Why Blowoff Episodes Reveals That The Boom Is The Disease!

Vainglorious ‘experts’ and many market ‘knowledgeable’ people have frequently resorted to rationalizing price actions with historical ‘fundamentals’. They try to “reason from price changes” as one popular monetary economist puts it.  

So when they see skyrocketing share prices, they associate this with (delusional) prosperity. They tend to see things or numbers selectively by eschewing all the negatives and embracing all the positives which they attribute to such price actions.  

And when offered the prospects of a crash, the frequent excuse is to ask “what will drive it?” Because prices are up and fundamentals look (selectively) rosy, they would automatically deny the probability of such an outcome.  

Experts of such quality are afflicted by the recency bias. They look at the ticker tape or headline news which they extrapolate into the future. They hardly have theories to back them up except to rely on statistics (past data) to constitute their presuppositions of the economy.  

Yet markets function as a discounting mechanism. Because they are a discounting mechanism, markets tend to reflect on fundamentals way ahead or even before they become apparent.  

Take a few examples.  

The Phisix peaked in February 1997, a few months before the Asian Crisis surfaced into the open (July 1997).  

The Phisix responded to the Great Recession months ahead before early 2008, when people began suspecting that the US had fallen into a deep economic downturn. To repeat the Phisix crashed in August 2007. Rallied back to recover all the losses, only to crash again in October.  

The National Bureau of Economic Research (NBER) belatedly dated the US Great Recession in December 2007.  

It’s easy to make explanations ex-post. That’s because hindsight is 20/20.  

Yet what explains the two crashes in the Phisix in 2015 and January 2016?  

Following the run to April’s 8,127.48 record, the Phisix began to wilt in prices and in the context of internal actions. I have been pounding on this at my prudent investor weekly outlook.  

When the China’s yuan depreciated in August, this proved to be a secondary order effect or the event risk trigger (aggravating circumstance) which further escalated on the already debilitating Phisix.  

The Phisix hardly recovered from the August debacle and weakened further through December.  It broke 7,000 by the year end to close at 6,952. By January 2016, the downside actions accelerated. This again climaxed with the yuan’s second significant weakening. The Phisix dropped to 6,084. Then came the G-7’s implicit Shanghai Accord plus the BSP’s silent stimulus which arrested the decline.  

In gist, developing conditions at the PSE caused its vulnerability. Hence, weak conditions made it ripe the for two crash events to transpire which external events exposed (via China’s yuan depreciation).  

At present, if there is anything the market has repeatedly been signaling, it has been that the gamut of hysteric or panic buying or the mania phase has only been masking an internal degradation process. The BOOM itself signifies the disease!  

That’s because the credit based artificial boom has been erected on unsound foundations. And from tenuous grounds, such temporary boom will eventually be fated to a reversion to the mean. Or the markets will clear.  

All the financial and economic imbalances and maladjustments from economic distortions brought about by the political tinkering with money prices through interest rates will have to readjust to conform with economic reality. Borrowing from the future will entail of future and present costs. There is no free lunch.  

Signs of the costs of imbalances have already existed: Faltering growth in tax revenues, downside pressures on the top line and earnings of PSE firms, manufacturing stagnation, export recession, jobless boom, soaring education prices, and incipient signs of strains even at the heart of the boom—real estate. Agriculture has been also down (partly from politically induced economic distortion and partly from weather).  

Don’t forget people employed in the manufacturing, agriculture and exports account for a big segment of the population. They comprise about 40% of the work force. So weak output in these industries should translate to lower spending and less jobs.  

Add to this the race to build capacity by the key engine of the Philippine economy—the bubble sectors—which implies the likelihood of lesser investments when surpluses vent itself through corporate profits.  

And all these have occurred, despite the government’s smokescreen of inflating the GDP numbers. In short, real economic indicators have been moving against survey based aggregated statistics.  

What has the repeated crashes (majors: May 2013, August 2015 and January 2016; minors: October and December 2014) have been telegraphing to us?  

