Tuesday, December 23, 2008

Snow. Christmas 2008. Beaver Creek, Colorado, USA.

...I am not actually at Beaver Creek for Christmas (very jealous of those who are, epecially after another 17" of snow on Christmas Eve!)

I am staying in Sydney for most of the holidays and will be in the office between Christmas and New Year and through January.

Happy Christmas and all the best for 2009.


Monday, December 08, 2008

IFA Quote of the Week 40 (William Bernstein)

The presentation below is from IFA.com and is targeted at US investors. A similar prudent approach to investment portfolio construction is available in Australia from Commercial Associates Financial Planning (contact details above.)

Note that there are no absolute guarantees in investing and past performance should not be used as a predictor of future returns.

Friday, December 05, 2008

Basic Instinct A Sound Move

by Kevin Bailey CFP, founder and Managing Director of The Money Managers Ltd.

Published in the Herald Sun - 12/1/2008

Investors everywhere are in a state of shock. The devastation wrecked by falls in shares around the world has not only affected our investment plans and confidence but it has also led many of us to question our ability to protect against these sorts of calamities in the future.

The over riding message from the crisis is that we have to ‘get back to the basics’ of planning our long term future. There is a desperate need for good comprehensive financial planning advice. Advisers who positioned themselves as investment specialists who could pick the right stocks to buy and offered promises of monitoring portfolios to get you into and out of the market at the most appropriate time have been shown to be charlatans. Advisers whose skill set was supposed to be picking the best performing fund managers based on their past results have likewise been shown to have empty promises.

The basics or fundamentals of good advice are constructing a financial plan that meets your income and growth requirements over your lifetime. Investment planning is one aspect of that process but the education that diversification is essential to consistent long term success is paramount. The information that we can’t time markets in advance so we need to diversify and constantly rebalance our portfolio to enable us to ride through the cycles that will include negative years about 20% of the time is central to good advice.

It is the people that forgot the basics and thought it was easier to buy a solution that included ‘absolute return funds that never fall in value’ that are now questioning the wisdom of that course of action. The financial engineering of the last decade has come crashing down and we have a right to question the promises that were made.

The answer lies now, as it always has, in returning to the basics of investing. The basics include good taxation planning, risk and insurance planning and understanding that there will be some very lean years. Retirement planning is all about preparing ourselves for the fluctuations of markets. We require growth assets as part of our investment mix if we are going to protect against inflation over time.

Estate planning and philanthropic planning are areas that can easily be neglected in times of crisis. These are areas that can give meaning to why we are investing and being so diligent about our finances. We can’t control markets or predict their direction in advance but there are many things that we can control and those are the things we should be focusing on at the moment. There is a far greater chance of getting through the current crisis if we have a plan and we stick to it rather than reacting emotionally and switching to try and save what we have left. A well constructed portfolio should still have 70% of the portfolio still intact to benefit from a recovery when it eventuates.

The difference between serious long term investing and speculating could not have been starker over the course of the last year. Anyone focusing on generating income for retirement has still got many choices of yield from shares, property and bonds. If you are primarily focused on dividend return then you should be prepared to buy the shares and then not be concerned about the share price. As long as the company is able to maintain its dividend, as a longer term income investor the share price shouldn’t matter.

It is obvious that it does matter to so many people. Psychologically, many of us were ill prepared for the frightening decline in valuations this year. Many advisers have earnt their keep recently by getting their clients to ‘stay the course’ and hold their nerve.

Many financial planners are working overtime to ensure investors don’t transfer to cash at the worst possible time in the market cycle. The efforts in this regard are going to be the major contributor to investors trading through the crisis. These are the worst of times but there is no doubt that they will lead to the best of times for those of us that focus on the fundamentals.

Friday, November 21, 2008

Driving to the bottom

From Robert Bowerman's Smart Investing Blog

Are we there yet? Four simple words that every parent dreads as they head out the driveway for a long road trip with the youngsters safely belted up in the back seat. For investors the question is when will we arrive at the bottom of this particularly painful market cycle?

Respected Age newspaper columnist Malcolm Maiden - admittedly looking for silver linings - made the point during the week that with every 1% fall in the market we are 1% closer to the bottom.

With our sharemarket benchmark index falling through the psychologically telling 50% barrier the global financial crisis has now cost us more value in percentage terms than the 1987 share crash. In retrospect the 1987 crash was dramatic but short-lived and while it took time to recover and climb new highs a floor was relatively quickly found and stability returned.

With the Australian market having shed 20% this month it feels like we are accelerating to the bottom and there seems no clear reason why - given the relative strength of our banking system and economy.

But it is a good time to go back to fundamentals and the principles of long-term investing.

Jack Bogle, the founder of Vanguard and who is acknowledged as one of the great investment thinkers of our time advances a straightforward way for investors to understand what drives share market returns.

He argues there are three variables that explain nearly all of the return:
- The dividend yield at the time of initial investment
- The subsequent rate of growth in earnings
- The chance in price-earnings ratio during the period of investment.

Bogle argues that the dividend yield is a known quantity at the time you invest, while the rate of earnings growth has been relatively predictable within fairly narrow parameters. But the change in the price-earnings ratio has been highly speculative.

An investor's total return is simply the sum of those three factors so a dividend yield of 3% combined with forecast earnings growth of 5% gets you a return of 8%. If the price-earnings ratio added 2% you get a 10% return.

Bogle's message is that short-term investing effectively ignores dividend yield and earnings growth because both are relatively inconsequential in a period of weeks or months. In the four years up to November 2007 the "speculative" component of Bogle's return formula delivered extraordinary returns - in excess of dividends and earnings growth combined.

But that bubble has not so much burst as exploded. The price-earnings ratio of the Australian market is now just above 9 - down from a peak of 17.9 in October last year.

Perhaps more dramatic is to look at the yields on some of our banks and retailers - on November 21 NAB's dividend yield was above 10%, Westpac's yield was 9.2% and both had price/earnings ratios of 7.2. Major retailer Woolworths, in contrast, is sitting on a more normal yield of 3.7% and p/e ratio of 18. While Harvey Norman has a yield of 6.5% and a p/e of 6.3.

No-one knows for sure when we will arrive at the bottom but the fundamental signposts pointing to underlying economic value - which should be the basis for all long-term investing - is saying we are getting closer.

What we can be certain about is that there will be a bottom. We also know that governments around the globe are committed to stimulating economic activity.

So the options are simple: stop the car, invest in cash and curl up in the foetal position or grit your teeth, tune out the market noise and keep driving keeping a watchful eye on investing costs and your asset allocation.

Source: Common Sense on Mutual Funds by John C. Bogle.

Saturday, October 25, 2008

Surprisingly, Bear Markets Don't Always End With a Bang -- Sometimes It's Just a Whimper

By Jason Zweig from The Wall Street Journal

Wall Street often resembles a blindfolded person looking in a darkened closet for a pair of black shoes that isn't there. With the Dow taking another battering in the past week, another round of futility is under way: the search for "capitulation."

There's a belief that the market can hit bottom only when vast numbers of investors finally capitulate, throwing in the towel and selling off the last of their stock portfolios. In theory, if you could spot this moment, you could make a killing buying at the bottom.

There are two problems here. First, capitulation is almost impossible to define. Second, even if you could get a positive ID on capitulation, that might not do you any good. Market lows aren't necessarily marked by tidal waves of frantic selling; just as frequently, stocks bottom out in a dull and lonely atmosphere as trading dries up and most investors no longer even care. Bear markets often end not in capitulation but stupefaction.

