Evaluating Country Risk For International Investing

Evaluating Country Risk For International Investing

 

by Brian Perry

 

Many investors choose to place a portion of their portfolios in foreign securities. This decision involves an analysis of various mutual funds, exchange-traded funds (ETF), or stock and bond offerings. However, investors often neglect an important first step in the process of international investing. When done properly, the decision to invest overseas begins with a determination of the riskiness of the investment climate in the country under consideration. Country risk refers to the economic, political and business risks that are unique to a specific country, and that might result in unexpected investment losses. This article will examine the concept of country risk and how it can be analyzed by investors. (For more, read Finding Fortune In Foreign-Stock ETFs.)

 

Economic and Political Risk
The following are two main sources of risk that need be considered when investing in a foreign country.

 

•Economic risk: This risk refers to a country's ability to pay back its debts. A country with stable finances and a stronger economy should provide more reliable investments than a country with weaker finances or an unsound economy.
•Political risk: This risk refers to the political decisions made within a country that might result in an unanticipated loss to investors. While economic risk is often referred to as a country's ability to pay back its debts, political risk is sometimes referred to as the willingness of a country to pay debts or maintain a hospitable climate for outside investment. Even if a country's economy is strong, if the political climate is unfriendly (or becomes unfriendly) to outside investors, the country may not be a good candidate for investment.

 

Measuring Economic and Political Risk

 

Just as corporations in the U.S. receive credit ratings to determine their ability to repay their debt, so do countries. In fact, virtually every investable country in the world receives ratings from Moody's, Standard & Poor's (S&P), or the other large rating agencies.

• A country with a higher credit rating is considered a safer investment than a country with a lower credit rating.
• Examining the credit ratings of a country is an excellent way to begin the analysis of a potential investment.

 

Another important step in deciding on an investment is to examine a country's economic and financial fundamentals.

• Different analysts prefer different measures, but almost everyone looks at a country's gross domestic product (GDP), inflation and Consumer Price Index (CPI) readings when considering an investment.
• Investors will also want to carefully evaluate the structure of the country's financial markets, the availability of attractive investment alternatives, and the recent performance of local stock and bond markets.
• (For more insight, see The Consumer Price Index: A Friend To Investors and The Importance Of Inflation And GDP.)

 

Sources of Information on Country Risk
There are many excellent sources of information on the economic and political climate of foreign countries.

• Newspapers, such as the New York Times, the Wall Street Journal and the Financial Times dedicate significant coverage to overseas events.
• There are also many excellent weekly magazines covering international economics and politics; the Economist is generally considered to be the standard bearer among weekly publications.

  

For those seeking more in-depth coverage of a particular country or region, two excellent sources of objective, comprehensive country information are the Economist Intelligence Unit and the Central Intelligence Agency (CIA) World Fact Book.

• Either of these resources provides an investor with a broad overview of the economic, political, demographic and social climate of a country.
• The Economist Intelligence Unit also provides ratings for most of the world's countries. These ratings can be used to supplement those issued by Moody's, S&P, and the other "traditional" ratings agencies.

 

Finally, the internet provides access to a host of information, including international editions of many foreign newspapers and magazines. Reviewing locally produced news sources can sometimes provide a different perspective on the attractiveness of a country under consideration for investment.

 

Developed Markets, Emerging Markets and Frontier Markets
When considering international investments, there are three types of markets from which to choose.

 

•Developed markets consist of the largest, most industrialized economies.

 

1. Their economic systems are well developed, they are politically stable, and the rule of law is well entrenched.
2. Developed markets are usually considered the safest investment destinations, but their economic growth rates often trail those of countries in an earlier stage of development.
3. Investment analysis of developed markets usually concentrates on the current economic and market cycles; political considerations are often a less important consideration.
4. Examples of developed markets include the U.S., Canada, France, Japan and Australia.

 

•Emerging markets experience rapid industrialization and often demonstrate extremely high levels of economic growth.

1. This strong economic growth can sometimes translate into investment returns that are superior to those that are available in developed markets.
2. However, emerging markets are also riskier than developed markets; there is often more political uncertainty in emerging markets, and their economies may be more prone to excessive booms and busts.
3. In addition to carefully evaluating an emerging market's economic and financial fundamentals, investors should pay close attention to the country's political climate and the potential for unexpected political developments.
4. Many of the fastest growing economies in the world, including China, India and Brazil, are considered emerging markets. (For related reading, see What Is An Emerging Market Economy?)

 

 

•Frontier markets represent "the next wave" of investment destinations.

1. Frontier markets are generally either smaller than traditional emerging markets, or are found in countries that place restrictions on the ability of foreigners to invest.
2. Although frontier markets can be exceptionally risky and often suffer from low levels of liquidity, they also offer the potential for above average returns over time.
3. Frontier markets are also not well correlated with other, more traditional investment destinations, which mean that they provide additional diversification benefits when held in a well-rounded investment portfolio.
4. As with emerging markets, investors in frontier markets must pay careful attention to the political environment, as well as to economic and financial developments.
5. Examples of frontier markets include Nigeria, Botswana and Kuwait.

 

Important Steps When Investing Overseas

 

Once country analysis has been completed, there are several investment decisions that need to be made. The first choice is to decide where to invest, by choosing among several possible investment approaches, including:

 

•Investing in a broad international portfolio
•Investing in a more limited portfolio focused on either emerging markets or developed markets
•Investing in a specific region, such as Europe or Latin America
•Investing only in a specific country(s)

 

It is important to remember that diversification, which is a fundamental principle of domestic investing, is even more important when investing internationally.

 

• Choosing to invest an entire portfolio in a single country is not prudent. In a broadly diversified global portfolio, investments should be allocated among developed, emerging and perhaps frontier markets.
• Even in a more concentrated portfolio, investments should still be spread among several countries in order to maximize diversification and minimize risk.

 

After the decision on where to invest has been made, an investor has to decide what investment vehicles he or she wishes to invest in.

• Investment options include sovereign debt, stocks or bonds of companies domiciled in the country(s) chosen, stocks or bonds of a U.S.-based company that derives a significant portion of its revenues from the country(s) selected, or an internationally focused exchange-traded fund (ETF) or mutual fund.
• The choice of investment vehicle is dependent upon each investor's individual knowledge, experience, risk profile and return objectives.
• When in doubt, it may make sense to start out by taking less risk; more risk can always be added to the portfolio at a later date.

 

In addition to thoroughly researching prospective investments, an international investor also needs to monitor his or her portfolio and adjust holdings as conditions dictate.

• As in the U.S., economic conditions overseas are constantly evolving, and political situations abroad can change quickly, particularly in emerging or frontier markets.
• Situations that once seemed promising may no longer be so, and countries that once seemed too risky might now be viable investment candidates.

 

Conclusion

 

• Overseas investing involves a careful analysis of the economic, political and business risks that might result in unexpected investment losses.
• This analysis of country risk is a fundamental step in the process of building and monitoring an international portfolio.
• Investors that use the many excellent sources of information available to evaluate country risk will be better prepared when constructing their international portfolios.

 

For more on investing internationally, read Going International.
by Brian Perry, (Contact Author | Biography)

 

Brian Perry is vice president and investment strategist at an asset management firm and an accomplished author and public speaker. He has published several articles and is a frequent presenter for several professional associations. Brian received a bachelor of science degree in finance from Villanova University in 1996, an MBA in International Business from National University in 2006, and is pursuing a master's degree in international affairs from Tufts University. Brian is also a candidate in the chartered financial analyst (CFA) program, has previously held Series 7 and 63 securities licenses, and taught an introductory class on investing at the International Center in New York City.

 

http://www.investopedia.com/articles/stocks/08/country-risk-for-international-investing.asp

Economics Basics: What Is Economics?

Economics Basics: What Is Economics?

In order to begin our discussion of economics, we first need to understand (1) the concept of scarcity and (2) the two branches of study within economics: microeconomics and macroeconomics.

1. Scarcity
Scarcity, a concept we already implicitly discussed in the introduction to this tutorial, refers to the tension between our limited resources and our unlimited wants and needs. For an individual, resources include time, money and skill. For a country, limited resources include natural resources, capital, labor force and technology.

