Business Valuations versus Stock-Market Valuations (2) - an illustration

"The company is worth more dead than alive."


The A&P Example

This example combines many aspects of corporate and investment experience. It involves the Great Atlantic & Pacific Tea Co. Here is the story:

1929: First traded on the "Curb" market, now the American Stock Exchange

1929: Sold as high as 494
1932: Declined to 104, although the company's earnings were nearly as large in that generally catastrophic year as previously.
1936: The range was between 111 and 131.
1938: In business recession and bear market. Fell to a new low of 36

The $36 price was extraordinary.

It meant that the preferred and common shares were together selling for $126 million.

The company had just reported that it held $85 million in cash alone and a working capital (or net current assets) of $134 million.

A&P was the largest retail enterprise in America, if not in the world, with a continuous and impressive record of large earnings for many years.

Yet, in 1938 this outstanding business was considered on Wall Street to be worth less than its current assets alone - which means less as a going concern than if it were liquidated.
(Better dead than alive!)

Why?

First, because there were threats of special taxes on chain stores.
Second, because net profits had fallen off in the previous year.
Third, because the general market was depressed.

The first of these reasons was an exaggerated and eventually groundless fear; the other two were typical of temporary influences.

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Let us assume that the investor had bought A&P common in 1937 at, say, 12 x its five-year average earnings, or about $80.

We are far from asserting that the ensuing decline to 36 was of no importance to him.

He would have been well advised to scrutinize the picture with some care, to see whether he had made any miscalculations.

But if the results of his study were reassuring - as they should have been - he was entitled then

• to disregard the market decline as a temporary vagary of finance,
• unless he had the funds and the courage to take advantage of it by buying more than the bargain basis offered.

SEQUEL AND REFLECTIONS.

1939: A&P shares advanced to 117 1/2.

This was 3 x the low price of 1938 and well above the average of 1937.

Such a turnabout in the behaviour of common stocks is by no means uncommon, but in the case of A&P, it was more striking than most.

1949-1961: The grocery chain's shares rose with the general market.

1961: The split-up stock (10 for 1) reached a high of 70 1/2 which was equivalent to 705 for the 1938 shares.

This price of 70 1/2 was remarkable for the fact it was 30 times the earnings of 1961.

Such a PE ratio - which compares with 23x for the DJIA in that year - must have implied expectations of a brilliant growth in earnings.

This optimism had no justification in the company's earnings record in the preceding years, and it proved completely wrong. Instead of advancing rapidly, the course of earnings in the ensuing period was generally downward.

1962: The year after the 70 1/2 high the price fell by more than half to 34.

But this time the shares did not have the bargain quality that they showed at the low quotation in 1938.

1970: The price fell to another low of 21 1/2/
1972: The price was 18, having reported the first quaterly deficit in its history.

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We see in this history how wide can be the vicissitudes of a major American enterprise in little more than a single generation, and also with what miscalculations and excesses of optimism and pessimism the public has valued its shares.

In 1938 the business was really being given away, with no takers.

In 1961, the public was clamoring for the shares at a ridiculously high price.

After that came a quick loss of half the market value, and some years later a substantial further decline.

In the meantime, the company was to turn from an outstanding to a mediocre earnings performer; its profit in the boom-year 1968 was to be less than in 1958; it had paid a series of confusing small stock dividends not warranted by the current additions to surplus; and so forth.

A&P was a larger company in 1961 and 1972 than in 1938, but not as well-run, not as profitable, and not as attractive.

1999: At year-end, its share price was $27.875
2000: $7.00
2001: $23.78
2002: $8.06

Although some accounting irregularities later came to light at A&P, it defied all logic to believe that the value of a relatively stable business like groceries could fall by three-fourths in one year, triple the next year, then drop by two-thirds the year after that.

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There are two chief morals to this story.

The first is that the stock market often goes far wrong, and sometimes an alert and courageous investor can take advantage of its patent errors.

The other is that most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse.


The investor need not watch his companies performance like a hawk; but he should give it a good, hard look from time to time.


Ref: Intelligent Investor by Benjamin Graham

Growth Stocks Paradox

David Durand, "Growh Stocks and the Petersburg Paradox," The Journal of Finance, vol. XII, no. 3, September, 1957, pp. 348-363.

This classic article compares investing in high-priced growth stocks to betting on a series of coin flips in which the payoff escalates with each flip of the coin.

Durand points out that if a growth stock could continue to grow at a high rate for an indefinite period of time, an investor should (in theory) be willing to pay an infinite price for its shares.

Why, then, has no stock ever sold for a price of infinity dollars per share?

Because the higher the assumed future growth rate, and the longer the time period over which it is expected, the wider the margin for error grows, and the higher the cost of even a tiny miscalculation becomes.

Book Value (Net Asset Value)

Synonyms:
Net asset value
Book value
Balance sheet value
Tangible-asset value
Net worth

= Total value of a company's physical and financial assets minus all its liabilities.

It can be calculated using the balance sheets in a company's annual and quarterly reprots.

From total shareholders' equity, subtract all "soft" assets such as goodwill, trademarks, and other intangibles.

Divide by the fully diluted number of shares outstanding to arrive at book value per share.

Business Valuations versus Stock-Market Valuations

The impact of market fluctuations upon the investor's true situation may be considered also from the standpoint of the shareholder as the part owner of various businesses.

The holder of marketable shares actually has a double status, and with it the privilege of taking advantage of either at his choice.

(1) As a minority shareholder or silent partner in a private business.

Here his results are entirely dependent on the profits of the enterprise or on a change in the underlying value of its assets.

He would usually determine the value of such a private business interest by calculating his share of the net worth as shown in the most recent balance sheet.

(2) As a common-stock investor.

He holds a piece of paper, an engraved stock certificate, which can be sold in a matter of minutes at a price which varies from moment to moment - when the market is open, that is - and often is far removed from the balance sheet value.

(Stocks now exist, for the most part, in purely electronic form and thus have become even easier to trade than they were in Graham's day).

The development of the stock market in recent decades has made the typical investor more dependent on the course of price quotations and less free than formerly to consider himself merely a business owner.

The reason is that the successful enterprises in which he is likely to concentrate his holdings sell almost constantly at prices well above their net asset value (or book value, or "balance sheet value"). [# Book Value (Net Asset Value) ]

In paying these market premiums the investor gives precious hostages to fortune, for he must depend on the stock market itself to validate his commitments.



A factor of prime importance in present-day investing.

The whole structure of stock-market quotations contains a built-in contradiction.

The better a company's record and prospects, the less relationship the price of its shares will have to their book value.

But the greater the premium above book value, the less certain the basis of determining its intrinsic value - i.e , the more this "value" will depend on the changing moods and measurements of the stock market.

Thus, we reach the final paradox, that the more successful the company, the greater are likely to be the fluctuations in the price of its shares.

This really means that, in a very real sense, the better the quality of a common stock, the more speculative it is likely to be - at least as compared with the unspectacular middle-grade issues.

(What we have said applies to a comparison of the leading growth companies with the bulk of well-established concerns; we exclude from our purview here those issues which are highly speculative because the businesses themselves are speculative.)

The argument made above should explain the often erratic price behaviour of our most successful and impressive enterprises.

For example
- IBM (International Business Machines).
The price of its shares fell from 607 to 300 in seven months in 1962-63; after two splits its price fell from 387 to 219 in 1970.
-Xerox - an even more impressive earnings gainer in recent decades - fell from 171 to 87 in 1962-63, and from 116 to 65 in 1970.

These striking losses did not indicate any doubt about the future long term growth of IBM or Xerox; they reflected instead a lack of confidence in the premium valuation that the stock market itself had placed on these excellent prospects.



The previous discussion leads us to a conclusion of practical importance to the conservative investor in common stocks.

If he is to pay some special attention to the selection of his portfolio, it might be best for him to concentrate on issues selling at a reasonably close approximation to their tangible-asset value - say, at not more than 1/3 (one-third) above that figure.

Purchases made at such levels, or lower, may with logic be regarded as related to the company's balance sheet, and as having a justification or support independent of the fluctuating market prices.

The premium over book value that may be involved can be considered as a kind of extra fee paid for the advantage of stock-exchange listing and the marketability that goes with it.




A caution.

