Archive for May, 2007

May 2007?greatest takeover month

Thursday, May 31st, 2007

In our previous article, Where is all the newly printed money going? Private equity bubble, we mentioned about the global spigot of money flowing into leveraged buyouts. Today, we will provide you with some numbers.

This month is the biggest takeover month in terms of size of deals. A total of US$497 billion worth of deals were being announced, excluding the recent Royal Bank of Scotland?s announcement of taking over ABN Amro, which is worth US$95.5 billion. In the current year to date, there are already US$2.2 trillion worth of takeover deals announced.

This is a sign of the times.

Is the Chinese stock market independent from the Chinese economy?

Thursday, May 31st, 2007

In our previous article, Can the bursting of Chinese bubble affect US long-term interest rates?, we mentioned that the bursting of the Chinese stock market can have tangible consequences. However, the general consensus among economists is that a crash in the Chinese stock market will have no real demand on the general Chinese economy, let alone the world economy. As this article in Bloomberg said,

They say China’s economy shows little correlation with its stock market, foreigners are mostly excluded from owning shares and Chinese participation is limited to less than 10 percent of the population, reducing the effect of a bursting bubble.

At this point in time, it may be true. But if the bubble keeps on growing at this rate, when will it no longer be true?

Reply from the ?Australian Stock Report?

Wednesday, May 30th, 2007

Today, we received a reply from the ?Australian Stock Report? (ASR) regarding our previous article, Beware of ?Australian Stock Report?. We have no quarrel with the underlying philosophies of their trading/investing approach?we are agnostic on technical and trend analysis, and at times, even utilise such an approach too. We definitely have no problems with them not being contrarians as we are?after all, if everyone is like us, then by definition, we are no longer contrarians.

There is one area of difference between ASR and us: their measurement of returns. As we mentioned before in that previous article, it can give a very misleading view on performance. Our suggestion to them (we do hope that ASR sees that as a constructive suggestion) is to use a hypothetical portfolio with sell and buy transactions that can be replicated by real live trades. This will provide a far more accurate and accountable measurement of performance, which can only serve to increase the perception of trust on their reports.

However, both ASR and us are in agreement on one thing: the conduct of that particular sales representative is, as they put it, ?outrageous.? We leave it to ASR to deal with this issue. We believe that the highly aggressive sales technique of that sales representative is a stumbling block to their business?if he angered us immensely, chances are, there will be others who feel the same way.

To be fair to ASR, we decide to include their full reply:

To whom it may concern

As the Editor-in Chief of the Australian Stock Report, I?d like to make a couple of points in regard to your recent article about our company (published 19 May 2007).

First, we consider the behaviour of our sales representative, if he acted in the way you describe, to be outrageous.

We would appreciate it if you would either inform us of the representative you dealt with, or the email you used to register your trial to the service. This will help us deal with situation, which, I can assure you, we will. We?d like to apologise for any distress or inconvenience.

That said, we?d hate to be entirely judged by the actions of one rogue sales representative.

We believe we produce a quality product that helps everyday Australians understand the sharemarket.

Importantly, just because our investment view, which typically consists of trend following, differs from your contrarian approach, we don?t see how this makes our strategy any less comprehensive or relevant. We?re not Warren Buffet, but don?t mean to be. Whether one form of investing is better then the other; well, I suspect that is an argument for the ages. However, I think you?ll agree that true contrarian investing takes a level of confidence and fortitude that the average person would find difficult to sustain.

We have three different reports, and each of these utilise technical and fundamental analysis to different extents.

Our Weekly Report expects to hold stocks for more than a year, and is chiefly driven by fundamental views, while our very short-term CFD Trader?s Report uses mostly technical analysis.

Moreover, we try to be a lot more than just a tipping sheet. We provide detailed analysis, both fundamental and technical, on many stocks that we don?t tip. This allows members to build their own portfolios. We give general advice on how to build portfolios, how manage risk, explaining how companies are valued and how technical analysis works. You might say ?well, they can get that information from a book? but they can also read it from us with easy-to-understand working examples.

You might scoff at the fact that we read ten research reports from ten brokers and then summarise it for the general public, but most of our members don?t have access to this information, and they are paying for us to help them interpret this. Any trading suggestions are entirely our own, and we cover very many stocks that are not covered by any of the large players.