Because all of our resources are limited in comparison to all of our wants and needs, individuals and nations have to make decisions regarding what goods and services they can buy and which ones they must forgo. For example, if you choose to buy one DVD as opposed to two video tapes, you must give up owning a second movie of inferior technology in exchange for the higher quality of the one DVD. Of course, each individual and nation will have different values, but by having different levels of (scarce) resources, people and nations each form some of these values as a result of the particular scarcities with which they are faced.

So, because of scarcity, people and economies must make decisions over how to allocate their resources. Economics, in turn, aims to study why we make these decisions and how we allocate our resources most efficiently.

2. Macro and Microeconomics
Macro and microeconomics are the two vantage points from which the economy is observed. Macroeconomics looks at the total output of a nation and the way the nation allocates its limited resources of land, labor and capital in an attempt to maximize production levels and promote trade and growth for future generations. After observing the society as a whole, Adam Smith noted that there was an "invisible hand" turning the wheels of the economy: a market force that keeps the economy functioning.

Microeconomics looks into similar issues, but on the level of the individual people and firms within the economy. It tends to be more scientific in its approach, and studies the parts that make up the whole economy. Analyzing certain aspects of human behavior, microeconomics shows us how individuals and firms respond to changes in price and why they demand what they do at particular price levels.

Micro and macroeconomics are intertwined; as economists gain understanding of certain phenomena, they can help nations and individuals make more informed decisions when allocating resources. The systems by which nations allocate their resources can be placed on a spectrum where the command economy is on the one end and the market economy is on the other. The market economy advocates forces within a competitive market, which constitute the "invisible hand", to determine how resources should be allocated. The command economic system relies on the government to decide how the country's resources would best be allocated. In both systems, however, scarcity and unlimited wants force governments and individuals to decide how best to manage resources and allocate them in the most efficient way possible. Nevertheless, there are always limits to what the economy and government can do.

http://www.investopedia.com/university/economics/economics1.asp

Macroeconomic Analysis

by Reem Heakal

When the price of a product you want to buy goes up, it affects you. But why does the price go up? Is the demand greater than the supply? Did the cost go up because of the raw materials that make the CD? Or, was it a war in an unknown country that affected the price? In order to answer these questions, we need to turn to macroeconomics.

What Is It?
Macroeconomics is the study of the behavior of the economy as a whole. This is different from microeconomics, which concentrates more on individuals and how they make economic decisions. Needless to say, macroeconomy is very complicated and there are many factors that influence it. These factors are analyzed with various economic indicators that tell us about the overall health of the economy.

Macroeconomists try to forecast economic conditions to help consumers, firms and governments make better decisions.

•Consumers want to know how easy it will be to find work, how much it will cost to buy goods and services in the market, or how much it may cost to borrow money.
•Businesses use macroeconomic analysis to determine whether expanding production will be welcomed by the market. Will consumers have enough money to buy the products, or will the products sit on shelves and collect dust?
•Governments turn to the macroeconomy when budgeting spending, creating taxes, deciding on interest rates and making policy decisions.

Macroeconomic analysis broadly focuses on three things:

• national output (measured by gross domestic product (GDP)),
• unemployment and
• inflation. (For background reading, see The Importance Of Inflation And GDP.)

National Output: GDP
Output, the most important concept of macroeconomics, refers to the total amount of goods and services a country produces, commonly known as the gross domestic product. The figure is like a snapshot of the economy at a certain point in time.

When referring to GDP, macroeconomists tend to use real GDP, which takes inflation into account, as opposed to nominal GDP, which reflects only changes in prices. The nominal GDP figure will be higher if inflation goes up from year to year, so it is not necessarily indicative of higher output levels, only of higher prices.

The one drawback of the GDP is that because the information has to be collected after a specified time period has finished, a figure for the GDP today would have to be an estimate. GDP is nonetheless like a stepping stone into macroeconomic analysis. Once a series of figures is collected over a period of time, they can be compared, and economists and investors can begin to decipher the business cycles, which are made up of the alternating periods between economic recessions (slumps) and expansions (booms) that have occurred over time.

From there we can begin to look at the reasons why the cycles took place, which could be government policy, consumer behavior or international phenomena, among other things. Of course, these figures can be compared across economies as well. Hence, we can determine which foreign countries are economically strong or weak.

Based on what they learn from the past, analysts can then begin to forecast the future state of the economy. It is important to remember that what determines human behavior and ultimately the economy can never be forecasted completely.

Unemployment
The unemployment rate tells macroeconomists how many people from the available pool of labor (the labor force) are unable to find work. (For more about employment, see Surveying The Employment Report.)

Macroeconomists have come to agree that when the economy has witnessed growth from period to period, which is indicated in the GDP growth rate, unemployment levels tend to be low. This is because with rising (real) GDP levels, we know that output is higher, and, hence, more laborers are needed to keep up with the greater levels of production.

Inflation
The third main factor that macroeconomists look at is the inflation rate, or the rate at which prices rise. Inflation is primarily measured in two ways: through the Consumer Price Index (CPI) and the GDP deflator. The CPI gives the current price of a selected basket of goods and services that is updated periodically. The GDP deflator is the ratio of nominal GDP to real GDP. (For more on this, see The Consumer Price Index: A Friend To Investors and The Consumer Price Index Controversy.)

If nominal GDP is higher than real GDP, we can assume that the prices of goods and services has been rising. Both the CPI and GDP deflator tend to move in the same direction and differ by less than 1%. (If you'd like to learn more about inflation, check out All About Inflation.)

Demand and Disposable Income
What ultimately determines output is demand. Demand comes

• from consumers (for investment or savings - residential and business related),
• from the government (spending on goods and services of federal employees) and
• from imports and exports.

Demand alone, however, will not determine how much is produced. What consumers demand is not necessarily what they can afford to buy, so in order to determine demand, a consumer's disposable income must also be measured. This is the amount of money after taxes left for spending and/or investment.

In order to calculate disposable income, a worker's wages must be quantified as well. Salary is a function of two main components: the minimum salary for which employees will work and the amount employers are willing to pay in order to keep the worker in employment. Given that the demand and supply go hand in hand, the salary level will suffer in times of high unemployment, and it will prosper when unemployment levels are low.

Demand inherently will determine supply (production levels) and an equilibrium will be reached; however, in order to feed demand and supply, money is needed. The central bank (the Federal Reserve in the U.S.) prints all money that is in circulation in the economy. The sum of all individual demand determines how much money is needed in the economy. To determine this, economists look at the nominal GDP, which measures the aggregate level of transactions, to determine a suitable level of money supply.

Greasing the Engine of the Economy - What the Government Can Do

Monetary Policy
A simple example of monetary policy is the central bank's open-market operations. (For more detail, see the Federal Reserve Tutorial.) When there is a need to increase cash in the economy, the central bank will buy government bonds (monetary expansion). These securities allow the central bank to inject the economy with an immediate supply of cash. In turn, interest rates, the cost to borrow money, will be reduced because the demand for the bonds will increase their price and push the interest rate down. In theory, more people and businesses will then buy and invest. Demand for goods and services will rise and, as a result, output will increase. In order to cope with increased levels of production, unemployment levels should fall and wages should rise.

On the other hand, when the central bank needs to absorb extra money in the economy, and push inflation levels down, it will sell its T-bills. This will result in higher interest rates (less borrowing, less spending and investment) and less demand, which will ultimately push down price level (inflation) but will also result in less real output.

Fiscal Policy
The government can also increase taxes or lower government spending in order to conduct a fiscal contraction. What this will do is lower real output because less government spending means less disposable income for consumers. And, because more of consumers' wages will go to taxes, demand as well as output will decrease.

A fiscal expansion by the government would mean that taxes are decreased or government spending is increased. Ether way, the result will be growth in real output because the government will stir demand with increased spending. In the meantime, a consumer with more disposable income will be willing to buy more.
A government will tend to use a combination of both monetary and fiscal options when setting policies that deal with the macroeconomy.

Conclusion

• The performance of the economy is important to all of us.
• We analyze the macroeconomy by primarily looking at national output, unemployment and inflation.
• Although it is consumers who ultimately determine the direction of the economy, governments also influence it through fiscal and monetary policy.

by Reem Heakal, (Contact Author | Biography)

http://www.investopedia.com/articles/02/120402.asp?viewed=1

Economic Indicators: Jobless Claims

Economic Indicators: Jobless Claims Report


By Ryan Barnes

Release Date: Weekly; Thursdays, prior to market open
Release Time: 8:30am Eastern Standard Time
Coverage Previous week (cutoff date is previous Saturday)
Released By: U.S. Department of Labor
Latest Release: http://www.dol.gov/opa/media/press/eta/main.htm



Background
The Jobless Claims Report is a weekly release that shows the number of first-time (initial) filings for state jobless claims nationwide. The data is seasonally adjusted, as certain times of the year are known for above-average hiring for temporary work (harvesting, holidays).

