 | Paul Gambles | Recognized as a regional financial expert, Paul is a regular speaker at industry events on market forecasting, financial planning, investing and legal issues for foreigners living or doing business in Asia. Besides Paul’s blog, Paul previously distributed his ‘almost-daily’ email – “Daily Updates”, where he gave his views on timely issues affecting financial markets, macro economics, micro economics and everything in-between. Born in South Yorkshire, England, Paul graduated from the University of Warwick with an Honours degree in English and European Studies. He began his financial career in the early 1980s as a technical inspector at HMIT with Inland Revenue. Following a successful career change to the Bank of Scotland in 1987, Paul moved to Bangkok in 1994 to help set-up an investment counseling practice, which today is known as MBMG International. www.mbmg-international.com |
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8 September 2010 Lord of Finance One of the more chilling aspects of Ahmad’s Lords of Finance is the way that cental bankers suddenly lost control of a situation that escalated beyond their ability to contain it. ‘The [ German] cabinet meeting finished at 2:00 a.m. Later that morning Luther boarded yet another plane, this time for Basel, to make one last desperate plea to the central bankers gathered at the BIS. After being closeted in conference for twelve hours, they emerged to announce that no new credits would be forthcoming. At 11.20 p.m. Basel time, Harrison got through to Norman. The Englishman sounded "tired, disgruntled and discouraged." The problem was just "too big for the central banks," he reported. The only solution was for the whole structure of war debts and reparations that had weighed down the world for the last dozen years to be swept away. On the morning of Monday, July 13, as Luther was setting off for Basel, the Danatbank had failed to open. On the locked doors of all its branches was posted a government decree guaranteeing its deposits. At a press conference, Jacob Goldschmidt revealed that the bank had lost 40 percent, some $240 million, in deposits over the last three months, about half of which were to foreigners. He blamed the run on wild rumors fuel1ed by anti-Semitic agitation in the Nationalist press. The Reichsbank, hoping that the impact might be contained, kept the rest of the banking system open that day. By lunchtime, branches of every bank in the country were besieged. The leading banks restricted withdrawals to no more than 10 percent of a depositor's balance. In the Berlin suburbs, savings banks were so overwhelmed that that they closed under heavy police guard. In Hamburg, sporadic riots were blamed on Communist agitators. The speed of capitulation from calm one day to utter collapse the next should never be forgotten – procrastinate and the last opportunity can be lost forever.
6 September 2010 A sign of strength is somebody that admits mistakes...but ultimately learns from them One sign of quality among operators in any business is their willingness to admit to their own mistakes. Unless you can put up your hands and take responsibility you won’t address your own failings and you won’t be able to improve in the future-this is especially true of the highest flyers who can perhaps be especially prone to believing their own PR. One aspect of Emerging Market legend, Mark Mobius that pleasantly surprised audiences during his recent trip to Bangkok the man’s humility and willingness to admit to his mistakes, rare as they have been over the years.
We’re therefore pleased that Carmignac director Eric Le Coz has assumed responsibility for his firm’s flagship fund’s poor performance in July in his latest monthly report following an ‘excess of prudence’ in the global strategy.
Eric Le Coz manages the Carmignac Patrimoine fund, a holding with the Osmium’ Iridium and Alpha portfolio and the largest fund in Europe it underperformed its benchmark in July, posting negative returns of 3.9% while the benchmark fell by 0.6%. In a candidly written report Le Coz admits ‘mea culpa’ for this rare period of underperformance.
‘The performances of our global management, which were disappointing last month, were the result of an excess of prudence and wariness towards the European circumstances,’
A few too many gold mines - the quintessential refuge - not enough financials, especially European, not enough euros and too many dollars – mea culpa,’
He added that last month they had maintained a low euro exposure and a significant underweight position towards equities. But the 'seasonal transitional phase' brought about a significant drop in the dollar (-9% for the currency since June 4) and a strong recovery of the financials equity sector (+27% for European banks since the low period of June 8).
‘I would rather not have to admit it, but we did not properly manage these movements throughout last month,’
In the report’s conclusion, Le Coz wrote that he believes this transition phase the market has been experiencing is reaching its end.
Bearing in mid that over the last five years the Carmignac Patrimoine fund has returned 53.1% while its Citywire benchmark, LCI MSCI World Free/Citigroup WGBI TR (50:50), has risen just 14.7% in euro terms over the same period, we can forgive them this rare blemish and perhaps this honesty explains why the fund, which with assets under management of more than €20 billion, is Europe’s largest, and why it continues to report huge inflows. In July alone it saw €3.2 billion of new money.
