Telcos: the dotcom crash all over again?

One of the market themes that is starting to looking interesting is telcos. You know, those boring mature industries, whose fixed phone line legacy business is gradually being whittled away by the internet?    

The ones who are dying a slow death whilst being whipped by regulators at the same time?    

Doesn’t really sound attractive?

Well some of the charts bear this horror story out – take a look at the largest Australian telco, Telstra for example:  

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If you’ve been sitting in this stock for 5 years you wouldn’t have been too pleased – and why should the situation change?   

For example isn’t it the case that:    

• telcos like say Telstra are haemorraghing fixed line subscribers and competing at the same time with VOIP?
•  cellphone service providers like Vodafone are going to be wiped out by upcoming technologies like Wimax?

Well… maybe … and maybe not.

Telco investment risk mitigation factors

What if it’s not quite as bad as the market perceptions of risk? What about:   

• PEs in single digits and high dividend yields (5-10%)
• growing broadband subscribers
• growth in mobile data (all those iPhones out there are the automobile equivalents of Hummers in the smartphone world and there is an avalanche of iPhone pretenders from manufacturers like HTC for Android – and soon Windows Phone 7 – emerging every month now)
• in the case of the larger telcos quite geographically diversified operations (i.e. natural currency hedges)
• for segments like mobile data with significant network effects (users want the widest possible signal coverage wherever they travel) there is limited competition from only one or two other players 

Here are some comparative figures for BT and Telstra (mixed mode telcos) and Cable and Wireless and Vodafone (more mobile based revenue): 

* Preliminary results to 31/3 

** half year ended 31 Dec 2009 v same period previous year 

The low digit PEs imply there is relative risk about some of these companies (and yep, as we all know it’s really risk that revs up your return).      

On the risk to fixed line revenues as they migrate to mobile-only households point consider a situation where 25% of the population works from home all of the time and a good proportion occasionally.  Are they going to rely solely on wireless for their connection to the cloud and business contacts?

What about the booming online gaming market (where latency is really important)? And what about the increasing availability of online movie download systems (whether legal or illegal!) – with the average movie over a gigabyte in size (Cisco is currently forecasting huge growth in video traffic over the next few years)?  

And as for the VOIP point, again you still need the underlying wireline for VOIP. And for many of these (use of web based applications, increased video, and voice)  latency is important and data flowing back ‘up’ the pipe to the telco is important (as opposed to situations like cable television based internet connections where the ‘up channel’ is much slower).   This all means more data coming up and down the pipes owned by these telcos.   

Wimax reportedly has quite a lot of issues in handling high volumes of traffic at its backend, and just to further naunce (hopefully that’s a verb) this picture there is also the issue of IPv6 (the world basically running out of IP addresses so if you currently have significant IP address range allocations, as some of these companies do, that could be regarded as a valuable asset).   

The best telcos if you believe data demand will support these stocks

If you think that perhaps reports of the death of the fixed line has been greatly exaggerated and data demand will soar, where might you go?  

Vodafone

Well Vodafone is more of a pure-play in mobile data if you look at their revenue  breakdown:

but at the same time it is a very European play if you are worried about currency exposure with about 3/4ths of its revenue from Europe.  

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So Vodafone’s one possibility if you are not worried about the Euro exposure. 

BT I have also been in and out of over the last 18 months however the issue with BT as a pure play (on the rise in IP-based data consumption on mobile and fixed lines) is that it has a large services component.  

If, however, you do not think it’s necessary to discriminate between telecoms companies on the basis of the revenue splits and currency exposure you could also always consider iShare’s Telecommunications ETF. Top holdings as at  11 June 2010 might also give you some other ideas as to specific stocks:

Cable and Wireless Communications

A less obvious play on mobile data (and less popular than Vodafone) which I’m currently holding is Cable and Wireless Communications

which is 84% USD “pegged or earned” revenue but diversified across some more interesting geographical regions (which however are not Europe and not the USA) such as Panama, the Caribbean, Monaco, and Macau (in order of descending EBITDA). 

The chart is somewhat meaningless since it was demerged from C&W earlier this year but here it is if you want to look at it. 

Telstra

Finally, I also hold Telstra (see chart at the top of this article). 

It is currently plagued in somewhat similar manner to BP by issues around regulatory risk as the Australian government implements the national broadband network.  

However it is also a very widely held share in Australia (i.e. the government would lose a lot of votes if it destroyed the value in it) and BT survived being split into a wholesale and retail arm so I think it is likely that Telstra will also survive.

