Drunk from binge borrowing?
A good friend who lives and works in the UK recently sent me an allegory that succinctly describes, for those who haven’t read Michael Lewis, the growth of sub-prime loans, the collateralised debt obligations into which they were securitised and the credit default swaps which were the tradable insurance contracts on the CDO’s. It then goes on to neatly leave us with the consequences.
If you have seen it before or believe you have a solid understanding of the events, you are many steps ahead of most. For the rest of us,
Heidi provides an explanation;
Heidi is the proprietor of a bar … She realises that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronise her bar. To solve this problem, she comes up with a new marketing plan that allows her customers to drink now, but pay later.
Heidi keeps track of the drinks consumed on a ledger (thereby granting the customers loans). Word gets around about Heidi’s “drink now, pay later” marketing strategy and, as a result, increasing numbers of customers flood into Heidi’s bar. Soon she has the largest sales volume for any bar in Manchester…
By providing her customers freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for wine and beer, the most consumed beverages. Consequently, Heidi’s gross sales volume increases massively.
A young and dynamic manager at the local bank recognizes that these customer debts constitute valuable future assets and increases Heidi’s borrowing limit. He sees no reason for any undue concern because he has the debts of the unemployed alcoholics as collateral!
At the bank’s corporate headquarters, expert traders figure a way to make huge commissions, and transform these customer loans into DRINKBONDS. These “securities” then are bundled and traded on international securities markets.
Naive investors don’t really understand that the securities being sold to them as ‘AAA Secured Bonds’ really are debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb – and the securities soon become the hottest-selling items for some of the nation’s leading brokerage houses.
One day, even though the bond prices still are climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi’s bar. He so informs Heidi. Heidi then demands payment from her alcoholic patrons. But, being unemployed alcoholics they cannot pay back their drinking debts. Since Heidi cannot fulfil her loan obligations she is forced into bankruptcy. The bar closes and Heidi’s 11 employees lose their jobs.
Overnight, DRINKBOND prices drop by 90%. The collapsed bond asset value destroys the bank’s liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community. The suppliers of Heidi’s bar had granted her generous payment extensions and had invested their firms’ pension funds in the BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her wine supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations, her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.
Fortunately though, the bank, the brokerage houses and their respective executives are saved and bailed out by a multibillion dollar no-strings attached cash infusion from the government. The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-drinkers who have never been in Heidi’s bar.
Its nicely articulated don’t you think? Fortunately the problem is contained to…Earth. But where too next?
Postscript: This week, China’s vice-premier and head of finance, Wang Qishan, predicted that the global economy has commenced a long-term recession. He observed: “Now the global economic situation is extremely serious and in such a time of uncertainty the only thing we can be sure of is that the world economic recession caused by the international crisis will last a long time.”
Posted by Roger Montgomery, Value.able author and Fund Manager, 25 November 2011.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Mike
:
Hi Roger,
I saw an excellent documentary movie about the whole sub-prime crisis and the GFC, called “Inside Job”. I thought it was fantastic, and I’m still shaking my head at how so many people got away with what they did.
Cheers
mike
Roger Montgomery
:
I enjoyed that one too Mike.
Kim Jordan
:
Have signed up to Skaffold and am finding my way around – extraordinary work (and amount of work) has gone into this, and it is a credit to all involved – very well made product that I have no doubt will continue to evolve.
Am wondering about its future directions e.g. if I could get printed reports out of it on my portfolio like I get out of ‘Removed by SubEd” portfolio manager that I also use, then I could ditch that product and not have to maintain my portfolio in both.
Also, They automatically recognises shares issued under dividend reinvesment (if you have elected for that) and makes the increment to your holding – nice feature.
Roger Montgomery
:
Hi Kim,
We have very ambitious plans for the Portfoilo Functionality – way beyond even your suggestions. So in time the answer is Yes. Stay tuned.
Brad
:
I went to the ARB factory open day on Saturday and took the factory tour – very interesting experience.
Surprisingly was quite low tech and low level of automation. Reason given by staff is, in the case of bull bars 110 different models. By he time they set up the robot, a wielder can make 10 welds. The two robots work on the prado bull bar, their biggest seller.
Air locker diff and fridge freezer are big sellers as well as shock absorbers and canopies. Manufacturing is in Melbourne and Thailand and the export to 84 countries. US and Middle East are biggest export markets.
Staff really seemed to take ownership of their parts of the business – real pride in performance.
Factories running flat out 3 x 71/2 shifts per day, warehouse emptying before they can fill it.
Roger Montgomery
:
Great scuttlebutt Brad. Thanks for sharing your experiences with everyone here.
Brad
:
the EU “crisis” hasn’t effected demand for bull bars
I really encourage readers of this blog to tune out from the market “noise” and tune into business
LukeS
:
Hi Roger
I enjoyed meeting you at the launch. Thanks for taking the time to chat. I was a little cranky all day as I was missing my good friend nicotine.
It was a big day for me. As well as your launch I went to my first ever AGM. My Net Fone (MNF) in Surry Hills.
You have them as a C2 and this is a fair assessment of their performance to date. I do not want to get involved in promoting them to the blog. In fact I would prefer if they were completely ignored and unloved for a while longer.
The AGM was a real experience. 5 board members, 2 Auditors and 4 shareholders including me. They were ready for a 5 minute meeting like usual when they asked if there were any questions about their financial statements. I pulled out my 2 page list of prepared questions. At that stage my mate nicotine was screaming in my ear. So my method of questioning may have started a little enthusiastic. I could feel myself getting worked up and stopped mid sentence and said, “This is my first AGM and I am here to have fun. People have told me when I am enjoying myself I can sometimes get over enthusiastic so… the safety word is banana.”
They all cracked up and we all started to chat in a friendly open way. Well that is how I saw it. One of the board called banana after a while so it may not have been as much fun for him.
The experience was great for a number of reasons. I was able to look them all in the eye. I could hear their enthusiasm for our business. I had questions answered directly and if not clear was able to ask again. I got clarity on some issues I did not quite understand. We discussed the future. I was the only one to ask anything.
One of the shareholders in the room was the father in law of a board member. Now there is a vested interest. Fathers love their daughters and tolerate much less than a father. I asked him in the meeting if I should trust these people. He said yes and we all laughed. I went there looking for something wrong. Always invert. I left happy.
I am guessing not all AGMs are like this.
LukeS
:
Should be Fathers love there daughters and will tolerate less from the board member son in law. We all want our daughters safe and secure.
Roger Montgomery
:
What a great story to share and an extraordinary experience for you. I would be delighted to see you post your questions and answers from the AGM – as I am sure would everyone else here at the Insights Blog.
Ash Little
:
Yes I agree Roger,
Nice story Luke and thanks for share it
LukeS
:
Hi Roger
I would dearly love to chat about what I like about this company, where I see it going, what are the risks and a host of other things. I am a little hesitant as I would like to take advantage of my research and buy more when people get scared. Hopefully the C2 will keep people away. With respect to the many people following you, some get it and plenty don’t. You wave your Roger wand over Embleton and others and people jump in with what looks like no true assessment.
I am investing for my retirement which is 10 or so years away. So I have an interest in share prices falling for as long as I am buying. The truth is I am investing for my wife’s retirement. If people followed the HWHL index they would not jump in to things. The Happy Wife Happy Life index has always proven to be a true indicator of the prevailing social and economic conditions.
