Monday, 31 May 2010

Capital Gains tax: buy-to-let investors must tear up retirement plans

Capital Gains tax: buy-to-let investors must tear up retirement plans

Britons relying on buy-to-let investments as their pension funds will have to tear up their retirement plans and start again, experts warned late last night.

By Myra Butterworth, Personal Finance Correspondent
Published: 12:01AM BST 28 May 2010

According to Savills' new annual forecast, house prices will fall 6.6pc in 2010

The tax rise is a fresh blow to more than a million Britons with buy-to-let mortgages who saw heavy falls in their investments amid the housing slump

The rise in tax paid on capital gains from its current level of 18 per cent will badly hit these investors when they come to sell their properties.

It means those near retirement will receive much lower returns than they were expecting if the Government increases the rate to 40 per cent or even 50 per cent, and will have to continue working later than they expected.

Jonathan Cornell, of mortgage brokers First Action Finance, said: “Clearly anyone that is hoping to fund their retirement from their buy-to-let portfolio would have taken capital gains tax into account. But they had better rip up those calculations and start again as their fund value will be decimated.”

It is a fresh blow to more than a million Britons with buy-to-let mortgages who saw heavy falls in their investments amid the housing slump.

Average values dropped more than 16 per cent during the financial meltdown in 2008, and even though they have since risen as Britain emerges out of the recession, current prices are still at 2005 levels, according to the latest house price index by Halifax.

Andrew Montlake, or mortgage brokers Coreco, said: “With the buy-to-let property boom during the past decade, many people switched their pension funds out of the stock market and into bricks and mortar. But with the rise in the capital gains tax, they will be hit hard and will no doubt feel let down by the Government.

“They’ll now have to be revisiting their retirement plans and considering their next steps. They made sensible investment decisions and are now being penalised.”

Accountants said it is “inherently wrong” to tax such investments at the same rates as income tax of up to 40 per cent or 50 per cent.

Mike Warburton, of accountants Grant Thornton, said: “It is one thing putting up tax rates, but it is fundamental unfair for inflationary gains to suffer tax at income tax rates.

If someone has invested in shares or property over a long period of time, a significant part of that gain is going to be inflationary. It is inherently wrong to tax that gain at income tax rates. Politicians need to be aware that this is an issue of fundamental fairness - as emphasized at the start of the Queen’s speech.”

Property investors are also suffering from a drought in mortgage finance with lenders restricting the best deals for those with a significant deposit.

The tough situation will force some investors to sell their properties while the lower rate is still in place.
Jeremy Leaf, a spokesman for the Royal Institution of Chartered surveyors, said: “The prospect of higher capital gains tax on the sale of property may in the near term encourage some existing landlords to take advantage of the current more benign tax regime.”

Gold bulls claim price could double to $3,000 in five years

Gold bulls claim price could double to $3,000 in five years

Fears that American, British and other governments intend to inflate their way off the rocks of excessive debt prompted record inflows into gold this week.

By Ian Cowie
Published: 7:35AM BST 20 May 2010

Now some fund managers claim the price could more than double to $3,000 (£2,080) per ounce within five years.

Heavily indebted governments throughout the developed world are struggling to fill deficits of black-hole dimensions in public finances by imposing spending cuts and tax rises. Both are expected in Britain's emergency Budget on June 22 and neither will be popular.

But keeping interest rates lower than inflation and letting the currency take the strain is another way to reduce the real value of debt. You can see why politicians may feel that is the ''least worst'' option.

Stealthily robbing savers by eroding the purchasing power of money is less likely to cause riots in the streets than spending cuts, because inflation tends to hit older people hardest while unemployment hits the young.

Governments can devalue their own currencies, but it is harder for them to make more gold. That fact helped prompt record inflows of $484m (£336m) into gold exchange-traded commodities this week, while gold trading volumes peaked at $2.1bn (£1.45bn).

However, the precious metal is not a one-way bet and it slipped back below $1,200 (£830) on Thursday as some investors took profits amid anxiety about an unsustainable bubble in the gold price.

Graham French, manager of the M & G Global Basics Fund, was undeterred. He said: "In a scenario of rising sovereign risk, where government finances are hugely overstretched and central banks have been systematically devaluing paper money, gold's value as a safe haven and a stable physical currency can only increase over the medium term.

"Against this backdrop, the gold price could go much higher than these already elevated levels. It wouldn't be too far fetched to see it rising above $2,000, or even up to $3,000."

Mr French's strategy is based on the belief that things that emerging markets sell will fall in price over the next five years, while things that emerging markets buy will rise in price.

The explanation is that demand from the heavily indebted developed world may remain subdued, while demand from largely debt-free consumers in emerging markets will rise.

Rupert Robinson, chief executive of Schroders Private Bank, said: "Gold is setting record highs in almost every currency, despite headwinds including a strong dollar and monetary tightening in India and China, the main end markets for gold. Today's economic environment makes gold a must in any client portfolio.
"Interest rates are at historically low levels; central banks are bailing out the system; we have seen a huge amount of quantitative easing; currencies being debased and governments around the world are short of money.

Nothing goes up in a straight line, indeed there are signs that gold may be becoming over-owned and too fashionable in the short term, but I think that over the long term gold is a good asset to hang on to. It could easily reach $2,000 per ounce within the next five years," Mr Robinson said.

Richard Davis, of BlackRock's Natural Resources team, added: "Gold always does well in times of uncertainty, and this week is no exception. Lingering concerns over the Greek bail-out, uncertainty over global economic growth, and an inconclusive election result in Britain have all created nervousness in stock markets, and risk-averse investors are looking to gold as a store of value.

The fact that gold bullion is a real asset, which does not depend for its value on any company or government, makes it compelling as a 'safe haven' investment. Gold bullion is particularly popular in Asia and the Middle East and investors in these regions have continued to pile money into the asset class.

"It is worth noting that, adjusted for inflation, gold is still some way off its all-time high of $850 per ounce in 1980, equivalent to more than $2,200 in today's terms."

Adrian Ash, of, said: "Inflation alone is not the driver. It's real interest rates that matter, because if cash is beating inflation, no one needs gold. Whereas when cash loses value, year after year – and if the major productive alternatives, such as bonds, shares and property, also fail investors as well – then gold really comes into its own.

"Cash is being actively devalued – and not just in Britain; the Eurozone crisis is only the latest prime mover. Underlying the decade-long upturn in gold is a repeated attack on the virtue of savings," Mr Ash said.

Gold's fundamental appeal remains that it is a store of value that is largely immune to government intervention.
Mr French observed: "The great Irish dramatist George Bernard Shaw said: 'You have to choose between trusting the natural stability of gold or the natural stability and intelligence of members of the government. And with due respect to these gentlemen, I advise you, as long as the capitalist system lasts, to vote for gold.' I have to say, I'm with Bernard Shaw on this."

MPC's Adam Posen warns Britain at risk of Japan-style deflation

MPC's Adam Posen warns Britain at risk of Japan-style deflation

Britain is at risk of sliding into a Japan-style episode of deflation, and may be even worse-equipped than the Asian country to escape, a Bank of England policymaker has warned.

By Edmund Conway
Published: 8:45PM BST 24 May 2010

Adam Posen, a member of the Bank's Monetary Policy Committee, said that although Britain and the US were unlikely to face repeated recessions, in many senses their plight was "scarier" than Japan's. The warning is of particular significance because Mr Posen - an American economist - was recruited to the MPC partly because he is a renowned Japan expert.

In speech at the London School of Economics, he said: "The UK worryingly combines a couple of financial parallels to Japan with far less room for fiscal action to compensate for them than Japan had."

Britain faces an uncomfortable trio of obstacles, none of which faced Japan in the 1980s or 1990s.

