I receive a regular email from John Mauldin and last night he made this comment which sums up the Euro dilemma nicely...
"I continue to believe that Europe in general and Germany in particular have no
good choices. They can only choose between Disaster A, which is keeping the
eurozone together, and Disaster B, which is breaking the eurozone apart. Either
will cost trillions of euros and mean much pain. It is not a choice of pain or
no pain. It is simply a decision as to what type of pain you want and in what
doses you want to take it. Choose wisely."
The email from John contains various commentary that continues to speculate on different options to resolve the crisis. The most interesting suggestion is that the EuroZone should kick Germany out of the monetary union as it is Germany that refuses to agree with the others. Without Germany, the rest of the Zone can monetise it's debt, devalue it's currency and create inflation. Something they have always done prior to joining the EuroZone.
All very interesting.
Tuesday, June 26, 2012
Sunday, June 24, 2012
Euro Confusion
I have attached a link to a very short and interesting article that highlights the real problem of the Eurodollar and the common currency. Pease take time to read it because it goes to the heart of the problem – (that is) Euro countries that are uncompetitive with Germany but unwilling to increase productivity and unable to devalue their currency to achieve this.
http://www.davidmcwilliams.ie/2012/06/19/hard-and-soft-options
I find this whole situation quite amazing in the sense that the problems are obvious, as are the solutions, yet there is no political will to implement them.
Just to confuse you more, I thought I would stretch the limits of your mind to remind you all of the Bretton Woods currency system implemented after World War 2. If you read this attached Wikipedia article, you will note that the system was implemented to PREVENT COUNTRIES FROM DEVALUING THEIR CURRENCIES TO INCREASE COMPETITIVENESS!!! (Can your bear it?)
Just as a refresher, the Bretton Woods currency system linked many world currencies to the US Dollar and the US Dollar was exchangeable for gold – so effectively a peg – much like the Eurodollar (although you were able to keep your own currency – the Lira, the Aussie, so on and so forth).
http://en.wikipedia.org/wiki/Bretton_Woods_system
Anyway, the Bretton Woods currency system collapsed in the early seventies. Gosh! That would have been an economic catastrophe...surely...what – you don’t remember? Shame on you, how quickly we forget.
Have a good week.
http://www.davidmcwilliams.ie/2012/06/19/hard-and-soft-options
I find this whole situation quite amazing in the sense that the problems are obvious, as are the solutions, yet there is no political will to implement them.
Just to confuse you more, I thought I would stretch the limits of your mind to remind you all of the Bretton Woods currency system implemented after World War 2. If you read this attached Wikipedia article, you will note that the system was implemented to PREVENT COUNTRIES FROM DEVALUING THEIR CURRENCIES TO INCREASE COMPETITIVENESS!!! (Can your bear it?)
Just as a refresher, the Bretton Woods currency system linked many world currencies to the US Dollar and the US Dollar was exchangeable for gold – so effectively a peg – much like the Eurodollar (although you were able to keep your own currency – the Lira, the Aussie, so on and so forth).
http://en.wikipedia.org/wiki/Bretton_Woods_system
Anyway, the Bretton Woods currency system collapsed in the early seventies. Gosh! That would have been an economic catastrophe...surely...what – you don’t remember? Shame on you, how quickly we forget.
Have a good week.
Monday, February 6, 2012
Dinner Party Banter - Banks
Bank Funding – Liven up your Dinner Party!
In today’s article I will attempt to do the seemingly impossible. I am going to try and make an article on Bank Funding Costs interesting..........stay with me here. Today the Reserve Bank of Australia made their monthly (except January) decision to set the official cash rate. This decision results in a frenzy of media speculation and political bank bashing from both sides of politics – although we have been spared this time round as the RBA has kept rates steady. Regardless, my attempt today, may not win you friends at dinner parties, but may give you a better understanding of how our financial system works, and consequently, the small mindedness of the political point scoring.
So here goes.......firstly, I want to provide some context about what occurred during the Global Financial Crisis.
Do you remember a company called RAMS Home Loans? Sure, it still exists today, but certainly not in the same form it did back then (indeed, the franchise is now owned by Westpac). RAMS was part of the Home Lending revolution in the late 1990’s that really saw the Non Bank Lenders (Aussie Home Loans being another) stick it to the major banks. They did this by introducing a new form of home loans that was financed by Mortgage Backed Securities (MBS). The new kids on the block were able to slash the interest rates that were being offered by the major banks and they took a reasonable chunk of market share. This was achieved via the plentiful and cheap funding of the MBS market plus the low cost base of their business model – fewer branches and no transactional banking. Times were good, good enough in fact for John Kinghorn, the founder of RAMS Home Loans, to pocket $650 million when he floated RAMS in July 2007 (with hindsight, a brilliant decision given what happened next!).
You see, because RAMS was not a deposit taking institution it was therefore not regulated by the Australian Prudential Regulation Authority (APRA). Without this prudential oversight, RAMS was able to raise much of its funding by issuing short term bonds in the MBS market.Unfortunately for them, much of this funding matured just as the Sub Prime crisis began to blow up in July 2007, not long after RAMS listed on the Australian Stock Exchange. The consequence? Bond investors either wanted their money back or rolled over at a much higher rate. And that was that. In Australia the MBS market pretty much died overnight and RAMS ceased to exist in its original form.
Now the reason I thought I would tell you about this is that it puts into context that our “Banks” in Australia simply cannot do this. This is because part of the conditions of being a licensed deposit taking institution in Australia is that you allow APRA to monitor your activities in your day to day banking duties. Put simply, Australian Banks are not allowed to borrow (take deposits) short term and invest (lend) long term. Australian Banks are required to match the “duration risk” of their deposits against their loans to borrowers. APRA oversees this.
So when we hear about the reserve Bank setting the “Official Cash rate” this is simply the overnight rate used by banks to settle their outstanding credits or debits in the banking system for that day. This has indeed become a de facto indicator of what sets the banks’ interest rates, even though it has little bearing on the overall pricing of a single bank’s loan book. Put simply, a bank cannot ask for an unlimited line of credit from the RBA at the current overnight cash rate, and, even if it could (interestingly, the European Central Bank has recently done exactly that....), APRA would not allow this to occur as it would shorten the duration of the bank’s liabilities, putting it at risk much like RAMS.
Adding to the cost pressures, the Banks also are required to finance part of their loan book by issuing Bonds overseas. The global credit crunch is also impacting the Banks ability to do this successfully. International investors are demanding higher returns when lending to Australian Banks, despite their sound credit ratings and seemingly safe location. Australia is a country that relies heavily on Foreign investment and as a result we are beholden to the mood of Global Credit markets. So this is why we have to be very wary of media reporting and political point scoring that demands that our financial institutions set their variable rates based on the official cash rate. It simply does not work like that.
(BTW, there is a lot more to the make up of funding for banks, but to go into more detail would risk your dinner party guests walking out).
At this stage of your dinner party, you might have upset some of your guests by defending the Banks, but why not further incite them by discussing the Banks “obscene” profits? Firstly I think it is important to point out that having a profitable local banking sector sure beats having the European version..... a collapsing, bail out ready banking sector. Warren Buffett put it beautifully in one of his Annual Reports a few years back when he stated.
“Borrowers then learn that credit is like oxygen. When either is abundant, its presence goes unnoticed. When either is missing, that’s all that is noticed”.
So having a well functioning banking sector is vital for the growth of our economy. Have they made mistakes? Yes. Have they been allowed to swallow up their competition? Yes. Do they pay their executives too much? Yes. But are we lucky to have the banks we do in Australia? Yes!
But let’s look at the alternative? A shrinking banking sector results in contracting credit that would inevitably lead to falling housing prices.....not an ideal outcome. We must also consider the wider implications of the political bank bashing because there are a few other unintended consequences. Pressure on bank profits will result in lower dividends to retirees, superannuation funds and personal investors. These lower dividends are also likely to result in lower share prices. Keep in mind also that the political pressure is on home loan rates – so banks may cave in to this pressure but leave business banking rates unchanged. It is no consolation if your home loan rate falls but you lose your job because your employer can’t obtain reasonably priced credit. So Wayne Swan et al, be very careful what you wish for.
But putting it in perspective, the Big 4 Australian Banks are VERY BIG. The balance sheet for the Commonwealth Bank (CBA) alone lists $668 billion in Assets for a profit of almost $10 billion before tax (2011 Annual Report). That makes for a return of just 1.5% on assets which is actually pretty poor. The Banks, however, are a little different to most Industrial Companies. This is because they are highly leveraged operations. The balance sheet for CBA also shows liabilities of $630 billion resulting in net assets or “book” equity of just $38 billion. The before tax profit return on this “book” equity is much better at 26%. Unfortunately for potential investors, the share market has valued the “book” equity in the CBA differently as its market capitalisation (share price multiplied by number of shares on issue) is almost $80 billion – twice its book value!!! So the profit is not as attractive at 12.5% (before tax) if you buy the shares on market today.