A constant striving for perfection and a healthy disappointment whenever anything less than that is achieved is a trait we find enduring in even the most successful investment managers, especially when the underperformance is due to an “ excess of prudence”
2 September 2010 Today we have a special report from Tim Price – Director PFP Wealth Management and Scott Campbell – Fund Manager MitonOptimal Scott Campbell , Managing Director and Fund Manager VALUATION VS THE MOMENTUM TRADE Many multitudes of commentators are pointing out the blinding glimpse of the obvious. “Would you prefer a regular income likely to rise
at least as fast as inflation or a lower fixed income with no prospect of increases?” Many dividend yields on blue chip global companies
now offer a higher income yield than government bonds in the US, UK, Europe and Japan. Historically high dividend yields vs 10 year
Government Bond yields is a buying opportunity for stocks, particularly in deflationary Japan. P/E multiples are at levels not seen for
a generation, free cash flow is fantastic and balance sheets are great. Recent M&A shows that CEO’s think there is value plus value,
fund managers are jumping out of their skin! The valuation argument is equally as compelling as it was in 2008/09. The following two charts from Investec show how in June 2008 corporate bonds and equities were then at valuation levels considered
cheap. They then proceeded to fall 30% or more! In fact Government Bond yields were at 30 year highs in June 2008 i.e. the most
expensive for three decades, and then proceeded to go higher! Clearly values are much better in developed world equities after indices have gone nowhere for 10 years. However, economic fundamentals are not looking good for the rest of the year. As 1999 or 2008 showed, valuation alone is not a great predictor of short term movement either way and the market can remain irrational longer than you can remain solvent. Tim Price , Director of Investment PFP Wealth Management Die Hard, with a vengeance “Money is like manure. You have to spread it around or it smells.” - J. Paul Getty. When it comes to dying hard, the cult of equities has few peers. You might have thought that the dotcom bust, the Enron / Worldcom scandals, the recent cascade of banking crises and the current widening stagflation would have beaten equity investors into some kind of sense of submission or at least acceptance by now. Not a bit of it. Notwithstanding the fact that global equity markets, as defined by the MSCI World Equity Index, are currently 22% below their level at the start of 2000, let alone a third below their highs of Q3 2007, the investment media continue breathlessly to report their every move. One can only conclude either that the modern equity investor is a glutton for punishment, or that the modern media producer is a sadist. The average radio or TV business report, if it offers any coverage of markets whatsoever, will tend to focus exclusively on the performance of equity indices. Even interest rates, for example, barely get a look in. Open a typical newspaper, journal or even financial magazine, and see how much coverage
– if any – is given to any other asset class than common stocks. For that matter, consider how much focus the fund management industry (retail or institutional) places upon equity vehicles as opposed to any other. While many (funds) may be launched whereas few will ultimately be chosen, it represents a real triumph of marketing over relevance to continue to peddle products that few consumers are likely to need, let alone want. The financial services industry surely attained critical mass by way of long-only equity variety years ago – and the growth of exchange-traded funds has not exactly diminished choice. It is testimony to the lingering attraction of the equity myth that it continues to this day to drive the production of redundant product by an endless array of me-too providers. Of course not all funds are bad, and not all equity funds are bad; but the signal to noise ratio, given the population of the managed fund universe, has to be low.
Most critically, in the context of managed funds, know what you own – which will take some of the sting out of any exposure to managed equities in the context of a potential bear market. “Equity myth” ? Isn’t that somewhat harsh ? Not really. Consider the following chart, which we have demonstrated before. It shows the annualised 20-year returns from the UK stock market over three centuries: the 18th, 19th and 20th. Three aspects of the chart are worthy of emphasis. Firstly, it looks much like the standard „bell curve‟ – which is what you would expect, but only over the very long term, a term realistically much longer than the typical investor’s timeline. Results cluster around an average return. Secondly, and more alarmingly, those average returns are dramatically lower than equity market propagandists would have you believe. The median real annual return from UK stocks, over a period of three centuries, broken down into smaller, 20- year durations, is approximately zero. Not only is “stocks for the long run” a ridiculous thesis, but the long-run return has had, if history is any guide – and it is our only guide –
a tendency to be vanishingly small. Perhaps the riskiness of the stock market is understated in popular conception ? The third observation is, to us, the most striking. It certainly answers the question posed in the title: why do so many financial advisers favour stocks ? Answer: because the chances are, those advisers all worked at least some stage during the last twenty years – the one period on the entire chart during which the annual 20-year real return from the stock market was
meaningfully large, at between 8% and 10%. To put it another way, the 1980-1999 experience was, in the context of the past three centuries, unique. To put it another way, the 1980-1999 equity market return was a 1 in 15 phenomenon. It was most certainly not the norm. But the fund management industry, with its perennial obsession with equities over any other form of asset, certainly behaves as if it was the norm. As the regulator insists, past performance is not necessarily any guarantee as to future returns. Equity market apologists today must fervently wish that to be the case.  Source: Global Financial Data, Datastream. Of course, the problem with statistics is that if you torture them for long enough, you can get them to confess to anything.
