There is no question that we are presently in the most volatile period I have ever experienced. All the years spent telling people why one should invest in shares for the long term is now being tested in real time so I’m puzzling over what comfort I can give. I can’t foretell the future and the potential outcomes are many. In the worst case scenario every country defaults on their debt and financial markets hit gridlock again. Panic ensues, people do really stupid things, the media exhausts itself but gradually a new base is found; there is nothing left to panic about apart from the mundane and we all begin to rebuild our lives. I still try to imagine what living in Europe was like during six years of war!

I borrow some of the below from Peter Thornhill and his presentation “Investing in a Perfectly Rational Sharemarket”.

“The share market has two primary functions; first and foremost it provides a mechanism that enables businesses to raise capital and secondly it provides a market that enables us to exchange for value, ownership of these valuable enterprises. Both these functions it carries out in an efficient and rational manner. I am now at great pains to point out to audiences that it is the people involved with the share market that are irrational. If I could just get rid of people we wouldn’t have the problems we face today. There are no restrictions on who or what can deal with this market. As a consequence we have traders and computers of every shape and size gambling and, as a result, shouldering to one side the investors of the world. 

Thus, short term, the stockmarket merely reflects the attitudes and mood swings of mindlessly cascading computer trading, hedge fund managers, CFD speculators, day- traders and assorted other lunatics. What is traded is of little interest and barely understood by many of these ‘players’. It could just as easily be bags of wheat or turnips. What attracts them is the extraordinary liquidity provided by the markets efficiency. “

Sadly the investment markets then get the bad press for merely providing a reflection of this largely useless speculation.

In a recent idle moment I searched the major newspapers websites using the word “fear”; the hits came thick and fast. I discarded all except topics associated with investment. It was a rich vein to tap. I cannot do justice to all the things ‘investors’ fear but here are a few I have pulled to include in my public presentations.

Italy’s vulnerability to debt crisis fuels fears. 

Markets tumble as investors fear GFC ll.

Shares slide as fear reigns.

Fear grips investors as rumblings of doom infect global markets.

Share stampede blamed on fear and irrationality.

Fear is based on ignorance. This breeds an insatiable desire to know and as Ross Gittins of the SMH once wrote: “our ‘crazy, unceasing urge’ to ask people who can’t possibly know to speculate on possible outcomes”. This unceasing urge to ask people who can’t possibly know to speculate on possible outcomes perfectly describes Morning Television. TV producers have near on 3 hours to fill with asking the above questions to people who can’t possible know the answers!!!

The share market ultimately reflects the endeavours of the human race, for better or worse. If you therefore believe that human endeavour is not dead then for heaven’s sake, buy with your ears pinned back; we are not going to go back to living in caves.

Greek Debt Issues

The EU and IMF have now allowed Greece to default and repay only 50% of capital back to bondholders. Why has this sent markets into a jump for joy over last week? The bond holders have been given their 50% loss back by the EU and IMF. So in effect they have lost no money and Greece does not have  further harsher austerity measures imposed on them.

But the banks and investors who have been bailed out have conditions imposed on how they use these funds. Along the lines of “You banks need to lend this money out and stimulate your local economy…”

So finally the markets have seen this as a repeatable model to help ailing Government economies in Southern Europe.

Dow Jones having best October in 25 years

The Dow Jones is up 13% now for the month of October, on the back of improving economic numbers out of new home starts and employment numbers.

Great Result from the National Bank today

NAB reported today and pretty much had the ideal result from a shareholders persepctive.

Dividend up 13% from same period last year. This is verse inflation of less than 3%. Costs down, revenue up, bad debts down. This is mission accomplished. We cannot ask more from the companies we invest in than to deliver results like these in, what are still troubled times globally. Dividend yield for 2011/12 forecast at 10.71% gross. Plus NAB shares up nearly 20% over last 3 weeks.

Congratulations Cameron Clyne and his board at NAB! (at least from all the PROPLAN clients who own shares in your company).

Domestic Rates to Drop

Went to lunch hosted by Westpac last Friday and Bill Evans (their chief economist). He is almost convinced that RBA will drop rates by 1% before June 2012. This will be to protect our softening jobs market. Then picking rates to go up again early 2013. This will provide lots of stimulus to our publc companies and to investment markets.

Still Plenty of Upside

Even with all this news our ASX200 is at 4385. To get back to October 2007 levels (high of 6,875), we still have upside in prices of 57%. So plenty of price recovery still in store.

When will we get back to 2007 levels? Who knows, but in the meantime we need to own investments like that NAB that provide a strong growing reward in the form of increasing dividends over the years.

PROPLAN News

We have moved to our new premises after their fit-out at 127 Sutton Street Redcliffe. Contact details all unchanged. Our other senior adviser Tony Warren is away on a hard earned holiday and will be back mid-November.

Congratulations to Shane and Rachel from our strategic partners, Pacific Home Loans, on the birth of their daughter Ruby!

