Month: March 2010

"My genuine concern for Australia is to pay very close attention to the macro-economic and micro-economic issues that will determine our future. Ideological objectives along with philosophical goals will not get us there and being lucky will not be enough. The successful leaders of today must understand that their power rests with the people for whom he or she is responsible. To tap that power the leader must abandon the old baggage of dominance, control and self-centredness."

The Hawke and Keating governments, for example, are singled out as particular milestones of national progress. Both leaders represented a ‘new breed’ of political leadership that was "not blinded by the ideologies of the past " and their governments had "courage and the foresight" to drive reforms that sustained improved productivity and national competitiveness. [Argus] says the Hawke-Keating macro-economic reforms were underpinned by a sustained, relentless and exceedingly well informed micro-economic agenda. By implication, Argus is unhappy with the economic logic that drives the Rudd government.

Interview with Don Argus, retiring Chairman of BHP, The Australian 25/3/ 2010.

Financial Market recovery: It is helpful that the global financial system is gradually recovering its poise, after a near-death experience eighteen months ago. Perhaps like a patient that has suffered an acute cardiac event, there has been some lasting tissue damage, but quick intervention avoided something much worse. A period of emergency life-support has been, followed by a period of recuperation, with some ongoing medication, during which the patient has been able gradually to resume normal activities.

The Banking Sector: The challenges that remain ahead for the banking sector in major countries nonetheless remain considerable.

Challenges from Sovereign Debt: For several important countries there was a trend increase in debt-to-GDP ratios going on before the crisis occurred. It is these more deep-seated trends that are really the greater cause for concern. So a number of advanced industrial countries face some difficult fiscal decisions over the years ahead. Unless a credible path to fiscal sustainability can be set out, growth could easily be stunted by rising risk premia built into interest rates as markets worry about long-run solvency.

Economic Recovery: In the United States growth spurred by a swing in the inventory cycle is thought to have marked the turning point in the second half of 2009, but most observers still expect only moderate growth this year. In Europe, the momentum for recovery has been less certain. In important emerging countries like China, India, Brazil and a number of smaller east Asian countries the letter ‘V’ is a reasonable description of the the trajectory to date. (But) we should expect to see some moderation in the pace of growth of production in some of these cases this year.

Glenn Stevens, Governor Reserve Bank, 26/3/2010.

Credit and debt, in short, are among the essential building blocks of economic development, as vital to creating the wealth of nations as mining, manufacturing, or mobile telephone. Poverty, by contrast, is seldom directly attributable to the antics of rapacious finaciers. It often has more to do with the lack of financial institutions, with the absence of banks, not their presence.

Niall Ferguson, "The Ascent of Money", 2008.

 

WHAT IS THE RESERVE BANK GOVERNOR TRYING TO TELL US?

In our view the Governor is saying that we have not yet returned to normal in economic terms, in banking, debt, and growth terms. Australia may be in better shape than most, but we are still dependent on the global economy returning to ‘normal’ as soon as possible. The time table is unlikely to be calendar 2010 though by year-end things should be clearer. Oblique references to ‘some countries’ and ‘several important countries’ seem to refer to the USA and Britain, but protocol demands that inference is better than outing.

Yesterday the Governor also took the unprecedented step of giving a TV interview specifically to warn people about assuming interest rates will remain low as they accelerated their housing purchases.

Australia is dependent very much on growth in the world economy and interest rates are moving up in a pre-emptive move against (asset) inflation. The RBA is giving itself plenty of scope to halt rate rises, or even to ease, if world growth stutters.

 

WHY CAUSE FOR PAUSE?

In summary –

• China is trying to slow its economy.
• The USA is far from out of the woods and the printing press limits to prevent deflation are near to being exhausted.
• The trade and currency tango occurring between the USA and China.
• Australia is raising interest rates.
• Ecinya has a suspicion that the first half of calendar 2010 is far from robust and 2010 full-year earnings will be a subdued base for a number of companies .
• Forecasts for local 2011 earnings are generally high and will come under strenuous review once 30 June 2010 arrrives.
• The SP500 has hit an intermediate peak at 1174, some 68% off its March 2009 lows.
• The XAO is similarly 55% off its march lows.
• Momentum in both the US and Australian markets is slowing.
• Political uncertainty in Australia is rising with waste apparent in several government stimulus programs.
• First quarter US growth is a confusion with reputable pundits split below 2% and above 3.5%. Our suspicions veer to the lower end of the forecast range.