The risk of the publically funded National Broadband Network (NBN) fibre to the home project not buying its assets or doing a deal with it is really factored into the price at this point – and looking at its revenue sources is probably most likely to impact on an area that is already in decline (PSTN revenue):

Telstra saw a reasonably chunky fall in PSTN by 6.9% over the last half year but actually would have actually had a revenue increase in spite of this if not for a fall in advertising revenues, and actually grew free cashflow by 37% to the end of 2009 (you almost have to feel sorry for Telstra management in the circumstances). 

Telstra seems like a stock where the bad news is in the price: it’s mostly A$ exposure (and with franking if you are an Australian shareholder the dividend is huge) and my view is that it makes sense just to wait out the regulatory / NBN uncertainty and be paid while you do.

You would not be entirely alone if you decided to hold it:  Maple Brown Abbott, a good long term value fund here in Australia, has Telstra as their largest holding.

To spread your risk further you could probably safely hold all three: Vodafone, CWC, and Telstra.

Posted under individual stocks, Risk

My utmost admiration for the government on the Miner’s Super-tax. There’s a true symmetry to this which just has to be mentioned.

It’s called a Super tax because it’s a tax on ‘Super-profits’ in the mining sector.

But of course the beauty of it is that it is really also a tax on the superannuation (‘super’) savings of most Australians (the impact on project starts, jobs etc is well covered elsewhere).

A mining tax on fat cat mining companies, that’s fine isn’t it? Well mining companies make up 20% of the ASX market cap.

Let’s assume that BHP’s share price fall from the date of the announcement on May 2nd as a big diversified miner is a proxy for the fall in the mining index associated with K Rudd’s new super dooper tax. As of today (4 weeks later at June 1st) it’s fallen about 10% (from $71 to $64).

So any Australian’s superannuation portfolio which mirrors the ASX may have seen that fall about two percent (10% of 20%) to the extent that it mirrors the ASX 100.

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How much is Mr Rudd going to get from that tax – well Ernst and Young had it at about $9bn per annum.

Some fairly old Wikipedia estimates of the Oz market cap put it at 1.39 trillion (yeah I know these figures are really rubbery but you get my drift).

2% of $1.39 trillion (that’s 13 with 11 zeros after it) is the market cap decline because of this tax or $26 billion.

But hey it’s not that bad because 40% of the market is owned by furriners (we don’t need them to buy in and support our market!) who we don’t care about so the market might only really have declined for Australian shareholders as a result of this tax by $15.6bn (60% of $26bn).

And Australian superannuation fund holders only hold part of the market owned by Australians (maybe 80% if we assume they mostly hold domestic portfolios) so maybe Australian collective super funds are down by $12.48bn.

Now we could go on but I can see you are yawning –  it’s not over yet because the tax revenue only comes in about 2 years time (2012) and that nasty forward-looking market seems to have made the money disappear now – so you’d have to discount cash Mr Rudd is not going to see for at least 2 years. On the other hand you could argue that some of the fall relates to Europe and not K Rudd.  Anyway I’ll stop here  …  you can see where this is going.

Magical huh?  A tax that is supposedly applied to fat cat miners turns out to really come out of Australian worker’s pockets, and makes a net $3.5billion just disappear (after you net off a -$12.48bn decline in national super holdings and $9bn in tax revenue on the plus side in 2012).

Poor Mr Rudd huh? Things you can do with a nation’s savings and a publically traded stockmarket are not the same as what you do with your own household budget.

 PS. I do not hold a position in ANY mining stocks (don’t understand them). And if you want more accurate figures go get ’em – mine are only based on some crude estimates and an hour’s work in Wikipedia (a dodgy website that the government needs to filter out presumably).

Posted under Risk

Video games: still a long term growth story

For a few years now the video/computer games sector has looked attractive as an investor. 

As most people would now be aware video games have passed movies in terms of gross revenue and there are a bunch of  factors which make them extremely interesting as a long term growth story.

