We had a good news story last week in the form of our old friend Northern Rock being in much better shape than expected and now being worthy of yet another infusion of cash. Although lacking both taste and judgement, the 10% staff bonus story concerns me less than the £10bn infusion package.
I mean, WTF? So it makes sense to reward the most reckless UK lender with a package to allow it to outcompete viable businesses and undertake yet more malinvestment? How about rewarding more responsible institutions (e.g. Nationwide / Cooperative / etc) that deserve to survive? Nah, far better to force them out of business and let Northern Rock survive. World gone mad...
I've held the view from the start that Northern Rock should have gone to the wall as it was painfully obvious even in 2006 that it would be the first bank to fail with its' suicidal business model. Hence it would be wasted ammo needed for bigger problems downstream. But that's not a popular position to hold.
The problem with everything associated with Northern Rock is the notion of moral hazard. Namely, the responsibility for managing risk. If bad decisions have no consequences, such as being left to collapse when your whole business model falls over, then it leads to more and more bad decisions.
Now, having bailed out most of the UK banking sector, a queue of begging bowls is forming with many major employers (particularly foreign owned) ready to blackmail the government to get their share of the cash that the bond market is just dying to throw at UK PLC over the next few months for 0% return*.
It's unfortunate that the good banks and businesses that deserve help the most will be at the back of this queue, so probably won't see the money. Is this really the best way to heal the economy?
* - bold section is ironic!
Monday, 26 January 2009
The Madness of Crowds
BBC Economics editor Stephanie Flanders started off her own editor's blog last week by suggesting that the current problems were a "bolt from the blue" and that no-one had predicted the recession we are in. This was met with a torrent of comments from people pointing out that many 'punters' saw the problems coming from a mile off yet the 'professionals' did not. Quite right too....
This opens up a can of worms relating to how crowd behaviour skews performance in a number of professions. 3 pertinent examples spring to mind: Journalists, Economists and Fund Managers. In these cases, it is seen as being less risky to 'fail with the crowd' than risk being 'proved right alone'. There's a famous quote by Keynes: "the market can stay irrational longer than you can stay solvent". Namely, you could be right in the long-term but the irrational behaviour would get you the sack before that happens!
So why bother listening to these people or investing with them????
Errrmmmm..... Pass.
In the case of fund managers, there have been a number of studies exploring the returns from tracker funds (automated funds for things like the FTSE 100). In most cases they provide better than average returns than funds with active managers. Between extra charges and listening to daily noise, the active managers end up doing worse than if they had done nothing!
Madness...
This opens up a can of worms relating to how crowd behaviour skews performance in a number of professions. 3 pertinent examples spring to mind: Journalists, Economists and Fund Managers. In these cases, it is seen as being less risky to 'fail with the crowd' than risk being 'proved right alone'. There's a famous quote by Keynes: "the market can stay irrational longer than you can stay solvent". Namely, you could be right in the long-term but the irrational behaviour would get you the sack before that happens!
So why bother listening to these people or investing with them????
Errrmmmm..... Pass.
In the case of fund managers, there have been a number of studies exploring the returns from tracker funds (automated funds for things like the FTSE 100). In most cases they provide better than average returns than funds with active managers. Between extra charges and listening to daily noise, the active managers end up doing worse than if they had done nothing!
Madness...
Friday, 23 January 2009
Housing Part 1
The housing market. The UK's favourite pastime. Until recently...
For the last 5-10 years it has been hard to find anyone over 25 who did not hold an opinion (or expertise) on housing. Even now, it's not uncommon to believe that rising house prices go hand in hand with a healthy economy. Like boom goes with bust?
For a subject matter that many people understand, the intricacies can be quite complicated. Things like:
The current cycle is a biggie! Using the Halifax data, the ratio peaked around 5.8 in mid-2007. That was 30-40% over the trend value (i.e. 30-40% overpriced).
It's currently (Dec 08) around 4.4, so is still 10-20% overpriced.
But note that prices overshoot on the down slope as well as the up. So house prices could well fall further...
If we assume that house prices bottoming out is key to putting a floor under the current problems (bank losses, repossessions, etc) then either prices need to fall quickly (deflation?) or wages rise quickly (inflation?).
This brings us to another key concept to master: 'nominal' and 'real' house prices. Nominal is the face value of the house at any point (e.g. £200k now and £200k 2 years later are the same nominally) whilst real house prices take account of inflation (so with 2 years of 10% inflation, the above example would have lost almost 20% and only be worth about £162k in equivalent terms). A lot of people don't 'get' real house prices - and our politicians know that!
If the politicians get their way and run the printing presses at full speed, nominal house prices could rise sooner than we think. But they would not 'real'-ly be going up in value...