We have stressed patience over the past few weeks in "Ah Magoo, you’ve done it again" , "Patience: The hardest of the market disciplines" and "Watching, waiting, wary." However, you can observe that we have stayed fairly fully invested up until this week.

 

WHAT TO DO?

An ECINYA investment rule says: "Good trading is a peculiar balance between the conviction to follow your ideas and the flexibility to recognise when you have made a mistake. In a bull market focus on price & momentum, a bear market focus on valuation."

The stock-market is currently bullish, but in our view the market momentum is elevated enough to think about taking some profits plus the gap between perceived value and price has narrowed sufficiently to support such action. Accordingly, we have turned the Bamboo account entirely to cash after 14 weeks of operation, and created some cash in Cactus (see Ecinya Funds). However, there are still stocks where the valuation parameters are favourable and these stocks are contained within our Stock Recommendations. However, the market is, in our view, more of an ‘accumulate’ market than an outright ‘buy’.

Long range plans engender the dangerous belief that the future is under control. Try to stay flexible, open minded and sceptical. Good trading is a peculiar balance between the conviction to follow your ideas and the flexibility to recognise when you have made a mistake. In a bull market focus on price & momentum, in a bear market focus on valuation.

Ecinya Investment Rules 8 & 10, formulated July 1997.

Quincy Magoo is a cartoon character created at the UPA animation studio in 1949. Mr Magoo is a wealthy, short-sighted retiree, who frequently gets into sticky situations as a result of his near-sightedness, compounded by his stubborn refusal to admit the problem. People impacted by his various calamities tend to think he is a lunatic. After each triumph (calamity to others) Magoo exclaims "Ah Magoo, you’ve done it again!"

Edited extract from Wikipedia

Games played amongst even professional investors of Old Maid, Snap and Musical Chairs can be played with zest and enjoyment, though all of 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 those newspaper competitions in which the 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 genuinely 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 practise the fourth, fifth and higher degrees.

John Maynard Keynes circa 1936

 

OVERVIEW

Ms Magoo has joined the ranks of the Ecinya confidants, people we talk to on a regular basis who are market participants, aware of our views as we are aware of theirs. Since about 4 March Magoo and our editor have diverged on their market view. Magoo is fixated on levels of 5200 for the All Ordinaries and 1200 for the SP500 prior to a significant turning point occurring. Frustratingly for editor, Magoo has been correct in her assessment since the beginning of March. Under intense questioning, editor has asked Magoo "Why?" and Magoo throws a document at editor presented to her by editor some years ago, and says "Six prettiest girls!".

Editor is of the opinion that a tradeable turning point will occur before 5200 and 1200 and hopes to be over-weight cash at that time.

On 4 March we said; "In relation to the All Ordinaries index, the last downwave low was 4544 and as we go to press we are sitting at 4702, a mere 3.5% above the downwave low. The reporting season has been satisfactory, but not outstanding. In looking at 100 of the majors that have reported, about 28% have increased their interim dividend and a few companies have declined to give guidance. This suggests that though the worst may be over for most companies, caution is still a dominant theme. Also the interim report of Toll Holdings was a disappointment as Australia’s largest transport operator is suggestive of a sluggish economy. Though Australia avoided a technical recession in 2009 this had more to do with Australia’s robust financial position going into the ‘global financial crisis’ than management of the crisis once it came to pass. Summary: Our tactical position is ‘Going with the flow, without conviction’ and we are ‘comfortable’ and NOT ‘confident’, ‘bullish’, ‘very bullish’, and certainly not ‘euphoric’."

Editor has moved from ‘comfortable’ to ‘concerned’ as markets drift higher with the SP500 (our global proxy) and the All Ordinaries because the context does not feel at all conducive to further upside momentum at the moment and our position is fluctuating on an intra-week basis from ‘uncertain’, ‘relatively clueless’ to ‘comfortable’, to ‘concerned’.

WHAT ARE THE CONCERNS?

