Technology Investor 

Harry Newton's In Search of The Perfect Investment Newton's In Search Of The Perfect Investment. Technology Investor.

Previous Columns
8:30 AM EST, Wednesday, September 12, 2007:
The dollar continues in free-fall against every major world currency. This will help our exporters, but hurt your pocketbook if, God forbid, you vacation abroad. The dollar will fall even more, now that the Fed (and nobody else) is considering cutting its interest rates. That means less investment money will be attracted to the U.S. Fortunately, my real estate syndicators have, in recent years, eyed overseas projects more zealously and I now have money in Canadian and German real estate. And we're eyeing Turkey. Also, I have money in Australian mining and exploration, which I continue to like. Australia remains China and India's quarry.

We need to keep reminding ourselves this is no longer the 1980s or even the 1990s. The dollar is no longer king. Overseas currencies -- like the Euro, the Australian dollar and the Pound Sterling -- are strong, and have replaced the dollar as a safe place to hold your money. This is a major paradigm shift.

Yesterday I visited a money manager with unusual ideas whose returns have been nothing short of phenomenal. I would have written about that visit today, except I later killed myself on the tennis court, pretending I was Mr. Federer. (I wasn't, but did make two Federer shots.) I'll write about that visit tomorrow.

For today I'm stealing some words from an Australian financial observer called Alan Kohler, who writes something called The Eureka Report. It doesn't matter that you never heard of him -- me neither. His words, which I've excerpted and bolded, are neat:

Buy the company, not the market

Before we get down to business and start talking about what’s going on with the market – and what you should do with your money now – let’s just remind ourselves that it’s all pointless anyhow, and that according to the greatest investment gurus of all time, successful market timing is impossible.

"I never ask if the market is going to go up or down next year. I know there is nobody who can tell me that". John Templeton

"We've long felt that the only value of stock forecasters is to make fortune tellers look good. Even now, Charlie and I continue to believe that short-term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown-ups who behave in the market like children". Warren Buffett

"If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stockmarket". Benjamin Graham

It’s what we’ve been banging on about for two years. Invest in quality companies for the long term and don’t try to pick the peaks and troughs of the market.

Which is all well and good, but what if you happen to buy at the start of a two-year bear market caused by, just for instance, a credit crunch that has nothing to do with the companies and their management, and only to do with lending $US1 trillion to poor people in the United States who want to stop renting but can’t actually repay the loans they’ve now taken on board and whose houses are now worth less than the value of the loans?

So you do the right thing and buy shares in a great company but it takes three years to get back to the price you paid because something else happened, entirely unrelated to that company.

So market timing doesn’t matter – except when it does.

Warren Buffett has been making fun of all the intermediaries he calls ‘helpers’ over the past couple of years, taking aim in his last couple of letters to Berkshire Hathaway shareholders at the investment bankers and hedge funds that are skimming a lot of money from the ultimate owners of companies with all their ‘helping’.

But it’s not a joke any more. Things have got to the point where the games of hedge funds and all the other creations of investment bankers have fundamentally changed the way the financial markets operate.

Prices are jumping around for reasons that are unrelated to the companies themselves, and the amount of debt being employed has increased the risk of investing in general.

Hopefully things will go back to the way they were when Peter Lynch, Benjamin Graham and Warren Buffett understood the markets – before prices were set by hedge funds speculating with borrowed money – but that’s unlikely to be painless either.

In fact, Morgan Stanley economist Gerard Minack is now suggesting that a 25 year bull market in the financial sector is coming to an end. Over the past quarter century, financial sector profits in the US (banks, investment banks and fund managers) have gone from 0.5% of GDP to 3.5%, and the sector is now much larger than manufacturing (the crossover took place 10 years ago so that finance now represents 18% of the US national income versus 12% for manufacturing).

The idea that the hegemony of the financial sector is coming to an end sounds pretty appealing to me, and maybe it’s true, but the truth we have to focus on for the time being, until that happy day arrives, is that the financiers rule the world and over the past few years they have buggered things up -- (Australian for messed things up).

In late July, market psychology swung totally from greed to fear virtually overnight. Suddenly it was doom and gloom everywhere and we were all going to be ‘rooned’, as the credit crisis spread from sub-prime CDOs to long-term corporate debt, to short-term commercial paper and to the overnight interbank market.

The London and European interbank cash flows seized up entirely and the European Central Bank was the first to step up and pump cash into the system. Other central banks quickly took it up, the cash pump, and then a bit more than a week ago the US Federal Reserve Board loosened up what’s called the discount window, through which it lends money directly to banks – cutting the rate by 0.5% and letting them keep it for 30 days instead of having to pay it back next day.

The overnight cash market around the world is now awash, and banks that need some readies have got plenty. Then last week, Bank of America coughed up $2 billion to the largest US non-bank lender, the struggling Countrywide, and now it seems to be OK, too.

As it happens, the Sydney Futures Exchange closed down at lunchtime for repairs mid last month, and all the hedge fund bears switched to the physical ASX (Australian Stock Exchange) to do their short selling for an hour and a half.

The market totally crapped out (a loose technical term), falling 150 points, and our good mate Charlie Aitken promptly and correctly called it the bottom in Eureka Report – BEFORE the Fed cut the discount rate – not because he’s some wizard market timer but because he is on the lookout for bargains and knows them when he sees them. Given the flow of profits and the prospects for the fundamental economy, the prices he was seeing were great value.

