Month: April 2010

To talk about economics requires more and more, that one write about politics.

Paul Krugman "The Great Unravelling" 2003.

It can fairly be said that the chain of catastrophic bets made over the past decade by a few hundred bankers may well turn out to be the greatest non-violent crime against humanity in history. They’ve brought the world’s economy to its knees, lost tens of millions of people their jobs and homes, and trashed the retirement plans of a generation, and they could drive an estimated 200 million people worldwide into dire poverty. In other words, never before have so few done so much to so many. And has there been even one major, voluntary resignation by an American financial executive? One sincere apology? One jail sentence? Why the American public hasn’t taken to the streets in revolt is a mystery that can be linked to our inherent belief in the virtues of capitalism.

Graydon Carter Editor Vanity Fair, June 2009 issue. The magazine is an excellent source of economic and political material. Reproduced from Ecinya’s first new web-site issue of 28 July 2009. Please note we have been publishing now for 10 years.

 

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 ll 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.

George Soros "The New Paradigm for Financial Markets. The Credit Crisis of 2008 and what it means." Reproduced from Ecinya’s first new web-site issue of 28 July 2009. Please note we have been publishing now for 10 years.

 

In just that week, the Party of No’s intransigent campaign of obstruction and obfuscation went belly up. The Obama White House moved to get its act together with an alacrity lacking in its health care campaign, abruptly adding Thursday’s New York speech to the president’s schedule. The bipartisan Financial Crisis Inquiry Commission at last issued it first supoena — to Moody’s, one of the rating agencies that for a fat fee slapped triple AAA ratings on the toxic garbage Goldman packaged and sold to benighted suckers on the other end of a huge bet placed by a favored client, the hedge fund player John Paulson.

Salutary as this rush of events is, it still adds up so far to just one small step for mankind. We don’t yet know how many loopholes lobbyists will slip into the bill-in-progress. We don’t yet know the outcome of the S.E.C. case, let alone what other much-needed legal pursuit of Wall Street may follow it. And we still don’t know what, if any, true correction lies ahead for the financial sector’s runaway casino culture — much of it legal — that turned a subprime-mortgage bubble in a handful of overheated American states into an international economic meltdown.

Frank Rich, The New York Times, 25 April, 2010. ‘The Party of No’ is the Republicans.

 

The US mortgage bond market was huge, bigger than the market for US Treasury notes and bonds. The entire economy was premised on its stability, and its stability in turn depended on housing prices continuing to rise. "It is ludicrous to believe that asset bubbles can only be recognized in hindsight" Michael Burry wrote. "There are specific identifiers that are entirely recognizable during the bubble’s inflation. One hallmark of mania is the rapid rise in the incidence and complexity of fraud…. The FBI reports mortgage-related fraud is up fivefold since 2000." Bad behaviour was no longer on the fringes of an otherwise sound economy; it was its central feature. "The salient point about the modern vintage of housing-related fraud is its integral place within our nation’s institutions," he added.

From page 55 Michael Lewis’s book "The Big Short, 2010. Michael Burry was a hedge fund manager exploiting the chasm that mortgage bonds was to become.

 

Success breeds excess: America has come to believe that its profligate behaviour in relation to energy consumption, poor wages in many areas of its economy, unfunded pension liabilities, a second class education system for many of its residents, the same in health, corporate welfare, tax shelters for those who can afford them, and excess of legal mantra over common sense and good sense, rampant debt creation largely involving other people’s savings, excessive speculation via derivatives and other exotic financial instruments, poor public and private accounting, has led to a country seemingly out of control and exposed to regular crises, few of which are anticipated and after the event, the response is shambolic.

The Ecinya pages 13 January, 2006.

 

Lawrence J Kotlikoff

Mr Kotlikoff is professor of Economics at Boston University and his Curriculum Vitae can be found via Google.com.

Last week (21/4/2010) Charles Babington, Associated Press Writer, reported as follows: "President Obama suggested Wednesday that a new value-added tax on Americans is still on the table, seeming to show more openness to the idea than his aides have expressed in recent days. before deciding what revenue options are best for dealing with the deficit and the economy, Obama said in an interview with CNBC, "I want a better picture of what our options are."

This report brings into focus the essay from Lawrence Kotlikoff which appeared in The Federal Reserve Bank of St Louis Review July/ August edition 2006. The essay was titled " Is the United States Bankrupt?"

