Built In Inflation in Their Early Cycle

Let’s look at money growth graph in United States below

While Average GDP Growth for March 2006 to August 2008 around 2,5% p.a. and Average GDP Growth for August 2008 to February 2011 around 0% p.a.

Fed main strategy to prevent deep depression is creating money that abundance enough to ensure deflation do not occurring. When GDP growth and Money Supply created in the past, Fed effectively create built in inflation pressure.

According to Wikipedia, Built in inflation is a type of inflation that results from past events and persist in the present. The built-in inflation originates from either persistent demand-pull or large cost-push (supply-shock) inflation in the past. (For current cases, built in inflation created from excessive growth in Money Supply). It then becomes a "normal" aspect of the economy, via inflationary expectations and the price/wage spiral.

• Inflationary expectations play a role because if workers and employers expect inflation to persist in the future, they will increase their (nominal) wages and prices now. (See real vs. nominal in economics.) This means that inflation happens now simply because of subjective views about what may happen in the future. Of course, following the generally accepted theory of adaptive expectations, such inflationary expectations arise because of persistent past experience with inflation.

• The price/wage spiral refers to the adversarial nature of the wage bargain in modern capitalism. (It is part of the conflict theory of inflation, referring to the objective side of the inflationary process.) Workers and employers usually do not get together to agree on the value of real wages. Instead, workers attempt to protect their real wages (or to attain a target real wage) by pushing for higher money (or nominal) wages. Thus, if they expect price inflation - or have experienced price inflation in the past - they push for higher money wages. If they are successful, this raises the costs faced by their employers. To protect the real value of their profits (or to attain a target profit rate or rate of return on investment), employers then pass the higher costs on to consumers in the form of higher prices. This encourages workers to push for higher money wages.

In the end, built-in inflation involves a vicious circle of both subjective and objective elements, so that inflation encourages inflation to persist.

We believe current inflation pressures in an early cycle, which mean more inflation pressure will occurring.

Investment implications, investor who hold paper asset will lose their wealth value and investor who hold real asset will main their wealth value.

IDX already in Bear Market

http://www.4shared.com/document/eRulx_OU/28_01_2011_Bear_Market_Analysi.html

Longer trading hour may transform us from humanlike creature into more robotlike creature

One of prerequisite condition for an efficient stock market is frictionless market. This prerequisite contradict with normal human activity such as lunch break and market close. Reason, lunch break and market close are market friction that prohibited continuous transaction in stock market. Since, new information arrival is a random event, it also mean their arrival also random, it may arrive in the lunch break, or may arrive when the market close. When new information arrive when the market close, price tend to experience significant slippage, or price jump, up or down, from previous price close. This phenomenon also not desirable from risk management perspective.
Currently stock market operator around the world, i.e. Singapore Stock Exchange, Australia Stock Exhange, etc., tries to eliminate this friction with reducing lunch break and extending trading hour, and if we extrapolate further, no more time for breakfast, lunch, and dinner, stock market need to operate 24/7.

While it seem right and needed from theoretical finance perspective, I do not believe it is right from human nature perspective. We, as human, need  a break and rest, contradict may it seems, break and rest reduce human error and increase human capabilities to process information and make good decision.

Some may argue using algorithmic trading atau computer aided trading, trading can be executed 24/7, computer do not need to eat breakfast, lunch, dinner, do not need to sleep, and the most important do not need to socialize.

Now it's up to you, do you want to be more humanlike creature or more roboticlike creature?

Technical Analysis: The Big Picture of IDX

Our technical analysis indicate that IDX performance may deteriorate even further. See graph below.

We do not like with what we saw because above graph indicate that when this bearish situation persist until first week of February 2011, IDX will experience a bearish year. We expect phase of bearish year will be, phase one, IDX deteriorating slowly in early February until late March, phase two, IDX deteriorating rapidly in April to June, phase three, IDX experience trendless market in August until Oktober, and finally phase four, IDX may experience bear market rally from early November until early to mid December.

The worst thing about above analysis is we cannot figure out what went wrong in IDX. From developed country perspectives, first, devastating effect of credit crunch already price in and we cannot expect things getting worse much from current condition, second from firm perspectives, firm with significant portion of investment in emerging market experience good earning growth, hence supporting currently high stock valuation in developed market; second, emerging market experience surge of inflation cause by improving economic condition and better economic outlook, this kind of inflation already managed properly by central bankers using monetary tools; third from indonesia fundamental perspectives, indonesia already in a clear path of rating upgrade due to clear progress of economic growth.

Maybe what religion leaders said about lies, include economic data, being made by government is true, then indonesia economy will soon reveal their ugly sides.

Final remark, IDX may not get into bearish phase if IDX rebound and cross 3.800 level. Currently we saw economic good news not being responded positively by the market. Get ready to cut loose and let it go down.