The answer: Whatever boom in the Philippine economy, it has been finding itself mired into an increasingly fragile state!  

Just think of what the supposed boom did to politics. Has it not been due to a perceived popular ‘protest vote’ that the new administration was elected from? Why would 16.6 million people see themselves as expressive of dissatisfaction and dissent when GDP continues to scintillate at elevated levels?  

Even from a standpoint of misperception, popular politics REINFORCES symptoms of economic contortions. Think of just what 10 months of 30%+++ of money supply growth in 2013-2014 did to the purchasing power of the average citizenry. Had I not warned that this would create popular discontent?  

Essentially, the popular ‘protest vote’ not only represented a backlash against, and the supposed repudiation of the outgoing administration’s policies, it most likely have been a sign that the Philippine bubble has been pricked!  

Yes it may be true that some of the discontent has been on social burdens as traffic, crime, drugs and etc., but which of them have been isolated from the economy or from economics?  

As a side note, think about all the surveys conducted by the government (particularly by the BSP) stating how satisfied consumers had been, prior to the elections. Also think about the privately done poll, which came up with the bizarre, risible and outrageous findings that a-third of the population had actually thought that the Philippines had attained developed economy status. The self-identified ‘protest vote’ essentially demolished all these as nothing more than a myth, if not propaganda. This represents another noteworthy example of demonstrated or revealed preference or people expressing themselves through actions rather through words.  

Yet by rationalizing popular politics as an extension of the previous boom, the establishment has been fighting wildly and furiously to camouflage the bubble from bursting through the deepening of the manic phenomenon at the domestic financial markets!  

Let us do some follow the money trail or examine how the vertical run may have been financed.

Falling credit growth has coincided with the recent decline of the PSEi seen both from a quarterly (upper window) and from the monthly basis (middle window). 

Because the PSEi fell to 6,084, and when compared to the trek towards 8,127 over the same period in 2015, the first quarter of 2016 posted huge losses in terms of relative or comparative growth (upper window). 

But because some unknown entity forcibly steepened, on what has been a sustained trend of flattening to inverting yield curve, banking credit growth did a magnificent turnaround and significantly ballooned in 1Q 2016! 

So bank credit growth soared as the PSEi recovered. 

YET three factors may have forced the unseen intervenor to act or deploy a silent stimulus: 

1. The masquerade of falling price levels (as measured by the government) which has inflated GDP is unsustainable. The government’s statistical artifices will be exposed if prices will not recover. And prices can only recover through the bank credit channel. 

Since GDP is about money based spending and since bank credit growth accounted for more than 70% of money supply growth, then this means that the core segment of GDP has accrued from bank credit growth. In short, bank credit growth is the quintessence of GDP performance. 

So the target of reversing the decline in credit growth trend may have been intended to boost statistical GDP. 

2. Election spending. There is no such thing as a free lunch. Election campaigns and vote buying will need to be financed. 

And banks did most of it! This can be seen in the growth of the money via M1, which consists of currency in circulation (or currency outside depository corporations) and peso demand deposits (BSP), have only been accelerating since 4Q 2015. And this intensified further in the first four months of 2016! (lowest window) 

So bank credit growth may have been targeted directly or indirectly to fund election spending. 

Question: how will these resources, which were directed through unproductive means, be repaid? 

3. Sustained crash of the PSEi. 

The surge in bank lending growth seems to have powered the recent run at the PSE! 

Aside from the 1Q 2016’s 16.12% surge in overall bank lending, at 18.5%, banking loans to the financial sector in April nearly doubled in terms of growth rate when compared to March’s 10.59% and tripled to that of February’s 6.33% and January’s 5.25%! 

As the PSEi moved higher so did bank loans to the financial sector! 

Yet how much of those vertical ‘panic buying’ moves have been bank financed? 

What happens to such loan portfolios when the ultra-expensive equity prices unravel? 

So the surge in bank credit growth may have been intended to indirectly bailout entities and institutions that have been heavily exposed to the stock markets. 