  • Unlike Japan, Britain has to sell a large proportion of its debt to overseas investors, who are more likely to exit the market if they become scared of Britain's fiscal prospects. 
  • The UK also faces the challenge of having to boost a troubled manufacturing sector if it is to recover sufficiently. 
  • Unlike Japan, it does not have the luxury of having a worldwide market with a large and growing appetite for exports.

He also warned that the banking system's continued troubles would undermine companies' abilities to raise funds, and pointed out that businesses already appeared to be hoarding savings - something which happened in Japan.

Using a film analogy, Mr Posen said that it was possible that there could be UK "remake" of the Japanese episode.

"Unfortunately, the ironic twist for this upcoming film is that in some ways the remake might be scarier than the original. That risk arises not only because the original Great Recession was not quite so scary as previously thought on close viewing, but because Japan actually had various resources with which to manage its situation while the UK and other economies are not similarly endowed, even if some Japanese policymakers failed to take advantage of them."

The warning may come as a surprise to some, since last week the Office for National Statistics revealed that the Retail Price Index measure of inflation had risen to an 18-year high of 5.3pc. However, there is a growing number of economists who fear that the current relapse of financial stress could spark a global double-dip recession.

Andrew Roberts, credit strategist at RBS, said last week that the world could be heading for Great Depression II. Albert Edwards of Societe Generale expects some years of deflation, followed by hyperinflation as countries monetise their deficits.

Euro crisis: how the experts are positioning their portfolios

Euro crisis: how the experts are positioning their portfolios

Markets have become more volatile in recent weeks, but many fund managers have ruled out any possibility of a full-blown stock market crash.

Published: 3:05PM BST 29 May 2010

However, the eurozone crisis is worsening and many analysts are predicting a double-dip recession and further market falls.

No one can predict what will happen but the best way to avoid boom-and-bust cycles is to make objective investment decisions that ignore fashions. We talked to the leading portfolio managers to see how they were mixing their assets.

We fear that Greece is merely the canary in the coal mine and there is, sadly, considerable potential for more social unrest in some European countries. We therefore have very limited exposure to European equities right now; but while the West has suffered from over-indebtedness, developing countries such as China and India continue to produce impressive economic growth.

This is why our Jupiter Merlin portfolios have significant exposure to Asia and Latin America, via Findlay Park Latin America and First State Asian Equity Plus. In such an uncertain environment, we believe that we should retain an element of insurance in our portfolios.

All our portfolios have what we deem to be sensible exposure to both gold, through a Physical Gold exchange-traded fund (ETF), and the US dollar through Findlay Park US Smaller Companies and Jupiter North American Income funds.

Our central expectation is that markets will stabilise temporarily but that recent euro troubles will reassert themselves over the summer. We are taking a cautious approach. We have been at our minimum allowable weightings in European equities, using defensively positioned funds such as the Ignis Argonaut European Alpha Fund and the BlackRock European Dynamic Fund.

We have also been hedging our euro exposure back into US dollars to prevent potential currency losses together with tactically selling Euro Stoxx futures to reduce the underlying market exposures in our portfolios. The currency and market hedging reflects efficient portfolio management but, most importantly, helps to protect our clients' money.

But the volatility of the past few weeks need not be a cause for panic. Pullbacks present potential buying opportunities and the number of companies beating earnings expectations could help to balance concerns about sovereign debts.

Weakness in the euro is beneficial to European exporters and any further setbacks to markets will leave European equities attractively valued. We will look to buy funds with exposure to high earnings revisions, exposure to industrials and minimal weighting to peripheral Europe.

We have been positioned for further malaise in markets. We felt that the backdrop for markets was deteriorating as valuations were reflecting a benign environment, whereas the weakness earlier in the year showed that there remained some stress in the financial system.

The Cazenove Multi-Manager Diversity fund has a cash position of 20pc and defensively positioned equity funds (Invesco Perpetual Income fund, JO Hambro UK Growth), and we have reduced the exposure to long biased hedge fund strategies in favour of funds where the manager was positioning for equity declines (Jupiter Absolute and the Eclectica Hedge fund).

Additionally, currency concerns relating to the euro saw us have a position in gold and other assets denominated in US dollars, as these typically do well in times of stress.

We are aware that markets have moved strongly, targeting the European equity market and the euro in particular. This will present an opportunity to buy cheap assets once the fear causes irrational selling, but we do not feel we are there yet.

Financial crisis has left China stronger, says HSBC head

Financial crisis has left China stronger, says HSBC head

The chief executive of HSBC in China has said the financial crisis has only made the country stronger, with its exporters becoming leaner and more efficient.

By Malcolm Moore and Adrian Michaels in Shanghai
Published: 7:30PM BST 30 May 2010

"As demand comes back, people are going to find that China has a better and more efficient export machine," said Richard Yorke, who has presided over a dramatic expansion plan for the bank on the mainland since 2005.

The Government's decision to pour an additional 7 trillion yuan (£70bn) of new bank loans into the economy last year, coupled with 4 trillion yuan of stimulus cash, allowed China's exporters to invest in new plants, many of them inland where costs are lower. The stimulus cash also paved the way for vast improvements to China's road, rail and port infrastructure, further cutting costs.

Mr Yorke said China's exports were poised to bounce back so strongly that the country could take an appreciation of the renminbi in its stride. "The currency can go up because costs have gone down.

Manufacturing inland means low or no housing costs and lower wages."

Chinese policymakers have remained cautious about the outlook for exporters, especially given the concerns over the eurozone, which is still China's biggest foreign market, accounting for 25pc of overall exports once the shipping routes through Hong Kong are factored in.

In March, China ran a $7.2bn (£4.9bn) trade deficit, although this was mostly due to the timing of the Chinese New Year holiday on factories and reversed to a $1.7bn surplus again in April. Mr Yorke said HSBC was continuing to build its China business, 70pc of which is presently made up of offering banking services to foreign multinational companies. However, he said that the mix of loans that HSBC is offering is shifting away from manufacturers and towards retailers, property developers and companies selling consumer goods as China moves into the next phase of its development.

He confirmed that HSBC is now looking for a joint venture with a Chinese partner that will allow it to trade securities. As Shanghai moves to become a major financial centre, Mr Yorke said the government would "continue to deregulate" the financial system "but sensibly". "The country is managed extremely well and has a very competent central bank," he said.

He also took a swing at the various Western banks, including Royal Bank of Scotland, which have sold down their stakes in Chinese financial institutions. "You cannot change your China strategy every quarter," he said.

Euro crisis: how will it affect me?

Euro crisis: how will it affect me?
What caused the European debt crisis, how long will it last, and how worried should Britons be?

By Paul Farrow
Published: 2:26PM BST 29 May 2010

Europe is in crisis. Austerity measures have been announced in several countries including Greece and Spain, the euro is under pressure and stock markets across the globe have fallen sharply from their recent highs – and it is all due mainly to sovereign debt.

But what is sovereign debt and why has it caused a crisis? And should people in Britain be worried?

We have spoken to the experts to help answer these questions.

Q I keep hearing about sovereign debt. What is it?
National governments issue bonds as a way of borrowing to help meet their spending on education, health, defence and so on. Just like any bond, a sovereign debt bond pays investors interest over its term and the bondholder gets his money back on maturity. In Britain, these bonds are better known as gilts.

Andy Howse, investment director for fixed income at Fidelity, said: "The promise to repay is not a guarantee. The strength of the promise is a function of the size of the debt compared to the economy in question and the cost of servicing that debt. This can change over time and between nation states."

Q What has caused the debt crisis?
In a word or two, over-borrowing. Sovereign debt is fine so long as the governments have no problem repaying the debt. But several countries have borrowed beyond their means – the ramifications of the financial crisis have left them struggling to repay their debt. This is why the IMF has agreed a financial package to bail them out.

