Strategic Outlook 2010 Part II

Strategic Investment Outlook Part II

Additional Reasons for the conclusion:

In Part I I concluded that I cant give a high conviction call to the overall strategic investment climate. In late 2008 it was much easier to make a conviction call, but in 2010 the recovery in asset prices (Australian residential property, Australian and Global Equities) means that there is no longer a sufficient margin of error to make such a bold statement.

Governments and central bankers around the world acted correctly by lowering interest rates, flooding the system with money and running loose fiscal budgets.
This was required at the time to give the economic and financial system time to heal.

The longer term economic impact though I feel is the increased probability of a longer ‘U’ shaped recovery (although asset markets I feel have a higher probability of displaying ‘W’ like returns, but not to the recent cycle low point).

Instead of allowing the excesses to be washed through the system by a severe depression, government and central bank intervention has transferred the corrective stage over a longer period of time. The net result of this will be a more muted net long term recovery.


I don’t think markets are adequately reflecting the risk of this.
Global equity markets have recovered, but part of this recovery is due to cyclical factors:
1) The carry trade with record low interest rates;
2) Closing out of record levels of short positions;
3) The economic rebound off the cyclical low (with large improvements in the forward looking indicators).

These factors whilst justifying the fact that equity markets didn’t deserve to trade at their low points, DO NOT JUSTIFY CONTINUED INCREASES IN EQUITY MARKETS.

The first point is an issue of relativity (in simple naïve terms dividend ylds vs interest rates), not an underlying reference to the intrinsic value of a company.
The second point is a reverse back of market manipulation.
The third point is more interesting. So far the forward looking indicators have been moving steadily upwards. But the key question here is for how long? If I am correct about a long term ‘U’ shaped recovery, then these forward looking indicators will start to slow in their progression, or even worse, dip (but not to the cyclical low points). In either cases the negative reaction from markets will be proportional to market asset pricing. The higher equity markets move the greater the negative reaction.

Now there are some underlying long term positive catalysts that will increase the long term intrinsic value of equities. These include:
1) Lowering of the fixed cost base.
2) Elimination of weaker players, which increases the market dominance of the remaining players.
3) Increased employee productivity.

However are these underlying long term positive catalysts of sufficient strength to offset the future removal of the current cyclical factors talked above (and with regards to equity pricing, ie asset price levels)?

Personally I think the catalysts remain for a continuation of the current cyclical bull market recovery, but there is insufficient data to prove a continuation of the secular bull market.

This question must be answered, especially for those investors who adopt a ‘buy and hold strategy’.
 
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Interesting comment by the CEO of ANZ that basically warns of increased risks of aftershocks in the wake of the GFC due to anaemic growth in the developed nations coupled with strong increases in asset markets. The increases in asset markets are not being reflected in real economic activity.
 
I've heard that it's historically common for a major financial crisis to be followed by smaller, less damaging aftershocks for years afterwards. I can't remember the source, unfortunately.

So Greece and Dubai are the aftershocks of the GFC. And there might be more to come.

In terms of asset prices, the US and UK governments, and others, have pumped billions or trillions into the financial system. This was intended to kick start lending, but that remains low. However this money has been looking for a home, and a lot seems to have made its way into proprietary trading by the banks. That could be what's pushing up prices.

The most interesting tip I heard recently was from Marc Faber (who's even more bearish than the average doom and gloomer). He suggested that Japan is a good buy right now.
 
I've heard that it's historically common for a major financial crisis to be followed by smaller, less damaging aftershocks for years afterwards. I can't remember the source, unfortunately.

So Greece and Dubai are the aftershocks of the GFC. And there might be more to come.

In terms of asset prices, the US and UK governments, and others, have pumped billions or trillions into the financial system. This was intended to kick start lending, but that remains low. However this money has been looking for a home, and a lot seems to have made its way into proprietary trading by the banks. That could be what's pushing up prices.

The most interesting tip I heard recently was from Marc Faber (who's even more bearish than the average doom and gloomer). He suggested that Japan is a good buy right now.

Greece and Dubai, are not aftershocks of the GFC.
They are merely adjustments to trading positions.
Greece is interesting, not because of the immediate ramifications, but because of game plan theory in regards to the Euro.

You are spot on about proprietary trading systems by the banks, but i would add hedge funds to this group. But again, time moves on, i dont think 2010 is going to be as easy as 2009 for propertary trading systems as you called it. The trade is much more crowded now.
 
Personally I think the catalysts remain for a continuation of the current cyclical bull market recovery, but there is insufficient data to prove a continuation of the secular bull market.
.