But think about that, buying shares in a company which has geared its “book” equity 17 times – I would want to be handsomely rewarded for taking on that risk, wouldn’t you?[Footnote: Banks profits are currently circa $30 billion per annum which results in tax revenue of around $9 billion. If the Federal Government really wants to achieve its budget surplus in 2012/13, it had better be careful not to bite the hand that feeds it!!!!]
Monday, January 16, 2012
Europe: The Problem, the Solution and Other Minor Inconveniences
Welcome to my first post in 2012. I hope to make regular contributions during the year to keep you updated with what is going on with the global economy and how it affects you. My aim is to do this on a basis that makes the financial markets and the politics of the same, easier to understand. So forget the convoluted language of your economists and commentators – here you will get the naked truth as frightening as it may be!
So we pick up in 2012 where we left off – that is, the Eurozone in crisis. In fact, the Eurozone has been the issue for most of 2010, 2011 and now indeed will remain so for the foreseeable future.
How did the Eurozone end up in such a apocalyptic situation? For those of you that haven’t heard, and I am sure there are not many who haven’t, Euro governments have borrowed too much money. This has come about as too many Europeans rely on their government to fund their lifestyle, either via employment (i.e. public servants) or by transfer payments (age pensions, unemployment benefits et al).
So how much can a government borrow? Milton Freidman, a renowned economist once said “Government will borrow whatever they can get away with, and a little bit more”, and I think that pretty much sums it up. The European situation is quite unique because Europe simply has so much history. The Europeans have been at war with each other for all of modern history and everything preceding that. So you have to understand that this constant fighting has left many Europeans pretty tired of confrontation. The 20th century saw two major conflicts WW1 and WW2 which resulted in complete destruction of parts of Europe and decimation of generations (incidentally, the Spanish Flu that spread throughout the world in 1918 killed more people then WW1).
So following WW2 (not withstanding the Cold War) Europe wanted to have closer economic ties to ensure that any future conflict would be decidedly less likely because they would all have too much to lose. So the European Union (EU) was born and then the Eurozone. Not all members of the EU are in the Eurozone (the Eurozone are the nations that have adopted the Eurodollar as their currency) the United Kingdom being a notable exception.
So everything went along grandly for some time. The Greek government was able to borrow money at the same rates as the German Government, the French workers demanded and got a 35 hour week, the Italians were able to continue to avoid paying tax but retire early on government pensions (Southern Italians I am told), the Europeans introduced taxes to make their manufacturing uncompetitive (ETS), so on and so forth. So everyone was happy because the increased government debt allowed more people to be paid more money and this translated into “economic growth” and the party kept going (sounds a bit like a Ponzi Scheme.................).
But then the music stopped. The US Sub Prime crisis blew up, creating a global credit crunch. When a credit crunch occurs everyone decides they don’t trust anyone anymore. People don’t want to lend money to other people and banks don’t want to lend to other banks. This drop in confidence and withdrawal of credit feeds on itself. This is because financial institutions are “highly geared”. They use a small amount of equity to lend a lot of money. If the financial institution suffers losses, this “equity” is quickly wiped out and the banks become insolvent. Insolvent banks require government support. In Iceland the banks simply had too much debt for the country to take over. They collapsed taking Iceland with it. In Ireland, the banks had too much debt as well, the government in Ireland has bailed them out, but this has forced Ireland into technical insolvency. In the UK, banks were bailed out to ensure credit kept flowing.
Credit crunches are very destructive. Banks stop lending to business and also individuals that want to buy houses. This negative feedback loop results in falling property prices, businesses cutting back on investment and job losses. Keynesian economics dictates that government must fill this gap and spend. This is of course what they did and borrow and spend is what they have done (Australia is no exception – Kevin Rudd went from a self proclaimed fiscal conservative to a social democrat in a matter of weeks!)
And now we have the hangover. Europe, the USA, the UK and many other developed countries have simply borrowed too much and the prospect of paying it back seems enormous.
So why is the Eurozone the current problem and not the USA or UK – given the USA and UK have massive amounts of public and private debt? It all comes down to the ability to use all the devices available to them. The USA and UK each control their own Central Bank and therefore currency. The Eurozone does not! The European Central Bank is effectively controlled by 17 different governments, some of which are reasonably healthy and others that are decidedly unhealthy.
What would normally occur in a situation where an economy is in strife is that the currency of that country would depreciate to make it workers and manufacturing more competitive (think Australia during the Asian Financial crisis in 1998 – our currency “plummeted” to 50 cents US and saved us from recession). The Eurozone, which has the Euro dollar, does not have this luxury. The Eurodollar as a currency reacts to the health of all of the 17 countries within it of which some are going OK and others are failing. So yes, the Eurodollar has depreciated, which has been of great benefit to exporting nations such as Germany, but by not nearly enough that would benefit Greece.
So ultimately, the Eurozone economies have a half baked system. They have monetary Union, but they also need Fiscal (government taxation and spending) union as well. Indeed, they probably require Political Union or “The United States of Europe”! They also need unified labour laws. Public servants in Greece are paid 30% more than public servants in Germany. Guess who probably works harder.....and you then realise that the system sure is broke.
On some levels, it shows how the culture of “entitlement” has now riddled the developed countries. By this, I mean that once a government “awards” an entitlement to a constituent, it is very hard to take that away. In Greece, it is high public service salaries or an Government Pension at age 55 , in Australia it is Family Tax benefits for middle class Australia. This is because people begin to establish their lifestyle on that increased entitlement and that allows them to spend more, borrow more, enjoy more. Taking that away is not easy for politicians who have to ensure they are re-elected at the next ballot.
At the other end of the scale, this entitlement culture also dominates board rooms in our listed companies. CEO’s earn multi-million dollar salaries and bonuses based on what is deemed “responsibility”. Even worse, some company boards actually reset performance hurdles when executives look like not achieving them to make the payment of bonuses more likely (see recently Wesfarmers and Bluescope). Not good and not healthy.
So Europe continues to lurch towards their solution. Essentially there is only one solution, and that is the write down of government debt to more sustainable levels. Simply put, Greece will never repay its debt and it will continue to grow in perpetuity unless it is written off. The holders of this debt which is mainly European banks will see a fall in their assets (equity) which will make them insolvent. The governments of each of these countries will then be required to prop up these banks by providing them with Capital (and I would suggest wiping out shareholders in the process) and this will of course require governments to borrow more....yes, I know this is insane – it will actually result in say Germany taking on more debt to effectively forgive Greek debt!
This increased debt load that will be the result of this exercise is unsustainable (as all developed countries have governments that spend too much to fund entitlements) and the final piece to the puzzle will be that the European Central Bank will begin the purchase of government bonds, or the fancy people call it Quantitative Easing – I just call it money printing. This exercise pushes additional money into the banking system to provide more money to buy more government debt. Although this sounds silly (OK, it is silly) it eventually results in inflation. Inflation is the great tool in a governments armoury as it is tax increases by stealth. Although the government does not announce an increase in taxation, taxation revenues increase as inflation makes people earn more in nominal terms but the level of debt stays the same as it is fixed. However, this is not a magic pudding because although peoples income and assets may rise in nominal terms, their “real” after inflation wealth is sure as hell going to decrease. Those with a long enough memory may remember the 1970’s and 1980’s when this similar policy was used......so we have been there before.
Make no mistake, this is going to be ugly. For Europe, it will be a tough decade or two. Investors will need to be highly disciplined and ensure that their portfolios are highly diversified and retain a structure to ensure they rebalance their holdings on a periodic predetermined basis. Remember, successful investors purchase assets when prices are low – not high. Do not be tempted to follow the herd. Also, be particularly wary of the doomsayers as they will provide some very enticing evidence for the end of the world as we know it (The Mayans may seem to be spot on – for Europe anyway!). Ultimately, Australians are extremely lucky that we are geographically located where we are, we sit in a dustbowl and brilliant economic management for the two decades preceding 2007 placed our government fiscal position well ahead of major developed economies. The bounce back in the Australian Share market is likely to be quick and impressive, although the timing of this is beyond my ability to predict!
Humans have an in seemingly intractable ability to adapt in the face of adversity. Assuming the politicians have the aptitude to face this reality, the light at the end of the tunnel may soon appear.
So we pick up in 2012 where we left off – that is, the Eurozone in crisis. In fact, the Eurozone has been the issue for most of 2010, 2011 and now indeed will remain so for the foreseeable future.
How did the Eurozone end up in such a apocalyptic situation? For those of you that haven’t heard, and I am sure there are not many who haven’t, Euro governments have borrowed too much money. This has come about as too many Europeans rely on their government to fund their lifestyle, either via employment (i.e. public servants) or by transfer payments (age pensions, unemployment benefits et al).