He especially likes at present Wesfarmers and RIO (2 of our core holdings). Click on the link below to watch, its 5 minutes but well worth it for the message of confidence.

http://www.morningstar.com.au/funds/video/fidelity/1989

What Caused latest sell off?

The US Federal reserve last night stated that risks to the global economy from the European dramas were “significant” and that it noted “strains in global financial markets” (well, duhh!)

European sovereign debt fears are nothing new. We’ve been talking about Greece’s problems for well more than a year now, and we’ve seen any number of plans attempting to solve the crisis from any number of groups. None of these plans has worked. It is becoming increasingly clear that Europe needs to accept that Greece is bankrupt and that a default will be necessary. Indeed, this will be a painful process. However, it could help remove the incredible uncertainty that is rocking the markets and help put Europe back on the path to growth.

What Does a Greek Default Mean?

With debt standing at 143 per cent of gross domestic product at the end of 2010 (and that number has gone nowhere but up given the country’s budget deficit), Greece will never be able to pay back its creditors 100 cents on the euro. The only way that the country can become solvent is to cut a huge amount of spending, for growth to pick up considerably, or for the government to find a way to meaningfully raise revenue. None of those seems likely.

On the growth front, Greece doesn’t have a particularly competitive economy, and much of the growth depends on government spending and subsidies. As these payments decrease, growth is likely to contract event further. With economic woes spreading across much of the world, the chance that expanding GDP will save Greece is approaching zero. Adding revenue might be even harder. Tax evasion is rampant across the country, and there isn’t much appetite to pay even more in taxes in order for banks to get bailed out. Passing new taxes is therefore unlikely to have a major impact because many of them might go unpaid. Plans to sell off publically owned companies and other assets to raise funds have faltered, as well. Add in the negative outlook for Greek economic growth, and there just won’t be that many takers even if big discounts are offered.

The only way to stave off the default then is for the rest of the European Union to pour bailout funds into the country. However, these structural problems are not going to be solved by some short-term cash that will need to be paid back at reasonably high interest rates. It’s better to rip off the proverbial band-aid now. Greece will take its lumps, but it will then be able to begin the long process of reconstruction and rebuilding of the economy. In default, the country can make the structural changes it needs to for long-term stability.

So it is likely that Greece will default, the banks and investors who have purchased Greek bonds over the years have to bear some of the losses and pain that is being shouldered by investors around the world. What impact the default will have is yet to be played out, but equity markets are forward looking and this default scenario seems to be “priced” in at the moment. The uncertainty surrounding Greece is a big problem. Without any clear indication of when the crisis is going to be over, investors are going to be very jittery every time a bad piece of news comes out. This is what we are seeing at present. The Australian market has dropped 5% this week on the back of fears of a slower growing world economy.

 The Australian market

We are a commodity based economy, and our dollar will get sold off as commodity prices drop. Commodity prices drop when there is a fear of a slowdown in economic growth, so we have seen big sell offs in BHP and Rio over the last 2 days. Whilst there is so much nervousness at present, every bit of bad news will cause sell offs.

Unfortunately we are at a point where we need strong decisive actions from our leaders and elected politicians. Given the quality, and experience of a lot of these elected leaders it is not really a surprise that they have no ability or will to come up with an effective plan to deal with Greece.

In the meantime…….

People will still buy food (Woolworths), pay their mortgage (all the banks), buy petrol (Woollies and Wesfarmers and Caltex), watch TV (Channel 7 and Channel Ten) and do all the other things they did yesterday and last week. The Australian economy is in good shape as are our public companies that you have invested in.

And the upside is you can buy a boring old National Bank Share and get paid a near 11% dividend as your share of their profits!

Don’t forget to “like” us on Facebook for continuous updates.

Your same $10,000 invested in a term deposit in 1993 paid you $1,200 interest. In 2011 it is paying you $600 interest. Take the word “share” out of the comparison and which would you consider a “safer” investment. The one that 18 years on is paying you a 6% yield or the one paying 84%????

And last but by no means least, the $10,000 term deposit is worth 18 years on, you guessed it, $10,000.

Your $10,000 of CBA shares are worth $91,000.

We have to remember that we own part of a business that operates and forms part of our economy. The facts are productive enterprises are what drive investing outcomes. The share market reflects human endeavour. Industry exists because it meets our needs. The long term future direction of markets must be up as human enterprise expands.

We are not buying a speculative “thing”, we are sharing in the fruits of the labor of the business we own. On any given day the world will vary in opinion on how much this part of the business is worth, but we will still share in its profits over time and as those profits increase over time, so to inevitably will the value.

Lastly thanks for many of your kind emails over the last week in response to our updates. Hopefully will not have to send out any more in the near future.

Also don’t forget to become “friends” with PROPLAN on Facebook for daily updates and comments on the world.!

First off what does this mean?

Investors rely on rating agencies to “rate” the relative risk of an investment in the issuer. The issuer in this case being the US Government. S & P therefore are saying that they believe that US Treasury Bonds are marginally more risky than this time last week. There are 12 other AAA rated economies (Australia being one of them) and only one other country with a AA+ rating other than the US, this being New Zealand.

