Ecinya

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.

A BRIEF ANALYSIS OF THE GLOBAL FINANCIAL CRISIS WITH SPECIAL EMPHASIS ON AUSTRALIA AND THE ROLE BEING PLAYED BY THE PRIME MINISTER, KEVIN RUDD

written 8 February 2009

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

Paul Krugman "The Great Unraveling" published 2003.

All countries which accumulate debt and habitually run big current account deficits are vulnerable. And for many centuries societies have been susceptible to irrational booms, South Sea Bubbles, tulip bulb booms, and dot-com busts. But no central bank can offset the cascading effects of bad government policy.

Peter Walsh, former Labor Party Finance Minister, Financial Review, 10/12/2003

The team that brought you "Financial Reckoning Day" reunite to provide you with the first in-depth look at how the American character has shifted to accommodate its new imperial role; how we have abandoned the private virtues of personal liberty, economic freedom, and fiscal restraint; and how the guv’mint has gained control of public life and the economy. The result has been, among other horrors, unfettered deficit spending, gluttonous consumption, and fearless military adventurism. All the while the nation slouches ever more precipitously towards bankruptcy.

Cover sheet "Empire of Debt" 2006 by Bill Bonner and Addison Wiggin

The Republican Party, now in the grip of the Reagan forces, had abandoned the reality of the retail world in which politics had always been done; they had put emotion to work in the service of ideology. The politics of the nation had been given into the hands of the salesmen, and it was certain that the salesmen would win, for they had learned the secret of modern politics, which is that no one can refute the arguments of the heart.

Earl Shorris "A Nation of Salesmen: the tyranny of the market and the subversion of culture", 1994

The political home of neo-liberalism in Australia is, of course, the Liberal Party itself………………………….In the current crisis, social democrats therefore have the great advantage of a consistent position on the central role of the state…………………………….For social democrats, it is critical that we get it right – not just to save the system of open markets from self-destruction, but also to rebuild confidence in properly regulated markets, so as to prevent extreme reactions from the far Left or the far Right taking hold……………Social democrats can chart an effective course that will see us through this crisis, and one that is also capable of building a fairer and more resilient order for the long term. This can only be achieved through the creative agency of government – and through governments acting together.

"The Global Financial Crisis", by Kevin Rudd et al, The Monthly, February 2009.

In the middle of what he describes as the worst economic crisis since the Depression, Prime Minister Kevin Rudd has decided to launch a divisive personal crusade against so-called "neo-liberalism". Rather than economic solutions, Rudd is seeking ideological retribution………………..Economics is not the monolithic ideological edifice Rudd seems to think…………..If you look at the present size of the public sector and the level of spending in Britain, the US and Australia, the only fair conclusion you can draw is that neo-liberals failed to successfully implement their agenda. In all cases the public sector is about the same size, and in the case of Britain and the US, public spending and debt have ballooned. Rather than neo-liberalism, the past 30 years have seen a form of stealth Keynesianism dominate economic policy.

Michael Costa, The Australian 6/2/2009, "Rudd on a dangerous, ill-informed crusade"

UPDATE REMARKS (today 1 September 2009)

THIS ESSAY was written in February 2009 and is re-produced here as it appears to be more pertinent now than when many (some of them self-serving) were exaggerating the ‘global financial crisis’, which now seems to have been not much of a crisis at all. All that was required was to simply throw large levels of fiscal and monetary stimulus at the problem. Keynes had done it before so that it was an old recipe. But it still seems to us that not enough current attention is being given to the basics – structural, systemic, and attitudinal – especially in America. The cult of ‘the free lunch’ has returned. The imbalances that provoked the ‘crash’ seem omni-present.

Australia is in relatively good shape. According to Westpac Economics our economy will grow at +0.2% for calendar 2009 in a world expected to regress at -1.2%. The underlying reason is our proximity to Asia where the Chinese economy is expected to achieve growth of 8.5%. But all of these figures are relative. In ‘normal’ circumstances the world should grow at around 3% per annum which means that world output doubles about every 24 years. Australia’s domestic economy enjoys high per capita GDP, a stable banking system, generally sound infrastructure, relatively full employment, a stable housing sector etc. But as a major trading nation we cannot expect immunity from the global economy.

PROLOGUE (written 8/2/2009)

This has been written to attempt a brief articulation of a major concern that far from saving Australia from the ‘global financial crisis’ the actions, rhetoric and policies of the current Australian government are going to totally immerse us in it, or delay our recovery from it, or both. We are just 1% of the global economy. Time is needed to see where the stimulus packages of China, America and Europe will lead the world. Current local policy prescriptions seem to be pre-emptive, excessive, and poorly targeted.

