth has been instrumental in delivering statistical economic growth, how on earth will this square with low inflation? Is the BSP suggesting that productivity growth—centered on largely construction-property and property related boom—will explode???!!! And because of such productivity blast, credit will serve less in the financing of economic expansion? This implies that 7-8% will be financed by savings and retained earnings??? What has these guys been S-M-O-K-I-N’?!

Does the BSP ever give a thought on how current debt levels will affect future growth?

Well as I have said in the past[9],

Debt represents the intertemporal distribution of spending activities. Borrowing money to spend simply means the frontloading of spending. The cost of debt financed spending today is spending in the future. Debt will have to be repaid at the expense of future spending. Of course there are productive and non-productive debts. But policies of financial repression via zero bound rates tend to promote non-productive ‘speculative’ and consumption debts.

Has the BSP identified which among the loan portfolio extended by the banks and by the bond markets have speculative or productive? Do they know of their proportionality and depth of possible chain links of creditors? The problem with looking in the prism of aggregates is to see and dissect things as a one size fits all phenomena.

Yes the government can manipulate statistics to show whatever they want, but they can’t make statistics put food on the table.

Statistics is not economics.

Record Phisix 7,800: Benjamin Graham and David Dodd’s View of Overvalued PERs

There is another thing that the PSE officials didn’t give an effort to explain at all.

They claim that record stocks represent “investors anticipate positive earnings results”

They didn’t explain that if record Phisix had indeed been about anticipation of positive earnings results, then why the proliferation of outrageous valuations?

Outlandish valuations have NOT been about positive earnings results but about performance, yield or momentum chasing rationalized on whatever that would stimulate such frenzied behavior. G-R-O-W-T-H has served nothing more than a shibboleth or a conditioned stimulus that triggers irrational behavior.

Yet here is why such rationalizations could be hazardous and dicey to one’s portfolio.

In a warning on US equities, the US treasury’s Office of Financial Research writes on why we shouldn’t rely on mainstream’s Forward Earnings

Forward PE ratios are potentially misleading for several reasons. First, forward one-year earnings are derived from equity analyst projections, which tend to have an upward bias. During boom periods, analysts often project high levels of earnings far into the future. As a result, forward PE ratios often appear cheap. Second, one-year earnings are highly volatile and may not necessarily reflect a company’s sustainable earnings capacity. Third, profit margins typically revert toward a longer-term average over a business cycle. The risk of mean reversion is particularly relevant today, because profit margins are at historic highs and analysts forecast this trend to continue.

Previously I have recently shown the LTM 3Q reported EPS by Phisix, its sectoral benchmarks and its member companies based on December reports from 2008-2014.

Let us see how the OFRs observations fare with developments in the Philippine setting. 

The OFR says of upward bias in earnings projections during boom.

2014 mainstream projection was at 6%, LTM 3Q data shows growth at 1.8%. √

The OFR says one-year earnings are highly volatile.

Given that—of the 29 issues with 2 year track record or more—there have been only 6 issues that had sustained earnings growth for 3 years, and 5 of these has been above 10, then this would mean another √

The OFR says profit margins typically revert toward a longer-term average over a business cycle

As explained before, growth has natural limits and thus this should be expected. Warren Buffett’s flagship Berkshire Hathaway should serve as great example. Nonetheless mean reversion over a business cycle will have to yet to be tested here. And that test will likely come soon.

Finally do you know what Warren Buffett’s mentor Benjamin Graham and his partner David Dodd thinks of buying issues with overpriced PERs[10]? (bold mine)

The notion that the desirability of a common stock was entirely independent of its price seems incredibly absurd. Yet the new-era theory led directly to this thesis. If a public-utility stock was selling at 35 times its maximum recorded earnings, instead of 10 times its average earnings, which was the preboom standard, the conclusion to be drawn was not that the stock was now too high but merely that the standard of value had been raised. Instead of judging the market price by established standards of value, the new era based its standards of value upon the market price. Hence all upper limits disappeared, not only upon the price at which a stock could sell but even upon the price at which it would deserve to sell. This fantastic reasoning actually led to the purchase at $100 per share of common stocks earning $2.50 per share. The identical reasoning would support the purchase of these same shares at $200, at $1,000, or at any conceivable price.

An alluring corollary of this principle was that making money in the stock market was now the easiest thing in the world. It was only necessary to buy “good” stocks, regardless of price, and then to let nature take her upward course. The results of such a doctrine could not fail to be tragic. Countless people asked themselves, “Why work for a living when a fortune can be made in Wall Street without working?” The ensuing migration from business into the financial district resembled the famous gold rush to the Klondike, except that gold was brought to Wall Street instead of taken from it

To repeat: The results of such a doctrine could not fail to be tragic.

