Category: Insights

BUBBLE #6 – GLOBAL WARMING
Fast-Forward to today. It’s early June in Washington, D.C. Barack Obama, a popular young politician whose leading private campaign donor was an investment bank called Goldman Sachs – its employees paid some $981,000 to his campaign – sits in the White House. Having seamlessly navigated the political minefield of the bailout era, Goldman is once again back to its old business, scouting out loopholes in a new government-created market with the aid of a new set of alumni occupying key government jobs.

AS ENVISIONED BY GOLDMAN, THE FIGHT TO STOP GLOBAL WARMING WILL BECOME A "CARBON MARKET" WORTH $1 TRILLION A YEAR.

Gone are Hank Paulson and Neel Kashkari; in their place are Treasury chief of staff Mark Patterson and CFTC chief Gary Gensler, both former Goldmanites. (Gensler was the firm’s co-head of finance) And instead of credit derivatives or oil futures or mortgage-backed CDOs, the new game in town, the next bubble, is in carbon credits – a booming trillion-dollar market that barely even exists yet, but will if the Democratic Party that it gave $4,452,585 to in the last election manages to push into existence a groundbreaking new commodities bubble, disguised as an "environmental plan," called cap-and-trade.

The new carbon-credit market is a virtual repeat of the commodities-market casino that’s been kind to Goldman, except it has one delicious new wrinkle: If the plan goes forward as expected, the rise in prices will be government-mandated. Goldman won’t even have to rig the game. It will be rigged in advance.

Here’s how it works: If the bill passes; there will be limits for coal plants, utilities, natural-gas distributors and numerous other industries on the amount of carbon emissions (a.k.a. greenhouse gases) they can produce per year. If the companies go over their allotment, they will be able to buy "allocations" or credits from other companies that have managed to produce fewer emissions. President Obama conservatively estimates that about $646 billion worth of carbon credits will be auctioned in the first seven years; one of his top economic aides speculates that the real number might be twice or even three times that amount.

The bank owns a 10 percent stake in the Chicago Climate Exchange, where the carbon credits will be traded. Moreover, Goldman owns a minority stake in Blue Source LLC, a Utah-based firm that sells carbon credits of the type that will be in great demand if the bill passes. Nobel Prize winner Al Gore, who is intimately involved with the planning of cap-and-trade, started up a company called Generation Investment Management with three former bigwigs from Goldman Sachs Asset Management, David Blood, Mark Ferguson and Peter Harris. Their business? Investing in carbon offsets. There’s also a $500 million Green Growth Fund set up by a Goldmanite to invest in green-tech … the list goes on and on. Goldman is ahead of the headlines again, just waiting for someone to make it rain in the right spot. Will this market be bigger than the energy-futures market?

"If it’s going to be a tax, I would prefer that Washington set the tax and collect it," says Michael Masters, the hedge fund director who spoke out against oil-futures speculation. "But we’re saying that Wall Street can set the tax, and Wall Street can collect the tax. That’s the last thing in the world I want. It’s just asinine."

Cap-and-trade is going to happen. Or, if it doesn’t, something like it will. The moral is the same as for all the other bubbles that Goldman helped create, from 1929 to 2009. In almost every case, the very same bank that behaved recklessly for years, weighing down the system with toxic loans and predatory debt, and accomplishing nothing but massive bonuses for a few bosses, has been rewarded with mountains of virtually free money and government guarantees – while the actual victims in this mess, ordinary taxpayers, are the ones paying for it.

Matt Taibbi, Rolling Stone Magazine 2/7/2009, "The Great American Bubble Machine"

Like Jared Diamond and Stephen Jay Gould, Tim Flannery has the ability to take complex ideas and – seemingly effortlessly – make them accessible. This book captures your imagination through its extraordinary range of argument, its vivid imagery, its wealth of research, quick wit and richness of detail. You need to read it carefully, twice.

Mr Flannery provides much more urgent, specific evidence of imminent peril. He also makes sure that you will never again look at an electric-light switch in quite the same way… "The Weather Makers" is detail-packed to the point of terrible fascination.

Newspaper Reviews on Tim Flannery’s, "The Weather Makers", by The Sydney Morning Herald and The New York Times, 2005

Most ministers’ ideas can be squashed by discrediting the facts they are based on. But if they are political ideas, facts don’t come into it.

From the 1989 diary of Sir Humphrey Appleby, Secretary to the Cabinet under the British Prime Minister, James Hacker.

INTRODUCTION

For purposes of this essay let us assume that climate change is real, and that greenhouse gas (CO2) is a major contributing factor. The dimension and urgency of the problem is something that we are not able to talk about, simply because we do not know. But we do sincerely believe that Messrs Rudd and Turnbull in their respective capacities as Prime Minister and Alternative Prime Minister are NOT providing real leadership on climate change. In fact, they are confusing the issues in their desire to be seen as nascent saviours of the world. Their motives are political and essentially counter-productive, and each in his own way is as bad and mischievous as the other.

EVEN IN OUR POSITION OF RELATIVE IGNORANCE

….. or lack of expertise, we cannot understand why Copenhagen is relevant at all. Australia can begin to solve its emission problems on a constructive timetable, and the rest of the world can follow later. We do not need an Emissions Trading Scheme (ETS). It seems to us that there are probably less than 2,000 significant carbon polluters in Australia. Why not simply give them a tax break on the expenditure required for them to create and/ or buy the technology that will reduce their emissions to agreed levels, and perhaps a bonus if they exceed their targets? In relation to households something can be done via direct subsidies and/ or tax relief, and education.

CARBON CREDITS

….. might cause the next bubble and be a significant factor in the next recession. The world discovered recently that America had a hidden bubble called ‘sub-prime’. Before that they had another bubble called ‘tech/ telco’. Every time America finds a new source of income, it manages to invent new sources of manipulation, embezzlement, obfuscation, fraud, or whatever name you wish to attribute to their bad behaviour. At the same time, China is something of a closed economy and they have a vast amount of $US holdings that might give them some advantages in a carbon credits market. Data can be manipulated, and countries are not always completely open and honest in their dealings with one another. Jack Lang, a former NSW Premier, famously said: "Put your money on self-interest; it’s the best horse in the race, because you know it’s always trying".