Since we‟re not in the business of promoting funds [either equity funds or those of any other kind we can speak with some degree of objectivity about the current make-up of the investment landscape. Whatever else it can be said to be, it is extraordinarily polarised. Stocks continue to bounce around in a largely trendless way, but the recovery / dead-cat bounce off the lows of March 2009 is undeniable. Government bonds, on the other hand, notably those within G7 markets, are predicting nothing less than deflation. There is no other way to interpret two-year US Treasury notes yielding 0.5%. Here is the chart of 10 year US Treasury bond yields over the
past decade: US 10 year yields, last 10 years  Source: Bloomberg LLP. The trend is undeniable. From a yield of almost 7% at the start of the decade, US yields have trended relentlessly lower, approaching 2% during the panic phase of the crisis in 2008, and sitting at around 2.75% today, and still trending downward. Other major government bond markets have delivered similar performance. But the historical precedent of one of those markets is the most instructive: that of Japan. Japanese 10 year government bond yields, 1990 to present day  Source: Bloomberg LLP. Japan was ahead of the West by almost 20 years. The seeds of its own property market and banking collapse were sown in the 1980s, and by the late 1990s the country was already floundering in deflation. Note also that the process of quantitative easing, the second iteration of which now threatens in the other industrialised economies, has achieved little by way of meaningful positive impact in Japan. At the risk of labouring the message about equities, Japan‟s Nikkei 225 Index is currently 75% below its bubble era high, reached some 21 years ago. To sum up, then.. The banking and financial services industry routinely overstates the performance and indeed relevance of exclusively long-only equity investing. This would be understandable if it were a message coming solely from stockbrokers, but is more galling to be being transmitted from institutions that should be asset class agnostic. The investment media, by and large, assist in this equity-centric propaganda. This is not to be simplistically critical of the idea of owning common stocks per se, but it is meant to be critical of an entirely equity-centric portfolio at a time when the likelihood of a full-blown deflation has not been higher since the 1930s (in western markets at any rate – this argument also underlines the admittedly longer term equity case for investment in the fundamentally more attractive emerging economies). To add kerosene to the tinder box, governments have not stood entirely idly by. Heavily influenced by the neo-Keynesian addicts to stimulus irrespective of sovereign solvency, western administrations, led in no small part by the US Federal Reserve, have thrown everything at their disposal by way of taxpayers‟ funds to try and ensure (vainly, thus far) that economic recovery will soon return – in much the same way that our ancient ancestors used to make human sacrifices to placate the gods of the harvest. While it has brought recovery no closer, it has managed to utterly distort the pricing signals of the financial markets and guarantee a foggy mixture of moral hazard and general economic confusion. Perhaps, as in the case of a forest fire, it might be better to let the conflagration burn itself out and allow the forest to prepare for cyclical re-growth. James Rickards nicely identified the problem of „moral hazard creep‟, writing in last Friday‟s Financial Times: “Policy, whether it be printing money, guarantees or deficit spending, can prop up asset values for a while. This may even be useful in a liquidity crisis. But a solvency crisis is another thing. The longer policy distorts markets by ignoring fundamentals, the longer those reliant on market signals will sit on their hands [investors: this means you]. The Fed‟s recent decision to continue asset purchases shows there is no exit once this path is chosen. As we approach the second anniversary of the Fannie and Freddie bailouts, are we better off ? Values cannot recover until they first hit bottom. In short, our economies would be growing more robustly today if we had taken our medicine in 2009.” No use crying over spilt milk, though. From the perspective of today‟s investor, the answer must surely be: diversify across multiple asset classes as appropriate, and keep some powder dry.
1 September 2010 Lord of Finance One recurrent theme of Lords of Finance is how despite their best intentions, the 4 key central bankers were unable to prevent narrow national self-interests from de-railing the global economy and its needs. The French were accused of being debt to an impassioned plea for help from the German ambassador, Dr. Leopld von Hoesch who asked “Did they really want to provoke a revolution in Germany?” Paul Einzig captured the view of many in Europe at that point when he later wrote, “On the ruins of the wealth, prosperity, and stability of other nations, France has succeeded in establishing her much desired politico-financial hegemony over Europe.” Ahmad writes that ‘The American ambassador in Berlin, Frederick Sackett, cabled to Washington that unless Germany received $300 million immediately, it would declare national bankruptcy and default on the $3 billion it owed American banks and investors. George Harrison convened an emergency meeting at the New York Fed with Under Secretary Mills and the two most knowledgeable men on Germany, Owen Young and Parker Gilbert. They concluded it would be throwing good money after bad, when the United States had already contributed $300 million by its moratorium on war debts.’ In an anti-reparations treatise of the time, German Central banker Schacht wrote of “bleeding Germany white” and “destroying Germany’s credit”Ahmed notes that ‘One excerpt in particular was heavily quoted in British and American newspapers: “Never has the incapacity of the economic leaders of the capitalist world so glaringly demonstrated as today….A capitalism which cannot feed the workers of the world has no right to exist.” ’ In 2010, we’re not quite at that point yet – although we weren’t too far from if recently on the streets of Alters!
