ECINYA’S LAST INSIGHT ESSAY… good night, goodbye, and good luck


ECINYA will cease publishing on Friday 20 September 2013 and close down its web-site by 15 October. We had 9 years with E*Trade up to December 2008 and 4 years from 2009 as a stand-alone web-site.  Our editor, George Sutton, has decided to retire or semi-retire on 13 December 2013. ECINYA thanks its confidants and associations over the years and has a measure of pride in what was produced over the 13 years of its existence.




If we could have just one final suggestion for Australia it would be to extend the Federal parliamentary term to 5 years with a minimum term of 4 years. 

Australia is an extremely talented and lucky country with abundant human and natural resources.  Our potential will never be fully realised if we seek to change direction dramatically every three years because political expediency and striving for points of difference over-take common sense policy continuity.   The economic and political cycles have become destructively disengaged at a time when economics and politics are more engaged than ever.  Policies take time to work in a globalised world of shifting trade and political alliances and often need to be fine-tuned over several parliamentary terms.  Good policy badly executed results in poor outcomes.  Bad policy well executed or badly executed results in even poorer outcomes.

With the change of government from the bizarre and grossly inept Rudd-Gillard-Greens to the Abbott-led Liberals there is a chance that Australia can return to a more sensible and balanced view of its opportunities and challenges.



In 2005 Ian Macfarlane, Governor of the Reserve Bank said –

The principal contribution that monetary policy can make to economic well-being is to maintain low and stable inflation.  I think it is true to say that if you wished to forecast the path of the Australian economy , and you were able to have fore-knowledge of only one economic variable, the one you would choose would be the path of the world economy.  That is not to say that we have no influence over our own destiny – we can make the situation better or worse than it would otherwise be – but we cannot escape the influence of the world business cycle and the other factors that feed off it.

Australia is about 1.5% of world GDP and about 0.03% of the world’s population.  This results in a high per capita GDP putting us easily within the top 10 countries.

It is relatively easy to say that there are four systems of government – capitalism, socialism, communism, and totalitarianism. Ecinya is of the belief that what we need for Australia is BALANCED FREE ENTERPRISE and we have been banging this drum for a very long time. Today, in developed economies we have governments in all of its various forms (federal, state, municipal) running at somewhere between 20 and 30% of the economy, squeezing the private sector. The capitalism vs socialism debate is not worth having for neither exists in abundance in the developed world, nor even in most parts of the emerging world.

Balanced free enterprise means that there is a valid and useful role for government including the provision of social and commercial infrastructure that provide appropriate community solutions. The genuinely disadvantaged have to be helped. Government is essentially an agency function where taxpayer’s money comes back to them via constructive government initiatives in education, health, infrastructure, security, law and order etc. Our editor’s recollection of the best years of government in Australia have been the Menzies era, the Hawke-Keating-Walsh years and the Howard-Costello years. The worst years have been Whitlam, Fraser, and then the disastrous Rudd-Gillard-Greens era.



It seems perfectly clear to us that Gross Domestic Product (GDP) is being driven by too much "G"…… an excess of Government which is ‘crowding out’ the private sector. Small business resides in the middle class where most of the employment is created so that when you crowd out the private sector you crowd out the aspirational middle class. The result is simple – less velocity in the economy, less income growth, less economic growth, less employment growth.

The simple equation for GDP is –

  • GDP= C+I+G+Net Exports

GDP is the total market value of all final goods and services produced in a country in a given year, equal to total consumer (C), total investment (I) and government spending (G), plus the value of exports less the value of imports (Net Exports). GDP is adjusted for inflation using one of several inflation measures. In America it is the Implicit Price Deflator.

Over short periods the GDP numbers can be a bit rubbery, but in the longer-term they are reliable enough and when supported by other anecdotal and hard evidence, we can generally say the GDP is rising or falling at a near-enough-to-accurate rate. GDP growth is important because it is the source of company profits and company profits play a part in stock-market advances and hence national wealth. Healthy growth in GDP usually means healthy profit growth, but if GDP is expected to fall then expectations take over and the forward estimates for profits and GDP influence share market outcomes. Perceptions of sustainable periods of economic growth lead to higher share prices. Such perceptions are called ‘confidence’.

Looking at world economic growth numbers from the IMF we see that world economic growth in the period 1992 to 2001 averaged 3.2%, and in the 8 years from 2002 averaged 3.6% but inclusive of a global recession of 0.6% in 2009. The peak years for growth over the last decade were 2006 and 2007 when GDP growth averaged 5.25%. In broad terms a 1% fall in GDP is akin to taking out of world growth about US$700 billion, about 75% of the entire Australian economy in purchasing power parity terms.

Another way of looking at it is, if the world economy grows at 3% per annum then it doubles about every 24 years, and at 4% per annum it doubles about every 18 years, a sizable difference.

Australia is a Federation of States and numbers are not available to us on a basis that consolidates the states and the Commonwealth, but numbers were given in a Ken Henry speech of 30 November 2009 that indicate that Government has become too large in Australia relative to the sum total of GDP. Because Government is funded by taxation, it is not being over-simplistic to state the following –

  • more taxation = more government
  • more government = less consumption due to less disposable income
  • less consumption = less production
  • less production + more imports = lower GDP growth



One of the great difficulties in the standard GDP formulation is that governments can increase their expenditures not only via increased taxation, but by increasing their debt. However, a couple of things result from this approach. Firstly, you have to pay interest on the debt and secondly at some future time you have to repay the debt. Ultimately, greater borrowings means that you have to have more income to repay debt and principal and/ or sell trophy assets (e.g Arnotts Biscuits, Speedo, Petersville Foods, and possibly GrainCorp).

For government the only source of income is taxation as all of their other services generally lose money. Higher taxation causes big businesses to want to pay less tax (by moving their tax base offshore, by transfer payments, by exploiting double tax agreements), or to reduce their costs of production. The easiest way for BIG companies to reduce their costs of production is to produce in lower cost countries. This means lower growth at home, less jobs, and over time can impact on the ability of a country to repay its debts in a timely manner. Then a debt downgrade results and a vicious circle begins. These processes take a long time to evolve and sometimes having evolved, take a long time to become a recognisable problem such as in Greece, Spain, Iceland, Italy, Portugal, Ireland, England, America etc.

However, there is no universal qualitative measure of GDP. For instance if the C …Consumption.. is debt funded/ leveraged then the quality is potentially diminished.  If the G… Government… is debt funded/ leveraged then the quality is even more diminished because the empirical evidence is that governments misallocate resources (waste) on a regular and recurring basis.  One wonders whether GDP should be adjusted each year by subtracting the net  increase in private and/ or public debt from the equation.

Back in October 1985 Peter Drucker had this to say –

I think, there has been an irrevocable shift in the last ten years. No matter who is in government, he would no longer believe in big government and would preach cutting expenses and would end up doing nothing about it. This is because we, the American people, are at that interesting point where we are all in favor of cutting the deficit – at somebody’s else’s expense. It’s a very typical stage in alcoholism, you know, where you know you have to stop – tomorrow.

It is now apparent that Mr Drucker was an incorrigible optimist because the rhetoric that has come from the Blair, Bush, Obama, Hollande, Rudd-Gillard-Greens governments is not anything about small government at all. The universal mantra is "Markets have failed. When markets fail, governments have to "step in". This is despite the fact that it was government inefficiency, poor policy formulations, and lack of oversight that caused the markets to fail in the first place. The failure of national governments over the past two or three decades to follow simple economic rules is now reflected in the structural and systemic problems that now need to be overcome. Quantitative Easing (QE) seems more like a band-aid than a lasting solution. Most probably, the hole is so deep that only a unified plan will shift the role of government back to the centre. Qianlong in his Qing Dynasty proclamation of 1645 is speaking from the grave.

The Way of Heaven is profound and mysterious and the way of mankind is difficult.  Only if we make a profound and unified plan to follow the doctrines of the centre, can we rule the country well.


The increase in the size of government relative to the size of the economy in Australia is not just a Rudd-Gillard-Greens problem. It goes back to the dark days of Whitlam and Fraser which were over-turned by the very good years of Walsh-Hawke-Keating and then all but the last 3 years (out of 11) of the Howard-Costello era when Mr Howard decided to try to buy a final election, such a tactic having worked in the previous election to a substantial degree. Messrs Rudd and Gillard though presided over a massive and ill-directed spending effort just before China and Asia were slowing and our resource export prices and volumes were about to come under pressure.

In pre-election 2007 Messrs Swan and Rudd visited their economic tailor and donned clothes of conservative economic mien but when the GFC came along they overreacted in order to appear to be on top of a problem most unlikely to have had a lasting impact on Australia thanks to the then strength of the Asian connection and commodity prices.



1.     Australian personal taxes are far too high; extend the GST to food. The exclusion of the Goods & Servcies Tax (GST) from the Henry tax review should have caused Henry to refuse to write the review. The GST is a big, elegant tax and it is relatively easy to make the food inclusion neutral at inception. The end result of excluding the GST from the review was the stupid idea of a resources and carbon tax. Additionally, other stupid taxes such as payroll tax, and many property taxes remain, which distort economic decision-making and reduce the desire of business to employ people and/ or to grow their onshore businesses. ‘STUPID’ is an apt acronym… Silly Taxes Upset Proper Industrial Development. Probably the only exclusion should be education fees.

2.     Capital gains taxes are too complex and counter-productive. The reform proposal is that all gains should be treated as ordinary income on a sliding scale: 100% gain taxable under year 1, 80% year 2, 60% year 3 etc etc. After 7 to 9 years all gains are tax free. This would bring a lot of residential property into the property markets. Capital mobility and capital velocity are important.

3.     Create a minister for state liaison: Federal budget accounting is a shonky cash flow exercise. As an annexure the Federal budget should consolidate itself with all of the states distinguishing between capital works and operational expenditure so that we know where the money comes from, and where it goes to. With such a large share of GDP government needs to be more accountable.

4.     Education should be handed over to the Federal government with state councils, including the responsible state and federal ministers, created to monitor results and direct policy.

5.     Health should be entirely federal or entirely a state responsibility. It is easy to travel within Australia for better healthcare outcomes so states of excellence might result in healthy competition.

6.     Jobs: It is impossible to be pro-jobs and anti-business. We are excessively focused on exports. We should have an import replacement policy as well. In fact we have gone backwards and even reversed many of the Keating work-place reforms. Small business, for purposes of the wrongful dismissal laws needs to be re-defined to something like at least 50 to 100 workers. The employment safety nets seem excessive – base pay+ compulsory superannuation+ workers compensation insurance+ payroll tax+ long service leave+ overtime in a 24/7 world+ parental leave+ legal compliance costs for rightful dismissal. In 2014 youth unemployment will become a major problem for Australian governments.

7.     Water resources needs an agreed national approach.

8.     Ethanol and other forms of energy saving needs a proper bi-partisan and appropriate policy response.

9.     Aboriginals need dedicated colleges and broad curriculums encompassing the arts as well as the sciences.

10. Big business (market cap over say $250 million) should report ANNUALLY at the end of every quarter with their statutory reporting date remaining unchanged. Four quarters in aggregate removes the seasonal bias. Continuous disclosure and guidance has become something of a nonsense, more in the nature of spin than substance.

11. Auditors should read aloud their report to shareholders at the annual general meeting to remind shareholders, boards, and themselves, that they have a duty of care to shareholders and to a much lesser extent, creditors.

12. Generally accepted accounting standards have become unacceptable with asset revaluations flowing through the profit and loss account, impairments in one year leading to misleading comparatives in the next, and potentially non-recurring items distorting the real underlying profits. True we can rely on competent analysts to read the fine print but it does become confusing for the mug punter, citizen or layman whatever you wish to call him or her.


(1) Political donations should be banned and an electoral bank established with distributions pre and post election to be distributed on a formula basis. Crony capitalism and crony socialism is pervasive. Vested interests have easy access and as illustrated in NSW and Queensland over recent periods, corruption has been in evidence. Tax deductions should apply for donors. Ecinya does not have a fully developed thesis on this , but we  have written a discussion paper. This is not to say that external groups outside of political parties cannot run their own campaigns provided there is some scrutiny/ disclosure of source.

(2) We live in a 24/ 7 world. So abolish penalty rates for weekend work and overtime even for priests, rabbis, and ministers who have to work on Saturdays and Sundays. People who work over 40 hours per week can enter into separate contracts in relation to overtime. Job protection does not work, and Greece is just another good example of the folly of job protection and uncontrolled welfare, albeit in a context where tax evasion is rampant. The Henry report recommendation on centralising welfare was totally ignored. Youth unemployment a looming problem as is the level of general under-rmployment.



We believe that the best of economic America is the best that is currently available and though we decry the concept of American exceptionalism much of what the world enjoys today has come from American enthusiasm, creativity, and engineering skills. But America now finds itself in a horrendous situation with huge federal debts running at 100% of GDP, a seemingly intractable domestic deficit, a current account deficit, insolvent states and municipalities, volatile house prices, high unemployment ,  often a pressured currency, and ongoing wars. However, we see a more ‘normalised’ and recovering America emerging out of the electorates disdain for foreign policy in the context of rising energy independence and falling real wage costs. Mr Obama still appears to be somewhat out of his depth and Mr Bernanke is looking like the charlatan that Mr Greenspan ultimately became.

America seems to have major structural problems in deficit spending and debt. Mr Bernanke seems to be following his predecessor Alan Greenspan and is in the process of creating another monster bubble via excessive money printing. Inflation at the asset level is just as dangerous as goods and services inflation and there seems to be a lot of money chasing a shortage of stable and viable assets. QE tapering is most likely to be too late and too little.



When Keynes’s masterpiece ‘The General Theory of Employment, Interest and Money’ came out in 1936, Schumpeter, by then the senior member of the Harvard economics faculty, told his students to read the book and told them also that Keynes’ work had totally superseded his own earlier writings on money. Keynes, in turn considered Schumpeter one of the few contemporary economists worthy of his respect. Yet Schumpeter considered Keynes’ answers to most economics questions as wrong. Schumpeter and Keynes are often contrasted politically with Schumpeter being portrayed as the ‘conservative’ and Keynes the ‘radical. The opposite is more nearly right. Politically Keynes’ views were quite similar to what we now call ‘neo-conservative’. His theory had its origins in his passionate attachment to the free market and in his desire to keep politicians and governments out of it. Schumpeter, by contrast, had serious doubts about free markets.( Peter Drucker’s ‘The Frontiers of Management’ , 1983.)

Ecinya Comment : Peter Drucker is acknowledged as one of the leading economic and business strategic thinkers of his age and his bio is obviously available on Google. From our readings over the years we believe that Drucker favoured Schumpeter over Keynes. Schumpeter held that a modern economy was always in dynamic disequilibrium, it is forever growing and changing, and is biological rather than mechanistic in nature. Keynes was more inclined to believe in the certainty of macro economics, a more prescriptive approach.

