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THE ESSENTIALS OF WINNING PSYCHOLOGY

by Ray Barros

It is my belief that successful trading is a function of:

• A written trading plan with an edge
• Effective Money Management and
• Winning Psychology

In this essay I shall:

1. Identify the essential element of winning psychology.
2. Identify the personal attributes required.
3. Show the belief structure necessary to achieve and maintain essential element.
4. Identify the blocks to winning psychology, and
5. Mention some tools I found useful in this context.

There are two concepts I should like to explore before beginning the article. The first has to do with the way I believe humans acquire knowledge.

There is an objective reality which humans perceive through the filters of their values, beliefs and rules. This perception can and usually distorts our sense of reality. The extent to which we reduce or eliminate the distortion is the extent to which we will be successful in life. This is especially true for traders.

The second idea I want to introduce is that of the evolution of a trader. For me the natural progression is:

1. The Rule Based Trader: "There is one rule: never break your rules"
2. The Subjective Trader: "There are two rules:
3. the first is never break your rules.
4. the second is know when to break the first".
5. The Intuitive Trader:"There are no rules. Whatever my intuition tells me is the right action on this trade is the correct action in the circumstances.

This belief accords with reality more often than not".

All types of traders can make money as long as they conform to the rules of that stage. e.g. a trader at the Rule Based Stage is more than likely to lose money in the long run if he breaks his rules. Finally, before I begin I should like to briefly explore what I consider the necessary empowering motivation to succeed.

Trading is success is simple to achieve but not easy. It is simple because the roadmap for success has been clearly laid out in all the three areas - written trading plan etc; it is not easy because following that roadmap is not easy.

What motivation is necessary to get us through the rough patches?

At some level we traders are attracted to this game because of the money we can earn. But, I have found that money alone is an insufficient motive. All good traders I know LOVE the game for itself. The fact that we get paid for it is merely a bonus. This love for the game is incorporated into the vision we want to achieve as a result of our trading and that vision is the zing that gets us through the rough patches. It goes without saying that for successfult traders, trading is fun.

I The Essential Element of Winning Psychology

At its core, winning psychology has as its base the "acceptance of the outcome of a trade".

By acceptance I mean the ability of being a aware of an emotion without "buying into" its content; some may call this 'mindfulness'. e.g.

Contrast:

Imagine you have just entered a trade and the very next bar is a big range bar against your position:

"My God here I go again! Can't I do anything right! What will my wife say if I take yet another losing trade!

May be I should move my stop? No I can't do that - the last time it cost me my bank! But what about the other day when I got stopped out only to have go my way? This is just too hard!!!!" etc etc. With:

Imagine you have just entered a trade and the very next bar is a big range bar against your position:

"The market is approaching my stop. I feel uncomfortable with the price action and I can live with the discomfort".

The first trader may think he has accepted the outcome but in fact he has failed to do so at the emotional level; the second trader has accepted the outcome at all levels.

This idea of acceptance applies not only to loses but to profits as well. The trader that "accepts" an outcome realizes that on an individual trade basis a positive outcome on one trade does not translate into a future of unlimited profits.

At its core "acceptance" realizes that trading is based on probabilities, as such every trade is unique. In other words, the past does not equal the future. More on this in the section dealing with beliefs.

II Identify the Personal Attributes Required

If we are to acquire "Acceptance", then certain personal attributes are essential:

• Awareness - the ability to step outside ourselves and observe. The more effectively we can do this, the easier our progress to "Acceptance".
• Honesty - the ability to seek to perceive reality in spite of our filters.
• Courage - the willingness to bear the pain brought about by our awareness and honesty.
• Commitment - the willingness to do whatever is necessary to achieve our goals.

In the words of Chin-Ning Chu author of "Thick Face, Black Heart" :

"Even though most people think they are trying to succeed, they are simply going through the motions. The last thing in the world they want is to get off the familiar treadmill and actually get somewhere".

We cannot succeed in our journey to "Acceptance" unless we acquire these attributes. To the extent that we have them is the extent to which we will experience fulfillment.

III The Belief Structure Necessary to Achieve and Maintain "Acceptance"

Ultimately to succeed, we, as traders, need to adopt two apparently contradictory beliefs:

"That the market is uncertain and unpredictable and that the market is relatively certain and predictable".

The resolution of this apparent conflict is found in the timeframes that we hold the beliefs. At the trade by trade level, what Mark Douglas, calls the micro level, we hold the first belief. Because the market can and will probably do anything, we seek first to protect our capital in the execution of our trading plan. In other words, we must always have an exit strategy.

