A week that knocked the financial world off its axis

Just another quiet summer week, really. The FTSE 100 started at 5,247 and ended at 5,320. It was hardly worth coming out of the sea to check your BlackBerry.

The chart shows the relative performance of Europe's high and low yielding shares but I could have shown a similar chart for Japan, where income has provided an escape from two lost decades for investors. 

By Tom Stevenson, on the Markets

2:40PM BST 13 Aug 2011

Comment

If only. The modest net gain for stock market investors disguised the most dramatic few days in the markets since 2008. If someone had offered no change as Wall Street was tumbling 6.7pc last Monday, few would have turned it down, I suspect.

That is perhaps the first lesson to be learned – the remarkable capacity for markets to confound investors' expectations. If the same patterns played out each time, we would have got the hang of it by now. But each crisis is different enough to ensure that history never quiet repeats itself, only rhymes.

I have drawn a few other conclusions from this fascinating week. First, while developed market shares are undoubtedly cheap they may remain so, and for good reason. It is quite unprecedented, that Fed chairman Ben Bernanke should have been prepared to pre-commit to near zero interest rates two years into the future. This speaks volumes about his pessimism regarding America's economic outlook. The persistent unemployment and low growth implicit in his assessment is incompatible with the Government's assumptions in its deficit reduction plan or many of Wall Street's earnings forecasts.

I think we are seeing a change in the investment environment on a par with the birth of the cult of the equity in the 1950s. That was when, for the first time, equities began yielding less than fixed income securities on the grounds that investors considered the growth potential of share dividends outweighed the extra risk borne by equity investors.

In recent years, the rare occasions when equities have yielded more than government securities have been viewed as a buy signal for shares, but in a low-growth, low-interest rate environment, this premium could become the norm again.

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Having been disappointed in recent years by the vain wait for jam tomorrow, in the form of capital growth, investors are likely to demand jam today, in the form of a high and sustainable income.

This renewed focus on income makes sense because, as the chart clearly shows, shares paying high dividends are not simply interesting to investors seeking to replace the income they can no longer find in cash or by investing in government securities. Income is both the main contributor to the total return from shares and an excellent indicator of future outperformance.

The chart shows the relative performance of Europe's high and low yielding shares but I could have shown a similar chart for Japan, where income has provided an escape from two lost decades for investors.

Looking forward, careful stock selection will be key to investment success. The sell-off has been indiscriminate and this is throwing up plenty of opportunities: good companies at great prices. I wonder whether we might not look back with some disbelief at a time when BP was available at just 5.5 times expected earnings or AstraZeneca at 5.7 times with a dividend yield of 6.5pc. Investor sentiment, measured using a combination of indicators such as market volatility, directors' dealings and fund flows, last week hit its lowest point since the collapse of Lehman Brothers .

What has also become clear this week is that we now inhabit a two-speed world. The transformation of emerging markets, especially those in Asia, continues regardless of the volatility in Western stock markets. It is interesting that the two worlds' markets have not become de-linked in the same way as their underlying economies have. I would be surprised if that did not change soon. The growth differential between Asia outside Japan and the developed world before, during and since the financial crisis argues for a much greater bias towards the region.

The unstoppable shift from West to East has important implications for stock markets closer to home because a key part of any analysis of companies quoted in London and New York is now their exposure to the growth potential of emerging markets. It is one reason why German stocks continue to look more interesting than their counterparts in other parts of Europe. Companies such as BMW and Siemens have understood and grasped the emerging market opportunity.

Meanwhile, let's hope tomorrow really does bring just another quiet summer week. We could all do with one.

Tom Stevenson is an investment director at Fidelity International. The views expressed are his own.


http://www.telegraph.co.uk/finance/comment/tom-stevenson/8699694/A-week-that-knocked-the-financial-world-off-its-axis.html

US Debt Crisis (Video)

US jobs data helps Wall Street rebound, credit markets jittery

Reuters | Aug 12, 2011, 12.06AM IST

NEW YORK: Investors swooped back into beaten-down global stocks on Thursday, encouraged by a surprise dip in the number of Americans claiming new jobless benefits, but credit markets tightened and a 30-year US bond auction met poor demand. 


US and European stocks climbed more than 3 per cent, reversing course after steep losses the previous day. The US data and corporate results provided a respite from overnight fears about the health of the euro zone banking system. 


But the sanguine view in the equity market contrasted with nervousness in the short-term funding markets, where there were tangible signs of concern. Fears over the health of French banks intensified European banks' scramble for dollars, driving up their dollar borrowing costs to levels not seen since the 2007-2009 global credit crisis. 


