Sunday, January 23, 2022

What Surprise is in Store for the 2022 Year of the Water Tiger?

 

Never succumb to the temptation of becoming bitter. As you press on for justice, be sure to move with dignity and discipline, using only the weapon of love. Let no man pull you so low as to hate him. Always avoid violence. If you succumb to the temptation of using violence in your struggle, unborn generations will be the recipients of a long and desolate night of bitterness, and your chief legacy to the future will be an endless reign of meaningless chaos—Martin Luther King, Jr.  

 

In this issue 

 

What Surprise is in Store for the 2022 Year of the Water Tiger? 

I. Year of the Water Tiger: How will the Philippine Economy and Financial Perform? 

II. Rising Temperatures on Geopolitical Flashpoints: From Cold War to Hot War? 

III. China’s Mounting Economic and Financial Risks 

IV. Have Global Financial Markets Reached a Minsky Moment? 

V. Falling Markets May Prompt Central Banks to Ease, Surging Global Inequality, Gold and Agriculture as Hedges against Fat-Tailed Risks 

 

What Surprise is in Store for the 2022 Year of the Water Tiger? 

 

I. Year of the Water Tiger: How will the Philippine Economy and Financial Perform? 

 

2022 is the year of the water tiger.  

 

From theChineseZodiac.org (bold original): According to the Chinese horoscope, 2022 is the year of the Water Tiger, a year of all types of extremes. In Chinese Astrology, the Chinese zodiac animal signs are grouped in six pairs according to the balance between Yin and Yang. Each of the six groupings is associated with one of six destiny aspects known as Houses. These Houses influence the overall characteristics of the time period in which the animal sign rules. The Second House is the House of Expansion, which is associated with the Tiger and Rabbit. In the Year of the Tiger, there will expansion through aggression and conflict in the world. In the year of the Rabbit, there will be expansion through diplomacy and talks usually to repair the damage caused by the Tiger’s aggression. 

 

From the standpoint of the domestic economy and financial markets, has the year of the Tiger indeed been a year of extremes? 

 

 

Figure 1 

The PSEi 30 has indeed had a wild ride in three of the last five years of the tiger. (Figure 1, topmost pane) 

 

It rewarded the bold and the daring by a historic 223.8% in 1986!  

 

It gave a hefty plum of 37.6% returns to the courageous in 2010!  

 

But it penalized risk-takers with a 14.3% loss 59 years ago or in 1962, which like today, was the year of the water tiger.  

 

So yes, magnified volatility may become a feature of this environment. 

 

Nota Bene: This author is agnostic on Feng-shui or zodiac signs. But the insights from these may not be from the zodiac signs but the cyclical episodes embedded in the evolution of the political economy.  

 

For instance, the last three years of the Tiger have coincided with the Presidential election years.  

 

1986 was not just about the elections. Importantly, it was the year of the EDSA Revolution 1.0 or the People Power Revolution, the overthrow of the former dictator. 

 

The three antecedent years of the Tiger were likewise post-recession or crisis years, which would seem to resonate with current conditions. 

 

Likewise, elevated inflation appears to be a prominent feature in the year of the Tiger, exhibited by the wide differentials between nominal GDP and the real GDP. (Figure 1, second to the highest window) 

  

In terms of GDP, 2010 and 1962 outperformed. However, stagflation emerged in the Asian Crisis of 1997-1998. At its close, the GDP suffered a slight economic contraction in 1998 

 

Meanwhile, it was a mixed outcome for the USD Peso. The USD strengthened in 1974 and 1986 but weakened in 1998 and 2010. (Figure 1, second to the lowest pane) 

Back to the PSEi. 1Q returns were also eye-popping in two of the three previous episodes. The 1998 version eroded its early gains, while premiums of 1986 and 2010 were appetizers for spectacular annual returns. (Figure 1, lowest pane) 

 

While there may be similarities, all the underlying conditions of the yesteryears were different.  

Furthermore, events in the Year of the Tiger were dependent on the previous years. Or, it would be a mistake to isolate events of the year to exclude the predecessors. 

  

Nonetheless, the Year of the Tiger seems to have a penchant for magnifying financial and economic volatility. 