For the last 5-10 years it has been hard to find anyone over 25 who did not hold an opinion (or expertise) on housing. Even now, it's not uncommon to believe that rising house prices go hand in hand with a healthy economy. Like boom goes with bust?
For a subject matter that many people understand, the intricacies can be quite complicated. Things like:
- What is a 'fair' average price?
- Have trends changed in recent years?
- Do granite worktops in kitchens add more value to a house than having 10 bathrooms?
- Is it linked to the current financial crisis? (obvious question!)
- How did high house prices contribute to our problems?
- What should 'normal' lending criterion be?
- What is a sustainable level of lending for the economy?
- If prices are too high, how can we tell when they are good value again?
- etc etc - the list is endless.
Here's my take on the key question:
What is a fair average price and how can we tell if housing is overpriced or underpriced?
Traditionally, house prices have a good correlation with earnings, so a good measure is the average price:earnings ratio. Namely:
Average Price / Average Earnings
The trend for the last 25 years (plus my 'best guess' of the next 3 years) is shown on the graph below.
Before the mid-70's, this ratio had a trend between 3 and 3.5 but more recently it has moved up closer to 4. Since the 1980's another theme has been that the ratio has fluctuated more - indicating more extreme boom and busts.
For the ratio to go up, either house prices have to rise or average earnings has to fall.
For the ratio to go down, either house prices have to fall or average earnings rise (inflation???).
The current cycle is a biggie! Using the Halifax data, the ratio peaked around 5.8 in mid-2007. That was 30-40% over the trend value (i.e. 30-40% overpriced).
It's currently (Dec 08) around 4.4, so is still 10-20% overpriced.
But note that prices overshoot on the down slope as well as the up. So house prices could well fall further...
If we assume that house prices bottoming out is key to putting a floor under the current problems (bank losses, repossessions, etc) then either prices need to fall quickly (deflation?) or wages rise quickly (inflation?).
This brings us to another key concept to master: 'nominal' and 'real' house prices. Nominal is the face value of the house at any point (e.g. £200k now and £200k 2 years later are the same nominally) whilst real house prices take account of inflation (so with 2 years of 10% inflation, the above example would have lost almost 20% and only be worth about £162k in equivalent terms). A lot of people don't 'get' real house prices - and our politicians know that!
If the politicians get their way and run the printing presses at full speed, nominal house prices could rise sooner than we think. But they would not 'real'-ly be going up in value...
The Blame Game
I was listening to a phone-in on the radio the other day. It was discussing whether the 'UK was finished?' This was in response to Jim Rogers suggesting last week that the UK financial industry as a powerhouse was finished.
Shock! Horror! One after another the callers were angry. Jim Rogers was to blame for the fall in sterling. What a nasty man - after all he ran the highly successful Quantum fund with that evil George Soros fella who forced us out of the ERM in 1992. It must be his fault...
I'd beg to differ. Having tracked Rogers' commentary of the problems that have been developing over the past few years (and read a couple of his books), he saw this coming years ago and has not jumped on the bankwagon recently like many lemming economists.
He's a free-thinking individual who is not afraid of airing unpopular views on economic policy. His advise on what the Federal Reserve chief (US central bank - the Fed) Ben Bernanke should do? "Abolish and Fed and then tender his resignation". You wouldn't get the Times' idiotic duo of Anatole Kaletsky and David Smith suggesting that...
When he says the UK is going to struggle due to running out of oil and the financial collapse, I struggle to see a flaw in his logic. But that would be too close to the truth for many of the current crop of politicians. So we might as well blame him for all our ills. It's easier than taking heed and doing something positive about it!
Rogers' expertise is in commodities and is a strong advocate of agriculture in the mid to long term. His suggestion for how to utilise the finance geeks who caused a lot of the problems we now face:
Shock! Horror! One after another the callers were angry. Jim Rogers was to blame for the fall in sterling. What a nasty man - after all he ran the highly successful Quantum fund with that evil George Soros fella who forced us out of the ERM in 1992. It must be his fault...
I'd beg to differ. Having tracked Rogers' commentary of the problems that have been developing over the past few years (and read a couple of his books), he saw this coming years ago and has not jumped on the bankwagon recently like many lemming economists.
He's a free-thinking individual who is not afraid of airing unpopular views on economic policy. His advise on what the Federal Reserve chief (US central bank - the Fed) Ben Bernanke should do? "Abolish and Fed and then tender his resignation". You wouldn't get the Times' idiotic duo of Anatole Kaletsky and David Smith suggesting that...
When he says the UK is going to struggle due to running out of oil and the financial collapse, I struggle to see a flaw in his logic. But that would be too close to the truth for many of the current crop of politicians. So we might as well blame him for all our ills. It's easier than taking heed and doing something positive about it!