If true, then what even happens more if financial institutions suffer from credit problems? More bailouts? And if true, then such bailouts simply strengthen indications of existing or incumbent problems unseen by the public. 

So up to what point before more of such invisible stimulus will be forced out into the open? 

Yet government’s own measures of prices have already been signaling dangers ahead.  While April’s CPI was at 1.1%, the government’s measure of retail price index soared to 1.6% a high almost at the April 2015 level at 1.8%. Sustained substantial increases in credit growth will likely distill into CPI too. 

Again higher economy (goods and services) prices will smite the already strained consumer spending or the pesos’ purchasing power! Think of what this will do to people (mostly employees) involved to sectors (agriculture, export and manufacturing) already suffering from an economic stagnation? 

And higher prices will affect business input while having little power to pass cost increases to the consuming public. Yet a recipe for more profit squeeze! 

So the secret stimulus may have spiked the PSEi, GDP and elections, but the drawback has also surfaced.  There is no free lunch. 

If the secret stimulus will prevail, then the risk is that there will be another outbreak of inflation (very soon). This again will force the BSP to tighten monetary conditions. But doing so, will only lead to the same outcome as we had seen in the recent past but at a worst degree. Remember the difference has been that leverage today has been larger than that of 2013-14 and that the real economy has been a lot weaker (despite the government numbers). 

And if the secret stimulus program will cease, then the recent boom will once again deflate. And again, Remember the difference has been that leverage today has been larger than that of 2013-14 and that the real economy has been a lot weaker (despite the government numbers). 

Such the Keynesian monetary parlor tricks have reached its climax.

From Marking the Close to Hype and Dump

Even more, there is not a single week where price fixing at the closing bell has been happening in rampancy. 

The least used version has been the pump and dump.

In one session last week, this became evident The PSEi has been puffed up the entire day and then, at the run off close, a sudden dump! That happened in June 2.

Curiously last May 31, when the PSEi closed .84% down, price fixers appeared to have lost control. Usually they coordinate their end of the market pumping. By coordination I mean generally push up key major issues.

But on Tuesday, price fixers went into different directions.

The most stunning portion was PLDT’s awesome pump and dump! PLDT was up 5% prior to the market intervention phase. At the runoff period, TEL just gave back more than 5% of its pre-closing gains to end the session down!

All it took was the market intervention period for pump and dump to happen! How prices can significantly change in an instant.

And notice of AEV’s stunning 4.1% price fixing or end of the session pump! That’s exactly how current record highs have been made of. AEV’s new record was a product of a marking the close PUMP!

The Bangko Sentral ng Pilipinas’ "Revised Rules and Regulations Implementing Republic Act No. 9160” (the Anti-Money Laundering Act of 2001 [AMLA], AS AMENDED BY REPUBLIC ACT NO. 9194 stipulates of the different price manipulations, which by SEC and BSP standards are considered illegitimate.

But all these have been occurring in a brazen fashion at the PSE. They set the rules, but are blind to such infractions. The Philippines IS the only country that openly practices this.

Stunningly media has long been silent about this. Interestingly incoming president Mr Duterte’s agitation against media lies on solid ground. The above should be an example. The exception has been that the means which Mr Duterte advocated to rectify such conflict of interests has implicitly been through violence: summary execution. Disregard of the due process shows that he doesn’t seem to be interested with reforms. Instead, what interests him is to control media. He wants everyone will sing halleluiahs to him! Such actions hardly lead to productive reforms. To the contrary, such actions lead to repression.

Yet such manipulations have been so egregious for even some lay people to have noticed this even without my informing them.

And as product of regulators, whom seem to have been asleep at the wheel, the ultimate consequence of such egregious manipulation has been to blow market activities out of proportion or drive them further away from reality.

At the end of the day, market forces will eventually rule: the obverse side of every mania (backed by manipulation) will be a bust.