As a man I want to beat you all, be a winner, have you all bow down before me. As I am investing for my wife she has no interest in that. She would like to not lose money, make a little and sleep well at night. If you invest like as long term married man you will avoid most of the danger out there. You will also get clean socks and undies neatly packed away.
I will post the MNF AGM questions and answers this weekend.
Roger Montgomery
:
Thanks Luke, I am really looking forward to your comments. Delighted to hear you maintain good hygiene too.
LukeS
:
MNF AGM Q & A plus thoughts.
I love owning parts of businesses. I want to cheer them on. Go you good thing. I know you should not get emotionally involved. I may be deluding myself but in the main I believe I own bits of good businesses with reasonable prospects. How can you not love them? I just love it when my mate rants about how he hates Woolies and I remind him I get a poofteenth of anything he spends with them. That alone is worth a stagnant share price.
So as a part owner of My Net Fone I have to start with an advert.
If you are in business from commercial premises, retail, home, a set location, a hole in the ground in the middle of Australia or of no fixed address, it is in your best interest to see the the future of voice communications at http://www.mynetphone.com.au
Aaaahh that’s better.
AGM
link to annual report
https://www.mynetfone.com.au/media/investor/annual-reports/MyNetFone_Annual_Report_2011.pdf
Lots of accompanying research may be needed to understand this business, especially the proposed purchase of Symbio. I know what all this stuff means mostly. Like any good industry it cloaks itself in jargon to maintain high prices. Works for a while.
Q. Cost of Sales ratio has risen. Is this a permanent thing?
A. Shows change in mix of products. More adsl with less margin. The trend will most likely continue, but of course we hope to add more new high margin products over time.
Q. Float is nice. Equals about 1 months sales. Ratio not keeping pace with sales.
A. Yes float is nice. Customers prepaying for calls yet to be made. Some never spend it. Ratio not keeping up with sales because we are adding a lot of post-paid customers, in the form of small businesses.
Q. Tech and Support – who is getting the $120k
A. Per annum – yes, Symbio.
Q. Outstanding amount to Symbio. I thought was a loan. Concerned about it increasing.
A. Spend more than $600k per month. Is the major part of Cost of Sales. Not a loan. Just slow paying. Always about 3 months in arrears. They say just normal credit terms.
I say thanks very much for letting us drag out payment. Don’t think you could get away with it if the money was owed to Telstra.
Q. Purchase of Symbio by MNF supposed to be discussed today.
A. Not ready yet. Due diligence finding pluses and minuses. Should be soon.
Q. Are you paying 8 Million?
A. Capped at 6 with a groan by the owners. Based on the next 2 years future performance. Won’t be 6 if the combined group does not perform.
Q. You said it would give 25% return?
A. Nods of heads
Q. Is that the best thing we can do with $6 million.
A. That is what we are looking at. Symbio has many high value international customers. It is a good business.
Q. MNF has over 90,000 customers, and 1000 business customers – must be more like me that are businesses still on residential accounts
A. Yes lots. Look at our website and you can see our marketing plan for businesses. We are targeting businesses. Developed lots of new features for Virtual Pabx.
Q. Microsoft Lync discussion
A. More than 30 customers so far. We are the only service provider certified in Asia-Pacific, and we were the 6th in the whole world. Definitely a good ice breaker when talking to enterprise.
Q. Why would businesses use you instead of Telstra, Optus, M2?
A. Symbio research gives MNF lots of current and future products and enhancements. We continue to pass on all our innovations to our existing customers. Lots of features we don’t charge for, some we do.
Q. Tell me more about Symbio
A. Owners of Symbio set up MNF as a plug and play business called Myfone. 10,000 customers very quickly. Floated. Buying Symbio will remove single point of failure. Symbio is a leading provider of wholesale VoIP and IP services and operates a carrier grade, high availability network in Australia, New Zealand and Singapore handling over 1 billion minutes of VoIP traffic annually. The company delivers managed services and termination services to a wide customer base including many ISP’s, carriers and providers in Australia as well as overseas.
More details on Symbio’s web site: http://www.symbionetworks.com/wholesale-voip
Q. Potential problem with existing customers of Symbio not liking the mnf buyout
A. Maybe – we’ve actually spoken one-on-one with all our major customers about the transaction, and they are all ok with it. Some of the smaller ones may feel more threatened, but the larger ones are all glad to see the scale of their supplier grow. Also as our scale grows it will allow us to attract bigger customers. Lastly in the telco space – the mature players are all used to buying from and selling to their competitors. We are a big customer of Telstra and Optus, etc, and we are also supplying them with some services too. It’s the way of the industry – behind the scenes we all know each other and trade services and capabilities, on the retail side we are fierce competitors.
Well that is about as much as I can remember based on my notes and filling in some gaps with extra web research.
They must be about to make a couple of announcements. One for the Symbio purchase and they usually give a guidance re first half sales.
One of the beautiful things with this type of business is being predictable. Lots of recurring income from lots of individual customers. As this is being written before any announcements let’s hope this is not a permanent record of my delusion.
So I am guessing they will have sales of over $7 mill for the half year. 7.5 would be nice.
Profit before tax should be over 500k. Might hit 600k
I have lots more to say, both questions and observations. Symbio is a different type of business to MNF. This acquisition will hold no surprises to the purchaser. It changes the game substantially. Not worth speculating. Will just have to wait for the announcements.
Roger Montgomery
:
Great STuff Luke…looks as though you were the AGM. The board mustn’t have expected it when they woke up that day.
LukeS
:
The announcement re the purchase said
“An independent valuation report, together with other documentation will be provided to shareholders.”
https://www.mynetfone.com.au/About/Investor-Information/ASX-Announcements
Now there is a job for you Roger – providing independent acquisition valuations. I wonder how many would proceed?
Roger Montgomery
:
I have always wondered why, if the independent values thought the shares were so cheap, they did go and buy them themselves.
LukeS
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Hi Roger,
Here is the announcement re purchase of Symbio. It is 62 pages including the independent valuers report. I have read through it once. I will go through it again in more detail this weekend. It makes interesting reading. I have never seen a valuation report before. I guess it does not come cheap. My first thoughts are they got a required figure and worked backwards to make the value fit the expectation of the purchasers. That is probably me being cynical.
Here is the MNF page on the asx site with a link to the report. Regardless of people’s interest in this company, the document is certainly full of concepts and points of view. While these may not match the ideals of a margin of safety investor it is interesting to see how professional valuers say they think about things.
http://www.asx.com.au/asx/research/companyInfo.do?by=asxCode&asxCode=MNF
Keith
:
MOVIE TRAILER – Margin Call (2011)
http://www.youtube.com/watch?v=uj4QrAcwVi0
A dramatisation of the start of the sub-prime crisis.
Over a 24-hour period, a securitisation firm realises the leveraged property securities they have been manufacturing are worthless and their attempts to get out before it was too late.
Loosely based on Lehman Brothers (eg. Dick Fuld = John Tuld, CEO of the fictional MIB) and Goldman Sachs and similar firms engaged in the securitisation process.
Harking back to Colin’s comments. These people are not inherently evil or particularly greedy. The overriding emotion is fear. Fear that they will lose their lifestyle (Money, Houses, Jobs) if they do not keep pushing the legal limits to keep making money to justify their existence.
As the writer director commented in Q&A, session at the Sundance Film Festival, “… these people are our best and brightest; do we as a society really want them engaged in this activities?”
