A Bear Market to Remember
How it's sparking richer fund analysis.
By Karen Dolan, CFA 04-16-09 06:00 AM
Stock and bond markets around the world have perked up lately, but the gloom of the past 18 months still hangs like a low dark cloud. In the years to come, we investors will surely be working to rebuild the nest eggs we've seen fractured--certainly battered, but hopefully we'll emerge a bit wiser.
Individually and as a group, our mutual fund analysts have spent a lot of time reflecting about what has happened over the past 18 months. We didn't predict how deep and severe this current crisis would become, but we're okay with that. We've never attempted to be macroeconomists or market strategists who can tell you where the Dow is headed. Our goal is to guide investors to the industry's best funds, not by focusing solely on what happened in the past, but by understanding how a fund's manager, strategy, fees, portfolio, and stewardship come together to form an investment case. We think we've done a good job achieving our goal over the long haul, but there have been cases along the way where we failed to spot the risk or challenge our own assumptions, as well as those of our readers', about investing in funds.
We've taken countless lessons away from this downturn already and we're still in the middle of learning more. The following four points don't represent a complete list of everything we've learned, but these are among the most noteworthy.
1. Value funds can lose more than you think.
Many, including us, have made the case for value-based investment strategies. Funds scrounging around the markets' bargain bin should offer better downside protection, because ignored and down-and-out stocks trading at discounts should be less susceptible to further declines. Numerous academic studies support the resiliency of value-based strategies, and some of the money managers with the best long-term records are practitioners of some flavor of value investing.
While the losses we've seen in the past 18 months have been deep, they are not the first for value funds. They got clocked by financials in 1990. The average large- and small-cap value fund lost by 6% and 14%, respectively, that year. And, although value funds looked like rock stars versus their punished growth rivals in the 2000-02 bear market, they still posted double-digit losses on average in 2002.
Any illusion of sturdiness for value funds was extinguished in this bear market, however. Value funds have posted steep losses, exceeding the slide experienced by their growth counterparts, the S&P 500 Index and value funds' own history.
I could go on for pages explaining why so many value strategies failed to preserve capital in this tough environment, but two key issues stand out. Most value funds focused too heavily on individual stocks without fully considering the bigger macroeconomic picture, and too many portfolio managers were caught holding companies with balance sheets they apparently didn't fully understand.
At the heart of the problem were the hefty financials-industry stakes in the value equity indexes and common to value funds. (Financial companies represented more than 30% of the Russell Value indexes at the market peak in October 2007.) Financials had been booming for years, so even though the stocks looked reasonably priced on common valuation metrics such as price/earnings and price/book ratios, they were indeed priced for perfection.
We gave a lot of credit (too much, in fact) to managers who were otherwise supposed to be research hounds and financial statement wizards, but who failed to recognize the embedded risks in their bank stock holdings--both in terms of overall leverage risk and asset quality. We're now spending more time finding new ways to stay on top of vulnerabilities that may be lurking in the portfolio and we're bringing an overall more skeptical mindset to our analysis of value strategies.
2. Expenses tell much of the story for bond funds, but not all of it.
Fractions of a percent have typically separated the bond-fund leaders' performance from the laggards'. Given the tight range of returns, we know that small differences in what a fund charges have proven to make a big difference in the end result for investors over the long haul.
In some cases, though, the analysis took that idea too far: cheap fund good, expensive fund bad. Our research has always been much more robust than that, but admittedly, we had a hard time seeing just how different the portfolios of fixed-income funds really were--in part because detailed bond portfolio data can be tough to come by. Until last year, an analysis of returns, interest-rate sensitivity, and sector compositions made bond funds look like they were more in line with each other than was really the case. Moreover, some bond managers really played down the risks of their strategies, often because they viewed them through the lens of some risk-management tool (which I'll tackle in greater detail in the next section).
The risks were there, though, and just waiting to blow some funds to shreds and severely hurt others. My colleague Eric Jacobson recently authored an illuminating article discussing these risks in greater details and highlighting some of the worst offenders.
The focus on expenses isn't wrong. Costs remain one of the most predictive nuggets of data we've studied. And, although expense ratios themselves didn't make or break a bond fund in 2008, there was a correlation between expenses and other behaviors that did make or break funds. The numbers confirm it. When you remove the effect of different expense ratios and look at 2008 gross returns, bond funds in the cheapest quartile ranked in the 47th percentile of their peer group while the most expensive quartile ranked in the 55th percentile. In other words, the cheapest funds got themselves into less trouble last year. This isn't a new finding. Morningstar's Don Phillips wrote a research piece about this phenomenon in 1995 called "A Deal with the Devil" where he found that bond funds with the added layer of 12b-1 fees were systematically taking on more risk, as measured by standard deviation.
Because managers are usually fighting over a couple hundredths of a percent to get ahead of their peers--something many managers are compensated for--funds operating at an expense disadvantage have a greater incentive to take "slightly" more risk to make up ground lost on expenses. When what seemed like slightly more risk turned into a lot more risk, those pricier funds were punished.
Expenses are thus still a cornerstone of our analysis, but we're taking a closer look at the bonds, derivatives, and even questioning the "so-called cash" in portfolios.
3. "Risk management" can and does fail.
Most firms use risk-management techniques. They employ sophisticated models to help summarize and quantify the risks they are taking. They package the output in fancy terms like tracking error and information ratio. However, it's all too easy to lose sight of the fact that risk management is a tool, not a panacea. Too much reliance on risk-measurement systems can and does hurt a fund if management relies on it too blindly. There is no way in which any risk-management system can appropriately account for every possible kind of outcome, especially those outcomes that have never happened in the past.
Firms known for industry-leading bond risk analytics, such as BlackRock and Fidelity, didn't dodge the big problem areas and posted some disappointing results. On the flip side, PIMCO, which also relies heavily on risk models, did much better because the firm has a well-oiled "gut-check" mechanism in place to run counter to what historical data may be signaling. It conducts an annual investment forum where the team of PIMCO investment professionals and invited guests shape their near- and long-term outlooks. Top-down considerations factor into their daily activities, too, leading to a mindset that opened the door for forward-looking inputs to make their way into the firm's risk models.
In a recent conversation about this topic, my colleague Eric Jacobson drew a comparison with a fighter pilot. Given the scads of electronics with which they now have to grapple, pilots often develop tunnel vision. A lot of training is therefore built around the need to maintain "situational awareness." At some point, it may become necessary to put the dogfight on hold to just look out the window and realize that you're flying upside down and toward a mountain.
We never gave risk models too much credence unless they were accompanied by a more fundamental and cultural aversion to risk. Yet, we've gained a greater appreciation for the danger risk models can introduce when they become a crutch for managers, leading them to believe they've accounted for the full extent of what could go wrong and not being as honest with shareholders or themselves about what may not be captured by the models.
4. There is a dear price attached to daily liquidity.
Liquidity has taken center stage in this environment. It is a big (and costly) consideration for banks, insurance companies, and corporations carrying debt--as well as for mutual funds. The underlying premise is simple and the same for all of them: If there's a mismatch between demands for money and the ability to supply it, there's vulnerability.
Daily liquidity is one of the best (and worst) things about mutual funds. There's real comfort and convenience in knowing you can cash in your shares on any given business day. But, it also introduces a big risk and one that doesn't often show its face, especially given that mutual funds have experienced money coming in more than they've had to deal with money going out--for decades. In the most extreme (and unlikely) case, all of a mutual fund's shareholders have the right to cash in all of their shares (all at once), but the fund is limited in its ability to turn around and sell its entire portfolio of securities in the open market. Some of the biggest problems have come from funds that were seeing investors flee at a faster clip than they could sell securities to meet those redemptions.
Because this had so rarely been a problem for mutual funds in the past, we did not adequately foresee just how serious a difficulty it could present to the mutual fund structure itself in a time of severe stress. Morningstar is calculating estimated fund flows now, which will help us flag funds facing outsized pressure from outflows. In addition, we plan to keep a more careful eye on portfolio changes from quarter to quarter and ask more about liquidity in manager interviews.
Conclusion
We're carrying all of these lessons into our analysis of mutual funds, but it's important to note that the key tenets of our approach remain the same. We always have and still do rely on a deep dive into a fund's manager, strategy, portfolio, stewardship, and fees to assess a fund's attractiveness for the long haul. We still believe that analysis of those factors leads to better results over long holding periods and that has proven to be the case with our Fund Analyst Picks. At the same time, we recognize there's always room for improvement and we're committed to staying on a continuous learning curve.
http://news.morningstar.com/articlenet/article.aspx?id=287023
Friday, 17 April 2009
Thursday, 16 April 2009
7 Myths About Marriage and Retirement
7 Myths About Marriage and Retirement
by Kimberly Palmer
Wednesday, April 15, 2009
Think married couples have it easy? Or that you should get your pension policy to pay out as much as possible, as soon as possible? Well, think again. Predicting that you'll die too early--or too late--can leave you and your spouse in a financial crunch. New research upends these 7 common myths about marriage and retirement:
Single people need less money. It's true that that single people spend less money each year than couples, but at all ages over 65, they spend more of their income than couples do, according to research by Michael Hurd, senior economist at Rand. Then, after age 65, single people's income goes down by three percent a year until it dwindles to 20 percent of its starting value at age 95. (For those at age 65, the probability of surviving to age 95 is around 11 percent.) Couples, meanwhile, maintain their income until the oldest member reaches age 79, when wealth starts to decline at around 3 percent a year. (On average, couples start out with three times the wealth of single people.) So while single people may need less money, they also tend to be less prepared for retirement and spend down their savings much more quickly. (Hurd's calculations are based on data from the University of Michigan Health and Retirement Study.)
Married couples have less to worry about. While married couples do tend to enter retirement with greater resources than their single peers, there is a small chance that both members of the couple will survive to old age. According to Hurd, at age 65, the chances that both survive to age 77 is less than half. Once one spouse dies, the surviving spouse tends to spend down their joint wealth much more quickly. By age 95, on average the surviving spouse has just 32 percent of the couple's initial level of wealth.
The worst case scenario is unlikely to happen. A recent survey by AARP Financial found that many people find themselves financially unprepared when the worst case scenario does strike, which compounds the tragedy. The survey, which focused on adults between ages 40 and 79, found that most (57 percent) had already experienced such a crisis, including long-term job loss, divorce, and death of a spouse or partner. Of those who lost a spouse, 63 percent said it had a significant impact on their finances.
Women are especially likely to be widowed, and to run into money problems once they are. According to the Census Bureau, more than 1 in 4 women over age 55 are widows; the proportion rises to two in three for women who are 75 and older. Divorce is another risk factor: While 12 percent of all women over age 65 live in poverty, the rate for divorced women is 21 percent, according to the Government Accountability Office.
Thinking you'll die young--or live forever. Deciding how much to save and spend depends partly on how long you plan to live, a prediction many people get wrong. According to Hurd's research, between ages 65 and 69, people tend to think they'll die sooner than they actually will, which puts them at risk for over-spending. Then, over age 75, people tend to think they'll live longer than they will, which means they may be overly frugal. Women tend to underestimate their chances of living longer compared to men. Between ages 65 to 69, women tend to underestimate their chances of survival by 12 percentage points compared to men's four, Hurd says.
Getting as much money as possible, as early as possible, is best. Many people make the mistake of opting for higher payments from pension or other benefits payments during their lifetimes, which means their surviving spouses are left with less later. Mary McGrath, executive vice president at Cozad Asset Management, a financial planning firm in Champaign, Ill., says even couples with other assets should consider selecting an option that allows benefit payments to the surviving spouse after death, because suddenly losing all income adds unnecessary stress to the grieving process. "It's too upsetting to the survivor to have all of the income cease when you die," she says.
High-earners have less to worry about. While people who earn above-average income during their working lives tend to have acquired more resources than those who earn less, they also need more money in retirement in order to maintain their lifestyle. Hurd adds that another challenge for wealthier individuals is that they pay much heftier taxes, a factor many people forget to take into account.
Retirees should maintain their wealth until age 100. You can't go wrong saving too much, but Hurd says it's reasonable to look at more realistic survival rates. He defines a household as "adequately prepared" for retirement if it has a five percent or less chance of outliving its resources if it reduced its initial spending by 15 percent. By that definition, 83 percent of couples and 70 percent of single people are prepared.
Annuities are too expensive. Hurd says that more people should consider annuities as a way to ensure they maintain their wealth as they age. Annuities, or contracts with insurance companies that allow consumers to purchase a guaranteed income stream, tend to be under-used because people hesitate to pay a large lump sum now for a payout much later. "In my view, individuals are likely distrustful that the annuity will be there in 25 or 30 years when it is needed," says Hurd. But, he adds, "even partial annuitization would reduce the burden of managing the level of spending and the portfolio."
