Euro Zone Update

Since my first posts on this topic in January, the Euro zone situation has gone from bad to worse.


Economic conditions in almost all of the member countries have deteriorated, even after massive bailouts and 'strengthening' measures.


Heads of state from around the globe seem to be meeting on an almost daily basis to discuss the best course of action, but very little has been done to rectify the problems faced.


As I hinted previously, the only way i see out of this is either -


a) Let Greece and the other weaker nations go to the wall and drop out of the euro


Or


b) Make huge inroads towards greater fiscal integration within the Euro zone.


The rhetoric we are hearing from Angela Merkel (Chancellor of Germany) and her peers suggests that they are well aware of this choice.


It seems that they think that choice a) (letting countries fall out of the single currency) would be so cataclysmic that it simply can't be allowed to happen.


Therefore they seem to agree that choice b) is the way to go.


This however is much easier said than done. The kind of integration needed to make this work would basically involve a huge redistribution of wealth from the richer countries (namely Germany & to a lesser extent France) to poorer nations such as Greece and Portugal etc on an ongoing basis.


Why should the people of Germany and France sign up to this? It simply isn't in their best interest.


My personal opinion is that the weaker countries should be left to go bankrupt.


It would be very messy in the short run, but in the long run everyone would be better off.


Greece etc would return to their old currencies, which would substantially devalue and allow them once again to compete in the international marketplace. Germany and the other, more prudent nations would survive as a stronger block.


Further fiscal integration would still be needed between the remaining countries but this decision would hopefully be an easier one to make as it would be more in everyone’s best interest.


A bit of history...


The precursor to the Euro was the ERM (Exchange Rate Mechanism), it was formed in 1979 and worked by pegging members currencies to each other to reduce exchange rate volatility.


The UK entered the ERM in 1990 and within two years dropped out due to the huge strains caused by essentially locking our currency to the German Deutschmark. The Germans had a radically different economy to ours and a fixed exchange rate was never going to work. During our time in the ERM our government spent 6 billion pounds trying to prop up our currency and also we experienced recession, partly caused by heinous interest rates of 10%+


The UK dropped out of the ERM on Black Wednesday (16th Sept 1992) and this was seen as a huge failure, but soon after our economy bounced back and unemployment fell significantly. Was it really such a bad thing falling out? At the time Norman Tebbit, a conservative MP, referred to the ERM as the 'Eternal Recession Mechanism' and I don’t think he was far wrong.


It will be far more complicated for Greece to drop out of the Euro, implementing their old currency for one will be very expensive. I am sure however that it is in their best interest long term to do so, and the sooner they do it the better for everyone involved.

Zero-Sum Game - The Perils Of Day Trading

In the film Wall St, the protagonist Gordon Gekko advocates that the stock market is a zero-sum game. This basically means that every dollar he makes, someone else must lose, because the net change in wealth must be zero.

There is much conjecture about this on the net, with many people arguing for and against.

Investopedia.com notes that ''A stock market is not a zero-sum game because wealth can be created in a stock market.''

I agree with investopedia, in the long run wealth can be created. The average (decent-profitable) company should grow at least in line with inflation (i.e. it passes it's increased input costs to it's customers), as well as returning a share of it's profits in the form of a dividend. Taken very roughly if you imagine average inflation to run at about 3% and average dividends also being about 3% it comes as no surprise that long term gains from the stock market equal about 6-7%
Obviously a great company will grow far faster than inflation and possibly distribute a higher proportion of its wealth, leading to much higher gains, compounded further if dividends are re-invested.

In the short run however, I think Gekko is right. Day traders like himself do not hold stock long enough for any wealth to be created, so it is in fact, a zero-sum game. If you take into consideration dealing costs it is actually a negative sum game. No surprise then that the vast majority of day traders lose money, to the benefit of a lucky few who usually have a competitive edge.

Contrarian Investing

I read this article today and it really got me thinking.

http://uk.finance.yahoo.com/news/anthony-bolton-3-things-private-072206523.html

I was particularly astounded by the statement that - 'during the period 1984-2002 -- a bull market when the equity markets turned $100 of spending power into $500 -- private investors succeeded in turning that same $100 into just $90.'

What? They lost money!? How could they when invested through such a bountiful era? I dread to think what returns these people have made (lost!) in the hard times since 2002.

