Ecinya

Though I am not wholly convinced that the government will be able to maintain the spending discipline required to return the budget to surplus by 2015-16, or to ‘pay off’ its net debt by some time in the early 2020s, as foreshadowed in the recent Budget. Achieving those goals will, I think, require ‘harder’ decisions, and more of them, than were contained in this year’s Budget. But if that timetable were to slip by two or three years, I for one would not be losing much, if any, sleep over it.
Let me conclude by noting that the spirit of Keynes the economist has been very much alive during the past year, and that we are all much the better for it.

Saul Eslake, Brisbane Polo Club, addressing a luncheon hosted by The Australia-Israel Chamber of Commerce and The Australian Business Arts Foundation 11/6/2009

 

Professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not the case of choosing those which, to the best of one’s judgement, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipate what the average opinion expects the average opinion to be. And there are some I, believe, who practice the fourth, fifth, and higher degrees.

John Maynard Keynes, around the 1930s

 

ECINYA COMMENT

We are nowhere near as relaxed or comfortable as Saul with the concept that the re-leveraging of the public sector is an entirely appropriate way to de-leverage the private sector. However, we are less uncomfortable in knowing that an economist as capable and thoughtful as Saul will ‘not be losing much sleep’ as our Federal budget surplus is replaced in hasty fashion by a deficit 10-12 times larger. We do not have a great deal of confidence in our government’s ability to allocate scarce resources effectively and efficiently.

Keynes was born in 1883 and died in 1946 and was particularly effective in persuading governments that the economic damage wrought by the combination of the great depression and World War ll could be remedied by governments spending and borrowing to boost economic activity. It can fairly be said that Keynes may not quite see the post 2000 world as he saw it between 1928 and 1946. The speed of economics and politics and the interaction between the two might have been somewhat different in his day. But we will never know.

But we can say that Keynes was an economist who based his concepts and theories not on precise macro, mathematically driven models, but on the economic behaviour of societal elements. These included producers, developers, consumers, governments, entrepreneurs etc. Data had to be assembled and evaluated in context of attitudes and motivations. He regarded the world as generally dynamic and capable of wild swings due mainly to wild swings in peoples’ perceptions.

Prime Minister Rudd, as part of his stimulus rhetoric, has cleverly said "We are all Keynesians now". However, we are of the opinion that careless spending would not have been sanctioned by Keynes and we suspect that much of the borrowing and the spending will be carelessly driven by politics as much as economics.

It seems hard to reconcile Keynes with the concept of the cash handout, which consumers spend on imported goods or a day at the races. But this is where about $10 billion of taxpayer funded debt has gone; or to a school’s programme that builds facilities not necessarily needed at this time.

So as governments in America and Australia are congratulating themselves on the good works wrought by fiscal stimulus, it seems reasonable to say that much of the stability that has been restored has had more to do with monetary policy (lower interest rates and printing money) than dubious concepts of borrow and spend.

America had little choice but to reflate as it has. ‘Globalisation’ has been a charade perpetuated by America’s bankers looking to support American manufacturers chasing cheap labour outside of the USA. Immediately after WW2 it was Japan followed by South Korea, Taiwan and now China. America lost the will to manufacture and has now lost many of the skills and structures, including a dynamic, manufacturing, education base. But America needs time to recover from its manifest malaises and profligate consumerism, and though the fiscal and monetary stimulus is probably excessive, it should do more good than harm.

Taking Keynesianism to extreme positions could create future problems and make the world vulnerable to the next ‘Black Swan’ event. Much of America’s problems are structural, brought about by absurd interpretations of Reaganomics.

If we had one economic input to suggest, for Australia, it would be the abolition or suspension of that worst of all the taxes: the dreaded payroll tax.

KEYNES THE INVESTOR

In going with the current flow of the market with little conviction of the underlying macro and micro fundamentals supporting current price and price momentum, we sometimes feel like a competitor in Keynes’ ‘six prettiest girls’ competition.

 

INSIGHTS: HEAD QUOTES

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

Graydon Carter Editor Vanity Fair, June 2009 issue. This magazine is an excellent source of economic and political material

 

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

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

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

 

ECINYA MACRO STRATEGY MUSINGS

Ecinya does not believe that the next bull-market has begun. Our market, and markets generally, are in early stage recovery and the biggest barrier to determining value is the earnings damage that has been inflicted on companies by the global financial crisis. Which companies are in best shape to resume future growth is uncertain as the base earnings position is something of a mystery for far too many companies. We are acutely conscious of the earnings dispersion flowing from analyst forecasts, which makes our models possibly less reliable than we would like. We hope our earnings expectations are close to our modelled expectations.

Sam Goldwyn (MGM) once said that "verbal promises aren’t worth the paper they are written on" and so we constantly document our market perceptions which then become a template against which we can measure and identify market progress. In January 2009 we wrote the following directional words as to how the ‘crisis’ would unfold: disequilibrium, abnormal, unprecedented, irrational, bizarre, nonsense. In this stage we also assembled the US market data from the tech-telco crash to see how that played out and discovered that the time frame from peak to trough was about 751 trading days (2.6 years including week-ends). We also purchased the Winston Churchill tapes to get the feel of a real crisis and the political force required to survive and transcend it.