Copyrighted, U.S.News & World Report, L.P. All rights reserved.
http://finance.yahoo.com/focus-retirement/article/106918/7-Myths-About-Marriage-and-Retirement?mod=fidelity-startingout
More from USNews.com: •
Smart Money Savings Tips You Need Now •
TwentySomething Finanancial Survival Guide •
How to Plan for Your Financial Future
Focus on Lifelong Investing
View more stories
by Kimberly Palmer
Wednesday, April 15, 2009
Think married couples have it easy? Or that you should get your pension policy to pay out as much as possible, as soon as possible? Well, think again. Predicting that you'll die too early--or too late--can leave you and your spouse in a financial crunch. New research upends these 7 common myths about marriage and retirement:
Single people need less money. It's true that that single people spend less money each year than couples, but at all ages over 65, they spend more of their income than couples do, according to research by Michael Hurd, senior economist at Rand. Then, after age 65, single people's income goes down by three percent a year until it dwindles to 20 percent of its starting value at age 95. (For those at age 65, the probability of surviving to age 95 is around 11 percent.) Couples, meanwhile, maintain their income until the oldest member reaches age 79, when wealth starts to decline at around 3 percent a year. (On average, couples start out with three times the wealth of single people.) So while single people may need less money, they also tend to be less prepared for retirement and spend down their savings much more quickly. (Hurd's calculations are based on data from the University of Michigan Health and Retirement Study.)
Married couples have less to worry about. While married couples do tend to enter retirement with greater resources than their single peers, there is a small chance that both members of the couple will survive to old age. According to Hurd, at age 65, the chances that both survive to age 77 is less than half. Once one spouse dies, the surviving spouse tends to spend down their joint wealth much more quickly. By age 95, on average the surviving spouse has just 32 percent of the couple's initial level of wealth.
The worst case scenario is unlikely to happen. A recent survey by AARP Financial found that many people find themselves financially unprepared when the worst case scenario does strike, which compounds the tragedy. The survey, which focused on adults between ages 40 and 79, found that most (57 percent) had already experienced such a crisis, including long-term job loss, divorce, and death of a spouse or partner. Of those who lost a spouse, 63 percent said it had a significant impact on their finances.
Women are especially likely to be widowed, and to run into money problems once they are. According to the Census Bureau, more than 1 in 4 women over age 55 are widows; the proportion rises to two in three for women who are 75 and older. Divorce is another risk factor: While 12 percent of all women over age 65 live in poverty, the rate for divorced women is 21 percent, according to the Government Accountability Office.
Thinking you'll die young--or live forever. Deciding how much to save and spend depends partly on how long you plan to live, a prediction many people get wrong. According to Hurd's research, between ages 65 and 69, people tend to think they'll die sooner than they actually will, which puts them at risk for over-spending. Then, over age 75, people tend to think they'll live longer than they will, which means they may be overly frugal. Women tend to underestimate their chances of living longer compared to men. Between ages 65 to 69, women tend to underestimate their chances of survival by 12 percentage points compared to men's four, Hurd says.
Getting as much money as possible, as early as possible, is best. Many people make the mistake of opting for higher payments from pension or other benefits payments during their lifetimes, which means their surviving spouses are left with less later. Mary McGrath, executive vice president at Cozad Asset Management, a financial planning firm in Champaign, Ill., says even couples with other assets should consider selecting an option that allows benefit payments to the surviving spouse after death, because suddenly losing all income adds unnecessary stress to the grieving process. "It's too upsetting to the survivor to have all of the income cease when you die," she says.
High-earners have less to worry about. While people who earn above-average income during their working lives tend to have acquired more resources than those who earn less, they also need more money in retirement in order to maintain their lifestyle. Hurd adds that another challenge for wealthier individuals is that they pay much heftier taxes, a factor many people forget to take into account.
Retirees should maintain their wealth until age 100. You can't go wrong saving too much, but Hurd says it's reasonable to look at more realistic survival rates. He defines a household as "adequately prepared" for retirement if it has a five percent or less chance of outliving its resources if it reduced its initial spending by 15 percent. By that definition, 83 percent of couples and 70 percent of single people are prepared.
Annuities are too expensive. Hurd says that more people should consider annuities as a way to ensure they maintain their wealth as they age. Annuities, or contracts with insurance companies that allow consumers to purchase a guaranteed income stream, tend to be under-used because people hesitate to pay a large lump sum now for a payout much later. "In my view, individuals are likely distrustful that the annuity will be there in 25 or 30 years when it is needed," says Hurd. But, he adds, "even partial annuitization would reduce the burden of managing the level of spending and the portfolio."
Copyrighted, U.S.News & World Report, L.P. All rights reserved.
http://finance.yahoo.com/focus-retirement/article/106918/7-Myths-About-Marriage-and-Retirement?mod=fidelity-startingout
More from USNews.com: •
Smart Money Savings Tips You Need Now •
TwentySomething Finanancial Survival Guide •
How to Plan for Your Financial Future
Focus on Lifelong Investing
View more stories
Wednesday, 15 April 2009
Has the bubble finally burst for capitalism? What may lie ahead?
The Sunday Times
April 12, 2009
Has the bubble finally burst for capitalism?
Global capitalism has been rescued from the brink of collapse by huge state bailouts.
Newsnight’s economics editor looks at what may lie ahead
Paul Mason
Hyman Minsky was an economics professor at Washington University, St Louis, who died in 1996. He was ignored by the political establishment and treated as crazy. Once you understand his theory, you can see why. He warned: “The normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciations, unemployment and poverty in the middle of what could be virtually universal affluence – in short . . . financially complex capitalism is inherently flawed.”
Minsky showed that speculative bubbles, and the financial collapses that follow them, are an integral part of modern capitalism. That is, they are not the result of accidents or poor decision-making, but a fundamental and recurrent feature of economic life once you deregulate the financial system.
He pointed out that, given sustained economic growth, there was a tendency for the finance system to move from a situation where everything is under control, to a speculative situation, which is precarious.
Minsky’s proposed solution to financial crisis was state intervention on two fronts:
the government should run a big budget deficit and
the central bank should pump money into the economy.
It will be noted, despite Minsky’s pariah status in economics, that his remedy is exactly what has been adopted – in America, Britain, the eurozone and much of the developed world. The problem is, it has not so far worked. Trillions of dollars of ready money, tax cuts and state spending were shovelled into the world economy to stop the credit crunch producing another Great Depression. Yet all these trillions are up against a collapse in the real economy.
Fortunately, Minsky had spent his time musing on a more permanent solution: the socialisation of the banking system. This he conceived not as an anticapitalist measure, but as the only possible form of a high-consumption, stable capitalism in the future. Minsky argued: “As socialisation of the towering heights is fully compatible with a large, growing and prosperous private sector, this high-consumption synthesis might well be conducive to greater freedom for entrepreneurial ability and daring than is our present structure.”
Minsky never spelled out the details of how it might be done. But there is no need to do so now. Stumbling through the underground passageways of Downing Street on the morning of October 8, 2008, I saw it happen. Tetchy and bleary-eyed, fuelled by stale coffee and take-away food, British civil servants had designed and executed it in the space of 48 hours. Within 10 days, much of the western world’s banking system had been stabilised by massive injections of state credit and state capital.
The state takeover of large parts of the banking sector was seen – like the tax cuts and liquidity injections – as a way of speeding the return to the “normality” of the past decade. It is also clear, on the basis of conversations with senior UK policymakers, that the consensus by the time of the Washington G20 summit last November was that the recession would be a blur, a sharp V-shape, over by mid 2009.
In reality, the world is facing a much more strategic problem: its growth model is in crisis, and the banking business model is in crisis.
“A VORACIOUS APPETITE for economic growth lies at the heart of the boom that has now gone bust,” wrote Morgan Stanley economist Stephen Roach on the eve of the meltdown. It is worth reiterating just how spectacular that growth has been, and how spectacularly uneven. In 2007 global GDP growth was 5% – well above its historic trend – for the fourth year in a row. Growth in the developing world averaged 8%; and in Asia it was 10%. Across the G7 countries it was 2.6% – slightly below the average for the 1990s. Roach summed up the problem: “An income-short US economy rejected a slower pace of domestic demand. It turned, instead, to an asset-and debt-financed growth binge . . . For the developing world, rapid growth was a powerful antidote to a legacy of wrenching poverty. And the hyper-growth that was realised in regions like developing Asia became the end that justified all means – including . . . inflation, pollution, environmental degradation, widening income disparities, and periodic asset bubbles. The world’s body politic wanted – and still wants – growth at all costs.”
He concluded: “This crisis is a strong signal that these strategies are not sustainable.” But if the old growth model has reached a dead end, what can follow it?
There are three rational options for the developed world. The first is to revive the high-debt / low-wage model under more controlled conditions; the second is to abandon high growth as an objective altogether; the third is to find a radically different basis for high growth, with a return to higher wages, redistribution and a highly regulated finance system.
The first course of action is implicit in the approach agreed last November at the Washington G20 summit. In the summit communiqu̩, globalised markets and free trade are treated as hallowed principles, as is the national basis of regulation. Regulation would be more coordinated, there would be more information sharing, governments would commit to do better next time Рbut the only concrete measures to reregulate the system remained disputed. Even within the EU there was strong resistance to a single banking regulator, as London, Frankfurt and Milan vied with each other to become global banking centres on the basis of different regulatory systems.
The second solution embraces the end of a high-growth, high-consumption economy: if it can’t be driven by wages, debt or public spending, then it can’t exist. And if it can’t exist in the West, then Asia’s model of high exports and high savings does not work either. In previous eras, any proposal to revert to a low-growth economy would have been regarded as barbarism and regression. Yet there is a strong sentiment among the antiglobalisation and green movements in favour of this solution. And it has found echoes in mass consciousness as the world has come to understand the dangers of global warming. The problem is that it is only an option for the developed world: every slum-dweller and roadside migrant labourer I have ever met south of the equator had electricity and a flush toilet high on their wish list, which will need high growth for at least another couple of decades – possibly half a century.
As for the third option – a high-growth economy that transcends the limitations of both Keynesian and neoliberal models– it was Minsky who spelled out how it could be achieved: nationalise the banking and insurance system; place strict limits on speculative finance; change the tax structure to decrease inequality so that the bottom half of the income scale benefits from growth, and growth itself sustains consumer demand rather than debt. Finally, limit the power of huge companies so that you create permanently benign conditions for entrepreneurs.
This, it should be stressed, was Minsky’s prescription to rescue capitalism, not to destroy it, though the outcome would seem highly “anticapitalist” to anybody who defines capitalism as being essentially about free markets.
Surreally, as this book goes to press, large parts of the Western financial system are either semi-nationalised or on life-support with taxpayers’ money. New laws to limit speculation are being formulated. A blunt form of the Minsky solution has been improvised as a crisis measure, but it leaves many questions unanswered.
It is uncharted territory for the bankers, but actually we have long experience of what happens when companies cannot make money, form a monopoly through mergers and acquisitions, and are essential to the functioning of the rest of business. They are called utilities. Many believe banking is now about to become just like a utility: heavily regulated, low-profit, orientated by law to achieve a social aim rather thana financial one. This prospect has already got some in the banking industry so depressed that they are predicting the mass departure of the teams engaged in the high-risk parts of the banking business into the hedge-fund and consultancy businesses.
With low-profit, utility-style commercial banking, the question then arises: if banks are being asked to meet social objectives, like avoiding home repossessions or continued lending to small businesses, and are already supported by vast quantities of state finance, would it not be more efficient for the state to own key parts of the banking sector? One senior figure in the industry told me: “Once they become low-profit utilities, I don’t really care whether they stay in the private sector or are nationalised – they’re just doing the same thing.”
In short, reality is pushing the banking industry towards a utility-style solution. The result could be some form of “mixed economy” in banking, with a base layer provided by a state-owned lender, large utility banks on top, and then a big gap between this world and a slimmed-down speculative sector.
As the crisis worsens, it is becoming common for pundits to observe that, although capitalism is collapsing, nobody has thought of an alternative. This is not true. The Minsky alternative – a socialised banking system plus wealth redistribution – is, I believe, the ground on which the most radical of the capitalist reregulators will coalesce with social-justice activists. And it may even go mainstream if the only alternative is low growth, decades of debt-imposed stagnation, or another rerun of this crisis a few years down the line.
© Paul Mason 2009 Extracted from Meltdown: The End of the Age of Greed, to be published by Verso on April 27 at £7.99. Available from The Sunday Times Books First at £7.59 (including postage and packaging) on 0845 271 2135 or at timesonline.co.uk/booksfirst
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6078127.ece
April 12, 2009
Has the bubble finally burst for capitalism?
Global capitalism has been rescued from the brink of collapse by huge state bailouts.
Newsnight’s economics editor looks at what may lie ahead
Paul Mason
Hyman Minsky was an economics professor at Washington University, St Louis, who died in 1996. He was ignored by the political establishment and treated as crazy. Once you understand his theory, you can see why. He warned: “The normal functioning of our economy leads to financial trauma and crises, inflation, currency depreciations, unemployment and poverty in the middle of what could be virtually universal affluence – in short . . . financially complex capitalism is inherently flawed.”