30 August 2010 Banks, Baht and Beer Money! Living and working abroad has its advantages, none more so than here in Thailand, Sun (outside of the rainy season) Sea and sand plus, the friendly people and the fantastic life that you can have here in Thailand. My family and I have recently moved to Bangkok from the UK. Having worked at HSBC for the past 8yrs and the 12yrs prior to that the Royal Air Force, I feel that my eyes are suddenly wide open to the many wonderful opportunities that living and working abroad can give you.
Offshore banking is a massive perk to living and working abroad, getting your money paid into an offshore bank account free from UK tax is like receiving a bonus every month, but it’s what you do with that bonus that is going to be the main thing.
Working within the HSBC wealth management team, I always felt that I was doing the correct thing for my customer, especially during the turbulent times of the past few years, and of course I was, in my eyes, and the eyes of the UK banking sector. Being offshore has broadened my horizons and showed me that truthfully, ‘there is another way’. I was always told as a young apprentice Financial Planning Manager, the best thing for a customer’s money was on deposit with the bank in some form or another, max out the ISA’s and go from there! It was safe and secure, but did the customers’ money really work for them? The interest rates in the UK for savers are pitiful and not much better for the offshore market either. Central Bank base rates are at all time lows and the GBP has had better and stronger days too. If you had your money, let’s say £100,000, deposited into a 12 month Barclays Wealth offshore bank deposit account 4yrs ago, you may have been getting a rate of interest of 5%, giving you an annual return on your investment of £5000. Today for the same money, in the same account, you would be getting a return of £1420, that’s £118pm. If you’re retired, sooner or later with those kinds of figures, you are going to start eating into your capital Thailand then, suddenly seems more expensive. Ask any retiree who has been here a while, what going from 70-50THB to a Pound has meant to their standard of living, add that with the sudden drop in savings rates and the couple of bottles of Singha beer on a Sunday lunch time may now be just the one! We all know, as its being widely reported over the past couple of years, that the big banks are currently not lending, they are like squirrels storing up for harder times to come, so they are hardly going to try and entice you in with high rates. To get a better rate you would need to go to a smaller bank, maybe in the Euro zone such as one of the Irish banks where you could get a maximum of 3.5%. When the credit crunch hit, the Irish government said that they would guarantee all deposits held within their banking system. Since then we have had the fall of Greece and a lot of the Euro Zone states wobbling, including the Irish, is that guarantee still reliable? If you have your money in an onshore bank account and receive interest income and you are non-resident, then you must look to fill in the relevant R85 (getting your interest without tax taken off) form from the bank or building society or the Inland Revenue. However, if this and any other income that may be derived from the UK, such as rental income, takes you over and above the UK income tax threshold, then one or two things may need to happen. First, sell your UK property, if you haven’t lived as a non-resident for five full tax years, then you may be liable to UK capital gains tax. So the best thing to do is that you should really look to move your money offshore. As I have already said getting a decent return on your savings at a bank is pretty much non-existent, so an alternative must be found. Such an alternative could be a Personal Portfolio Investment Bond, which will allow you to invest in a wide array of assets that will reflect your risk exposure. With Today’s economic climate as it is, emphasis should be placed upon capital protection. You can place your cash in the bank on a fixed 12 month deposit (or longer to get a better rate), but if for some reason you want your cash out now, any interest you may have built up would then be lost due to early withdrawal. With an investment bond you can have up to 90% of your investment from day one, you can make regular withdrawals or one offs. Going back to the UK, you can take 5% of the capital per year for 20yrs or roll up the 5% year on year for 20yrs until you have taken the full capital amount, without paying income tax. More good news is that the interest will carry on being paid gross until a chargeable event happens, such as you withdraw more than the allotted 5% for that year. This means that if you decide to retire back abroad, the bond will become free of UK tax once again. As previously stated, capital preservation is recommended at this time, especially if you’re saving for education fees or it’s your retirement nest egg. The 21st Century fund is a secure, high yielding regular income fund which is hedged into a currency of your choice, using a range of currencies. The fund is Mauritius regulated, mainly comprised of asset backed lending instruments that produce a targeted return of 7%. All of these instruments are very low-risk with assets cover that currently exceed 160% of liabilities. If you’re looking for consistent, above average returns even in volatile markets, If your living and working in Thailand and therefore spending Thai Baht, this is the fund for you, as it helps protect you against currency risk, as it’s available not just in Sterling, but also USD, EUR and THB. 12 Month Deposit Bank/Fund | Deposit Amount | USD | GBP | EUR THB | | Anglo Irish Bank Corp | GBP100,000 | 2.85% | 3.55% | 1.33% N/A | | 21st Century Fund | GBP100,000 | 6.5% | 6.6% | 6.4% 6.8% |
For a full list of all offshore deposit rates in all major currencies please contact us at MBMG In a recent interview with the Telegraph, Michelle Slade of Moneyfacts said: ‘Monthly interest is only available on a third of offshore accounts, leaving savers after a regular income from their money in a difficult position.