"The idea is, 'We'll know we've hit bottom when the fat lady capitulates,' " says finance professor Robert A. Schwartz of Baruch College at the City University of New York. "But she could just sputter instead, or capitulate more than once, or slowly slide around along the bottom." Warns Prof. Schwartz: "On the way down, you get a lot of faux capitulation. And how do you know, until after the fact, whether it is friend or faux?"

Oddly, even market pundits who believe in capitulation admit they can't define it. "Capitulation is a state of mind, without any specific definition," says Al Goldman, chief market strategist for Wachovia Securities. "You can't measure it; it's best identified in hindsight." Hugh A. Johnson, chief investment officer at Johnson Illington Advisors, says almost wistfully: "I wish I could quantify it for you so I could say, 'Here, this is capitulation.' But a lot of this is anecdotal. Talk to enough investors and you get an idea of whether we have capitulation."

Talk to them later, however, and you may get a different idea altogether. What seems like capitulation today will no longer qualify if the market goes even lower tomorrow. Mr. Goldman puts it best: "I think I'm right that we had capitulation on Oct. 10 [the day the Dow lost nearly 700 points]. But if we keep going down from here, then I would have to say that I was wrong and that it wasn't capitulation."

This is somewhat like insisting that your pet is a dog until you notice that it is meowing.

In truth, bear markets often end not in a crescendo of selling but a cloud of indifference. For example, take Dec. 6, 1974, a day that will long live in market infamy. The Dow closed at 577.60, down 45% from its levels in January 1973. Total trading volume was a tepid 15.5 million shares; a few days earlier, it had totaled only 7.4 million, tying the lowest level in more than three years. Lucien Hooper, one of the nation's leading security analysts, told The Wall Street Journal that day that the market was "just waiting the bad times out." Far from throwing in the towel, most investors weren't even at ringside.

"The most interesting thing about [the 1974 market bottom] was its dullness," veteran fund manager Ralph Wanger recalled to me. "It wasn't a crash, it was a mudslide. You came in, watched the market go down a few points and went home. The next day you went through the same thing all over again." And then, without a moment's warning, the bull woke up and took off. By Jan. 6, 1975, the market had shot up 10%, and a year after that the Dow had risen 54% from its 1974 low.

In short, bear markets sometimes end with a bang, sometimes with a whimper. You're more likely to see a unicorn in your backyard or a chimera in your kitchen than you are to spot an indisputable sign of market capitulation. The obsessive attention so many investors are paying to the huge swings in the Dow suggests that we may not have hit bottom yet; stupefaction seems not to have set in yet. What we can be quite certain of, however, is that stock markets around the world are already on sale. If you have cash to spare, put some to work. If you don't, save up until you do. But don't kid yourself into thinking that you will ever get a clear signal out of such an unclear indicator.

Thursday, October 23, 2008

Is it Different This Time?

Weston Wellington delves into his vast library of press clippings to offer perspective on the unpredictability of market movements, how the current market downturn compares to past bear markets, and the resilience markets have historically shown.


Sunday, October 19, 2008

WARREN BUFFETT: If you wait for the robins, spring will be over...

From The New York Times, 17 October 2008

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.


A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Saturday, October 18, 2008

PAUL KRUGMAN: Let’s Get Fiscal

From The New York Times, 16th October, 2008

The Dow is surging! No, it’s plunging! No, it’s surging! No, it’s ...

Nevermind. While the manic-depressive stock market is dominating the headlines, the more important story is the grim news coming in about the real economy. It’s now clear that rescuing the banks is just the beginning: the nonfinancial economy is also in desperate need of help.

And to provide that help, we’re going to have to put some prejudices aside. It’s politically fashionable to rant against government spending and demand fiscal responsibility. But right now, increased government spending is just what the doctor ordered, and concerns about the budget deficit should be put on hold.


Thursday, October 16, 2008

Joseph Stiglitz

Joseph Stiglitz explains why the economic crisis won't end just because the stock market does well... From Colbert Nation

Wednesday, October 15, 2008

The More Things Change . . .

Jim Parker, Regional Director, DFA Australia Limited

"The problem is leverage, clear and simple," was how one journalist summed up developments in financial markets, noting that markets were freezing up, liquidity was lacking and investors had become risk averse.1

The onset of recession, a weak US dollar and sinking real estate made for a gloomy combination, wrote another.2

The crisis had all the markings of the end of an era, observed a third,3 suggesting that it would take years to clean up the mess of debt and high-risk products left behind by the sharper operators of Wall Street.

The financial strains were accompanied by political tensions. In the US, the Bush administration was under attack over its handling of the war in Iraq, which had driven up oil prices, and its management of the economy.

Sound familiar? All of those observations were made within a few days of each other in January, 1991, more than 17 years ago.

At that time, the Anglo-Saxon economies of the US, Canada, the UK, Australia and New Zealand were all either in or flirting with recession.

The recession came on the heels of an era of financial excess, as exemplified on Wall Street by the junk bond king Michael Milken and in the movies by Gordon "greed is good" Gekko.

In the US, excessive and imprudent lending for real estate had contributed to the failure of hundreds of community-based 'savings and loans' institutions, triggering a multi-billion dollar government bailout.

In the United Kingdom, consumers who had leveraged themselves heavily to real estate suffered a severe blow when rising interest rates pushed house prices sharply lower, both in real and nominal terms.4

In Australia, too, market deregulation had given way to an era of increasingly reckless lending by financial institutions, which until that point had had little experience in managing risky commercial loans.5

The consequence in Australia was the failure of a number of major financial institutions, including the state banks of Victoria and South Australia, the Teachers' Credit Union of Western Australia, the Pyramid Building Society, merchant banks Tricontinental, Rothwell's and Spedley's and the Estate Mortgage trust.

Examining the causes of the early 1990s bust in the Anglo-Saxon economies, a Reserve Bank of Australia governor later observed that any boom built on rising asset values and financed by increased borrowing had to end.6

At that time, the crisis seemed intractable and insoluble. Journalists and economists talked of systemic breakdown and a global challenge for market capitalism, much as they are now.

Now, while no two market crises are ever the same, it is fair to say there are parallels between today's downturn and the events of early 1990s, particularly in the damage caused by excessive leverage and insufficient oversight by many financial institutions of the risks they were taking on.

For those who lived through that period as investors (or even market commentators), you might recall the sense of doom and gloom and the over-riding fear in the financial markets at that time.

The important point is that markets worked through that period of dislocation and uncertainty to emerge stronger. Indeed, the early '90s recession was followed by a stellar decade for equities, one that would have passed by those who had given up in 1991 and hunkered down in cash.

This is not to predict that today's markets are ripe for a similar Phoenix-like revival, but it is a sage reminder that nothing lasts forever and that if you want the returns available from risk assets, you need to stay in your seat...

