Thursday, 10 February 2011

Economic trust and confidence

Business Mirror

‘Trust is the oil in the engine of capitalism; without it, the engine seizes up. Confidence is like the gasoline; without it, the machine won’t move.”

Trust is the belief that a person or other entity has integrity. That is, that their word is good. They will do what they say.

Confidence is the belief that the person or entity will be consistent and reliable over time in doing all that they can to maintain the trust that you have placed in them.

The most common public perception of “trust” in the Philippines is found in the frequent surveys, which ask respondents if they trust a particular political leader or institution. These are often headlined as “approval” ratings, but that is not accurate. Probably we all have a friend whom we approve of, but who deserves so little trust that we would never lend him/her money, expecting not to be paid back.

While we expect that public officials maintain their integrity to the job they hold by not being corrupt, the truth is that these officials can still be corrupt and also be “trustworthy.” Simon Cameron, US financier and politician, said in the late-1800s, “An honest politician is one who, when he is bought, will stay bought.”

We hold trust and confidence in many other institutions far removed from the government. We trust that the cashier at the department store is going to charge us the right price for the goods we buy and we continue going back to that store because we have confidence that our trust will be continuously fulfilled

Economies move up and down, in large measure, based on trust and confidence in that trust. A major factor in the global meltdown these last years was that people lost trust and confidence in their governments. When the problems first surfaced in 2007, governments responded with the typical, “we’ve got it under control” and “we’re going to fix it” assurances. Both were lies. And once trust and confidence are broken, it takes time to restore them.

Trust eroded much farther in 2008 and 2009, when US government action—the trillions of dollars of bailouts—failed to produce positive results. Combined with the US government’s continuously providing absolutely false and made-up economic numbers about a recovery, trust was at virtually zero. However, confidence was high; Americans firmly believe that the government will continue to lie about the economy.

Note the major bull market in gold over the last two years as trust and confidence in that trust of governments had deteriorated. Gold has always been a store of value when people do not trust the political stability of governments or believe in a better economic future.

So why then do the US stock markets continue to go higher and higher? Federal Reserve Chairman Ben Bernanke may be the most “trusted” man in the world.

Bernanke has made it clear over these past two years that 1) the government will provide an unlimited amount of money to “bail out” the banks; 2) that the Fed will continue to print money and loan to the US government in whatever amounts necessary; and 3) that this policy will continue forever, if he thinks necessary.

An interesting financial-market phenomenon occurred that little has been said about. Bernanke has lowered interest rates to almost nothing. The result has been that financially sound companies were able over the last two years to borrow cheap money to keep them in business.

Companies that were on the verge of bankruptcy were also able to borrow because of the situation. These companies issued high interest rate, “junk bonds.” Investors were willing to buy this “junk” because of the high return and because Bernanke has indicated that he will not let these companies fail. Hundreds of thousands of small businesses in the US have closed shop because they do not have access to the capital markets and banks are not lending. But the thousands of publicly listed companies are kept afloat through government policy. And because they are still alive, stock prices have boomed in the last six months.

Add the fake economic numbers as a justification for higher stock prices, and you have a rising stock market.

Now, if trust and confidence that the trust that you place will be rewarded over the longer term is important for stock prices, do we dare ask why the Philippine Stock Exchange is currently struggling?

Positive and increasingly better corporate results are almost taken for granted. With only a few exceptions, listed companies have experienced great financial results over the last two years. Stock prices have both predicted and reflected those results. There is no reason to believe that the next 12 months will hold any negative surprises for our local companies. Expansion and development plans continue, and the amount of money allocated to these ventures is growing. The bottom-line profit results will continue to be very favorable for stocks prices.

It might be easy to say that stock prices have gotten ahead of corporate results, but that is not accurate either. PLDT and Megaworld, for example, are both selling at a PER of less than 12. Because of some unique situations like Meralco’s PER of 40+, the overall exchange is selling at 16 times earnings but that is acceptable.

The stock market looks like it wants to fall another 275 points before a bottom is found. That would be about a 20-percent drop from the higher; perfectly acceptable in technical terms. However, the timing is suspect in that it is too soon after the high, reached only in November 2010.

Perhaps, it is trust and confidence in government, as embodied in the President? While the President still commands a very favorable “approval/trust” rating, maybe there is a growing lack of confidence for the future. So growing a sense of caution or hesitation in the President could be reflected in our stock exchange. The next weeks of trading activity will be very interesting as we get nearer to 3,600 on the index.

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