Minsky showed that speculative bubbles, and the financial collapses that follow them, are an integral part of modern capitalism. That is, they are not the result of accidents or poor decision-making, but a fundamental and recurrent feature of economic life once you deregulate the financial system.
He pointed out that, given sustained economic growth, there was a tendency for the finance system to move from a situation where everything is under control, to a speculative situation, which is precarious.
Minsky’s proposed solution to financial crisis was state intervention on two fronts:
the government should run a big budget deficit and
the central bank should pump money into the economy.
It will be noted, despite Minsky’s pariah status in economics, that his remedy is exactly what has been adopted – in America, Britain, the eurozone and much of the developed world. The problem is, it has not so far worked. Trillions of dollars of ready money, tax cuts and state spending were shovelled into the world economy to stop the credit crunch producing another Great Depression. Yet all these trillions are up against a collapse in the real economy.
Fortunately, Minsky had spent his time musing on a more permanent solution: the socialisation of the banking system. This he conceived not as an anticapitalist measure, but as the only possible form of a high-consumption, stable capitalism in the future. Minsky argued: “As socialisation of the towering heights is fully compatible with a large, growing and prosperous private sector, this high-consumption synthesis might well be conducive to greater freedom for entrepreneurial ability and daring than is our present structure.”
Minsky never spelled out the details of how it might be done. But there is no need to do so now. Stumbling through the underground passageways of Downing Street on the morning of October 8, 2008, I saw it happen. Tetchy and bleary-eyed, fuelled by stale coffee and take-away food, British civil servants had designed and executed it in the space of 48 hours. Within 10 days, much of the western world’s banking system had been stabilised by massive injections of state credit and state capital.
The state takeover of large parts of the banking sector was seen – like the tax cuts and liquidity injections – as a way of speeding the return to the “normality” of the past decade. It is also clear, on the basis of conversations with senior UK policymakers, that the consensus by the time of the Washington G20 summit last November was that the recession would be a blur, a sharp V-shape, over by mid 2009.
In reality, the world is facing a much more strategic problem: its growth model is in crisis, and the banking business model is in crisis.
“A VORACIOUS APPETITE for economic growth lies at the heart of the boom that has now gone bust,” wrote Morgan Stanley economist Stephen Roach on the eve of the meltdown. It is worth reiterating just how spectacular that growth has been, and how spectacularly uneven. In 2007 global GDP growth was 5% – well above its historic trend – for the fourth year in a row. Growth in the developing world averaged 8%; and in Asia it was 10%. Across the G7 countries it was 2.6% – slightly below the average for the 1990s. Roach summed up the problem: “An income-short US economy rejected a slower pace of domestic demand. It turned, instead, to an asset-and debt-financed growth binge . . . For the developing world, rapid growth was a powerful antidote to a legacy of wrenching poverty. And the hyper-growth that was realised in regions like developing Asia became the end that justified all means – including . . . inflation, pollution, environmental degradation, widening income disparities, and periodic asset bubbles. The world’s body politic wanted – and still wants – growth at all costs.”
He concluded: “This crisis is a strong signal that these strategies are not sustainable.” But if the old growth model has reached a dead end, what can follow it?
There are three rational options for the developed world. The first is to revive the high-debt / low-wage model under more controlled conditions; the second is to abandon high growth as an objective altogether; the third is to find a radically different basis for high growth, with a return to higher wages, redistribution and a highly regulated finance system.
The first course of action is implicit in the approach agreed last November at the Washington G20 summit. In the summit communiqu̩, globalised markets and free trade are treated as hallowed principles, as is the national basis of regulation. Regulation would be more coordinated, there would be more information sharing, governments would commit to do better next time Рbut the only concrete measures to reregulate the system remained disputed. Even within the EU there was strong resistance to a single banking regulator, as London, Frankfurt and Milan vied with each other to become global banking centres on the basis of different regulatory systems.
The second solution embraces the end of a high-growth, high-consumption economy: if it can’t be driven by wages, debt or public spending, then it can’t exist. And if it can’t exist in the West, then Asia’s model of high exports and high savings does not work either. In previous eras, any proposal to revert to a low-growth economy would have been regarded as barbarism and regression. Yet there is a strong sentiment among the antiglobalisation and green movements in favour of this solution. And it has found echoes in mass consciousness as the world has come to understand the dangers of global warming. The problem is that it is only an option for the developed world: every slum-dweller and roadside migrant labourer I have ever met south of the equator had electricity and a flush toilet high on their wish list, which will need high growth for at least another couple of decades – possibly half a century.
As for the third option – a high-growth economy that transcends the limitations of both Keynesian and neoliberal models– it was Minsky who spelled out how it could be achieved: nationalise the banking and insurance system; place strict limits on speculative finance; change the tax structure to decrease inequality so that the bottom half of the income scale benefits from growth, and growth itself sustains consumer demand rather than debt. Finally, limit the power of huge companies so that you create permanently benign conditions for entrepreneurs.
This, it should be stressed, was Minsky’s prescription to rescue capitalism, not to destroy it, though the outcome would seem highly “anticapitalist” to anybody who defines capitalism as being essentially about free markets.
Surreally, as this book goes to press, large parts of the Western financial system are either semi-nationalised or on life-support with taxpayers’ money. New laws to limit speculation are being formulated. A blunt form of the Minsky solution has been improvised as a crisis measure, but it leaves many questions unanswered.
It is uncharted territory for the bankers, but actually we have long experience of what happens when companies cannot make money, form a monopoly through mergers and acquisitions, and are essential to the functioning of the rest of business. They are called utilities. Many believe banking is now about to become just like a utility: heavily regulated, low-profit, orientated by law to achieve a social aim rather thana financial one. This prospect has already got some in the banking industry so depressed that they are predicting the mass departure of the teams engaged in the high-risk parts of the banking business into the hedge-fund and consultancy businesses.
With low-profit, utility-style commercial banking, the question then arises: if banks are being asked to meet social objectives, like avoiding home repossessions or continued lending to small businesses, and are already supported by vast quantities of state finance, would it not be more efficient for the state to own key parts of the banking sector? One senior figure in the industry told me: “Once they become low-profit utilities, I don’t really care whether they stay in the private sector or are nationalised – they’re just doing the same thing.”
In short, reality is pushing the banking industry towards a utility-style solution. The result could be some form of “mixed economy” in banking, with a base layer provided by a state-owned lender, large utility banks on top, and then a big gap between this world and a slimmed-down speculative sector.
As the crisis worsens, it is becoming common for pundits to observe that, although capitalism is collapsing, nobody has thought of an alternative. This is not true. The Minsky alternative – a socialised banking system plus wealth redistribution – is, I believe, the ground on which the most radical of the capitalist reregulators will coalesce with social-justice activists. And it may even go mainstream if the only alternative is low growth, decades of debt-imposed stagnation, or another rerun of this crisis a few years down the line.
© Paul Mason 2009 Extracted from Meltdown: The End of the Age of Greed, to be published by Verso on April 27 at £7.99. Available from The Sunday Times Books First at £7.59 (including postage and packaging) on 0845 271 2135 or at timesonline.co.uk/booksfirst
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6078127.ece
What will happen in more politically unstable Asian countries
From The TimesApril 15, 2009
And if it can happen in Singapore...
With more bad economic news out of the city state, the worry is what will happen in more politically unstable Asian countries
David Wighton: Business editor's commentary
They are not talking about green shoots in Singapore, at least not economic ones.
The city state's central bank effectively devalued its currency yesterday as figures showed that the economy shrank by an extraordinary 11.5 per cent in the first quarter compared with a year earlier.
The Government revised its forecast for the full year to a slump of between 6 and 9 per cent.
So successful for so long, Singapore is heavily exposed to sectors hardest hit in the current downturn - finance, shipping and manufacturing. Exports were down 17 per cent in the first quarter.
The very modest devaluation will not help much - at least until export markets pick up - and the authorities will be wary of a bigger depreciation of the currency in case it undermines the confidence of international investors.
Analysts believe the downturn may prompt an exodus of expatriate workers undermining the efforts to encourage immigration and turn Singapore into a finance hub for South East Asia.
The worry is that where Singapore goes, other less politically stable Asian countries may follow.
http://business.timesonline.co.uk/tol/business/columnists/article6094612.ece
And if it can happen in Singapore...
With more bad economic news out of the city state, the worry is what will happen in more politically unstable Asian countries
David Wighton: Business editor's commentary
They are not talking about green shoots in Singapore, at least not economic ones.
The city state's central bank effectively devalued its currency yesterday as figures showed that the economy shrank by an extraordinary 11.5 per cent in the first quarter compared with a year earlier.
The Government revised its forecast for the full year to a slump of between 6 and 9 per cent.
So successful for so long, Singapore is heavily exposed to sectors hardest hit in the current downturn - finance, shipping and manufacturing. Exports were down 17 per cent in the first quarter.
The very modest devaluation will not help much - at least until export markets pick up - and the authorities will be wary of a bigger depreciation of the currency in case it undermines the confidence of international investors.
Analysts believe the downturn may prompt an exodus of expatriate workers undermining the efforts to encourage immigration and turn Singapore into a finance hub for South East Asia.
The worry is that where Singapore goes, other less politically stable Asian countries may follow.
http://business.timesonline.co.uk/tol/business/columnists/article6094612.ece
Survivors of crisis find a silver lining
From The TimesApril 15, 2009
Survivors of crisis find a silver lining
David Wighton: Business editor's commentary
For a moment, it looked just like the good old days. Goldman Sachs' profits soar way above forecasts to $1.8billion in the first quarter as it plans for a 20 per cent pay rise for staff. Crisis, what crisis?
Except, of course, the crisis has had a big impact on Goldman. It is just that the impact on Goldman - and rivals such as Barclays Capital - has not been all bad.
The reason that Goldman's huge fixed income, currency and commodities arm generated record revenues of $6.56 billion was not that its customers did record business, although volumes were healthy enough.
It was because half of its competitors have blown themselves up and many of the others are wandering around in a daze. As a result, customers are having to pay up to get trades done.
The spread between the buying and selling prices for everything from sterling to silver has widened dramatically, fattening up Goldman's margins a treat.
These trading profits absorbed continued losses in credit products, including about $800 million before hedges on commercial mortgage loans and securities.
Elsewhere things were not so pretty. Equities trading, the advisory businesses and asset management were all down and there were further losses from property and other investments.
The returns to shareholders have been diluted by the big increase in Goldman's capital, which is now being expanded by another $5billion, which may be used to pay off the $10 billion owed to the US Government.
But Goldman still managed to generate a return on equity of 14 per cent.
The speed with which the underlying business of the surviving investment banks seems to be bouncing back must make companies in other stricken sectors look on with incredulity.
Boston Consulting Group has constructed a “bull” case that has global investment banking net revenues before writedowns reaching $374billion next year.
That is 15 per cent higher than the record level of 2007. Even its “bear” case of $258billion is not far off the level of 2006. Returns will not be as high, because of lower leverage, but then the cake will be shared out between fewer mouths.
The Goldman figures looked particularly encouraging for Barclays.
Thanks partly to its rescue of Lehman Brothers' US business last year, Barclays Capital is strong in all those areas where Goldman reported good results - particularly debt, currencies and commodities - and smaller in those areas that struggled.
London investors took note and Barclays shares jumped another 10per cent to 195.5p yesterday, four times their low in January.
A lot could still go wrong. But the history of previous banking crises shows that the survivors not only live but live well. Those that double up at the bottom, like Barclays, can live very well indeed.
http://www.timesonline.co.uk/tol/comment/columnists/article6094574.ece
Related Links
Another 'triumph' for the PPI industry
And if it can happen in Singapore...
Survivors of crisis find a silver lining
David Wighton: Business editor's commentary
For a moment, it looked just like the good old days. Goldman Sachs' profits soar way above forecasts to $1.8billion in the first quarter as it plans for a 20 per cent pay rise for staff. Crisis, what crisis?
Except, of course, the crisis has had a big impact on Goldman. It is just that the impact on Goldman - and rivals such as Barclays Capital - has not been all bad.
The reason that Goldman's huge fixed income, currency and commodities arm generated record revenues of $6.56 billion was not that its customers did record business, although volumes were healthy enough.
It was because half of its competitors have blown themselves up and many of the others are wandering around in a daze. As a result, customers are having to pay up to get trades done.
The spread between the buying and selling prices for everything from sterling to silver has widened dramatically, fattening up Goldman's margins a treat.
These trading profits absorbed continued losses in credit products, including about $800 million before hedges on commercial mortgage loans and securities.
Elsewhere things were not so pretty. Equities trading, the advisory businesses and asset management were all down and there were further losses from property and other investments.
The returns to shareholders have been diluted by the big increase in Goldman's capital, which is now being expanded by another $5billion, which may be used to pay off the $10 billion owed to the US Government.
But Goldman still managed to generate a return on equity of 14 per cent.