His paper concluded that countries can go broke, that the United States was going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of US financial institutions was essential to securing the nation’s economic future. The paper offered three policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy:

• A national retail Sales Tax
• Personalized Social Security
• A globally budgeted universal healthcare system.

It is interesting to Ecinya that Australia has all three of Kotlikoff’s measures in place today, not necessarily operating with a sustainable degree of perfection, but close enough. They are called:

• The goods and services tax
• The superannuation guarantee levy
• A universal healthcare system run by the state governments.

It is interesting to note that America has just one leg in place of the Kotlikoff three-legged stool and even that leg was constructed against a background of extreme angst and controversy, and has not yet begun.

 

WHY CONTINUE TO FOCUS ON AMERICA??

US gross domestic product is about US$14.8 trillion and this translates into GDP per capita of US$43,180. China’s GDP is about US$9.8 trillion and this equates to $7,350 of GDP per capita. Let us assume for the sake of argument that the USA’s GDP does not change over the next 8 years and China’s GDP continues to expand at 9% per annum. Let us further assume that China’s population stays at its current figure of 1,339 million. On these bizarre assumptions China’s GDP would rise to US$19.7 trillion and per capita GDP would rise to $US14,705, equivalent to 34% of America’s current per capita GDP per capita. It does not take much imagination to see that the world wants and needs a robust and efficient and growing United States of America.

 

BACK TO KOTLIKOFF

The GST (the national sales tax) came about in Australia because it was first proposed by the Labor Party under Paul Keating, Bob Hawke and Peter Walsh, acting on advice received from Treasury. But Hawkie decided he could not sell it to a sufficient mass of voters that would get him re-elected so he abandoned it. Mr Keating as the appointed chief salesman (later fall-guy) said he was not at all miffed, but subsequently went to the backbench and from that vantage point rolled good old Bob and became Prime Minister. The Liberal Party could see an opening during all of this so they elected John Hewson as leader who tried to sell the concept of a GST, but failed miserably, and Keating was elected Prime Minister in his own right (‘The sweetest victory of all’). Along came John Howard, sold the GST to the electorate, and the defeated Paul Keating moved to the Eastern suburbs of Sydney to join Mr Hewson in sniping at Mr Howard for the next 11 years.

What is the message? The GST saved Australia because it was sensible policy and facilitated better spending decisions, lower company and personal tax rates, fostered lower interest rates, and about 11 years of further economic expansion was added to the Hawke- Keating years, assisted,of course, by the rise of China and other emerging nations. As Keynes said: "Fundamental change does not occur quickly."

President Obama is coming to town. It will be interesting to see whether, or not, and presuming the Banking and Financial sector reforms currently going through Congress are passed, that towards the end of the year and going into next year the next major reform in America is a national sales tax. Let us hope he gets to meet John Howard to discuss the matter. Let us hope that some of his economic advisers know what is going on in Australia that might be relevant to their own country. One can only hope.

 

THE PHILADELPHIA FED APPEARS TO HAVE JOINED THE KOTLIKOFF CHORUS

Even with a GST Mr Rudd has dug a great big hole which we are in the process of falling into by declaring "We are all Keynesians now" and spending vast amounts of money on over-funded projects which either have failed or are in the process of failing or are doomed to failure beyond the next election. These of course are the emissions trading scheme debate, the $900 hand-outs and the national home insulation roll-out, the Building Education revolution, and last week the "new" health system. In relation to the latter many health professionals don’t appear to know how it will work, how it is supposed to work, who will be responsible for it working, and what it might cost. The same questions appear to apply to the proposed $43 billion national broad band network concept (is it a plan?)

We have found an edited transcription of remarks given at the Philadelphia Fed’s policy forum "Policy lessons from the Economic and Financial Crisis of December 4, 2009 by N Gregory Mankiw (an Harvard Professor) titled "Questions about Fiscal Policy: Implications from the Financial Crisis 2008-2009". It appears that the St Louis Fed is also involved in this paper’s creation.

Mankiw believes in Keynesian theory but not without reservations and suggests that enhanced government spending can inadvertently drive up interest rates and taxes. He poses a number of questions:

• Can governments spend large amounts of money quickly and wisely?
• Are the relevant multipliers that are applied to Keynesian spending correct as opposed to the multipliers that pertain to lowering tax rates? He says the Keynesian conclusions are questionable.
• Do tax rates influence work and savings incentives?
• Will healthcare legislation reduce healthcare spending?
• Is the VAT coming?