We admit our performance has been below our expectations, and we are very disappointed, but this is obvious from our Full Trade List. We are not trying to hide from this fact.

I will say, however, the comments regarding the way the cumulative portfolio impact on performance have not been drawn to my attention before. If we decide this provides a misleading view of our performance, then I can assure you this will be changed.

Also, I would note the article from the Australian you quote is flawed: it is neither our CFD Trader?s Report that number refers to nor is the list selective, and the article actually portrayed us as ?the best of a bad bunch?.

As for our track record, we had been around for more than four years, we?d display a longer track record. However, there is very little we can do about that.

In any case, all the best, and I hope I?ve gone some way to explaining what we are trying to achieve. I can understand why many experienced investors and traders lack faith in ?tipping sheets? but, the fact is, a tipping sheet was the first experience, and first guiding hand, for many of us still battling away years later.

I didn?t mean this letter to turn into a point-by-point rebuttal, but I did want to clarify that we try to produce a report that helps provide ordinary people access to what is, to most people, an overwhelming, frightening, but ultimately rewarding occupation: the Australian sharemarket. Sometimes our trading strategy falls flat – but doesn?t everyone?s?


Steven Dooley
Australian Stock Report

Can the bursting of Chinese bubble affect US long-term interest rates?

Monday, May 28th, 2007

Back in What if the Chinese stock market bubble burst?, we mulled at the implications of a Chinese stock market crash. Today, we have some more thoughts on that.

There is absolutely no doubt that there is a stock market bubble right now in China. Sooner or later (more likely sooner), as it always happens to all bubbles, it will burst. There are some who speculated that the Chinese government would not allow the bubble to burst before the Beijing 2008 Olympics. Our question is, can the Chinese government really control the timing of the burst? Human greed knows no bounds and can never be controlled. Can any government, no matter how totalitarian or paternalistic, control the greed (and its twin, fear) that is inside the human heart?

Back in Analysing recent falls in oil prices?real vs investment demand, we put a distinction between the real side and the financial side of the economy. Our belief was that since the financial side of the Chinese economy is relatively less well developed and important compared to the real side, a financial market meltdown should not derail the long-term growth of China. We believe this is generally true in the very long run that is measured in terms of decades. But upon seeing the increasingly out of hand stock-market craze in China right now, we cannot help but feel that a stock market crash will have tangible consequences.

Right now, price inflation is a serious concern in China (see Why is China printing so much money?). Saving money in a Chinese bank will result in a loss because the interest that is earned will not cover price inflation. Therefore, in the eyes of many ordinary Chinese, the only way to get ahead of price inflation is to use the money to buy stocks. Recently, for the first time ever, the amount of savings in the banks fell below the total market capitalisation. Of even greater concern, there are reports of people using their homes and retirement savings as collaterals to punt in the stock market.

Thus, the longer the bubble expands, the more savings that will be ploughed into the asset price bubble. What will happen to all these savings if the stock market crashes? In that case, vast amount of Chinese middle-class wealth will be wiped out. In such a situation, Chinese domestic demand will surely contract suddenly, resulting in social instability. In addition, with the Chinese banking sector already having enough bad debt problems of its own, will such a scenario compound this problem when the retail stock speculators default en masse on their margin lending and collateral loans? It is not hard to imagine the possibility of a financial crisis in China, which can result in a ?hard? landing in China (a dramatic slowdown of growth to 4-5% is considered a ?hard? landing in China). Should a ?hard? landing occurs, what will happen to the hundreds of millions of workers who had migrated from the rural regions to work in the factories in the cities in search of a better life?

The Chinese government, who prize stability above everything else, will ensure that this will never happen. The only way out is to print money?to prop up the stock market or the banking sector to prevent a liquidity crisis. We can see that price inflation, which is already a serious concern, can get worse.

But there is another problem?the Chinese currency is still not a freely floating one. Printing money and cutting interest rates is devaluation on the currency?it is something the Chinese government is very well tempted to do. However, it is not possible to control the money supply, interest rates and fix the exchange rate simultaneously?you can control either one or the other but not both. With the protectionist mood getting ugly in the US, devaluation of the RMB will not tolerated by the US. What can the Chinese government do? In that case, the only choice left is for the Chinese central bank to liquidate the trillion US dollar reserves. What will be the outcome? See China unwilling to hoard US dollars?what?s the implication?.