Due to the short sample period, week-to-week results can be volatile, so reported results are most often headlined as a four-week moving average, so that each week's release is the average of the four prior jobless claims reports. The release will show which states have had the biggest changes in claims from the previous week; the revised edition shows up about a week later, at which time a full breakdown by state and U.S. territory is available.

Also released with this report are the relatively minor data points of the insured unemployment rate and the total unemployed persons. These are not seen as valuable indicators because the total unemployed figure tends to stay relatively constant week to week. (To learn more, read Surveying The Employment Report.)

What it Means for Investors
New jobless claims for the week reflect an up-to-the-minute account of who is leaving work unexpectedly, reflecting the "run rate" of the economy's health with little lag time. The Jobless Claims Report gets a lot of press due to its simplicity and the theory that the healthier the job market, the healthier the economy: more people working means more disposable income, which leads to higher personal consumption and gross domestic product (GDP).

The fact that jobless claims are released weekly is both a blessing and a curse for investors; sometimes the markets will take a mid-month jobless claims report and react strongly to it, particularly if it shows a difference from the cumulative evidence of other recent indicators. For instance, if other indicators are showing a weakening economy, a surprise drop in jobless claims could slow down equity sellers and could actually lift stocks, even if only because there isn't any other more recent data to chew on.

A favorable Jobless Claims Report can also get lost in the shuffle of a busy news day, and hardly be noticed by Wall Street at all. The biggest factor week to week is how unsure investors are about the future direction of the economy.




Most economists agree that a sustained change (as shown in the moving averages) of 30,000 claims or more is the benchmark for real job growth or job loss in the economy. Anything less is deemed statistically insignificant by most market analysts.

Strengths:

•Weekly reporting provides for timely, almost real-time snapshots.
•As a tightly-presented release, investors can easily pick up the raw release and quickly apply the information to market decisions.
•Initial claims are provided gross and net of seasonal adjustments, and give a breakdown for every state's individual results.
•Some states' figures are shown along with a comment from that state's reporting agency regarding specific industries in which noteworthy activity is happening, such as "fewer layoffs in the industrial machinery industry".

Weaknesses:

•Summer and other seasonal employment tends to skew the results.
•Highly volatile - revisions to advance report can be very big on a percentage basis
•Jobless claims in isolation tell little about the overall state of the economy.
•No industry breakdowns are provided, just the national figure.

http://www.investopedia.com/university/releases/joblessclaims.asp

Markets and the US Dollar Turn Higher Sign in to Recommend

Markets and the Dollar Turn Higher Sign in to Recommend

By DAVID JOLLY
Published: December 4, 2009

Stocks and the dollar rose Friday and bonds fell after the release of a much-better-than-expected jobs report in the United States.

The Dow Jones industrial average reached a high for the year, gaining 95 points, or 0.9 percent, in late morning trading. The Standard & Poor’s 500-stock index rose 1.1 percent, and the Nasdaq 1.5 percent.

On the year, the Dow is up 19 percent while the S.&P. 500 is 23 pecent.

The Labor Department said in Washington that the United States lost 11,000 jobs in November, less than a tenth of the roughly 125,000 job losses economists had been expecting. The unemployment rate improved to 10 percent from 10.2 percent in October.

While companies are still shedding workers, the pace was the best since the recession began in December 2007, and suggested to some analysts that the economy is headed toward recovery.

Jeffrey Saut, chief investment strategist for Raymond James, characterized the November job-loss number as “an outlier.”

“There’s no doubt the recession is in the rear-view mirror,” he said, “but I wouldn’t be surprised to see the jobless rate ticking up again in the months ahead.”

Unemployment, he added, is a lagging indicator, so investors who wait for the labor market to turn around have historically missed out on major market gains.

Lawrence Glazer, managing partner at Mayflower Advisors in Boston, said would-be stock buyers remained somewhat cautious, despite the surprising data.

“Investors are still seeing a divergence between Wall Street’s gains and Main Street’s malaise,” he said. “The market has been anticipating better data all along. The question hasn’t been ‘is the market pricing in a recovery,’ but ‘is the market pricing in too big of a recovery.’ ”

Mr. Glazer said institutional investors had already begun to close positions and did not want to be reshuffling portfolios toward the end of the year, damping the effect of the positive surprise.

In other economic news, the Commerce Department reported that orders to American factories unexpectedly rose 0.6 percent in October, which was better than the flat reading that economists had expected.

In Europe, the Dow Jones Euro Stoxx 50 index of euro zone heavyweights was trading 1.4 percent higher after the data, while the FTSE-100 index in London was up 0.7 percent. In Asian trading, the Tokyo benchmark Nikkei 225 stock average rose 0.5 percent. European markets had been down before the American jobs report was released.

The yield on the benchmark 10-year Treasury rose one-tenth of a percentage point to 3.5 percent.

The dollar rose against other major currencies. The euro fell to $1.4911 from $1.5053 Thursday, and the British pound fell to $1.6572 from $1.6540. The dollar rose to 89.81 yen from 88.26 yen.

Spot gold fell 2.3 percent to $1,180.20 an ounce.

http://www.nytimes.com/2009/12/05/business/05markets.html?_r=1&ref=business

Malaysia's economy stagnant, needs reform

By Agence France-Presse, Updated: 12/1/2009

 

Malaysia's economy stagnant, needs reform: finance minister
Malaysia's economy has been stagnating for the past decade and is now trailing badly behind its neighbours, a senior minister said Tuesday, calling for "urgent" and wide-ranging reforms.

 

Malaysia's economy has been stagnating for the past decade and is now trailing badly behind its neighbours, a senior minister said Tuesday, calling for "urgent" and wide-ranging reforms.

 

Malaysia's export-dependent economy has been hit hard by the global recession, contracting by a forecast 3.0 percent this year and jeopardising its ambitions of becoming a developed nation by 2020.

 

"Malaysia is trapped in a low-value-added, low-wage and low-productivity structure," Second Finance Minister Ahmad Husni Hanadzlah told an economic outlook conference.

 

Among its peers China, India, Vietnam, Indonesia, Philippines and Thailand, Malaysia's economic growth over the past three years was second-lowest, he said.

 

"Our economy has been stagnating in the last decade. We have lost our competitive edge to remain as the leader of the pack in many sectors of the economy. Our private investment has been steadily in decline."

 

"While Singapore and Korea's nominal per capita GDP grew within the last three decades by 9 and 12 times respectively, ours grew only by a factor of four."

 

In a withering assessment, Ahmad Husni said

• the services sector is underdeveloped,
• private investment is half the levels before the 1997-98 Asian crisis, and
• the manufacturing sector is suffering from lack of investment.

 

"The (need for) transformation is particularly urgent when we take the external environment into account," he said.

 

"The global environment is changing. We can no longer rely on our traditional trading partners and we need to address the competitive pressure from other emerging markets on our existing exports."

 

He called for sweeping measures including an emphasis on meritocracy and ensuring all Malaysians are given "equal opportunity to participate in the economy".

 

Malaysia has for decades practiced a system of positive discrimination for Muslim Malays who dominate the population, but critics say the policy is fuelling corruption and is hurting the nation's competitiveness.

 

"We must also consider the gradual dismantling of our open-ended protection of specific sectors and industries which have introduced a climate of complacency and artificial levels of supply," the minister said.

 

"The long-term success of the nation's economy must take precedence over the short term interests of a few protected groups."

 

Prime Minister Najib Razak -- who is also finance minister -- came to power in April with plans to tackle graft which is endemic in the ruling party and society at large.

An anaemic recovery should be welcomed, not feared.

Bill Mott: 'An anaemic recovery should be welcomed, not feared'

Fundamentalist view: our series in which an expert at making money grow analyses the financial world and gives his advice to savers and investors.