PLDT GLO Deal Forges 4G Monopoly: Benefits Seen, Costs Ignored

The market has been looking for anything that would justify a breakaway run from 7,400. So given the limited participation from the ranks of PSEi 30, the latest mega telco deal provided a catalyst for another parabolic move which this time involved telco issues. The pump on telco issues lifted sentiments to drive the PSEi to 7,500. TEL’s weekly gain of 13.67% and GLO’s 7.4% spearheaded the push towards 7,500 

The collapse of the deal between Australia’s largest telecom Telstra and San Miguel’s Liberty Telecom last March, essentially paved way for the Php 70 billion sales of latter’s telecom business to the two major players of the industry, TEL and GLO last week. Both firms agreed to evenly split in the acquisition of SMC’s business unit. And funding for the acquisition will mostly be through leverage or debt. That’s aside from the proceeds from the recent asset sale of PLDT’s 25% stakeholdings in Beacon Holdings (which has a stake at Meralco) to sister company Metro Pacific. 

So unless there will be further changes in the ownership, what used to be sold to the public as a two firm ‘competition’ in the telecom industry has now been structurally changed. With the said transaction, the two competitors have essentially formalized a cartelized relationship or a cartel which becomes an indirect monopoly! Through the newly acquired firm, the 4G becomes a direct monopoly.

Given the market’s response, credit rating Fitch sees that this would be positive for the industry due to the “coveted 700MHz spectrum” which may “provide telcos with plenty opportunities if they offer faster 4G LTE services”. Fitch admitted that “mobile market is highly saturated…but most users are on 2G networks” 

What Fitch essentially has been saying is that the industry’s problems have mainly been about a supply side technology based stasis. And because of the introduction of the new technology, in particular 4G, upgrades would redound to growth! Thereby, such growth would justify the cost of acquisition! 

I wish it had been such a simplistic world. 

To be clear, I will not deny that there will be benefits from the transaction. But it is not just about benefits but about tradeoff with the cost that matters. 

Moreover, the changing nature of the telecom’s political economy will also signify a critical issue. 

And it’s not written on the stone that there will be big demand for 4G, because ultimately demand will depend on prices offered. If upgrades will be priced at ZERO (or close to zero) then for sure there will be a huge demand. However if upgrades will be charged at a Php 1 billion a month, then demand will likely be close to zero. 

So it would be rather parochial to suggest that new technology equals growth! 

Price elasticity (price sensitivity) has been variable among telecom products. According to UN’s International Telecommunication Union’s (ITU) “Telecommunication Handbook Appendices” (2000) “Demand for any given service is less elastic for business users than for residential users.”  (B-9) 

What this means is that if the price for an upgrade will be steeply higher compared to its perceived and or calculated benefits (access and usage) then demand may not be as strong. 

Yet given the huge of cost of acquisition and the transition of the industry from two competitors (or players) to a formalized cartel and a monopoly for 4G services, low or affordable prices will not be a guarantee. 

That’s because in absence of competition, the company have now garnered effective control over prices! Consumer’s choice would now be reduced to buying from them, or not to buy at all. That’s instead of the previous conditions where consumers would have a choice in the products of competing providers. 

Additionally, upgrades are no guarantee of growth if economic conditions falter.

Since 2014, based on 1Q data, the combined gross revenues of both PLDT and GLO have been plateauing. Being a two party competition, GLO has been taking a larger market share of the pie from PLDT. But in general, competition has masked the deteriorating gross revenue conditions of the industry. 

So this could be a sign of industry saturation and this could also be signs of economic conditions. Or in fact both could signify a symptom. 

Five years back PLDT acquired Gokongwei owned Digitel supposedly to take advantage of the “synergies” between the companies and to reduce the former’s capex. 

Yet what happened to the merger? PLDT’s income today has been under pressure. 

And this could be why the duopoly seems desperate to acquire SMC’s telecom business. 

And such desperation has been sold as a game changer. 

On the other hand, of course, SMC seems all too eager to sell to get access to liquidity to finance its highly levered business model

There is another very important component being ignored: the political environment encompassing the industry. 

Below is an excerpt of the arguments I made in my April 3, 2011 “Philippine Telecom Industry: Buyouts And Mergers Don’t Kill Competition, Laws Do” article 

The path towards the monopolistic character of our telecom industry is a product of our existing laws. 