The mistakes of the past are oft repeated and economists are said by Drucker to be the slowest learners of all as they are ‘prisoners of totally invalid but dogmatic theories’. The last term of the Howard government spent too much and expanded the role of government beyond reasonable limits. Mr Rudd then got elected by portraying himself as a conservative and when the GFC came saw it as his opportunity to be a revolutionary. He was resisted in this by Lindsay Tanner, but encouraged by Messrs Gillard and Swan and then influenced Treasury, or was encouraged by them, to attack the American and European financial crisis with massive Keynesian expenditures lest we became ensnared in the sub-prime crash web. There are more than enough natural disasters to challenge our finances without wasting resources through ill conceived or badly implemented policy – NBN, pink batts, $900 refunds aggregating over $10 billion to buy a TV or go to Bali etc.

Ecinya comment: To compound the problem Keynesian theories are being twisted to cover-up inept policy and inept execution. For example, Labor embarking on a National Broadband roll-out of dubious merit, proposing to tax the mining industry, and proposing a carbon tax which at a time when the consumer was going on strike and committing the unpardonable sin of saving rather than borrowing to consume at elevated interest rates. Also we built a number of high cost desalination plants around the country and other infrastructure errors which soaked up scarce resources. Policy had become a patchwork that seemed to reflect massive disequilibrium without Schumpeter’s dynamism.


A conventional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield; since there will be no strong roots of conviction to hold it steady.  In abnormal times in particular, when the hypothesis of an indefinite continuance of the existing state of affairs is less plausible than usual even though there are no express grounds to anticipate a definite change, the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning and yet in a sense legitimate where no solid basis exists for a reasonable calculation.

It might be supposed that competition between investment professionals possessing judgement and knowledge beyond that of the average private investor would correct the vagaries of the ignorant individual left to himself.  But many are concerned not with what an investment is really worth to the man who buys it ‘for keeps’, but what the market will value it at, under the influence of mass psychology, three months or a year hence.

Games played amongst even professional investors of Old Maid, Snap and Musical Chairs can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.

Thus, professional investment may be likened to the newspaper competitions in which competitors have to pick out the six prettiest faces from a hundred  photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view.  It is not the case of choosing those which to the best of one’s judgement, are really the prettiest, nor even those which average opinion generally thinks the prettiest.  We have reached the third degree where we devote our intelligences to anticipate what the average opinion expects the average opinion to be.  And there are some, I believe, who practice the fourth, fifth and higher degrees.

Ecinya Comment: John Maynard Keynes was one of few economists who achieved success in financial markets trading on his own account thus the thoughts above are interesting in themselves and in that context.


In just about every rich country, the global financial crisis has morphed NOT into the triumph of Keynesian economics but into the fiscal crisis of the modern welfare state. The Tea Party rebels and the bond kings are advancing on Capitol Hill, the British are enduring their most bracing budget austerity in generations and there are street riots in European cities. This hasn’t happened here for one reason: Australia escaped the rich world recession not because our budget stimulus was much bigger or better than the rest, as Wayne Swan suggests in his weekend ‘Keynesian in the Recovery’ essay for the Fabians. We’ve stood out because of the unique China boom…. The Treasury calculates that Swan’s 2012-13 budget surplus still would be propped up by the unsustainable high iron ore and coal export prices. The budget will remain in an underlying "structural" deficit until 2019-20 on its reckoning. This amounts to a serious national vulnerability. (Michael Stutchbury, Economics Editor, The Australian 12/4/ 2011.)

Ecinya Comment: Michael Stutchbury, in our view, is an extremely balanced economics writer and takes issue with the self-serving and convoluted approach to Keynes adopted by Treasurer Swan. Keynes did not promote unfettered or loose government spending as the path to prosperity.


I finally saw the light. Slowly, I discovered that the left was inherently totalitarian…… The Reagan revolution could never be won unless the establishment politicians and opinion makers gave our ideas a fair hearing. They had to be convinced that sound money, lower tax rates, and a vast curtailment of federal spending, welfare, and subsidies was the only recipe for sustained economic growth and social progress…… The abortive Reagan revolution proved that the American electorate wants a moderate social democracy to shield itself from capitalism’s rougher edges. Recognition of this in the Oval Office is all that stands between a tolerable economic future and one fraught with unprecedented perils.

From the cover sheet: Despite the powerful mandate given to President Reagan by the American people, his program faces increasing difficulties as it encounters political realities. Even those members of Congress who favor spending cuts in principle hastily vacate the battle field when this conflicts with powerful demands of their own constituencies. Eventually Stockman, the revolutionary, is forced to accept the reality of his theories, which looked so convincing on paper, have been based on a profound misjudgement of the American political system. ("The Triumph of Politics: Why the Reagan Revolution Failed’ by David Stockman published 1986, Director of the Office of Budget and Administration 1981-1985.)

Ecinya comment: Reagan sowed the seeds of the modern welfare state into the fabric of the American dream and Congress and various presidents have compounded the problem. It has probably been facilitated by the fact that the $US is the world’s reserve currency and America has historically been regarded as a safe haven and hence able to borrow at favourable rates.


Adam Smith, at least, lived to have high hopes for the new country. He thought it was normal for human beings to want to live in a prosperous society, but that it was also normal for them to live in a broadly just society. Their desire for self-improvement was in many ways mysterious, but in the end it was inherently social, rooted not only in the love of acquiring but in the love of haggling, bargaining, interacting – the whole work of building worlds out of wishes. What then moved men to make markets was ultimately their love of pleasure and happiness, and who Smith wondered, could live happily in a society where all the wealth had been confiscated and kept in a few hands? He believed not that markets make men free but that free men move towards markets. This difference is small but decisive; it is most of what we mean by humanism. (AFR 29 December 2010 – Adam Gepnik of The New Yorker writing on Nicholas Phillipson’s "Adam Smith: An Enlightened Life.")

Ecinya comment: Wall Street is the tail that wags the American body politic dog and America seems relatively ungovernable at this time.


All countries which accumulate debt and habitually run big current account deficits are vulnerable. And for many centuries societies have been susceptible to irrational booms, South Sea Bubbles, tulip bulb booms, and dot com busts. But no central bank can offset the cascading effects of bad government policy. (Peter Walsh former Labor Party Finance Minister, Financial Review 10 December 2003.)

Ecinya comment: Peter Walsh is Ecinya’s most highly regarded post Menzies politician and was for a long time the real power behind the Hawke Keating era.


The propensity of Congress to create benefits for constituents without specifying the means by which they are to be funded has led to deficit spending in every fiscal year since 1970, with the exception of the surpluses of 1998 to 2001 generated by the stock-market boom. The shifting of real resources required to perform such functions has imparted a bias toward inflation. In the political arena, the pressure to make low-interest-rate credit available and to use fiscal measures to boost employment and avoid the unpleasantness of downward adjustment in nominal wages and prices has become nearly impossible to resist. The American people have tolerated the inflation bias as an acceptable cost of the modern welfare state. (Alan Greenspan in "The Age of Turbulence", September 2007.)

Ecinya comment: It must be a source of regret for Mr Greenspan that he waited until his retirement to be so clear and forceful about the role of fiscal policy in shaping a sustainable and viable economic destiny for America rather than pandering to the political establishments that he served for such a long time. A lot of commentators have a low regard for Mr Greenspan and Ecinya would be amongst them.


Treasury was at its most influential during the term of the Hawke government, but I give credit for that to our greatest ever treasurer, Paul Keating, a man with a deep understanding of how to obtain and use political power, and who needed a purpose to fight for. Treasury supplied that purpose, affecting his conversion to economic rationalism. Treasury’s highest institutional objective has long been to dominate the economic advice going to the government, and no secretary has been more successful in this than Ken Henry, thanks to the arrival of the deeply insecure Rudd government, which sought to hide behind the authority of the supposedly independent Treasury. (Ross Gittins, The Sydney Morning Herald, 27 December 2010.)

Ecinya comment: Ken Henry never appealed as anything other than a compliant conspirator in a period of extremely poor economic management.


Global economic recovery more superficial than real: Liquidity injections and bailouts can buy time, but are not the solution for economies in need of structural repairs….. Time is not the answer for economies desperately in need of structural or fiscal consolidation, private sector deleveraging, labour market reforms, or improved competitiveness. Nor does time cushion anaemic post crisis recoveries from the inevitable next shock. (Stephen S Roach, Non-Executive Chairman Morgan Stanley Asia, Financial Times 5 July 2011.)

Ecinya comment: It is difficult to imagine Stephen Roach as an advocate of rampant QE policies.


I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket, and trying to lift himself up by the handle. (Winston Churchill)

Ecinya comment: Taxpayers are reluctant contributors to fiscal waste and economic vandalism.

After our daring and delightful dance with Sir Percy


Markets move in waves and the waves morph into cycles. Economic progress or regression does not move in a linear fashion with stock-markets, but at some stage they intersect. When they do the prevailing positive cycle moves to a position of excess and upon reversal to a position of despair…. and excess despair is recession or depression. This process is the underlying foundations of The Ecinya Market Barometer.

The stock-market, inter alia, is said to be a leading indicator and we concur with this view. But that was before Dr Bernanke and his predecessor, Alan Greenspan, turned central banking into a political sport designed to protect the ‘too big to fail’ investment and commercial banks of the world. The current global QE response to the excesses is fraught with danger and could end in tears if those involved continue to obfuscate or tell deep untruths or pursue uneconomic agendas such as is happening in France. The world needs to get back to meaningful work which will also involve less wars and less welfare. Fundamental change does not occur quickly and the global and national timetables should not be rushed.

Since March 2013 our strategic directions and advice has been to sell strength and maintain cash balances. This view continues but comes to a natural end if we get a sufficiently large enough retracement. The focus would then shift to identifying prospects for an improving local and global economy and we would look for signs of a sustainable cyclical recovery. We are not prepared to make that assumption just yet. Housing, employment, commodity prices, and car sales will give some clues. At that point in time earnings forecasts should be being revised upwards. For the moment we consider that markets are making an intermediate top and a retracement is underway, or close at hand. Stay alert and remain nimble.

To navigate the waves Ecinya uses its TACTICAL MATRIX to give some discipline and direction to the process, as follows –


1. Going with the flow, with conviction.

2. Going with the flow, without conviction.

3. Going against the flow, with conviction.

4. Going against the flow, without conviction.

5. Ambivalent/ neutral.

To identify and define the cycles Ecinya uses the following –


Our Macro Market Context operates on 10 levels:

1. Deep despair

2. Very bearish

3. Bearish

4. Concerned

5. Ambivalent/ neutral

6. Comfortable

7. Confident

8. Bullish

9. Very bullish

10. Euphoric



Tactically, we are happy to sell strength, buy weakness, and stay over-weight cash despite poor returns. Hedge fund activity on uncontrolled futures markets keeps us away from chasing bank dividend yields with gusto. Strategically we hover between 6 and 4.

In a strategic sense we are on the sunny side of ambivalent looking for an ultimate or intermediate low where value can be identified on a sustainable basis so that we could recommend a move towards an investment bias rather than an overweight cash/ trading bias. The world is not in good shape. If it were central bankers would not be acting in the way that they are. Given that most central bankers are economists and have little or no idea about how business and the consumer really works, the fact that they are acting in concert is a major concern. Excesses in fiscal policy can lead to unintended consequences and excessive monetary policy just makes it worse.

When the major commercial and investment banks became an arm of government and hence ‘too big to fail’, central bankers became a flock of vultures digging over the bones of hapless taxpayers, workers and retirees. In foregoing their independence they surrendered their integrity. Fortunately tahnks to Peter Costello and APRA this did not happen in Australia.

Ecinya has always had an immense distrust of Alan Greenspan, and Dr Ben Bernanke has not sufficiently distinguished himself to settle our underlying doubts about his foresight and abilities. His appearances with Hank Paulson pre and during the American banking crisis should not be easily forgiven. The fact that Lehman Bros became the sacrificial lamb to the GFC, and others were spared, was central banking and politics at its worst. Someone prominent should have gone to jail. Our admired central bakers are Paul Volcker, Ian Macfarlane, and Glenn Stevens. One of our abiding reference points came from Ian Macfarlane on 14 June 2005, when he said –

The principal contribution that monetary policy can make to economic well-being is to maintain low and stable inflation. I think it is true to say that if you wished to forecast the path of the Australian economy, and you were able to have fore-knowledge of only one economic variable, the one you would choose is the path of the world economy. That is not to say that we have no influence over our own destiny – we can make the situation better or worse than it would otherwise be – but we cannot escape the influence of the world business cycle and the other factors that feed off it.

Thanks to the gross stupidity and inexperience of Wayne Swan, Kevin Rudd, Julia Gillard and Ken Henry in and around the GFC, Australia now runs the risk of having an economic crisis unless the world saves us. Our fate has been transferred abroad. Lyndsay Tanner is exempted from this, though he was part of ‘the gang of four’ at the time. An Ecinya essay at the time criticising the response has proven to be correct….. unfortunately.



The music never stops, the band plays on, and the dance continues.

Ecinya last published on 15 March 2013 and prior to that on 8 March. The thesis was that our market was about to fall and accordingly there was no great need to exit cash and chase stocks, except on a trading basis.. As part of our deliberations we published an essay on 8 March titled ‘Ecinya’s delightful and daring dance with Sir Percy’. That essay set out the details of a bet between Sir Percy and our editor and during the course of the bet we gave an extension of time to Percy until 31 May to equalise the time frame and allow a more cogent outcome. We levelled the playing field.

Percy had the All Ordinaries index falling 2% and we had the market falling 8%. In fact it fell 3.9% by the relevant date, 31 May. The bet was settled on the basis that the mid point between 2% and 8% was 5% and editor could only be the winner at 5.1%. However, in the days thereafter the XAO had fallen by greater than 5.1% and had the bet settled on 12 June editor would have been 99% correct in his estimate, guesstimate, projection, however you wish to describe it. The duration of the bet was 100 days.

The important point was that direction was correct on both our parts and dimension was satisfactory to excellent, albeit 12 days late…… a very close miss.

The table below sets out the timetable of the wager.

XAO % Change from 20/02/13

However, the point of the bet was not to win, but to engage in thought and have a physical marker at settlement date. An old Jewish proverb says "There is nothing so beneficial as an argument between persons of goodwill." The bet may be over, but the thinking goes on.


ECINYA’S BACKGROUND REASONING AND MAJOR CONCERNS enunciated as part of the bet were first outlined as part of our Strategy Essay of 25 January and comprised –

1. Australian fiscal management during and since the GFC – the chickens are coming home to roost and unemployment, slow growth. and higher taxes are on the horizon in a massive landscape of poor policy development and execution. Mid term (circa 2014) we remain bullish on hard and soft commodities. Australia needs a Federal election as soon as possible. The current Australian government is so far beyond incompetent that bizarre and absurd at both the policy and personnel level seems a more apt description.

2. Dr Ben Bernanke is treating a disabled patient with massive doses of monetary stimulus when the real medical disorder is fiscal profligacy and waste. America may well be ungovernable as it seems increasingly difficult to get Congress and the Obama administration to realise that the Rosy Scenario tango requires both monetary and fiscal policy to be on the same dance floor.