Ecinya has suggested that payroll tax relief, personal tax cuts being brought forward, and some relaxation of capital gains taxes for long-term residential property holders upon sale would provide sufficient short-term relief. We are totally opposed to the $950 per person hand-out which apparently will cost about $11 billion and we don’t understand the pre-occupation with direct infusions for commercial property as opposed to working through the banking system. We are strongly in favour of infrastructure spending, but the schools programme is blatantly political and can unfold more slowly than currently envisaged. Some of the ‘green’ programmes seem also to be politically inspired.

On the rhetorical side we have suggested that ‘balanced free enterprise’ replace ‘capitalism’ and ‘socialism’; that ‘beneficial trade’ replace ‘free’ trade; and that the Chinese Communist Party change its name to the ‘China Central People’s Party’ to mitigate cheap shots from the west during its past 30 year transition and integration into the global economy.

(postscript 11/2/09: Two of my confidants (esteemed colleagues) found it an unwelcome and irrelevant diversion that China should be mentioned in this prologue. They seemed sufficiently chastened when it was pointed out to them that China was currently central banker to the world economy, that China and the US between them account for close to 30% of global GDP, that China had provided about 25% of world GDP growth over the past 8 years, and therefore, needed to become a fully fledged member of the global financial community. The word ‘communist’ enables rednecks and assorted ideologues to treat them with insufficient respect.)

We do not share Mr Rudd’s convenient faith in the International Monetary Fund and despite our long-held support for Mr Obama (since 2006) his success is far from guaranteed, given the recent performances of the US Congress and statutory agencies. He has to overcome significant congressional obstacles and tear down some false fiscal and political gods and prophets, and embrace some others with his own balanced perspective.

Prosperity is the tide that carries us to realisation of our social and material aspirations and re-leveraging the public sector to de-leverage the private sector is fraught with difficulty and invites unintended consequences. One cannot help but feel that Mr Rudd is out of his depth and being overtaken by his personal ambitions

 

THE ECINYA RESPONSE

Even at schoolboy level we are taught that the daily economic battle is between ‘wants, which are unlimited in extent and variety, and resources, which are limited.’

The Austrian school of economics places great emphasis on the fact that mis-allocation of (scarce) resources is at the epi-centre of sub-optimal or bad economic outcomes. Bad policy is bad policy. Good policy poorly implemented results in bad outcomes. The results are all too obvious – inflation, high interest rates and taxes, low productivity, excess capacity, current account deficits, poor health-care etc.

THIS RECESSION has been a long time in the making. It has been an evolution and no talk of ‘revolution’ or the adoption of one of the ‘isms’ such as ‘social democratism’ will achieve a sustainable solution. It is equally true that laying the blame at the feet of any other ‘ism’ provides an unsound framework for sustainable solutions.

BUT if we had to choose an ‘ism’ we would select ‘common sensism’. In economics, what doesn’t make good common sense is hardly likely to make good economic sense. There is no single ‘ism’ that fully explains what has happened, what is happening, and what will happen. The world is a hybrid – all of the ‘isms’ swirl around in a dynamic framework, sometimes winning and sometimes losing. This can be referred to as ‘cycles’.

Prime Minister Rudd’s lengthy essay, written in conjunction with advisors and colleagues "with common interest in the ideological origins of the current crisis", adds nothing to the debate. Rather, it gets lost in an intellectual indulgence that fails to understand the role of the government in context of a parliamentary democracy where even the Opposition is elected to give voice to the people. "President" Rudd, just like Messrs Bush and Cheney, believes in Executive Government where parliament is expected to endorse, support, anticipate and agree with the Government of the day. It is convenient to label dissenters as ‘ideologues’, ‘radicals’, ‘racists’, ‘neo -liberals’, or ‘the do-nothing brigade’.

Mr Rudd’s "analysis" leaves out some important contributing factors – the role that the Australian states play in industrial relations, in health, in education and other areas of spending such as infrastructure, and for the most part of the recent boom, those states were Labor. Mr Costa, in the article mentioned above, says: "So deregulation, privatisation, greater market competition and expanded private participation in equity markets through compulsory super, is OK if it’s undertaken by Australian Labor governments, but it is neo-liberal ideology if anybody else does it. All the way through his essay Rudd tries to have it both ways, cherry-picking economic history to support his political prejudices."

Ecinya respectfully suggests that Mr Rudd has been caught by the gentle breezes of Kirribilli House, the star filled nights, the easy harbour-side celebrations, and with aligned minds in attendance, each with a glass of chardonnay poured from the public purse, is moving to govern through the prism of his ego or his own lack of self -esteem, or some other psychological disorder. There is no air of quiet confidence that creates a sense of managerial competence. Rather, there is a sense of papal infallibility. If God had meant politicians to lie he would not have invented behaviours like obfuscation, false and misleading and deceptive conduct, innuendo or delusions of grandeur. Mr Rudd was elected to govern, not ordained. Government is principally about economic management, law and order, and future investment (education, social and commercial infrastructure).