 

SHORT TERM FEARS AND RIDDLES

• The IMF has said global growth has returned to circa 4%. They didn’t know about the GFC until it slapped the entire world in the wallet. Thus we should treat their pronouncements and actions with some scepticism. Currently, their Greece solution seems to be fluid in context of rubbery Greek numbers on the depth of the ‘crisis’ and the political reality of potential solutions.
• What has emerged with Goldman Sachs thus far looks like the the first cockroach, meaning that more are sure to exist. (Michael Lewis’s book throws up a lot of questions)
• The new GDP numbers for most of the developed world have been achieved via massive fiscal and monetary stimulation so that unqualified comparisons seem misleading. Australia has moved pre-emptively on interest rates and that seems good policy in context of sub-optimal fiscal policy outcome.
• US housing is still cum the housing credit and better weather for construction.
• Can the US continue to borrow abroad at current interest rate levels? Watch 10 year bond yields.
• The Henry tax review is likely to be substantial nonsense.
• The All Ordinaries index looks weak vis the SP500.
• The SP500 looks stretched and vulnerable.
• The Shanghai index looks to be rolling over.
• The copper price looks like the Shanghai index.
• British politics looks to be complicated leading into the election.
• America believes it is a capitalist country and wants to debate socialism under Obama and capitalism under anyone else. Congress seems to be fighting old wars on dogma and confusing and disappointing main-street.

 

Don’t you see that the whole aim of Newspeak is to narrow the range of thought?

George Orwell, 1984

A powerful agent is the right word.

Mark Twain

No nation was ever ruined by trade.

Benjamin Franklin

President Bush left for Canada today to attend a trade summit. Reportedly, the trade summit got off to an awkward start when the president pulled out his baseball cards.

Conan O’Brien

ECINYA SUBMISSION: MORTIMER TRADE ENQUIRY

The following is a submission made by the Ecinya editor to the Mortimer Trade Enquiry in 2008. The enquiry was undertaken to assist the development of an integrated trade policy that would “drive productivity growth, enhance international competitiveness and improve export performance”. The ideas introduced, including an increased role for government and the importance of containing the trade deficit remain central to future growth, and as the economy shows signs of a possible recovery it is timely to review these issues.

 

1 April 2008

David

This is meant to be extremely broad brush, more in the nature of a conceptual framework rather than specific in terms of direction or solutions.

1.     The major aim of this submission is to introduce two Ecinya concepts to the debate: The expression ‘beneficial trade’ should replace ‘free trade’. The expression ‘balanced free enterprise’ should replace ‘capitalism’.

2.     Words do have a precise meaning. How can we speak of bilateral trade agreements on one hand, and ‘free trade’ on the other. Better that we look for a new expression and ‘beneficial trade’ might be the descriptive answer.

3.     It is clear that there is a role for government in relation to matters economic. The days are past when unfettered capitalism was a useful description of the way developed economies work, or a reliable framework for poorer economies to attain sustainable prosperity. The recent exotic debt implosion and the previous dot com bubble/bust are contemporary examples where capitalism has clearly failed. In each of these busts the government was found wanting. It is axiomatic that ‘socialism’ has failed, but the welfare state is far from dead. The challenge for free enterprise economies is to define the limits of government involvement, and the scope and manner of intervention.

4.     Prosperity is the tide that carries us all to realisation of our material and social aspirations and trade is an aspect of the attainment of prosperity. It is axiomatic that an effective trade policy requires a strong and balanced domestic economy. ‘Balance’ requires a viable and progressive tax system. It is obviously outside the scope of your enquiry, but one cannot but feel that while-ever we exempt food from GST we cannot achieve real tax reform that delivers reward for merit and also provides an appropriate social safety net within an efficient and targeted welfare system.

5.     The government sponsoring a trade enquiry is sufficient evidence that government aim to play a substantive and positive role in commerce. Government expenditures as a share of GDP is probably the clearest statement of all.

6.     Why trade at all? University economics tells us that overall living standards can be raised via trade. The theory was the comparative advantage would lead to the appropriate scale, best productivity outcomes, and the lowest price within a defined quality. But we now know that the expansion of education over the past 25 years or so has meant that knowledge and skills has enabled relatively poor countries to produce the goods and services that were the exclusive domain of the developed countries.

7.     “Globalisation” is the broad expression used to partly describe how the theory of ‘comparative advantage’ has become obsolete. Yet one cannot but feel that ‘globalisation’ was the American response to its inability to control the American manufacturing unions and so jobs were exported as American companies found it easier and cheaper to manufacture abroad. The longer-term and perhaps inevitable result has been the rise of Japan, followed by Taiwan and South Korea, and now China. European trade with Asia has also expanded rapidly over the past few years which is probably a belated recognition that an inept welfare system and union power has cooked the European manufacturing goose.