More Water in The Sky

2 day ago, we talk to one of our investor who have big agribusiness, he said that global warming increase atmosphere capabilities to hold water, thats explain why we witnessing more cloud in the sky. His explanation trigger our mind to rethinking of the consequences of atmosphere capabilities to hold water. Here is our thought:
1. atmosphere capabilities to hold water have limit, and we don't know how much, we certain that when the limit reached, there will be heavy rain and catastrophic flood all over the world.
2. if flood do occur, we think food price may skyrocket because limited supply, we also will experience what australia currently experience, a biblical flood,
3. if flood in australia makes mining activity suspended, the same will occuring in Indonesia, rather than too optimistic on price surge, we think we should more concern on production disruption that mya occur in mining landfield.
4. currently, money supply exceed real product, including value added that being created, significantly, this condition start to create vicious circle of inflation pressure, combine inflation pressure with possibility of more catastrophic flood, inflation pressure will be getting higher.

how we may benefit or mitigate the negative impact of more inflation induced by catastrophic flood
1. bullish to property stock, preferably with high land bank
2. bullish to pharmaceutical stock,
3. bearish to banking, multifinance, and insurance companies
4. neutral to mining stock and agribusiness stock

Impact of Growing Importance of Dark Pool to Market Efficiency

Investopedia explains Dark Pool LiquidityThe dark pool gets its name because details of these trades are concealed from the public, clouding the transactions like murky water. Some traders that use a strategy based on liquidity feel that dark pool liquidity should be publicized, in order to make trading more "fair" for all parties involved.

We read this new in 04 January 2011

Another factor jumped into the fray in December: dark pools. Off-exchange trading accounted for more than a third of the trading volume in December, says Raymond James. While these trades are eventually reported to the public markets, they further damage price discovery, an essential element for a fair securities market, investors said.

http://www.cnbc.com/id/40907838/

this news got a serious implication to market efficiency, reasons:

first, from market participant perspective, dark pool was created to accommodate trading and liquidity needs of institutional investor. Since, institutional investor got capabilities and resources to analyze stock, their transaction match the assumption of efficient market hypothesis. Stock price always right. Another implication will be regular stock market mostly accomodate trading and liquidity needs of retail investor, which we quite doubting their capabilities and resources to analyze stock, their transaction do not match the assumption of efficient market hypothesis.

second, from efficient market hypothesis assumption perspective, since transaction in dark pool being performed by investor who have adequate information and capabilities to analyze, transaction by this kind of investor match the assumption of efficient market hypothesis, hence we would expect stock price change in dark pool market tend to be random. Transaction in regular market usually performed by retail investor, who do not have enough information and enough capabilities to analyze stock, hence we would expect their ransaction do not match the assumption of efficient market hypothesis, we would expect market sometimes have random behavior and some other times have a price drift behavior or stock price change have some predictability feature. Or, we have two kind of market efficiency in one stock market.

third, from reflexivity perspective, a term we borrow from legendary hedgefund manager, George Soros, we do see that dark pool and regular stock market influence each other, and we suspect there are (1) a lot of cases stock price divergence between dark pool market and regular stock market and (2) price divergence will convergence again and the process may be an abrupt change.

Will Indonesia experience mean reversion return in 2011?

A quick review about history, IDX IHSG eoy 2007 is 2.745,825, eoy 2008 is 1.355,407 or down 50,6% from previous year, eoy 2009 is 2.543,355 or up 86,7% from previous year and getting near it's previous high in year 2007, and finally, eoy 2010 is 3.703,512 or up 46,1% from previous year.

After this spectacular performance, analysts still present an upbeat forecast about indonesia economy. The most simple argument is indonesian company expected to enjoy good earning growth with cumulative average growth around 20% p.a. with hindsight analysis, this forecast seem achievable. This argument using BOLD asumption, Indonesia economy already decouple with the rest of the world economy. An assumption that we do not believe.

Now we turn our attention to empirical result about stock market. Finance literature find that stock market return always revert to their mean, a concept known as mean reversion. Indonesia stock market return also shows mean reversion phenomena. First, we experience golden period of stock market return in period of 1989 to 1997 before bursting because of monetary crisis. Second, dark period in 1997 to 2003 because of mass debt restructuring effort from companies and fiscal austerity measures implemented by government. And, third we experience another golden period of stock market return from 2003 until now and may be longer, because of economic recovery, including heavy reliance on domestic demand, and commodity boom. Surprisingly, this golden period occuring even subprime mortgage burst in 2008, and bring along world gdp into recession period. From empirical perspective, sub par to negative stock market return is a certainty but the question will be WHEN?

To answer the WHEN question, we turn our attention to money supply growth that significantly exceeding real economic growth and creating inflation pressure.

Source: Bloomberg.

Note: Green line denote Indonesia GDP Growth, Red line denote Indonesia CPI Growth

We do not like inflation because inflation kill peoples purchasing power, firms earning, and finally, increasing discount rate with direct consequences lower stock market valuation. From the graph above, we do see that Indonesia GDP growth start to faltering while inflation pressure accumulating. This data implies possibilities that earning growth in Q4 2010 will not as good as Q3 2010, hence create investor disappoinment.

Return expectation is one of the main input in invesment allocation, if Indonesia firm earning growth slowing, Indonesia stock market return expectation cannot be high, hence global investor may shift their allocation away to other stock market.

Concluding remark, we believe IDX will experience a correction, hopefully fast and deep correction, because first, extraordinary return in the past two year, +86,7% in 2009 and +46,1% in 2010, second, inflation already getting higher and put limit to GDP growth, and third, possibility of global investor to shifting their investment temporarily until valuation getting reasonable again.