"Greece and other countries will struggle to pay off these debts. This has led to a dramatic spike in borrowing costs for these countries, exacerbating the problems further," Mr Howse added. "Investors have begun to question the future of European Economic and Monetary Union and whether the crisis may spread beyond the peripheral European countries."

Q Which countries are affected?
Before last week the main countries that had been affected were Greece, Italy and Portugal. Last week it was the turn of Spain to announce austerity measures, while Ireland has problems too, although it is trying hard to cut its deficit.

Q Will it spread to Britain?
Only Rip van Winkel would be unaware that the UK also has a huge deficit, and so there are concerns that the crisis could spread to these shores. This was why the new coalition moved swiftly by announcing £6bn worth of cuts. This has assured investors, for the time being, that Britain will be able to reduce its deficit and repay gilt investors.

"We have more flexibility and it was very important for George Osborne to reassure global markets that our deficit is being tackled," said Azad Zangana, European economist at Schroders.

Mr Howse agreed: "A weaker pound should boost the economy by making exports more competitive, and interest rates should remain very low for an extended period. But we can't ignore this debt crisis in Europe because of the effect it may have on the level of global economic activity."

Q Should I be worried?
The good news is that Britain has some advantages over the likes of Greece and Spain. The main one is that it does not belong to the euro and so is able to manipulate the pound to try to boost our economy via interest rates. "We can devalue our currency, which makes the borrowing cheaper. Greece can't do that because it belongs to the euro," said Mr Zangana.

But don't get too complacent. Britain's position is still precarious – £6bn worth of spending cuts won't be enough to clear our £156bn deficit, and remember that our economy is reliant on its trade links to Europe. "The UK is in a relatively good position. It can set its own interest rates and has its own floating currency, which are important mechanisms for managing economic growth," said Mr Howse.

"However, the UK is not insulated from debt problems and it is in our interest that the crisis is contained and managed by the EU, IMF and other central banks."

Q How big an impact could the crisis have on the UK?
Half of all of Britain's exports go to the Continent, so if Europe's economy grinds to a halt we will feel the impact. Companies could struggle to increase sales, our economic recovery could hit the buffers and, ultimately, jobs could come under pressure.

Howard Archer, an economist at Investec, said: "There is increased pressure on Britain. The FTSE has been hit already, there are concerns of a double dip, and it's bad news for exporters, which could have a knock-on effect of the wrong kind on our domestic economy.

"The June 22 Budget is key. If the measures don't work there will be a loss of confidence in UK assets and that could store up other problems such as higher interest rates."

Q What about my investments?
You won't need reminding that every time a dark cloud hangs over our economy, or the economies of our trade partners, stock market investors run for the hills, causing share prices to fall. This is what has happened over the past fortnight or so – the FTSE100 has tumbled from 5,700 to under 5,000, although this week share prices recovered despite the eurozone crisis worsening.

But, again, don't be complacent. Most experts agree that markets are likely to be jittery for a while yet.

Q Is there a danger of a second banking crisis?
This is something that the markets have been speculating over during the past few weeks. Greek, Spanish and Italian bonds are widely held by governments, banks and institutions worldwide and this is why bank shares have been particularly hit in the recent turbulence.

Mr Howse said: "Central banks and governments have learned tough lessons from the financial crisis of 2008/09 and are very unlikely to let these problems go so far as to break the global banking system."

Q I bank with Santander. Should I move bank accounts?
Santander recently emphasised that its British operation is self-funding, raising cash from British savers to back loans to British borrowers, and does not require capital from its Spanish parent. Santander's British subsidiaries are regulated by the Financial Services Authority and individual savers are protected by the Financial Services Compensation Scheme.

The FSCS, a statutory safety net, can pay out 100pc of the first £50,000 lost per saver per bank or building society. Up to 90pc of pension and life assurance savings are also protected by the FSCS safety net.

A Santander spokesman said: "Customers need not be worried as both Santander and Santander UK are strong businesses focused on retail banking with no exposure to toxic financial products. Our UK business is strong and has a standalone credit rating of AA."

Q Will the crisis go on for much longer?
Most likely. The Greek bailout is over three years, which suggests there is no quick fix. "I think we will have a bumpy ride for a few years. There is a real sense of uncertainty on how this crisis will pan out," said Mr Zangana.

Mr Archer added: "It is very, very fragile and the eurozone crisis is deep-seated and so will not disappear overnight. We need the bailout package to be implemented as soon as possible and for the affected countries to get their act together."

Q I'm worried about losing money. What should I do?
Fund managers will talk about market blips throwing up buying opportunities while economists will make predictions that are wrong as often as they are right. It comes down to your attitude to risk and your financial goals.

It's your money and if you are of nervous disposition then invest in safe assets. The safest is cash, of course. Interest rates are low but ask yourself whether you would rather make 2pc or risk losing 10pc.

Review any investments and ensure that your portfolio is diversified for damage limitation reasons if markets implode.

Kenmark shares halted as MD goes AWOL

Kenmark shares halted as MD goes AWOL

By Lee Wei Lian May 31, 2010
KUALA LUMPUR, May 31 — Shares of furniture maker Kenmark Bhd were suspended after they sank this morning as news that its managing director went absent without leave spread in the market.

In a response to a query from Bursa Malaysia, Kenmark said only two independent directors of the company were present during the company’s audit committee meeting on May 27 to discuss the company’s fourth quarter results and that managing director James Hwang, a Taiwanese, has not been contactable since last Tuesday.

Kenmark also said that the independent directors discovered at the audit meeting that key company executives, including deputy general manager Goh Kim Chon as well as the finance and administration manager, have also resigned.

The May 27 audit committee meeting could not proceed as there was no representation from the management, and the fourth quarter results that was to be discussed was not made available. The independent directors subsequently tried to contact the MD on his mobile phone but were unsuccessful.

Attempt to contact the Hwang and the other executive directors at the company’s Taiwan office via the telephone and fax also failed.

Kenmark shares had fallen 19 sen to 14 sen by 9.15am and dropped another 3.5 sen before being suspended at 10.10 am. Trading in the shares will resume tomorrow.

The independent directors, Zainabon Abu Bakar and Yeunh Wee Tiong, had on the morning of May 29 gone to Kenmark’s premises at Port Klang. There, they noted that the premises had been sealed and a security guard placed to secure the premises.

Former Kenmark executives informed the independent directors that EON Bank Berhad (EBB) has been notified of the situation and EBB had, on May 27, placed their security guard at the premises. EBB will also be appointing a receiver over the assets of the company.

Kenmark Paper Sdn Bhd, a wholly-owned subsidiary of Kenmark, received a letter today from EBB’s solicitors, dated May 28, advising of the appointment of a receiver.

Kenmark’s website states that the company was incorporated on Sept 15, 1988 and was listed on the Second Board of the KLSE on Nov 3, 1997, before transferring to the Main Board on Sept 3, 2001.

The website also states that part of the manufacturing facilities have been moved to Vietnam.

The independent directors will now make an appointment to meet with Bursa Securities today and said that they were willing to co-operate with all parties concerned.

Capital Gains Tax: Uncertainty causing panic among private investors

Capital Gains Tax: Uncertainty causing panic among private investors

Stockbrokers are being "overwhelmed" with calls from worried and confused investors.

By Ian Cowie
Published: 12:05AM BST 30 May 2010

Stockbrokers are being "overwhelmed" with calls from worried and confused investors unsure what to do about the threat of a rise in Capital Gains Tax to 40pc.

The Coalition Government has said that it intends to increase the rate of CGT in line with income tax, but it has been scant on detail about which non-business assets will be caught in the net and whether there will be any relief to take inflation into account.