The general mass of private investors by their very nature are anti-contrarian. They are doomed to buy at the peak of the market, buy into fad sectors that are grossly overvalued and they end up losing a fortune as bubbles pop and markets correct.

'Buy low, sell high', it sounds so easy doesn't it? In reality it is very hard as it involves overriding our feelings of greed and fear.
In the super market when prices of a certain product fall, people act rationally and buy more, possibly even stockpiling if they have the facility. In the stock market though, when prices fall people get scared. They lose faith in their investment and often sell out and stuff their money under the proverbial (or actual) mattress. This being exactly what they shouldn't do. If anything they should be buying more.
If they thought XYZ plc was a good buy at £2.00 a share, surely if they fell to £1.00 a share they would want to buy more? This is rarely the case, and is the main reason why the average investor is doomed to under perform the market.
As Warren Buffet says - 'Be greedy when others are fearful, and be fearful when others are greedy'


To understand when the market is cheap, as active investors we must familiarise ourselves with valuation measures like P/E ratios PEG ratios, Dividend Cover and Net Asset Value (NAV) so that we might determine when companies are ripe for investment.

If you are a passive investor your chances of success can be increased by making regular payments into a fund, thus negating your chance of getting the timing wrong, also try not to get scared if your fund is showing a loss, stopping your investment payments would probably be a costly mistake in the long run!

March 2012 UK Budget

Highlights.

1. Top 50p rate of tax reduced to 45p

2. Tax free allowance threshold raised to £9,205 from April 2013.

3. 40p tax band threshold reduced from £42,475 to £41,450.

4. Pensioners' tax free allowance to be cut in real terms.

5. Child benefit to be curtailed if a household member earns more than 50k, if earning more than 60k child benefit ceases altogether.

6. Fuel duty still to go up in August.

7. Cigarettes up 37p beer up 5p.

8. Corporation tax cut to 24%, to be cut to 22% by 2014.

9. Stamp duty raised to 7% for houses worth 2m. 15% if bought by an offshore company.

10. Money for military accommodation and council tax relief for soldiers

The Case For Tesco

2012 has so far brought disappointment for Tesco shareholders. After lacklustre Christmas figures and a small drop in market share, Tesco shares plunged over 20%, and have stayed close to these levels despite a strong rally in the underlying market.



For a long time Tesco’s UK stores have had little to worry about from their native competition. Their superior supply chain management, clubcard scheme and the general quality of their stores and great service has kept them firmly at the forefront of the UK grocer business. The piles of cash derived from the UK stores have also helped fund massive expansion into overseas markets making them the worlds 2nd largest retailer (by profits) behind Wal-Mart.



It seems however, that the competition is catching up. Tesco are facing strong price competition from the likes of Asda (Wal-Mart), and smaller discount retailers such as Lidl and Aldi are also posing a threat. Additionally they are facing increasing product and service competition from Waitrose, Sainsbury’s and Morrison’s.



It hasn’t helped matters that Tesco have branched out much further than the other supermarkets into areas such as consumer electronics, clothing, banking and insurance. All these areas are have been hard hit by the economic downturn, and as such have left Tesco more sensitive to adverse trading conditions than many of its rivals.
Some of these areas, especially ones that are exposed to cheap online competition, need to be looked at and evaluated accordingly, then when the economy finally improves, Tesco could perhaps be in a prime position to outperform once more.



At the current share price Tesco’s P/E ratio is 8.97 making it the cheapest UK listed grocer relative to earnings. Furthermore it offers a tasty 4.62% dividend yield, making it an attractive prospect for an investor seeking income, with also good potential for capital growth. A combination not to be sniffed at!

Get Fracking!

Oil and gas (and electricity) are vital fuels for our modern way of life. It is hard to imagine what our lives would be like without them.
For most of us, hydrocarbons are being burnt every single minute of the day to make our lives more tolerable.
Most of our electricity is still generated from the burning of fossil fuels, so your fridge for example, is more than likely running on coal. Then of course you have the gas central heating keeping you warm, and gas oven allowing you to cook your food, and don't forget the petrol/diesel that gets you to work everyday!
According to the Sunday Times (26.02.12), of the 203 million tonnes of oil equivalent energy we used in 2011, 185 million tonnes came from fossil fuels, 15.5m from nuclear, while wind and hydro power were just under 2m (less than 1%!).  The same article also states that North Sea petroleum and gas production were down 17% and 20% respectively. Imports of oil are now greater than UK production for the first time since 1978.