At the level of a "large sample size" (the macro level), we hold the second belief. To the extent our trading plan has an edge, will be the extent to which the market will be predictable and certain. In short we accept that with trading we are dealing with probabilities and not certainties. It is of imperative importance we hold these beliefs not only at an intellectual level but also at every level of our being - especially the emotional level.

As a trading coach I have seen, time and again, lip service acceptance to the idea of probability; but when it comes to actually trading, the traders behave as if each and every trade must be a winner - they have a need for certainty. How else can we explain the popularity of services advertising 90% hit rates? If the ads were not drawing an adequate response, they would disappear.

Probability thinking leads to a host of other states and beliefs:

1. Because we know that we will succeed in the long run and because we know we will protect ourselves no matter what the market does, we acquire the state of "self trust" and the state of being "carefree". In turn these states allow us to remain....
2. Focused, confident and carefree when we are experiencing the inevitable prolonged drawdown.
3. Because at the micro level we know that the market is random, we will not allow euphoria to set in and lead us to reckless trades. Each trade will only be one in a series of probabilities.
4. We will view market information not as a source of pleasure/pain but merely as data providing us with opportunities.

This is not to say trading should not be fun; indeed not only should it be but for most traders it MUST be. However, the fun comes from the flawless execution of the rules appropriate to our stage of evolution and not from trade by trade results.

IV Identify the Blocks to Winning Psychology

The main enemy to "Acceptance" is Fear.

The universal fears are:

• The fear of being abandoned and
• The fear of losing control.

If we reflect for a moment, we'll see how the fear of being abandoned comes about. As young children, we are totally dependent on our parents. Very quickly we come to realize that if they ever abandon us, we shall be unable to care for ourselves. Most of us fail to confront this fear as we grow into adulthood. As a result we automatically deal with it by attempting to control our environment - the people, conditions and events that surround us.

This tendency to control may or may not be appropriate in other areas of life but as a strategy for trading the markets it is a bust. Most of us are incapable of influencing the market even for the shortest moment, let alone control it.

Mark Douglas's four fears are but an outgrowth of the two universal fears:

1. Fear of loss
2. Fear of being wrong
3. Fear of missing out
4. Fear of leaving money on the table.

These may be more familiar to the trader.

I first gained an insight into effects of fear some years ago. At that time, I was trading futures through Jackson Futures. The company provided a trading room and I met a quiet chap. He came in a few minutes after the US Bonds opened and left just after the close. Given that trading opened (Aussie time) 12:30 am and closed 5:00 am, this was no mean effort. One morning I noticed he looked very distressed and I struck up a conversation with him. He told me he had bet the farm shorting a strong bull market. As his red rimmed eyes stared off in the distance he said:

"I don't know why I just didn't cut the position earlier; anyone would have seen the strength - why didn't I?

I never saw him again.

That is the effect of fear - it drives out knowledge; it leads to myopia; it immobilizes us and leads to inaction.

The mirror image of fear is euphoria - the feeling that we can do no wrong. As much as fear, euphoria will ultimately lead to trading failure. Since trading is a game of probabilities, we will experience times when we can do no wrong. But these times will come to an end. The trader caught in the euphoric trance will not recognize this and taking one risk too many will eventually get caught in a heavy loss. If he is lucky, the loss will not be a catastrophic loss.

Fear and Euphoria can catch not only newbies but also the most experienced and successful trader. Witness the demise of (Trader) Vic Sperandeo. Vic started trading public funds in 1972 and for over 25 years had a very successful career. His view on trading can best be summarized by the passage below:

"I'm a market professional....and I am very good at what I do.... I never gamble more than I can afford to lose.... I think my unique strength is in my consistency.. I pride myself in my ability to successfully stay in the game..."

(Trader Vic - Methods of a Wall Street Master page ix)

This year Vic went bankrupt as a result of one trade.

Euphoria or Fear?

It doesn't matter. Whatever the reason, Vic lost a reputed US$50 million and is now out of the game. Two other factors impact on our fear or euphoria:

* Our expectations. Rather than accept market information in its pure form, we impose our expectations. In turn these expectations impact on our fear and/or euphoria.

* Our own psychosis. Each of us grows into adulthood with our psychosis - what Stephen Wolinsky calls "trances". Thus many times our responses to market information are not a response to present information but to past events. In other words, we are not trading in the NOW or with PRESENT TENSE INFORMATION.