And here we have confirmation of the continued cyclical bull run:
http://www.bloomberg.com/apps/news?pid=20601087&sid=aRjQPuqaM_0U&pos=2

and just wait for the day that employment turns positive!!!!!!
employment mathematically cannot remain negative indefinately.

However again this is of a cyclical nature, not a secular nature.
I'm not worried about the cyclical only the secular.
In the mean time, let s make money whilst the Sun shines:D
 
My personal view is that individuals, corporations and nations have built up a vast amount of debt over the past ten to fifteen years, driven by cheap credit (low base rates in the US, EU and UK and a savings glut in Asia).

The GFC was a credit contraction, as banks became less able to lend (over-levered, bad loans, etc.) and lost money. In a sense, Greece is a bit like a subprime mortgagee, who's overborrowed when money was cheap, and now the situation has changed they cannot continue their spending habits.

So I think that Greece and Dubai are part of the GFC on a larger picture view. And I suspect that the next decade is going to be slow as debts are paid down.

On an unrelated topic, more talk of a China bubble, but no burst in the immediate future. Australia to boom off the back of it for the next few years?

http://ftalphaville.ft.com/blog/2010/03/25/186756/is-china-blowing-bubbles/
 
Hi IV

I dunno really. What I have noticed is a lot of local and international blue chip companies are now carrying far less leverage than they used to courtesy of significant capital raisings at bargain prices through the GFC. Conservative balance sheets are back in fashion and some of them look downright lazy at the moment. Of course we can blame the banks for that but the net result is the same. I also notice Don Argus with his comments that 15% leverage is prudent for BHPB in these times - that's pretty darn low in my book!

I reckon the price recovery we have seen is in large part a reflection of the lower risks now inherent in these companies through this reduction in leverage.

Existing shareholders got heavily diluted of course but in exchange they now own a smaller portion of a much less risky company from a leverage POV (all else being equal of course, which it ain't!). So I agree asset price growth in many of these companies will be slow as they just don't have that much leverage anymore.

Still, if the underlying businesses perform it will be a matter of "slow and steady wins the race" with less volatility in share prices as a result and asset price growth tracking earnings growth more closely. We are already seeing that with shares "marking time" lately. So I see a number of these companies as very solid long term investments now, particularly those paying good dividends on top of strong balance sheets.

The removal of financial engineering and increasing transparency in reporting makes it much easier for the average punter to value as well, which can only be a good thing. So for me now is not the time to be selling quality stocks. A lot of stocks now look like the kind of long term buy and hold investment I always wanted to make in the share market but couldn't really find within my comfort zone.

Just my 2c.
 
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Greece is interesting, not because of the immediate ramifications, but because of game plan theory in regards to the Euro.

I agree and it becomes more interesting because they'll need to refinance a large % of their debt this year.

Unfortunately for the Greeks they'll be the EURO zone guinea pigs and they'll pay the price of being in a monetary zone which doesn't have the tools to protect it's member states from speculators
 
Hi IV

I dunno really. What I have noticed is a lot of local and international blue chip companies are now carrying far less leverage than they used to courtesy of significant capital raisings at bargain prices through the GFC. Conservative balance sheets are back in fashion and some of them look downright lazy at the moment. Of course we can blame the banks for that but the net result is the same. I also notice Don Argus with his comments that 15% leverage is prudent for BHPB in these times - that's pretty darn low in my book!


This is a very good point HiEquity. Its one of the reasons why i prefer common stock to property. Having low debt will enable these companies to better weather any turbulent times ahead.

However you still need to pay attention to 'near term market expectations of earnings growth' against longer term sustainable earnings growth, and then balance this against current market prices.

Over the medium term (5yrs) this is going to be very much a stock pickers market.


I reckon the price recovery we have seen is in large part a reflection of the lower risks now inherent in these companies through this reduction in leverage
.

I politely disagree with you on this point. There are many factors that are driving the market, some sustainable, some not. Because stocks are liquid and because there are 'no owner occupiers' in stocks, psychological belief plays a significant role in determining market price. Most of the time psychological belief has no bearing on true intrinsic value.




Existing shareholders got heavily diluted of course but in exchange they now own a smaller portion of a much less risky company from a leverage POV (all else being equal of course, which it ain't!). So I agree asset price growth in many of these companies will be slow as they just don't have that much leverage anymore
.