So how much can a government borrow? Milton Freidman, a renowned economist once said “Government will borrow whatever they can get away with, and a little bit more”, and I think that pretty much sums it up. The European situation is quite unique because Europe simply has so much history. The Europeans have been at war with each other for all of modern history and everything preceding that. So you have to understand that this constant fighting has left many Europeans pretty tired of confrontation. The 20th century saw two major conflicts WW1 and WW2 which resulted in complete destruction of parts of Europe and decimation of generations (incidentally, the Spanish Flu that spread throughout the world in 1918 killed more people then WW1).
So following WW2 (not withstanding the Cold War) Europe wanted to have closer economic ties to ensure that any future conflict would be decidedly less likely because they would all have too much to lose. So the European Union (EU) was born and then the Eurozone. Not all members of the EU are in the Eurozone (the Eurozone are the nations that have adopted the Eurodollar as their currency) the United Kingdom being a notable exception.
So everything went along grandly for some time. The Greek government was able to borrow money at the same rates as the German Government, the French workers demanded and got a 35 hour week, the Italians were able to continue to avoid paying tax but retire early on government pensions (Southern Italians I am told), the Europeans introduced taxes to make their manufacturing uncompetitive (ETS), so on and so forth. So everyone was happy because the increased government debt allowed more people to be paid more money and this translated into “economic growth” and the party kept going (sounds a bit like a Ponzi Scheme.................).
But then the music stopped. The US Sub Prime crisis blew up, creating a global credit crunch. When a credit crunch occurs everyone decides they don’t trust anyone anymore. People don’t want to lend money to other people and banks don’t want to lend to other banks. This drop in confidence and withdrawal of credit feeds on itself. This is because financial institutions are “highly geared”. They use a small amount of equity to lend a lot of money. If the financial institution suffers losses, this “equity” is quickly wiped out and the banks become insolvent. Insolvent banks require government support. In Iceland the banks simply had too much debt for the country to take over. They collapsed taking Iceland with it. In Ireland, the banks had too much debt as well, the government in Ireland has bailed them out, but this has forced Ireland into technical insolvency. In the UK, banks were bailed out to ensure credit kept flowing.
Credit crunches are very destructive. Banks stop lending to business and also individuals that want to buy houses. This negative feedback loop results in falling property prices, businesses cutting back on investment and job losses. Keynesian economics dictates that government must fill this gap and spend. This is of course what they did and borrow and spend is what they have done (Australia is no exception – Kevin Rudd went from a self proclaimed fiscal conservative to a social democrat in a matter of weeks!)
And now we have the hangover. Europe, the USA, the UK and many other developed countries have simply borrowed too much and the prospect of paying it back seems enormous.
So why is the Eurozone the current problem and not the USA or UK – given the USA and UK have massive amounts of public and private debt? It all comes down to the ability to use all the devices available to them. The USA and UK each control their own Central Bank and therefore currency. The Eurozone does not! The European Central Bank is effectively controlled by 17 different governments, some of which are reasonably healthy and others that are decidedly unhealthy.
What would normally occur in a situation where an economy is in strife is that the currency of that country would depreciate to make it workers and manufacturing more competitive (think Australia during the Asian Financial crisis in 1998 – our currency “plummeted” to 50 cents US and saved us from recession). The Eurozone, which has the Euro dollar, does not have this luxury. The Eurodollar as a currency reacts to the health of all of the 17 countries within it of which some are going OK and others are failing. So yes, the Eurodollar has depreciated, which has been of great benefit to exporting nations such as Germany, but by not nearly enough that would benefit Greece.
So ultimately, the Eurozone economies have a half baked system. They have monetary Union, but they also need Fiscal (government taxation and spending) union as well. Indeed, they probably require Political Union or “The United States of Europe”! They also need unified labour laws. Public servants in Greece are paid 30% more than public servants in Germany. Guess who probably works harder.....and you then realise that the system sure is broke.
On some levels, it shows how the culture of “entitlement” has now riddled the developed countries. By this, I mean that once a government “awards” an entitlement to a constituent, it is very hard to take that away. In Greece, it is high public service salaries or an Government Pension at age 55 , in Australia it is Family Tax benefits for middle class Australia. This is because people begin to establish their lifestyle on that increased entitlement and that allows them to spend more, borrow more, enjoy more. Taking that away is not easy for politicians who have to ensure they are re-elected at the next ballot.
At the other end of the scale, this entitlement culture also dominates board rooms in our listed companies. CEO’s earn multi-million dollar salaries and bonuses based on what is deemed “responsibility”. Even worse, some company boards actually reset performance hurdles when executives look like not achieving them to make the payment of bonuses more likely (see recently Wesfarmers and Bluescope). Not good and not healthy.
So Europe continues to lurch towards their solution. Essentially there is only one solution, and that is the write down of government debt to more sustainable levels. Simply put, Greece will never repay its debt and it will continue to grow in perpetuity unless it is written off. The holders of this debt which is mainly European banks will see a fall in their assets (equity) which will make them insolvent. The governments of each of these countries will then be required to prop up these banks by providing them with Capital (and I would suggest wiping out shareholders in the process) and this will of course require governments to borrow more....yes, I know this is insane – it will actually result in say Germany taking on more debt to effectively forgive Greek debt!
This increased debt load that will be the result of this exercise is unsustainable (as all developed countries have governments that spend too much to fund entitlements) and the final piece to the puzzle will be that the European Central Bank will begin the purchase of government bonds, or the fancy people call it Quantitative Easing – I just call it money printing. This exercise pushes additional money into the banking system to provide more money to buy more government debt. Although this sounds silly (OK, it is silly) it eventually results in inflation. Inflation is the great tool in a governments armoury as it is tax increases by stealth. Although the government does not announce an increase in taxation, taxation revenues increase as inflation makes people earn more in nominal terms but the level of debt stays the same as it is fixed. However, this is not a magic pudding because although peoples income and assets may rise in nominal terms, their “real” after inflation wealth is sure as hell going to decrease. Those with a long enough memory may remember the 1970’s and 1980’s when this similar policy was used......so we have been there before.
Make no mistake, this is going to be ugly. For Europe, it will be a tough decade or two. Investors will need to be highly disciplined and ensure that their portfolios are highly diversified and retain a structure to ensure they rebalance their holdings on a periodic predetermined basis. Remember, successful investors purchase assets when prices are low – not high. Do not be tempted to follow the herd. Also, be particularly wary of the doomsayers as they will provide some very enticing evidence for the end of the world as we know it (The Mayans may seem to be spot on – for Europe anyway!). Ultimately, Australians are extremely lucky that we are geographically located where we are, we sit in a dustbowl and brilliant economic management for the two decades preceding 2007 placed our government fiscal position well ahead of major developed economies. The bounce back in the Australian Share market is likely to be quick and impressive, although the timing of this is beyond my ability to predict!
Humans have an in seemingly intractable ability to adapt in the face of adversity. Assuming the politicians have the aptitude to face this reality, the light at the end of the tunnel may soon appear.
Monday, June 27, 2011
Carbon debacle
As you know, the purpose of the carbon tax puzzles me. Because to reduce carbon emissions. Of course – we have to stop using it.
"The vast majority of Australian households won't pay a cent as a result of the price on carbon," Ms Gillard told ABC Radio on Monday morning (June 27th 2011).
So where are we heading with this? One can only imagine that this is a symbolic move to be seen to be doing something. Others would suggest it is an ideological agenda to redistribute wealth and enlarge government.
The tax will be paid by the big polluters they claim. Yes, sure, I agree with this, and they will simply increase their prices to maintain profits and pass this on to consumers who will have more redistributed wealth so will not make any changes to their behaviour – ho hum and off we go.
Here is Julia Gillards explanation as to why this tax will work on Q & A (March 14th 2011);
“Well, the effect is that in the shops when you come to buy things, products that are made with relatively less carbon pollution will be cheaper than products that are made with more carbon pollution. So you're standing there with your household assistance in your hand. You could still keep buying the high carbon pollution products if you want to or what you're far more likely to do is to buy the cheaper, lower carbon pollution products. That means that the people who make those things will get the consumer signal, gee, we will sell more, we will make more money if we make lower pollution products. That drives the innovation. So I want you to have that household assistance in your hand but I also want you to see price effects which make cleaner, greener things cheaper than high pollution commodities. That's why it works.”
Great explanation! And in a fantasy world of Australian Utopia it could almost work. Problem is, we live in a global economy. So to pick apart the argument the Prime Minister puts forward, the first most glaring omission is that it ignores the rest of the world (i.e. imports). Imports will not have a carbon tax and will therefore most likely be much cheaper – indeed, our manufacturers are already struggling under the pressures of cheap Chinese goods and a high Australian dollar. So given this, the consumer will buy the third option Julia failed to mention – the cheap imported good – made from coal that we exported!
