Will You Be Satisfied With 7% Returns?

Will You Be Satisfied With 7% Returns?
By Alex Dumortier, CFA
March 18, 2009 Comments (41)

7.2%.
That's what Jeremy Grantham recently predicted stocks will return -- after inflation -- on an annualized basis over the next seven years.

Is that good enough for you?
Who on earth is Jeremy Grantham? Jeremy Grantham is the co-founder of investment firm GMO, which currently has approximately $90 billion in assets under management.

Grantham is often dismissed as a "perma-bear" when his views go against Wall Street's institutionalized optimism -- but the truth is, he's a rock-solid investment thinker, grounded in reality, who calls 'em like he sees 'em.

He believes that "mean reversion is the most powerful force in financial markets." In other words, periods of abnormally high returns must be balanced out by periods of abnormally low returns, and this holds true across the gamut of different assets, whether it be commodities, stocks, or bonds.

On that basis, at the end of 2001, Grantham predicted that the S&P 500 would suffer an annualized decline of 1.1% over the following seven years -- which was decidedly optimistic, since the annualized real return turned out to be negative 3.9%.

In July 2007, as the credit crisis was in its infancy, Grantham wrote: "In five years, ... at least one major bank (broadly defined) will have failed." We've all witnessed the multiple failures, rushed takeovers, and government rescues in the financial sector since then.

So, it's worth taking his predictions seriously.

7%? Seriously?
It may be hard to imagine 7% annual returns (after inflation, no less!) right now, what with the S&P 500 down approximately 50% from its all-time high in October 2007, but that decline has, in fact, set the stage for investors to earn 7% -- near the average historical return on stocks -- going forward.

The drop has been a source of enormous pain for investors -- but from the point of view of the prospective stock buyer, it's a great opportunity since stocks are at lower valuations than they have been in years.

In fact, Grantham called U.S. blue chips "manna from heaven"; indeed, when the credit crisis began to escalate, he said "they were about as cheap, on a relative basis, as they ever get."
I wanted to verify that claim, and I was able to confirm that over one in four non-financial stocks in the S&P 500 are cheaper in terms of their price-to-book value multiple than they have been in over 14 years. They include these superb companies:

Price/Book Value
Forward Price/Earnings

Oracle (NYSE: ORCL)
3.3
10.4
Cisco Systems (Nasdaq: CSCO)
2.5
14.5
Procter & Gamble (NYSE: PG)
2.3
12.7
eBay (Nasdaq: EBAY)
1.3
8.4
CVS Caremark (NYSE: CVS)
1.1
12.3
General Electric (NYSE: GE)
1.0
8.1
Alcoa (NYSE: AA)
0.4
N/A
Source: Capital IQ, a division of Standard & Poor's, as of March 16, 2009.

But what if you aren't satisfied with 7% returns?

Getting to 7% *plus*
Grantham's prediction is based on the S&P 500, in aggregate, being fairly valued (he's currently pegging its fair value at 950). And if you pay fair value for the index, you can expect to earn the weighted average return that the underlying companies earn on their equity.

But within the S&P 500, some stocks will likely be overvalued, and some will likely be undervalued. If you're able to buy an individual stock for less than its fair value, that margin of safety will turbo-charge your expected return beyond the company's accounting return on shareholders' equity.

Grantham expects a subset of U.S. stocks -- those he labels "high quality" -- to produce after-inflation annualized returns of 11.2% over the next seven years. Four percentage points on an annualized basis is an enormous difference -- and gives investors plenty of incentive to identify those "high quality" stocks.

Although Grantham doesn't directly define "high quality," he provides some clues in an interview with Forbes in which he said, "And the best bet, for my money, then and now, a year later, was to buy the great franchise companies, the great quality companies." This suggests that he favors companies that possess a moat -- a sustainable competitive advantage -- and that earn excess returns over their cost of capital.

Helping you earn better returns
No investor is "condemned" to 7% returns going forward -- and neither are we promised them. Investing -- at reasonable prices -- in excellent businesses that are likely to grow is the best strategy for securing your long-term returns.

Of course, even among stocks that are perceived as "high quality," you can expect a range of different returns. The trick is identifying which stocks are genuinely undervalued.


Alex Dumortier, CFA has no beneficial interest in any of the companies mentioned in this article. Procter & Gamble is a Motley Fool Income Investor pick. eBay is an Inside Value and a Stock Advisor recommendation. The Fool owns shares of Procter & Gamble.

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http://www.fool.com/investing/value/2009/03/18/will-you-be-satisfied-with-7-returns.aspx

How You Can Tailor-Make a Winning Portfolio

How You Can Tailor-Make a Winning Portfolio
By Dan Caplinger March 25, 2009

Anybody can throw a bunch of investments together and call it a portfolio. It takes a lot more, however, to find a select group of promising prospects that fit well with your temperament, your time horizon, and your particular financial goals.

Too often, investors don't think about their investment portfolio as a single unit. Instead, they grab shares of various stocks and funds willy-nilly, based solely on their individual characteristics -- never thinking of a new stock's impact on the holdings they already own.

Make the right portfolio
In this month's brand-new issue of Motley Fool Champion Funds -- which goes live this afternoon at 4 p.m. EDT -- Foolish fund expert Amanda Kish takes a look at this question from a unique angle. Part of what Amanda's newsletter offers subscribers every month are three model portfolios, each of which represents a blend of some of the funds that the service has recommended over the years.

But of course, unless you're just getting started with your investing, you'll probably already have some stocks and funds to bring to the mix. In addition, even if you have cash available, you may not have access to buy the exact funds you want -- especially if you have to choose from a fixed menu of investment options, as many workers must in their 401(k) plans.

Given those limitations, what's the best way to choose investments in a way that will complement your existing portfolio rather than create problems?

Watch out for the concentration trap
With individual stocks, problems often come from haphazardly choosing promising companies that aren't well diversified. For instance, here's an extreme example of stocks you might have been tempted to add to your portfolio based on these news items from early last year:

• With the discovery of a massive oil field off the cost of Brazil, Petroleo Brasileiro (NYSE: PBR) found itself fortuitously positioned to take maximum advantage of the news.
• The red-hot Haynesville shale play brought quick profits to natural gas players like Petrohawk Energy (NYSE: HK) and Chesapeake Energy (NYSE: CHK).
• Demand for fertilizer rose much faster than supply, giving industry players like Potash Corp. (NYSE: POT) and Mosaic (NYSE: MOS) great returns during the first six months of 2008.
• Early in 2008, heavy demand for industrial metals from China and other development-hungry economies bolstered prospects for copper producers like Southern Copper (NYSE: PCU) and Freeport-McMoRan (NYSE: FCX) -- and with China's economy forecast to grow strongly, the end seemed far away.

Clearly, if you'd acted on those temptations, you would've owned a portfolio that was way overweighted in energy and commodities stocks -- stocks that came crashing down during the latter half of the year.

Dealing with funds
With mutual funds, there are a bunch of things to keep in mind when tailoring a fund portfolio for your particular wants and needs. For instance:

• If you have a strong relationship with a particular fund company, you might want to use their offerings in particular asset classes rather than mixing and matching across different fund companies.
• Even within broad categories like large-cap value or small-cap growth, you'll find dozens of different strategies. Some may appeal to you more than others, even if all of them have been equally successful at creating gains over the long haul.

