2010 retrospective

Economists never know anything until about twenty years later. There are no slower learners than economists. There is no greater obstacle to learning than to be the prisoner of totally invalid but dogmatic theories. The economists are where the theologians were in 1300: prematurely dogmatic.

The days of the welfare state are over, but we are not going to abolish it. We have to find its limits. What are the limits? At what point does welfare do damage? This is the real question, and its brought up by the success of the welfare state. The problems of success are the basic issues ahead of us.

No matter who is in power, he would no longer believe in big government and would preach cutting expenses and would do nothing about it. This is because we, the American people, are at that interesting point where we are all in favour of cutting the deficit – at somebody else’s expense. It’s a very typical stage in alcoholism, you know, where you know you have to stop – tomorrow.

Peter Drucker, 1985 interview with Tom Richman of ‘Inc’.

America is facing conditions that are highly volatile. On the right, rage is all the rage. Progressives, meanwhile, are awash in disappointments, finding it hard to come to terms with the fact that this president is just not that into them. And America’s middle class is facing a very uncertain future. Wall Street may have its casino up and running again, but Main Street shows no signs of bouncing back anytime soon. Awful statistics – on bankruptcy, unemployment, home foreclosures – flash warnings that the middle class is under assault, and that America risks turning into a third-world nation.

Arianna Huffington’s contribution to The Economist’s ‘The World in 2011" published December 2010.

Mis-reading a putt is not a problem. If you then mis-hit it there is a good chance that it will go in the hole.

Our editor talking about golf.

People who make their living looking into crystal balls are destined to eat a lot of broken glass.

Larry Williams ‘Long-term Secrets to Short-term Trading’ , 1999.

OUR HEAD QUOTES EXPLAINED ( 90% of the message is in the head-note)

  1. Economists, central bankers and politicians who let us down badly in 2008 and 2009 are now leading us back to the promised land of prosperity. We should be careful, and remain watchful and sceptical.
  2. Ms Huffington has succintly defined the starting point for 2011, but may be being prematurely pessimistic as America has great capacity to re-invent itself, or to be delusional in perpetuity. Both conditions are dynamic not static, and if clearly recognised, can lead to progress and profits.
  3. To a large extent Ecinya got it right in 2010, but for some of the wrong reasons. More on this below.
  4. Just a reminder to you and to us that a view or thesis once expressed then requires constant vigilance to determine confirmation or divergence.

 

A SUMMARY OF OUR 201O OVERVIEW INSIGHT ARTICLES PUBLISHED 12/1 and 19/1/ 2010

In January of 2010 we said : "Though we regard the primary trend for 2010 to be UP, volatility will be a feature as the recovery will be complex. Most of the forecasters will have their moment(s) of directional accuracy, but will not be right for the entire year. Distrust any forecaster who just gives you a year-end index figure, which is a simplistic and lazy forecast, and relatively worthless."

"2010 will be a difficult year simply because we had a complex recession with misleading and deceptive behaviour from many institutional and market related sources. Political correctness, self-interest, and convenient informal conspiracies have combined over the past decade to induce complacency and to mute criticism of behaviours that were near to fraudulent at worst and criminally careless at best, in relation to this credit crisis and the last tech/ telco crash. These institutions include bankers and brokers, government ministers, long-term fund managers, hedge funds, companies, the accounting profession, ASIC, the ASX, the IMF, and central bankers. Thus the natural tendency of market participants and informed commentators towards scepticism has been in retreat, and, to varying degrees, we have been slapped in the wallet by yet another harsh dose of reality. The commentariat has polarised into rampant bulls on one side of the debate, and negative zealots on the other. The response of the thoughtful should be to develop a strategy around viable data, consonant with an effective review and monitoring process. Only the nimble can outperform the swirling mass of ‘noise’ that hits us on a daily basis."

Our overall macro conclusions were

  • "Recovery with retracements, recovery comprising muted, subdued advance …….. 60% probability
  • Double dip recession, more and/or new stimulus, secular bear overtakes…………..33% probability
  • All other possibilities, new bull, depression, something we are unaware of……………7% probability"

REVIEW

We were looking for a 2010 SP500 low of 950-1000 and a year-end close around 1225. The low was expected in the first quarter of 2010. We missed the low by 2-7% which averages out to 4.5%, and we missed the timing of the low by 3 months. But we got the direction and the year-end number near enough to correct. So all is well enough, in hindsight.

