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There is zero formal financial education through the standard schooling system. Your formal education prepares you for your career and making money! ...but after graduation you're on your own trying to figure out what to do. This leads to a lot of frustrated, furious people! Finance and Fury pick…

Finance & Fury

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    Is the property party coming to an end?

    Play Episode Listen Later Nov 1, 2021 25:17

    Welcome to Finance and Fury – In this episode, we will be looking at the future of property prices based around recent changes in lending assessment, bond yields and what this means for interest rates It comes as no surprise when I say that property prices have gone up a lot over the past 2 years – well above forecasts – at the same time, and in a causal manner, interest rates and bond yields have declined to record lows – but is the party coming to an end sooner than expected? As there are some emergences in the bond markets which may spell an interest rate increase ahead of schedule – putting downwards pressure on property prices - There is a bit to unpack here – do so in three parts – we will go through the current state of the property market – then what happened last week in the bond market in Australia – then what this means for central bank policy on interest rates   To start with - Looking at housing prices – Almost in lockstep – prices have increased at rapid rates across the world, reaching new heights in many cities – But rural and urban markets have shared in the spoils - which is noteworthy for two reasons First – lockdowns and movement restrictions have given rise for remote working – which has actually weakened the case for urban housing – but yet prices in urban areas continued to rise Second - housing affordability in cities was already heavily strained even before the latest irrational exuberance in property took hold - yet the lack of affordability of homeownership for large parts of the population has evidently not been an obstacle to price increases Why is this the case? Record low financing costs have increased borrowing capacity for property buyers – Plus – there is an entrenched expectation that most people hold when it comes to property in Australia – that is of long-term value gains which has made owning a home so appealing that the price level doesn't seem to matter – FOMO – it can be hard to wait to buy, if you think that in doing so the prices will be 10% higher next year, as this is what you are used to seeing These higher prices have led to higher household leverage levels - as the current acceleration in mortgage volumes clearly demonstrates – Data from CBA shows that across the country, the new average mortgage across the whole of Aus (higher in Syd and Melb, lower in NT) stands at $580,900 – which is up by around 16%, or $80,000 over the past 12 months – is it any wonder why prices have gone up by so much? This has exacerbated worsening affordability, unsustainable mortgage lending practices, and a rising divergence between prices, household incomes and rents – all of which have historically served as forerunners of a housing crises But as long as financing costs trend toward zero, property prices, incomes, and rents can continue to decouple from the real ability of borrowers to cover these debts These have been trends just not seen in Australia, but worldwide - As a result, the growth of outstanding mortgages has accelerated almost everywhere in the last 12 to 18 months, and debt-to-income ratios have risen—most markedly in Canada, Hong Kong, and Australia Due to this - pressure is mounting on governments and central banks to take action – even before lockdowns - Lending standards were being relaxed due to ever declining interest rates over the past decade – Overall, housing markets have become even more dependent on very low interest rates, meaning a tightening of lending standards could bring price appreciation to an abrupt halt in most markets New entrants into the property market have to borrow increasingly large amounts of money to keep up with higher prices – or even people wishing to upsize to a new property - As a result, the growth of outstanding mortgages has been growing due to the relaxed lending standards and falling mortgage rates. Therefore - ever-higher property prices and leverage levels imply ever-higher risks due to the property market being under the spell of a dangerous narrative – that the party will keep going The main barriers for borrowing that most households face is now based around creditworthiness – i.e. how much people can borrow – so once that obstacle is cleared, coupled with the expectation of ever-growing house prices – this has exacerbated the FOMO making homeownership look attractive regardless of price levels and leverage that it costs This rationale may keep markets running for the time being – whilst interest rates are low - But it's not sustainable in the long run. Households have to borrow increasingly large amounts of money to keep up with higher prices – resulting in higher levels of principal repayment each month – on top of the risk that interest rates rise Does all of this mean we are in a bubble? – looking at a paper released by UBS on the Global Real Estate Bubble Index - Price bubbles are a recurring phenomenon in property markets across the world – but the term bubble is a little tricky The term “bubble” refers to a substantial and sustained mispricing of an asset, the existence of which cannot be proved unless it bursts – this is because all because the price of something increases massively, to almost unsustainable levels – it doesn't mean that it is a bubble – because ironically it is only a bubble if it pops – if rates stay near zero, or even go negative and stay there, property prices can continue to climb But historical data reveals a pattern that exists with a bubble in the property market – the most typical sign is that of a decoupling of prices from local incomes and rents, as well as occurring at the same time as imbalances in the real economy, such as excessive lending and construction activity But again – even prices in Sydney are not considered to be in a bubble unless there is a turnaround in interest rates – otherwise the decade-long upward trend of house prices is likely to continue, given ongoing population growth But there are some risks to the property market now emerging – coming from APRA and the RBA Over the past month - APRA has started trying to reduce lending risks – directing banks to tighten up their assessment Price growth has clearly outpaced local incomes, stretching affordability and thereby increasing dependence on easy financing conditions even further. The growth of outstanding mortgages is accelerating again, as households are taking advantage of historically low interest rates – even people who own property are refinancing to make renovations on their existing property – Therefore - A tightening of lending rules would likely result in a setback for prices. It is now recommended by APRA that banks increase their 'buffer' from 2.5% to 3.0% on top of their loan serviceability rate This is the assessment that banks take when you apply for a loan – they look at what you could afford based around this serviceability rate, not the current interest rates However - Only two years ago, APRA's loan serviceability floor was set at 7.25% - this was more or less a hard fix – but at interest rates dropped, pressure built to change the rules which took force in 2019 - Today - On a 1.99% home loan, a borrower would be assessed on their ability to repay the mortgage at an interest rate of 4.99% - the interest rate plus the new APRA buffer of 3.0%  In reality - serviceability rates are also often calculated on standard variable rates, which are higher than discounted rates that most banks offer – but it is still lower than 7.25%   This change is expected to reduce the borrowing power of property buyers by around 5% Therefore, using some simple maths – each 0.5% of serviceability rate equates to 5% of borrowing capacity – As an example, someone who could borrow $1 million under the old buffer could now only borrow about $950,000 – but now compare this to the rules prior to 2019 – if the serviceability rate was 7.25% compared to say a standard variable rate of 5.5% (2.5% standard rate plus 3%) – this is 17.5% more that people could still borrow, even after the tightening of the lending rules While the banking system is well capitalised due to their ability to bail in with equity or capital notes - increases in the share of heavily indebted borrowers, and leverage in the household sector more broadly, mean that medium-term risks to financial stability are building The expectation is that housing credit growth will run ahead of household income growth in the period ahead – this means that more tightening could come to help curb the level of leverage – where the buffer rates increases to 3.5% and beyond What is interesting, is that these moves from APRA came after a recent RBA's post meeting statement flagged the importance of loan serviceability buffers – Which brings us nicely to the new development with the RBA -   Looking at The RBA - have said they will keep interest rates on hold until 2024 – giving forward guidance to the market, that rates will be on hold until at least until this time – to achieve this in practical terms through monetary policy, the RBA has been helping the bond markets through market operations, purchasing bonds of the secondary market to keep yields at their current target rate for 3 years at 0.1% - by any other name this is called QE But going back to Thursday last week – Or on the 28th of October depending on when you are listening - The RBA made no offer to buy the next trance of government bonds – they declined to buy the April 2024 line of bonds as part of their regular market operation, even though the yields of these bonds were already above their target of 0.1%, sitting at 0.16% - This created a shock to the market – Central banks had given clear guidance that they would do whatever it took to keep the yields of these bonds in line with the cash rate – but all of a sudden, they reneged on their agreement with not a peep As expected - the market responded poorly – by dumping these bonds, resulting in the price dropping and pushing the yield up further to 0.30% - The market waited to see if this was just a blunder – or if they were waiting until Friday – Friday came and no purchase were made – so more of these bonds were sold off and the yields spiked even higher to 0.67% Remember that a yield is the % return based around the price of the bond The fact that the RBA out of the blue decided to not purchase these bonds, which are a core part of their stimulus programme – started stoking market speculation that there is going to be an early hike in interest rates than previously thought This failure to deliver on what the RBA has promise has fuelled markets expectations that rates will have to rise much earlier than 2024 – based around the current pricing – it appears that the consensus is that there will be a 50 basis points of tightening by mid next year, and 100 basis points by year end – so interest rates will be around 1% by the end of 2022 – rather than being 0.1% Offshore events added to the drama and probability that this may occur - with the Bank of Canada stunning markets on Wednesday by ending its bond buying altogether and flagging a hike as soon as April 2022. We also had many Central banks, including is New Zealand raising the reserve cash rate by 0.25% The RBA is now under intense pressure to do something at its monthly policy meeting at the start of next month – where they will either defend its yield curve target, soften it, or drop it altogether. The RBA currently aims to buy A$4 billion a week in bonds as part of QE programme – This was always going to be reconsidered in February 2022 – But this recent unexpected withdrawal from purchasing bonds could signal the end to this plan sooner rather than later This action signals that the first-rate hike back to 0.25% could occur sooner than later, compared to 2024 – followed by four more moves to 1.25% by the third quarter of 2024 Overall – if any increases in interest rates occur, then it can be expected that these will be shallow and gradual based around a tightening cycle – it is unlikely that the RBA will increase interest rates to 1.25% in one go next year - given the elevated level of household indebtedness But this increase in interest rates ahead of schedule does put a potential downwards pressure on property prices Given that an increase by 0.5% in serviceability rate creates a reduction of 5% in borrowing standards – an increase to 1.25% for the interest rate results in around 12.5% less borrowing capacity – which means that the part may be over for ever increasing property prices – as people can borrow less and the costs to borrow become more stark but on top of this, an increase in servicing costs - If the average mortgage is $580,900 – then an increase of 1.25% results in an additional $7,261.25 p.a. in interest repayments – there are around 10.3m properties in Aus, and around 6m of these have a mortgage attached to them for which this average is based around – doing some rounding, that means that an additional $43.6bn will be spent on interest costs of owning a property This takes funds away from other spending in the economy and puts a downwards pressure on GDP spending Summary – Property in Australia is being spurred by interest rates, no surprise here – due to the increasing amounts that people can borrow, increasing the capital available to big her amounts on property – it is supply and demand If the RBA fails to follow through with their commitments to keep the 2-year bond yields at 0.1%, instead letting this spike to closer to the free market rate of 0.67% due to not purchasing these bonds – This could mean that an interest rate increase is likely to happen sooner rather than later – If increases in rates occur before is anticipated, this will have major impacts on the market – Servicing costs of households will increase From an Asset pricing perspective – prices of property could decline – or at the best reach a stagnant growth until wages and immigration rates catch up The market is currently addicted to almost free money – needs this to continue for price growth to continue, if not the prices of assets would come back in line with the fair value that interest rates represent The current price of property is technically a fair value based around record low interest rates – if interest rates go up, then the fair prices, or market price, would go down for property – if rates go negative, then prices can continue to grow Will the increase of rates and the decline in property be this week – probably not – but can we trust when the RBA has been telling us? No - the forward guidance has been that they won't increase rates until 2024 – either they will do this on the exact day these bonds mature – in April – or there is a chance that this occurs ahead of time – Either way – this is a warning – for those new home buyers – if you are purchasing for the first time – make sure you can afford repayments at a buffer of 1 to 2% interest rate above your current margin If these market predictions come true, it would dampen the potential price growth that property has been going through – so don't be banking of some short-term capital growth from a property purchase – to purchase now and be able to accumulate equity quickly to upscale Based around the rough numbers from CBA – borrowing declines by 5% per 0.5% in interest rates – so prices have the potential to decline – putting pressures in LVRs For existing buyers as well – same thing applies – make sure your cashflow can afford the interest repayments – if anything, this is an opportunity to get ahead of mortgage repayments before the interest rate cycle reverses Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Are we heading towards “Stagflation”?