MATT TAIBBI’S ARTICLE

….. should be read in its entirety. The arguments are cogent and hence difficult to refute. Our editor is relatively convinced that Goldman Sach’s exaggerated many aspects of the ‘tech/ telco’ era and in more recent years led the cheer squad for ‘$200 per barrel oil’, whilst running major trading operations in commodities. It does not take much imagination to see that carbon credits becomes the next ‘growth’ industry. Eventually we could see carbon derivatives, collaterised carbon credits, and sub-prime CO2 certificates. The financial engineers could have a ball, a predators’ ball, at a ‘prime’ (not sub-prime) venue. Good intentions do not always translate into beneficial policy outcomes.

John Howard described many of the participants ostensibly looking after Aboriginal welfare as ‘the Aboriginal Industry’. Our editor, having visited ATSIC HQ in Canberra a few years ago, and from general observation, it seems that certain people in the ‘Aboriginal Industry’ are relatively well-off compared with vast sections of the Aboriginal population, drifting inexorably into squalor and hamstrung by significant lack of opportunity.

BARNABY JOYCE

….. is a seemingly clear-thinking and articulate spokesperson for rural Australia and, on many occasions, sounds eerily similar to Senator Peter Walsh, Finance Minister in the Hawke Government from 1984 to 1990. Prior to that Mr Walsh was Minister for Resources and Energy from 1983 to 1984. He was, and probably still is, a wheat and sheep farmer in Western Australia. Anyone who has spent time in rural Australia knows about the level of wise counsel and common sense utterances that come from this source. Labelling people ‘mavericks’ or ‘smart arses’ who disagree with the populist and alternative view is just nonsense and a denial of democratic rights. In our opinion, Senator Walsh is one of the unsung heroes of Australia’s current prosperity and global position. If Messrs Rudd and Turnbull are unsympathetic to regional concerns, then taxpayers should be concerned.

WHEN

….. are we going to see a full-page ad or government editorial that sets out the cost of the technology and the infrastructure that will reduce carbon emissions? At Ecinya we feel substantially uninformed, yet we sense that our taxes and operating costs will rise and emissions will not fall proportionately. Mr Rudd, giving a press conference on climate change and other matters as he leaves church, seems to imply that his god has ordained his view or at least confirmed the substance and tempo of his approach to economic, social, and global challenges.

IF CARBON EMISSIONS ARE SO DANGEROUS WHY NOT

….. seek a consensus with competing and supportive views represented in equal measure? Ross Garnaut is reported in today’s AFR (13 October, pg 5) as follows: "Meanwhile, Ross Garnaut, author of the federal government’s climate change review, said the rancorous political debate on an ETS was one of Australia’s worst cases of policy-making on a major issue. "It is a very difficult issue, so I suppose it was never going to be easy. But the way it has broken down is extraordinary."

We disagree with Mr Garnaut in that we find it totally unnecessary to have an ETS. Through the tax system at the corporate level and education at the household level, some electric cars, the acceleration of some alternative fuels such as ethanol, gas, solar and wind, we believe that solutions exist. We understand from recent readings that new and cheaper and more effective forms of nuclear are about 5 years away.

The bottom line is that our major polluters are in essential industries. Additionally, talking about the debate in per-capita terms distorts an absolute problem. On a per-capita basis our numbers look universally good or bad depending on the statistical point you wish to make. We have a lightly populated country (if you ignore water resource problems) with vast resources and per-capita stats always look meaningful.

HAS THE RECESSION BEEN FORGOTTEN?

A few weeks ago, a few months ago, the world was in a global recession, the worst since WWll. Governments have de-leveraged the private sector by running up huge amounts of public debt and providing stimulus packages from coast to coast, village to village. Somehow at some time, the taxpayer will have to pay extra taxes and suffer higher interest rates and perhaps just then the cost of carbon will hit with a ferocity of which we are totally unaware.

WE DON’T LIKE TO BE CRASS

but Mr Turnbull is an ex-Goldman Sach’s man. We hope that his information and insights are not being derived from this self-interested and self-indulgent source. We hope that local election coffers on both sides are not being filled by climate change industry participants.

Former US Federal Reserve chairman Paul Volcker said the rise of China and other emerging economies underscored a decline in the comparative economic and intellectual leadership of the US. "I don’t know how we accommodate ourselves to it," said Mr Volcker, who heads President Barack Obama’s Economic Recovery Advisory Board, in an interview with PBS television. "You cannot be dependent upon these countries for 3 to 4 trillion dollars of your debt and think that they’re going to be passive observers of whatever you do," he said.

The Australian Financial Review, 30 September 2009.

I believe an administration – any administration – that ignores business expectations is committing a grave error of judgement. That this is precisely what Obama and his Chicago cronies are doing is supported by rumours that they are ignoring the counsel of Rubin, Volcker and the rest of the White House economic advisers. No one should be surprised at this since left-wing ideologues have never had any real time for economics. For them, politics trumps all, including economic laws – or so they think. Nevertheless, one should NEVER allow personal feelings to cloud one’s judgement. The fact remains that this recession began before Obama was elected just as the last recession began – irrespective of what hard-core Democrats assert – before Bush won the 2000 election.

Gerard Jackson, BrookesNews.Com, 4/10/2009.

Myer is over-valued, even at the low end of the pricing range, possibly as much as $1 a share on my calculations. But valuing the business is not the same as predicting its share price: The stock could rise on the back of sentiment. In the long run however, Myer will need much stronger earnings growth to justify its valuation and I am not convinced it can achieve it. I am also concerned that the owners of Myer are selling out. Better opportunities are elsewhere.

Roger Montgomery, independent share analyst, as reported in the AFR 3/10/2009.

Department stores overseas have been among the biggest casualties of the global crisis and long-term performance has been weak. There are certainly easier ways to make money than department stores. Customers are increasingly fickle and willing to shop around, the stores need lots of floor space in expensive areas, have high inventory costs, high staff costs and fashion sensitive products. It has not been a great industry to invest in globally and the outlook is deteriorating.

Stephen Ogden-Barnes, Australian Centre for Retail Studies, Monash University as reported in the AFR 3/10/2009.

"Too many people believe that today is yesterday," said editor. "I like that," said Compass.