Please email or text me if you would like a copy of the full article with tables... Andy

1'Deleveraging: Relief from a Big Debt Hangover', Corporate Cashflow Magazine,Jan 1, 1991
2'A Year to Forget? US Investors Left with a Chill After '90', Dallas Morning News, Jan 2, 1991
3'U.S. Securities Industry Going Through Rough Ride', Associated Press, Jan 2, 1991
4Roger Bootle, 'UK High Street Has Echoes of 1990s Recession', Daily Telegraph, Jan 15, 2008
5Ellis Tallman, 'Australian Banks during the 1986-93 Credit Cycle', Economic Review, 2000, Q3
6Ian Macfarlane, 'The Boyer Lectures: The Recession of 1990 and its Legacy', ABC, Dec 2006

Sunday, October 12, 2008

Recessions and Stock Markets / Resilience of Capitalism

Mark Hebner, President, Index Fund Advisors

Mark has also posted several interesting pieces on his web-site over the past few weeks including references to "The Four Pillars of Investing" by William Bernstein. Chapter 6 is titled Market Bottoms: The Agony and the Opportunity. It’s only 10 pages and Mark suggests that it is worth the read. In his section titled How to Handle the Panic Bernstein says:
What separates the professional from the amateur are two things: first, the knowledge that brutal bear markets are a fact of life and that there is no way to avoid their effects; and second, that when times get tough, the former stays the course; the latter abandons the blueprints, or, more often than not, has no blueprints at all.

See also Mark's presentation: Should You Be Worried About Your Investments?

Friday, October 10, 2008

New Quote of the Day

I've never been a big fan of financial advisers, but now I'm sympathetic to the hand-holding function they perform.

This isn't the time to be making any major financial shifts, although there is one caveat: I do think all portfolios should hold a tiny sliver of gold. I haven't looked at my portfolio. I only do that every January, when I rebalance.

Burton Malkiel 76, professor of economics, Princeton University; author, A Random Walk Down Wall Street

Good news is a scarce commodity...

Out of the gloom world growth is emerging

From Robert Bowerman's Smart Investing Blog

Good news is a scarce commodity on investment markets these days.

But this week's report card from the International Monetary Fund on the global economy and its forecasts of economic growth offer some interesting insights into the scale of the impact of the turmoil of the financial crisis on real world economies as measured by gross domestic product.

One of the big concerns of recent market events is that the major shocks that the global financial system is reeling from will - to use the US analogy - transfer from Wall Street to main street.

Now given all the gloom and doom about credit and equity markets in the US it may be a surprise that the IMF is forecasting that even with the subprime mortgage collapse and its subsequent ripple effects the US economy is tipped to narrowly miss dipping into recession. The IMF is forecasting GDP growth in the US next year of 0.1%. That is hardly dynamic growth or signalling a sprint-like recovery but given the daily dramas played out on Wall St most people would probably have said the US is already in recession and the real question is how deep a recession it will be.

The caveat that some of the world's leading economic minds have put on that forecast is that the emergency measures put in place by governments in the US and Europe and our own Reserve Bank's interest cut this week succeed in restoring confidence in the financial system.

Whether the US does dip into recession is moot but the IMF forecasts underline the separation between the financial and the non-financial markets. Clearly main street - the non-financial economy - is doing its bit to cover the Wall St malaise.

The good news for the Australian economy is two-fold: For a start our economic growth is predicted to be 2.2% in 2009 - subdued compared to recent years admittedly but way better than our American cousins and most of western Europe.

So the old, developed world is expected to do it tough for the next year or two. But let's look at some of the developing countries. China is of course the obvious first point of reference and the IMF is predicting lower growth for this emerging economic colossus but that sees economic growth pegged back to 9.3% (down from 9.7%).

There is a new axis of economies emerging on the world economic stage - the so-called BRIC countries (Brazil, Russia, India and China).

According to the IMF while these emerging economies are certainly not immune from the global financial crisis the forecast growth is robust and looks downright rosy compared to the so-called "developed" economies.

The IMF is predicting economic growth for India of 6.9%, Russia 5.5% and Brazil at 3.5%.

Now that is not going to be enough to offset the impact of the developed economies slowing dramatically. And while there has been much discussion about "decoupling" of economies like ours from the US impact the reality is that there is no such thing in these days of globalisation.

Indeed the IMF says world economic growth in total is decelerating fast and expects the recovery to be "unusually protracted" as financial markets continue to "deleverage". In plain language that means we have to get the toxic debt that was built up in the financial system out - a process that is well underway - while restoring confidence in the financial system is developing as the biggest challenge for regulators and governments around the world.

As a result the IMF has downgraded its growth forecast for world output to 3% - which is down from 5% in 2007.

The IMF is forecasting world economic growth will continue to slow for the rest of this year and the first half of next year before beginning a gradual recovery later in 2009.

Australia cannot expect to be immune from that slowdown - slower world economic growth means weaker demand for commodities - but the good news is that we are better placed than many other developed countries to weather the storm.

Wednesday, October 08, 2008

It is time for comprehensive rescues of financial systems

By Martin Wolf, from FT.com

As John Maynard Keynes is alleged to have said: “When the facts change, I change my mind. What do you do, sir?” I have changed my mind, as the panic has grown. Investors and lenders have moved from trusting anybody to trusting nobody. The fear driving today’s breakdown in financial markets is as exaggerated as the greed that drove the opposite behaviour a little while ago. But unjustified panic also causes devastation. It must be halted, not next week, but right now.

The time for a higgledy-piggledy, institution-by-institution and country-by-country approach is over. It took me a while – arguably, too long – to realise the full dangers. Maybe it was errors at the US Treasury, particularly the decision to let Lehmanfail, that triggered today’s panic. So what should be done? In a word, “everything”. The affected economies account for more than half of global output. This makes the crisis much the most significant since the 1930s.

First of all, the panic must be dealt with. This has already persuaded some governments to provide full or partial guarantees of liabilities. These guarantees distort competition. Once granted, however, they cannot be withdrawn until the crisis is over. So European countries should now offer a time-limited guarantee (maybe six months) of the bulk of the liabilities of systemically important institutions. In the US, however, with its huge number of banks, such a guarantee is neither feasible nor necessary...


Monday, October 06, 2008

Like J.P. Morgan, Warren E. Buffett Braves a Crisis


In the midst of a financial crisis, a towering figure of American business steps forward with his reputation and financial resources for public good and personal gain.

Their times and personalities are vastly different, of course. But J. Pierpont Morgan’s role in the Panic of 1907 has its echo in Warren E. Buffett’s actions during the current financial troubles.

“What Buffett is doing is similar in ways to what Morgan did in 1907,” said Richard Sylla, an economist and financial historian at the Stern School of Business at New York University. “It’s what you might call profitable patriotism.”

Comparing the two men and their moves in periods of market turmoil, just more than a century apart, reveals how much some things have changed over the years and how other things have not, according to business historians and finance experts.

Morgan was 70 during the financial crisis of 1907, in the twilight of his career. Mr. Buffett is 78. Like Morgan so long ago, Mr. Buffett now finds himself “at the center of things; he draws headlines and he inspires confidence,” said Robert F. Bruner, dean of the Darden School of Business at the University of Virginia, and a co-author with Sean D. Carr of “The Panic of 1907: Lessons From the Market’s Perfect Storm” (Wiley, 2007).

In the last two weeks alone, Mr. Buffett has exercised his influence mainly by investing in embattled blue-chip companies, committing a total of $8 billion to Goldman Sachs and General Electric. He drove hard bargains and invested on favorable terms.

Mr. Buffett has been fielding many phone calls recently because of his cash, his reputation and his ability to act quickly. The G.E. investment, for example, was put together in a matter of hours, after G.E. reached out to Mr. Buffett through his longtime banker at Goldman Sachs, Byron D. Trott.

“In the last few weeks, everyone who has been in trouble or thought they were in trouble has called him,” said Alice Schroeder, author of “The Snowball: Warren Buffett and the Business of Life,” a biography released last week by Bantam. Ms. Schroeder, a former Wall Street analyst, is the first Buffett biographer to receive his cooperation, and she said she talked to him regularly.