There are concerns that any tax rise and reduction in CGT allowances will hurt the small shareholder the most, rather than wealthy "fat cat" speculators. According to HM Revenue & Customs' own statistics, more than half, or 53pc, of all the people who paid CGT in 2008 – the last year for which HMRC has published figures – did so on gains of less than £25,000, a sum equivalent to the national average wage.

As a result, these 130,000 investors paid a total of £211m in tax or just 3pc of total CGT revenues from individuals that year. About 17,000 people declared gains of less than £10,000 before deduction of the current CGT annual allowance of £10,100 – and they accounted for 0.8pc of gains.

By contrast, more than 80pc of all individual CGT was paid by people declaring gains of more than £100,000 each. About 2,000 individuals declared gains of more than £1m each and paid a total of more than £2.9bn in CGT.

Charlotte Black of Brewin Dolphin, the private client investment manager, said: "We are being overwhelmed with clients calling for advice – particularly those approaching retirement, for whom this might destroy their plans to be self-reliant in their old age. We are deeply anxious that any rise in CGT is done without penalising small investors and savers and treating them like get-rich-quick merchants."

Gavin Oldham, the chief executive of the Share Centre, said: "We've had lots and lots of calls from worried small shareholders. Spread-betting is the mighty anomaly in this. This will take money out of the stock market and put it into the pockets of the bookies as gains on spread bets are not liable to CGT."

The Telegraph is calling on the Prime Minister to protect the savings of small investors and second home owners from the rise in CGT. While we support the Government's efforts to cut the deficit, we fear that changing the rules on CGT will hit those who have prudently saved by investing in property or shares.
Ms Black added that investors were confused and that the rise would damage their ability to manage their portfolios efficiently. She cited the National Grid rights issue as a case in point.

"Removing the annual exemption will hit small investors who put their money directly into shares, but choose to sell their holdings in one company and buy in another for portfolio management reasons e_SEnD or, for example, to take up the current rights issue at National Grid," she said.

"They will be effectively locked into holdings, making the market less fluid and reducing the ability of individuals to manage their investments. Or they may feel forced to use more expensive investment vehicles such as offshore bonds, which are not subject to CGT."

Amid rising concern about the unintended consequences of the proposed changes, the Association of Private Client Investment Managers & Stockbrokers (Apcims) has written to George Osborne, the Chancellor of the Exchequer, asking him to consider small investors before he acts in next month's emergency Budget.
The association said the proposals seemed to be "unfair and discriminatory against small shareholders".

In particular, Apcims has urged the Chancellor not to cut the CGT allowance. The Government proposes to raise the rate of CGT from its current fixed 18pc to a level closer to individual investors' top rate of income tax; this could raise CGT to 40pc or 50pc. The Liberal Democrat manifesto said the allowance or starting point for this tax should be cut from £10,100 to £2,000.

John Hall, Apcims' chairman, asked the Chancellor to balance any increase in the rate of CGT with reliefs to reflect the illusory element of gains comprised by inflation. He said: "The impact falls particularly heavily on the smaller individual investor who is more likely to be a longer-term investor than a professional.

He added that experience showed that higher rates of CGT resulted in lower revenues, as investors either used avoidance strategies or simply decided not to sell.

This is the conclusion from the Adam Smith Institute. Its study The Effect of Capital Gains Tax Rises on Revenues states: "Capital gains tax rates in the USA have changed considerably up and down in recent decades and provide a rich seam of data with which one can come to solid conclusions on the revenue effects of such changes.

"The current policy debate in the UK is being conducted amid a remarkable absence of facts. Policy-makers need to proceed carefully and ensure they take an evidence-based approach in order to avoid unforeseen negative consequences of rushed, ill-informed decision-making.

"The pattern shows that every time capital gains tax has been cut, CGT revenues have risen. Every time the tax has been raised, revenues have fallen."

Experts agree that while the pressure is on the new Government to come up with ways of squeezing extra tax revenue from all available sources, there is a danger that we will see a series of short-term decisions on CGT that could have unintended consequences for small investors, owners of second homes, buy-to-let landlords and business entrepreneurs.

Jayne and John Symons (pictured) own shares and a buy-to-let investment to help fund their retirement. Mr Symons said: "It is very difficult to plan ahead, but when the Government changes the rules so drastically, it is even harder. We could end up having to work forever."

Richard Mannion of accountants Smith & Williamson pointed out that CGT was never going to be a huge money spinner for the Government, so its main purpose was probably in completing the range of taxes in order to prevent leakage of income tax. He said: "The most difficult policy areas are arguably the treatment of business assets and the private home. Should business assets be liable at a lower rate of tax and if so how best to accommodate that policy?

"Should private homes be liable to tax? The lack of tax cases on the subject over recent years suggests that the present system for dealing with private homes works and so one would recommend the 'if it ain't broke, don't fix it' principle.

"We need to have a CGT system which is as simple as possible and which will last to provide certainty for all."

Beijing in a sweat as China's economy overheats

Beijing in a sweat as China's economy overheats

China is struggling to contain the threat of an overheating economy in the face of rising house prices, inflationary wage increases and a continuing surge in money supply, the head of the country’s second-largest bank has warned.

By Peter Foster and Adrian Michaels in Beijing
Published: 8:40PM BST 30 May 2010

China is contending with a continuing surge in money supply

Guo Shuqing, chairman of China Construction Bank, said that the latest figures for China’s M1 money supply – a key predictor of inflation – had raised concerns that the country’s vast stimulus and bank-lending was running too hot.

“I saw the figures for last month and M1 is still very high, increasing 31pc from last year, which is one per cent higher than last month,” he said in an interview with The Daily Telegraph.

“We are seeing a lot of money coming to China which is creating a current and capital account surpluses.”

China’s regulators have introduced a raft of measures in recent weeks in an attempt to cool down the economy, forcing banks to raise the capital adequacy ratios and hitting second home buyers with regulation designed to drive speculators out of the property market.

However, Mr Guo warned that the effectiveness of measures to cool house prices, which have risen by up to 40pc this year in some major cities, could be blunted by the massive reserves of cash still being held by private developers. “Sales are falling but prices are not,” he said.

“Developers have a lot of cash, so they’re not too concerned at the moment.”

“Property prices are definitely seeing something of a bubble, but it differs from city to city. You can see prices going very high on the coastline, but in the inland areas and western areas, even in provincial capitals, it’s still not so high.”

China has moved quickly to apply the brakes after first quarter figures showed the economy expanding at 11.6pc year-on-year, driving down sentiments on the country’s benchmark Shanghai index, which has fallen 27 per cent this year.

However, while loan growth is slowing from 2009, huge amounts of fresh loans continues to pour into the Chinese economy with the total outstanding loans still growing at a rate of 18pc this year.

After issuing 10 trillion yuan (£1 trillion) of new loans in 2009, Chinese banks are targeted to inject another 7.5 trillion yuan this year, a reduction but still nearly twice the 4.6 trillion yuan of the loans disbursed in 2008.

Mr Guo warned that the continuing splurge in lending also raises the risk of a sharp rise in non-performing loans among smaller Chinese banks that have funded local government infrastructure projects, often of dubious viability.

“I think that small banks last year newly issued loans grew even fast, some even doubled their liability and assets,” Mr Guo said.

“At the moment the banks seem healthy but I think that small banks, because we don’t know the structure of their assets, maybe have got more risk exposures because they are growing too fast and their risk management is not as good as big banks.

“And secondly because they are very small and their loans are going to a more concentrated number of customers, that also could definitely cause a problem.”

Mr Guo added that with such massive stimulus Chinese inflation, currently running at 2.8pc, was at growing risk of rising. Almost all the coastal provinces that make up China’s manufacturing heartland had granted wage increases averaging 20pc this year.