Champion Funds gives portfolio recommendations for conservative, moderate, and aggressive investors. But if you find yourself halfway between two of those categories, then an easy way to split the difference may be to add another fund.

In this month's newsletter, Amanda goes through these and other reasons you may have for making switches -- and gives you a useful set of tools to help you evaluate whether a particular fund you may have in mind is the right one to keep your overall portfolio strong. And with dozens of different fund recommendations to choose from, Champion Funds subscribers don't have any shortage of great funds to plug into their overall investment strategy.

Putting together a tailor-made portfolio will take some work, but the rewards will last a lifetime.

For more on winning investment strategies, read about:
Yes, you can defend your portfolio from losses.
Will 7% returns really make you happy.
Want to retire? You need options.

Fool contributor Dan Caplinger is constantly making adjustments to his portfolio. He owns shares of Freeport McMoRan and Chesapeake Energy. Petroleo Brasileiro is a Motley Fool Income Investor pick. Chesapeake Energy is a Motley Fool Inside Value recommendation.

http://www.fool.com/investing/mutual-funds/2009/03/25/how-you-can-tailor-make-a-winning-portfolio.aspx

Pyramid Your Way To Profits

Pyramid Your Way To Profits
by Cory Mitchell (Contact Author Biography)


Pyramiding involves adding to profitable positions to take advantage of an instrument that is performing well. It allows for large profits to be made as the position grows. Best of all, it does not have to increase risk if performed properly. In this article, we will look at pyramiding trades in long positions, but the same concepts can be applied to short selling as well.


Misconceptions About Pyramiding

Pyramiding is not "averaging down", which refers to a strategy where a losing position is added to at a price that is lower than the price originally paid, effectively lowering the average entry price of the position. Pyramiding is adding to a position to take full advantage of high-performing assets and thus maximizing returns. Averaging down is a much more dangerous strategy as the asset has already shown weakness, rather than strength. (For further reading, see Averaging Down: Good Idea Or Big Mistake?)Pyramiding is also not that risky - at least not if executed properly. While higher prices will be paid (in the case of a long position) when an asset is showing strength, which will erode profits on original positions if the asset reverses, the amount of profit will be larger relative to only taking one position.

Why It Works

Pyramiding works because a trader will only ever add to positions that are turning a profit and showing signals of continued strength. These signals could be continued as the stock breaks to new highs, or the price fails to retreat to previous lows. Basically, we are taking advantage of trends by adding to our position size with each wave of that trend.

Pyramiding is also beneficial in that risk (in terms of maximum loss) does not have to increase by adding to a profitable existing position. Original and previous additions will all show profit before a new addition is made, which means that any potential losses on newer positions are offset by earlier entries. Also, when a trader starts to implement pyramiding, the issue of taking profits too soon is greatly diminished. Instead of exiting on every sign of a potential reversal, the trader is forced to be more analytical and watch to see whether the reversal is just a pause in momentum or an actual shift in trend. This also gives the trader the foreknowledge that he or she does not have to make only one trade on a given opportunity, but can actually make several trades on a move.

For example, instead of making one trade for a 1,000 shares at one entry, a trader can "feel out the market" by making a first trade of 500 shares and then more trades after as it shows a profit. By pyramiding, the trader may actually end up with a larger position than the 1,000 shares he or she might have traded in one shot, as three or four entries could result in a position of 1,500 shares or more. This is done without increasing the original risk because the first position is smaller and additions are only made if each previous addition is showing a profit. Let us look at an example of how this works, and why it works better than just taking one position and riding it out.

Real-World Application

For simplicity, let's assume we are trading stocks for our first example, and have a $30,000 trading account limit. The maximum we want to risk on one trade is 1-2% of our account. Using a 1% maximum stop, in dollar terms we are only willing to risk $300. A stop will be placed on the trade so that no more than this is lost. We look at the chart of the stock we are trading and pick where a former support level is. Our stop will be just below this. If the current price is 50 cents away from the last support level and we add a small buffer (so, 55 cents), we can take 545 shares ($300/$0.55=545). Round this number down and only take 500 shares; our risk in now less than $300. We could buy our 500 shares and hang on to them, selling them whenever we see fit, or we could buy a smaller position, perhaps 300 shares, and add to it as it shows a profit. If the stock continues to trend, we will end up with a larger position (and thus more profit) than 500 shares, and if the stock falls we only lose money on 300 shares - a loss of only $165 ($0.55*300) as opposed to $275 ($0.55*500) if we only took a static 500 share position.Now, let's take a look at an example using a 15-minute chart of the Great Britain pound against the Japanese yen (GBP/JPY). The circles are entries and the lines are the prices our stop levels move to after each successive wave higher.

Figure 1: November 4, 2008
Source: ForexYard

In this case, we will use a simple strategy of entering on new highs. Our stops will move up to the last swing low after a new entry. If a stop price is hit, all positions are exited. Our entries are 155.50, 156.90, 158.10 and 159.20 as we add to our position with each successive move to new highs after a reversal. The latest reversal low gives us an original stop of 154.15 and then progressively 155.50, 157.00, 157.50. Finally, we have a reversal and the market fails to reach its old highs. As this low gives way to a lower price, we execute our stop at order at 160.20, exiting our entire position at that price. (For more, see Is Pressing The Trade, Just Pressing Your Luck?)

The Verdict

Assume we can buy five lots of the currency pair at the first price and hold it until the exit, or purchase three lots originally and add two lots at each level indicated on the chart. The buy-and-hold strategy results in a gain of 5 x 470 pips, or a total of 2,350 pips. The pyramiding strategy results in a gain of (3 x 470) + (2 x 330) + (2 x 210) + (2 x 100) = 2,690 pips. This is almost a 15% increase in profits, without increasing original risk. This can be further increased by taking a larger original position or increasing the size of the additional positions.

Problems With Pyramiding

Problems can arise from pyramiding in markets that have a tendency to "gap" in price from one day to the next. Gaps can cause stops to be blown very easily, exposing the trader to more risk by continually adding to positions at higher and higher prices. A large gap could mean a very large loss. Another issue is if there are very large price movements between the entries; this can cause the position to become "top heavy," meaning that potential losses on the newest additions could erase all profits (and potentially more) than the preceding entries have made.

Final Notes

It is important to remember that the pyramiding strategy works well in trending markets and will result in greater profits without increasing original risk. In order to prevent increased risk, stops must be continually moved up to recent support levels. Avoid markets that are prone to large gaps in price, and always make sure that additional positions and respective stops ensure you will still make a profit if the market turns. This means being aware of how far apart your entries are and being able to control the associated risk of having paid a much higher price for the new position. (For more on preventing losses, see A Logical Method Of Stop Placement.)

by Cory Mitchell, (Contact Author Biography)Cory Mitchell is an independent trader specializing in short- to medium-term technical strategies. He is the founder of http://www.vantagepointtrading.com/, a website dedicated to free trader education and discussion. After graduating with a business degree, Mitchell has spent the last five years trading multiple markets and educating traders. He has been widely published and is a member of the Canadian Society of Technical Analysts and an affiliate of the Market Technicians Association.

http://www.investopedia.com/articles/trading/09/pyramid-trading.asp?partner=NTU3

What is the difference between inflation and stagflation?