The markets have developed a speculative tone which is manifesting itself in two ways. Firstly, that a strong global economic recovery is surely happening. Fiscal 2011 forecasts are bullish; in our view, prematurely bullish. Secondly, local resource stocks, many in the ‘penny dreadful’ category, are rising indicating that people are looking for ‘easy’ profits. "Investment is not speculation" and to further emphasise the point we stress "speculation is not investment".

1) Strong global recovery: The economic stats are coming off such a low base that they are frequently said to be ‘exceeding expectations’. America is forecast to be providing 24% of total world growth for calendar 2010. But consider the following summary provided by James Quinn of quinnadvisors.com:

"Economic Factor	Peak to Trough So Far (as at 4 March 2010)
Real GDP Decrease	3.7% real decline from December 2007 until June 2009 totalling $500 billion
Personal Income	Personal income declined by $339 billion from mid-2008 to the 1st Qtr of 2009
Investment	Fixed investment has declined by $543 billion, or 24%, since December 2007
Unemployment	There are 8.1 million less people employed today than in 2007
Industrial Production	Has fallen 12% since 2007
Bankruptcies	National bankruptcies have risen from 800,000 in 2007 to 1.4 million in 2009, a 75% increase
Trade	Exports and imports declined by 22% and 31%, respectively, between July 2008 and June 2009
Currency	The USD has fallen 17% in the last year versus a basket of world currencies
Bank Failures	140 banks failed in 2009, with 700 banks in danger of failing, according to the FDIC"

 

In relation to bank failures some 26 banks have failed in Calendar 2010. Mr Quinn does not mention the fiscal difficulties being experienced by about 10 major US states, including California which on a stand-alone basis would be the world’s 6th largest economy. The Wall Street Journal Economics survey for March 2010 has 28% of their 57 economists with a GDP growth forecast for 2010 below 2.5%, and 9% below 2.0%. Consenus has moved since the February survey from 3.0% to 2.9%.

China is said to be in a speculative bubble involving mainly property speculation on the part of both investors and developers. There are many blog editorials on this subject. Doug Noland of Credit Bubble Bulletin encapsulates these views in the following transcripts –

China Bubble Watch:

March 17 – Bloomberg (Sophie Leung): "The World Bank indicated that China… should raise interest rates to help contain the risk of a property bubble and allow a stronger yuan to help damp inflation expectations. The nation’s ‘massive monetary stimulus’ risks triggering large asset-price increases, a housing bubble, and bad debts from the financing of local-government projects, the… World Bank said… The group raised its economic growth forecast for this year to 9.5% from 9% in January."

March 17 – Bloomberg (Bei Hu): "China is in the midst of ‘the greatest bubble in history,’ said James Rickards, former general counsel of hedge fund Long-Term Capital Management LP. The Chinese central bank’s balance sheet resembles that of a hedge fund buying dollars and short-selling the yuan, said Rickards, now the senior managing director for… Omnis Inc. ‘As I see it, it is the greatest bubble in history with the most massive misallocation of wealth,’ Rickards said…"

March 17 – Bloomberg (Jeremy van Loon): "China replaced the U.S. as the biggest investor in renewable energy for the first time in five years as the Asian nation raced to meet rising demand for power and reduce carbon emissions. China invested $34.5 billion in wind turbines, solar panels and other low-carbon energy technologies in 2009… The U.S. spent about half as much last year…"

 

CONCLUSION

Despite Ms Magoo’s pleasure in being ‘ahead of the curve’ and ahead of us, we are remaining sceptical in this market, adding to value positions, and taking short-term profits as they appear. However, based on the quant and technical aspects of the market, Magoo could be right for the month of March.

It is unlikely that God’s plan for the universe includes making you rich. Success in the stockmarket requires effort, discipline and patience. 90% of success is having the discipline to be consistent.

Ecinya Investment rule #1/ 10, July 1997

The task of a man is not to see what lies dimly in the distance, but to do what lies clearly at hand.

Thomas Carlyle, 1838.

Patience is a minor form of despair, disguised as a virtue. Patience is sometimes considered a virtue when it is merely a case of not knowing what to do.

20,000 quips & quotes edited by Evan Esar, 1968

A wise man seldom fails because he anticipates problems.