 

II. Rising Temperatures on Geopolitical Flashpoints: From Cold War to Hot War? 

 

Well, it is not just the local arena.   Geopolitical risks are on the rise.  

 

 

Figure 2 

 

Aside from the eroding concerns over the pandemic, potential geopolitical flashpoints for a hot war may occur.  

 

For instance, the US-Russian impasse over Ukraine (Russia’s vehement objection over the slippery slope of NATO’s expansion into her borders), China’s flexing of its military muscles over Taiwan (Figure 2, topmost pane) while simultaneously asserting its sphere of influence at the disputed territories of the South China Sea and the Senkaku Islands. There are also ongoing border disputes between China and India at the Himalayan Aksai Chin and the south of the McMahon Line and between India and Pakistan over Kashmir 

 

So yes, if diplomacy fails, the higher the risks that standoffs morph into a hot war.  

 

The Year of Tiger has been no stranger to such events, historically.  

 

At the onset of its annexation, Nazi Germany invaded Austria and Sudetenland, Czechoslovakia in 1938, which paved the way for World War II. 

 

North Korean invasion of the South-controlled territories in June 1950 opened the 1950-1953 Korean War theatre 

 

1962 was also the year the world nearly tipped into World War III.  Threats by the Soviet Union to install nuclear missiles in Cuba in response to the failed invasion by US CIA-led exiles of Cuba at the Bay of Pigs caused a 1-month and 4-day standoff with the US, known as the Cuban Missile Crisis 

 

Unknown to most, a lowly Soviet Navy officer Vasili Aleksandrovich Arkhipov supposedly staved off a thermonuclear war (“saved the world”). According to Wikipedia, the chief of staff and second-in-command of the diesel-powered submarine B-59, Mr. Arkhipov refused to authorize the captain's use of nuclear torpedoes against the United States Navy, a decision requiring the agreement of all three senior officers aboard. 

 

The Watergate scandal forced the resignation of US President Richard Nixon in 1974, the first US president to do so.  

 

Soviet nuclear reactor in Chernobyl Ukraine exploded in 1986, which caused a disaster. 

 

But it was not all bad news.  

 

1998 signified the end of the Asian Financial Crisis. 

 

In 2010, the global economy started to recover from the Great Recession of 2007-2009. 

 

There was barely any significant conflict in the last outings of the Year of the Tiger. 

 

III. China’s Mounting Economic and Financial Risks 

 

Circling back to 2022. 

 

But the ramifications from the imbalances from policies built up from the past, compounded by the response to the pandemic, may have started to unravel, magnifying global financial and economic risks. 

 

For instance, several significant developments in China occurred this week. Slowing GDP has prompted monetary authorities to increase the scale of bailouts of its embattled economy. (Figure 2, second to the highest window)  It slashed two interest rates. It fixed its yuan rate at its strongest level since 2018.  

 

Nonetheless, mounting pressures on foundering property markets have left many property developers strapped for cash, further magnifying the risks of defaults.  The construction sector suffered its first ever recession. (Figure 2, lowest pane) Aside from the easing measures, the PBOC has reportedly urged banks to boost lending to the sector. (Figure 2, second to the lowest window)  

 

But political inequality must be in the mindset of authorities. 

 

The battered tech industry hasn’t had enough from the recent crackdown. Authorities announced new measures to curb the industry’s influence on the government. 

 

IV. Have Global Financial Markets Reached a Minsky Moment? 

 

 

Figure 3 

To shorten this outlook, we shall focus on signals from the global financial markets. 

  

As a result of its relative outperformance, the US equity markets have taken a sizable share of the global stock market. (Figure 3, upmost left pane) Instead of divergence, this looks like intensifying concentration risks. That is, "when the US sneezes, the world catches cold."  

  

The recent pullback of US stocks has resonated somewhat with the MSCI World. The MSCI World was down by 6.5% as of January 21. (Figure 3, middle pane) 

 

For instance, the tech-heavy Nasdaq suffered its worst January performance since 2008! The Nasdaq was lower by 12% in 2022. (Figure 3, upmost right pane) 

 

As of Friday, US S&P 500, Japan’s Nikkei 225, China’s Shanghai Composite, and Germany’s DAX index have declined by 7.7%, 4.4%, 3.22%, and 1.77%, respectively. (Figure 3, lowest window)  

 

Figure 4 

But there is more. 

