INTRODUCTION
Wattyl was a paint and coatings company that was taken over sometime in recent memory. One of their products was ‘Estapol’ which was a coating product for timber flooring. Correct surface preparation and then application of the product was important for optimum results. Consequently, the lid of the tin said "When all else fails read the instructions."
Ecinya is ever-mindful of the necessity of not losing touch with the basics and through a combination of our investment rules under the ‘Market Wisdom’ tab, The Ecinya Market Barometer’, our Insight articles and performance evaluation of our two modest portfolios we attempt to ‘practice what we preach’. However, over the years, despite a more than adequate performance in our own activities, our expressed views on the future, and our Ecinya Recommendations derived from our own modelling, we still manage to make mistakes. Our experience is that we have called bottoms well, and tops not as well. Tops can often be driven to a level that constitutes ‘irrational exuberance’.
Analysis, review and introspection more often than not leads us to the conclusion that timing is where most of us get it wrong. Bull markets are born on pessimism, grow on scepticism, mature on optimism, and die on euphoria. Bull markets are driven by liquidity, and falling interest rates can be trusted to begin a new bull market. However, the current bull market looks and feels artificial as it has been fueled by ‘money printing’ around the globe and over-exuberant debt fueled government spending, particularly in the healthcare and social services sectors.
Earnings momentum in the context of economic growth is not in evidence.The economic growth that has occurred has been muted and company earnings driven more by currency devaluations and corporate cost cutting. When markets are elevated we tend to look for fundamental reasons as to why they should fall and when markets are down we believe that cyclical factors operate for them to rise from the ashes. Very often early signals at both the top and the bottom are recognisable using quantitative and technical analysis plus anecdotal evidence from business associates. Technical analysis in our view has limited forecasting attributes, but can assist to identify potential turning points and support levels. Technical observations seem to indicate that markets trends are testing upper trend limits. Our market quant model uses algorithms derived from All Ordinaries and SP500 data and the current 103 day upwave appears to be coming to an end. Refer Ecinya Market Barometer.
MACRO CONCERNS
Our major concerns were outlined as part of our Strategy Essay of 25 January and our ‘Delightful and daring dance with Sir Percy’ Insight essay on 8 March and were –
1. Australian fiscal management during and since the GFC – the chickens are coming home to roost and unemployment, slow growth and higher taxes are on the horizon in a massive landscape of poor policy development and execution. Mid term we remain bullish on hard and soft commodities. Australia needs a Federal election as soon as possible.
2. Europe needs to address creeping imbalances all over the place.
3. China may have a massive credit and property bubble which has not yet popped.
4. The normal menu of global unrest has a new entree in that China and Japan are in dispute in and around the China seas.
5. Dr Ben Bernanke is treating a disabled patient with massive doses of monetary stimulus when the real medical disorder is fiscal profligacy and waste. This is our major major concern as fiscal and monetary policy are natural dance partners.
Commentary on the above –
1. The Hawke-Keating and the Howard-Costello governments were very good over about 80-90% of their respective terms in office with both of them being fairly described as ‘centrist’ governments with well above average communications skills. Re-election pressures towards the end of extended terms of government caused each of them to embrace policy that pandered to perceptions of ‘appeasing the base’. The Rudd-Gillard-Greens government has been a sad indictment of misallocation of scarce resources.Cash hand-outs were squandered on imported flat screen televisions and overseas holidays, flimsy climate change policy, broadband without cost-benefit analysis, and education building revolutions have been dismal failures. Realisation of these failures ushered in the carbon tax and a mining resources tax just as a cyclical peak was occurring in the global economy. The result in our view will mean that an incoming government will inherit an extremely poor fiscal position, worse than will be disclosed by the departing government in the forthcoming May budget update.
2. Europe still messy with France and Germany soon likely to add to growing uncertainties.
3.. China is attempting to rein in its growth trajectory and aiming for a ‘soft landing’. ‘Soft landings’ are difficult to achieve, but with real GDP growth around 7% and large current account surpluses such a landing seems reasonably plausible.