Our editor talking to Compass, an Ecinya Confidant, at 3.50 pm, 6/10/2009

Straws and camels, questions searching for answers

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

Anyway, to clear his head our editor went for a walk to the bank and to buy some lunch. This caused him to think about the up-coming Myer float, which he considered to be considerably over-priced. He then remembered that he had removed page 45 from the Weekend AFR with a view to reading it at some appropriate time. That appropriate time had, in his view, now arrived as he searched for some clues to what might lie ahead in the markets – the XAO and the S&P 500 in particular.

Looking at some other straws, but the same camels

The stimulus straw: A number of learned economists have asked the question "What happens when the stimulus is withdrawn, what will be the quality and quantity of economic growth post-stimulus?" David Rosenberg of Gluskin Sheff of Canada estimates that 80% of the rebound in US growth has been induced by stimulus measures.

The bull markets are driven by liquidity straw: Much of the liquidity injections provided by central bankers acting in concert around the world, has found its way into equity markets. This has prompted ‘cash on the side-lines’ to join the party. So after about 150 days from the retracement bottoms of March 2009, the All Ordinaries index has hit an intermediate peak of + 49.7% on 29 September, following the peak in the S&P 500 (our global proxy) at 53.4% on 18 September. Averaging these numbers we get a nice bounce of 52%.

The equity re-capitalisation straw(s): Many companies are talking of revised guidance, but not emphasising the earnings-per-share number. They are simply ignoring the dilution impact. David Jones is running full-page fashion look-alike ads talking about ‘growth’, their share price performance from 3 January 2003, dividends etc. But hidden away in the disclaimer are the words: "Past performance is not a reliable indicator of future performance". And no mention of EPS growth or what interest rate rises might do to retail spending between now and Christmas.

The real unemployment straw: In Australia the ‘official’ unemployment figure has stayed below 6%, but the number of people now working on a part-time basis (the under-employed) has not been factored in and the number of people that have given up looking for work is never factored in.

The US banking straw: The number of US banks that are now on the FIDC’s stressed list has almost doubled over the past year from circa 1458 banks to 2256 banks. It seems that accounting changes, government guarantees and quasi-nationalisation has delayed banks having to recognise bad and doubtful debts.

The municipalities in distress straw: Obviously the most notable of these is California, the world’s 6th largest economy, but many Australian councils and even several state governments are short of money.

The regulation solves the problem straw: As Nero fiddled while Rome burned so has the American regulators. The problem has not been lack of laws and regulations, but lack of supervision, oversight and accountability. Australia has been relatively fortunate in this regard as APRA and the commercial banks have performed reasonably well. A few notable exceptions – Babcock & Brown group, Allco, various property groups, Timbercorp, Great Southern, Opes Prime, Storm Financial etc.

The G20 ‘aren’t we marvellous’ straw: Having adopted massive Keynesian type stimulus packages that have not been seen since the end of World War ll, world leaders from developed nations recently basked in the Washington/ New York glory that they had saved the world from disaster. In fact they probably did, but much of the spend has been frivolous and reckless, and taxpayers have not been made aware of when and how they will pick up the tab.

But are we over-reacting?

And "whether or not it is clear to (us) no doubt the universe is unfolding as it should" (The Desiderata) and time will tell. But we have now written on this topic four times if you include today’s issue: ‘Time to pause’ was written on 25 August; ‘Pendulums swing, imbalances ebb and flow, and the band plays on’ was written on 15 September; and ‘On the bus on the road to recovery, transitioning slowly towards sustainability’ was written on 22 September.

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

 

 

All knowledge is ambiguous.

J S Hapgood, British Ecliastic, The Observer, 1991

America makes prodigious mistakes, America has colossal faults, but one thing cannot be denied: America is always on the move. She may be going to Hell, of course, but at least she isn’t standing still.

E E Cummings, US poet, Vanity Fair, May 1927 ‘Why I like America’.

It has always been my contention that the only way to be a successful investor is to avoid the disasters. I say this because it only takes one bear market to wipe out years of hard-earned profits. In essence, stock market participants should realize from the outset that losses come with the territory. Being wrong is not a weakness, but staying wrong is.

Source unknown.

A hunch can be trusted if it can be explained.

Max Gunther, The Zurich Axioms.

INTRODUCTION

Four mornings of each week we participate in a telephone conference with 3 offices of a brokerage house.

On Monday 2 March 2009 we wrote a memo for circulation outlining the case for a market bounce. Our conclusion under ‘Reasons for Optimism below was : "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."

This memo is not re-produced to show how clever or knowledgeable we have been, but to demonstrate the value of documented thought which can then be translated into action. THINK< ACT< REVIEW are Ecinya constants and knowledge is ephemeral, and mistakes are a constant irritating niggle. Profits won on one adventure can quickly disappear in the next act of folly. Performance over time must be measured, and mistakes and victories are a source of learning.

 

MORNING MEETING – MONDAY 2 MARCH, 2009

From ECINYA:  This is not meant to be exhaustive or definitive, just a few thoughts to assist your own deliberations…. grist for the mill.

BACKGROUND

Remember this is a ‘made in America’ recession.

On Friday 27 Feb the S&P 500 made a new closing low of 735.

From the October peak of 1565 this means that the S&P has now fallen 53.0%. We want to see the S&P quickly get above 835. Overall we are looking for a triple, or quadruple bottom in the S&P, so far we have had two bottoms, one completed (752), one possibly completed (735).

Concurrently the XAO has fallen 52.1% from its November peak of 6853 to last Wednesday’s low of 3281. A lower low today is likely.  We want to see XAO move towards 3450-3500, which would represent a minimum bounce of just  5%.

The prior low on the S&P was 752 on 20 November and the bounce from that level was 24% to 934 on 6 January.   

Our market in XAO terms has been consonant (in harmony with) these moves. The XAO bounce from the previous low was 5.9% from 3300 to 3496.

We all know what is required – US housing to stabilise, US and global banking to stabilise etc

BUT things are ‘getting worse before they get better’.  Last week it was Royal bank of Scotland, Pacific Brands, CitiBank.

Governments and central bankers are stimulating the ailing patients – local economies, bank nationalizations, corporate re-capitalisation. We have moved from a ‘debt is divine’ mentality, to ‘debt is a diabolical travesty’.  All, seemingly, in a time horizon that leaves us (almost) speechless. Markets appear to be grossly over-sold.