3. Europe needs to address creeping imbalances all over the place. Europe doesn’t bother us as much as people might imagine as our observations is that outside of the capital cities the cash economy functions beautifully and la dolce vita or the sweet life is well in evidence. Of course, European banks are another story as is employment (particularly youth unemployment) and productivity, Germany excepted.

4. China may have a massive credit and property bubble which has not yet popped. The evidence here is moving from anecdotal, scattered and intermittent to more regular and factual. We point out, even now, that Greek GDP per capita is about twice that of China in Purchasing Power Parity terms, considered the most relevant measure for country comparisons.

5. The normal menu of global unrest has a new entree in that China and Japan are in dispute in and around the China seas. We said ‘entree’ not ‘main course’ or ‘dessert’. The protagonists are dancing around one another with more preening than threats. (PS: Egypt and Syria are now centre stage)



The Australian model is broken and has become almost totally dependent on the strength of the recovery in the global economy.

A bankrupt was asked "How did you go broke?" He replied, "Slowly at first, then it accelerated."

Australia has an extremely deep and narrow export base built around iron ore, coal, and wheat. Other hard and soft commodities add to the mix. At the same time our import base is deep and wide. We manufacture very little and in relation to a major industry, motor vehicles, we subsidise it heavily. Ecinya is of the view that we should and could have a viable car industry, but not under current policy settings.

Our commodities bonanza has existed for a very long time, but was propelled to boom proportions by Asia, China in particular, but Japan, South Korea, and Taiwan before that. Not only did they take massive quantities of commodities from us they also provided a cheap affordable source of imports. Nirvana was upon us. We became the lucky country. But then Asia started to produce building products and cars in abundance as well as consumer goods making our already diminishing manufacturing even more pressured. The policy response has been a shambles of historic proportions.

At the same time State and Federal Labor governments funded by copious amounts of GST taxation (a tax they opposed) decided to expand the welfare state without a comprehensive understanding of sustainable economics. They had no comprehension of the need to save for a rainy day and the basic requirement of providing the structures, skills and physical infrastructure necessary to reduce our dependence on imports when exports have their inevitable and historical cyclical slow-down. Even at the export level basic infrastructure has been lacking and the costs of getting to port and onto ships has been an impediment to longer term success in places like Newcastle and Queensland.

Our model is broken in today’s globalised world. The free trade mantra has become costly and weakened our negotiations. Our wage costs makes us uncompetitive in manufacturing and is now placing stress on our commodities industries as bulk prices have fallen.

Programmes like Gonski, National Disability, and Paid Parental leave plus our ongoing Refugee Programme only enlarge the HOLE we are digging for ourselves. We continue to believe that we are rich, and yet through creeping imbalances, now in early stage acceleration, we have begun to live the delusions being promoted by Prime Minister Rudd. The underlying realities are being lived by households and businesses and the unemployed and under-employed. Still there appears to be a host of persons looking for the simple solutions that Mr Rudd offers.

Ms Gillard lacked experience and the DNA of her Welsh father was a major impediment to her economic and business understandings and governance. For many people a law degree provides a sheltered workshop, and words become a plausible substitute for understanding followed by action. In a 24/ 7 world we get so caught up in dynamism that we forget and forgo basics and fail to learn history’s lessons. The excitement of being in office again led to hubris and now that hubris may lead to a lot of pain.

Just a quick look at wage costs. Stephen Roach former Chief Economist of Morgan Stanley long ago recognised the global labour arbitrage that was going on. The massive investment in emerging world education after WW2 driven mainly by America’s consumption needs and dominance of the world’s financial system created the means for goods and services to be provided by the emerging world. This has now made the the western democracies fat and lazy. In economic terms the word is ‘unproductive’. America has recognised its errors and has stopped exporting jobs, and is now bringing them home.

In Australia, which is always our central focus wage costs comprise the base wage+ holiday pay +penalty rates + superannuation + long service leave + workers’ compensation + payroll tax + legal costs and systems to rationalise labour costs via dismissals in order to save the remaining jobs. The safety nets are now well and truly overdone.

The policy response to globalisation has been a shambles. Ultimately what happens is that we have to sell significant assets, the crown jewels, in order to survive. A few examples that spring easily to mind are Speedos, Arnotts Biscuits, Petersville Sleigh, Fosters and Tooheys beer, Penfolds Wines. Other brands and operations are sure to follow and Graincorp is already on the predator’s menu. No company under our existing economic landscape is safe and the price will be cheap, cheap, cheap. Every dividend paid to a foreigner, every dollar of taxation avoided by even legal means, has the same impact as an import in terms of the balance of payments.



The Federal Labor party , in our view, is totally unfit for government. This is not meant to endorse the Liberal party as we will only be able to judge their competence in office, if they were to be elected. Mr Abbott’s Paid Parental Scheme does not impress at this point in time nor does his blue-book on ‘policy’ positions.

The Labor party does not do policy, it does concepts – NBN, NDIS, education, climate change, mineral resources tax etc. ‘Policy’ would require cost-benefit analysis and we have seen no evidence of that over the period of the Rudd-Gillard-Greens coalition in governments since 2007. We see no John Howard, no Paul Keating, no Bob Hawke, no Peter Costello.

Ecinya funds it difficult that you can be anti-business and yet proclaim to be pro-jobs. There is no concept of balance, no appreciation of macro economics nor micro implementation. Mr Rudd was an incompetent prime minister at the time of his ouster and remains so at the time of his resurrection.. The Labor party does not do ‘reform’, it does tax and spend, and hinders via imperfect legislation. The end result is deficits, debts and declining productivity. In a globalised world this is a path to rising unemployment, rising costs, less than optimum growth, and ultimately a fall in the standard of living.

After the next election a referendum should follow extending the Federal Parliamentary term to a minimum of four years and a maximum of four and a half years.

Australia is standing still until the election happens. Confidence in the big-employment sector of small business is comotosed until then. Additionally, major public companies are down-grading their profit outlook on an almost daily basis. During the month of May companies that downgraded their earnings outlook included AGL Energy, Ausenco, Boral, Coca Cola Amatil, Newcrest Mining, Coffey, Virgin Australia, UGL, Worley parsons, Fleetwood, Transfield, Boart Longyear, Cardno, AMP, Invocare, Cochlear, Transpacific and Wotif.

A quick look at the following table will tell you what QE has done for Wall Street. Main Street has yet to become so lucky.

XAO, SP500, SP500 Peak and Retracement

Kevin Armstrong: Don’t rely on central banks or even TINA!

Strategy Thoughts

July 2013

Don’t rely on central banks or even TINA!


Over the last month many markets have suffered their most dramatic setbacks of the year. Severe falls have been seen in precious metals and selected emerging markets, bonds have also fallen sharply as yields have spiked and developed equity markets have also corrected. Amazingly these more turbulent times have been greeted with a high degree of calm, a complacent desire to ‘buy the dips’ and an almost religious belief that all is well in equity markets because 1) the Federal reserve won’t allow anything bad to happen, and 2) equities have to be bought because there is no alternative (TINA). All of this alarms me greatly.

In many cases the recent falls are merely continuations of  bear markets that began after the recovery from the GFC lows of 2008/9 with some dating back to 2010 while others rolled over in 2011 or 2012. Of increasing concern is the fact that recent weakness has increased the number of markets that have now rolled over into bear market territory. When fewer and fewer markets remain in clear bull trends the overall health of the investment world declines and the basis for any hope about those few remaining bull markets becomes increasingly fragile. This is where I see the world now, no doubt there will be bounces as each sell off for a while is seen as an opportunity to ‘buy the dips’ or to get in on a ‘healthy correction’ but more and more markets have now joined the ‘slide down the slope of hope’.

I remain as cautious now as I have been since 2007.

In this month’s Strategy Thoughts I review the idiocy of the belief in TINA being a reason to buy equities and look back at a similar attitude, and its subsequent failure, from fourteen years ago. I look at the misplaced faith in central bankers that is currently so prevalent and other lessons that have been forgotten through the recent equity bull market, and I also review a few old and some new bear markets. Finally I will include a summary of my views as to both the cyclical and secular positions of a selection of asset classes.

Don’t trust TINA

One of the primary planks that so many bullish commentators are basing their optimism upon, particularly over the US stock market, is that there is no alternative (TINA). With bonds falling and yields still historically low they offer little attraction, with commodities seemingly locked in a bear market they too have lost their appeal and even the so called ‘safe haven’ of the last decade, gold and to some extent silver, have been collapsing. With that backdrop for the assets that had been working and the prospect of earning nothing, or next to nothing, for cash on deposit then the yield on stocks and the, until recently, rising stock market appear to offer the only chance of generating the return that investors require.

Superficially this seems to make sense and can, for a while, become self-fulfilling. However, what all those investors that have jumped out of poor performing bond funds and into previously rising equity markets have missed is the very important fact that, just because a particular return is required it does not have to be available and if it is then it certainly does not have to be sustainable.

As I have listened to and read about the driving force for equities being TINA I was struck with a powerful sense of déjà vu. The last time I could remember hearing the argument that equities had to rise because there simply was no other alternative was in the very late nineties. Undoubtedly the poster child of the nineties bull market was the internet and the NASDAQ but the broader market rose too. In fact the S&P 500 was rising throughout that entire decade at an annualised rate of about 17%. At that same time the ‘Baby Boomer’ generation was realising that they had to think about taking care of their retirement. Most had saved very little and when the y sat down with a financial adviser and laid out what they had saved, what they could save and when and what income they wanted to retire on they quickly realised that they needed a spectacular return from their current and future savings. When they looked at bonds and cash they saw that they would never get where they needed to be but the stock market appeared to give just what they needed, a return that would double an investment every four years or so. It seemed obvious to so many that there simply was no alternative. As a result the boomers poured massive amounts into equity investments. This undoubtedly sustained the market’s rise for a little longer than it otherwise would have lasted, but ultimately the price was paid when the markets suffered their most severe bear market in decades. Just because a particular return was required it was certainly not sustainable a little over a decade ago, similarly now, just because it seems so hard to find anything that will give a positive return it does not mean that one should put everything into the only asset that is still rising.

At times merely preserving capital, not generating a return, is the best one can hope for and it actually increases ones relative wealth. An investor who merely marked time in low or zero yielding cash through the GFC was far better off in an absolute sense, and even more so in a relative sense, than those that had chased returns. The same was true through the 2000 to 2003 bear market.

Through such periods, or cyclical bear markets, there does not have to be an alternative and the mere fact that TINA is being so readily utilised to rationalise piling into an equity bull market that is now more than four years old should be a warning sign in itself.

Are the Fed really in control

Perhaps the most alarmingly complacent commentary I have heard over the last month, while markets were falling and then attempting to rally, was that there was no need to worry about the question of whether the Federal Reserve were going to ‘taper’ their bond buying or not. This fear was supposedly what triggered the falls after Bernanke seemed to make clear that there would be some degree of tapering. Then, again supposedly, the subsequent recoveries were as a result of calming words to the contrary, that is that the Fed will be there as long as they are needed. Commentator after commentator has seemingly implied that the Fed have such a tight control over the stock market and the economy that there is no need for anyone to worry. If any taper is done too soon then don’t worry they will be right back in buying before any real damage can be done. They will make sure that things are just right, not too hot and not too cold, a perfect ‘Goldilocks’ environment!

It may be comforting and soothing to believe such nonsense but sadly even recent market history should make it abundantly clear to any investor that no such control exists. Twelve months ago I wrote the following;

The current HOPE, and the hope that was so present until the very end of the decline in markets associated with the GFC four years ago, that central bankers would conjure up a solution is very reminiscent of the hope that was placed in the so called ‘Plunge Protection Team’ that was formed in the wake of the 1987 crash by Ronald Reagan or as Time Magazine in February 1999 put it ‘The Committee to Save the World’ with a cover photo of Larry Summers, Alan Greenspan and Robert Rubin.

These titans of finance, economics and business were supposed to stop any sort of financial meltdown, three years later world markets had suffered their worst collapse in more than a quarter of a century, the tech bubble had burst and the NASDAQ had fallen 80%. Undoubtedly a ‘plunge’ had occurred but there did not seem to be too much protection. Yet still the media talks about the almost mythical powers of this group to prevent a severe market decline, particularly as ‘they’ also have the supposed ‘Bernanke put’ and everything at his disposal to rely upon as well.

Prior to the Dotcom bust in the early 2000’s and then the GFC there was a general belief that Wall Street couldn’t have a severe decline because ‘The Federal Reserve wouldn’t let it’. The naiveté of this attitude is obvious now, after two of the worst declines in history, yet still so many cling to this hope. However, the naiveté should have also been obvious in the late nineties.  A decade earlier there was a similar widespread belief, and hope, that the Japanese market could never suffer a severe decline, because the almighty Ministry of Finance wouldn’t let it happen. It is hard to believe that after witnessing in real time the devastation of the Japanese market from 1989 to now, and the two massive bear markets of the last twelve years, investors still do believe and hope that somehow someone is going to prevent a severe fall. As long as that hope persists, and makes headlines, a bottom has not been seen, irrespective of valuations or economics!

It is certainly the case that no bottom has been seen yet and it should be of increasing concern that the HOPE, or belief, in central bankers’ ability to keep things just right remains so high. Whenever the next bear market bottom arrives don’t expect central bankers to be the ones being thanked for having softened the fall. Any belief in their abilities will have long been evaporated and rather than being thanked they will more likely be being blamed.

A currency bear market

Last month I discussed the weakness that had been seen in the Australian dollar. Since then, as with so many other assets, there has been further weakness. It is worth reviewing just how expectations have changed toward the Aussie over the last few important reversals it has experienced.

In late 2008, having fallen precipitously expectations had become very bleak indeed for the Aussie as this Brisbane Times headline from October 20th 2008 illustrated;

Aussie dollar tipped to slump further

The article quoted forecasts that the AUD/USD exchange rate in the first quarter of 2009 would fall to 62 cents, or even 59 from one bank economist. At the time the currency was at 69 cents. Just a few months earlier, in May of 2008 the article reported that many of the same economists were forecasting parity with the US dollar. The Aussie dollar did fall after that article appeared, for one more week. It then embarked upon an incredible bull market that took it all the way up to 1.10 US$ in late July 2011, by which time some economists were dangerously referring to a ‘permanently high plateau’ for the Aussie dollar and all were ratcheting their forecasts higher. What followed was a plateau, or at least a trading range between 94 cents and $1.10, but it has not proved permanent.

Back in April, with the Aussie dollar trading around $1.05 one major Australian bank was forecasting for it to correct slightly to $1.01 by the end of this year, and then 96 cents by 2014 and 94 cents in eighteen months’ time. Over the next two months the currency fell all the way to where it was supposed to be in a year and a half, the natural result was that the bank cut there forecast, all the way to 94 cents in September this year and 93 cents by year end, still higher than the level it had already fallen to.

When the current Aussie bear market ends expect to see fairly bleak forecasts and targets below where the currency has already fallen to. Only then is it likely that expectations will have been smashed to such an extent that a new bull market can start.

The potential for surprise or disappointment on the Aussie still seems to be strongly favouring the risk of disappointment.