The companies benefit from the credibility dividend that comes with the Buffett endorsement. Last Thursday, the day after he announced his investment in G.E., the company raised more than $12 billion in a public sale of shares.

Mr. Buffett is also the largest shareholder in Wells Fargo, which last Friday swept in with a $15 billion bid for another banking company, Wachovia, offering seven times what Citigroup did at the start of the week.

Mr. Buffett is the world’s richest person, topping this year’s ranking of billionaires by Forbes magazine with $62 billion. Mr. Buffett has pledged to give most of that fortune to charity upon his death.

Yet even more than money, Mr. Buffett brings the reputational capital that comes from being a peerless long-term investor, revered for his acumen and sound judgment.

“So there is immense signaling power to Buffett’s moves, showing others that now may be a good time to invest,” Mr. Bruner said...


Wednesday, October 01, 2008

Quote of the Day

"I have not looked at any of my holdings and don't intend to. I don't want to be tempted to jump because I think I'd be more likely to jump in the wrong direction than the right one. My advice has always been to choose a sensible diversified portfolio and stop reading the financial pages. I recommend the sports section."

Quotation attributed to Richard Thaler, professor of behavioral science and economics, University of Chicago Graduate School of Business.

Young, Lauren. "Where the Pros Are Putting Their Own Money." Business Week, October 6, 2008.

Where Will the Money Come From?

from Paul Krugman's New York Times Blog, 30 September 2008

In the end, the US government will rescue the financial system — not today or tomorrow, maybe not Thursday, but soon, and for the rest of our lives, or anyway until the next crisis.
But, people ask me, where will we get the money? Won’t we have to borrow it from the Chinese?
Actually, no.

Ten years days ago, I explained that the Paulson plan would actually move money in a circle. No outside financing would be needed.

What if we turn to a different and better plan, one that recapitalizes the financial system. Won’t that need outside funds? No.

First, a real-world example, the rescue of Wachovia. The FDIC got Citi to take over Wachovia’s assets and liabilities with a deal under which the feds limit the losses — they will cover any losses on mortgage paper over $42 billion — in return, basically, for receiving a share of ownership, in the form of warrants and preferred stock. No actual money changed hands, which illustrates a fundamental principle: recapitalization doesn’t mean laying out real money, at least initially — it just means having taxpayers take on some of the risk.

A large-scale recapitalization would probably take the form of a giant swap of debt for equity: the Treasury would issue several hundred billion dollars’ worth of bonds, and give them to financial firms in return for preferred stock. The bonds wouldn’t have to be sold to outside buyers — they would simply be credited to firms’ balance sheets.

The effect would be that if the financial firms did well, taxpayers would share in their good fortune via those stock holdings; if firms did badly, they could meet their obligations by selling some of those bonds, which would cut into the value of all their stock, including the stuff Uncle Sam owns. So as in the case of Wachovia, what’s really happening is that the taxpayers are taking on some of the risk.

So is all this magic? No, over time Treasury has to pay interest and principal on the bonds it issues; the value of the bonds comes from the fact that people believe the US government can do that, which ultimately comes from the government’s ability to raise taxes. If investors lose faith in that …

For now, however, none of the rescue schemes we’re talking about involve large-scale net borrowing from abroad.

Tuesday, September 30, 2008

When Buyers Meet Sellers

Jim Parker, Regional Director, DFA Australia Limited

"Sellers were out in force on the market today after negative news on the economy." So say the talking heads on television each night. But have you ever wondered if there are so many sellers out there, who is buying?

The notion that in bear markets sellers outnumber buyers just doesn't make sense. What the newscasters should say, of course, is that there were not enough people willing to buy shares at the prices the sellers were seeking.

What happens in such a case is either the would-be sellers sit on their shares or prices adjust lower until supply and demand come into balance. This is when transactions occur and is described by economists as "equilibrium".

But equilibrium isn't a permanent state. That's because new information continually is coming into the marketplace, forcing would-be sellers and would-be buyers to constantly adjust their expectations.

That new information might be company-specific news like an earnings warning. It might be news that has implications for an entire industry—like a spike in oil prices forcing airline stocks lower. Or it might be an economic development that affects the entire market, like a change in interest rates.

Given this constant flux in news and information flows and the forever changing expectations of participants, individual securities and the market itself are said to be always moving toward equilibrium.

When markets are going down, it can be reassuring to remember that at some point supply and demand must come into balance. Buyers eventually will see value in the market and will invest if the prices are low enough.

Trying to time these inflexion points is a fool's game, by the way. That's because prices tend move in a random way. So it is next to impossible to predict with any consistency what the market will do next.

This in turn reflects the difficulty of successfully forecasting the future. That doesn't stop many people from trying, mind you. And sometimes they get it right. But that's usually down to good guesswork, not scientific method.

But during times like these, investors can comfort themselves in the knowledge that in a market economy, over the long term, there is a return on capital. If there wasn't, capitalism would no longer work.

They should also recall that when companies' share prices are low relative to their fundamental values, their cost of capital is going up. In other words, investors are being offered a higher expected return.

So rest assured, there are still plenty of buyers out there. The market is doing its job and the rewards will be there if you remain disciplined and diversified.

A shock from the House

From Economist.com

The House of Representatives rejects the $700 billion bail-out plan

IT WOULD have been one of the most unpleasant laws that Congress had found itself writing so close to an election. Devoting $700 billion of taxpayers’ money to rescuing the country’s least popular industry was clearly not a vote winner. That Democratic and Republican congressional leaders held their noses this weekend and came up with the Emergency Economic Stabilisation Act was encouraging evidence that they appreciate the gravity of the financial crisis. But with a vote of 228 to 205, the House rejected it. World stockmarkets promptly slumped...


Note to Investors: Don't Play Games with Asset Allocation

Published: September 17, 2008 at http://knowledge.wharton.upenn.edu

For investors, 2008 has been a nightmare. The most widely followed market barometer, the Standard & Poor's 500, is down more than 16%, shrinking the holdings of millions of ordinary people who have put their faith into index-style investing.

Other major U.S. stock indexes have been hammered as well. And although many investors had bet on foreign stocks, hoping that international diversification would soften the ups and downs of their U.S. portfolios, most foreign stocks are down dramatically, too. And a recent rebound in the U.S. dollar, while it boosts Americans' buying power, has undermined their foreign holdings even further.

What are small investors to do in such a climate? Have the rules of the game changed in some fundamental way?

Stocks are still the best bet for long-term investors, offering better returns than bonds or cash, says Wharton finance professor Jeremy Siegel. But with all the turmoil in the financial services industry, he's not betting on quick gains in the S&P 500. "I don't think it will be up this year," he says, adding, however, that the market "is searching for a bottom. All we need is a few weeks of calm to return and I think we will have a very good base for a rally in the market."

Much of the damage to the S&P 500 can be traced to financial stocks. If one were to remove them from the list, then the ratio between share prices and corporate earnings would be a healthy 14 to one -- less than half the level reached during the stock bubble early in the decade. He calls those levels "really very reasonable."

"Nine of the 10 [S&P 500] sectors have higher earnings to date in 2008 than they had in 2007," Siegel says. Moreover, the international economic slowdown has caused prices of oil and many other commodities to fall, reducing the risk of serious inflation. "I really don't' think that's a concern anymore, and that's really important."

Small Investors Should Sit Tight

As in most crises, small investors will do better sticking with their long-term plan rather than pulling money out in a downturn, says Wharton finance professor Richard Marston, who adds that it's just too hard to spot the market's high and low points except in hindsight. He believes the credit crunch could continue to drive stocks down but that investors who move to the sidelines would risk waiting too long to get back in, missing the rebound.