In Australia the earnings season so far is poor, commodity prices have generally halved,  the government is almost panic stricken etc. With the Victorian bushfires we have an unfortunate dampener on confidence offset by the magnificent response to the tragedy, bringing the Victorian water problems into sharp focus. In Queensland we have an opposite natural disaster with major floods. Given the possibility of such natural problems occurring, with their consequent impact on lives and economic activity, it is regrettable that we create from time to time man-made economic problems such as those encapsulated in the expression ‘global financial crisis.’

 

CONTEXT TO LAST FRIDAY’S US S&P 500 CLOSING LOW

There are 3 cuts to quarterly US growth following the end of the quarter. At the end of the first month the ‘advance’ number appears, end-second month the ‘preliminary’ number issues, and end of third month the ‘final’ number. The advance number for Q4/ 2008 was negative 3.8% (annualised) issued end-January, the February preliminary number released on Friday by the Bureau of Economic Analysis was negative 6.25%.

This was the biggest contraction in real GDP since the first quarter of 1982.

In looking at the Wall Street Economics Panel of 52 economists, 9 (17%) are predicting that Q1 of 2009 will be more than negative 5.9%. Paul Kasriel of Northern Trust is an economist that we have an extremely favourable view of, and he is currently forecasting negative 6.4% Q1, to be followed by negative 2.5% Q2, negative 0.8% Q3, and a positive fourth quarter of 2.2%. (Kasriel is the recipient of the 2006 Lawrence R Klein Award for Blue Chip Forecasting Accuracy).

In looking at past stimulus periods (in particular the 30’s) Kasriel had this to say in early February:

“If the federal government embarks on a large spending spree and the Fed "prints" the money to fund the spending, then the pace of real economic activity is bound to increase. How long it will take for higher prices to begin to erode real activity is another question. But never underestimate the initial positive impact on aggregate demand of that powerful combination of increased federal government spending/tax cuts and a central bank running the monetary printing press at a high speed.”

“It is not my role to endorse government policies. It is my role to forecast the impact of government policies on the economy. I believe that large increases in federal government spending that are monetized by the Fed and the banking system will result in a recovery in real economic activity. When that recovery sets in depends on how quickly the federal government increases its spending and by the magnitude of that increase. We can debate whether tax rates should be cut or federal spending should be increased. We can debate what kinds of spending should be increased. We can debate whether the federal government should increase any of its spending. But the facts of the 1930s appear to be pretty clear – monetized increased federal government spending does result in increased real economic activity in the short run.”

“The economic data are likely to be abysmal through the first half of this year. The popular media will reinforce the gloom of the data. The same pundits who did not see this downturn coming will not see the recovery coming either. My advice to you is to keep your eye on the index of Leading Economic Indicators. If history is any guide, the LEI will signal a recovery well ahead of the pundits.”

Ecinya caveat: Though all forecasts are to be approached with a healthy degree of scepticism, Kasriel has cogent arguments to support a ‘things will get better’ thesis.

 

EXCERPTS FROM THE MARCH 2 EDITION OF TIME MAGAZINE – “Obama’s Rx for the budget”

“How does the White House buy time to spend now without spooking the markets or stoking fears that the US intends to inflate its way out of debt.  Obama’s aides say they can do it by winding down the war in Iraq, cutting fat and raising taxes on the wealthiest Americans – and later, by entitlement reform.”

“From his hard-edged inaugural vow that ‘Our time of standing pat, of protecting narrow interests and putting off unpleasant decisions – that time has surely passed’, to his frequent promise of smarter government, Obama has reflected a national consensus that the old way of doing business is bankrupt. The result of getting the stimulus package passed was not perfect according to Obama, but he said  ‘My bottom line was, am I getting help to people who need it?”

Ecinya comment:  That politicians need to be approached with a healthy degree of scepticism is axiomatic. The Obama administration seems capable of getting it right over time, the Bush administration showed no signs of ever getting it right at any time.  Obama’s critics will be prominent and noisy. We can but wait and see.  We are hopeful, almost to the point of confidence, but Keynes once said “Fundamental change does not occur quickly.”

 

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.

Macro watch-list: Watch the oil price, China, takeovers, copper, and the S&P 500 for early signs of bounce or resurgence.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

SOME INTERESTING COMMENTS FROM DAVID MORGAN

From David Morgan (ex-treasury officer and former Westpac CEO) Saturday’s Weekend Australian.

“The government guarantee:  It is now timely to seek to sensibly wind back these initiatives to something more measured and less distortive.”

“The Australian banking sector:  The banking sector in Australia in the future will be characterised by a significantly smaller number of much better capitalised institutions, of genuine economic scale by global standards.”

“The outlook for the global economy: We will NOT have another Great Depression.  We have learnt the policy lessons from that mistake.  But the balance of probabilities is that the global economy is set for the worst recession in the post war period.”

“The global financial crisis: Plainly, we nearly lost the global banking system in the September-November period of 2008.”

 

THE IDEOLOGICAL DEBATE

Prime Minister Rudd has blamed the ‘neo-intellectuals in a 10 page paper in a recent issue of “The Monthly”.

ON page 12 of the Financial Review under the head-note “Obama prepared for rough budget fight” it is said “United States President Barack Obama has thrown down the gauntlet to Congress in his efforts to secure passage of a US$ 3.55 trillion budget that has drawn howls of protest from a Republican opposition warning of an American decline into socialism.”

BUT debates about various ‘ISMs” do not assist the recovery process.  We live in an increasingly integrated world and having over the past several decades transferred manufacturing capacity and skills to Asia, and away from Europe and the USA, it is becoming somewhat appreciated that without healthy debt markets for consumers we now live in a world of excess capacity in almost all goods, from TVs to telephones, from cars to condominiums.

The only ‘ISM’ needed at the moment is ‘common sensISM’ and that requires as its base a banking system that can take sensible lending risks to sensible borrowers. Peter Drucker recognised many years ago that ‘capitalism’ was conceptually deficient and that one absolute standard such as ‘profit’ would not get us very far on a consistent basis. He focused very much on Schumpeter’s thesis of ‘creative destruction’.

Most of the assumptions we base our actions on are obsolete. It is the function of the central bankers and elected officials to manage economies on a sustainable basis. Currently, and to varying degrees, we have been misled.

It is always interesting that economic troubles are mostly enmeshed with significant conflicts – WW ll, Vietnam, and now Iraq and Afghanistan, and the Middle East.