A stock does not become a sound investment merely because it can be bought at close to its asset value.

The investor should demand, in addition,
1. a satisfactory ratio of earnings to price (PE),
2. a sufficiently strong financial position, and
3. the prospect that its earnings will at least be maintained over the years.

This may appear like demanding a lot from a modestly priced stock, but the prescription is not hard to fill under all but dangerously high market conditions.

Once the investor is willing to forego brilliant prospects - i.e., better than average expected growth - he will have no difficulty in finding a wide selection of issues meeting these criteria.

(In the present market situation, may stocks meet this asset-value criterion. Many sell below their tangible-asset value. Many are now available at prices reasonably close to their asset values.)

The investor with a stock portfolio having such book values behind it can take a much more independent and detached view of stock-market fluctuations than those who have paid high multipliers of both earnings and tangible assets.

As long as the earning power of his holdings remains satisfactory, he can give as little attention as he pleases to the vagaries of the stock market.

More than that, at times he can use these vagaries to play the master game of buying low and selling high.


Ref: Intelligent Investor by Benjamin Graham

Market Fluctuations of the Investor's Portfolio

Every investor who owns common stocks must expect to see them fluctuate in value over the years.

The behaviour of the DJIA probably reflects pretty well what has happened to the stock portfolio of a conservative investor who limited his stock holdings to those of large, prominent, and conservatively financed companies.

Since the individual stocks set their high and low marks at different times, the fluctuations in the Dow Jones group as a whole are less severe than those in the separate components.

The price fluctuations of other types of diversified and conservative common-stock portfolios are not likely to be markedly different from the above.

In general, the shares of second-line companies* fluctuate more widely than the major# ones, but this does not necessarily mean that a group of well established but small companies will make a poorer showing over a fairly long period.

( *non index linked stocks, #index linked stocks)

In any case, the investor may as well resign himself in advance to the probability rather than the mere possibility that most of his holdings will advance, say, 50% or more from their low point and decline the equivalent 1/3 (one-third) or more from their high point at various periods in the next 5 years.

A serious investor is not likely to believe that the day-to-day or even month-to-month fluctuations of the stock market make him richer or poorer.

But what about the longer term and wider changes?

Here practical questions present themselves, and the psychological problems are likely to grow complicated.

A substantial rise in the market is at once a legitimate reason for satisfaction and a cause for prudent concern, but it may also bring a strong temptation toward imprudent action.

Your shares have advanced, good! You are richer than you were, good!

• But has the price risen too high, and should you think of selling?
• Or should you kick yourself for not having bought more shares when the level was lower?
• Or - worst thought of all - should you now give way to the bull-market atmosphere, become infected with the enthusiasm, the overconfidence and the greed of the great public (of which, after all, you are a part), and make larger and dangerous commitments?

Presented thus in print, the answer to the last question is a self-evident NO, but even the intelligent investor is likely to need considerable will power to keep from following the crowd.

It is for these reasons of human nature, even more than by calculation of financial gain or loss, that we favour some kind of mechanical method for varying the proportion of bonds to stocks in the investor's portfolio. The chief advantage, perhaps, is that such a formula will give him something to do.

As the market advances, he will from time to time make sales out of his stockholdings, putting the proceeds into bonds; as it declines he will reverse the procedure.

(For today's investor, the ideal strategy for pursuing this formula is rebalancing)

These activities will provide some outlet for his otherwise too-pent-up energies. If he is the right kind of investor he will take added satisfaction from the thought that his operations are exactly opposite from those of the crowd.

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Note carefuly what Graham is saying here.

It is not just possible, but probable, that most of the stocks you own will gain at least 50% from their lowest price and lose at least 33% from their highest price - regardless of which stocks you own or whether the market as a whole goes up or down.

If you can't live with that - or you think your portfolio is somehow magically exempt from it - then you are not yet entitled to call yourself an investor.

(Graham refers to a 33% decline as the "equivalent one-third" because a 50% gain takes a $10 stock to $15, a 33% loss [or $5 drop] takes it right back to $10, where it started.)


Ref: The Intelligent Investor by Benjamin Graham

"Formula Investment Plans"

In the early years of the stock-market rise that began in 1949-50, considerable interest was attracted to various methods of taking advantage of the stock market's cycle.

These have been known as "formula investment plans."

The essence of all such plans - except the simple case of dollar averaging - is that the investor automatically does some selling of common stocks when the market advances substantially.

In many of them, a very large rise in the market level would result in the sale of all common-stock holdings; others provided for retention of a minor proportion of equities under all circumstances.

This approach had the double appeal of sounding logical (and conservative) and of showing excellent results when applied RETROSPECTIVELY to the stock market over many years in the past. Unfortunately, its vogue grew greatest at the very time when it was destined to work least well.

Many of the "formula planners" found themselves entirely or nearly out of the stock market at some level in the middle 1950s. True, they had realized excellent profits, but in a broad sense the market "ran away" from them thereafter, and their formulas gave them little opportunity to buy back a common stock position.

(Many of these "formula planners" would have sold all their stocks at the end of 1954, after the US stock market rose 52.6%, the second highest yearly return then on record. Over the next five years, these market-timers would likely have stood on the sidelines as stocks doubled.)

There is a similarity between the experience of those adopting the formula-investing approach in the early 1950s and those who embraced the purely mechanical version of the Dow theory some 20 years earlier.

In both cases, the advent of popularity marked almost the exact moment when the system ceased to work well.

We have had a like discomfiting experience with our own "central value method" of determining indicated buying and selling levels of the Dow Jones Industrial Average.

The moral seems to be that any approach to moneymaking in the stock market, which can be easily described and followed by a lot of people is by its terms too simple and too each to last.

"All things excellent are as difficult as they are rare."

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Easy ways to make money in the stock market fade for two reasons:

• the natural tendency of trends to reverse over time, or "regress to the mean", and,
• the rapid adoption of the stock-picking scheme by large numbers of people, who pile in and spoil all the fun of those who got there first.

Buy Low Sell High Approach

We are convinced that the average investor cannot deal successfully with price movements by endeavoring to forecast them.

Can he benefit from them after they have taken place - i.e. by buying after each major decline and selling out after each major advance?

The fluctuations of the market over a period of many years prior to 1950 lent considerable encouragement to that idea.

In fact, a classic definition of a "shrewd investor " was "one who bought in a bear market when everyone else was selling, and sold out in a bull market when everyone else was buying."

Between 1897 and 1949, there were ten complete market cycles, running from bear-market low to bull-market high and back to bear-market low.

• Six of these took no longer than 4 years,
• four ran for 6 or 7 years, and
• one - the famous "new era" cycle of 1921 -1932 - lasted 11 years.

The percentage of advance from the lows to highs ranged from 44% to 500%, with most between about 50% and 100%.

The percentage of subsequent declines ranged from 24% to 80%, with most found between 40% and 50%. (It should be remembered that a decline of 50% fully offsets a preceding advance of 100%)

Nearly all the bull markets had a number of well-defined characteristics in common, such as

(1) a historically high price level,
(2) high price/earnings PE ratio,
(3) low dividend yields as against bond yields,
(4) much speculation on margin, and
(5) many offerings of new common-stock issues of poor quality.

Thus to the student of stock-market history it appeared that the intelligent investor should have been able to identify the recurrent bear and bull markets, to buy in the former and sell in the latter, and to do so for the most part at reasonably short intervals of time.

Various methods were developed for determining buying and selling levels of the general market, based on either value factors or percentage movements of prices or both.

But we must point out that even prior to the unprecedented bull market that began in 1949, there were sufficient variations in the successive market cycles to complicate and sometimes frustrate the desirable process of buying low and selling high.

The most notable of these departures, of course, was the great bull market of the late 1920s, which threw all calculations badly out of gear.

Even in 1949, therefore, it was by no means a certainty that the investor could base his financial policies and procedures mainly on the endeavor to buy at low levels in bear markets and to sell out at high levels in bull markets.

It turned out, in the sequel, that the opposite was true. The market's behaviour in the past 20 years has not followed the former pattern, nor obeyed what once were well-established danger signals, nor permitted its successful exploitation by applying old rules for buying low and selling high.

Whether the old, fairly regular bull-and-bear market pattern will eventually return we do not know.