Analysts add there is an increasing anecdotal evidence to suggest that China’s official inflation figures do not reflect the true pace of price rises being felt by people on the ground. The price of some foodstuffs is up 20pc this year.

Tom Miller of the Dragonomics consultancy in Beijing said: “The Chinese government recently mooted that food subsidies be handed out to rural low-income families, which is a sure indication of the government’s true concerns on inflation.

“The last time the government took that kind of measure was in April 2008 when consumer price inflation hit 8pc for three months running, which suggests the government knows that real inflation is higher than the official numbers suggest.”

The growing inflationary strain has increased pressure in the country for a rise in interest rates, a tool that China’s central bankers have been reluctant to use for fear of damaging exporter competitiveness and piling more burdens on the loan bills of already over-stretched provincial governments.

However, Lu Feng, professor of economics at Beijing University, said that time was running out for China’s monetary authorities to act.

“Although the Chinese government’s efforts to control inflation are impressive, the prospects for fighting this inflation without effectively addressing the problems of loose money are not very encouraging,” he wrote this week on

“In order to control inflationary pressures effectively, China needs to use the policy instrument of interest rates as a matter of urgency.”

Hoping for a debt crisis end

Hoping for a debt crisis end
May 29, 2010

After US stocks wrapped up their worst month in more than a year, investors will face next week with caution as things are unlikely to get better until the Europeans force their debt crisis to an end game.

A Fitch Ratings downgrade of Spain on Friday drove the three major US stock indexes down 1 per cent for the day. For some investors, Fitch's decision highlighted the need for the European Central Bank to come up with stronger response to the debt crisis before stocks will be able to rally.

The first wave of May US economic data next week could bring what investors fear most: signs that shock waves from Europe are crossing the Atlantic. That would probably show up first in the two monthly ISM surveys, seen as an early reading of the US economy's pulse.

If those reports - based on statements from purchasing and supply executives in the manufacturing and services sectors - are weak, it will come down to a strong May US nonfarm payrolls number on Friday to help investors keep their faith in the US recovery.

"All of the macro data is going to be seen through the prism of Europe," said John Praveen, chief investment strategist at Prudential International Investments Advisers in Newark, New Jersey. "You've had this huge problem in Europe. Is there any fallout from that on US economic data?"

Investors also need to watch for negative earnings pre-announcements. Shares of a tiny IT company called Blue Coat Systems Inc plummeted on Friday after it cut its outlook, citing Europe's turmoil, while retailer Guess Inc fell after it said the weak euro would hurt profits.

On the bright side, market technicals may favour a relief rally - providing there is no bad news.

Chart-minded investors say stocks are oversold, with the Standard & Poor's 500 Inde down below its 200-day moving average.

Carmine Grigoli, chief US investment strategist at Mizuho Securities in New York, also points to the widening spread between the number of S&P 500 stocks advancing and declining.

"The market (is) deeply oversold, actually almost the most oversold condition we've seen since the height of the (financial) crisis," he said.

In May, the S&P 500 fell 8.2 per cent in its worst monthly slide since February 2009, the month before the broad-based index hit a 12-year closing low. The Dow industrials lost 7.9 per cent in May, while Nasdaq tumbled 8.3 percent.

The sharp drop marked the worst May for the S&P 500 since 1962 - and the worst for the Dow since 1940. It also called to mind the old stock market adage: "Sell in May and go away."

Prudential's Praveen believes that despite slight gains in the last week of May, the US stock market won;t make significant progress until the European Central Bank steps up its purchasing of government debt as the US Federal Reserve did early last year.

"The end game in this European crisis, at least for the near term, is going to be if the ECB comes up with some kind of quantitative easing package," Praveen said.

After an initial bounce, stocks have fallen further in the three weeks since the EU approved a $1 trillion safety net for indebted nations, with financial markets unconvinced that the measures are sufficient to avert the spread of the crisis.

The export and new orders components in the Institute for Supply Management's surveys on the manufacturing and services sector could show early signs that weakness in Europe may be affecting the United States.

"There is a presumption that all the turmoil in Europe and the global financial markets is going to have a negative impact on the US economy," said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut.

The ISM manufacturing index is due out on Tuesday, the first US trading day in a holiday-shortened week, with Monday a public holiday, while the ISM services index is due on Thursday.

"If the data hold up pretty well, it's going to be a bit of a challenge to the view that the US economy is going to falter, but probably won't convince the most skeptical of people," Stanley said.

The employment index in the ISM surveys can also be an indication of how Friday's payrolls number will shape up.

The headline number in the government's monthly jobs reports will be clouded by temporary Census workers and investors will likely focus on the ADP's private-sector payrolls number for a better indication of how underlying employment trends are shaping up.

"If that is north of 250,000, then the markets will react very positively," Praveen said. "If that number comes out on the weaker side, even though the headline number may be flattered by the Census number, then we will probably have some anxiety in the markets."

The payrolls report is due out. Economists in a Reuters poll expect the headline number to show the economy added 503,000 jobs in May.


The process of deciding to sell a stock is a difficult one unless an investor has developed a methodology.

The process of deciding to sell a stock is a difficult one at best unless an investor has developed a methodology and adheres to it mechanically in order to avoid inevitable internal mental battles.  

When a loss is involved, the sell decision is even more difficult because the issue of pain-avoidance is now present.

It is human nature to seek self-preservation, and pain is a phenomenon that indicates a danger to well-being.

Some investors are obsessed with safety, but most are reasonably balanced in their tolerance of the risk involved in earning a profit.  But every investor has some threshold at which pain is avoided, sometimes at ridiculous cost.  

Dealing with an investment or trading loss involves not only financial pain, but also ego pain.  A majority of shareholders at some point attempt to avoid both pains by failing to deal with the reality of their losses.  

One of the most convenient ways to avoid the pain of loss - or even of profit squandered - is denial.  They prefer not to think about it, or they minimize it.  

When specific stock positions go bad, the pain-avoider becomes a longer-term holder who is more accurately a collector of stocks.  He has no real investment motive or astuteness of value judgement and is, in fact, simply denying the pain of potential loss.

Sunday, 30 May 2010

A quick look at Hing Yiap (30.5.2010)

Stock Performance Chart for Hing Yiap Group Berhad

A quick look at Hing Yiap (30.5.2010)

Benjamin Graham Checklist for Hing Yiap (30.5.2010)

Home page of Hing Yiap Group Bhd (for analysts' research reports)

Cash Flow Computation

Cash Flow Computation
The total cash flow for a period can be computed as:

Income from Operations (*see below)
+ Depreciation
- Taxes
- Capital Spending
- Increase in Working Capital
Total (Free) Cash Flow


Income from operations equals revenue minus costs and expenses and is the major source of cash.  

However, two adjustments must be made to get to actual cash inflow:

  • Income from operations is before taxes are deducted, so taxes need to be subtracted here to get a corrected cash flow,
  • Also, depreciation charges are included in income from operations but do not lower cash in the period, so depreciation is added back to get a corrected cash flow.
Finally, only changes (up or down) to the components of working capital (inventory, receivables, payables, etc.) in the period are part of computing cash flow.  If working capital has increased, cash is required this will need to be subtracted from total cash flow.

(Additional note:  The total cash flows used in an NPV (net present value) analysis should come from well-prepared proforma financial statements developed for the project.  The total project cash flows for a period can be computed as above.)


