Month: November 2009

We’re enjoying sluggish times, and not enjoying them very much…….. The year ended with the concern for Americans that are hurting, because of this sluggish economy. I mean, when families are having trouble making ends meet or are thinking, even if they have a job, I might not have one tomorrow. Fear. You worry about that. I worry a lot about that.

George Bush snr, 1992

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 generally available and to use fiscal measures to boost employment and avoid the unpleasantness of downward adjustments 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, "The Age of Turbulence", September 2007.

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 foreknowledge 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.

Ian Macfarlane, former Governor of The Reserve Bank, 14 June 2005.

 

ECINYA COMMENT

All governments talk of lower taxes, lower interest rates, higher spending on more and more pervasive benefits for the disadvantaged, incentives for the corporate sector if they also happen to be benefactors at election time, and spending on ‘nation building’. The fact that governments have no money of substance other than what they raise from taxes or borrow, one would think that expenditures would be thoughtful, careful and have a reasonable set of priorities. Alas, that is hardly ever the case, with Peter Walsh and early Howard regarded as notable exceptions.

So we are left with the central bankers to provide the checks and balances through monetary policy, to apply some brakes to the natural political inclination to be profligate and wasteful. In America this has not worked for some considerable period because Mr Greenspan became part of the political system. But in Australia it has worked. Hence, when we are talking about the sustainability of ‘the recovery’, we must rely on the good intentions and thoughtful policies of The Reserve Bank.

We find it interesting that Mr Greenspan talks of the ‘welfare state’ and America is still having a debate about ‘capitalism’. It sometimes seems that there is more free enterprise in Communist China than in Capitalist America… funny hah, hah! Just think about the bail-outs of the US auto and banking industries; not that they were unnecessary but the scale and enthusiasm was almost grandiose.

Once upon a time, business leaders used to speak up against bad policy – people like the Chairman of The Stock Exchange and senior bankers. But they are now so fearful of subtle forms of ‘punishment’ that no longer happens. It is left to the press to be the investigators that reveal bad, sometimes reckless, fiscal behaviour.

Our tax system needs reform, but will it occur? There will be some changes promoted as ‘reform’, but the main ingredients are likely to be confused and confusing. On top of the ’emissions trading scheme’ confusion, we may enter a period of multiple confusions. The GST should be imposed on food; payroll taxes removed; capital taxes relaxed to reward longer-term holders and encourage capital velocity; pensioners, teachers, nurses, and policemen should be paid more.

BUT if the world economy continues to move from emergency relief to recovery, Mr Macfarlane says we will be all right, and we agree with him. Therefore, we need to be continually alert to what is happening in the world economy. In general terms we are looking for a negative year of circa 1% GDP growth for calendar 2009, followed by 3.0% for 2010 and 3.5% for 2011. Trend is about 3%, which means that world GDP doubles about every 24 years.

THE STOCKMARKETS

In order to assess levels and direction for the Australian stock-markets our primary focus is on the S&P 500 and the All Ordinaries index. The latter is currently contained in a range 4500 to 4800 and the former in the range 1075 to 1110. Our expectation is that a correction will occur soon that takes our market to around 4400 and the S&P to around 975. This equates to an 8% correction for the All Ordinaries and about 13% for the S&P 500. Volatility might be, at times, uncomfortable.

As we drift towards the end of 2009 we need to understand that the drift is in context of an Australian market 50% above its lows in March of this year, but still 30% below its peak in November 2007. The corresponding numbers for the S&P 500 are 30% below the peak and 60% above the March lows.

Why ‘drift’? Volumes are low and muted, and the momentum of the advance is declining. Also, at the time of new Ecinya’s first publication our buy-accumulate-spec buy ratio as a percentage of our total stock universe was 39% and it is now running at about 19%.

FEAR AND THE WISDOM OF TWO BUSH PRESIDENCIES THAT INHERITED STRONG ECONOMIES AND BEQUEATHED RECESSIONS

Much comfort can be found in the wisdom of George Bush snr, a kindly, well intentioned man, but something of an economic illiterate, just like his son. We advise everyone to read the Bush quotes over-and-over again, and then stoutly ignore them, remembering that government is hardly ever the friend of the honest taxpayer-worker. Simply exercise caution in your own affairs, because Messrs Obama and Rudd, though articulate to varying degrees, seem to be playing the economic game of ‘the free lunch’. Each seems to be more of a celebrity than a manager.