The speed with which the underlying business of the surviving investment banks seems to be bouncing back must make companies in other stricken sectors look on with incredulity.
Boston Consulting Group has constructed a “bull” case that has global investment banking net revenues before writedowns reaching $374billion next year.
That is 15 per cent higher than the record level of 2007. Even its “bear” case of $258billion is not far off the level of 2006. Returns will not be as high, because of lower leverage, but then the cake will be shared out between fewer mouths.
The Goldman figures looked particularly encouraging for Barclays.
Thanks partly to its rescue of Lehman Brothers' US business last year, Barclays Capital is strong in all those areas where Goldman reported good results - particularly debt, currencies and commodities - and smaller in those areas that struggled.
London investors took note and Barclays shares jumped another 10per cent to 195.5p yesterday, four times their low in January.
A lot could still go wrong. But the history of previous banking crises shows that the survivors not only live but live well. Those that double up at the bottom, like Barclays, can live very well indeed.
http://www.timesonline.co.uk/tol/comment/columnists/article6094574.ece
Related Links
Another 'triumph' for the PPI industry
And if it can happen in Singapore...
Intel claims PC market has 'bottomed out'
From Times Online
April 15, 2009
Intel claims PC market has 'bottomed out'
Alexi Mostrous
Intel claimed today that the downturn in the personal computer sector had bottomed out, even as its shares slid nearly 6 per cent after economic uncertainty prevented it from offering financial forecasts for the rest of 2009.
The chip-making giant said that personal computer sales hit a trough in the first quarter but there was still too much market and economic turbulence to allow a precise projection for the second quarter.
However, Paul Otellini, president and chief executive of Intel, said: “We believe PC sales bottomed out during the first quarter and the industry is returning to normal seasonal patterns.” Stacy Smith, Intel's chief financial officer, added: “I believe the worst is now behind us.”
Intel reported a net profit in the three months ending March 28 of $647 million (£436 million) down 55 per cent from $1.44 billion, a year ago but above analysts' expectations.
Although earnings per share were more than three times the average Wall Street forecast, they were helped by a drastically lower effective tax rate of one per cent in the quarter, versus internal expectations of 27 per cent, analysts said.
Intel said its revenues in the first quarter of 2009 had slumped to $7.1 billion or 26 per cent lower than a year before, as chip demand hit a low point. Operating income was down 68 per cent at $670 million compared to the same period the year before.
Shares of the chip giant, a bellwether for the market and the global PC industry, fell during after-hours trading to $15.20 from a close of $16.01. Before yesterday, Intel stock had leapt 32 per cent from a 2009 low point of $12.01.
Gross margins at the company came to 45.6 per cent in the first quarter, compared to 53.1 per cent in the fourth quarter of 2008 but higher than analysts’ expectations.
“I would have liked to see higher gross margin guidance,” Edward Jones analyst Bill Kreher told Reuters. “The stock has had heck of a run in recent weeks, so it may be time for a breather here given that visibility does remain limited.”
Intel executives said that the timing of the eventual recovery was uncertain. “The company is currently planning for revenue [in Q2] approximately flat to the first quarter,” the company said.
Intel admitted that the “current uncertainty in global economic conditions makes it particularly difficult to predict product demand.”
In a statement, Intel also identified possible effects of the credit crisis on its business, including “insolvency of key suppliers resulting in product delays; inability of customers to obtain credit to finance purchases of our products, customer insolvencies; counterparty failures negatively impacting our treasury operations and increased expense or inability to obtain short term financing of Intel’s operations.”
Intel, which controls 80 per cent of the microprocessor market and is larger than rival Advanced Micro Devices, is a barometer of overall IT industry health.
The corporation had put out successive revenue warnings since late 2008 and cautioned it would be shutting or scaling down plants across Asia and the US and trimming jobs. On Tuesday, executives said the company had rid itself of 1,400 employees since the fourth quarter.
Speaking of the personal computer sector in general, Nathan Brookwood, a research fellow at Insight 64, said: “Things are no longer looking completely dark. There is light at the end of the tunnel. It would be even better if people were feeling good enough about it that they could put stakes in the ground ... (with) a revenue estimate.”
http://business.timesonline.co.uk/tol/business/industry_sectors/technology/article6096192.ece
April 15, 2009
Intel claims PC market has 'bottomed out'
Alexi Mostrous
Intel claimed today that the downturn in the personal computer sector had bottomed out, even as its shares slid nearly 6 per cent after economic uncertainty prevented it from offering financial forecasts for the rest of 2009.
The chip-making giant said that personal computer sales hit a trough in the first quarter but there was still too much market and economic turbulence to allow a precise projection for the second quarter.
However, Paul Otellini, president and chief executive of Intel, said: “We believe PC sales bottomed out during the first quarter and the industry is returning to normal seasonal patterns.” Stacy Smith, Intel's chief financial officer, added: “I believe the worst is now behind us.”
Intel reported a net profit in the three months ending March 28 of $647 million (£436 million) down 55 per cent from $1.44 billion, a year ago but above analysts' expectations.
Although earnings per share were more than three times the average Wall Street forecast, they were helped by a drastically lower effective tax rate of one per cent in the quarter, versus internal expectations of 27 per cent, analysts said.
Intel said its revenues in the first quarter of 2009 had slumped to $7.1 billion or 26 per cent lower than a year before, as chip demand hit a low point. Operating income was down 68 per cent at $670 million compared to the same period the year before.
Shares of the chip giant, a bellwether for the market and the global PC industry, fell during after-hours trading to $15.20 from a close of $16.01. Before yesterday, Intel stock had leapt 32 per cent from a 2009 low point of $12.01.
Gross margins at the company came to 45.6 per cent in the first quarter, compared to 53.1 per cent in the fourth quarter of 2008 but higher than analysts’ expectations.
“I would have liked to see higher gross margin guidance,” Edward Jones analyst Bill Kreher told Reuters. “The stock has had heck of a run in recent weeks, so it may be time for a breather here given that visibility does remain limited.”
Intel executives said that the timing of the eventual recovery was uncertain. “The company is currently planning for revenue [in Q2] approximately flat to the first quarter,” the company said.
Intel admitted that the “current uncertainty in global economic conditions makes it particularly difficult to predict product demand.”
In a statement, Intel also identified possible effects of the credit crisis on its business, including “insolvency of key suppliers resulting in product delays; inability of customers to obtain credit to finance purchases of our products, customer insolvencies; counterparty failures negatively impacting our treasury operations and increased expense or inability to obtain short term financing of Intel’s operations.”
Intel, which controls 80 per cent of the microprocessor market and is larger than rival Advanced Micro Devices, is a barometer of overall IT industry health.
The corporation had put out successive revenue warnings since late 2008 and cautioned it would be shutting or scaling down plants across Asia and the US and trimming jobs. On Tuesday, executives said the company had rid itself of 1,400 employees since the fourth quarter.
Speaking of the personal computer sector in general, Nathan Brookwood, a research fellow at Insight 64, said: “Things are no longer looking completely dark. There is light at the end of the tunnel. It would be even better if people were feeling good enough about it that they could put stakes in the ground ... (with) a revenue estimate.”
http://business.timesonline.co.uk/tol/business/industry_sectors/technology/article6096192.ece
Singapore devalues currency after GDP plunge
From The TimesApril 15, 2009
Singapore devalues currency after GDP plunge
Leo Lewis
Singapore’s central bank effectively devalued the city state’s currency yesterday as its Government warned that the global economic crisis would bring the worst economic plunge on record.
Singapore’s unprecedented contraction between January and March was described by analysts as “horrendous”. First-quarter GDP shrank by 11.5 per cent compared with a year earlier, far outstripping analysts’ predictions.
But worse was the Government’s dramatic revision of GDP forecasts for the full year, said traders in Singapore dealing rooms. Previous forecasts of a 5 per cent contraction were revised to one of between 6 per cent and 9 per cent. It was the third time forecasts have been adjusted in the past five months.
Economists rushed to recalculate their outlooks for Singapore and what one told The Times were the “diminishing prospects of an early recovery”.
The Trade Ministry said that recent, tentative signs of stability in, for example, the US housing market, did not yet amount to clear signs of a turnaround. The Monetary Authority of Singapore (MAS) — the central bank — said that “considerable downside risks to growth remain”. That was one of the reasons the MAS gave for easing monetary policy for only the second time since 2003.
The Singapore dollar moves within a trade-weighted band, which is set by the MAS. Moving the entire band lower, as the central bank did yesterday, leads to the currency undergoing an instant devaluation.
Singapore’s dollar advanced as much as 1.2 per cent to S$1.4965 against the US dollar, the strongest level in two months, after the MAS recentered the trading band. It said it does not plan to seek either appreciation or depreciation.
http://business.timesonline.co.uk/tol/business/economics/article6094207.ece
Related Links
Singapore faces devastating exodus of foreigners
Asian central banks step in as turbulence hits
Singapore devalues currency after GDP plunge
Leo Lewis
Singapore’s central bank effectively devalued the city state’s currency yesterday as its Government warned that the global economic crisis would bring the worst economic plunge on record.
Singapore’s unprecedented contraction between January and March was described by analysts as “horrendous”. First-quarter GDP shrank by 11.5 per cent compared with a year earlier, far outstripping analysts’ predictions.
But worse was the Government’s dramatic revision of GDP forecasts for the full year, said traders in Singapore dealing rooms. Previous forecasts of a 5 per cent contraction were revised to one of between 6 per cent and 9 per cent. It was the third time forecasts have been adjusted in the past five months.
Economists rushed to recalculate their outlooks for Singapore and what one told The Times were the “diminishing prospects of an early recovery”.
The Trade Ministry said that recent, tentative signs of stability in, for example, the US housing market, did not yet amount to clear signs of a turnaround. The Monetary Authority of Singapore (MAS) — the central bank — said that “considerable downside risks to growth remain”. That was one of the reasons the MAS gave for easing monetary policy for only the second time since 2003.
The Singapore dollar moves within a trade-weighted band, which is set by the MAS. Moving the entire band lower, as the central bank did yesterday, leads to the currency undergoing an instant devaluation.
Singapore’s dollar advanced as much as 1.2 per cent to S$1.4965 against the US dollar, the strongest level in two months, after the MAS recentered the trading band. It said it does not plan to seek either appreciation or depreciation.
http://business.timesonline.co.uk/tol/business/economics/article6094207.ece
Related Links
Singapore faces devastating exodus of foreigners
Asian central banks step in as turbulence hits
Tuesday, 14 April 2009
Buffett queried on 'buy and hold' on CNBC
"Buy and hold" strategy. Is this strategy dead?
In a recent CNBC interview, Warren Buffett was asked by a sender of email regarding buy and hold strategy. His reply was a short one. This strategy works for certain selected stocks. He added other strategies can be profitable for some too.
My comments:
Stock selection is of course very important. This can be achieved through applying the right investing knowledge, diligent study of the company and hard work.
Over the short-term, you will probably be right (positive returns) 50% of the time. However, over the long-term, you are more likely to be right most of the time.
Be sure to ride the winners, add more to the winners for big gains. If one has made a mistake, cut the losers early to keep the losses small.
In my experience, long term buy and hold investing has been rewarding. It has been safe (safety of principal) and has also generated good return for the given reward/risk ratio.
Always buy the stock at a bargain (margin of safety). This minimises the downside risk and provides potentially a higher return.
In a recent CNBC interview, Warren Buffett was asked by a sender of email regarding buy and hold strategy. His reply was a short one. This strategy works for certain selected stocks. He added other strategies can be profitable for some too.
My comments:
Stock selection is of course very important. This can be achieved through applying the right investing knowledge, diligent study of the company and hard work.
Over the short-term, you will probably be right (positive returns) 50% of the time. However, over the long-term, you are more likely to be right most of the time.
Be sure to ride the winners, add more to the winners for big gains. If one has made a mistake, cut the losers early to keep the losses small.
In my experience, long term buy and hold investing has been rewarding. It has been safe (safety of principal) and has also generated good return for the given reward/risk ratio.
Always buy the stock at a bargain (margin of safety). This minimises the downside risk and provides potentially a higher return.
The Worst Move You Could Make Now
The Worst Move You Could Make Now
By Dan Caplinger April 13, 2009 Comments (0)
Tough times have forced many people to take desperate measures. Unfortunately, some of the changes people are making to their portfolios won't do anything but cause them more heartbreak in the long run.
With many pundits proclaiming the death of buy-and-hold investing, day trading and other short-term investing strategies are on the rise. Having become immensely popular during the tech boom of the late 1990s, day trading has sent many investors to the poorhouse whenever the stocks that traders use stop performing well.
Tired of losing
Given the complete collapse in confidence in the financial system, it's no surprise that investors are taking matters into their own hands. When stocks move smoothly up over time, slow and steady gains generally make most investors happy. But when you no longer believe that simply dumping money into an index fund will earn you profits over time, you may well be at a loss to figure out what to do.