The other glaring omission is that clean green power is still prohibitively expensive and not practical. By putting this price on carbon - $20 a tonne, $30 a tonne – whatever, Clean Green power will still be non economical. Unless Australia embraces a clean green scalable energy source – such as nuclear power, we are just kidding ourselves (by the way, because we have an abundance of cheap coal, Nuclear Power is not viable in Australia without a carbon price of $40 a tonne or higher). As a result – Australians will still buy the good produced with Carbon Dioxide intensity.
Indeed, the major problem of this argument is that government intervention does not “drive innovation”. It never has and never will. Minimal government interference in the movement of capital and investment will promote innovation.
So, what is the point? Australia as a nation should not feel guilty for our abundance of cheap coal. Indeed, we should not think that we are somehow acquitted of this guilt by imposing a carbon (dioxide) tax whilst at the same time exporting our coal to China, Japan and South Korea who will happily consume our folly and return it to us in cheap manufactured goods. For those of you frightened by the prospect of a “world heating dangerously”, take heart in recent data that suggests that “climate change” is simply a permanent feature of our planet and that Carbon Dioxide increases in our atmosphere over the past 10 years has not resulted in any increased warming as predicted by IPCC models.
The current Prime Minister and her Government should indeed stop the “Alarmist” predictions and give the Australian population a little more credit than they have in the past 12 months. Their continued indifference to this may be highly destructive to our economy and future.
"The vast majority of Australian households won't pay a cent as a result of the price on carbon," Ms Gillard told ABC Radio on Monday morning (June 27th 2011).
So where are we heading with this? One can only imagine that this is a symbolic move to be seen to be doing something. Others would suggest it is an ideological agenda to redistribute wealth and enlarge government.
The tax will be paid by the big polluters they claim. Yes, sure, I agree with this, and they will simply increase their prices to maintain profits and pass this on to consumers who will have more redistributed wealth so will not make any changes to their behaviour – ho hum and off we go.
Here is Julia Gillards explanation as to why this tax will work on Q & A (March 14th 2011);
“Well, the effect is that in the shops when you come to buy things, products that are made with relatively less carbon pollution will be cheaper than products that are made with more carbon pollution. So you're standing there with your household assistance in your hand. You could still keep buying the high carbon pollution products if you want to or what you're far more likely to do is to buy the cheaper, lower carbon pollution products. That means that the people who make those things will get the consumer signal, gee, we will sell more, we will make more money if we make lower pollution products. That drives the innovation. So I want you to have that household assistance in your hand but I also want you to see price effects which make cleaner, greener things cheaper than high pollution commodities. That's why it works.”
Great explanation! And in a fantasy world of Australian Utopia it could almost work. Problem is, we live in a global economy. So to pick apart the argument the Prime Minister puts forward, the first most glaring omission is that it ignores the rest of the world (i.e. imports). Imports will not have a carbon tax and will therefore most likely be much cheaper – indeed, our manufacturers are already struggling under the pressures of cheap Chinese goods and a high Australian dollar. So given this, the consumer will buy the third option Julia failed to mention – the cheap imported good – made from coal that we exported!
The other glaring omission is that clean green power is still prohibitively expensive and not practical. By putting this price on carbon - $20 a tonne, $30 a tonne – whatever, Clean Green power will still be non economical. Unless Australia embraces a clean green scalable energy source – such as nuclear power, we are just kidding ourselves (by the way, because we have an abundance of cheap coal, Nuclear Power is not viable in Australia without a carbon price of $40 a tonne or higher). As a result – Australians will still buy the good produced with Carbon Dioxide intensity.
Indeed, the major problem of this argument is that government intervention does not “drive innovation”. It never has and never will. Minimal government interference in the movement of capital and investment will promote innovation.
So, what is the point? Australia as a nation should not feel guilty for our abundance of cheap coal. Indeed, we should not think that we are somehow acquitted of this guilt by imposing a carbon (dioxide) tax whilst at the same time exporting our coal to China, Japan and South Korea who will happily consume our folly and return it to us in cheap manufactured goods. For those of you frightened by the prospect of a “world heating dangerously”, take heart in recent data that suggests that “climate change” is simply a permanent feature of our planet and that Carbon Dioxide increases in our atmosphere over the past 10 years has not resulted in any increased warming as predicted by IPCC models.
The current Prime Minister and her Government should indeed stop the “Alarmist” predictions and give the Australian population a little more credit than they have in the past 12 months. Their continued indifference to this may be highly destructive to our economy and future.
Thursday, October 7, 2010
Go figure!
I am thoroughly convinced that the economic world is simply irreconcilable. Here’s a summary of the week just past.
On Friday morning I was surprised to hear that the stock market in the USA had fallen due to strong jobs growth! Hang on, isn’t the USA relying on stronger employment to buoy the consumer who will spend more, lifting confidence and thereby start paying back their home loans and perhaps spark recovery in the housing market (the core of the current problems). Nope, apparently this was going to reduce the chance of the Federal Reserve printing money and thereby closing an opportunity for easy money and inflation.
But it gets worse. This week in Japan the Central Bank dramatically cut interest rates.....from 0.1% to between 0% and 0.1%. Goodness me, I doubt this will make much of a difference but who am I to argue against their collective wisdom – given that the Japanese economy has deflated for 20 years now – more of the same? Why not?
Also there was an interesting conversation this week about the banks and warnings for them not to lift interest rates outside the normal RBA increases - intimidation? Both sides of politics are guilty of this but would any of them actually take any action? Let’s imagine a “Super Profits” style tax was imposed on our banks. The most likely result of this action would be a flight of foreign capital from our shores resulting in a huge increase in banks funding costs and that would result in...oh dear... higher interest rates.
But hang on, if it’s no good for banks to increase costs to consumers why is it OK for Energy companies to increase costs without any repercussions. From 2005 to 2010 Electricity prices have increased by 61.3% in Sydney. A recent article on Business Spectator by Robert Gottliebsen suggested that power prices may actually quadruple over the next 4 years.
Directly relating to this, the State Government is set to axe its solar energy scheme. In this scheme, people that install solar panels can sell power to the grid for 60 cents per kilowatt hour and then buy it back for a quarter of that. The government is forcing Energy Companies to pay for the difference and all of us who don't have solar panels are thereby paying for this with increased BILLS. The irony is that the greatest demand for household power comes in the evening when the sun don’t shine. As a result, the Coal Fired Power Stations remain at full capacity!
It is also a regressive system as only wealthy people can afford to install the panels and poorer people end up paying for it with higher energy bills. So once again we find a government action with the best intentions being implemented with the worst outcomes. I would suggest you ain’t seen nothing yet!!!
So in conclusion it has been a crazy week. The award for the most unforgiving job in the country goes to all the Economists who predicted a rate rise this week. Forecasting is certainly a mugs game.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
On Friday morning I was surprised to hear that the stock market in the USA had fallen due to strong jobs growth! Hang on, isn’t the USA relying on stronger employment to buoy the consumer who will spend more, lifting confidence and thereby start paying back their home loans and perhaps spark recovery in the housing market (the core of the current problems). Nope, apparently this was going to reduce the chance of the Federal Reserve printing money and thereby closing an opportunity for easy money and inflation.
But it gets worse. This week in Japan the Central Bank dramatically cut interest rates.....from 0.1% to between 0% and 0.1%. Goodness me, I doubt this will make much of a difference but who am I to argue against their collective wisdom – given that the Japanese economy has deflated for 20 years now – more of the same? Why not?
Also there was an interesting conversation this week about the banks and warnings for them not to lift interest rates outside the normal RBA increases - intimidation? Both sides of politics are guilty of this but would any of them actually take any action? Let’s imagine a “Super Profits” style tax was imposed on our banks. The most likely result of this action would be a flight of foreign capital from our shores resulting in a huge increase in banks funding costs and that would result in...oh dear... higher interest rates.
But hang on, if it’s no good for banks to increase costs to consumers why is it OK for Energy companies to increase costs without any repercussions. From 2005 to 2010 Electricity prices have increased by 61.3% in Sydney. A recent article on Business Spectator by Robert Gottliebsen suggested that power prices may actually quadruple over the next 4 years.
Directly relating to this, the State Government is set to axe its solar energy scheme. In this scheme, people that install solar panels can sell power to the grid for 60 cents per kilowatt hour and then buy it back for a quarter of that. The government is forcing Energy Companies to pay for the difference and all of us who don't have solar panels are thereby paying for this with increased BILLS. The irony is that the greatest demand for household power comes in the evening when the sun don’t shine. As a result, the Coal Fired Power Stations remain at full capacity!
It is also a regressive system as only wealthy people can afford to install the panels and poorer people end up paying for it with higher energy bills. So once again we find a government action with the best intentions being implemented with the worst outcomes. I would suggest you ain’t seen nothing yet!!!
