Financial Decisions blog: 2012

Thursday, 11 October 2012

View - investment newsletter spring 2012

Welcome to our spring 2012 edition of Views.

In this edition, you will find our latest update and opinion on the current commodities and economic cycle.

Liquidity is the principal focus in markets today. Markets feel that liquidity will give support to the stock market, the European banking system and the Euro, as well as help commodity prices from sinking. As widely expected, the Europeans, Chinese and Americans provided investors with more of the same “drugs” they wanted in order to prolong the solvency issues.

Policy expectations during September have dominated market movements, which has helped to trigger a rally following these announcements. Ultimately, the underlying data trends will be the key to a more sustained rally.

Read more...

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Wednesday, 26 September 2012

Diversifying fixed interest

PORTFOLIO UPDATE: Fixed interest investments are secure with low volatility but still achieve solid returns. Read more about diversifying fixed interest...
http://bit.ly/TxZ8Ce

Quantitative easing – round 3

Image thanks to KJGarbutt

The latest big announcement by the Federal Reserve is to continue with more quantitative easing (QE) until the labour market improves. This open ended statement caused markets to react positively.

So what is QE and why does it seem to be the only game in town?

To be fair, QE is not actually money printing, even though it has a similar effect. While money printing puts the money in the hands of the public, QE allows central banks to finance fiscal deficits with the aim of giving banks more money to lend at the same time as reducing long-term interest rates to bump up business and consumer activity.

With interest rates in these troubled economies are virtually at zero, policy makers have almost no other politically acceptable tools available other than to increase the balance sheet of central banks by buying more assets with central bank money.

The first two rounds of QE have produced little effect to push down unemployment and secure consumer activity and sustainable business lending. Therefore whether another round will ultimately work remains to be seen. We have no option but to give them the benefit of the doubt.

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Tuesday, 28 August 2012

Loss aversion bias

Investors are often far more interested and consumed with the daily movements of stocks and the possibility of placing a winning trade than sitting down and understanding how our brains work and how this undermines our performance in the market.

One of the most common errors identified by psychologists and behavioural finance studies is that investors always tend to have a bias against losing money. Unfortunately humans fear losses more than we appreciate gains. This was confirmed in a simple university survey using a coin toss whereby the participants would need an average payoff of $40 on a winning toss to offset the pain of taking a potential loss of $20 on a losing toss. In other words, the pain of a loss is twice as potent as the pleasure generated by a gain.

As advisers, the above result demonstrates the reason we have more trouble getting clients to sell a losing position, even when clients also believe the position is likely to continue its loss for quite some time, in the hope that they recover. Many times, this recovery rarely takes place, particularly with small speculative companies with no profits.

This fear of loss and negativity bias may in fact blind an investor to take advantage of good opportunities. It is often important to weigh up the prospect of loss with that of the opportunity costs. It may also mean that the portfolio struggles to outperform over time, as this loss aversion bias leads to having too many losers being kept and too many winners being sold (often too early).

Wednesday, 8 August 2012

Paradigm on investments

Image thanks to RambergMediaImages

Following our recent paper titled "Portfolio paradigm", please refer to this recent AFR article which provides further evidence that there is a paradigm on investments.

Thursday, 2 August 2012

Investing is a game of expectations

Have you ever wondered why a good earnings result is sometimes met by a drop in the share price? Or maybe why stocks rise even after poor economic data has been announced to the public?

There are many instances where it is hard to explain the daily movements of shares due to the contradiction between news and price. In our opinion, these unexpected movements are directly related to human behaviour and the expectations investors have in relation to a certain company or event.

Traders and investors buy and sell based on what they believe future news will be, whether that is tomorrow or next month. So when investors are nervous and cautious about the earnings of a company, they lower their expectations and have a tendency to sell prior to the earnings announcement.

If the earnings are not as bad as they originally feared, shares are inclined to increase as investors buy the stock back.

When the Global Financial Crisis hit top gear in the early part of 2009, the markets started to rise much earlier than the economy, as expectations of an improving economy in the latter part of 2009 caused investors to buy stocks again. By the time the economy had shown signs of improvement, many markets around the world had risen approximately 50%.

Monday, 16 July 2012

A problem with the budget surplus forecast

Financial crisis will hurt jobs, Swan warns

Wayne Swan, Treasurer
Image thanks to publik16

There was an interesting comment recently in the “Money Minute” segment on Channel 9’s Today Show that mentioned the small but significant rise in unemployment from 5.1% to 5.2%. It doesn't seem like there is anything for us to worry about, which may be true for now.

The concern is that Wayne Swan has forecast a slim budget surplus by the end of this coming financial year. A big component of this forecast stipulates our unemployment level to be no higher than 5.25% for the next 12 months. Therefore, if unemployment increases further by just another 0.1% to 0.2% over the coming months, the slim surplus that the treasurer has been confidently predicting over the past few months will be wiped out.

The affect on the surplus

When unemployment runs up, less people are at work and thus there will be less tax paid to the Government. Conversely, there will be more Government handouts to those not working. That’s a "double whammy" for the Government.