One, there is a constitutional limitation on foreign ownership in public utilities to 40%. 

Two, licenses per se are not issued to telecom service operators in the Philippines unlike many countries. Instead, operators are required of a legislative franchise (issued by Congress). 

Three, another requirement is the certificate of Public Convenience and Necessity issued by the National Telecommunication Commission (NTC), and 

Lastly, approval to provide telecom service via grant authority for operation also from the NTC, which usually covers a provisional period of 5 years. 

The above is a manifestation of the huge structural obstacle imposed against companies wishing to enter and compete with present participants in the telecom industry. 

Such regulatory labyrinth represents as the anti-competitive anti-business nature of the Philippine business climate that enables such monopolistic character to take place because it substantially raises the barriers to entry, increases the hurdle rate for investors just to comply with these web of statutes and whose success to secure license-to-operate would depend on the whims of venal politicians. 

Imagine, any business entity wishing to enter and compete with the entrenched bigwigs would need huge sums of lobby money to get a franchise, and to outbid the existing companies protected by these laws, who would likewise spend enormous amounts of lobby money to oppose their entry! 

And that’s not all. There are other administrative regulatory compliance costs such as the NTC requirements et. al. with which prospective new players need to deal with. 

So in effect, alot of productive capital will go down the drain just to acquire licenses, pay regulatory fees, and also to oppose entry of competition! And alot of those wasted money would only go to the pockets of these grandstanding politicians and the bureaucrats. And this doesn’t even count on the productive time lost to secure licenses and to comply with such regulations. 

The point is: Buyouts and mergers don’t kill competition, (anti-competition) laws do. 

This week’s formalization of a cartel and the forging of an indirect monopoly essentially proved my point and validated my forecast of the trend towards a monopolistic character of the industry. 

And monopolies are a product of a highly politicized environment, or to quote Austrian economist George Reisman, “Monopoly is actually the result of government intervention. Specifically it is the reservation of a market or part of a market to one or more suppliers by means of the initiation of physical force. Exclusive government franchises, protective tariffs, and licensing laws are examples” 

As noted above, by competition, consumers are given the power through choice to discipline or regulate providers or suppliers through the profit and loss system. And given the absence of the discipline from competition, will services actually improve when profits have virtually been guaranteed due to the embedded protectionist political climate? 

Bureaucratic politics have rendered the duopoly to become palpably insensitive to consumers. Yet will more fiat, executive orders and threats from central authorities provide the necessary incentives for such politically incented institutions to align their goals with the consumers? 

The incoming president, Mr. Duterte, had it right when he threatened existing firms that “he would allow the entry of foreign players if service providers failed to make the country's internet service faster” He should make good of this with or without actions by the duopoly. Unfortunately for this to happen means to change the constitution. And a constitutional change could signify a Trojan Horse. 

Mr. Duterte’s ‘improve or else’ stance was also right for the wrong reasons. Why? Because by using consumers as an excuse, he impliedly offered protection to the oligarchs. Of course, services can it improve, but at what price to the consumers? 

If he really cared for the consumers, then he just dismantle ALL THE LEGAL OBSTACLES on the industry for competition to really flourish. 

It’s not just legal barriers to entry, this also should involve the legal obstacles that underpins the incumbent bureaucratic politics. 

In sum, the monopolization of the 4G services from the joint acquisition, as well as, the formalized cartel will insure of a captured stream of income for both TEL and GLO. That’s the benefit. 

But this doesn’t guarantee that such would imply of sustainable growth because prices and economic conditions will play a key part in consumer’s choice and the shaping balance sheet conditions of the duopoly. 

And if growth may not be guaranteed, then vastly increased leverage used for acquisition could mean increased pressures on the bottom line. This could even lead to increased credit risk. 

Additionally there might be other textbook economic costs to such monopolization: high prices, allocative inefficiency, productive inefficiency, less cost sensitive, low output, inflated profits, diseconomies of scale and poor product quality/services