On a more global perspective he fails to mention the economic leakage caused by the wars in Afghanistan and Iraq, and the major transfers of wealth caused by the oil price surge, and the out-sourcing of global production to China, India, Mexico, Brazil, Canada and elsewhere. Essentially, Mr Greenspan gave the world this recession, this ‘crisis’, by creating a false economic boom to hide a war based on falsehoods. This is a ‘made in America’ recession. Led by the local branches of the Wall Street machines like lambs to the slaughter, we all participated with gusto and glee. The music has stopped, the game of musical chairs is over, and many old maids find themselves unseated. A wolf in sheep’s clothing provides no solution.

A RECENT ECINYA SURVEY

Three weeks ago (January 2009) we asked 8 of our confidants to join our editor and to write down their five major fears/ worries for 2009. This gave us 45 responses (9 times 5).The table below summarises the results

Responses

• US in all aspects, $US, Obama… 10……………………………………………………….22%
• Australian government policies & abilities… 8………………………………………..18%
• Deflation – recession deepens, asset values continue decline… 6………. 13%
• Geo-political – oil price, middle east, wars etc… 4…………………………………… 9%
• Wages and employment… 3……………………………………………………………………. 7%
• Banks willing to lend, bigger bank losses… 3………………………………………….7%
• Confidence – market, DIY super losses… 2……………………………………………. 4%
• Public & private debt levels… 2……………………………………………………………….. 4%
• Drugs, alcohol, law & order… 2……………………………………………………………….. 4%
• Australian management… 1……………………………………………………………………. 2%
• China over-saves… 1………………………………………………………………………………. 2%
• Trade wars… 1……………………………………………………………………………………….. .2%
• Energy policies globally… 1……………………………………………………………………. .2%
• Resources bust… 1………………………………………………………………………………… 2%
• X factors… 1…………………………………………………………………………………………….. 2%

We found the second most dominant fear to be interesting and consonant with our own fears. The Hawke-Keating government were sound economic managers, before turning into micro-populists, mainly instigated by Mr Hawke in his final term. The Howard-Costello government were sound economic managers before turning into micro-populists, mainly instigated by Mr Howard in his final term. Transition is just as important in government as it is in business, and poorly orchestrated leadership changes are costly for taxpayers.

In the wake of the global financial crisis of 2007-2009, economists have cause to ponder the adequacy of their intellectual frameworks for understanding the way economies, and especially systems and markets, function. Many of what had come to be widely-accepted verities – including the ‘efficient markets hypothesis’, the merits of self-regulation, the assumptions that people behave in rational and predictable ways, the use of statistical models to measure risk – have been seriously challenged by the course of events. So too has our reputation for being able to forecast crises and cyclical turning points.

Saul Eslake, The Shann Memorial Lecture, University of WA, 19/8/2009

We need a new science of macroeconomics. A science that starts from the assumption that individuals have severe cognitive limitations; that they do not understand much about the complexities of the world in which they live. This lack of understanding creates biased beliefs and collective movements of euphoria when agents underestimate risk, followed by collective depression in which perceptions of risk are dramatically increased. These collective movements turn uncorrelated risks into highly correlated ones. What Keynes called ‘animal spirits’ are fundamental forces driving macroeconomic fluctuations.

Paul De Grauwe, Financial Times, London, 22/7/2009 – "Warring economists are carried along by the crowd."

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.

Ecinya Investment Rule #4, 1997. Refer to ‘Market Wisdom’ tab for the complete set of rules.

Firm predictions are out of the question. The future depends on the policy responses the financial crisis will provoke. But we can identify the problems and analyse the policy options. We can also make some firm predictions about what the next era will NOT look like. The post-World War ll period of credit expansion will not be followed by an equally long period of credit contraction. Boom-bust processes are asymmetric (not identical) in shape: a long, gradually accelerating boom is followed by a short and sharp bust. Consequently, most of the credit contraction can be expected to occur in the near term.

The Bush administration shows no understanding of the predicament in which it finds itself. Eventually, the US government will have to use taxpayer’s money to arrest the decline in house prices. Until it does, the decline will be self-reinforcing, with people walking away from homes in which they have negative equity and more and more financial institutions becoming insolvent. The Bush administration resists using taxpayer’s money because of its market fundamantalist ideology and its reluctance to yield power to Congress. It has left the conduct of policy largely to the Federal Reserve. This has put too much of a burden on an institution designed to deal with liquidity, not solvency, problems.

George Soros "The New Paradigm for Financial Markets: The Credit Crisis of 2008 and what it means."

The sharemarket posted its biggest one-day gain in more than a month yesterday, underpinned by US central bank optimism about the prospects for global recovery as well as earnings upgrades flowing from the local profit reporting season. The S&P/ ASX 200 Index added 135.5 points, or 3.3 per cent, to close at 4426.1, as upbeat US housing data and optimistic comments from Federal Reserve Chairman Ben Bernanke bolstered confidence about the global outlook.