For example:

1. increased availability of high speed broadband
2. increased availability of large, high definition screens in the home
3. the growth of whole new genres which are different from the traditional shoot-em-ups such as edutainment titles which teach children far more effectively than any human teacher could, and gaming physical fitness titles exemplified by the Nintendo’s Wii Fit series which have redefined the user interface so that physical activity forms a strong component of the game
4. social gaming systems such as World of Warcraft (owned by Activision) with 11m players
5. new generations for whom gaming is not a marginal activity such as the under 20s and increasing numbers of women gamers

At the same time as a sector it’s pretty damn scary. 3-5 year console cycles cause stock prices to fluctuate like a yo-yo and it perhaps bears a passing resemblance with large title production costs and big marketing budgets to the movie business (not a business that looks tempting as organisations like Vivendi and Sony have learned to their cost). Equally there is the argument that, like the music business, titles can be pirated with high speed connections. Looking at all this you just have to keep reminding yourself equity investors really get returns for taking on risk…

However something that has significantly changed is that the multiples on all these gaming stocks have fallen over the last couple of years which is what makes them more interesting at the moment from the perspective of a value investor in what used to be regarded entirely as a growth stock play.

The big cap pure-play video games companies

The three big (pure) players are Activision, Electronic Arts, and Nintendo (given the risk levels on individual titles the smaller companies seem to be significantly riskier). None of these companies have any debt and all have significant cash on the balance sheet (in Nintendo’s case net assets excluding intangibles accounts for over a third of its market cap – about US$8bn of which is cash).

Whilst Sony and Microsoft are of course large in the games industry as well they also have other priorities and it looks hard on the surface of it to disentangle their games activities and the resulting impact on their stock prices from their other businesses.

Long term (see chart here) Activision seems to have tracked Nintendo (both of which are generally thought to have excellent management teams) up until the beginning of 2009, whilst comparatively Electronic Arts has languished in the last 2 years (EA focusing heavily on sports titles compared to the other two).

Comparative valuations for Activision, Nintendo and Electronic Arts

Some comparative valuation metrics for all three stocks are listed below:

There is some degree of fear out there on these stocks – see “Can Nintendo Rebuild?” for example in Businessweek. Generally video game sales have not been good recently (Nintendos’ sales fell for about 8 months straight this year and it expects annual revenues to fall for the first time in 6 years), there is nervousness about the impact of social gaming via systems like Facebook, and the rise and rise of iPhone games has made people wonder what impact that might have on dedicated handheld devices like the Nintendo DS or Sony PSP.

Nintendo, for example is trading at half its price in 2007:

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 and even Activision with the recent success of its Call of Duty: Modern Warfare title is trading at $10 or so from a high of $18 back in 2007 (but not an apples for apples comparison given its 2008 merger with Blizzard and their World of Warcraft franchise). 

Of these 3 stocks it is Nintendo that seems to jump out (although both Activision and Electronics Arts are trading below Morningstar’s fair value estimate and it would probably be entirely reasonable to take a diversified bet on all 3).

The case for investing in Nintendo?

As a US$34bn company with the majority market share in many areas (Sony has sold about 9m PS3 units in the UK with Nintendo selling 25m Wiis)  Nintendo is surprisingly hard to find investor coverage on – Morningstar in the USA for example does not provide analysis on it.

If the reason is concerns about the way that some Japanese companies are run, these don’t seem warranted in Nintendo’s case.  At current stock prices they even pay a 5% dividend – the only company of these three to do so and a rarity in the games industry generally.

Nintendo is however definitely a long term bet. Their revenue has halved in the last 6 months compared to a year ago and a chartist probably wouldn’t touch them with a bargepole.

However they are still busily shipping units of the Wii (with a price cut) and the portable DS (with roughly 10% of the all time entire total sold in the last 6 months) and if you look at their geographical revenue split what happens in the US is both very important but equally very impacted by US dollar weakness (the USD having fallen against the Yen by about 20% over the last 2 years).

As the activity type table above suggest Nintendo is not just a hardware company with revenue over this period (during which not many new titles were released) being split about half software, half hardware. Recent falls in revenue reflect a lack of new compelling titles or hardware launches but the company’s franchise with casual gamers places less stress on coming up with radical new cutting edge consoles (as is the case perhaps with the Xbox or Playstation). Their Mario Brothers franchise is still going strong and the title was released in 1983!

The concerns about the iPhone seem to be overrated to me. The iPhone lacks gaming controls so you have to use your fingers on the screen (reducing its visual area), it comes with data charges, and to argue that gaming apps are cheaper for the iPhone is a little like arguing  that nobody is going to go to the cinema because they can watch movies for free on television (the better movie experience still counts for the consumer).  Just on that minor point $10 for  cinema ticket for a one-off 2 hour’s enjoyment still seems to be outranked by potentially weeks of enjoyment in sharing a game with your family at home.