So in conclusion it has been a crazy week. The award for the most unforgiving job in the country goes to all the Economists who predicted a rate rise this week. Forecasting is certainly a mugs game.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
Wednesday, September 29, 2010
Choice?
Is too much choice simply too much for some people to handle these days?
Interestingly, the more choice we have, the more disappointed we subsequently become. This is actually contrary to most people’s belief that the more choice, the better. Let’s take for example a simple trip to the ice cream shop – there are so many flavours to choose from now. Inevitably you choose something and take the first bite and then wish you had chosen the other flavour. The same applies at the restaurant, and how about choosing the colours to paint your house. How many shades of white are there for goodness sake?
So despite the fact that economic theory suggests that we are rational economic agents who know their own business best, perhaps this is simply not true when investing. This is why the government is implementing MySuper, a low cost and no frills solution for those of you who show high levels of apathy towards their superannuation and retirement.
Guess what, in my experience this is absolutely correct. To this stage I have not been convinced that the majority of Australians would not be advantaged by investing into a MySuper option. The reason for this is that most investors overestimate their ability to choose good investments. Furthermore, they are also prone to making investment decisions based on past performance rather than an intellectual framework. Finally, they also get caught up in the fear and greed cycle resulting in taking less risk when things are bad and taking more risk when things are good which is unfortunately the incorrect course of action (Warren Buffet states "Be fearful when people are greedy, be greedy when people are fearful").
The Dalbar study supports this. In the 20 years to the end of 31 December 2009, the S & P 500 index in the USA averaged 8.2% per annum wherea’s the average investor achieved a return of just only 3.17% over the same time period.
Someone who wants to really make a difference to their long term goals should consider paying for some advice but I must warn you...achieving your long term goals rarely has much to do with picking the right investments - it is more about understanding the key financial levers that affects your long term outcomes including income, expenses and asset allocation.
If you think that by chopping and changing your investments and trying to pick the next winner is your path to financial prosperity, I say good luck!!!!
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
Interestingly, the more choice we have, the more disappointed we subsequently become. This is actually contrary to most people’s belief that the more choice, the better. Let’s take for example a simple trip to the ice cream shop – there are so many flavours to choose from now. Inevitably you choose something and take the first bite and then wish you had chosen the other flavour. The same applies at the restaurant, and how about choosing the colours to paint your house. How many shades of white are there for goodness sake?
So despite the fact that economic theory suggests that we are rational economic agents who know their own business best, perhaps this is simply not true when investing. This is why the government is implementing MySuper, a low cost and no frills solution for those of you who show high levels of apathy towards their superannuation and retirement.
Guess what, in my experience this is absolutely correct. To this stage I have not been convinced that the majority of Australians would not be advantaged by investing into a MySuper option. The reason for this is that most investors overestimate their ability to choose good investments. Furthermore, they are also prone to making investment decisions based on past performance rather than an intellectual framework. Finally, they also get caught up in the fear and greed cycle resulting in taking less risk when things are bad and taking more risk when things are good which is unfortunately the incorrect course of action (Warren Buffet states "Be fearful when people are greedy, be greedy when people are fearful").
The Dalbar study supports this. In the 20 years to the end of 31 December 2009, the S & P 500 index in the USA averaged 8.2% per annum wherea’s the average investor achieved a return of just only 3.17% over the same time period.
Someone who wants to really make a difference to their long term goals should consider paying for some advice but I must warn you...achieving your long term goals rarely has much to do with picking the right investments - it is more about understanding the key financial levers that affects your long term outcomes including income, expenses and asset allocation.
If you think that by chopping and changing your investments and trying to pick the next winner is your path to financial prosperity, I say good luck!!!!
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
Thursday, September 9, 2010
Emotions - your greatest enemy
Here is an interesting thought.
When the price of a good or service goes up, let’s say Banana’s or Petrol, our first inclination is to buy less. Right?
Then why do we not apply the same philosophy to financial assets? If the price of a listed share goes up, why are people more inclined to buy it......and looking at the reverse, if the price falls, they sell it. The same can be said for managed funds. Investors and Financial Planners are more inclined to purchase managed funds that have performed well over the past 12 months.
The problem is, people appear to incorrectly extrapolate past price changes into the future. This is unfortunate for so many reasons, not least the fact that there is overwhelming evidence to suggest that this behaviour destroys wealth. The Dalbar Study in the USA has found that over the 20 year period to 31 December 2009 the US Sharemarket S & P 500 Index had an annual return of 8.2% whereas the average stock fund investor averaged a paltry 3.2% (barely above the rate of inflation).
Investor behaviour is shaped by the false belief that there are market guru’s that can predict the future. This faith is placed in stock brokers, economists, managed fund analysts and Financial Planners. If the truth be known many investors are none the wiser as they do not have the ability to benchmark or “judge” their investment performance with their peers.
Poor asset allocation decisions and market timing nightmares also compound the problem.
Emotion is your greatest enemy. When people are most fearful, future expected returns are actually at their highest. Knowing this, why are people tempted to withdraw money from the share market at this time? Ultimately, investors will only succeed if they have the right plan and discipline in place.
Charles Kindleberger once wrote “There is nothing so disturbing to one’s well being and judgement as to see a friend get rich”. This is a very poignant statement, but should be a lesson to people that we need to constantly battle our emotions and biases and this sometimes needs the help from an expert.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
When the price of a good or service goes up, let’s say Banana’s or Petrol, our first inclination is to buy less. Right?
Then why do we not apply the same philosophy to financial assets? If the price of a listed share goes up, why are people more inclined to buy it......and looking at the reverse, if the price falls, they sell it. The same can be said for managed funds. Investors and Financial Planners are more inclined to purchase managed funds that have performed well over the past 12 months.
The problem is, people appear to incorrectly extrapolate past price changes into the future. This is unfortunate for so many reasons, not least the fact that there is overwhelming evidence to suggest that this behaviour destroys wealth. The Dalbar Study in the USA has found that over the 20 year period to 31 December 2009 the US Sharemarket S & P 500 Index had an annual return of 8.2% whereas the average stock fund investor averaged a paltry 3.2% (barely above the rate of inflation).
Investor behaviour is shaped by the false belief that there are market guru’s that can predict the future. This faith is placed in stock brokers, economists, managed fund analysts and Financial Planners. If the truth be known many investors are none the wiser as they do not have the ability to benchmark or “judge” their investment performance with their peers.
Poor asset allocation decisions and market timing nightmares also compound the problem.
Emotion is your greatest enemy. When people are most fearful, future expected returns are actually at their highest. Knowing this, why are people tempted to withdraw money from the share market at this time? Ultimately, investors will only succeed if they have the right plan and discipline in place.
Charles Kindleberger once wrote “There is nothing so disturbing to one’s well being and judgement as to see a friend get rich”. This is a very poignant statement, but should be a lesson to people that we need to constantly battle our emotions and biases and this sometimes needs the help from an expert.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
Wednesday, August 18, 2010
Visionary or White Elephant?
The Federal Labour government are proposing that we spend $43 billion on the National Broadband Network (NBN). It is a being promoted as a Nation Building project that will increase the productivity of Australia and lead us into the 21st Century. Is this fact or fiction?
I pride myself on the fact that I am a bit of a technical Luddite (by the way, the Luddites were a social movement of British textile artisans in the nineteenth century who protested – often by destroying mechanized looms – against the changes produced by the Industrial Revolution, which they felt was leaving them without work and changing their way of life) so I am not really impressed when people start discussing current speeds, data downloads (and uploads for that matter) and fibre optic cable. However, I acknowledge that to retain our status in the real world some areas of our economy require much faster broadband speeds.
But for me to really determine whether the NBN is a good idea or not I would like to see a fully researched Business Plan.
Unfortunately, a Business Plan has not been established for the NBN (well it sort of has but the government won’t let us see it). I assume this is due to a couple of reasons, one being the uncertainty of who will avail themselves of this new technology and also ultimately what it will cost. There is little doubt that when a government (of any political persuasion) is involved in large projects there appears to be cost blow outs due to overarching bureaucracy and the temptation for people involved to simply increase their prices.
New technology is currently being developed at a very rapid pace. A pace that has probably never been seen before. We cannot forget, however, the lessons of the past. New technology always results in over investments (think railway lines is the late 19th century) and wasteful spending. I also acknowledge that people will raise the Snowy Mountains Hydro project of an example of a large infrastructure Nation Building project but the facts show that the cost of the Snowy Hydro Scheme adjusted for inflation was only $6 billion (in 2004).