Front page Australian Financial Review "Bernanke’s optimism lifts shares."

PROLOGUE

This week’s Insights follow on from last week’s "Navigate the Noise" and run in tandem with each of our Insight articles since our new site began on a stand-alone basis on 28 July (vis previously being part of the E*Trade web-site).

THE MARKETS’ ENDLESS DANCE

Economic recoveries are a waltz, and the market since the March lows has been doing the tango, the cha cha cha, and in some cases, rock and roll. The ASX All Ordinaries and the S&P 500, our global proxy, have performed as follows:

XAO/ S&P

• Wave 1 : 43 days UP +25.6%/ +37.4%
• Wave 2: 5 days DOWN -4.1%/ -5.1%
• Wave 3: 20 days UP +8.1%/ +7.3%
• Wave 4: 20 days DOWN -6.7%/ -7.1%
• Wave 5: 31 days UP +17.0%/ +16.6%

Overall primary trend UP from March lows: 119 days XAO +39.8%/ S&P 500 + 47.3%

Our models are suggesting that most stocks are at or near fair value and that forward earnings forecasts do not suggest a significant advance from here. Once forecasts are boosted by a more robust macro-economic picture of enduring quality, the market will have good reason to continue its advance.

About Mr Bernanke

Firstly, Mr Bernanke is an economist and an acknowledged expert of ‘The Great Depression’ so that his policy response has been appropriate. However, it has also been accompanied by a Congressional/ Presidential fiscal stimulus as great as that which followed the end of WWll. Mr Bernanke is up for re-appointment in about October of this year, as his term as boss of the Federal Reserve ends. Many believe he has saved the world economy from a serious depression-type melt-down, and others believe he is the architect of the next great crash. But it cannot be said by the AFR or anyone else that his remarks were ‘upbeat’ and ‘optimistic’. His remarks were heavily qualified, and though some tinges of optimism were evident, the colour of his remarks were a brighter shade of grey, rather than of vibrant red or yellow.

Secondly, though Ecinya attributes much of the ‘crash’ to Mr Greenspan (Mr Bernanke’s predecessor), Mr Bernanke was in The White House as Chairman of the Council of Economic advisers, and no statement of the coming melt-down, the manifest excesses or banking irregularities flowed from The White House. So, Mr Bernanke’s recent record is not without blemish. In fact, it could be said that he followed Mr Greenspan’s view of central banking, as being nearly always politically correct or obfuscatory to induce a sense of comfort. Central banking in the US appears to be only notionally independent, rather than strictly independent. The checks and balances were/ are not in evidence, at this stage of the recovery process.

The US Housing numbers

True, sales of existing dwellings rose at twice the rate they had risen in the previous month, and July was the fourth month of successive rises. However, the AFR reporting neglected to point out, at least at the beginning (our editor stopped reading after the second paragraph), that median house prices fell by 1.9% over the previous month, and on a year-over-year basis have fallen by 6%, and in some regions by double-digits. Given that the median house price is $US168,800 it could fairly be said that the United States housing market is the Aldi of the developed world. Houses are cheap relative to incomes and per-capita GDP.

Summary

The point we are making is that although the share-market rose, the attributed reasons are spurious, shallow, and misleading. A better explanation lies in a more holistic story that repossessions are high and speculation is being fuelled by massive liquidity injections by the Fed. Though housing has nearly stopped its precipitous decline, the housing turn-around only begins when both housing volumes and house prices move up together.

BUT

this ‘made in America’ global recession will, on Thursday of this week, be hit with a BIG important number. The Office of Budget and Administration is expected to report that the US domestic budget deficit forecast over the next 10 years will move from a projected deficit of $7.1 trillion to a projected deficit of $9 trillion. That’s bad news! But the ‘good’ news is that the 2009 deficit will go down from an estimated $1.84 trillion to $1.58 trillion, a reduction of 14%! Under President Bush there was considerable anguish when the actual budget deficit reached $400 billion, approximately equal to 3% of GDP.

At $1.58 trillion the ratio of debt to GDP is around 11.8%. Will this number be the catalyst that drives the US, and other global markets, down? During the week Warren Buffett warned that the US could become a ‘banana republic’, given the growing mountain of official debt. He is reported as having said: "Unchecked carbon emissions will likely cause icebergs to melt. Unchecked greenback emissions will certainly cause the purchasing power of the currency to melt."

We can only wait and see. America cannot afford a national health scheme in its present economic state, but some comfort can be taken that a national health scheme that has to be paid for will not emerge until 2010 at the earliest as the debate ebbs and flows.

AND

Iraq and Afghanistan are still consuming significant resources

AND

US unemployment continues to rise, retail sales continue to fall (except for motor vehicles where the government ‘cash for clunkers’ scheme is proving effective), and the oil price is somewhat elevated above $72, threatening to go higher.