Last November I highlighted the danger in gold given the still high expectations for the metal and the publicity surrounding a new book forecasting a price of $10,000. At the time gold was trading around $1700. Two months later, in January of this year, I noted in a brief comment titled ‘Gold versus the market’ that the correlation between the price of gold and the US stock market had, over the prior year, been remarkably close, but that given the bout of weakness that gold had suffered the two prices were diverging. I wrote;

Whether this divergence is set to simply grow over the coming months, or whether gold is presaging a reversal in the market only time will tell. But it will be fascinating to follow.

Well, it has been fascinating to follow and for a while the divergence did grow as gold continued to fall while the market continued to rise. However, since late May the two have once again started moving together.

As I was studying the most recent dramatic decline in the price of gold I was struck by a similarity to another fallen darling of investors and another bear market that I have been tracking for about a year; the bear market in Apple.

Gold Compared to Apple

The chart above shows the last fourteen months price action in both Apple and the gold exchange traded fund GLD. There is more than a passing similarity and it is particularly noteworthy that the sharpest falls in GLD have been quickly followed by falls in Apple. Obviously there is no similarity in the underlying investments and there can be no cause and effect at play here. What this does highlight, once again, is just what drives markets, and that is the collective social mood of investors. Both gold and Apple held very special places in the hearts of investors as their prices soared. In the end the fundamentals were not driving either investment, both were being driven upward by the herd instinct of those clamouring to get involved. Now the reverse is playing out as their respective bear markets unwind and I continue to anticipate further downside in both. Naturally there will be bounces along the way but attitudes to both have only moved slightly since their respective bear markets began. Incredibly gold’s recent decline is still being described as a ‘healthy correction’, this despite the fact that the metal has been falling for two years now and has lost more than a third of its value.

Attitudes to Apple have also changed only slightly. The stock has fallen 46% since its peak last year but still the average analyst has a Buy rating on it, the average price target is nearly 40% higher than where the stock is currently trading and in the latest poll of most respected companies Apple may have slipped but it still lies third. When one thinks about just how much wealth has been wiped out in Apple alone it is remarkable that it is still thought of so constructively and kindly. At the stocks bear market trough the reverse will almost certainly be the case.

More characteristics of bear markets

A couple of years ago I wrote at some length about commentators, analysts and economist’s tendency to underestimate the magnitude of a move, be it a bull market or a bear market, most of the time. However, towards the very end of a move their tendency switches from being that of underestimation to overestimation. Unfortunately it seems the majority only finally fully commit to a move when that move is in its dying days. They shift from questioning the magnitude and durability of a move to embracing and then extravagantly extrapolating that move.

This behaviour has been seen in each of the cyclical bull and bear markets that have been seen in the developed world indices over the last fifteen years. At the peak in 2000 extrapolations as to how far the markets could rise were rampant, the following bear market was initially seen as a healthy correction and the magnitude of the potential fall was consistently underestimated until right at the end when, with the IMF talking about ‘stagnation’, the bleak prospects for equities was obvious to all. The same kinds of shifts in expectations were seen in the bull market of 2003 to 2007 and then throughout the GFC.

The same underestimation, until capitulation plays its part, can be seen in the moves discussed above. The targets for the Aussie dollar through its decline during the GFC were always above where it actually was until right at the currency’s trough, and then the subsequent rise was always viewed cautiously, until the ‘permanently high plateau’ was reached. Now the underestimation is in full swing.

The gold market has also seen the same extrapolation extremes at the bottom fourteen years ago when central banks were dumping their holdings to more recently when different central banks were piling in and targets were through the stratosphere.

None of this tells us how long any bear market will last, and there are now a growing number of them to monitor, but it does shed some light on the kind of news and sentiment backdrop one could expect to see at any bear market bottom. Perhaps the most obvious and consistent theme seen in all those market moves discussed this month has been that at low points the consensus forecast has been for prices to go much lower, whether it is a currency, a commodity, an individual share or a market as a whole. Given this, it is unlikely that the lows have even come close to being seen in most stock markets, commodities or in the Australian dollar.

Was that a crash in emerging markets?

Chart for iShares MSCI Emerging Markets Index (EEM)Chart forSPDR S&P BRIC 40 (BIK)

The chart above shows the performance of the SPDR S&P BRIC 40 exchange traded fund. It aims to track the performance of the underlying BRIC 40 index made up of forty leading companies in Brazil, Russia, India and China. The very recent plunge can be seen on the far right hand side. From the peak on the 22nd May to the most recent low on the 24th June the fall was just over 20% with over half that fall coming in just four trading sessions. Perhaps more importantly is the fact that the index has now fallen almost 25% since its peak in January and 33% since the post GFC high recorded in April 2011. Investors in this ETF have endured many bull and bear markets over more than the last six years but on balance have made no money.

A very similar picture is seen in the broader ishares MSCI emerging markets exchange traded fund. The falls in most of these emerging markets over the last few weeks have been dramatic, but given what was endured in these same indices five years ago it is probably a stretch to call it a crash. Nonetheless, no one should complacently believe that all is well in their equity portfolio with this increase in volatility, particularly given its downside bias of late.

The bear market in long dated treasuries

In the August edition of Strategy thoughts last year I wrote the following;


For a very long time I have proclaimed the virtues of long dated US treasury bonds, and anticipated that yields would go lower than virtually any economist was forecasting. I also didn’t expect long dated yields to rise until the consensus view had given up on looking for higher rates and accepted low rates for a very long time. In June I wrote;

“Until the fear of deflation and ever lower yields becomes widely embraced and discussed it is likely that further surprises on the downside in yields, not a sudden reversal to the upside, are in prospect.”

At the time ten year treasuries were yielding a little over 1.7%, over the next eight weeks yields plunged, briefly falling below 1.4%. As a result there has been an interesting shift in investor expectations and attitude. Two days ago Bloomberg ran the following story;

Treasury Bears Submit To Fed As Bond Optimism At High

Jay Mueller, who manages $3 billion of bonds for Wells Capital Management in Milwaukee, resisted buying Treasuries for four months, anticipating the Federal Reserve would drop its pledge to keep interest rate at a record low through late 2014. No more. With the economy growing at a 1.5 percent annual pace, the odds of a recession have risen to 60 percent, making 1 percent yields on 10-year notes a possibility, he said. Wells Capital’s parent, Wells Fargo & Co., boosted its Treasury holdings 32 percent to $11.5 billion in May alone, according to the latest data compiled by Bloomberg. “We’re in a low-rate environment for a long time, longer than I had thought,” Mueller said in a July 26 interview at Bloomberg headquarters in New York. “I’m finally throwing in the towel.” So are Pioneer Investment Management Inc., Pacific Investment Management Co., Federated Investors Inc., Northern Trust Global Investments and Columbia Management Investment Advisers LLC. They are adding to holdings of Treasuries as economic growth cools. Of the 20 firms that own the most Treasuries, 16 bought more U.S. government debt during their most-recent reporting periods, Bloomberg data show.

If treasury yields continue to rise, as they have over the last three weeks, and spreads start to widen junk bond returns will start to struggle.

With the benefit of eleven months of hindsight it is fascinating, and instructive to see just how attitudes had changed back then, how many ‘towels’ had been metaphorically ‘thrown in’ and how much long dated treasury yields have risen since then. The chart below shows the movement of the ten year US Treasury yield over the last twelve months;

Chart forCBOE Interest Rate 10-Year T-No (^TNX)


The all-time low in yields was recorded in the last days of July last year, since then yields have risen a massive 91% at their very recent high.

It is highly likely that the low last year marked the end of the more than three decade long secular bull market in bonds. With that as a back drop there is both good news and bad news for investors. The good news is that yields are likely to become more attractive over coming years, the bad news is that one doesn’t want to be investing in long dated bonds as they will continually be being marked down in price. Naturally this is the reverse of the environment that we have all enjoyed for so long. As I noted last year in the extract above, it is also likely that high yield bonds will suffer more as spreads rise.

I continue to believe that very high quality, relatively short dated fixed income, along with cash deposits, remain the most appropriate investments for investors with a focus on absolute return and capital preservation rather than a relative return against a benchmark that may fall sharply. I also continue to favour the US dollar in the potentially much more challenging period ahead.

Another bear market?

Without garnering substantial media headlines yet another commodity, lumber, has plunged in price over the last three months and was down 30% at its recent low as can be seen in the chart below.

LSN13 - Lumber (CME)

Interestingly, in January of this year there was talk of a new ‘super cycle’ in wood products prices driven by a resurgent US housing market and the expectations were for new highs in 2013 and record all-time highs in 2014. Given the crack that has now been seen in lumber prices it appears that those extravagant extrapolations should have been a hint that a reversal may have been imminent. Of perhaps greater concern, particularly to the US, is that the lumber market may be telling investors more about where housing and housing starts may be headed rather than the other way around, as the following headline from hints.

Lumber Market Says Next Housing Top in Sight

NAHB Index & Lumber Prices

The article pointed out;

Supply chains offer valuable insights into the state of the market. For example, many analysts believe Apple has a new product coming later this year because their contractors in China are hiring. This idea allows investors to identify industry trends that could help generate profits.
Right now, lumber futures have entered a bear market and that could be warning of a downturn in home building.
Orders for lumber are placed before homes are built. When orders for lumber or any commodity fall, prices generally slump for that commodity. Since March, lumber prices have fallen by 25 percent. A decline of 20 percent is often used to define a bear market.Lumber price peaks and troughs have led trend reversals in the stocks of homebuilders in the past. Home building stocks have been among the leaders in this bull market, but the fundamentals are no longer pointing to gains in this sector.

It would certainly be a disappointment to the currently fairly sanguine bulls on the US market and economy if housing starts and housing prices were to roll over into another bear market as lumber prices are currently hinting.


For several months I have been concluding that little has changed to change my views, this continues to be the case although I do find it interesting that despite the action of the last few weeks my views continue to be very much in the minority. Perversely perhaps this heartens me, it would certainly be a concern if my views had somehow become the broad consensus.

Preservation of capital through holding cash deposits and very high quality fixed income instruments of short maturity continues to be my favoured strategy along with some exposure to US dollars. Avoid chasing yield or potential returns in equities or commodities.

Kevin Armstrong

2nd July 2013


  Summary of selected asset secular and cyclical positions    

A final observation on the value of waiting for a secular low to become overweight any asset class goes to the octogenarian market letter writer Richard Russell who last week wrote;

“Investing in the stock market is not the ideal method of getting rich. No, but there is one exception — you wait for a primary bear market to hit bottom. Then against all your emotions, you load up on good, dividend-paying issues, and sit with them while reinvesting the dividends, sit until the crowd gets excited. At that point you sell out, and patiently wait for the next crash or bear market.”


Estapol and thinking out loud, staying on cautious tack


Wattyl was a paint and coatings company that was taken over sometime in recent memory. One of their products was ‘Estapol’ which was a coating product for timber flooring. Correct surface preparation and then application of the product was important for optimum results. Consequently, the lid of the tin said "When all else fails read the instructions."

Ecinya is ever-mindful of the necessity of not losing touch with the basics and through a combination of our investment rules under the ‘Market Wisdom’ tab, The Ecinya Market Barometer’, our Insight articles and performance evaluation of our two modest portfolios we attempt to ‘practice what we preach’. However, over the years, despite a more than adequate performance in our own activities, our expressed views on the future, and our Ecinya Recommendations derived from our own modelling, we still manage to make mistakes. Our experience is that we have called bottoms well, and tops not as well. Tops can often be driven to a level that constitutes ‘irrational exuberance’.

Analysis, review and introspection more often than not leads us to the conclusion that timing is where most of us get it wrong. Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria. Bull markets are driven by liquidity, and falling interest rates can be trusted to begin a new bull market. However, the current bull market looks and feels artificial as it has been fueled by ‘money printing’ around the globe and over-exuberant debt fueled government spending, particularly in the healthcare and social services sectors.

Earnings momentum in the context of economic growth is not in evidence.The economic growth that has occurred has been muted and company earnings driven more by currency devaluations and corporate cost cutting. When markets are elevated we tend to look for fundamental reasons as to why they should fall and when markets are down we believe that cyclical factors operate for them to rise from the ashes. Very often early signals at both the top and the bottom are recognisable using quantitative and technical analysis plus anecdotal evidence from business associates. Technical analysis in our view has limited forecasting attributes, but can assist to identify potential turning points and support levels. Technical observations seem to indicate that markets trends are testing upper trend limits. Our market quant model uses algorithms derived from All Ordinaries and SP500 data and the current 103 day upwave appears to be coming to an end. Refer Ecinya Market Barometer.



Our major concerns were outlined as part of our Strategy Essay of 25 January and our ‘Delightful and daring dance with Sir Percy’ Insight essay on 8 March and were –

1. Australian fiscal management during and since the GFC – the chickens are coming home to roost and unemployment, slow growth and higher taxes are on the horizon in a massive landscape of poor policy development and execution. Mid term we remain bullish on hard and soft commodities. Australia needs a Federal election as soon as possible.

2. Europe needs to address creeping imbalances all over the place.

3. China may have a massive credit and property bubble which has not yet popped.

4. The normal menu of global unrest has a new entree in that China and Japan are in dispute in and around the China seas.

5. Dr Ben Bernanke is treating a disabled patient with massive doses of monetary stimulus when the real medical disorder is fiscal profligacy and waste. This is our major major concern as fiscal and monetary policy are natural dance partners.


Commentary on the above –

1. The Hawke-Keating and the Howard-Costello governments were very good over about 80-90% of their respective terms in office with both of them being fairly described as ‘centrist’ governments with well above average communications skills. Re-election pressures towards the end of extended terms of government caused each of them to embrace policy that pandered to perceptions of ‘appeasing the base’. The Rudd-Gillard-Greens government has been a sad indictment of misallocation of scarce resources.Cash hand-outs were squandered on imported flat screen televisions and overseas holidays, flimsy climate change policy, broadband without cost-benefit analysis, and education building revolutions have been dismal failures. Realisation of these failures ushered in the carbon tax and a mining resources tax just as a cyclical peak was occurring in the global economy. The result in our view will mean that an incoming government will inherit an extremely poor fiscal position, worse than will be disclosed by the departing government in the forthcoming May budget update.


2. Europe still messy with France and Germany soon likely to add to growing uncertainties.


3.. China is attempting to rein in its growth trajectory and aiming for a ‘soft landing’. ‘Soft landings’ are difficult to achieve, but with real GDP growth around 7% and large current account surpluses such a landing seems reasonably plausible.


4. Add in the North Korean situation and things look volatile. Given America’s traditional allies are South Korea and Japan, history suggests that America will support its allies and that patience is wearing thin with North Korea.


5. Fiscal and monetary policy has become wrapped in the summer and winter coat of politics. Unfortunately all around the world winter is in evidence. In a host of countries including Great Britain, Ireland, Iceland, Italy, Spain, Greece, Cyprus, the USA, political springs and summers seem far away. It appears that economic uncertainty in France and Germany is on the horizon. Apart from Australia’s Reserve Bank which acts independently other major central bankers have decided to become a submissive arm of government rather than fulfilling their normal ‘check and balance’ role. The quotes below highlight this –

However, the task of putting private and public finances on sustainable paths in several major countries is far from complete. Accordingly, financial markets remain vulnerable.