That's why day trading can be so attractive. If you pick the right stocks -- especially low-priced beaten-down shares like Citigroup (NYSE: C), General Electric (NYSE: GE), and Ford (NYSE: F) -- you can see plenty of potential benefits: With these companies in the news all the time, their prices move radically over short periods.
Low share prices let you pick up more shares for your money, accentuating the feeling that you're accomplishing something with your actions.
In an economy where many have lost their jobs, grabbing a quick profit from a day trade can be your only source of income.
But even if Wall Street's shenanigans have convinced you that the overall stock market is rigged, trying to beat the Street at its own game isn't the answer. Fortunately, there's a better way.
What's the better way?
Long-term investing strategies give you simple rules to follow in good times and bad. But to use them correctly, you have to be willing not to panic during bear markets, and add money even when your gut tells you it's the worst move you could make.
That's a big problem for many people. It's hard to invest when you know you could endure losses for months or even years at a time. But rather than going all the way to the other extreme by day trading, why not instead look for stocks that can thrive in today's market environment?
With thousands of stocks to choose from, you can be virtually assured of finding some with promising prospects. More importantly, though, when you understand why you own shares of a company, it's easier to be patient and wait for a great business model to prove itself.
For instance, consider e-commerce giant Amazon.com (Nasdaq: AMZN). When its shares fell to single digits during the tech bust, day traders lost fortunes. But those who believed that the company would eventually become the dominant force in Internet retail didn't settle for nicking a penny or two off share gains -- they saw their fortunes rise more than 13-fold in the ensuing years.
Take a stand
Which stocks belong in your portfolio? It depends on your financial situation, risk tolerance, and comfort level with investing, as well as your take on what the future likely holds.
If you're convinced the recession is just getting started, then a dividend-paying recession-proof consumer stock like Kimberly-Clark (NYSE: KMB) looks awfully attractive. On the other hand, if you're comfortable taking risks and see the economy booming back in short order, then beaten-down oil and gas stocks like Chesapeake Energy (NYSE: CHK) or ConocoPhillips (NYSE: COP) could recover in a hurry.
The key, though, is to take ownership of your investments. Rather than day trading, where all the odds are stacked against you, the best way to beat Wall Street at its own game is to learn how to play it better. By learning how to find market-crushing stocks, you'll avoid the mistakes that will inevitably bring day traders even more losses.
For more on making the most from your investments, read about:
The greatest company in the history of the world.
Wall Street's 10 favorite stocks.
Warren Buffett's biggest mistake.
Fool contributor Dan Caplinger makes plenty of mistakes, but does his best to avoid the big ones. He owns shares of Chesapeake Energy and General Electric. Kimberly-Clark is a Motley Fool Income Investor selection. Chesapeake Energy is a Motley Fool Inside Value pick.
http://www.fool.com/investing/general/2009/04/13/the-worst-move-you-could-make-now.aspx
By Dan Caplinger April 13, 2009 Comments (0)
Tough times have forced many people to take desperate measures. Unfortunately, some of the changes people are making to their portfolios won't do anything but cause them more heartbreak in the long run.
With many pundits proclaiming the death of buy-and-hold investing, day trading and other short-term investing strategies are on the rise. Having become immensely popular during the tech boom of the late 1990s, day trading has sent many investors to the poorhouse whenever the stocks that traders use stop performing well.
Tired of losing
Given the complete collapse in confidence in the financial system, it's no surprise that investors are taking matters into their own hands. When stocks move smoothly up over time, slow and steady gains generally make most investors happy. But when you no longer believe that simply dumping money into an index fund will earn you profits over time, you may well be at a loss to figure out what to do.
That's why day trading can be so attractive. If you pick the right stocks -- especially low-priced beaten-down shares like Citigroup (NYSE: C), General Electric (NYSE: GE), and Ford (NYSE: F) -- you can see plenty of potential benefits: With these companies in the news all the time, their prices move radically over short periods.
Low share prices let you pick up more shares for your money, accentuating the feeling that you're accomplishing something with your actions.
In an economy where many have lost their jobs, grabbing a quick profit from a day trade can be your only source of income.
But even if Wall Street's shenanigans have convinced you that the overall stock market is rigged, trying to beat the Street at its own game isn't the answer. Fortunately, there's a better way.
What's the better way?
Long-term investing strategies give you simple rules to follow in good times and bad. But to use them correctly, you have to be willing not to panic during bear markets, and add money even when your gut tells you it's the worst move you could make.
That's a big problem for many people. It's hard to invest when you know you could endure losses for months or even years at a time. But rather than going all the way to the other extreme by day trading, why not instead look for stocks that can thrive in today's market environment?
With thousands of stocks to choose from, you can be virtually assured of finding some with promising prospects. More importantly, though, when you understand why you own shares of a company, it's easier to be patient and wait for a great business model to prove itself.
For instance, consider e-commerce giant Amazon.com (Nasdaq: AMZN). When its shares fell to single digits during the tech bust, day traders lost fortunes. But those who believed that the company would eventually become the dominant force in Internet retail didn't settle for nicking a penny or two off share gains -- they saw their fortunes rise more than 13-fold in the ensuing years.
Take a stand
Which stocks belong in your portfolio? It depends on your financial situation, risk tolerance, and comfort level with investing, as well as your take on what the future likely holds.
If you're convinced the recession is just getting started, then a dividend-paying recession-proof consumer stock like Kimberly-Clark (NYSE: KMB) looks awfully attractive. On the other hand, if you're comfortable taking risks and see the economy booming back in short order, then beaten-down oil and gas stocks like Chesapeake Energy (NYSE: CHK) or ConocoPhillips (NYSE: COP) could recover in a hurry.
The key, though, is to take ownership of your investments. Rather than day trading, where all the odds are stacked against you, the best way to beat Wall Street at its own game is to learn how to play it better. By learning how to find market-crushing stocks, you'll avoid the mistakes that will inevitably bring day traders even more losses.
For more on making the most from your investments, read about:
The greatest company in the history of the world.
Wall Street's 10 favorite stocks.
Warren Buffett's biggest mistake.
Fool contributor Dan Caplinger makes plenty of mistakes, but does his best to avoid the big ones. He owns shares of Chesapeake Energy and General Electric. Kimberly-Clark is a Motley Fool Income Investor selection. Chesapeake Energy is a Motley Fool Inside Value pick.
http://www.fool.com/investing/general/2009/04/13/the-worst-move-you-could-make-now.aspx
The ABCs of Screwball Economics
The ABCs of Screwball Economics
By Alyce Lomax April 13, 2009 Comments (2)
We've had TARP (and the return of the TARP), we've had TALF, now we've got the PPIP. Our government's interventions into the economy have come hand in hand with a great propensity for acronyms that are becoming less clever all the time. (I mean, come on, PPIP?)
I've got some great acronyms for what I think these are going to do for our economic situation, but most are not appropriate for our family-friendly site. Here's one that makes it through: SNAFU. Or how about ROFLMAO, if you've got a gallows sense of humor. I still see little possibility that the government's actions are going to help our economic situation in the least.
IPS (It's the price, stupid)
The new PPIP basically fails to admit what more and more people have been arguing, and that is that the major banks like Bank of America (NYSE: BAC), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC) don't have liquidity problems, but rather solvency problems.
There is toxic garbage on their books (and continued lack of transparency on them). The prevailing idea that it's acceptable to price these assets at fantasy levels sounds absurd to me, but the banks want to price these assets at unrealistic levels, and the recent loosening of mark-to-market rules pretty much tells you what you need to know -- somebody wants the fantasy to continue. (Even worse, some are wondering if the banks are just going to sell the assets to one another, with government help.)
The real marketplace wants to price those toxic assets, as low-down and nasty as those prices may be, and doesn't want to pay artificially inflated prices. (Meanwhile, why would we want the government to subsidize purchase of these assets at artificially high prices anyway?). Suffice it to say, it doesn't follow that prices should be whatever these companies decide they should be and the government should support that.
IDS (It's the debt, stupid)
The government's programs have been geared toward stimulating lending again. But here's the thing that's been driving me crazy for ages: There's a heck of a lot of indebtedness in our system already; it's part of the problem, and that goes for corporations, consumers, and our government itself.
Of course, the government wants to kick up lending again. Our past economic growth was based on an artificial daisy chain fed into by bubbly asset prices, low interest rates, and the inevitable loads and loads of debt being taken on. Of course, this has to correct because if you really think about it, it's been utterly unsustainable, but nobody wants to take the inevitable medicine. The smart consumers and companies that didn't dig themselves into massive debt holes probably don't want to borrow right now. So, who's left?
Consumers were melting the MasterCard (NYSE: MA) and Visa (NYSE: V) cards buying up Coach (NYSE: COH) handbags and Tiffany baubles, or flat-screen TVs or Sirius XM (Nasdaq: SIRI) radios. Unfortunately, we can now gather that a heck of a lot of their spending wasn't based on real income, but rather subsidized by debt or taking equity out of their bubbly priced homes. Now many consumers are busted broke, with slashed credit lines, defaulted loans, and lost jobs. Should they borrow more?
Meanwhile, many corporations loaded up on debt, too. I remember thinking it was weird for companies to take on debt to say, pay dividends or buy back shares (much less to finance their operations). Back then, it made sense to just about everybody, and everybody was doing it. But now? It's pretty clear that many companies weren't concerned about a rainy day coming, a day when it might become difficult for them to service that debt. Well, it's come. Should they borrow more?
IES (It's the economy, stupid)
It's morally reprehensible that the government should expect already overly indebted consumers to keep on borrowing to reinflate our deflating economy. Some of us are concerned that our economy has been an accident waiting to happen, given the fact that consumer spending represents 70% -- the lion's share -- of GDP. The emphasis on services and the financial industry's love for pushing pieces of paper around has put us in a precarious position indeed, as has the emphasis on debtor spending to make our economic world go round.
Meanwhile, it looks like my fears of a zombie apocalypse economy are coming to pass. Throwing good money after bad not only robs taxpayers, but it also robs healthy companies of capital as the zombies are kept alive. Propping up losers means that soon, all we'll have are losers, and an awfully big bill to pay.
BBIAF, with more bad acronyms
There are many arguments emanating from many different schools of thought about what to do. I've always thought that the government should stay out of this so we could have a difficult, but likely shorter lived, correction, clear out the artificial excess, and get to work on moving back to an economy with real innovation and truly healthy businesses -- all the while leaving bubbly fakery behind.
I know many people don't agree with my point of view, but it seems like more and more people from many different economic camps are starting to come around to the idea that the fixes from government intervention from both the previous administration and the current one are simply helping politically connected bankers and doing little to actually fix what ails the real economy. The word "oligarchy" seems to be cropping up an awful lot, in fact.
Let's hope that the next acronym program won't be one that denotes being completely out of luck, but after endless government interventions that don't seem to help and seem more likely to hurt, it's starting to feel like that's our destiny. Let's hope not.
Alyce Lomax does not own shares of any of the companies mentioned. The Fool has a disclosure policy.
http://www.fool.com/investing/general/2009/04/13/the-abcs-of-screwball-economics.aspx
By Alyce Lomax April 13, 2009 Comments (2)
We've had TARP (and the return of the TARP), we've had TALF, now we've got the PPIP. Our government's interventions into the economy have come hand in hand with a great propensity for acronyms that are becoming less clever all the time. (I mean, come on, PPIP?)
I've got some great acronyms for what I think these are going to do for our economic situation, but most are not appropriate for our family-friendly site. Here's one that makes it through: SNAFU. Or how about ROFLMAO, if you've got a gallows sense of humor. I still see little possibility that the government's actions are going to help our economic situation in the least.
IPS (It's the price, stupid)
The new PPIP basically fails to admit what more and more people have been arguing, and that is that the major banks like Bank of America (NYSE: BAC), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC) don't have liquidity problems, but rather solvency problems.
There is toxic garbage on their books (and continued lack of transparency on them). The prevailing idea that it's acceptable to price these assets at fantasy levels sounds absurd to me, but the banks want to price these assets at unrealistic levels, and the recent loosening of mark-to-market rules pretty much tells you what you need to know -- somebody wants the fantasy to continue. (Even worse, some are wondering if the banks are just going to sell the assets to one another, with government help.)
The real marketplace wants to price those toxic assets, as low-down and nasty as those prices may be, and doesn't want to pay artificially inflated prices. (Meanwhile, why would we want the government to subsidize purchase of these assets at artificially high prices anyway?). Suffice it to say, it doesn't follow that prices should be whatever these companies decide they should be and the government should support that.
IDS (It's the debt, stupid)
The government's programs have been geared toward stimulating lending again. But here's the thing that's been driving me crazy for ages: There's a heck of a lot of indebtedness in our system already; it's part of the problem, and that goes for corporations, consumers, and our government itself.
Of course, the government wants to kick up lending again. Our past economic growth was based on an artificial daisy chain fed into by bubbly asset prices, low interest rates, and the inevitable loads and loads of debt being taken on. Of course, this has to correct because if you really think about it, it's been utterly unsustainable, but nobody wants to take the inevitable medicine. The smart consumers and companies that didn't dig themselves into massive debt holes probably don't want to borrow right now. So, who's left?