Neither, if you look at Nintendo’s R&D spend, does it look like Nintendo intends to stand still with a high definition Wii supposedly in the works as well as link-ups with organisations like Netflix. Yes, motion-sensing controllers may well be on the way from Sony and Microsoft but this is a company with a history of innovation.

Nintendo’s management has successfully broken into whole new areas – with a market share for example of up to 80% of US female gamers and almost singlehandedly created a new genre, the fitness/exercise game.

Nintendo’s profitability and track record makes their US ADRs look like a buy (US: NTDOY) and the rumours of a stock split would make them more attractive as well. However looking at their chart averaging in looks warranted – this is not for the faint-hearted.

Posted under individual stocks

In the never-ending quest for the unpopular asset class that you might be able to pick up on the cheap it is difficult to go past commercial real estate at the moment.

But there are a few problems:

1. commercial real estate can be very illiquid
2. with the gearing in this sector, falling property values, and historically low interest rates that may increase, there may be risk in a particular fund that it is hard to identify

So what might be interesting would be a commercial real estate exchange traded fund that is both liquid and spread across a number of different property trusts.

In Australia you can find exactly this with the State Street Spider S&P/ASX 200 Listed Property Fund (roughly $15 billion market cap with 16 holdings and a .4% management cost with quarterly income distributions).

SLF Net Asset Value has halved over the last year

If your approach to buying stocks is chartist/technical, stop reading here because the chart (ASX:SLF)
 is a bit ugly to look at, with net asset value at 1/2 of its 12 month high, and down 2/3rds over the last 2 years.

SLF ETF fall in net asset value since Aug 08

We have started (and intend to continue) buying it in multiple small parcels and as a long term investment.

SLF income picture

SLF is currently trading at a  nominal double digit yield which is estimated to fall to about 8-9% i.e. you can assume that a further fall in income distribution is already factored into the current price.

Roughly 7 out of 10 of the top 10 holdings are trading at single digit PEs and the outlook from analysts for the whole property industry is still gloomy.

Stock-Specific Risk in SLF

It seems strange to talk about stock specific risk with an ETF but as of August 7th Westfield made up 47% of total assets so if you don’t like Westfield don’t buy this (here are the top 10 holdings): 

Here’s the sector breakdown:

Like it? Hate the idea? Let us know by commenting below!

Posted under index trackers

Does dollar cost averaging really work better in a volatile equity market?

Say that your equity market outlook assumes that one of two scenarios is true.  Either:

1. You expect equity markets to be volatile over the next 10 years or,
2. You are convinced that neither you nor anyone else knows what equity markets are going to do over the next 10 years!

but you still expect equities to outperform other asset classes over this term.

In this kind of environment a program of drip-feeding funds into the market makes sense as most research seems to suggest that market timers usually do worse than a more unemotional dollar cost averaging process. 

What is dollar cost averaging?

Dollar cost averaging refers to the process of investing the same amount to some regular timescale. When the price of the equities is low you will acquire more, and when high you will acquire less.

It may seem obvious, but is still worth stating, that dollar cost averaging essentially delays investing, which means that broadly as prices tend to rise over time this may reduce your returns…

Dollar cost averaging however itself has two problems aside from the implied delay element:

1. There are transaction costs
2. Can it be automated?

Transaction costs of dollar cost averaging

Ostensibly the transaction costs do not seem that high. You can download a very simple Excel model where you can put your own portofolio figures in here: Dollar cost averaging share purchases transaction costs.  

On the basis of $150k portofolio spread out over 10 sectors asset allocation sectors, with 10 trades per sector (100 trades in all), at $32 per trade (eTrade’s costs in Australia to private investors) you are looking at a transaction cost of around 2.13% on the whole portfolio using a dollar cost averaging strategy in establishing your portfolio:

Can you fully automate dollar cost averaging?

In an ideal world many time-poor private investors would prefer to set up a plan in advance e.g. ‘complete my dollar cost averaging plan over the next 2 years’, for example.  

This raises the question of whether share purchase orders set ‘at market’  or ‘at best’ can be poorly priced, whether deliberately or accidentally by the broker?

The short answer is the jury is out …. there didn’t appear to be any easily identifiable research and presumably it differs on a broker by broker basis.

However a common-sense approach might suggest that low liquidity shares with bigger bid/ask spreads might be more at risk of mispricing than broadly traded shares or ETFs.   

Know better? Comment below.