By Bill Mott
Published: 12:05PM GMT 26 Nov 2009


Bill Mott: 'This autumn 2009 rally cannot continue much longer' Any fans of late Fifties and early Sixties American music will know the Drifters song Save the Last Dance for Me. The plaintive boyfriend tells his girlfriend that she can enjoy the party without any cares, but ultimately her price for this enjoyment is to ''save the last dance for him''.

As a fund manager, I am watching the party become increasingly boisterous as market momentum powers ahead. I would like to be well on my way home with my portfolio positioned away from areas of excess optimism before the last dance is played. Looking at the British economy, it seems there are three possible scenarios from here.

Scenario one is a long period of anaemic growth during which the economy gradually rebalances, avoiding "Armageddon'', but does not rally very strongly. I believe this outcome has a 75pc probability.

Scenario two is a ''double dip'' – or W-shaped – recovery in which the market and the economy experience a further downturn as recovery fails to take hold, and has a 15pc chance.

Scenario three is a V-shaped recovery, namely a continuation of the current near-euphoric, liquidity-driven rally and has a 10pc probability of occurring.

As it became clear, at the end of last year and during the first quarter of 2009, that Britain and the global economy were on the brink of meltdown, authorities worldwide began co-ordinated action to stabilise the economy. Generally, a ''kitchen sink'' liquidity policy was introduced. In effect, policy-makers were telling us that long-term economic policy was being suspended to tackle immediate economic dangers.

As a result, the current early signs of economic stability or recovery are dependent on the largesse of governments and central banks. Investors have responded aggressively to these government actions, fuelling a robust asset price reflation in all types of asset across the spectrum from equities to commodities to bonds. This rise in asset prices is itself supporting the economic recovery. The Deputy Governor of the Bank of England recently suggested that one of the expected consequences of quantitative easing – printing money to buy back government gilts – was to raise asset prices.

Clearly a rise in asset prices from March 2009 lows was desirable to improve confidence, but when does a ''helpful rise'' in asset prices evolve to the beginning of a new ''asset bubble'' and where are we in this process?

It is our view that the UK market rally has gone too far, too quickly. Many investors, lamenting that the ''train has left the station'' without them, are playing catch-up. The trouble with this approach, as in all bubble situations, is that continuing to buy overvalued assets now requires you to believe that, although the drivers of the market are not sustainable, you will be able to sell before the inflection point at the peak.

This autumn 2009 rally cannot continue much longer, simply because very low interest rates were not the sole cure that helped us recover from the last bust. So while we have avoided globally a Thirties-style Depression, we need to implement a partial exit strategy to avoid another asset bubble and more financial turbulence. Ideally, we must have an anaemic global recovery (Scenario one) so global imbalances can be slowly corrected without too much dislocation. The dilemma is that tightening policy through tax increases and interest rate rises could result in a double-dip recession, but if loose policy continues, with no action taken, then an asset bubble is more likely.

An anaemic recovery should be welcomed, not feared. Monetary policy must not neglect asset-price movements. If premature tightening of policy causes a mild double-dip recession, this would be better than another asset bubble.

We have avoided the very worst and if the price of us all not dying from pneumonia is a blocked nose for a few years, then it will not have been a bad price to pay.

We have positioned the PSigma Income fund as a hybrid between defensive UK equities with limited economic sensitivity and UK equities that we believe can grow faster than average in a ''bracing but not impossible'' global economy. Putting quantitative easing on hold would be a good first step and would signal that the authorities are determined not to let another asset bubble develop.

As any West Ham United football fan will tell you, liquidity-driven bubbles are not forever…

Bill Mott manages the PSigma Income fund.

http://www.telegraph.co.uk/finance/personalfinance/investing/shares/6636435/Bill-Mott-An-anaemic-recovery-should-be-welcomed-not-feared.html

Diary of a Private Investor: 'I'm licking my wounds'

Diary of a Private Investor: 'I'm licking my wounds'
I am going through a bad patch and I am still licking my wounds over the demise of Aero Inventory

By James Bartholomew
Published: 4:36PM GMT 02 Dec 2009

What decides which way stock markets go? Most brokers and pundits focus on things like profits, charts, historical precedents and so on. But I am coming to the view that there is something even more important for short-term movements that is hardly mentioned: the Government. Actually not so much the Government itself, but the Bank of England monetary policy committee.

I submit that the major reason for the rally since March has been the so-called quantitative easing or, in ordinary parlance, printing of cash. The Bank has bought up government bonds and corporate bonds, putting cash into the hands of investors who have then bought other corporate bonds or shares.

The ultra-low interest rates – also decided by the committee – have made it sensible for people like me with Bank Rate-based mortgages to go on borrowing the money and keep it invested, again helping share prices.

So this has been, I suggest, a government-made rally. I am grateful to Tim Congdon of International Monetary Research for helping me see the importance of this early in the year and thus emboldening me to take part in the rise. But this is a point to remember for the future: for the short-term direction of the stock market, see what the Government is doing to the supply of money.

Right now, it is not as positive as previously. The Bank of England is continuing with quantitative easing, but more slowly. This suggests the market might continue to chug along, but is unlikely to make another major surge in the short term.

As for my portfolio, I am going through a bad patch. I am still licking my wounds over the demise of Aero Inventory, which held aircraft parts, in which I had a big stake. Since then, Harvey Nash, a recruitment and outsourcing company, has had disappointing results and the shares have fallen. Telecom Plus has come out with lower half-year figures. I have sold a few shares in both. After the Aero Inventory disaster, I am nervous about big stakes in individual companies.

Meanwhile, my three aggressive plays on recovery are performing badly. Enterprise Inns, a pub group, Tullett Prebon, a broker and Barratt, a house builder, have been through weak patches.

But I am certainly not selling any Barratt. Banks are much more willing to lend than earlier in the year and therefore house prices are likely to continue to rise. The number of mortgage deals available to those offering only a 10pc deposit has doubled since August. Barratt should benefit from stronger house prices.

Incidentally, despite all the technology about – much of it free – I still have not managed to find a website that tracks my portfolio satisfactorily. I use no fewer than four websites to follow my shares. I look at ADVFN, but since I decline to pay for the service, I never know when it is going to log me out. The service is live and in real time and it includes shares in other markets such as Hong Kong, America and so on.

But it has a way of deciding on the share price that I can't fathom. Sometimes it is neither the latest price dealt nor the middle between the buy and sell price. I also use Morningstar, which has the advantage of always showing the mid-price so I know I am comparing like with like, but the prices are a quarter of an hour out of date and not live.

If I want the latest price, I go to Hemscott where I do pay for the company's premium service to get access to brokers' forecasts and details of recent trades. But Hemscott does not show my whole portfolio in real time, which is a disadvantage.

Recently, I have also found the Yahoo portfolio service. This is free and live and it also includes Hong Kong shares. But it does not show the mid-market price and, of course, it does not include detailed broker forecasts. So none of these sites are perfect. I hope I have not been unfair to any of them. If readers know of a better way to follow a portfolio, I would be glad to hear of it.

http://www.telegraph.co.uk/finance/personalfinance/investing/6711000/Diary-of-a-Private-Investor-Im-licking-my-wounds.html

****A good value is something you can buy for less than it is actually worth.

 

A good value is something you can buy for less than it is actually worth. While that shouldn’t be possible in the theoretical world of “rational” investors, recent experience suggests investors aren’t always rational. They sometimes overpay for a stock (recall any one of the many tragic Internet or tech stories), and sometimes don’t understand value when they see it. (Vincent van Gogh couldn’t sell his work during his lifetime.)

 

Then, how can an investor assess the relative merits of the candidates on his or her list?

A good place to start is to remember that each share of stock represents ownership of a piece of a business. This suggests that two things should be very important to a stock buyer:

 

• How good is the business I am buying?
• How big a piece do I get for my money?

 

To make the point, imagine you’ve been offered a chance to buy into an ideal vacation property in a great location with all the amenities you could ask for. Although you couldn’t afford this on your own, by sharing the cost and use with others, the price comes to about your annual vacation budget. It looks like the perfect investment for you until you find out that, because of the number of total partners, your turn amounts to 1 hour and 20 minutes every March 6 from 3 to 4.20 a.m.! This otherwise great buy is a terrible deal because it costs too much for the piece you’re getting.

 

Many stock “values” have the same kind of problem. If a stock costs just $5 per share, but you’re only getting a penny’s worth of profit value, it’s not a good deal - even if the business is thriving.

