Managing Stockmarket Crashes Ultimately determines your long-term success!
Stockmarket crashes are a fact of life that value investors need to be prepared for. How well you handle a stock market correction (more than a 10% fall) or a crash (more than a 20% fall) will ultimately determine your level of success as an investor over the long term.
The reason for this is that these stock market downturns (a polite phrase for a correction or crash) provide opportunities to purchase stock in wonderful businesses whose stock prices have been swept down in the tide of fear that accompanies these events.
AS A LONG-TERM VALUE INVESTOR, YOU HAVE TO BE PREPARED TO MANAGE STOCK MARKET CRASHES.
WHY? - BECAUSE THEY ARE GOING TO HAPPEN FROM TIME TO TIME!
If the above statement bothers you, but you still want exposure to a stock market, then invest in an index fund instead.
If you think that predicting stockmarket crashes is something that you might get good at - THEN FORGET IT!. Unlike the slow and relatively steady rise in prices that occurs in a bull market, stock market crashes are swift and sudden.
Panic selling is commonly associated with stockmarket crashes. This is characterised by wholesale selling of stock, causing a sharp decline in price. Investors just want to get out of the investment, with little regard for the price at which they sell.
The speed of the market decline may be exacerbated by automated stop losses, pre-arranged sell orders, and the entry of short sellers into the market, selling stock that they don't own and buying it at lower prices to make a profit.
Margin calls on margin loans may cause the downturn to be even worse. The main problem with panic selling is that investors are selling in reaction to pure emotion and fear, rather than evaluating fundamentals. Almost all stockmarket crashes are a result of panic selling.
In the case of individual stock crashes, stock exchanges may place a market halt on some stock in order that the market can better digest the reason for the fall.
Terms associated with stockmarket crashes include a dead-cat bounce which describes a temporary recovery of a market from a decline, after which the market continues to fall.
A falling knife is a term given to a stock whose price or value falls sharply in a short period of time. The term suggests to me that you might get bloodied (lose money) if you try to catch it (buy it) on the way down.
There are several ways I have been able to partially insulate myself from these potentially catastrophic events. I have learnt this from experience as I have gone through several stockmarket crashes in the past ... and they say that experience is the best teacher.
If you can learn from other people's experience then the pain of having to learn the hard way can be minimised.
The first signs of trouble is usually increasing euphoria in the financial press which gradually gives rise to heightened interest by the general public. This can reach the point where everybody wants to buy shares and shares become part of dinner table conversation.
When the taxi driver wants to talk to you about shares, you know that it is time to start selling!
The stock market index provides another rough clue. When the market index approaches historic highs, it is time to be cautious.
The overall price/earnings ratio for the market is another clue. Overall market P/Es commonly vary from a low of about 12 to a high of about 20 with an average of about 15 to 17. Less and less shares appear undervalued as the average market P/E increases.
As the market index and average P/Es rise in a bull market, particular shares in my portfolio start to become overvalued. I compare its P/E ratio to its historical highs and lows for the last few years. If the value gets close to, reaches, or exceeds the average historic high, I commence a staggered sell.
I do this for other companies in my portfolio as the market heats further. As I do this, my margin loan reduces from a maximumm loan valuation ratio (LVR) of 50% and heads down towards 30% - or my bank investment account grows.
Somewhere along the line, a stockmarket crash or downturn occurs. Inevitably, I will still be invested to some extent, but at a lesser level.
But I will have accumulated a cash holding, or will have reduced my margin loan sufficiently to be in a position to start staggered buying back into the market - and quite likely back into the same stock that I sold off previously.
Staggered selling followed by staggered buying is an important strategy for me. Because I can never pick the top of the market - or if I do it is a gigantic fluke! - and a staggered sale allows me to enjoy some more upside if the market continues to rise.
I ACCEPT THAT THE MARKET MAY CONTINUE TO RISE! ... and I view this as part of the exercise ... but being able to sell some more stock helps to ease the pain of thinking that I have exited too soon.
The opposite situation arises for staggered buying after the downturn. If I do a staggered buy when the market looks as if it is getting some life ... and then a dead cat bounce occurs, I have the opportunity to buy more stock at a lower price.
Of course there are two downsides to this strategy that I accept. The first is that I have to pay more brokerage than I needed to, as I am going to be doing extra buying and selling than normal.
The second downside is that the market may fall faster than I anticipated. Depending on the stock, if I am still making a good profit as the market drops to a lower price for the stock, I will sell anyway and not spit chips.
It is common to under-estimate how far prices can fall, so I do not want to be holding over-priced stock that is likely to fall further.
And the opposite case is that the market may rise faster than I anticipated as it recovers from fear and depression.
As the market inevitably overshoots to undervalued levels in these crash situations, losing a small part of the following rise in the price of some stocks that I buy into is something that I am happy to accept.
In this discussion, I should not forget retirees (like me) who are enjoying income from superannuation funds. They are also in a position to ride out stockmarket crashes in a sensible manner.
As we are all living longer, it is important that our superannuation has exposure to the share market since it offers the best returnss over the long term.
As most of us will live for some 20 to 25 years after retirement, superannuation is, from the beginning of retirement, still a long-term investment. So it should be exposed to the best returning asset class ... namely shares, in order to make it last by allowing for growth over time.
But retirees, unlike most other people, need to withdraw funds regularly to cover living expenses and other purchases.
The strategy I use is to insulate three year's living expenses, together with any major purchases I am planning to make in that time, in cash and put the remainder in equities, local and international.
This means that the assets can better ride out stockmarket crashes by having living expenses withdrawn from the less volatile cash component rather than having to sell more volatile shares, the price of which are depressed during a market crash.
In summary, my experience tells me that to be a successful long-term value investor, market crashes need to be managed by being prepared for them.
It is these inevitable events that give rise to the best opportunities to buy the best businesses at prices below their intrinsic value ... and that is what value investing is all about!
http://www.make-money-stock-value-investing.com/stockmarket-crashes.html
Friday, 7 November 2008
Stock Valuation
Variable values of a dollar of earnings
Assumptions used to calculate value
Stock valuation
Stock valuation 2
Stock Valuation 3
Stock Valuation 4
Stock valuation 5
Stock Valuation 6
Stock valuation 7
Stock Val's@ valuation formula:
{[(APC/RR) x Reinvestment + Dividends]/RR} x Equity per share = VALUE
**Will fortune favour the brave in this climate?*
http://www.businesstimes.com.sg/sub/views/story/0,4574,304573,00.html
Business Times - 07 Nov 2008
Will fortune favour the brave in this climate?
OVERVIEW
FORTUNE is said to favour the brave, but is it bold or foolhardy to venture back yet into bombed-out equity and other financial markets? A panel of investment veterans assembled by The Business Times was of the view, on balance, that now is indeed the time to be venturing back into the markets, although one expert was bearish to the point of suggesting that financial markets could yet be brought to a standstill by confusion over the valuation of assets. There was a consensus too that the worst is by no means over yet for the global macro-economy.
Anthony Rowley: Welcome, gentlemen, to this Investment Roundtable, and it's good to have so many veterans of the investment world back with us at a time like this. The crisis has persisted for more than a year since the sub-prime mortgage problem first surfaced. How much longer could it continue, and how much deeper might it get? Jesper, I know you feel that there's more to come. Tell us why.
Jesper Koll: We are probably past the point of maximum pain in the financial crisis. However, it is far from over. Across all financial economies, leverage will be cut back much further, and this unwind is poised to cause more losses to jobs, to growth and to future returns. So far, global wealth destruction is equivalent to about one year of global GDP. In Japan during the 1990s, the total wealth destruction ended up coming to about 3 times GDP.
Robert Lloyd George: The crisis is not yet over entirely but reflationary supports have been put in place in all major countries and therefore I would not expect it to get much deeper. However, there will still be some shocks, surprises and losses which surface unexpectedly in large institutions.
William R Thomson: Japan took about five years from the time it started to recapitalise its banks. Sweden and Thailand took a little less time but neither were V-shaped recoveries. There is a far greater urgency to efforts now in the US and Europe after a year of dithering and denial but these are early days and the scale, being global, is larger and we have the unprecedented scale of the derivative problem.
It could still spiral out of control, requiring the whole banking sector to be taken into public ownership, but more likely we will have an extended period of recession and subnormal growth covering much of the Obama presidency.
Christopher Wood: My view has long been that US-related debt write-offs could easily total US$1.5 trillion eventually. There is also the issue of other regions' vulnerability, such as Europe's own debt excesses.
Rowley: How deeply do you expect the crisis to ramify into the 'real' economy and how long will the overall downturn last?
Mr George: The real economy has already felt the drying up of credit particularly in trade finance and in customer credits. This is very serious and will impact trade volumes. We have seen, for example, the collapse of the Baltic Dry Index, which may be the most immediate and sensitive indicator of this shrinking of global trade. My hope is that the slump in the real economy will not last more than about 9-12 months given all the efforts of the international authorities to support it.
Mr Koll: Money and credit are a leading indicator for growth and, unfortunately, the world has become increasingly dependent on credit and financial engineering. This is not just a US problem; look at China, where last year almost half of the corporate profit growth was due to financial engineering. Overall, the global economy needed about US$5 of credit growth to make US$1 of global income by the end of last year. A decade ago, that ratio was closer to two-to-one.
Everywhere - US, China, Europe - the private sector will wean itself off this credit addiction. The key question is how aggressive public investment and public spending will be to counter this downdraft. The more fiscal spent now, the shorter the recession. And the real winners will be those countries that have great technocrats and long-standing experience of actually implementing public spending projects that actually lay the groundwork for future private sector growth. Asia in general, Japan in particular, look promising in this respect.
Mr Thomson: In my opinion, we could well be at one of the transition points in economic history. The past 30 years of market liberalisation and deregulation are going to be challenged and called into question in a way unimaginable 2-3 years ago. It is quite possible that US president-elect Barack Obama will be presented with problems akin in magnitude to those Franklin Roosevelt faced in 1933, forcing a major rethink in the way the economy is managed. Old industries, such as automobiles, are on their last legs and looking for government handouts. Millions are facing foreclosure of their homes. The healthcare and pensions crises require addressing and they come at the worst possible time when the financial sector is in meltdown. The whole concept of globalisation, on which prosperity has been based, could face substantial challenges if the US economy in particular deteriorates significantly.
Mr Wood: The present systemic financial problem faced by the Western world poses a severe deflationary risk for the world economy. Recent government policy activism may save Western economies from the sort of V-shaped downturn suffered by Asia 10 years ago. But the cost will be a dramatically longer period of sub-par growth. This will likely mean in the US and the Western world in general a more protracted L-shaped economic growth trajectory.
I do not believe that recent efforts by the US authorities to reflate a credit-driven growth cycle in America will work. The deflationary deleveraging pressures unleashed by the unwinding of structured finance are too large.
Mr Kepper: This latest financial crisis indicates that the world economy has come to be based on a representative monetary system whose numbers can't be valued. Today's monetary system to a large degree is a mental construct that is made workable by the confidence people have in it. When we see very large trillion-dollar failed institutions such as Freddie Mac and Fannie Mae being kept operating with government guarantees, banks with failed practices being bailed out by the government, a lack of transparency in the financial markets and the inability to determine basic value, there is reason to believe there could be a semi collapse of the global financial game. Developments of this kind, where traditional market fundamentals and basis of evaluation don't hold true, could force policymakers to close financial markets in order to control panic selling especially when sellers outnumber buyers and corporate earnings start to fall.
Rowley: Has the crash in stock and other financial markets created buying opportunities yet? Or, if it is still too dangerous to move back into markets, what signs and signals should investors look for to tell them when it is time to move?
Mr George: The stockmarket crash, particularly in the last month, has created extraordinary buying opportunities and I believe that now is the time to act. You could simply take the 50 best companies in the world with strong balance sheets, strong cash flow, and valuable and sustainable franchises. I would also include some oversold banks. This is an excellent time, as Warren Buffet also argues, to make long-term investments.
Mr Thomson: The crash has been precipitated in no small measure by indiscriminate hedge fund liquidation of good assets as their loans are called by their banks and prime brokers. This means that many good assets now have real value even if the markets have not reached their ultimate bear market lows. A sure sign of value is companies with unimpeachable dividend records yielding 50-100 per cent more than 10-year Treasury bonds. Look at BP and Royal Dutch Shell, for instance. These sorts of opportunities do not arise every day. Studies show that a significant part of the long-term returns from stocks are from dividends. Well covered dividends that can grow are a vital protection against long-term inflation that could well be the result of the explosion of liquidity the central banks are pouring into the markets once fear dissipates and animal spirits resume more normal service.
Mr Wood: I believe that there is likely a relief rally in world equity markets through to year-end driven by declines in signals of risk aversion, such as interbank rates, and growing hopes that the authorities are getting ahead of the problem in terms of their efforts to throw liquidity at it.
But any such relief rally will then unwind in early 2009 with the realisation that a severe economic downturn is underway in the West. I would expect a retest of recent market lows in America next year and quite possibly a move lower, most particularly if the US dollar remains strong in a deleveraging cycle.
Mr Koll: The big performance killer this year has been volatility. Across all assets - stocks, bonds, currency, commodities - we have seen a huge surge in volatility which kills short-term performance measures. In a way, the rise in volatility reflects the rise in uncertainty. From here, a drop in volatility is the key signal that the panic, that the uncertainty, is coming to an end.
I doubt that we will move back quickly to an overarching bull market in any asset class. But I do think that stock picking will become more and more important. Companies with high barriers to entry, companies that have strong balance sheets and strong management will be the big winners. The strong will get stronger and the weak will wither.
Rowley: If there are buying opportunities, where and what are they?