We think Mr Obama will change, we sense that Mr Rudd cannot escape his predilection for spin over substance and mischievous and clever wedge politics. If we had longer Federal parliamentary terms, the perception that spin is valuable might change to some degree. Suffice it to say, Ecinya has more faith in the substance of the Australian people than its current crop of politicians.

Mr Obama needs to change direction in 2010 and become something of an economic pragmatist, now that the emergency has passed. Mr Rudd will have to be forced by an election set-back in early 2010 to regain his self-confessed, conservative credentials and hope that external conditions can make Australia continue to look good. In our prayers we should all mention China and India. America has a long way to go and Europe just limps along, aided by the tourist dollar.

ECINYA’S SURVEY

In January 2009 we asked 8 of our confidants to join our editor (making 9 in all) to write down their five major fears/ worries for 2009. This gave us 45 responses (9 times 5).The table below summarises the results:

Responses

• US in all aspects, $US, Obama… 10……………………………………………………….22%
• Australian government policies & abilities… 8………………………………………..18%
• Deflation – recession deepens, asset values continue decline… 6………. 13%
• Geo-political – oil price, middle east, wars etc… 4…………………………………… 9%
• Wages and employment… 3……………………………………………………………………. 7%
• Banks willing to lend, bigger bank losses… 3………………………………………….7%
• Confidence – market, DIY super losses… 2……………………………………………. 4%
• Public & private debt levels… 2……………………………………………………………….. 4%
• Drugs, alcohol, law & order… 2……………………………………………………………….. 4%
• Australian management… 1……………………………………………………………………. 2%
• China over-saves… 1………………………………………………………………………………. 2%
• Trade wars… 1……………………………………………………………………………………….. .2%
• Energy policies globally… 1……………………………………………………………………. .2%
• Resources bust… 1………………………………………………………………………………… 2%
• X factors… 1…………………………………………………………………………………………….. 2%

We found the second most dominant fear to be interesting and consonant with our own generalised fears. The Hawke-Keating government were sound economic managers, before turning into micro-populists, mainly instigated by Mr Hawke in his final term. The Howard-Costello government were sound economic managers before turning into micro-populists, mainly instigated by Mr Howard in his final term. Transition is just as important in government as it is in business, and poorly orchestrated leadership changes are costly for taxpayers.

SO WHERE ARE WE NOW?

David Rosenberg gives the following summation of the American condition:

• Short-term negative interest rates in the bond market with people more concerned with capital safety than yield
• Housing crisis far from over
• Dose of near-term caution for the commodity sector; though remaining long-term bullish
• Some yellow flags over the holiday retail sales season
• Lots of hesitation in capex as excess capacity remains high
• No sign that the recession is "really over"

The US economy has been hopelessly managed since Ronald Reagan said "It’s always morning in America", except for a period where the abrasive Newt Gingrich controlled the economic debate through a Republican controlled Congress. However, things can change and as John Maynard Keynes (everyone’s favourite dead prophet) said "Fundamental change does not occur quickly".

AND IN AUSTRALIA

Our major worries are : The tax system, a flawed approach to carbon emissions, a poor prime minister and treasurer in economic terms. Even Peter Walsh recently described Mr Rudd as an ‘economic illiterate’. Additionally, we are also watching China with a more than usual degree of care.

Go placidly amidst the haste and noise remembering what peace there may be in silence.

The Desiderata, Max Ehrmann, 1927

Chaos is not dangerous until it begins to look orderly. A hunch can be trusted if it can be explained. It is unlikely that god’s plan for the universe includes making you rich. Optimism means expecting the best, but confidence means knowing how you will handle the worst; never make a move if you are merely optimistic.

Extracts from The Zurich Axioms by Max Gunther, circa 1980

The good news is that we have not fallen off into another Great Depression. With the degree of stimulus there seemed little chance of that, and we have consistently expected a global economic recovery by late this year or early next year. The operating ratio for industrial production reached its lowest level in decades. It should bounce back and, if it moves up from 68 to 80 over three to five years, will provide a good kicker to that part of the economy. Inventories, I believe, will also recover. In short, the normal tendency of an economy to recover is nearly irresistible and needs coordinated incompetence to offset it – like the 1930 Smoot-Hawley Tariff Act, which helped to precipitate a global trade war. But this does not mean that everything is fine longer term. It still seems a safe bet that seven lean years await us.