Roger Montgomery
:
If the financial industry paid them less, the “best and brightest” my start something that actually could make the world a better place?
Roger Gibson
:
As a Mancunian by birth I,m sure I would have taken Heidi’s credit but not bought the Drinkbonds because Value-able doesn’t provide examples on calculating the IV on bonds!! However, we now must consider the affect on the rating and value of DCG of its current capital raising.
My initial reaction is positive but I’m scratching my head as to how to revalue the company. Has anybody has a go at a 2012/2013 IV after the JV?
William Gill
:
DCG.
Raising 85 million at $2.05 increases shares on issue by 41.6 million but as the $2.05 is greater than the current equity per share. Equity per share will increase. Everybody will have different thoughts on what happens to the ROE.
Roger Montgomery
:
Excellent William.
Michael
:
Hi Roger,
How often after an event like a capital raising are the intrinsic values etc. in Skaffold updated? Does it just depend if and when the underlying data, such as analysts’ forecasts, are updated?
Also I’ve noticed that often that data in Skaffold is vastly different to that in Commsec. For example, the ROE for DCG is listed as 22.5% in Skaffold for 2010, but in Commsec it is only 8.7%. This is a big difference for such an important measure. Which one is to be believed?
Thanks,
Michael
Roger Montgomery
:
Hi Michael,
We rely on Skaffold not Commsec. There have been many threads here on the insighst blog about the accuracy of data on electronic broker sites. Regarding how often Skaffold updates, the answer is; constantly! A capital raising will impact the valuation once the shares begin trading!
Ash Little
:
In this case you need to look at earnings from continuing operations
Roger Gibson
:
Thanks William. Simple but a good starting point.
Craig in Brisbane
:
For the folks getting all confused with the mass of data and reports apparently bombarding them I’m reminded of an old saying that goes: ‘I can’t stop the birds flying in the air, but I can stop them landing in my hair’. Consequently, I find that simplifying my thinking to the very basics and not religiously reading the Fin Review every day, together with doing my own reviews on the key things I’ve learnt well, then deciding and acting affirmatively all leads to better, less stressful investing and life. It’s your money not the crowd’s no matter how comforting or wrong their momentum may be.
Brad
:
Anyone have any thoughts on Big Air (BGL) ?
Roger Montgomery
:
What are yours Brad?
Brad
:
I have had a look at this business and it looks interesting. They’re continuing to build out their wifi network filling “gaps” left by the major telecom providers but I’m not sure if the co. has a competetive advantage.
Doesn’t look cheap at these levels so I haven’t dug too deep yet but owing a wifi network could be valuable.
Justin
:
Hi Roger,
I am wondering what your thoughts are on Data3 (DTL). It recently underwent a share split. Its P/E ratio is currently around 12. I can find very little to dislike about this company but I am confused by the impact that the share split might have had on its valuation. Are you able to shed any light on it? Is it cheaper now in an intrinsic sense than it was when it was trading at around $13 prior to the share split?
Roger Montgomery
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Hi Justin, a share split has a proportional or pro-rata impact on the intrinsic value per share but no change to the intrinsic value of the company.
Greg
:
I was just reading that RIO is tipped to take a $5 billion writedown due to their poor decision to pay an excessive price for Alcan.
Why is it that executives and boards seem to have a free call option when it comes to performance related remuneration?. They are happy to take the performance shares when their peers on the board decide thay have met their hurdles, but never have I seen them sacrifice remuneration when they underperform and cost the shareholders some equity as RIO has done. A very unfortunate culture of pure greed seems to have developed when it comes to corporate renumeration structures.
I have seen how easily people accept the culture in which they work. I have worked in the mining industry where an expectation of high pay and good conditions are taken for granted by all (although many in the industry still think they are hard done by!). I have also seen the public service culture (at least in an administration type department), where the norm has become a culture of counting hours for flexi time and the like and many would be shocked if they had to work in a busy private practice. It doesn’t take long for the workplace culture to become the norm for the individuals involved ( I admit I accepted the workplace norms) and is quite an insidious process.
My point is that a culture of executive greed has developed and rationalised with the “everyone else is paying this amount therefore we need to as well” line. This needs to be restrained for fear of the gap between the haves and have nots developing even further. If nothing is done, the occupy Wall Street/Martin Place/Melbourne, movement will grow stronger. Envy is a powerful and potentially destructive emotion.
Sorry about the rant but needed to get it off my chest. I will understand if this is too off topic for publication.
Roger Montgomery
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When remuneration is aligned with shareholders interests on the upside but not aligned on the downside it is not aligned at all.
Michael Connor
:
Hello fellow value investors I was canvassing the company ZGL Zicom Group.I was put off by it a few months ago when directors were selling however recently directors have been buying again.It has drifted lower.Do people see value in this one or is it too boring?
Brad
:
Insiders have been buying, no guidance for FY 12 so far but big tailwind in this well run manufacturer being offshore oil and gas industry.
Their three start ups are also interesting. ROE of >20%, POR 20% and PE < 10 makes stock cheap at current levels.
Roger Montgomery
:
Thanks Brad
Brad
:
only 2 shareholders at the ZGL AGM! I spoke to the non-execs and GL Sim after the meeting – my money’s safe with them.
John C
:
Thanks Brad. I’ve quietly accumulated 130,000 ZGL so far, so was pleased to read your comments. I also like the prospects of ZGL’s start-ups, with what they term “disruptive technologies” (and paid for out of their own cash flow without resorting to debt). Although their share price will be influenced greatly by offshore oil and gas industry orders (because it’s their largest division), they are well diversified, and any increase in activity in the building industry will also help their profits along. It’s good to hear that you trust the current management team. Thanks again for sharing.
Roger Montgomery
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and you also JohnC. Thanks for sharing.
John
:
130,000 ZGL ?? Now there’s an “investment” that’s going to end in tears.
John
John C
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Why so John? I haven’t reached my target weighting yet; I plan to buy more as the price drops further.
John C
:
150,000 now, and I’ll stop buying for a little while… probably… and keep a close eye on them. They’re not my biggest holding, but they’re getting up there. My four biggest currently are FWD, MIN, MND & SWL. After those 5, my top 10 is completed by WLL, DJW, RMS, TGA & CWP. Of those DJW is currently under review, as I’m not so keen on LICs as I was when I bought them some years ago. WAM, I’m happy with, so far, but I’ve reduced holdings in AFI, and have quit ARG altogether. So, apart from DJW, I’m pretty comfortable with my top 10.
I don’t think I’m going to lose money on ZGL, unless they go bust, or I change my investment strategy and decide to sell them at a loss (I don’t think I’m going to do that). With hardly any debt, they are unlikely to go broke any time soon, and they are sufficiently diversified and focussed on innovation to make me comfortable about their long term future. Brad’s comments (re- their AGM) are also helpful. I don’t get to go to AGMs myself so a little insight from Brad’s visit is appreciated. Thanks again Brad.
Andrew
:
Been AWOL for a couple of weeks due to getting married and spending the week after that working out what Hamilton island bar has a competitive advantage in mixing Mai tai’s and lychee martini’s. Jury is still out. I see I have a lot of catching up to do here with a lot of interesting topics.
The above post is probably the best definition I have read on the sub prime mess. In what person’s mind is investing in unemployed alcoholics debts providing either a safety of principle Or a reasonable certainty of return on that principle. Another area which got my back up were the fincorp’s etc where retiree’s were investing their funds in what appears to be a junk bond for a “company” that had no assets other than the invested funds which were than borrowed by a looney affiliated property development company.