V Some Tools I Have Found Useful

To achieve "Acceptance", we need to manage "Fear and Euphoria". For me the decisive tool was learning strategies to be aware, acknowledge, and manage the twin emotions of fear and euphoria. This meant starting with small pains and slowly becoming comfortable with my feelings. When I first started trading successfully, I used discipline as my main weapon. But when I started fund management in 1991, I found it inadequate. Dr George Lianos helped me discover the way of managing emotions - not eliminating, MANAGING. George taught me that a step by step approach was the best way for me. Learning to manage small fears, I slowly learnt to handle FEAR and EUPHORIA in my trading. I have developed a process based on the works of S Wolinsky (Tao of Chaos) and C Andreas (Core Transformation).

Anyone interested should e-mail a request at rbarros@adest.com.au

Other tools I have found useful are:

1. Meditation and/or mindfulness. These techniques taught me how to remain unruffled and centered during the hurly-burly of real-time trading. More thanany other tool I use, they teach me that AWARENESS is everything. They re long-term tools.
2. The ideas and distinctions of Mark Douglas. Another long term technique.
3. Neuro Linguistic (NLP) techniques. Useful for absorbing pain. A medium term technique.
4. Breathe work and Posture. Learning to breathe, stand and/or sit properly are effective short-term tools to remain calm in periods of stress.

VI SUMMARY

To succeed a trader must have a vision about where he is heading and must internalise that Winning Psychology rests on Acceptance of the trading outcome. This means managing Fear and Euphoria. To do this, we need to ACCEPT, with every fibre of our body the belief that at the micro level the market is uncertain and unpredictable and at the macro level is relatively certain and predictable.

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WINNING STRATEGIES FOR THE NEXT TEN YEARS

In the financial world, "long term" can mean six months from now. but real people need to make choices that are good for at least a decade. Here's what Wall Street won't tell you about investing for the long haul.

SUSAN E. KUHN
REPORTER ASSOCIATE KRISTIN DUNLAP GODSEY

FOR MOST PEOPLE, wealth creation has little to do with the minute-by-minute fluctuations of the world's financial markets. Wealth grows--and affects your life--over decades. It means being able to send the kids to good colleges, to live in nice houses and travel freely, to switch to a more fulfilling career, to afford top-flight medical care, to retire early and in style.

Investing for long-term prosperity is fundamentally different from trying to win at the short-term game. Indeed, Wall Street's measures for forecasting near-term results can be useless compasses for an investor whose horizon is ten years off. But it is the long view that will have the greatest impact on your worth.

Think back to January 1965, when many people took sunny economic prospects, low interest rates, and low inflation as signals to load up on stocks. After ten years those investments didn't look so shrewd. A ferocious bear market in the early Seventies had reduced the average annual return on stocks for the decade to 1.2%--not nearly enough to keep pace with inflation. Or consider the mid-Eighties, when all the signs were pointing to prosperity and investors rushed to put cash into residential and commercial real estate. From an investment standpoint today, many of those properties are hardly worth the dirt they're built on.

Now more than ever, investing for the long haul means screening out extraneous noise. Unplug your Quotron. Hit the mute button on CNBC. Let the Wall Street Journal pile up unread. Buy a map of the world, put it on the wall over the kitchen table where the whole family can study it, and learn to think in terms of the fundamental forces of economic growth for the U.S. and the world.

The performance of different classes of assets varies radically over ten-year periods (see table); the toughest challenge is to discern which class has the best long-term prospects. Making that call has never been more complicated than today, as governments and businesses scramble to take advantage of the end of the Cold War. Only recently have trends become clear that will shape the performance of investments between now and 2005.

The most important factor on which to base a long-term investing choice? Inflation, or its opposite, deflation. Both can be insidious destroyers of wealth. Spiraling inflation chokes economic growth, diminishing the value of stocks and bonds while increasing the appeal of hard assets like real estate and gold. Deflation is even more frightening. It eats away the value of every asset except cash and destroys a population's willingness to invest at all.

Most observers believe price stability will characterize the next decade throughout much of the world. Central bank watchdogs in North America, Europe, and even China are trained to sniff out the beginnings of rising inflation and snuff it out fast, as they have been doing. In the U.S., inflation has averaged a mild 3% a year since 1990. Deflation has reared its bearish head in Japan and may become a problem in Germany, but the odds of its spreading beyond those nations are considered low. Says Martin Walker, CEO of Society Asset Management in Cleveland: "Steady growth is our watchword for the economy. Inflationary expectations will be dampened, and as for deflation, Japan is simply an extreme."