Mr Thomson: Outside the government bond markets, prices in most asset classes are very much more attractive than they have been except for the bottom of the markets in 2003 and 1974. That's not to say we have seen the ultimate lows. I do not believe we have, but I can foresee a decent recovery rally after the extreme drop into the early days of the Obama presidency. That could easily run out of steam as the magnitude of the challenges and the size of the mountain to climb become apparent again. But where there is great value, it is a time to buy as Warren Buffett has shown. It's not a crime to lock in a profit later.
Emerging markets have been savaged, especially the BRIC favourites. China alone is off 65 per cent from its peak and valuations are accordingly more reasonable. China's growth will slow in 2009 but is likely to exceed 7 per cent whilst OECD members show zero economic growth. Value is obviously there. At the same time, those emerging markets, especially in Eastern Europe - such as the Baltics, Hungary and Ukraine - that ran large current account deficits are in very real trouble and will be seeking assistance from the IMF. They have been decimated but do not have the resiliency of Asia.
Mr George: The best buying opportunities are in the most oversold markets and I believe that the emerging markets such as China and India which have been down 60-70 per cent will rebound twice as strongly as the UK or the USA. The action (this week) of the Reserve Bank of India is a good signal of confidence and I believe we will see domestic investors stepping in to buy shares where hedge funds have been forced sellers and driven down prices to unreasonably low levels. This is an important signal for us. I would not be buying bond markets now.
Mr Koll: It's back to basics now. You must focus on individual companies and their competitive edge, rather than whole countries or asset classes. Yes, global infrastructure spend will rise, probably with a strong environmental edge. So Japan's capital goods companies are in a very good position to benefit from this. Agricultural policy around the world is poised to become more focused on raising efficiencies, so makers of top-notch agricultural machinery should benefit. Medical devices are going to be in hot demand. The theme of global greying - the ageing of the world - should offer big opportunities and any company making products that allow us all to age more gracefully should benefit.
Mr Wood: I would say, Asia and emerging market stocks.
Mr Kepper: The current sell-off makes perfect sense. The market is simply recalculating stock values to account for shrinking earnings and cash flows. It stocks can be considered cheap, that is only relative to their values over the recent past when they were grossly overvalued. Current price-earnings ratios can be expected to fall well below their long-term average of 16 before a turnaround kicks in. As corporate earnings started to drop, stocks would have to fall in order to maintain a price-earnings average. From this point of view, stocks are anything but cheap at this time. I would expect stocks to fall another 15-20 per cent before bottoming out. Don't expect any sort of serious rebound until the credit markets recover from the greatest creation of liquidity over the last 10 years that the financial system has ever seen. That will take years. Therefore, the next 12 months or so will likely be a period of much confusion in equity markets.
Rowley: And the outlook for gold and other precious metals?
Mr Thomson: I believe a position in gold absolutely must be retained - in fact, enhanced if at all possible. The sell- off since August reflects the giant margin call that hedge funds have faced as banks are trying to reduce their loan books. There is a huge disconnect between the paper market in precious metals as represented by futures and the physical market as represented by coins and bullion. The latter has been on fire and physical is selling at a premium to the paper form. The US government is up to its usual games making gold ownership more expensive by suspending the production of gold coins whilst, at the same time, debasing the dollar like never before. It is not beyond the realms of possibility that they will try and make ownership of gold by Americans illegal again in any future crisis. Would you rather own gold or the paper of a hugely indebted government whose budget deficit next year could get close to double digits? Silver and platinum are even more depressed but both metals have some industrial uses which are less in demand under present circumstances. They are cheap on a relative and an absolute basis.
Mr George: Gold is at US$730 per ounce today. My expectation is that the price will be three times higher - that is, between US$2,000 and US$2,500 per ounce - in 2010 to 2012. The reason is simply that the amount of paper money created in order to stave off the crisis and reflate the banking system will take about 18 months to feed through into inflation, and that the value of the US$ will again fall sharply as a result. In addition, low or even zero interest rates will favour gold and other commodities. I also expect oil to rebound from the current low levels to at least US$200 within 2-3 years.
Mr Wood: Gold, not oil, should be the ultimate prime beneficiary of the likely coming demise of the US dollar paper standard. My long-term gold bullion target remains US$3,360 per ounce by the end of 2010. Short-term pressure so long as the US dollar remains strong as a consequence of deleveraging. This dollar rally will become vulnerable, the more 'unconventional' the Federal Reserve becomes in its conduct of monetary policy.
Mr Kepper: Gold was and is a form of cash; and it probably always will be. Paper currency, on the other hand, is a promise to redeem in terms of something else - and as national debts mount higher, the chances of default mount with it. Further, though the US prints increasing numbers of dollars, the amount of gold backing up those dollars is small - and will probably get smaller. With the dollar's value falling, people will begin to buy gold; its potential upward rise will then be unlimited. Gold mining stocks are riskier than owning bullion as there are dangers from fire, flood, resource depletion, and nationalisation. But as gold prices climb, so do the prices of stocks. Moreover, many gold stocks average 15 per cent dividends. If your net worth is between US$100,000 and US$1,000,000, 25-50 per cent of your assets should be in gold and silver. Of the gold, a rough breakdown would be 60 per cent in bullion and coins, 30 per cent in gold mining stocks, and maybe, if you have the appetite, 10 per cent in penny stocks.
Rowley: Any final points you'd like to make?
Mr Thomson: Commodities, in general, have been hammered and in some cases, such as oil, are at a level close to the cost of finding and bringing new production on stream. They also have much better value than earlier this year as many of the leveraged speculators have been forced out.
Property in those countries that experienced the biggest booms - the US, UK, Ireland and Spain - still has a way to go to reach the bottom. That may not happen till 2010 or even later. Whilst that situation endures, the consumer will be under pressure to rebuild his balance sheet. The pressure will have to be taken up by government investment in areas such as infrastructure and alternative energy as well as domestic demand in Asia, whose currencies should strengthen against their Western competitors.
Mr George: Finally, I believe that we are now in a new era of less leverage and less debt where capital will be more scarce or therefore better rewarded. Here in Asia we have high savings, and this should be a very valuable support for market and economies in the coming years. There will be a wholesale aversion to risk and to fancy instruments like derivatives in the next few years, and much more focus on fundamental investing and fundamental values. On the whole, I think it is a welcome change.
Mr Koll: The key question is: how active, how interventionist will government get? Yes, the world all over needs public investment and more active industrial policy. But this must lay the groundwork for future private investment. Build the road - but let the private sector build the houses, the factories and the call centres and hospitals on the new roadside. I think the next bull market will start when it becomes clear that government is ready to let private entrepreneurs take over again.
PARTICIPANTS
in the Roundtable
Moderator:
Anthony Rowley, Tokyo correspondent, The Business Times
Panellists:
Jesper Koll, president and chief executive officer, Tantallon Research, Japan
Robert Lloyd George, chairman and CEO of Lloyd George Management, Hong Kong
Ernest Kepper, former official of the International Finance Corporation and Wall Street investment banker heading an Asian financial consultancy
William R Thomson, chairman of Private Capital Ltd, Hong Kong
Christopher Wood, managing director and equity strategist, CLSA Asia-Pacific Markets, Hong Kong
Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.
My Comments:
Opinion versus certainty
Cheap - relative basis versus absolute basis
Business Times - 07 Nov 2008
Will fortune favour the brave in this climate?
OVERVIEW
FORTUNE is said to favour the brave, but is it bold or foolhardy to venture back yet into bombed-out equity and other financial markets? A panel of investment veterans assembled by The Business Times was of the view, on balance, that now is indeed the time to be venturing back into the markets, although one expert was bearish to the point of suggesting that financial markets could yet be brought to a standstill by confusion over the valuation of assets. There was a consensus too that the worst is by no means over yet for the global macro-economy.
Anthony Rowley: Welcome, gentlemen, to this Investment Roundtable, and it's good to have so many veterans of the investment world back with us at a time like this. The crisis has persisted for more than a year since the sub-prime mortgage problem first surfaced. How much longer could it continue, and how much deeper might it get? Jesper, I know you feel that there's more to come. Tell us why.
Jesper Koll: We are probably past the point of maximum pain in the financial crisis. However, it is far from over. Across all financial economies, leverage will be cut back much further, and this unwind is poised to cause more losses to jobs, to growth and to future returns. So far, global wealth destruction is equivalent to about one year of global GDP. In Japan during the 1990s, the total wealth destruction ended up coming to about 3 times GDP.
Robert Lloyd George: The crisis is not yet over entirely but reflationary supports have been put in place in all major countries and therefore I would not expect it to get much deeper. However, there will still be some shocks, surprises and losses which surface unexpectedly in large institutions.
William R Thomson: Japan took about five years from the time it started to recapitalise its banks. Sweden and Thailand took a little less time but neither were V-shaped recoveries. There is a far greater urgency to efforts now in the US and Europe after a year of dithering and denial but these are early days and the scale, being global, is larger and we have the unprecedented scale of the derivative problem.
It could still spiral out of control, requiring the whole banking sector to be taken into public ownership, but more likely we will have an extended period of recession and subnormal growth covering much of the Obama presidency.
Christopher Wood: My view has long been that US-related debt write-offs could easily total US$1.5 trillion eventually. There is also the issue of other regions' vulnerability, such as Europe's own debt excesses.
Rowley: How deeply do you expect the crisis to ramify into the 'real' economy and how long will the overall downturn last?
Mr George: The real economy has already felt the drying up of credit particularly in trade finance and in customer credits. This is very serious and will impact trade volumes. We have seen, for example, the collapse of the Baltic Dry Index, which may be the most immediate and sensitive indicator of this shrinking of global trade. My hope is that the slump in the real economy will not last more than about 9-12 months given all the efforts of the international authorities to support it.
Mr Koll: Money and credit are a leading indicator for growth and, unfortunately, the world has become increasingly dependent on credit and financial engineering. This is not just a US problem; look at China, where last year almost half of the corporate profit growth was due to financial engineering. Overall, the global economy needed about US$5 of credit growth to make US$1 of global income by the end of last year. A decade ago, that ratio was closer to two-to-one.
Everywhere - US, China, Europe - the private sector will wean itself off this credit addiction. The key question is how aggressive public investment and public spending will be to counter this downdraft. The more fiscal spent now, the shorter the recession. And the real winners will be those countries that have great technocrats and long-standing experience of actually implementing public spending projects that actually lay the groundwork for future private sector growth. Asia in general, Japan in particular, look promising in this respect.
Mr Thomson: In my opinion, we could well be at one of the transition points in economic history. The past 30 years of market liberalisation and deregulation are going to be challenged and called into question in a way unimaginable 2-3 years ago. It is quite possible that US president-elect Barack Obama will be presented with problems akin in magnitude to those Franklin Roosevelt faced in 1933, forcing a major rethink in the way the economy is managed. Old industries, such as automobiles, are on their last legs and looking for government handouts. Millions are facing foreclosure of their homes. The healthcare and pensions crises require addressing and they come at the worst possible time when the financial sector is in meltdown. The whole concept of globalisation, on which prosperity has been based, could face substantial challenges if the US economy in particular deteriorates significantly.
Mr Wood: The present systemic financial problem faced by the Western world poses a severe deflationary risk for the world economy. Recent government policy activism may save Western economies from the sort of V-shaped downturn suffered by Asia 10 years ago. But the cost will be a dramatically longer period of sub-par growth. This will likely mean in the US and the Western world in general a more protracted L-shaped economic growth trajectory.
I do not believe that recent efforts by the US authorities to reflate a credit-driven growth cycle in America will work. The deflationary deleveraging pressures unleashed by the unwinding of structured finance are too large.
Mr Kepper: This latest financial crisis indicates that the world economy has come to be based on a representative monetary system whose numbers can't be valued. Today's monetary system to a large degree is a mental construct that is made workable by the confidence people have in it. When we see very large trillion-dollar failed institutions such as Freddie Mac and Fannie Mae being kept operating with government guarantees, banks with failed practices being bailed out by the government, a lack of transparency in the financial markets and the inability to determine basic value, there is reason to believe there could be a semi collapse of the global financial game. Developments of this kind, where traditional market fundamentals and basis of evaluation don't hold true, could force policymakers to close financial markets in order to control panic selling especially when sellers outnumber buyers and corporate earnings start to fall.
Rowley: Has the crash in stock and other financial markets created buying opportunities yet? Or, if it is still too dangerous to move back into markets, what signs and signals should investors look for to tell them when it is time to move?
Mr George: The stockmarket crash, particularly in the last month, has created extraordinary buying opportunities and I believe that now is the time to act. You could simply take the 50 best companies in the world with strong balance sheets, strong cash flow, and valuable and sustainable franchises. I would also include some oversold banks. This is an excellent time, as Warren Buffet also argues, to make long-term investments.
Mr Thomson: The crash has been precipitated in no small measure by indiscriminate hedge fund liquidation of good assets as their loans are called by their banks and prime brokers. This means that many good assets now have real value even if the markets have not reached their ultimate bear market lows. A sure sign of value is companies with unimpeachable dividend records yielding 50-100 per cent more than 10-year Treasury bonds. Look at BP and Royal Dutch Shell, for instance. These sorts of opportunities do not arise every day. Studies show that a significant part of the long-term returns from stocks are from dividends. Well covered dividends that can grow are a vital protection against long-term inflation that could well be the result of the explosion of liquidity the central banks are pouring into the markets once fear dissipates and animal spirits resume more normal service.
Mr Wood: I believe that there is likely a relief rally in world equity markets through to year-end driven by declines in signals of risk aversion, such as interbank rates, and growing hopes that the authorities are getting ahead of the problem in terms of their efforts to throw liquidity at it.