Jeremy Grantham, a distinguished US Fund Manager, October 2009

Clearly, the central bank of Zimbabwe has overdone it. But if the central bank of the USA has overdone it few seem aware of it. The secret is to give people more money, but not so much more that they realize all they’re getting is pieces of paper. Paper money may be a fraud, but it still represents purchasing power. When more units of it appear, people assume they have more purchasing power. And when they spend more, the merchants think there is more demand and increase production. Pretty soon there is a boom.

Bill Bonner writing on fiat money, 2007

Information received since the Federal Open Market Committee met in September suggests that economic activity has continued to pick up. Conditions in financial markets were roughly unchanged, on balance, over the intermeeting period. Activity in the housing sector has increased over recent months. Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability. With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

US Federal Reserve statement 4/11/2009

 

ECINYA COMMENTARY

From 19 October 2007 to 9 March 2009 the All Ordinaries index and the S&P 500 (our global proxy) were in a primary downtrend for 355 days of 55% and 57% respectively. From 9 March 2009 the primary uptrend has lasted 178 days and the All Ordinaries is up 51%, and the S&P 500 is up 59%. Our Insights column of November 3 was written against the background of an S&P level of 1042 and XAO of 4546. As of last night these numbers are 1108 and 4773, a ‘bounce’ of 6% and a ‘bounce’ of 5%. Our expectation, and our hope, back in early November was that the markets would fall by about 8-15% which in our generalised view would have the indices more in line with our fundamental perspective.

From those levels, the economic and earnings fundamentals could re-assert themselves and an orderly market advance would follow with a focus on sustainable economic, earnings-per-share, and dividend growth. Balance sheets would have been restored from new share issues and the earnings recovery.

But it now seems to us that the global stimulus has barely impacted the real economy – the production of goods and services – and instead flowed in abundance into the symbol economy – money and credit. Bankers, the architects of the ‘great recession’, are back in bonus and it seems that a government debt bubble, in guise of nation-building without analysis, is manifesting itself. Politicians, central bankers, the IMF all in charge of sustainability and stability, were asleep at the wheel. These same institutions with little semblance of change are now meeting in various places to pronounce a new era of global co-operation abroad, amid ‘co-ordinated’ stimulus at home. The choirs are singing from the same hymn book. Only Mrs Merkel seems to embody a sense of truth and responsibility. The rest are today’s heroes, saving our women and children from the burning building that they set alight in the first place.

The fact that we are likely to emerge triumphant from ‘the great recession’ is not currently in doubt……. but our hunch is that the markets are too far ahead of that emerging recovery. We want a ticket at the game, but we don’t want to pay too much to participate in the applause.

It is Tuesday about noon, and last night in the US our global proxy rose to 1108. CNBC TV said that this was due to ‘better than expected, indeed strong, retail sales’. We looked at our daily US market site, Nasdaq.com, and the commentary said ‘retail sales data for October comes in a bit mixed, while business inventories for September decline less than expected’. With these statements seemingly in conflict, we visited DismalScientist where the data is set out in great detail and discovered that retail sales month-on-month rose 1.4%, but if you exclude autos then they rose 0.2%. Further, if you go into the year-on-year numbers, retail sales fell 2.6%. Knowing that our stockmarket is dominated by US brokers and that there is a 2 day nexus between New York and the XAO, sometimes leading by a day and sometimes lagging by a day, we were disturbed on Monday our time that our market was strong in the afternoon. This strength was vindicated by the overnight strength in the US. But today, our market is lacklustre and yesterday turnovers were exceptionally light. We are uncomfortable.

Additionally, on a more macro and longer-term perspective we are finding our modelled assumptions are not throwing up a large number of buying opportunities and so our conclusion is that about 80% of our stock universe is effectively on hold. In February/ March 2009 the position was largely reversed with about 60% of our stock universe on ‘buy’. When we first published the new ECINYA pages on 28 July 2009, 39% of our stock universe was on buy/accumulate/spec buy. Today that number is 18%.

STRATEGY

Our strategy is to be over-weight cash; about 30% in investment-accumulate mode, 43% in special situations, and about 12% in speculative stocks and 15% in cash.

TACTICS

Going with or against the flow, with or without conviction, comprises the 4 pillars of our tactical positioning. The fifth pillar is ‘Ambivalent, uncertain, relatively clueless’. This is where we are today, at this moment.

LOOKING TO OUR QUOTES ABOVE

The Zurich Axioms are just old-fashioned cynicism, but contain significant truths.

We are not as pessimistic as Jeremy Grantham about his home country, America, but we can understand his relative pessimism, and his caution.