What is the difference between inflation and stagflation?

Inflation is a term used by economists to define broad increases in prices. Inflation is the rate at which the price of goods and services in an economy increases. Inflation also can be defined as the rate at which purchasing power declines.

For example, if inflation is at 5% and you currently spend $100 per week on groceries, the following year you would need to spend $105 for the same amount of food.

Economic policy makers like the Federal Reserve maintain constant vigilance for signs of inflation. Policy makers do not want an inflation psychology to settle into the minds of consumers. In other words, policy makers do not want consumers to assume that prices always will go. Such beliefs lead to things like employees asking employers for higher wages to cover the increased costs of living, which strains employers and, therefore, the general economy.

Stagflation is a term used by economists to define an economy that has inflation, a slow or stagnant economic growth rate and a relatively high unemployment rate. Economic policy makers across the globe try to avoid stagflation at all costs.

With stagflation, a country's citizens are affected by high rates of inflation and unemployment. High unemployment rates further contribute to the slowdown of a country's economy, causing the economic growth rate to fluctuate no more than a single percentage point above or below a zero growth rate.

Stagflation was experienced globally by many countries during the 1970s when world oil prices rose sharply, leading to the birth of the Misery Index. The Misery Index, or the total of the inflation rate and the unemployment rate combined, functions as a rough gauge of how badly people feel during times of stagflation. The term was used often during the 1980 U.S. presidential race.

(To learn more about inflation and stagflation, see Stagflation, 1970s Style and Inflation: What Is Inflation?)

http://www.investopedia.com/ask/answers/09/inflation-vs-stagflation.asp?partner=NTU3

A global economic order less dominated by the U.S. and other wealthy nations.

MARCH 24, 2009 China Takes Aim at Dollar Article

By ANDREW BATSON

BEIJING -- China called for the creation of a new currency to eventually replace the dollar as the world's standard, proposing a sweeping overhaul of global finance that reflects developing nations' growing unhappiness with the U.S. role in the world economy.

The unusual proposal, made by central bank governor Zhou Xiaochuan in an essay released Monday in Beijing, is part of China's increasingly assertive approach to shaping the global response to the financial crisis.

Mr. Zhou's proposal comes amid preparations for a summit of the world's industrial and developing nations, the Group of 20, in London next week. At past such meetings, developed nations have criticized China's economic and currency policies.

This time, China is on the offensive, backed by other emerging economies such as Russia in making clear they want a global economic order less dominated by the U.S. and other wealthy nations.

However, the technical and political hurdles to implementing China's recommendation are enormous, so even if backed by other nations, the proposal is unlikely to change the dollar's role in the short term. Central banks around the world hold more U.S. dollars and dollar securities than they do assets denominated in any other individual foreign currency. Such reserves can be used to stabilize the value of the central banks' domestic currencies.

Monday's proposal follows a similar one Russia made this month during preparations for the G20 meeting. Like China, Russia recommended that the International Monetary Fund might issue the currency, and emphasized the need to update "the obsolescent unipolar world economic order."

Chinese officials are frustrated at their financial dependence on the U.S., with Premier Wen Jiabao this month publicly expressing "worries" over China's significant holdings of U.S. government bonds. The size of those holdings means the value of the national rainy-day fund is mainly driven by factors China has little control over, such as fluctuations in the value of the dollar and changes in U.S. economic policies. While Chinese banks have weathered the global downturn and continue to lend, the collapse in demand for the nation's exports has shuttered factories and left millions jobless.

In his paper, published in Chinese and English on the central bank's Web site, Mr. Zhou argued for reducing the dominance of a few individual currencies, such as the dollar, euro and yen, in international trade and finance. Most nations concentrate their assets in those reserve currencies, which exaggerates the size of flows and makes financial systems overall more volatile, Mr. Zhou said.

Moving to a reserve currency that belongs to no individual nation would make it easier for all nations to manage their economies better, he argued, because it would give the reserve-currency nations more freedom to shift monetary policy and exchange rates. It could also be the basis for a more equitable way of financing the IMF, Mr. Zhou added. China is among several nations under pressure to pony up extra cash to help the IMF.

John Lipsky, the IMF's deputy managing director, said the Chinese proposal should be treated seriously. "It reflects officials' concerns about improving the stability of the financial system," he said. "It's interesting because of China's unique position, and because the governor put it in a measured and considered way."

China's proposal is likely to have significant implications, said Eswar Prasad, a professor of trade policy at Cornell University and former IMF official. "Nobody believes that this is the perfect solution, but by putting this on the table the Chinese have redefined the debate," he said. "It represents a very strong pushback by China on a number of fronts where they feel themselves being pushed around by the advanced countries," such as currency policy and funding for the IMF.

A spokeswoman for the U.S. Treasury Department declined to comment on Mr. Zhou's views. In recent weeks, senior Obama administration officials have sought to reassure Beijing that the current U.S. spending spree is a short-term effort to restart the stalled American economy, not evidence of long-term U.S. profligacy.

"The re-establishment of a new and widely accepted reserve currency with a stable valuation benchmark may take a long time," Mr. Zhou said. In remarks earlier Monday, one of his deputies, Hu Xiaolian, also said the dollar's dominant position in international trade and investment is unlikely to change soon. Ms. Hu is in charge of reserve management as the head of China's State Administration of Foreign Exchange.

Mr. Zhou's comments -- coming on the heels of Mr. Wen's musing about the safety of China's dollar holdings -- appear to be a warning to the U.S. that it can't expect China to finance its spending indefinitely.

The central banker's proposal reflects both China's desire to hold its $1.95 trillion in reserves in something other than U.S. dollars and the fact that Beijing has few alternatives. With more U.S. dollars continuing to pour into China from trade and investment, Beijing has no realistic option other than storing them in U.S. debt.

Mr. Zhou argued, without mentioning the dollar by name, that the loss of the dollar's de facto reserve status would benefit the U.S. by avoiding future crises. Because other nations continued to park their money in U.S. dollars, the argument goes, the Federal Reserve was able to pursue an irresponsible policy in recent years, keeping interest rates too low for too long and thereby helping to inflate a bubble in the housing market.

"The outbreak of the crisis and its spillover to the entire world reflected the inherent vulnerabilities and systemic risks in the existing international monetary system," Mr. Zhou said. The increasing number and intensity of financial crises suggests "the costs of such a system to the world may have exceeded its benefits."

Mr. Zhou isn't the first to make that argument. "The dollar reserve system is part of the problem," Joseph Stiglitz, the Columbia University economist, said in a speech in Shanghai last week, because it meant so much of the world's cash was funneled into the U.S. "We need a global reserve system," he said in the speech.

Mr. Zhou's idea is to expand the use of "special drawing rights," or SDRs -- a kind of synthetic currency created by the IMF in the 1960s. Its value is determined by a basket of major currencies. Originally, the SDR was intended to serve as a shared currency for international reserves, though that aspect never really got off the ground.

These days, the SDR is mainly used in the IMF's accounting for its transactions with member nations. Mr. Zhou suggested countries could increase their contributions to the IMF in exchange for greater access to a pool of reserves in SDRs.