IN CONCLUSION

Though Rosy Scenario is on the dance floor with all of her beguiling charm and flamboyance, dancing with her and falling under her magical spell is dangerous folly at this stage in the markets’ advances. The market lyrics are out of sync with the economic tune, being too far advanced for our comfort.

What is noise?

"Noise" (physics): A usually persistent disturbance that obscures or reduces the clarity of a signal.

American Heritage Dictionary as expressed in Richard Bernstein’s "Navigate the Noise – investing in the new age of media and hype", 2001.

Games played amongst even professional investors of Old maid, Snap, and Musical Chairs can be played with zest and enjoyment, though all the players know that it is the Old Maid which is circulating, or that when the music stops some of the players will find themselves unseated.

John Maynard Keynes circa 1930s.

Ultimately, success in the stock-market comes down to you, for no matter how much we know, the future is difficult to predict, both in relation to time and dimension. No one cares as much about your money as you do and Ecinya encourages you to develop sources that can assist you to take advantage of many sources of information. In looking at source material be mindful of confirmations and divergences of opinion. The aim of the Ecinya pages is to help you to build a set of thought processes to assist you to successfully invest, and occasionally trade. It is considered that occasional trading can enhance performance. In defining the Ecinya approach, which is almost exclusively fundamental, our proximate matrix is 35% fundamental company, 25% the global economy, 20% the national economy, 13% technical analysis, and 7% quantitative analysis.

"About Ecinya", written 2001.

In a society confronted with social, political, religious and ethnic conflicts, whose victims are often children, the youth and women, sport and the Olympic ideal provide hope, and the sports field remains the best place for peaceful confrontation. Sport is a school of human values which we frequent when we are young and need to make further use of as a means of preventative education, in order to face the scourges which poison our society. Investing in education and youth is an investment in the future.

Juan Antonio Samaranch, at the XXVll Olympiad, Sydney 2000.

THIS WEEK’S THESIS

THE GAME OF GOLF

Once upon a time when our editor was but a young man (from age 9 to age 16) he played competitive tennis, man against man; one man or team lost, one man or team won. At the end of the season the scores were tallied, the finalists determined and the finals played, and the prize-giving night awarded the trophies to the victors of the various divisions. The game was really all about winning and losing. The best player in our team of six had his mother in attendance each Saturday and she would critique the play of her son’s partners ("noise"), but her son always played without blemish or error. On one notable occasion her son’s partner carried the day and the team of two qualified to play at Sydney’s then home of tennis, White City, in the Milo Cup. On that day she remained silent lest her congratulations of her son’s partner would reveal the shortcomings of her son on that fateful day. Such is life and such are the rigours of intense competition. At age 17, our editor found golf, and his life was changed forever.

GOLF is very different to most competitive sports. Here is a sport where the course is the master and you have only yourself to compete against in that context. Our editor plays each Saturday in the club competition with 3 mates selected from a wide circle of mates who have been members of the club together for many years. As the game is being played there is frequent exclamations of "good shot", or "bad luck". There is a consistent and certain joy in one of your playing companions playing well, particularly if it results in him winning the day’s competition, which in some cases results in having your name ‘on the board’ along with past winners of that particular trophy. This coming Saturday our editor will play with three mates and two of them will be past winners of that day’s competition, The Captain’s Trophy, an event of considerable prestige.

BUT WHAT HAS THIS TO DO WITH THE STOCK-MARKET?

Golf is a game played in isolation, the only person you have control over is yourself. Though you have 192 players in the field, the progress of only four participants is known to you, for good or ill, yourself and your three companion golfers. One of you could have the best score of the four, and a score that is considered to have likely won the day, though players are still ‘on the course’. As you enter the clubhouse for the mandatory drink and discussion, you meet other players who have completed their round and discover that someone has had a better score than the best of your foursome. Though you have not won the day, you have played well. That ‘someone’ with the better score may also not have won. We won’t know that until the day’s competition is complete. Every player has a handicap which represents an assessment of their contemporary ability. Our editor in his youth played off six, so that a round of 78 (72 plus 6) meant that he played precisely to his attributed ability. As of today his handicap is 16, so that a score of 88 reflects break-even or par for him. The idea in golf is that your good shots exceed your bad shots. In the market, the idea is that your good decisions exceed your poor decisions and that you are not blown out of the water by being over-weight a bad decision.