Bill Bonner reminds us that central bankers (and fiscally reckless parliaments) can create illusions of wealth and economic activity.

Ben Bernanke is part of the Greenspan-Rudd school of double-speak and speaks and behaves like a politician. In his defence, perhaps, he cannot tell us the truth, simply because as Jack Nicholson said in the movie " A Few Good Men’, "We can’t handle the truth!!"

SO

Our hunch is to avoid chasing the obvious momentum and wait for better, and more sustainable, official and anecdotal data to emerge. Beating low expectations is hardly progress. As Peter Ustinov once said: "I love the guy who aims low and misses."

BUT AUSTRALIA

…… is in relatively good shape because the Howard-Costello fiscal legacy has given us deep pockets and our central bankers are independent and are raising interest rates. Additionally, we have the China story to under-pin our economy and that appears to be relatively sustainable.

‘Argument’: A discussion in which reasons are put forward.

Collins Dictionary

There is nothing so beneficial as an argument between persons of goodwill.

Old Jewish proverb, source unknown

‘Research is to contemplate the possibility that, intuitively, you may not know the answers, and worse still, you may not even know the questions. Information insightfully interpreted will help avoid being caught in a position where you can lose a lot for reasons not understood. Try to avoid making the facts fit the theory, especially in relation to timing. Speculation is not investment. Know when you are merely engaged in speculative activities.

Ecinya Investment rule #2/ 10, July 1997

The information you have is not the information you want. The information you want is not the information you need. The information you need is not the information you can obtain. The information you can obtain costs more than you want to pay.

"Against the Gods: The Remarkable Story of Risk" Peter L Bernstein, 1996

In preparing for battle I have always found that plans are useless, but planning is indispensable.

Dwight D Eisenhower, circa 1942

 

A subscriber comment/ question from Mr Bolton 3/11/2009:

‘Do you anticipate producing detailed info on companies along the lines ETrade used to or revealing a little about the logic behind your modelling?’

 

Editor’s initial response 4/11/2009:

‘Dear Brian

 Having known you for some years now and enjoyed your capacity for meaningful dialogue and earnest debate your question requires a lengthy answer. You probably knew that, but need to maintain your reputation for mischievous behaviour. Next week’s insight issue will be devoted to our answer which should be of benefit to you, other readers, and ourselves.

 But a quick response is still warranted. ‘Do you anticipate producing detailed info along the E*Trade lines’….. the answer is yes, but not until we move into our new city premises early next year. Never forget though that Huntley’s Your Money Weekly has good coy info and nearly every company has a web-site you can easily access. Our real value is our recommendations on market direction, and when, and at what price to buy stocks. Sell decisions are mainly up to you. We really just say every week the amount we are prepared to pay for a stock. We will initiate a sell reco only if we think the stock is well over-priced/ over valued.

 BUT we will reveal a lot of the logic behind our modelling in our response to you next week, but not in so much detail that we give away our proprietary ‘secrets’. A bit like a Scotsman you have to imagine (or analyse) to a certain extent what may be under the kilt.’

 

The Bolton Response

ECINYA operates on multiple levels and these may be referred to in familiar terms of ‘top down’ and ‘bottom up’. However, it is essential that they meet in the middle as a formulated and structured basis for action. The market is so dynamic that our convictions, though firm, are changed by new information, challenged by new questions, and thwarted or rewarded by subsequent events -nearly all of which are outside our control and influence. All we are in charge of, really, is ourselves. The process of Think, Act, Review springs from our deliberations.

In the About Ecinya section we say: ‘ECINYA is an acronym for Exercise Caution In Your Affairs and is meant to remind both you, and us, that in order to get rich quickly you should endeavour to get rich slowly, as all endeavours require appropriate management of risk, and time. The stock-market from time to time appears to be an easy endeavour, but neither the economic cycle or market cycle is dead, and profits won on one adventure can disappear in the next. Folly can easily follow triumph. Those that tell you the market is easy, ‘either do not know, or do not know that they do not know’ (J K Galbraith).

Ultimately, success in the stock-market comes down to you, for no matter how much we know, the future is difficult to predict, both in relation to time and dimension. No one cares as much about your money as you do and Ecinya encourages you to develop sources that can assist you to take advantage of many sources of information. In looking at source material be mindful of confirmations and divergences of opinion. The aim of the Ecinya pages is to help you to build a set of thought processes to assist you to successfully invest, and occasionally trade. It is considered that occasional trading can enhance performance.