Implication for the next ten years: Financial assets, particularly stocks, should continue to thrive, while most hard assets will remain underachievers (read on for some important exceptions). But that's not all. The global upsurge in financial assets will be buttressed by other major trends:

U.S. long-term interest rates will continue to decline. With economists and analysts poring over each new twitch in interest rates, a decade-long forecast might seem like groundless speculation. In fact, there are discernible trends that point the way toward such long-term market moves. Over a span of decades, interest rates generally rise and fall in response to the level of government spending and debt financing as well as to changes in inflation. Interest rates rose from the end of World War II, when yields on 30-year Treasuries were below 2%, until 1981, when Treasuries yielded more than 13%. Since then, rates have been declining and returns on bonds have been well above historical averages. That trend is likely to continue, though at a diminished rate.

Even so, bonds, the traditional means of guaranteeing income in your portfolio, make little sense from the standpoint of ten-year performance. As Art Steinmetz, a bond manager at Oppenheimer Management, puts it: "With this long a time frame, bonds in general are an awful asset class." True, bonds have been wonderful performers over the past few years--they have returned 12% on average since 1985--but that performance is not likely to be repeated in our lifetimes. More likely, expect to receive your yield plus an occasional dollop of capital gains.

If you decide to own bonds all the same--perhaps you want a predictable stream of income flowing from your portfolio--Steinmetz and others say the best buys for individual investors are in junk. Many institutions can't own anything less than investment-grade debt, and issuers of junk bonds are willing to offer rich yields to attract individuals. Junk bonds today yield 9% or more, vs. 6% to 7% for Treasuries; most experts are betting that for the coming decade, yields will stay about the same. In addition, if the issuer succeeds in generating enough cash flow to improve its credit rating, the bonds can offer equitylike gains. "It sounds strange to call high-yield bonds an anchor diversifier for a portfolio," says Bill Landes, who heads Putnam's global asset allocation team. "But they are my favorite diversifying asset class." (For a list of the best junk-bond funds, see "The Best Mutual Funds.")

Baby-boomers entering their peak saving years will turn to stocks. The Labor Department estimates that the percentage of workers 35 and older, now 57% of the labor force, will rise through 2005. The opposite occurred in the Sixties and Seventies, when the percentage of workers in that age group declined. Older Americans tend to invest more of their net worth in stocks and bonds and less in housing. A slowdown in demand for single-family homes should continue, and as for stocks? Today the average U.S. household has just 26% of its assets in stocks, well below the all-time high of 45% in 1968. That leaves plenty of room for allocations to equities to increase, fueling a continued rise in the market (for more on how to play demographic trends, see "Betting on the Boomers").

Emerging markets will offer the richest returns for the next ten years. Talk about global change. Ten years ago Berlin was still two cities, the Soviet Union was one country, China had barely embarked on free-market reforms, and Latin America was crippled by defaults on government loans. Today capitalism and the companies that serve it are expanding virtually unopposed, as tariffs and regulations that hamper trade are being stripped away. As a result of this unshackling, GDP growth is expected to average 4% a year in Latin America and 6% or more in the Pacific Rim. Says Paul Hopkins, chief investment officer of IDS International in London: "Much of the wealth creation since 1982 has been driven by falling inflation, falling bond yields, and rising multiples. The next decade will be driven by free trade and the rapid modernization of large population centers, including Brazil, India, and China."

For a chance at cashing in directly on global growth, consider shifting assets to stocks or stock funds in emerging markets (for advice on which economies look best, see opposite page).

The U.S. market will slow, but global growers will thrive. Constrained by shrinkage in the total labor force and the inexorable outflow of capital to emerging nations, growth in the U.S., as in other developed countries, is expected to bump along at just 2% to 3% per year in the next decade. That will make it hard for American companies to widen profit margins or greatly increase earnings. Margins today are at 15-year highs, though still below peaks attained in the 1960s. Says Brad Perry of David L. Babson & Co. in Boston: "Even if greater productivity gains are achieved in the second half of the 1990s, real growth in American economic activity could decelerate to the slowest pace since before World War II."

For businesses intent on expanding profits and boosting the value of their shares, the solution will in most cases lie abroad. Says David Roche, head of Independent Strategy, a global investment consulting firm in London: "Successful equities will be those of companies that participate in global restructuring. That means equities will increasingly divorce from the conditions of their home economy if business warrants it." By one key measure, American business will need to expand abroad even more aggressively than at present merely to move stock prices above today's levels. David Bostian, chief investment strategist at Herzog Heine Geduld in New York, points out that U.S. stock market capitalization as a percentage of gross domestic product, now 77%, is hitting overvalued highs last reached in 1968 (see chart, "Why U.S. stocks need a boom in world trade"). Yet looking at U.S. stocks from a global perspective, Bostian argues they can rise much higher: "If you consider expanding world trade, the ratio could go to 90% or 100% before the market is overvalued."