Taking the current XAO level of 4830 and SP500 level of 1233 as data and assuming that will be near to the 2010 year-end close we can say a few things:

  • Thinking in terms of waves within cycles….. in the 2010 calendar year there were 4 up-waves totalling 177 days, and 4 down-waves totalling 84 days.
  • The current cycle began with the lows reached in March 2009.
  • Assuming there is no change in direction the current up-wave is at day 72 of the 88 days that takes us to year-end… the markets were going up 68% of the time and down 32% of the time. ‘Markets’ here is defined as the XAO (All Ordinaries) and the SP500.
  • Up-waves during the calendar year averaged 44 days, and down waves averaged 22 days.
  • From the 2010 opening the XAO went negative 7%, positive 8%, negative 13%, positive 7%, negative 3%, and is currently positive 9%. At year’s end the overall peformance for the year will be negative circa 1%.
  • Our global proxy, the SP500 was negative 5%, positive 13%, negative 15%, positive, 9%, negative 6%, and is currently positive 18%. From beginning to end for 2010 the SP500 is positive 11%.

 

Looking at the broader cycle from the March 2009 lows –

  • The primary up-wave from the March 2009 lows is 453 days old and will be 468 days old by end 2010. The markets moved much slower in 2010 than they did in 2009.
  • The SP500 rose by 80% over 289 days from March 2009 to April 2010
  • Then fell 15% over the next 51 days to July 2010.
  • On the same time frame the XAO rose 61% and fell 13%.
  • By 2010 year-end the intermediate trend will be 129 days in duration and from the July retracement lows the SP500 will be up 20%, and XAO up 14%.
  • All in all a pretty volatile and exciting period but not all that good for the ‘buy and hold’ methodolgy.

Please note that in the analysis immediately above we are not talking about technical analysis. We are talking about quantitative analysis of the market movements which are related to macro policy from central bankers and government impacting on the decisions taken by investors and traders. We are also talking about the micro decisions taken by corporations to repair their operations and balance sheets as well as the response of households to the changed economic circumstances. Of course not every household or corporation made it through the crisis.

Annual performances for the SP500 and XAO have been:

  • 2003: +22% SP500/ +9% XAO
  • 2004: +9%/ +23%
  • 2005: +5%/ +17%
  • 2006: +13%/ +18%
  • 2007: +3%/ +16%
  • 2008: -39%/ -43%
  • 2009: +23%/ +32%
  • 2010: as above +11%/ -1%

 

COMMENT

2009 was the ‘bounce-back/ crisis is over’ year, 2010 has been the consolidation/ transition year. The world did not end between July 2008 and March 2009. The ‘crisis’ passed. The markets are reflecting a recovery in confidence, monetary stimulus via generally low interest rate settings, fiscal stimulus for taxpayers and consumers, bail-outs for institutions deemed too big too fail, and quantitative easing by the Federal Reserve. In 2011 the real economy (the production of goods and services) needs to take over from the symbol economy (money and credit).

We will publish our 2011 Overview on 13 January 2011. We hope that between now and 13 January we can identify the questions and provide some answers.

We assigned a 60% probability to there being a recovery with some retracements and defined the 2010 year as likely to be ‘subdued’. That was near enough to correct BUT…. within the alternative ‘double dip’ possibility we mentioned ‘more, and/ or new stimulus’. As it turned out the 60% recovery possibility required more, and new, stimulus measures. So in effect the subdued result was stimulus driven and much more stimulus was required than we could ever have imagined. Even now there are rumblings that Spain, Belgium, and Italy may need bail-out assistance. Once the stimulus finishes can a sustainable recovery take hold? Mr Bernanke is clearly of the view that he is Atlas carrrying the world on his shoulders, and has said he will maintain stimulus settings as long as they are needed. Did Atlas have a beard?

 

From our 12 January 2010 document –

"WHAT WE LEARNED FROM THE 2009 CREDIT CRASH REMEMBERING ALSO THE LESSONS OF THE 2000 TECH/ TELCO CRASH

  1. In summary, not much really, except that Ecinya is inclined to be somewhat too optimistic on occasions. We were very pleased to have called the March 2009 bounce with a high degree of logic and accuracy, and to have anticipated most of the carnage of 2008.
  2. Countries must retain sovereignty over their banking systems.
  3. An independent central bank is an indispensable check and balance mechanism – additionally, APRA worked. The US central bank is not independent as are very few American institutions, being too closely aligned to the political establishment.
  4. American investment banks and hedge funds are untrustworthy.
  5. The US Treasury Secretary should be viewed with caution, especially if he emanates from Wall Street. Paul O’Neill, ex Alcoa CEO and not of Wall Street, got the sack for being an honest man.
  6. Auditors and independent directors are not fully accountable to shareholders.
  7. Commercial banking and investment banking/ stockbroking are a bad mix.
  8. Global forums are dangerously beguiling and need to be approached with care as they inhibit your sovereign status and thinking. The IMF is sleepy and belatedly competent. The UN is poorly structured and inept.
  9. America needs a fundamental change in attitude, having adopted the ugly twin sisters of crony capitalism and worship of celebrity status. Mr Obama and his team needs to be lesser celebrities and greater managers.
  10. Everywhere, language has become imprecise, euphemistically misleading and deceptive. Spin is rampant, a bushfire destroying social and commercial values. Be wary of cant. Television is dumbing down the populace.
  11. Australia came through the global financial crisis because of the Hawke-Keating-Walsh-Howard-Costello legacy. Mr Rudd has extinguished that legacy and extracted little or no sustainable value from it."