Income Statement
for the period x through y

Net Sales
- Cost of Goods Sold
Gross Profit

Sales & Marketing
Research & Development
General & Administrative
Operating Expenses

Gross Profit
- Operating Expenses
Income from Operations*
+ Net Interest income
- Income taxes
Net Income

Saturday, 29 May 2010

A quick look at Integrax (29.5.2010)

A quick look at Integrax (29.5.2010)

Benjamin Graham's Checklist for Integrax (29.5.2010)

Tapping young investors

Saturday May 29, 2010

Tapping young investors

IN this week’s Monday Starters column in StarBiz, deputy executive editor Soo Ewe Jin wrote about Bursa Malaysia’s goal of getting more young adults to invest in our stock market. One suggestion from the exchange is that people should buy stocks for their children so as to kindle an interest in share investing at an early age.

It’s a modest step but the ideas behind it are important – that we should start young and that parents have a major role in shaping their kids’ attitudes towards investments. If we lose sight of these, it’s the equities market that may suffer.

To maintain its liquidity and vibrancy, our stock exchange needs a healthy proportion of buying and selling by individual investors. Last year, retail participation accounted for a third of the trading value in Bursa Malaysia’s securities market.

It’s an improvement from the 24% recorded in 2008, but still a long way from the 60% level seen about a decade ago.

In trying to draw in retail investors, Bursa Malaysia is targeting the youthful set. In the chief executive officer’s message in the exchange’s annual report 2009, Datuk Yusli Mohamed Yusoff wrote: “We are cognisant that we need the young generation investor base.”

Recent market research commissioned by the bourse found that there’s a generation gap in the Malaysian share investing arena.

The findings are presented in a booklet published as part of Bursa Malaysia’s Rethink Retail project.

According to Omar Merican, the exchange’s chief operating officer, the project’s aim is “to reach out to younger audiences to create more awareness on the capital market and how they can become more involved”.

The research has determined that investors aged between 20 and 29 make up almost 30% of the investing population but only 12% of share investors. Most of the other share investors (nearly 60%) are at least 40 years old.

It’s not that the young don’t have the money to invest in shares. They prefer to seek returns from other avenues – savings accounts, unit trust, investment-linked insurance and property.

Says Yusli in the booklet’s foreword: “We believe the future growth lies with the young Malaysian segment that is the untapped potential for the growth of this industry. There is, however, a challenge in getting more youngsters interested in viewing share investing as an option to building their investment portfolio.”

There’s a perception problem here. The research shows that the majority of young potential investors are intimidated by the risks associated with shares. They think investing in futures, options and foreign currency is less risky.

They see share investing in Malaysia as having “a strong speculative character”, and some liken it to gambling.

Just where did they get that notion? We should look at the dominant component of the share investing population – those who are 40 and above. And most of them are, in fact, parents.

Are these moms and dads teaching their children about investing in the stock market? Are they imparting the skills and knowledge that come through the experience of riding the ups and downs of the market?

If the parents cum share investors are not doing enough to help their children develop a firm understanding of share investing, the likely issue here is that they’re poor at engaging with and relating to the kids. Or maybe the parents don’t know all that much about investing in stocks.

Or could it be that parents think that share investing is so tough and perilous that don’t fancy the idea of the children going into it, in the same way that a smoker won’t encourage his child to start lighting up? If that’s the case, that’s just bad parenting – “Yes, I do it, but that doesn’t mean you should.”

There’s another possible reason for the young people’s aversion to share investing. They do passively learn about it from their parents, except that they largely pick up on the negative aspects.

The Rethink Retail booklet hints at that: “The speculative image (of share investing in Malaysia) is further fuelled with the emotional success and failure stories told by friends, family, colleagues and others”

And let’s not forget that some investors don’t rely on fundamentals and diligence. Instead, they trade based on tips and rumours. What conclusions will a child form about share investing when he often hears his parents spouting lines such as “Can still go in. They’ll push it up to RM4.30.” or “The general election is coming. The share price will surely fly?”

Bursa Malaysia has plans to convert youngsters into share investors.

In the booklet’s conclusion, the stock exchange says: “If we are able to reach out to potential investors, especially the young investors, we can change their perceptions of share investing and make shares an option to savings, deposits, property, unit trust and investment-linked insurance.”

Sure, Bursa Malaysia can do this on its own. Still, it wouldn’t hurt if the parents buy into the programme as well. But for that to happen, the parents must first believe that stocks are solid long-term investments as long as everybody plays by the rules. Now that’s the real challenge, isn’t it?

>Deputy executive editor Errol Oh is working on a pre-schoolers’ book on the stock market, tentatively titled The Stock That Sank Like A Rock. But he’s stuck because he can’t find simple, familiar words that rhyme with ‘Bursa’, ‘dividends’, ‘warrants’ (nope, ‘blackcurrants’ doesn’t work in this context) and ‘unusual market activity’.

When Banks Don't Trust Banks

COMMENTARY May 27, 2010, 5:00PM EST
When Banks Don't Trust Banks
Credit markets are misbehaving again. But having survived the panic of 2008, investors may no longer be so easily rattled

By Pierre Paulden

As Europe's sovereign debt crisis shows signs of turning into a contagion, infecting everything from interbank lending rates in London to the U.S. junk bond market, credit markets are experiencing déjà vu. The almost $1 trillion pledged by European finance ministers this month to bolster the region's finances has failed to mollify investors who worry that euro zone trouble could cause another Lehman-like disruption in worldwide financial markets.

A primary cause for concern now, as then, is the banks. Independent Credit View, a Swiss rating company, estimates that global banks may have a capital deficit of more than $1.5 trillion by the end of 2011 and some may need state help to survive. Libor, the short-term rate at which banks lend to one another, has shot up to 0.538 percent, the highest since July; it was less than half that as recently as March. Other types of short-term IOUs also show strain, with financial companies having to pay an average rate of 0.47 percent on 90-day commercial paper, the highest in a year, Federal Reserve data show. "Failure is not off the table for large financials," says Brian Yelvington, head of fixed-income strategy at Knight Libertas in Greenwich, Conn.

Just a few weeks ago, the credit markets were almost back to pre-Lehman normality. Investors were asking precious little of the borrowers they shoveled money at. As of mid-May, 60 percent of high-yield borrowers were able to get away with weaker investor safeguards on new debt, according to Covenant Review, a New York-based research firm that analyzes bond offerings. Caps were removed on the amount of debt companies can carry, and fewer restrictions were placed on using assets as collateral for future borrowing, effectively reducing what's available to satisfy creditor claims in a bankruptcy. All of these were symptoms of a larger phenomenon that many viewed as healthy: An appetite for risk had returned.

That now appears to have been premature. Though Lehman-style panic has not set back in, market conditions are, to say the least, fraught. Issuance of corporate debt has slowed considerably, falling from $183 billion in April to $53 billion in May, the lowest monthly total since December 1999, according to Bloomberg data. More than 19 companies have delayed or postponed $5 billion of debt deals since Apr. 13, with immediate consequences for corporate spending. Allegiant Travel (ALGT), a Las Vegas-based passenger airline, was forced to put off a $250 million bond offering that it planned to use to pay for MD-80 and Boeing 757 aircraft already under contract. Jones Apparel Group (JNY), a New York-based retailer, pulled a $250 million bond offering that was going to help it acquire a majority stake in shoe designer Stuart Weitzman Holdings. Meanwhile, companies able to raise new debt have to pay a richer premium over benchmark government securities, adding up to 1.96 percentage points, an increase of 0.47 since the end of April. That's the biggest monthly jump since October 2008, a month after Lehman Brothers collapsed. There is carnage in the market for junk bonds, which slid 4.56 percent this month, their worst performance since dropping 8.43 percent in October 2008.

The silver lining is that while bond investors are fleeing credit markets, they are moving into Treasuries, pushing up prices and lowering the government's borrowing cost. The yield on the benchmark 10-year Treasury note fell to 3.06 percent this week, down from 4 percent in April. Among other felicitous effects, that has pushed down mortgage rates and aided the fragile recovery of the national housing market; homeowners can now get a standard 30-year mortgage at 4.85 percent, down from 5.26 percent in early April, according to in North Palm Beach, Fla., spurring a new flurry of refinancing and boosting new-home sales by 15 percent to their highest levels since May 2008.