If one plans a long-term asset allocation of, for example, 60% stocks, 30% bonds and 10% cash, the best strategy is to stick with it through thick and thin, he says. That means putting money into stocks when that portion of the portfolio falls below the target, as it has this year for many people. "The most important strategy is to make sure that the long-run allocation is kept intact during market downturns like we are experiencing," according to Marston.

Franklin Allen, also a finance professor at Wharton, says investors should steer clear of illiquid assets right now, otherwise they might not be able to get their money out if those investments turn out badly. That obviously includes real estate, which he thinks may fall another 10% to 20%. Even some generally sound holdings, such as municipal bonds, look too risky now because panic in the credit markets could undermine prices or mean a dearth of buyers if one needs to unload.

"If you think you are going to need cash, be careful that you hold liquid assets," Allen says, adding that the traditional rule of thumb still holds: Money should not be held in stocks unless it can be tied up for at least five years. Bank savings are a good place for cash, he notes. But given the risk of bank collapses, investors should not keep more than $100,000 at any single bank, since that's the maximum federal deposit insurance.

Some market followers have argued that popular investment strategies, such as indexing, are not as appealing as they once were. Mutual funds and exchange-traded funds that follow indexing strategies simply buy and hold stocks in an underlying index like the S&P 500, seeking to match the market's gains rather than beat it. Low costs and taxes help boost their returns.
Late in the summer, Dan Wiener, publisher of the Independent Adviser for Vanguard Investors, a newsletter for shareholders in Vanguard Group mutual funds, told his readers this had been a "lost decade" for those holding shares in the firm's S&P 500 index fund, one of the nation's largest funds. In August, the index was at its early-2000 level, leaving annualized returns near zero for the decade.

Wiener, who charges subscribers a fee for his advice on getting the most out of Vanguard funds, argued that index investors had been ill-served by the strategy. Specialized Vanguard funds that focus on energy, mining, real estate and some other sectors had trounced the S&P 500, returning over 10% a year during the decade, he pointed out.

But Siegel believes the index-investing strategy remains sound. In an early-September interview, he noted that at the start of 2000 the market was near its peak at the tail end of the dot-com bubble. Comparing today's level to that bloated peak is misleading, he said.

Results look much better if one starts at the post-bubble bottom in October 2002. From then through the end of August the S&P 500 was up about 9% a year. Add dividends and investors made 10.5% to 11% total annual return. "That's a pretty good return," Siegel notes.

In real life, not many investors put all their cash into a single investment on a single date, either the peak or trough, he says. Instead, they add money gradually over time. With steady investing known as "dollar cost averaging," a given sum buys more shares when prices are lower than when they are high, helping to reduce the per-share cost as a holding accumulates. Over time, an investor is likely to do better this way than by trying to judge the best moments to move money in or out of the market.

Siegel points out that the S&P 500 was at 600 in 1995, while it is over 1100 today. Investors who stuck with the index rather than bailing out during the dot-com crisis early in this decade or in the turmoil of the past year enjoyed handsome gains, he notes.

Beware of 'Economic Patterns'

According to Marston, economic patterns are an unreliable guide for those who want to bet on the stock market's peaks and troughs. "In the nine recessions since 1950, the market, measured by the S&P 500, rose at least 30% in the first 12 months once the market reached bottom. In eight of the nine recoveries, the market reached bottom before the end of the recession."

The problem, he says, is that the end of the recession can only be spotted in hindsight -- often many months later. So investors who waited on the sidelines for that signal would have missed the rebound.

And the relationship between the economy and the market doesn't always hold. The most recent recession ended in November 2001, but the S&P 500 did not bottom out until October 2002. Those who used the recession's end as a signal to buy -- assuming they could identify the end as it occurred and not later -- would have lost money over the subsequent 11 months.

"The lessons from this are... don't play games with the asset allocation because you will inevitably be out of the market long after the rally begins...and it will be difficult to know when to increase equity positions," Marston says.

Many investors cannot resist the temptation to play the peaks and troughs, Marston concedes, though it's best to try this with only a small portion of one's holdings. Those investors might find some bargains today in classes of stocks that have been badly hammered: foreign stocks in general, especially emerging-market stocks, and small-company stocks.

"Many Americans are significantly underweighted in foreign industrial country and emerging-market stocks, so they should consider adding to those positions," he says. "But be aware that some foreign economies such as Germany and Japan are deteriorating faster than ours, so expect some bumps in the near future."

Siegel, too, believes most American investors don't own enough foreign stocks, which can be purchased most easily through mutual funds or exchange-traded funds. He argues that as much as 40% of an American investor's stock portfolio should be in foreign issues, allowing one to match global stock returns. This very broad diversification can soften the downturns, and global returns may be boosted from the higher growth potential of developing countries, though these returns can be volatile. He also cautions against piling into stocks in regions that have enjoyed big gains in recent years, such as China.

While stocks always pose risks, the dangers may be worse in some other investments, Marston says. Real Estate Investment Trusts, which are like mutual funds that own real estate, "don't seem to have fully priced in the tightening of credit" and may lag stocks in the next recovery. Credit investments such as high-yield bonds, known as "junk" bonds, "are still deteriorating," he says. "Only the very brave are going into distressed assets at this time."

High oil prices have been a key issue in the past year, helping to drive inflation up and threatening to undermine consumer spending, which is key to the U.S. economy and stock performance. Now that oil has fallen below $100 a barrel and gasoline below $4 a gallon, this threat is easing, Siegel says. That leaves trouble in the housing market as the key factor in the economy, and it is not clear when this crisis will end, he adds.

Allen worries that rising unemployment could help to undermine housing prices as more homeowners default on their mortgages -- not a good sign for the stock market because people who feel poorer spend less.

While he, too, would stick with a long-term plan, maintaining the desired mix of stocks, bonds and cash, Allen warns that there is "huge uncertainty" in today's markets. "I think you have to be conservative at the moment, because there are a lot of very difficult times coming up."

Jeremy Siegel on the Resilience of American Finance

From The Wall Street Journal, 16 September 2008

The turmoil in the financial markets will reorganize the financial landscape. But this does not mean the financial industry will shrink dramatically. In fact the current crisis could well lead to an increase in the demand for financial services, as the world grapples with the need for new financial instruments, new risk management techniques, and the increasing complexity of the financial world.

There is no doubt that some of the most hallowed names in the industry, such as Bear Stearns, Merrill, Lehman and others will disappear as separate entities. Their demise was caused by bad risk management, and a failure to understand the high risks of an overheated real-estate market, the root cause of our current problems.

We can argue about who was responsible for the overleveraging of the financial industry and the poor to nonexistent credit standards that prevailed in real estate. Certainly the regulatory agencies, including the Federal Reserve, should have sounded a warning. But the lion's share of the blame must go to the heads of the financial firms that issued and held these flawed credit instruments and then, in many cases, "doubled down" by buying more when their price was falling.

Overleveraging has been the cause of many past financial crises, and will undoubtedly be the cause of those in the future. It was the cause of the 1998 blowup of Long Term Capital Management, where the Fed also intervened to prevent a crisis. Then two years later the tech and Internet boom burst. If banks would have been allowed to buy on leverage these stocks during the bubble, they would have been in even more trouble than now.