Consumers were melting the MasterCard (NYSE: MA) and Visa (NYSE: V) cards buying up Coach (NYSE: COH) handbags and Tiffany baubles, or flat-screen TVs or Sirius XM (Nasdaq: SIRI) radios. Unfortunately, we can now gather that a heck of a lot of their spending wasn't based on real income, but rather subsidized by debt or taking equity out of their bubbly priced homes. Now many consumers are busted broke, with slashed credit lines, defaulted loans, and lost jobs. Should they borrow more?
Meanwhile, many corporations loaded up on debt, too. I remember thinking it was weird for companies to take on debt to say, pay dividends or buy back shares (much less to finance their operations). Back then, it made sense to just about everybody, and everybody was doing it. But now? It's pretty clear that many companies weren't concerned about a rainy day coming, a day when it might become difficult for them to service that debt. Well, it's come. Should they borrow more?
IES (It's the economy, stupid)
It's morally reprehensible that the government should expect already overly indebted consumers to keep on borrowing to reinflate our deflating economy. Some of us are concerned that our economy has been an accident waiting to happen, given the fact that consumer spending represents 70% -- the lion's share -- of GDP. The emphasis on services and the financial industry's love for pushing pieces of paper around has put us in a precarious position indeed, as has the emphasis on debtor spending to make our economic world go round.
Meanwhile, it looks like my fears of a zombie apocalypse economy are coming to pass. Throwing good money after bad not only robs taxpayers, but it also robs healthy companies of capital as the zombies are kept alive. Propping up losers means that soon, all we'll have are losers, and an awfully big bill to pay.
BBIAF, with more bad acronyms
There are many arguments emanating from many different schools of thought about what to do. I've always thought that the government should stay out of this so we could have a difficult, but likely shorter lived, correction, clear out the artificial excess, and get to work on moving back to an economy with real innovation and truly healthy businesses -- all the while leaving bubbly fakery behind.
I know many people don't agree with my point of view, but it seems like more and more people from many different economic camps are starting to come around to the idea that the fixes from government intervention from both the previous administration and the current one are simply helping politically connected bankers and doing little to actually fix what ails the real economy. The word "oligarchy" seems to be cropping up an awful lot, in fact.
Let's hope that the next acronym program won't be one that denotes being completely out of luck, but after endless government interventions that don't seem to help and seem more likely to hurt, it's starting to feel like that's our destiny. Let's hope not.
Alyce Lomax does not own shares of any of the companies mentioned. The Fool has a disclosure policy.
http://www.fool.com/investing/general/2009/04/13/the-abcs-of-screwball-economics.aspx
Saturday, 11 April 2009
Market Strategies Review Notes I (January 2009)
AVERAGING DOWN
Averaging Down: Good Idea Or Big Mistake?
THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):
THRIVING IN EVERY MARKET
MR. MARKET
SUITABLE SECURITIES AT SUITABLE PRICES
PAYING RESPECT TO THE MARKET
TIMING VERSUS PRICING
BELIEVING A BULL MARKET
THE PAUSE AT THE TOP OF THE ROLLER COASTER
MAKING FRIENDS WITH A BEAR
BARGAINS AT THE BOTTOM
SIGNS AT THE BOTTOM
BUYING TIME
IF YOU ABSOLUTELY MUST PLAY THE HORSES
BALANCE SHEET VALUE: ASSETS AT WORK
1.Balance Sheet Value: Assets at Work
2.Reliability of financial data
3.Asset valuation approach in liquidation
4.Asset valuation approaches in active companies
5.Valuing Hidden assets
6.Subtracting liabilities in asset valuation
7.Balance Sheet Value: Summary
INCOME STATEMENT VALUE
Income Statement Value: The Earnings Payoff
Adjustments in Current Earnings figure
Avoid Pro Forma financial figures
Avoid Extrapolated Future Earnings Growth figures
Estimating Growth in Value Investing
Franchise Value
GROWTH'S VALUE
GROWTH'S VALUE (illustrations)
CASH FLOW STATEMENT VALUE
Cash Flow Statement Value
Discounted Cash Flow valuation method
Hazards of the Future and Limitations of DCF
UNDERSTANDING DISCOUNT RATES
Understanding Discount Rates
Risk-free rate
Traditional Method: Discount rate or WACC (I)
Traditional Method: Discount rate or WACC (II)
Modern Portfolio Theory
Portfolio Theory: Market Risk Premiums
Portfolio Theory: Beta
Is the market efficient, always?
Discount Rate Determinations: Summary
STOCK MARKET PRICES
Stock Market Prices
Market metrics P/E and Intrinsic value
Rational Thinking about Irrational Pricing
The Anxiety of Selling
Control Value of Majority Interest
10 TENETS OF VALUE INVESTING
MR. MARKET PRINCIPLE
BUSINESS ANALYST PRINCIPLE
REASONABLE PRICE PRINCIPLE
PATSY PRINCIPLE
CIRCLE OF COMPETENCE PRINCIPLE ****
MOAT PRINCIPLE
MARGIN OF SAFETY PRINCIPLE ****
IN-LAW PRINCIPLE
ELITISM PRINCIPLE
OWNER PRINCIPLE
SUBSETS OF RISKS:
Partitioning Risk
Business risk
Financial risk
Purchasing power risk
Interest rate risk
Foreign exchange risk
Political risk
Social risk
Also read:
My Investment Philosophy and Strategy
****Investment Philosophy, Strategy and various Valuation Methods
Averaging Down: Good Idea Or Big Mistake?
THRIVING IN EVERY MARKET
Value Investing Made Easy (Janet Lowe):
THRIVING IN EVERY MARKET
MR. MARKET
SUITABLE SECURITIES AT SUITABLE PRICES
PAYING RESPECT TO THE MARKET
TIMING VERSUS PRICING
BELIEVING A BULL MARKET
THE PAUSE AT THE TOP OF THE ROLLER COASTER
MAKING FRIENDS WITH A BEAR
BARGAINS AT THE BOTTOM
SIGNS AT THE BOTTOM
BUYING TIME
IF YOU ABSOLUTELY MUST PLAY THE HORSES
BALANCE SHEET VALUE: ASSETS AT WORK
1.Balance Sheet Value: Assets at Work
2.Reliability of financial data
3.Asset valuation approach in liquidation
4.Asset valuation approaches in active companies
5.Valuing Hidden assets
6.Subtracting liabilities in asset valuation
7.Balance Sheet Value: Summary
INCOME STATEMENT VALUE
Income Statement Value: The Earnings Payoff
Adjustments in Current Earnings figure
Avoid Pro Forma financial figures
Avoid Extrapolated Future Earnings Growth figures
Estimating Growth in Value Investing
Franchise Value
GROWTH'S VALUE
GROWTH'S VALUE (illustrations)
CASH FLOW STATEMENT VALUE
Cash Flow Statement Value
Discounted Cash Flow valuation method
Hazards of the Future and Limitations of DCF
UNDERSTANDING DISCOUNT RATES
Understanding Discount Rates
Risk-free rate
Traditional Method: Discount rate or WACC (I)
Traditional Method: Discount rate or WACC (II)
Modern Portfolio Theory
Portfolio Theory: Market Risk Premiums
Portfolio Theory: Beta
Is the market efficient, always?
Discount Rate Determinations: Summary
STOCK MARKET PRICES
Stock Market Prices
Market metrics P/E and Intrinsic value
Rational Thinking about Irrational Pricing
The Anxiety of Selling
Control Value of Majority Interest
10 TENETS OF VALUE INVESTING
MR. MARKET PRINCIPLE
BUSINESS ANALYST PRINCIPLE
REASONABLE PRICE PRINCIPLE
PATSY PRINCIPLE
CIRCLE OF COMPETENCE PRINCIPLE ****
MOAT PRINCIPLE
MARGIN OF SAFETY PRINCIPLE ****
IN-LAW PRINCIPLE
ELITISM PRINCIPLE
OWNER PRINCIPLE
SUBSETS OF RISKS:
Partitioning Risk
Business risk
Financial risk
Purchasing power risk
Interest rate risk
Foreign exchange risk
Political risk
Social risk
Also read:
My Investment Philosophy and Strategy
****Investment Philosophy, Strategy and various Valuation Methods
Derivatives trading crackdown begins
Derivatives trading crackdown begins
Banks start talks on bringing order to chaotic derivatives market for credit default swaps
Elena Moya guardian.co.uk,
Tuesday 7 April 2009 16.30 BST Article history
An attempt to bring order to the chaotic, multibillion-pound world of credit derivatives began in London today with moves to standardise contracts in the market.
Banks last year traded about $54tn of credit default swaps (CDSs), contracts that protect investors against the default of a bond or loan, but the global financial crisis triggered the collapse of the market, bringing down AIG, the world's biggest insurer.
The G20 summit in London last week made it a priority to bring order to the market and today specialists from banks including UBS and Morgan Stanley agreed to trade standardised contracts, as well as organise committees that would oversee cases where there was a default.
"The proposed changes provide a means to guarantee greater unanimity of results across positions, add more openness and transparency to the process, and give formal representation to members of the buy-side community," said Markit, a leading provider of data on CDSs.
The London-based firm has also started to publish CDS pricing data on its website. Apart from CDSs on specific corporate loans or bonds, the public can also see the price investors pay to protect themselves against debt issued by sovereign countries such as Britain or the US. The riskier a country is perceived to be, the more expensive its insurance.
"Regulators are very keen to see this being put into place," said David Austin, a director at Markit.
As the unsupervised market grew after 2000, the number of CDSs issued rose well above the number of loans or bonds outstanding, as any bank could issue these insurance products and receive hefty fees for them.
AIG issued large amounts of CDSs on products that contained sub-prime mortgages, and could not honour the payments when they defaulted. It was like selling insurance on a car to five people, even if only one owned the car. If the car crashed, five people claimed the insurance. AIG is now partially nationalised.
With so many CDSs linked to a particular loan or bond, creditors queue to receive payments but some will not be paid because there are more contracts than real lenders. With corporate defaults expected to soar, a better way of dealing with payments after a default is needed.
Standard contracts are seen as a first step towards a central clearing house – a place where all banks contribute collateral to be used as a lifeline in case a bank or institution collapses. At present, banks trade with each other, not through a central house.
The G20 said last week it would push for the creation of centralised clearing houses as a way of improving market confidence. US and European governments are spending billions of pounds to insure the banks' worst assets, or to buy them from their books, in order to restore inter-bank lending and kick-start the economy.
http://www.guardian.co.uk/global/2009/apr/07/derivatives-trading-crackdown
Banks start talks on bringing order to chaotic derivatives market for credit default swaps
Elena Moya guardian.co.uk,
Tuesday 7 April 2009 16.30 BST Article history
An attempt to bring order to the chaotic, multibillion-pound world of credit derivatives began in London today with moves to standardise contracts in the market.
Banks last year traded about $54tn of credit default swaps (CDSs), contracts that protect investors against the default of a bond or loan, but the global financial crisis triggered the collapse of the market, bringing down AIG, the world's biggest insurer.
The G20 summit in London last week made it a priority to bring order to the market and today specialists from banks including UBS and Morgan Stanley agreed to trade standardised contracts, as well as organise committees that would oversee cases where there was a default.
"The proposed changes provide a means to guarantee greater unanimity of results across positions, add more openness and transparency to the process, and give formal representation to members of the buy-side community," said Markit, a leading provider of data on CDSs.
The London-based firm has also started to publish CDS pricing data on its website. Apart from CDSs on specific corporate loans or bonds, the public can also see the price investors pay to protect themselves against debt issued by sovereign countries such as Britain or the US. The riskier a country is perceived to be, the more expensive its insurance.
"Regulators are very keen to see this being put into place," said David Austin, a director at Markit.
As the unsupervised market grew after 2000, the number of CDSs issued rose well above the number of loans or bonds outstanding, as any bank could issue these insurance products and receive hefty fees for them.
AIG issued large amounts of CDSs on products that contained sub-prime mortgages, and could not honour the payments when they defaulted. It was like selling insurance on a car to five people, even if only one owned the car. If the car crashed, five people claimed the insurance. AIG is now partially nationalised.
With so many CDSs linked to a particular loan or bond, creditors queue to receive payments but some will not be paid because there are more contracts than real lenders. With corporate defaults expected to soar, a better way of dealing with payments after a default is needed.
Standard contracts are seen as a first step towards a central clearing house – a place where all banks contribute collateral to be used as a lifeline in case a bank or institution collapses. At present, banks trade with each other, not through a central house.
The G20 said last week it would push for the creation of centralised clearing houses as a way of improving market confidence. US and European governments are spending billions of pounds to insure the banks' worst assets, or to buy them from their books, in order to restore inter-bank lending and kick-start the economy.
http://www.guardian.co.uk/global/2009/apr/07/derivatives-trading-crackdown
Which shares for income?