But it seems unrealistic to us for the investor to endeavor to base his present policy on the classic formula - i.e., to wait for demonstrable bear-market levels before buying any common stocks.

Our recommended policy has, however, made provision for changes in the proportion of common stocks to bonds in the portfolio, if the investor chooses to do so, according as the level of stock prices appears less or more attractive by value standards.



Ref: Intelligent Investor by Benjamin Graham

Buy Low Sell High

How Low Can Stocks Go?

How Low Can Stocks Go?
http://www.fool.com/investing/value/2008/10/18/how-low-can-stocks-go.aspx

Morgan Housel

October 18, 2008

Between Oct. 6 and Oct. 10, the Dow Jones Industrial Average dropped nearly 2,000 points. If it kept falling at that rate, the index would hit zero in less than a month.

Of course, we won't see zero. No matter how ugly markets get, the pain we saw these past few weeks can't continue for long.

But here's the bad news: Zero may be out of the question, but that doesn't mean stocks won't plummet from here. In fact, they could fall much, much further.

And history agrees.

What goes up ... The history of long-term market downturns is pretty abysmal. When times are bad, markets don't just get drunk with fear -- they start downing vodka shots of fear.

At times like this, nobody wants to own stocks. Their palms begin to sweat every time they watch CNBC. They bury their heads in the hope that the pain will go away. They throw in the towel and sell stocks indiscriminately. In short, it gets ugly.

Just how ugly? Have a look at the average P/E ratio of the entire S&P 500 index over these three periods of market mayhem:

Period
Average S&P 500 P/E Ratio
1977-1982....8.27 times
1947-1951....7.78 times
1940-1942....9.01 times

Compare that to the average P/E ratio today of around 20 times and a seven-year average of more than 24 times, and it's pretty apparent that stocks could fall much, much further than they already have, just by returning to the lows they historically hover around during downturns.

Assuming earnings stay flat, revisiting those historically low levels could easily mean a nearly 50% decline from here. For the Dow Jones Industrial Average, that'd correlate to roughly Dow 5,000 -- give or take. Of course, I'm not predicting, warning, or forecasting -- I'm just taking a long look at history.

But what if it did happen? What would happen to individual stocks? Here's what a few popular names would look like trading at P/E ratios of 8:

Company
One-Year Decline ...... Further Decline From Current Levels With P/E of 8

Yahoo! (Nasdaq: YHOO)
(51%)....(56%)

Apple (Nasdaq: AAPL)
(40%)....(60%)

Bank of America (NYSE: BAC)
(48%)....(62%)

Adobe (Nasdaq: ADBE)
(39%)....(56%)

Starbucks (Nasdaq: SBUX)
(60%)....(52%)

Pfizer (NYSE: PFE)
(27%)....(37%)

Schlumberger (NYSE: SLB)
(52%)....(33%)

Look scary? It is. And it could easily happen.

But here's the silver lining: Every one of those stocks -- heck, the overwhelming majority of stocks -- are worth much more than a measly 8 times earnings. The only thing that pushes the average stock to such embarrassing levels is an overdose of panic, rather than a good reading on what the company might actually be worth.

Be brave As difficult as it is right now, following the "this too will pass" philosophy really does work. No matter how bad it gets, things will eventually recover. Those brave enough to dive in when no one else dares to touch stocks are the ones who end up scoring the multibagger returns.

Need proof? Think about the best times you could have bought stocks in the past:

• after the economy recovered from oil shocks in the '70s,
• after the magnificent market crash of 1987, after global financial markets seized up in 1998, and
• after the 9/11 attacks that shook markets to the core.

As plainly obvious as it is in hindsight, the best buying opportunities come when investors are scared out of their wits and threaten to give up on markets altogether.

And that's exactly where we are.

Pick what side you'd like to be on The next few years are likely to be quite a ride. On the other hand, the history of the market shows that gloomy, volatile periods also provide once-in-a-lifetime opportunities that can earn ridiculous returns as rationality gets back on track.

If you need a few ideas, our team at Motley Fool Inside Value is sifting through the market rubble to find those opportunities. To see what they're recommending right now, click here to try the service free for 30 days. There's no obligation to subscribe.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Pfizer and Bank of America are Motley Fool Income Investor recommendations. Starbucks and Pfizer are Inside Value picks. Starbucks and Apple are Stock Advisor picks. The Fool owns shares of Starbucks and Pfizer. The Motley Fool is investor writing for investors.
Legal Information. © 1995-2008 The Motley Fool. All rights reserved.

Market Fluctuations as a Guide to Investment Decisions

What does the past record promises the investor - in either:

• the form of long-term appreciation of a portfolio held relatively unchanged through successive rises and declines, or,
• in the possibilities of buying near bear-market lows and selling not too far below bull-market highs.

Since common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices, the intelligent investor should be interested in the possibilities of profiting from these pendulum swings.

There are two possible ways by which he may try to do this:

• the way of timing and
• the way of pricing.

By timing we mean the endeavor to anticipate the action of the stock market - to buy or hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downward.

By pricing, we mean the endeavor to buy stocks when they are quoted below their fair value and to sell them when they rise above such value.

A less ambitious form of pricing is the simple effort to make sure that when you buy you do not pay too much for your stocks. This may suffice for the defensive investor, whose emphasis is on long-pull holding; but as such it represents an essential minimum of attention to market levels.



We are convinced that the intelligent investor can derive satisfactory results from pricing of either type.

We are equally sure that if he places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator's financial results.

This distinction may seem rather tenuous to the layman, and it is not commonly accepted on Wall Street.

As a matter of business practice, or perhaps of thoroughgoing conviction, the stock brokers and the investment services seem wedded to the principle that both investors and speculators in common stocks should devote careful attention to market forecasts.

Pretensions of stock-market forecasting or timing.

The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking. Yet in many cases he pays attention to them and even acts upon them. Why?

Because he has been persuaded that it is important for him to form some opinion of the future course of the stock market, and because he feels that the brokerage or service forecast is at least more dependable than this own.

*

A great deal of brain power goes into this field and undoubtedly some people can make money by being good stock market analysts.

But it is absurd to think that the general public can ever make money out of market forecasts.

For who will buy when the general public, at a given signal, rushes to sell out at a profit?

If you, the reader, expect to get rich over the yers by following some system or leadership in market forecasting, you must be expecting to try to do what countless others are aiming at, and to be able to do it better than your numerous competitors in the market.

There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he is himself a part.

Timing is of Psychological importance to the speculator

There is one aspect of the "timing" philosophy which seems to have escaped everyone's notice.

Timing is of great psychological importance to the speculators because he wants to make his profit in a hurry. The idea of waiting a year before his stock moves up is repugnant to him.

But a waiting period, as such, is of no consequence to the investor.

What advantage is there to him in having his money uninveted until he receives some (presumably) trustworthy signal that the time has come to buy?

He enjoys an advantage only if by waiting he succeeds in buying later at a sufficiently lower price to offset his loss of dividend income.

What this means is that timing is of no real value to the investor unless it coincides with pricing - that is, unless it enables him to repurchase his shares at substantially under his previous selling price.

Ref: Intelligent Investor by Benjamin Graham

Bear market amnesia

Without bear markets to take stock prices back down, anyone waiting to "buy low" will feel completely left behind - and all too often, will end up abandoning any former caution and jumping in with both feet.

That's why Graham's message about the importance of emotional discipline is so important.

From October 1990 through January 2000, the Dow Jones Industrial Average marched relentlessly upward, never losing more than 20% and suffering a loss of 10% or more only three times.

This was the second - longest uninterrupted bull market of the past century; only the 1949 - 1961 boom lasted longer.

The longer a bull market lasts, the more severely investors will be afflicted with amnesia.

After five years or so, many people no longer believe that bear markets are even possible.

All those who forget are doomed to be reminded; and, in the stock market, recovered memories are always unpleasant.

Think for Yourself

The cheaper stocks got, the less eager people became to buy them.

They were imitating Mr. Market, instead of thinking for themselves.

The intelligent investor shouldn't ignore Mr. Market entirely. Instead, you should do business with him - but only to the extent that it serves your interests.

Mr. Market's job is to provide you with prices; your job is to decide whether it is to your advantage to act on them.

