Yellowtail Blog

The end of the year is almost here, and yet according to the press it might as well be the end of the world.

Listening to the media, 2011 started as a catastrophe waiting to happen! Even before the year began the global financial system was on its last legs, and the eurozone was within a few weeks of a melt-down – it still is, and has been for the last couple of years! The initial problem was the potential for Greece to default on its debt obligations. This shouldn’t come as a surprise, Greece has been defaulting on its external sovereign debt obligations since the fourth century BC (back then they defaulted on the funds borrowed to build the Temple of Delos).

Let’s put this into perspective; the Gross Domestic Product (GDP) of Greece is only twice the size of Kazakhstan’s.  To put a number on it, it represents barely 2% of the entire European Union GDP (GDP represents the total market value of all goods and services produced in a country in a given year). So how does such a small economy threaten to bring down the financial system of the entire world? Well, we’re told that if Greece fails it would set off a chain reaction, like the first domino to fall.

Journalists and commentators like this because it keeps them busy. Once Greece has been sorted the story simply moves on to the next sick economy. Italy, Spain and Portugal are already in the spotlight. Bad news sells papers; and there’s every incentive to keep these stories running. Heaven forbid that there should be any good news out there.

But whilst we’ve been focused on Europe, the rest of the world has been managing their exposure to the eurozone. They’ve been putting their efforts into more promising economies like China, India, and Brazil. There are some great stories out there but they’re not being told.

Now we’re being told to watch for a double dip recession, not just in Europe but in America too. Journalists on both sides of the Atlantic frequently remind us that it’s all doom and gloom, whilst Warren Buffett invests billions in stocks and corporate bonds. Nobody thought to mention that America has never had a double dip recession. In fact, industrial production accelerated sharply in 2011 – that sounds like good news.

We’ve been told that the economy would drop like a stone, markets would freefall, and Western currencies like the Pound and the Dollar would become worthless (whilst gold became the only true repository of value). If we’re only ever exposed to this type of news it stands to reason that we’ll believe this is the only story out there – it isn’t.

We thrive on bad news, it’s almost masochistic! In some ways it’s hard wired into our psyche – look at how popular bad news stories are. But with our focus on all the bad news out there, are we missing any good news of any consequence? I think we are; large global companies have seen earnings, cash flows and balance sheets climb steadily upward throughout 2011 – and many have reached new all time high levels. Investors reliant on dividends (which were cut back in 2008 and 2009) have seen their income levels bounce back (though they are not yet back to previous highs).

Admittedly we have witnessed some very volatile markets the past 12 months, and yet despite all the bad news we’ve been exposed to, the FTSE 100 share index is down by less than 4% over the past year. From everything I have been reading I would not have been surprised if markets had halved. In fact, having read nothing other than doom and gloom it is a surprise that markets have been so resilient.

So, what are we to believe? One idea is that the market is wrong i.e. that a crash is on its way and has only been delayed. The other is that much of the gloom and doom is misplaced, and that markets are right after all.  The earnings, cash flows and balance sheets of great companies are telling the truth.

Yes, there are significant macroeconomic problems within Europe and the United States and we face several years of austerity measures. Nor have large multinational companies escaped unscathed – share prices are still below their all time highs and the wider economic problems are also reflected in their share prices. It’s not all good news, and it’s not all bad news.

As we approach the year end, why not reflect on your wise decision not to resort to panic given all the bad news you’ve been exposed. We’re not out of the woods yet, but a well diversified portfolio constructed with the long term in mind is the best approach you can take in the current conditions.

A well respected fund manager managing a few billions recently commented that in his thirty years in the industry he’d never been in a situation like this. This year at their annual gathering for investors in the fund most of the questions he had been asked were related to the outlook for the economy. At past meetings the economy was rarely mentioned.

I’m not surprised by the questions given the challenges facing our economy and the focus of the commentary in the press. ‘Double dip recession’ news story anyone?

We were invited to participate in a survey by the Economist Intelligence Unit on our perceptions on the economy, and how the press report on it. I was able to tell from some of the questions that the press is aware that they can come across as a little bit negative sometimes.

For example, question 3: Do you agree or disagree with the statement ‘I mainly see negative stories in the financial press’?

There wasn’t an option for me to choose ‘very strongly agree’.

Given the tsunami of negativity, you may have missed the positive comments from leaders of some of the world’s largest organisations which we have the pleasure of sharing with you below.