In defining the Ecinya approach, which is almost exclusively fundamental, our proximate matrix is 35% fundamental company, 25% the global economy, 20% the national economy, 13% technical analysis, and 7% quantitative analysis.’

 

OUR PRICING/ VALUATION MODELS

The Ecinya valuation models operate at both a macro and micro level. The macro involves a view on current and future interest rates, confidence, and the current stock-market. The macro inputs apply to our entire stock universe. At the micro level we have a rating matrix for operational and corporate credibility, excess growth potential, x-factors and gearing levels. The sum of the macro and micro gives us a ‘fair value price-earnings-ratio’ for each stock. We determine the EPS from Aegis Equities Research, consensus numbers, our view of company guidance, Huntleys, and our own formulated view on the company’s earnings profile. We DO NOT rate management, and instead assume that management is self-serving, engaged in self delusion, obfuscation, or outright lies. Over many years our editor has met just one trustworthy company that does not spin, or engage in market and self-deception. We read many annual reports, stock-market announcements etc. We have a wide range of confidants who have views on a wide range of industries. Our models give us a target price 6 months hence, 12 months hence and 18 months hence. Essentially, our models are really all about the macro and micro mathematics.

 

WATCH THE LANGUAGE

Language is important in corporate communications. So much of it is truly dreadful, and in such quantity we can only believe it is aimed at encouraging you not to read any of it. We are especially wary of euphemistic expressions like ‘robust’, ‘solid’, ‘challenging’, ‘values’, ‘governance’, ‘key performance indicators’, ‘benchmarks’ , ‘stakeholders’, etc. We are cognisant and a devotee of the ideas of Don Watson expressed in his book ‘Death Sentence: The Decay of Public Language.’ We do not like annual reports obviously written by public relations ‘experts’. Recently, we were greatly amused by the theme of the Transpacific annual report ‘365 days of progress’ following a year in which the company had to restructure, dilute shareholders, and experience a share price fall from about $10 to near $1. Also watching David Jones run full-page ads about how they were a better investment than Myer pre-float, without even mentioning their track record on EPS growth, was truly disappointing. How did responsible directors approve of such rubbish? We believe that David Jones should have received a warning from ASIC on the content of these ads. Also the Myer prospectus seemed to imply that Jenifer Hawkins was a good reason to buy shares in their over-priced float.

 

GLOBAL and LOCAL ECONOMICS

We read books, we subscribe to various web-sites and magazines. The Dismal Scientist is an expansive and expensive web-site that provides global data on a daily basis. We build macro-economic models from these sources, looking for trend and absolutes. Data is hardly ever meaningful until you have accumulated a lot of it and attempted to make the macro data fit with the market cycle and the micro stock views. The fit is never easy, but the data analysis causes you to determine confirmation or divergence. Timing is always the problem. In relation to the national economy we generally pay particular attention to ANZ Economics and Westpac Economics as we have timely access to their publications and have developed a view as to the reliability of their conclusions.

 

TECHNICAL ANALYSIS

We always look at a chart and have developed a set of principles around which we can analyse and interpret charts. Charts are described by Carl Swenlin as "a wind-sock, not a crystal ball". Our interpretive principles involve measures like moving averages, price channels, bollinger bands, trend lines, support and resistance levels, momentum etc. What we are looking for is confirmation, or divergence, from our calculated fundamentals. If our model says a stock should be going up and it is going down, it is generally clear that the market is either mistaken, or knows something we do not know. Can we find the question? Can we find the answer? The market is not always right; there are frequent divergences between price and value. We also consult with a gifted chartist whom we call ‘Compass’ and we seek his views on a regular and on-going basis. We read various chartist web-sites, mainly in relation to our global proxy, the S&P 500, as well as charts on commodities and currencies.

 

QUANTITATIVE ANALYSIS

One of our former employees developed a model built around the principles enunciated in publications by Victor Sperandeo. This was originally called the SM model, but our editor added some bells and whistles and it is now called the SMS model. It is updated daily and calculates a daily forecast on the All Ordinaries and S&P 500 indices. Inputs plus algorithms generate an answer. We describe the results as giving us confirmation, divergence, or extreme divergence. It is then up to the market to agree or disagree with the extrapolated results.

 

ICE

ICE is a simple acronym for interest rates, confidence, and earnings. Having a view on each is a handy guide to formulating our views.