You do not have to trade with him just because he constantly begs you to.

By refusing to let Mr. Market be your master, you transform him into your servant. Afterall, even when he seems to be destroying values, he is creating them elsewhere.

-----

In 1999, the Wilshire 5000 index - the broadest measure of US stock performance - gained 23.8%, powered by technology and telecommunications stocks.

But 3,743 of the 7,234 stocks in the Wilshire index went down in value even as the average was rising.

While those high-tech and telecom stocks were hotter (than the hood of a race car on an August afternoon), thousands of "Old Economy" shares were frozen in the mud - getting cheaper and cheaper.

The stock of CMGI, and "incubator" or holding company for Internet start-up firms, went up an astonishing 939.9% in 1999.

Meanwhile, Berkshire Hathaway - the holding company through which Graham's greatest discipline, Warren Buffett, owns such Old Economy stalwarts as Coca-Cola, Gillette, and the Washington Post Co. - dropped by 24.9%.

But then, as it so often does, the market had a sudden mood swing. The Old Economy stinkers of 1999 became the stars of 2000 through 2002.

As for the two holding companies, CMGI went on to lose 96% in 2000, another 70.9% in 2001, and still 39.8% more in 2002 - a cumulative loss of 99.3%.

Berkshire Hathaway went up 26.6% in 2000 and 6.5% in 2001, then had a slight 3.8% loss in 2002 - a cumulative gain of 30%.

Ref: Intelligent Investor by Benjamin Graham.

Controlling the controllable

Recognize that investing is about controlling the controllable.

You can't control whether the stocks or funds you buy will outperform the market today, next week, this month, or this year; in the short run, your returns will always be hostage to Mr. Market and his whims.

But you can control:

• your brokerage costs, by trading rarely, patiently and cheaply.
• your ownership costs, by refusing to buy mutual funds with excessive annual expenses.
• your expectations, by using realism, not fantasy, to forecast your returns.
• your risk, by deciding how much of your total assets to put at hazard in the stock market, by diversifying, and by rebalancing.
• your tax bills, by holding stokcs for at least one year and, whenever possible, for at least five years, to lower your captal-gains liability.
• and, most of all, your own behaviour.

News You Could Use

Stocks are crashing, so you turn on the television to catch the latest market news. But instead of CNBC or CNN, imagine that you can tune in to the Benjamin Graham Financial Network. On BGFN, the audio doesn't capture that famous sour clang of the market's closing bell; the video doesn't home in on brokers scurrying across the floor of the stock exchange like angry rodents. Nor does BGFN run any footage of investors gasping on frozen sidewalks as red arrows whiz overhead on electronic stock tickers.

Instead, the image that fills your TV screen is the facade of the New York Stock Exchange, festooned with a huge banner reading: "SALE! 50% OFF!" As intro music, Bachman-Turner Overdrive can be heard blaring a few bars of their old barn-burner, "You Ain't Seen Nothing Yet."

Then the anchorman announces brightly,

"Stocks became more attractive yet again today, as the Dow dropped another 2.5% on heavy volume - the fourth day in a row that stocks have gotten cheaper.

Tech investors fared even better, as leading companies like Microsoft lost nearly 5% on the day, making them even more affordable.

That comes on top of the good news of the past year, in which stocks have already lost 50%, putting them at bargain levels not seen in years.

And some prominent analysts are optimistic that prices may drop still further in the weeks and months to come."

The newscast cuts over to market strategist Ignatz Anderson of the Wall Street firm of Ketchum & Skinner, who says, "My forecast is for stocks to lose another 15% by June. I'm cautiously optimistic that if everything goes well, stocks could lose 25%, maybe more."

"Let's hope Ignatz Anderson is right," the anchor says cheerily. "Falling stock prices would be fabulous news for any investor with a very long horizon." And now over to Wally Wood for our exclusvie AccuWeather forecast.

Ref: The Intelligent Investor by Benjamin Graham

Embracing a bear market

Over a 10- or 20- or 30-year investment horizon, Mr. Market's daily dipsy-doodles simply do not matter.

In any case, for anyone who will be investing for years to come, falling stock prices are good news, not bad, since they enable you to buy more for less money.

The longer and further stocks fall, and the more steadily you keep buying as they drop, the more money you will make in the end - if you remain steadfast until the end.

Instead of fearing a bear market, you should embrace it.

The intelligent investor should be perfectly comfortable owning a stock or mutual fund even if the stock market stopped supplying daily prices for the next 10 years.

Paradoxically, "you will be much more in control," explains neuroscientist Antonio Damasio, "if you realize how much you are not in control." By acknowledging your biological tendency to buy high and sell low, you can admit the need to dollar-cost average, rebalance, and sign an investment contract.

By putting much of your portfolio on permanent autopilot, you can fight the prediction addiction, focus on your long-term financial goals, and tune out Mr. Market's mood swings.

Ref: The Intelligent Investor by Benjamin Graham

"Fight or Fright" Response

When the stocks drop, that financial loss fires up your amygdala - the part of the brain that processes fear and anxiety and generates the famous "fight or flight" response that is common to all cornered animals. Just as you can't keep your heart rate from rising if a fire alarm goes off, just as you can't avoid flinching if a rattlesnake slithers onto your hiking path, you can't help feeling fearful when stock prices are plunging."

In fact, the brilliant psychologists Daniel Kahneman and Amos Tversky have shown that the pain of financial loss is more than twice as intense as the pleasure of an equivalent gain. Making $1000 on a stock feels great - but a $1000 loss wields an emotional wallop more than twice as powerful.

Losing money is so painful that many people, terrified at the prospect of any further loss, sell out near the bottom or refuse to buy more.

Panic Selling

Another big plunge in the prices of stocks in our market today.

At the rate it is going, it will not be surprising to see:

1. The blue chips selling at 50% of their fair value price.
2. The good mid-cap stocks selling at 30% of their fair value price.
3. The prices for the other stocks probably can reach a bottomless pit.

In a severe capitulation, the selling tends to overshoot on the way down.


Reliving the 1997-1998 Asian Financial Crisis

How do I gauge the trend of interest rate?

Question: How do I gauge the trend of interest rate?

Generally, the central bank of a country uses interest rates to control inflation. Therefore, an understanding of interest rate trend is important since it invariably affects the stock market.

Basically, the trend of interest rates tend to depend on several factors.

One of the more important factors concerns the growth of money supply, that is, by comparing M3 with the economic growth which is that of Gross Domestic Product (GDP).


Illustration.

Country "A" (Broad Money Supply M3) Year 1993

*Broad money supply (M3) = A + B + C = $38.3bn
Annual % change in M3 = 24%

GDP (Rate of expansion) = 12.6%

Base Lending Rate (BLR) Current = 7.1% - 7.25%

Conclusion: The economy is facing high risks of inflation as the M3 growth rate of 24% is twice as fast as the rate of expansion which is 12.6% in nominal GDP.

Possible Action: As there is likely to be a surge in inflation in the immediate future, an increase in the BLR to 8.5% is a possible move in order to bring M3 growth rate back to about 15%.

Effect: Interest rate in Country "A" could be on the rise.


_____________

*Broad Money Supply (M3) = A+B+C
The Determinants are:......................... 1993......... % change

A. Net Lending to Government..........1.6bn........-1.0%

B. Private Sector Credit Demand........18.1bn......11.3%
Manufacturing...................2bn....+1.2%
Construction....................1.3bn....0.8%
Commerce.......................1.8bn....1.0%
Transport........................2.2bn....1.4%
Other Business...............1.0bn....0.7%
Personal...........................9.8bn...6.2%

C. External Liquidity.........................21bn......13.7%
Traders & Income
Repatriation........-5.4bn....-6.0%
Investments..................11.7bn....8.4%
Short Term Funds........15.5bn...11.3%


Ref: Making Mistakes in the Stock Market by Wong Yee

Why is US 30-year treasury bond price important?

Why is US 30-year treasury bond price important?

It is a norm that when bond price rises, interest rate falls and vice versa.

Thus investors need to to be able to read the bond price chart in order to understand the trend of US interest rate.

As the US is the world's largest economy, the impact of their interest rate tends to affect smaller countries such as Singapore and Malaysia.

In turn, the interest rates changes will affect the stock market in these countries.