Posted under investment strategies, market timing

Why Woolworths and Coles pricing matters

Supermarket expenses account for about 16% of our annual household expenditure for our family of 4 (2 adults, 2 children excluding mortgage costs). In cash terms, roughly $25,000 per year, and the second highest category of expenditure in the household after childcare. The Australian competition regulator, the ACCC, in an enquiry last year (2008) identified groceries as representing 12-14% of the average household’s after tax income.

The price of supermarket goods year-in year-out therefore has a quite significant impact on household savings.

Whilst there are new entrants coming in like Costco and Aldi the ACCC still considers the market ‘workably competitive’  but notes in its July 2008 report that there are “limited incentives for Coles and Woolworths to compete aggressively on price”.

Online supermarket shopping: checking the pricing of Coles Online versus Woolworths Homeshop

The increasingly sophisticated nature of Coles and Woolworths online shopping operations means you can monitor comparative pricing for the basket of groceries your particular home normally buys.  This is because both online websites enable you to save a ‘shopping basket’ of regular items. You can also see on the sites when goods are ‘on special’.

Unlike physically visiting a supermarket it doesn’t make a lot of difference to an online buyer where the food comes from e.g. you don’t have to understand the store layout and you basically don’t care whether the food has to travel 5 kilometres or 15 kilometres to get to you. So some concerns that have been raised about the limitations of the government’s ‘Grocery Watch’ price monitoring may not apply to online shopping so much.

Basically if you’re willing to recreate your normal shopping basket on “the other supermarket’s website” it’s easy to switch (and in our experience it may take you a couple of hours to do this once you print out your list and re-enter each item).

Who is really cheaper: Coles Online or Woolworths Homeshop?

The results from our household basket of about 54 branded items based on our last 6 months purchases (the absolutely identical item from both supermarket chains that you can find at the bottom of this article) was that although more of the items were slightly cheaper at Woolworths the difference was so marginal  that it’s not worth worrying about (the average item price difference across the two supermarkets was less than 1%).

In the end our 54 item basket came out at $334 at Woolworths and $333 at Coles (see below). However if one takes into account the delivery charges for the two chains (the minimum delivery charge at Woolworths is currently $5 and at Coles it’s $9) it all comes out almost identical again.

Are all online products similarly priced though? 

Despite the list below which suggests an average individual price difference of less than 1% (we’re sure the supermarkets themselves monitor eachother closely which may account for this extremely close pricing) we suspect that not all pricing is so equal.  

Our list was based on absolutely identical products. What we could not easily comparatively price, were goods like own-branded goods, and we’re sure the supermarkets are aware of this in the assumptions they make themselves about organisations like the ACCC trying compare their prices or even many individual shoppers comparing pricing.

In these areas the price differences can be much more marked. For example, Woolworths 3 litre milk is $3.95 where Coles 3 litre milk is $3.16, a 20% difference…

The ACCC’s report tends to bear this out:

“Price competition is strongest on promotions of key value items (which are products known by the supermarkets to be used by consumers to assess value). This is to be expected, given that the pricing of these products is most likely to encourage consumers to change where they buy
groceries.”

You need to check this with your own household basket and we suggest bread, milk, and salad may be where you find some of these more extreme differences (just don’t assume they apply across your whole groceries basket).

Are online supermarket shopping prices more expensive than in-store prices?

 We had heard this so we actually asked Woolworths by email:

“Hi, could you clarify how your Homeshop pricing compares to your in-store pricing? My assumption was that the pricing was the same with the exception of the delivery charge (which reflects your increased costs in terms of the delivery components). However I have been informed that Woolworths has a markup on online items over and above the in-store price. Is that correct? “  

 For what it’s worth this is Woolworths’ response:

“The prices charged online are comparable to that of a metro supermarket. Not all supermarkets charge the same prices in each store for all items, therefore the prices online may differ to that of your local Woolworths supermarket. Homeshop still offers a convenient, high quality and competitively priced service direct to your door. We regularly review our pricing against other online grocery services and generally find we are cheaper on the total basket. “

We have not validated this assertion about identical instore/online pricing (subject to ‘local’ variations) by checking Woolworths dockets versus their online pricing.

However we have looked at Coles docket pricing from our local Coles versus their online operation and there did appear to be some signficant differences (see the Online v Instore column in the table below) with items like bread and butter and pasta and yoghurt between 8% and 18% cheaper in-store than via Coles Online (in fact any items we directly compared, albeit on a small sample, the online pricing was always more expensive).

We’d be interested to hear what you’ve found!