Markets were also on edge after banking sources told Reuters that one bank in Asia had cut credit lines to major French lenders while others in the region were reviewing trades and counterparty risks due to concerns about the exposure of French banks to peripheral euro zone bonds. 
US initial claims for state unemployment benefits fell last week to the lowest level since early April. Analysts said one week was not enough to show definitive improvement in the struggling labor market, but the better-than-expected data was a welcome surprise. 


"Had we seen a jump (in claims) it would have reinforced recession fears. What we've seen here is not anything to allay those fears, but just to set them aside temporarily," said Bucky Hellwig, senior vice president at BB&T Wealth Management in Birmingham, Alabama. 


The anemic pace of US first-half growth has fueled worries of another recession, and analysts are watching for signs the recovery could pick up steam in the rest of 2011. 


The US Treasury sold $16 billion worth of 30-year long bonds at a poorly received auction, with investors showing the weakest overall demand in 2-1/2 years and foreigners largely steering clear. 


In the open market, the 30-year bond lost 5 points in price immediately after the auction results. The benchmark 10-year bond yielded 2.30 per cent, up from 2.12 per cent late on Wednesday. 


The dollar and euro soared more than 5 per cent versus the Swiss franc after the Swiss National Bank said it could ease monetary policy further. Markets focused on the possibility of a temporary peg between the franc and the euro to rein in a soaring currency. 


The dollar rose 4 per cent to 0.7552 franc and the euro was up 4.3 per cent at 1.0731 francs. It set a record low of 1.0075 on Tuesday. 


The MSCI world equity index gained 2.4 per cent, changing course after early losses, and the pan-European FTSEurofirst 300 closed up 2.7 per cent. 


The Dow Jones industrial average, led by shares of energy and financial companies, gained 403.84 points, or 3.77 per cent, at 11,123.78. The Standard & Poor's 500 Index was up 48.31 points, or 4.31 per cent, at 1,169.07. The Nasdaq Composite Index was up 101.88 points, or 4.28 per cent, at 2,482.93. 


Wall Street was also boosted by a surge in Cisco Systems, up more than 16 per cent the day after it forecast a modest increase in current-quarter revenue. 


Legendary investor Warren Buffett told Fortune magazine he has been buying during this week's sharp market declines and has not yet seen anything that suggests another downturn. 
Gold slid from record highs as investors cashed in recent gains and after CME Group said it was hiking margins for trading COMEX gold futures. Spot gold was down 1.8 per cent at $1,762.39 an ounce 


NERVOUS MARKETS 


Societe Generale, at the center of Wednesday's storm that took its shares down more than 20 per cent at one point, rose 3.7 per cent, while BNP Paribas edged up 0.3 per cent. 


In the credit markets, the cost of insuring French bank debt hit new records, reflecting worries about the health of those banks, which are heavily exposed to troubled euro zone sovereign debt. It pulled back a bit as European markets closed. 


Societe Generale's CDS costs were last up 8 basis points on the day to 342 basis points, after earlier trading as high as 383 basis points, Markit data show. 


That means it would cost 342,000 euros per year for five years to insure 10 million euros in debt. This cost has more than doubled in the past two weeks. 


BNP Paribas' CDS costs were little changed on the day at 236 basis points, after earlier rising to 256 basis points, and are up from 110 basis points in early July. Credit Agricole's swap costs last traded at 271 bps, up from 130 basis points in early July, Markit data show.

Reaping the rewards

Lesley Parker

August 10, 2011

Drink to that ... make an early calculation of how much you need.

Planning makes all the difference when it comes to achieving a comfortable retirement.

A couple wanting a ''comfortable'' retirement - where they can afford to have some fun, not just pay the bills - now needs more than $1000 a week, by one estimate. A ''modest'' lifestyle requires $600 a week, according to the super industry's retirement benchmarks.

But what is comfortable and what is modest - and how much do you need to save for one or the other?

The Association of Superannuation Funds of Australia (ASFA) releases a Retirement Standard every three months and its most recent calculation is that a couple now needs $54,562 a year for a comfortable retirement and $31,263 for a modest one - an increase of 2 per cent to 3 per cent on the annual income required a year earlier.

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Source: Super Ratings.

ASFA describes a modest lifestyle in retirement as being something ''better than the age pension but still only able to afford fairly basic activities''.

A comfortable lifestyle means an older, healthy retiree can take part in a broad range of leisure activities and can afford to buy such things as household goods, private health insurance, a reasonable car, good clothes and a range of electronic equipment, it says. They should be able to afford holidays in Australia and, occasionally, overseas.