Feng Menglong

Domestic Economic Conditions: A significant amount of data had become available since the previous meeting ….Overall, these data had tended to be quite firm………Business surveys were generally showing that business conditions remained at fairly healthy levels. Surveys showed business confidence and hiring plans to be relatively high, but also suggested a degree of caution in many businesses’ investment plans. This was consistent with the recent ABS Capital Expenditure Survey, which suggested that investment outside of the mining sector was expected to remain relatively subdued.

Members noted that the contraction in business credit had slowed noticeably; the January data showed a decline of 0.1 per cent in the month, compared with declines of more than 1 per cent per month a few months earlier. Loan approvals had started to rise and the rate of repayments by firms was estimated to have begun to fall. More generally, banks were now reporting greater willingness to lend to businesses and there were fewer reports from firms of very tight credit conditions, while liaison indicated falls in risk margins paid by some borrowers.

The retail trade data had suggested relatively subdued sales in December but solid growth in January. Household surveys suggested that households were fairly confident overall about the future but (like businesses) were somewhat cautious in their views about spending.

The market for established housing had been very buoyant, with auction clearance rates at high levels, notably in Melbourne. Data for housing prices suggested that nationwide prices had continued to grow at a rate of close to 1 per cent per month in December and January. Building approvals in December and January were running at a relatively high level compared with the past year, but at a rate that was below the levels of previous peaks in home-building. Data for housing loan approvals had declined somewhat recently, consistent with what had occurred in previous episodes of monetary policy tightening. The recent falls were concentrated in approvals to owner-occupiers, with approvals to investors increasing, particularly in Victoria.

There had been no new data on consumer price inflation over the past month. However, the data for the wage price index for the December quarter indicated that growth in private-sector wages had remained quite low, while public-sector wage growth had remained firm. Overall, the staff still expected consumer price inflation to be around 2½ per cent over 2010.

Selected passages from the Minutes of The Reserve Bank of Australia dated 2/3/2010, released 16/3/2010.

 

ECINYA COMMENT

Two weeks ago we were of the opinion that March would be a good month to stay long and strong in equities. Then last week our technicals and quant data indicated that markets were hesitating and that an imminent retracement might be on the near-term horizon. Over the past fortnight news has surfaced that China may be in bubble territory, particularly relating to property speculation. The Shanghai composite index has retraced some 11% from December 2009 to date, and this provides some support to the emerging thesis that China growth may be slowing as the Chinese fiscal and monetary authorities focus on withdrawing stimulus from the economy. Trade and currency tensions are rising between China and the USA.

Locally, many of the people we speak to are wary of the sustainability of the recovery with some of the view that ‘it is not happening’.

Though ‘patience’ can easily be described as ‘not knowing what to do’ we are remaining cautious and have withdrawn funds from our portfolios, including Cactus.

 

OUR FUNDAMENTAL FEAR LIST FOR 2010 was contained in our Overview paper published on 12 January, 2010

We set out below those expressed fears in bold, followed by our current view:

America economic aggregates, and policy settings; negative trends in employment, current account and domestic deficits: The economic aggregates in America have worsened considerably over the past 3 months, with persistently high unemployment levels and rising public debt levels. Australia’s domestic deficit appears to be driving interest rates up and the stimulus package policies appear to have been substantially mis-managed.

The aftermath of American foreign policy history and its implications for global resource allocation and growth: The oil price has risen above US$80 per barrel and tensions between Israel, Iran and Palestine remain elevated. America appears to be losing patience with Israel.

The global economy and the possibility of growth rates disappointing as stimulus is withdrawn: This remains a real fear but official GDP numbers have not been revised down at this point in time. We remain sceptical and suspicious as Europe is slowing and the first quarter in the US appears to be sluggish. The Chinese Premier has warned of a double-dip global recession, led by American imbalances.

The lead into various elections around the world that might encourage profligate fiscal behaviour (UK, Australia, and US mid-terms are on the horizon): This is happening and is likely to accelerate as election dates are announced.

Higher global and local interest rates, particularly the latter, in context of rising inflation: Because ‘the global recovery’ is still in doubt, interest rates are likely to be subdued, though the Reserve Bank of Australia has acted pre-emptively and is ahead of the curve.

The unintended consequences of additional stimulation: Insulation batts and the schools building programme, centre-pieces of the last stimulation, are illustrative of this fear.