We don't have a problem with people having an opinion and forecasting what they think may happen. But when the Government, represented surely by “one of the smartest mathematicians” in the Labor Government, provides himself with almost no margin for error, the forecast often tells us more about the forecaster than the forecast itself.

Tuesday, 26 June 2012

View - investment newsletter winter 2012

Welcome to our winter edition of Views. In this edition, we have provided an update on the continuing debt crisis in southern Europe and examine in detail how we see the crisis potentially panning out.
There have been many commentaries comparing the current market pullback to the one experienced last year. Certainly from a timing perspective it seems to be a case of déjà vu.

The underlying issues are predominantly the same and the outlook is also difficult and lengthy to resolve at best.

Read more...

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Wednesday, 20 June 2012

What to make of the Greek Election

Hold off on the Champagne!

While the recent election in Greece provided victory to the pro-bailout parties, the win was not convincing showing the obvious disharmony and split of opinions between its citizens. What the election did achieve was to relieve markets of the uncertainty surrounding the future of Greece within the Euro, at least in the immediate future.

From a political standpoint, the new government will need to regain some of the confidence lost over the last couple of years before it can implement any measures to take the economy out of its current mess.

From an economic standpoint, solid restructuring needs to be undertaken as the underlying issue of Greece’s heavy debt burden is still unresolved. The market gave an immediate cheer by sending most markets upwards straight after the election win. However, any relief of this sort will only be short-term, as the hard work has only just commenced.

The austerity measures to reduce government debt from 160% to approximately 120% of GDP by 2020 will be difficult at best. Greece needs its citizens to get back to paying their taxes and for the government to be frugal and disciplined at the same time. Only time will tell if Greece will continue to hold onto its spot inside the Eurozone.

Friday, 1 June 2012

Greece - To default or not to default

There was a small but interesting article this week in the Australian Financial Review in relation to Greece. With the recent initial public offering of Facebook, the hundreds of millions of younger generation, tech-savvy individuals can even provide their two-cents worth on the Greek crisis through this social media. Amid all the “Greece bashing” about whether or not it should exit the Euro, it is worth looking back at history.

The last time that Greece had fallen into hard times and defaulted was just prior to the start of World War II. In fact, Greece has been bankrupt and defaulted five times before. More alarmingly, Spain has defaulted 19 times with the last time also being during World War II. These figures demonstrate that over the longer term, the world will continue to prosper and these countries may come back again with some form of balance sheet.

Unfortunately, markets have a short-term focus. That’s just the reality. There is no doubt that there will be some significant knock-on effect from any default in the near-term if Greece defaults. Our main concern about this knock-on effect is not about the actual event itself, but about the globalised world we now live in. The threat of contagion and massive market volatility can be triggered by a single click these days. In our view, technology and the psychological aspect this plays on investors is even more far reaching than the event itself of whether or not Greece goes bankrupt.

Thursday, 10 May 2012

Federal Budget 2012 overview

The 2012 Federal Budget contained few surprises as many of the measures had already been legislated or pre-announced.

The main winners were lower income earners, families and the elderly.

Summary

The key new announcements include:

tax may increase on certain employment termination payments;
the reduction in the company tax rate isn’t going ahead;
the increase in the concessional contribution cap for people aged 50 or over with less than $500,000 in super will be postponed until 1 July 2014;
the tax payable on concessional super contributions by people earning $300,000 pa or more will increase from 15% to 30%; and
a “SchoolKids Bonus” of $820 a year for each child at high school and $410 for every child in primary school will automatically be paid to parents who are eligible for Family Tax Benefit Part A, replacing the Education Tax Refund.

The Government has also confirmed that:

people earning under $80,000 pa will receive modest tax cuts;
the minimum income payments for a superannuation pension/income stream won’t increase until 1 July 2013; and
funding will go ahead for the landmark changes to Australia’s Aged Care System announced recently.

Why is cash a bad long-term “investment” ?

When asked, many people will no doubt describe investing as the process of laying out money now in the expectation of receiving more money in the future. We prefer to redefine investing as transferring purchasing power now with a calculated probability of receiving more purchasing power in the future. These two definitions can vary widely. The first definition simply calculates the increase in value in absolute terms. The second implies the loss of purchasing power and keeping up with inflationary pressures.

According to the Australian Bureau of Statistics, a litre of milk in 1990 cost approximately $0.85. By 2011, the average price was $2.50. Accordingly, any investments made in 1990 would have to rise by 200% just to keep up with buying the same litre of milk 20 years ago. In percentage terms, the rate of return in your cash account would have to be at least 5.50% per annum over the past 20 years. Using an average tax rate of 30%, investors will need a gross annual return of 7.85% in order to keep up with the rise in goods.

We have been in an extraordinary period of low and stable inflation since 1990, therefore the above comparison may not seem overly difficult to achieve. The next 10 years may not be so easy for cash to keep up with purchasing power if inflationary pressures come through over the next two to three years.

Wednesday, 2 May 2012

US Treasury yields

The US Federal Reserve has indicated several times that it will continue its current “Accommodative” policy stance at least until late 2014. This signifies that the Federal Reserve will continue to keep interest rates where they are now for at least two more years.