It’s the Economy

The economy was one of the major themes at a meeting of business leaders, academics and policy makers at the 2010 Montana Economic Development Summit.  Given the attendees and their comments one of the striking things was the lack of in depth media coverage.

Here are some of the comments from famed investor Warren Buffett, and the chief executives of two of America’s largest companies, Steve Ballmer of Microsoft and GE’s Jeff Immelt at the conference.  Their comments give a different perspective on the positives for the global economy and its’ engine, the US economy.

Jeff Immelt, GE

“Angry political rhetoric is not helpful and headlines are too focused on finding negative indicators.”

“Business at GE is improving. Signs across the world show growth improving as evidenced by a rise in GE’s orders.”

Warren Buffett

“I’ve seen sentiment turn sour in the last three months or so, generally in the media. I don’t see that in our businesses. I see we’re employing more people than a month ago, two months ago.”
 
“The things that worked for the country through a century of two world wars, a depression and more — all while increasing the standard of living — will work again.” 

“I’m a huge bull on this country…we won’t have a double dip recession. I see our businesses coming back almost across the board…it’s night and day from a year ago.”

Steve Ballmer, Microsoft

“There soon will be more technological advancement and invention than there was during the Internet era and that will help drive business growth.”

“I am very enthusiastic what the future holds for our industry and what our industry will mean for growth in other industries.”

“We will see new technologies that move beyond the Internet to tie together computers, phones, televisions and data centers to create amazing new products. And the pace of innovation will increase as technology makes workers more productive.”

Their comments are backed up by the recent quarterly Economic Conditions survey from McKinsey, the consulting firm.  McKinsey surveyed 2,000 executives around the world and their responses show 58 percent say the economy in their countries is recovering, and 38 percent expect to hire by the end of the year, the greatest share expecting to hire in the near term since before the crisis.

It’s unrealistic to suggest there won’t be challenges ahead for the economy.  Of course there will.  But we believe it’s important to keep things a little more balanced and stay optimistic for the long-term.   It’s very easy to pay attention only to the views of those that are the most negative, especially as they seem to be shouting the loudest right now.

The big hurrah that greeted Alistair Darling’s increase to ISA limits is worth just £10.40 for those saving in a cash ISA, and even less if you’re a basic rate tax payer.  So the widely reported big incentive to encourage savings turns out to be marketing over substance – for now that is.

He (the chancellor) announced that the limit on ISA savings will be raised to £10,200, for the over 50s in the current 2009/10 tax year and for everyone else from April 2010.  But buried in the fine print was the news that the increased limit won’t be available until 6 October for the over 50s.  In keeping with the existing ISA rules half of the annual allowance can be invested in cash or the entire amount in Stocks & Shares based ISA.

So, what does it actually boil down to? Well the best ISA rates we could find right now will pay 3.5% interest, whether they are still paying that in October is another matter, but let’s press on.  The additional £1,500 invested in an ISA from October 6th would generate interest of £26.02 in the current tax year.   For a 40% tax payer the tax saving is a mere £10.40

Of course it’s better than nothing, yet the amount of newspaper column inches given over to a £10.40 tax saving this year is disproportionate to the size of the tax benefit.   Yet, if as we predict interest rates and inflation begin to rise, the tax benefits will become substantially higher in the coming years.

I read Chris Dillow’s Stumbling and Mumbling blog regularly.  An interesting recent piece on house prices has a chart showing the ratio of real house prices to real GDP.  His argument is that over the long-run house prices have risen more or less in line with GDP, so even though we believe house prices are a good investment, they haven’t been in the past with a real return since 1955 of 2.7%.

I would qualify that argument a little because the chart shows if you were buying a house in 1996 or 1997, when house prices had bottomed in relation to GDP, things would probably have turned out well for you (they did for my neighbour).  The graph also suggests that house prices aren’t as cheap as they have been in last market bottoms, as do other figures such as house prices to average earnings.  

Dennis Hall appeared on BBC 2′s Working Lunch programme today before the Bank of England’s latest interest rate decision.

Dennis answered questions on the impact of a cut on interest rates on savers, whether it is a good idea to take out a fixed rate savings product to lock in higher rates, and the neede to keep rainy day money available in these uncertain times.

This has been a month of headlines about frauds, Madoff’s ‘$50bn loss’, and today news that the chairman of Anglo Irish Bank has had to resign after transferring loans off the bank’s books for a number of years.