Reserve Bank of Australia 3/4/2013


The unfortunate reality is that it is normal for forecasts to be wide of the mark.

Deputy RBA Governor Philip Lowe 10/1/2013


No central bank will admit it is keeping interest rates low to help governments out of their debt crises. But in fact they are bending over backwards to help governments to finance their deficits….. With high debt to GDP ratios it is difficult for a central banker to raise interest rates. I believe the shift towards less independence of monetary policy is not just a temporary change.

Carmen Reinhart of Harvard University 10/4/2013. Note Ms Reinhardt was the co-author of "This Time is Different" with Kenneth Rogoff.


The greatest flaw in the Fed’s unprecedented gambit could well be an emphasis on short-term tactics over longer-term strategy. Blindsided by the crisis of 2007-2008, the Fed has compounded its original misdiagnosis of the problem by repeatedly doubling down on tactical responses, with two rounds of QE preceding the current, open-ended iteration. The FOMC, drawing a false sense of comfort from the success of QE1 – a massive liquidity injection in the depths of a horrific crisis – mistakenly came to believe that it had found the right template for subsequent policy actions.

Stephen Roach ex Morgan Stanley Chief Economist, now Senior Fellow at Yale University’s Jackson Institute of Global Affairs 27/2/2013.


We may say that we are aiming for nominal growth of, say, 5 percent. Who thinks you can really do that? It doesn’t correspond to the real world. When have economists been able to predict how much will be inflation and how much real economic activity? Monetary policy has little or no control over the real economy and issues, and yet we persist in using it as a tool for generating growth.

Paul Volcker , former Chairman of the US Federal Reserve in an April interview ‘Dangerous Economic Territory’.


The problem with central banking is that there are no longer any bankers in central banking. Too many economists, particularly of the interventionist kind. The latter spend their time and taxpayers earnings in trying to alter economic history, rather than understanding it. The most glaring error is the notion of a "national" economy. When it comes to credit markets, they have been international since at least Roman Times. They insist that because two things occur at the same time they are causally related. Yes, credit does increase with a business expansion and vice versa. But credit expansion does not cause the business boom. Actually, in the final stages of a boom speculators leverage up against soaring prices. In which times, credit expansion depends upon the boom. How could so many for so long be so wrong? Central bankers get wages and glory for their attempt to provide unlimited funding for another sordid experiment in unlimited government. The problem is that even with electronic printing presses and endless buying of lower grade bonds market forces eventually overwhelm arbitrary ambition. As for "wages and glory", the former should be viewed as rent-seeking and the latter as ephemeral.

Bob Hoy, American commentator 12/4/2013



Markets have raced away from their 2010 and 2011 lows, but there are enough balls in the air to indicate a retracement of current gains is overdue. Dr Bernanke has led an orgy of money printing that seems to indicate that past mistakes are in the process of being repeated. The American economy is improving but savers are being asked to suffer low interest rates on mainstreet while Wall Street continues to behave recklessly. In the USA, the world’s dominant economy, housing and employment is picking up but national, domestic, municipal and state deficits persist. Company profits around the globe appear to be driven more by cost cutting than revenue expansion. Our Australian company models suggest that valuations are stretched. Exercise caution.


Kevin Armstrong: How attitudes have changed since 2009!


Very little has changed over the last four weeks. Markets have NOT rolled over, as I have feared they would for many months now, but this does not reduce my level of anxiety, rather it heightens it. Now is not the time for comfortable complacency about the prospect for ever better returns, but that is what we are seeing to an ever increasing degree with each day that passes. It is vital that all investors recognise just how far attitudes and expectations have changed over the last four years.

This month’s Strategy Thoughts may turn out a little different than normal (if there indeed is a ‘normal’ for Strategy Thoughts), partly because of the need to explore the degree to which attitudes have developed but also due to my imminent departure to the US for the month of April to promote my first book, ‘Bulls, Birdies, Bogeys and Bears’. I have also spent ample time over the last two months outlining both my longer term (secular) views, which by their nature should change only rarely, and also my shorter term view that the cyclical bull market that began four years ago for most markets is either already over or in its final stages. This remains firmly intact so it is therefore unnecessary to revisit those previous rationalisations.

In addition to reviewing the attitudinal shift among investors that is so important I will also comment, possibly slightly tongue in cheek, on the latest headlines created by the former ‘Maestro’ Alan Greenspan and also the headline grabbing story from Australia about the plans for ‘Australia 108’ the proposed tallest building in the southern hemisphere.

Attitudes and complacency

I do spend a lot of time watching the financial media, particularly CNBC, and reading the financial and investment press. This probably does not surprise readers, but I have been particularly struck over the last few weeks, as the ‘countdown’ to new highs took place in America and each subsequent new high was celebrated with almost breathlessly excitement, with the degree to which the ‘bulls’ have grown in confidence. This is understandable, they have been correct, however, it can become dangerous when ones confidence grows too fast and goes too far.

On a smaller scale (although not that small) this behaviour and danger was seen last year in Apple. Then bullish analysts were seemingly battling to leap frog each other to be the most bullish and I suppose feel the most right. With hindsight we can now see that the crescendo of the fervour, and targets in the thousand plus dollar area, occurred immediately prior to the stocks 40% collapse in less than six months.

Recently I have been amazed how commentator after commentator has been wheeled out to proclaim that a new secular bull market has just begun. This confuses me, firstly because surely that new bull market, of whatever degree, must have begun more than four years ago and at levels 50% or more lower. Secondly, I wondered what these fervent long term bulls were saying back in March 2009 when it would have been particularly useful to have called a new long term bull market, even if it only turned out to last four years.

I started to note down the names of each rampant bull and then began Googling their comments from early 2009. You probably won’t be surprised with what I found!

Before going through some of those individuals’ transformations, from scared to super bullish, I thought it only reasonable that I look back at what I was writing in early 2009.

March 2009 revisited

In early March of 2009 I titled that month’s Strategy Conclusions “A reversal in everything (again), the bottom of the ‘slope of hope’”and raised the strong possibility that, given the extreme gloom that was by then dominating all forms of media, an important turning point may well have been seen. Later that month, on the 24th March, I wrote the April edition of Strategy Thoughts and titled it;

 Has a cyclical low been seen?

I concluded that month’s Strategy Thoughts with the following;

Strategy Conclusions last month concluded with the belief that the bottom of ‘the slope of hope’ was close at hand and may even have been seen and that as a result we were now as optimistic about equity markets globally as we had been for at least four years. We stated that this was not a trading move but equally this was not the start of a once in a generation or more buying opportunity at the end of a secular bear market and so the beginning of a secular bull market. This continues to be my view for a whole host of reasons, some of which hopefully I have illustrated in this month’s Strategy Thoughts, and it will continue to be my view even if, as expected, the so called fundamentals continue to deteriorate. In fact if the markets can hold their own, or continue to advance, in the face of seemingly poor news it would only serve to increase my confidence in the prospects for a meaningful cyclical bull market.

I believed that a new bull market was beginning, but that it was only a cyclical bull market, comparable to that enjoyed from 2003 to 2007 not to the secular bull market from 1982 to 2000. Nonetheless, I anticipated that it would be a rewarding bull market and that one should be invested to take part in what would be another climb up a ‘wall of worry’.

Within that edition I also raised the question of how a new cyclical bull market, if that was what had indeed begun, might end. I wrote;  

This question is obviously incredibly premature given that the current rally is not even the largest of those seen during the bear market to date. Nonetheless, it is still worth thinking about as it helps to crystallise the distinction between the longer term, secular, positioning of world markets and the intermediate, cyclical, position.

If a cyclical bull market has indeed begun then it is starting amid a bleak global economic environment, as described above, just as all bull markets of any degree tend to and the love of risk two years ago has been transformed into an outright fear. The issues that are creating that sense of fear and foreboding all relate to the longer term, secular, unwinding that is still required both economically in the form of global deleveraging and within equity markets by them becoming historically very cheap (not just a little below fair value). This will all take time and is unlikely to occur in a neat orderly fashion with the ultimate destination, in both time and price, being clear to everyone. Rather the path to a secular bottom is made up of a series of cyclical bull and bear markets. So far during this still relatively young global secular bear market we have suffered two cyclical bear markets and one cyclical bull market. It is likely that we will enjoy and suffer at least one more cyclical bull and bear phase before it ends.

As every cyclical bull market in a longer term secular bear market progresses eventually the belief grows that the worst has been seen and the recession / bear market are over and it’s off to the races again. One only has to think about the psychological progression that markets went through from disbelieve in a ‘jobless’ global recovery in 2003 and deep scepticism about any recovery in investment markets to the broad belief two years ago that the ‘ocean of liquidity’ would ensure that all markets for everything would continue to rise. Obviously we now know it didn’t. 

Without intending to be disrespectful to the IMF, it is likely that any new cyclical bull market will end amid similar beliefs to those witnessed at the end of the last cyclical bull market two years ago. With equity markets substantially higher and the fear of risk once again having, at least partially, evaporated it is probable that forecasts for economic growth will be being revised higher and a general belief that the ‘Great Depression II’ has passed and been survived. Credit will undoubtedly be given to the various central bank and treasury officials globally who will appear to have engineered the recovery and all the long term concerns and fears that are so near the surface currently will be forgotten. A ‘wall of worry’ will have been climbed and so another slide down the ‘slope of hope’ will be about to begin.

All of this is getting somewhat into the realm of fantasy, clearly it is far from certain that a new cyclical bull market has begun, but if it has it will be useful to keep some of these perspectives in the back of one’s mind as the bull market runs its course, however far it goes and long it runs.

I have reproduced so much of that section that I wrote almost exactly four years ago because it described the shift in attitudes, and importantly investor time frames, that occurs as a bull market matures. The problems that were so obvious to everyone back in early 2009 have not been fixed; they are still there and are very long term in nature. They are a secular problem. Within secular bear markets the cyclical inflection points are not brought about by valuation or any fundamental drivers, rather they are brought about by extremes of mood, or sentiment. At a cyclical trough, like that in early 2009, or in early 2003, the very long term problems become all-encompassing, and dominate virtually all investors’ outlooks. That is the bottom of the ‘slope of hope’ and so the start of the climb up the ‘wall of worry’. At cyclical peaks the reverse is true, the long term problems are easily overlooked amid rising prices and attitudes reflect an expectation of a continuation of the bull market that by then has become accepted as ‘normal’. Investor appreciation of time frames concertinas in and out with each bear then bull market. At troughs no one can think about long term opportunities the problems are too obvious, at peaks no one worries about short term corrections, the long term opportunity is all that matters.

Perhaps the most important sentence in the section that I wrote four years ago was the final one regarding the value of aiming to keeping some perspective as the bull market runs its course. Unfortunately the majority now appear to have lost that perspective and are only focussed on the long term opportunity.

Then and now!

What follows is just a selection of the many one hundred and eighty degree reversals that have been seen over the last four years, but what was also interesting in reviewing the bulls of today with their attitudes of four years ago was that many of the current spokespeople weren’t in their current jobs back then and some may not even have been in the investment business.

Morgan Stanley now: Adam Parker, Morgan Stanley’s chief U.S. equity strategist, has adopted a positive view of stocks for the first time since he started his job in 2010. (21st March 2013)

Morgan Stanley then:Investors should sell into the recent stock market rally, Morgan Stanley’s strategist said Monday, arguing that it can’t last as corporate earnings deteriorate further.
“We simply do not believe that the market has completely priced in the prospect of further earnings weakness or that it will, without interruption, look through this weakness to recovery,” Morgan Stanley strategist Jason Todd wrote. (late March 2009 after the first 25% rise)

Michael Hartnett now: “Relative U.S. economic outperformance on the back of the housing market’s ongoing improvement and the energy independence story will lead a secular uptrend in the dollar," said Michael Hartnett, chief investment strategist at BofA Merrill Lynch, a unit of Bank of America Corp. (BAC). Meanwhile U.S. equities’ leadership in the shift "suggests developed market equities are the likeliest winner in this scenario." (19th March 2013)

Michael Hartnett then: In the survey, America still comes up as a popular stock market, but not because of bullish prospects. "It’s really seen as a safe haven in troubled times," says Michael Hartnett, co-head of international investing strategy at the Wall Street firm. That’s not the kind of optimistic perception that powers a sustained bull run. (March 19 2009)

Rich Bernstein now: We have thought for some time that the current bull market might be one of the strongest of our careers, and could potentially rival the 1980s bull market (March 7th 2013)

Rich Bernstein then: Just Monday, he advised selling bank stocks after their recent rally, saying the government’s latest plan to get rotting assets off banks’ balance sheets would just delay an inevitable further industry consolidation. (LA Times March 24th 2009)

Nouriel Roubini now:  ROUBINI: ‘Short-Term Bullish, Long-Term Catastrophe’

Nouriel Roubini then: ‘Dr Doom’ predicts further shocks in the market (The Independent April 21st 2009)

Warren Buffett now:  “Always be bullish on America” Warren Buffett (4th March 2013)

Warren Buffett then: “the economy will be in shambles, throughout 2009, and, for that matter, probably well beyond.” ( NYT 1st March 2009)

The mood in early 2009 was certainly not optimistic and was a world apart from what so many seem to see now. Businessweek summed up the mood very well in their edition on the 4th March 2009. The headline read;

When Will the Bull Return?

The article began;

While 17 months may feel like an eternity, it could turn out merely to be a prequel. The questions on the minds of investors, money managers, and corporate executives are threefold: How much longer will the bear market last? How low will the averages go? And when might investors get their money back? As Warren E. Buffett has said: "Beware of geeks bearing formulas." It’s especially difficult to predict the direction of the markets these days because the most popular gauges, from price-earnings ratios to measures of investor "capitulation," have stopped working. The peculiar nature of this bear market limits the kit of useful tools to just a handful of bond market and business confidence indicators. Those signals, along with interviews with financial historians, market strategists, and economists, point mostly to painful scenarios. Stocks don’t seem likely to fall much more from here—but market turmoil could continue for months or even years. Worse, by the time the market revisits its highs, so many years are likely to have passed that many older people will have gotten out of stocks, missing out on the rebound. The flip side is that new money put into the stock market now will likely do comparatively well over the long term. That’s welcome news for twentysomethings and executive compensation consultants, but perhaps not for soon-to-be retirees.

The consensus at the time was very bleak indeed and bullish voices were generally decried as not understanding the true severity of the situation. When the rally continued to surge higher the doubters continued to dominate the media headlines. In late April of 2009 I wrote the May 2009 edition of Strategy Thoughts I included the following selection of headlines put together by Investec research;

Rally, Yes; Bottom, No – 3/10/09

No Way You’re Getting Me Back in This Market

Yahoo! Finance – 4/8/09

Is this a sustainable bull market?

The March run likely will lead to weakness

MarketWatch – 4/1/09

Warning: The bear isn’t hibernating yet – 4/1/09

Goldilocks rally meets the bears

March was good, but a downturn is inevitable

MarketWatch – 4/1/09

Don’t Buy the Chirpy Forecasts

The history of banking crises indicates

this one may be far from over.