 

One measure investors use in their search for value is a stock’s price relative to its 52-week high and low. The thinking is that a stock that traded at $70 per share at its 52-week high and now trades at just $40 per share at or near its 52-week low is a value. While this may be a useful flag for identifying possible values, it could have some serious drawbacks if used alone in your security selection. The stock may cost less today because:

• it’s actually worth less, or
• maybe it was never really worth $70 in the first place, and investors are finally waking up to that fact.

 

 

Doing Your Homework: Finding the up to date Information for every Stock on Your List

Doing Your Homework: Finding the up to date Information for every Stock on Your List

 

Knowing the list of key information critical to stock selection isn’t enough for success. You have to actually find that information for every stock on your list. And, because the information is constantly changing, you also have to keep your analysis up to date - preferably quarterly.

 

How much time your research effort will take depends on how you do it.

 

Library:  Visiting the library and writing or calling for annual reports will certainly work, but you’ll spend a lot of time gathering data. If you’re able to automatically download the information you want directly into a spreadsheet or database, that part of your research can happen in minutes every day - while you’re sleeping.

 

Internet:  It’s hard to imagine anything that has done more to ease the burden of securities research for the individual investor than the development of the Internet. The amount and quality of information you can easily access from the comfort of your own home truly boggles the mind.

• Need an annual report? Click.
• Access to government fillings? Click.
• Prices, charts, analysis, commentary? Just click again.

Information that once took vast amounts of time and dedication to assemble now rushes to your fingertips down the information superhighway.

 

Technology can certainly help you cast a wider net in your search for winning stocks, but your ultimate success as an investor will most likely be determined by how you use the information you find, rather than how you find it.

 

There are three fundamental ways in which the information you’re looking for will vary:

 

1. Cost

• A surprising amount of information is available for free, either directly from companies themselves, from government agencies like the Securities and Exchange Commission (SEC), or certain Web sites.
• Brokerage firms often make some form of research available to their customers.
• Subscription services vary dramatically in price, from the cost of a daily newspaper to thousands of dollars per month for comprehensive data and analysis services.

 

 

2. Format
Information is available in print or electronic format.

• Newspapers, magazines, and annual reports are familiar in print.
• Electronic versions of all these items are commonly available, as are a host of software applications and Web sites.

 

3. Content

• Financial statements, balance sheets, and company reports provide a rich source of data items, but you will probably still have to compute the ratios yourself.
• Many third party information services provide exactly this kind of processed information already calculated for you.
• Key financial ratios, earnings trends, and per share data are commonly listed, along with analysis and commentary, including rating services and lists of specific security recommendations.
• The amount of information is usually commensurate with its cost.

 

The cost, format and content of all kinds of information sources are rapidly evolving, and any attempt at a comprehensive listing would be almost instantly obsolete. By pointing out a few alternatives across the spectrum of choices, we hope to show you a sample of the kind of information that’s available. How you choose to proceed will depend on your level of interest, resources, preferences, and expertise with computers.

 

----

 

Printed Materials:

• Newspapers (business sections)
• A company’s annual report
• Stock rating publications: Value Line Investment Survey, Standard & Poor’s Stock Reports, Morningstar Stock Analyst Reports

 

Internet Sources

• Most recent annual and quarterly reports
• Recent news releases and access to a news release archive
• A calendar of events, including planned shareholder meetings.
• Notes and commentary from recent analysts meetings, speeches, or other presentations.

 

Software and Data Services

• These are software programs and data providers that deliver an almost unimaginable amount of detailed financial data on virtually every publicly traded stock.
• They include powerful analysis tools and forecasting models, charting capabilities, and interfaces with spreadsheets and other software programs.
• They are also expensive.

 

Once you find the right source of information for you, it’s time to use your data to define the universe of stocks you will be tracking.

Slow Grower versus Fast Grower

Rather than focus on price alone, we prefer to use measures of value that relate the price of a stock to some measure of how the company is performing as a business. There are many to choose from, but we recommend two tried and true favorites:

• The price-to-earnings ratio (P/E) and 
• The price-to-sales ratio (P/S).

These ratios measure a stock’s price relative to its earnings or its sales. In the simplest terms, they show a prospective investor how many years’ worth of one share’s earnings (or sales) it would cost to buy a single share of a company’s stock.

Example:

http://spreadsheets.google.com/pub?key=tACdu4SdYelgtyWJpKMMkjQ&output=html

If a stock had a price of $10 and earnings of $1, it would have a P/E of 10. An investor would have to pay 10 years’ worth of a share’s earnings to buy a share of stock in this company. A $10 stock with a P/E of 20 is only earning 50 cents per share, and by this measure, would be twice as expensive as the other $10 stock, since it would cost the investor 20 years’ worth of earnings to buy it.

The lower the P/E, the cheaper the stock - not necessarily in dollar terms, but in terms of this measure of their value. How could such a large difference in value exist?

A P/E ratios are based on the current price and current earnings. (Analysts use either the last year’s earnings or a forecast of next year’s earnings in the calculation.) If a company’s earnings are expected to grow quickly over the years, then this higher expected future earnings stream is considered by buyers to be worth a higher price up-front (i.e. higher P/E).

The table shows the implied future price of two $10 stocks with differing earnings growth rates, assuming they continue to sell at whatever price keeps their P/E ratios unchanged (at 10 for the slower grower, and at 20 for the fast grower). The “expensive” $10 fast grower could look pretty cheap 10 years from now compared to the slow grower, even if it costs twice as much relative to earnings today.

Notice that even though the fast grower’s earnings don’t actually catch up to the slow grower’s earnings until year 15, by then the stock is worth twice as much. The fast growth rate and the expected effect on future prices are driving the price, not the actual level of earnings.

The problem, of course, is that the expected future often has a way of being very different from the future that actually happens. If the lofty expectations priced into a high P/E stock aren’t met, the price tends to take a bigger hit than if expectations were more modest.

One of the advantages of the P/E ratio (or multiple) is that it is very easy to find. Many newspapers publish this number daily, right alongside the price.

Doing Your Homework: Rule of thumb

Basic Financial Metrics

Sales per share
Rule of thumb: The higher the better.


Dividends per share
Rule of thumb: The higher the better.


Cash Flow per share
Rule of thumb: The higher the better.


Yield
Rule of thumb:  The higher the better.

Quick Ratio:
Rule of thumb:  Greater than 1 and the higher the quick ratio the better.  If the ratio is less than 1, you would want to assure yourself that the company is generating enough cash flow from operations to cover both its normal expenses and any short-term debt obligations that come due.

Valuation Ratios

Price-to-Sales ratio: 
Rule of thumb:  ratios less than 2 indicate good value

Price to Earnings ratio (P/E):
Rule of thumb:  Historically, stocks are a good value when the ratio or multiple is around 14.  We will consider stocks that have a P/E of less than 20 a decent value based on this ratio - the lower the ratio the better.

Dividend Ratios

Dividend Coverage ratio: 
Rule of thumb:  Minimum of 120%

Dividend Payout ratio:
Rule of thumb:  The higher the better, so long as the ratio does not exceed 100%.   By maintaining a conservative payout ratio of 30%, this allows management to consider increasing dividends as earnings increase.

Growth Ratios

One-year revenue growth rate:
Rule of thumb:  greater than 10% increase in revenue

One-year earnings growth rate:
Rule of thumb:  greater than 10% increase in earnings


Trend Analysis

All preceding ratios
Rule of thumb:  Look for positive trend with an increasing growth in sales, earnings, cash flow, and dividends per share.  The quick, leverage, value and dividend ratios are all positive or well within acceptable ranges.



Caution:  A parting word about a standard rule of thumb
Although convenient, rules of thumb should not be adhered to in isolation. 

For example, electric utilities normally have current liabilities that exceed their current assets, yielding a quick ratio of less than 1.  However, investors are not concerned because utilities have strong cash flow from operations and their accounts receivables are from electricity users who must pay their bills if they want to continue to receive electricity.  If your rule of thumb were rigid, a low quick ratio would be a signal for you to avoid the company and discard promising stocks individually or even across an entire industry.

Ultimately, by integrating these ratios into a single analysis for any given company, you should be able to confidently select dividend-paying stocks that will help you to accomplish your investment goals and to build your wealth slowly over time through compounding dividends and price appreciation.