4. Add in the North Korean situation and things look volatile. Given America’s traditional allies are South Korea and Japan, history suggests that America will support its allies and that patience is wearing thin with North Korea.
5. Fiscal and monetary policy has become wrapped in the summer and winter coat of politics. Unfortunately all around the world winter is in evidence. In a host of countries including Great Britain, Ireland, Iceland, Italy, Spain, Greece, Cyprus, the USA, political springs and summers seem far away. It appears that economic uncertainty in France and Germany is on the horizon. Apart from Australia’s Reserve Bank which acts independently other major central bankers have decided to become a submissive arm of government rather than fulfilling their normal ‘check and balance’ role. The quotes below highlight this –
However, the task of putting private and public finances on sustainable paths in several major countries is far from complete. Accordingly, financial markets remain vulnerable.
Reserve Bank of Australia 3/4/2013
The unfortunate reality is that it is normal for forecasts to be wide of the mark.
Deputy RBA Governor Philip Lowe 10/1/2013
No central bank will admit it is keeping interest rates low to help governments out of their debt crises. But in fact they are bending over backwards to help governments to finance their deficits….. With high debt to GDP ratios it is difficult for a central banker to raise interest rates. I believe the shift towards less independence of monetary policy is not just a temporary change.
Carmen Reinhart of Harvard University 10/4/2013. Note Ms Reinhardt was the co-author of "This Time is Different" with Kenneth Rogoff.
The greatest flaw in the Fed’s unprecedented gambit could well be an emphasis on short-term tactics over longer-term strategy. Blindsided by the crisis of 2007-2008, the Fed has compounded its original misdiagnosis of the problem by repeatedly doubling down on tactical responses, with two rounds of QE preceding the current, open-ended iteration. The FOMC, drawing a false sense of comfort from the success of QE1 – a massive liquidity injection in the depths of a horrific crisis – mistakenly came to believe that it had found the right template for subsequent policy actions.
Stephen Roach ex Morgan Stanley Chief Economist, now Senior Fellow at Yale University’s Jackson Institute of Global Affairs 27/2/2013.
We may say that we are aiming for nominal growth of, say, 5 percent. Who thinks you can really do that? It doesn’t correspond to the real world. When have economists been able to predict how much will be inflation and how much real economic activity? Monetary policy has little or no control over the real economy and issues, and yet we persist in using it as a tool for generating growth.
Paul Volcker , former Chairman of the US Federal Reserve in an April interview ‘Dangerous Economic Territory’.
The problem with central banking is that there are no longer any bankers in central banking. Too many economists, particularly of the interventionist kind. The latter spend their time and taxpayers earnings in trying to alter economic history, rather than understanding it. The most glaring error is the notion of a "national" economy. When it comes to credit markets, they have been international since at least Roman Times. They insist that because two things occur at the same time they are causally related. Yes, credit does increase with a business expansion and vice versa. But credit expansion does not cause the business boom. Actually, in the final stages of a boom speculators leverage up against soaring prices. In which times, credit expansion depends upon the boom. How could so many for so long be so wrong? Central bankers get wages and glory for their attempt to provide unlimited funding for another sordid experiment in unlimited government. The problem is that even with electronic printing presses and endless buying of lower grade bonds market forces eventually overwhelm arbitrary ambition. As for "wages and glory", the former should be viewed as rent-seeking and the latter as ephemeral.
Bob Hoy, American commentator 12/4/2013
CONCLUSIONS
Markets have raced away from their 2010 and 2011 lows, but there are enough balls in the air to indicate a retracement of current gains is overdue. Dr Bernanke has led an orgy of money printing that seems to indicate that past mistakes are in the process of being repeated. The American economy is improving but savers are being asked to suffer low interest rates on mainstreet while Wall Street continues to behave recklessly. In the USA, the world’s dominant economy, housing and employment is picking up but national, domestic, municipal and state deficits persist. Company profits around the globe appear to be driven more by cost cutting than revenue expansion. Our Australian company models suggest that valuations are stretched. Exercise caution.