THE STOCK-MARKET is a game of relativities; your handicap is your experience, your ability, and the time you care to devote to investing, and occasionally, trading; the other players are numerous and what they are thinking is largely unknown to you, though some clues are contained in the market aggregates; every day in the market is a brand new day; the unexpected can happen, the bad bounce, the fortunate bounce. The stock-market requires effort, discipline and patience, so does golf. Your performance is a matter of record. When you act upon a decision the outcome will not be revealed for some time, the stock may go up or down. If it goes down you may re-visit your assumptions and buy some more. Past success does not guarantee future success. Your reading of the market may be awry, the timing may be out of kilter. ECINYA has always suggested that in a bull-market focus on price and momentum; in a bear-market focus on value. Sometimes it is difficult to tell whether, or not, you are in a bull or bear-market, or participating in a rally or retracement in either context. Today, much of our thoughts revolve around that complex question; Has the recession ended? What will shape the recovery? Are the banks fully provisioned? Is there more bad news to come?

THE NOISE

Now that we have compulsory superannuation in Australia the stock-market has become a feature of our daily lives. We are all aware of The Dow, moves in global stock-markets, we know the name of The Reserve Bank Governor, the Treasury Secretary; their speeches are played on our TV sets. Interest rates, a dominant economic variable, are discussed ad-nauseum. Housing prices feature prominently. If you have Foxtel you have a wide range of business programmes of which Sky Business, CNBC, and Bloomberg are the most notable. CNBC is largely ‘infotainment’ and the commentators are made up of good-looking females, earnest young men, and a few old sages to give a balance. In fact "balance" and "perspective" are alleged features of the broadcasting commentary. But there are also a few ‘ratbags’ who rant and rave over the day’s affairs. When a villian is caught his crime, his motives and his detainment are reported with zeal and regulatory agency failures recognised. Examples of this are the recent episode with Mr Madoff, the sub-prime calamity, Storm Financial. People on the infotainment channels who called the market make guest appearances to forecast the future and dwell on the past whether, or not, they anticipated the likely course of events. There is a lot of noise everywhere.

NAVIGATING THE NOISE

An old adage in newspaper publishing is "90% of the message is in the head-note." But generally the day’s head-notes tend to follow, rather than lead the market; if the market is up the stories are generally bullish, if the market is down the stories are generally bearish, if the market is steady, the one lead head-note is generally bullish, the other generally bearish or neutral. Recent examples on the same day from The Australian Financial Review Market Wrap lead-page:

• 18/8/09: Harsh reality sinks shares/ Sustained recovery hinges on consumers.
• 12/8/09: Experts sceptical over earnings/ $A soars to 13 year peak against pound.
• 10/8/09: Pundits factor in early increases/ RBA holds longer-term view of China.
• 27/7/09 : Word of recovery is spreading/ Strong $A dulls shine of overseas orders.
• 24/7/09: Don’t miss boat analysts warn/ Alarm bells ring over commercial property.
• 23/7/09: Shares rise seven days in a row/ Price of stimulus may be a slow recovery.
• 22/7/09: Gains prompt soaring hopes/ As crisis eases, the next move will be up.
• 20/7/09: Hopes high for reporting season/ Busy week to test new found optimism.
• 15/7/2009: Rosy data sparks dash higher/ Boom on way for corporate funding.
• 14/7/09: banks and resources wipe gains/ Earnings recovery down the line.

From 13 July until 14 August in All Ordinaries terms the market rose 17.8% and our global proxy, the S&P 500 rose 14.2%. These numbers were clearly unsustainable and last night the S&P fell 2.5%. A retracement is almost certainly underway and this, in our view, will last 5 to 40 days with a most likely time-frame of circa 20 days. The recession is not over; the world has not returned to sustainable growth. Keynes would say that the ‘game of musical chairs is being played with zest and vigour and some will find themselves unseated’. Volatility is high. Though the reporting season is meeting our modelled expectations, those expectations are low to lowish, and the euphemism for the days ahead from most of the managing directors is "challenging."

So how to read the newspapers: Firstly, we recommend The Australian and The Financial Review, with an occasional glance at Ross Gittins in The Sydney Morning Herald. Go through the head-notes to get a sense of ‘bullish’ or ‘bearish’, mark the articles that you wish to return to, and then read them in full. Sometimes the head-note can be misleading. If a stock attracts you, go to a chart and look at the trend. Then visit the company’s web-site to get a feel for what the company does. If you can access research reports then do so. We recommend Aegis Equities Research and Huntleys/ Morningstar. Focus on sales and earnings growth.

THE IMPORTANCE OF HAVING INVESTMENT AND TRADING RULES

Rules provide a framework around which you can make investment and trading decisions. The Ecinya Investment rules are contained under our tab-heading ‘Market Wisdom’ though we do suggest that you devlop your own rules and benchmarks. Over the course of the next few months we will add the rules from a number of other published sources. There are many ways to think about investment, just as there are many ways to swing a golf club to good effect. BUT there are certain fundamentals that have been proven to work on a sustainable basis over the years. In golf you must be balanced, accelerate but don’t rush, avoid bouts of despair and euphoria; when in trouble take your punishment, get back to a position where you can play an aggressive shot towards the target; play one shot at a time etc. Success in the stock-market is similar – ‘let your profits run, cut your losses’; if it’s too good to be true it generally is; stay alert to what is going on around you. An elevated noise level is a sign of a potential turning point – up or down.