    Play Episode Listen Later Oct 25, 2021 21:50

    Welcome to Finance and Fury. Currently, the prospect of stagflation is being seriously debated by economists and policy makers across most economies – the big question is – will we suffer stagflation – and if so, how do markets react? The first stages of an energy crisis are currently in the making - In Europe - natural gas prices have tripled in the last three months – with rising petrol prices across the globe – even in Aus, petrol prices are up – Why do energy prices matter and what does this have to do with stagflation? Energy is an input into everything – transportation, manufacturing, even keeping office lights on – all of this flows through into increasing prices over time Coupled with this – annual CPI currently is sitting at 5.3% in the US, 5.8% in Poland, 7.4% in Russia and 9.7% in Brazil – even Aus is at around 3.8% - so all countries are sitting above their target rates – the countries suffering the most severe inflation are those suffering from supply shortages The major concerns are that these energy spikes in conjunction with supply shortages will lead to lasting inflation – and due to the potential of slowdown in economic output (which is also related to the supply shortages, leading to less economic activities) – economies have the potential to enter a stagflation situation Stagflation was a phenomenon that plagued the economies of the world back in the 1970s – you had an energy crisis, with soaring prices, which had flow on effects to every sector – You also had slowing economic growth, where a few quarters in the mid-70s hit negative GDP growth rates - and there were accompanied with higher levels of unemployment – and due to energy prices, massive levels of inflation Defining stagflation – what does this actually mean? Relating the term stagflation simply to the economy of the 1970s is a little too simplistic – just saying that it is a time where there is inflation, lowering GDP, a wage-price spiral and high unemployment doesn't quite define the issue at hand This is because the issue is, there is no hard definition of stagflation when it comes to the metrics involved with the actual definition – i.e. how much inflation needs to be present, and what does the growth rate of the economy need to be to equate to stagflation – so here are three broad definitions for stagflation that can narrow this down Growth around zero or negative, and inflation well above target Growth below trend and inflation comfortably above target a strong slowdown in growth and strong pickup in inflation Out of these, instead, what if we say that ‘stagflation' is a period where inflation expectations are rising above the central bank target rate and growth is slowing and is below trend (i.e. expected to drop below growth forecasts)? This is a softer definition and much easier to apply – if inflation reaches a rate of above 3% and is expected to climb higher, and economic growth, as measured by GDP is forecasted to be 3% but turns out to be 2.5%, i.e. the forecasted nominal rate – then do we meet stagflation? I would say that this would be a situation where an economy would be in a stagflation environment There's just one problem: when compared to the economic environment of the 1970s - looking at the current state of the economy, things are a little different Where then do markets actually sit? Look deeper at inflation expectations and GDP growth To start with – looking at the US – inflation is high – at a 13 year high at around 5.4% - However – the US manufacturing Purchasing Managers' Index(PMI) has risen over the last two months whilst inflation rates have remained the same over this time period The PMI is an indexof the prevailing direction of economic trends in the manufacturing and service sectors – if this is on the rise, then it is expected that the costs for manufacturing and services is expected to increase – this leads to further inflation expectations down the road In Australia – The PMI has dropped heavily since July – so we seem to be doing better than the US – with lower potential inflation outbreaks Scenarios of slowing growth and rising inflation clash with most forecasts - recent moves in inflation expectations, especially in the US are a bad situation – but growth doesn't seem to be slowing at this stage – especially when compared to how the 1970s played out Over the past 18 months - GDP growth rates have gone through negative downturns – most western economies saw around three quarters of GDP growth rates – but will this continue? Well no – they rebounded rather quickly – US GDP dropped by around 9.1%, then sat at -2.9% and -2.5% over the next quarters respectively, but then rebounded to 12% growth – this 12% is a rebound from the bottom – so will calm down in terms of growth rates – but what is more important is the nominal level of GDP – this is sitting at about $20.9trn, from the peak in 2019 of around 21.4trn – or a $500bn loss Australia's GDP actually peaked back in 2012 at just shy of $1.6trn – crashed by 2016 – then recovered – but still lower at about $1.3trn But the question is, will growth rates revert back to negative – or below forecasted growth? It doesn't appear to be the case at this stage – not when growth forecasts have been slightly downgraded – to explain this further – if say you expect annual GDP to be 1.5% p.a. and it grows by 1.6% - this is a great result – because it is above forecasts – but is it really? Not if inflation is around 5% for the long term In Australia – Growth has rebounded after a negative growth period – dropped to negative 6.2%, then sat at -3.7% and -1% over the next quarters respectively rebounded to 9.6% in the second quarter of 2021 Where we are sitting – if growth can pick back up – and maintains a positive position – and the last quarter of rebounded growth wasn't just a once off that helped to mitigate the negative period of growth – then the only concern is inflation, not stagflation – but the risk to financial markets still remains – But many economists predict that growth with stagnate from here - stagflation is economists' base case expectation - even though many have cut their GDP forecast while hiking their inflation outlook – Because to add another element to this issue - Asset pricing also couldn't be more different between now and the last episode of stagflation in the 70s When looking over the 100 years – ever since the Fed was created - the 1970s represented the lead up to an all-time high for nominal interest rates that occurred in the 1980s - and an all-time low for equity valuations – had nominal rates in the US Comparing this to the markets today – we are at all-time lows when looking at both nominal and real interest rates – whilst witnessing all-time high valuations for almost every asset class – property, equities, fixed interest, even commodities – gold, copper, etc.    Historically - How do shares perform during stagflation – Spoiler alert: it isn't great in situation where stagflation does emerge – you seeweak historical performance of most equities – this is why even the term stagflation can freak out investors This being said - equity investors who are active today have likely had little experience with stagflation first hand – it would be rare to find an active investor who was participating in markets back in the 1970s - since 1960 – there have been 41 quarters (17% of this time period) that have met these criteria, but the vast majority of those occurred between the late 1960s and early 1980s – since the 2000s - stagflation has been virtually non-existent Over this time period - the S&P 500 has generated a median real total return of +2.5% per quarter – however in these stagflation quarters, the average return per quarter fell to -2.1% - This is actually worse than the returns when you had either weak economic growth or high inflation by themselves Most of this weakness during stagflationary environments has been attributable to pressure on corporate profit margins – due to inflation, declining profit margins and real earnings have been incurred, which indicates that companies struggled to raise prices quickly enough to offset rising input costs - P/E multiples have also declined modestly during stagflationary periods alongside rising interest rates. Another issue with the market compared to the 1970s and now is the amount of debt that corporations have – It was hard to try and find accurate data on this going back this long, best was the 90s – but the BIS did release a paper showing that as a % of GDP, corporate debt in the US has gone from about 40% to 80% from 1970 to 2020 – in addition, household debts are through the roof - Why does this matter? inflation is already showing up and impacting monetary policy.In just the last three weeks, many central bank rates have increased their interbank cash rates - 25bp in New Zealand, 25bp in Russia, 50bp in Peru, 50bp in Poland, 75bp in the Czech Republic and 100bp in Brazil – beyond NZ, each of these countries are already suffering high levels of inflation One final reason why markets can take a downturn during stagflation periods could be due to the wealth effect – i.e. not just economic growth declines but also the declining growth of household wealth – this can become its own self-fulfilling prophecy – if people are expecting tough times, or going to need additional cash/funds – they sell assets – which drops asset prices Household net worth has grown by a median real rate of 0.5% per quarter since 1960, but just a 0% rate during periods of stagflation.These periods have also been associated with declining household allocations to equities, helping explain the weakness in equity valuation multiples. Home prices have typically declined in real terms during stagflation while gold has appreciated.     Who are the winners and losers during stagflation? Nobody is really a winner in this environment – the population suffers due to monetary policy, the prices of goods increasing and growth slowing, leading to potentials of job losses When looking at shares – some perform better than others - Who are the winners in this scenario Looking at sectors - Energy and Health Care have typically generated the strongest returns during periods of stagflation. That may explain why during the past month, Energy has been the strongest sector in the market, rising by 14% alongside an equivalent surge in crude oil Healthcare may just be a coincidence – or simply be able to reprice better than other sectors – but energy makes a lot of sense – when energy prices go up in stagflation environments – energy companies can made additional revenues – therefore a good hedge has been energy providers in this environment Who are the losers - Industrials and Information Technology have generally lagged most during stagflationary environments - IT sector is less cyclical now than it was during the stagflationary years of the late 1960s to early 1980s due to the compositional shift toward software and services firms. Today, however, the sector's massive long long-term growth profile has given it a longer “duration” than most other equities, making it particularly sensitive to real interest rates It is estimated by investment banks like Goldman that a 0.3% increase in the cash rate would knock some 15% off tech stock prices For industrials - construction and engineering, infrastructure, transport and commercial services – many of these are sensitive to interest rate costs due to financing for capital expenditure Both of these sectors are sensitive to interest rate rises which would occur if central banks aim to combat inflation The biggest question when it comes to stagflation – will the high inflation be temporary? It is almost a given that growth will be low – low in the terms of nominal rates – but if inflation is too high, then real growth may be near zero or negative   In summary – The market is focused on stagflation; it just hasn't quite decided what that term really means Where we currently stand – many view the surge in energy prices as temporary, and that the most comparable period to the current stagflationary scare is more comparable to 2005 when CPI hit 3.5%, energy prices were booming and Stagflation was in the news a lot – it even graced the cover of The Economist - These fears eventually passed as growth rebounded and inflation moderated - so 2005 may provide a useful reference point for a scare that comes far short of the 1970s My "gut feel" is that while risks to financial markets are high, due to monetary policy responses, especially on the inflation side, the phrase “stagflation” is being used too aggressively at the moment – time will tell We don't appear to be in this sort of environment – the economy isn't looking great – many assets are overvalued – growth is lower than the average of a decade ago, and inflation expectations are rising – But the risk of stagflation don't appear to be present at this stage looking forward over the next 12 months If you are concerned about stagflation – the best play historically has been energy shares and precious metals, like gold – this isn't advice – but just general information based around historical occurrences But the trouble with energy is that it is cyclical – once the fears of stagflation blow over – or even if stagflation hits – once the decline to the market takes place, then energy shares tend to lag the next cycle of the market Thank you for listening to today's episode. If you want to get in contact you can do so here:

    “The survey says…” - What Wall Street currently thinks the biggest risks to markets are

    Play Episode Listen Later Oct 18, 2021 22:27

    Welcome to Finance and Fury. I was looking at an interesting survey that is regularly conducted – so in this episode What do investment managers think the top risks to the markets are? This is a survey that Deutsche Bank regularly does where it surveys investment managers and Wall Street participants – The results help to gives some insight to the thinking of portfolio positions from those that control some of the largest levels of money flows in the investment landscape – This is interesting because of what actions investment managers take in response to their predictions – if they think markets will go down, they might be slightly more defensive in their allocation – or sell off some of their higher growth holdings – resulting in a decline of those shares - What happens to the price of assets on markets often occurs ahead of any event materialising – prices move at first due to the anticipation of an event materialising   Looking at the DB survey - One of the questions that the 600 participants were asked: “Which of the following do you think pose the biggest risks to the current relative market stability?” – where they had 13 answers in total to choose from – These are not in order – but I will list all 13 out and let you think about what you think the biggest threats are to financial markets and see how it stacks up against the predictions of wall street Domestic policies (such as tax or spending that governments make) – This partially relates to Fiscal policy – the policy that governments make, how much to tax people, what stimulus packages are taken, if business are to be shut down due to lockdown restrictions Worries about the debt burden – This is the risk to domestic governments, particularly in the US that the increase in the debt has on markets – can the government repay their debt obligations? Geopolitics – This is international politics which could affect markets – this ranges from hot wars, such as if a war between the US and China breaks out over Taiwan – which is very unlikely – all the way to a tariff policy on commodities Worries about longer term structural consequences of the covid shock – supply issues from government shut downs Waning vaccine efficacy – this can be a risk to markets as it can spell further government shutdowns and restrictions An uneven global vaccination campaign and economic recovery – this relates to countries having different policies to one another New variants that bypass vaccines Tech bubble busting – FANG shares and other large tech companies which make up a large portion of markets like the NYSE and Nasdaq collapsing – this is possible when looking at their PE ratios Strong economic growth failing to materialise or being very short lived – Policy makers have forecasted good growth of GDP coming out of a slump in GDP – this has been prices into the markets, so if it doesn't materialise then markets can negatively react A Central bank policy error – For example – not increasing interest rates when they should – continuing QE longer than necessary – tightening too quickly Fiscal policy being tightened too quickly – the stimulus measures being reduced too quickly Higher than expected inflation/bond yields – inflation materialises at a higher rate than anticipate – and bond yields start to rise – which means their prices have collapsed Other – could be anything else   So what do you think? – No right or wrong answers – the results are simply the opinions of the 600 survey participants Is it Covid related – with vaccines not working as promised, or a new variant coming out? Is it due to geopolitics, or domestic policies, like a debt burden? Or is it central bank related, with policy errors or fiscal policy being tightened too quickly? Or is it inflation and bond yields being higher than expected   The poll shows that it appears that the fears from government responses to covid is officially over - According to the latest monthly survey of 600 global market participants conducted by DB - for the first time this year, the biggest perceived risk to markets is no longer government responses to covid. Instead, the top three risks are: higher than expected inflation and bond yields – This is the highest by any margin – 74% central bank policy error – where a CB may tighten too quickly – i.e. increasing interest rates rapidly to combat the number 1 perceived risk of higher than expected inflation strong growth failing to materialize or being very short lived (i.e. stagflation and/or recession). These three are rather related – in reality – Inflation materialises – with no growth – such as a stagflation event – then central banks may respond but make an error – then this exacerbates the issues   Overall – higher than expected inflation/bond yields are the biggest perceived risk by professional investment managers – but the flow on effects from this are really what matters So lets break these three down further – looking at what wall street anticipates from here The most likely catalyst for the coming correction is in the form of higher interest rates – higher than expected at least – coming from a shock to interest rate rises that are out of cycle or not foreshadowed in the forward guidance Or at least that's what this survey suggests – when asked “with regards to 10 year US treasuries, will the next full 25bps move be higher or lower than current levels?” – the vast majority, or 84% of survey respondents expect the next 25bps move in 10Y yields to be higher, and just 11% lower. In reality though - only 5% of the respondents were honest saying that they don't really know – DB then asked respondents if they believe the policy error for major central banks - Fed, ECB, BOE - is going to be too dovish or hawkish Dovish refers to keeping policy too loose for too long – such as what has happened for the last 11 years in the USA – and may other countries in the world Hawkish refers to being too hard in a short period of time with policy – such as tightening too quickly The risks were seen as high everywhere but the Fed/ECB were seen more likely to keep policy too loose with the BoE expected to err on the hawkish side. Dovish – 42% for the Fed, 46% for the ECB and 20% for the BOE That they will get it right - 24% for the Fed, 26% for the ECB and 20% for the BOE Hawkish - 33% for the Fed, 21% for the ECB and 45% for the BOE So overall the consensus is that the US and EU is likely to continue to have low rates when compared to the BoE – When combining two of the top three results – that is Looking at the combination of higher inflation and lower real growth – i.e. stagflation - the next question is “what are the risks of stagflation over the next 12 months according to your definition?” the concept of your definition is an interesting one – as technically there is a fluid definition of stagflation - where there is no overwhelming consensus definition for "stagflation" based around the levels of growth and inflation – I.e. does a 3% inflation with 2.5% GDP growth equal stagflation? Technically yes – but this is pretty normal for some western nations and wouldn't be of concern For now – lets look at three simple categories – all of which can technically meet some definition of stagflation A strong slowdown in growth and a strong pickup in inflation – 25% of participants agreed with this definition – with most expecting a very high or high chance of this occurring in the UK – not as much in Asia or the US – but 40% chance in EU Growth around zero or negative and inflation well above target – 45% of participants agreed with this definition – again with the higher chances in the UK But very low chances of around 15% in Asia and 20% in the USA - Growth below trend and inflation comfortably above target – 30% of participants agreed with this definition – again the UK was the stand out with 75% of the respondents believed that that this was very high or highly likely When looking at inflation expectation – the survey asked “the fed currently believes the recent increases in inflation are largely transitionary. Which of the following statements most accurately reflects your view?” Virtually all transitionary – 2% - Mostly transitionary – 62% - Mostly permanent – 31% - Virtually all permanent – 3% - Don't know – 2% This is an interesting result – as the answer to this question all depends on how you view inflation – the fact that we get 5% inflation this month – but then inflation goes back to 2% next still means that whatever inflation has been incurred is still permanent – unless we get deflation the following month – therefore – 100% of respondents should respond with ‘virtually all permanent” – but what they are referring to is the % increase over time – is 5% permanent or will this go back to 2.5%? This is what the respondents are answering The final question of relevance – and what is most important to investors – the end result of market prices – “in your opinion, do you think there will be an equity correction before the end of the year?” When asked if there will be an equity correction before year-end, only 29% said no, while solid majority, or 63%, expect a drop between 5 and 10% before year end. Just 8% expect the coming drop to be bigger than 10%. Then 29% think there will be no correction of magnitude – However market sentiment has changes slightly over the past month since September – Going from 58% to 63% for those that market will decline by 5-10% - but then those that think more than 10% has gone down, -10-8% So in summary – did your views line up with wall street? Wall street think the biggest risk to markets are higher than expected inflation and bond yields – This is the highest by any margin – 74% central bank policy error – where a CB may tighten too quickly – i.e. increasing interest rates rapidly to combat the number 1 perceived risk of higher than expected inflation strong growth failing to materialize or being very short lived (i.e. stagflation and/or recession). Most think that the biggest risk is increasing interest rates – with transitionary inflation And that markets will have some mild declines between now and the end of the year – dropping by 10% at max, given markets have already dropped by 5% Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Moral hazard and the Evergrande collapse