Holding more international reserves in SDRs would increase the role and powers of the IMF. That indicates China and other developing nations aren't hostile to international financial institutions -- they just want to have more say in running them. China has resisted the U.S. push to make an immediate loan to the IMF because that wouldn't give China a bigger vote. Ms. Hu said Monday that China, which encourages the IMF to explore other fund-raising options, would consider buying into a bond issue.

The IMF has been working on a proposal to issue bonds, probably only to central banks. Bond purchases are one way for the organization to raise money and meet its goal of at least doubling its lending war chest to $500 billion from $250 billion. Japan has loaned the IMF $100 billion and the European Union has pledged another $100 billion.

—Terence Poon in Beijing, James T. Areddy in Shanghai, and Bob Davis and Michael M. Phillips in Washington contributed to this article.
Write to Andrew Batson at andrew.batson@wsj.com

http://online.wsj.com/article/SB123780272456212885.html

Geithner about-turn on dollar status shocks currency markets

Geithner about-turn on dollar status shocks currency markets

Sterling jumped more than a cent against a sharply falling dollar on Wednesday, with the greenback winded after US Treasury Secretary Timothy Geithner said he was "quite open" to China's suggestion of moving toward SDR-linked currency system, Reuters reported.

Last Updated: 2:52PM GMT 25 Mar 2009

Geithner about-turn on dollar status shocks currency markets
By 1408 GMT, the pound had jumped to a session high of $1.4725.

However, the dollar soon pared losses after the Treasury Secretary added that the dollar was likely to remain the world's reserve currency for a long time.

"The market is purely reacting to the Geithner comments and it's taken out a whole load of stops [in euro/dollar and cable]," a London-based trader said. "With a comment like that people just cut all their positions."

Initially, investors viewed the comment as an about-turn because on Tuesday Mr Geithner had firmly dismissed suggestions that the global economy move away from using the dollar as the main reserve currency.

In a congressional hearing on Capitol Hill, US Republican Michele Bachmann, a Minnesota Republican, asked Mr Geithner: "Would you categorically renounce the United States moving away from the dollar and going to a global currency as suggested this morning by China and also by Russia, Mr Secretary?"

Mr Geithner replied, "I would, yes."

Chinese central bank chief Zhou Xiaochuan on Monday urged an overhaul of the global monetary system to allow for wider use of Special Drawing Rights (SDRs) created by the International Monetary Fund as an international reserve asset in 1965.

Mr Zhou's comments followed remarks by Russia last week which said it would put forward a proposal at a meeting of the Group of 20 in London on April 2 for the creation of a new global reserve currency.

http://www.telegraph.co.uk/finance/economics/5049436/Geithner-about-turn-on-dollar-status-shocks-currency-markets.html

Stock market: 'Eventually shares will have the mother of all rallies'

Stock market: 'Eventually shares will have the mother of all rallies'

The stock market has jumped by about 500 points in the past couple of weeks, but investors thinking of putting their Isa money into shares want to know one thing: is this the start of a sustained recovery or a dead cat bounce?

By Richard Evans
Last Updated: 1:08PM GMT 25 Mar 2009

Stock markets have shown signs of life in the past few weeks. Since London's benchmark FTSE100 touched a six-year low earlier this month, falling below 3,500 at one stage, it has rallied strongly, closing at 3,912 on Tuesday.

America's Dow Jones index has also put in a good performance, posting one of its largest ever one-day rises following the announcement of a bail-out for banks' toxic assets.

But British investors wondering whether to use this year's Isa allowance before the deadline of April 5 have reason to be cautious: the markets have staged several apparent recoveries during the economic crisis, only to fall back again.

So is it different this time – is this a long-term recovery or just a dead cat bounce? Should you forget taking out a stocks and shares Isa this year, or dip a toe in the market? We asked the experts where they thought the market was heading and which equity investments, if any, Isa buyers should consider buying.

MARK HARRIS, FUND OF FUNDS MANAGER AT NEW STAR

"The direct answer is that there is no way of knowing for sure whether the recent rallies are a blip or something more sustainable, but in my view the March lows were significant.

"In early March we saw markets deeply oversold and widespread investor pessimism. Conditions were ripe for a bounce. Interestingly, a number of markets such as Brazil and China did not make new lows – they did not fall below their levels of November 2008.

"We have seen a marked increase in the determination of the US Federal Reserve to combat the various issues plaguing the financial system. This has resulted in a 20pc-plus bounce in most equity markets, which is the extent of the rallies in 2008 to January 2009.

"Valuations are supportive at lower index levels, but we have little visibility on earnings. In fact the earnings season through April is likely to be extremely difficult and may result in the markets retracing some of this rally's gains.

"I think the lows in March may prove to be significant, but that a 'test' may occur in April. If we can make a higher low for equities in April, it will be positive for further gains. But I should reiterate that I still believe that we are in a very challenging environment, and that it will be a couple of years before we can say that this bear market is truly over.

"So, put simply, we will see the rally which is just unfolding, then a correction of about 15pc, and then a further rally to take the market up in total by about 40pc from the lows."

JUSTIN URQUHART STEWART OF SEVEN INVESTMENT MANAGEMENT

"Shares on a five-year view may be OK, although prices could be highly erratic.

"I think it's too risky putting all my money into one asset class so I've diversified my investments into a mix of commodities, property, international shares and fixed interest securities such as bonds.

"You can do this yourself in a self-select Isa but it could be expensive and time consuming. An easier way is to buy a multi-asset fund, which you can hold within an Isa.

"Multi-asset funds can be actively or passively managed. I favour the passive type because costs – which can make a big difference over 10 years – are lower. Active funds can have total expense ratios of 2pc.

"Passive funds track the performance of the various asset types using exchange traded funds (ETFs). Examples include Seven's own and products from Evercore Pan Asset.

"Among the managers to offer active funds are Jupiter, Merlin, Seven, Midas, Credit Suisse, M&G, Fidelity and Jupiter. Fidelity's Wealthbuilder has a good record while Jupiter's fund is higher risk but well managed."

MARK DAMPIER, HEAD OF RESEARCH, HARGREAVES LANSDOWN

"Come what may, do buy an Isa – use your whole allowance (£7,200, of which £3,600 can be cash).

"Unless you trust politicians – and I don't – they are going to try to get more money out of you by raising taxes. So shelter as much as possible from tax while you can.

"Some people think the Isa allowance is so small that it's not worth bothering. But the yearly sums accumulate: a couple who had used their full allowances for every year that Isas and their predecessors, Peps and Tessas, have existed could have built up £190,000 by now – and that's discounting investment growth.

"If you are nervous about the markets you can keep your money in cash, even in a stocks and shares Isa (although without the tax breaks), to drip feed into the market. This prevents you from putting it all in just before a fall.

"I suspect this rally is more of a dead cat bounce; it comes from a very low position. There seems to be a base at about 3,500. Let's be a bit careful but with the market about 50pc below its peak it has to be an interesting time to think about investing.

"I don't believe, as some do, that corporate bonds are a bubble. If you buy through a fund such as M&G Strategic, Jupiter or Investec Sterling Bond, you will get a yield of 5pc to 6pc. If equity markets do eventually improve, bonds will have risen first.