 

The latest meltdown in cryptocurrencies led by Bitcoin and Ethereum has wiped out over $1 trillion of the global market cap! (Figure 4, topmost pane) 

 

Why so? 

 

Many central banks have commenced tightening in the face of elevated global inflation (World Bank), which has reduced liquidity and prompted higher fixed-income yields higher (price—lower). Global bond prices plunged to the lowest since at least 2020! (Figure 4, second to the highest to the lowest windows) 

 

With the exploding liabilities from almost everywhere, global debt hit a record $226 trillion or 256% of the GDP (IMF Blog)! (Figure 5, topmost window) 

 

Figure 5 

And a slowdown in liquidity may not only be about to weigh on the global economy, but it will likely undermine solvencies of firms/nations bankrolled by central bank easing as well as their credit profiles. Tightening US conditions presages the global PMI index. (Danske Bank) (Figure 5, middle pane) 

 

It is unclear how the divergence in China's easing will impact the tightening of most central banks. Though, the PBOC appears to lead the way.  

 

In short, have the self-reinforcing cycle of excess liquidity and rising asset prices reversed? 

 

More precisely, have credit financed speculative excesses, grotesque asset mispricing, and massive economic malinvestments finally have reached a "Minsky Moment?" 

 

As of the moment, to be sure, losses in the heavily leveraged global financial system are mounting. 

 

V. Falling Markets May Prompt Central Banks to Ease, Surging Global Inequality, Gold and Agriculture as Hedges against Fat-Tailed Risks 

 

Any evidence of a downturn could likely prompt central banks to ease anew by expanding their balance sheets and or cutting rates. That has been their path-dependent approach to any signs of economic slowdown or the emergence of financial market pressures. 

 

But unlike the pre-pandemic days, such actions will come at the heels of elevated inflation, which could storm higher annulling actions of monetary authorities. Nonetheless, this only buys time but would further expand imbalances. 

 

On the other hand, if authorities stay on the sides, we can expect global financial markets to endure amplified strains, possibly wiping out trillions of paper money or fake wealth.  

 

 

Figure 6 

 

It is unlikely that bets on decoupling will benefit from these scenarios.  

 

Instead, commodity prices have prospered from this rotation, so far.  However, spiking industrial commodities is unlikely to power higher should an economic downturn occur. The commodity index has almost resonated with 5y5y inflation expectations (with a time lag). (Figure 6 topmost pane) 

 

Recently, a short squeeze and low inventories have caused Nickel prices to go parabolic! Long-term, a huge bearish rising wedge hounds the price chart of Nickel! (figure 6, second to the highest pane) 

 

However, commodity beneficiaries of the current environment may be gold and agriculture. (Figure 6, third to the lowest and lowest pane) 

 

Nevertheless, aside from health policies, political frictions have emerged from the widening inequality brought global central banks’ invisible redistribution benefiting the wealthy. (Figure 5, lowest pane) 

 

What is true here appears to be also true abroad. 

 

2022: The Diminishing Returns of Trickle-Down Rescue Policies and The Illusion of a Political Superhero, January 9, 2022 

 

The mounting wealth divide has fueled increased political clamor for a wealth tax on billionaires. 

 

Divisive politics from these policies are likely to add to social, economic and health strains. 

 

Finally, with deteriorating economic growth, will governments shift the blame to other nations by escalating the geopolitical divide to preserve their hold on power? 

 

Specifically, will the Communist Party of China advance its claim on territorial disputes or on Taiwan to save its skin? Will US Democrats push for a showdown with Russia over Ukraine to cover their plummeting approval ratings? 

 

If so, will the 2022 Year of Tiger usher in Fat-Tailed risks? 

 

Yours in liberty, 

 

The Prudent Investor Newsletters 

 

_____ 

Notice:  This newsletter is intended to apprise readers of the market conditions based on the information available at the time of the items’ writing, whose accuracy and timeliness of the issues concerned are subject to change without prior notice.  The contents of the newsletter are not expressed solicitation to trade and that the positioning on particular issues discussed merely reflect the opinions of the writer.