‘With rates so low savers are seeing their income depleted and many now have to eat into their capital which only exacerbates the problem’. This is starting to be borne out in a lot of the banks who are removing the offshore arm of their business. Banks such as Northern Rock, Irish Permanent and Yorkshire Building Society, who took over Chelsea Building Society this year, are all making a run for the hills. Northern Rock Guernsey will close its doors on September 2nd this year and as an incentive, it will make a “goodwill” payment equivalent to 10 days’ interest – with a minimum payment of £20 – for those savers who move their money by the deadline. Of course if you are already retired, then it’s the monthly income that you are looking for, an investment bond and 21st Century fund will provide you with this, unlike the majority of the offshore or onshore banking world at the moment. This will give you a regular income on your investment, hedged in to Thai Baht, giving you extra spending power whilst here in Thailand. Even if you want to keep your money in a UK onshore account and need some help with the Inland Revenue forms, or if you want to shop around for the best offshore bank deposit rate bond, then come and speak with me, Antony Bell at MBMG-International, after all ‘there is another way’!
27 August 2010 Today we have a special report from Tim Price – Director PFP Wealth Management and Scott Campbell – Fund Manager MitonOptimal Scott Campbell, Managing Director and Fund Manager THE REALLY REALLY LONG TERM? Some weeks ago we wrote about the high frequency traders needing to rent office space in the stock exchange buildings, as 4 miles down the road was non competitive from a time perspective! Last week we looked at the tactical asset allocation call around the probabilities of a double dip recession. This week it is opportune to review strategic asset allocation and our philosophy based around the Kondratieff inflation / deflation long cycles. In the really long term, equities have and will produce the best real returns, however over the past century there has been two, and we are in the middle of the third, time where developed world equities can produce nothing for 10-15 years. No investor I know has a 100 year time horizon, but then being patient for 15 years is equally rare.  As our Investment Philosophy Seasons chart above highlights, in the winter period of deflation which commenced in the western world during 2000, strategic asset allocation would require a significant overweight to cash, government bonds and gold bullion. Diversification theory requires significant underweight exposure to equities and property in this period. Whilst it is important to note that many emerging markets are in different season and opportunities still abound, the western world is still 70%+ of global stock market capitalisation and economic activity.  However, the above chart for this week’s FT clearly shows that being an eternal gold bug, or only owning bonds and cash forever is also folly. The problem with most funds is that strategic asset allocation is based on 10-20 years worth of data and takes no account of these really really big picture issues. The best example being at the turn of the century after an extremely bullish disinflationary time period and almost all balanced strategic asset allocation was 75% equity / 25% bonds. Patience during the winter deflationary long cycle is very important but equally important is that spring reflation is around the corner which requires a whole new strategic asset allocation. How will we know when we are at that point? Well most balanced strategic asset allocation will be gold, bonds and cash I guess! Tim Price , Director of Investment PFP Wealth Management The going gets tougher “There are times when the burden of taking other people’s money forces you to be active when you dont really have conviction. It gives you a sense of pressure and expectation. When it‟s your own money you don‟t have to do anything.” - Tony James, President of Blackstone, commenting on Stanley Druckenmiller‟s decision to wind up his hedge fund. As reported in The Financial Times. The Investment Commentary will shortly be taking its summer holiday. It will return, on Monday 20th September. As capsule summaries of ‘agency risk’go, the one above takes some beating. As any honest trader will confirm, being forced to be active without conviction is a licence to lose money. Doubly so in such a convictionless market as the one in which investors are now becalmed. Henny Sender‟s article (“The letter that shook hedge funds”) for last Thursday‟s FT cites a hedge fund executive similarly bemoaning the apparent lack of alpha male assuredness in alternative asset management: “Nobody is sending out definitive „this is my view‟ letters these days. Nobody has any conviction. We go through rallies and we go through sell-offs and nothing is well sustained.” Well, tough. Above the noise of the world‟s smallest violin playing on behalf of the hedge fund community, nobody ever promised them, or anyone else, a rose garden. If the author of the anonymous quote above had been a traditional banker, we could at least have gone onto an extended rant about moral hazard, moral bankruptcy, and the sad triumph of a parasitic underclass that has gone on to devour its host and much of the rest of the economy. As it is, all we can suggest is that in such an apparently challenging market, those who can manage risk should now thrive at the expense of the hordes of overpaid chancers who pollute the ranks of the supposedly homogeneous hedge fund sector. The problem is most acute in the world of so-called global macro funds. In more tightly defined strategies, say credit arbitrage, you make the best – and the worst – from the asset universe available. But in global macro the investible universe is pretty much infinite; there is arguably too much choice, if there can be said to be such a thing. And if a lack of conviction were really warranted, each of those choices today essentially represents an opportunity for the active manager to hang