"If you do want to buy equities, I would always go for a fund manager with a long-term track record such as Neil Woodford of Invesco Perpetual. But at the other end of the spectrum I also back emerging market funds such as Aberdeen's – that's where real long-term growth will be found, although prices will be volatile.

"With inflation of over 3pc on the CPI you would normally have interest rates at 5pc, not 0.5pc. So given the risk of inflation taking off I'd consider gold, via a fund such as BlackRock Gold & General.

"This rally is still more hope than anything else, the kind that has a habit of disappointing. I wouldn't push a load of money in; I'd wait for bad days and drip-feed it in then. The markets are not about to race away but one of these days they will, so don't wait for ever.

"Eventually, there will be the mother of all rallies."


http://www.telegraph.co.uk/finance/personalfinance/investing/shares/5047837/Stock-market-Eventually-shares-will-have-the-mother-of-all-rallies.html

Geithner rescue package 'robbery of the American people'

Geithner rescue package 'robbery of the American people'
The US government plan to free beleaguered banks of up to $1 trillion (£690bn) of toxic assets will expose American taxpayers to too much risk, leading economist Joseph Stiglitz has cautioned.

By James Quinn, Wall Street Correspondent
Last Updated: 11:45AM GMT 25 Mar 2009

Joseph Stiglitz said Geithner's plan amounted to 'robbery of the American people'

The Nobel Prize-winning economist, speaking a day after the Dow Jones Industrial Average rose by almost 7pc in support of the novel public-private partnership (PPIP), said that the plan is "very flawed" and "amounts to robbery of the American people."

Professor Stiglitz on Tuesday led a list of well-known economists and high-profile industry figures who have said Treasury Secretary Tim Geithner's toxic asset plan may not be as successful as it first seems.


The plan involves ensuring up to $100bn of government funding is matched by private investors, with the monies combined and leveraged up, in some cases to by as much as 20:1, with the help of the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC), to buy pools of unwanted assets.

Professor Stiglitz, speaking at a conference in Hong Kong, said that the US government is essentially using the taxpayer to guarantee the downside risks, namely that these assets will fall further in value, while the upside risks, in terms of future profits, are being handed to private investors such as insurance companies, bond investors and private equity funds.

"Quite frankly, this amounts to robbery of the American people. I don't think it's going to work because I think there'll be a lot of anger about putting the losses so much on the shoulder of the American taxpayer."

His comments echo those of fellow Nobel Prize winner Paul Krugman, who said on Monday that the plan is almost certain to fail, something which fills him "with a sense of despair."

Others to criticise the plan include former Securities and Exchange Commission chairman Arthur Levitt, and Bill Gross, of bond manager PIMCO, who has said he does not believe the plan will be enough to solve the banking crisis.

It is understood that the PPIP was only finalised after Treasury officials, led by Mr Geithner, spoke to a number of senior bankers on Wall Street, including JP Morgan Chase chairman Jamie Dimon, in the hope of getting a plan that was workable for the market, following the dismissal of Mr Geithner's earlier attempt to solve the financial crisis.

As a result, a number of major banks and bond houses are understood to have already agreed to sign up to the programme, with PIMCO and BlackRock among two investors to have raised their hands.

Others remain less convinced.

http://www.telegraph.co.uk/finance/financetopics/recession/5045421/Geithner-rescue-package-robbery-of-the-American-people.html

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How do you measure a company’s financial health?

Wednesday March 25, 2009
How do you measure a company’s financial health?
Personal Investing - By ooi Kok Hwa


Altman’s Z-Score helps investors determine the bankruptcy risk of a firm


DESPITE the recent strong stock market rally as a result of the current tough economic environment, some investors may still doubt the financial health of some listed companies.

At present, apart from some common financial ratios such as debt-to-equity and interest coverage ratios, investors are looking for a ratio that can provide an indicator on the potential bankruptcy risk for any listed companies.

In this article, we will look into a method called Altman’s Z-Score, which can help us determine the bankruptcy risk of a company.

The Altman’s Z-Score Method was developed by Dr Edward I. Altman in 1968. It is a multivariate formula to measure the financial health of a company on whether it will enter into bankruptcy in the coming two years.

This method uses five common business ratios: earnings before interest and tax (ebit)/total assets ratio; sales/total assets ratio; market value of equity/market value of total liabilities; working capital/total asset ratio and retained earnings/total assets.

The Z-Score is computed using a weighted system based on the formula below:-

Z= 3.3X1 + X2 + 0.6X3 + 1.2X4 +1.4X5

Where:

X1 = ebit/total assets

X2 = sales/total assets

X3 = market value of equity/total liabilities

X4 = working capital/total assets


X5 = retained earnings/total assets

According to Altman, if the score is 3.0 or above, bankruptcy is not likely. If the score is 1.8 or less, potential financial embarrassment is very high.

A score between 1.8 and 3.0 is the grey area where the company has a high risk of going into bankruptcy within the next two years from the date of the given financial figures.

Hence, we can conclude that we should look for companies with higher Z-Scores for investing.

We have computed Z-Scores for two listed companies, Company A and Company E. Company A is consumer-based whereas Company E is property-based. We notice that Company A has a strong Z-Score value of 5.78 versus a very low 0.62 for Company E. Based on Z-Score, Company A is very unlikely to go bankrupt (5.78>3.00) whereas the chances of Company E going into bankruptcy is very high (0.62<1.80).

The reason behind the very low Z-Score value for Company E was because it had a very low market value over its total liabilities as compared to the high market value for Company A. In fact, Company E is currently having financial difficulties and is under PN17 (Practice Notes 17).
In short, companies with higher profit margins, sales, market value, working capital and retained earnings against their total assets will command a higher Z-Score.

This method is popular in the Western countries where some accountants found it quite reliable and accurate.

In the Malaysian context, according to a user manual published by Dynaquest Sdn Bhd, they found that the cut-off at around 1.5 is a better measurement of the likelihood of bankruptcy as compared to the 1.8 stated by Altman.

It may appear that companies selling at higher market value are safer than companies with lower market value. However, sometimes we may be tempted to nibble companies with lower stock prices.

We should be aware that the current very low stock prices for certain companies may indicate to us that the coming financial results of these companies might be quite disappointing.

However, we should be aware that Z-Score does not apply to every situation. We may want to use additional financial ratio like debt-to-equity ratio to complement this method.

Ooi Kok Hwa is an investment adviser and managing partner of MRR Consulting.

http://biz.thestar.com.my/news/story.asp?file=/2009/3/25/business/3547415&sec=business

Canmaking is on the increase

From The Times

March 23, 2009

Can we survive the recession? Yes we can


There has been an increase in demand of up to 50 per cent for tinplate, the key material in food and drink cans, as customers economise buying more tinned beans and puddings


Christine Buckley, Industrial Editor
Baked beans for dinner? Maybe a little comfort sponge pud afterwards?

The recession is altering our eating habits, with staying in becoming the new going out and economising taking over from indulging in many households. And this, in turn, is fuelling an often overlooked sector of industry, The Times has learnt.