    Play Episode Listen Later Oct 11, 2021 25:00

    Welcome to Finance and Fury. In this episode we will be looking at the Property market in China and focus on the Evergrande developments – in particular if there is actually a timebomb starting to surface – and look at the potential contagion risks to the rest of the world – such as the Aus and US Many in the press are comparing what is happening to Evergrande as another Lehman's moment – which was one of the defining collapses of a financial institution that lead to the flow of effects culminating in the GFC – it is understandable that the media takes this route – Lehman's is a recognisable name and fear and doom scenarios generates more clicks and sells more adds – but is this worst-case scenario true? Is the collapse of Evergrande really going to lead to another global financial crisis? A few weeks ago – we covered where the next financial collapse is likely to come from – between the USA and China - Two factors were the focus – leverage and contagion risks Looking at leverage - Credit growth is a major risk to almost every market – both from bonds from investors and lending from bank of financial institution borrowing – both of these are relevant to the private sector in China Credit growth is even a concern in Australia – APRA worried about banks and lending – they have increased their servicing cost by 0.5% - worried about credit growth vastly outpacing income growth But the major focus for any systemic issue is the contagion risks – if one company defaults, does this create a GFC, or just a collapse of an isolated entity – The loss potentials are substantially different between both scenarios – one is investors in a company losing money versus every investor globally losing funds due to collapsing markets world wide – the degree they collapse also is different If Evergrande fails – what does this matter? At this stage - The irony of the contagion risks is from the increased news coverage that this topic is being granted – if a topic is covered in the news everywhere – this creates uncertainty and fear – investors can panic – this creates real market declines, so the risk of market declines become a self-fulfilling prophecy – even me covering this topic can create some level of risk aversion, which may cause people to sell off investments – but is there more than just the normal fears in the markets from media coverage occurring? To start with - What is happening in China – We need to look at their property market, or more specifically the debt that property developers hold – especially in relation to Evergrande and Chinese economy at large Chinese economy - the rise and fall of Evergrande is tied into the economy of China quite heavily – Evergrande is China's second largest property developer – but this ranks around 147th in the world – but it is the most indebted property developer in the world – which should start to ring some alarm bells – it's on balance sheet liabilities amount to around 2% of Chinas GDP – off balance sheet – this could be higher – and likely is A company in isolation with debt isn't much of an issue – but a company with too much debt can be a problem – In isolation this isn't too much of an issue – if the company defaults but business in other sectors of the economy continues as normal then markets may go down a bit but then continue as normal – but what if this one company is a sign of greater systemic issues - where most of the companies in your country in this sector have the same problems – that of having too much debt that they are likely to default on? Especially in the property sector – The BIS released a paper showing that Chinese non-financial companies have 160% Debt to GDP, versus in the US where it is about 80% - so double in China compared to the US – Property also has an overweight on GDP compared to the US It is estimated that property development makes up around 25% of China's GDP – this growth has been fuelled by Debt – this is a major issue for the CCP - China property market – the history over the past 20 years The increase in demand for property and the increase in pricing has been fuelled by massive amounts of urbanisation – rural workers/population moving to cities for work and a better income for their families High demand for properties in desirable cites has massively inflated the property values in these urban environment – developers often sell every property in a development in advance of the construction even starting This has led to lower quality – contractors skimming on materials to lower costs – where constructions can actually collapse in a few years after completion Prices to income ratios – results in a situation where you have generations of people living in one apartment trying to repay the loans We think that Australia is bad – and it is – but many major cities in China, such as Shenzhen see 43 times the average household income in property prices – compared to Sydney which was around 13 times at the peak of the market Speculation – large increases in property prices saw massive speculation in developers – if you think that the property that you will construct today can lead to a 50% gain in the next year or two – then you will likely borrow large chunks of money to bank on this trend Lead to many apartments not being rented, and purchasers buying up more than one property – but the limit per family is capped The population is also limited in what they can invest in – so property is where most of the upper middle class and beyond put their life savings Large property developers are politically connected – But this has created moral hazard – every loan given, or bond investments have been made based around how likely it is for the government to bail out these developers Rather than on their ability to meet the debt repayment cashflow Moral hazard is a large component of any investment or economic decision – as an example – say you have an expensive car – now in one situation you have comprehensive insurance and in another you have no cover – in which situation are you likely to drive a little more recklessly, or park this in a car park unattended overnight? Same goes for insurances – especially if you are forced to have insurances – you may as well use it for your premiums – such as health insurances – But what if we are talking about a government backing debt for bail outs – and that is the expectation of the markets – this creates a moral hazard - But China realised they have a debt problem – as well as a moral hazard problem - so policy makers tried to reign this in – focusing on moral hazard first and foremost Policy changes – the CCP put together that their economic growth is mostly paper/debt based – where the growth they are receiving in GDP is funded through borrowing from property expansion – which is not sustainable in real terms They want to transition their economy to more long-term sustainable growth – real estate is the most important sector in their economy at the moment – but this is debt reliant – they prefer real returns – which is why you see a push towards resources and other manufacturing sectors – but a real issue in China is the affordability of property ­ Look at government policy across the world – they always say that they promise to tackle issues of property affordability – but then comes a situation where prices are starting to decline – what do governments do? Create policies to help prop prices up to avoid a decline which could have further reaching issues – governments don't want bubbles, but they don't want a collapse China appears to be the first government in a long time to not follow this pattern – they are trying to change moral hazard – and expectations in the market -which can easily lead to collapses in the property sector Rather than bail out Evergrande – which would be easy for the CCP – it appears that at this stage they have decided to let this company deal with their own problems This is technically how it should be – but it is rare to see this response I think this is mostly due to their Hard lines polices – trying to reduce the economy reliance on debts – They actually introduced three hard line policies on property developers in Aug 2020 These are hard limits on property developers – relating to their liability to asset ratios, net debt to equity ratios, cash to short term debt ratios – all of these are important when it comes to developers who fund their projects using debt now for equity in the future Had an instant effect on property development firms – no longer could you raise capital through debt funding as most developers were above the allowable ratios What made this is worse, is they had to reduce their debt levels – to do so they were quickly forces to sell down assets and taking losses – this caused prices of property to fall, so the valuation on their assets started to go down This made it worse - These losses make their ratios look worse – making these companies need to deleverage further – this can lead into a downwards spiral On top of this – because the prices of property started to slow as well last year – to make more pre-sales – Evergrande needed to offer some discounts on the pre-sales – this lead to less liquidity available – less liquidity meant they don't have the money to fund debt repayments as they come due Evergrande itself – In the property sector – the company acts like a conglomerate Property development, property management, and Wealth management products – They are looking to sell of property management – recoup $5bn But wealth management products – WMPs may be a concern – this is around $6bn – Small number – but investor fury has made this more of a social issue But these investors were told they would get a guaranteed 12% return on their investment p.a. This money was used to help close funding caps that the parent company had in construction – This is fine, as long as the returns on the property sales in the year are more than 12% to repay investors - But for a time they weren't – this meant that new investor flows had to be used to make repayments to existing investors – in the process there was less to help close the funding gap – But then add onto this the slump in sales – then you start to have a real issue – as more and more new investor flows need to be used to repay existing investors – which is the basis of a ponzi scheme – but moral hazard still existed – investors had the certainty in their own minds that this was a sure bet – as any defaults would be covered by the government The issue is based around the moral hazard – investors thought their returns were guaranteed with little risk - but where it can get bad is contagion risks Fallout effects – will come from two areas – property domestically in China – which will spread out and have their own issues – as well as contagion risks throughout the economy and throughout the world Property prices in China – Can see a decline – if they liquidate and need to sell off the property development – could see a fire sale of assets and property prices decline The fact they are trying to sell quick is bad for property – fire sales see massive price reductions Domestic fallout – People who have placed deposits on properties that may never be built – lose those funds People who have invested in the WMPs – will also lose money – you will start to see some social issues This will reduce the trust in property investment – Evergrande employs lots of people – around 4m – which would be huge for a country like Australia – but out of a population over around 1.4bn is about 0.29% of the population Contagion risks – who owns the debt and are there any derivatives on this? Look at the debt - $300bn of debt – bonds issued – estimated that only around $20bn of this is overseas debts – the rest is domestic – these foreign bonds are priced in at around 25-30c on the dollar – depending on their maturity China is a large economy – it can pretty easily soak up these losses – even though $300bn is a large amount of debt to cover This is owned across 128 banks and 121 non-bank institutions Investment managers – investing in risky emerging market debts - Ashmore group, BlackRock Inc, UBS and HSBC hold $450m, $400m, $300m, and $200m, respectively – which isn't too much for these groups to absorb Best case scenario – Evergrande will be allowed to collapse – the parts will be bought up by other developers in the nation at a fire sale rate – i.e. getting a good discount The People Bank of China will also likely buy out some of the debt - Like JP Morgan Buying Bear Stern back in the GFC – with help and oversight from the FED – but this doesn't solve all the problems But the issue comes back to the moral hazard – the CCP wants to minimise speculative risks Evergrande by itself defaulting isn't a risk for markets – but it does spell some risks – of over leverage throughout the system – if many other developers start to see the same systemic issues of overleverage and issues in meeting their debt obligations, then you get into further trouble Fantasia – another property developer failed to make a bond payment - missed $315 million in payments to lenders – created further fears that financial strains in the country's outsized property sector are spreading beyond the troubled Evergrande conglomerate. S&P and Moody's slapped "default" credit ratings on Fantasia Lessons to be learnt – The moral hazard and the belief in a sure thing – the belief before the GFC is that debt on peoples homes was a sure thing – not many people would default all at once, so package up 1000s of mortgage holders debt and make bets on this But due to this belief, lax lending standards were employed – this then turned out that due to the belief that things couldn't go bad, resulted in them going bad due to too much risk How this is different from the GFC – Derivative used in making bets on the property market Credit swaps, derivatives on CDO – this doesn't seem to be occurring in China – and the banks' ability to eat losses on the debt isn't too great to not be able to recover Lehman's collapse was considered to be the plug of the dam being pulled in the GFC – property prices dropped, people defaulted on debt then Lehman went into default – but only due to their exposure to complex CDOs and derivative positions – If these don't exist on Evergrande – which it appears at this stage they don't – then there is less contagion risk – But who knows – there is no way to tell until it is too late – however, there hasn't been much in the way of transaction in credit default swaps in banks like HSBC which have greater exposure to the Chinese debt markets It took Lehman over a year to default and go bankrupt – so time will tell how this pays out Where things could get worse – is if more developers start to default – showing greater systemic risks My gut feel is that the China growth from property is coming to an end – This will likely have larger effects on the commodity markets – such as iron ore – than it will on the global share market in the short term – but if their property market starts to decline due to defaults on developers and a lack of trust – this leaves their economy very susceptible Your guess is as good as mine as how this will turn out – we will keep an eye on this Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Finding your purpose and building your ideal life