I still think that a financial iq course should be mandatory in high school so people can be better prepared and perhaps teach their parents
Roger Montgomery
:
Welcome back Andrew. Delighted you enjoyed yourself.
Marion
:
Hi Andrew
My daughter has just completed a one day session on Finance. She came home and started quizzing me on how we invest/save our money, what size mortgage, if any, we have, what our income is (so she could check where we stood on a global scale on an internet web page she was given). She’s in Year 7 (Primary school here in Qld). The School she goes to next year has business as one of the subjects she’ll be doing, most schools we looked at offered some sort of financial literacy courses.
The trend is there. We just need to hope it continues.
Ilya
:
Andrew, A financial IQ course would be banned in schools because it is actually politicians who have the lowest financial IQ out there!
Roger Montgomery
:
Surely with the Goverments Financial Literacy agenda in train, you are jesting.
Ilya
:
Roger, sure enough politicians think that saving money, balancing budgets and all that boring stuff is important to us plebs, but it does not apply to them. We wouldn’t be in such a mess right now if politicians run their countries’ finances the way most of us manage our household budgets.
They want us to be literate about our own finances while at the same time believing that government should stimulate, “create jobs”, deficit spend, “invest” in stuff that no sane person would invest their own money, give pay rises and holidays at “someone else’s” expense and so on. It’s a parallel universe.
I think it was Adam Smith that pointed out that running a country is not that different to running a household. Same rules apply.
Roger Montgomery
:
On that, different point, we agree.
Di Bentley
:
Hi Roger
A brillant analogy of the situation. One that I will keep for my grandchildren to read and possibly understand.
Cheers
Di
gabe
:
The problem all investors have at the moment is information overload leading to frustration and angst. We have to come to terms that a world recession will be on our doorstep early next year. So my answer is to take advantage of the downturns and buy quality good value companys with the portions of you funds that can sit for 2years
Next buy the value business that have a good returns eg. dividends
With the other portion have it in term deposits. Something tells me from here there wont be very large dips however in my opinion there is a further 20% downside. Clear our heads and the confidence will
return. Hopefully so will the market – bye from pottsville beach nsw.
Grant W
:
Roger
In the last few months I seem to have read so many opinions about market direction that my head is spinning. Having personally been through too many market ups and downs it seems to me that the view that we are on the verge of a major downturn could well be off pace but so too could the argument that we are on the cusp of taking out the 2010 highs. Both these scenarios ignore the fact that the market is quite possibly likely to do neither of these things.
Why do I say this? – because markets can and do go sideways for prolonged periods of time.
A little history from this old codger: the current market reminds me a bit of the period post the 1987 crash – a never to be forgotten experience if you were in the market at the time. The All Ords made one of its biggest advances in history from a low of 443 in July 1982 to the pre-crash high of 2312 on 21Sept 1987 (a bit over 420% in 5 years – those were the days of wine and roses!). The final low, post crash, was 1149 on 11 Nov 1987. From there the market rallied by 55% to 1787 in Sept 1989 – fairly similar to the recent rally from Mar 2009 to Apr 2010. But it is what happened thereafter that I find interesting. The market traded in a range between the Nov 87 low and the Sept 89 high until July 1993 – a period of nearly four years from the Sept high. ( As a side issue: with the exception of a single day, in Feb 94, the market did not get back above its Sept 1987 pre-crash high until Oct 1996 – 9 years later).
Going back further in history and looking at the Dow Jones index: it made a low in July 1962 at 524 followed by a high in Feb 66 (1001). The index traded within this range for just over 16 years finally breaking out in Nov 1982 on its way to the famous 1987 high.
All of this has very little to do with identifying companies with outstanding management and prospects at stunningly attractive prices but nonetheless I thought I’d add my two bob’s worth to the general topic that seems to be getting aired at the moment. Of course, during sideways markets, investors should get multiple chances to buy into outstanding companies during market dips as their prices fall whilst their profits and values rise. Certainly that is what happened in the late eighties and early nineties and I am sitting with my list of companies I want to own and the prices I’m prepared to pay – the hand is hovering just above the holster and the eyes are peeled!
Brad
:
Hi Grant, that’s a great take on the past and what’s going on now. When investors are in a Bear market it can feel like an enternity for them but when it’s over and if they’re long cash, it can be worse than buying stocks and watching them go down.
I try and tune out from the market noise and tune into businesses.
Roger Montgomery
:
Well said.
Brad
:
I was at a BBQ yesterday getting grilled on the market (as usual) – common theme from some punters there was they’re out of the market and are waiting until “things are more certain”.
When is anything certain?
Good luck….
Roger Montgomery
:
…you pay a high price for a cheery consensus? Thanks Brad.
Ash Little
:
Make sure you tell us when you go to a BBQ and they are all taking about gold and silver..
Thanks
Roger Montgomery
:
Chris also writes:
“Roger,
Nicely put.
However, it makes me wonder. Essentially, the US went and sold all these CDOs around the world.
Being the largest holder of US paper (debt of all forms), it makes me wonder exactly how many does / did China hold and secretly, did they take a bath on it quietly to save face and not be so embarrassed that they bought such junk ?
I would say so. It would be highly embarrassing for the Chinese to admit that they had been hoodwinked by the USA.
P.S. Your feelings re: TRS, agree completely, however, I was kind of thinking that from the word “go” when you first covered it in a very old Smart Investor interview. I just thought it was cheap Chinese junk that broke and there was a proliferation of other shops. I wondered what the competitive advantage was (economic moat) versus people like “The Warehouse” and “Sams”, there were just TOO many of these $2 shops and I just wasn’t interested in TRS. If you are selling cheap “goods” (how ironic a word) and competing only on price, you will end up with a price war. With someone like Oroton, you maybe have the ‘exclusivity’ of being a luxury brand that can only be bought in certain places. People like Bunnings run very good distribution networks, which allows them to get pallets of ‘stuff’ and sell it cheap – that is their moat, by being the 300 pound gorilla.
Until China stops all this stuff re: fakes, food labelling and production standards, no one is really going to take them seriously as a quality manufacturer. Personally, I try my hardest NOT to buy food made in China because their standards are far lower than ours, and the stories regarding what goes on – locations of farms and what gets put onto them re: fertiliser and irrigation just turns me right off.
For me, it was very much a case of “when the shoe shine guy starts buying stocks and giving tips, sell” (because everyone else is interested). Like I said in another communication, there was a time in 2007 where everyone was interested in stocks, and to me, it spoiled it. It was like a secret that had got out and then everyone knew about it, everyone was making money, and a good crash was needed to flush out the newly arrived who were not in it for the long term. Well, that came about.
Funny thing is, I had a talk to a very good friend of mine about 3 weeks ago, and he runs investment courses through an educational provider (they are legitimate, they are not ‘boiler rooms’ or dodgy one hour ‘get rich in CFDs, FOREX’ schemes, his courses are full six month ‘night school’ type courses and take you from ‘I know nothing, not even the basics’ right through to the advanced concepts) and he said that the interest in the property course is almost nil, and the sharemarket course was even worse for this year’s intake.
Time to buy, I think – when no one else is interested, be greedy.
Chris.”
Michael Horn
:
Roger
There is one thing that I have never understood, and that is endless carping by Robert Gotliebsen, Bill Evans and others that our “stupid” Reserve Bank “zealots” should drop the target Cash Rate. Media commentators usually extrapolate decreases in the target Cash Rate to how much the typical mortgagor is going to save (and hence spend on gewgaws, pogosticks and candy floss, and thus save the economy).