While large parts of heavy industry struggle with idle plants and short-time working, canmaking is on the increase. So much so that Corus has raised the price of tinplate — a key material for food and drink cans — because of an increase in demand of up to 50 per cent. The Anglo-Dutch steelmaker has also slowed down a previous plan to cut production at its only tinplate plant in Britain.

According to the Metal Packaging Manufacturers' Association (MPMA), the can industry's trade body, can output in the final quarter of last year jumped by 10 per cent and is continuing at the same rate this year.

Nick Mullen, director of the MPMA, said that some of the 14 canmaking operations in Britain, particularly those making drinks cans, are working around the clock seven days a week to keep up with demand from the food and drink producers who fill the cans. He said: “We saw a bit of a step-change in the last quarter of 2008. I think in the economic downturn, people revert to a very natural self-preservation. It's about cost, but it is also about what people are familiar and comfortable with.”

According to TNS, the market research group, baked beans and tinned puddings are the stars of the canned food market. For the year to the end of February, the volume of baked beans sold rose 2.1 per cent to 295 million. Edward Garner, a research director at TNS, says that for baked beans a jump of 2 per cent is high, because of the sheer volume consumed. “When you have a staple product that is sold in such large amounts, a rise like this is very significant.”

And in the midst of the unending gloom in the economy, Britons increasingly are turning back to childhood pleasures. The volume of tinned sponge puddings rose by 9.5 per cent in the same period to just under six million. Rice pudding has increased by 4.8 per cent to 35.9 million cans.

Mr Mullen said that there was also evidence of a rise in popularity in tinned pet food, as cat and dog owners switch back from pouches.

The drinks can industry is also expecting a boost from drinkers deciding to have a beer or two at home rather than at the pub.

Vince Major, chairman of Can Makers, which represents the industry, said: “The price differential between purchasing alcoholic drinks in the on and off trade is a key driver for growth in the beer and cider sector. The current economic climate will, we anticipate, further influence growth in the off-trade market as we expect less people to visit pubs and instead choose to drink at home.”

Canmakers, which employ about 5,000 people in the UK, are unhappy with the leap in price for tinplate — flat-rolled steel covered with tin. Crown Food Europe, Britain's biggest canmaker, said that it would have to pass on the costs to its customers.

Corus, which produces tinplate in the Netherlands and in South Wales, said that contracts for tinplate were negotiated annually and there was no spot price for the metal. A spokesman for the company, which has implemented job cuts and has reduced overall output by 30 per cent, said that it was delaying making production cuts in the UK tinplate factory.

Just for openers

- In 1810, Nicholas Appert, a Frenchman, was the first to preserve foods in containers, using glass jars, by driving out the air with heat before sealing. They were used for troops at the Russian front

- Soon after, Peter Durand, an Englishman, patented some ideas for a process that could include the tinplate can, using solder for sealing

- It was another 80 years before a high-speed mechanical seaming process was developed — by the Sanitary Can Company of the United States

- About 400 billion cans are made globally every year for food, drinks, industrial products and aerosols

- The United States is the biggest market for cans, with more than 100 billion for drinks and about 31 billion for food

- In Europe demand for drinks cans has grown at between 2 and 5 per cent for the past decade, fuelled in part by Eastern Europe and Russia

Source: The Canmaker

http://business.timesonline.co.uk/tol/business/industry_sectors/industrials/article5956227.ece

Inflation explained

From Times Online
November 3, 2008

Inflation explained

David Budworth

Savers need to take the threat of inflation very seriously because it can erode the value of deposits at startling speed. If the value of your savings does not keep pace with rising prices, its buying power will be depleted quickly - and you may not be aware of it until it is too late.

Here we explain why inflation matters and what you can do to combat it.

What is inflation?

Inflation is a general rise in prices across the economy. The inflation rate is a measure of the average change over a period, usually 12 months.

There are two main measures. The consumer prices index (CPI) was adopted as the Government's preferred measure in 2003 and is used by the Bank of England for the purpose of inflation targeting. The target is 2 per cent, but inflation is currently a lot higher. In September it hit 5.2 per cent, which means that prices overall are 5.2 per cent higher than in September last year.

The oldest measure of inflation, the retail prices index (RPI), dates back to before the First World War. In September the RPI stood at 5 per cent.

What is the difference between RPI and CPI, and which is more useful?

The CPI excludes most housing costs. Rents are included, but house prices, council tax and mortgage payments are not. This usually means that CPI inflation is lower than RPI inflation, although this is not always the case.

Everyone should keep an eye on the CPI for an indication of whether interest rates are likely to rise or fall.

For anyone in receipt of a pension or benefits, though, the RPI is the one to watch because increases remain linked to the RPI rather than the CPI. Inflation-linked products, such as index-linked gilts, are also linked to the RPI.

Remember, though, that both of these official measures are calculated on the basis of an average notional shopping basket, but an individual’s spending patterns can differ dramatically. The Office for National Statistics has an inflation calculator that enables you to enter your personal expenditure patterns to calculate an approximate personal rate of inflation (see websites below).

Why does this matter to my savings?

Savings must grow by at least the rate of inflation to maintain their value. If they rise in nominal terms but fail to beat inflation, their real value will fall in terms of purchasing power.

With the CPI at 5.2 per cent, higher-rate payers need to earn at least 8.63 per cent gross interest before they start to make a positive return. Basic-rate taxpayers require at least 6.5 per cent.

If your savings account does not match or beat this rate you are effectively losing money.

Here is a guide to the interest that basic and higher-rate taxpayers need to earn to match inflation

Inflation rate of 5%

Basic-rate taxpayers need 6.25%

Higher-rate taxpayers need 8.34%

Inflation rate of 4%

Basic-rate taxpayers need 5%

Higher-rate taxpayers need 6.25%

Inflation rate of 3%

Basic-rate taxpayers need 3.75%

Higher-rate taxpayers need 5%

Inflation rate of 2%

Basic-rate taxpayers need 2.5%

Higher-rate taxpayers need 3.34%

Inflation rate of 1%

Basic-rate taxpayers need 1.25%

Higher-rate taxpayers need 1.66%

Do any savings accounts provide protection against inflation?

Index-linked savings certificates from National Savings & Investments (NS&I), which are backed by the Government, are tax-free and guaranteed to keep pace with the RPI for a fixed term.

The return is made up of a set interest rate plus the RPI figure, fixed for three or five years. You can invest up to £15,000 per issue, so you could shelter £30,000 in both the three and five-year plans.

You have to tie up your money for the fixed term to receive the advertised rate.

Look out for inflation-beating savings accounts and Isas from banks and building societies, too.


http://www.timesonline.co.uk/tol/money/reader_guides/article5001065.ece


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Q&A: How will quantitative easing affect me?

From Times Online
March 5, 2009

Q&A: How will quantitative easing affect me?

David Budworth

The Bank of England voted today to begin quantitative easing — effectively printing money — to drag the UK out of recession. Here we explain how this radical decision could impact on your finances in the months and years to come.

Q: Who is going to benefit directly from the extra money printed?

A: Banks, other big institutional investors and possibly large companies, but not the average person.