WEEKLY BUDGETS

ASFA's latest weekly budget for a couple enjoying a comfortable lifestyle includes just less than $200 for food, $135 to own and run a car, $120 for health insurance and health care, $30 for phones and the internet, $44 for power, about $75 for housing (including insurance and maintenance), $57 towards clothing and about $85 for services such as cleaning and haircuts.

In the $300-odd budgeted for leisure, there is $80 to dine out, $40 to have a drink, plus the equivalent of one movie a week. About $130 of that amount is set aside for holidays, including $50 earmarked for overseas travel.

The budget for a modest lifestyle steps things down a bit, at $155 for food, $88 to own and run a car and $55 for housing costs. And it halves the amount for health care, communications, clothing and services. Power stays about the same.

The biggest cuts come in leisure, where only $100-odd is set aside, including $25 to dine out and $15 to have a drink - though movie night stays. As for holidays, just $36 is set aside, for domestic travel only.

The head of technical services at MLC, Gemma Dale, says you will need a sizeable nest egg to generate the income the ASFA standards target - comfortable or modest.

''It will take a lot of money to provide these income levels over what could amount to 20 or 30 years,'' Dale says.

A couple, with each partner aged 60, would need to retire with a nest egg of about $535,000 to have only a modest lifestyle lasting as long as the official life expectancy of the partner likely to live longest - that is, 26 years (to 86) for the woman. If the couple wanted a comfortable lifestyle, they'd need to retire with about $940,000 in capital.

''That's after paying off your mortgage,'' Dale says. These figures assume the couple uses their super to start a pension, providing them with tax-free income, and that they don't qualify for the age pension. It also assumes their money earns 7 per cent a year and that they're prepared to use up their super over those 26 years.

They would need even more if they wanted to build in a ''buffer'' in case one or both of them lived longer than expected, or to provide an inheritance.

The earlier you would like to retire and the higher the annual income you'd like in retirement, the more super you'll need. If the couple retires at 55, rather than 60, they'll need $1.05 million for a comfortable retirement to age 86, or $590,000 for a modest lifestyle, by MLC's calculations. In contrast, if they keep working until 65, the nest egg they'll require drops to $850,000 and $480,000 respectively, because of the shorter period to cover to age 86.

Investment options also play a key role and members should take advice, compare investment options and risks when planning ahead for their eventual retirement. Some options, such as ''growth'' are slightly more aggressive than ''balanced'' options.

USE A CALCULATOR

So how much do you need to save?

That depends on how old you are now and how much you have in super already.

MLC gives the example of a couple both aged 50 - let's call them Mark and Lisa - who would like to retire comfortably, in line with ASFA's definition, when they reach 60. They will need $940,000 in super in today's dollars. Let's say they have $325,000 and $150,000 in super already and they earn pre-tax salaries of $100,000 and $50,000 respectively, with their employers making the minimum superannuation guarantee (SG) contributions of 9 per cent a year, and assume their super is earning 7 per cent a year.

Ignoring the proposal to progressively increase the SG rate to 12 per cent by 2019-20 (which isn't yet legislated), they could accumulate about $810,000 in today's dollars - falling short of their target. This means they could run out of money by the time Lisa turns 81. But if they were both to sacrifice $5000 of their pre-tax salary into super for the next 10 years, they could enjoy that comfortable lifestyle until Lisa reaches age 86. If they salary-sacrificed $10,000 each, they'd have a buffer in case one of them lives until 91. This is without considering other strategies to give their super a boost, such as starting a transition-to-retirement pension when they reach 55 so they can enjoy the tax savings of super while still working.

You can do your own sums using the super calculator at mlc.com.au. This estimates how much super you might need and how much you might end up with. It allows you to dial variables up and down to see how you might bridge any gap.

Read more: http://www.smh.com.au/money/super-and-funds/reaping-the-rewards-20110809-1ijn2.html#ixzz1UlYroB75

Return to peak may take decades, says expert

Stuart Washington

August 12, 2011

A BEAR market could last 20 years before sharemarkets sustainably exceeded previous peaks, a markets researcher warned yesterday.

A director of a financial research firm, Heuristic Investment Systems, Damien Hennessy, said the S&P 500 had not yet cleared the peak it achieved in December 1999, based on total returns adjusted for inflation.

He said in two similar situations in the US - during the 1930s Great Depression and the 1960s inflation crisis - it had taken an average of 17 years before the market exceeded its previous peak, adjusted for inflation.

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''One thing that becomes fairly clear is really they don't sustainably break above their previous peak on those two occasions that have occurred to date until about 200 months - your 15 to 20-years period,'' he said.

Mr Hennessy's analysis allows for mini-bull markets to occur within the bear-market period before the previous peaks are passed.