himself. Individual investors may lack conviction, but as we pointed out last week, the markets themselves have no such reservations. Stock markets admittedly seem caught in a state of funk. But bond markets are screaming it from the rooftops: deflation is coming. How else to explain 30 year German government bonds at all-time record yields below 3% ? Or 2 year Treasury notes hovering at 0.5% ? The investment media, of course, have an answer: it’s a bond bubble. But it’s difficult to feel the same way about lending money to „AAA‟-rated governments as most people did about piling into profitless internet businesses 10 years ago selling online petfood. (Interesting, in passing, to recall that Mr. Druckenmiller by all accounts lost a huge amount punting internet stocks. It’s not enough to say it was just a matter of market timing, and mistaking the ninth inning for the eighth. Being late and being wrong can be the same thing.) Yes, it could be a bubble, but “bubble” seems an odd way to describe an asset that most people pursue to preserve rather than expand their wealth. A bit like talking about a “bubble” in saving. Which doesn’t stop the likes of Jeremy Siegel, author of one of the most notorious examples of equity cult fetishism (“Stocks for the long run”), whining about “The Great American Bond Bubble” in the Wall Street
Journal. To take one admittedly extreme example, from the one economy that has endured outright deflation recently, one of the surest ways of losing money throughout the 1990s was by shorting, as opposed to buying, Japanese government bonds as their yields sank, and sank, and sank further. 10 year Japanese government bond yields, 1990-1998 
(Source: Bloomberg LLP) It seems plausible to conclude that there are at least two types of institutional investor – aside from central banks – buying government bonds and who are largely price insensitive. One is pension funds, who have actuarial and liability-driven reasons for doing so. The second is, ironically enough, the banks who were, alongside governments, most complicit in causing the crisis in the first place: as recipients of essentially free, government-sponsored money, parking those proceeds in the government bond market allows them to earn what they would call “riskless” profits – though we know enough about banks by now, and ratings agencies, to treat their definition of “riskless” with a pinch of salt. Japan gets something of a bad press when it comes to its deflationary lost decade. As Richard Koo points out in “The Holy Grail of MacroEconomics: lessons from Japan‟s Great Recession” (John Wiley, 2008), the damage incurred after its property and equity bubble burst in 1989 was worse than that suffered by the US during the Great Depression. Japanese commercial real estate prices fell by 87% from their peak. (As Koo suggests, imagine the effect on the US economy if urban real estate values fell that far.) The loss of wealth from the value of land and shares in Japan came to 1500 trillion Yen. That is three years‟ worth of Japan‟s GDP: “about the largest loss of wealth in human history during peacetime.” By comparison, the loss of wealth in the US during the Depression summed to “just” one year‟s worth of US GDP. Japan really had it bad. And yet, while the US unemployment rate soared to 25% during the Depression, during Japan‟s contraction its own unemployment rate never rose above 5.5%. Cultural hostility to lay-offs no doubt played some role, but a larger role was played by the Japanese government, which stepped in to replace private sector spending, albeit by issuing enormous amounts of government bonds. And yet despite this issuance, Japanese government bond prices never fell. Individuals and banks, rebuilding their shattered balance sheets, bought them. Despite suffering the financial equivalent of an atomic blast, Japanese GDP didn‟t fall during the 1990s. But more to the point, after a colossal collapse in both property and the banking sector, government bond prices can act in somewhat counter-intuitive fashion. The problem facing Western governments is that the policy cupboard is almost bare. Conventional monetary policy is spent: interest rates, particularly policy rates, simply can‟t go any lower. Nor is there ammunition in the fiscal armoury: most governments have now belatedly rediscovered austerity, so there is no realistic prospect of tax cuts, quite the opposite. The only tool left is the unorthodox and last ditch one known as quantitative easing. As Koo points out, this was staggeringly ineffectual in Japan: he calls it “the twenty-first century‟s greatest monetary non-event”. The BoJ implementation of QE at a time of ZIRP (Zero Interest Rate Policy) was “similar to a shopkeeper who, unable to sell more than 100 apples a day at Y100 each, tries stocking his shelves with 1,000 apples and, when that has no effect, adds another 1,000. As long as the price remains the same, there is no reason consumer behaviour should change – sales will remain stuck at about 100 even if the shopkeeper puts 3,000 apples on display. This is essentially the story of quantitative easing, which not only failed to bring about economic recovery [in Japan], but also failed to stop asset prices from falling well into 2003.” In an unnecessary but valiant attempt to placate our earlier anonymous hedge fund executive, here are our views. QE2 looks like a done deal across Western administrations,and we expect it to be comparably as futile as the Japanese found it to be. But it may well sow a sufficiently critical mass of inflationary and currency-destructive seeds to justify, ultimately, inflation protection. In the meantime, government bond markets will remain well bid since deflationary pressures trump any other. We prefer, however, to invest in true quality rather than perceived high quality, and are therefore focused on the most creditworthy sovereign borrowers in the world which happen also to provide excellent yields by comparison to the overcrowded conventional yields available in usual suspect markets like the US, the UK, Germany.. Investment vehicles such as the New Capital Wealthy Nations Bond Fund (investment grade sovereign debt, which yields c. 7%) and Stratton Street’s Renminbi Bond Fund (Asian investment grade sovereign debt with a structural exposure that is long Renminbi and short US Dollar; current yield c. 6%) strike us as significantly more attractive on a risk-adjusted basis than the conventionally “riskless” government markets of heavily indebted countries like the US and the UK. In equity terms we have favoured for some time the most defensive blue chips. In other respects we see little by way of compelling wealth insurance except for absolute return funds with a demonstrable track record of capital preservation and growth, and gold. Happily for us, we are not managing a global macro hedge fund: in those areas outside our zones of highest conviction, we will be doing precisely nothing.