No wonder U.S. companies that sell to the world are being touted as the Nineties' answer to the Nifty 50, stocks that in the Sixties led the market to new heights. Marshall Acuff, portfolio strategist at Smith Barney, favors a group of 14 global growers: "In mature stages of the bull market, as investors see earnings growth wind down, they will be increasingly willing to pay more for companies that produce the growth. These stocks will go higher than people envision." He and other analysts expect the group, which includes stalwarts like Coca-Cola, Caterpillar, Motorola, Hewlett-Packard, and Intel, to generate annual earnings gains of 10% to 20% over the next five years, vs. 5% annual earnings growth for the S&P 500. In the past five years, the group outperformed the S&P by 150% (see chart, left).

The rise of global growers will overshadow conventional stock market cycles. Forget trying to allocate money in sync with ordinary market movements. Says Louise Yamada, a Smith Barney technical analyst: "Traditional cycles, such as capital-goods vs. consumer-goods stocks and small caps vs. large caps, will become subtrends. We are looking at a very different two-tier market, favoring globally exposed U.S. equities over domestic-oriented companies."

The shift is already apparent. Typically, capital-goods stocks and consumer stocks pass through long cycles during which one group soundly beats the other. But in the Nineties, companies like Motorola and Coca-Cola are doing equally well, largely because China and other developing nations are ravenous consumers of both cellular phones and soda pop.

Similar change is reflected in the behavior of small-cap stocks. When growth shifts abroad, investors usually expect large companies to thrive and small companies, which typically focus on markets near home, to languish. But small U.S. companies today increasingly generate overseas sales early in their life cycles. Notes Paul Brountas, a partner at the Boston law firm Hale & Dorr who has spent decades representing venture capitalists: "We are seeing startup high-tech companies generating 50% of their sales abroad within five years." The shift helps explain why small and large stocks have surged ahead recently in no apparent pattern. Frederick Kobrick, manager of the State Street Research Capital fund, has divided $3 billion evenly among small-, medium-, and large-cap stocks. He says: "The old small-cap cycle is bogus. Investors will have to be blind to market caps and just buy the best companies."

A variety of stock groups will benefit from global growth, notably financial services and health care. Citibank already derives half its revenues and 58% of operating profit from foreign locations. And no matter what health care systems exist in ten years, pharmaceutical companies will be selling to them: Merck and Pfizer have staying power because they have strong product pipelines, while Sandoz of Switzerland is considered one of the world's premier investors in biotech alliances. Sam Isaly of the Capstone Medical Research Investment fund is looking for Sandoz's earnings to expand 15% a year for five years.

Information technology stocks will be long-term, though highly volatile, market leaders. Wall Street is obsessed with high-tech companies that supply the tools that make possible many of the world's productivity gains. While technology stocks have risen nearly three times as fast as the overall market in the Nineties, it is not unreasonable to think that their rally will stretch for years. In an article last June entitled "Prospects for the U.S. Long-Wave Expansion," The Bank Credit Analyst compared the infotech revolution with the building of America's railroads. At its peak in the 1880s, U.S. spending on railroads represented more than 12% of GDP; spending on infotech hardware, by contrast, so far accounts for a scant 4% of GDP.

Yet high-tech stocks are notoriously volatile--not necessarily the kind of investment you would want to salt away for a decade. Says Bluford Putnam, chief strategist for the global investment management unit at Bankers Trust: "Technology is the wave of the future, but deciding which stocks will own the future is risky. Portfolios will have to be actively managed."

A tamer way to play the technology revolution is to invest in telephone-equipment providers. In the developed world, deregulation and technological change are transforming the phone industry from a sleepy utility business into a high-growth competitive free-for-all. Meanwhile, in emerging markets, demand is exploding. Says State Street's Kobrick: "Commerce blossomed in the U.S. with the arrival of the telegraph; throughout developing countries, it will with telephones."