Newsweek – 3/30/09

Bear Rallies Turn Market Into a Circus

Wall Street Journal – 3/23/09

Enjoy the Sucker’s Rally, Says Merrill’s Rosenburg

Yahoo! Finance – 3/19/09

Roubini Says Rally is a “Dead Cat Bounce”

The Business Insider – 3/16/09

Is This A Real Rally Or Dead Cat Bounce?

Investors Business Daily – 3/16/09

The Forbes story included a quote from Art Hogan;

“You’ll know the current hard times are over when the government tells you, by way of improved economic data.The bad news would need to decrease in magnitude” said Art Hogan, chief market analyst at Jefferies”. That same Art Hogan was quoted in a recent article: “We’re certainly in an environment where good news is great and bad news is just okay. The market has just found the path of least resistance to the upside in the near term and it’s hard to find something to knock it off there.”

The CNN money articlequoted John Lynch and Bill Stone with reasons why the market would soon retest the March lows and that it was too soon to get back into the market;

“Bill Stone, Chief Investment Strategist with PNC Wealth Management in Philadelphia, said it’s looking like the economy probably shrunk by at least 5% in the first quarter, following a more than 6% drop in the fourth quarter of 2008. He added that the job market is still in bad shape as well. So with that in mind, Stone agreed with Lynch that it would not be a major surprise if stocks retreated back toward this year’s lows. "It’s never safe to say we’ve hit bottom," he said.

Four years later the same Bill Stone was interviewed by The Wall Street Journal and explained why the new high in the Dow was a reason for confidence (I think he may have got that around the wrong way!)

The Marketwatch column subtitled ‘the March run will likely lead to weakness’ was written by Drew Kanaly of Kanaly Trust. That same firm’s first quarter outlook for 2013 was far more optimistic, including the key points, Major global event risks have faded, the majority of global equity markets in a bullish trend, economic recession risk is low and raising the prospect of a new secular bull market.

It is important that investors recognise just how dramatic an attitudinal shift has occurred over the last four years. Something long term and secularly good is not starting now and it didn’t start in 2009 either.

Finally, just to illustrate how far things have come, I was amused by the headline in Barron’s regarding the US budget impasse and the automatic cuts, or sequester, that kicked in;

The Sequester: More Opportunity Than Danger

At the start of a new bull market such a thing would be universally recognised as being bad for the economy and so bad for the market. That is the kind of back drop that is found when a ‘wall of worry’ is being climbed. By the time the top of that wall is reached it is not that there is no longer anything to worry about, rather the majority choose not to worry about it or even dresses it up as a positive. I was also amused by the following headline on Bloomberg;

Short Sales Decline 53% as Bull Market Enters Fifth Year Bloomberg 4th March

The article pointed out that short sales, or bets on stocks going down, had fallen dramatically now that the bull market was over four years old. The irony of them being the lowest since 2007 seemed to be lost on the author. Likening anything in the markets now to 2007 should not be seen in anyway as a positive.

Active share revisited, again!

Some readers may remember comments I made over the last few months regarding ‘active share’. It is a measure of how active fund managers actually are and is increasingly raising questions as to why an investor should pay for active management when all they are getting is ‘closet indexing’. This tendency towards indexing, that is attempting to ensure that one’s fund is not too different to the index, is, it seems, deeply embedded in the fund management industry. It is better to be wrong with everyone else than to do what you believe to be right and risk being wrong alone. This sentiment was brilliantly captured in a recent ALEX cartoon sent to me by ever observant reader Neil Beattie.

The scene has Alex lunching with his client Jeremy:

A: You’ve been bearish on stocks for the last year Jeremy, but now you are piling in

J: I still believe the fundamentals are all wrong Alex, but I manage money on behalf of my investors…markets are booming and if my fund doesn’t own equities I miss out on making a profit. At the end of the day I’ve got to remember where my obligations lie and whose money it is I’m investing.

A: Someone else’s??

J: Quite…so what have I got to lose?

A: Well your job if you continued to do nothing…

J: Exactly. It focusses the mind wonderfully.

Active share will likely get more and more coverage if markets once again become challenging. It will be important for all investors to know just which risks their fund managers worry the most about, their clients or their own.

Irrational exuberance or not?

Alan Greenspan made his famous ‘irrational exuberance’ statement in December 1996 as the Dotcom boom was getting into full swing. Now, with the benefit of hindsight we all know that the exuberance had far further to run and that it had to become far more irrational before the bubble would burst, unfortunately for Mr Greenspan he changed his mind as to whether the markets were irrational just when we now know they were irrational. Like so many investors he got whipsawed. He later stated that economists couldn’t detect a bubble until after it has burst, a sentiment that his successor seems to share. Perhaps these ‘misses’ should alert investors as to the value or otherwise of Mr Greenspan’s assessments of markets, but still the media appears to hang on every word of the former ‘Maestro’.

On the 15th of March this year Greenspan told CNBC that irrational exuberance is the last term he would use to describe today’s market. He went on to say that stocks by historical standards are ‘significantly undervalued’.

These comments no doubt will have boosted the confidence of the growing herd of stock market bulls discussed earlier, however, history clearly shows that investors should place very little confidence on Mr Greenspan’s observations, no matter how well intentioned they may be.

In the past I have frequently questioned the value of employing economic views (not just Mr Greenspan’s) as the basis for an investment view. History repeatedly shows that it is of minimal value, the markets forecast the economy far better than the other way around and markets are virtually uncorrelated to GDP. These comments don’t sit comfortably with a lot of investors who intuitively feel that the economy should be reflected in the market. In prior editions of Strategy Thoughts I have explained at some length why I don’t believe this to be the case so when I saw the chart above in the Economist magazine from the 9th March I thought it was worth sharing.

The chart looked at all the bull markets in the US since the late forties, how much they rose and how strong the economy was throughout the rise. The following comments accompanied the chart;

It is tempting to attribute the strength of the Dow to optimism about the American economy. Tempting, but wrong. Studies have shown almost no correlation between GDP growth and equity returns. Indeed, the Shanghai stockmarket trades at less than half its 2007 peak, even though the Chinese economy has performed much more strongly than that of America since then. As the chart shows, this rally in the Dow has been accompanied by the weakest GDP growth of all the bull markets since the second world war the economist magazine

The important phrase is Studies have shown almost no correlation between GDP growth and equity returns’ but still the majority seek the comfort offered by an economic rationalisation. Unfortunately these rationalisations will all be optimistic when markets are peaking and miserable when investment opportunities are highest.

Look Out Australia (Pride comes before a fall!)

Back in late 2008 and in mid 2006 I wrote two articles under the title ‘Pride comes before a fall’. The first was prompted by Dubai’s stock market weakness after the construction of the tallest building in the world began and the second was after Kuwait announced they were aiming to build something taller. The gist of both articles was that by the time any country, city or state becomes so confident that they want to build the tallest building in the world then hubris may have replaced mere confidence. History is littered with examples of the next tallest building in the world being planned and announced at the crest of a boom only for that boom to have turned to bust by the time the building is opened. Obviously it is not the case that such an announcement causes economies and markets to retreat, rather it is the case that the desire to build such a tower is a symptom of the excessive confidence that is found at an important peak. It was therefore with some alarm, but not total surprise, that I received  an email from long time reader Matt Hol after the announcement of the approval to build Australia 108 in Melbourne. CNN ran the headline;

Going up Down Under: Southern Hemisphere’s tallest building

The 388-meter futuristic Australia 108 in Melbourne will become a record holder, for a short while at least

21 March, 2013


Naturally none of this means that the ‘lucky country’ is about to collapse, but it does indicate that internally at least confidence is at a very high level. Investors would do well to remember that ‘pride really does come before a fall’.


For many months now I have not changed my view, now is a time for caution amid the increasingly optimistic media.. Preservation of capital will be most important through the next cyclical downturn and the current environment is not unlike those seen at prior cyclical peaks. It was no surprise that the recent very brief sell off was seen as another opportunity to ‘buy the dips’. Don’t be surprised if a more serious sell off occurs and it is dismissed as just a ‘healthy correction’, all bear markets in their early stages are seen as this ‘oxymoron’.

This months Strategy Thoughts aimed to illustrated just how far attitudes have changed. Seeking the comfort of a bullish concensus may provide the comfort of the herd and this may feel good for a moment but it will become very  uncomfortable when the ‘healthiness’ of any correction eventually becomes less obvious.

Kevin Armstrong

26th March 2013

More thoughts on Apple

Bloomberg anchor, and an older user of an iPhone, Tom Keene, asked a simple question of a technology expert recently;

"What I see is a generational divide, is that true? Older people use iPhones, younger people use Samsungs."

I don’t know the answer, although I do probably fall into the ‘older’ category, and I do use an iPhone. I have been commenting for many months now that the market has been telling us something about Apple that the majority, until perhaps now, after a 40%+ fall, didn’t want to face up to.

Waiting for the reasons as to why any bear market has happened does nothing to protect an investment. Most bear markets occur not because the underlying fundamentals deteriorate; rather they happen because expectations were far too optimistic at the peak. A minor disappointment to highly exaggerated expectations can trigger a meaningful bear market.

Final note

This morning chief investment strategist at Standard and Poor’s, Sam Stovall  was on CNBC forecasting 1680 for the S&P500 by the end of the year, a wonderful extrapolation of the bull market to date. I just checked what Sam was saying four years ago. This from Businessweek in early March 2009;

An analysis by Sam Stovall of Standard & Poor’s is discouraging for those who hope the declines just can’t reasonably get any worse—or last much longer—than this. The 15 bear markets since 1929 have lasted an average of more than 18 months and lost investors a median of 34%. However, for "mega-meltdowns"—where indexes fell more than 40%—the average drop was 51% and the bear market lasted more than two years. Between 1929 and 1932, the S&P 500 fell 86%. The 1938 to 1942 bear market lasted 42 months. When this bear market is finally over, nothing says it couldn’t have experienced the worst of all levels," Stovall wrote in a Mar. 2 note. (emphasis added)

Ecinya’s delightful and daring dance with Sir Percy


In the Ecinya pages over the years since 2000 readers have met many of our confidants such as SOT (the Sage of Toukley), The Prince (from the Grand Duchy of Luxembourg), DOG (a derivatives and commodities trader), Compass (a chartist of considerable skill and experience), The Delphic Oracle ( a Greek fund manager pregnant with market invective and occasional wisdom), Maximus (a stockbroker of Italian origin) plus others currently beyond instant recall.

Today we introduce Sir Percy Blakeney, the hero created by Baroness Emmuska Orczy in the novel and play ‘The Scarlet Pimpernel’ set during the reign of Terror following the start of the French Revolution. Sir Percy Blakeney was a hero with a secret identity and was the elusive Scarlet Pimpernel. Our Percy turns up on an irregular basis chock full of opinions about the past and the future and oft demanding an actionable idea. When presented with Ecinya’s view of ‘actionable ideas’ he often has a plethora of prejudices or reasons not to initiate action, but always renders the caveat ‘he will know it when he sees it’.

Our Percy and Ecinya have made a bet: Percy has bet that the All Ordinaries (XAO) will retrace by 103 points from its 21 February level of 5114 to 5011 by 4 April. Ecinya’s wager is that the XAO will retrace by 409 points to 4705 by 31 May. Percy’s retracement is thus 2% and Ecinya’s is 8%. The proceeds of the bet will go into our Parisian money box joining other accumulated bets from many sources which will eventually be realised as part of the cost of a trip to Paris or a bottle of French Champagne depending upon the realisation date. This is our first bet with Sir Percy.

Obviously the purpose of the bet is for someone to be correct and someone to be wrong. Opinions are much like posteriors, everyone has one. Essentially, Percy is saying not much will happen at all and the delightful dance that is the market goes on from almost the same level. Ecinya thinks the retracement will be more robust and interesting.

Given Percy’s customary elusiveness he has provided no explanation or documented reasoning. However, this is not to say that Percy will be wrong as ‘A hunch can be trusted if it can be explained‘ and no doubt Percy will one day mystically visit and enunciate his reasoning.

Why daring? For our part we do not wish to have the luxury of being elusive. Ecinya has a view that is stout and worth shouting about; Percy is prima facie placid, prosaic and perfunctory.



Perhaps, Sir Percy, in handing back to us the thoughts of Jesse Livermore ( which have been set out under Ecinya’s Market Wisdom tab for a decade or more) considered that he had provided meaningful and inarguable reasoning for his opinion. It should be noted that in 1929 Mr Livermore was reputedly worth US$100 million and at the time of his suicide in 1940 at the age of 63, in a Manhattan Hotel cloakroom, was still worth a not insignificant $5 million. Mr Livermore traded stocks before the invention of the internet, prior to globalisation, rampant hedge funds, dark pools and algorithmic- high frequency trading. However, incompetent bankers and politicians certainly were prominent during the wonderful years when he owned mansions around the world plus a yacht, private railway carriage and other toys and joys, including several wives.

Sir Percy provided the following from Mr Livermore:

It is too difficult to to match up world events or current events, or economic events with the movement of the stock market. This is true because the stock market always moves ahead of world events.

The market often moves contrary to apparent common sense and world events, as if it had a mind of its own, designed to fool most people, most of the time. Eventually the truth of why it moved as it did will emerge.

It is foolish to try and anticipate the movement of the market based on current news and current events such as: The Purchasing Managers’ report, the Balance of Payments, Consumer Price Index and the Unemployment figures, even the rumour of war, because these are already factored into the market.

After the market moved it would be rationalised in endless post mortems by the financial pundits and later when the dust had settled, the real economic, political and world events would eventually be brought into focus by historians as to the actual reasons wht the market acted as it did.

But, by that time it is too late to make any money.



Our major concerns were outlined as part of our Strategy Essay of 25 January and were –

1. Australian fiscal management during and since the GFC – the chickens are coming home to roost and unemployment, slow growth. and higher taxes are on the horizon in a massive landscape of poor policy development and execution. Mid term we remain bullish on hard and soft commodities. Australia needs a Federal election as soon as possible.

2. Dr Ben Bernanke is treating a disabled patient with massive doses of monetary stimulus when the real medical disorder is fiscal profligacy and waste.

3. Europe needs to address creeping imbalances all over the place.

4. China may have a massive credit and property bubble which has not yet popped.

5. The normal menu of global unrest has a new entree in that China and Japan are in dispute in and around the China seas.


Embellishing the above

1. The current Australian government is so far beyond incompetent that bizarre and absurd at both the policy and personnel level seems a more apt description.

2. America may well be ungovernable as it seems increasingly difficult to get Congress and the Obama administration to realise that the Rosy Scenario tango requires both monetary and fiscal policy to be on the same dance floor.

3. Europe doesn’t bother us as much as people might imagine as our observations is that outside of the capital cities the cash economy functions beautifully and la dolce vita or the sweet life is well in evidence. Of course, European banks are another story as is employment (particularly youth unemployment) and productivity, Germany excepted.