 

STRATEGY

Our strategy is to be long the market and to switch between stocks and cash. We do not like the expression long-term, believing that the long-term is the result of the accumulated short-term (less than six months) and the medium-term (less than 18 months). The Ecinya Market Barometer is our short-term view reduced to a simple picture and is available on the web-site. We break our stocks into 3 broad categories: Investment Accumulate, which is about 60% of our total portfolio positions; Situations, which is about 30%; and Speculative, about 10%. In relation to Speculative this would include small and mid-cap oil stocks, gold stocks, commodity stocks other than majors, takeover targets, recoveries such as Elders, a bio-tech stock such as Bionomics, or Clean Seas Tuna. We are accumulating modest positions in a few lithium stocks at present that are very speculative, but there is an underlying story. We try to avoid ‘tips’, but are always interested in ideas and concepts.

Our Portfolio Menus under the Stock Recommendations tab segments our 135+ recommendations into Core Investments, Core Potential, Major Cyclicals and Situations, Resources, Secondary Cyclicals and Situations, Small Caps (under $250m), and Speculative.

 

TACTICS

Our tactical stance determines the shares/ cash mix. It is covered under the Strategy tab each week and comprises five tactical positions: (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, uncertain, relatively clueless.

 

IDEAS/ CONCEPTS

…..spring from discussion. Sir Alex Cairncross, talking about ‘ideas’ and John Maynard Keynes said: "I remember particularly a lecture in 1933 when he tried to convey how new ideas were born. Never did they arrive, he said, with the hard edges that later critics came to attribute to them when trying to define their terms. Ideas were apt to be like fluffy balls of wool with no fixed outline and the relationship between concepts when first perceived was likely to be equally wooly." Keynes mistrusted intellectual rigour of the Ricardian type as likely to get in the way of original thinking and saw that it was not uncommon to hit on a valid conclusion before finding a logical path to it.

 

OUR CONFIDANTS

An exchange of views between long-term colleagues is always useful. Our confidants are frequently mentioned in the Ecinya pages: DOG (the Duke of Glenorie) a macro-derivatives trader and expert on the Middle East, SOT (the Sage of Toukley) a long-term investor and short-term trader with specialist knowledge on commodities, the Delphic Oracle – a Greek fund manager of some fervour, Compass the chartist and market participant, Vector a quant analyst… There are others. We share insights, debate direction and quiz one another on fundamentals.

 

POLITICS

Much of modern economics centres around the role of government and the action, inaction, and misguided and occasionally successful outcomes of politicians. We like stability, quiet achievement, low taxes, sound fiscal policy, and sounder monetary policy from an independent central bank.

Paul Krugman in ‘The Great Unravelling’ 2003 said: "To talk about economics requires, more and more, that one write about politics."

Governments fight wars with taxpayers’ money, social inequality, and build commercial infrastructure, institutions, fly people to the moon and back, educate our children etc. All of this is understandable but there is a real problem when the private sector is squeezed by government excess, and the ‘invisible hand’ of private enterprise and innovation is stifled. Once government gets beyond about 22% of the economy we are generally troubled.

 

THE DESIDERATA

Exercise Caution IN Your Affairs (ECINYA) is an acronym derived from The Desiderata, which was written by Max Ehrmann in 1927. It is in our foundation document and has been for about the past 30 years. As is everything else that we can think of, it is available via Google.

 

No Doubt

…..Mr Bolton will be relatively satisfied with our response, but we are expecting more questions over time. We thank him most sincerely for his interest and the role he has already played in the evolution of the ECINYA pages. He has made us think; in turn, we hope we have made him think.

Our editor and The Sage of Toukley (‘the Sot’) have frequent conversations about the direction and pace of market expansion and contraction, always in a jocular and constructive context, but with occasional differences in emphasis and sometimes, significant disagreement. In fact, it sometimes is disturbing to each of us when we reach a point of unequivocal agreement. It is reasonable to say that we have discussed ‘turning points’ on many occasions over the past few years, obviously against the background of four years of excess returns. One only falls from dizzy heights. If ‘it’s too good to be true’, it often is, as investors in Westpoint and Fincorp have recently discovered.

We, Sot and editor, do agree that the world has dramatically changed in an economic sense over the past two decades, and more especially over the last decade. A lot of this, Sot and editor put down to growth in education (especially in the emerging nations), and communications, plus the end of the natural and historical advantages enjoyed by the United States of America during the bulk of the post World War ll period. Knowledge, ability and achievement of results are more widely dispersed than ever.