Makers of wireless-phone equipment are a particularly attractive investment because of the relative ease with which wireless systems can be built in developing regions. For the world's three cellular powers--Motorola, Finland's Nokia, and Sweden's Ericsson--earnings have been growing at 35% to 45% a year; analysts foresee 15% to 20% annual gains for the next decade. Oscar Castro, manager of the Montgomery Global Communications fund, also likes the stocks of cellular providers in developing countries: Korea Mobile Telecom, Grupo Iusacell in Mexico, and Piltel in the Philippines. He expects earnings growth for each to average 20% to 35% in the next five years, slowing to 15% to 18% over ten. (Grupo Iusacell has an ADR that trades in New York; Korea Mobile's global depositary shares trade in London; Piltel is available only on the Manila exchange.)

A great long-term inflation hedge will be real estate. What happens if, contrary to expectations, inflation heats up? No portfolio of stocks, not even gilt-edged global growers, is likely to escape serious erosion of value under those circumstances. As always, the best defense is diversification: put some of your net worth into assets that will buffer you from stocks' volatility.

Demographic and economic forces today make most real property--particularly the house you live in--an unpromising ten-year investment. But trends are working strongly in favor of two sectors: apartment buildings and suburban office buildings. The easiest way to invest in either is to buy shares in a real estate investment trust. REITs specialize in properties that generate rental cash flows, trade as stocks, and generally pay high yields.

Suburban offices are what Robert Frank, Alex. Brown's head of real estate securities research, calls "the current power alley." Such buildings are in demand because technology makes it feasible for corporations to move whole departments to the outskirts of cities, where costs are lower than at headquarters downtown. In 1994, for the first time ever, the vacancy rate of suburban office buildings fell below that of downtown offices, 14%, vs. 16%. Yet there are few suburban office buildings under construction: builders in most regions are still convalescing from the construction frenzy of the Eighties (see chart).

The ideal suburban-office investment would be to buy shares in a national chain that can adapt flexibly to ebbs and flows in regional growth. Crescent Real Estate Equities, a REIT in Fort Worth, owns properties in many fast-growing sunbelt markets and is the closest thing to a national chain today. Carr Realty, a well-regarded developer in Washington, D.C., has plans to build a national chain of suburban office buildings. In November, Security Capital, a private backer of REITs in Santa Fe, promised to commit $250 million to Carr. Security Capital Chairman William Sanders believes that by 2004 demand for office space will grow 20% in the corridor between Florida and Washington, D.C., and in the Rocky Mountain states--regions Carr is expected to explore.

Suburban apartment buildings appeal both to transient Generation Xers and, surprisingly, to baby-boomers. As boomers age and their children leave for college, many are choosing to trade in the family home for a luxury apartment. The unexpected demand has driven up rents and provided an impetus for construction. Notes Martin Cohen of Cohen & Steers, a New York investment advisory firm specializing in real estate: "There's a move toward upscale, luxury-oriented apartments. And a lot of suburban apartments out there are obsolete and ugly. Much of the existing stock needs to be rebuilt."

Apartment demand should expand rapidly in the Rocky Mountain states and the Southeast. Among the REITs with the management skill to tackle long-term apartment development projects, says Cohen, are Columbus Realty Trust, which deals in middle- and upper-income apartments near Dallas, Post Properties in Atlanta, and Security Capital Pacific Trust in El Paso, the largest apartment REIT in the West.

A promising contrarian bet for the next decade is oil. Inflation will be muted in the years ahead, but if there's an unpleasant surprise, it's likely to come from oil prices. Higher prices look increasingly likely thanks to demand from thirsty markets like China, where per capita oil consumption has increased 33% in the past decade, and India, where per capita consumption has increased 50%. With the price of crude, recently a scant $17 a barrel, bumping along at its lowest level since 1973 adjusting for inflation, companies like Atlantic Richfield and Amerada Hess would welcome a price rise. Both have vast reserves of crude; every $1-a-barrel increase adds 90 cents to Arco's earnings and 80 cents to Hess's.

Come 2005, not all these investments will necessarily be winners. But by staying alert to shifts in inflation and interest rates, by looking large at the world and small at sectors like real estate, you can get rich by making more right bets than wrong ones.

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Foreign Investment and Colonial Mentality
by John Mangun
Director for Portfolio Management at I. B. Gimenez Securities, Inc.

For several years, I have held an unpopular opinion regarding foreign investment in the Philippines. In fact, on several occasions, the discussion deteriorated to where those who disagreed with me have questioned, if not my sanity, at least my ‘hidden agenda’. I do not accept the supposed economic miracles of Foreign Direct Investment (FDI). I also believe that our policy makers and politicians have put far too much emphasis on attracting FDI. In June of 1998, I wrote in this column, "I have never felt the need to bow down to the god of "Foreign Direct Investment". The idea that FDI is a lasting commitment to a nation’s economy is simply not true. Ford Motor invested in the Philippines, left the Philippines, and is coming back to the Philippines. This is not a ‘til-death-do-us-part' marriage; it is short time at a motel in Malibay."