The above in retrospect –

  1. We decided in the second half of 2010 to be more aggressive with our Ecinya Market Barometer settings.
  2. Even more important, but Joe Hockey with his current bank bashing assault might provoke the Labor-Greens-Independents coalition into BAD policy.
  3. Our central bankers have done a splendid job in 2010 though probably with one rate rise too far. Rate rises should not take place on Melbourne Cup day.
  4. No change, absolutely no evidence that Wall Street has learned anything.
  5. Mr Geithner has never had a real job and has been a big disappointment. The Treasury Secretary is more important than the President.
  6. More work is needed here and executive remuneration is ‘over the top’ in too many cases. Note the 32% vote at yesterdays’s Ten Network AGM against the remuneration report.
  7. No change here.
  8. Definitely no change here despite occasional bouts of competence and clarity from the IMF.
  9. Oprah Winfrey is in town and is said to have been responsible for 1 million of Obama’s 2008 vote. Definitely no change here.
  10. This may be changing but watch closely the response to Wikileaks which may result in a media revolt or anti-democratic laws. America is the land of the free yet Presidential/ Vice Presidential aspirants Messrs. Huckabee and Palin have called the death penalty on Mr. Assange.
  11. This has now become the accepted wisdom in some areas but not yet acknowledged by Wayne Swan, the Greens and the Independents.

But we would add –

  • Be wary of start-ups ( Clean Seas Tuna springs easily to mind).

 

 

 

 

David Murray: A bridge too far?

The outspoken chairman of the Future Fund, David Murray, has backed demands for a new banking inquiry, raised concerns about the possible sale of the Australian Securities Exchange, and believes Australia’s economy and financial system are at risk from the nation’s high level of foreign debt.

Front page The Australian Financial Review, Wednesday 1/12/2010.

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

Old Jewish proverb.

 

PROLOGUE

Business leaders were conspicuously silent during the entire period of the Rudd government and it has been suggested that retribution was a possibility if criticism was forthcoming. Mr Rudd was universally regarded as being both ‘thin-skinned’ and somewhat vindictive. It is a feature of governments all over the world that appointments are often made across the political divide to counter criticism of mates receiving favours. The old adage of having them inside the tent being better than outside the tent easily comes to mind. For example, Brendan Nelson got a great gig to Europe after losing the Liberal leadership enabling Mr Rudd to wax lyrical about what a great talent he was thus belittling by implication his replacement, Mr Turnbull as no great talent and thus an inferior replacement. Additional kudos came from the impression of grand generosity to a defeated foe, much like the Caesars of old. Recently Ms Gillard has appointed Don Argus ex BHP chairman to the Mining Tax Review panel probably in the belief that his solution will be acceptable to the government and receive critical acclaim from the voters as he seems to have a DNA unaligned to Labor.

Politicians build bridges to various constituencies through their regular awards and appointments. The ‘Australian of the Year’ can be a scientist, a climate change activist, a medico and best of all a sportman, preferably a cricketer. The Governor general can be an eminent lawyer, a political colleague, a woman or churchman.

David Murray joined the Commonwealth Bank in 1966 and became Chief Executive in 1992 serving in that capacity for the 13 years to 2005. In April 2006, sometime after his retirement, he was appointed chairman of the Future Fund by John Howard.

Ecinya thinks that his interview is noteworthy because it concerns a number of well expressed statements on issues of significant importance that require considerable thought and considered action.

 

THE MURRAY INTERVIEW

The David Murray interview covered 5 main areas –

  • A new banking inquiry.
  • The mining tax and what should happen to funds collected, should it proceed.
  • The Australian agriculture sector.
  • The Singapore bid for the ASX.
  • Australia’s high level of net foreign liabilities.

 

A Banking Inquiry

The Wallis inquiry reported in 1997 and a new inquiry would enable a calm debate to take place about what changes to banking regulations might be appropriate. Mr Murray specifically mentioned that the ability to switch mortgages was an important issue.