Lower rates have also brought down borrowing costs for companies fortunate enough to live at the top of the credit food chain. Abbott Laboratories (ABT), maker of the lucrative arthritis drug Humira, sold $3 billion of bonds on May 24, its first offering in more than a year. The coupon on the biggest portion of the deal, a $1.25 billion slice due in 2040, was 5.3 percent, a full percentage point lower than similarly rated bonds due in more than 15 years, based on Bank of America Merrill Lynch (BAC) index data. "There is a flight to quality, to solid investment-grade companies," says Nicholas Pappas, co-head of flow credit trading in the Americas at Deutsche Bank (DB) in New York.

Even high-yield debt still has fans—or at least bargain hunters willing to swoop in when they spot an attractive price. After junk bonds gained a record 57.5 percent in 2009 and 7.1 percent through April of this year, the market is "correcting," says Jeff Peskind, founder of hedge fund Phoenix Investment Adviser in New York. He scooped up the bonds of credit-card processor First Data and other large leveraged buyouts as prices tumbled this month, anticipating a rebound. First Data, bought by KKR & Co. for $27.5 billion, has seen its bonds decline 17.5 percent this month through May 25, raising concerns among investors about the Atlanta-based company's ability to roll over the $14.3 billion of loans and bonds it has coming due by 2014.

First Data is not alone. Junk-rated borrowers, some of whom were taken private at the height of the leveraged buyout boom in 2007, have $1.25 trillion of debt coming due through 2015. Their prospects are, at best, mixed. "LBOs need growth to de-lever. They also need access to capital markets to continue pushing out maturities," says Jason Rosiak, the head fund manager overseeing $2.7 billion at Pacific Asset Management, an affiliate of Pacific Life Insurance in Newport Beach, Calif.

As for the ol' Libor, well, it could get worse before it gets better. Deepening concern about the quality of banks' collateral and attempts to regulate the banking industry could force it as high as 1.5 percent by September, says Neela Gollapudi, a strategist at Citigroup Global Markets (C) in New York.

That's still a safe distance from its peak. Thus far, market participants tend to agree on one point—if the European debt crisis is a contagion, it will probably not lead back into full-blown panic. The recent experience of a brutal, worldwide, coordinated market plunge left calluses, as well as a resolve not to be left out of the next buying opportunity of a lifetime. A lesson from 2008 is that those with the nerve to wade back into markets at their scary lows can reap remarkable profits; just because some investors head for the exits doesn't mean there will be a mad scramble. As Morgan Stanley (MS) strategists Laurence Mutkin and Elaine Lin put it in a May 26 report: "The repricing of spreads in financing markets, sharp and swift though it has been, still does not amount to evidence of anything like the levels of stress during 2008. Nor, given that central banks have already revived their backstop measures, do we think that it will. Financing markets remain orderly and open."

Paulden is a reporter for Bloomberg News. With Tim Catts and Shannon Harrington.

The Recovery: Why Deflation Remains a Threat

The Recovery: Why Deflation Remains a Threat
Economic growth isn't strong enough yet to keep deflation at bay—and turmoil in Europe and market jitters amplify the risk

By Peter Coy

Bargains are everywhere in America these days. Men's shirts and sweaters were 3.4 percent cheaper this April than a year earlier. Prices also fell for eggs, peanut butter, bananas, potatoes, hotel and motel rooms, cosmetics, curtains, rugs, tools, and lawn care. Excluding gasoline and other energy items, the consumer price index rose just 0.9 percent for the year. That's the smallest increase since January 1962, when John F. Kennedy was President.

Everybody likes to save money, but flat to falling prices are not entirely good. They're a symptom of continued weakness nearly a year after the U.S. economy supposedly hit bottom. The same softness of demand that keeps goods cheap is pressuring workers. Annual growth of average hourly earnings fell from 3.5 percent in April 2007 to 1.6 percent this April.

The economic recovery, while welcome, isn't yet strong enough to ensure against the risk of deflation, in which prices fall across the board for an extended period. Deflation caused by a shortfall in demand can be dangerous. People delay purchases, waiting for lower prices, which exacerbates the slowdown. Bankruptcies rise because even though pay falls, debt levels don't. To keep deflation at bay, the Federal Reserve's Open Market Committee voted in April to keep the federal funds rate at near zero. Even with an overhang of more than $1 trillion of excess reserves in the banking system, ready to be lent, committee members cut their inflation forecasts by 0.2 percentage point between the January and April meetings, to a range of 1.2 percent to 1.5 percent for this year.

Turmoil in Europe is amplifying the risk of deflation in the U.S. It's driving up the dollar's value, making American goods less competitive in world markets and retarding growth. Europe's problems also are pushing down the U.S. stock market, which makes consumers fearful and less likely to spend. The Standard & Poor's 500-stock index has fallen 12 percent from its April high. A sharp decline in oil prices since the end of April shows that growth worries are worldwide, since it's global demand that determines the price of oil. Crude hit $71 a barrel in late May, down from $86 at the end of April. Gold is moving the other way, rising to more than $1,200 an ounce by late May from a recent low of less than $900 in April 2009, as investors seek a refuge from chancy markets and banks. All the grim indicators have made their mark. "Call it a nightmare," says one of the most prominent bears, David A. Rosenberg, chief economist and strategist at the Toronto-based investment firm of Gluskin Sheff + Associates.

The decline of output during the 2007-09 recession was so steep that there's still a huge amount of excess productive capacity. According to Federal Reserve data, only 69percent of total industry capacity was used in April, vs. an average of 81percent in the previous 38 years. As for labor, the unemployment rate remains stubbornly high because every uptick in hiring encourages more people to start looking for work again—and thus boost the official jobless rate.

The optimistic take on the economy is that the threat of deflation is temporary and will diminish as excess capacity gets eaten up. Kurt Karl, chief U.S. economist of Swiss Re, says employment gains are producing income that will be spent, generating more jobs and more spending in a virtuous upward spiral. "I'm still bullish," says Karl, adding, "employment growth has turned a major corner." Deflation, he adds, "would be a permanent kind of problem only if you didn't have any employment momentum." He predicts a decrease in the unemployment rate from 9.9percent in April to about 9.5percent at the end of 2010 and about 8percent at the end of 2011.

Certainly there are some signs of progress. On May 25 the Conference Board announced that its May index of consumer confidence rose to the highest level since March 2008. MasterCard Advisors' SpendingPulse measure of consumer purchases has ticked up sharply since early 2009. Luxury retail chains including Barneys and Saks (SKS) are scaling back discounts and promotions they offered to attract shoppers during the recession. In February, Tiffany (TIF) raised prices across the store. Consultants Bain & Co. say U.S. sales of luxury goods may rise 4percent in 2010 after declining 17percent in 2009.

There are worrisome signs, though, that the recovery could stall. Employment has been boosted by the Census Bureau's temporary hiring for the decennial census, but as summer approaches that source of employment will fade. Job creation will slow as the year goes on and be "anemic" in 2011, predicts Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University's J. Mack Robinson College of Business. Says Sumit Chandra, a supply chain expert who is a partner at A.T. Kearney consultants: "The recovery is real. It's happening. But I think the magnitude of the recovery, the level of confidence we have in it, is fragile."

Kelly Services (KELYA), the temporary help firm, sees the tentativeness of the expansion at ground level. Demand for its services is strong because companies "want to maintain maximum flexibility" in case the recovery fades, says George S. Corona, Kelly's executive vice-president. Meanwhile, upward pressure on wages is nil in most segments, says Corona. "We have a lot of résumés coming in the door," he says. "We're not having to work hard to find people." Exactly. Cheap shirts and sweaters are cold comfort for unemployed people who are sitting at home in their pajamas.