Our caveat though is that Sot and editor are never complacent and the debates will continue. At a fundamental level we grew up as realists and optimists and this endemic condition remains unchanged.

Ecinya’s ‘When Rooster Sot begins to crow, be careful’ issue published on the E*Trade web-site on 13/4/2007.

THE MARKETS’ ENDLESS DANCE: Economic recoveries are a waltz, and the market since the March lows has been doing the tango, the cha cha cha, and in some cases, rock and roll. Our models are suggesting that most stocks are at or near fair value and that forward earnings forecasts do not suggest a significant advance from here. Once forecasts are boosted by a more robust macro-economic picture of enduring quality, the market will have good reason to continue its advance.

Ecinya Insight 25/8/2009.

THIS is a ‘made in America’ global recession. IT IS NOT POSSIBLE for the Obama administration to have so quickly solved the problems that have caused the ‘global financial crisis’….. the GFC. All that the Keynesian response has done is to have ‘plugged the holes’. The ship is still full of water, and making its way towards the safe-haven of the shore where coconuts and fresh water are in abundance. The G20 account for 80% of world GDP and Australia accounts for 1% of world GDP. It seems that the US markets are already pricing in 4% GDP for calendar 2010 according to some economic and market commentators. America is about 20% of global GDP and for the world economy to function at, or near, a ‘normal’ level, America has to be functioning at or near its potential. ‘Potential’ is about 3% GDP growth per annum. America has not yet faced up to its systemic and structural problems, though they have begun to be addressed.

Ecinya Insight 15/9/2009

Straws and camels, questions searching for answers: Sometimes analysis is simply a question searching for an answer. Sometimes we are just looking for the straw that might break the camel’s back. After a day off to celebrate Labour Day in New South Wales, the ACT and South Australia, we began the day with a high level of uncertainty and had moved to our number 5 tactical position of ‘ambivalent, uncertain, relatively clueless’. (The other four tactical positions are outlined under the Strategy tab.) What brought this on?

Anyway, to clear his head our editor went for a walk to the bank and to buy some lunch. This caused him to think about the up-coming Myer float, which he considered to be considerably over-priced. Tactically, up until recent weeks, we stayed on the bus. We have just hopped off and decided to wait for the next bus. For us, the straw that has broken the camel’s back has been the pricing of the up-coming Myer float at between 14.3 and 17.3 times earnings when we think a reasonable multiple might be around 12 times. Based on median earnings per share of 27.8 cents, the vendors are targeting a share price/ value of $3.90 to $4.90. Our rough calculation puts us at about $3.35. But perhaps yesterday has arrived again today and perhaps the old Jewish proverb "Ecinya, you are my friend. I would not advise you to buy what I am selling" does not apply today.

Ecinya Insight 6/10/2009

JUMPING OFF THE BUS, BUT STILL AT THE BUS STOP WAITING FOR THE NEXT BUS TO COME ALONG: We have just moved to 25% cash across our portfolios including our published portfolio ‘Cactus’ where our cash balance stands at 32%. Good trading and investment is a peculiar balance between the conviction to follow your ideas and the flexibility to recognise when you have made a mistake. The problem with today’s markets, vis those of the nostalgic past, is that markets have many more participants, are more globalised, often driven by computer programs, entry and exit costs are cheaper than ever, there is an excess of bad behaviour including rampant spin from gifted professional pundits and the companies themselves. Additionally, the ASX, once it became a public company became less robust in policing bad behaviour and ASIC is always behind the curve as it is under-funded and its personnel under-trained and lacking in experience. This all adds up to one word …..’volatility’. We have long believed that a trading mentality must accompany an investment mentality if you wish to out-perform the general indices.

Ecinya Insight 20/10/2009.

IS RECOVERY CALLING?

In short, we believe the answer is ‘yes’. But the caveat is ‘what sort of a recovery?’ Our guess/ extrapolation/ forecast is that the recovery express will be somewhat volatile and uneven this side of Christmas with Christmas itself likely to be relatively subdued for most retailers and this naturally flows back into the banking, production and distribution sectors. The strength of the $A will assist profitability for local retailers as most of the stuff they sell is imported, but discounted sales will be rife. The question that we need to address is momentum (the rate of advance) of the recovery and sustainability of the recovery.

In looking at the recovery through the prism of the market our position for some time has been that the market had got ahead of the fundamentals, that speculation had returned, and that earnings uncertainty was high. None of this has changed.