''Sure, the 1960s poked its head above on a couple of occasions and there's big cycles within that [period] … so the big rallies occur, but in terms of passing the previous peak, it took 15 to 20 years.''

Mr Hennessy also pointed to periods in Japan during its ''lost decades'' in which investors could make returns of 40 per cent to 50 per cent.

But despite these strong runs, Japan's Topix is 45 per cent below its previous 1997 peak using the same measure of total returns, adjusted for inflation.

Mr Hennessy also highlighted the policy challenges facing governments and central banks, referring to the Great Depression experience of the US government - reining in spending just as economic recovery was taking place.

''From around about 1934 to 1936-37 you had quite a healthy pick-up in activity,'' he said. ''GDP [gross domestic product] started to expand nicely again, they were spending on cars, durables …

''Then, in 1937 you had two things happen. You had social security taxes for the first time, which basically tightened fiscal policy by about 2.5 per cent, and you also had the Fed [Federal Reserve] increase the reserve-requirement ratio,'' he said.

''So you had tightening in monetary and tightening in fiscal policy … it extended the Depression by about two years, basically, and deflation by two years.

''I think one of the issues the market has at the moment is just thinking: are we in the process of making another one of these mistakes?'' he said.

Mr Hennessy said investors' perspectives on present prospects for the sharemarket depended on their views on inflation, because either high inflation or deflation negatively affected sharemarket returns.

The annual inflation that most suited sharemarket investors was between 1 per cent and 3.5 per cent, associated with high or expanding price-earnings ratios, he said.

''A low-inflation period with low bond yields, such as the Fed is trying to achieve, could, as a scenario, sustain PEs at relatively high levels.''

http://www.smh.com.au/business/return-to-peak-may-take-decades-says-expert-20110811-1iow4.html

S&P 500 Composite Chart

Here's Why The Stock Market Is Screwed

Henry Blodget | Mar. 6, 2011, 9:31 AM 

Now that the economy is finally starting to chug along--and now that the stock market has almost doubled off its lows--everyone's bullish again.

Uh oh.

Anytime everyone's anything--bullish OR bearish--your alarm bells should start ringing.

And there's an even better reason your alarm bells should be ringing: Fundamentals.

What fundamentals?

Prices and earnings.

Stocks appear reasonably priced when measured against this year's expected earnings, but this year's expected earnings aren't normal earnings. They're earnings inflated to near-record high profit margins.

In the past, whenever we've had unusually high profit margins, we've eventually returned to normal profit margins (and below). This mean-reversion has hammered earnings growth--and, with it, the stock market.

Is that absolutely for certain going to happen this time?

Of course not. Nothing's ever certain.

But the only reason it won't happen this time is if "it's different this time."

Those of you who have had the misfortune to live through the last three stock-market crashes--and any of the stock-market crashes before that--know why "it's different this time" are described as the "four most expensive words in the English language."

Now, bulls will argue vociferously (in a variety of ways) that it IS different this time. And you should always be happy to listen to those arguments. But given that, with respect to profit margins, it has NEVER been different this time, you should view all such arguments with serious skepticism.

Importantly, of course, profit margins and price-earnings ratios tell us NOTHING about what the stock market will do this week, this month, this year, or even next year. They're just not good short-term market indicators.

What profit margins and price-earnings ratios have told us in the past, however, is what the stock market's long-term returns are likely to be. And today's combination of near-record high profit margins, combined with high P/E multiples (on normalized earnings), suggest that long-term stock returns are likely to be lousy.

Does that mean you just just dump all your stocks tomorrow?

No.

Doing anything to an extreme with respect to portfolio management is almost always a recipe for disaster, especially when you're managing your own money (as opposed to someone else's money, which is what most money managers manage).

And in the current environment, when a decade or more of high inflation seems a distinct possibility, the last thing you want to do is get caught holding only cash or bonds.

So, as ever, you should maintain a diversified portfolio of multiple asset classes, including stocks, bonds, cash, and real-estate. If the stock portion of that portfolio has inflated massively in the past two years, however, you might want to consider rebalancing.

And, for planning purposes, you shouldn't expect the stock market to deliver anything close to its long-term average return of 10% a year.

Okay, here's the story in pictures:

First, a chart from Northern Trust's Paul Kasriel. It shows corporate after-tax profit margins as a percent of GDP (with inventory adjustments) for the past half-century.

Image: Northern Trust

Note that only 5 times in the past 60 years have corporate profit margins approached the levels they're at today. And note what happened each time thereafter. (They regressed to--or beyond--the mean.)