With Cotten Timberlake

The bottom line: The recession created so much extra capacity that the economy is struggling to absorb it, even as the recovery takes hold.

Coy is Bloomberg Businessweek's Economics editor.

Investors learned the lessons of the recent recovery a bit too well

May 27, 2010, 5:00PM EST

The Sun Also Sets
Investors learned the lessons of the recent recovery a bit too well

By Roben Farzad

Who could blame an investor today for feeling a tad nostalgic for the Panic of 2008? There was a simplicity to the thing. It was such a brutal and impartial rout—slaying just about every asset class—that it made you want to swear off all markets forever. There was comfort to be found in stashing a shoebox full of $50 bills in the freezer. No paperwork. No jabberwocky from your broker. Just the reassuring face of Ulysses S. Grant juxtaposed with your cold, raw fear.

By March 2009, with U.S. stocks at 1996 levels, equities had returned less than Treasuries over the previous 10-, 20-, and 30-year periods—debunking the equity-risk premium so central to Econ 101. Until, of course, the market reversed course and surged 80 percent in 13 months, reminding investors that it was at least theoretically possible to make money in equities. That change of mood edged out fear just in time for the 2010 edition of the credit crisis, an international production that began with Greece's near-collapse and soon spread to Portugal, Ireland, Italy, Spain, and beyond. The Standard & Poor's 500-stock index has now fallen 12 percent in a month, its first official correction since the new bull began last spring.

Corrections are routine and even healthy events; they come along about once every 11 months on average and wring out the excesses and false expectations that rallies inevitably bring. "To the extent that current worries squeeze long positions, extinguish optimism, or even lead policymakers to pursue courses of action that are more supportive—not more punitive—for markets, the selloff may be creating more favorable entry points for investors to buy into a still recovering global economy," writes Stuart Schweitzer, global markets strategist for JPMorgan Private Bank, in a May 24 note to clients. That may all turn out to be true—provided investors don't panic, rush for the exits, and help turn a routine recovery into the second leg of a double-dip recession.

If the lesson of March 2009 is that the sun comes up—the most brutal selloff is just a prelude to the next rally—then the lesson of the recent runup is that the sun can shine too brightly, blinding us to boulders in the road. And then it can set.

With payrolls still slack and credit still tight, the contours of these peculiar economic times are becoming apparent. Last year's snapback is not going to bring a garden-variety, V-shaped recovery. Instead, investors are again having to confront the messy unfolding of a long and overly generous credit cycle, global in nature and marked by a spate of bank and business failures. How the economies of the world digest it is anyone's guess. When the next leg up begins, though, it will mark a critical milestone for a stock market that still needs to rally by almost half to revisit its 2007 high. Getting there despite profound economic challenges is going to take some hard traveling.

"In the U.S., we have no living precedent for this," says Donald Luskin, chief investment officer at strategy firm Trend Macrolytics, whose search for domestic parallels to this credit crisis took him all the way back to 1907. "We have had a living laboratory for it in Japan for the past 15 years. But in the U.S., we're all attuned to the little upticks in metrics that don't necessarily inform much." In other words, we seek auguries where there are none by comparing traditional business cycle statistics such as payrolls and housing starts to once-in-a-lifetime lows from late 2008 and early 2009. Luskin predicts the market will be range-bound for at least five more years as companies and consumers shed debt. "This is not a particularly bearish view," he says. "It's just the expansion-less, low-return world we're now in."

Luskin's unenthusiastic outlook—which contrasts with the prevailing optimism among Wall Street strategists in a May 25 Bloomberg survey—brings to mind the "new normal" paradigm coined last year by Bill Gross and Mohamed El-Erian at Pimco, the bond giant. The idea is that a bitter confluence of deleveraging and reduced consumption and employment will necessarily bring a long period of low growth and low returns. In the absence of a healthy consumer, the neo-normalists point out, there is no other driver to magically propel the economy.

All of which is reasonable—and has largely been ignored amid a recent rush to riskier, less stable sectors at the expense of large-cap companies. This rush was less than rational; if returns are negligible and credit is tight, one would have expected investors to move into big, stable equities that pay dividends. But they didn't, even though the private equity feeding frenzy and promiscuous lending that made small-cap company buyouts all the rage a few years back are long gone. Small companies today are less likely to be self-financed and far more likely to be dependent on volatile-rate bank debt (assuming it is offered to them at all). Even so, the S&P's small-cap index has returned 3.6 percent so far this year—almost 10 points better than the 5.8 percent loss registered by the S&P 100 (the bluest of blue chips, including IBM (IBM) and ExxonMobil (XOM)). Going back to the market's low last spring, the excess return is hardly inconsequential: 90 percent for small stocks, vs. 50 percent for the mega-caps.

The lesson? The financial conflagrations of the past three years did not signal a permanent flight to quality. Appetite for the high-risk/high-reward trade is alive if not well. The resurgence of large-cap equities has, again and again, been exaggerated. According to Leuthold, a Minneapolis fund management firm, small-cap stocks now sell at a "very fat" valuation premium of 20 percent relative to large caps, an all-time record disparity. Nobody seems to care that Johnson & Johnson (JNJ), with a $165 billion market cap and impeccable financials, pays a 3.62 percent dividend—more than 10-year Treasuries. AT&T (T), the country's largest phone company, an inveterate booster of its dividend over 26 years, yields almost twice that, but its shares have badly lagged the broader market this year. All this as banks believe they are doing you a favor by advertising 1 percent for your cash.

To some, any case for U.S. stocks—small, large, whatever—is also exaggerated. Pimco is now lumping the U.S. together with Japan, France, Spain, and Greece in what it calls a sovereign debt risk "ring of fire"—an ignominious league of nations that will increasingly have problems paying their debts. That association would suggest a lot more downside for U.S. shares, whose aggregate 4 percent drop so far in 2010 is but a sliver compared with the S&P Euro Index's 12.5 percent plunge.

Everywhere you look in the U.S. and Europe is another investing dead end. Together, they make the case for aggressive allocation away from developed markets and into emerging markets—yesteryear's financial basket cases turned today's paragons of growth. According to the International Monetary Fund, the developing world has catapulted itself from 18 percent of global GDP in 1994 to 31 percent last year, with its share still gaining at the expense of Japan, Western Europe, and the U.S.

That sort of growth means it is now far too prudish to allocate a mere 10 percent of one's portfolio to developing powers such as Brazil and India. "U.S. investors should move from a U.S.-centric worldview and toward a larger allocation to emerging market economies," says John West of Research Affiliates, an index strategy shop, also of Newport Beach. "They don't face the hurricane-like headwinds of deficit, debt, and demographics that developed markets, including the U.S., do." Since the market's low, the MSCI Emerging Markets index has shot up 77 percent—20 full percentage points better than the S&P 500. Not that no one has noticed: Emerging-market stock funds have consistently taken in multiples of their U.S. counterparts for five years. And while the U.S. and Europe have swooned in the past month, the emerging markets have fallen 15 percent, a resilient showing for a category that has historically been incapable of handling contagion. West thinks that investors in emerging markets amid this global risk realignment will be disproportionately rewarded over the coming decade.

If you don't have the stomach for increasing volatility, you might just take the old advice to sell in May and go away. Or you might park your dollars in gold, which is trading at an all-time high and is certain to go higher, unless it doesn't. Or you might go to cash, which the Federal Reserve is deliberately pegging at all-time low yields, guaranteeing that inflation eats away at what you have.

The sun will rise again, but in the meantime, no one is saying anything about sleeping well tonight.

Bloomberg Businessweek Senior Writer Farzad covers Wall Street and international finance.