But any such relief rally will then unwind in early 2009 with the realisation that a severe economic downturn is underway in the West. I would expect a retest of recent market lows in America next year and quite possibly a move lower, most particularly if the US dollar remains strong in a deleveraging cycle.
Mr Koll: The big performance killer this year has been volatility. Across all assets - stocks, bonds, currency, commodities - we have seen a huge surge in volatility which kills short-term performance measures. In a way, the rise in volatility reflects the rise in uncertainty. From here, a drop in volatility is the key signal that the panic, that the uncertainty, is coming to an end.
I doubt that we will move back quickly to an overarching bull market in any asset class. But I do think that stock picking will become more and more important. Companies with high barriers to entry, companies that have strong balance sheets and strong management will be the big winners. The strong will get stronger and the weak will wither.
Rowley: If there are buying opportunities, where and what are they?
Mr Thomson: Outside the government bond markets, prices in most asset classes are very much more attractive than they have been except for the bottom of the markets in 2003 and 1974. That's not to say we have seen the ultimate lows. I do not believe we have, but I can foresee a decent recovery rally after the extreme drop into the early days of the Obama presidency. That could easily run out of steam as the magnitude of the challenges and the size of the mountain to climb become apparent again. But where there is great value, it is a time to buy as Warren Buffett has shown. It's not a crime to lock in a profit later.
Emerging markets have been savaged, especially the BRIC favourites. China alone is off 65 per cent from its peak and valuations are accordingly more reasonable. China's growth will slow in 2009 but is likely to exceed 7 per cent whilst OECD members show zero economic growth. Value is obviously there. At the same time, those emerging markets, especially in Eastern Europe - such as the Baltics, Hungary and Ukraine - that ran large current account deficits are in very real trouble and will be seeking assistance from the IMF. They have been decimated but do not have the resiliency of Asia.
Mr George: The best buying opportunities are in the most oversold markets and I believe that the emerging markets such as China and India which have been down 60-70 per cent will rebound twice as strongly as the UK or the USA. The action (this week) of the Reserve Bank of India is a good signal of confidence and I believe we will see domestic investors stepping in to buy shares where hedge funds have been forced sellers and driven down prices to unreasonably low levels. This is an important signal for us. I would not be buying bond markets now.
Mr Koll: It's back to basics now. You must focus on individual companies and their competitive edge, rather than whole countries or asset classes. Yes, global infrastructure spend will rise, probably with a strong environmental edge. So Japan's capital goods companies are in a very good position to benefit from this. Agricultural policy around the world is poised to become more focused on raising efficiencies, so makers of top-notch agricultural machinery should benefit. Medical devices are going to be in hot demand. The theme of global greying - the ageing of the world - should offer big opportunities and any company making products that allow us all to age more gracefully should benefit.
Mr Wood: I would say, Asia and emerging market stocks.
Mr Kepper: The current sell-off makes perfect sense. The market is simply recalculating stock values to account for shrinking earnings and cash flows. It stocks can be considered cheap, that is only relative to their values over the recent past when they were grossly overvalued. Current price-earnings ratios can be expected to fall well below their long-term average of 16 before a turnaround kicks in. As corporate earnings started to drop, stocks would have to fall in order to maintain a price-earnings average. From this point of view, stocks are anything but cheap at this time. I would expect stocks to fall another 15-20 per cent before bottoming out. Don't expect any sort of serious rebound until the credit markets recover from the greatest creation of liquidity over the last 10 years that the financial system has ever seen. That will take years. Therefore, the next 12 months or so will likely be a period of much confusion in equity markets.
Rowley: And the outlook for gold and other precious metals?
Mr Thomson: I believe a position in gold absolutely must be retained - in fact, enhanced if at all possible. The sell- off since August reflects the giant margin call that hedge funds have faced as banks are trying to reduce their loan books. There is a huge disconnect between the paper market in precious metals as represented by futures and the physical market as represented by coins and bullion. The latter has been on fire and physical is selling at a premium to the paper form. The US government is up to its usual games making gold ownership more expensive by suspending the production of gold coins whilst, at the same time, debasing the dollar like never before. It is not beyond the realms of possibility that they will try and make ownership of gold by Americans illegal again in any future crisis. Would you rather own gold or the paper of a hugely indebted government whose budget deficit next year could get close to double digits? Silver and platinum are even more depressed but both metals have some industrial uses which are less in demand under present circumstances. They are cheap on a relative and an absolute basis.
Mr George: Gold is at US$730 per ounce today. My expectation is that the price will be three times higher - that is, between US$2,000 and US$2,500 per ounce - in 2010 to 2012. The reason is simply that the amount of paper money created in order to stave off the crisis and reflate the banking system will take about 18 months to feed through into inflation, and that the value of the US$ will again fall sharply as a result. In addition, low or even zero interest rates will favour gold and other commodities. I also expect oil to rebound from the current low levels to at least US$200 within 2-3 years.
Mr Wood: Gold, not oil, should be the ultimate prime beneficiary of the likely coming demise of the US dollar paper standard. My long-term gold bullion target remains US$3,360 per ounce by the end of 2010. Short-term pressure so long as the US dollar remains strong as a consequence of deleveraging. This dollar rally will become vulnerable, the more 'unconventional' the Federal Reserve becomes in its conduct of monetary policy.
Mr Kepper: Gold was and is a form of cash; and it probably always will be. Paper currency, on the other hand, is a promise to redeem in terms of something else - and as national debts mount higher, the chances of default mount with it. Further, though the US prints increasing numbers of dollars, the amount of gold backing up those dollars is small - and will probably get smaller. With the dollar's value falling, people will begin to buy gold; its potential upward rise will then be unlimited. Gold mining stocks are riskier than owning bullion as there are dangers from fire, flood, resource depletion, and nationalisation. But as gold prices climb, so do the prices of stocks. Moreover, many gold stocks average 15 per cent dividends. If your net worth is between US$100,000 and US$1,000,000, 25-50 per cent of your assets should be in gold and silver. Of the gold, a rough breakdown would be 60 per cent in bullion and coins, 30 per cent in gold mining stocks, and maybe, if you have the appetite, 10 per cent in penny stocks.
Rowley: Any final points you'd like to make?
Mr Thomson: Commodities, in general, have been hammered and in some cases, such as oil, are at a level close to the cost of finding and bringing new production on stream. They also have much better value than earlier this year as many of the leveraged speculators have been forced out.
Property in those countries that experienced the biggest booms - the US, UK, Ireland and Spain - still has a way to go to reach the bottom. That may not happen till 2010 or even later. Whilst that situation endures, the consumer will be under pressure to rebuild his balance sheet. The pressure will have to be taken up by government investment in areas such as infrastructure and alternative energy as well as domestic demand in Asia, whose currencies should strengthen against their Western competitors.
Mr George: Finally, I believe that we are now in a new era of less leverage and less debt where capital will be more scarce or therefore better rewarded. Here in Asia we have high savings, and this should be a very valuable support for market and economies in the coming years. There will be a wholesale aversion to risk and to fancy instruments like derivatives in the next few years, and much more focus on fundamental investing and fundamental values. On the whole, I think it is a welcome change.
Mr Koll: The key question is: how active, how interventionist will government get? Yes, the world all over needs public investment and more active industrial policy. But this must lay the groundwork for future private investment. Build the road - but let the private sector build the houses, the factories and the call centres and hospitals on the new roadside. I think the next bull market will start when it becomes clear that government is ready to let private entrepreneurs take over again.
PARTICIPANTS
in the Roundtable
Moderator:
Anthony Rowley, Tokyo correspondent, The Business Times
Panellists:
Jesper Koll, president and chief executive officer, Tantallon Research, Japan
Robert Lloyd George, chairman and CEO of Lloyd George Management, Hong Kong
Ernest Kepper, former official of the International Finance Corporation and Wall Street investment banker heading an Asian financial consultancy
William R Thomson, chairman of Private Capital Ltd, Hong Kong
Christopher Wood, managing director and equity strategist, CLSA Asia-Pacific Markets, Hong Kong
Copyright © 2007 Singapore Press Holdings Ltd. All rights reserved.
My Comments:
Opinion versus certainty
Cheap - relative basis versus absolute basis
Wednesday, 5 November 2008
Gold again
Is gold such a wonderful long-term investment?
Gold price was fixed for more than 100 years at US $20.65 an ounce. Its price in 1932 was US $20.69 an ounce.
Based on a price of US $ 744.84 in 2007, the price has doubled 5.25 times in the past 75 years.
{The annual compounding rate using the rule of 72 is [(72/75) x 5.25] = 5.04 per cent (actual rate = 4.89 per cent per annum.)}
In real-money terms, the price of gold has barely kept pace with the rate of inflation. So there has been little real-money value capital appreciation in the value of gold over the past 75 years.
If you go back much further, its real-money value has deflated.
Why? Very little gold is consumed - once produced it remains in circulation as jewellery or bullion, so annual production continues to add to availability.
Gold price was fixed for more than 100 years at US $20.65 an ounce. Its price in 1932 was US $20.69 an ounce.
Based on a price of US $ 744.84 in 2007, the price has doubled 5.25 times in the past 75 years.
{The annual compounding rate using the rule of 72 is [(72/75) x 5.25] = 5.04 per cent (actual rate = 4.89 per cent per annum.)}
In real-money terms, the price of gold has barely kept pace with the rate of inflation. So there has been little real-money value capital appreciation in the value of gold over the past 75 years.
If you go back much further, its real-money value has deflated.
Why? Very little gold is consumed - once produced it remains in circulation as jewellery or bullion, so annual production continues to add to availability.
Stock market as a conduit for transferring wealth
The stock market is a conduit for transferring wealth from those who confuse price with value to those who do not, and from the impatient to the patient.
An investor, armed with knowledge of what their stock is worth, will sit tight and ony buy and sell when the price created by speculative traders is most advantages. Real investors don't generate a lot of brokerage fees.
Also, if a recommendation by advisory newsletters is not accompanied by an assessment of value and the business performance that created the value, a stock can only be bought on faith and sold on ignorance.
An investor, armed with knowledge of what their stock is worth, will sit tight and ony buy and sell when the price created by speculative traders is most advantages. Real investors don't generate a lot of brokerage fees.
Also, if a recommendation by advisory newsletters is not accompanied by an assessment of value and the business performance that created the value, a stock can only be bought on faith and sold on ignorance.
Irrationality of the Efficient Market Hypothesis
Buffett gratefully acknowledges the irrationality of the efficient market hypothesis:
".....these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore, calculations of business value - and even thought itself - were of no importance in investment activities. We are enormously indebted to those academics: what could be more advantageous in an intellectual contest - whether it be bridge, chess, or stock selection - than to have opponents who have been taught that thinking is a waste of energy? .. it's like telling a bridge player that it doesn't do any good to look at the cards."
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Although business performance is likely to be far from fixed or stable, most listed companies have an average price variation in the course of a 12-month period of about 40 to 50 percent (meaning that the difference between the 12-month high and low prices is about 40 to 50 percent of the low price). One would need to be exceedingly credulous to believe that, on average, the value of a business varies by 40 to 50 per cent every 12 months.
When a stock market falls 10 per cent or more overnight, does this mean that the value of all businesses comprising the market decclines by an average of 10 per cent while we sleep? When the Australian market fell 50 per cent in 51 days in 1987, was market pricing correct both before and after prices declined?
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However, one should not assume that the market is always wrong. In fairness to believers in EMH, it should be acknowledged that mispricing also results from
".....these institutions were then under the spell of academics at prestigious business schools who were preaching a newly-fashioned theory: the stock market was totally efficient, and therefore, calculations of business value - and even thought itself - were of no importance in investment activities. We are enormously indebted to those academics: what could be more advantageous in an intellectual contest - whether it be bridge, chess, or stock selection - than to have opponents who have been taught that thinking is a waste of energy? .. it's like telling a bridge player that it doesn't do any good to look at the cards."
------
Although business performance is likely to be far from fixed or stable, most listed companies have an average price variation in the course of a 12-month period of about 40 to 50 percent (meaning that the difference between the 12-month high and low prices is about 40 to 50 percent of the low price). One would need to be exceedingly credulous to believe that, on average, the value of a business varies by 40 to 50 per cent every 12 months.
When a stock market falls 10 per cent or more overnight, does this mean that the value of all businesses comprising the market decclines by an average of 10 per cent while we sleep? When the Australian market fell 50 per cent in 51 days in 1987, was market pricing correct both before and after prices declined?
--------
However, one should not assume that the market is always wrong. In fairness to believers in EMH, it should be acknowledged that mispricing also results from
- accounting fraud,
- profit misrepresentation,
- a company's false or incorrect profit projections and
- recommendations of analysts that on occasion have been shown to be intentionally fraudulent.
Saturday, 1 November 2008
Disparity between Price and Value
"The business performance creates the value - the price creates the opportunity."
We are taught that value is the price a willing but not anxious vendor is prepared to accept and a buyer is prepared to pay. However, such a definition applies to collectables, commodities and resources that are subject to variations in supply and demand.
Although stock prices are also generated by supply and demand, their value is not. Positive sentiment will increase demand (optimistic buyers) and reduce supply by limiting the number of willing sellers, while negative snetiment will have the opposite effect.
Although few would support the notion that the value of a financial security such as a stock is determined by the influence on prices of greed, fear, optimism and pessimism (market sentiment), reality implies the opposite.
At his breakfast meeting address to the Philanthropy Roundtable on 10th November, 2000, Charlie Munger said:
"It is an unfortunate fact that greed and foolish excess can come into prices of common stocks in the aggregate. They are valued (priced) partly like bonds, based on roughly rational projections of value in producing future cash. But they are also valued (priced) partly like Rembrandt paintings, purchased mostly because their prices have gone up, so far. This situation, combined with big 'wealth effects', at first up and later down, can conceivably produce much mischief."