25 August 2010 Lord of Finance One lesson from reading ‘Lord of Finance is that danger can lurk in the unlikeliest places-very much in line with our current themes of ‘expect the unexpected’ and the era of ‘Bob and Jack’. ARNOLD TOYNBEE, IN his magisterial review of the year's events on behalf of the Royal Institute of International Affairs would later compare the events of the summer of 1931 to the summer of 1914. Both began with relatively minor events far from the hub of the world that nevertheless set in train a cascade that plunged out of all control and brought down an entire world order. In 1914, it was the assassination of the Austrian heir presumptive, the archduke Franz Ferdinand, at Sarajevo. In 1931, it was the failure of the Credit Anstalt, the oldest and largest bank in Austria.
On Friday, May 8, the Credit Anstalt, based in Vienna and founded in 1855 by the Rothschilds, with total assets of $250 million and 50 percent of the Austrian bank deposits, informed the government that it had been forced to book a loss of $20 million in its 1930 accounts, wiping out most of its equity. Not only was it Austria's biggest bank, it was the most reputable-its board, presided over by Baron Louis de Rothschild of the Vienna branch of the family, included representatives of the Bank of England, the Guaranty Trust Company of New York, and M. M. Warburg and Co. of Hamburg. After a frantic weekend of secret meetings, the government made the problem public on Monday, May Il, at the same time announcing a rescue package of $15 million, which it would borrow through the BIS.
Austria was a small country, about a tenth the size of Germany, with a population of fewer than seven million and a GDP of $1.5 billion. Nevertheless, the news burst like a bombshell upon the City of London and the Bank of England
It’s reported that Harry Siepmann, one of the Bank of England governor's principal senior advisers, knowing something of the scope of the tangled mess that lay behind the headlines, announced, "This, I think, is it, and it may well bring down the whole house of cards in which we have been living."
This time the devastating blow from the periphery is as likely to be Greek, Spanish, Portuguese or Irish as it is Austrian but actually Italy could be the most likely source.
23 August 2010 Experience and Expertise will separate the men from the boys
James Phillipps pointed out on Citywire recently that we should have all been ready for the current correction following the sharp market rally in 2009 as history suggests a 30-40% correction this year is the inevitable consequence – citing David Rosenberg, former chief North American economist at Merrill Lynch who warns this fall could be the start of bear run. ‘There have only been two other times when the stock market ran parabolically up from a low in barely over a year, as was the case this time around- the 112% surge from June 1, 1932 to September 7, 1932, and the 116% run-up from March 2, 1933 to July 18, 1933,’ he says. ‘In the first case, we had a 40% correction and in the second, the correction was 34%. So, we are talking here about the prospect of a pretty hefty reversal in the S&P 500 that could very easily take the index down to as low as 850, if the history of these types of givebacks is any indication.’ That’s still some way above our fears of a S&P botton of 300-580 but Rosenberg, who is now chief economist and strategist at Gluskin Sheff, insists that there is little to be positive about, accepts that this is reflected in a lot of the key indicators and therefore believes that the market has started to price in the macro outlook. However we believe that he fails to take account if how far markets might dip-The Shiller Price to Earnings ratio (which calculates the P/E ratio of the market using ten years worth of earnings) implies that the market is overvalued by about 20% - however a crash rarely sees a neat and today mean reversion – a S&P base at around 800may eventuate and from there, ‘If history is a guide, when the Shiller P/E is at these levels, the 10 year annualised return of equities is just over 5%,’ Rosenberg says. But before that base is built don’t be surprised to see the equity markets keep falling and property and maybe commodities too. Phillipps sees Rosenberg’s view as being consistent with the fact that since March, the Fed’s balance sheet has expanded by a further $50 billion from taking on more mortgage-backed securities. So much for the Fed moving into tightening mode and a poke in the eye for the advocates of a V shaped recovery. The key to such markets is connecting the dots (what George Soros calls reflexivity), waiting for the buying opportunities (the patient asset allocation of Martin Gray’s Osmium Portfolios) understanding the intrinsic value of assets (Warren Buffett’s Berkshire Hathaway approach) and understanding the macro environment well enough to interpret the data in away that corresponds with deciding the right time to enter or exit markets (which no-one does better than Iridium’s Scott Campbell). There are times when the value of expertise will be well and truly highlighted – or as MitonOptimal’s Joanne Baynham says “when the markets separate the men from the boys”.