Post Christmas our guess/ extrapolation/ forecast is that the question of sustainability will become clearer. To assist with the analysis, a re-visit to George Soros’ "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and what it means" might assist.

 

GEORGE SOROS

……..said : "Firm predictions are out of the question. The future depends on the policy responses the financial crisis will provoke. But we can identify the problems and analyse the policy options. We can also make some firm predictions about what the next era will NOT look like. The post-World War II period of credit expansion will not be followed by an equally long period of credit contraction. Boom-bust processes are asymmetric (not identical) in shape: a long, gradually accelerating boom is followed by a short and sharp bust. Consequently, most of the credit contraction can be expected to occur in the near term."

"The Bush administration shows no understanding of the predicament in which it finds itself. Eventually, the US government will have to use taxpayer’s money to arrest the decline in house prices. Until it does, the decline will be self-reinforcing, with people walking away from homes in which they have negative equity and more and more financial institutions becoming insolvent. The Bush administration resists using taxpayer’s money because of its market fundamentalist ideology and its reluctance to yield power to Congress. It has left the conduct of policy largely to the Federal Reserve. This has put too much of a burden on an institution designed to deal with liquidity, not solvency, problems."

 

LEADERSHIP

Sot reminded editor just this morning that "leadership should not be under-estimated when coming out of an economic crisis". Sot reminded editor of the basket case economy inherited by Geoff Kennett when he became Premier of Victoria in October 1992, following 8 years of Labor government under John Cain and 2 years under Joan Kirner.

There is little doubt that America has swung to the left under the Obama-Reid-Pelosi led Democrats with an expressed belief that more government is better than less. Harking back to March 2005 following our editor’s visit to China, the following recollection was published as part of his series "The China Diaries":

"As our editor walked back down the steps of the Hall of Central Harmony in The Forbidden City, he noticed an immaculately dressed and handsome African American reading the information board he himself had read some minutes before. Editor addressed the man: ‘Do you think George Bush would understand that?’ He replied in a wonderfully resonant voice : ‘No way man, that boy wouldn’t even come close.’ We both chuckled and moved on to the next palace. The board read:

"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."

This was a proclamation of Emperor Qianlong of the Qing Dynasty made in 1645."

Australia’s fortunes depend principally on the strength of the world economy, though we can make things better or worse by inappropriate policy. America is about 20% of the global economy and this has a flow-on impact to Asia in particular, and the world in general. Will the Obama administration return to the centre? That is the question. We are hopeful, but not yet confident and that fits neatly into the theme enunciated by Soros above.

America is not yet united behind Obama. Significant sections of the Republican party still cling to the myth that Ronald Reagan (1981 to 1989) was a competent economic manager. His administration was saved by Paul Volcker in an economic sense and America endured significant pain as hyper-inflation was brought under control. Also, Ronald’s devotees believe that he won the cold war and discount the role played by Gorbachev. It was the Reagan administration that spawned Cheney and Rumsfeld, regarded by many as substantially incompetent across a wide range of geo-political and economic landscapes. It has always been a point of some interest that both of the George Bush presidencies, father and son, inherited an economy in very sound shape and managed to exit their presidencies leaving behind a recession of some significance.

Obama has a to-do list that is awesome and covers: Iraq, Afghanistan, Pakistan, peak oil and climate change, Wall Street villains, an unprecedented budget deficit, healthcare and an aging population, a malaise in manufacturing and an intractable current account deficit, tax reform, protectionism and free trade debates. Resolution of all or some of these questions also fits neatly into the Soros theme above.

It is about the 1 year anniversary of Obama’s election win and next January will be the first anniversary of his Presidential reign. Ecinya will be looking for changes that will begin to properly address the systemic and structural problems that accelerated under Reagan more than 28 years ago. Unity will be important.

 

SO WHERE TO NOW IN MARKET TERMS?

Fundamantally the market is generally fairly fully priced. Technically we expect that 1012 and 4400 in S&P and All Ordinaries index terms should hold our market. If the S&P bounces from the evolving current 7 day down-wave and bounces above 1061 then the down-wave is questionable, and may be over. If 1012 is broken on the S&P then 992, 972, and 952 comes into focus and levels in the All Ordinaries below 4300 are possible. But at this stage we are not expecting such downside. The markets are still being manipulated and dominated by hedge funds and Wall Street villians that have migrated to the developed and emerging world. Transparency is not transparent as yet, but it will need much more than regulation to achieve properly functioning markets. Exercise caution in your affairs.