    Play Episode Listen Later Oct 4, 2021 19:28

    Welcome to Finance and Fury. In the last episode we talked about finding meaning in life, even in the worst of possible situation. That topic leads in nicely with purpose, which we will be covering in this episode. As Finding a purpose gives life additional meaning – and having fulfilment in life through having meaning helps to fuel a purpose – which further fulfils meaning – quite a symbiotic relationship – But to build on this purpose and work towards this, goals are also important -   But Finances are important – which can also be seen in the concept of resources – as cash/money is a medium of exchange to purchase resources, or other investments – either way, having infinite resources or money without purpose or meaning is worthless – What is the point of having millions of dollars if you have no reason to wake up every day? Most of us don't find ourselves in this position – but if we have no financial means, or resources, then fulfilling our purposes can be harder – finding meaning can still be achieved if you have no money or place to live, but unfortunately, the way that society is structured does require some means of resources to cover the outflows for living – even if you buy some land outright, you still need to pay rates So, what financial goals are you working towards to have enough to achieve your end goal – as well as maintaining purpose and having meaning in life? This is not just about being able to accumulate investment or make money, but be happy along the way and feel like you are fulfilling your purpose and find meaning is waking up every day – The journey to financial independence is a long road for most people, so having something to work towards and enjoying the journey allows you to actually wait it out – rather than work for 2 years and then start to hate your working life – life is about the journey, not the destination How do you go about this? Find your purpose – and find some career where you can generate an income to direct toward financial resources to build towards financial independence – how do you achieve this? Get some goals in place   First step, if you don't already know what it is – is to figure out what your purpose is – this is the path that will give you guidance It is important to find your purpose as if you don't know what you want, it is impossible to get it. ‘what is the meaning of life?' – I actually see this as a rather silly question – as there is no one overall meaning to life, if this is considered to be our collective existence, except to exist and eventually die But there is a meaning to your life – at the individual level and family level – we each have desires and goals, which go towards forming our own individual meaning towards our existence – Therefore, you just need to find your purpose and live up to your potential in achieving this – this actually goes back to last week's episode – because state and politicians do try to give the perception that there is a collective purpose for a whole society that will fill everyone with meaning - you need to decide what you want and what is important. You have to Be clear why you are here! To do this – you have to look at what you want – not what others want When we are younger and getting out of school, we are often looking for meaning and some direction in life – we have very strong influences from either our school, parents or friends in what direction we take At lot of this has to do with programming in life – where we simply follow in the path of what is easily laid out in front of us – so this slowly changes our real purposes to conform to the new social norms or what is set out in front of us. This leads to taking actions in life which will get the approval of others rather than ourselves We are told from childhood the word ‘no' and ‘don't do that'. While this was said to help protect us, it has led to crushing dreams. While conformity has been important in evolution (by not sticking out and getting ousted by the tribe), it has lead into conforming to a normal level of life or living someone else's dreams. This is why you need a reason to get out of bed in the morning which is your purpose. If you have this purpose, something to work for, you will be successful and happier along the way. So – how do you find out what your purpose is? – if you don't know, to figure this out requires a bit of brain storming. It requires the creation of a list – where you need to write some lists of things that are important in your life. At financeandfury – there is a workbook which can help – but this has 3 columns: I care about, What I am great at, I love doing – try to write 20 things for each: total of 60 The more the merrier – doesn't have to be something big, more = more brainstorming beside each one put a plus or minus against it – if you really enjoy or are great at = put a plus against it. something that you just put in there to make up the numbers, put a minus sign against it. From those from each list – select the top 2 with plus signs against them – put them in the below this This will leave you with 6 things in total. You might find that the things you are great at are the things that you love doing, because you care about them! common to see this sort of overlap as generally, if you enjoy doing something, you are normally pretty good at it! This is how you find your purpose in life. It will take some playing around with to get right. Be honest with yourself. example: care: Making a difference in lives, great at: personal finance, I enjoy doing: Teaching Different iterations of this – but form a purpose statement – once sentence - where you use your skills at what you are great at, to do the thing that you care about, in a way that you enjoy doing Making a difference in peoples lives through teaching and advising people about their personal finances. It really is that simple and needs to be refined over time, but what is really important is action. Taking action towards your purpose will be the difference between following your purpose versus following someone else's.   Once you have your purpose statement, you need to know what you want out of it: getting the vision right and start achieving it! Time to build a vision of your ideal life - Having a purpose is the reason to get out of bed each day. Having a vision, allows you to complete a picture of your ideal life. A vision is an ideal picture of how you want your life to look. It is what you want the future to hold for you. But you have to make it happen! – Negotiating with your current self for your future benefit Your vision should show you where you want to head and provide some motivation and focus to help achieve this. Life happens, there will always be setbacks but the best way of overcoming setbacks is keeping your long-term vision in mind and working towards this. So how do you build your vision? - first step is to make three lists, What I want: This list is for the material things you wish to have in your life. From houses, cars, even owning a business. What I want to be: This list is for the type of person you want to be, from happy and positive to being a leader in your field. What I want to achieve before I die: This list is practically a bucket list where you can think about the things that you want to achieve in life. Under each heading, you need to list 20 things for each one so once you are done you should have 60 in total. hard to come up with 20 things for each, so listing small things or expanding on larger ‘wants' can help. So instead of just saying ‘I want to be successful', list out individual items which mean success to you. Once you have a list of 60 things - sort through your lists and placing each in to seven areas of your life. This covers off 7 areas in total. For each one you need to have a clear picture of what each area should look like! Work/career – What are you doing for your career? Is it something that you enjoy? Is it something you can have freedom? Can you make a lot of money from it? Finances – What does your financial situation look like? Are you out of debts? Do you have a portfolio of investments, paying you an income? This is the key to financial independence after all. You need to have enough in finances to give you all the free time in the world to focus on everything else. Free time/Recreation – What do you do in your free time? Are you going on holidays each year? Health/Fitness – What is your ideal fitness? Are you 80 still in great physical and mental health? Relationships – Marriages, kids, parents, everyone etc. Contribution to the world – Do you give back to society? Personal goals – What do you want to do before you die? Can fit into the previous – so merge Remember, that your personal vision is where you want to be – so you need a clear picture on what it looks like, what it feels like, you should almost be able to taste it! Purpose is what drives you towards this – but goals set out the actions on what to take   Goals - hone your inner GPS – help to fill in the gaps and reverse engineer some steps to build your ideal life Goals are the ‘building blocks' of your vision - want to lose weight, start saving or investing? these aren't really goals - they are just good ideas. arbitrary goals that don't align up to our vision typically fail to be achieved – no motivation through resistance This is why having your vision and knowing what you want is so important. can't achieve something if you don't know what it is, and you must actually want it Put a goal against each vision to build your purpose Where I want to be: Vision Where I am: Personal inventory Fill in the gap! Reverse engineer - nobody is going to make your dreams come true - action on your goals will! Smart Goals S – Specific: Who, what, where, when, how & why? – Comes back to the overall vision for each M – Measurable: Something measurable on what you want to achieve. A – Attainable: Believe that your goal is attainable, developing the skills and attitude to achieve them. R – Realistic: Must represent something that you are willing and able to work towards. The bigger the better – This can create a high motivation! T – Timely: This anchors a timeframe by when your goal will be achieved. Putting a date on a goal allows for you to break this time down and with it, the goal in to smaller segments.   This is where knowing exactly what you want to achieve really helps as the more definite your vision is, the more details you can use when defining your goal. Now it comes time to do an action plan on your goals. The last part is the hardest, especially if you don't know how to. However, what you are trying to do is likely what someone else has done, or knows how to do. We all stand on the shoulders of giants - Isaac Newton: So you can ask for help from them.  One of the best bonuses from this is an Increased happiness from working towards goals! Achieving them is great, but working towards them and planning them gives bigger dopamine releases, studies have found. This is why setting goals is really important as well, not only to achieve your vision, but to enjoy the ride along the way.  That is it for this episode. In summary: Try to find what is going to get your out of the bed in the morning – purpose You can sit around pondering what is the meaning of life, but it is much easier to find the meaning of your life Set your SMART Goals based on your vision. Break it down into small achievable tasks. Do your action plan Once your reverse engineer - Ask people/research what needs to be done. Remember to go to Finance and Fury to get the pdf workbook for this Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Society, individual purpose and the undiscovered self

    Play Episode Listen Later Sep 27, 2021 25:48

    Welcome to Finance and Fury. I'd like to start a serious conversation about the individual self and our drive for meaning within society. This relates to economics and by extension, personal finance – as economics focuses on how the individual incentives drive decision making – all with the aim to maximise our utility – i.e. gain the maximum benefit – which could mean we driven by money, freedom, or some other purpose - What drives the way that we act? - so in this episode, we will be adding a philosophical element to this topic – this episode isn't about the property or share market, so if that is why you tune in - feel free to not listen – the purpose of this episode is more abstract – and aims to help those who want to help themselves through making sense of the current state of the world and prospering through this – To do this – we will draw on some of the teaching of the greatest philosophers through history – like John Locke, Carl Jung, and Viktor Frankel to name a few – this will be a bit of a longer episode – as there is a lot to unpack If you are still with us - To start with, I am going to read a passage from Carl Jung's book, The Undiscovered Self – 1958 – then we will break this down to unpack the individual in relation to society and the state “Instead of the concrete individual, you have the names of organizations and, at the highest point, the abstract idea of the State as the principle of political reality. The moral responsibility of the individual is then inevitably replaced by the policy of the State. Instead of moral and mental differentiation of the individual, you have public welfare and the raising of the living standard. The goal and meaning of individual life (which is the only real life) no longer lie in the individual development but in the policy of the State, which is thrust upon the individual from outside and consists in the execution of an abstract idea which ultimately tends to attract all life to itself. The individual is increasingly deprived of the moral decision as to how he should live his own life, and instead is ruled, fed, clothed, and educated as a social unit, accommodated in the appropriate housing unit, and amused in accordance with the standards that give pleasure and satisfaction to the masses. The rulers, in their turn, are just as much social units as the ruled, and are distinguished only by the fact they are specialized mouthpieces of State doctrine. They do not need to be personalities capable of judgment, but thoroughgoing specialists who are unusable outside their line of business. State policy decides what shall be taught and studied.” There is so much to unpack in this one paragraph alone – The first few lines look at once individual responsibility has been replaced by the policy of a Government – the differences of the individual are no longer celebrated in society – it is used to create an us versus them mentality – when a government have two primary parties, politics becomes a sceptical, like a game of rugby, AFL, cricket, NFL – there are two teams competing for the win – and each side has their supporters – and each side has some level of animosity towards the other – often not much, but you can see this spill over – like in some south American football (i.e. soccer) games Once we get to this point – there is no need to focus on the individuals rights or happiness – as we are supporting a team – “goal and meaning of individual life (which is the only real life) no longer lie in the individual development but in the policy of the State” – therefore, the state (or government) tries to replace your own individual goals with public policy – in a utilitarian way - this then leads into the state focusing on their own definition of public welfare and the raising of the living standard – which requires increased authority of the state The desire to increase public welfare and raise the living standard is a noble goal – but unfortunately centralised powers have a hard time actually achieving this goal – and throughout human history – I cannot find any examples where the state, when given extreme powers to achieve this goal, have been able to deliver in the long term – otherwise the USSR, Cuba, North Korea, Cambodia, Vietnam, Venezuela and the list goes on, would have been able to economically outperform countries with less centralised state control – and provide their populations with higher living standards This ties back to the statement “the policy of the State, which thrust upon the individual from outside and consists in the execution of an abstract idea which ultimately tends to attract all life to itself” – the state tells you how you should live in an abstract idea – which through social reinforcement leads to a trend, where public consciousness starts to sway towards this end – this is where sentiments such as eat the rich come from Remember – the economy is the sum of our individual economic output – so the more power the individual has to better their lives, the better the society and at large the economy become – plus, one single policy cannot be utilitarian by definition, as every individual has different goals and desires, so there is no one size fits all style of policy making Jung's insights here do seem profound – given this book was written in the 50s – but in reality, we as humans have not changed in this time period – and the same governmental forces existed throughout Jung's life - Remember – people were drafted to go half around the world to fight wars in WW1, WW2, Korean and Vietnam wars – over 16m men were drafted in the US alone in these wars We actually have access to more information than ever – through the internet and platforms like youtube - in response – governments and state media needs to try even harder to shut down any alternative information But just like a sports team – people choose who to believe, follow and root for The one major difference between Society now compared to a few decades ago – we have legislation on legislation – which has created a more complex society and economy – this legislation has had one demonstrable outcome – increased government control through more and more laws – there was a book written over a decade ago – Three felonies a day – which covers people unknowing breaking laws – the fact that the average person can break three laws every day and not realise this is a sign of the over legislation of society Does any of this really matter? Yes and no Yes – these laws that politicians put in place are the framework in which we live – and if you put all of your hopes into the state solving your problems, you might be less likely to take agency over your own life – to find your purpose and solve your own problems No – Because we can try our best to work withing that framework – the more the overreach of the state – the more it just requires additional effort to overcome the laws – legally to prosper – but the important thing is to at least retain some semblance of freedom to make choices that can benefit ourselves – What becomes the issue here is the ability to make choices all depend on rights If society reaches a point where there is a loss of the induvial self – and loss of the individual rights – then what do we have as a society?   This is where we move on to John Locke – with the concepts of your rights – you might call the human rights, I prefer to think of them as natural rights Rights are a concept meant to help us define the ethical limits of human behaviour in society In other words - what types of interactions with other people are and are not acceptable? But rights are based around an individual and societal moral agency – if we are going to make any claims about what is right and wrong in society, the individual must be able to choose how to act – this is the very nature of free will – the individual should be allowed to act in their own best interest – as long as this does not infringe on another person – i.e. I cannot steal from you There is where the individual should be held accountable for their actions if it impacts on the rights over others This is the distinguishing factor between natural (aka negative rights) and positive rights – natural rights are those that protect the individual – nobody has the right to take your property, or coerce you into any decision – but positive rights by their definition require that you are infringing on the natural rights of someone else This is where the original concept of Rights was distinct from privileges or entitlements – it's not about demanding free stuff at the other persons expense (which would be a positive rights) – it is about how we act to better our own situation in life and in response, how we expect others to act – positive rights are a relatively new concept which take away the agency of the individual – as positive rights need to be enforced by an expanding state – i.e. through legislation as enforcement At the very base of natural rights - We should all have the expectations to not be assaulted or murdered, or stolen from or enslaved by other individuals Also – we have the expectations to not be coerced by other people – or imprisoned without cause – in other words, we should be secure in our property rights and sovereign selves The corollary to all of this is the responsibility to uphold those same rights for everyone else – these are all the basis for natural rights – Functioning societies all over the world depend on people and institutions respecting individual rights – I did an episode a few weeks ago on freedoms – and how we have been lucky for quite some time – but when a state and by extension, the society is lead into not respecting individual rights – the more volatile society gets and the poorer the population becomes over time It comes back to moral agency and responsibility – rights holding agent is both capable of demanding their rights be respected – but also demonstrated the ability to respect those same rights in others This is something that every human can do – even if we don't always do this – But Rights are specific to human beings – without the concept of the self and our natural rights, we are no different from animals Animals can't have genuine rights - they are neither capable of respecting the rights of others – nor are they held personally accountable for their actions when they are in breach of another's rights No polar bear or shark will ever be arrested or put on trial for murdering and eating a seal to survive No seagull will be put into a prison for sealing your chips at the beach – as this is the easiest way for them to find food - On top of this – they wouldn't comprehend it if they were – As a society – we need to respect the moral agency of everyone – we sustain society through voluntary interactions – this is reduced at every stage when governments increase their control over our lives Imagine that we have a government that promises us that they will pay for our food and housing – in this situation we would want to have all the pros and none of the cons – live in a house that we choose and eat the food that we want – in reality this isn't the case – as the government will only spend $100 per week to cover your housing and $50 to cover food costs Let's say that we do get to spend all we went on housing and food at the tax payers expense – even though in reality this is never the case, as if nobody is working where does this tax based come from? - but let's say in a hypothetical situation, we can live in a mansions and have all of our desires paid for - all of these pros can actually lead to some major cons for us as individuals – if life becomes so easy that you no longer need to stive for anything, or have a purpose to wake up every morning – essentially removing any meaning to your life, does this help or hinder you? It is hard to have any meaning in life if all your desires are now met – there will be outliers who still want to forge their own path – but this is likely a minority of the population at large In the situation where the government is in complete control – we often see populations become apatetic and drift into nihilism – this is a perfect situation for the totalitarian state The state can highjack our inbuilt desire to follow the path of least resistance – naturally we want to get what we want in the easiest way possible – without governments, this leads to innovation and an ingrained purpose to prosper on our own – but with governments – we can be provided what appears to be the easy way out - but if we always take the easy way out, does this make us stronger or devoid us of purpose? Without the right to make our own choices and have the freedom to fail – individual purpose can be diminished further   With this framework in mind - How do we find meaning in the worst of situation - Viktor Frankl's philosophy of Logotherapy can help to answer this – he himself lived through a number of concentration camps under the Nazi, where he was separated from his wife where she died, plus his parents and brother – he came up with this theory in the camps where people could still find meaning and happiness – Logotherapy is based on the premise that the human person is motivated by a “will to meaning,” an inner pull to find a meaning in life. The following three principles are the basics of logotherapy: Life has meaning under all circumstances, even the most miserable ones. Our main motivation for living is our will to find meaning in life. We have freedom to find meaning in what we do, and what we experience, or at least in the stand we take when faced with a situation of unchangeable suffering. Frankl wrote extensively on discovering meaning – and the importance of suffering and sacrifice According to Frankl, "We can discover meaning in life in three different ways: by creating a work or doing a deed; by experiencing something or encountering someone; by the attitude we take toward unavoidable suffering" and that "everything can be taken from a man but one thing: the last of the human freedoms—to choose one's attitude in any given set of circumstances" This is where finding work that you find fulfilling, which can also provide you a monetary compensation is important for two reasons – gives you purpose but also, the path to create your own financial freedom – By no means does this mean that life will be easy every day – this is against the point – the point is to find some purpose in life, whether this is doing a trade, or some service role in society which you can earn a living – then work towards your end goal of generating enough in material wealth to become self-sufficient – where you now have the choice to continue working – if it bring you fulfilment -then most people continue to work You can also find meaning through building strong relationships within your community If someone finds meaning through certain actions which are promoted by governments – where the government choose to use their final freedom i.e. things like universal basic income – the individuals attitude towards a certain situation can be coerced into agreeing with the government – then their individuality can be said to no longer exist, but simply follow the collective doctrine – but ironically at the same time, this individual will find meaning in this – even though this stance is antithetical to their own self interest in the long term – Frankl also noted the barriers to humanity's quest for meaning in life. He warns against "...affluence, hedonism, and materialism..." – if someone is purely living for money, with no higher purpose of enjoyment of their job, providing for their family, or some other form of fulfilment in what they do, such as providing a public benefit, then the quest for meaning in life can be stunted This comes back to Jung - “Instead of moral and mental differentiation of the individual, you have public welfare and the raising of the living standard. The individual is increasingly deprived of the moral decision as to how he should live his own life, and instead is ruled, fed, clothed, and educated as a social unit, accommodated in the appropriate housing unit, and amused in accordance with the standards that give pleasure and satisfaction to the masses.” Frankl observed that it may be psychologically damaging when a person's search for meaning is blocked by governments, or even other people. Positive life purpose and meaning has either been associated with strong religious beliefs, membership in groups or a community, dedication to a cause, life values, as well as having clear goals. In this framework - maturity emphasizes a clear comprehension of your life's purpose, having a direction to follow, and intentionality which contributes to the feeling that life is meaningful. To give an example from your own personal situation - I have found a transition in my own life over the years – from being very materialistic and monetarily focused, to my family needs and community focused – strengthen relationships with neighbours and build a community I've been thinking about this over the past few years – if someone was living off the gird, fully self-sufficient, as well as being in a community of others – the government would need to really totalitarian to affect them – this is why I have been designing my own life in this way – to become more self-sufficient as possible – not reply on supply chains as much as possible – but this is hard – it is much easier to go to WOW or Coles to buy broccoli and sweet potato compared to growing this yourself – I know that it will take decades to build towards these goals, but that gives some long term purpose, something to work towards This is the beauty of this philosophy – everyone can come to their own conclusion – what is correct for you and what matters – it is all about finding your own path and purpose in life – I would recommend anyone interested read the works of Jung, Frankl and Locke In summary - The point of this episode is to help find your own purpose in life – create your own leaning in life – build goals and desires – then use your ability as an individual to create your vision in life Find your own meaning – do not let others or the state dictate to you what you should do Don't become nihilistic or let the state of the world get you down – if you are unhappy, explore these feelings and look at where you would like your life to go Come up with a game plan to achieve your ideal outcome Thank you for listening to today's episode. If you want to get in contact you can do so here:

    What is an economic moat and how can this help an investment portfolio?

    Play Episode Listen Later Sep 21, 2021 22:57

    Welcome to Finance and Fury. In this episode, we will be looking at investing using a moat. Moats are an effective tool for defence historically – you would put one up around a fortified structures – such as a castle or town – can be filled with water or not, many different types and variations – but the whole aim is to make a location more defensive from attacks – so what does a moat have to do with investing? Well – in this episode we aren't talking about defending your castle from some medieval invaders – we are talking about moats that can be identified to provide some defence for your investments – in particular – we will focus on Economic Moats - What is an economic moat? An economic moat – simply put – is the ability of a business to maintain a competitive advantages over its competitors This – like a moat around a castle - helps a company to protect its long-term profits and market share from competing firms – which in this analogy would be the attackers a competitive advantage is essentially any factor that allows a company to produce goods or services better, or more cheaply than its competitors – this means that this company is likely to outperform its competitors due to capturing a larger market share and therefore, generating better profits Castles also had competitive advantages – you could place one on top of a hill – or have a drawbridge across a moat – making it harder to breach the gates – no two castles were exactly the same, as the landscape and designs of the time all vary from location to location This is the same when looking at shares in a company - When talking about companies – a competitive advantage is evident if the company has been able to maintain a market share due to a combination of different competitive advantages – essentially putting it in a monopolistic or oligopolistic environment Different types of economic moats – There are several ways in which a company creates an economic moat that allows it to have a significant advantage over its competitors – we will go through 6 types – But by no means are these all-inclusive - Cost Advantage - a cost advantage that competitors cannot replicate can be a very effective economic moat. Companies with significant cost advantages can undercut the prices of any competitor that attempts to move into their industry, either forcing the competitor to leave the industry or at least impeding its growth. Companies with sustainable cost advantages can maintain a very large market share of their industry by squeezing out any new competitors who try to move in. Successful Resource companies often have a cost advantage over their competitors – when you look at this industry – the price of the materials can vary – but if you have the lowest costs – you can weather the storm BHP – has a cost base of just under $12 per tonne for iron ore – this is the cheapest in the industry – when prices plummet to $40 – they are still making $28 – a good margin – when the prices are around $125 – they are making a killing The next best is Fortescue with $15 per tonne – but that $3 is still a large difference – 25% more in costs This comes with economies of scale – which leads into the second competitive advantage Size Advantage - Being big can sometimes, in itself, create an economic moat for a company At a certain size, a firm achieves economies of scale where there can be synergies between businesses – or they can control the supply chains as well This is when more units of a good or service can be produced on a larger scale with lower input costs. This reduces overhead costs in areas such as financing, advertising, production, etc. Large companies that compete in a given industry tend to dominate the core market share of that industry, while smaller players are forced to either leave the industry or occupy smaller "niche" roles. High Switching Costs – This is a tricky tool that companies can use – increase the costs to switch between them and their competitors products Thinking about Apple and Android for a second – I have had a Samsung phone for about 13 years now – after having an iphone for about 2 years prior – I made the switch, but I remember the difficulty in not only switching IOS – but also the transfer of contacts and data – it is almost like starting from scratch This is where the size advantage can also come into benefit - When a company is able to establish itself in an industry, suppliers and customers can be subject to high switching costs should they choose to do business with a new competitor. Competitors have a very difficult time taking market share away from the industry leader because of these cumbersome switching costs. Intangibles - Another type of economic moat can be created through a firm's intangible assets, which includes items such as patents, its brand, government licenses and other factors which give it the edge over competitors – such as loyalty Strong brand name recognition allows these types of companies to charge a premium for their products over other competitors' goods – generic brands versus the house hold names - Patents or IP can also block any competitors from entering your industry Barriers to entry – This can either be in the form of legislative restrictions or a high cost of capital to enter the industry Airlines are an example – as well as other highly regulated entities – can have not only legislative hurdles to overcome, but also upfront capital – Which can be hard to raise – either need wealthy investors, or banks to lend – which they are not that likely to do unless it is a low risk enterprise for them – smaller loans of $1m are not too great a risk – but loans in the hundreds of millions to start a larger company are almost impossible for a start up to come by Soft Moats - Some of the reasons a company might have an economic moat are those factors which are harder to quantify – this might be from exceptional management or a unique corporate culture – this is because a unique leadership and corporate environment can contribute to a company's ability to generate a competitive advantage, adding to their success and profits    Economic moats are generally difficult to pinpoint at the time they are being created. Their effects are much more easily observed in hindsight once a company has risen to great heights. From an investor's view, it is ideal to invest in growing companies just as they begin to reap the benefits of a wide and sustainable economic moat. In this case, the most important factor is the longevity of the moat. The longer a company can harvest profits, the greater the benefits for itself and its shareholders.   Many of the best businesses often encompass more than one of these economic moats – let us look at a hypothetical example - Say there is company A – and they have sent all of their production overseas, whilst there competitors are domestic – this has reduced their labour costs and costs of production by around 40% - this allows them to undercut the prices of competing companies producing the same product This low prices lead to an increase in the number of customers buying your good, as you are now – lets say 20% than the next competitors for the same product – from this - you see an increase in profits But - it probably wouldn't take very long for your competitors to notice that you have offshored and follow suit – therefore, now their cost decreases can match yours – and they can likely drop prices by around 20% more – or lets say they go to 25% decrease – which would eat into their profits by still make an additional profit of 15% instead of 20% - These other produces would start to lower this companies market share and profit – in response they may need to lower their prices as well However – lets say that you have been using your profits and investing in R&D – you develop a new technology that allows you to get 30% more efficiency out of your product – making it 30% better for the same price Over this time, your competitors will have no way of duplicating your methods – therefore, your competitive advantage is protected by your patent So in the end – your economic moat is the patent that you hold – not that you started producing overseas at a lower price In the end - a company's economic moat represents its ability to keep the competing companies at bay for a longer period of time – in a way that is not easily replicable As the strategy of offshoring was replicable – but the patent isn't The interesting thing about moats is that they have no obvious dollar value Real world examples – Amazon – Cost – Amazon have developed a low cost offering – often delivery is nothing, or lower cost than something like Aus post – the goods prices are also often the lowest in the market – due to supply chains that are straight to the producers Size – due to size, they have a massive distribution network – can get you anything, and in the quickest time Intangibles – have a major brand name – would have to go to some Amazonian tribe to find someone who doesn't know amazon – ironically talking about the company here soft moats – the soft moats relate amazons ability to lobby and have a legal department in every state to petition the local politicians for lower taxes and some subsidies to take business to the state – many other businesses don't have the clout of amazon to negotiate such deals These moats are all well and good – but how do they stand up over time - One of the basics of competitive market theory - is that, given time, competitors will adopt and adapt your practices – this can erode any competitive advantages enjoyed by a firm This is more likely to occur in nations with relatively free markets – where firms are allowed to competing for competitive advantages – if any company innovates and adopts a superior model – at a lower cost or better product – then other companies will copy as soon as possible – in a truly free market – there is nothing to stop these companies – therefore in the long term – it would be almost impossible for any company to maintain a long term competitive advantage – it would be gone, and better for us – we get better goods and lower prices But when it comes to a monetarily and politically controlled economy we live in – where do you look for competitive advantages – as they do exist – and are actually easier to pick than in a truly free market Frist – look for any companies with superior operations – this can mean that have the market share of sales, or excess profits in their industry, or the brand name recognition – The reason these two are important is that they are outside of normal market competition – existing larger companies have a competitive advantage over other companies that don't have the same political or economic influences that they do – this does disrupt what would occur in a theoretical free market – so reality does need to be accounted for It is important to identify what moats of the business are likely to last – and which can be replicated – i.e. is it a shift in business practice which can be easily replicated – or is it some form of competitive advantage that allows this company to stand alone Things like businesses practices can be replicated – but the political connections and lifeline protections are harder -   This leads into the application of identifying moats and selecting shares Say you have identified a company with a moat – does this mean that you rush in and buy? Technically not – the second part of moat investing is all about the fair value of the company – This is where this style of investing does require some degree of value investing applied to it – so if you identify a moat company that is priced at $40, but has a fair value based around future cash flows of $30, you may not purchase this company This is for one major reason – back the concept of a moat – for defensive purposes – therefore, being more defensive, investors would purchase at a below fair value – or at the very least, not at a 30% increase in value In the end - The goal is to not just find businesses that have moats, but undervalued businesses that have moats – this is easier said than done - This strategy does sound great – but how well has it actually performed – due to being a value-based approach of undervalued businesses who possess a moat – a moat value investment strategy has underperformed other strategies Over the past few decades – when measuring purely based on return - index or a growth approach would have performed better This is where if a company has a real moat around it – it likely isn't trading below fair value – other investors would have identified the moat and purchased around this – an important factor may be ignoring the fair value approach – but at the same time not blowing it out of the water – Traditionally – fair value is paying a sum less than the fair value – but what about purchasing at the fair value – or 10% above? This is the real problem with this strategy – unless this is your fulltime job – the market will likely notice the moat before the individual investor So how do you apply the use of moats when it comes to investing – Individual shares – You can spend some time understanding the individual shares, or there are also some researchers that provide a moat rating – like Morningstar and you can get an idea of a company's potential from sites like simply wall street – these can be a useful tool Active managed funds – You can look at some fund managers who use moats and value approaches – or at the very least a moat approach – especially in the large to mid-cap of the market this strategy has historically worked well to protect a downside ETFs – There are a few ETFs that tilt a portfolio to focus on certain factors, like moats through the quality of the companies Summary - All businesses have some sort of competitive advantage – especially once they get to the size of being listed on the market   So, it can be side to assume that once a business has grown and survived long enough to get listed on a share market – there is some advantage – but is it a long-term competitive advantage? Or can competitors catch up and perhaps even overtake it? The idea of moat investing is to identify companies with competitive advantages that can persist long term and then invest if the price is attractive This can help a portfolio limit risks where the underlying investments can maintain their market share and continue to deliver performances Thank you for listening to today's episode. If you want to get in contact you can do so here:

    What are the best ways to save for a home deposit?