Doing Your Homework: Trend Analysis

The information in the financial statements (BS, IS or RE statement), the basic (per-share) financial metrics and the various ratios are snapshots of the company's financial condition at a point in time, but there are trends in motion that need to be identified so you can understand if the company's position is improving or deteriorating.

For example: 

http://spreadsheets.google.com/pub?key=tdTJEsOwTqdvL-tOgwfeb9A&output=html

• Company ABC's year-over-year trend analysis indicates a generally positive trend with an increasing growth in sales, earnings, cash flow, and dividends per share. 
• The leverage, value, and dividend ratios are all positive or well within acceptable ranges, with the exception of the quick ratio. 
• Based on analysis, the dividend looks to be secure and Company ABC would be a good buy.

Doing Your Homework: Basic Financial Metrics and Ratios Analysis

Ratios Analysis

Ratios are widely used not only to evaluate a company, but to compare a company's financial position with other companies'.  The data used to calculate ratios are readily available in each company's annual and quarterly reports.  You can concentrate your analysis in the following two areas.


Building Block One:  Basic Financial Metrics

These are formulas that allow you to view any company's results on a per share basis.  Once financial data are reduced to the shareholder level you can easily compare companies that might be very different in size or in different industries.

For example, trying to compare the annual sales of General Motors with the annual sales of a much smaller car company like Porshe might not tell you much, but by comparing sales per share (divide each company's sales by the number of shares outstanding), you have a more meaningful measurement.  Generally, the company generating higher sales per share is going to be the better value. 

Some useful basic financial metrics you can use for your analysis are:

Sales per share
= Sales/Shares outstanding  (Source: IS; BS)

Earnings per share
=Earnings/Shares outstanding (Source: IS; BS)

Dividends per share
=Dividends/Shares outstanding (Source: RE; BS)

Cash flow per share
= (Net Income + Depreciation)/Shares (Source: IS, BS)

Yield
= Dividend per share/Price per share (Source: DPS; newspaper)



Building Block Two:  Ratio Analysis

Ratio analysis allow you to analyse a company's financial performance

• against other companies in the same industry,
• against all stocks in the market, or
• against industry standards, which are sometimes known as "rules of thumb." 

Although there are a great number of ratios that you can use to analyse a company, below is a short list of ratios that will give you the information you need to pick good dividend-paying stocks.

Liquidity Ratio
Quick Ratio
= (Current Assets - Inventory) / Current Liabilities (Source:  BS)

Debt Coverage Ratio
Short-term Debt Coverage Ratio
= Operating Income/Short-term debt (Current Liabilities)  (Source: IS; BS)

Valuation Ratios
Price-to-Sales ratio
 = Stock price/Sales per share (Source: Newspaper; Sales per share)
Price-to-Earnings ratio
= Stock price/Earnings per share (Source:  Newspaper; Earnings per share)

Dividend Ratios
Payout ratio =
Dividend per share/Earnings per share (Source:  Basic metric formulas)
Dividend coverage ratio =
Cash flow per share/Dividend per share (Source:  Basic metric formulas)

Growth Ratios:
Revenue growth rate ratio
= Year over Year percent change in revenues (Source: IS)
Earnings growth rate ratio
= Year over Year percent change in earnings (Source: IS)

Doing Your Homework: Analysing Financial Statements to pick Great Stocks

How do you pick great stocks?

If you don't have a crystal ball or inside information, then the best way you can tell a winning stock from a loser is by analysing a company's financial statements.

Before you dismiss this simple answer because you find financial statements confusing or boring, you should know that you don't have to become an accountant or financial analyst.  Just a nodding acquaintance with the fundamentals will allow you to make better decisions about

• which stocks you should investigate and
• which stocks you should own as part of your (e.g. dividend-focused or growth-focused) portfolio.

Financial statements are an important source of information regarding a company's profits or losses, assets and liabilities, and sources of funds used to operate its business.  You should concentrate on the basics: 

• the balance sheet,
• income statement, and
• statement of retained earnings.

The balance sheet
This gives you an overall picture of a company's assets, liabilities, and equity at the end of an accounting period (i.e. quarterly or year-end).

The Income statement and the statement of retained earnings
These tell you how much revenue, expense, and profit the firm generated over a specific period of time (e.g. its fiscal year).

Together, these statements provide you with all the financial data you need to perform a ratio analysis to determine if you would want to buy a stock.

Since financial transactions occur continuously, this information becomes rapidly dated.  Be sure you are looking at the most recent statements and continue to review the updated statements of those stocks you decide to hold.

Future expectations can be approached in two different ways: Qualitative or Quantitative approach

According to Benjamin Graham, the current price reflects both

• known facts and
• future expectations

was intended to emphasize the double basis for market valuations.

Corresponding with these two kinds of value elements are two basically different approaches to stock analysis. 

Every competent analyst looks forward to the future rather than backward to the past, and realizes that their work will prove good or bad depending on what will happen and not on what has happened.

The future expectation itself can be approached in two different ways, which may be called:

• 1.  the way of prediction (or projection) and
• 2.  the way of protection.

-----

1. The way of prediction (or projection)

Those who emphasize prediction will try to anticipate fairly accurately just what the company will accomplish in future years - in particular whether earnings will grow rapidly and consistently.  These conclusions may be based on a very careful study of such factors as

• supply and demand in the industry-
• or volume, price and costs -
• or else they may be derived from a rather naive extrapolation from past growth into the future. 

If these authorities are convinced that the fairly long-term prospects are unusually favourable, they will almost always recommend the stock for purchase without paying too much attention to its current price.

This first, or predictive approach, could also be called the qualitative approach, since it emphasizes prospects, management and other nonmeasurable, abeit highly important factors that go under the heading of quality.

--

2. The way of protection.

By contrast, those analyst who emphasize protection are always especially concerned with the price of the stocks at the time of study.  Their main effort is to assure themselves of a substantial margin of present value above the market price - a margin large enough to absorb any unfavourable developments in the future.  Generally speaking, therefore, it is not so necessary for them to be enthusiastic over the company's long-run prospects as it is to be reasonably confident that the enterprise will get along.

The second or protective approach may be called the quantitative or statistical approach, since it emphasizes the measurable relationships between selling price and earnings, assets, dividends and so forth. 

Incidentally, the quantitative method is really an extention into the field of common stocks of the viewpoint that security analysis has found to be sound in the selection of bonds and preferred stocks for investment.

----

Choosing the "best" stocks is a controversial one.

In Benjamin Graham's own attitude and professional work was always committed to the quantitative approach. 

• From the first he wanted to make sure that he was getting ample value for his money in concrete, demonstrable terms. 
• He was not willing to accept the prospects and promises of the future as compensation for a lack of sufficient value in hand.

This has by no means been the standard viewpoint among investment authorities; in fact, the majority would probably subscribe to the view that prospects, the quality of management, other tangibles, and the "human factor" far outweigh the past performance records, the balance sheet and all other cold figures.

Thus this matter of choosing the "best" stocks is a controversial one.

Buffett gambles £27bn on rail to get back on track

Buffett gambles £27bn on rail to get back on track
Warren Buffett has placed the largest single wager of his investing career, gambling on "the economic future of the United States" by taking control of the American rail giant Burlington Northern Santa Fe in a $44bn (£27bn) deal.

By James Quinn
Published: 8:53PM GMT 03 Nov 2009

Warren Buffett has bought Burlington Northern Santa Fe, the rail operator, in a $44bn deal. Burlington is America's largest railway by revenue, operating freight across large swathes of the west and mid-west. Its tracks are also used by a variety of passenger services.

Mr Buffett believes that Burlington will benefit as the US economy recovers.

The septuagenarian billionaire argues that railway operators cannot do well unless the businesses and consumers who use the products they transport are beginning to spend again. "It's an all-in wager on the economic future of the United States," said Mr Buffett. "I love these bets."

In typical Buffett style, the cash-and-shares deal was struck in a 15-minute conversation with Matthew Rose, Burlington's chief executive.

It is the largest single investment Mr Buffett has made since taking control of Berkshire Hathaway, the investment conglomerate he has run since 1965.

It contrasts with his more recent deals, which have been big bets on the financial services sector including multi-billion dollar gambles on the recovery of shares in General Electric and Goldman Sachs, both of which have repaid him handsomely.

However, not all of his financial gambles have paid off, with 2008 going down as Berkshire's worst financial year since Mr Buffett took the helm, following a 62pc fall in profits and a drop in net worth of 9.6pc.