It is said that investors in the US are not keen to buy shares once the 30-year treasury bond hits a yield of more than 8%.


Bond price ----> Bullish (rises)
===> decrease in interest rate ===> rise in share prices

Bond price----> Bearish (falls)
===> increase in interest rate ====> fall in share prices

Currency movements and stock market

Question: What is the impact of the currency movements on the stock market?

This simple article is of interest to those investing in overseas stock markets.


24-10.08
http://biz.thestar.com.my/business/exchange.asp

Units of Malaysian ringgit per unit of foreign currency:
1 US DOLLAR = 3.6070
1 AUSTRALIAN DOLLAR = 2.4250
1 BRUNEI DOLLAR = 2.4040
1 CANADIAN DOLLAR = 2.8860
1 EURO = 4.6510
1 NEW ZEALAND DOLLAR = 2.1580
1 PAPUA N GUINEA KINA =1.4810
1 SINGAPORE DOLLAR = 2.4035
1 STERLING POUND = 5.8310


A possible impact could be that when the local currency is on the rise, foreign investors will want to sell their shares to realise their gains (shares realise value and exchange rate profit).

Similarly, when the local currency is falling, foreign investors may have the tendency to buy local shares since the cost is relatively cheap, provided the stock market is still bullish.

Scenario 1

MR rises ---> means that foreign investors will
---> sell shares,
---> change back into their own currency for capital gains

Scenario 2

MR falls ---> means that foreign investors will
---> retain local currency
---> buy Malaysian shares as the latter are relatively cheap

Ref: Making Mistakes in the Stock Market by Wong Yee

What causes investors to buy or sell shares?

Question: What causes investors to buy or sell shares?

Always remember that in every trade, there is a buyer and there is a seller.

Generally, the buy and sell actions can be said to be governed by two basic elemets - "HOPE" and "FEAR".

People buy shares because they "hope" to make money. Similarly, people sell shares because they "fear" that their share prices will tumble.

"Hope" is normally centred around a country's economic performance. When there is "hope" of an economic expansion, share prices will rise in anticipation of the said economic upturn. Perhaps, the reason being, during an economic upturn, companies will make or are expected to make more money.

"Fear", on the other hand, is associated with unpleasantness in situations such as recessions, political crisis or social unrest. All these tend to create a sense of fear among market players thereby causing them to sell their shares. The fear of inflation or high interest rates have made market players rather jittery. The latest global financial and economic meltdown have similarly caused a worldwide selling in the stock markets.


Mind of the Market Player

Economy good? Bonus issue? ====> BUY

Recession? Political uncertainty? Riot, inflation, higher interest rate? ====> SELL


Reference: Making Mistakes in the Stock Market by Wong Yee

Major overseas market falls sharply, should we sell our shares?

Question: When a major overseas market falls sharply, should we sell our shares (in panic)?

The crux of the issue is to always bear in mind that generally each stock market has its own trend. The problems and environment defer from country to country.

Thus, the peculiarity of the stock market may not necessarily affect the other.

Instead, the rise or fall of a stock market tends to depend on how investors perceive the particular situation say, in 6 months to 1 year. That is the future prospect of the country.


However, some may argue that the above view is erroneous.

Take for example, the October 1987 Wall Street Crash which rocked the stock markets of the world. To this, one needs to understand that the Oct 1987 crisis was due to a fear of a worldwide recession due to the insurmountable trade deficit in the US.

On the contrary, the even that caused the Hong Kong Hang Seng to plunge 633.85 points in 3 days on 11.3.93, 12.3.93 and 15.3.93 was attributed to the political issue between Hong Kong and China over the handling over of Hong Kong to China in 1997. Despite the drastic fall of the Hong Kong Hang Seng Index, the ST Industrial Index of Singapore remained firm. Therefore, if you had panicked and sold off your stocks, you would stand to lose out.


Each country has its own problems, economic or political.
Therefore, each country's stock market trend defers one from the other.
EXCEPTION: Worldwide fear could have a down effect.


Ref: Making Mistakes in the Stock Market by Wong Yee

Comments:
What about the present crisis?
How will this play out?
My opinion is the financial markets are not decoupled.
But what of the individual economies? Likewise too.
But let us not despair.
History has shown that after each crisis, the world rebounded back to higher levels of growth.
It is only a matter of when this crisis will be over.
You should have invested in a manner to be in a position to take advantage of the crisis.
For others, surviving the crisis unscathed maybe challenging.

Ref: Consequences must dominate Probabilities

Fundamental analysis useful in bear market

Question: When should we use fundamental analysis?

Fundamental analysis is a good tool to engage at all times. It is particularly useful during a bear phase of the stock market.

When prices have fallen sharply to an unrealistic level, you could reap a handsome profit in future by using fundamental analysis to guide you in buying shares.

• First, ascertain whether stock market is in a bull or bear phase.
• If it is a Big Bear, then use Fundamental Analysis.

Ref: Making Mistakes in the Stock Market by Wong Yee

What is a bear rally? What should I do?

Question: What is a bear rally? What should I do?

During a bear phase - a situation whereby share prices keep on falling to a new low after each rebound - share prices will, at a certain level, stage a steep upturn all of a sudden.

The buying power is so real that it appears as if a new bull market has been born.

Nevertheless, such a bear rally is often short-lived with a retraceable estimate of either 1/3, 1/2, 2/3 or even 100% of the fall.

(Note the recent 1000 points rise in 1 day of the Dow index and today's new low in Dow index)

During such a scenario, an investor should exercise caution when buying shares.


BEAR MARKET

Prices falling from point A -----> lower ----> to new low at point B ----
----------------------> Bear Rally (?% up 1/3, 1/2, 2/3 or 100% of AB)


Ref: Making Mistakes in the Stock Market by Wong Yee

Effects of good news on share price

Question: Is the statement "When a company declares good profits the share price must rise" correct?

In most instances, the above-mentioned may be the case provided

• the good news have not been discounted by the market yet and
• that the prevailing market sentiment is still bullish.

After all, in a bull market, all good news are regarded as bullish news.

On the contrary, in a bear market, good news may not necessarily cause the share price to rise.

In a bullish market

If good news:

• share price will rise
• if good news already discounted, share price will not rise.

In a bearish market

If good news:

• share price may fall

Ref: Making Mistakes in the Stock Market by Wong Yee

Historical Earnings

Question: Is it advisable to buy shares based on historical earnings?

One of the fundamental errors of market player is to make decisions based on historical earnings. Such a decision can be a costly affair.

Reasons being, economic situation always keep changing. In addition, each industry also has its own cycles.

It is thus more advantageous to do your own research to try and forecast the profits of a particular company.

If the profits forecast is better than the historical earnings, then it is worth investing in the said company shares.

Points:
Historical Data is just a guide
Do not base your decision on historical profits.
If possible, do both present and future forecasts.


Ref: Making Mistakes in the Stock Market by Wong Yee

What should I do in a bear market situation?

The best strategy is to go for a holiday and let the market cool off.

When things have settled down, you may commence to do some bargain hunting.


Ref: Making Mistakes in the Stock Market by Wong Yee

What is a bear market?

It is a situation whereby share prices keep on falling lower and lower.

Although at a certain point in time share prices will head for a rebound, the rebound normally will not be sustained.

Thus, the downward escalation of share prices resumes as bad news keeps surfacing one after another.

Investors and speculators become jittery and sell their shares at a loss.

Bad debts become the order of the day and lawyers are busy issuing demand letters.

Suddenly, those smiling faces are replaced with sadness and a solemn mood.

Brokers also find themselves in trouble when clients fail to settle debts.

STOCK MARKET INDEX ----> falling -----> Low ------> New Lows----->

Scenario:
Bad news abound
Forced selling by brokers
Bad debts to be collected
Sad faces around

What should I do in a bull market situation?

As share prices will be rising since speculators are chasing after the shares, the best strategy to adopt is to buy during a correction.

In case the share price should drop after buying, you need to do some averaging.

However, remember to keep on selling once you have profits.

SHARE PRICE -------> Rising --------> Correction or consolidation ===> Buy!

Always buy downwards and buy to average i.e. lowering your cost.

Ref: Making Mistakes in the Stock Market by Wong Yee

What is a bull market?