As far as I can understand, the target Cash Rate is merely the RBA signalling what it wants the interest to be for loans to banks for settling overnight inter-bank imbalances. In that limited sphere the signalling has teeth, because the RBA is allowed to play in that market. In fact, until relatively recently the RBA did not issue a target Cash Rate, it merely made overnight-settlement funds available at the rate of interest it wanted to apply, and alternative lenders in the game would take their lead from that.
It would make little sense for banks to lend money to mortgagors and others at rates other than a few points higher than the marginal cost that the mortgagee pays to source funds.
Next time you are on the Peter Switzer show (he is another lower-the-target-cash-rate carper), could you ask him why the target Cash Rate should have any causal relationship to mortgage and business-lending rates, seeing that the lenders (he banks) do not, and cannot, source their funds from the RBA. The banks traditional source of wholesale funding to top up shortfalls in deposit funding has been the European banking establishment, and in the current situation that source will decline, so expect the banks cost of money to increase, irrespective of the RBA’s target Cash Rate.
Roger Montgomery
:
Hi Michael,
Check out a source of info on Open Market Operations (OMO). Should give some guidance.
Bargeass
:
Many a previously great nations and empires will be in ashes before this economic calamity passes.
While ever people tolerate governments that operate on the false notion that you can get soemthing for nothing it’s all downhill.
Tony Connellan
:
To Roger & fellow followers of the blog:
The last 2 topics under discussion do appear to me to be straying away from the themes of Rogers great book Value.able.Have we finished with Value.able? No,I believe we have a way to go yet.
A topic that has not been looked at yet ,to my memory is the role of founding fathers in the running of listed coys.
We have recently seen some discussion on EMB, a coy on which the founding family,have a very tight grip. Another is TWD.Are any of you shareholders in TWD? In coy anouncements they recently posted a 195 page notice of meeting – 3 items, Items 2 & 3 were most interesting. This is another small coy with the founding fathers having a strong grip. In short, the founding fathers propose to buy up excess stock ( houses ) from the coy, and thus provide the coy with funds to eliminate long term debt and buy back 13.7m (13.5 from the founding fathers ) out of 39m shares on issue.At the end of the day the founding fathers will still have the controlling interest in the coy. Is this action a win – win for both the minority & controlling share holders ? The consultants report says it is fair and reasonable (Why else would they employ the consultants ) The votes at the AGM agreed. What do others think?
Another unrelated topic would be why did DTL have a 10 -1 share split ? Surely the pre split trading price would not scare off investors.What benefit to the existing shareholders was this share split ?
Another topic is the use of windscreen and rearvision viewing in the economic evaluation of coys.EMB was the subject of a recent discussion (did you see the share price go for a run after that ) EMB has a lot of rearvision info but what do you see in the future? MCE another little coy , did not show up much in the mirror But was seen to have a grand future ( It also had its day in the sun with the share price ).
I would enjoy reading others thoughts if you feel these topics fit in with Value.able sentiments.
Regards Tony
Roger Montgomery
:
I cannot believe the speed with which investors rush to buy something even at prices well above my estimated intrinsic value just because it is mentioned. I don’t own EMB. Its in a competitive industry and there is insufficient liquidity. Clearly they are not doing their own homework. I haven’t yet identified its competitive advantage, although I suspect there is one. The same thing happened at MCE – another company I didn’t own any substantial quantity of shares (after the half yearly results). A company can be an A1, it can have little or no debt, great returns on equity and if an understanding of prospects, cashflow or industry dynamics is not grasped (plenty of bloggers here warned about MCE) even an A1 can pose risks for the impatient.
Colin
:
I suspect a similar thing (to RM comment following) will happen with Skaffold to some extent. People don’t like using their brain. I dare say there will be plenty of investment decisions based on little more than a promising Skaffold line and a green dot. That said – even that basis for a decision would probably be an improvement on the present average. :)
Zimplats Holdings is a likely suspect. Notwithstanding being in production and still no dividends plus share liquidity issues I’m tempted to take a small punt – but talk about sovereign risk! Not generally a good idea to stand between Robert Mugabe and a pile of cash. Even the company announcements warn you off doing so.
Roger Montgomery
:
When investors have nothing to go on but an article or tv appearance one suspects the fear of missing the next idea leads to hasty decisions. A years membership to Skaffold (or a decade) will provide the confidence that ‘this’ idea won’t be the last. An investor can then take their time and fully understand what Skaffold provides for every company and at any point during the market cycle.
Brad
:
Lev has taken Executive Chair role at AIR and from last weeks AGM it would appear this co. will be his focus. Share price trading at or slightly above NTA – should be an interesting next few years.
Re DTL: it’s common for co’s to split shares, and John Grants explanation that it is to provide liquidity is reasonable, IMHO.
Ash Little
:
Hey Guys
Unfortunatley I like the way Wang Qishan is thinking atm
Much care is needed,
Never forget Buffet rule number one……………Never loose money
Michael
:
The mood on the blog has turned very sombre. How can anyone hope to follow value investing principles if they bury themselves in negative news?
I am choosing to hold off on pressing the panic button. We have the stock market falling rapidly, but no longer have much discussion on the great businesses that will weather the storm. In the stock market, the light in the darkest hour is fear.
Roger Montgomery
:
Excellent resetting of the compass Michael. I reckon there are eight high quality companies trading at sufficient discounts to warrant interest from a field over over 2000.
Roger Montgomery
:
COlin has been attempting to post a comment but was frustratingly being blocked by the ‘system’. Here’s Colin’s comment and my response via email:
First Name: Colin
Message: Sorry Roger but i spent ages writing this for your latest Blog
entry and your spam filter barred it. I hope it’s worth reading but if it’s
too long for the blog I’ll understand. The proposed post was as follows:
The allegory is cute but like most accounts I’ve heard that try simple
explanations of securitisation it falls very short. I was a lawyer working
in one of the top securitisation practices in Australia just prior to the
GFC. The one thing I’ve seen way too much of is simplistic stories that
make the securitisation of bad assets seem preposterous and the failures
that took place inevitable. EG. the notion that terrible loans were simply
packaged and then rated triple A.
The truth is far more complicated (and once understood far more reasonable
sounding).
All such packages were packaged with subordinated classes of notes. In
order for some of these notes to be rated triple A a large number were
rated as rubbish and more at lesser grades. The rationale behind the
triple A rated notes was that in order for there to be any capital loss on
them all the subordinate notes would have to be rendered valueless first
(which statistically was inconceivable assuming a normal range of
mortgages). This generally meant that the whole portfolio of loans would
require more than (say) 15% of the loans become delinquent. Then the
remaining 85% were secured by a credit default swap to a AAA rated bank.
The AAA Bank’s failure to assess the risk properly was because of actuarial
numbers indicated that such a liklihood was extremely low and the corollary
was that AAA was appropriate (being the rating of the insuring bank).
Given the actuarial figures, the AAA Banks figured that the swap fee was
easy money.
The problem was that the underlying assets were in fact junk and payment of
huge amounts under the credit default swaps was inevitable.
It was the massive losses of the third party banks as the credit default
swaps were triggered that was the problem in the GFC. These Banks (in most
cases) were not the ones which wrote the rubbish loans in the first place.