4. The evidence here is moving from anecdotal, scattered and intermittent to more regular and factual. We point out, even now, that Greek GDP per capita is about twice that of China in Purchasing Power Parity terms, considered the most relevant measure for country comparisons.

5. We said ‘entree’ not ‘main course’ or ‘dessert’. The protagonists are dancing around one another with more preening than performance.

Nothing has changed over the last month except that markets have continued to rise at a healthy pace.



Janet Yellen is seen by many to be the favourite to succeed Fed Chairman Ben Bernanke. However, Paul Volcker has recently publicly criticised the Fed’s QE policies that are emphatically supported by Ms Yellen and Dr Ben.

James Shugg of Westpac appears to be on the same page as Volcker and Ecinya –


Westpac’s Shugg ‘still smoking’

WESTPAC’S plain-speaking London economist James Shugg remains as gloomy about the global economy as he was over a year ago, when he said the Australian dollar could plunge to US80c and a break up of the eurozone would prompt a "global catastrophe".

Mr Shugg said yesterday he thought the renaissance of economic optimism this year was built on a mirage, a result of "quantitative easing" in Europe and Japan, rather than fundamental economic improvements. He suggested Greece, and potentially other European countries, were likely to default next year.

"I stand by every word of what I said in November 2011," he told The Australian from London.

At a Rockhampton, Queensland, conference in late 2011, Mr Shugg said he had never been so worried about the economic outlook in 25 years.

"I’ve started smoking; I can’t get to sleep at night. Markets are freezing up and things are even worse than you are reading about," he reportedly said then.

Mr Shugg, who is still smoking, claims he was slightly misquoted, and had projected a global financial meltdown only if global creditors had not renegotiated Greece’s severe debt repayment schedule, which they did early last year. "The European Central Bank has also put its big bazooka behind European banks since then, promising to lend unlimited amounts to banks at a discounted rate."

As global stockmarkets surge to new highs, Mr Shugg said: "There’s still so much unjustified optimism out there; the fact is, we’re in a sovereign debt crisis that will last for a decade."

Westpac’s senior London economist, who grew up in Tasmania, said the required transfers required to keep Greece and Italy in the eurozone were so great that Germany would be better off leaving the group, even though its banks would need to be recapitalised at great cost.

"As we’re seeing in Italy, people are voting out governments that harm their kids and their grannies," he said, suggesting people were "sick of austerity", which was undermining key social services.

Mr Shugg also suggested Europe was likely to be the trigger of future problems, but said the US was "living on life support".

"We have a situation where $US85 billion ($82.6bn) a month is being pumped into the US economy, interest rates are at record lows and the economy is only growing at 2 per cent," he said.

More broadly, he said global economic clout was shifting inexorably from the west to the east.


AND Paul Volcker has never left the Exercise Caution In Your Affairs page –

Paul Volcker: Reasonable, rational, largely ignored. Why?

Fri 22 Oct 2010

  • ECINYA NOTE: This is from The Wall Street Journal and is so relevant to the current economic debate taking place in America that we are producing it in its entirety and without comment. We consider this to be part of the necessary rehabilitation that America needs to undergo to restore its economic, domestic and geo-political fortunes. We have considerable faith that America will soon begin to get it right, again. As Winston Churchill once said: "You can always rely on America to do the right thing, once they’ve exhausted the alternatives."
  • Paul Volcker was Chairman of the Federal Reserve from August 1979 to August 1987. In our view he was the last personally decent and competent boss of the Fed. Greenspan was close to being a charlatan and Bernanke has not yet impressed, and is unlikely to do so. America is on the path to recovery BUT only, sustainably so, if the views of Volcker are understood, appreciated, and his recommendations and insights implemented. We are hopeful, but not yet confident. We re-produce in its entirety a Wall Street Journal reporting which we consider to be of the utmost importance and relevance to the omnipresent debate about global stock-markets.
  • September 23, 2010, 4:38 PM ET – THE WALL STREET JOURNAL…………..

"Volcker Spares No One in Broad Critique"

Former Federal Reserve Chairman Paul Volcker scrapped a prepared speech he had planned to deliver at the Federal Reserve Bank of Chicago on Thursday, and instead delivered a blistering, off-the-cuff critique leveled at nearly every corner of the financial system.

Standing at a lectern with his hands in his pockets, Volcker moved unsparingly from banks to regulators to business schools to the Fed to money-market funds during his luncheon speech.

He praised the new financial overhaul law, but said the system remained at risk because it is subject to future “judgments” of individual regulators, who he said would be relentlessly lobbied by banks and politicians to soften the rules.

“This is a plea for structural changes in markets and market regulation,” he said at one point.

Here are his views on a variety of topics.

1) Macroprudential regulation — “somehow those words grate on my ears.”

2) Banking — Investment banks became “trading machines instead of investment banks [leading to] encroachment on the territory of commercial banks, and commercial banks encroached on the territory of others in a way that couldn’t easily be managed by the old supervisory system.”

3) Financial system — “The financial system is broken. We can use that term in late 2008, and I think it’s fair to still use the term unfortunately. We know that parts of it are absolutely broken, like the mortgage market which only happens to be the most important part of our capital markets [and has] become a subsidiary of the U.S. government.”

4) Business schools — “We had all our best business schools in the United States pouring out financial engineers, every smart young mathematician and physicist said ‘I don’t want to be a civil engineer, a mechanical engineer. I’m a smart guy, I want to go to Wall Street.’ And then you know all the risks were going to be sliced and diced and [people thought] the market would be resilient and not face any crises. We took care of all that stuff, and I think that was the general philosophy that markets are efficient and self correcting and we don’t have to worry about them too much.

5) Central banks and the Fed — “Central banks became…maybe a little too infatuated with their own skills and authority because they found secrets to price stability…I think its fair to say there was a certain neglect of supervisory responsibilities, certainly not confined to the Federal Reserve, but including the Federal Reserve, I only say that because the Federal Reserve is the most important in my view.”

6) The recession — “It’s so difficult to get out of this recession because of the basic disequilibrium in the real economy.”

7) Council of regulators — “Potentially cumbersome.”

8) On judgment — “Let me suggest to you that relying on judgment all the time makes for a very heavy burden whether you are regulating an individual institution or whether you are regulating the whole market or whether you are deciding what might be disturbing or what might not be disturbing. It’s pretty tough and it’s subject to all kinds of political and institutional blockages as well.”

9) On procyclicality — “It’s the hardest thing as a regulator in my opinion…when things are really going well, the economy is going well, the market is not disturbed, but you see developments in an institution or in markets that is potentially destabilizing, doing something about it is extremely difficult. Because the answer of the people in the markets is, ‘what are you talking about? Things are going really well. We know more about banking and finance than you do, get out of my hair, if you don’t get out of my hair I’m going to write my congressman.’”

10) Risk management — “Markets that are prone to excesses in one direction or another are not simply managed under the assumption that we can assume that everybody follows a normal distribution curve. Normal distribution curves — if I would submit to you — do not exist in financial markets. Its not that they are fat tails, they don’t exist. I keep hearing about fat tails, and Jesus, it’s only supposed to occur every 100 years, and it appears every 10 years.”

11) Derivatives — “I’ve heard so many stories about how important” derivatives are but “there doesn’t seem to be much doubt that the creation of derivatives has far exceeded any pressing need for hedging.”

12) Money market funds — “Money market funds have encroached so much on the banking market. They are nothing, in my view, but a regulatory arbitrage. The purpose that they serve in handling payments and short term paper is a commercial banking function” but they don’t hold the capital or face the regulation of banks.

13) The Fed and Dodd-Frank — Volcker said it was a “miracle” that despite all the criticism aimed at the Fed the central bank “came out with enhanced regulatory authorities rather than reduced regulatory authorities.” "


Kevin Armstrong: Comfortable Company or Anxious Isolation, Which should an investor choose?

Kevin Armstrong’s Strategy Thoughts

February 2013

Comfortable Company or Anxious Isolation, Which should an investor choose?



I have frequently commented that ‘comfort and success rarely go hand in hand in investing’. This does not mean that one should always seek to do the opposite of what everyone else is doing, just to be uncomfortable and different for the sake of being different. Primarily this is because at no time will absolutely everyone else be doing the same thing, they can’t be, in any market for every buyer there always has to be a seller. However, at extremes of either optimism or pessimism it is vital that an investor recognise that extreme and be prepared to adopt a contrary, and by definition uncomfortable, position. By definition that will be uncomfortable, it will require going against whatever the then prevailing conventional wisdom may be and in a rising market will result in missed opportunities to pick up what the majority will be describing as ‘obvious’ and ‘easy’ returns. The reverse will be true as the troughs of bear markets approach and this discomfort will almost certainly endure for an extended period. This extended period will ‘test’ the resolve and intestinal fortitude of the contrarian that by then may be considering abandoning their ‘anxious isolation’ in favour of the alternative of ‘comfortable company’. This temptation to capitulate must be overcome if the investor is going to achieve true success, hence comfort and success often do not go hand in hand in investing.

Over the last dozen years or so there have been several critical turning points for investors to recognise if they were not going to merely endure a repeated whipsawing at the hands of the markets. In the late nineties it took great courage not to believe in the ‘new era’. In 2002 and early 2003 with markets down fifty percent or more anyone doubting the IMF’s outlook for economic ‘stagnation’ seemed crazy, similarly the same organisations extreme optimism throughout 2007 and into 2008 provided comfort to the majority who wanted to extrapolate the prior four years gains further into the future. Most recently anyone forecasting a cyclical bull market in early 2009 was ridiculed given the ‘end of the financial world as we know it’ attitude that prevailed at the time. A similar attitudinal extreme is now building resulting in extreme discomfort for the dwindling number of cautious contrarians.

The last eight months, since the June 2012 lows, during which the US markets have risen about fifteen percent, with the brief exception of the October / November sell off, has been one of those periods when my own extremely ‘anxious’ outlook has become increasingly uncomfortable and it has certainly become an increasingly ‘isolationist’ view. And the almost parabolic rise seen in markets since the beginning of the year has only served to increase that discomfort. However, now is not the time to seek the comfort of the growing bullish consensus, now is the time for a disciplined adherence to core investment beliefs, no matter how uncomfortable they may become.

In this month’s Strategy Thoughts I will illustrate just how extreme the consensus has become, I will also revisit Apple, and what its bear market may be telling investors and finally I will expand on some comments I made a couple of months ago regarding ‘Active share’.


Two months ago, in the December 2012 edition of Strategy Thoughts, I quoted the US fund manager John Hussman to illustrate why one should be cautious. Hussman is an investor whose writings I have followed for many years and whilst he looks at markets in a quite different way to me, in that he frequently describes things in a highly complex and academic manner from an economic standpoint, his longer term outlook that aims to identify secular rather than cyclical moves in markets is one that I relate to. He looks to outperform over an entire cycle and so not to be whipsawed by cyclical swings.

In his weekly commentary dated the 28th January he provided a chart that neatly displays why one should be cautious. The chart below shows the US market going back to the 1970s, overlaid upon the chart are blue bars that illustrate periods that Hussman describes as; overvalued, overbought, overbullish and rising yields.


He measures those attributes as follows; Overvalued is when the cyclically adjusted P/E, or Shiller P/E, exceeds 18, overbought is when the market is within 3% of its upper Bollinger band over daily, weekly and monthly resolutions and more than fifty percent above its four year low (this is a measure driven by plotting a band plus or minus two standard deviations from the current price), overbullish is when the two weekly average of advisory bullishness, as measured by Investors Intelligence, is greater than 52% and bearishness is less than 28%, and finally rising yields kick in when the ten year Treasury bond yield is higher than it was six months earlier.

Over the last forty three years all these conditions have occurred simultaneously on only five prior occasions; 1972, 1987, 2000, 2007 and 2011. Subsequently the market fell 50% in 1972, suffered the worst crash since the 1920s in 1987, fell in half in both 2000 and 2007 and suffered an almost 20% decline in 2011. As can be seen on the chart all those conditions are once more in place.

A change in attitudes amongst individual investors, no doubt driven by the seemingly relentless rise in the markets, has been picked up by the mainstream media. On Sunday the 25th January the New York Times ran the following headline;

"As Worries Ebb, Small Investors Propel Markets."

The article began;

Americans seem to be falling in love with stocks again. Millions of people all but abandoned the market after the 2008 financial crisis, but now individual investors are pouring more money than they have in years into stock mutual funds. The flood, prompted by fading economic threats and better news on housing and jobs, has helped propel the broad market to within striking distance of its highest nominal level ever.

This change in attitude that the New York Times was describing is part of the ‘overbullish’ feature that Hussman was highlighting and it is not just the Times that has noticed this shift. Forbes reported on the latest survey results from the American Association of Individual Investors (AAII);

AAII Sentiment: Bullish Sentiment Reaches Two-Year High

The article went on to describe how in the latest weekly survey of individual investors bullish sentiment rose 8.4% on the week to 52.3% bulls, the highest reading since early 2011, and the number of bears ‘plunged’ 5.3% to 23.4%, the lowest reading in almost a year.

None of this means that markets should reverse immediately but it does highlight that attitudes are shifting and the comfortably bullish consensus is growing and this trend is not only being seen in the US.

Bullish Expectations Internationally

Ahead of the recent World Economic Forum, in Davos Switzerland, Bloomberg ran the following headline on 23rd January;

Investors Are Most Optimistic on Stocks in 3 1/2 Years

The story went on to describe an international trend very similar to that reported by Forbes in the US and highlighted by John Hussman;

International investors are the most bullish on stocks in at least 3 1/2 years, with close to two- thirds planning to raise their holdings of equities during the next six months, according to a Bloomberg survey.


The article went on to point out that the global economy was in “its best shape since May 2011.”

What the authors failed to point out was that the last time the global economy was apparently this good, or better, was immediately prior to an almost thirty percent bear market in just five months in the Global Dow Index. It must be remembered that markets always peak when everything seems great, because at such a time expectations have understandably been raised and the scope for disappointment is huge. With optimism, at least on some measure, as high as it has been since the bull market began, investors must realise that the risk of disappointment and so a decline in markets, has increased dramatically. It certainly has not decreased.

It is also valuable to take a slightly longer term perspective, and to also look at some sentiment readings that have in the past been a little more prescient. Last November I described how the Conference Board’s survey of CEO’s confidence had shown some anticipation of prior market peaks, whereas consumer confidence surveys tended to be quite lagging indicators for the market. The latest quarterly release from the Conference Board continues to show a reading below 50%, indicating more negative than positive responses, well down from the levels seen in the first couple of years of the bull market in 2010 and 2011. Interestingly the same is true of the global Dow, as shown below.


At the same time as the media was focussing upon Davos PWC reported the results of their latest annual global survey of CEO confidence and this should not be seen as encouraging to the growing number of rampant bulls. Again this survey seems to be closer to a leading indicator than any of the more widely followed consumer confidence surveys. The survey is conducted in the last few months each year and reported in January of the following year, so there is some lag in the results coming out, nonetheless they have been fairly indicative of the cyclical position of markets.