Let us try to investigate this by a 'thought experiment'. One of the big British pension funds once bought a lot of ancient art, planning to sell it ten years later, which it did at a modest profit. Suppose all pension funds purchased ancient art, and only ancient art with all their assets. Wouldn't we eventually have a terrible mess on our hands, with great and undesirable macroeconomic consequences? And wouldn't this mess be bad if only half of all pension funds were invested in ancient art? And if half of all stock value became a consequence of mania, isn't the situation much like the case wherein half of pension assets are in ancient art?
One thing we know with absolute certainty is that stock prices and their value can vary hugely. If price and value were synonymous, all stocks whose future business performance was in accordance with market expectations would produce similar long-term investment returns - a notion tha is contemporaneously accepted as valid, although universally acknowedged in retrospect as false. Market commentators who fail to recognise this by referring to market prices as valuations, are by inference treating stocks as common commodities.
Althoug prices are deemed to reflect consensus, it should be remembered that prices are determined not by the majority of shareholders who are uninterested in buying or selling at the current temporary price, but by the tiny minority who are.
Following the adage that says it's impossible to be reasoned out of a belief that we were never reasoned into in the first place, if stocks are bought without reference to value, they will in turn be sold without reference to value.
Warren Buffett says:
"What could be more exhilarating than to participate in a bull market in which the reward to the owners of the business become gloriously uncoupled from the plodding performance of the business themselves? Unfortunately, however, stocks can't outperform businesses indefinitely."
When prices increase at a greater rate than can be justified by business performance, they must eventually stagnate until the value cathces up or they must retreat in the directions of the value. Only when a stock is bought at less than its value can price increases that exceed incremental increases in value be justified.
It is useful to understand some of the reasons for the disparity between price and value.
We are taught that value is the price a willing but not anxious vendor is prepared to accept and a buyer is prepared to pay. However, such a definition applies to collectables, commodities and resources that are subject to variations in supply and demand.
Although stock prices are also generated by supply and demand, their value is not. Positive sentiment will increase demand (optimistic buyers) and reduce supply by limiting the number of willing sellers, while negative snetiment will have the opposite effect.
Although few would support the notion that the value of a financial security such as a stock is determined by the influence on prices of greed, fear, optimism and pessimism (market sentiment), reality implies the opposite.
At his breakfast meeting address to the Philanthropy Roundtable on 10th November, 2000, Charlie Munger said:
"It is an unfortunate fact that greed and foolish excess can come into prices of common stocks in the aggregate. They are valued (priced) partly like bonds, based on roughly rational projections of value in producing future cash. But they are also valued (priced) partly like Rembrandt paintings, purchased mostly because their prices have gone up, so far. This situation, combined with big 'wealth effects', at first up and later down, can conceivably produce much mischief."
Let us try to investigate this by a 'thought experiment'. One of the big British pension funds once bought a lot of ancient art, planning to sell it ten years later, which it did at a modest profit. Suppose all pension funds purchased ancient art, and only ancient art with all their assets. Wouldn't we eventually have a terrible mess on our hands, with great and undesirable macroeconomic consequences? And wouldn't this mess be bad if only half of all pension funds were invested in ancient art? And if half of all stock value became a consequence of mania, isn't the situation much like the case wherein half of pension assets are in ancient art?
One thing we know with absolute certainty is that stock prices and their value can vary hugely. If price and value were synonymous, all stocks whose future business performance was in accordance with market expectations would produce similar long-term investment returns - a notion tha is contemporaneously accepted as valid, although universally acknowedged in retrospect as false. Market commentators who fail to recognise this by referring to market prices as valuations, are by inference treating stocks as common commodities.
Althoug prices are deemed to reflect consensus, it should be remembered that prices are determined not by the majority of shareholders who are uninterested in buying or selling at the current temporary price, but by the tiny minority who are.
Following the adage that says it's impossible to be reasoned out of a belief that we were never reasoned into in the first place, if stocks are bought without reference to value, they will in turn be sold without reference to value.
Warren Buffett says:
"What could be more exhilarating than to participate in a bull market in which the reward to the owners of the business become gloriously uncoupled from the plodding performance of the business themselves? Unfortunately, however, stocks can't outperform businesses indefinitely."
When prices increase at a greater rate than can be justified by business performance, they must eventually stagnate until the value cathces up or they must retreat in the directions of the value. Only when a stock is bought at less than its value can price increases that exceed incremental increases in value be justified.
It is useful to understand some of the reasons for the disparity between price and value.
Value assessment does not rely on precision
Investing is the intention to seek a required rate of return (RR) relative to risk, based on an assessement of value.
The deployment of capital in the absence of assessment of value is called speculation.
Value investing can be defined as buying a share at a price lower than its calculated value. Only investors who have the ability to calculate value can call themselves "value investors"
The very factor on which investing is based, namely value, is little understood, and therefore nearly always ignored.
Warren Buffett once said: "I'd rather be approximately right than precisely wrong."
Stock valuation is subjective in that it requires a judgement of the sustainability of past profitability and is therefore far from being an exact science. Like price, value will not increase in neat, even increments year after year, but will vary with the changing fortunes of the business.
An assessment of value is determined by making forward assumptions of a business's performance based on its historical performance. Depending on the current outlook for the business and its future prospects, the adopted performance criteria (APC) may differ from thsoe that past performance indicates. One also needs to make an assessment of the RR to compensate for many factors. The adopted assumptions are then used to calculate the value, the preciseness of which is not as important as being, as Buffett suggests, "approximately right."
As essential as valuation is in determining the margin of safety between value and price, other factors need to be considered when deciding whether a stock should be bought or sold.
The argument that value is misleading because it infers precision is as foolish as suggesting that real estate valuations are a waste of time because they too imply precision.
A recommendation may be correct, but unless it is accompanied by evidence of value, it can be considered only an unjustified expression of opinion.
Investing in stocks is not about buying scrip that will go up and down in price, but about investing long term in a sound business that represents good value at its present price.
The deployment of capital in the absence of assessment of value is called speculation.
Value investing can be defined as buying a share at a price lower than its calculated value. Only investors who have the ability to calculate value can call themselves "value investors"
The very factor on which investing is based, namely value, is little understood, and therefore nearly always ignored.
Warren Buffett once said: "I'd rather be approximately right than precisely wrong."
Stock valuation is subjective in that it requires a judgement of the sustainability of past profitability and is therefore far from being an exact science. Like price, value will not increase in neat, even increments year after year, but will vary with the changing fortunes of the business.
An assessment of value is determined by making forward assumptions of a business's performance based on its historical performance. Depending on the current outlook for the business and its future prospects, the adopted performance criteria (APC) may differ from thsoe that past performance indicates. One also needs to make an assessment of the RR to compensate for many factors. The adopted assumptions are then used to calculate the value, the preciseness of which is not as important as being, as Buffett suggests, "approximately right."
As essential as valuation is in determining the margin of safety between value and price, other factors need to be considered when deciding whether a stock should be bought or sold.
The argument that value is misleading because it infers precision is as foolish as suggesting that real estate valuations are a waste of time because they too imply precision.
A recommendation may be correct, but unless it is accompanied by evidence of value, it can be considered only an unjustified expression of opinion.
Investing in stocks is not about buying scrip that will go up and down in price, but about investing long term in a sound business that represents good value at its present price.
Friday, 31 October 2008
Panic-Resilient Stocks
There are, by contrast, several groups that tend to act well in a post-panic environment, especially if the crash itself drives prices to incredible levels.
Sub-par performers in a post-crash environment
Stocks that tend to be sub-par performers in a post-crash environment are the following:
- low-priced stocks
- lower NASDAQ issues
- small total capitalization issues
- thinly traded, analyst under-covered or non-covered stocks.
- fundamental in industry laggards
- stocks in recession-sensitive industries
- brokerage firms' own stocks (the public will be slow to return to active investing)
- discredited groups
- stocks in panic-trigger related groups
Because of fear, nervousness and absence speculative appetite after a crash or panic, the first 6 groups (some of which will overlap for individual stocks) lack sponsorship. In addition, because market panics generate immediate scare headlines in the media, predictably there will be talk of recession (or depression) and parallels drawn with 1929. Recall the October 1987 and October 1989 bashings and the smaller one-day drubbings during the early and middle 1990s; depression talk was rampant in post 9/11 months until mid-2002.
The final 2 categories should be off your hold list for similar reasons. Sometimes there is an industry or category of stocks related to the news that triggers the panic. Even immediately after any panic itself has passed, investors and traders will have keen memories of what started the debacle, and will avoid such stocks for an extended time. The present mid-2007 trouble with sub-prime mortgage losses drives a major drop and banks will be on the defensive thereafter, even if they look cheap.
[Cyclicals such as autos, steels, chemicals, papers and capital goods producerss are not prime early choices for participating in the bounce. Similarly, vacation-related (airline, hotel and casino) and luxury stocks fare poorly early on.]
Tuition fees for painful lessons may be worthwhile!
If an investor is down to just a few core holdings anyway, he is better advised to tough it out. The very experience of playing in pain through a (temporary) crash is of enormous instructional value and thus actually worth the modest monetary cost involved.
The process of crisis thinking and the need to make wrenching decisions that prove valid in short order will serve a person well for the rest of his or her investment career.
Once an investor has successfully navigated the worst of the choppy investment seas, she will have learned survival lessons and will have internalized feelings and a vivid experience that will be of permanent psychological and instructive value.
The process of crisis thinking and the need to make wrenching decisions that prove valid in short order will serve a person well for the rest of his or her investment career.
Once an investor has successfully navigated the worst of the choppy investment seas, she will have learned survival lessons and will have internalized feelings and a vivid experience that will be of permanent psychological and instructive value.
Thursday, 30 October 2008
Market remains very volatile.
The market remains very volatile. Until this volatility settles to a more reasonable level, it is extremely difficult for the market to find a bottom.
The global financial crisis and meltdown have resulted in fundamental damage to worldwide businesses and economies. Some businesses will be badly hurt and some slightly. However, a few will actually be benefitting from this crisis.
How to value these companies' businesses today? This will be difficult. The earnings for the next few quarters will need to be tracked. Past earnings are historical and due to fundamental changes in the businesses of various companies, assessing the value of these companies based on historical earnings will be unwise.
However, some companies can be anticipated to do not too badly. These are traditionally in the defensive sectors of food and beverages, gambling, healthcare and utilities.
For other companies, particularly in the industrial, plantations, tradings, construction, and housing sectors, the future earnings will be difficult to project with any degree of certainty at present. Yes, some of these companies might have been oversold in the general negative sentiment of the present market but one can only be very certain of this when the results of the next few quarters are known.
In fact, the Singapore Stock Market is now below that of the time when SARS struck in 2003. Whether it will rebound quickly after the present crisis will not be so easy to fortell. The present issues are quite different. Moreover, the financial meltdown is worldwide.
In any crisis, there will be opportunities. As this crisis continues, unfolds and deepens, more opportunities will surface. Presently, the crisis still shows little sign of abating.
Have we got over the worst yet? Will the volatilities in the market abate soon?
Well, if you do know the answers, please share here. Meanwhile, my view is there are plenty of opportunities available and you do have the time to pick the cherry/cherries at leisure, now and/or later.
The global financial crisis and meltdown have resulted in fundamental damage to worldwide businesses and economies. Some businesses will be badly hurt and some slightly. However, a few will actually be benefitting from this crisis.
How to value these companies' businesses today? This will be difficult. The earnings for the next few quarters will need to be tracked. Past earnings are historical and due to fundamental changes in the businesses of various companies, assessing the value of these companies based on historical earnings will be unwise.
However, some companies can be anticipated to do not too badly. These are traditionally in the defensive sectors of food and beverages, gambling, healthcare and utilities.
For other companies, particularly in the industrial, plantations, tradings, construction, and housing sectors, the future earnings will be difficult to project with any degree of certainty at present. Yes, some of these companies might have been oversold in the general negative sentiment of the present market but one can only be very certain of this when the results of the next few quarters are known.
In fact, the Singapore Stock Market is now below that of the time when SARS struck in 2003. Whether it will rebound quickly after the present crisis will not be so easy to fortell. The present issues are quite different. Moreover, the financial meltdown is worldwide.
In any crisis, there will be opportunities. As this crisis continues, unfolds and deepens, more opportunities will surface. Presently, the crisis still shows little sign of abating.
Have we got over the worst yet? Will the volatilities in the market abate soon?
Well, if you do know the answers, please share here. Meanwhile, my view is there are plenty of opportunities available and you do have the time to pick the cherry/cherries at leisure, now and/or later.
Warren Buffett Isn't You. Don't Listen to Him.
October 28, 2008
Warren Buffett Isn't You. Don't Listen to Him, Don't Trust Him, He is Wrong.Posted by Karen DeCoster at October 28, 2008 08:15 PM
My article from last week, Warren Buffett, Government Propagandist, drew more emails than anything I can recall in recent times. There were 200+ favorable, and only three that disagreed with me. Some web surfing this morning revealed some others who joined the fray. This article, 5 Reasons to Ignore Buffett, is eerily parallel to my piece (sometimes point-for-point), and declares Warren a "verbal interventionist." Then, here's a piece by C.S. Jefferson that states:
The difference for the average investor is that while it’s common for legendary traders of Wall Street to mock how the sheep get sheared by buying at the top and selling at the bottom, they neglect to remember that most people sell not because they want to, but because they have to make bill payments and pay for basic necessities such as food and shelter. Sound advice by professional money managers falls on deaf ears when the margin of error means being able to feed your family or not.