I’d be blunt or more direct, the obverse side of every mania is a crash.

Crashes signify as tragic outcomes.

US Treasury’s OFR Warns on US Stocks! BOE Sounds Financial Instability Alarm as Four Central Banks Cut Rates!

The reason I mentioned the US Treasury’s Office of Financial Research has been because of their lengthy and detailed admonition on US equities which they describe as having been severely overvalued and overleveraged.

The US government’s OFR conclusion[11]

Markets can change rapidly and unpredictably. When these changes occur they are sharpest and most damaging when asset valuations are at extreme highs. High valuations have important implications for expected investment returns and, potentially, for financial stability.

Today’s market environment is different in many ways from the period preceding the Great Recession, because regulators and market participants have made adjustments to enhance financial stability since the financial crisis. In that time, stock returns have been exceptional and market volatility generally subdued. Today, many market strategists see the bull market extending throughout 2015.

However, quicksilver markets can turn from tranquil to turbulent in short order. It is worth noting that in 2006 volatility was low and companies were generating record profit margins, until the business cycle came to an abrupt halt due to events that many people had not anticipated. Although investor appetite for equities may remain robust in the near term, because of positive equity fundamentals and low yields in other asset classes, history shows high valuations carry inherent risk.

Based on the preliminary analysis presented here, the financial stability implications of a market correction could be moderate due to limited liquidity transformation in the equity market. However, potential financial stability risks arising from leverage, compressed pricing of risk, interconnectedness, and complexity deserve further attention and analysis.

Warnings from political authorities are back in the fad again.

This week, the Bank of England cautioned against financial stability risks[12] (bold mine)

Among officials’ top concerns is the risk that participants in financial markets are too sanguine about their ability to quickly sell assets if economic news sours, a fragility the BOE has been highlighting for some time.

This drying-up of market liquidity risks heightening volatility in financial markets and could undermine financial-sector stability, the panel said.

Aside from the OFR and BoE’s negative guidance, four more central banks have slashed interest rates last week, particularly Sweden, Pakistan, Hungary and Sierra Leone. Last week’s combined actions adds to 10 central bank rate cuts for the month and 28th for the year. Aggressive rate cuts represent crisis resolution measures being undertaken by global central banks. This tally board excludes other easing measures, like QE.

In the past, rate cuts had been used when the economic downturns become apparent. Today rate cuts are being applied preemptively. In other words, like bear markets, economic downturns or recessions are prohibited. Central banks will use all available tools to ward them off. The problem is that if their magic wand fails, and when the slump becomes apparent, then central banks would have exhausted their tools. 

28 rate cuts means many part of the world have been showing signs of emergent distress from which has prompted their respective central banks to act.

Nonetheless many stock markets have been at various record or milestone highs. Such euphoric mood runs in the opposite direction to the reactions of central banks with respect to their real economy. Record high stocks seem as in a state of intoxicated ignorant bliss.

Yet when they awake from their inebriation, a big hangover will befall on them.

---

[1] Philippine Stock Exchange PSE index posts 20th record close for 2015 March 26, 2015

[2] see Phisix: PNOY’s 5th SONA: Desperately Seeking The Return of Boom Time Conditions August 3, 2014

[3] Mahar Mangahas Self-rated poverty proves its reliability March 14, 2015 Inquirer.net

[4] Bangko Sentral ng Pilipinas Speech before the Euromoney Philippines Investment Forum, Sustaining the Economy's Growth Saga through The 3Ps of Policymaking: Proactive, Pre-emptive, and Prudent, bsp.gov.ph March 24, 2015

[5] IMF 2014 ARTICLE IV CONSULTATION—STAFF REPORT; PRESS RELEASE; AND STATEMENT BY THE EXECUTIVE DIRECTOR FOR INDONESIA March 2015

[6] See The Flaws of BSP’s Real Estate Monitoring and Banking Stress Tests May 20, 2013

[7] Money and Banking Interview with Masaaki Shirakawa March 25, 2015

[8] See Phisix 7,800: Record Phisix as the BSP Continues with Deflation Spiel! March 9, 2015

[9] See Rationalizing the Record Phisix 7,700 February 8, 2015

[10] Benjamin Graham and David Dodd, The New-Era Theory Chapter 27 THE THEORY OF COMMONSTOCK INVESTMENT Security Analysis Sixth Edition (p 359-360) Paulasset.com

[11] See Wow. US Treasury’s Office of Financial Research warns of US Stock Market’s Extreme Valuations, Overleverage and Rising Risks of Financial Instability March 27 2015

[12] See More Central Bank Panic: Bank Of England Warns of Elevated Risks to Financial Stability, Four More Central Banks Cut Rates Last Week! March 27, 2015