We shudder to think of this.

Tidal wave of money coming! Sovereign wealth funds!

Saturday, May 26th, 2007

In our previous article, Awash with cash?what to do with it?, we mentioned that with the US printing so much dollars to fund its current account deficit, ?those foreign countries that account for the vast majority of US imports (namely the oil-producing Middle Eastern nations, Russia, China and Japan) are sitting on so much US dollars that they do not know what to do with it.?

Indeed, this is a problem. With each passing day, those freshly printed US dollars will dilute the value of the existing ones, resulting in reduced worth of every dollar. Given that the US dollar still has the status of the world?s reserve currency (albeit a very shaky status), it gives the US the unique power to export inflation overseas (see How does the US export inflation?). It is no coincidence that around the world, central bankers are ?fighting? inflation (the idea that central banker ?fight? inflation is itself a ridiculous concept?see Cause of inflation: Shanghai bubble case study) and that global asset prices are still in a raging bull market.

In recent times, there is a beginning of a new force sweeping the global financial markets?sovereign wealth funds (SWF). Traditionally, central banks hold foreign currency reserves (namely the US dollar) as a form of ?savings? for a rainy day. Usually, these currency reserves are stored in the form of relatively safe and liquid Treasury Bonds.

Now, what if there are so much of them (and growing rapidly) that they far exceed their use as ?savings?? The Singapore Government?s Temasek Holdings is the pioneer in the concept of SWF. It is a government investment company that invests Singapore?s foreign exchange reserves and savings around the world. Now, this concept has spread to countries like Japan, China, Norway and Middle Eastern nations.

According to Morgan Stanley, the SWF may have as much as US$2.5 trillion at its disposal. The global hedge funds industry may be as large as US$1.5 to US$2 trillion. With that amount of new money from SWFs, they are a potent force to be reckoned. However, since they act as an arm of the governments, there will be issues with transparency and political controversy.

What are the implications? Good question. We do not really know the answer, but we are sure this new development will eventually add on to the problems of asset price inflation and general price inflation.

Where is all the newly printed money going? Private equity bubble

Wednesday, May 23rd, 2007
In Cause of inflation: Shanghai bubble case study, we mentioned that the root cause of price inflation is monetary inflation (where fiat currency is being debased in value by ?printing?). As a consequence of monetary inflation, we have price bubbles in the housing market (see The Bubble Economy). Now despite the fact that the housing bubble is deflating in the US and no longer inflating in Australia, monetary inflation (a.k.a. ?printing? of money) is still going on. The fact that stocks, bonds and even art are in a raging bull market shows that the global spigot of liquidity is still spewing out endless streams of money and money substitutes. No wonder central bankers around the world are busy ?fighting? inflation (see Have we escaped from the dangers of inflation?)!

In addition, there is another phenomena that is the consequence of monetary inflation?private equity bubble. You can see the graph for the growth of global leverage buyout activities here:

Global Leveraged Buyout Activity

According to the March 2007 Financial Stability Review of the Reserve Bank of Australia (RBA),

On the regulatory front, central banks and supervisors in a number of countries are attempting to understand the implications of the LBO-private equity phenomenon. On the one hand, private equity clearly has the potential to improve the performance of underperforming firms, and thus contribute to the efficient allocation of global capital. On the other hand, there are concerns that the current boom might turn out to have a number of less welcome consequences. These include: the amplification of a future economic downturn due to a sharp rise in leverage in a period when capital markets have provided debt on very generous terms; a reduction in the flow of information to investors if the size and depth of public equity markets are reduced; and the increased potential for market abuse reflecting the sizeable flows of price sensitive information in the period leading up to the transaction, and the conflicts of interest that can often exist for management and financial institutions over these deals.

In other words, the private equity bubble is causing debt to balloon in the corporate sector. Already, the consumers in the US economy are heavily in debt. The US government is heavily in debt. Now, the corporate sector is building up debt.

Eventually, something has to give.

Second lesson of ?29 crash?bear rebound

Monday, May 21st, 2007
Continuing from our previous articles, The Great Crash of 1929 and First lesson of ?29 crash, there is another lesson we can learn from the Great Crash.

