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8:30 am  Monday  15 August 2011

Waiting for my flight gives me some time to write my thoughts.  In my over 30 years of following the New York stock exchange, I have never seen a week as volatile as the week just past.  For those who can still remember the September 2008 sell-off on account of the Lehman Brothers failure, the market direction was pretty clear.  It was down.  In the recent sell-off, we have been seeing over 500 point declines in the Dow in both directions day after day.  The S&P downgrade of U.S. debt was something that people could not digest that easily.  Consequently, people just sell and speculators short the market then cover shorts or buy back exacerbating directional market moves.  I think the investment community is already digesting the consequences of the down grade.

Normally, a credit rating downgrade would cause a rise in yield of the downgraded debt.  It is pretty obvious that a downgrade categorically declares that the debt has more likelihood of default now than it was previously thought.  But what happened to U.S. treasury yields during this week of the downgrade?  It actually went down which is very counter intuitive because a decline in bond yields is actually a result of a rise in bond prices.  Why would the debt of a recently downgraded issuer rise in price?  Shouldn’t it drop as many doomsayers have been predicting in the event of a downgrade

My take is that the downgrade, while coming as a surprise, made a lot of sense to a lot of people.  It makes fund managers look at the credit of the U.S. more objectively within the framework they use in analyzing other sovereign debt issuer.  Personally, AA+ is not such a disaster particularly if you have your eyes wide open.  The certainty of debt repayment from the issuer’s asset base and cash flow remains to have a large cushion with a AA+ rating.  They rating agency has only factored into the equation instances like the recent debt ceiling impasse.

As for equities, I think the volatility seen last week was a result of massive rebalancing of portfolios as fund managers adjust to their historical parameters of risk.  However, in the coming weeks, I foresee a re-evaluation of those risk parameters possibly granting specific risk guidelines to U.S. Treasury notes and bonds.  People cannot ignore that the U.S. financial market has the deepest and most developed infrastructure in the world.  We cannot do without it.  Nowhere else can hundreds of billions of funding can be raised within the day except in the U.S. markets.  Until an alternative financial market infrastructure emerges with the same depth and breadth, the world will simply have to accept the new level of risk that is in the U.S.  Given the situation, the adjustment will likely be slow, and the markets will eventually give the U.S. the time it needs to adjust.

In the meantime, I think it is back to fundamentals time with Philippine stocks.  Earnings reports have started to come and there have been very impressive results particularly with banks.  MBT’s net income for 2Q-2011 rose 83 % y-o-y.   For 1H-2011, net income was Php 6.1 billion up 45 % y-o-y boosted by higher earnings from loans and fees.  The all important net interest income increased 12 %.  I will share some more corporate updates this week.

As for the local mining sector, I recall an old credit card advertisement which to my mind describes my sentiment on mining stocks: “Don’t leave home with out it!”

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