Based on recent movements in Treasury yields, markets are clearly experiencing a much improved and far more sustainable economic recovery, particularly in the US. We believe that this policy stance may be challenged earlier if markets continue to see positive growth.

We are of course aware of the many issues that still lie ahead, predominantly in Europe. As such, if the recent sell-off in Treasuries is any indication, we could be seeing a trend toward higher yields and lower long- term bond prices in the months and years ahead, barring any unexpected downturn especially in the US. Like any asset price movement, the move will not be a straight-line and could be gradual over the next couple of years.

We have stayed away from any fixed long-term bonds for some time while focusing on those that are usually no more than five years in duration and that are floating-rate in nature.

It will be important to keep up with the movements in Treasuries and long-term government bonds as that will have longer term implications on stock market movements and valuations around the world. As many important growing regions such as China and Hong Kong are largely pegged to the US dollar, the implications are further and wider than what most investors would expect.

Thursday, 15 March 2012

The problem with our big banks

After a recent slight downgrade of our big four banks in November 2011 by Standard & Poor’s from AA to AA-, there have been discussions that April will be important in ascertaining whether any or all of our big four banks will again be downgraded due to their dependence on overseas funding.

There is no doubt that when compared to many of their global peers, our banks have a strong market structure and are reasonably concentrated. However, our banks’ persistent reliance on offshore wholesale credit markets makes them more risky than other AA rated banks.

What this means is that our big banks have less deposits to tap into if they needed emergency funding while other stronger offshore banks can utilise their higher deposit base to cushion any possible banking crisis that could occur in the future. Our banks on average have only between 54% and 65% of the funding mix coming from deposits. This compares less favourably to strong Asian banks that have close to 100% of the funding mix from deposits or even Canada’s big banks with around 80%.

The ratings agencies are looking at these funding structures and the risk they pose to the banks as their rationale for this possible downgrade.

Wednesday, 15 February 2012

Three reasons to feel confident

With so much negative news in the press, it is easy to feel like you should just give it all up, grab your money and live in the Bahamas for a few years.

However, while we are cautious with the difficulty surrounding the political environment and immense debt issues in many major markets, virtually everyone knows and acknowledges that the world will survive and continue to grow. Amid all the depressing facts headlining business news, we highlight three reasons why as opportunists, value investors and optimists, we feel there are good fundamental signs to be confident about the future.

1.	Valuations – Across major markets, we are not seeing stretched valuations. It is difficult to foresee a complete break-down in markets without high prices. While there can always be short-term declines and volatility, it is unlikely to stay there over the long-term unless you believe the entire world will go into a depression. As such, we are comfortable in holding onto the very best companies at these reasonable prices. Certainly, this is not the best of times. Nevertheless, companies are still making good money and while they continue to sell at reasonable levels, long-term investors can still find good opportunities.
2.	World growth – Like it or not, the world continues to grow at respectable rates of growth. Not brilliant, but definitely reason for optimism. Some of this growth has no doubt been zapped by the recession in Europe and the sluggishness from the United States, but world growth at 2% to 3% per annum still translates into reasonable earnings for companies.
3.	Europe – Given the sovereign debt and fiscal problems, we still believe that the Eurozone will remain intact. There may be slight adjustments and variations down the road, but after 10 years the members of the European Union will push for an outcome to make Europe continuously relevant. If they do not improve their fiscal union and strengthen their monetary system, they will become inconsequential on the world stage. With that, we do not believe that Europe is ready to call it quits and leave it to the United States and China to steer global economic and political policies.

Wednesday, 11 January 2012

Potential unknown disruptive forces in 2012

While there are plenty of “known knowns” from the US presidential election to the possible contagion in Europe, investors will continue to react towards front page news. There is almost no doubt that the issues arising from Europe’s sovereign debt crisis will dominate business news over the coming months. Beyond that, we have identified several seemingly smaller but disruptive forces that may provide an already jittery market with more reason to stay cautious.

1.	Conflict with Iran – Tensions are rising after the economic sanctions were placed on Iran for its nuclear weapons programme. This could drive oil prices up and hurt an already slow global economy.
2.	North Korea’s New “Kim” – The youngest son of the late Kim Jong-Il has just taken over his father’s reign but at only 28, the world is already nervous about how he will rule this secretive and closed-off communist country with an advanced nuclear weapons programme.
3.	Iraq Civil War – While United States (US) forces have pulled out of Iraq, the new but fragile coalition government is already at risk of dissolving, creating more instability in the region.
4.	Pakistan and US alliance weakening – Keeping a balance in its relationship after recent Pakistani soldiers were accidentally killed will be critical. It is also important as its neighbouring country, India, is a US ally.
5.	Russian election – Uncertainties still remain about whether the Russian people really want Vladimir Putin to return as President as his coalition government lost its majority seats. Any shift in power could have implications for the energy sector as Russia is the largest oil producer in the world.

There seems to be a definite trend in these uncertainties – they are all political in nature. That really sums up what we believe 2012 may be all about!

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