TACTICS

We do not like the expression ‘long term’ and our models take an 18 month view on a rolling full year basis. This means that after we have factored in the actual results for the year ended 30 June 2009, we will have a full year view for the year ended 31 December 2009, the year ended 30 June 2010, and the year ended 31 December 2010. These rolling full year views obviously morph into a longer-term view. But within that context we have a tactical trading perspective to assist with timing and asset allocation between equities and cash. These tactical positions are described as (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

MACRO ECONOMICS

Briefly, we cover the macro in a simplistic acronym – ‘ICE’: Interest rates, Confidence, and Earnings. Of these, Earnings is generally the most important. The ECINYA Market Barometer demonstrates where we are in the market cycle and to, a lesser extent, the economic cycle.

We access The Economist and ANZ Economics, particularly their Quarterly Outlook document and The Wall Street economics panel. We view all economic forecasts with a degree of scepticism and are more interested in trend or mood changes than the actual numbers themsleves. We also talk to a lot of small businesses to gauge how sales and sales trends are. When visiting super-markets and other retail shops, gauging the difficulty of getting a car space, talking to cab drivers, our spouse etc. There is a lot of observable information about. We know what our friends are doing. We talk to our travel agent on a regular basis, even though we are infrequent overseas travellers. We talk to people who have just returned from overseas. John Mauldin is an American financial adviser who writes regularly on the blogosphere and Paul Kasriel is an American economist who writes clearly with precision. When we see views expressed by them we print them out and highlight and underline their conclusions. And there is always Google.

CONFIDANTS

Over the years, associations are formed with people who are investing in the market. We talk to these people on a regular basis. We call these people our ‘confidants’ and occasionally refer to their thoughts and actions in the ECINYA pages, either to agree or disagree. You should do the same. We try to avoid falling in love with our various theses and if market action is proving us wrong we re-visit our assumptions.

BOOKS

IF we had just two books to recommend on the stock-market they would be Victor Sperandeo’s "Trader Vic – methods of a Wall Steet master" and Richard Bernstein’s "Navigate the noise – investing in the new age of media and hype". Both of these books belie their titles and offer significant insights beyond that suggested by their titles.

THE OVERALL MESSAGE is that you have to develop your own sources of insightful information, balanced against what you see and read around you. Write down why you are investing in any particular stock in a note-book and then re-visit your notes when something goes terribly right or terribly wrong. Naturally we are hoping that ECINYA becomes one of your trusted sources. Our aim is that the ECINYA pages, over time, assist to remove a lot of the ‘noise’ from your investment deliberations.

 

 

 

 

 

 

 

 

 

 

 

‘Crony’: A friend or companion

Collins Dictionary

It is a mixture of money and politics that Australians have become accustomed to over the last decade. But this culture of paying for access has become increasingly problematic in recent weeks as lobbying scandals make headlines nationwide……….

Dick Warburton, a former Reserve Bank director and prominent company director, has had enough. He is scathing about the fund-raising culture that has developed in Australia. The former chairman of David Jones and Caltex says "it has become a racket"……………….

Warburton, as an elder statesman pulling back from corporate life, can be frank. For most others it would be a poor business decision to speak out against a system that both major parties rely on to fill their election coffers……………..

"Access can now be purchased, patronage is dispensed, mates and supporters are appointed and retired politicians exploit their connections to obtain ‘success fees’ for deals between business and government," Fitzgerald told an audience in Brisbane last month.

Australian Financial Review 8/8/2009 "Democracy For Sale."

With Labor governments mired in cronyism as established fact all up and down the eastern seaboard, the emerging irony is this: it may yet be the Liberal Party that emerges to save what reputation for decency these shabby outfits have left.

The man most likely to restore Labor’s moral compass at both the state and federal level is Michael Ronaldson. Ronaldson is well known in Victoria, but less so outside that state. He was Malcolm Turnbull’s numbers man against Brendan Nelson. He remains part of the Opposition Leader’s inner coterie. Which means he’ll be a busy man this week.

He’s survived cancer and still smokes. That makes him a mug when it comes to his health and I’ve told him so. But he’s no political mug. A direct talker in the Australian tradition, he’s known almost universally on both sides of politics as "Ronno". He’s determined; when cancer felled him he was forced to retire from his seat of Ballarat. That was in 2001. He came back to Canberra via the Senate in 2005.

And he knows a crooked system when he sees one.

The "crooked system" I refer to is campaign financing. And as it turns out, as shadow special minister of state, it’s the system Ronaldson has responsibility for. When Labor’s moral warhorse John Faulkner asked for and was given the Special Minister of State portfolio by Kevin Rudd after Labor’s 2007 election victory, he was on a mission to clean up political funding in Australia.