Simply put, a bull market is a situation where share prices are rising higher and higher giving the impression that this upward movement will continue indefinitely - with little pockets of correction along the way.

Everyone seems to be making money. Good news is in abundance and bad news does not seem to exist.

Smiling faces can be seen everywhere and restaurants are often fully booked. Conversations on buying new cars or expensive watches never seem to end.

STOCK MARKET INDEX reaches a ------> Peak -------->correction or consolidation ------
--------> Higher Peak ----------> Correction or consolidation --------> Higher Peak

Great Depression versus Now

http://biz.thestar.com.my/news/story.asp?file=/2008/10/22/business/2335258&sec=business

The Star Online > Business
By OOI KOK HWA" name=AUTHOR>
Wednesday October 22, 2008

Great Depression versus now

Personal Investing

By OOI KOK HWA

As much as there are similarities between the two crises, the damage caused by the current turmoil is likely to be less severe given the swift actions of central banks.

AS a result of the recent financial tsunami, some experts have started to ponder whether we are headed for a depression.

The current credit crunch and the meltdown in some financial institutions were quite similar to what happened during the Great Depression in the 1930s.

In this article we will analyse the reasons behind the 1929 Wall St crash, which kickstarted the Great Depression and compare it to the current situation to identify any signs that a depression is approaching.

Milton Friedman, the leading advocate of monetarism, argued that every great depression had been accompanied or preceded by a monetary collapse.

According to Ben Bernanke, the US Fed chairman, the main reason behind the Great Crash of 1929 was due to the tight monetary policies adopted during that period.

He said the high interest rates back then caused the US economy to fall into a recession that led to the great market crash in October 1929.

As the US dollar was backed by gold, the acute selling of dollars for gold resulted in a run on the dollar.

The Fed continued to increase interest rates in an effort to preserve the value of US dollar.
As a result, high interest rates caused bankruptcies for many companies.

At the peak of the Great Depression, the US unemployment rate hit 25%

To rub salt into the wound, massive withdrawals of cash by panicky depositors were the last straw that brought about the total collapse of financial institutions.

In that period, bank deposits were uninsured and the collapse of the banks caused depositors to lose their savings.

And due to the economic uncertainties, the surviving banks were reluctant to give out new loans.
Another culprit in the 1929 crash was margin financing which caused excessive speculation in the stock market.

Investors needed only to put up 10% capital and borrow the rest from the bank to invest in the stock market.

The collapse of stock prices led to margin calls and further selldowns.

Coming back to the 2008 crash, the banking and credit-market crisis was mainly due to the property boom and subprime bust.

The collapse of subprime loans sparked the credit crunch, which dragged some financial institutions into trouble.

As a result of the securitisation and the creation of innovative financial products like collateralised-debt obligations and credit-default swaps, the collapse of one financial institution had a domino effect, leading to the collapse of other financial institutions.

Now, the pertinent question is whether we are in a long bear market and heading for a depression.

We believe a depression like the one in 1929 may not happen exactly the way it did before.
Given the fast actions taken by central banks around the world, the damage caused by this crisis will be less severe than the one in 1929.

Central banks around the world have been putting in concerted efforts to make sure the global economy will not fall into a depression.

The rescue packages being implemented throughout the world will help stabilise the financial system.

We believe the reduction of interest rates and the increase in money supply will help cushion the impact of the credit crunch.

Besides, deposits placed with most financial institutions are guaranteed by central banks.
Even though the US unemployment rate may rise to 10% from 6.1% currently, it is still far below the peak of 25% hit during the Great Depression.

In the 1929 crash, the Dow Jones Industrial Average took about three years to reach bottom in July 1932 from its peak in September 1929.

From the peak to the trough the Dow lost about 90%.

The Great Depression in the US started in August 1929 and ended only in March 1933.
The stock market started to recover eight months before the US economy ended its depression.
At present, the Dow has already dropped for a year from its peak in October 2007, currently down about 37.5% against its peak of 14,164 points on Oct 9, 2007.

In view of the possible economic recession in most developed countries, we think the Dow will drop further from current levels.

Nevertheless, we believe it will recover much faster and the magnitude of the fall will be far less severe than the one in 1929.

Lastly, we believe the stock market will eventually recover.

At this point, to be more prudent, we may take a “wait and see” approach until things stabilise.

> Ooi Kok Hwa is an investment adviser licensed by Securities Commission and the managing partner of MRR Consulting
© 1995-2008 Star Publications (Malaysia) Bhd (Co No 10894-D)

Protect your savings against inflation

Inflation eating into retirement nest-egg of Malaysians

By Jeeva Arulampalamjeeva@nstp.com.my

FOUR out of 10 Malaysians feel the need to continue working after their mandatory retirement age, driven by the fear that they will not be able to support themselves based on current retirement savings.

A survey by life insurer Prudential Assurance Malaysia Bhd in August 2008, called the Prudential Retire-Meter 2008, found that 36 per cent of people approaching retirement age were less confident about their retirement from a year ago."

About 81 per cent of these individuals said that inflation had gone up and had an effect on their lifestyles," Prudential Assurance Malaysia chief executive officer Bill Lisle said at a media briefing in Kuala Lumpur yesterday to release the survey findings.

While close to 72 per cent of the respondents said they saved, about 77 per cent of those who saved invest in low-yielding savings vehicles such as fixed deposits and savings accounts."

About 41 per cent said they don't know how much to save to meet their retirement needs and 64 per cent said they did not separate their retirement savings from their other savings," said Lisle.

Lisle said the lack of awareness for retirement savings needed to be addressed since Malaysians should ensure that their retirement plans are inflation and recession proof.

He added that Prudential will continue with its retirement education programme in November, under the "What's your number" campaign that seeks to identify and revise one's estimated retirement savings on an annual basis.

Global research agency Research International was commissioned to conduct the Prudential Retire-Meter 2008 survey which covered key urban centres in Peninsular Malaysia, Sabah and Sarawak.

A total of 1,024 Malaysians with a monthly household income of RM3,000 and higher were interviewed for the survey.

Mail webheads for site related feedback and questions. Write to the editor or contact sales for other kind of help. Copyright © The New Straits Times Press (Malaysia) Berhad, Balai Berita 31, Jalan Riong, 59100 Kuala Lumpur, Malaysia.

http://www.btimes.com.my/Monday/OurPick/20081022004144/Article

Outyielding Blue Chips

Browsing the business section of the local paper enabled one to pick up stocks with dividend yields of 4.0% or greater.

No intelligent investor, no matter how starved for yield, would ever buy a stock for its dividend income alone; the company and its businesses must be solid, and its stock price must be reasonable.

But, thanks to the bear market that began the last few months, some leading stocks (blue chips) are now outyielding FDs.

So, even the most defensive investor should realize that selectively adding stocks to an all-bond or mostly-bond portfolio can increase its income yield - and raise its potential returns.

Ref: modified version based on Intelligent Investor by Benjamin Graham

Developing world has been caught up big time in the global credit squeeze

New York Times

October 20, 2008


Editorial
Collateral Damage


Developing countries have sparked their share of international financial crises over the years. But this time it is not their fault.


As the world’s richest nations spend trillions to rescue their own financial systems from the maelstrom caused by years of excess, they must also be prepared to provide billions to poorer countries that did not cause this crisis but are nevertheless its victims.


The developing world has been caught up big time in the global credit squeeze, as beleaguered foreign banks have cut their credit lines and panicked foreign investors have pulled their money out. Private capital flows to emerging markets are expected to plummet 30 percent this year.
Exports are suffering as rich economies slow and commodity prices retreat. Remittances from migrant workers — a core source of earnings for many developing countries — are falling fast.
Eastern and Central Europe, where much of the banking system is controlled by Western banks, is in particularly dire straits. Ukraine asked the International Monetary Fund for $14 billion to prop up its financial system as money flees. Hungary got 5 billion euros from the European Central Bank.


Pakistan — America’s hoped-for ally in the fight against Al Qaeda that also has nuclear weapons — is said to need $3 billion to $4 billion to finance a gaping trade deficit.


Even robust economies with strong budgets and ample reserves have been walloped by the capital crunch. Two weeks ago, the Mexican peso suffered its steepest drop since the peso crisis of December 1994. The Brazilian real and the Korean won have plunged by a quarter against the dollar.