Another major institutional failure in the USA: Fannie and Freddie still under pressure, but no new notable failures in evidence.

A downgrade of US debt: Moodys have warned Britain and the USA that their AAA rating is in doubt, and probably under review.

China having a few problems which are currently overlooked such as slowing exports, failures in the small business sector, and non-performing bank loans: China fears are on the rise.

Rising taxation levels. In Australia this will be euphemistically called ‘tax reform’: The Henry Review has been withheld.

A break-out in local wages: Good news, not happening.

Unemployment staying persistently high: Real unemployment (adjusting for under-employed and casual workers) is still too high here and abroad.

Commercial property values globally: Commercial property is generally soft.

Municipal and state failures in the USA . The 10 most troubled states in the USA are Arizona, California, Florida, Illinois, Michigan, Nevada, New Jersey, Oregon, Rhode Island and Wisconsin. Other states, not far behind, are Colorado, Georgia, Kentucky, New York and Hawaii.

US local bank failures (144 banks have failed since December 2008 and more are said to be at risk): An additional 26 US banks have folded in calendar 2010.

 

THE RESERVE BANK MINUTES

A reading of the full transcript is recommended. Particular note should be taken of the qualifying adjectives and sentences e.g. ‘mixed’, ‘significantly’, ‘quite firm’,’ appeared’, ‘relatively’, ‘somewhat’ etc.

Go placidly amid the noise and haste, and remember what peace there may be in silence. Exercise caution in your business affairs; for the world is full of trickery. But let this not blind you to what virtue there is.

Max Ehrmann, ‘The Desiderata’, 1927.

 

Ecinya Comment

Over the past two weeks the market has not surprised us, but we have entered limbo-land waiting for the next move. It is easier to relate to our published portfolio (Cactus) to explain our mood and reflect on where we might be.

We are holding 50 stocks costing around $726,000 and currently worth around $683,000. These stocks have been funded by circa $466,000 of cash, realised gains of $246,000 and dividends and interest of $14,000. The Cactus Fund started on 6 January 2009 and progressed until March 2009 in a relatively passive way. Activity accelerated after 31 March, 2009. The returns have been very good and exceeded our benchmarks.

For the past 7 weeks Cactus has stood still with unrealised losses averaging about $41,000. All of these losses are contained in 7 stocks – Ceramic Fuel Cells, CMA Corporation, Primary Healthcare, Galaxy Resources, Clean Seas Tuna, CSR, and Redflex Holdings. Apart from Clean Seas we remain comfortable with these holdings whilst appreciating that ‘the market’ is disinterested.

Technically, the XAO enjoyed a 7.5% advance for the 51 days to 19 January 2010, folllowed by a 6.5% retracement for the 19 days to 15 February. The current XAO upwave is now 15 days old and the advance has been 5.4% or some 249 points, equivalent to an average of 36 basis points per day. This is all good, steady stuff.

Why then in limbo? We guess the answer lies in the fact that we cannot identify a catalyst that will dramatically drive the market higher in the short term, but a few things are possible. Firstly, we are about to enter the northern spring and economic activity in that hemispere traditionally picks up as the snow melts and the sunshine appears. Secondly, in Australia and elsewhere house prices seemed to have ceased their dramatic fall. Our local banking system is only wounded, but not broken, and lending is slowly on the mend… we emphasise slowly as banks seem to have A, B, and C class customers. The reporting season was, overall, satisfactory. So it all comes down to takeovers. That would give us a boost!

So we are watching, waiting, and wary.

 

Technical points of interest.

Our global proxy, SP500, reached an intermediate, post-crash high of 1150 on 19 January and XAO reached 4936 the day prior. SP500 is within 1% of that intermediate peak and XAO is within 2% of its intermediate peak. Keeping it simple, watch 1127 and 1115 on the SP500 and around 4725 on the XAO.

 

Context

Economic stats are getting better, but they are cum-stimulus and coming off low bases. Sustainability remains elusive.

 

Brevity

This is a brief article, well outside of our normal offering. Sometimes it is better to do nothing. Sometimes it is wise to remain silent.