When a central bank like the Bank of England embarks on quantitative easing it has to find a way of pumping the extra money created into the economy. The Bank is expected to offer to buy government bonds, called gilts, from institutional investors and the corporate treasury departments of large companies using the billions created. It might also offer to buy corporate bonds from the same investors but private individuals will not be part of the buy-back programme.

Q: How will this cash makes its way into the wider economy?

A: The investors who get their hands on the money are expected to deposit this cash in the banking system, helping to boost bank reserves.

Q: If banks have more money in their coffers, will it become easier to borrow money?

A: Anxious banks are still reluctant to lend money to individuals and businesses despite historically low rates. However, if quantitative easing works, it will become easier to take out a mortgage or loan and here is how it could work.

Quantitative easing will flood the UK banks with hard cash, but because the base rate is only 0.5 per cent they will earn hardly anything by sitting on that money.

Hopefully this will persuade the banks that it will be more profitable to lend the money out, ending the lending freeze that has crippled the economy and exacerbated the house price slump.

Q: What will that mean for economic growth?

A: If households and businesses are able to borrow more, they will have extra money in their pockets. This should increase spending helping to stimulate economic growth, boost employment prospects and even drag us out of recession.

Q: Will it work?

A: No one can be sure.

Ian Kernohan, the chief economist at Royal London Asset Management, said: "It is still not clear why banks have been so anxious about lending. If it is because they haven't had access to enough funds then it could work. But if they are worried about lending at a time when we are in recession and house prices are falling they may not want to boost lending."

There is a danger that the banks will simply sit on the money rather than increase lending.This is what happened in Japan at the early part of this decade. Because the money wasn't dispersed into the wider economy Japan suffered from a long-term recession.

Q: How long will it be before we know if it has worked?

A: Months not weeks.

Q: Are there any downsides to central banks creating money through quantitative easing?

A: There is a risk that the extra money will encourage too much growth and ignite inflation. The Bank could then have to raise interest rates aggresively.

However, it could be several years before this becomes apparent as deflation — falling prices — is the most serious risk in today's environment. And if the Bank makes the right decisions in the coming months it should be able to control inflation before it gets out of hand.

Q: Isn't the Bank of England being reckless by encouraging more borrowing?

A: Reckless lending sparked the financial crisis, but most economists think that we have gone too far in the other direction and are not borrowing enough to keep the economy running smoothly.

Kernohan said: "We have gone from feast to famine and need to get back to a more normal situation where businesses and individuals can have access to credit. At the moment we are in a vicious circle and the bank is aiming to change that into a virtuous circle."

Q: Will I be affected if I am invested in gilts?

A: Martin Gahbauer, a senior economist at Nationwide Building Society, said: "In the short term, this could push gilt yields down. Yields have already fallen quite significantly in expectation that the Bank was going to do this."

Bond yields are one of the main influences on annuity rates so this could be bad news for those approaching retirement.


http://www.timesonline.co.uk/tol/money/property_and_mortgages/article5851508.ece


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Deflation can be good, but now it's bad

From The TimesMarch 24, 2009

Deflation can be good, but now it's bad

Ian King, Deputy Business Editor


Deflation does not have to be bad. There are, it is generally accepted by economists, two types of deflation — one good, one bad.

Good deflation is the type that Britain enjoyed during the Victorian era. Prices fell for most of the 19th century, thanks to a “virtuous circle” in which higher demand led to greater profits, which led to greater investment, better productivity — mainly due to the spread of railways — and, in turn, lower prices. There was huge industrial expansion, the advance of mass production, the rise of the City of London and the advent of the large corporation as we know it today.

In the period between 1870 and 1896, wholesale prices fell by 50 per cent, while Britain’s economy grew, on average, by a staggering 4 per cent each year.

Good deflation was also a key factor in the US during the Roaring Twenties when technological advances — in mass electrification and car manufacture — led to huge increases in productivity.

The common factor was that productivity improved so rapidly it led to excessive supply — and hence lower prices.

From the mid-1990s onwards, it seemed reasonable to suppose that the world was in for a rerun of those happy times, with the advance of the internet, increasingly powerful microchips and the development of mass communications. This belief was given greater impetus with the emergence of China as the workshop of the world, churning out ever-cheaper goods in ever-greater quantity.

Unfortunately, in this instance, the virtuous circle was broken because that vast output, quite literally, required fuelling. China’s insatiable demand for oil, petrochemicals and other commodities fed through to inflation elsewhere in the world — eventually hampering demand for its goods.

Instead, there is now a danger that we are in for a period of “bad” deflation. Bad deflation, like good deflation, occurs when supply exceeds demand. The difference is that, while good deflation is caused by booming supply, bad deflation is caused by weak demand. This was the case during the Great Depression of the 1930s in the US and, more recently, in Japan.

Bad deflation sucks the life out of economies. Rather than a virtuous circle, the effect has been likened to a “negative feedback loop”, in which one piece of bad news leads to another. An example of this would be how consumers react to a fall in the stock markets — by cutting back their spending. This forces companies to slash the price of goods and services, leading to lower profits, and then to lower employment and a further reduction in spending.

The reason that most observers fear we are in an era of bad deflation is because of the vast amounts of debt now in the economy. That is particularly true of the US and Britain.

Just as inflation is good for people with large debts, such as homeowners with big mortgages, deflation is even more painful because the size of the debt becomes relatively bigger. That is why governments everywhere are spending vast amounts on trying to provide economic stimulus. Demand needs to be reintroduced to the world economy — and fast.

http://business.timesonline.co.uk/tol/business/article5962898.ece

The return of inflation?

The return of inflation?
Posted By: Edmund Conway at Mar 24, 2009 at 11:18:26 [General]

So, after all that, we're not in deflation. To general shock and amazement throughout the City, the Retail Price Index did not creep into negative territory last month, dropping instead from 0.1pc to zero.

Consumer Prince Index inflation, the measure targeted by the Bank of England, actually rose from 3pc to 3.2pc, meaning the Governor Mervyn King has had to write another letter of explanation to the Chancellor.

All of this is a bit of a nightmare for the Bank. Having already cut interest rates to near zero and embarked on quantitative easing - the most radical means of monetary policy available to a central bank - its main alibi had been that the UK was facing the serious threat of deflation. To have then to find yourself trying to explain why inflation is still above its 2pc target is not just embarrassing but undermining. After all, part of its job is to influence peoples' decisions on financial and economic matters, and having spent months warning about the risk of falling prices, now the figures seem to have proven them wrong, in the meantime at least.

Most economists believe (and I am inclined to agree) that this month's figures were a blip, and that deflation will inevitably follow in the coming months. After all, RPI may not be in negative territory yet, but at zero it is still at the lowest level since 1960. Likewise, almost all the other evidence in the economy - everything from pay cuts to falls in commodity prices - points towards falling rather than rising prices.


Indeed, in his letter to the Chancellor, which you can find here, alongside Alistair Darling's response, King himself says: "notwithstanding the inflation outturn for February, it is likely that over the next year CPI inflation will move below target, although the profile of inflation could be volatile, reflecting the reversal of the temporary change in VAT on CPI inflation."