America spends about US$700 billion out of global defence spending of about $1.4.trillion. In economics the cost of one thing is the other thing forgone – this is known as ‘opportunity cost’. Dwight Eisenhower expressed it well (about 1956) when he said: “every gun that is made, every warship launched, every rocket fired, signifies in the final sense a theft from those who hunger and are not fed, those who are cold and are not clothed . The world in arms is not spending money alone. It is spending the sweat of its labourers, the genius of its scientists, the hopes of its children.”

 

A SOLUTION TO AMERICA’S WOES

Laurence J Kotlikoff published a 14 page essay in the July/ August 2006 edition of The Federal Reserve Bank of St Louis Review, titled  “Is the United States bankrupt?”  The conclusions were that countries could 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 necessary to securing the nation’s economic future.

Kotlikoff offered three policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy: a retail sales tax, personalized social security, and a globally budgeted universal healthcare system.

This paper is an easy read and well worth a visit. All is not yet lost.

 

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.

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.

8. 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, a bear market focus on valuation.

Ecinya Investment Rules #2, #7 and #8. The entire 10 are under Market Wisdom.

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.

Fascism was really the basis of the new deal.

A misguided Ronald Reagan in exaggerated prose, 1976.

None of us really understand what’s going on with all these numbers.

David Stockman, Budget Director under Reagan, 1981.

It’s a very good question, very direct, and I’m not going to answer it.

George Bush l talking about deficit-reduction, 1990.

The promises of yesterday are the taxes of today.

Canadian prime minister Mackenzie King, 1931.

All of the political quotes above are taken from "Political Babble", 1992.

The impact…. of the problems in the sub-prime market seems likely to be contained.

Ben Bernanke addressing Congress, March 2007.

From a technical perspective the recession is very likely over.

Ben Bernanke, 15/9/2009.

 

ECINYA COMMENT

INTRODUCTION

Since we penned ‘Time to pause’ on 25 August and ‘Pendulums swing, imbalances ebb and flow; and the band plays on’ on 15 September, the All Ordinaries has risen about 6% and the S&P 500 (our global proxy) has risen 3.5%, and only 7% from its relatively minor pull-back of 2 September. So, in essence, we have been wrong for about the past 4 weeks. This should convince you that Ecinya is NOT in charge of what goes on in the market. However, using our Tactical matrix (outlined below) we have stayed engaged in the market (moving in and out of cash) and the Cactus Portfolio is some evidence of that.

 

SUMMARY CONCLUSIONS

Progress is not linear; progress is uneven, given to bursts, followed by retracements. As the underlying trend keeps you on the bus, stay alert and awake lest you miss your ultimate stop.

We are (globally) in RECOVERY mode. True, but not without caveats. There are many balls in the air.

• The economic variables are GDP, inflation or deflation, employment, stimulus packages, mooted exit strategies.
• On the bourse itself there is hedge fund activity lacking transparency, accountability, and regulation.
• In central banking we have seemingly cosy connections with elected officials lest we scare the chastened consumer retreating from the abyss of excessive borrowing and minimal savings.
• In commercial banking we have government guarantees and equity recapitalisation to offset loan write-offs. Yet we feel that losses are under-provisioned and central bankers are acting as lenders of last resort; lending at favourable interest rates to allow time for economic recovery to drive profits to further assist bank re-capitalisation.
• American-style banking seems bizarre: of the 8,133 US banks, 2,256 are said to be severely distressed, equivalent to 28% of the banking universe and up from 17% (1,458) a year ago (data courtesy of Institutional Risk Analytics USA). It seems to us that if you are ‘too big to fail’ then you are too big to exist, and we note Glenn Mumford’s article on page 23 of today’s AFR is pertinent to this debate. If America wants to maintain its position as the world’s reserve currency it cannot have a dysfunctional banking system.
• At the corporate level the stress of past mistakes is being relieved by equity injections at deep discounts and a significant number of executives taking comfortable retirement packages to soften admissions of failed strategies through debt-funded acquisitions.
• At the political level there has been major changes in the developed world. The four brothers (BROS) have emerged, each spruiking the concept of global engagement and partnership in response to the FCS ‘crises’ – Financial, Climate, and Security ( terrorism). These brothers in arms are Brown, Rudd, Obama and Sarkozy. If summit verbosity, photo-ops, learned reports and statements of intent were part of global GDP, the growth number would be 5% in perpetuity, rather than the sub-optimal 2% consensus number we are looking at.

President Obama needs to transition from style towards substance, from celebrity status to management effectiveness. We take considerable comfort in this week’s abandonment of the ‘silly’, Star wars European project, which was described by Joseph Cirincoine in The Australian on 21/9/09 as "Obama replaces a system that did not work against a threat that did not exist with weapons that can defend against the real Iranian missile capability". Obama’s decision was supported by Defence Secretary Gates, a George Bush appointee who continues in office under Obama.

 

STRATEGY versus TACTICS

Strategy: Our definition of long-term is 1-2 years, medium-term 6-12 months, and short-term 1 week to 6 months. But all of our views are rolling views, so that we can hold the same 2 year view for the next 5 or 6 years. But, at the moment, we are not comfortable with either our own views or anyone else’s view beyond about the next 2 years. There are always too many variables, and now that hedge funds trade significantly in advanced and liquid markets, volatility is simply a fact of life. At the transition stage from recovery to sustainability, the underlying narrative can swing quickly from bullish to bearish and vice-versa.

Thus, our strategy is to build core holdings over a bullish-cycle and trade around the edges of those holdings to achieve out-performance.  At the same time we are likely to buy a few stocks that we do not wish to hold longer-term, but are relatively ‘cheap’ in context of where the market is, at any one time.  We tend to sell such stocks early, or if new information unfolds, re-assess their longer-term potential. Many have said “If new information appears, I change my mind… don’t you?”

We tend not to focus on sectors in the Australian market because Australia is such a relatively small market, thus only a few stocks are dominant in any sector.  Hence our focus is stock-specific, not sector specific. We do not invest or trade offshore. We don’t have the appropriate contacts or depth of knowledge; currency risk is an obvious impediment. Essentially, we do not wish to ‘lose a lot for reasons not understood.’