But few were willing to admit that subprime real-estate loans could be as risky as stocks. It was just too profitable to issue these mortgages. So eyes were closed and the money kept pouring in. Groupthink prevailed. To paraphrase John Maynard Keynes, it is much easier for a man to fail conventionally than to stand against the crowd and speak the truth.

There is no doubt in my mind that if we didn't have a proactive Federal Reserve and deposit insurance, we would have been following the same course as we did in the 1930s, when the bursting of the stock bubble and fear of loan defaults led to thousands of bank failures and ushered in the Great Depression.

That will not happen this time. The rapid provisions of liquidity by the Fed will prevent any full scale downturn. In fact, I take it as a mark of confidence in our financial system that the Fed did not feel compelled to bail out Lehman Brothers as they did last March when they folded Bear Stearns into J.P. Morgan. Certainly politics played a role in this election year, as critics (and some Congressmen) criticized the government for bailing out the big boys, while letting homeowners twist in the wind.

Despite the recent turmoil, there is good evidence that the worst is over, especially for the commercial banks with access to Federal Reserve credit. Despite yesterday's severe sell-off, most are significantly higher than their July 15 low, and some such as Wells Fargo and UBS are up over 50%.

Nevertheless, the current crisis will change the financial landscape. Certainly Bear, Merrill, Lehman and others will disappear as separate corporate entitles. But other institutions, specifically the commercial banks that absorb these firms, and who have direct access to Federal Reserve credit, will become larger.

The demand for financial services will in no way disappear as the automobile pushed out the horse and buggy a century ago. Although unemployment on Wall Street will undoubtedly rise, many workers will be reabsorbed elsewhere in the industry. The current financial crisis calls out for new products and services as well as more, not less, information about what is safe and profitable in the future environment.

It is easy to be pessimistic about the future of financial services in the current climate. But objective facts indicate that the future demand for these services will be high. Looking beyond past losses, the demand for financial services, especially internationally, has been strong. The growth of the developing countries, combined with the aging in the developed countries, will lead to huge international capital flows that will be facilitated by new and existing financial intermediaries.

It is shocking that firms that withstood the Great Depression are now failing in what economists might not even call a recession. But their failure was not caused by lack of demand for their services. It was caused by management's unwillingness to understand and face the risks of the investments they made. The names of the players will change, but the future growth of the financial services industry is assured.

Mr. Siegel, a professor of finance at the University of Pennsylvania's Wharton School, is the author of "Stocks for the Long Run," now in its 4th edition from McGraw-Hill.

Friday, September 19, 2008

When sharemarkets and the real world collide

from Smart Investing with Robin Bowerman

The relationship between the real world and the stockmarket can sometimes seem tenuous.

The rout on financial markets is inescapable yet people are still going to work earning money, going to the supermarket or the pub to spend it, buying fridges, TVs and even luxury cars. Spring is in the air and football finals fever is building. In short life goes on.

So reconciling what is happening with sharemarkets around the globe and trying to comprehend the mind-bending numbers that are tossed up regularly in the media about the size of losses or asset writedowns is far from a straightforward exercise.
For the person on the street it is not surprising if the problems besetting Wall Street investment banks seem a long way from real-life in downtown Australia. With the obvious exception of the bank employees who have dramatically lost their jobs the gyrations of the sharemarket can appear strangely disconnected from everyday business.

With words like crisis, panic and financial contagion bombarding us via newspapers, websites and nightly TV radio and news broadcasts it is no surprise that consumer and investor confidence has taken a battering and for the first time in 20 years bank term deposits top the rankings in consumer surveys as the wisest place to invest.

So the need for context - and a clear head - has never been more important. We know from previous market corrections/crashes that making emotional decisions in the heat of short-term events can simply turn bad to worse.

So a critical issue is whether you believe the financial market gyrations are a portent of bad things to come in the real world economy or that over time as confidence returns in company earnings that the sharemarket will return to realistic valuations based on the long-term growth in both our economy and more broadly the global economy.

There is no doubt the financial sector - notably US investment banks - have done a spectacularly good job at distancing themselves from the real world. Amazing profit growth within what has been dubbed the "shadow banking system" in recent years has been exposed for what it is - increasing amounts of poor grade debt bundled up in a way that disguised or at least obscured the true level of risk.

Now the default risk is there for all to see suddenly we are faced with a system that is seizing up on itself. It's akin to driving a car with a fine engine but a gearbox that is struggling to engage the right gear. Repairs - be it via regulation or markets forcing mergers and takeovers - will clearly be required.

Yet there is plenty of good news around on the economic front: oil and food prices are down from their mid-year highs; the US economy seems surprisingly strong (the US economy had the strongest growth of the G7 countries for the June quarter) while unemployment rates - a critical economic indicator - both here and in the US are at low levels.

In the Australian economy the Reserve Bank governor Glenn Stevens reported to Parliament this week that domestic demand in Australia rose 4% in the first six months of this year - down from about 5.5% last year. That is in itself good news because it takes the pressure off inflation from the Reserve Bank's perspective and in turn gives them the flexibility to lower interest rates.

So the economic scorecard paints a much more positive picture than the daily gyrations of sharemarkets. But for investors who are receiving super fund statements or checking account balances online that will be cold comfort. And there are lessons - albeit painful ones - to be learned from extraordinary periods like these.

With all the market activity swirling around us the hardest thing can be to sit still and do nothing. Now if you are young and you are invested in a diversified portfolio in your super fund it should be easy to file the statement and write yourself a note to check back around the same time next year. If you are older, perhaps approaching or in retirement the challenge may seem several orders of difficulty higher.

But at times like these diversification - spreading your money across a range of investments, a number of asset classes and over time - is the best way to handle the risk.

Australian shares - as measured by Vanguard's Australian shares index fund is down 14.7% for the 12 months to the end of August. In contrast the diversified balanced index fund is down a much more modest -4.7% for the same period. No-one likes negative numbers but that really shows the power of having a portfolio that has a good level of exposure to fixed interest and bonds as your defensive asset mix.
The other perspective is to remind yourself that when you are investing in the sharemarket - and particularly with super - you are investing for the long-term. Looking over five years the Australian share market index fund has grown 14.3% a year to the end of August. If someone had told you that was the return you would get five years ago most people would have signed up happily.

When it comes to what happens next in the short-term your guess is as good as the next person's. What a review of financial crises and crashes back to the 1929 Wall St crash does tell us though is that they are typically caused by some speculative build up which is where markets and the real world economy tend to part company. After the bubble - and the seemingly inevitable hangover - the real world economic value can again be seen more clearly and normal cyclical service is resumed.

Tuesday, September 16, 2008

Memo to the Uneasy Investor: Be Strong

This article was written by RON LIEBER (NEW YORK TIMES, NYTIMES.COM)

It’s pretty hard to stick with a long-term plan for your money when the financial world seems to be unraveling around you.

You were probably already uneasy about home prices, job stability and inflation. Then the government took over Fannie Mae and Freddie Mac, Lehman Brothers scrambled for a buyer and the stock of Washington Mutual fell below $3 amid concerns about its own shaky standing — and that’s just in the last week.

The temptation is to climb under the covers, money safely in the mattress, and hide from a world that has surely changed forever.

“The big question that people ask during these things: ‘Is it different this time?’ ” says J. Mark Joseph, of Sentinel Wealth Management in Reston, Va.

And is it? Well, no, not really. And as with any market disruption, you need to start by staring down the volatility and putting it in context. Then, face up to whatever fears led you to stop investing money or to move everything into safer vehicles — or to seriously ponder those alternatives.

Finally, resolve to be brave (and well diversified).