But this increase in CPI is already prompting a few people to reconsider their positions on inflation (after all the consensus forecast was for fall to a 2.6pc). The fact is that not only did some of the volatile items' prices increase (things like petrol and food) but so did core inflation - which strips out these unpredictable items and is regarded as a more steady, reliable indication of what prices are doing. This is probably due to the weakness of the pound in recent months - sterling has depreciated by more than a quarter over the past 18 months, and this was bound at some point to feed through to higher domestic prices.

But what if - and it is a big if - the massive amount of medicine already ladelled into the UK economic system - the cut in rates from 5pc to 0.5pc, the extra cash pumped in by the Government, the fall in the pound and the Bank's decision to start creating money and buying up bonds - is starting to work already, counteracting the recession and boosting prices. What if that deflation threat so frequently mooted by the Bank and others, was far less severe than was ever the case? In that case it would have profound implications for monetary policy, meaning the Bank may have to reconsider its decision to spend up to £150bn on quantitative easing and exit this strategy even before it has properly got it underway.

There is a hint of this doubt in King's letter, which says: "At its next policy meeting the MPC will want to consider further the extent to which the balance of risks has changed in light of the latest inflation figure and all the other relevant data. In particular, in the context of the CPI data this month, the Committee will need to judge to what extent the main upside risk to the inflation outlook identified in the February Inflation Report - that there is greater pass-through of the exchange rate depreciation to inflation - is crystallising, or whether the inflation outturn reflects other factors."

I doubt, however, that this will change the Bank's fundamental position - that the UK is heading into a nasty recession (something that almost always goes hand in hand with falling prices), that the risk of debt deflation, the phenomenon which affected the US in the Great Depression, remains bigger than the risk of inflation being thrown up as a result of its remedies, and that it must keep rates low for some time.

King is currently appearing at the Treasury Select Committee, from which we'll have more later. As I post this, he's just blamed the fall in sterling for the increase in inflation - saying that this was "one of the upside risks" laid out in the Inflation Report last month.


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http://blogs.telegraph.co.uk/edmund_conway/blog/2009/03/24/the_return_of_inflation

Paper gold: nice idea, shame about the politics

Paper gold: nice idea, shame about the politics

The world outgrew the gold standard decades ago. But a “paper gold” standard might be one way out of the global financial crisis. Zhou Xiaochuan, governor of China’s central bank, has proposed shifting the world from its dependence on the US dollar to a new reserve currency managed by the International Monetary Fund. The idea is good – if only China meant it.

By John Foley, breakingviews.com
Last Updated: 11:27AM GMT 24 Mar 2009

The greenback has been the world’s dominant reserve currency – equivalent to a financial lingua franca – since the end of the Second World War. Countries hold it in spades to back their own currency. The IMF reckons that two-thirds of the $7 trillion of foreign currency holdings worldwide are in US dollars. The euro, the second most-held currency, makes up just a quarter.

Were international trade switched instead to an IMF-managed currency – Zhou suggests a little-used device called a “special drawing right” or SDR – Uncle Sam would have a real headache. America’s borrowing and trading costs would spike. After all, the US saves by rarely needing to convert its own money – a perk known as “seigniorage”.

But in the long term, the US would benefit. Being the currency of choice has made it unnaturally cheap for the US to borrow and fund its consumers’ profligate habits. Besides, as Zhou points out in a scholarly flourish, there’s the Triffin Paradox to consider. This says that so long as the US agrees to feed the world with dollars, it can’t successfully control its own currency.

Having a central currency – let’s call it the Zhou-Triffin Doubloon (ZTD) – managed by a supra-national organisation would make it more difficult for any one country to get into too much debt to another. If the supply of ZTD in issue were controlled properly – say by expanding it in line with global GDP – it would serve as a steady store of value, with little risk of devaluation.

Moreover, a credible ZTD would have many of the advantages of the now-defunct gold standard. It would be strictly limited in supply and ready acceptability everywhere. Indeed, it would be even better than the yellow metal, which is after all too cumbersome for a modern economy and too scarce to serve as a measure for international trade.

In sum, the ZTD would add much needed ballast to international finance. And China would not be alone in promoting this single currency. Russian authorities have been thinking along similar lines.

So why not get cracking? There are many obstacles: most notably getting the IMF up to the task. Nor is China in any position to move quickly. A truly global reserve currency would have to be based on a basket of world currencies, which would include the renminbi. China would have to make its tightly controlled currency freely convertible – which it shows no desire to do.

Indeed, China probably has other things in mind than financial stability, such as augmenting its global financial sway. Right now, the Middle Kingdom has only a 3pc vote in the IMF, no more than Belgium, because votes are linked to each country’s contribution to the fund. Were China able to claim credit for its prodigious foreign reserves, it could replace the US at the top of the table.

At best, China’s proposal is self-serving. At worst, it could be merely another manifestation of growing hostility towards the US – to be filed alongside recent protectionism, naval skirmishes and Chinese criticism of US spending habits. That political undercurrent is a shame. Paper gold looks like one of the best ideas to come out of the financial crisis.



http://www.telegraph.co.uk/finance/breakingviewscom/5042739/Paper-gold-nice-idea-shame-about-the-politics.html

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Deflation expected to return to UK for first time in 50 years

Deflation expected to return to UK for first time in 50 years



Deflation is expected to return to the UK for the first time in nearly 50 years with the announcement that prices are falling nationwide rather than increasing.

By Caroline Gammell
Last Updated: 9:26AM GMT 24 Mar 2009

George Buckley: George Buckley, Deutsche Bank's chief UK economist, told The Daily Telegraph that he is forecasting an RPI reading of -0.7 per cent





The retail price index (RPI) - which measures the average month-to-month change of the prices of goods and services - is thought to have slid into negative figures.

The last time the UK experienced deflation was in 1960 when Harold Macmillan was prime minister.

Inflation expected to fall as oil retreats and VAT cut kicks inThe widely expected downturn follows figures released by the Office for National Statistics in January which showed that RPI increased by just 0.1 per cent compared with the previous year.

Consensus forecasts by leading City economists suggest RPI fell -0.5 per cent in February, forced down by falling mortgage rates and rapidly decreasing house prices.

The latest RPI figures will be released by the ONS at 9.30am.

The Bank of England is worried about the effect deflation could have on indebted families.

It says families with high debts could fall prey to the debt deflation trap. This means that the cost of their debts, which are fixed, would rise compared to average prices throughout the economy.

While inflation erodes debts, deflation makes them relatively higher.

There are also fears that millions of public sector workers - teachers, nurses and council workers - could face pay freezes for the next three years as deflation takes hold.

Public sector pay, which accounts for about a quarter of all public spending, is tied to RPI.

George Buckley, Deutsche Bank's chief UK economist, told The Daily Telegraph that he is forecasting an RPI reading of -0.7 per cent, and believes it could get as low as -4 per cent over the summer months.

Asked if the negative reading will lead to pay freezes, he said: "That's certainly a possibility. You won't see anywhere near the increases in pay that we've been used to. But few are unlikely to see falling pay."

Economists at BNP Paribas warned over the weekend that prices in Britain will continue to fall for another two-and-a-half years.

The French bank's UK economist, Alan Clarke, said that he expected gross domestic product (GDP) to contract by more than four per cent this year, and deflation to linger through to 2012.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/5041459/Deflation-expected-to-return-to-UK-for-first-time-in-50-years.html





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