So I would suggest that we slow down on the project and have an honest and open discussion about the costs, the benefits and threats before we embark on what could be an expensive mistake. Some people have likened the NBN to a 4 lane highway. What we have to remember is that not every house in Australia needs a 4 lane Highway to their front door.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
I pride myself on the fact that I am a bit of a technical Luddite (by the way, the Luddites were a social movement of British textile artisans in the nineteenth century who protested – often by destroying mechanized looms – against the changes produced by the Industrial Revolution, which they felt was leaving them without work and changing their way of life) so I am not really impressed when people start discussing current speeds, data downloads (and uploads for that matter) and fibre optic cable. However, I acknowledge that to retain our status in the real world some areas of our economy require much faster broadband speeds.
But for me to really determine whether the NBN is a good idea or not I would like to see a fully researched Business Plan.
Unfortunately, a Business Plan has not been established for the NBN (well it sort of has but the government won’t let us see it). I assume this is due to a couple of reasons, one being the uncertainty of who will avail themselves of this new technology and also ultimately what it will cost. There is little doubt that when a government (of any political persuasion) is involved in large projects there appears to be cost blow outs due to overarching bureaucracy and the temptation for people involved to simply increase their prices.
New technology is currently being developed at a very rapid pace. A pace that has probably never been seen before. We cannot forget, however, the lessons of the past. New technology always results in over investments (think railway lines is the late 19th century) and wasteful spending. I also acknowledge that people will raise the Snowy Mountains Hydro project of an example of a large infrastructure Nation Building project but the facts show that the cost of the Snowy Hydro Scheme adjusted for inflation was only $6 billion (in 2004).
So I would suggest that we slow down on the project and have an honest and open discussion about the costs, the benefits and threats before we embark on what could be an expensive mistake. Some people have likened the NBN to a 4 lane highway. What we have to remember is that not every house in Australia needs a 4 lane Highway to their front door.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
Sunday, August 15, 2010
The Madness of Crowds
Charles McKay’s eloquently stated in his book “Extraordinary Popular Delusions and the madness of crowds” (published in 1841), that “Men, it has been well said, think in herds: it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one”.
You will see, from time to time, this phenomena occur whether it be the Global Financial Crisis, the Swine Flu scare, Tulip mania, the Internet Boom and the list goes on. It is important for the individual to try and recognize these events and consider running against the herd and learning from past mistakes.
In the Late 19th century the world had witnessed a huge increase in the population in urban centres. In the USA the population of cities had increased by 30 million over the preceding 100 years of which half of that growth had occurred in just 20 years.
According to the new book “Super Freakonomics” by Steven Levitt & Stephen Dubner, this rapid population explosion in cities caused a huge “Emission’s” problem from the major mode of transport – Horses! Their Emission’s of course was manure. New York City alone was occupied by 200,000 horses at the turn of the 20th Century. It is said that these horses produced 5 million pounds of dung a day.
This was indeed a problem. Streets were lined with dung and huge mountains of horse manure were built up around the city on vacant blocks. The smell and the hygiene issues had authorities and residents in a state of panic.
Indeed in 1898 New York hosted the first international urban planning conference to try and address the issue facing cities around the world. The conference only completed 3 of the planned 10 days as no solution could be found.
But then, all of a sudden, the problem vanished. Not by imposition of a big new tax, or legislation banning horses, or an uprising of disgruntled citizens. It was solved by the invention of the automobile.
Levitt & Dubner put it down to this….”Humankind has a great capacity for finding technological solutions to seemingly intractable problems……”. And I have no doubt that this will apply to the current catastrophic scenarios that are allegedly facing us today!
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
You will see, from time to time, this phenomena occur whether it be the Global Financial Crisis, the Swine Flu scare, Tulip mania, the Internet Boom and the list goes on. It is important for the individual to try and recognize these events and consider running against the herd and learning from past mistakes.
In the Late 19th century the world had witnessed a huge increase in the population in urban centres. In the USA the population of cities had increased by 30 million over the preceding 100 years of which half of that growth had occurred in just 20 years.
According to the new book “Super Freakonomics” by Steven Levitt & Stephen Dubner, this rapid population explosion in cities caused a huge “Emission’s” problem from the major mode of transport – Horses! Their Emission’s of course was manure. New York City alone was occupied by 200,000 horses at the turn of the 20th Century. It is said that these horses produced 5 million pounds of dung a day.
This was indeed a problem. Streets were lined with dung and huge mountains of horse manure were built up around the city on vacant blocks. The smell and the hygiene issues had authorities and residents in a state of panic.
Indeed in 1898 New York hosted the first international urban planning conference to try and address the issue facing cities around the world. The conference only completed 3 of the planned 10 days as no solution could be found.
But then, all of a sudden, the problem vanished. Not by imposition of a big new tax, or legislation banning horses, or an uprising of disgruntled citizens. It was solved by the invention of the automobile.
Levitt & Dubner put it down to this….”Humankind has a great capacity for finding technological solutions to seemingly intractable problems……”. And I have no doubt that this will apply to the current catastrophic scenarios that are allegedly facing us today!
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
Wednesday, June 30, 2010
Safety in the Market?
In a recent magazine publication an article caught by eye. They had put together a list of “10 Must-Have Shares in a Tricky Market”. The list includes picks that “provide a mix of balance sheet strength, exposure to upside growth potential and an ability to weather any further erosion in economic conditions”.
The chosen stocks were all well-known, highly reputable, blue-chip companies. All the supporting evidence allowed me to conclude that “yes indeed” the people writing the article were extremely accurate and intelligent. It all made sense.
But unfortunately, this is where the Stock Market is poorly understood. The Stock Market is an amazingly efficient mechanism whereby all the available information on anyone company can quickly be priced into a company’s stock. Therefore, shouldn’t all the good news and qualities of the company’s “picked” by the article be already factored into the share price? The market already knows that these are solid companies with good prospects. But does that make them good investments? It’s a different thing.
A good company often is priced at a premium to the market.
And besides, as we’ve seen over the past couple of years, there’s no guarantee anyway that idiosyncratic risk will not mess up your “safe” blue chip gamble (Babcock and Brown for instance).
This is why a concentrated portfolio of blue-chip stocks provides no guarantees. You are simply taking non-systematic risks that you are not rewarded for.
The answer is to diversify, accept that good prospects are almost always in the price already and to understand that low prices relative to fundamental factors mean higher expected returns. The mix of “good” and “bad” companies in your portfolio will depend on your appetite for risk.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances. Comment on this article at http://thenakedinvestor.blogspot.com
The chosen stocks were all well-known, highly reputable, blue-chip companies. All the supporting evidence allowed me to conclude that “yes indeed” the people writing the article were extremely accurate and intelligent. It all made sense.
But unfortunately, this is where the Stock Market is poorly understood. The Stock Market is an amazingly efficient mechanism whereby all the available information on anyone company can quickly be priced into a company’s stock. Therefore, shouldn’t all the good news and qualities of the company’s “picked” by the article be already factored into the share price? The market already knows that these are solid companies with good prospects. But does that make them good investments? It’s a different thing.
A good company often is priced at a premium to the market.
And besides, as we’ve seen over the past couple of years, there’s no guarantee anyway that idiosyncratic risk will not mess up your “safe” blue chip gamble (Babcock and Brown for instance).
This is why a concentrated portfolio of blue-chip stocks provides no guarantees. You are simply taking non-systematic risks that you are not rewarded for.
The answer is to diversify, accept that good prospects are almost always in the price already and to understand that low prices relative to fundamental factors mean higher expected returns. The mix of “good” and “bad” companies in your portfolio will depend on your appetite for risk.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances. Comment on this article at http://thenakedinvestor.blogspot.com
Thursday, June 17, 2010
Hedge Fund Meltdown
This week on ABC TV the Current Affairs programme 4 Corners ran a story on the Australian based hedge fund Basis Capital. The premise behind the story was that the Hedge fund had lost a significant amount of capital for its investors based on a dodgy deal with the US Investment Bank Goldman Sachs. Caveat Emptor comes to my mind but we’ll let the courts decide that matter.
Of more interest to me was the fact that two investors in the Basis Yield Fund were interviewed and asked if they were aware what the fund had invested in. Of the two investors interviewed, one had been recommended the fund by a Financial Adviser, and the other had chosen the fund himself. So how obvious was it that the Basis Yield fund was not the safe fixed interest investment that some touted it as? I decided to Google and get a copy of the Product Disclosure Statement (PDS) dated 2nd April 2007 (just 3 months before it went belly up).
What I like to look for is Red flags that would indicate the riskiness of the investment or otherwise. This is important because all PDS’s have to be approved by the Australian Securities and investments commission (ASIC) and they will happily approve a PDS if the risks are disclosed.
It did not take long for the alarm bells to start ringing. It was clearly disclosed that;
1. The fund invested in a sole fund registered in the Cayman Islands;
2. The fund invested in CDO’s (Collateralised Debt Obligations) including the equity tranche of structured credit special purpose vehicles which are often the first loss position in event of default (much like an ordinary share);
3. The fund used LEVERAGE (Borrowings) to further diversify the portfolio. The PDS clearly stated that any forced selling of this portfolio would result in capital loss;
4. In the calendar year 2006 the fund returned 26.41% before fees of 6.08% leaving the investor a return of 20.33%;
5. The ratings of the securities held show that 61.93% of the portfolio was invested in “unrated securities”. There were no AAA, AA, or A securities at all!