8.     America’s response to the demise of local manufacturing, using the advantage of being the world’s reserve currency, was to become a ‘service economy’, a nation of bankers. However, having lost the will to manufacture, America then lost the skills. Ultimately, we now have many, many products that are produced abroad that are of comparable quality – form pianos to barbeques, from television sets to cars etc. The problem ultimately becomes that a nation that produces little has to import a lot. Having lost the desire to produce, you then lose the capacity to produce on a competitive basis. Consumers, who had manufacturing jobs, end up with few jobs, and/or declining incomes, and consumption has to be propped up by lower interest rates. So you end up with the worst of all possible worlds – low employment growth, declining incomes (except for bankers), an indebted consumer, and an intractable current account deficit mainly brought about by the trade deficit.

9.     TRADE IS NOT A ONE WAY STREET: Too often when we have a trade enquiry all we talk about is exports. But IMPORTS are just as important. In looking at the trade balance we need to look at the question of import replacement. What industries do we wish to maintain our skills in? Should we maintain a basic capacity in almost everything? Why should we import olive oil and jam when we can grow our own inputs and put them in a can or jar? Why create a job in China at the expense of losing all of our jobs in that product category in Australia? What goods are we not producing, when with some investment, we could produce them? Perhaps all of these questions can be asked and solutions addressed within the concept of ‘beneficial trade’.

10. Beneficial trade means that we will import from, and export to, countries where it is beneficial to us. China buys our resources in large quantities, we buy their manufactured goods. Brazil exports iron ore to China why should we buy their farm produce when we can grow our own? We grow olives and can produce olive oil, why buy Italian olive oil in such quantities? We buy enough of their suits anyway.

11. Running a persistently high trade deficit means that we are consuming more than we are producing. This cannot last forever. It is bad longer-term policy. We need a local manufacturing policy that works, and dove-tails with our export capacities and aspirations.

12. ‘Beneficial’ might mean politically beneficial in some instances e.g. to assist a poor or emerging country to become more viable we will develop a trade relationship. We have no doubt that China has benefited from trade to such an extent that democracy is less than two decades away. As living standards rise the demand for democracy grows.

13. SO THE OVER-ARCHING QUESTIONS become: How much trade OUT do we want? How much trade IN do we want? What good and services should it be? Who with? What investment do we need now in order to get it in the right balance later? If it cannot be now, when can it be? Why trade with that country in that commodity when we can trade with another? Where are our good relationships?

14. Once upon a time in economics the real economy (the production of goods and services) used to drive the symbol economy (money and credit). That has now changed and money and credit seem to be the primary driver. But it may be swinging back with the fast reducing role being played by the US given their entrenched economic problems – twin deficits, wars over time and budget, oil prices, health, education, infrastructure. The multi-nationals are a big factor in trade flows. A dividend paid to a foreigner producing locally, is the same as an import as regards the current account deficit. Hence the role of foreign investment is another aspect of a beneficial trade policy.

15. As Rudyard Kipling said: “I keep six honest serving men, They taught me all I knew, Their names are What and Why and When, And How and Where and Who.”

16. Or as Ecinya once put it – “Research is to contemplate the possibility that intuitively you may not know the answers, and worse still, you may not even know the questions.”

1. 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.

2. "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.
Buffetology: Can we understand the business? Does it have a sustainable competitive advantage? Do we like the people? Are we getting it at the right price?

3. Trust falling interest rates to begin a new bull market. Bull markets are driven by liquidity. It takes a lot of bad news to reverse a bull market, and a lot of good news to reverse a bear market. Calculate and analyse ‘trend’ very carefully.

4. Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria. BUY when others are despondently selling. SELL when others are greedily buying. When too many people are doing the same thing the market will adjust. Bull markets are driven by liquidity.

7. Human behaviour cannot be predicted. Distrust anyone who claims to know the future. Chaos is not dangerous until it begins to look orderly. Beware the historian’s trap, beware the chartist’s illusion.

A selection from the Ecinya Investment Rules, formulated July 1997.

I keep six honest serving men, They taught me all I knew. Their names are What and Why and When, And How and Where and Who.

Rudyard Kipling.

Even Karl Marx had to be right occasionally. When he observed that capitalism contained the seeds of its own destruction, he had at least a talking point.