Mr Murray said: "I would like to see more competition in the financial services sector but not through government involvement. When governments own banks the asset allocation decisions become tilted by political considerations and their efficiency is impaired. It doesn’t work having government banks and in fact they have been some of the biggest disasters for governments here. The one mistake in running a bank is to attach the mortgage rate to the official cash rate. It’s incorrect matched pricing. When you set up mismatches like that in a bank it has other consequences. And by artificially determining how those prices should be set you actually cause the banks to take their eye off the quality of the management of their balance sheets."

 

The Mining Tax

Mr Murray echoed the ‘thought bubble’ created by Mr Glenn Stevens of the Reserve Bank that some of the increased revenue from the historically favourable terms of trade be quarantined in a ‘prosperity’ fund. Mr Murray thought that such moneys could find their way into the Future Fund, extending its original mandate. Given that the purpose of the proposed mining tax is to bring the budget back into surplus it seems difficult to imagine that the government would embrace the idea of putting any of the projected tax into any existing or new fund.

There are quite a few flaws and red herrings in the common conclusion of Messrs Stevens and Murray. Firstly, the Future Fund was really set up to enable an independent sell-down of the 16.4% stake in Telstra held by the government. Secondly, there is the implication by Messrs Stevens and Murray that the real purpose of quarantining any funds (via mining tax or terms of trade gains) is to keep them away from a government that has not spent its funds wisely whilst in office on matters such as pink batts, other climate change subsidies, schools, detention centres, one-off tax refunds etc. Paying off government debt is a form of savings so the projected use by the government is a legitimate aspiration. It is also hard to intellectually agree with Mr Murray that his "biggest driver is that we exist for our children and not for ourselves. If you look at all this stuff going on you wouldn’t believe we even have any children." A prosperous nation in all of its manifestations is good for our children, so it is hard to fathom that that an arbitrary allocation of a tax windfall ‘for our children’ is a fully developed economic thesis. Rather it seems to be a moralistic argument to justify some other shortcoming.

If Mr Murray thinks the government are poor economic managers then he should say so. Mr Stevens is in no position to make such a statement. His job is clear cut and relatively unambiguous. His criticisms and suggestions need to be behind closed doors and expressed in higher or lower interest rates if fiscal policy is inadequate or inappropriate. Additionally, if Mr Murray thinks the Opposition have some balmy ideas such as the election-induced paid maternity leave scheme and a billion dollar hospital for Mr Wilkie’s Hobart then he should say so as well.

 

The Australian Agricultural Sector.

Mr Murray said: "With our land mass and the aggregate amount of water that falls on it we should be able to supply food to the world. The most important initiative in this country is to sort out water rights and water availability." Ecinya emphatically agrees. The rural sector has been ignored for years and systematically abused over time as the twin ravages of drought and flood have been exacerbated by high interest rates and food imports. Additionally some rural policies such as the dairy industry have been devastating for rural areas.

 

Singapore’s bid for the ASX

Mr Murray said: "Australia is a very sophisticated economy. Its efficiency relies upon a very good system of exchange for securities. I think it’s important to make sure that the system isn’t impaired or rendered inefficient by any merger."

Mr Murray’s comments are more in the nature of a caveat rather than opposition to the proposed merger but there are many that believe that foreign ownership means foreign control, less transparency, and less supervision.

In the same newspaper on the same day as the reported Murray interview (page 3), the corporate regulator ASIC called for a wide-ranging examination of the share-market rules, including listing criteria, that allowed small, high risk companies to float on the share-market. Many old hands in the stock-market are of the view that standards have dropped over the years since the ASX listed as it became a toothless tiger. In relation to annual reports and prospectuses quantity has replaced quality.

 

Australia’s high level of net foreign liabilities

Mr Murray makes the point that Australia’s foreign debt at 60% of GDP is higher than that of the United States or France and therefore, if the mining boom should abate then our economy is fragile indeed. He maintains that Australia is in "a very, very risky position". We are a nation that imports far too much and our export base is fairly narrow. Manufacturing has all but disappeared in Australia.

 

ECINYA OVERVIEW

Business has, over the past several decades, the last decade in particular, become extremely muted in its suggestions to and criticisms of government at both the state and federal levels. It is a welcome development that Mr Murray has joined the debate as he has a profile that carries some weight. In relation to the banks we refer you to Ecinya’s recent Insight article (clik for access). We also hope that others are encouraged to join the debate. It is very interesting that skills shortages are back on the agenda and for years many tradesmen employers complained about the trade training schemes implemented by government that discouraged the practical employment of apprentices.

We hope that the government begins to listen to legitimate business concerns in relation to the matters raised by Mr Murray and others. We hope that the bridge to business that Mr Murray is part of, is ‘not a bridge too far’.