Tactics: We have mentioned this on several occasions since the web-site published on 28/07/09. Our tactical stance is –

1.       Going with the flow, with conviction.

2.       Going with the flow, without conviction.

3.       Going against the flow, with conviction.

4.       Going against the flow without conviction.

5.       Ambivalent, uncertain, relatively clueless.

 

BULL VERSUS BEAR

We are not ‘bulls’ and we are not ‘bears’. We either believe the market is going UP, DOWN, or SIDEWAYS.  If it is going sideways then we will have a view that it is going to break to the upside or to the downside, but generally will not act decisively (with gusto) until that break-out or break-down is confirmed by market action. If we believe the market is going up we describe ourselves as ‘bullish’. If we believe it is going down we describe ourselves as ‘bearish’; being a ‘bull’ or a ‘bear’ is a generic condition and inhibits flexibility. We are not in charge of the world or the markets and our opinions and actions are hardly likely to influence events. But in our modest way we are players and we always remember: “The game is greater than the player”

 

DAVID BABSON’S RULES:

1.       Markets are unpredictable and ill-suited to forecasts

2.       Long-term fundamentals are key

3.       Investor emotion leads to volatility

4.       Valuation discipline should guide investment selection

5.       Perspective and patience are rewarded

All of that having been said, we still make forecasts or develop views; long-term fundamentals are under constant review; other people’s emotions should be of benefit to the unemotional; we have a robust valuation discipline; and though we have a perspective we often fail to be patient. Patience is NOT one of our virtues, but we have learned to live with this behavioural imperfection.

 

THIS ALL LEADS BACK TO THE RECOVERY BUS

The bus is part of the public transport system, often regarded as inherently unreliable. The bus crew is the BROS (the brothers Brown, Rudd, Obama, and Sarkozy). Mr Rudd wants to be the driver but the others know he is from Queensland and so he is just the ticket collector, but he has a smile for all of the passengers and they are feeling good. He has mentioned his experience with Toyota utility trucks, but that has not swayed the other brothers to let him have the wheel.

1. Using our global proxy, the S&P 500, the bus started its journey at 676 on 9 March and continued for 43 days at an average of 150 basis points per day. Let’s describe this metaphorically as 150 people went along for the ride.
2. The bus paused for 5 days to re-fuel and have a barbeque and resumed its journey on 18 May getting to the next stop on 12 June, a further 60 people came on board.
3. There was a 20 day stop-over and 64 people got off to wait for the next bus. Kevin thought about getting off as well so he could drive this bus, but decided to stay with the other brothers. He said ‘In every crisis journey the brothers must act as one, and stick together."
4. From 13 July to 21 September (just yesterday) the bus arrived at bus stop number 3 after 51 days with another 75 people on board. The bus is getting a little crowded and though the number of new passengers is half of the first journey, everyone is having a good time, including Kevin because we have landed in Washington.

THE MESSAGE

There is a time to be on the bus, a time to get off; have some knowledge of who is driving; watch for road rage and other erratic behaviour; sometimes get off and wait for the next bus.

America today has elements of all of the discredited ‘isms’ of yesterday hidden behind the facade of a supposedly free-enterprise economy and democratic system, though only about 26% of the population vote for any administration in office, and even less if the gerrymander is analysed in greater detail. The ‘isms’ are fascism, capitalism, social welfarism, big government conservatism, legalism, religious dogmatism, and powerful cronyism, amidst pervasive elitism. The American elite has created national and international kaffirs, and within America itself the second class citizen, not encouraged to vote, are as below the rule of law as the elite is above it.

Success breeds excess: America accepts without question its profligate behaviour in relation to energy consumption, poor wages in many areas of its economy, unfunded pension liabilities, a second class education for many of its residents, the same in health, corporate welfare, tax shelters for those who can afford them, an excess of legal mantra over common sense, rampant debt creation largely involving other people’s savings, excessive speculation via derivatives and other exotic financial instruments, poor public and private accounting. These successes and excesses have led to a country often seemingly out of control and exposed to regular crises, few of which are anticipated, and after the event, the response is shambolic, creating the conditions for the next ‘bubble’.

Why not try common-sense conservatism? In America common-sense conservatism has been replaced by a religious dogma that god is somehow more favourably disposed towards American goodness and superiority than most other nation states. The creators of hope, freedom, and progress for such a long time, appear to be prisoners of their own worship of American capitalism rather than balanced free enterprise. They prefer to promote fear over hope; war over peace; manufactured myth over debated fact; spin over substance; force over persuasion; the might of the law over the rule of law; the replacement of politicians of good sense, judgement and integrity by charlatans and fools. In short the ends, as defined by an elitist minority of church and state, justifies the means; winning is not the most important thing, it is the only thing.

But a world without a good and effective America is a deprived and deficient, and less efficient, world. Not all of America is misguided, corrupt, or ignorant. The problem is that recent Administrations appear to have had too few good men capable of articulating and executing a vision for the good of mankind. The next President of the United States is a most important, perhaps even a critical, appointment. A man with an iron fist, a velvet glove, and the rhetorical skills to match wisdom and attitude. Ecinya cannot see it happening without major electoral reform, but America does not yet appear to have a pervasive belief that the system is broken,

The ECINYA pages 13/1/2006.

Exactly how it has managed to do it is a bit of a mystery, but the Rudd government has somehow been able to produce a labour relations mess that is exactly as bad as the one it said it planned to replace.

Peter Ruehl Australian Financial Review 15/9/2009.

The global economy is beginning to pull out of a recession unprecedented in the post World War ll era, but stabilization is uneven and the recovery is expected to be sluggish. Financial conditions have improved more than expected, owing mainly to public intervention, and recent data suggest that the rate of decline in economic activity is moderating, although to varying degrees among regions. Despite these positive signs, the global recession is not over, and the recovery is still expected to be slow, as financial systems remain impaired, support from public policies will gradually diminish, and households in countries that have suffered asset price busts will rebuild savings.

International Monetary Fund World Economic Outlook Update 8/7/2009.

ECINYA COMMENT

The question was recently asked of our editor: "Have we seen the bottom?" The answer is, most probably, "yes", but there is more than a single ‘bottom’ on the road to recovery. In each up cycle there are typically 3 bottoms. So the answer depends on which ‘bottom’ we are talking about. At the March 2009 lows the All Ordinaries index had fallen 55% from its 2007 high to 3111, and our global proxy, the S&P 500 had fallen 57% to 676. Since the March lows the All Ordinaries has risen 43% to 4536 and the S&P 500 has risen 51% to 1049.