20 August 2010 Gambles - A Lunch with the Godfather ...An offer I couldn't refuse
Yesterday the guru of emerging market investments , Dr. Mark Mobius of Templeton , chatted to a packed audience at Bangkok’s FCCT. Dr. Mobius had the audience hanging on his every word as he took us with him on his odyssey though emerging markets for the last 4 decades. While his most valuable insights were his unique understanding of the relative opportunities of developed , emerging and frontier markets and of his time working alongside the great disciplined value investor , Sir John Templeton. I particularly enjoyed the following exchange which arose in response to a question from the floor about the definition of developed, emerging and frontier markets.
ST PHOTO: NirmalGhosh Mark Mobius – “Back in the 1980s we tended to rely on income per capita as a guideline to how developed a market was. That’s still a good benchmark today. It’s interesting that as some markets have developed, they are moved along the chain and moved away from us. The recent crises have even seen some like Greece come back to us; their Euro membership seemed to make them . More like developed markets but now they seem to be emerging markets again”
Paul Gambles – “That’s a really interesting point; looking at the relative outlook for both China the USA , is it possible that we could see an emerging market as the world’s largest economy ?
Mark Mobius – Well, Paul, I don’t think that America is in quite such bad shape yet, that its per capita income will fall to emerging economy levels not yet anyway…”
Paul Gambles – Sorry, what I meant was could China overtake the US as the largest economy, while China still has emerging market income per capita ?”
Mark Mobius – Oh yes ,that’s definitely possible . I see what you mean. Yes that could happen.
Paul Gambles – But now you’ve really started me thinking about how far the US spiral can go. I like your answer on that.
For more information about Dr. Mobius’s talk, please don’t hesitate to contact us.
18 August 2010 Lord of Finance One lesson from reading ‘Lords of Finance is that danger can lurk in the unlikeliest places-very much in line with our current themes of ‘expect the unexpected’ and the era of ‘Bob and Jack’. ARNOLD TOYNBEE, IN his magisterial review of the year's events on behalf of the Royal Institute of International Affairs would later compare the events of the summer of 1931 to the summer of 1914. Both began with relatively minor events far from the hub of the world that nevertheless set in train a cascade that plunged out of all control and brought down an entire world order. In 1914, it was the assassination of the Austrian heir presumptive, the archduke Franz Ferdinand, at Sarajevo. In 1931, it was the failure of the Credit Anstalt, the oldest and largest bank in Austria. On Friday, May 8, the Credit Anstalt, based in Vienna and founded in 1855 by the Rothschilds, with total assets of $250 million and 50 percent of the Austrian bank deposits, informed the government that it had been forced to book a loss of $20 million in its 1930 accounts, wiping out most of its equity. Not only was it Austria's biggest bank, it was the most reputable-its board, presided over by Baron Louis de Rothschild of the Vienna branch of the family, included representatives of the Bank of England, the Guaranty Trust Company of New York, and M. M. Warburg and Co. of Hamburg. After a frantic weekend of secret meetings, the government made the problem public on Monday, May Il, at the same time announcing a rescue package of $15 million, which it would borrow through the BIS. Austria was a small country, about a tenth the size of Germany, with a population of fewer than seven million and a GDP of $1.5 billion. Nevertheless, the news burst like a bombshell upon the City of London and the Bank of England It’s reported that Harry Siepmann, one of the Bank of England governor's principal senior advisers, knowing something of the scope of the tangled mess that lay behind the headlines, announced, "This, I think, is it, and it may well bring down the whole house of cards in which we have been living." This time the devastating blow from the periphery is as likely to be Greek, Spanish, Portuguese or Irish as it is Austrian but actually Italy could be the most likely source. |
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