The reaction to US foreshadowed stricter regulation of the financial world has caused reported falls in stocks across the board. This is an interesting reaction to a scenario that theoretically promises greater stability, less risk, less volatility and less room for manipulation than presently is available. I would be interested in Ecinya’s rationale as to why it considers the market is correct in falling when, to the layman, the promise of a more reliable less risky market place should make the market rise- or could it be as simple as the manipulators cashing in to go and play theft somewhere else?.

Brian Bolton, an Ecinya subscriber, 26/1/ 2010.

While I can understand the logic of your views on the Greek crisis, and the sovereign debt issues washing over the PIIGS, where are the solutions?

Prince Geoffrey, an Ecinya subscriber 22/2/ 2010.

There can be no respect for the truth without respect for the language. Only when language is alive does it have a chance. As the powerful in legend turn the weak or vanquished into stone, they turn us into stone through language. This is the essential function of a cliche, and of cant and jargon: to neutralise expression and ‘vanish memory’. They are dead words. They will not do for truth. When journalists ignore abuses of the public language by people of influence and power, and reproduce without comment words that are intended to deceive and manipulate. When this happens journalism ceases to be journalism and becomes a kind of propaganda; or a reflection of what Simone Weil called ‘the superb indifference that the powerful have for the weak’.

Don Watson in "Death Sentence: The Decay of Public Language", 2003.

Perceptions of the potentially distorting nature of large donations – either cash or other resources – to political parties will degrade the public’s trust in the integrity of the political process.

Senator John Faulkner 17/2/ 2010.

 

CONTEXT

The questions "Where are the markets going?" and "What happens next?" are obviously constants, and opinions are always divided. In fact it is a reasonable observation that when there is a substantial consensus it is liable to be wrong. In relation to ‘crises’, they can be real or imagined, and sometimes even convenient. The written word sets an opinion in stone, but the writer will change his mind as the data and/ or circumstances change. Also each person must interpret advice in context of his own positions and his own aspirations, and tolerance for risk. This is why we talk of ‘strategy’ and "tactics’ under our weekly Strategy tab and run a couple of portfolios using real money which attempts to impose some discipline upon ourselves.

Our current reading of the markets: Our global proxy, the SP500 is above 1100, closing last night at 1115. In the 19 day downwave which (on our calculations) finished on 15 February, the downwave low was 1057, about 6% below current levels. At the same time we are seeing some improvement in the US data that indicates that the USA will enter spring in better shape than the gloomy periods of Autumn and Winter of 2009/2010. Wherever the SP500 goes, any fall of 2% in a day or 3% in a week will be viewed with some concern. This translates into an SP500 level of 1092.

In relation to the All Ordinaries index, the last downwave low was 4544 and as we go to press we are sitting at 4702, a mere 3.5% above the downwave low. The reporting season has been satisfactory, but not outstanding. In looking at 100 of the majors that have reported, about 28% have increased their interim dividend and a few companies have declined to give guidance. This suggests that though the worst may be over for most companies, caution is still a dominant theme. Also the interim report of Toll Holdings was a disappointment and as Australia’s largest transport operator is suggestive of a sluggish economy. Though Australia avoided a technical recession in 2009 this had more to do with Australia’s robust financial position going into the ‘global financial crisis’ than management of the crisis once it came to pass.

Summary: Our tactical position is ‘Going with the flow, without conviction’ and we are ‘comfortable’ and NOT ‘confident’, ‘bullish’, ‘very bullish’, and certainly not ‘euphoric’.

An Interesting chart

This chart plots the course of the SP500 over successive up/down waves. It can be seen that the up-waves are getting weaker, indicating momentum loss, but the down-waves are of short duration and dimension from 2009

Our response to Mr Bolton

Markets work in the immediate past, the foreseeable future, and some commentators have a sense of history. Re-regulation of the markets will not automatically provide greater stability, less risk, less volatility, nor less room for manipulation. The markets always reflect the prevailing opinions and mood, and are never ‘correct’, in a strict sense. There is always a buyer and a seller, and one of them is right or wrong. There will always be mispricing and differing opinions of ‘value’. There was, and is, plenty of ‘regulation’ to control excesses, both accidental and fraudulent. Rather, the problem was to do with the inability of American regulators to recognise risk and in some cases to not act upon information and insights that clearly pointed out the risks involved in the American markets, and global markets generally (Madoff, IAG, sub-prime, General Motors).