Our guess is that the next ‘bottom’ will be around S&P 940 to 950 implying around 4200 to 4300 for the All Ordinaries. A 10% fall in the S&P 500 would probably result in a 6-8% correction in Australia.

"Is the recession over?" Once again, a question that does not get you too far. On 25 August we wrote the Ecinya Insight essay "Time to pause". In that essay there was a very pertinent quote from a market doyen, George Soros, that in essence said ‘the answer depends upon the inputs’.

Australia is well placed in hard and soft commodities and the fortuitous happening of The Gorgon gas field is Australia’s latest economic salvation project. Additionally, we benefit from the perceived need for the Chinese to convert their US dollar holdings into real and productive assets and this underpins our asset values to a certain extent.. The China focus is likely to be Africa and Australia.

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

The incorrect systemic diagnosis is: "MORE REGULATION" is needed. The real problem is that more SUPERVISION is needed. America has plenty of laws and legal agencies that exist to curtail and control excess, but American crony capitalism is built upon the twin concepts of celebrity and excess. It breeds people like Mr Madoff, Mr Kenneth Lay of Enron and the various chief executives of bailed-out organisations like IAG, Morgan Stanley, Merrill Lynch, Bear Stearns, Lehman Brothers, CitiBank etc. Overseeing these various failures was Presidents Reagan (1981-1987), George H W Bush (1989-1993), Bill Clinton (1993-2001), and George W Bush (2001-2009). And, always in the wings, the politically attuned, Mr Greenspan fuelling the flames with accommodative monetary policy.

It is a bit unfair to include Bill Clinton because he did oversee a period of relative prosperity, mainly due to the fact that Newt Gingrich was in control of the US Congress and kept fiscal spending under control. America actually was in surplus at the end of the Clinton era which provided the cash for Mr Bush to pursue his military adventures.

BUT WHAT OF AUSTRALIA?

Because Australia had a fiscal surplus going into the GFC, a strong band of central bankers led by Mr Alan Macfarlane and then Mr Glenn Stevens, plus the Australian Prudential Regulation Authority and the labour market reforms introduced by Paul Keating and retained by the Howard/ Costello team, Australia has escaped the worst of the GFC. The global commodities boom also assisted significantly.

BUT there are caveats to Australia’s current relative immunity. Much of what we can achieve is dependent on the health of the external economy, but we can make things harder for ourselves if we waste scarce resources as much of our consumption sucks in imports. Australia still needs to work on import replacement rather than creating jobs in China and Asia generally.

Let’s start with Westpac Economics August Market Insights offering: "The global investment community went cold on growth trades in June – but they got their risk appetite back in the second half of July. The full gamut of growth orientated asset classes have performed very well of late. The apparent catalyst for this formidable return of confidence has been the apparent improvement in the US data flow, a better than expected corporate earnings season and further evidence of resurgent growth in China. We believe in the third factor, but the first two are illusory. Better data emanating from the balance sheet constrained jurisdictions is due to the intersection of the inventory cycle and fiscal stimulus. Add that to low quality earnings driven by corporate cost cutting and you have a house of cards. All that said, the market believes, and will have little reason to change its mind for some months, possibly even quarters, as these transitory factors play out."

BUT in Ecinya’s view the transition from recovery to expansion is not linear in either market or economic terms. The Rudd government is making serious mistakes in its industrial laws which will impact adversely on jobs, wasted expenditures in indigenous housing and school facilities plus a serious and confusing pre-occupation with the global emissions trading debate and the broadband roll-out. Mistakes are likely to occur as other infrastructure spending packages roll out.

Our belief is that the Hawke/ Keating government was thoughtful in policy formulation and thorough in execution. Hawke/ Keating achieved broad support through lucid and logical explanation. The Liberals under Howard Costello were thoughtful in policy formulation and thorough in execution and achieved reasonable support via explanation and persuasion. The GST has been the biggest policy success in domestic terms in the post WWII era of ‘modern’ economics. It is interesting that Mr Keating is reported as expressing disappointment in Labor policy and attitudes saying the current Federal administration is focused on power, lacking policy passion.

Mr Rudd is a regression to the Whitlam years of bluster, filibuster, spin and nonsense. Hence without a large dose of luck emanating from the global stage Australia will find itself saddled with high private and public debt relative to income as local and global interest rates rise towards ‘normal’. Mr Rudd is so obsessed with re-writing the economic history of Australia that he has forsaken management of the present to secure a comfortable future. We fully expect the Ken Henry tax ‘reform’ package to reflect the governments lack of understanding of the reality of practical economics.

DEBT is never a problem if the money is well spent, but there is clear evidence of spending for spending’s sake. BUT it is not just Mr Rudd that has fallen for a wholesale mis-interpretation of Keynesian economics. David Rosenberg, ex Merrill Lynch, and now with Gluskin Sheff of Canada, said on 10 September "All the growth we are seeing globally this year is due to fiscal stimulus".

There are two related local and global fears – Firstly, that take away the fiscal stimulus and you are left with very little that assists sustainable growth. Secondly, we have a muted and jobless recovery.

At Ecinya we always take great comfort in Bill Bonner’s 2007 statement on fiat money : "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 & increase production. Pretty soon there is a boom." In January of 2009 we said; "Fiscal stimulus should work based on historical precedent and barring a serious war, but some of it will be well & truly wasted." As of today our fears are, unfortunately, being realised.

Westpac are forecasting global growth for 2010 at 2.6% and negative 1.2% for 2009. Australia is at 1.8% for 2010 and 0.2% for 2009. A 1% shortfall in global growth is about US $700 billion, just a tad less than the entire GDP of Australia. This is a significant number. It is akin to Australia disappearing from the world economy for an entire year.

CONCLUSIONS

• We are through stage 1 of the ‘recovery’. There are two up stages yet to be completed after two periods of consolidation, retracement, or stagnation – whatever you wish to label it.
• We need a period of consolidation or retracement, about 8 to 10% of the current indices would be appropriately constructive and technically and economically logical.
• Mr Obama has to address some serious long-term structural and systemic issues.
• There are dangers in the pursuit of ideological agendas in climate change and US health-care. Affordable health-care is important for America, but a big agenda item for recessionary times.
• The Middle East remains an omni-present threat.
• Bankers in Europe, America and China are not yet telling the ‘whole truth and nothing but the truth’.
• China is beginning to get impatient with America and trade-war debates are surfacing. America is perpetually impatient with China.
• Global employment has not stabilised.
• The possibility of a US$ crisis is real. Watch gold and precious metals generally.
• Excesses are returning, local examples being the float prices for CarSales.com and Myer. American examples are investment banking profits and salaries.
• Markets do not go up forever; they need to pause to allow time for the real economy to catch-up. The real economy is the production of goods and services. The symbol economy is money and credit.