So to me, it was obvious that with such high returns, a large amount of risk had been taken. To put in perspective, in the same calendar year (2006) a diversified portfolio of AAA bonds returned about 4.61%. High fees are also a warning sign, particularly when performance fees are involved as this may encourage risk taking for the sake of trying to outperform. The fact that the fund was using borrowings to enhance return was also a big warning sign. Borrowing can magnify the gains and in this case magnified the losses.
The simple rule is that risk and return are related and you should only take on risks that you are rewarded for. Taking extra risk in fixed interest portfolios quite often does not result in the extra reward that you are expecting. Was the Basis yield fund safe? – quite clearly, the PDS states that it is not.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
Of more interest to me was the fact that two investors in the Basis Yield Fund were interviewed and asked if they were aware what the fund had invested in. Of the two investors interviewed, one had been recommended the fund by a Financial Adviser, and the other had chosen the fund himself. So how obvious was it that the Basis Yield fund was not the safe fixed interest investment that some touted it as? I decided to Google and get a copy of the Product Disclosure Statement (PDS) dated 2nd April 2007 (just 3 months before it went belly up).
What I like to look for is Red flags that would indicate the riskiness of the investment or otherwise. This is important because all PDS’s have to be approved by the Australian Securities and investments commission (ASIC) and they will happily approve a PDS if the risks are disclosed.
It did not take long for the alarm bells to start ringing. It was clearly disclosed that;
1. The fund invested in a sole fund registered in the Cayman Islands;
2. The fund invested in CDO’s (Collateralised Debt Obligations) including the equity tranche of structured credit special purpose vehicles which are often the first loss position in event of default (much like an ordinary share);
3. The fund used LEVERAGE (Borrowings) to further diversify the portfolio. The PDS clearly stated that any forced selling of this portfolio would result in capital loss;
4. In the calendar year 2006 the fund returned 26.41% before fees of 6.08% leaving the investor a return of 20.33%;
5. The ratings of the securities held show that 61.93% of the portfolio was invested in “unrated securities”. There were no AAA, AA, or A securities at all!
So to me, it was obvious that with such high returns, a large amount of risk had been taken. To put in perspective, in the same calendar year (2006) a diversified portfolio of AAA bonds returned about 4.61%. High fees are also a warning sign, particularly when performance fees are involved as this may encourage risk taking for the sake of trying to outperform. The fact that the fund was using borrowings to enhance return was also a big warning sign. Borrowing can magnify the gains and in this case magnified the losses.
The simple rule is that risk and return are related and you should only take on risks that you are rewarded for. Taking extra risk in fixed interest portfolios quite often does not result in the extra reward that you are expecting. Was the Basis yield fund safe? – quite clearly, the PDS states that it is not.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
Friday, June 11, 2010
Super Stupidity
The “Super profits” mining tax is currently a political hot potato for the Rudd Government as it is their silver bullet solution to bring the Budget back into surplus. What is also becoming apparent is that most people have a poor understanding of how it works.
The reality, however, is the way the tax works is quite simple. The 40% tax is set to replace the existing Royalties scheme which is a rent charged to mining companies by our State Governments which accounts for the use of the resources.
The Resource Super Profits Tax (RSPT) proposal allows a mining project to deduct the costs of extracting the resources from the price they sell the resources at. This “super profit” is taxed at the rate described above. For example, if the “Super Profit” is $100 then the new tax will deduct $40 from the net revenue.
But here is the sting as the tail. The Mining Company will still have to pay the Company Tax rate after the RSPT is deducted. That is, a further 30% tax may be deducted. This could be applied to the remaining $60 left over or a further $18. This would result in $58 in tax being paid which is the 58% rate that is being thrown around at the moment (However, keep in mind the Corporate tax rate is reducing to 28%).
But there is a flipside to this, which the government claims will encourage Mining Investment but critics claim will severely increase the downside risk to government expenditure should a mining boom collapse. The flip side is that the government will allow a 40% tax credit to Mining Project losses and this may be carried forward to offset future “super profits”. Each year that this credit is carried forward the Mining Project will be able to increase this credit by 6%. This is the mysterious 6% bond rate that is being discussed as the threshold on which the tax cuts in – which has not been reported correctly.
And that, ladies and gentleman is it! The government rightly points out that the existing system is not quite perfect so after consultation with the miners it is hoped that a compromise can be found to bring confidence back into the mining sector.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
The reality, however, is the way the tax works is quite simple. The 40% tax is set to replace the existing Royalties scheme which is a rent charged to mining companies by our State Governments which accounts for the use of the resources.
The Resource Super Profits Tax (RSPT) proposal allows a mining project to deduct the costs of extracting the resources from the price they sell the resources at. This “super profit” is taxed at the rate described above. For example, if the “Super Profit” is $100 then the new tax will deduct $40 from the net revenue.
But here is the sting as the tail. The Mining Company will still have to pay the Company Tax rate after the RSPT is deducted. That is, a further 30% tax may be deducted. This could be applied to the remaining $60 left over or a further $18. This would result in $58 in tax being paid which is the 58% rate that is being thrown around at the moment (However, keep in mind the Corporate tax rate is reducing to 28%).
But there is a flipside to this, which the government claims will encourage Mining Investment but critics claim will severely increase the downside risk to government expenditure should a mining boom collapse. The flip side is that the government will allow a 40% tax credit to Mining Project losses and this may be carried forward to offset future “super profits”. Each year that this credit is carried forward the Mining Project will be able to increase this credit by 6%. This is the mysterious 6% bond rate that is being discussed as the threshold on which the tax cuts in – which has not been reported correctly.
And that, ladies and gentleman is it! The government rightly points out that the existing system is not quite perfect so after consultation with the miners it is hoped that a compromise can be found to bring confidence back into the mining sector.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
Thursday, June 3, 2010
Resource Tax
http://blogs.abc.net.au/nsw/2010/06/explaining-that-tax.html?site=riverina&program=riverina_breakfast
Tuesday, June 1, 2010
Don't Worry, Be Happy
There is a lot to worry about for investors at the moment – mining taxes, Euro zone debt fears, Middle East tension. What is an investor to do?
I have been in the Financial Planning Industry for over ten years now and I must say, it doesn’t get much better than this (although memory dulls the pain).
Let’s start by casting our minds back to the Asian Financial Crisis in 1997. This was followed by the Russian debt crisis in 1998 and the collapse of the ironically named hedge fund – Long -Term Capital Management.
In 1999 all we had to contend with was the Y2K bug. Remember that? Planes were going to fall out of the sky! With that safely behind us, the internet bubble burst in the year 2000 wreaking havoc to speculative investors around the world. In 2001 we had the terrorist attacks in the United States on September 11.
In 2002 the United States had another Terrorist attack which was home grown. It came in the form of “the smartest guys in the room” at energy company Enron Ltd. They caused a market meltdown as investors questioned the honesty of corporate America.
And in 2003 we had the war on Iraq......are you starting to get the picture?
This perception of fear has been heightened in the past decade or so with the emergence of a Media focused on the 24 hour news cycle. We have more information at our finger tips (the internet) and a quick glance at Pay TV shows even locally we have access to three 24 hour Business News channels. This is a lot of content that needs to be filled each day!
For investors there will always be something to worry about. However, what we can learn from history is that maximum financial opportunity occurs when investors are most fearful, or put another way, future expected returns are at their highest when prices are at their lowest.
The future is a series of unpredictable events so if an investor would like to achieve a return greater than the risk free rate, they had better get used to some bad news.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
Monday, May 24, 2010
Hands off
This quote pretty much sums it up.....
You cannot legislate the poor into prosperity by legislating the wealthy out of prosperity. What one person receives without working for, another person must work for without receiving.
The government cannot give to anybody anything that the government does not first take from somebody else. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that my dear friend, is the beginning of the end of any nation.
You cannot multiply wealth by dividing it.
Adrian Rogers, 1931
You cannot legislate the poor into prosperity by legislating the wealthy out of prosperity. What one person receives without working for, another person must work for without receiving.
The government cannot give to anybody anything that the government does not first take from somebody else. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that my dear friend, is the beginning of the end of any nation.
You cannot multiply wealth by dividing it.
Adrian Rogers, 1931
Wednesday, May 12, 2010
Money up in Smoke
The way I see it, you have two pathways to financial independance;
1. Take lots of risk. Be a punter on the share market and maybe get lucky, or start your own business and make it hugely successful; or
2. Be disciplined and patient. Stick to a long term strategy, start early, and allow the miracle of compound interest to kick in.