The comparative online pricing for this article from Coles and Woolworths

Posted under savings levels

Beliefs of Americans about investment returns from different asset classes

The thing that has bothered me over the years about investing in low cost equity tracker funds which eliminate all that stock-specific risk and have historically performed far better than any other asset class, is that they seem like such a no-brainer. Surely it is so obvious that everyone can see this with average actively managed fund performing worse than low cost passive vehicles?

And if everyone can see this then isn’t there going to be a whole pile of ‘dumb’ money piling in driving index constituents to ever higher price earnings multiples, whilst ignoring the fundamentals of these stocks? Who’s going to be left to actually look at individual stocks to do the number crunching to really evaluate their value?

Ok, I realize that nobody ever went broke (particularly casinos) by basing their business on the public thinking they were cleverer than the average Joe but still? Admittedly there is also a lot of rubbish quoted out there that makes it look like stocks do not offer good long term returns. One of my pet hates is writers just quoting the index e.g.

“the S&P is back where it was 10 years ago”

and the writer not realizing that, for example, (from Standard and Poors) dividend income has represented roughly 1/3rd of the monthly total return on the S&P 500 since 1926, ranging from a high of 53% during the 1940s to a low of 14% in the 1990s (when investors focused on growth).

But there is also a huge amount of very compelling research identifying long term returns on different asset classes…

It looks like I needn’t have worried about crowd mentality when it comes to trackers looking at this survey though!  Sadly another thing that stands out about the Gallup results is that lower income investors are more likely to view savings accounts as better investments (obviously imposing an inherent ceiling on their growing their personal wealth) although equally oddly higher income investors believe most in investment in real estate!

The study also bears out that  we investors are so into driving by looking into the rear vision mirror … with equities (now that they represent better value) falling in popularity by 15% or so over the last 2 years (the same survey has been carried out since 2003) and bonds and cash which have performed better over the same period (despite the forward inflationary risk with a wall of government debt bearing down on us) becoming much more popular…

Posted under index trackers, investment strategies

Watching the Obama government fiddle around with the various creditors in Chrysler (and in other government bailouts where political calculations are coming into play in Australia and the UK) it’s pretty obvious that there is ‘political risk’ coming back into investment in a big way.

It is something that Bill Gross at Pimco was also keen to stress in his latest podcast, “2+2=4”, that equity and debt holders may be looking at a highly regulated future where the ‘dead hand of government’ plays a significant role in setting future growth rates and income distributions (no doubt Mr Gross would be horrified by this oversimplification).

Another way to look at it is simply that the debt being run up in stimulus packages may create an irresistible temptation for governments to tap funding sources which currently might appear to be protected.

One obvious group of people who are being ‘stuffed’ in the current environment are holders of cash, with interest rates of .5% in the UK or a (comparatively) generous 3% in Australia, perhaps a realization which may play a small part in the recent market runup.  In a future environment it may be that holders of non-inflation protected assets are also going to get stuffed.

As someone I know puts it more succintly, “the older generation are going to get stuffed somehow.”

However one other obvious source for governments to target are Super funds and pension funds.

As Kris Sayce puts it well in ‘Money Morning’ with regard to Australia:

“perhaps the biggest giveaway is the $1 trillion held in private superannuation accounts. At the moment these balances are almost untouchable by the government. It is up to the fund managers and trustees of the funds to decide where the money is invested.

That is a position that no government will allow to remain for too long. Not when there is a $300 billion public sector debt to be paid off. And a $100 billion public sector pension liability to be financed.

Not to mention all the increases in welfare payments that will arise in the next few years.”  

Given the time horizons involved we should all be thinking about what the government might do to get their hands on it to pay their bills. Mr Sayce’s view is that there may be inducements from the government to “swap their defined contribution super plans in return for a defined benefit government pension”, however we probably need to consider other possibilities as well. For example:

• could the government change the tax rates on super funds from 15%?
• could the government set maximum super fund sizes?
• could the government change the cap on non-concessional contributions (currently $150k)?
• could the government change the preservation age (the age most of us can access their super) – it’s been suggested that preservation age move to 67 by the interim Henry Review?
• could the government further target temporary residents (it is already taking their unclaimed super within 6 months of them departing Australia)?
• introduce tax on super income streams after preservation age (60), currently for most people there is no tax if the cash was taxed ‘going’ in).