Given the depth of the crisis here, it might be tempting to ignore the plight of developing economies. But it is in the clear economic interest of wealthy nations to help. The I.M.F. expects these countries to be the only engine of global growth in the next year or so.


Fortunately, some people are thinking ahead. The International Finance Corporation, an arm of the World Bank, is mulling a $3 billion fund to help recapitalize shaky banking systems in the world’s poorest countries. The Inter-American Development Bank said it would increase its lending and announced a $6 billion facility to help companies in smaller Latin American countries that lose access to funding.


The I.M.F. said it is flush with cash —$200 billion plus an additional $50 billion in standing credit arrangements with donor countries — to mobilize if needed. For that it will need the go-ahead from the United States and other big contributors. The I.M.F. must also be ready to relax — within reason — the battery of preconditions it usually attaches to its help.


The world’s richest countries have exhibited enormous myopia throughout this crisis — originally scurrying for ad hoc individual “solutions” that worsened the collective mess. Less than two weeks ago, Washington and Brussels allowed Iceland to go bust.


As the world’s financial powers struggle to contain the disaster, they should not lose sight of its effect on other countries. Every economy for itself makes no sense — and could prove highly dangerous — in today’s interconnected world.



http://www.nytimes.com/2008/10/20/opinion/20mon1.html?_r=1&hp&oref=slogin

Consequences must dominate Probabilities

In making decisions under conditions of uncertainty, the consequences must dominate the probabilities. We never know the future.

The intelligent investor must focus not just on getting the analysis right. You must also ensure against loss if your analysis turns out to be wrong - as even the best analyses will be at least some of the time.

The probability of making at least one mistake at some point in your investing lifetime is virtually 100%, and those odds are entirely out of your control. However, you do have control over the consequences of being wrong.

Many "investors" put essentially all of their money into dot-com stocks in 1999; an online survey of 1,338 Americans by Money Magazine in 1999 found that nearly one-tenth of them had at least 85% of their money in Internet stocks. By ignoring Graham's call for a margin of safety, these people took the wrong side of Pascal's wager. Certain that they knew the probabilities of being right, they did nothing to protect themselves against the consequences of being wrong.

Simply by keeping your holdings permanently diversified, and refusing to fling money at Mr. Market's latest, craziest fashions, you can ensure that the consequences of your mistakes will never be catastrophic. No matter what Mr. Market throws at you, you will always be able to say, with a quiet confidence, "This, too, shall pass away."

Ref:

The Intelligent Investor by Benjamin Graham

Pascal's Wager
http://www.infidels.org/library/modern/theism/wager.html

The risk is not in our stocks, but in ourselves

Risk exists in another dimension: inside you.

If you want to know what risk really is, go to the nearest bathroom and step up to the mirror. That's risk, gazing back at your from the glass.

If you overestimate how well you really understand an investment, or overstate your ability to ride out a temporary plunge in prices, it doesn't matter what you own or how the market does.
Ultimately, financial risk resides not in what kinds of investments you have, but in what kind of investor you are.

The Nobel-prize-winning psychologist Daniel Kahneman explains two factors that characterize good decisions:

1. Do I understand this investment as well as I think I do? ("Well-calibrated confidence")

2. How will I regret if my analysis turns out to be wrong? ("Correctly-anticipated regret")

To find out whether your confidence is well-calibrated, look in the mirror and ask yourself: "What is the likelihood that my analysis is right?" Think carefully through these questions:

• How much experience do I have? What is my track record with similar decisions in the past?
• What is the typical track record of other people who have tried this in the past?
• If I am buying, someone else is selling. How likely is it that I know something that this other person (or company) does not know?
• If I am selling, someone else is buying. How likely is it that I know something that this other person (or company) does not know?
• Have I calculated how much this investment needs to go up for me to break even after my taxes and costs of trading?

Next, look in the mirror to find out whether you are the kind of person who correctly anticipates your regret. Start by asking: "Do I fully understand the consequences if my analysis turns out to be wrong?" Answer that question by considering these points:

• If I'm right, I could make a lot of money. But what if I'm wrong? Based on the historical performance of similar investments, how much could I lose?
• Do I have other investments that will tide me over if this decision turns out to be wrong? Do I already hold stocks, bonds, or funds with a proven record of going up when the kind of investment I'm considering goes down? Am I putting too much of my capital at risk with the new investment?
• When I tell myself, "You have a high tolerance for risk," how do I know? Have I ever lost a lot of money on an investment? How did it feel? Did I buy more, or did I bail out?
• Am I relying on my willpower alone to prevent me from panicking at the wrong time? Or have I controlled my own behaviour in advance by deversifying, signing an investment contract, and dollar-cost averaging?

"Risk is brewed from an equal dose of two ingredients - probabilities and consequences."

Before you invest, you must ensure that you have realistically assessed

• your probability of being right and
• how you will react to the consequences of being wrong.

What is risk? First, don't lose

What is risk? You will get different answers depending on whom, and when, you ask.

In 1999, risk didn't mean losing money; it meant making less money than someone else! What many people feared was bumping into somebody at a barbecue who was getting even richer even quicker by day trading dot-com stocks than they were.

Then, quite suddenly, by 2003 risk had come to mean that the stock market might keep dropping until it wiped out whatever traces of wealth you still had left.

While its meaning may seem nearly as fickle and fluctuating as the financial markets themselves, risk has some profound and permanent attributes. The people who take the biggest gambles and makes the biggest gains in a bull market are almost always the ones that get hurt the worst in the bear market that inevitably follows. (Being "right" makes speculators even more eager to take extra risk, as their confidence catches fire.)

And once you lose big money, you then have to gamble even harder just to get back to where you were, like a race-track or casino gambler who desperately doubles up after every bad bet. Unless you are phenomenally lucky, that's a recipe for disaster.

First, don't lose

No wonder, when he was asked to sum up everything he had learned in his long career about how to get rich, the legendary financier J.K. Klingenstein of Wertheim & Co. answered simply: "Don't lose."

Losing some money is an inevitable part of investing, and there's nothing you can do to prevent it. But, to be an intelligent investor, you must take responsibility for ensuring that you never lose most or all of your money.

For the intelligent investor, Graham's "margin of safety" performs an important function. By refusing to pay too much for an investment, you minimize the chances that your wealth will ever disappear or suddenly be destroyed.

"Imagine that you find a stock that you think can grow at 10% a year even if the market only grows 5% annually. Unfortunately, you are so enthusiastic that you pay too high a price, and the stock loses 50% of its value the first year. Even if the stock then generates double the market's return, it will take you more than 16 years to overtake the market - simply because you paid too much, and lost too much, at the outset."


Ref: Intelligent Investor by Benjamin Graham

Value above Price

Clear-cut undervaluations of leading common stocks (blue chip stocks) tend to occur only during bear markets. The intervals between successive market bottoms have been much longer, so that this type of opportunity must now be considered as infrequent.

In the secondary field (non-blue chip stocks), by contrast, undervaluations may be found at all times except when a bull market is well advanced. Thus the investor or analyst who is strongly interested in the undervaluation approach will find what he is looking for, more continuously or consistently, among the secondary issues.

Ref: Security Analysis by Benjamin Graham

[Bear markets occur infrequently. As a guide, perhaps, for every 4 bulls, one expects to meet 1 bear. Very severe bear markets were uncommon. This occured about 1 in 10 years, namely 1987 and 1997.]

3 exceptions to sell the losers rule

Value, in terms of growth potential, is based on earnings and earnings growth.

Analysis of earnngs and news about a company can give some insight into the quality of earnings.

If management has increased earnings by firing half the company's personnel, or the increase is derived from closing several facilities, the quality of the increase is not as valuable as it would be if it reflected improved sales and other revenues.

Slash-and-burn strategies can lead to a further decline in productivity, resulting in additional weakness in earnings and eventually lower prices for the stock.

On the positive side, drastic cuts can force companies to become more efficient, thereby increasing the quality of earnings, which may lead to higher stock prices.

The investor must analyse the company's growth and observe the stock price in action. From the analysis, the investor can determine whether the value of a stock is more likely to:

• increase,
• remain flat, or
• begin to decline.