Warren Buffett can buy with impunity, unlike the rest of us with limited resources. Because he is rich enough that whatever decision is made to invest, he can, literally, afford to be wrong until the markets turn around and agree with him at some point or another.
In the National Post, Diane Francis writes Buffett is Wrong: Avoid Stocks and Buffett is Wrong: Avoid Stocks, Part II. In the Sunday Times, Jennifer Hill writes Capital Hill: Buffett is wrong: the market madness is still far from over.
http://www.lewrockwell.com/blog/lewrw/archives/023716.html
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"Dear Warren Buffett"
Knoxville blogger 500Jerk has penned an open letter to HIs Greatness:
Dear Warren:
I appreciate your advice in the NYT last week, you know, where you advise being greedy when others are fearful and fearful when others are greedy. That's very helpful. And its good advice, to the extent being greedy is praiseworthy at all. But I get your drift, I truly do: buy now, because American companies are on sale. And believe me, I would like to take advantage of the deep, deep discounts currently available in the stock market, because like you, I believe these investments will result in fabulous profits years from now.
Here's the thing, though, Warren, and I know you don't have this particular problem, but maybe you can mull it over on one of those cold Nebraska nights: Like most Americans, I DON"T HAVE ANY MONEY LEFT TO INVEST IN THE STOCK MARKET. While you may have millions rolling around in your pockets, I invested my spare change. Now I've watched it devalue 25%. So although I'd like to be courageous (I like that word better, don't you?), I can't actually afford to do that. For now, I'll have to hang back and hope the stock market rebounds in fairly short order so I can recover what I've lost.
Thanks for the words of encouragement, though. Maybe I can use them in the next recession. And good luck to you shopping for bargains.
Sincerely yours,
500Jerk
http://blogs.knoxnews.com/knx/granju/2008/10/dear-warren-buffett.html
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Comment: I have blogged on this here.
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.
http://myinvestingnotes.blogspot.com/2008/10/consequences-must-dominate.html
Warren Buffett Isn't You. Don't Listen to Him, Don't Trust Him, He is Wrong.Posted by Karen DeCoster at October 28, 2008 08:15 PM
My article from last week, Warren Buffett, Government Propagandist, drew more emails than anything I can recall in recent times. There were 200+ favorable, and only three that disagreed with me. Some web surfing this morning revealed some others who joined the fray. This article, 5 Reasons to Ignore Buffett, is eerily parallel to my piece (sometimes point-for-point), and declares Warren a "verbal interventionist." Then, here's a piece by C.S. Jefferson that states:
The difference for the average investor is that while it’s common for legendary traders of Wall Street to mock how the sheep get sheared by buying at the top and selling at the bottom, they neglect to remember that most people sell not because they want to, but because they have to make bill payments and pay for basic necessities such as food and shelter. Sound advice by professional money managers falls on deaf ears when the margin of error means being able to feed your family or not.
Warren Buffett can buy with impunity, unlike the rest of us with limited resources. Because he is rich enough that whatever decision is made to invest, he can, literally, afford to be wrong until the markets turn around and agree with him at some point or another.
In the National Post, Diane Francis writes Buffett is Wrong: Avoid Stocks and Buffett is Wrong: Avoid Stocks, Part II. In the Sunday Times, Jennifer Hill writes Capital Hill: Buffett is wrong: the market madness is still far from over.
http://www.lewrockwell.com/blog/lewrw/archives/023716.html
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"Dear Warren Buffett"
Knoxville blogger 500Jerk has penned an open letter to HIs Greatness:
Dear Warren:
I appreciate your advice in the NYT last week, you know, where you advise being greedy when others are fearful and fearful when others are greedy. That's very helpful. And its good advice, to the extent being greedy is praiseworthy at all. But I get your drift, I truly do: buy now, because American companies are on sale. And believe me, I would like to take advantage of the deep, deep discounts currently available in the stock market, because like you, I believe these investments will result in fabulous profits years from now.
Here's the thing, though, Warren, and I know you don't have this particular problem, but maybe you can mull it over on one of those cold Nebraska nights: Like most Americans, I DON"T HAVE ANY MONEY LEFT TO INVEST IN THE STOCK MARKET. While you may have millions rolling around in your pockets, I invested my spare change. Now I've watched it devalue 25%. So although I'd like to be courageous (I like that word better, don't you?), I can't actually afford to do that. For now, I'll have to hang back and hope the stock market rebounds in fairly short order so I can recover what I've lost.
Thanks for the words of encouragement, though. Maybe I can use them in the next recession. And good luck to you shopping for bargains.
Sincerely yours,
500Jerk
http://blogs.knoxnews.com/knx/granju/2008/10/dear-warren-buffett.html
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Comment: I have blogged on this here.
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.
http://myinvestingnotes.blogspot.com/2008/10/consequences-must-dominate.html
Weathering a Panic
When you are caught in a market panic, the bottom-line reality question is whether capitalism in the United States and other major Western nations will continue to function after the panic ends. If the answer is yes, then there is no reason to sell at foolish levels.
In fact, the only rational thing to do is take courage and make buys. Being gutsy enough to act on our contrarian test - refusing to sell good stocks cheap because Wall Street and Main Street have lost faith for a few days - ensures that your earlier selling at better levels, or not at all, will prove appropriate.
It will be emotionally difficult to buy in a panic. those who can do so are demonstrably rational and therefore also calm enough to sell with discipline as the prior highs approached.
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When appropriate selling has left an investor with only a few, high-quality stocks, he can and should hold onto those gems and play through the difficult experience of a panic or crash. He will be holding only a relatively small portfolio, so his level of pain will be no worse than moderate.
His cash holdings will give emotional comfort and provide the resources for acquiring stocks advantageously when prices get really low and buying feels scary.
A comforting perspective for those less than 50% committed to stocks is that each decline means their cash is gaining stock-buying power faster than their remaining holdings are losing cash value! Think about that.
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Once the panic subsides, there is a lift in the market. But its effect is significantly different across various kinds of stocks. For some issues, there is a sharp snap=back rally; for others, very little improvement.
Just as it is not advisable to sell directly into the panic, it is prudent to reassess positions after the selling frenzy has subsided and an initial bounce in prices has begun.
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Decide in real time, what to sell and what to hold.
Selling should not be urgent because pre-bear phase tactics will have raised a lot of cash, so there is no need to sell to raise cash for margin calls or for new buying.
But because the goal is always to maximize return on capital and to take advantage of the time value of money, look closely at what to hold and what to sell now that the panic's dust has cleared.
One must look forward at future prospects rather than backward at now-irrelevant old (higher) prices.
Some investors may see a contradiction in the advice to hold the remaining few gems through the worst psychological heat, because earlier they were counseled that avoid losses is the first priority and the best reason for selling.
But taking a limited short-term dose of paper losses in a crash - by holding a few items of real quality - is a lesser risk than selling out during the fury and hoping to have the courage and good timing to get back in at lower prices shortly afterward.
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Ref: It's when you sell that counts, by Donald Cassidy
In fact, the only rational thing to do is take courage and make buys. Being gutsy enough to act on our contrarian test - refusing to sell good stocks cheap because Wall Street and Main Street have lost faith for a few days - ensures that your earlier selling at better levels, or not at all, will prove appropriate.
It will be emotionally difficult to buy in a panic. those who can do so are demonstrably rational and therefore also calm enough to sell with discipline as the prior highs approached.
-------
When appropriate selling has left an investor with only a few, high-quality stocks, he can and should hold onto those gems and play through the difficult experience of a panic or crash. He will be holding only a relatively small portfolio, so his level of pain will be no worse than moderate.
His cash holdings will give emotional comfort and provide the resources for acquiring stocks advantageously when prices get really low and buying feels scary.
A comforting perspective for those less than 50% committed to stocks is that each decline means their cash is gaining stock-buying power faster than their remaining holdings are losing cash value! Think about that.
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Once the panic subsides, there is a lift in the market. But its effect is significantly different across various kinds of stocks. For some issues, there is a sharp snap=back rally; for others, very little improvement.
Just as it is not advisable to sell directly into the panic, it is prudent to reassess positions after the selling frenzy has subsided and an initial bounce in prices has begun.
------
Decide in real time, what to sell and what to hold.
Selling should not be urgent because pre-bear phase tactics will have raised a lot of cash, so there is no need to sell to raise cash for margin calls or for new buying.
But because the goal is always to maximize return on capital and to take advantage of the time value of money, look closely at what to hold and what to sell now that the panic's dust has cleared.
One must look forward at future prospects rather than backward at now-irrelevant old (higher) prices.
Some investors may see a contradiction in the advice to hold the remaining few gems through the worst psychological heat, because earlier they were counseled that avoid losses is the first priority and the best reason for selling.
But taking a limited short-term dose of paper losses in a crash - by holding a few items of real quality - is a lesser risk than selling out during the fury and hoping to have the courage and good timing to get back in at lower prices shortly afterward.
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Ref: It's when you sell that counts, by Donald Cassidy
Reviewing and Understanding Earlier Panics
On the way down, each temporary bottom during a bear trend is typically characterized by increases in fear and therefore in trading volume, with a bit of panicky dumping to mark each new interim low.
The final downside climax is most violent and usually sees the greatest trading volume. Selling pressure becomes so intense that it literally cannot be exceeded; it becomes exhausted as large numbers of the previously brave finally capitulate and sell even at obvious bargain levels.
As a large crowd jumps overboard simultaneously, the moment they are finished is why and when prices hit a bottom. This is the long-repeated profile of a final bottom, that is, the culmination of a selling frenzy and the end of a sharp downward movement in prices.
Minyanville founder, Todd Harrison, a wise commentator, says that all markets (up and down) go through 3 stages in sequence:
The final downside climax is most violent and usually sees the greatest trading volume. Selling pressure becomes so intense that it literally cannot be exceeded; it becomes exhausted as large numbers of the previously brave finally capitulate and sell even at obvious bargain levels.
As a large crowd jumps overboard simultaneously, the moment they are finished is why and when prices hit a bottom. This is the long-repeated profile of a final bottom, that is, the culmination of a selling frenzy and the end of a sharp downward movement in prices.
Minyanville founder, Todd Harrison, a wise commentator, says that all markets (up and down) go through 3 stages in sequence:
- disbelief,
- migration and
- panic.
The panic stage is usually followed on lower volume by timid bargain-hunting. When that process runs its course and the bulls run out of guts and/or ammunition, the initial base-building or rally falters. Such failure to hold ground leads to renewed fear, which builds in a minor crescendo to a new, sometimes lower, cascade-shaped bottom on moderately high volume. The key to note here is the less dramatic price drop and volume rise than those seen earlier; the difference proves that the prior low was one of psychological exhaustion or washout.
Major market bottoms often produce a W shape on the charts over two or three months; the two bottom points need not be at exactly the same level.
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Recall the chaotic pace of trading on Oct 19, 1987, when the Dow lost 508 points (23%) and made its bottom for the move on then-record volume.
A more recent is the aftermath of the Sept 11, 2001 terrorist attacks. The US market actually closed for the rest of the week. After its re-opening on Monday, Sept 17, several trading sessions were required for the emotions and new thinking of the post 9/11 world to be worked out before the selling was all exhausted.
Re-reading reports and looking at newspaper stock-price tables from that time will provide a vivid flavour of the fear psychology that defines a market crash. If there has not been a major crash lately when you read this, the instructive value will be all the greater.
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Important bottoms are typically referred to as selling climaxes because they consist of prices falling in a cascade or waterfall shape (when plotted on a graph against time), accompanied by a sharp concentration of heavy trading volume as investor emotions widely take control and completely trample logic.
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My comments: While the bottom of the market is yet to be certain, many stocks have been sold down hugely. Studying the charts of these stocks reveal many of these stocks are already trading at their bottom for some time, even though the market continues to slip down further.
Ref: It's when you sell that counts, by Donald Cassidy
Managing Investment Risk
Risk equals the potential that actual returns will differ from expected returns.
1. The best way to manage risk is to allow yourself ample time. Start investing now rather than later. When you have time on your side, more of your money can be invested in stocks rather than in bonds and money market instruments because you would have a larger capacity to ride the ups and downs of the stock market.
2. Secondly, you can manage risk by diversifying your money into stocks, bonds and money market investments. This is called asset allocation.
3. Finally, the way you divided your investments depends on your specific situation and your goals. Spend some time thinking about the best way to divide your money based on your needs and the type of risk you can take. This exercise will make a big difference to your investment success.
Ref: Make Your Money Work for You, by Keon Chee & Ben Fok
1. The best way to manage risk is to allow yourself ample time. Start investing now rather than later. When you have time on your side, more of your money can be invested in stocks rather than in bonds and money market instruments because you would have a larger capacity to ride the ups and downs of the stock market.
2. Secondly, you can manage risk by diversifying your money into stocks, bonds and money market investments. This is called asset allocation.
3. Finally, the way you divided your investments depends on your specific situation and your goals. Spend some time thinking about the best way to divide your money based on your needs and the type of risk you can take. This exercise will make a big difference to your investment success.
Ref: Make Your Money Work for You, by Keon Chee & Ben Fok
Wednesday, 29 October 2008
More on risk
We defined risk as the chance of losing money when you sell your investment. We need to make 2 refinements to this working definition.
1. In investments, risk is defined more broadly as the chance of receiving a return that is different from the return we expected to make.
Risk, in fact, includes not only bad outcomes such as lower than expected returns, but also good outcomes like higher than expected returns.
Thus, if the expected returns of an investment is 5%, the risk that you will earn a 10% return or 0% is exactly the same. In other words, using standard deviation, you do not distinguish between downside risk and upside risk.
For this reason, some investors may not be completely comfortable with standard deviation as a measure of risk.