From the government’s point of view there are  two risks:

1. loss of votes amongst a segment of the population that is getting larger (retirees)
2. reducing the savings rate (pretty much what it wants to do at the moment anyway and of course a mandatory super contribution level in effects sets a savings rate the government can fiddle with as well)

The level of risk overall should a key factor (especially for wealthier individuals given the budget changes to super) in whether you choose to put your money into the superannuation sandbox or operate outside it.

Posted under investment strategies, Risk

In the old (pre-internet) days to create a market rumour you actually had to go to the trouble of making a phone call to a broadsheet journalist. As a university prank we rang a major newspaper’s Property columnist, told him we were from the (fictitious) “Real Estate Institute” and did he know if there was any truth to the market rumour that there was a Sheikh in town with $200m to spend on property?

Unsurprisingly (because we’d just made it up) he didn’t know if there was any truth to it but that didn’t stop him printing it prominently the following day, “the real estate scene is abuzz with the rumour that there is a Sheikh in town with $200m to spend on some property acquisitions…” (I have no idea whether or not that benefited someone flogging property over the succeeding couple of weeks, if it did please forward me a cheque care of this blog). 

[PS Don’t try this sort of thing at home, it’s too easy to succeed, and probably illegal into the bargain.]

These days you don’t need to even get someone on the other end of a phone. Last Monday you could watch the internet equivalent of  this sort of rumour-mongering playing out in the blogosphere and email world and it’s interesting to take a closer look at how the rumour spread and why.

The Rumour

On Wednesday I received the following item forwarded by email:

“Monday, April 20, 2009
Stress Test Results Leaked

Posted by [name omitted] at 8:08 AM
Turner Radio Network out with a shocker on what they claim are the leaked Stress results. We paraphrase:

The Turner Radio Network has obtained “stress test” results for the top 19 Banks in the USA.

The stress tests were conducted to determine how well, if at all, the top 19 banks in the USA could withstand further or future economic hardship.

When the tests were completed, regulators within the Treasury and inside the Federal Reserve began bickering with each other as to whether or not the test results should be made public. That bickering
continues to this very day as evidenced by this “main stream media” report.

The Turner Radio Network has obtained the stress test results. They are very bad. The most salient points from the stress tests appear below.

1) Of the top nineteen (19) banks in the nation, sixteen (16) are already technically insolvent.

2) Of the 16 banks that are already technically insolvent, not even one can withstand any disruption of cash flow at all or any further deterioration in non-paying loans.

3) If any two of the 16 insolvent banks go under, they will totally wipe out all remaining FDIC insurance funding.

4) Of the top 19 banks in the nation, the top five (5) largest banks are under capitalized so dangerously, there is serious doubt about their ability to continue as ongoing businesses.

5) Five large U.S. banks have credit exposure related to their derivatives trading that exceeds their capital, with four in particular – JPMorgan Chase, Goldman Sachs, HSBC Bank America and
Citibank – taking especially large risks.

6) Bank of America`s total credit exposure to derivatives was 179 percent of its risk-based capital; Citibank`s was 278 percent; JPMorgan Chase`s, 382 percent; and HSBC America`s, 550 percent. It gets even worse: Goldman Sachs began reporting as a commercial bank, revealing an alarming total credit exposure of 1,056 percent, or more than ten times its capital!

7) Not only are there serious questions about whether or not JPMorgan Chase, Goldman Sachs,Citibank, Wells Fargo, Sun Trust Bank, HSBC Bank USA, can continue in business, more than 1,800 regional and smaller institutions are at risk of failure despite government bailouts!

The debt crisis is much greater than the government has reported. The FDIC`s “Problem List” of troubled banks includes 252 institutions with assets of $159 billion. 1,816 banks and thrifts are at risk of failure, with total assets of $4.67 trillion, compared to 1,568 institutions, with $2.32 trillion in total assets in prior quarter.

Put bluntly, the entire US Banking System is in complete and total collapse.

More details as they become available. . . . . .” 

Spreading a Rumour

There were two other interesting features about the email aside from the fact that it took two whole days (!) to get to us.

Email Your Market Rumour

Firstly, my contact had had this email to him on Tuesday by a large investment banking house which I won’t name whose employee noted that “I am sharing this not to create undue panic but simply to let you know what is out there right now” and who also noted that he was sending this to his “valued clients and friends”.

One could argue that in a sense it’s this professional investor’s job to send round stuff like this if it, a) creates a reason to do a trade (!) and b) to let his clients know what rumours are doing the rounds in the rest of the market. Of course one could also argue that there is a bunch of people out there who could also use the those relatively unknown tools available like Google to check  the truth of what they’re disseminating.