Practical Impact of this?

S & P are only one of  3 big rating houses, the others being Moodys and Fitch. So ultimately it is only an opinion. S & P are not exactly covered in glory with their ratings history as they rated the junk bundled mortgages that were sold as bonds (and were basically the initial trigger cause of the GFC) as AAA. Many lay the blame for the GFC squarely at the feet of the rating agencies like S & P. There are some estimates of what this may mean for bond yields. These estimates vary between nothing and $100 billion a year in extra interest that the US government may have to pay on Treasury bonds as investors will demand a higher yield because S & P say they should. Obviously if the US have to pay more interest this leaves them with less dollars to stimulate their economy.

The biggest impact is the further hit to confidence in the worlds investment markets and this will translate into further downside at least today on world share markets. The Whitehouse is apparently seething over the release of this downgrade and have commented that they see “no justifiable rationale” for the move and a quote “Stunning lack of knowledge” displayed by S & P . S & P blame the politicians failure to adequately address debt reduction in the agreement they nutted out on August 2^nd, for the downgrade.

As the US economist and money manager Zachary Karabell wrote last week, “the best possible outcome would be for them to downgrade the US – and for the world to shrug, with rates set by the multitude of buyers and sellers. That would at least demonstrate that these emperors, clothed though they are, wear very frayed robes.”

Billionaire Warren Buffett also said S&P erred when it lowered the U.S. credit rating and reiterated his view that the economy will avoid its second recession in three years. The U.S. merits a “quadruple A” rating, Buffett, 80, said Aug. 6 in an interview with Betty Liu at Bloomberg Television.

What to do?

As I said on Friday, today is a day to un-react. Investors expectations are resetting the value of the markets at present, so may be rocky for a few more days.

“ A Basic Business Model”

Imagine a small family business that makes lemonade and sells it at local market. They started business with $100 to buy a trestle table, esky and juice squeezer. We modelled the business and pricing to generate a return on our capital/equity (ROE) of 10 per cent, In year 1 business runs as planned and we generate a 10% return and a $10 profit!

We must now set our payout ratio, which is how much profit is paid out to shareholders in a dividend. We elect 50%. The shareholders enjoy an immediate dividend of $5 and the balance of profit is ploughed back into business as retained earnings or profits. We used these retained profits to upgrade our juicer as clients said they wanted fewer pips. In year 2 we generated again our 10% ROE but now on our expanded assets of $105. This means a slightly higher dividend. We then plougher $5.25 of retained earnings back into business and bought glass instead of plastic cups.

Year 3 went to plan as did the following years. Every year we did not increase our ROE from the 10% in year 1, but just doing it on a larger pot of equity. You can see the dividend, profit and assets growing over time.

Here are some real life numbers.

These numbers are not the “price” but the “value” of our investments.

This is about as complicated as business gets. Shareholders provide capital that generates a return. Shareholders are rewarded with a dividend and the balance of profit is ploughed back into the business. Share prices and businesses rise over the long term for perfectly rational reasons. A lack of understanding of this simple concepts causes much of the fear associated with investing.

Next PROPLAN Companion we will talk about how to treat yourself as a business and to pay yourself a dividend!

The Climate verse the Weather!

Investing is a bit like the weather: one day fine and the next day stormy. Short term or speculative investment decisions are about as reliable as forecasting the weather from day to day.

Meteorologists are notoriously poor at forecasting tomorrows weather conditions and are subject to much derision and cynicism as a result. They can however predict the climate with considerable accuracy. That’s because the climactic forecasts are a result of weather readings meticulously recorded over many hundreds of years. We know with accuracy that we will have four seasons this year, that it will be colder on average in Winter than it is in Summer. But that does not mean we can’t have really warm days in Winter or cooler days in Summer.

When choosing a climate to live in, would we be deterred by last week’s weather? The weather in Melbourne, when considered over a long period of time, becomes a sensible and reliable climate. This is despite the days of sweltering heat or bitter cold often occurring so unpredictably.

If we have a long term frame of mind- if we looked at the investment climate instead of the speculative weather – none of the above would be an issue.

The daily news programmes are obsessed with one thing only. What was the weather today?  Short term violent “weather” is much more sensational than long term predictable climate. The short term attention grab headline reads much better as:

“Wall Street Plunges” than “ Wall Street Companies grow their earnings by 7% this year”.

The climate for Australian Industrial Companies is a very predictable one. Inflation ensures, for example that Westpac makes more money in 10 years time than they do today. The average home loan will increase as house prices increase. Inflation ensures that to replace a house in a decade will cost more than it does today. It takes no more for a Westpac loans officer to complete a $400,000 loan application than it does to do a $200,000 application, but the bank makes more margin on the larger loan.

As an example, see the table below showing growth in dividends from some of our biggest companies. The CBA nearly tripled their dividend over the last 13 years, Woollies increased theirs 6 fold over same period.

The long term investment “climate” is good, don’t let the daily focus on the “weather”  distract us from the table above, which is the real reason we own investments in enterprise and business.