In the last month there has been much discussion from Congress to the newspapers about several Multi-National Companies (MNC) that are scaling down their operations here in the Philippines. There seems to be two basic assumptions being made. The first is that this is a terrible loss to the economy. The second is that maybe, somehow, we are not ‘attractive’ enough for these foreigners to continue to do their business here. On both counts, these conclusions are as worse a case of ‘colonial mentality’ as promoting skin whiteners to young Filipinas or paying Fil-Am basketball players more than the home grown, regardless of talent.

Colgate-Palmolive is reducing its local production facility. Commentators have lost no time in proclaiming an impending economic crisis to be brought about by a multitude of newly displaced laborers. When Colgate does slow production, it will have been because Hapee toothpaste has been cutting into Colgate’s market share. It is conveniently forgotten that Colgate’s workers made unemployed, might well be absorbed by others such as Hapee, which will naturally have to expand to meet the demand. Welcome to the free market system.

The commentators would also have you believe that the reason why these MNCs are leaving is because the Philippines is a terrible place to do business. Let’s examine specific examples. Remember that these companies decided to do business here, not out of the goodness of their hearts, but to make money.

Abbott Laboratories has been in the Philippines for a long time. They dominated the market for intravenous (IV) solutions used by the medical profession. Over the last few years, they have seen they market share reduced two-thirds by (you won’t believe this!) a Filipino company, Euro-Med (EURO). Not being able to compete with Euro-Med and looking at a dimmer and dimmer future, Abbott has taken their FDI and gone away. Euro-Med just bought out Abbott’s IV business. Abbott would have done better to make a Portfolio Investment in the IPO of EURO and seen a 200% profit in the last year. Van Melle, the makers of Mentos candy left also. Their leaving had less to do with the business conditions here in the Philippines. It had more to do with Filipino consumers liking Universal Robina’s (URC) Maxx candy better.

The simple fact is this; local manufacturers have been able to produce products of equal or better quality at a cheaper cost, and increased market share until these MNC’s could not compete.

Far too often, foreign investment has been viewed as absolutely necessary for any developing country. Every politician has spoken of the need to tell the world how attractive the Philippines is for foreign investment. Not only that, we’ve been made to believe also, that the only foreign investment worth attracting is FDI. Foreign "portfolio investment" in the stock market was considered bad because it was ‘hot money’ and could be taken out at any time. Now the ‘experts’ are discovering the truth that FDI can be taken out just as quickly as Portfolio Investments.

This current rash of colonial mentality that says we cannot live without foreign money and that the Philippines cannot build its own economy is tragic. Let me give you another example of this foolish mentality.

A few years ago, a design engineer came to the Philippines with an idea to design a computer, using existing technology, which is much better and much cheaper than anything on the market. Along with two local engineers, they developed a computer that is 40% faster and at least 20% cheaper than any product from IBM or Acer or anyone else. Using some ten million Pesos of their own money, they are now ready to begin manufacture, which will require some P50 million. The financials look very attractive with almost a 100% per year profit, after the first year. In five years, the company will go public and be listed on the Philippine Stock Exchange. Now the story goes sour. They approached several large Philippine companies and groups for the investment. The comments they received were basically the same. How could Filipino engineers make this breakthrough in design? And even if the Filipinos could, we would not invest in a high tech product manufactured by locals. Now if it were Texas Instruments or Compaq Computer that had approached these investors, the funds would have been instantly available for the foreign partners. These men have now contacted me and I will raise the money from local investors, if necessary a million Pesos at a time, from Filipinos like you who have shed the colonial mentality that permeates the financial and business community. It will be the Filipinos who make the profits, not the foreigners.

If the MNCs invest in the Philippines, it is certainly advantageous, but more to them than to us. They make the profits. If they leave, it might be because they cannot compete against local companies. The MNC’s success or failure is not our success or failure. But until we can back to the idea that "Yes, the Filipino Can’ and shed our financial colonial mentality, we will never succeed.

( back )

Myths About the Philippine Economy
by John Mangun
Director for Portfolio Management at I. B. Gimenez Securities, Inc.