    Play Episode Listen Later Sep 13, 2021 22:28

    Welcome to Finance and Fury – For this week's episode we are answering a question from listener David – surrounding some options to save for a home deposit “The conventional wisdom is to save for, say, a home deposit in a bank account with as high as possible interest rate. However, recently it seems house prices are rising quicker than I can save, and interest rates are lower than CPI. If my goal is to have a sufficient deposit in ~3 years' time, what are your thoughts in keeping savings in a conservative (or even higher risk?) mutual fund instead? Wouldn't a low-risk fund be less risky than cash during an inflationary period?” This is a great question – and brings up an important point – is the long term conventional wisdom on saving for a home deposit in cash no longer wisdom but a horrible idea? Especially in the current economic environment where your cash savings are earning a negative return in real terms when accounting for inflation – so let's have a look at this and look at some alternatives Historically - that conventional wisdom of saving for a home deposit in cash has been ingrained in the deposit saving strategy – and for a very good reason – that reason has been due to volatility in the short term – why take any risk on your savings if you can generate 4-5% p.a. in interest returns and inflation is only 2%? However – if you are getting 0% interest return and inflation is 3% - does this sound like a good idea? Also – home prices have been booming since interest rates have declined, with 2- or 3-year fixed rates being in the high 1% range – this has fuelled increases in prices which are beyond what cash can provide With home prices increasing and no returns on cash savings – you need to constantly save more and more to make up the short falls Example – want to buy a $550,000 home – need $110k as a deposit – plus $10,600 for stamp duty Say it will take you 4 years to save for this – but in this time property prices go up by 15% - same property is now worth $632,500 Now you need $ in deposit and $14,300 in stamp duty – this is a further $16.5k in deposit and $3.7k in stamp duty – so this may take you a further 6 to 12 months to save for – in which time property prices can go up even further So what do you do? Just keep saving more, or look at investing these funds in the hope of getting a decent return? This is a very important question – due to this increase in price of property and the opportunity cost of keeping funds in cash – are there better alternatives? The issue with using savings to invest into growth assets, such as shares, especially with the aim that these funds increase in value in the short term, is that this is investing purely based around hope – and that hope is that the invested funds increase at a greater rate than a savings account can provide by the time you need to use the funds The irony is that these days a savings account will likely provide you a 0% return in nominal terms = a negative return when accounting for inflation and the price increase of property This leaves savers in a horrible position – either save more to minimise the short fall or – invest funds in assets that can provide an above property price growth level of return But this investment needs to help balance any risks – especially in the short term What are some alternatives to saving in cash? Let us look at a Conservative investment fund – Conservative funds are those that have the majority of their allocation in defensive investments Their allocation is normally a majority of FI assets and some cash – with a smaller allocation to shares – both Aus and Int to help generate some growth returns The aim of these funds is to normally get a return of a few percentages above cash rates As an example – there is the Vanguard conservative index fund – either in ETF or managed fund versions The comparative returns of this fund have been good – especially when compared to cash – Cash returns over the past 3 years on average has provided 1% p.a. which is far below most peoples target when incomes to achieving a savings rate How has the conservative fund performed? Over the past 3 years it has provided a return of 6.5% = 4.5% of this has been income with around 2% being capital growth Looking even further out – you have the 5-year average returns of 5.54% – the income return has been 4.75% and growth has been around 0.68% In hindsight – and as a comparative tool – investing funds in the vanguard Conservative ETF would have provided additional capacity to save than pure saving funds in cash – but investing Is always perfect in hindsight Conservative fund has around 62% in FI and 8% in cash – total of 70% defensive – then has 18% International shares and 12% Australian shares – this significantly reduces its volatility when markets take a downturn Look at volatility – Looking back over time – Drawdown analysis - What happened in GFC? – In 2008 – fund lost 2.5% - but then had a total drawdown of 10% by 2009 Recently had a drawdown in 2020 of 7.5% - but thanks to markets recovering it didn't stay there for too long The average larger drawdown beyond the two outliers has been about 2.5% when the market does down (has occurred 5 over the past 18 years) Rolling return periods – 1 year rolling returns – there was a 2 year period where the returns were around -5% - if you invested in 2008 then by 2010 you would have not made any returns Conservative funds – high allocation to bonds and cash – allocation to shares as well – Compare the opportunity costs for savings between getting 0% and 5% - based around historical returns a conservative fund would have worked better But what about looking forward – everything in hindsight is a fantastic strategy – but how would this form of conservative investment fair if interest rates were to rise – Likely not well – given the make up of the funds is 62% fixed interest – this asset class would likely suffer in pricing if interest rates rise – It invests in index funds – the index of bonds is many large countries Government bonds - due to the size of debts that governments have issued on fixed interest These bonds have QE propping up demand for the bonds – but if interest rates need to go up due to inflation concerns, and the liquidity dries up in response, what happens to the bond market? Pricing of a bond – every bond is issued with a fixed coupon – often that of the interbank cash rate of the nation Say interest rates of Aus go back to 1% - would you buy a bond for $100 if it was only paying 0.1%? Likely not, as you may want to save funds in the bank and get 1%, or close to it – so what has to happen to bonds in response to incentivise investors? The price of the bond needs to drop – if it is 10 years out from maturity, the price of the bond would be $91 – if were a 30 year bond, the price would be $77 – remember each of these bonds would have a current price very close to their face value = a potential loss of 10-20% Therefore, cash may actually provide a better return in the short term than a conservative fund – which in this time period may likely have a near 0% if not negative return. As over the last few quarters – the aggregate bond index can decline by about 0.8% if fears of inflation and interest rate increases are priced in The flip side of this – if interest rates were to increase, property prices may stagnate or even start to decline – this would mean you need less in savings to afford the same home – but it would also mean that you likely have less in a conservative fund Alternative options – if you are a first-time home buyer ­– you may have some better alternatives than saving in personal funds First home SSS – Using superannuation is a viable strategy in most situations, even though it can be a little restrictive. It essentially allows for larger savings through the reduction in total tax paid on the level of savings (through not receiving it as a taxable income). How it works: From 1 July 2017, individuals can make voluntary contributions of up to $15,000 per year and $30,000 in total, to their superannuation account to purchase a first home. Pre tax conts. – Taxed at 15%, along with deemed earnings, can be withdrawn for a deposit. Done through employer – Salary sacrifice – rather than saving personally Self employed – Can still do and claim a deduction on personal conts later Must remain within concessional (pretax) cap of $27,500 – this means that whatever your employer puts in, plus your SS needs to be below $27,500 Withdrawals will be taxed at marginal tax rates less a 30 per cent offset and allowed from 1 July 2018. Amount of withdrawal = Net contribution plus deemed return (90 day bank bill plus 3%) 3.1% currently – will change as the RBA cash rate changes Who is eligible - You can start making super contributions from any age. However, you must be 18 years old or older to request a determination or a release of amounts under the FHSS scheme. Also, you must have: never owned property in Australia – this includes an investment property, vacant land, commercial property - Eligibility is assessed on an individual basis. This means that couples can each access their own eligible FHSS contributions to purchase the same property. If any of you have previously owned a home, it will not stop anyone else who is eligible from applying.   Examples and looking at a comparison - Individual earning - $60,000 a year (or anyone earning between $45k-$120k for a rate of 34.5% including the Medicare levy) – Never bought a home before They direct $10,000 of pre-tax income into superannuation increasing her balance by $8,500 (after 15% tax) Continue for 3 years – Contribute up to $30k in total Withdraw $26,700 Net contributions of $25,500 Plus deemed earnings on those contributions (3.1%) each year the funds were sitting there Withdrawal tax of MTR (34.5% inc Medicare levy) minus 30% offset $1,202 in tax paid Net withdrawal - $25,500 $5,850 more than if saved personally in cash ($11,700 more if you are a couple than if you were saving these funds personally) Now – if you had invested your net income at the same rate in the Vanguard fund – left with $20,955 – so even at a higher earnings rate of 6.5% - the FHSSS would have provided a better result This scheme has two things working for it – First is that the returns are guaranteed – regardless of what your super does, the deemed earnings will be the RBA cash rate plus 3% The downside to this is that if your superannuation does decline, then you are withdrawing a larger lump sum whist the account value may be down – as an example, your net contributed amount may lose 10%, but you would still be withdrawing an amount as if it had earnt the 3.1% p.a.) Secondly – it is tax effective – the saving of funds through superannuation allows you to save some additional funds through reduce your tax burden The downside is that a maximum of $30,000 can be put towards this, which after tax is $25,500 – or $51k for a combined couple – Given that property is rather expensive – this may get you half of the way towards a deposit for the average home in some major cities, excluding Sydney or Melbourne   This leaves the option of continuing to save either in cash or looking at an alternative option – such as investing in a conservative ETF – Monthly investing into a conservative fund – The longer the timeframe, the better – If you are 10+ years away from a deposit, then you can look at something higher growth In the end – it is impossible to say what will provide you with the best return in the short term – i.e. 3 years – as nobody knows the future But over longer periods of time, statistics and averages start to play a bigger role I hope this helps to clarify things. Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Will the next financial crisis come from the USA or China?