One of the failures of the system is that those who wrote the rubbish loans
were not punished for it – their backstops were.
Accordingly the common notion that banks loaned money to bad clients and
then when those loans defaulted the stupid banks got money to bail them out
is wrong. That would be truly stupid ( and that is largely the situation
the above allegory sets out).
It wasn’t so morally black and white because the banks that got burned had
not in fact made the dud loans – they were the insurers of the dud loans.
The figures were backed by actuaries on reasonable statistical models.
Short of investigating every individual loan made by the predatory lenders
the insurers (swap providers) were reasonable to accept the swap terms.
Hindsight is 20-20. So yes the failure was probably inevitable. It was
stupid in many ways but unlike many of the common understandings – the loss
did not fall where the predatory lending took place. Those who were bailed
out were not the guilty parties. They were (in that respect at least) the
innocent ones. They may well have been somewhat careless plus they may
have been cavalier in all kinds of other speculation but on the CDS’s their
decisions were rational.
People like to hate banks and like to think governments are stupid. There
are plenty of arguments to suggest both points can be justified however
this allegory is a cheap shot that clearly mis characterises the flaws of
both the banks and those who bailed them out.
There were bad banks, Unfortunately in a frustratingly grey world they
are not the ones who took the fall (in most cases). There were also silly
government bailouts but nor were they targeted at the predatory
institutions who bundled up dreadful mortgages (with essentially 100%
chance of delinquency). IT was the dodgly lenders who suggested that their
bundled mortgages fell into merely worse than average even by a full
standard deviation and labelled them “subprime”
The statistical models still indicated that by moving the default rate by a
standard deviation the probabilites would be roughly equal to a
“normal”pool of mortgages (or other securitised assests). The truth was
the chance of delinquency was almost 100%.
Hindsight is great but neither the CDS issuing banks nor the governments
who bailed them out are as stupid as the above story makes them out to be.
Sorry about the long post. Mostly I lurk here but when I write it doesn’t
seem to come out short :)
Hi Colin,
Thanks for your email. I will post it as a comment on the blog as you request.
I am sure you have also read Michael Lewis’ account in The Big Short?
I confess to devouring it in several hours. The $400-$700k loans made to mexican strawberry farmers earnings less than $20k per year, if true, were nothing if not preposterous.
You neatly simplified the structuring of some CDOs yourself by saying “The problem was that the underlying assets were in fact junk” and “with essentially 100% chance of delinquency”
The true events are indeed always more complicated and it is the apparent sophistication that often befuddles the unwary.
I would be delighted to put everyone straight on the blog.
Kindest regards
Roger Montgomery
Colin
:
Thanks Roger
Hopefully that post made a few things clear. The real take home messages are as follows:
The ratings agency weren’t stupid or incompetent in rating some of these securities as they did – they were simply misled.
The insuring banks were also misled into thinking the default profile of the packaged loans was normally distributed but with a higher (but certainly not 100%) likely default rate.
The Banks that made the dodgy loans weren’t punished for it (other than nasty rhetoric)
Very few AAA note holders lost anything.
Almost all other classes of noteholders lost everything.
The real losers didn’t really do anything wrong.
Because the real losers were innocent parties (and for other obvious financial reasons) governments felt obliged to bail them out.
Buying these notes (or any investment) does usually require an assumption that the vendor is acting in good faith. Due diligence can only take you so far. People were used to taking risk associated in normally distributed pools of assets. These will have a few bad apples in them but the overall, the quality is there.
In the market at the time no-one would have thought that someone would collect all the truly rotten apples into a barrel and then securitise them and characterise the underlying asset as “slightly less fresh than the other apple securities you’re buying”
We often make our biggest mistakes when we assume things. It is ridiculous to package rubbish loans and securitise them. For that very reason no one at the time considered that someone would actually do it. We also tend to assume that something so obviously dodgy would be forbidden by laws. The problem was that at the time the regulation was way behind the state of play.
Securitisation is nifty but like anything it can be abused and of course it was to devastating effect.
Roger Montgomery
:
It most certainly was abused. Ratings agencies are charged with the responsibility to avoid being misled, when (if) they take a fee, being misled is much easier.
Keith
:
The key point is these “Fees” became so big that rating agencies management were prepared to sell out their reputation for short term profits.
The more conservative analysts were shunted aside to allow the firms to pursue deals which should never have been rated just to grab the “easy” money.
Similarly, those financial intermediaries were look for excuses (eg. Rating agency AAA rating) to enable them to lower their underwriting standards to compete for that same money.
So I suggest the “Misled” is too tame a description.
I think “Wilful ignorance” is a more appropriate description.
Paul
:
Securitisation may well be nifty, but was it necessary. Interesting to read or listen to Jeremy Grantham on the massive increase in the finance industry and whether it has actually contributed much to the efficient running of the capitalist economy.
More importantly I think it is disingenuous to simply excuse the rating agencies because they were ‘misled’. If that is the case then they would seem to serve no purpose whatsoever. It would also appear that none of the rating agencies took the time or made the effort to look carefully at the underlying securities – perhaps not surprising considering who was paying them. A few others did, and made billions.
Similarly to suggest that the insuring banks, those selling the CDS insurance, were somehow less ‘guilty’ than those who wrote the bad loans, seems to let them off a bit easily. The excuse that they too were ‘misled’ seems to obviate them from any responsibility in the management of their business. They were writing the equivalent of bad loans.They should have assessed the risks associated with the underlying securities, not the rated CDO, and more importantly considered their leveraged position. To believe that ‘the chance of delinquency was almost 100%’ without doing the necessary homework, seems a fairly rash basis for such high leverage.
Seems to me that there is enough blame to go around – loan originators, CDO creators and sellers, CDO buyers, CDS insurers and ratings agencies.
Sav
:
Hi Colin,
excellent summary. However, I’m not sure that your average punter (well semi-financially literate ones) think that the fault lay mainly with the investment banks. Pretty much everyone knows that the real fault in the whole system were the initial bank loans to sub-prime customers. The banks took no risk because they on-sold the loans further up the chain. By removing any risk on their part they made stupider and stupider loans to riskier and riskier people. Why wouldn’t they? They had absolved themselves from any risk at all!
The investment banks only then went on and did what all investment banks try and do – try and make as much money as they can. So they did, by bundling the loans and securitising them. But no pension fund, local council, or foreign bank would have bought them them if they didn’t bear the AAA imprimatur of the ratings agency.
Moodys, S and P, Fitch. They should hang their heads in shame. I take exception to you saying they were just “misled”. They were being paid good money not to just rubber stamp things but actually analyse them. And if that meant at least randomly sampling a selection of loans at their starting point then so be it. The reality is that the guys being paid the big money with the most smarts worked at the investment banks, not the ratings agencies. And so they were outsmarted. Along with the decoupling of risk and reward at the initial loan stage the ratings agencies total failure to just do what they were being paid to do is where the problem lay. To excuse them of their responsibility on the basis that they were hoodwinked is just not good enough. They didn’t do their job. Plain and simple. And the fact that all three have largely escaped the criticism they deserve is nothing short of criminal.
How they are still able to operate as credible “independent” authorities is beyond me.
Colin
:
Hi all
I largely agree with all these subsequent posts. However my major point was simply one of trying to make everyone’s understanding of the GFC a little more complex (and accordingly a little more realistic). Most versions you hear tend to indicate that every single tiny step was stupid and never should have happened. In my view that is utter nonsense. Many of the errors, oversights and miscalculations are in my view easy to understand in isolation. Like most complex systems however where no one is actually in control of it – the confluence of such mistakes tends to produce disasters.