In the immediate aftermath of a severe correction or crash, usually there will be a rebound. This is a bear market rally. Back in 1929, the bear market rally lasted for around 6 months from November 1929 before resuming a downward trend. In May last year, after the short-term gold bubble burst, there was a rebound before continuing its slide to a short-term low of around US$545. This is a recurring theme.

No doubt, after a big fall, there will be some who thinks that prices are at ?bargain? territory and thus, buy. This is the time we would sell if we happen to be caught out in a severe correction or crash.

Beware of ?Australian Stock Report?

Saturday, May 19th, 2007

Note: See Reply from the ?Australian Stock Report? for ASR’s reply to this article.

In our previous article, Stock tip-sheets?influential or manipulative?, we warned of the manipulative nature of some of the stock tip-sheets. Today, we will particularly name a company for their questionable ethics.

Yesterday, a sale representative of the Australian Stock Report (ASR) called us to sell us their tip-sheet?he was the most aggressive salesman we had ever seen. By the end of the phone conversation, he was badgering us and was almost shouting. Finally, we had no choice but to hung up on him. The first question he asked was how much our return was. We gave him an arbitrary figure. Then he proceeded to tell us that if there was a way that we can get a return of 50% (which was higher than the arbitrary figure that we gave him), would we be interested in his product?

That sounded tempting. But that salesman insinuated that only an idiot would refuse to subscribe to such a too-good-to-be-true product such as ASR. We pointed out to him that such alleged returns would not be a guaranteed result. Bound by the Australian securities regulation, he was forced to admit that there was no such thing as a guaranteed return.

When we baulked at such a steep price of ASR?s tip-sheet, the salesman promptly cut the price from $1490 to $650 and threw in a bonus free month of subscription?an instant cut of 60% on a per-month basis! If you look up their web-site, you can see that the official price of the Daily Report package was $1490. Isn?t it interesting that we can get an instant 60% ?discount? just by being sceptical of their product? What about those people who paid the ?full? price of $1490?

We then asked him about ASR?s analysis methodology. He told us that ASR used both fundamental and technical analysis and that their analysts had a combined x number of years of experience, devoted a combined x number of hours of research for each stock and so on. Along the way, he told us that ASR took the reports and recommendations from the large and famous brokerage houses (e.g. UBS, Credit Suisse) as input and from there, out came a stock tip-sheet product that includes daily SMS and email alerts as well as direct access to their analysts everyday. Did he mean that ASR relied on analysis from those large brokerage houses to derive their recommendations? If so, than that means such ?analysis? of theirs was derived secondary analysis from the large and famous brokerage houses? primary analysis. Therefore, this sort of ?analysis? is just another child?s play?just collect a bunch of primary analysis, rephrase and combine them in your own words, throw in some of your own ideas and out come another ?analysis!? This is easy?we confessed that we had done it ourselves before since there is rarely such a thing as a truly original idea. Most ideas are derivations and combinations from previous ideas. The extent of un-adulteration to which one?s ideas are derived from others? shows the extent of emptiness of one?s ideas. This is something that you may want to check out on for ASR?s reports.

Next, the salesman claimed that ASR relied on both fundamental and technical analysis. But take a look at their trade list, which showed their buy and sell tips along with the theoretical returns. There is no denying that they were recommending short-term trades. Such activity is highly uncharacteristic of long-term value contrarian investors with the same philosophy as Warren Buffett. Therefore, to classify ASR as a tool for investors is highly misleading?they are more suitable for short-term traders.

Then we asked him about the length of their track record. He told me they had 4 years of track record. That was our main point of contention. In the world of investments, 4 years of track record is nothing. For the past 4 years, there was a raging bull market. We are more impressed with Warren Buffett, who had been investing since 1960s and had consistently surpassed the index benchmark most of the time in all sorts of market conditions. Australia?s famed Platinum Asset Management had at around 16 years of consistent track record. These investors have real financial assets to back up their claims. For ASR, they had nothing to back up their claims except for theoretical returns that relied on numerous flawed assumptions (more on that below). Other investment newsletters like The Intelligent Investor include a hypothetical portfolio that you can verify and invest according to if you want to.