    Play Episode Listen Later Sep 6, 2021 21:43

    Welcome to Finance and Fury This episode, look at where the next financial crisis may come from – Will it be from the USA or from China? This is a question I was thinking about the other day – as there is a lot of talk about the Chinese economic being built on a house of cards and at risk of collapse – but if this does collapse, will it lead to a world-wide economic recession? Or, will the USA beat China to the chase and trigger the next collapse? So, in this episode – we will look at the likely nature of the next financial collapse and whether this will be triggered by economic issues in the USA or China Looking back in history - the idea of a global financial crisis is relatively new in the scheme of things it has and can only occurred in times when economies are interconnected in terms of trade, or financial reliance – in the modern era – this is coined as globalisation – but the trigger has tended to come from the economically dominant country in this economic system – i.e. the most connected nation that a global economy is reliant on Therefore – it is no surprise that over the last 100 years, the United States has become the primary source of economic collapses that have spread to throughout the rest of the world In reality - over the last 200 years, the USA averaged a financial panic every twenty years – which over this timer period puts it in competition with the UK for the most occurrences of economic disaster of any country on the planet – What is different is the size and scale on these panics' effects on the rest of the world – The USA has only really been an economic powerhouse from the post WW1 Era – hence previous panics, such as the Railroad panic of 1873 has far less effect on the global economy and their financial markets when compared to an event like the GFC, or even share market collapse that preceded the great depression of the 1930s There is an emerging trend within an interconnected global economy – when the major economic powers catch a cold, the rest of the world starts to sneeze – Which brings up China – which over the last few decades has emerged to be the second largest economy behind the USA – where both countries are heavily reliant on one another – USA relies on China for consumption and debt funding, and China on the USA on net exports and reinvesting those funds in treasury notes through foreign exchange – but this relationship can be rocky Almost like business partners who have grown to hate one another over the years – but both parties know that without the other their business would fail This brings us back to today's topic – the next financial collapse Regardless of where it comes from - The form of the next financial crisis will very likely be initiated from the financial system – and in the from excess levels of leverage within a fragile system, created through speculation Technology and innovation have adapted in regards to leverage as well as investors access to leverage – When looking through all financial crisis – whist the triggering cause has differed – the common characteristic has been that the economy become fragile due to excess levels of leverage – i.e. borrowed money creates additional asset bubbles and exacerbates downturns Looking back in history - the crash of 1929, which triggered the great depression, came from an overleveraged market that was built up through the introduction of margin loans in the previous decades, as they became popular around the 1890s - then the requirements of these loans, that have the shares as collateral, became even more loose in the early 1900s – leading to the build-up and eventual collapse of the share market – Skipping forwards to the 2000s – systems of leverage had evolved dramatically - with CDOs, as well as synthetic derivatives which first came into use in the 1980s – These instruments combined with speculation lead to the inevitable collapse that occurred in the GFC In the modern era we are now looking at highly leveraged crypto positions using derivatives, as well as the age-old overleveraged markets both in property and shares – So - regardless of the technology of the mechanism that the money flows into - one common characteristic stays the same is that financial corrections comes from over-leveraged positions that occurred due to speculation – in other words – the higher the level of capital which can be introduced into an economic system under speculation, the greater the risks are to that system This brings us to today – where the fact that leverage has been allowed to increase at ever increasing pace due to low interest rate policies globally means that at some point – the mount of excess leverage that exists within the economy increases beyond the productive level of the economy – hence it becomes speculation – therefore, at some level it must come unstuck Speculation through leverage (i.e. debt) – used to have an opportunity cost – the concept of an economy having a near-zero interest rate policy like we currently have in place was considered to be extreme monetary policy and only to be utilised for emergencies – but in a country like the US, this has been in place since 2009 – rates did rise from 2016 to 2020 to 2.5% but then came back to 0.25% and will likely be there for a number of years – like is the case in most economies – Aus is at 0.1% The economy is a complex system – it is almost impossible to understand fully – when one input it introduced, there is no way to tell what the economic consequences will be long term beyond the first order of consequences Whilst not a perfect analogy – think of the economy as the human body – a very complex system with many different factors as inputs – some people are allergic to peanuts – whilst others aren't low interest rates act as a pain killer to the economy like morphine to the human body – when someone goes into an emergency and break their leg – they will likely get morphine to help relieve the pain – and understandably so – but normally after the initial pain has been endured and the bone is set – the morphine is reduced and eventually removed – because what happens otherwise? It is an opioid – and highly addictive – if you stay on too long you eventually get hooked and this can lead to a dark road – Your life can fall apart and at some point - you either die from an overdose due to needing to increase the load of the dose - or have to detox – which is also not a fun process – this is where much of the world economy is currently at – we will need to detox from low interest rates at some point – or see an economic death – in the form of a monetary reset Regardless of this fact – Monetary officials are still working off the theory is that low interest rates allow individuals and businesses to borrow money and pay less interest - which should encourage further spending throughout the economy and support the multiplier effect and economic growth but this theory neglects the Cantillon effect – where the money is first received – receives the highest level of benefit – and as the increase of borrowing and level of debt is directly injected into the property market, as well as injecting liquidity into the share market – these are two of the primary areas which have seen pricing move into overvalued territories – i.e. they have seen rises dramatically in price in a short amount of time that isn't proportionate to its value This also makes sense from a risk perspective – when interest rates are low - money becomes cheap and investors can afford to invest more money into higher-risk asset classes – the opportunity cost of losing money becomes less – i.e. if you can borrow for 2% then the risks of investing in the share market are lower than if you had to borrow funds at 7% p.a. – where you need a higher hurdle rate to compensate your borrowings – this also leads to a spike to asset prices In most economies - the signs of a boom are everywhere - House prices are soaring, demand for consumer goods is high, financial markets are at record levels, commodity prices are booming with iron ore and copper is hitting fresh records This is where asset bubbles can then lead to recessions when the flow of new money stops or slows significantly and prices drop, causing some to lose large sums of money – this is due to the leveraged nature of speculation – the amount of money can artificially be increased by borrowings – so if borrowing are recalled, the nominal rate of money is reduced at a greater rate than otherwise possible What would trigger such a crash? To be honest – I have no idea – it could come from any number of reasons – and likely will not come from one induvial cause, but instead be a cascade of events to lead to a complete market collapse – This being said - markets are essentially deep into the late stages of a bubble and is over leveraged – but as long as leverage can continue to grow, there is no reason for this gain to drop – but if it doesn't, there are many sectors that are susceptible to deleveraging – through interest rate hikes or call backs from financial institutions Many businesses have had to borrow more money to finance their revenue losses through the lockdowns Property markets are up – with people borrowing more and more, increasing the overall household debt levels Share market is up – combined leverage rate of margin loans are at elevated levels Governments are also highly leveraged – with government deficits increasing at accelerated paces At some point, something will spook the market – whether it be some more inflation, the threat of an interest rate increase resulting in major market defaults – and central banks not willing to start up the printing presses to bail out these companies - your guess is as honestly as good as mine   But where will it come from? USA or China – which are both rapidly growing in unproductive debts – so let's look at each one separately Risks from China – this is the most populous and second largest economy in the world – it also has the largest rates of economic growth in history – transitioning from a improvised nation to an economic powerhouse within a few decades – pulling hundreds of millions out of poverty – which is fantastic – and speaks volumes of the power of a free market compared to centrally planned economies (China started the transition in 1978 out of) – where individuals were empowered with the ability to incentivised to keep what they produce – in terms of labour and being paid a wage, or even agriculturally – which is what sparked Chinas transition of population starvation from the 1980s But this meteoric rise is not without its issues – many of these are overlooked – because when things are going well you tend to not pay attention to the underlying problems The number one issue to the Chinese economy is unproductive debts - China's debt has grown dramatically over the past decade and is one of the biggest economic challenges confronting the ruling Chinese Communist Party - which actually has just turned 100 this year The CCP has identified the ballooning debt pile as a potential threat to its economic stability, and in recent years tried to reduce the economy's reliance on debt for growth – as well as rebalancing levels of public debt within private debts China's build-up of debt to fuel economic growth has raised fears of an eventual collapse - So, what factors would precipitate such a collapse? And if one were to occur, how would it affect the rest of the world? How can Chinese policymakers guard against financial crisis?  Looking at the figures – and a big disclaimer – all of these figures are generally based around what China reports – so there is no way to tell that these are accurate – not only exclusive to China, as it is hard to trust any Government Data China does have high levels of debt – but not the same ratios as many western nations – China's overall debt was 270.1 per cent of gross domestic product – increasing by 10 times over the past 15 years – which is a massive increase However – unlike many other nations – this level of debt is in the non-financial corporation sector – compared to counties like Aus where it is in household debt Around 70% of their domestic debt is in non-financial corporations – only 10% is in household debt Almost all of this lending is official, coming from the government and state-controlled companies. Over the years, China has been lending to emerging economies such as those in Africa. On top of this debt – their Loans to low-income countries - According to a report by the Institute of International Finance in January 2021, China's outstanding debt claims on the rest of the world increased from about US$1.6 trillion in 2006 to more than US$5.6 trillion as of mid-2020, making China one of the biggest creditors to low-income countries. Now - China is starting to see the pressures of an over-leveraged nation – up until now they have seen strong consistent growth – One major factor that is keeping their economy from collapsing is FDI -which is increasing year or year still Whilst there is real growth – people will see their quality-of-life increase – but everything good has to come to an end – Due to urbanisation of population – major cities in China's property markets are incredibly inflated when compared to disposable incomes But this overleverage economy is susceptible to downturns in the leveraged markets Risks – Collapse from business debts – also, defaults from African nations But Chinas interest rate is around the 3.85% - far from a ZIRP – so they do have the capacity to lower interest rates further Risks from USA – comes from the level of their overall debts and their financial system complexity There is little new here – the real economic output of the USA is now becoming stagnant again – infrastructure and manufacturing, as well as gas jobs are now on hold, if not gone completely, due to politics But the USA does have one thing going for it – the Federal Reserve – if any market declines occur – the Fed is well positioned to step in and bail out any market declines But this saving grace is their economic destruction in the same sequence – one hand can give whilst the other hand can take everything away – the propping up of financial markets can occur for an indefinite period All whilst the real economy, i.e. real economic employment, can come crumbling down, amongst it all I think that America still has one or two more systemic crashes in it before China becomes another source – it all has to do with reliance and banking policies China to date has been a relatively segregated financial system – when looking at the interconnected markets of financial derivatives and speculative leverage, China surprisingly has low levels of connectivity – USA is still number 1 – therefore, there is a higher level of risk from their financial system – a small risk can snowball Risks to Australia – the same risks as in the past – both China and USA have highly correlated economies to Australia The risk to Australia from China comes in the form of demands for our goods – which is our export market of many of our natural resources But regardless – when looking at historical crashes that have dropped out market – these have come from financial market crashes - In summary – in my personal view – the next triggering event will likely come from the USA – the world is more reliant on the USA than China at the moment – I know that in Australia, our net exports are a different story, as we are likely more reliant on China as an economy – but we are talking financial markets here – where the ASX is more closely linked to the US markets than the Shanghai Composite or the Shenzhen Component Index Thank you for listening to today's episode. If you want to get in contact you can do so here:

    How can factor investing help you achieve your desired returns?

    Play Episode Listen Later Aug 30, 2021 20:46

    Welcome to Finance and Fury. In this episode we are going to look at the different factors to consider when deciding on how you should select investments This is an interesting topic – as everyone will have different factors that influence their investment decisions – but the ultimate outcome for most people is to make money – i.e. you wish to receive a return on your initially invested capital – and do so at a rate that beats your opportunity cost – i.e. the next best use of the funds, like repaying debt But this is easier said than done though – So in this episode – we will look at the major factors that influence investments and see which one has had the largest impact on out performing the index as well as minimising volatility – in other words, what has provided the best returns over the past 20 years at the lowest comparable level of risk – we will also look at if these trends can help to provide some insights into investing moving forward I think it goes without say that this episode is not advice, but just general information based around a historical analysis – because we are not taking into account anyone's personal situation   Why do investments perform the way they do? This question has an obvious answer – the price of an asset is based upon the supply and demand of the investment – if the demand is high and the supply low or capped, then prices will rise – but it isn't this simple – it is easy to say that an investment is simply in high demand with lower supply – hence the price goes up – but this becomes more complex when trying to figure out why this has been the case? Why have certain investments been in higher demand than others? focusing on the different factors that investments can have attributed to them can help to understand this nuanced question – this is where factor investing comes into the picture What is Factor investing? It is an investment approach that involves targeting quantifiable characteristics – these quantifiable characteristics are what are referred to as “factors” These can help to explain differences in investments and how they have performed – both in terms of returns as well as volatility, which is the measurement of risk Now - a factor is any characteristic that can explain the risk and return performance of an asset The approach to identify these is considered to be quantitative – hence it is based on observable data, such as an investments price in relation to its financial information, rather than on relying opinions or speculation characteristics that may be included in a factor-based investing include two general categories – being that of macroeconomic factors as well as style factors - Macroeconomic factors – these are the larger picture economic factors that tend to influence markets at large Economic growth – This includes an investments exposure to the business cycle Real interest rates and inflation – which focuses on the risks of interest rate movements and the exposure to changes in prices that a business faces from price increases Emerging markets – these can be beneficial however are exposed to political and sovereign risks, as well as currency risks Liquidity – exposure to illiquid assets Each of these factors is important at the macro level – but instead – we will look at the other factors based around investment style factors Those of Style factors – These include the value, volatility, momentum, quality, and size of the investments Value – A share is considered to be of value if the current price is considered to be discounted relative to their fundamental value, also known as fair value – As an example – say a share is trading at $10 – but some analysts punch the numbers and determine that this company, based around its free cashflow and growth prospects should only be worth $8 – then this would not be a value purchase – however, if a share was valued at $15 and trading at $10, then this would be an obvious buy Therefore - value investments aim to capture excess returns through purchasing shares that have lower prices than their fundamental value There are many different methods used – but most commonly, value managers track price to book and price to earnings ratios, dividend growth forecasts, and the present value of free cash flows as part of their fundamental analysis The best way to think about value investing is when you see a special at the supermarket – if an item is on sale, for 30% reduce price, are you more or less likely to purchase the item? So in essence - The value factor attempts to capture excess returns to shares that have low prices relative to their fundamental value. This factor has generally performed best during economic recoveries – when fundamentals matter more to investors Minimum volatility – This is a focus on stable, lower risk shares – i.e. those that are consider safe harbours, such as blue chips and have stable business models and often provide a service with a moat around them – essential consumption with companies like WOW or COL would be an example There is some research that suggests that shares with low volatility earn greater risk-adjusted returns than highly volatile assets – so whilst the total returns may not be as high as some small cap companies, they can have less of a downside – e. – a share providing a 10% return with a 10% volatility has a better risk adjusted return than a company providing 15% return with a 22% volatility p.a. These numbers are also based around the averages – because a risk adjusted return does not equate to an absolute return – as previously mentioned, one share may provide a return of 5% p.a. at 5% volatility, whilst another provides returns of 10% p.a. at 15% volatility – which would you prefer? It does depend on your situation – but higher returns for more volatility can be acceptable This comes back to the measurement for volatility – which is often done in the form of a variance – which can be further reduced to a standard deviation This measures the potential price movement of an asset from its mean value over a certain time period – most of the time this is from a one- to three-year time frame But volatility measures upwards movements as well as downwards – so if a share hypothetically does go up in value a lot over 3 years, even if it doesn't have any major downturns in this period it would still look volatile The low volatility factor attempts to capture excess returns to share with lower-than-average risk – however this factor has generally performed best during economic slowdowns or contractions - when the downside risks of volatility are their highest – because remember that volatility also measures the upside movements – so being in low volatility shares in a bull market can lead to underperformance when compared to the index Momentum – These are shares with strong upwards price trends – i.e. Shares that have outperformed in the past tend to exhibit strong returns going forward as long as their trends continue – because of this - these momentum strategies are grounded in relative returns from three months to a one-year time frames The momentum factor attempts to capture excess returns to shares with stronger past performance – and it has generally performed best during economic expansions This form of investment factor does require a higher level of active management behind it – it requires to buy into momentum as it is commencing and to get out prior to momentum fully losing steam – which is easier said then done Momentum can work very well whist there is momentum behind the price movement – To explain this further – take for example a movie review – if you are deciding on what to watch, you are more likely to choose a movie that has a high audience ratings as well as if friends or family are telling you that it is a good movie – if it is highly recommended and your friends tell you to watch it, then you will likely watch the movie, boosting the viewer numbers – This doesn't mean you will like the movie – but the trend is set and due to social conformity, you don't want to be the only one who hasn't seen this movie – the same sort of factors work their way into the share market – investors don't want to be the only ones that miss out on the returns – so more people demand the share and the prices continue to rise – however – like movies, once everyone has seen it, the hype behind the movie starts to wane, box office numbers go down and people move on to the next blockbuster Quality – This is the representation of investing into financially healthy companies – quality shares are often defined due to the company having low debt, stable earnings, consistent asset growth, and strong corporate governance Investors can identify quality shares by using common financial metrics like a return to equity, or debt to equity and earnings variability as well as dividend growth – so there is a fair bit of fundamental analysis required The quality factor attempts to capture excess returns in shares of companies that are characterized by their quality metrics – therefore this factor has generally performed best during economic contractions – there is some overlap with quality and value investing – most managers who focus on value investing will look at quality companies and make investing decisions based around the price of the asset compare to the fair value – but for a pure quality investor, they will just buy the company if it is of high quality, even if the price has is above the fair value Size – This is the purchase of smaller, higher growth companies - Historically, portfolios consisting of small-cap shares exhibit greater returns than portfolios with just large-cap shares This is why I have been a major fan of small to microcap companies when putting together a portfolio, especially for myself when it comes to getting higher capital growth over the long term – The low size factor attempts to capture excess returns of smaller firms (by market capitalization) relative to their larger counterparts. It has generally performed best during economic recoveries This strategy can have higher levels of risk however – but by investing in the lower end of market caps of the share market, it can help investors capture the size factor for additional capital growth over large caps   These are the style major factors – But what is the purpose of this considering these factors when investing – From a theoretical standpoint – why would anyone try to focus on size over the quality investment factor? – why not just invest in the index? the purpose of doing so is for three major reasons - to enhance diversification, generate above-market returns and to lower risks when compared to the index – but most importantly – tailor the allocation towards which of these is most important to you = would you prefer lower risk or higher returns? When looking at Diversification - factor investing can offset potential risks to investing in shares through targeting shares that provide long term drivers of returns – such as quality or momentum, which often have different performance cycles when markets crash equities tend to move in lockstep with the broader market – where the price of these go down across the board – however in down turns, some securities don't decline by as much You might also want to invest in shares at a lower volatility, or risk when compared to the index – Through focusing on a diversification between different types of shares, in different sectors – the risks of investing purely in one factor or sector of the market is reduced But On top of this – you can focus on certain factors of the market that have lower volatility – such as the low volatility share factors You might also want Higher levels of returns – This is where Certain factors can also provide additional capital growth above the index, but with higher levels of volatility In short – investors can focus on certain factors that meet their returns profiles – In every investment there will be all three components present (diversification, risk and returns) But through investing in certain factors – you can help to tailor an allocation towards your investment goals – do you want less risk/volatility? Do you not care about risk and just want higher growth? Do you want growth whilst still managing risks? What factors help to achieve these sorts of goals? To answer this, we need to look at what are the risks and returns of each have been from 2000 to 2020 - comparing the risk and return of each factor compared to the MSCI World Index Value – return of 7.9% p.a. with a risk of 17.9% Minimum volatility – return of 7.6% p.a. with a risk of 11.1% Momentum – return of 9.4% p.a. with a risk of 14.8% Quality – return of 8.7% p.a. with a risk of 13.9% Low size – return of 8.0% p.a. with a risk of 17.0% Compared these to the MSCI world index – which had a return of 6.6% p.a. with a risk of 15.6% This time period of investments had some major ups and downs – but over the past 20 years, all five of the factors have had greater historical returns than the benchmark index, and some have also had lower risk – If you are going for the highest returns - momentum investing would have provided the higher level of annualised returns – out performing the index by 2.8% p.a. This makes sense from a perspective of following trends – but interestingly it has also had a lower risk, measured through volatility, when compared to the index If you are going for the lowest level of risk - Not surprisingly - Minimum volatility has provided the lowest risk – but also had the lowest return – it did out perform the index by 1% over this time period, but was 4.4% lower in the measured level of risk Quality has also had a decent return with a relatively low risk – I find this interesting as some of these factors can overlap – remember that value and quality investors look at similar metrics, but the major difference is the price that they have set to their entry points – hence, if a share has momentum behind it – a value manager will likely not purchase this, whilst a quality manager will   The downsides to this style of investing – trying to guess which factor to focus on and actively manager this yourself – These attributes are readily available for most securities and are listed on popular share research websites – but it required the researchers to be correct and for you to constantly be checking to make sure the shares still meet the factor you wish to invest in Trying to pull this off perfectly is impossible, trying to pull this off well is hard – but there are professional ETF managers who do this style of investments So in summary – If you are looking for high growth returns then small size, quality or momentum have historically provided above market returns over the longer term However – if you are looking for lower risks in equities – both quality and minimal volatility shares can help to achieve this compared to the index – not to say that these investments don't lose value, because they do in the short term, but historically they have had lower downside volatility when compared to the index But through investing in certain factors – you can help to tailor an allocation towards your investment goals – So depending on what your return requirements are, this style of investing can help to get investors closer to their returns profiles Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Investing in megatrends for long term capital growth