Because, like Ronaldson, Faulkner recognises that all those rent seekers in suits, sitting sleekly around the likes of Joe Tripodi in Jordan’s Seafood Restaurant outside the ALP conference at Darling Harbour a fortnight ago, are bad news for the democratic process.

Glenn Milne writing in The Australian 10/8/2009

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

Paul Krugman "The Great Unravelling" 2003.

ECINYA TEXT

ECINYA has long believed that Australia had the opportunity to adopt the best of Britain and the best that America has to offer. Though we are fighting the ‘good fight’ and generally winning, the opportunity to adopt the worst of both of these countries’ cultures is alive and well. One of Ecinya’s enduring obsessions is that the 3 year Federal parliamentary term leads to poor policy formulation and, too often, poor execution. The daily battle between scarce resources and unlimited wants and needs in context of tight political deadlines all too often leads to poor outcomes. The formal expression of this is ‘misallocation of resources.’ In a parliament as dysfunctional as our current parliament, with a Leader of the Opposition on training wheels, and a Prime Minister full of bellicose bluster sprouting economic hog-wash in local and global forums and writing convoluted essays, the problem of misallocation of resources looms as potential policy failure.

Towards a solution

Crony capitalism is one of the factors that has brought the United States of America to its economic knees. We should be consciously aware of the American model.

The recent debate surrounding alco-pops demonstrates the dilemma faced by politicians. We assume the alcohol, pubs, gaming industry are keen supporters of democracy and offending them might be dangerous for many, although we doubt that sports sponsorship leads to binge drinking, except for the highly paid sports stars themselves, and that might be a function of their income rather than advertising sponsorship. The recent revelations of connected and vested interests in Queensland is but another example of a system veering towards the American model.

How about Australia leads the world in electoral reform, and its hand-maiden, electoral funding transparency

Australia creates The Electoral Bank Fund ….. it collects donations made by interested parties, corporations and individuals, which are tax deductible, and also the Treasury makes a contribution as well. The funds are invested and earn a return between elections.

Once the election is announced, sitting members receive an allocation of funds on some formula basis, and pre-selected candidates do as well.

Any such candidate can ask for extra funds provided he/ she puts up some adequate security. Moneys spent on winning or losing an election that are not reimbursed become tax deductible.

An independent candidate can also borrow funds on a secured basis and contest the election. They will have a portion of his/her loan dissolved, provided they win a certain number of votes. Perhaps they have to win say 5% of the votes to qualify for dissolution of portion of their loan. If they were to win outright, or to win say 25% of the votes, their loan would be extinguished in its entirety, subject to some defined limits. Bribing voters by cash payments would not constitute ‘allowable expenditure’. ‘Allowable expenditures’ would have to be subject to adequate audit and verification.

Candidates would not be able to use funds provided from any source, be it union, corporate or otherwise.

All fund raising activities would have to be accredited and the funds remitted to the Electoral Bank. Fund raisers could nominate a beneficiary of their efforts, but it would not necessarily be binding upon the Bank Trustees, except in the case of an independent where, subject to source, extra funding might be allocated irrespective of win or loss.

For relatively safe seats funding might be scaled to reflect the realities that a loss is unlikely so that contestable seats are ‘over-allocated’ funds wise.

Obviously, we at Ecinya, do not have the experience or the information to know how to design the system in its entirety to make it workable BUT this brief essay may contain the germ of an idea that might just work to keep our democracy healthy.

In passing, we note that the major candidates in the last American election spent over $1 billion: circa $730 million from Obama, about $330 million from the McCain camp and about 4 independents spent another $60 or so million.

In Australia, the last election was our most expensive ever, according to Google, and some $163 million found its way from the private sector back to the private sector.

Resources are scarce; if they are allocated according to patronage the outcomes will be sub-optimal. State governments are struggling for revenues and the Federal government has become significantly interventionist, ostensibly sanctioned by a dead prophet in John Maynard Keynes. It is relatively clear that the Federal government is keen to get to the polls on an exaggerated debate about climate change after winning the second-hand Toyota utility truck debate. Additionally, we are going to soon have a limited debate about the meaning of tax reform as the Henry report arrives before the next election, which will presumably be aimed at replenishing public coffers. Electoral funding and favours asked for and given, seems an important issue for taxpayer scrutiny, for in the end they pay the piper for his tune. The ‘tune’ is estimated to be something above $200 billion of public debt. If this debt achieves little because a lot of it goes to cronies, then that would be a monumental waste of resources.

The success of the exceptional Hawke-Keating policy, compulsory superannuation, demands corporate transparency. If we do not have transparency at the top of our political system, it is hard to imagine that it will exist in sufficient quality in the middle and at the bottom. Electoral reform and an extended federal term is long overdue.