Rogers' expertise is in commodities and is a strong advocate of agriculture in the mid to long term. His suggestion for how to utilise the finance geeks who caused a lot of the problems we now face:
"Bankers should learn to drive tractors"
At least we could blame them if the harvest were to fail...
Monday, 19 January 2009
Dominoes...
Whilst the UK continues to pour more good money after bad, I noticed an article from arch-doomster Ambrose Evans-Pritchard (AEP) over the weekend about how the financial crisis is evolving in Europe.
I'm always wary of AEP's articles being factually biased. He seems to have an axe to grind on a number of fronts, with his favourite target of criticism being the Euro. But leaving aside the pros and cons of the currency at present, the bit that interested me was social unrest. His article mentioned riots in a number of countries over the past week, citing the example of Latvia.
Upon doing a search on it, it turns out it is true, but has been kept very quiet in the mainstream press. In the last week there has been rioting in a number of locations in eastern Europe. Generally, these are coming on the back of the introduction of austerity measures in countries that have run out of cash.
To my simple mind, rioting indicates people being surprised by a rapid downturn in events. In this instance, it seems to be young people realising that they have fewer opportunities 'to get on' in life. If circumstances change slowly, people adapt. They might become angry, but they won't riot. When things happen quickly, such as following say an IMF bailout, then rioting happens. (in the UK think Thatcher in the early 80's)
The key to avoiding trouble seems to be to put your house in order gradually, rather than having to be forced to cut spending by the global markets. Easier said than done.
Isn't it better to spray the cash around now and hope things get better in the future??!! (sarcastic smiley)
With limited 'real' cash around, the risk in the next year or so is for there to be an increasing number of sovereign defaults (countries running out of cash). What we are seeing now are the small countries being the first in line to take a spanking on the currency markets. The 'terrorists' in Iceland were the first to hit the buffers late last year. Now places like Greece, Latvia, Bulgaria and so on are following suit in a disorderly line. Even Ireland is on credit watch and could hit the buffers soon.
Then there are the big countries with spending problems. These include the likes of Spain, Italy and, dare I upset Gordon, the UK. These countries ran deficits in the good times and are now finding their government spending deficit is going out of control rapidly. Spain risks being the first to hit the buffers as unemployment is exploding at an incredible rate. They have also been running down their reserves, including almost all their gold, over the last few years. Now the kitty is empty...
The daddy of deficits (in value-terms) is the US of A. Last week, another $825bn of tax cuts and more spending was announced by Obama on top of a forecast overspend of $1.2+tr for 2009. Talk about pouring petrol onto the fire to help extinguish it! The mind boggles...
So, as the UK government commits potentially £100bn's to another bank bailout package, the dominoes continue to fall around Europe. Are we solving problems or making them worse?
I'm always wary of AEP's articles being factually biased. He seems to have an axe to grind on a number of fronts, with his favourite target of criticism being the Euro. But leaving aside the pros and cons of the currency at present, the bit that interested me was social unrest. His article mentioned riots in a number of countries over the past week, citing the example of Latvia.
Upon doing a search on it, it turns out it is true, but has been kept very quiet in the mainstream press. In the last week there has been rioting in a number of locations in eastern Europe. Generally, these are coming on the back of the introduction of austerity measures in countries that have run out of cash.
To my simple mind, rioting indicates people being surprised by a rapid downturn in events. In this instance, it seems to be young people realising that they have fewer opportunities 'to get on' in life. If circumstances change slowly, people adapt. They might become angry, but they won't riot. When things happen quickly, such as following say an IMF bailout, then rioting happens. (in the UK think Thatcher in the early 80's)
The key to avoiding trouble seems to be to put your house in order gradually, rather than having to be forced to cut spending by the global markets. Easier said than done.
Isn't it better to spray the cash around now and hope things get better in the future??!! (sarcastic smiley)
With limited 'real' cash around, the risk in the next year or so is for there to be an increasing number of sovereign defaults (countries running out of cash). What we are seeing now are the small countries being the first in line to take a spanking on the currency markets. The 'terrorists' in Iceland were the first to hit the buffers late last year. Now places like Greece, Latvia, Bulgaria and so on are following suit in a disorderly line. Even Ireland is on credit watch and could hit the buffers soon.
Then there are the big countries with spending problems. These include the likes of Spain, Italy and, dare I upset Gordon, the UK. These countries ran deficits in the good times and are now finding their government spending deficit is going out of control rapidly. Spain risks being the first to hit the buffers as unemployment is exploding at an incredible rate. They have also been running down their reserves, including almost all their gold, over the last few years. Now the kitty is empty...
The daddy of deficits (in value-terms) is the US of A. Last week, another $825bn of tax cuts and more spending was announced by Obama on top of a forecast overspend of $1.2+tr for 2009. Talk about pouring petrol onto the fire to help extinguish it! The mind boggles...