Berkshire is offering $26bn for the 77.4pc of Burlington it did not already own, 40pc in shares and the balance – $16bn – in cash, drawn equally from existing reserves and a bank syndicate. Berkshire will still have $20bn of cash.

Including Berkshire's previous investment and the assumption of $10bn of debt, the deal is worth $44bn.


http://www.telegraph.co.uk/finance/businesslatestnews/6496667/Buffett-gambles-27bn-on-rail-to-get-back-on-track.html

US to reduce Quantitative Easing as rates kept low

US to reduce Quantitative Easing as rates kept low
The Federal Reserve reiterated its desire to keep American interest rates “exceptionally low” for an extended period, but gradually reduce some of its quantitative easing as the US economy begins to recover.

By James Quinn, US Business Editor
Published: 8:51PM GMT 04 Nov 2009

America’s central bank, holding interest rates in a range of 0 to 0.25pc, did not signal when borrowing rates might rise, as it remains wary of knocking the US’s nascent recovery off course just a week after productivity figures signalled the country emerged from recession in the third quarter.

The decision comes ahead of the results of the Bank of England’s Monetary Policy Committee meeting, which is due to report its views on interest rates and quantitative easing on Thursday.

In a more upbeat assessment of the state of the US economy, the Federal Open Markets Committee (FOMC) said that it would begin to pull back on some of the extraordinary capital injections it made into the US economy during the crisis.

The Fed has completed its $300bn (£181bn) US Treasuries purchase programme, and reduced the fund for buying agency debt through the first quarter of next year from $200bn to $175bn. But it will continue with its $1.25 trillion purchase programme of agency mortgage-backed securities.

The FOMC’s unanimous decision to hold rates came as it noted that “activity in the housing sector has increased over recent months” and that businesses are beginning to slow the rate of cutbacks.

New data from the FOMC included the latest ADP payroll survey, which showed that the US private sector lost 203,000 jobs last month, ahead of tomorrow’s government unemployment figures, which could show the US unemployment rate hit 10pc in October.

Dividend incomes do not depend on the kindness of strangers

The vast majority of stock transactions are simply investors selling the same stocks back and forth among themselves.  Prices change as their opinions change about what each share is worth to them.  They rise as a buyer tries to entice an owner to sell, and they fall as sellers try to attract a buyer.

Assuming that your stock has risen in price since the day you bought it, how do you benefit from this increase in your wealth? 

• You could borrow against your shares, but then you're really using someone else's money, and the stock is just collateral.  You still have to repay the loan, plus interest, somehow.
• If you ever want to spend the money, you have to sell the stock.  In order to sell your shares, you have to find someone to buy them.

Dividend incomes, on the other hand, does not depend on the kindness of strangers in the same way that appreciation does.  Dividends are driven primarily by the ability and willingness of the company to share its profits with its shareholder owners.  They are tied more closely to the business itself and are less subject to the emotional response of investors to world or market events. 

Investors holding stocks for the income they provide, on the other hand, enjoy an ongoing advantage that "pure growth" investors don't  - they get to keep their shares.  Obviously, once you've sold your shares, it's somebody else's stock.  You no longer have a stake in the fortunes of the company.  The benefits and profits that may follow - as well as the future appreciation in share price - are of no further value to you.  Of course, you don't necessarily have to sell all your stock at once and can therefore continue to enjoy some of the good fortune that may continue to visit the company whose shares you're selling. 

The simple fact remains, though, that as you sell your shares, you have less of an ownership interest than you did before.  By periodically liquidating your holdings, you are systematically reducing your ownership in the very thing that is your store of investment wealth.  Appreciation has its advantages too, and fortunately, dividend investors can enjoy the appreciation in the value of their shares while they continue to collect the ongoing income from their holdings.

When the time eventually comes to take income from your portfolio to support your lifestyle, either in retirement or to help defray major expenses such as education costs, the investments do not have to be sold to create cash flow.  The dividends are already flowing cash to you.  You simply have to adjust how much of it you're reinvesting and how much of it you can afford to spend.

What is Predictable? Market Cycles

You can count on Performance Bursts

Years
Percentage Change*---- Cycle

1901-1903 
-30.55%  Correction
1904-1905   
95.89% Burst
1906 -1907 
-38.93%  Correction
1908-1909
68.60%  Burst
1913-1914
-37.89%  Correction
1915
81.66%  Burst
1916-1917
-24.98%  Correction
1918-1919
44.17% Burst
1920
-32.98% Correction
1921-1922
37.22% Burst
1929-1932
-80.02%  Correction
1933-1936
200.18%  Burst
1937
-32.82%  Correction
1938
28.06%  Burst
1939-1941
-28.30%  Correction
1942-1945
73.86%  Burst
1973-1974
-39.59%  Correction
1975-1976
63.03%  Burst

*Year over year percent change in DJIA Index, excluding dividends.

What most investors don't know is that market cycles are fairly predicatable (see above).  This is good news! 

The above exhibit shows the powerful performance bursts that have followed each market decline of 20% or more as measured by the year over year change in the DJIA Index. It's as if the markets understand Newton's law of physics, that for every action there is an equal and opposite reaction. Over the past 100 years there have been 9 year over year market corrections of 20% or more and after each correction a performance burst has helped to salvage investors' fortunes.

In April of 2003, the markets had already started to reverse the bear trend.  Unfortunately, many investors are still sitting on the sidelines because they were burned by losses incurred in the Y2K bear market.  Most investors, retail and institutional alike, were surprised by the uptrend, but once again a good working knowledge of market history would have allowed them to anticipate a significant move to the upside.  After every major market decline, markets have snapped back with a performance burst to the upside.  These uptrends tend to be very powerful, lifting investors' account balances and spirits at the same time.  

****The most insidious risk of all - Investor Risk

Investors are justifiably wary of the various risks that can beset a portfolio.  In addition to the eroding effects of volatility, there's

• business risk,
• currency risk,
• market risk,
• interest rate risk, and
• inflation risk. 

Perhaps the most insidious risk of all, though, is the one that's the hardest to protect yourself from - investor risk.  Investor risk is the risk we face just by being human.

It is easy to understand the concept that to be successful as an investor you should buy low and sell high.  But if you invest over a long enough time period to see both rising and falling markets, you'll see just how hard it can be to actually bring yourself to do this. 

• Buying at highs and selling at lows is the opposite of success and can cause yur portfolio irreparable harm, but it's .  extraordinarily common
• Had you asked those investors who were rushing into Internet or other high-flying stocks in early 2000, after the Nasdaq had just jumped more than 85% in 1999, if they thought they were buying high, you probably would have heard all kinds of reasons why this time was different.  There was a "new paradigm"; the old rules of valuation no longer applied.  
• Had you asked many of these same investors in early 2003 if they felt they were selling low after three years of crushing stock market declines, you would likely have heard that the market was going to keep falling, the world had changed, and prospects looked bleak for as far as the eye could see.

Investors were once thought to be "rational," efficiently processing all known market data and making decisions on the basis of the logical pursuit of their own best interests.  A whole branch of study called behavioural finance has sprung up to study the question of how investors really behave, and the short answer is that it's rarely rational. 

• Nature has 'wired' us to react in certain ways so we can quickly process information, understand patterns (like those that occur in nature), and make good, quick survival decisions. 
• Unfortunately, many of the same ways of thinking that have proven so helpful to our survival as a species can get us killed as investors.

Emotional responses, uneven reactions to risk and reward, looking for patterns where none may exist, believing our recent experience will persist, and overconfidence in our initial judgements are just some of the natural tendencies that can lead us astray.  Rather than trying to overcome our nature - to overcome the thinking processes and habits that have been woven into our very beings for millennia - we can try to invest in such a way as to reduce this investor risk and increase our odds of financial survival.

The markets will continue to rise and fall, but if your account doesn't fall so much that it triggers your primal urge to sell, you'll still be invested for the rebound. 

• Even the most robust market recovery doesn't help the investor who has already sold everything before it starts. 
• To reap the long-term performance advantages of being an investor, you have to find a way to stay invested for the long term. 

To the extent a lower volatility, dividend-based portfolio provides you with an investment experience you can live with in all kinds of markets, your portfolio is more likely to evolve into a fortune - and less likely to face extinction.

The Performance Illusion: Higher returns have long been associated with higher risks.