Accordingly I’ve still taken a fairly simple view which naturally draws out all the criticisms pointed out above. My comments on blameworthiness should only be seen as relative and not absolute.
Hindsight bias makes the disaster look inevitable. When you break the causal chains down however most people when placed in the position of making a single judgment call somewhere in the chain with the knowledge they had at the time would either make the same call or understand how the person who did made the error.
Likewise (I like to think so anyway) you would be hard pressed to find any person who if informed of the gross consequences of their part in the crisis would make the same call again.
Deep in the system there was a fundamental mispricing of risk. Furthermore lots of specialists were relying on the opinions of lots of other different specialists without fully understanding the factual underpinnings of those opinions. Likewise generalizations were accepted as facts and insufficient due diligence was carried out.
That said – the actual cost of proper due diligence (ie looking into the majority of securitised loans or leases or whatever other assest) would have precluded many of the deals. In hindsight again its obvious that it should have – but this was taking place in an environment where everyone else was doing it and there was money to be made. Most importantly in these deals, no-one acts for the final stakeholders (note holders) who bore much of the brunt of it all.
The whole system could not see the climate for the weather. It is a typical human failing. I’m really just trying to grey out the generally black and white view many people have :)
Vinny
:
Colin,
Forgive me but I for one am not willing to accept such a sanguine view of circumstances that tries to re apportion the blame between the concerned parties. I do not putport to hold expertise of any nth degree but these are just my gatherings/ rumblings:
“which statistically was inconceivable assuming a normal range of
mortgages”
A smart statistician is the one who is well averted with actually doing the above, claiming something to be inconceivable, hiding/ disclaiming away the liability in a probabilistic fashion.
“Given the actuarial figures, the AAA Banks figured that the swap fee was
easy money”
Easy money bites the hardest in the end. This seems to have held true now as well. They got blinded by the notion of risk-free return instead of risk-adjusted return. I believe even WB has written options over S&P Index maturing 2020 or thereabouts. But he never claims it to be impossible. He always categorized them as improbable, and were they to eventuate being in the money, he is willing to live with that. But he doesn’t claim higher moral ground of having found a mantra to easy money.
“They were (in that respect at least) the innocent ones”
Innocent might not be the appropriate word IMHO. Insurers of natural disasters are figuring out recently that one in 100 year events seem to be eventuating on a routine basis. Should they claim innocence as well on grounds of weather patterns misbehaving? No. They should continue to assess the risk in a more cautious fashion in light of unfolding events and charge premiums accordingly.
“They may well have been somewhat careless plus they may have been cavalier in all kinds of other speculation but on the CDS’s their decisions were rational”
Yes they were rational on grounds that it was their opinion that they were adequately being compensated for risk of writing those premiums. It then follows that it is also completey rational if their guarantees are called upon in not so normal times. Theoretically the written premiums on average over the years should have allowed for payments of these losses. Anyhow, my personal opinion remains that some of these supposedly experts who later cried foul, should really have taken a more sanguine view of the assets they were insuring by having a time frame that lasts a few more decades to take account of the longer term cycles at play (read human behavior)
Lastly, on st dev’s, normality of loss distributions and expected losses, I recall Roger on one of his appearences at Switzer iterating some of his reservations about the theory or validity of it. Real wisdom there in that clip, that rises above the otherwise proclaimed – experts risk assessment tools.
Brad
:
Stock market sentiment can turn on a dime: good read is Buffett’s New York Times piece “Buy American, I am” -November ’08.
“if you wait for the Robbins, spring may be over….”
Jason Drewe
:
Hi Roger
My memory is a little hazy, some weeks ago you stated figures around your investment fund being more or less half invested, I can’t remember the exact percentages. Have you become active lately or are you still waiting for what could be further fall out from the Euro crises taking place? Regards Jason
Roger Montgomery
:
Still not heavily invested at all.
Rob S
:
That’s about it. Add in there everyone in power has been trying desperately to ignore the severity of what has happened and ‘move forward’ whilst denying the core issues.
The one good thing about this multi-generational-sized-deleveraging phase is that the more extreme forecasts for global warming – based on extrapolations of pre-2007 economic growth rates – are now less likely…
Roger Montgomery
:
“multi-generational-sized-deleveraging phase” Nice Rob. Thanks.
Darren
:
Debt to GDP in the USA at the end of 1945 was 121% and Europe was in ruins, now USA debt to GDP is around 96%. From the 50’s to the late 60’s the world had a massive boom and Australia and America had full employment. (my parents told me stories of if the boss p*ssed you off at 10am you could find another job by 2pm).
You can be chicken little if you want but the world will fine. (You will be just paying higher taxes….. Like the wealthy did in the 50’s and 60’s.)
Cheers.
Roger Montgomery
:
Terrific perspective Darren. Thanks for sharing.
Ilya
:
“Debt to GDP in the USA at the end of 1945 was 121% and Europe was in ruins, now USA debt to GDP is around 96%.”
Huge difference Darren, back in 1945 US was the world’s largest producer with a huge trade surplus. Now US is the worlds biggest debtor running massive deficits. Back in 1945 US borrowed to build factories, now they are borrowing to buy junk made overseas and pay off debts.
As an analogy they used to be a gainfully employed bloke with a large debt, and now they are an unemployed bum living off credit cards and past glories.
Brad
:
Or higher prices due to inflation….
Rob S
:
Darren,
‘Debt to GDP in the USA at the end of 1945 was 121% and Europe was in ruins, now USA debt to GDP is around 96%.’
The issue has been a massive housing bubble and bust in the private sector, not the public sector. Many economists will tell you that private debt doesn’t matter, but I think given the last few years we can conclude that most economists got it wrong, and that private debt does matter.
Over the same period (1945 to now) US private debt went from about 45% in 1945 to a peak of 301%, and is now down to about ~255% in the space of 2 years. For context, in the 1930’s, private debt peaked out at 235% of GDP, but most of that debt was in businesses rather than households (which cut prices aggressively to service their debt, and which is why deflation was much larger this time around). This time around we will just see anaemic aggregate demand as long as the debt deflation continues.
Government debt is not a problem as long as you have the ability to print money. The private debt deleveraging is the drain on the US economy that will keep growth low for a good while.
As for Australia, between 1945 and1965, private debt to GDP was stable at less than 30%, before increasing exponentially to a peak of almost 160% in 2008. We are now on the downward slope too, although deleveraging has yet to accelerate as it has in the US. For context, this surpasses the peaks of ~75% in the 1930’s, and just over 100% prior to the 1890’s depression (which consequently lasted ~10 years, and saw the beginnings of the ALP).
Ilya
:
Rob, “Government debt is not a problem as long as you have the ability to print money. ”
That’s like saying your personal debts don’t mater as long as you can write your own checks. That’s true but what if nobody wants to take your checks any more? Then what?
Any currency is only valuable because it is scarce. Print enough of it and nobody wants it. Why do you think US can pull off a trick that everyone from Zimbabweans to Romans failed to pull off?
Darren
:
Thanks Rob,
The point I am trying to make, is at the end of WW2 large parts of Europe and Asia had been destroyed and over 60 million people had been killed, most economist at the time thought the world would descend into another depression because of the large debts, returned soldiers and large numbers of workers no longer being employed making armaments, none of the doom and gloom predictions turned out to be correct.