This backdrop paints a grim picture for the future of our oil and gas prices. With surging demand from emerging economies like China, India, Africa etc, prices of oil and gas are set to go only one way in the long run. Up! These higher prices will pose the biggest long term threat to global growth.

Hopefully new technologies in the oil/gas exploration industry, such as fracking, will increase supply and temper the rise in demand, thus buying us time to build some renewable energy infrastructure, so that the eventual transition from hydrocarbons to renewable sources might be less painful. Fingers crossed!













    

Investment Horizons

In these uncertain times where should we place our hard earned savings? Gold, commodities, bonds, equities, cash, fine art, wine, antiques, property?

I've never seen such a divergence of opinion in this regard, and perhaps the best policy would be to spread the risk a little and diversify into all these asset classes while we ride out the storm.

I myself however, am 100% equities, and this is why.

1) Cash: quite frankly with inflation running so high and interest rates so low cash is a VERY bad place to have your money as its purchasing power will gradually be eroded over time. Rather than being risk free there is a 100% risk of you losing money. Stay away!

2) Gold: there are lots of gold bugs out there right now; including many governments who are buying up all the gold they can, thus driving up the price to extreme levels. Gold is a traditional 'safe haven' asset, and with all the unprecedented loose monetary policy (Low interest rates/Quantitative easing) going on, the price may have a lot further to run.
However, gold has no real underlying value to underpin the price. Sooner or later when economic conditions improve, people will move out of gold en masse and the price will collapse. Add this to the fact that gold produces zero returns (actually might cost you quite a bit to store) and it appears to me that far from being a safe haven it is actually one of the more risky asset classes out there right now. I may be proved wrong in the short/medium term because i have no idea how much further the price will run, but eventually the price will collapse and there will be tears (not mine).

3) Bonds: usually bonds play an integral role in any portfolio, and can be a very useful asset class for those with a lower appetite for risk but who also wish to protect their savings from the ravages of inflation. However because of the recent mass intervention into bond markets by western governments the world’s bond markets have become very unstable and unpredictable, bond yields are also very low in those countries that are perceived as safe, therefore offering minimal protection against inflation right now.
Corporate bonds might be a better option in these times as they are offering higher yields and also it could be argued that the issuing companies are at far less risk of default than the countries in which they are listed.

4) Property: There is a strong case for UK property based on supply/demand dynamics. However when interest rates finally start to rise again, affordability will hamper the market. It is my personal view that housing will significantly under perform equities in the long term and that you would be better off buying shares in certain house builders than houses themselves.

5) Fine art/ Antiques/ Vintage Wine: I'm sure that there is some serious money to be made in these asset classes. As countries like China get increasingly richer these luxury goods will probably skyrocket in price due to the extra demand. I myself know nothing about fine art and antiques though, and would probably just drink the wine. So I won't be bothering with any of these.

That leaves equities, my asset class of choice. I think if you have an investment time horizon of 15+ years then equities are definitely the place for your money for the following reasons.

a) They are very cheap. The FTSE is currently trading at a P/E ratio of about 11, that's significantly lower than its long run average of 14/15 so there is easily potential for 30% + gains before shares become even fair value.

b) Dividends are high and getting higher. Many mega cap stocks such as Vodaphone, AstraZeneca etc are throwing off 5/6% dividends, this coupled with a huge potential for capital gains means that double digit annual returns should be possible over the long term for investors in these businesses.

c) Companies on the whole are in very good shape. Yes there have been casualties of the recession, especially in High St Retail where firms are suffering from strong competition from internet based firms. But many firms, such as the two mentioned above, are sitting on huge cash piles and have overseas exposure so are capitalising on emerging markets. It should be noted that most companies in the FTSE100 do more business abroad than they do in Britain, so an investment in a UK FTSE100 tracker for example, offers substantial global diversification.

So there you have it! If you have a long enough investment time line to see through the global debt crisis and the Euro zone single currency problems, then equities are probably the asset for you. This is my view and any further crisis that drives down the price of equities I will view as a buying opportunity.