This is partially true. Inherent risk is reduced by the lower leverage. But its not leverage that dictates long term earnings growth. And its long term earnings growth that sustains long term share price appreciation.
Therefore adequate focus must be given to the sustainability of long term earnings growth if you want to invest on a buy and hold principle.



The removal of financial engineering and increasing transparency in reporting makes it much easier for the average punter to value as well, which can only be a good thing. So for me now is not the time to be selling quality stocks. A lot of stocks now look like the kind of long term buy and hold investment I always wanted to make in the share market but couldn't really find within my comfort zone.


How many quality stocks do we truely have on the ASX. Not many. But you are right on one hand, if i had to make a long term investment decision right now, and couldnt change that decision, i would go with shares over residential property at this point in time.
 
PS i would be weary of much of the economic data that gets presented over 2010, much of it will be comparing 2010 to 2009 (when the after effects of the GFC was still showing through the figures).

It wont be until 2011 that we can start to compare apples with apples.
 
I should also point out that the reason for posting this is to provide the backdrop to a number of comments that i am posting in this forum.

To be honest i dont have answers at this stage. I am not as confident in my decision making as i was last year.

Because i am not as confident in my strategic investment allocation, i am weary of taking on high levels of strategic debt (ie long term debt).

For the record let me be very clear, i am not suggesting selling everything and moving to cash. I am only consistently suggesting that people on this board give very serious consideration to the liquidity of the underlying asset class and to their debt situations.

In this environment i want to be as nimble as possible.

For residential property this means low LVR ratios (but with property refinancing occuring to capture any upside in property values)

For the stock market this means lower than normal LVR ratios, with an emphasis on running an overall cash flow positive portfolio, and with attention to holding companies whos market price is significantly below intrinsic value. In this market i am not prepared to pay for blue sky anticipated future results, nor am i prepared to pay for anticipated results based on a v-type economic recovery.
 
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IV, to save me trundling back through the thread, what's your stock margin LVR now, and how do you stay nimble? what kind of stops do you use? You seem to be concerned about growing volatility, a significant retracement, and global deleveraging.

I think these are valid concerns, as does BHP with a LVR of 15%.....keeping their powder dry to snap up the carnage.
 
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IV, to save me trundling back through the thread, what's your stock margin LVR now, and how do you stay nimble? what kind of stops do you use? You seem to be concerned about growing volatility. and a significant retracement.

Stock LVR has declined from 50-55% at the peak down to around 38% at present.

I dont use stop losses. However i am very weary of a price decline of an individual stock in a stable or rising market (what does the market know that i dont). So extra care must be given to buying an individual stock on price decline.
 
I am not as confident in my decision making as i was last year.

Me too. And I agree re: your point that other things can come into the valuation of a stock. However IMO there are still a number of quality stocks that can be bought today that show good cashflow, strong earnings and pretty reasonable upside over the longer term. I agree with you though - there aren't many of them on the ASX and the potential for strong short to medium term gains is less.

With the gains we made last year, I still feel confident increasing our exposure in some of the stocks we have invested in. Call it dollar cost averaging on the way up instead of on the way down...

But our share investing horizon is long term and we can write any losses off against tax in the meantime so I see long term buy and hold share investing for us as asymmetrical in risk. We stay with our gains (don't sell) and we write off our losses - this way our losses are (just under) half as bad as our gains from a post tax POV.

Mind you, we never leveraged up as much as you on the margin loan - we have always stayed under 30% and will probably stay there. That's because the leverage is already provided by our RIP equity so we are effectively "doubling up" on leverage and we are very mindful of that.
 
Does that mean you'll ride a downtrend to the bottom, or exercise discretion in when you exit?

Firstly i dont think we will have the turbulance that was seen in 2008/09.
The catalysts for such extreme downtrends are no longer present.

My main concern is that share indexes drift up and down in cyclical upturns and downturns, with the medium term performance being only mediocre.
Hence the risk of a straight buy and hold, hence also the increased risk of holding debt.

In regards to riding a downtrend, it will depend on the catalysts for that down trend and with reference to the types of shares i am holding.

If the catalysts for the downturn have a high risk of reducing the intrinsic value of the shares i hold , then i will sell, if not hold and possibly buy more.


But i want the freedom of choice, thats why i want lower LVR's accross all my investments.
 
I hate that word.....strategic.....it adds nothing to the descriptor.


What's the difference between an investment plan and a strategic investment plan ?? By definition, a plan has to be strategic.


What is your outlook ?? Steady as she goes. No no....what is your strategic outlook ?? Ahhh, now that's completely different - it's going to be rough and we are going to sell everything....:rolleyes:
 
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