They may go for:
2. There are also investments whose expected return is known ahead of time.
For example, when you buy a bond that pays a fixed interest payment every six months and the return of principal at maturity, you can tell ahead of time what your actual return will be.
1. In investments, risk is defined more broadly as the chance of receiving a return that is different from the return we expected to make.
Risk, in fact, includes not only bad outcomes such as lower than expected returns, but also good outcomes like higher than expected returns.
Thus, if the expected returns of an investment is 5%, the risk that you will earn a 10% return or 0% is exactly the same. In other words, using standard deviation, you do not distinguish between downside risk and upside risk.
For this reason, some investors may not be completely comfortable with standard deviation as a measure of risk.
They may go for:
- a measurement called the semi-variance where only returns that fall below the expected return are considered.
- they may go for simpler yet common-sensical proxies for risk. For example, it makes sense that stocks of technology companies are riskier than those of food companies. Others prefer to create ranking categories. (For example, ranking money market instruments as lower risk and technology stocks at higher risk.)
2. There are also investments whose expected return is known ahead of time.
For example, when you buy a bond that pays a fixed interest payment every six months and the return of principal at maturity, you can tell ahead of time what your actual return will be.
Anatomy of a Crisis
The urge to panic in the wake of a crisis is understandable and this is one of the greatest fears that many investors face.
One of the best ways to confront our fears is to understand them.
(Basically, we are faced with the following fears: Fear of failure, fear of loss and fear of the unknown.)
In this section, we look at what generally happens in a crisis and some of the questions you should ask when a crisis hits. We will also look back in history and feature some events to draw out important lessons for the future. From this, you can figure out what actions are more likely to be productive and what actions are more likely to be counter-productive.
When a crisis hits
Take 9-11, for example. Now, imagine that it is the day after the destruction of the Twin Towers. Profound shock waves will be felt in New York and beyond, and this will send ripples through to the world economy for some time.
On the morning after, it is near impossible to know exactly how events will play out over the next few weeks or months. But there is a set pattern to how financial markets react to a crisis, historically, and there are a few things worth noting.
Firstly, the inital reaction will be shock. Financial markets hate uncertainty, and nothing creates more uncertainty than a sudden, shattering crisis. The result of the shock is typically a "flight of safety", as investors dump stocks in favour of bonds and cash. Stock prices will, therefore, almost always fall.
At this point, the greatest danger to investors is not shock or that prices are falling, but the urge to panic. When investors panic, they sell at low prices and end up buying back the same stocks later at much higher prices. This knee-jerk effect comes at a high cost for investors, who buy high and sell low.
The second reaction, which usually happens immediately, is increased volatility in the commodity markets. Will the terrorists bomb oilfields and stem supply? Will grain shipments be interrupted? Will demand for gold rise sharply? Uncertainties that affect basic commodities usually cause spasms in the markets.
A third reaction is over-compensation. The first shock wave of selling is often broad and steep. Then, when uncertainty dissipates, investors usually overreact in the opposite direction, sending prices back up to pre-crisis levels.
Things never seem the way they are during a crisis. What you should remember is that the impact of a crisis itself is typically a short-term matter. After a few weeks, calm usually returns. This is not to say that crises are inconsequential or insignificant. The tsunami disascter (26 December 2004) which caused tremendous destruction in Indonesia will require billions of dollars and many years of restoration work. Certain markets may stay depressed for longer.
Historically, what effect a crisis has on the financial markets depends on whether the crisis creates a long-term change in the fundamental nature of an economy. And in most cases (even in the case of the tsunami disaster), the fundamental structures of the affected were not subjected to drastic modifications.
To sum up, the typical pattern following a major crisis is this:
So, should you find yourself in the midst of a crisis in the future, remember:
Make sure your overall portfolio is designed to limit your potential losses during a substantial market decline. This is where you need to invest in many different things.
Ref: Make your Money work for you, by Keon Chee & Ben Fok
One of the best ways to confront our fears is to understand them.
(Basically, we are faced with the following fears: Fear of failure, fear of loss and fear of the unknown.)
In this section, we look at what generally happens in a crisis and some of the questions you should ask when a crisis hits. We will also look back in history and feature some events to draw out important lessons for the future. From this, you can figure out what actions are more likely to be productive and what actions are more likely to be counter-productive.
When a crisis hits
Take 9-11, for example. Now, imagine that it is the day after the destruction of the Twin Towers. Profound shock waves will be felt in New York and beyond, and this will send ripples through to the world economy for some time.
On the morning after, it is near impossible to know exactly how events will play out over the next few weeks or months. But there is a set pattern to how financial markets react to a crisis, historically, and there are a few things worth noting.
Firstly, the inital reaction will be shock. Financial markets hate uncertainty, and nothing creates more uncertainty than a sudden, shattering crisis. The result of the shock is typically a "flight of safety", as investors dump stocks in favour of bonds and cash. Stock prices will, therefore, almost always fall.
At this point, the greatest danger to investors is not shock or that prices are falling, but the urge to panic. When investors panic, they sell at low prices and end up buying back the same stocks later at much higher prices. This knee-jerk effect comes at a high cost for investors, who buy high and sell low.
The second reaction, which usually happens immediately, is increased volatility in the commodity markets. Will the terrorists bomb oilfields and stem supply? Will grain shipments be interrupted? Will demand for gold rise sharply? Uncertainties that affect basic commodities usually cause spasms in the markets.
A third reaction is over-compensation. The first shock wave of selling is often broad and steep. Then, when uncertainty dissipates, investors usually overreact in the opposite direction, sending prices back up to pre-crisis levels.
Things never seem the way they are during a crisis. What you should remember is that the impact of a crisis itself is typically a short-term matter. After a few weeks, calm usually returns. This is not to say that crises are inconsequential or insignificant. The tsunami disascter (26 December 2004) which caused tremendous destruction in Indonesia will require billions of dollars and many years of restoration work. Certain markets may stay depressed for longer.
Historically, what effect a crisis has on the financial markets depends on whether the crisis creates a long-term change in the fundamental nature of an economy. And in most cases (even in the case of the tsunami disaster), the fundamental structures of the affected were not subjected to drastic modifications.
To sum up, the typical pattern following a major crisis is this:
- first, there will be a wave of panic selling when the news breaks.
- Then, there will be a short period of instability,
- followed by an upward sweep once investors realise the crisis itself is not likely to have a long-term effect on the economy.
So, should you find yourself in the midst of a crisis in the future, remember:
- Do not engage in panic selling.
- Sit tight and stick to your strategy.
- If you are a long-term, buy-and-hold investor, do hold on.
- If you are an adventurous investor, follow your strategy to buy on dips.
Make sure your overall portfolio is designed to limit your potential losses during a substantial market decline. This is where you need to invest in many different things.
Ref: Make your Money work for you, by Keon Chee & Ben Fok
Investing in the market or in the movements of the market
How do you react to the present market crisis? Would you sell or stay put?
Uncertainty often clouds judgement, sending even the best of us into panic and gloom. But history shows that negative events do not necessarily spell doom for investors.
Historical evidence suggests that most investors can benefit by staying put in a severely sold down market.
Some investors are skilled at anticipating market movements. They would buy on ups and sell on downs. But how many people can do that consistently? (Observe investing here and make your own conclusions: http://fusioninvestor.blogspot.com/ )
The big question for many of us is whether it makes sense to stay invested regardless of market fluctuations. According to a study by Ibbotson & Associates, the anwer is "yes".
They found that a dollar invested in the S&P 500 in 1925 grew to $1371 in 1996. That's a compound annual return of 10.6%. But when the best 35 months (less than 4% of total time invested) were removed from the analysis, the same dollar grew to only $12.50, a compounded annual return of only 3.6%.
$ invested in S&P 500
$1 invested in 1925
Value in 1996 (stay put throughout) $1,371.00
Value in 1996 (minus 35 best months $12.50
So, unless you are confident of accurately predicting the best and worst months for your investment dollar, stay put.
Uncertainty often clouds judgement, sending even the best of us into panic and gloom. But history shows that negative events do not necessarily spell doom for investors.
Historical evidence suggests that most investors can benefit by staying put in a severely sold down market.
Some investors are skilled at anticipating market movements. They would buy on ups and sell on downs. But how many people can do that consistently? (Observe investing here and make your own conclusions: http://fusioninvestor.blogspot.com/ )
The big question for many of us is whether it makes sense to stay invested regardless of market fluctuations. According to a study by Ibbotson & Associates, the anwer is "yes".
They found that a dollar invested in the S&P 500 in 1925 grew to $1371 in 1996. That's a compound annual return of 10.6%. But when the best 35 months (less than 4% of total time invested) were removed from the analysis, the same dollar grew to only $12.50, a compounded annual return of only 3.6%.
$ invested in S&P 500
$1 invested in 1925
Value in 1996 (stay put throughout) $1,371.00
Value in 1996 (minus 35 best months $12.50
So, unless you are confident of accurately predicting the best and worst months for your investment dollar, stay put.
Options versus Futures
Differences.
The purchaser of a futures contract is obligated to buy the underlying asset at the specified price (and the seller of a futures contract is obligated to sell).
The owner of a call option is not obligated to buy unless he wishes to do so; he has the right, but not the obligation.
The buyer of an option has a limited downside, but the buyer of a futures contract doesn't.
Similarities.
Options and futures contracts also share some common features. Both have standardised features that allow them to be traded quickly and "cheaply" on organized exchanges.
Ref: Make Your Money work for you, by Keon Chee & Ben Fok
The purchaser of a futures contract is obligated to buy the underlying asset at the specified price (and the seller of a futures contract is obligated to sell).
The owner of a call option is not obligated to buy unless he wishes to do so; he has the right, but not the obligation.
The buyer of an option has a limited downside, but the buyer of a futures contract doesn't.
Similarities.
Options and futures contracts also share some common features. Both have standardised features that allow them to be traded quickly and "cheaply" on organized exchanges.
Ref: Make Your Money work for you, by Keon Chee & Ben Fok
Tuesday, 28 October 2008
Returns on buying and selling futures
Participants in futures are either hedgers or speculators.
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Hedgers seek to reduce price uncertainty over some future period.
For example, by purchasing a coffee contract, the coffeeshop owner can hedge and lock in a specific buying price for coffee and be protected from any price increases.
Similarly, sellers can protect themselves from downward price movements too.
The coffee farmer might sell a coffee future contract to hedge against a fall in coffee prices.
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Speculators, on the other hand, seek to profit from the uncertainty that will occur in the future.
If they expect prices to rise, contracts will be purchased, and if they expected prices to fall, they would sell contracts.
Ref: Make Your Money Work For You, by Keon Chee & Ben Fok
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Hedgers seek to reduce price uncertainty over some future period.
For example, by purchasing a coffee contract, the coffeeshop owner can hedge and lock in a specific buying price for coffee and be protected from any price increases.
Similarly, sellers can protect themselves from downward price movements too.
The coffee farmer might sell a coffee future contract to hedge against a fall in coffee prices.
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Speculators, on the other hand, seek to profit from the uncertainty that will occur in the future.
If they expect prices to rise, contracts will be purchased, and if they expected prices to fall, they would sell contracts.
Ref: Make Your Money Work For You, by Keon Chee & Ben Fok
Option returns
When you buy a call option, you are essentially betting that the price of the underlying common stock will rise, making the call option more valuable.
Conversely, put buyers are betting that the price of the underlying common stock will decline, making the put option more valuable.
Returns are only in the form of capital gains.
Since you do not own the stock but only the right, dividends paid on the underlying stock do not benefit you.
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The seller receives a fee called an option premium for selling you a call or put.
Once an option is created and the seller receives the premium from the buyer, it can be traded in the secondary market.
The premium is the market price of the derivative, and the price will fluctuate along with changes in the underlying common stock.
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Put and calls allow both buyers and sellers to speculate on the short-term movements of common stocks.
Buyers obtain an option on the common stock for a small, known premium.
This known premium is the maximum that the buyer can lose.
If the buyer is correct about the price movements of the common stock, capital gains are magnified because only a small investment is committed.
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There are two particularly important types of derivatives - options and futures.
Many other types exist, but they can usually be created from these two basic building blocks, possibly by combining them with all sorts of other investment assets including stocka and bonds, stock indexes, gold and commodities such as wheat and corn.
Ref: Make your money work for you, by Keon Chee & Ben Fok
Conversely, put buyers are betting that the price of the underlying common stock will decline, making the put option more valuable.
Returns are only in the form of capital gains.
Since you do not own the stock but only the right, dividends paid on the underlying stock do not benefit you.
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The seller receives a fee called an option premium for selling you a call or put.
Once an option is created and the seller receives the premium from the buyer, it can be traded in the secondary market.
The premium is the market price of the derivative, and the price will fluctuate along with changes in the underlying common stock.
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Put and calls allow both buyers and sellers to speculate on the short-term movements of common stocks.
Buyers obtain an option on the common stock for a small, known premium.
This known premium is the maximum that the buyer can lose.
If the buyer is correct about the price movements of the common stock, capital gains are magnified because only a small investment is committed.
-----------
There are two particularly important types of derivatives - options and futures.
Many other types exist, but they can usually be created from these two basic building blocks, possibly by combining them with all sorts of other investment assets including stocka and bonds, stock indexes, gold and commodities such as wheat and corn.
Ref: Make your money work for you, by Keon Chee & Ben Fok
Derivatives - options and futures
Stocks and bonds are financial assets.
A derivative is also a financial asset but it differs from stocks in one fundamental way: the value of the derivative is based on the performance of an underlying financial asset that you do not own.
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Options
Options are one of the most common types of derivative.
There are 2 main types of options - calls and puts.
A call option gives the buyer the right but not the obligation, to purchase a specified number of shares of a particular stock at a particular price (called the exercise price) within a specified time frame.