So while i do agree that people in western countries are carrying to much debt, I point out that now we have 2 billion people in Asia and South America charging towards the middle classes. They will get there and they will want the same things we in Australia have, ie: Nice house, 2 cars per family, 2 TV’s, 2 computers, smart phones, nice schools for their kids and they will want to go somewhere nice for their holidays every year.
So if people want to run around like chicken little, that’s fine, But me, I am sure the world will be more prosperous in ten years time and I will invest accordingly.
Cheers
Roger Montgomery
:
Great points Darren.. Thanks for sharing.
John C
:
I like your perspective Darren – thanks for sharing it. I too continue to invest (about 90% invested), but only in ASX listed companies and most of those (about 75%) have little to no debt. When I consider risk, debt is one of my main concerns within individual companies.
As far as countries are concerned, I leave that up to the economists to argue about. I sometimes get a little worried that the whole world is being engineered towards a one-world-government with a single global currency, and that they (the powers that be) are prepared to accept much collateral damage to occur while they move towards that goal. In fact, more GFC-type-events may assist them is achieving that goal sooner. That is a very cynical and pessimistic view, and it does occasionally cause me to slow down and act with a little more caution. However, whether or not that is actually occurring (as opposed to just being a view being pushed by conspiracy theorists) is a mute point to me, with regard to my investment philosphy. Not investing in good quality underpriced companies in Australia because you think the world’s going to end (as we know it), to me, is like deciding not to have children (for the same reasons). I can’t predict the future. I can only try to assess present conditions. I invest in shares because I believe the returns will (over time) outperform cash-in-the-bank.
One of my main KPI’s of my own strategy’s success is to access my gross dividend yield (from my entire portfolio) against prevailing cash-in-the-bank returns. I have too many individual stocks (over 40), so it takes a bit of time to stay on top of all of them all, and about 10% of them don’t pay dividends at all (HOG, RMS, KRM, although those last two will pay div’s soon), and a few more pay low dividends (ILU, MML, NFK, SRX, ZGL; all should increase over time, especially ILU!), but the majority of the stocks in my portfolio pay good to excellent dividends and the majority of those are fully franked, so my gross dividend yield last FY was 8.3% (including franking credits) and this year is shaping up to be about the same.
As long as I can maintain a GDY above 7%, I’m happy to stay invested in shares, as I’ve got the income stream I desire, and I’ve got the exposure to capital gains at some point in the future if and when the market turns positive. This is obviously enhanced by choosing quality stocks (at discounts to IV) with little or no debt.
The individual company debt issue for me is about companies’ ability to survive rising interest rates and/or external shocks, such as GFC-type-events. I never had any shares in ABC Learning, but I learned a value.able lesson from the demise of Babcock & Brown (BBL; who I bought into years ago when they bought out Alinta). I would never invest in a company like that now. They remind me now of a mini-Macquarie-Bank (but with far more gearing). I can only imagine what Skaffold would have made of BBL if it (Skaffold) had existed back then. Probably a C5.
In summary, I note that there are increasing numbers of Chicken Littles running around all over the place, but I agree with your sentiments Darren, and think that although some people might sleep better at night being 100% in cash, they may not sleep so well if the market rises and they miss it. I don’t think that is going to happen for a while, but I’m not about to sell up (thereby realising losses on about half of my holdings), and wait for it to happen, when I can stay invested and beat the bank deposit rate with dividends.
John C
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3rd paragraph, should read “assess my gross dividend yield” not “access my gross dividend yield”, sorry.
Ilya
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Two ways forward:
A). Swallow the bitter medicine and let the markets liquidate all of the imbalances and malinvesments in the economy. It is clear that the current level of public and private debt cannot be sustained. It is also clear that the welfare state model is all but bankrupt. This will be very tough initially but it is the only way to enable the free market to work properly. The initial pain will be great but it will eventually lead to restoration of a healthy economy.
B). Do what they are doing now – bail out, stimulate, waste, pretend there is some magical easy way out. This seems like an easier option right now but it will lead to a much bigger crisis down the road because none of the imbalances are addressed.
Option A is taking a drug addict to a rehab. Option B is to give addicts more money to buy drugs because it feels good and doesn’t involve the pain of withdrawal.
The past track record of social democratic model is not great. Our populations are accustomed to getting something for nothing at somebody else’s expense. Our politicians are only interested in politically expedient short-term fixes and pork barrelling. It is possible that our leaders will do the right thing, but they will try every other way first.
Roger Montgomery
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“The past track record of social democratic model is not great”. Theres a book called the 23 things they don’t tell you about capitalism…worth a read.
Ilya
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I haven’t read a book but I can get a general gist of it from reading about it on Amazon. There is a huge problem with it as with most of capitalist, free market critique out there. The writers accept that the system we live under is free market or capitalist as intended. It is anything but!
How is it possible in a free market to have a Fed chairman – a commissar – to set interest rates for the entire economy? How is it in a free market Australia we have government and five mining companies decide what the mining tax will be? Privatise profits and socialised losses, a la bailouts? Industry assistance? Green jobs? This is not free market capitalism but corporatism, crony capitalism, special interest capitalism or fascism. Call it what you will, but free market capitalism based on classical liberal ideas has not been practiced in the West since the early last century and we are clearly poorer for it. All our triumphs behind us. Our competitors are catching up and in many cases leaving us for dead.
Right now we have a choice – return back to free market capitalism and let the markets work or continue on our way to serfdom.
Brad
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FOMC sets monetary policy in the US
Tzar got shot in 1917 by the bolsheviks
Ben Bernanke wrote a book about the depression being made worse by government policies of the day; tightening monetary policy, not running defects, increasing tariffs and return in UK to gold standard.
The West can’t save it’s way out of debt: inflation here we come….
Ash Little
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Hey Guys,
Looks like we have a few Austrian Economist converts on the blog,
Good to see
Ilya
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Hi Ash, Austrian school offers a clear and logical explanation of the current mess. Much better than Roubini’s “black swan”, or Keynesian “animal spirits” voodoo.
Austrians like Peter Schiff are also on record in predicting and sounding the alarm about the coming crisis before it actually happened. Schiff took so much flack and ridicule for his predictions, unlike so many “experts” that sprung up after the fact with a benefit of 20/20 hindsight.
Ilya
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Brad, I agree. There is absolutely no way to pay off the debts. Inflation is more politically expedient than default, so inflation we will have.
Inflation is default by another name. With default you don’t pay your creditors some or all of what is owed, with inflation you pay them with currency of diminished or no value. The inflation is worse though because it also destroys the purchasing power and savings of the citizens in the process.
Thomickers
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usually authoritarian governments get “economic development” right if there is a foreign/national rival (ie south korea vs north korea, singapore vs malaysia, taiwan vs china). If there is no natural rival, authoritarian governments are likely to get economic development really wrong (ie african nations, indonesia under suharto).
Social democratic governments (welfare states) have been good up until the nation experiences “many cultures”. Once there are many cultures, governments need to let more free market capitalism sort things out otherwise, you get serious racial/social division. Also because Europe has experienced “social unity” with no rival/predator for decades, most democratic leaders have been “playing politics” with capital instead of using policy to further enhance capitalism.
ANTHONY SCELZI
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So true. I think debt collectors are the only winners..Maybe a good time to buy shares in credit corp
Roger Montgomery
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While the share price may swing about and perhaps even down more than up, Credit Corp may indeed be worth investigating.