Which shares for income?
The yield on BT of 19pc sounds good, but remember the adage "if it looks too good to be true, it probably is.
By Gavin Oldham
Last Updated: 6:47PM BST 10 Apr 2009
With the equity market close to a six-year low and with equity yields at historically high levels compared with gilts, the temptation is there for investors to switch into shares: not only in the hunt for income but also factoring in that one day the equity market will recover.
The challenge is, however, to find those rewards without shouldering too much risk; because whereas cash savings can face risk of default, it is in equities that you face investment risk.
Related Articles
Other inflation hedges
Is silver the new gold?
US fund manager declares war on UK trackers
Inflation: how to protect your portfolio
Deflation: How to protect your portfolio
Investors 'ready to return to stock market'
However, it is also worth remembering that since 1900 high-yielding shares have outperformed the stock market as a whole, 85pc of the time over 10-year periods. They've also outperformed the market since September 2008, when the markets really went into freefall.
As an example of the relationship between risk and yield, let's compare two blue chips with apparent dividend attractions: BP and BT.
This week, the yield on BT is 19pc net of basic-rate tax. Sounds good, but remember the adage "if it looks too good to be true, it probably is". Every analyst in the City expects BT to cut its dividend next time around. Investors should be cautious of above-average share yields: the market is telling you "the higher the yield the higher the risk".
BP has a yield of 9pc. Recently, there has been speculation that the low oil price may force the company to cut the dividend. This has proved unfounded, as BP's management has said the dividend will be maintained this year and it will try to maintain it into 2010, even if the oil price stays at current levels. So here we have some medium-term visibility and potential for capital growth if the oil price rises over the medium term.
When considering an investment for yield, note the dividend cover; this is how many times the profits cover the dividend and is an indicator of whether a company will be able to pay future dividends at the current rate or higher. It is calculated by dividing the net earnings per share by the net dividend per share.
For example, if a company has earnings per share of 5p and it pays out a dividend of 2.5p, the dividend cover will be 5/2.5 = 2. The higher the cover, the better the chance of maintaining the dividend if profits fall. However, a lower figure may be acceptable if the group's profits are relatively stable.
So a good portfolio of equity income shares would feature mainstream companies with good dividend cover and a relatively recession-proof business (such as energy), plus a good helping of the FTSE 100 iShare – a form of exchange traded fund (ETF) marketed by Barclays – to provide some extra diversification, and to provide the opportunity to take advantage of market volatility.
Such a portfolio might include BP, yielding 9pc with 2.6 times dividend cover; GlaxoSmithKline, yielding 5.5pc with 1.6 times cover; National Grid, yielding 6.5pc with 2 times cover; Scottish & Southern, yielding 5.7pc (1.7); Shell, yielding 4.2pc (3.5); Vodafone, yielding 6pc (1.8) plus the FTSE iShare yielding 5.1pc with no cover calculation available.
An investment of £12,000 could therefore give you about £710 income over a full year, an overall yield of 5.9pc.
These equity shares could provide a relatively stable source of income combined with the potential for capital growth. There is, of course, a risk of further setbacks in the markets that could take your investment value lower, but with blue-chip companies like these it's a relatively low-risk portfolio as equities go.
Keep in touch with the companies you've invested in: if you hold the shares in an Isa or a broker's nominee, opt in for shareholder communications direct from the company. It's your right to be kept informed and it shouldn't cost you extra.
Your holding in the FTSE 100 iShare may provide the opportunity to do some tactical purchases or sales. Rather than buying the whole holding at once, you could invest in £1,000 steps as the market falls back, then set a limit at, say, 10pc up on your purchase price to sell as the market strengthens.
This way you can take advantage of short-term volatility to improve the return on the portfolio as a whole. Finally, if you're a taxpayer make sure you use your Isa allowance to minimise your income tax bill.
Gavin Oldham is chief executive of the Share Centre
http://www.telegraph.co.uk/finance/personalfinance/investing/5131421/Which-shares-for-income.html
The yield on BT of 19pc sounds good, but remember the adage "if it looks too good to be true, it probably is.
By Gavin Oldham
Last Updated: 6:47PM BST 10 Apr 2009
With the equity market close to a six-year low and with equity yields at historically high levels compared with gilts, the temptation is there for investors to switch into shares: not only in the hunt for income but also factoring in that one day the equity market will recover.
The challenge is, however, to find those rewards without shouldering too much risk; because whereas cash savings can face risk of default, it is in equities that you face investment risk.
Related Articles
Other inflation hedges
Is silver the new gold?
US fund manager declares war on UK trackers
Inflation: how to protect your portfolio
Deflation: How to protect your portfolio
Investors 'ready to return to stock market'
However, it is also worth remembering that since 1900 high-yielding shares have outperformed the stock market as a whole, 85pc of the time over 10-year periods. They've also outperformed the market since September 2008, when the markets really went into freefall.
As an example of the relationship between risk and yield, let's compare two blue chips with apparent dividend attractions: BP and BT.
This week, the yield on BT is 19pc net of basic-rate tax. Sounds good, but remember the adage "if it looks too good to be true, it probably is". Every analyst in the City expects BT to cut its dividend next time around. Investors should be cautious of above-average share yields: the market is telling you "the higher the yield the higher the risk".
BP has a yield of 9pc. Recently, there has been speculation that the low oil price may force the company to cut the dividend. This has proved unfounded, as BP's management has said the dividend will be maintained this year and it will try to maintain it into 2010, even if the oil price stays at current levels. So here we have some medium-term visibility and potential for capital growth if the oil price rises over the medium term.
When considering an investment for yield, note the dividend cover; this is how many times the profits cover the dividend and is an indicator of whether a company will be able to pay future dividends at the current rate or higher. It is calculated by dividing the net earnings per share by the net dividend per share.
For example, if a company has earnings per share of 5p and it pays out a dividend of 2.5p, the dividend cover will be 5/2.5 = 2. The higher the cover, the better the chance of maintaining the dividend if profits fall. However, a lower figure may be acceptable if the group's profits are relatively stable.
So a good portfolio of equity income shares would feature mainstream companies with good dividend cover and a relatively recession-proof business (such as energy), plus a good helping of the FTSE 100 iShare – a form of exchange traded fund (ETF) marketed by Barclays – to provide some extra diversification, and to provide the opportunity to take advantage of market volatility.
Such a portfolio might include BP, yielding 9pc with 2.6 times dividend cover; GlaxoSmithKline, yielding 5.5pc with 1.6 times cover; National Grid, yielding 6.5pc with 2 times cover; Scottish & Southern, yielding 5.7pc (1.7); Shell, yielding 4.2pc (3.5); Vodafone, yielding 6pc (1.8) plus the FTSE iShare yielding 5.1pc with no cover calculation available.
An investment of £12,000 could therefore give you about £710 income over a full year, an overall yield of 5.9pc.
These equity shares could provide a relatively stable source of income combined with the potential for capital growth. There is, of course, a risk of further setbacks in the markets that could take your investment value lower, but with blue-chip companies like these it's a relatively low-risk portfolio as equities go.
Keep in touch with the companies you've invested in: if you hold the shares in an Isa or a broker's nominee, opt in for shareholder communications direct from the company. It's your right to be kept informed and it shouldn't cost you extra.
Your holding in the FTSE 100 iShare may provide the opportunity to do some tactical purchases or sales. Rather than buying the whole holding at once, you could invest in £1,000 steps as the market falls back, then set a limit at, say, 10pc up on your purchase price to sell as the market strengthens.
This way you can take advantage of short-term volatility to improve the return on the portfolio as a whole. Finally, if you're a taxpayer make sure you use your Isa allowance to minimise your income tax bill.
Gavin Oldham is chief executive of the Share Centre
http://www.telegraph.co.uk/finance/personalfinance/investing/5131421/Which-shares-for-income.html
How and Why Do Companies Pay Dividends?
How and Why Do Companies Pay Dividends?
by Investopedia Staff, (Investopedia.com) (Contact Author Biography)
Look anywhere on the web and you're bound to find information on how dividends affect stockholders: the information ranges from a consideration of steady flows of income, to the proverbial "widows and orphans", and to the many different tax benefits that dividend-paying companies provide. An important part missing in many of these discussions is the purpose of dividends and why they are used by some companies and not by others. Before we begin describing the various policies that companies use to determine how much to pay their investors, let's look at different arguments for and against dividends policies. (Read more about widows and orphans in Widow And Orphan Stocks: Do They Still Exist?)
Arguments Against Dividends
First, some financial analysts feel that the consideration of a dividend policy is irrelevant because investors have the ability to create "homemade" dividends. These analysts claim that this income is achieved by individuals adjusting their personal portfolios to reflect their own preferences. For example, investors looking for a steady stream of income are more likely to invest in bonds (in which interest payments don't change), rather than a dividend-paying stock (in which value can fluctuate). Because their interest payments won't change, those who own bonds don't care about a particular company's dividend policy.
The second argument claims that little to no dividend payout is more favorable for investors. Supporters of this policy point out that taxation on a dividend is higher than on a capital gain. The argument against dividends is based on the belief that a firm that reinvests funds (rather than paying them out as dividends) will increase the value of the firm as a whole and consequently increase the market value of the stock.
According to the proponents of the no dividend policy, a company's alternatives to paying out excess cash as dividends are the following: undertaking more projects, repurchasing the company's own shares, acquiring new companies and profitable assets, and reinvesting in financial assets. (Keep reading about capital gains in Tax Effects On Capital Gains.)
Arguments For Dividends
In opposition to these two arguments is the idea that a high dividend payout is important for investors because dividends provide certainty about the company's financial well-being; dividends are also attractive for investors looking to secure current income. In addition, there are many examples of how the decrease and increase of a dividend distribution can affect the price of a security.
Companies that have a long-standing history of stable dividend payouts would be negatively affected by lowering or omitting dividend distributions; these companies would be positively affected by increasing dividend payouts or making additional payouts of the same dividends.
Furthermore, companies without a dividend history are generally viewed favorably when they declare new dividends. (For more, see Dividends Still Look Good After All These Years.)
Dividend-Paying Methods
Now, should the company decide to follow either the high or low dividend method, it would use one of three main approaches: residual, stability, or a hybrid compromise between the two.
Residual
Companies using the residual dividend policy choose to rely on internally generated equity to finance any new projects. As a result, dividend payments can come out of the residual or leftover equity only after all project capital requirements are met. These companies usually attempt to maintain balance in their debt/equity ratios before making any dividend distributions, which demonstrates that they decide on dividends only if there is enough money left over after all operating and expansion expenses are met.
For example, let's suppose that a company named CBC has recently earned $1,000 and has a strict policy to maintain a debt/equity ratio of 0.5 (one part debt to every two parts of equity).
Now, suppose this company has a project with a capital requirement of $900. In order to maintain the debt/equity ratio of 0.5, CBC would have to pay for one-third of this project by using debt ($300) and two-thirds ($600) by using equity. In other words, the company would have to borrow $300 and use $600 of its equity to maintain the 0.5 ratio, leaving a residual amount of $400 ($1,000 - $600) for dividends. On the other hand, if the project had a capital requirement of $1,500, the debt requirement would be $500 and the equity requirement would be $1,000, leaving zero ($1,000 - $1,000) for dividends. If any project required an equity portion that was greater than the company's available levels, the company would issue new stock.
Stability
The fluctuation of dividends created by the residual policy significantly contrasts with the certainty of the dividend stability policy. With the stability policy, companies may choose a cyclical policy that sets dividends at a fixed fraction of quarterly earnings, or it may choose a stable policy whereby quarterly dividends are set at a fraction of yearly earnings. In either case, the aim of the dividend stability policy is to reduce uncertainty for investors and to provide them with income.
Suppose our imaginary company, CBC, earned the $1,000 for the year (with quarterly earnings of $300, $200, $100, $400). If CBC decided on a stable policy of 10% of yearly earnings ($1,000 x 10%), it would pay $25 ($100/4) to shareholders every quarter. Alternatively, if CBC decided on a cyclical policy, the dividend payments would adjust every quarter to be $30, $20, $10 and $40 respectively. In either instance, companies following this policy are always attempting to share earnings with shareholders rather than searching for projects in which to invest excess cash.
Hybrid
The final approach is a combination between the residual and stable dividend policy. Using this approach, companies tend to view the debt/equity ratio as a long-term rather than a short-term goal. In today's markets, this approach is commonly used by companies that pay dividends. As these companies will generally experience business cycle fluctuations, they will generally have one set dividend, which is set as a relatively small portion of yearly income and can be easily maintained. On top of this set dividend, these companies will offer another extra dividend paid only when income exceeds general levels.