Thursday, September 11, 2008

Lessons from a Theme Park

Jim Parker, Regional Director, DFA Australia Limited
(reprinted with permission.)

Have you ever watched people exiting those nausea-inducing rollercoaster rides at theme parks? Some stumble down the steps as they try to regather their balance, others look deathly pale, the worst are physically sick.

Yet other rollercoaster riders seem to retain their sense of equilibrium amid the unpredictable twists and turns. Some avoid motion sickness by focusing on a distant point on the horizon and reminding themselves that even the scariest ride, however terrifying, is finite.

This is an approach that investors would be well advised to take at a time of extreme volatility in the financial markets, as we have seen in the past year.

To be sure, the daily churn of the indices can feel destabilising if you focus on it too closely. But if you keep in mind that these extreme ups and downs will pass, if you stay focused on your long-term investment goals and if you keep your emotions in check, the volatility can be a lot easier to stomach.

These two charts of the S&P/ASX-200 index, Australia's equity benchmark, might help. The first looks back on a particularly rocky period—from around the middle of 2001 to the end of the first quarter of 2003. If you cast your mind back, this was a period when investors were buffeted by the tech wreck, US recession fears, the 9/11 attacks, the Enron and WorldCom accounting scandals and the build-up to the Iraq war.

This was a volatile, stomach-churning time and you could have been forgiven for calling out 'stop the ride, I want to get off'!

Now take a look at the second chart, which shows the same index over a seven-year period from mid-2001 until the present day. The shaded area represents the 21-month period shown in the previous chart.

You see what a difference a bit of distance makes? (I've used the Australian benchmark index here, but if you charted the S&P-500 or the FTSE-100 or the S&P/TSX Composite, you would see something similar.)

This is not to downplay the momentous nature of the geopolitical, economic and corporate events of that time or the real suffering they caused. But this example does serve to show that if you want to secure the returns of capital markets, you need to keep your nerve through volatile times like these.

The fact is that markets, like economies, go through up and down cycles. We have been in a downward cycle since late 2007. We do not know when this rough ride will end. We do know that it will not last forever.

Tuesday, September 02, 2008

New Vanguard Index Chart (to 30 June 2008)


Lessons from the Credit Crisis

Stephen J. Garth, Portfolio Manager, DFA Australia Limited

Benign financial conditions encouraged excessive risk-taking in fixed interest markets in recent years. But as the tide of cheap credit and plentiful liquidity receded, many investors have seen their portfolios washed up on the rocks. In this presentation, Steve Garth charts an all-weather approach to fixed interest and its proper role in a diversified portfolio. (Running time: 22:57)


Saturday, August 09, 2008

Are Australian Investors Smart?

Some interesting research by Philip Gharghori, Charly Sujoto and Madhu Veeraraghavan published in the Australian Journal of Management, Vol. 32, No. 3, Special Issue, March 2008.

The ability of investors to select funds whose future performance is superior has been termed the smart money effect. The researchers examine the smart money effect on Australian superannuation funds. Specifically, they investigate whether Australian investors make smart choices in selecting funds.

The research fails to uncover any supporting evidence for a smart money effect in the Australian superannuation fund industry, concluding that Australian investors generally are not able to recognise high performing superannuation funds.

Thursday, August 07, 2008

Unbridled optimism and fear bordering on panic

Thursday, July 31, 2008

The Prescient Are Few

By MARK HLBERT, New York Times, July 13, 2008

HOW many mutual fund managers can consistently pick stocks that outperform the broad stock market averages — as opposed to just being lucky now and then?

... A new study builds on this research by applying a sensitive statistical test borrowed from outside the investment world. It comes to a rather sad conclusion: There was once a small number of fund managers with genuine market-beating abilities, as judged by having past performance so good that their records could not be attributed to luck alone. But virtually none remain today. Index funds are the only rational alternative for almost all mutual fund investors, according to the study’s findings...

... Professor Wermers says his advice has evolved significantly as a result of this study. Until now, he says, he wouldn’t have tried to discourage a sophisticated investor from trying to pick a mutual fund that would outperform the market. Now, he says, “it seems almost hopeless.”



Saturday, July 12, 2008

Take the Bait, Ruin Your Investing Life

This is an old Ben Stein article (Feb 14, 2008) but worth another read today...
Nothing good happens when investors lose focus in a topsy-turvy market and give in to self-serving doom and gloom...


Don't Panic - Buy Index Funds and Real Estate

by Ben Stein at Yahoo Finance

Now for some reassuring words. Of all of the columnists writing in this space, I suspect I am the oldest. This means I have seen the most economic fluctuations. This also means I am less terrified about them than younger heads.

Let me put this differently. I read recently in The Wall Street Journal that the stock market was at the time of that writing almost in "Bear Market Territory," which is to say, down roughly 20% or more from its high. This, said the author of the piece, shows that we are about to have very bad economic times. The author helpfully noted that the market has been down into "Bear Market Territory " some nine times since the mid-1960's. Without doubt, this author was trying to do his best, and to serve his readers.

But here's a relevant addendum: yes, the market may have fallen 20% or more nine times since then. But there have only been five recessions since then.
That is to say, the stock market predicts 10 out of five recessions. Not such a great record...

However, let's assume we do have a recession. I hope we don't, but we might. What do we do about it? What can we do about it? Just keep plugging along. Just keep buying broad indexes. Just keep a good chunk of liquid assets. None of us can control the economy. Thus, we just have to keep swimming in the roiled waters.

As we cling to our life jackets, please remember this: no recession lasts forever. I can well recall so many times in the past when every single headline in The Wall Street Journal was about some record growth of sales or profits. Then time passes and every single headline is about horrible news. Then time passes and there is mixed news, and then it's all good news again.

Economies go through cycles. But the long-term trend is up...

The plain fact is that you don't know when real estate will be at bottom until it's too late. If you see a home you love, buy it now if you plan to be in it a long time. And know that the headline writers want to whip you up and make you crazy about the economy. They sell fear. Stay calm and stay well to do.


Thursday, July 10, 2008

The Stock Picks From Hell

Jim Parker, Regional Director, DFA Australia Limited

Whenever equity markets turn rocky, we're told that stock pickers start sharpening their pencils and proving their worth. So with the year half over, it's interesting to note how the "hot stock picks" for 2008 are panning out.

Late last year, Sydney's Daily Telegraph decided to ask some of Australia's "leading analysts" for the "inside word on the hottest stocks for 2008".1

Six analysts from six separate broking and financial services firms were selected to provide a handful of individual stock selections—the cream of the cream, the best of the bourse, the flower of the flock.

But looking at the dire performances of their individual selections, one is left wondering whether the tipsters mistook their bottom drawer for their top.

Even taking into account the fairly ordinary performance of the overall Australian market this year (down 21 per cent as of early July), the Daily Tele's "hottest stocks for 2008" appear to be very cold fish indeed.

Of the 27 stock tips, all but three had underperformed the market by early July, many of them significantly.

Retailer Harvey Norman, we were told, would continue to benefit from falling prices for electronic goods imports and the strong Australian dollar. Maybe it is, but that's not reflected in its share price (down 54 per cent year to date).

Major debt collection group Credit Corp was said to be due for a rebound, having been hammered in 2007. Well, as it has turned out, the hits have just kept on coming, as Credit Corp shares are down 80 per cent in 2008.

Another analyst told readers that Babcock & Brown Power was likely to be a strong performer this year, given its focus on gas-fired generation—or maybe not, because this particular stock was down 73 per cent as of July.