A put option does the reverse - it gives the buyer the right but not the obligation, to sell a specified number of shares of a particular stock at a specified price within a specified time frame.
A definite advantage for the buyer of an option - whether a call or a put option - is that there is no obligation to exercise the option.
A simple example of a call option.
Suppose that you want to own 1,000 Microsoft shares at $30 each.
If you are fortunate enough to have this large amount of money ($30,000) at hand, you can pay up right away and own the shares.
But suppose you do not have this sum of money to invest directly, and your roommate is willing to sell you the right to buy the 1,000 shares at $30,000 each. For this right, he will charge you a fee of $1,500 and this right lasts three months. In effect, your roommate has sold you a call option.
If you buy the call option, the value of your investment now depends on the underlying asset - the share price of Microsoft.
If the price of Microsoft goes up, so does the value your call option.
If the price of Microsoft goes down, your derivative falls in value.
When you buy a call option, you pay the seller $1,500 for the right, but not the obligation, to buy the shares at $30,000.
If you change your mind because you found a better deal elsewhere, you can just walk away. You will only lose $1,500, which is called the option premium.
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Futures
Suppose a coffeeshop owner wants to buy 5 metric tons (mt) of Robusta coffee in six months, and he worries that the price of coffee might increase threefold by that time.
One thing he can do now is to strike a deal today with a farmer whereby he promises to pay, say, $1,000 per mt in 6 months' time for 5 mt of coffee. In other words, the coffeeshop owner and the farmer agree that 6 months from now, the coffeeshop owner will exchange $5,000 for 5 mt of coffee.
The agreement that they have created is a futures contract.
With the futures contract, both the coffeeshop owner and the farmer have locked in the price of coffee six months from now.
Suppose that coffee is selling for $1,500 per mt in 6 months' time. If this happens, then the coffeeshop owner would have benefited from having entered into the futures contract.
However, if the coffee sells for only $700 per mt then, he would have made a loss of $1,500, because he is forced by contract to pay $1,000 per mt.
A futures contract is therefore a bet on the future price of whatever is being bought or sold.
An important feature of traded futures contracts is that they are standardised, meaning each contract calls for the purchase of a specific quantity of a particular underlying asset.
The contract specifies in detail what the underlying asset is and where it is to be delivered.
For example, with a Robusta coffee contract, the contrct would specify that a specified quantity of a particular type of coffee will be delivered at one of a few approved locations on a particular date in exchange for the agreed-upon futures price.
A derivative is also a financial asset but it differs from stocks in one fundamental way: the value of the derivative is based on the performance of an underlying financial asset that you do not own.
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Options
Options are one of the most common types of derivative.
There are 2 main types of options - calls and puts.
A call option gives the buyer the right but not the obligation, to purchase a specified number of shares of a particular stock at a particular price (called the exercise price) within a specified time frame.
A put option does the reverse - it gives the buyer the right but not the obligation, to sell a specified number of shares of a particular stock at a specified price within a specified time frame.
A definite advantage for the buyer of an option - whether a call or a put option - is that there is no obligation to exercise the option.
A simple example of a call option.
Suppose that you want to own 1,000 Microsoft shares at $30 each.
If you are fortunate enough to have this large amount of money ($30,000) at hand, you can pay up right away and own the shares.
But suppose you do not have this sum of money to invest directly, and your roommate is willing to sell you the right to buy the 1,000 shares at $30,000 each. For this right, he will charge you a fee of $1,500 and this right lasts three months. In effect, your roommate has sold you a call option.
If you buy the call option, the value of your investment now depends on the underlying asset - the share price of Microsoft.
If the price of Microsoft goes up, so does the value your call option.
If the price of Microsoft goes down, your derivative falls in value.
When you buy a call option, you pay the seller $1,500 for the right, but not the obligation, to buy the shares at $30,000.
If you change your mind because you found a better deal elsewhere, you can just walk away. You will only lose $1,500, which is called the option premium.
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Futures
Suppose a coffeeshop owner wants to buy 5 metric tons (mt) of Robusta coffee in six months, and he worries that the price of coffee might increase threefold by that time.
One thing he can do now is to strike a deal today with a farmer whereby he promises to pay, say, $1,000 per mt in 6 months' time for 5 mt of coffee. In other words, the coffeeshop owner and the farmer agree that 6 months from now, the coffeeshop owner will exchange $5,000 for 5 mt of coffee.
The agreement that they have created is a futures contract.
With the futures contract, both the coffeeshop owner and the farmer have locked in the price of coffee six months from now.
Suppose that coffee is selling for $1,500 per mt in 6 months' time. If this happens, then the coffeeshop owner would have benefited from having entered into the futures contract.
However, if the coffee sells for only $700 per mt then, he would have made a loss of $1,500, because he is forced by contract to pay $1,000 per mt.
A futures contract is therefore a bet on the future price of whatever is being bought or sold.
An important feature of traded futures contracts is that they are standardised, meaning each contract calls for the purchase of a specific quantity of a particular underlying asset.
The contract specifies in detail what the underlying asset is and where it is to be delivered.
For example, with a Robusta coffee contract, the contrct would specify that a specified quantity of a particular type of coffee will be delivered at one of a few approved locations on a particular date in exchange for the agreed-upon futures price.
Returns from Investment
Stock returns
The returns from owning stocks come from 2 sources.
Cash dividends are earnings that are distributed to shareholders. (Unlike bonds, stocks do not guarantee the timing or the amount of dividends).
At any time, they can be increased, decreased or taken away altogether.
The other source of returns is capital gains. This is the main reason people buy stocks.
The value of your stock may rise when the earning prospects of the company are favourable.
And of course, your shares may also lose value if the company performs poorly.
Bond returns
The returns from owning a fixed-income security come in two forms.
There are the fixed interest payments and the final payment of principal at maturity.
Secondly, there is the potential for capital gains when you sell a bond before its maturity at a price higher than when you purchased it.
Imagine a see-saw. The price of a bond rises when the interest rates fall, and there is thus the possibility of a capital gain from a favourable movement in rates. Of course, inversely, a rise in interest rates will produce a loss.
Money market returns
Money market investments maintain a stable value, pay interest and can easily be converted into cash.
Of the three types of investments, money market instruments pay the lowest rate of return.
So why bother with them?
For the same reason that you leave large chunks of your uninvested money in fixed deposit - safety.
When you buy a money market investment, you are pretty sure you will get your money back with some interest.
The chances of losing money - whether from the government or the bank defaulting on its payment or a loss in principal value of the investment - are very low.
When you invest in a money market investment, you are taking very little risk and your expected return should reflect the amount of risk that you have taken.
When is a money market investment appropriate? When you need to use the money in a year or so, and you want to know that the money will be there with few surprises.
The returns from owning stocks come from 2 sources.
Cash dividends are earnings that are distributed to shareholders. (Unlike bonds, stocks do not guarantee the timing or the amount of dividends).
At any time, they can be increased, decreased or taken away altogether.
The other source of returns is capital gains. This is the main reason people buy stocks.
The value of your stock may rise when the earning prospects of the company are favourable.
And of course, your shares may also lose value if the company performs poorly.
Bond returns
The returns from owning a fixed-income security come in two forms.
There are the fixed interest payments and the final payment of principal at maturity.
Secondly, there is the potential for capital gains when you sell a bond before its maturity at a price higher than when you purchased it.
Imagine a see-saw. The price of a bond rises when the interest rates fall, and there is thus the possibility of a capital gain from a favourable movement in rates. Of course, inversely, a rise in interest rates will produce a loss.
Money market returns
Money market investments maintain a stable value, pay interest and can easily be converted into cash.
Of the three types of investments, money market instruments pay the lowest rate of return.
So why bother with them?
For the same reason that you leave large chunks of your uninvested money in fixed deposit - safety.
When you buy a money market investment, you are pretty sure you will get your money back with some interest.
The chances of losing money - whether from the government or the bank defaulting on its payment or a loss in principal value of the investment - are very low.
When you invest in a money market investment, you are taking very little risk and your expected return should reflect the amount of risk that you have taken.
When is a money market investment appropriate? When you need to use the money in a year or so, and you want to know that the money will be there with few surprises.
Risks of Investments
Stock risk.
As a group, stocks generally move up and down in value more than any other type of investment in the short-term.
People are usually afraid of purchasing stocks because they hear about bear markets, corporate scandals and stock market crashes.
But this should be a concern only to investors who need their money back within a few years.
In fact, over the longer-term, you stand a greater risk of losing money if you don't invest in stock.
Unlike money market securities, stocks are high risk investments in the short-term but are lower risk investments in the long term.
Bond risk.
Besides interest rate risk, bonds have default risk.
Default risk refers to the possibility that the borrower will not make the promised payments.
This risk is almost non-existent for government bonds, but for many other issuers such as private companies, the risk of default is very real.
Money market risk.
Beware of inflation.
The longer you leave your money in fixed deposit, the higher the risk of inflation eating away the purchasing power of your money.
Money market investments are safest when the money is needed in the short-term.
The very same safe investments become high risk the longer they stay invested.
Stocks are on the opposite track. They are high risk investments in the short-term, but are lower risk investments in the long term:
Fixed deposit
1yr = Low risk 10 yrs = High risk
Stocks
1 yr = High risk 10 yrs = Low risk
As a group, stocks generally move up and down in value more than any other type of investment in the short-term.
People are usually afraid of purchasing stocks because they hear about bear markets, corporate scandals and stock market crashes.
But this should be a concern only to investors who need their money back within a few years.
In fact, over the longer-term, you stand a greater risk of losing money if you don't invest in stock.
Unlike money market securities, stocks are high risk investments in the short-term but are lower risk investments in the long term.
Bond risk.
Besides interest rate risk, bonds have default risk.
Default risk refers to the possibility that the borrower will not make the promised payments.
This risk is almost non-existent for government bonds, but for many other issuers such as private companies, the risk of default is very real.
Money market risk.
Beware of inflation.
The longer you leave your money in fixed deposit, the higher the risk of inflation eating away the purchasing power of your money.
Money market investments are safest when the money is needed in the short-term.
The very same safe investments become high risk the longer they stay invested.
Stocks are on the opposite track. They are high risk investments in the short-term, but are lower risk investments in the long term:
Fixed deposit
1yr = Low risk 10 yrs = High risk
Stocks
1 yr = High risk 10 yrs = Low risk
Major types of Investments
Major types of Investments
Main types
1. Stocks or equities
2. Bonds or fixed income securities
3. Money market investments
Derivatives
1. Options
2. Futures
Unit trusts
1. Money market funds
2. Bond funds
3. Equity funds
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Bonds or fixed income securities
Bonds are loans issued by companies and governments to borrow money, and they have two main characteristics:
1. They have lifespan greater than 12 months at the time of issue.
2. They typically promise to make fixed interest payments according to a given schedule.
Bonds are hence also called fixed income securities.
Bonds have their own unique terms: Suppose you buy bonds with a face value of $10,000. These bonds mature in 2 years and pay 4% interest annually. The 4% interest equates to $400 a year. The face value of the bond, or the principal amount of $10,000 will be returned to you when the bond matures in 2 years.
-----------------------
Money market securities
Money market securities are similar to bonds except that they are short-term investments. They have two main characteristics:
1. They are loans issued by companies and government to borrow money.
2. They mature in less than a year from the time they are sold, which means that the loan must be repaid within a year.
Some of the most common money market securities include
Main types
1. Stocks or equities
2. Bonds or fixed income securities
3. Money market investments
Derivatives
1. Options
2. Futures
Unit trusts
1. Money market funds
2. Bond funds
3. Equity funds
---------
Bonds or fixed income securities
Bonds are loans issued by companies and governments to borrow money, and they have two main characteristics:
1. They have lifespan greater than 12 months at the time of issue.
2. They typically promise to make fixed interest payments according to a given schedule.
Bonds are hence also called fixed income securities.
Bonds have their own unique terms: Suppose you buy bonds with a face value of $10,000. These bonds mature in 2 years and pay 4% interest annually. The 4% interest equates to $400 a year. The face value of the bond, or the principal amount of $10,000 will be returned to you when the bond matures in 2 years.
-----------------------
Money market securities
Money market securities are similar to bonds except that they are short-term investments. They have two main characteristics:
1. They are loans issued by companies and government to borrow money.
2. They mature in less than a year from the time they are sold, which means that the loan must be repaid within a year.
Some of the most common money market securities include
- Treasury Bills (issued by the government and considered the safest investments around),
- fixed deposits,
- bank savings accounts and
- certificates of deposits.
----------------
Properties
The outright ownership of real estate has long been considered as a sound long-term investment, carrying with it a goodly amount of protection against inflation.
Unfortunately, real-estate values are also subject to wide fluctuations; serious erros can be made in location, price paid, etc.; there are pitfalls in salesmen's wiles.
Finally, diversification is not practical for the investor of moderate means, except by various types of participations with others and with the special hazards that attach to new floatations.
This too is a field not without risk. As the usual advice given to investors: "Be sure it's yours before you go into it."
Unfortunately, real-estate values are also subject to wide fluctuations; serious erros can be made in location, price paid, etc.; there are pitfalls in salesmen's wiles.
Finally, diversification is not practical for the investor of moderate means, except by various types of participations with others and with the special hazards that attach to new floatations.
This too is a field not without risk. As the usual advice given to investors: "Be sure it's yours before you go into it."
Monday, 27 October 2008
Managing gold in your portfolio
Managing gold in your portfolio
Gold has an extensive history of maintaining its value. Still, gold like all investments involve risk. Gold prices have historically seen strong fluctuations.