The second thing that I thought was interesting was the speed this rumour spread at and how it spread.  In email terms there were already 3 headers from three different on-forwarders on the version of this story I sent.  Assume, for example, that each person in those 3 ‘layers’ forwarded it to 10 people then that’s 1000 individuals (10 X 10 X 10). Clearly some would have not forwarded it at all and some might have forwarded it to more or less than 10 but you get my drift (and it makes the math trivial).

Blog Your Market Rumour

Bloggers receiving this email unaware (maybe) or at least not bothering to check what was on the web just posted it verbatim on their blogs (actually they had been sent by email the full text of a blog post that was already up). In what NPR’s must-listen-to “On the Media” refers to as the “echo chamber of the blogosphere” it spread quickly, with on Wednesday there being about 96 web pages posted repeating the item verbatim, and when I did this search today (Saturday) there were 441 web pages repeating it. If you’re familar with Google you will also realize that Google’s PageRank system regards a link as a ‘vote’ for the importance of a website (whether your link actually says “here’s a bunch of crap” or “hey look at this item I think is a permanent and unique truth”).

So if you’re trying to spread a bear market rumour you need to realize that a blog post may not be enough: you really need to use email as a mechanism to get it out there (because bloggers reading the email may assume that the item is only being circulated by email and therefore that if they post it quickly on their blogs they may be amongst the first to break it on the web).

What Makes a Market Rumour Work

The best kinds of rumours ride the concerns already out there. This rumour was probably helped by two things: Bank of America’s results happened to also come out on Monday and they weren’t good (a 41% leap in non-performing assets) and of course the general concerns swirling around about banks anyway.

The best kind of spam also circulates effectively because it references an ‘authoritative source’.  The ‘Turner Radio Network’ from the email sounds pretty authoritative doesn’ t it?

Well errr… actually it’s totally unrelated to Turner Broadcasting and as is a blog run by a guy called Hal Turner and hosted using Blogspot’s free hosting service (I’m not going to link to it because PageRank does what it does and I’d merely be driving more traffic to it).

A $527m Market Rumour

Mr Turner himself seems to have been pretty impressed with the results:

“When the U.S. Stock Markets opened, Bank stocks were immediately impacted by folks spreading my report. Bank stock values plunged by eleven percent within 6 minutes. On the S&P 500 alone, bank stock values plunged by about $527 million dollars.”

 And he’s not alone on this anway: CNBC notes that the “Select Sector SPDR Financial ETF was down 5.4 percent after the blog post was widely disseminated by at least two third-party news services” and that a Treasury spokesman actually had to publically say the Treasury didn’t have the Stress Test results.

On one point it looks pretty clear Mr Turner is right, a good market rumour spread by people who don’t fact check carries its own momentum. As he noted on Monday night:

“Sorry guys, but whether the Turner Radio Network has the real results or not is no longer material.”

If you’d read this item from Mr Turner and immediately gone out and shorted US bank stocks (and maybe even forwarded it along ,and filed it a few times yourself as comments on articles on prominent financial sites) you also wouldn’t care whether it was right or wrong.

Posted under investment strategies, market timing

It will not have escaped people’s notice that shorting some indices last year would have been very lucrative. What about in 2009?

As a company we do some business with Hong Kong and Chinese clients. Recently we’ve been receiving letters in response to our invoices which read along the lines of:

“whether there is a possibility of a one-off discount for this year.. In view of the economic clouds and down cycle on the horizon our ..budgets for 2009 are very tight and in fact downsized – we would very much appreciate your kind and considerate courtesy in this matter.”

At the same time there is quite recent investor comment around about shorting China. For instance the Christmas edition of MoneyWeek suggests using the ‘Ultrashort FTSE/Xinhua 25 Proshares (US:FXP), an exchange traded fund that matches 200% of the inverse movement in the Chinese market.

However, looking at an indices chart of emerging markets  comparing the FXI (the long version of the FXP) and the Indian equivalent (the BSE30) and the Dow Jones index both China and India large caps have tracked down very closely (and at least 10% more than the DJI) at levels of 50% or so.

Admittedly China is not the worst emerging market performer of last year (Russia is down for example some 70%) but this does not appear to be a ‘new’ story (on a 5 year view these indexes are down some 150% from the heights they reached at the end of 2007) so one suspects that shorting China at this point could be a risky business. 

In ‘short’, this boat has sailed.

Posted under index trackers, investment strategies