The 2003 survey, conducted late in 2002, showed a very depressed outlook with a reading of just 26% of respondents very confident about the prospects of revenue growth over the next twelve months. That was the trough reading as by late 2003 the number had risen to 31% and continued to rise, with markets, right through to late 2006 when the measure peaked at 52% (reported as the 2007 number in early 2007). By late 2007, when markets had only just started what was at the time dismissed as a correction, even that oxymoron a ‘healthy correction’ the survey had rolled over. It then plunged through 2008 to a new low of just 21%. However, by the time of the next survey in late 2009 the survey reading was once again rising, and continued to rise for another year with the peak result, to date, for the last cyclical bull market having been reported in early 2011 at 48%, just below the peak of the prior cyclical bull market. Since then the readings have declined to the most recent result of 36%.

These CEO surveys seem fairly consistent in at least reflecting the current position of markets and at times heralding a reversal. They are also consistent with the idea that confidence levels generally peak at lower levels with each subsequent cyclical peak as a secular bear market progresses.

Whilst an increasing number of indices have recorded minor new highs the peak in the Global Dow, back in early 2011 when CEO confidence also peaked, may well ultimately be seen as the actual peak of the last cyclical bull market and that all that has happened since are merely bear market rallies that have finally delivered the optimism amongst the majority typically seen at a peak.

Getting back to Davos and the World economic forum, the headline that investors are as confident as they have been in three and a half years should be compared to the message coming out of Davos four years ago. Then the Bloomberg headline was;

Grimmest Davos ever brings anger, finger pointing at bankers

Quotes within that article included; ‘Everyone I spoke to says it’s the grimmest Davos they’ve ever been to’ ‘we’re in a multiyear problem, the mood is very depressed. It’s a low burn depression.’

Quite a contrast. Late January 2009 will be looked back upon as a time when everyone should have been jumping into risk assets aggressively. They weren’t, they were petrified, the VIX index of volatility was at incredibly high levels in the mid 40’s, markets had been collapsing for a year and a half and everyone knew what was wrong with the world. Now, the VIX is at 12.5, a low level not seen since 2007, markets have been rallying and there is a growing belief that central banks have fixed the world’s problems and this is reflected in the complacent bullishness that has emerged.

Hedge fund manager Doug Kass publishes a list of potential surprises each year and this year, based upon the generally upbeat consensus view held by strategists, he sees the potential for far more disappointments than positive surprises. In assessing what the consensus view for 2013 was he wrote;

‘As we enter 2013, investors and strategists are again grouped in a narrow consensus on economic growth (+2% real GDP), bond yields (higher) and year-end 2013 closing stock market price targets (on average at about 1575, a gain of 10%). U.S. monetary policy is now effectively shooting blanks, and fiscal policy will now turn to be a drag on growth. Moreover, the likely reluctance and inertia by our leaders in addressing our budget will continue to turn off the individual investor class to stocks this year. Finally, my ursine tone is also a reflection that, by most measures, the U.S. stock market is not meaningfully undervalued and that given the dynamic of the headwinds of slowing economic growth, a poor profit outlook and the developing weakness of policy are unlikely to be revalued upward in 2013 (as many strategists suggest).’

I certainly share his concern regarding what the complacent consensus is and where the greatest risk of surprise lies.

‘Wall of Worry’, revisited

I continue to believe that the peak of the ‘Wall of Worry’, or the summit of the last cyclical bull market, for the average market in the world was seen in the first half of 2011. That was the peak in the index of the Global Dow, as shown in the chart on the previous page. What has been since then has been the start of the next cyclical bear market and a substantial bear market rally. Nonetheless, for a number of important markets in the world, notably the US, the recent strength has seen new recovery highs in the major indices and so I must concede that their bull markets did not end almost two years ago. However, some longer term perspective as to what has been delivered since early 2011 is probably of value given the hype and excitement that the very recent strength has garnered and the marked attitudinal shift that has resulted.

The UK market recorded its 2011 peak in February of that year since when the FTSE index has risen just 3% on balance over the intervening twenty three months. In Germany the peak came in May of 2011 and over the last twenty months since then the DAX has also risen just 3%. The CAC in France peaked at the same time as the FTSE, February 2011, since when it has fallen 10%. In Korea the picture is very similar to France, the KOSPI is down 13% since the index peaked in April of 2011. In Hong Kong the Hang Seng index is down 5% since its November 2010 peak and the Singapore market peaked at the same time and is still fractionally below that peak. In Japan the Nikkei peaked earlier still, in April of 2010, and despite its recent rally is still 4% below that bull market peak. The Australian market remains 3% below its April 2011 high and finally the Chinese index remains 30% below the high it recorded all the way back in the second half of 2009.

Given all the above it is perhaps surprising that bullishness has rushed back quite as dramatically as it has, nonetheless it has and this should raise a cautionary flag for all investors.

Finally, for those markets that have recorded new bull market highs, and so are still climbing the ‘Wall of Worry’ it is important to remember just how the analogy works. It is not that at a market peak there is nothing to worry about, although the New York Times article quoted earlier appears to imply that there is now far less to worry about, what happens at a market peak is the majority of investors choose not to worry about anything and only see the positive in any news that comes out.

Perhaps the most intriguing aspect of the recent strength in markets is that it has all been achieved without the help of the bull markets most sensational stock, Apple.


Chart forApple Inc. (AAPL)

From September last year through to January this year Apple’s share price fell from $705 down to below $450. This 36% decline, while the market rose slightly, has been the first period of marked underperformance by the stock in more than five years. What is remarkable is that the general attitude towards the stock by investors continues to be very positive. According to Yahoo there has only been one downgrade of the company by an industry analyst throughout the period of its fall, and that was on January 28th when it had already fallen 36% and the average rating continues to be somewhere between a strong buy and an outperform. One reaction that alarmed (and amused) me the most came from the analyst who in late April last year published the highest price target yet for the company; $1111, this was an increase from his prior highest target of $1001, at the time the stock price was $615. In the wake of the fall that has now been suffered the same analyst has lowered his target to $888, a large cut but still looking for the stock to almost double, this is actually even more aggressive than his prior target was as that was only looking for the stock to rise another 80%. This was all more amusing than alarming, what I found most alarming was that he described the price action since September as having been a ‘pullback’. This has to be one of the greatest understatements ever about such a widely followed stock. By comparison, over a similar length of time, from August 1987 to December 1987, the US market fell an almost identical 36%. No one was talking about the ‘pullback’ that the market had suffered then, no, previously bullish attitudes had been decimated and expectations were through the floor which is why the market was able to rise in a remarkable bull market over more than the next decade. Expectations, and hype, about Apple probably have further to fall.

I first wrote about the phenomenon that was Apple ten months ago, partially prompted by the sensational targets that the stocks already remarkable performance was spawning, partially because it had become the biggest company in the world and partially because it had announced its first dividend for many years. I wrote in the April 2012 Strategy Thoughts;

Apple is not only the largest company in the world but it has now become the most closely followed. This obviously has some positive implications in that the more people follow a stock the more potential buyers there are, and there have undoubtedly been an enormous number of those given the spectacular run up the stock has enjoyed. However, there are draw backs as well as the article below from the associated press highlights;

Apple’s market clout likely to draw more scrutiny

Apple’s power, ambitions to dominate ‘post-PC’ era may attract more antitrust attention


By Michael Liedtke, AP Technology Writer | Associated Press 12th March 2012

In everything it does, from product design to business deals, Apple strives for as much control as possible. But as the world’s most valuable company sets out to define and dominate the rapidly evolving markets it created with the iPhone and the iPad, Apple is likely to face antitrust regulators who want to curb its power. Apple’s clout is coming under scrutiny as the U.S. Justice Department considers filing a lawsuit against the company and five U.S. publishers on allegations they orchestrated a price-fixing scheme on electronic books. The involved parties are trying to avoid a high-profile court battle by negotiating a settlement, according to The Wall Street Journal. The newspaper broke the news last week about the government’s plans to allege that Apple Inc. and the publishers tried to thwart e-book discounts offered by Inc. and drive up prices since the 2010 release of the iPad. "I think this might be a bit of a wake-up call for Apple," says Ted


Other companies that have achieved the stature of being the ‘biggest in the world’, notably Microsoft, have faced similar scrutiny. As I discussed in a Thoughts and Observations article, “Revisiting ‘How the Mighty Fall! Or, the curse of being biggest’” on the 13th February, being the biggest can gave its drawbacks. More importantly secular bear markets have not been kind to any company that achieves the ‘Biggest’ title.

This raises the question of; what could possibly go wrong for Apple? At first blush this seems to be a rather dumb question, everyone knows about the incredible innovation, the slew of new products, the amazing sales, the spectacular stock market performance, the fact that Steve Jobs’ passing seems to have been absorbed with barely a blip and now the dividend. The story is undoubtedly phenomenal and that is why the average rating by the 46 analysts that cover the stock, and are monitored by Thomson / First Call, is 1.7, where 1 is a buy and 5 is a sell. The average rating is somewhere between an outperform and a buy. Not only is Apple a great story, everyone agrees that it is a great story. As an investor one has to ask; how can it get any better, where is the next positive surprise going to come from. Perhaps there are more rabbits that they can pull out of the hat to attract an even wider audience of investors, but it must be getting harder.

Up until late September of last year it didn’t seem that anything could go wrong with Apple, the news was all good as the following headline from ABC News on the 18th September last year illustrates;

IPhone 5 Soaring Pre-Sales Lift Apple (AAPL)

 The article started; ‘Just how high can Apple go?’

It seems that amid the excitement that was then Apple there were plenty who wanted to answer that question. The next day Yahoo ran a banner story under the headline;  

Apple Shares to Hit $1,650 by Late 2015: Eric Jackson

Others saw 20% or 30% upside and there was a general scramble for analysts to get their targets ahead of the stock price. And despite the gains the most used adjective for the stock was; ‘inexpensive’.

Ever since then the stock has ‘pulledback’ in a spectacular and worrying fashion. Whether such a poor performance from what was undoubtedly the market’s darling and bellwether is telling investors anything only time will tell. However, it is of some concern to look back at earlier ‘biggest companies in the world’ and market bellwethers. In the second half of the 1960’s General Motors was the market bellwether. The stock hit its all time high in late 1965 and then collapsed by about 75% over the next nine years, dramatically underperforming the market. This heralded an end to the markets post war secular bull market and ushered in a secular bear market characterised by a series of cyclical bull and bear markets that resulted in a broad trading range.

Ultimately the market broke out to new recovery highs in 1982. It would be another twelve years before GM got back to its mid sixties high.

Activeshare revisited

In the December 2012 edition of Strategy Thoughts I included a section that explored the concept of ‘active share’. I concluded that section with the following;

‘an investor should not be paying active fees for a manager or adviser who opts to ‘hug’ the index in the pursuit of comfort. As the current secular bear market continues to unfold, and long term returns continue to disappoint, it is highly likely that ‘active share’ will become increasingly examined and discussed. In an environment of low returns active fees for comfort seeking passive management will not prove sustainable.’

expand large image

At that time I had only just been introduced to the concept of ‘active share’ in a small article in Barron’s. Two months later my forecast that ‘active share’ would become increasingly examined and discussed seemed to be proved correct. Rather than the small story hidden on the inside of Barron’s magazine last December the subject had become the cover story in the January 14th 2013 edition.

The concept of ‘active share’ was originally devised by two academics, Antti Petajisto and Martijn Cremers, who were intrigued by the accusations being made that large fund managers were closet indexers. The original article described ‘active share’ as follows;

Active share is a measure of the portion of a mutual fund’s holdings that differs from its benchmark index. In other words, it’s a measure of how actively managed your actively managed fund is. Stated as a percentage of the fund’s holdings, it takes into account both security selection and any overweighting or underweighting of the stocks in a fund versus the index. "One of the most important considerations when buying an actively managed fund is that you expect the fund to be substantially different from the index," Cremers says. "Active share tells you what percentage of the portfolio is different."

I highlighted the previous article because closet indexing and the desire to be not too different from the next fund manager or asset allocator are characteristics that have long troubled me about the asset management business. It is not that there is anything wrong with hugging an index, so long as you don’t charge active fees for it as there are now a myriad of products that can give an investor index performance at minimal cost. High fees for index hugging was one of the primary focuses of the recent cover story. ‘Active share’ has become mainstream and is now employed by major fund consultancies such as Morning star and Lipper. A few quotes from the article illustrate the importance and value of the concept;

“If nothing else, active share pulls back the kimono on managers who charge high fees for piggybacking the index. "It gives you a very quick and dirty indication of how active a fund is, relative to the index," says Michael Herbst, director of active-funds research at Morningstar.”

“Active share is no crystal ball, but that doesn’t take away from its significance, says Terry Dennison, U.S. director of consulting for Mercer Investments. Dog-eared, marked-up, and splattered with coffee stains, the Yale paper has a permanent spot on his desk, where it’s "within arm’s reach all the time," says Dennison, who has incorporated active share into the firm’s analysis of individual fund managers, as well as of entire portfolios. "High active share is no guarantee that a fund will outperform, but it is likely a necessary condition," he says. "You can’t beat the index if you look exactly like it."”

“"If you are a closet indexer charging high fees, you are doomed to fail. It’s almost impossible to win," Swedroe concedes, adding that "it doesn’t take a genius" to come to that conclusion. "But that doesn’t mean the odds are good of winning just because you have high active share."”

‘Active share’ is not a simple solution that will ensure consistently healthy and index beating returns, however, it is an important indication as to what fees an asset allocator or fund manager should be charging. Hopefully, as it becomes employed more widely, it will also encourage the industry to become less concerned about looking at what each other is doing and more focussed upon doing what they believe to be the absolutely best thing for their clients. Unfortunately it will likely take more of the frustrating trading range markets that have been suffered for the last thirteen years to bring such a change about.


Despite, and to a large extent because of, the rallies that have been seen since the beginning of the year my level of concern has only grown. Now is not the time to seek the comfort of what is now a swelling and increasingly complacent crowd that are jumping into equity markets. Now, as John Hussman highlights, is the time for caution. Equities are over bought, they are overvalued, investors, as hopefully I have illustrated, are over bullish and Treasury yields have certainly risen. The US thirty year Treasury yield is now almost 30% higher than it was in late July, 3.17% now compared to less than 2.5% then. I wrote in the October 2012 edition of Strategy Thoughts that ‘the chances of the low, seen in late July in ten year treasury yields, being an important long term secular low as very high.’ That continues to be my view and I still believe that capital preservation should be investors’ primary consideration through 2013, not chasing returns.

Kevin Armstrong

30th January 2013


I had planned to write a little this month about a book I just bought, however, space is limited and my comments on ‘The Signal and the Noise, The Art and Science of Prediction’ by statistician Nate Silver will have to wait a month. Silver gained his reputation by correctly forecasting 49 of the 50 states presidential votes in 2008 and in 2012 he was correct in all 50 plus the District of Columbia. The book was named Amazon’s nonfiction book of the year in 2012 and was on The New York Times best seller list. I have thoroughly enjoyed his refreshing take on predicting, especially his perspectives on the shortcomings of economic forecasts (particularly when compared to weather forecasters who he is quite complimentary about), and would highly recommend it. I aim to include some perspectives from the book next month


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