Meanwhile, as Charlie jumped into the pool with a splash shouting “THE WATER IS FINE, C’MON IN,” I hung back wringing my hands and worrying about whether it’s going to get cold and choppy again. Typical. If only I had re-mortgaged the house and gone long that Thursday lunchtime I would have caught the biggest week in 32 years and I could retire now. This could be seen as encouraging high risk behaviour, i.e. next 150-point drop wade in.

But it was OK, because I had been too busy reading Peter Lynch’s book about value investing to sell when the market was falling, so I was still fully invested last week: I went down the Big Dipper in late July early August and then up again late last month.

It’s all good fun watching the bulls and bears slug it out and watching the market temperament switch from greed to fear and then back to greed again, as long as you’re not running around betting the house on picking the peaks and troughs.

As Alex Green of The Oxford Club wrote recently: “Great market timers exist only in the land of garden fairies and elves that live in hollow trees. Superior stock market performance is the result of security selection, not trying to pick the next rally or correction.

Anyway, I think there are two profound changes taking place in the world that are feeding my caution about the investment environment, and changing the way I think about the future:

1. A permanent increase in volatility and risk has taken place that will increase the demand for capital.

2. A major acceleration is now occurring in the long term transfer of economic power from the United States to Asia and, to a lesser extent, Russia.

Data from the US Federal Deposit Insurance Corporation shows that $US1.4 trillion worth of sub-prime mortgages were securitised between 2001 and 2006. I have seen estimates that suggest up to $US500 billion of these (more than a third) are bad loans. Fed chairman Ben Bernanke estimates that there will be losses to the banking system of $US50–100 billion.

These are scary numbers. Moreover, the level of mortgage resets that are causing the defaults is still rising and will continue to be high for at least 12 months.

According to the International Monetary Fund, we have seen $US100 billion of resets since December 2006.

Matthew Johnson of futures broker ICAP estimates that there are “over $US650 billion of adjustable rate mortgages (ARMs) to reset over the next 18 months, and the intensity of the resets is going to rise: the maximum reset flow thus far was $US25 billion a month in May 2007. This is expected to rise to about $US40 billion per month in early to mid-2008, as the glut of 2006 vintage sub-prime mortgages adjust. As the intensity of resets rises, the flow of defaults is expected to rise.

In other words, the cutting of the discount rate a week ago was not the end of the sub-prime crisis – it has really only just begun, and the consequences are unpredictable.

Furthermore, we have shifted to a higher volatility world – the unsustainably low volatility, high complacency period of the past few years, which led to the risky lending practices in the US, is over.

Matthew Johnson again: “Volatility now is about where it was before LTCM (Long Term Capital Management) blew up (1998). We should not expect it to settle back down to old levels.

“Given this, prudential reserves held to cover the market risk of any given asset will not return to H1’07 levels. An increase in prudential capital requirements is a permanent increase in the cost of carrying any asset on the balance sheet – and given the increase in the cost of carrying assets, the value of assets will have to fall.

“This is a direct consequence of the increase in volatility; the spell has been broken. If the cost of carry (the 'carry trade') has increased, the price of assets must fall, as the required rate of return has increased. As a result of this, we should not expect that asset values, even outside the sub-prime mortgage-backed security class, will return to their previous levels (all other things equal).”

The combination of the still-unfolding sub-prime crisis and the related increase in financial volatility, requiring an increase in prudential capital, has still got a long way to go.

Whether it gets a lot uglier from here depends largely on the actions of the world’s central banks, and specifically the US Fed. If Bernanke reacts decisively to any signs of a major collapse by cutting the Fed funds rate (the rate at which banks lend to each other, as opposed to the rate the Fed charges them for money, which is the discount rate) then perhaps everyone will muddle through. I really hope so.

I think that $US1.4 trillion in sub-prime mortgages over five years has created the conditions for a significant acceleration in the shift of economic power from the US to Asia. That shift was happening anyway because of the build up of current account surpluses in Asia – especially China – and current account and budget deficits in the US, largely as a result of America’s habit of building debt to spend on wars as well as unsound mortgages.

The search for the nurse's pen
A nurse walks into a bank totally exhausted after a 20 hour shift.

Preparing to write a check, she pulls a rectal thermometer out of her purse and tries to write with it.

She looks at the flabbergasted teller and without missing a beat says, "Well, that's great..........that's really great......... some asshole's got my pen."

Time to be PC
"In what aisle could I find the Polish sausage?" asks the shopper.

The clerk looks at him and says, "Are you Polish?"

The guy (clearly offended) says, "Well, yes I am. But let me ask you something. If I had asked for Italian sausage would you ask me if I was Italian? Or if I had asked for German bratwurst, would you ask me if I was German? Or if I asked for a kosher hot dog would you ask me if I was Jewish? Or if I had asked for a Taco would you ask if I was Mexican? Would you? Would you?"

The clerk says, "Well, no!"

"If I asked for some Irish whiskey, would you ask if I was Irish?"

"Well, I probably wouldn't!"

With deep self-righteous indignation, the guy says, "Well then, why did you ask me if I'm Polish because I asked for Polish sausage?"

The clerk politely replies, "Because you're in Home Depot."

Rosh Hashanah starts tonight
Rosh Hashana is the first day of the Jewish New Year. The year will be 5768. You can wish your Jewish friends a happy new year. The traditional greeting on Rosh Hashanah is "Shana Tova", Hebrew for A Good Year.

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads. Thus I cannot endorse any, though some look mighty interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Claire's law school tuition. Read more about Google AdSense, click here and here.
Go back.