Boom and bust are customarily depicted as the extreme points in the regular operations of the business cycle, the comfortable conclusion being that we need not and cannot do anything about them. There are two grounds for challenging this belief. The first is that recessions do not treat all companies equally. Businesses do not collapse through any iron rules of an economic cycle but because of the greed and folly of the people who run them. Well-run companies survive the most vicious economic downturns but badly run companies don’t.The second ground for challenge is that if the business cycle is working the way it is supposed to then we had better do something to change it, because the damage being done is becoming intolerable.

Trevor Sykes "Two Centuries of Panic – a history of corporate collapses in Australia", 1998.

There are market players and value players, both in stocks and commodities. The market player relies on his knowledge of price movements in the market as a whole to make money. The value player looks for buy-and-hold opportunities in specific stocks or commodities that are likely to appreciate over time. Most consistently successful pros are both, but more the former than the latter.

Victor Sperandeo , "Trader Vic- methods of a Wall Street master", 1991.

This is not a black-and-white business.

The ‘secret’ is the shorter your time frame of trading, the less money you will make.

A perfect system or approach does not exist. Never has, never will.

Life is a judgement call, but that call is based on having data and systems to make life work better. So it is with trading. I need a systemic approach to get me in and out of trades, I need absolute stops, and I sure as heck need precise entry rules.

The first rule of life is to survive; the second rule is that all rules can be broken if that supports the first rule. In trading, always use stops.

Larry Williams "Long-term Secrets to Short-Term Trading", 1999.

 

BUY and HOLD

In seeking outperformance within reasonable risk parameters that do NOT define you as a ‘speculator’, Ecinya believes that it is necessary to trade around the edges. The buy-and-hold strategy works well in prolonged upturns, but does not prepare you for the (inevitable) downturn. Thus developing trading strategies is the pathway to outperformance. This is the approach that the Cactus Fund takes, though we do have two other unpublished portfolios that are essentially passive. Also if you are a regular reader of the Ecinya pages you will have noticed that we recently abandoned a published portfolio called ‘Bamboo’ after just 14 weeks of operation as we were of the opinion that the markets had gotten too far ahead of themselves in terms of the SP500, our global proxy, and the XAO, our local benchmark reference point.

The stock-market has changed a lot. On-line brokers have reduced the cost of doing business. Participation and knowledge has increased exponentially. Hedge funds are active and volatility has increased as a result. Overseas fund managers are comfortable with our market and about 60% of the market turnover comes from overseas brokers with all of the American majors having large local operations. DIY superannuation is common. Compulsory superannuation under-pins the market.

 

HOW, AS AN INVESTOR, DO I LEARN TO OCCASIONALLY TRADE?

1. Always make a note as to WHY you bought a stock in the first place. Have an idea or concept of price and of value.
2. THINK in terms of essentials – Rudyard Kipling might assist here. Always have a macro perspective.
3. Experiment with charts, toss them around, add indicators, access help menus to assist your comprehension of them.
4. Develop some trading and investment rules. Under the tab THINK we have four contributors who might assist in this.
5. Record and measure your investment performance, document some benchmarks.
6. Learn to read quickly, don’t expect to have perfect knowledge in an imperfect world. Watch the language.
7. Enjoy your successes, learn from your failures, but do not expect to fail otherwise you will.
8. Read Victor Sperandoe’s book (Methods of a Wall Street Master) if you read no other. After you finish it put it away then invest and trade, read your notes and read the book again. After about 5 readings you will learn to appreciate its value.
9. Read the Ecinya pages. If you have a query send us an email or a response.
10. Have some fun; golf and the market are essentially mind games.

Commentary on the above –

1. Memory is often self-serving and/ or unreliable. Even if the diary note is "Bill Bloggs said to buy it", at least you know you have not developed an opinion of your own. But a better note would be "Bill said he had bought it, i looked at it, I looked at a chart and felt good about the economy in broad terms, so I bought it. The things I liked about the stock were…." . In our Stock Recommendations our entry price is derived from our valuation models. We set the entry price at 90% of our ‘fair value’, one year hence. We do not want to buy stocks that are over-priced, or even fully priced. The Ecinya valuation models operate at both a macro and micro level. The macro incorporates 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 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.