So, as the UK government commits potentially £100bn's to another bank bailout package, the dominoes continue to fall around Europe. Are we solving problems or making them worse?
Wednesday, 14 January 2009
I'm now a billionaire!
Well actually I'm being a little modest with the title. I'm now a hundred billionaire!
What's my stategy? Whose self-help book did I read?
Quite simple really. I went onto ebay and searched for "Zimbabwe Dollar" and found a Z$100bn note from 2008 going for £3.99.
That's an exchange rate of Z$25bn : £1. Gordon Brown's strong pound policy against the ZWD is clearly reaping dividends!
This might seem amusing but the human and economic story of Zimbabwe is horrific. It demonstrates that fiscal incontinence and money printing is never a good solution to problems. Zimbabwe used to be a net exporter in agriculture but why bother producing things to generate cash when the government just prints masses of money out of thin air? Now this industry (and practically every other) is in ruin.
I'll keep the bank note as a momento of grand folly and keep my fingers crossed that we don't go down the same route!
PS Guess which country had the best performing stock market in 2007?? That's right.... Zimbabwe! It grew by an impressive 322111%. I can't find the figures for 2008 because of the problems associated with the currency having to be reset TWICE due to hyperinflation....
What's my stategy? Whose self-help book did I read?
Quite simple really. I went onto ebay and searched for "Zimbabwe Dollar" and found a Z$100bn note from 2008 going for £3.99.
That's an exchange rate of Z$25bn : £1. Gordon Brown's strong pound policy against the ZWD is clearly reaping dividends!
This might seem amusing but the human and economic story of Zimbabwe is horrific. It demonstrates that fiscal incontinence and money printing is never a good solution to problems. Zimbabwe used to be a net exporter in agriculture but why bother producing things to generate cash when the government just prints masses of money out of thin air? Now this industry (and practically every other) is in ruin.
I'll keep the bank note as a momento of grand folly and keep my fingers crossed that we don't go down the same route!
PS Guess which country had the best performing stock market in 2007?? That's right.... Zimbabwe! It grew by an impressive 322111%. I can't find the figures for 2008 because of the problems associated with the currency having to be reset TWICE due to hyperinflation....
Sunday, 11 January 2009
Fear and Greed!
Now's both a very scary and exciting time to be watching the global economy. I often find myself trying to measure sentiment - be it at a national level, corporate level or individual (people watching?). In a relatively short period of time, the mood can change noticeably. Does it follow any pattern?
The wave pattern below (hat tip to John Nofsinger) is one of my favourite charts and I mentally refer to it on a regular basis when observing situations. It's based on the Kübler-Ross grieving cycle and shows how sentiment can affect investment cycles, particularly bubbles.
You can apply this to many situations and markets. At present we are spoilt for choice as many situations are currently sliding down the euphoria-fear-despondency stage of the cycle. However, economies and markets need not be at the same point in the cycle as each other, since some things lead/lag others.
The best current example for tracking sentiment is the housing market. The UK peaked in mid-2007 when it was popular to view property as a one-way bet to millions. Since then we have started to slide down the chart. My guess is that we are (in Jan 09) in the process of moving from fear to desperation and are moving along a step every 5 months or so.
In the US, they are about 12 months ahead of us on the down curve. I'd guess that they are now at the capitulation stage and the market could bottom in the next year.
It goes without saying that everyone has their own opinion on where things are in the cycle! Still it's an interesting approach to watching the world evolve...
Edit (22/01): Just seen a forum discussion asking where we are in the housing cycle. The consensus view seemed to be between denial and fear at present and moving slower than I thought. So there you go!
The wave pattern below (hat tip to John Nofsinger) is one of my favourite charts and I mentally refer to it on a regular basis when observing situations. It's based on the Kübler-Ross grieving cycle and shows how sentiment can affect investment cycles, particularly bubbles.
You can apply this to many situations and markets. At present we are spoilt for choice as many situations are currently sliding down the euphoria-fear-despondency stage of the cycle. However, economies and markets need not be at the same point in the cycle as each other, since some things lead/lag others.The best current example for tracking sentiment is the housing market. The UK peaked in mid-2007 when it was popular to view property as a one-way bet to millions. Since then we have started to slide down the chart. My guess is that we are (in Jan 09) in the process of moving from fear to desperation and are moving along a step every 5 months or so.
In the US, they are about 12 months ahead of us on the down curve. I'd guess that they are now at the capitulation stage and the market could bottom in the next year.
It goes without saying that everyone has their own opinion on where things are in the cycle! Still it's an interesting approach to watching the world evolve...
Edit (22/01): Just seen a forum discussion asking where we are in the housing cycle. The consensus view seemed to be between denial and fear at present and moving slower than I thought. So there you go!
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