OVERALL

The pendulums swing, imbalances ebb and flow; and the (fiat money) band plays on.

 

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.

5. Focus on value and strength. Cut losses, let profits run. Good profits are generally made on new highs. When a market is making a new high it is telling you something. Buy stocks that are coming out of broad bases and are beginning to make new highs. Price going back into a base is bearish.

6. In the long run the stock market indices fluctuate around the upward trend in earnings per share.

The Ecinya investment rules #1 to #6 of 10. Refer to ‘Market Wisdom’ under the ‘THINK’ TAB.

Eighty percent of success is showing up

Woody Allen.

It was a sunny spring afternoon on Balmoral beach in 1913 when stockbroker Phillip Pring asked his beloved Shirley for her hand in marriage. Knowing his reputation as a ladies man she smiled and inscribed her answer in the sand with her parasol: LINWAR. A puzzled Phillip enquiring as to its meaning was informed "Life Is Nothing Without A Risk".

From LINWAR Securities "Introduction to the firm" booklet.

A NOTE FOR JANE

note: names have been changed for purposes of identity protection.

About two weeks ago Jane came to visit our office for an introduction to equities. She was recommended to do so by her husband, Tarzan. Tarzan is a great admirer of his wife’s abilities, enthusiasm and her level of computer competence. Tarzan runs a successful Australian based manufacturing business employing about 30 people. It is profitable and well established. They have their own superannuation fund. Jane helps Tarzan with administrative matters and we suppose she is well remunerated for her inputs. It is reasonable to say that Jane is a little scared of the stock-market and her belief that she knows ‘not a lot about it’.

Jane wants to learn about shares and manage part of her and Tarzan’s superannuation funds.

We explained that investment is all about yield, growth, and risk management. In relation to yield, we introduced Jane to the concepts of the ‘Price Earnings Ratio’ of which the reciprocal is the ‘Earnings Yield.’ A PER of 13 equates to an earnings yield of 7.7%. We talked of the importance of focusing on operating profits and earnings per share rather than ‘reported profits’ which contain potentially non-recurring items, of which the most common in the current environment is the write down of ‘impaired assets’ in context of the "global financial crisis" and new parameters of assessing risk. We also talked about the importance of earnings growth, or earnings sustainability, for it is from growth that balance sheets remain strong, dividends are paid, debt is reduced, new assets are acquired etc.

We also explained that in calculating ‘earnings per share’ analysts make adjustments for shares that will be issued under share employee and executive programmes, but also under re-capitalisation share issues, a lot of which are currently taking place on a large scale as banks seek to get debt repaid.

BUT WHAT WE DIDN’T TALK ABOUT WAS GETTING STARTED

The stock-market is difficult to predict in relation to time, direction and dimension, but as Woody Allen said; "turn up". A simple course of action for a new investor is suggested along the following lines:

• Select some reliable sources of insightful information. We recommend ‘Share Analysis’ from Aegis Equities Research Group, Huntleys ‘Your Money Weekly’, and ECINYA.
• Select 10 stocks and get to know something about each of them. Ring the companies and say you are thinking of becoming an investor, ask them to send you an annual report.
• Open an account with an on-line broker preferably one with a decent technical charting facility. We currently use E*Trade, but Westpac On-Line, and Commsec may be worth looking at.
• Allocate 5 to 10 hours per week to manage your portfolio.
• Every time you buy or sell a stock write down your reasons in a note-book of substance – A4 or foolscap.
• Read a book or two on the share market: We recommend Victor Sperandeo’s "Trader Vic: Methods of a Wall Street master."
• Embrace a group of confidants that you can talk to from time to time.
• Avoid speculation in the early days.
• Occasionally read some macro economic documents from your bank.
• Construct an Excel spread-sheet to measure your progress.
• Read The Australian newspaper regularly, and occasionally the Australian Financial Review, especially the Market Wrap section.

Now 10 stocks to start with: Westpac Bank, Commonwealth Bank, QBE Insurance, CSL limited, Ramsay Healthcare, Primary Healthcare, Computershare, NewsCorp, BHP and Woodside.

At the moment we are waiting for a better entry point than is on offer with most of the above stocks, but a few of them are close to acceptable entry points, and a few of them are on our list of currently recommended buys.

Let us assume that your starting out dollar amount is $40,000, which is about equivalent to $4,000 per stock. Buy some now or soon, preferably at or very near our entry point level (you have to start somewhere), and buy more later. Weak days are better buying days than strong days. If our market retraces banks are likely to lead the whole market down.

Technical analysis

We always look at charts but NOT for forecasting purposes. We just want to know the primary trend, resistance and support levels, what the price is doing in relation to a moving average, momentum. For daily charts we use an 18 day moving average, for weekly charts we use 13 weeks. We use Williams%R to massage an entry point. Charting is something that a little practice will assist greatly. When you print out a chart, attach a note as to what you think it is telling you, so that you can review it later on.

Thinking

Regularly we plot our mood from the following matrix:

1. Deep despair
2. Very bearish
3. Bearish
4. Concerned
5. Ambivalent
6. Comfortable
7. Confident
8. Bullish
9. Very bullish
10. Euphoric.

Obviously, entry into the ‘very bullish’ and ‘euphoric stages’ is a signal of danger ahead.

Tactics

Our tactical position is comprised of 5 parts:

1. Going with the flow, with conviction.
2. Going with the flow, without conviction.
3. Going against the flow, with conviction.
4. Going against the flow, without conviction.
5. Ambivalent, uncertain, relatively clueless.

A combination of our thinking matrix and our tactical stand determines the level of cash and shares held at any one time.

At close of business today we are finalising some changes to the website to make it cleaner (less cluttered), more navigable, and hence more readable. These changes should take effect next week, or the week after.

Please read "Strategy" to see where our thoughts lie this week. We are personally maintaining cash levels around 22% of our portfolios.