The market continues to reward those who are smart enough to ignore the nonsense. Since April 5th, the PHISIX is up almost twenty percent. Again, the real story is found in the price movements of individual stocks. This month, 40 issues have gained at least twenty percent in price. Now the market will pause briefly near 2460 on its inevitable march towards 2600.

Unfortunately, many investors would still rather put reason aside and listen to fantasies in making their investment decisions. It is hard to blame them though. There are so many fairy tales surrounding our country right now. That is the problem with myths. If these stories are told often enough, you tend to accept them as truths instead of what they truly are: fiction.

Lest my good friend Jimmy Cua accuse me of simply showing my Philippine nationalistic attitude, let me say that it is more my frustration with the prevailing simpleminded thinking. The problem with dimwitted reasoning is that it too often translates into reckless and irresponsible action. So many commentators, in and out of the media, who take upon themselves the role of trying to shape public opinion and thought, draw nonsensical conclusions from inaccurate 'myths'. Remember that a 'myth' is a mistaken judgement based on misinterpreted information. The myth of mermaids came from early sailors coming to tropical waters and seeing female aquatic mammals (manatees or dugong) nursing their young on the ocean's surface. We have our own 'mermaid' style myths about the Philippine economy.

'Crony Capitalism' is potentially one of the most damaging forces that can affect a country. It can debilitate, if not destroy an economy, and is a dangerous and insidious enemy of freedom. 'Crony capitalism' is the practice of using public funds and government influence to protect the business interests of 'friends'. To hear some people talk, the Philippines invented this problem while under martial law. A good example of 'crony capitalism' would be when Queen Victoria awarded the British East India Company franchise to the husband of her niece. 'Crony capitalism' is NOT getting a long time friend a good seat at your presidential inauguration. It is NOT allowing a campaign supporter and friend call you 'Pare' in private. A country is NOT in the grip of 'crony capitalism' when a twelve-year legal battle is resolved in favor of a presidential ally. 'Crony capitalism' does exist when public money is used to rescue a private corporation that is in trouble, because the owner of the company is close to the government. Prime Minister Mahathir and Malaysia just did it with Renong Berhad. It is not happening with Philippine Airlines. The South Korean government forced banks to support failing companies whose directors were political allies. Piltel (PLTL) probably wishes it were Korean. Japan made the stronger banks take over failing financial institutions under threats and pressure. Remember Orient Bank? We must be vigilant and always on guard against allowing the government to protect its cronies. However, to imply that the Philippines is now rampant with this problem is to exaggerate the case. The relationship between government and business is more free-market based here than in any other Asian country. The danger is that by exaggerating the 'Crony capitalism' myth, we ignore opportunities and are discouraged from taking the actions that would create employment, prosperity, and ultimately, social progress. .

Another dominant myth that is discouraging a favorable view of the future and a reasonable response is that our growth of exports is of small importance and not sustainable. For the past two years, the Philippines has had the highest rate of export growth in the world. A historically unfavorable balance of payment deficit has turned into a massive surplus. Our imports have decreased and our exports have ballooned. Last year the 'experts' were telling us that a decrease in imports was the start of a decrease in exports. It has not happened and will not. The reason our export growth is sustainable is because we sell more goods than anybody else does to the richest customer in the world. Over the last eight years, shipments of Philippine exports to the United States has equaled more than 30% of our total. This compares with less than 20% for Malaysia, 22% for Hong Kong, and 25% for Taiwan. Our largest supplier of imports is Japan, who is so desperate for more overseas business to save their economy, their selling prices have been steady to falling. We sell more goods to the best customer in the world. Over the last year and a half, one-third of the total increase in global wealth (as measured by Gross Domestic Product in actual terms) has been in the U. S.

The last idea is more of a myth in the making. For nine months, we have been hearing how the non-performing or bad loans of the banks here in the Philippines would skyrocket. Malaysia's bad loans are equal to about 40% of their banks total portfolios. Philippine banks are around 10-15% with Bank of the Philippine Islands (BPI) about 6%. There are two things to consider about this myth. The first is that the Philippines, unlike the others, has not changed its definition of a bad loan, i.e. A loan that has not been serviced for 90 days. Malaysia's definition on the other hand is; regardless of whether you have paid anything, if you are even THINKING about paying on your loan sometime in the future, it is a good loan. Further, the slight increase in the rate of bad loans here was due to a contraction of the banks total portfolio rather than an increase in the actual amount of bad debt. But even then, the percentage of non-performing loans has fallen in the last two months. This myth is harmful as it negatively reflects on the very important banking institutions.

So, base your investing on reality and not figments of imagination. You make more money that way.