Elsewhere, Regional Express, we were advised, was "the forgotten airline in a climate of unprecedented growth". But it seems the market is still suffering a memory lapse, because Region's shares were down 47 per cent as of July.

On the speculative front, one of the analysts tipped Destra Corporation. He had interviewed the company's CEO, he told us, and had come away with the impression that here was a "very tech-savvy guy". He may well be. But that hasn't helped his company's share price, down 83 per cent year-to-date.

Also among the stock picks from hell were Record Realty (down 89 per cent), Perilya (down 74 per cent), Strathfield (down 50 per cent) and Image Resources (down 55 per cent).

Maybe the analysts' pencils weren't sharp enough. Or maybe they just need to go back to investment school and learn the benefits of diversification.

The fact is successful investing means not only capturing risks that generate expected return but reducing risks that do not. Avoidable risks include holding too few securities, betting on countries or industries and following market predictions—even ones written by "top analysts".

That's not to say you shouldn't read these articles. But you might be better off treating them more as entertainment, than as information.

1'The Hot Stocks of 2008', The Daily Telegraph, Dec 14, 2007


Jeremy Siegel on the Bear Market and Sky-high Oil Prices

Jeremy Siegel is the Russell E. Palmer Professor of Finance at the Wharton School of the University of Pennsylvania. This interview was produced by Knowledge@Wharton and published on YouTube.

Tuesday, June 17, 2008

Your Own Worst Enemy

Jim Parker, Regional Director, DFA Australia Limited, June 2008

It's a difficult pill for many of us to swallow, but sooner or later we need to realise that the biggest obstacle to enjoying investment success often is not the market itself, but our own behaviour.

This tough lesson about investment is never more important than in the volatile markets we have seen in the past year. It is at these times, more than any other, that people tend to make dumb mistakes.

Those mistakes include neglecting to diversify, failing to track expenses and ducking in and out of the market in counter-productive attempts to miss the worst of the losses and capture the sweet spot in the rebound.

The fact is that as fallible human beings we tend to over-rate our own abilities and imagine that we can see things that others can't. In an extremely competitive arena such as the financial markets, this can be ruinous.

Just how ruinous poor individual judgement can be to your financial health is revealed in a newly updated annual quantitative analysis of investor behaviour by the US financial services research group Dalbar.1

That latest survey, covering a two-decade period, echoed the findings of previous surveys—that returns are far more dependent on investor behaviour than on fund performance and that most fund investors who buy and hold typically earn higher returns than those who try to time the market.

In the 20 years to December 31, 2007, the average US equity fund investor would have earned an annualized return of just 4.48 per cent, Dalbar found. This was more than seven percentage points below the return of the S&P 500 index and less than 1.5 per cent over the inflation rate.

Fixed interest investors would have fared even worse. Their average annualized return over the same period was 1.55 per cent, below the index return of 7.56 per cent and not even keeping up with inflation. In other words, the average fixed interest investor went backwards over that time.

Dalbar concluded that investor returns are markedly different from the returns promoted by fund managers because most people try to time their entry and exit points—and often get it wrong. Secondly, the holding periods of individual investors tend to be shorter than those of fund managers.

Interestingly, the survey also found that investors are more likely to make 'correct' timing decisions when the market is going up. Correspondingly, they are more likely to mess things up when the market is down.

In other words, most people fail to exercise patience in tough markets. The consequence is they fail to secure the rewards available to them.

It seems that you really can be your own worst enemy.

1Quantitative Analysis of Investor Behaviour, 2008, Dalbar

Monday, June 09, 2008

Give me the luxuries of life...

From The Writer's Almanac with Garrison Keillor: (LISTEN to this newsletter)

It's the birthday of architect Frank Lloyd Wright, born in Richland Center, Wisconsin (1867). He believed in designing houses that were in harmony with their environmental surroundings and said, "No house should ever be on a hill or on anything. It should be of the hill. Belonging to it. Hill and house should live together each the happier for the other."

The houses he designed were usually low to the ground, hugging the earth, with a large fireplace and a small kitchen. Often, instead of interior walls, he would use furniture to separate living spaces. He loved to use glass and incorporate lots of natural light. In his early homes, his glass windows featured geometrical designs and colored lines; in later models, when technology allowed working with large sheets of glass, he would sometimes replace whole exterior walls with glass. He also took special care in designing carpets, choosing geometric patterns that were played a significant role in the floor plan.

Late in his career, he turned to commercial projects - including designing furniture and creating wallpapers, carpets, and paint colors for major American companies. He also designed model homes that were featured in Life magazine and Ladies Home Journal.

He once said, "Give me the luxuries of life and I will willingly do without the necessities."

Thursday, May 15, 2008

So... The Budget was boring

This from Joshua Gans at ABC Online:

Back to Boredom

by Joshua Gans (13th May, 2008)

When I was growing up, Budget Night was a dull affair. It was a mind-numbing statement of a raft of statistics, tax changes and expenditures. The best thing to look forward to was the headline balance in the budget accounts. How large would that deficit be was the question in the early 1980s? How large would the surplus be was the question for the rest of that decade. Other than that, there were a few new initiatives and it was hardly a ratings puller for the ABC.

To keep interest flowing, the Howard government would use its Budget Night for some new announcements. Usually these were a new round of changes to tax thresholds but occasionally they would throw in baby bonuses and child care rebates to create some talking points.

Tonight’s affair was back to the sleep inducing days of old. Put simply, there were no surprises. The Rudd government has done pretty much everything it promised to. The only new stuff were some spending cuts achieved in small little bits throughout the public service. The image of a widespread razor gang armed with small blades is hardly a recipe for excitement. The Australian Chamber Orchestra will be reeling but the vast majority of us aren’t going to notice.

Now there was one small thing to talk about and, in desperation, talk about it shall. About 20,000 babies born after the 1st January 2009 are not going to deliver the $5,000 baby bonus to their parents. The baby bonus will be means tested with households earning more than $150,000 missing out. And I suspect that the government will hardly lose a vote amongst those folks. When it comes down to it, it was with some embarrassment that those parents were extracting $100m per annum from the social pool.

What is more interesting is why the government chose the 1st January 2009 for the big cut-off date and not 1st July when the baby bonus is due to rise to $5,000. As Andrew Leigh and I have demonstrated based on past baby bonus hikes, that rise will cause some delay in births. One might think that cutting the bonus for high income households would have accelerated births into the current fiscal years for those. To be sure, that would seem to smooth the waters but from a medical perspective, giving parents an incentive to rush things would be a bad idea. That incentive will not be transferred until the last week of the year. However, then parents are going to have to convince doctors to come in for special deliveries on what is usually a low birth week. I would have preferred a graduated elimination of the bonus but if you are going to remove it, best to do so at that time. (And by the way, no point in rushing out this week to make that birth date: you’ll find yourself a couple of months too late).

While it won’t create much talk soon, the infrastructure expenditure plans will probably be the lasting economic reform from this budget. The move to a fund for capital works signals a clear role for the government in providing transportation, digital, health and educational foundations. This is a big break from the previous government and makes it look more like the Bill and Melinda Gates Foundation than our big corporations. I like that image.

John Maynard Keynes hoped for a future where economics would be a boring activity — he aspired for them the status of dentists. Wayne Swan has delivered a budget that lives up to that aspiration. My children decided to watch the speech with me. It put them straight to sleep even more quickly than a Dr Seuss book. And it should be, should be, should be like that.

Joshua Gans is an economics professor at Melbourne Business School. He blogs on these issues at economics.com.au.