The SP500 peaked at 1520 on 6 November, 2007 and the All Ordinaries peaked at 6853 on 1 November,2007, and are still 30% off their peak, though about 50% above their retracement lows. As early as 16 April, 2005 Paul Volcker in his full page article in The Washington Post – "An economy on thin ice" said: "Yet, under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks – call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What concerns me is that there seems to be so little willingness or capacity to do much about it."

That Mr Volcker, a doyen amongst practical economists and central bankers, was ignored for so long, indicates that the failings were of personnel, not regulation. And he was not alone then, or subsequently.

 

Our response to Prince Geoffrey

As a European, Prince Geoffrey sees a lot of the world on his frequent travels and in one of his university honorariums gets to speak with many academics and people involved in economics and the markets. The Prince cries out "Don’t tell me what I already know!" But, I respectfully point out that if we know so much and don’t act upon it, then what do we really know? (This is said with love and affection.) The Prince has been caught with his pants down on some occasions as he sticks to his well-worn thesis: "I am a long-term investor". So Prince, here are Ecinya’s solutions, specific to Australia:

• Australia should move to a 4 year Federal parliamentary term with a minimum period of 3 years. Ecinya is not in favour of fixed terms.
• Australia needs to get back on track with tax reform. We fear that the Henry Report will fail to address real tax reform and fail to impress us, you, and others.
• Donations to political parties should be abolished and a pool should be established to distribute donor cash – please see the Insights article Crony Capitalism: Capitalism’s Cancer. Crony Socialism: Socialism’s Endemic Malady
• The GST should apply to all goods and services, including food, and a raft of state and Federal taxes and charges should be abolished such as payroll tax, insurance taxes etc The Australian Treasury publication of August 2008 identified 125 different taxes imposed on Australian households and businesses.
• Capital gains tax should be ammended to define all capital gains as income and taxed on a sliding scale based on the time assets are held with nil taxation applying after say 7 to 9 years. Too many assets, particularly property, are being held in long-term hands because of the tax liability that would crystallise on sale. Capital velocity is important in a dynamic economy.
• The perennial, and mostly self-serving, debate about capitalism and socialism should be replaced by the expression ‘balanced free enterprise’. Peter Drucker often talked about the end of ‘capitalism’ and that it had, in fact, ceased to exist. He said on one interview occasion "Although I believe in the free market, I have serious reservations about capitalism. Any system that makes one value absolute is wrong. Basically, the question is not what are our rights, but what are our responsibilities." Balanced free enterprise would involve a defined role for government in the economy – say in good times government, expenditure should not exceed 20% of GDP; in bad times, it might float up to 25%.
• Companies should report annually every 3 months with a full year statutory report at the end of each 12 months. Continuous disclosure should be rigorously policed.
• Yellow cards should be issued to companies who transgress, obfuscate, engage in misleading or deceptive conduct. Three yellows and you get a red, and a visit from the corporate regulator follows. Myer, David Jones and Transpacific should have received yellow cards over the past few years, in our view.
• ASIC should be properly funded.

 

THE MARKET GENERALLY LEADS THE ECONOMIC RECOVERY

Investors can usually rely on the stock-market to foreshadow economic recovery and this particularly applies when the bust is cyclical in nature. This current bust has been somewhat structural in nature with massive failures in banking, oversight, fraud, and careless corporate behaviour. In relation to forward economic estimates about 60% of global growth of US$1.5 trillion for 2010 is forecast to come from just 3 countries, 30% from China, 24% from the USA, and 6% from India. American bank credit is limping and banks are reluctant to lend to the small business sector. In Australia a glance at the RBA statistics indicates that year on year residential mortgage borrowing are up about 10%, property investment borrowing are up about 4%, but business loans are down about 9%.

We continue to talk about the three economies- the real economy being the production of goods and services, the symbol economy – money and credit-, and the political economy. Clearly, the symbol economy is lagging the recovery and banks are reluctant to lend. Our concerns with the political economy are all to do with misallocation of resources and we are witnessing the insulation fiasco. Shortly, the school buildings programme will become a front page headline and this will dwarf the insulation debacle for waste. All government waste is paid for in higher interest rates and higher taxes.