One reason for fluctuating prices is that the value of a bullion coin or a gold unit trust is directly affected by the current spot or market price of bullion. This price fluctuates daily and can be affected by a multitude of factors such as the perceived scarcity of gold, current demand, market sentiment and economic factors. Therefore, the price of your gold investment can go down as well as up in value.
Second, like all prices, the gold price reflects not only the inherent value of gold, but also the relative strengths of the currency in which it is quoted. For example, the dollar price of gold may increase more in percentage terms than the sterling price, to the extent that the change in price is a reflection of dollar weakness (in this case, against sterling) rather than an intrinsic change in gold market fundamentals. So if you purchase a gold investment in US dollars and the US dollar has increased by 20% by the time you sell it 12 months later, your investment would have fallen in value by 20% - regardless of any change in gold market fundamentals.
The strength of the US dollar during the two decades between 1980 and 2000 was an important reason why the gold price did not perform well during those years. It was in part the rapid rise in the dollar that hurt the dollar gold price. Another reason for gold's poor performance between 1980 and 2000 was the success of the world's central bankers in fighting inflation. Gold's role as a hedge againts inflation can be one of the main reasons that people buy it.
Despite the volatility of gold prices and its sensitivity to fundamental factors, the diversification benefits of gold in a portfolio are backed by strong evidence. Ibbotson Associates, a leading authority on asset allocation, performed a study with respect to the portfolio diversification benefits of gold, silver and platinum bullion covering a 33 year period from February 1971 to December 2004. Ibbotson determined that of the seven types of assets covered in the study, the precious metals asset class is the only one with a negative correlation to other asset classes. What this means is that precious metals perform best during the years that traditional asset classes such as stocks and bonds had negative returns. Ibbotson determined that investors can potentially improve their portfolio risk-reward performance by including precious metals with allocations of between 7.1% and 15.7% for conservative to aggressive portfolios respectively.
Historically, gold has produced excellent long-term gains during up cycles; however, it may not be suitable for everyone. You should acquire a good understanding of gold products before you invest. Since all investments including gold can decline in value, you should have adequate cash reserves and disposable income before considering a precious metal investment.
In the end, speculating in gold should be avoided at all cost by most conservative investors. Speculting involves short-term trading and the early withdrawal from accounts or securities can result in substantial penalties or fees - in addition to any decrease in gold prices due to fundamental factors.
Ref: Make Money Work For You by Keon Chee & Ben Fok
Gold has an extensive history of maintaining its value. Still, gold like all investments involve risk. Gold prices have historically seen strong fluctuations.
One reason for fluctuating prices is that the value of a bullion coin or a gold unit trust is directly affected by the current spot or market price of bullion. This price fluctuates daily and can be affected by a multitude of factors such as the perceived scarcity of gold, current demand, market sentiment and economic factors. Therefore, the price of your gold investment can go down as well as up in value.
Second, like all prices, the gold price reflects not only the inherent value of gold, but also the relative strengths of the currency in which it is quoted. For example, the dollar price of gold may increase more in percentage terms than the sterling price, to the extent that the change in price is a reflection of dollar weakness (in this case, against sterling) rather than an intrinsic change in gold market fundamentals. So if you purchase a gold investment in US dollars and the US dollar has increased by 20% by the time you sell it 12 months later, your investment would have fallen in value by 20% - regardless of any change in gold market fundamentals.
The strength of the US dollar during the two decades between 1980 and 2000 was an important reason why the gold price did not perform well during those years. It was in part the rapid rise in the dollar that hurt the dollar gold price. Another reason for gold's poor performance between 1980 and 2000 was the success of the world's central bankers in fighting inflation. Gold's role as a hedge againts inflation can be one of the main reasons that people buy it.
Despite the volatility of gold prices and its sensitivity to fundamental factors, the diversification benefits of gold in a portfolio are backed by strong evidence. Ibbotson Associates, a leading authority on asset allocation, performed a study with respect to the portfolio diversification benefits of gold, silver and platinum bullion covering a 33 year period from February 1971 to December 2004. Ibbotson determined that of the seven types of assets covered in the study, the precious metals asset class is the only one with a negative correlation to other asset classes. What this means is that precious metals perform best during the years that traditional asset classes such as stocks and bonds had negative returns. Ibbotson determined that investors can potentially improve their portfolio risk-reward performance by including precious metals with allocations of between 7.1% and 15.7% for conservative to aggressive portfolios respectively.
Historically, gold has produced excellent long-term gains during up cycles; however, it may not be suitable for everyone. You should acquire a good understanding of gold products before you invest. Since all investments including gold can decline in value, you should have adequate cash reserves and disposable income before considering a precious metal investment.
In the end, speculating in gold should be avoided at all cost by most conservative investors. Speculting involves short-term trading and the early withdrawal from accounts or securities can result in substantial penalties or fees - in addition to any decrease in gold prices due to fundamental factors.
Ref: Make Money Work For You by Keon Chee & Ben Fok
How to invest in gold?
How to invest in gold?
Investors who wish to invest in gold can do so in 5 ways:
1. Gold bullion bars and coins
2. Gold certificates
3. Gold mining shares
4. Gold unit trusts
5. Gold derivatives
Prices for all these investment options are available daily from banks and brokerages.
Investors who wish to invest in gold can do so in 5 ways:
1. Gold bullion bars and coins
2. Gold certificates
3. Gold mining shares
4. Gold unit trusts
5. Gold derivatives
Prices for all these investment options are available daily from banks and brokerages.
Buy gold!
The standard policy of people all over the world who mistrust their currency has been to buy and hold gold.
--------
Here are some historical data from Intelligent Investor by Benjamin Graham:
The price of gold in the open market rose from $35 per ounce over 35 years to $48 in early 1972 - a rise of only 35%. But during all this time, the holder of gold received no income return on his capital, and instead incurred some annual expense from storage. Obviously, between 1937 - 1972, money earning interest in a saving bank, in spite of the rise in the general price level, was better than investing in gold.
It was obvious that during that period, the near-complete failure of gold to protect against a loss in the purchasing power of the dollar must cast doubt on the ability of the ordinary investor to protect himself against inflation by putting his money in either gold or "other things."
Very few readers will find the swimming safe and easy investing in gold.
----------
There were others who pointed out that there were years when gold showed robust ability to outpace inflation. A tiny allocation to this metal (say, 2% of your total assets) is too small to hurt your overall returns when gold does poorly. But when gold does well, its return are often so spectacular - sometimes exceeding 100%.
---------
--------
Here are some historical data from Intelligent Investor by Benjamin Graham:
The price of gold in the open market rose from $35 per ounce over 35 years to $48 in early 1972 - a rise of only 35%. But during all this time, the holder of gold received no income return on his capital, and instead incurred some annual expense from storage. Obviously, between 1937 - 1972, money earning interest in a saving bank, in spite of the rise in the general price level, was better than investing in gold.
It was obvious that during that period, the near-complete failure of gold to protect against a loss in the purchasing power of the dollar must cast doubt on the ability of the ordinary investor to protect himself against inflation by putting his money in either gold or "other things."
Very few readers will find the swimming safe and easy investing in gold.
----------
There were others who pointed out that there were years when gold showed robust ability to outpace inflation. A tiny allocation to this metal (say, 2% of your total assets) is too small to hurt your overall returns when gold does poorly. But when gold does well, its return are often so spectacular - sometimes exceeding 100%.
---------
Sunday, 26 October 2008
Bargains abound in the stock markets
http://www.raymondjames.com/inv_strat.htm
In conclusion, we received a plethora of questions regarding the quote we used last week from The Wall Street Journal (WSJ) that there are currently one in ten listed companies trading for less than the value of the cash and marketable securities on their balance sheets. To proof test this statement we ran a similar screen and found more companies than the WSJ did. Of course the screen they must have used was similar to ours in that “net debt” on the balance sheet was excluded. When we included “net debt” we come away with a much smaller number. Still, this exercise goes to show that “things” are overdone on the downside and people like Warren Buffett are taking notice. Verily, when investors en masse attempt to adjust their portfolios toward more conservative investments, there is a negative feedback loop that leads to a decline in the price of less liquid assets, which in turn begets even more selling pressure, causing an overshoot on the downside. And that, ladies and gentlemen, is where we are currently.
----------
P.S. – “Strikingly, today’s conditions bear quite a close resemblance to what Graham described in the abyss of the Great Depression. Regardless of how much further it might (or might not) drop, the stock market now abounds with so many bargains it’s hard to avoid stepping on them. Out of 9,194 stocks tracked by Standard & Poor’s Compustat research service, 3,518 are now trading at less than eight times their earnings over the past year – or at levels less than half the long-term average valuation of the stock market as a whole. Nearly one in 10, or 876 stocks, trade below the value of their per-share holdings of cash – an even greater proportion than Graham found in 1932.” (The WSJ the week of October 6, 2008.)
In conclusion, we received a plethora of questions regarding the quote we used last week from The Wall Street Journal (WSJ) that there are currently one in ten listed companies trading for less than the value of the cash and marketable securities on their balance sheets. To proof test this statement we ran a similar screen and found more companies than the WSJ did. Of course the screen they must have used was similar to ours in that “net debt” on the balance sheet was excluded. When we included “net debt” we come away with a much smaller number. Still, this exercise goes to show that “things” are overdone on the downside and people like Warren Buffett are taking notice. Verily, when investors en masse attempt to adjust their portfolios toward more conservative investments, there is a negative feedback loop that leads to a decline in the price of less liquid assets, which in turn begets even more selling pressure, causing an overshoot on the downside. And that, ladies and gentlemen, is where we are currently.
----------
P.S. – “Strikingly, today’s conditions bear quite a close resemblance to what Graham described in the abyss of the Great Depression. Regardless of how much further it might (or might not) drop, the stock market now abounds with so many bargains it’s hard to avoid stepping on them. Out of 9,194 stocks tracked by Standard & Poor’s Compustat research service, 3,518 are now trading at less than eight times their earnings over the past year – or at levels less than half the long-term average valuation of the stock market as a whole. Nearly one in 10, or 876 stocks, trade below the value of their per-share holdings of cash – an even greater proportion than Graham found in 1932.” (The WSJ the week of October 6, 2008.)
Ref:
Business Valuations versus Stock-Market Valuations (2) - an illustration
"The company is worth more dead than alive." The A&P Example
Saturday, 25 October 2008
The Investor and Market Fluctuations - Summary
Summary:
- The most realistic distinction between the investor and the speculator is found in their attitude toward stock market movements.
- The speculator's primary interest lies in anticipating and profiting from the market fluctuations.
- The investor's primary interest lies in acquiring and holding suitable securities at suitable prices.
- Market movements are important to the investor in a practical sense, because they alternatively create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.
- It is far from certain that the typical investor should regularly hold off buying until low market levels appear, because this may involve a long wait, very likely the loss of income, and the possible missing of investment opportunities.
- On the whole, it may be better for the investor to do his stock buying whenever he has money to put in stocks, EXCEPT when the general market level is much higher than can be justified by well-established standards of value.
- If he wants to be shrewd, he can look for the ever present bargain opportunities in individual securities.
- Aside from forecasting the movements of the general market, much effort and ability are dircted on Wall Street toward selecting stocks or industrial groups that in matter of price will "do better" than the rest over a FAIRLY SHORT PERIOD IN THE FUTURE. Logical as this endeavor may seem, we do not believe it is suited to the needs or temperament of the true investor - particularly since he would be competing with a large number of stock market traders and first class financial analysts who are trying to do the same thing.
- As in all other activities that emphasize price movements first and underlying values second, the work of many intelligent minds constantly engaged in this field tends to be self-neutralizing and self-defeating over the years.
- The investor with a portfolio of sound stocks should expect their prices to fluctuate and should neither be concerned by sizeable declines nor become excited by sizable advances. He should always remember that market quotations are there for his convenience, either to be taken advantage of or to be ignored.
- The investor should never buy a stock BECAUSE it has gone up or sell one BECAUSE it has gone down.
- The investor would not be far wrong, if this motto read more simply: "Never buy a stock immediately after a substantial rise or sell one immediately after a substantial drop."
An Added Consideration.
- The shareholder judges whether his own investment has been successful in terms both of dividends received and of the long-range trend of the average market value.
- The same criteria should logically be applied in testing the effectiveness of a company's management and the soundness of its attitude toward the owners of the business.
- For as yet, there is no accepted technique or approach by which management is brought to the bar of market opinion. On the contrary, managements have always insisted that they have no responsibility OF ANY KIND for what happens to the market value of their share.
- It is true, of course, that they are NOT accountable for those FLUCTUATIONS in price which, bear no relationship to underlying conditions and values.
- But it is only the lack of alertness and intelligence among the rank and file of shareholders that permits this immunity to extend to the entire realm of market quotations, including the permanent establishment of a depreciated and unsatisfactory price level. (This is now known as "corporate governance."
- Good managements produce a good average market price, and bad managements produce bad market prices.
Ref:
The Investor and Market Fluctuations in Intelligent Investor by Benjamin Graham
Benjamin Graham's 113 wise words
This may well be the single most important paragraph in Graham's entire book.
In these 113 words Graham summarised his lifetime of experience.
If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you.
"The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement."
* Only to the extent that it suits his book" means "only to the extent that the price is favorable enough to justify selling the stocks." In traditional brokerge lingo, the "book" is an investor's ledger of holdings and trade.
In these 113 words Graham summarised his lifetime of experience.
If you keep them close at hand and let them guide you throughout your investing life, you will survive whatever the markets throw at you.
"The true investor scarcely ever is forced to sell his shares, and at all times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.* Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons' mistakes of judgement."
* Only to the extent that it suits his book" means "only to the extent that the price is favorable enough to justify selling the stocks." In traditional brokerge lingo, the "book" is an investor's ledger of holdings and trade.
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