When corporate profit margins are expanding, profits grow faster than revenue, and stock multiples usually expand (stocks track profits over the long haul).

When corporate profit margins are shrinking, profits grow more slowly than revenue, and stock multiples usually contract.

Here's another look at profit margins, from Vitaliy Katsenelson.  This one focuses on the past 30 years:

Image: Vitaly Katsenelson

Yes, there is always a possibility that we're in a "new normal" in which profit margins will keep expanding for years, if not forever. (Well, okay, not forever. Even the biggest bull would be forced to agree that, at some point, profit margins have to stop expanding, or profits will get bigger than revenue.)

Based on the history of the past 60 years, however, this seems unlikely. At several points in the past 60 years, it looked like profit margins had hit a new normal, only to see them collapse to the mean. And the odds are that the same thing will happen this time.

What could bring profit margins down?

Any of a number of things:

• Increasing commodity prices, which companies might not be able to pass through to end users

• Higher taxes, as federal and local governments try to balance their budgets

• Higher labor costs, as weak-dollar policies raise the cost of foreign manufacturing

• Deflation, as companies are forced to compete by cutting prices because consumer demand remains weak

• Recession. No one's talking about a double-dip now, but that doesn't mean we won't eventually get one. And have a look at what corporate profit margins have done in past recessions.

If corporate profit margins stay at today's high level for the next several years, the only way the stock market will deliver strong returns is if the market's P/E ratio continues to expand. Again, it's possible that the PE ratio will do this, but as the chart below from Professor Robert Shiller shows, the PE ratio is already high.

Specifically, on cyclically adjusted earnings (more on this here), today's PE ratio is about 24X, versus a long-term average of 16X.

Blue = cyclically-adjusted price earnings ratio; red = 10-year interest rate

Image: Robert Shiller

Yes, it's possible that the market's PE will stay elevated (or get even more elevated).  But it's more likely that the PE ratio will also regress to the mean.

In today's market, in other words, we have both extremely high profit margins and abnormally high PE ratios. In all previous history, both measures have tended to regress to--and beyond--the mean.

Read more: http://www.businessinsider.com/stock-market-forecast-2011-3#ixzz1UhFTUiZe

THE CRASH IN CONTEXT: Stocks Are Still ~30% Overvalued

Henry Blodget | Aug. 4, 2011, 4:23 PM |

The DOW dropped 512 points today.

And that's on top of the several hundred points it dropped last week.

The S&P 500, a broader market measure, is now down more than 12% off its recent peak.

So what does that mean?

Is it a "buying opportunity"?

Over the short-term, who knows? If this carnage keeps up, a panicked Ben Bernanke will probably rush to announce some huge new quantitative easing program. Or Congress will quickly rethink its recent commitment to "austerity" and announce trillions of new spending. And those initiatives might boost stocks for a while.

The bigger picture, however, is less encouraging. Even after the recent plunge, stocks are still about 30% overvalued when measured on "normalized" earnings--which is one of the only valuation measures that works.

Specifically, even after the crash, stocks are still trading at 21X cyclically adjusted earnings, as we can see in the following chart from Professor Robert Shiller of Yale. Over the past century, stocks have averaged about 16X those earnings. So we're still about 30% above "normal."

PE ratio = blue, 10-year interest rate = red Image: Professor Robert Shiller

In recent months, eager to suggest that stocks are "cheap," most analysts have talked about the market P/E ratio relative to next year's projected earnings. And relative to those earnings, stocks do seem modestly "cheap" (12X, or something).

Unfortunately, measuring stock values against next year's projected earnings has a couple of flaws. First, no one knows whether those projections will materialize. Second, and more important, those projected earnings assume that today's near-record-high profit margins will persist. 

Over history, corporate profit margins have been one of the most reliably "mean-reverting" metrics in the economy. When margins get extended to super-high (today) or super low (2009) levels, they generally revert toward the mean. This radically changes the PE ratio.

And measured on average profit margins, not today's super-high margins, the stock market is still expensive. (We discuss this in detail here).

Sadly, this doesn't tell you anything about what the market will do next.  As you can see in Professor Shiller's chart, the market has spent decades above and below the average.

What this PE ratio does tell you is that stocks still have lots of room to fall--30%, just to get back to normal, much more than 30% if they "overshoot."

And it also tells you that long-term returns are still likely to be sub-par.

Through history, one of the most reliable predictors of next-10-year returns is the valuation level at the beginning of the period. Today's valuation level is not as high as yesterday's. But it's still higher than average.

Read more: http://www.businessinsider.com/the-crash-in-context-stocks-are-still-30-overvalued-2011-8#ixzz1UhBL6Oxm