The Global Debt Crisis -Whose Fault?

So whose fault is the global debt crisis?

When this question is asked on the TV the standard response seems to be 'greedy bankers'. While they certainly played their part through creation of highly complex tradable debt instruments and excessive use of gearing (debt), to place the blame squarely on their shoulders is laughable.

At the end of the day bankers are just people, and people respond to incentives. If they are given huge incentives to take big risks for short term gains, that is what they will do.

Are governments to blame?

To an extent yes, they are in charge of the legal framework that controls the bankers, so they should be held accountable to some degree for the breakdown of the system. It is clear that there is a limit to how 'free' markets should be. Rules and restrictions should be in place to curb the 'greed' of bankers and encourage them to take a longer term view of their strategies and actions.


There is however one set of players who I believe are far more responsible than bankers and government leaders for causing this mess.

They are also a group that has pretty much avoided any apportionment of blame whatsoever.

They are the Bank of England, the US Federal Reserve and the European Central Bank.

All three have been guilty of keeping interest rates ultra low during boom years when really they should have been much higher.

The central bankers have been acting under the false pretence that it is possible for a western economy to grow its GDP 3% a year indefinitely. When figures dropped below this, the Central banks dropped their rates to stimulate new growth.

What this did, through cheap and easy mortgage lending, was create the biggest property boom that the world has ever seen. They did not factor in the industries cyclical nature, and didn’t envisage what might happen when prices eventually toppled.

The scary thing is that these powers that be do not seem to have learnt from their mistakes, they have accepted no blame and are still yapping on about the need for growth to pull us back from the brink.

Growth is all well and good, but it must be healthy, sustainable growth. Not artificial growth that is derived from excessive borrowing of cheap money.

I personally don't think it is possible for a Western economy to grow much more than 1/2% a year healthily. The Bank of England and their global counterparts should take a long hard look at their growth figures and come up with better targets.

Euro Zone Mess Continued...

To recap on my last post, and add a few points, here is a little list of the pitfalls of the European single currency as it stands.

1. The currency of individual countries will not depreciate when experiencing times of hardship. Currency depreciation is a useful tool that can give disadvantaged economies a competing edge.
2. Countries can no longer set their own interest rate. Is the ECB rate really what they need?
3. No common Eurobond, this means that government borrowing costs across the eurozone can vary dramatically from country to country.
4. Vastly different legal systems, rules and ethics between countries, thus making integration difficult and somewhat unfair.
5. No defined system for the re-distribution of wealth from poorer countries to richer countries.

To my mind, as it stands in its current framework, there is no way the single currency can survive.
If it is to ever work in the long term the above points need to be addressed. Can this be done?

Points 1 and 2 cannot be rectified. Points 3, 4 and 5 however can.

A common eurobond must be created thus taking pressure off the debt servicing of countries like Greece, Portugal etc.

There needs to be huge fiscal integration between countries. Same tax laws, same tax collection system, same retirement age, same working conditions laws etc. Why should Germans have to retire at 68 whilst many Greek public sector workers retire in their early 50's?

There must be a system of wealth redistribution from richer nations such as Germany to poorer nations such as Greece.

If this were to be successful we would basically end up with a United States of Europe, only then could the Euro be seen as a triumph.

Will this ever happen? It's up to the richer countries really, Germany will need to step up and take responsibility for the poorer nations. At the moment this is looking highly unlikely.

Euro Zone Mess!

Ok, my first blog, and i'll jump right into the deep end and cover the Eurozone debacle a little.

I'll try and keep this short, but its quite a complicated topic, so here goes! Basically my view on the Eurozone 'experiment' is that it cannot work in its current format, and will end up being an efficiency drain on all members that use the single currency.
The weaker countries will continue to suffer as a result of using a currency far too strong for their economies to stomach. Just look how bordering countries like Turkey are prospering from a huge influx of tourism that would otherwise be weighted more towards Greece, Italy, Spain etc if their currencies were more competitive.
In contrast, very strong Economies like Germany's are benefiting as the euro is weaker than the DeutchMark would be if they had kept their old currency. Small wonder there has been a huge boom in German car sales since the Euro's inception, they have a significant export advantage.

Will cover more on this topic in my next blog :)