Which would you rather have, a portfolio with an average annual return of almost 34%, or one with an average annual return of just 5%?  Let's llok at a couple of examples that show why sometimes less is more.

Exhihit 1
The  Performance Illusion:  High Average Return

Year 1
Starting Value $100,000  Return 100%  Gain or (Loss) $100,000
Ending Value $200,000

Year 2
Starting Value $200,000  Return -99.00%  Gain or (Loss) ($198,000)
Ending Value $2,000

Year 3
Starting Value $2,000  Return 100%  Gain or (Loss) $2,000
Ending Value $4,000

Average Annual Return: 33.67%
Change in Value: ($96,000)
Percentage of Initial Investment Gained or (Lost) after 3 years: -96%



Exhihit 2
The  Performance Illusion:  Low Average Return

Year 1
Starting Value $100,000  Return 15%  Gain or (Loss) $15,000
Ending Value $115,000

Year 2
Starting Value $200,000  Return -15%  Gain or (Loss) ($17,250)Ending Value $97,750

Year 3
Starting Value $97,750  Return 15%  Gain or (Loss) $14,662.50
Ending Value $112,412.50

Average Annual Return: 5%
Change in Value: $12,412.50
Percentage of Initial Investment Gained or (Lost) after 3 years: 12.41%


Which return would you rather have? Of course, to illustrate the dangers of a high-volatility approach to investing, these two examples include an extreme case. Surely no one would ever face the kind of volatility shown in the 100 percent up and 99 percent down example ... but they might come close.



Exhihit 3
Nasdaq Composite Index

Year 1999
Starting Index Value 2192.69; Return 85.59%; Point Gain or(Loss) 1876.62
Ending Value 4069.31

Year 2000
Starting Index Value 4069.31; Return -39.29%; Point Gain or(Loss)(1598.79)
Ending Index Value 2470.52

Year 2001
Starting Index Value 2470.52; Return -21.05%; Point Gain or(Loss)(520.12)
Ending Index Value 1950.40

Year 2002
Starting Index Value 1950.40; Return -31.53%; Point Gain or(Loss)(614.89)
Ending Index Value 1335.51

Year 2003
Starting Index Value 1335.51; Return 50.01%; Point Gain or(Loss)667.86
Ending Index Value 2003.37

Average Annual Return: 8.74%
Change in Index: -189.32
Percentage of Initial Investment Gained or (Lost) after 5 years: -8.63%


Exhibit 3 shows the actual results of the Nasdaq Composite Index (Nasdaq) over five years beginning in 1999 and ending on December 31, 2003.

The truly remarkable 86% return posted by the Nasdaq in 1999 was followed by a truly gruesome bear market mauling over the three years. From the start of 2000 to the end of 2002, the Nasdaq shed an amazing 2,733 points - more than 67% of its value. The year 2003 brought welcome relief, but even after a 50% rise, the Nasdaq was still more than 8.6% below where it had stood five years earlier.

An investor unlucky enough to have missed out on the gains over this time span - either by coming late to the party or bailing out before the rebound - would have suffered a massive financial setback. As of the end of 2003, the Nasdaq remains more than 3,000 points, or 60%, below its all time closing high.


Exhibit 4
The Y2K Bear Market

Nasdaq
Index Closing High 5048.62
Date Hit 03/10/2000
Index (On 12/31/2003) 2003.37
Decline -60.32%
Points from High 3045.25
Gain Needed to Recover 152.01%

S&P 500
Index Closing High 1527.45
Date Hit 03/24/2000
Index (On 12/31/2003) 1111.92
Decline -27.20%
Points from High 415.53
Gain Needed to Recover 37.37%

DJIA
Index Closing High 11722.98
Date Hit 01/14/2000
Index (On 12/31/2003) 10453.92
Decline -10.83%
Points from High 1269.06
Gain Needed to Recover 12.14%


The Exhibit 4 shows the damage the Y2K bear market has visited on three major U.S. stock market indexes. The S&P 500 and DJIA did not soar nearly as high as the Nasdaq during the technology/telecom/Internet boom of the 1990s, and they suffered much less damage during the bust that followed.

The scenarios above are to illustrate, that there are consequences to taking risks. The easy success of the late 1990s bull market lulled many investgors, including many professional investors, into believing risk had lost its bite. Why not shoot for a 30 percent return? If you don't get it, you'll probably just have to settle for 20%. But that's not how it works in the real world - at least not in the long run. The experience of the Nasdaq versus the DJIA during the Y2K Bear Market wasn't a fluke. Higher returns have long been associated with higher risks.

Dividend stocks for Growth Investors

Don't gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. 

If it don't go up, don't by it. 

Will Rogers

For many investors, current income is not an important consideration in building their portfolios. They may have sufficient income from other sources, including employment. For them, building and growing the overall value of their portfolios may be the primary focus of their efforts. Should these “growth investors” concern themselves at all with a strategy built around investing in dividend paying securities?

One of the classic advantages of dividends is their large contribution to the long-term performance that has made stocks so attractive to investors. (About 50% of the returns of your stocks are contributed by dividends.) Reinvesting those dividends can compound the growth of a portfolio. The attraction dividend-paying stocks hold for investors looking for a steady and rising stream of income to support their lifestyles is pretty clear.

The goal of a growth investor, is to increase the overall size of the portfolio so that it will be large enough to meet a future need. That need may be a lump sum to pay for college expenses, or a much larger account from which to draw retirement income. In either case, the object of the game is to make the pot of money bigger in the time available. The key to winning the game lies in understanding that total return is what counts.

Total return is made up of two parts: price appreciation and income. A security that goes up in price by 5% and pays 5% in income adds as much to the financial pot as one that goes up by 10% in value, but pays no income. Still, like the customer who insists on having his pizza cut into 6 slices because he doesn’t think he can eat eight, some investors want their returns delivered only as appreciation.

Stocks that pay dividends do tend to be more mature companies, with characteristically slower growth rates. This is sometimes taken to mean they have low total-return prospects. More accurately, they offer a different path to total return, and that path can lead to an excellent outcome. Flashy price gains are exciting; steady and reliable income can seem boring by comparison. To the extend those flashy gains come at the expense of increased volatility in annual returns, chasing them could lead you down the road to disaster.

Dubai bites the bullet on debt

Dubai bites the bullet on debt
Dubai has finally entered a treatment facility voluntarily.

By Una Galani, Breakingviews.com
Published: 6:12AM GMT 26 Nov 2009

Dubai World, one of the emirate’s biggest holding companies, has shocked creditors by asking for a standstill on the $60bn of debt attached to its entire portfolio, which includes ports operator Dubai Ports World, investment vehicle Istithmar and Nakheel – the property developer responsible for one of the Gulf’s most iconic sights: a series of man-made palm islands. If the emirate’s request is granted that would amount to a technical default.

Though Dubai’s troubles had been widely heralded, investors had been expecting a timely repayment of bonds. Sheikh Mohammed bin Rashid al-Maktoum even recently told critics of the emirate’s ability to meet its financial commitments to “shut up”. No surprise then that the request for a standstill from Dubai World until May 2010 sent the price of Dubai’s five year credit default swaps leaping to 420 basis points – up 100 basis points. That is still less than half the high Dubai’s CDS reached in February when confidence in the emirate was at an all time low.

Dubai has been smart to prove that it can still raise money. At the same time as asking creditors for more time, Dubai announced it had raised a further $5 billion tranche of its $20 billion emergency support bond from two government-owned banks in Abu Dhabi. Two weeks ago, the emirate also placed $2 billion worth of Islamic sukuk bonds with private investors, although those proceeds were not raised for distressed entities.

So why isn’t Dubai putting its hand in its pocket to help Dubai World meet its most pressing maturity, namely Nakheel’s $3.5 billion sukuk due mid-December? One reason could be because Dubai World faces at least a further $2.2 billion of maturities in the coming six months and more after that. Deloitte’s Aidan Birkett, who will lead the restructuring effort, will be one of the first outsiders to see the true scale of the problem that lies within.

Creditors might not like having to grant concessions, but anyone with a long term interest in Dubai should be pleased that the emirate is biting the bullet. Authorities last week took the decision to remove some of the key architects of modern Dubai from their positions. Now the debt laden emirate appears to have finally realised that it can’t pay off all of its debts without a serious financial restructuring. The first step to a cure is admitting there’s a problem.