The analysis can be difficult at times because a winner can temporarily take on the appearance of a loser.

Three situations:

• daily price fluctuations,
• market declines, and
• price advances followed by weaknesses

can make a winner appear to look weak, but they are not necessarily a signal to begin selling. These are usually temporary situations and are therefore exceptions to the sell-the-losers rule.

Exception 1: Daily Price Fluctuations

Stock prices fluctuate up or down in day-to-day trading. A glance at any daily price chart will show what may be considered normal daily fluctuations for any individual stock. Stock prices also move from one trading range to another.

For example, a stock price could have a daily fluctuation of $30 to $35 but could occasionally move to $40 and then drop back to the $30 to $35 range. The trading range would be considered $30 to $40. When the stock moves up and begins fluctuating between $40 and $55, it is trading in a new, higher range.

The trading ranges and daily fluctuations can be readily observed on a price pattern cahrt. The investor should take the time to become familiar with these trading ranges and fluctuations from the preceding few months.

Familiarity with price movements will help the investor differentiate between a normal fluctuation and a breakout to a new trading range.

If a lower stock price is within the normal range, it may still be a winner, even if the investor is experiencing a small loss - assuming that the initial analysis showed the stock to be a winner in earnings and growth. Therefore, the kind of weakness seen in a normal fluctuation does not indicate that the time to sell out and take a loss has arrived.


Exception 2: Market Decline

A significant drop in the overall stock market can force the price of a winner to lower levels. All stocks can eventually look like losers, and some will become losers.

Most often these severe market corrections are a time for concern, but not panic.

As we have seen in recent years, the stock market can drop 100, 200, or more than 500 points and recover quickly. Stocks that were winners before the correction will likely be winners agains when the market recovers.

In October 1987, the Dow Industrials dropped more than 508 points (22.6%). Looking back in 2004, that is still the largest percentage drop in one day. Merck & Company had already been showing some weakness, but on the sharp correction on October 19, it dropped from $11.00 to $8.50, a significant $1.50. This correction was an overall market reaction. For Merck, the weakness of the market in late 1987 was an excellent buying opportunity. It began a quick recovery, and by April 1988, after prices were adjusted for a stock split, Merck was trading above $9.00 a share.

In a Continuing Decline

If the market correction is sudden and appears to stabilize in just a few days, it may be best to hold a position and even consider buying more shares of the same stock. Many investors recognized the severe correction in 1987, for example, as a buying opportunity. Although the Dow remained volatile, it reached new highs in early 1989.

Unless they are severe and extend over a few weeks and months, market corrections do not necessarily turn winners into losers.

If a market decline continues, however, the investor should consider selling and moving the funds to the sideline. Extended market corrections are bear markets where stock prices decline and interest rates rise.


Exception 3: Price Advance Followed by a Weakness

A significant upward move to a new trading range, followed by some price weakness, is a fairly normal occurrence. As a stock price makes a major upward movement, many investors will begin to take profits.

Although there is nothing wrong with taking profits, the upward price movement might have only just started. Even so, it is inevitable that some profit taking will occur, and the stock price that has risen to new highs will show some downward price correction.

A signal is given if a stock begins to fall lower than its daily trading range and the overall market is unchanged or advancing.

If a stock price that normally trades between $45 and $50 a share drops to $43 and then to $40, it is time to be concerned. The signal is even stronger if the stocks of comparable companies are not showing a similar weakness.

It is a signal to either sell the stock or find out the reason for the price decline.

Sell the Losers and Let the Winners Run

"Sell the Losers and Let the Winners Run"

"Cut your losses and let your profits run." (Daniel Drew, 1800)

The concept is sound. In fact, it is one of the most important understandings an investor can have about the stock market.

It is prudent for an investor to sell stocks that are losing money, stocks that could continue to drop in price and value. It makes equally good sense to stay with stocks that show significant gains, as long as they remain fundamentally strong.

But just what is a loser?

• Is it any price drop from the high?
• Is a stock a loser ony if the investor is actually in a loss position - that is, when the current price is below the original purchase price?

Any price drop is a losing situation. Price drops cost the investor money. They are a loss of profits. In some circumstances, the investor should sell, but in other situations the investor should take a closer look before reaching a sell decision.

The determination of whether a stock is still a winner depends on the cause of the price correction. If a price drop occurs because of a weakness in the overall market situatio or is the result of a "normal" daily fluctuation of the stock price, the stock can still be a winner.

If however, the cause of the drop has long-term implications, it could be time to take the loss and move on to another stock. Long-term implications could be any of the following:

• Declining sales
• Tax difficulties
• Legal problems
• An emerging bear market
• Higher interest rates
• Negative impacts on future earnings.

Any event that has a negative impact on the long-term picture of earnings or earnings growth can quickly turn a stock into a loser. Many long- and short-term investors will sell out their positions and move on to a potential winner.

Asian Financial Crisis 2?

In the Asian Financial Crisis of 1997, the IMF Packages (US$) to bail out:

Korea was US$ 57bn (Dec 3, 1997)
Thailand was US$ 17.2 bn (Aug 20, 1997)
Indonesia was US$ 43.0 bn (Oct 31, 1997)

The present financial crisis that started in 2007 in US is spreading globally. It is so much bigger. It has spread to Europe. Will Asia be affected too? Will we be revisited by another financial crisis?

Could it happen again?

The possibility of having another 1997-type crisis continues to create concern among policy-makers. The reason is no other than the disruptive effects of capital flows, especially in the emerging markets.

Statistics will show why such fear still exists. During the Asian Financial Crisis, a crude estimate of private capital that flowed into the five troubled countries of South Korea, Thailand, Indonesia, Malaysia and the Philippines was almost US$ 100 billion in 1996, which was one third of worldwide flows into the emerging markets (estimated at over US$ 295 billion). That was a five-fold increase over the 1990-1993 average.

When it suddenly reversed to an outflow of US$ 12 billion the following year, it had a devastating effect on these economies. Recent statistics from the Institute of International Finance reveal a staggering fact: net private capital flows was at a high of US$ 502 billion in 2006 after a record US$ 509 billion in 2005. The amount in 2007 might be slightly lower, but still well above the level of the heady days of 1990s.

Net portfolio of equity which recorded an outflow of nearly US$5 billion in 2002 reversed to inflows of US$ 39.1 billion in 2004 and to US$69.7 billion in 2006. Imagine what this amount of flows can do to emerging economies if it were to reverse and flow out.

What was seen in 1996-97 in Asian markets was an extraordinary change in confidence, what John Maynard Keynes termed as the "animal spirit". Such reversals in sentiment are quite common, even in developed economies, but the magnitude of such incidents is greater in emerging economies because foreign investors tend to lump them together without differentiating each country.

Even when investors are able to differentiate between the fundamentals, they do not think it is logical not to follow the herd mentality as they may still incur huge losses if they do not do so.

Because of the volatility of foreign capital flows, manoeuvring macroeconomic policies becomes a difficult task for emerging economies. Excess liquidity created by huge inflows tends to cause an increase in interest rates, which in turn attracts more capital into the country.

Another policy-makers' concern over capital flows is related to the devastating socioeconomic and political effects of the Asian Financial Crisis. Economic malaise then caused a rapid increase in suffering and poverty level as millions of people were thrown on the streets without a job.

The current global economic and financial conditions are similar to the situation in the heyday of the late 1990s. Because of massive liquidity induced by extremely low interest rates in some developed countries like Japan and US, particularly during the 2001 recession, global equity and bond markets boomed.

There are of course other reasons. Some countries which are preventing their currencies from excessive appreciation find themselves saddled with huge foreign reserves following huge surpluses in their current accounts.

While some countries try to avoid a build-up in liquidity, some only exercise partial sterilisation through issuance of bonds. As a result, the massive liquidty makes its way into the stock and property markets, causing an asset bubble. Not surprisingly, stock market indices in the US, China and many countries in Southeast Asia hit new historical highs last year. Valuations were rich and in a country like China, and its price-earnings multiples look horrendous.

At the same time, mounting reserves from China and Japan ended up in the US treasury market, causing yields to drop significantly.


Ref:

Malaysian Business July 16, 2007

http://fusioninvestor.blogspot.com/2008/10/usd-596004000000000.html
US$ 600 trillion