On 19 June we decided that the nonsense stage had passed and we were now into the UP phase. Our descriptive tag-lines were: bottoming, stabilizing, anecdotal recovery signs, recognisable recovery, growth, and then normal.

As of today we are in the stabilizing phase and ‘recovery’ is somewhere between assumption and forecast with an overlay of wishful thinking. The world is always full of hopeful possibilities, but economics is still the dismal science and does not dance to the cacophony coming from politicians and commentators, most of whom were oblivious to the crisis disease anyway, and are now flailing their batons at the orchestra that is their national economy.

Obama had no choice but to reflate, but is now hostage to how long, and at what price, the surplus countries will fund America’s economic shortfalls. The price will not be low. In 2010 Obama is going to have to consider a national sales tax (akin to our GST) to remedy a chronic domestic deficit which has moved from an inept Bush administration (invoking a jaundiced view of Reaganism) level of $400 billon to a post Bush cum-Obama $1 trillion. KEEP YOUR EYES FIXED FIRMLY ON GLOBAL INTEREST RATES and countries will have to sell some of the family jewels to the surplus country creditors. China will wisely use some of its surplus US dollars to buy productive companies at bargain basement prices to move from their over-weight US$ position.

BUT WHAT OF STRATEGY IN OUR LOCAL MARKET? Since the retracement low in XAO terms to 3111 on 6 March 2009, from 6853 on 1 November 2007 gave us a ‘crash’ of a staggering 55%, we have bounced back 33% to a current 4147. But this bounce has been uneven and that is the nature of the ‘bottoming’ process. First wave up from 3111 was 43 days +26% to 3919, followed by 4 days 5% down to 3710, 20 days 8% up to 4061, 21 days down 8% to 3738, and now 11 days up 9% to 4147 as we go to press. BUT the reporting season is about to commence and Australia is in a significant slow-down, and in per capita terms, in recession. According to our favoured economist Saul Eslake, Australia has moved from +4% actual GDP growth in calendar 2007 to a negative 0.9% in calendar 2009, and a muted recovery level of +0.7% in 2010. The world has gone from +4.8% GDP growth to negative 0.1% in the same time frame.

WE RESPECTFULLY SUGGEST that our market is still more of a trader’s market than an investor’s market, except for the extremely patient. We have long deplored the expression ‘long-term’ as we consider it the rhetorical province of advisers that get you into stocks at the wrong price and wrong time. If you look after the short-term, the long-term looks after itself. That having been said, we trade mainly in stocks where fundamental value can be recognised so that if we make a timing error, which we frequently do, we can average down (buy more stock at a lower price) at or near the bottom of the down-wave. Modest trading around the edges of a thoughtful and substantive portfolio will yield better results. In a portfolio of whatever size this probably requires an attention span of about 5 hours per week. Our Portfolio Menus are predicated on rolling full year views 18 months ahead, which means that we have a target price at 30 June 2009 for the year ended 31 December 2009, the year ended 30 June 2010, and the year ended 31 December 2010. We are not clever enough, and certainly are chastened enough, to not move beyond a period of 18 months in formulating our expectations. The Ecinya Investment Rules documented under the tab ‘Market Wisdom’ embellish these views.

SOROS SAYS ‘firm predictions are out of the question’, and we agree, because it is easier at the moment to list our fears and to regard many of the commentators we read as living their fantasies. The world will recover less quickly than anticipated by many. The US market (we focus on the S&P 500) has to make a triple-bottom to satisfy us and we believe this will be in the region of 830 to 875, some 13% to 20% below the next most likely target level of 1000. It is at 982 as we go to press this day. According to our quant model this implies an XAO level around 3700, some 20% above the retracement low of 3111, although if commodity prices hold our market should at 3800, and perhaps even a little better than that if bank provisioning does not accelerate.

OUR FUNDAMENTAL FEARS! Disappointment in the earnings season. A firmly held belief that the Labor government and the Liberal Opposition are currently inept economic managers and communicators; our stimulus package has been driven by populist-political pap and not sound economics. Misallocation of resources will be the unintended consequence; our public debt will be too high, and place undue pressure on domestic interest rates. America is insolvent and higher global interest rates would worsen the appalling condition of their domestic deficit.. The possibility of a US dollar crisis is a view too well-held to be ignored. The US Senate has 21% of its members over 70 and they are genial rather than thoughtful or energetic and too beholden to vested interests. America has big problems in education, welfare, and health. Public and private accounting is rather too flexible for our liking, public and private auditors have become accustomed to turning a blind eye. China is not without its problems in property and stock-market speculation, regional riots as factories close, and non-performing bank loans. Global excess capacity. Global employment is a co-incident indicator before it becomes a lagging indicator, a lot of American jobs, in particular, may be lost for almost forever.

REASONS FOR OPTIMISM! History suggests that boom follows bust as surely as night follows day. Obama is a breath of fresh air, but the task is immense. Lots of fiat money swirling around looking for a home. Hard and soft commodities should stay up, but not past dizzy heights, and this is good for Australia . Yes, best of all, as expressed by Bill Bonner in 2007 in "Empire of Debt" we live, work, and play in a fiat money system.

"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 sill 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. Pretty soon there is a boom."

That’s enough for now, have a good week, and exercise caution in your affairs.