I’m reminded of an argument by Charles P. Kindlberger in his book Manias, Panics and Crashes.  Kindlberger gives a history of different speculative bubbles and shows a feature of many of them is that frauds are perpetrated that only come to light after the bursting of the bubble.

If history is a guide, we’ll see more fraud uncovered before this shakeout is over.  As Warren Buffett says, ‘you only find out who is swimming naked when the tide goes out’. 

Going back to my earlier post on measuring economic output per person or capita, Bill Mitchell on his website obviously thought that ranking Olympic achievements on a per capita basis was going to be fairer than the overall picture presented by the conventional medal table.

As he says, “I consider [the per capita ranking] to be more meaningful than the official rankings which just reflect world power derived from economic might.”

Bill has an interesting taken on the data, but be warned he uses the unique-to-the-US ranking style, tallying the total number of medals, rather than the number of gold medals ranking used by the rest of the world.  Coincidentally Team USA are ranked first in the world on a US ranking only, not in golds won.   

The report today that the UK economy is grinding to a halt, based on the release of Gross Domestic Product (GDP) figures by the Office for National Statistics, reminded me of an interesting article in the Economist about GDP.

According to the author the conventional view is that America’s economy has been more buoyant than Japan’s in the last few years.  The rate of growth in GDP backs this up, with annual real growth in GDP of 2.9% versus Japan’s 2.1%. 

There’s more to the story than the headline figures though, and the article argues “the single best gauge of economic performance is not growth in GDP, but GDP per person…a rough guide to average living standard.”

Looking at GDP growth per capita as it’s known between 2003 and 2007, Japan has actually done better than America because Japan’s population has been shrinking. 

With countries where politicians take credit for booming economies such as Australia, figures look less flattering through the lens of GDP per capita because population has grown rapidly at the same time.  In the 5 years to 2007 the Japanese and Australian economies have expanded at the same rate.

If we agree that GDP per person is a better measure maybe we should apply the same thinking to the Olympics – gold medals per capita anyone?

Want to live rent free in London?  I read an interesting comment in the property section of London Lite yesterday.  Yes, I know I shouldn’t be reading that rag, but it’s difficult holding my investment management textbook open on a crowded tube!

The Director of a property search company was talking about a few lucky clients who are now living rent free after selling their property.  She went on to say that her clients have, “put their money in the bank at six percent interest, and that pays their rent, so some of them are effectively living rent free.” 

I know what she is thinking – my wife and I have had the same discussion.  If you can live on the interest, you still have the capital left, so in effect you are living for free, right?  Wrong. 

Unfortunately it doesn’t work that way.  When you lend your money to a bank they will pay interest, this partially compensates you for delaying the purchase of something else with your money (new Porsche anyone?).

Go back to 1975 and we find inflation touching 25% a year.  Suppose at the start of 1975 you had £10,000 on deposit after selling your house.  With that money you could have bought 4 Porsche 911s.  But the bank is offering you 25% interest so against your better judgment you put the Porsche brochure in the sock drawer and use the interest to pay your rent.  You decide to live “rent free.”

At the end of the year, you’ve received £2,500 interest which you’ve given to the landlord.  But every time you look in the sock drawer the Porsche brochure grabs your attention and after a year you decide to dip into your savings to buy that Porsche you’ve always wanted – you saved for a year right? 

Unfortunately for you Porsche workers demanded more money, the price of oil and steel increased and Porsche were forced to raise their prices – now your £10,000 only buys 3 Porsches and a tank of petrol…oh and your landlord has decided to put up the rent, the price of his Porsche has also gone up.

Inflation isn’t as extreme today, but the same principle applies.  You can save your capital and spend your interest to live “rent free,” but the longer you do this the less you will be able to buy with your remaining capital.  And even if you save the interest the value of your money is eroded, as over the longer term the interest you earn after tax is less that you need to beat inflation.

If you are currently renting and can’t rent for free you should be praying for property prices to drop by more than your rent.  But that’s another story… 

Dennis Hall wrote an article containing Top Ten Tips for Worried Investors.

Are you worried about the markets? Thinking of cashing in your chips at the investment casino? It’s been a dreadful year for most investors, and the last few weeks have been particularly dire.

His advice is to stay calm and bear his points in mind.  You can read the rest of the Top Ten Tips for Worried Investors in the articles section of our website.