2. In Kipling terms, apart from WHY, other questions might be: WHAT does the company do? HOW well do they perform? WHERE do they operate from? WHO runs the company? In relation to Kipling’s wisdom we have always found the ‘WHEN’ question the most vexing of all, and the ‘WHO’ question as being one that can be mostly ignored except for smaller companies where directors are often after a quick buck. 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. Bankers are often the biggest spinners of all, especially US central bankers.

In relation to having a macro perspective 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 these publications and have developed a view as to the reliability of their conclusions.

3. 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. Larry Williams says; "Charts do not make the market, the market makes the chart." "History repeats, but not with precision."

4. Knowing that you know what you are attempting to do is important. Verbal thoughts are not worth the paper they are written on.

5. Our benchmarks are – absolute and positive returns overall; outperform the All Ordinaries by at least 400 basis points (if the XAO is up 10% then we want to be up 14%).

6. 90% of the message is in the head-notes. A quick read of the headnotes can ‘put you in the picture’. Are the head-notes positive or negative? We use a tick when we understand something we are reading and agree with, a cross when we understand and disagree, and a question mark when we are uncertain as to understanding or agreement, or disagreement. In reading company announcements and annual reports 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, simply because she is beautiful.

7. Losses come with the territory. Being wrong is not a sign of weakness or failure, but staying wrong is.

8. Just do it it!! Everyone we have recommended read this book have thanked us immensely.

9. Our aim is to keep ourselves thinking and to get you to think as well. You can even profit from our errors.

10. Mae West said: "You only live once, but if you do it right, once is enough".

 

OVERVIEW

ECINYA operates on multiple levels and these may be referred to in the 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."

OPPORTUNITIES

Opportunities come in various forms. Stocks may be over-sold. A market turning point may be in prospect. ‘Fallen angels’ may represent an opportunity – Toll Holdings fits this bill. New management or new investors may have come on board. Digestion problems may have occurred as companies have paid too much for an acquisition or the integration process has not gone well. Recognising takeovers can be lucrative. Turning points represent major opportunities and do not come all that often as they occur at peaks and at troughs. In March 2009 we identified a potential turning point and documented it in our Insight article "March 2009, a retrospective". Part of that article said:

 

"MAJOR REASONS FOR OPTIMISM

There is currently no hard evidence that the bottoming process is complete in market terms and there is accelerating evidence that the local and global economies are performing ever-more poorly. BUT the market bounce will lead  the economic bounce.

The combination of lower interest rates and stimulus packages will work. The vexatious question is WHEN.  The market itself should tell us.  The bottom is a process, not an event. So expect bounces, retracements…. then at some time, consolidation…. and later a faltering advance as the good news begins to overtake the bad.

Plenty of things can go wrong.

Black swans are now in vogue and flying everywhere (disequilibrium). White swans are the norm (equilibrium) and the periods of sustainable growth over the course of history have exceeded periods of severe, or soft, recession. One recession in a long period of growth (though some of it was fraudulent) does not seem unreasonable.

Using our ancient acronym of ICE – Interest rates, Confidence and Earnings we can currently say : Interest rates are going down, Confidence will return only when global confidence has a bounce, and soon the EARNINGS focus in Australia should be on fiscal year ended 30 June 2010. IF analysts behave as they have in the past, earnings forecasts will be wound back excessively as this reporting season passes.

ANECDOTAL EVIDENCE IS IMPORTANT IN ANY TRANSITION FROM EARNINGS DECLINE TO EARNINGS RECOVERY. MARKETS DON’T RECOVER FROM A SINGLE CATHARTIC EVENT, BUT FROM AN ACCUMULATION OF DATA AND A GRADUAL RE-BUILDING OF CONFIDENCE.

The world economy is still running at around $US70 trillion compared with $60 trillion in 2006. The BIG thing that has happened is the implosion in the American banking system and the flow-on impact to the real economy – “From Wall Street to Main Street.”

ECINYA’S theme for 2007 was “A year of living dangerously within a framework of cheerful paranoia” – there was an expectation that Mr Market wanted to take some of our profits. In January 2008 the theme in our Overview was “A tale of two halves and the long good bye to two half-wits”….. Messrs Greenspan and Bush.

BUT the downturn evolved slowly in 2008 and then the US banking implosion, and its still unfolding disclosures, hit with sudden force and this completely negated prospects for early recovery. Direction was well anticipated, dimension was not.

Remember that we live in a fiat money system. 

Bill Bonner (2007) expressed it well, with just a tinge of cynicism : "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 – hiring workers and ordering machinery. Pretty soon there is a boom."

Ecinya comment: Stimulus should work, but some of it will be well and truly wasted.