OUTSIDE THE BOX
SINCE the beginning of the year, there has been a genuinely important discussion as to whether the Philippines is facing an asset bubble in its stock market and property sector and if prices could fall significantly at some time in the future, sooner rather than later.
It is necessary to understand what an asset bubble truly is. The common notion of a bubble is that the price of an asset goes up too quickly to a level not reached in recent memory or in history for that matter. That is not accurate.
Imagine for a moment that scientists had proved that paracetamol could extend human life. There would suddenly be a huge demand increase and people would be willing to pay almost anything for this drug. Prices would stay high until supply was increased to fulfill the demand. That is not a bubble; it is a normal market price reaction to supply and demand.
Further, most of the purchases of the paracetamol would be for consumption not for price speculation. In fact, those who initially bought to make a profit would lose money as soon as supply stabilized.
Even “expert” economists cannot agree on a proper definition or even if asset bubbles, where the market price goes far above intrinsic value, even occur. Market prices often deviate widely from intrinsic value.
The first use of the term “bubble” occurred in the early 1700s. The British government granted exclusive trading rights to different companies covering large parts of the world.
The South Sea Company was a British stock company that was granted a monopoly to trade in Spain’s South American colonies. In return, the company took over half of the British government national debt. To pay for the debt, they issued shares of stock to raise money.
In order to raise the funds they needed, they announced the most ridiculous rumors of the money they would make from their monopoly; the shares went up widely. The price went from 100 to 1,000. The company even loaned money to people to buy the shares.
Other joint-stock companies jumped into the game, selling shares and making extravagant claims about foreign ventures and bizarre schemes. These were nicknamed “bubbles.” At 1,000, the selling came in and the price of South Sea went all the way back down.
The US Dot Com bubble was a five-year boom followed by a one-month bust that was fueled by cheap borrowed money used for stock speculation.
The bubble ended after the last nine months of the stock-price run-up during which the Federal Reserve raised interest rates six times. The era of the cheap money was over as was the stock-price bubble.
The Philippine Stock Exchange is not experiencing an asset-price bubble. Stock prices may go lower in the future but not because of speculative exuberance.
The mining stocks have been advancing because metal prices are in a strong uptrend and expected to go higher. Banks are booming because good quality lending is growing and interest-rate margins are favorable for earnings growth. Consumer-oriented companies are up because consumer-spending growth doubled from 2010 to 2011. Property companies are seeing appreciation because margins are high and personal-wealth creation is providing stable demand.
These price increases are being driven by common sense, not wild speculation. Further, no investor in the Philippines is mortgaging their financial soul to the banks to borrow money to buy shares. There are, of course, issues that may be considered “speculative” in that they may not have a solid financial track record to warrant the current price increases. But so far none have announced they have found a way to turn lead into gold, attracting share buyers.
There is a building boom in the Philippines. Is it a bubble?
For property prices to collapse, all those newly built units would have to be sold at a much lower price. But the developers do not have to reduce prices. They can wait for demand to catch up over time. Ayala Land’s net-profit margin is over 25 percent. SM Development Company operates at over 30-percent net margin. These are amazing financial numbers. They can easily afford to discount to sell units or they can sit on the inventory as the property companies did after the 1997 crisis. And their share prices are justifiably going higher.
Property speculators may individually run into trouble. Too bad. That is life in the free markets and they are a small minority. The amount of foreclosed property that the banks are currently carrying proves that point.
All the “bubble” talk is good. It keeps us prudent and sensible. Invest in the stock market and buy property to live in. That is proper money management.
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