Conclusion
If a company decides to pay dividends, it will choose one of three approaches: residual, stability or hybrid policies. Which a company chooses can determine how profitable its dividend payments will be for investors - and how stable the income.To read more on this subject, see Dividend Facts You May Not Know.
by Investopedia Staff, (Contact Author Biography)
Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.
http://investopedia.com/articles/03/011703.asp?partner=basics4bb
by Investopedia Staff, (Investopedia.com) (Contact Author Biography)
Look anywhere on the web and you're bound to find information on how dividends affect stockholders: the information ranges from a consideration of steady flows of income, to the proverbial "widows and orphans", and to the many different tax benefits that dividend-paying companies provide. An important part missing in many of these discussions is the purpose of dividends and why they are used by some companies and not by others. Before we begin describing the various policies that companies use to determine how much to pay their investors, let's look at different arguments for and against dividends policies. (Read more about widows and orphans in Widow And Orphan Stocks: Do They Still Exist?)
Arguments Against Dividends
First, some financial analysts feel that the consideration of a dividend policy is irrelevant because investors have the ability to create "homemade" dividends. These analysts claim that this income is achieved by individuals adjusting their personal portfolios to reflect their own preferences. For example, investors looking for a steady stream of income are more likely to invest in bonds (in which interest payments don't change), rather than a dividend-paying stock (in which value can fluctuate). Because their interest payments won't change, those who own bonds don't care about a particular company's dividend policy.
The second argument claims that little to no dividend payout is more favorable for investors. Supporters of this policy point out that taxation on a dividend is higher than on a capital gain. The argument against dividends is based on the belief that a firm that reinvests funds (rather than paying them out as dividends) will increase the value of the firm as a whole and consequently increase the market value of the stock.
According to the proponents of the no dividend policy, a company's alternatives to paying out excess cash as dividends are the following: undertaking more projects, repurchasing the company's own shares, acquiring new companies and profitable assets, and reinvesting in financial assets. (Keep reading about capital gains in Tax Effects On Capital Gains.)
Arguments For Dividends
In opposition to these two arguments is the idea that a high dividend payout is important for investors because dividends provide certainty about the company's financial well-being; dividends are also attractive for investors looking to secure current income. In addition, there are many examples of how the decrease and increase of a dividend distribution can affect the price of a security.
Companies that have a long-standing history of stable dividend payouts would be negatively affected by lowering or omitting dividend distributions; these companies would be positively affected by increasing dividend payouts or making additional payouts of the same dividends.
Furthermore, companies without a dividend history are generally viewed favorably when they declare new dividends. (For more, see Dividends Still Look Good After All These Years.)
Dividend-Paying Methods
Now, should the company decide to follow either the high or low dividend method, it would use one of three main approaches: residual, stability, or a hybrid compromise between the two.
Residual
Companies using the residual dividend policy choose to rely on internally generated equity to finance any new projects. As a result, dividend payments can come out of the residual or leftover equity only after all project capital requirements are met. These companies usually attempt to maintain balance in their debt/equity ratios before making any dividend distributions, which demonstrates that they decide on dividends only if there is enough money left over after all operating and expansion expenses are met.
For example, let's suppose that a company named CBC has recently earned $1,000 and has a strict policy to maintain a debt/equity ratio of 0.5 (one part debt to every two parts of equity).
Now, suppose this company has a project with a capital requirement of $900. In order to maintain the debt/equity ratio of 0.5, CBC would have to pay for one-third of this project by using debt ($300) and two-thirds ($600) by using equity. In other words, the company would have to borrow $300 and use $600 of its equity to maintain the 0.5 ratio, leaving a residual amount of $400 ($1,000 - $600) for dividends. On the other hand, if the project had a capital requirement of $1,500, the debt requirement would be $500 and the equity requirement would be $1,000, leaving zero ($1,000 - $1,000) for dividends. If any project required an equity portion that was greater than the company's available levels, the company would issue new stock.
Stability
The fluctuation of dividends created by the residual policy significantly contrasts with the certainty of the dividend stability policy. With the stability policy, companies may choose a cyclical policy that sets dividends at a fixed fraction of quarterly earnings, or it may choose a stable policy whereby quarterly dividends are set at a fraction of yearly earnings. In either case, the aim of the dividend stability policy is to reduce uncertainty for investors and to provide them with income.
Suppose our imaginary company, CBC, earned the $1,000 for the year (with quarterly earnings of $300, $200, $100, $400). If CBC decided on a stable policy of 10% of yearly earnings ($1,000 x 10%), it would pay $25 ($100/4) to shareholders every quarter. Alternatively, if CBC decided on a cyclical policy, the dividend payments would adjust every quarter to be $30, $20, $10 and $40 respectively. In either instance, companies following this policy are always attempting to share earnings with shareholders rather than searching for projects in which to invest excess cash.
Hybrid
The final approach is a combination between the residual and stable dividend policy. Using this approach, companies tend to view the debt/equity ratio as a long-term rather than a short-term goal. In today's markets, this approach is commonly used by companies that pay dividends. As these companies will generally experience business cycle fluctuations, they will generally have one set dividend, which is set as a relatively small portion of yearly income and can be easily maintained. On top of this set dividend, these companies will offer another extra dividend paid only when income exceeds general levels.
Conclusion
If a company decides to pay dividends, it will choose one of three approaches: residual, stability or hybrid policies. Which a company chooses can determine how profitable its dividend payments will be for investors - and how stable the income.To read more on this subject, see Dividend Facts You May Not Know.
by Investopedia Staff, (Contact Author Biography)
Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.
http://investopedia.com/articles/03/011703.asp?partner=basics4bb
How Low Can The Market Go?*
How Low Can The Market Go?*
Henry Blodget
Henry Blodget
Mar. 5, 2009, 4:49 PM59
*UPDATE: After today's 4% drop, the S&P 500 is now at 680, an 11.85 P/E.
EARLIER: On days like today, it helps to look at the silver lining. Here it is: The farther stocks fall, the cheaper they get--and the higher the expected long-term return becomes. Unfortunately, that doesn't mean we don't have a long way to go on the downside.
There were four massive stock bubbles in the 20th Century: 1901, 1929, 1966, and 2000. During each of these bubble peaks, the S&P 500 neared or exceeded 25X on professor Robert Shiller's cyclically adjusted P/E ratio.* After the first three of these peaks, the S&P 500 PE did not bottom until it hit 5X-8X. We're still in the middle of the last one.
The most recent bubble peak, 2000, was by far the most extreme we have ever experienced. In 2000, the S&P 500 by prof. Shiller's measure exceeded 40X (it had never before exceeded 30X). With the S&P 500 hitting 700 today, the PE has now fallen back to 12X. (See chart above.)
Three major bubbles are not enough historical precedent to confidently conclude where the S&P 500 will bottom this time around, but it seems reasonable to conclude that the trough will be in line with--or below--the preceeding lows (Given that we just had the highest peak in history by a mile, it doesn't seem absurd to think that we might be headed for the lowest trough in history by a mile.)
So where are we now?
Based on Professor Shiller's latest numbers, we're at about a 12X P/E. (Prof. Shiller's last update was at 805 on the S&P 500, which produced a 14X P/E. Plugging in today's 700 on the same earnings number, we get about a 12X P/E). The 12X PE compares favorably to the long-term arithmetic average of 16X, but it's still way above the historical troughs of 5X-8X.
So where would the S&P bottom if we hit the previous trough PE lows? It depends how we get there.
If the stock market stops falling and earnings eventually begin to grow again, we would be close to the bottom: The market could simply move sideways for 5-10 years while earnings growth gradually reduced the PE to the 5X-8X range. This is what happened in the 1970s.
Alternatively, the market could just keep dropping, as it did in the early 1930s.
Using Professor Shiller's latest earnings data, here's where the numbers would fall out if the market just kept dropping and 10-year average earnings didn't grow from today's level:
P/E S&P 500 Level
*UPDATE: After today's 4% drop, the S&P 500 is now at 680, an 11.85 P/E.
EARLIER: On days like today, it helps to look at the silver lining. Here it is: The farther stocks fall, the cheaper they get--and the higher the expected long-term return becomes. Unfortunately, that doesn't mean we don't have a long way to go on the downside.
There were four massive stock bubbles in the 20th Century: 1901, 1929, 1966, and 2000. During each of these bubble peaks, the S&P 500 neared or exceeded 25X on professor Robert Shiller's cyclically adjusted P/E ratio.* After the first three of these peaks, the S&P 500 PE did not bottom until it hit 5X-8X. We're still in the middle of the last one.
The most recent bubble peak, 2000, was by far the most extreme we have ever experienced. In 2000, the S&P 500 by prof. Shiller's measure exceeded 40X (it had never before exceeded 30X). With the S&P 500 hitting 700 today, the PE has now fallen back to 12X. (See chart above.)
Three major bubbles are not enough historical precedent to confidently conclude where the S&P 500 will bottom this time around, but it seems reasonable to conclude that the trough will be in line with--or below--the preceeding lows (Given that we just had the highest peak in history by a mile, it doesn't seem absurd to think that we might be headed for the lowest trough in history by a mile.)
So where are we now?
Based on Professor Shiller's latest numbers, we're at about a 12X P/E. (Prof. Shiller's last update was at 805 on the S&P 500, which produced a 14X P/E. Plugging in today's 700 on the same earnings number, we get about a 12X P/E). The 12X PE compares favorably to the long-term arithmetic average of 16X, but it's still way above the historical troughs of 5X-8X.
So where would the S&P bottom if we hit the previous trough PE lows? It depends how we get there.
If the stock market stops falling and earnings eventually begin to grow again, we would be close to the bottom: The market could simply move sideways for 5-10 years while earnings growth gradually reduced the PE to the 5X-8X range. This is what happened in the 1970s.
Alternatively, the market could just keep dropping, as it did in the early 1930s.
Using Professor Shiller's latest earnings data, here's where the numbers would fall out if the market just kept dropping and 10-year average earnings didn't grow from today's level:
P/E S&P 500 Level
10X 575
8X 460 (highest previous trough low)
7X 400 (average previous trough low)
6X 350
5X 300 (lowest previous trough low)
In short, if the S&P fell straight to the high-end of its previous trough range (8X PE, or 460), it would fall another 35% from today's level (700)
If the S&P fell straight to the low-end of its previous trough range (5X PE, or 300), it would fall another 55+% from today's level.
Here's hoping we don't set a new low on the downside.
--------------------------------------------------------------------------------
* Shiller's "cyclically adjusted" PE takes an average of 10 years of S&P 500 earnings instead of using a single year's. Why? Because the business cycle makes single-year earnings misleading. In boom times, profit margins are high, and P/Es look artificially low (and stocks look misleadingly cheap). In busts, profit margins collapse, and P/Es look artificially high (and stocks look misleadingly expensive--as is the case this year). Shiller's cyclically-adjusted PE mutes the effect of the business cycle and, therefore, provides a much more informative and predictive PE ratio.
Here's a link to Professor Shiller's site, where you can download an Excel spreadsheet with all of the S&P 500 data >
Today's Bear Market Now Not As Bad As The Great Crash!
Today's Bear Market Now Not As Bad As The Great Crash!
Henry BlodgetApr. 6, 2009, 6:17 AM7
We are happy to report, via Doug Short, that today's bear market is no longer as bad as the Great Crash, as measured by depth-of-decline-over-time. Thanks to the rally of the past month, we've crawled back above the Great Crash trendline.
Henry BlodgetApr. 6, 2009, 6:17 AM7
We are happy to report, via Doug Short, that today's bear market is no longer as bad as the Great Crash, as measured by depth-of-decline-over-time. Thanks to the rally of the past month, we've crawled back above the Great Crash trendline.
It's worth noting, however, that the rip-roaring bull market of the past month does bear an unnerving resemblance to a similar pattern in 1931...before the last leg of the Great Crash took the DOW from down 50% to down 89%.
Visit dshort.com for an interactive version of this chart, as well as a bunch of other cool charts and analyses >
Is the Stock Market Cheap?
In times of critical importance, the conventional P/E ratio often lags the index to the point of being useless as a value indicator. "Why the lag?" you may wonder. "How can the P/E be at a record high after the price has fallen so far?" The explanation is simple. Earnings fell faster than price. In fact, the negative earnings of Q4 is something that has never happened before in the history of the S&P Composite.
The P/E10 Ratio
Legendary economist and value investor Benjamin Graham noticed the same bizarre P/E behavior during the Roaring Twenties and subsequent market crash. Graham collaborated with David Dodd to devise a more accurate way to calculate the market's value, which they discussed in their 1934 classic book, Security Analysis. They attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle. Their solution was to divide the price by the 10-year average of earnings, which we'll call the P/E10. In recent years, Yale professor Robert Shiller, the author of Irrational Exuberance, has reintroduced the P/E10 to a wider audience of investors.
April 3, 2009 revised April 6th
An old-fashioned way to answer this question is to look at the historic Price-to-Earnings (P/E) ratio using reported earnings (as opposed to earnings estimates).
The "price" part of the P/E calculation is available in real time on TV and the Internet. The "earnings" part, however, is more difficult to find. The authoritative source is the Standard & Poor's website, where the latest earnings are posted on the earnings page in a linked Excel file (see column D). More...
Subscribe to:
Posts (Atom)