Most people find the first option exciting but generally fail by making the wrong decision and the people that choose the second option more often than not get distracted by impatience or greed - todays pleasures beckon stronger than tomorrows pain.
I must admit though, I have great admiration for people that smoke cigarettes. They have the discipline and ability to find what is now $17 each day to purchase their poison. This is especially true of lower socio -economic groups that appear to have a higher take up of smoking.
Imagine if this discipline was instead forced on their savings. If a smoker could quit and could instead put that $17 a day aside into an investment, how would this look when they retired - how would this $6,200 per annum which previously went up in smoke change their life?
I have asumed that an 18 year old decides that instead of smoking, they will save that amount each year (until they are 65) and earn an after inflation and tax rate of return of 5%.
At age 65 this investment would be worth approximately $1.2 million (in todays dollars). This is extraordinary in reality because it actually demonstrates that even the poorest people in our society can become millionaires (they can smoke, so why not?).
Double the impact if the husband and wife both smoke.
So the lesson here is to start early and stick with it. Very few people can actually manage to do this which is a pretty sad reflection on our society.
1. Take lots of risk. Be a punter on the share market and maybe get lucky, or start your own business and make it hugely successful; or
2. Be disciplined and patient. Stick to a long term strategy, start early, and allow the miracle of compound interest to kick in.
Most people find the first option exciting but generally fail by making the wrong decision and the people that choose the second option more often than not get distracted by impatience or greed - todays pleasures beckon stronger than tomorrows pain.
I must admit though, I have great admiration for people that smoke cigarettes. They have the discipline and ability to find what is now $17 each day to purchase their poison. This is especially true of lower socio -economic groups that appear to have a higher take up of smoking.
Imagine if this discipline was instead forced on their savings. If a smoker could quit and could instead put that $17 a day aside into an investment, how would this look when they retired - how would this $6,200 per annum which previously went up in smoke change their life?
I have asumed that an 18 year old decides that instead of smoking, they will save that amount each year (until they are 65) and earn an after inflation and tax rate of return of 5%.
At age 65 this investment would be worth approximately $1.2 million (in todays dollars). This is extraordinary in reality because it actually demonstrates that even the poorest people in our society can become millionaires (they can smoke, so why not?).
Double the impact if the husband and wife both smoke.
So the lesson here is to start early and stick with it. Very few people can actually manage to do this which is a pretty sad reflection on our society.
Tuesday, May 11, 2010
Superannuation avoids a bathing
One of the greatest disincentives for people to invest in superannuation these days is the belief that the government will tinker with the rules that affect an individuals ability to control and access their superannuation. The Henry Tax review and the 2010 Federal Budget are now behind us so we can take a look at the bad news for superannuation.........
..........and now let’s look at the good news.
The Good news is that there is no bad news for superannuation. The government have recognised that constant tinkering with superannuation does undermine the confidence in the system and with an aging population this is not good policy.
Certainly, Henry did recommend some changes to superannuation that were ruled out by the government for good reason. This included aligning the preservation age of superannuation (when you can access it) to the Age pension Age (this is going up to 67). Henry also thought a government annuity type product would be a good idea but Rudd & co rightly ruled this to be a private sector matter.
Let’s not forget, the Government already offers an Annuity Type product – it’s called the Age Pension and many people hope to never have to use it but it is a useful safety net for many.
In addition to this it must be noted that the Government has completely ruled out the potential to remove the tax free superannuation payments for those aged over 60. In fact, this was ruled out in the terms of reference for the Henry Tax review.
The changes that have occurred in superannuation are minor, but retain confidence in the system which is invaluable. For those that earn less than $37,000, they will not pay the 15% tax for their super contributions and the Superannuation guarantee levy is increasing from 9% to 12%. Although the increase in the superannuation levy is a blow to employers (particularly small business) who have to pay it - it is being phased in over 10 years and I would think that it will be a factored into future wage negotiations anyway. Other initiatives are also being implemented to assist those over the age of 50 who have low superannuation balances and enable them to contribute more without penalty.
So with only the Cooper Inquiry into Superannuation remaining, the future looks very bright for the retirement savings industry and many can now breathe a sigh of relief.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
..........and now let’s look at the good news.
The Good news is that there is no bad news for superannuation. The government have recognised that constant tinkering with superannuation does undermine the confidence in the system and with an aging population this is not good policy.
Certainly, Henry did recommend some changes to superannuation that were ruled out by the government for good reason. This included aligning the preservation age of superannuation (when you can access it) to the Age pension Age (this is going up to 67). Henry also thought a government annuity type product would be a good idea but Rudd & co rightly ruled this to be a private sector matter.
Let’s not forget, the Government already offers an Annuity Type product – it’s called the Age Pension and many people hope to never have to use it but it is a useful safety net for many.
In addition to this it must be noted that the Government has completely ruled out the potential to remove the tax free superannuation payments for those aged over 60. In fact, this was ruled out in the terms of reference for the Henry Tax review.
The changes that have occurred in superannuation are minor, but retain confidence in the system which is invaluable. For those that earn less than $37,000, they will not pay the 15% tax for their super contributions and the Superannuation guarantee levy is increasing from 9% to 12%. Although the increase in the superannuation levy is a blow to employers (particularly small business) who have to pay it - it is being phased in over 10 years and I would think that it will be a factored into future wage negotiations anyway. Other initiatives are also being implemented to assist those over the age of 50 who have low superannuation balances and enable them to contribute more without penalty.
So with only the Cooper Inquiry into Superannuation remaining, the future looks very bright for the retirement savings industry and many can now breathe a sigh of relief.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
Monday, May 10, 2010
The Road to Serfdom
What is it with the Financial World? There never seems to be a shortage of things to commentate on. This becomes explicitly more exciting when politics decides to tangle itself into the capital markets. Truth be known, Governments of the world will always try and influence finance through taxes and legislation as they try and manipulate constituents voting behavior.
This week has seen some massive events. These events are all manufactured in one way or another but basically have the same theme. Governments around the world have been too generous with their spending and its time to pay the piper.
Let’s start at home. Our government sprays money about in a manner that looks irresponsible. Suddenly it is time to start funding that expenditure (repaying the debt? That will have to wait for another day). Let’s look for an easy target. Mining! Lets tax the “super profits” of the Mining Industry who are largely “foreign owned”. This policy is deeply flawed and looks like it may have been stolen from the One Nation policy handbook (One Nation would like to curb foreign investment in Australia).
The reality is, Australia relies on foreign investment. It is not hard to forget this when you look at our Gross Foreign Debt which stands at over $1.2 trillion (as at end of December 2009). If we upset foreign investors we might just face a Financial Armageddon of our own.
Speaking of which, how about the Greeks! They are protesting in the streets regarding the “bail out” package put together by the European Union. They have to face the facts here. The Greeks don’t want their “standard of living” cut by the harsh budget measures but the reality is that the Greeks never should have had the standard of living they enjoyed because it was all built on Debt – which is not sustainable – clear and simple. So now they have to take the medicine, which looks much like Castor Oil and it will not taste good. This is however, better than the alternative, which is death.
There are many democratically elected governments around the world that now have to make the harsh decisions. The current low taxes against a back drop of high public funding of health and pensions and benefits for all those with their hands out crying for more (symptoms of a “Nanny State”) are about to cumulate in a very sharp reversal of political and economic fortunes.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
This week has seen some massive events. These events are all manufactured in one way or another but basically have the same theme. Governments around the world have been too generous with their spending and its time to pay the piper.
Let’s start at home. Our government sprays money about in a manner that looks irresponsible. Suddenly it is time to start funding that expenditure (repaying the debt? That will have to wait for another day). Let’s look for an easy target. Mining! Lets tax the “super profits” of the Mining Industry who are largely “foreign owned”. This policy is deeply flawed and looks like it may have been stolen from the One Nation policy handbook (One Nation would like to curb foreign investment in Australia).
The reality is, Australia relies on foreign investment. It is not hard to forget this when you look at our Gross Foreign Debt which stands at over $1.2 trillion (as at end of December 2009). If we upset foreign investors we might just face a Financial Armageddon of our own.
Speaking of which, how about the Greeks! They are protesting in the streets regarding the “bail out” package put together by the European Union. They have to face the facts here. The Greeks don’t want their “standard of living” cut by the harsh budget measures but the reality is that the Greeks never should have had the standard of living they enjoyed because it was all built on Debt – which is not sustainable – clear and simple. So now they have to take the medicine, which looks much like Castor Oil and it will not taste good. This is however, better than the alternative, which is death.
There are many democratically elected governments around the world that now have to make the harsh decisions. The current low taxes against a back drop of high public funding of health and pensions and benefits for all those with their hands out crying for more (symptoms of a “Nanny State”) are about to cumulate in a very sharp reversal of political and economic fortunes.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances
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