In any case, that salesman was trying to argue with us regarding the issue of track records, even resorting to patronising our personal investing history and experience. He even tried to question whether we could even find anything with such long track records that we were looking for. His failure in recognising others in the industry that had much longer history than ASR showed his complete lack of professionalism. It was laughable to hear of his assertion that Warren Buffett?s 30-year investment history was ?proof? of obsoleteness and that ASR was always up to date. Clearly, that salesman was ignorant, given that he completely failed to understand the point of track record. With such failure of comprehension, he rattled off with other irrelevant assertions that we were not interested in. In exasperation, we had to tell him off that we could not care less of his irrelevant points. Indeed, if we use ASR?s method of measuring returns, their record for 2007 was atrocious (see their trade list)?they lost money in 7 out of 9 trades with an average return of negative 5 percent!

Next, ASR?s measurements of returns (as shown on their trade list) were highly dishonest. Take a look at their trade on SRK on December 2006. They recommended a buy in December 2006 and a sell in April 2007. But guess when they designate their ?profit?? If you look carefully at their figures, the ?profit? was assigned in December 2006 when the theoretical sale of the stocks was in April 2007. That ?profit? was then added to the cumulative value of their portfolio in December 2006! Subsequent trades were then based on this flawed cumulative value, thereby artificially inflating their alleged returns. This is so far just an example of a shenanigan that we have caught.

As we said before in Stock tip-sheets?influential or manipulative?, ASR, with such a large subscriber base, their ?recommendations? would be likely to become self-fulfilling. Furthermore, if their job consisted of monitoring broker reports from the large and famous broking houses, recommending a buy recommendation the moment brokers upgraded their recommendations was hardly ingenious. In that case, the amount of your profit will depend on how quickly you react their SMS/email alerts, fighting your way to the market before the rest of their subscribers.

ASR?s employment of extremely aggressive sales tactics should put a big red flag on their level of integrity. As this article in the mainstream news media said,

ASR could not provide a definitive response on its performance methodology and its website advertises an astonishing, though presumably selective, 408 per cent return on its “CFD Traders” product.

First lesson of ?29 crash

Thursday, May 17th, 2007

Continuing from our previous article, The Great Crash of 1929, what lessons can we learn from that Great Crash?

First, the greatest danger lies when bullish sentiments are at the extreme. This may sound counter-intuitive, but it makes sense when you think deeper about it. By the late 1920s, speculative boom had led to millions of Americans to invest heavily in the stock market, even borrowing money to do so. By September 1929, bullish sentiments were at its peak when the stock market reached a record high.

Right at the stock market peak, the expectations of everyone will be overwhelmingly positive on the stock market. However, as you can attest from personal experiences, whenever your expectations are dashed, your mood can easily turn from gladness to madness?the greater the initial euphoria is, the greater the disillusionment will be. In the same way, during a stock market peak, when the crowd?s overwhelmingly optimistic expectation was ruined, their mood can easily turn overwhelmingly pessimistic. In a flash, extreme greed can give way to extreme fear.

This reminds us of what is happening in China right now. We heard that people over there are using their house and retirement funds as collaterals for borrowing money to speculate in stocks.

What if the Chinese stock market bubble burst?

Tuesday, May 15th, 2007

In China unwilling to hoard US dollars?what?s the implication?, we mentioned that

Of course, it is unlikely for the Chinese Central Bank to go berserk. It is not in their interest to see their accumulated US$1 trillion of reserves go up in smoke.

As we ponder about this, we realise that there is a scenario whereby the Chinese Central Bank may go ?berserk.?

Currently, it is said that China has 55 million stock broking accounts. Each day, 250,000 new accounts are opened by people who are financially illiterate and are least able to afford financial losses. Many of these people are pouring their savings into the stock market casino. In a year?s time, at this rate it is going, the number of stock broking accounts will double. Right now, the Chinese stock market is in such a dangerously bubble juncture that the Chinese government has to admit that it is indeed a serious problem. What happen if the bubble burst 12 months from now? The government will have to face the wrath of 100 million angry people who lose a large part of their hard earned savings into the stock market. You can see that this is going to be an acute social problem that will be politically destabilising. Since the Chinese government prize political stability above everything else, you can be sure this issue will be keeping them awake at night.

What are the options for the Chinese government when such a nightmare scenario eventuates?