    Play Episode Listen Later Aug 25, 2021 22:19

    Welcome to Finance and Fury. This episode we are going to have a look at investing in megatrends. When investing – there are many different approaches people can take – people have different return requirements – hence, when constructing a portfolio of investments, you may try to isolate certain sources of return – such as capital growth or income focuses If you are retired and needing a passive income, then an income focus is more important – so purchasing share that pay FF dividends, or owning a property that has no leverage or debt on it will be the focus If you are an accumulator – you may wish to focus on capital growth, or target sectors of that don't typically pay out high level of income returns, but have the potential for higher levels of capital growth – such as technology or healthcare shares As part of this focus on capital growth – one method that is available to investors is to target specific investment themes – or “megatrends” This is where investors focus on high growth opportunities in sectors of the economy that are expected to grow at higher rates than the economy at large So in this episode - we unpack what megatrends are, how they can be identified and invested in, and what they can offer investors as well as the dangers to look out for What are megatrends? A megatrend is a long-term structural shift that transforms economies – I studied these trends in a course at Uni, UQ which offered – Evolution of Economic Systems It involves trends of technological and demographic changes – as well as creative destruction To be classified as a megatrend – they have to have defining characteristic that distinguish them from normal economic cycles in the way that any changes they create are enduring – i.e. long lasting beyond a normal business cycle One of the biggest examples in the past 100 years is that of the creation of cars - this ended the industry of horse drawn carriage industry within 30 years This created major economic destruction – as not only did it displace a use for horses which were seen as a major economic good, but also those involved in providing carriages, driving those carriages as well as breeding the horses – ask yourself, who would invest in horse drawn transportation in the modern era? But go back to 1850 and this was a major business The invention and effect of cars (or automobiles) was dramatic and long lasting - Creating cars did not just make humans more mobile, it also created the modern geography of cities, including highways, suburbs and shopping centres. But it did take a number of years to get off the ground – as initially cars were only available to the wealthy who could afford the new novelty – but as supply ramped up with many competitors coming to the market, prices started to drop to the point that cars started to become affordable The introduction of the television is another example – this was first introduced to Australia in 1956 in a commercial capacity – and by 1975 there was a television in most households Television wasn't just a revolution for media and entertainment, it has also had profound social and cultural impacts. We have also had the megatrend of the internet – But this is where two or more megatrends can combine to create another dominate force in the economy, which translates into investment opportunities – In our current world – this would be in the form of streaming services, like Netflix What megatrends all have in common is they are intertwined with demographic and technological changes - However – to take off fully, they typically need to be allowed to occur by governments – i.e. the legislative power – we saw this back in England with cotton gins – which are a machine that quickly and easily separates cotton fibres from their seeds, enabling much greater productivity than manual cotton separation – this is also called ginning – but in the UK back in the day, to be granted a business licence you needed to seek royal assent - so the inventor of the cotton gin went to the Queen of England for a licence to start a business using this new technology, but was denied due to the economic destruction this would have caused – so they went to France and got granted the right to start their business Like all megatrends - the uptake in the use of the technology or service is usually exponential; at first there is a time-lag for adoption, then soon the megatrend is everywhere – which is why the UK soon allowed cotton gins to not fall behind the garment production of the French Needless to day - Megatrends can have implications for investors who can correctly identifying and act on them Those who invested in media businesses in the 1960s, went on to reap super profits. So too did those buying into computer businesses like Microsoft, Apple and IBM in the 1970s for the PC revolution. This is all an exercise in hindsight of course, however, illustrates the power that megatrends can play in shaping markets and investment outcomes – but there are also megatrends that just turn out to be part of a normal business cycle before creative destruction swallows them up – such as blockbuster   Examples looking forward - Transformative Technology, Society & Lifestyle, Health & Wellness, and Environment & Resources. Transformative Technology - Such as cloud computing, 5G, robotics, automation and artificial intelligence, and machine learning. Technological breakthrough is the most obvious and has been a defining megatrend since the industrial revolution, which created factories and modern mechanics, But investing in disruptive technology is easier said than done. With many investors missing out even when the opportunities stare them in the face. The better question to ask is where might technological breakthroughs come from this decade? One possibility is robotics, automation and artificial intelligence (RAAI), or “industry 4.0”. There was Industry 1.0 – this was the Mechanization and the introduction of steam and water power Industry 2.0 Mass production assembly lines using electrical power, Industry 3.0 – was about automated production, IT systems, and robotics Industry 4.0 is about looking forward – it includes smart factory, Autonomous systems, IoT (or the internet of things), machine learning - Industry 4.0 is the increasing automation of manufacturing and services, such that machines manage other machines—via “machine learning”. In concrete terms, industry 4.0 is where businesses use modern robotics, the internet, and big data to create remotely controlled factories, self-driving cars, and self-programming computers and more. When looking at existing businesses as an example - Amazon's giant warehouses come to mind Historically, warehouses consisted of static shelves. Workers would come and add or remove items to and from the shelves as supplies and demand came in – each industrial revolution has increased the capacity of this economic environment – from people having to carry the goods through horse and buggy and manually lift the goods to shelves – to having trucks transfer the goods and machines like forklifts doing the heavy lifting However – looking forward – In an Amazon warehouse, the shelves are all mobile and moved by robots. The robots move items as customers buy them via a complex barcoding and computer system. Thanks to machine learning, the robots holding trending or popular items, have learnt to move nearer delivery points. In this picture, much of the work done by humans, has been replaced by machines This trend once introduced will likely not decline – so there is potential for further investment growth in this market segment Society & Lifestyle – This comes in the form of demographic changes like aging populations, the growing middle class in emerging economies and the further expansion of social media This is one of the more complex megatrends due to the tie into other megatrends – as an example -in emerging markets, especially India, the population is getting younger – however - in developed countries, especially Japan and North Europe, populations are ageing – so in some areas of the world – there is an ever-greater amount of social life that moving online where millennials' purchasing power is increasing, but in others the older population make up more of the social fabric of economic spending – what they spend money on also differs – however – across the board, online spending is increasing as well as socialisation online as well as working environments and socialisation The major winners of social life moving online have been Facebook, Apple, Netflix, Google and the other so-called “FANG” stocks. Facebook and Google have replaced newspapers as the primary distributors of information and cannibalised their business models (selling audiences to advertisers) As part of a work demographic trend - Women entering the workforce has caused a booming day-care industry Demographic changes promise to create winners and losers, however, investment opportunities at this stage are less straightforward. India and China collectively have 1 billion young people, most of which are heavy internet users thanks to smartphone availability. This creates a strong runway for the digital economy in emerging markets. Meanwhile, aging populations have meant Japan buys more adult nappies than children's nappies. Aging populations have consequences for robotics and automation which will be required to meet labour shortfalls and likely consequences for healthcare – this brings up the next trend Health & Wellness – this includes biotechnology, genomics and gene editing technologies of the future the healthcare megatrend has been in play for a number of years where as there in an increasing demographic of wealthy older population across developed nations, there is naturally an increase in the money spent on medicines and longevity technologies Healthcare spending is growing faster than GDP in most countries, data from the World Health Organisation indicates. This means that that the healthcare sector is taking an increasingly large share of the global economy. Most of the growth owes to government support, which is substantial and increasing. Governments' hands have been forced into greater healthcare spending. On top of this, you have the wellness movement - Wellness refers to the growing concern with diet, exercise and lifestyle that has developed in developed countries – This predominately is within the younger generations which represents a different market share from that of the aging population But perhaps more problematically, obesity is climbing in many western countries. According to the WHO, the percentage of overweight adults is approaching 40% globally. Healthcare problems stemming from obesity are manifold – or in other words, obesity leads to many different health conditions - including heart conditions, diabetes, and some cancers – so health care providers have no shortage of demand for their services – both from the elderly population but also from younger portions of the population that require medical treatment due to obesity or other antithetical health behaviours – such as alcoholism or obesity however, healthcare technologies are also improving, tying into the first megatrend. Biotechnology has been a major area of development Environmental & Resources – this is part of the global political trend in the west to transition away from fossil fuels towards renewables and technology like battery storage – however - countries that we export our production to, such as China or India aren't beholden to the same regulations, which is why we see the trend of any energy or pollutant heavy industry being outsourced to these countries – This brings out the next megatrend – the western developed nations are focusing on sustainable energy and emissions when it comes to production of economic output - Batteries are essential for sustainable energy, as they store the electricity produced by wind, solar and hydro. Renewables are receiving renewed attention and government policies and subsidies – weather efficient or not – this is where hundreds of billions of dollars are anticipated to be spent in this industry   So these are the four main areas of megatrends - The criticisms of investing in thematic trends – you are buying overpriced growth shares – Purchasing into thematic ETFs can result in buying expensive in vogue share, where their valuations have stretched too far due to people over purchasing these shares – i.e. they can have a negative earrings but be overpriced This is due to the market likely being already aware of the megatrend and hence has already “priced it in” to a shares price – which can often occur overoptimistically Tesla is an example - featured prominently in criticism to this effect in recent years, with many investors saying that Tesla is a “bubble”. This line of criticism is often extended to argue that investors are better off buying into “value” stocks, which are companies that trade on lower price-to-book or price-to-earnings. Or simply buying a passive market weighted index fund like the S&P 500 and not taking any long-term views. This brings up another point - that just because a company's share price looks expensive, does not mean it cannot rise further – this is based around traditional metrics – where if a company has a PE of 40+ it is considered growth – but this could mean that other people still want to buy and the PE rises further As an example - the rise of Afterpay is an example of this dynamic – a company with no PE due to having lost 10s of millions of dollars each period can be valued at the same market cap as Telstra   How to access – you can try and select the share you think is going to do well yourself In my opinion – the better way would be to buy a basket of shares in a megatrend – through an ETF - there are many ETF providers for this form of investment thematic Megatrends can offer investors a lot - But trying to guess what the next trend is and accessing them has not always been straightforward. Previously, investors would have to research and identify the trend themselves, do all the work identifying potential winners, then go buy them With the rise of thematic ETFs over the past few years - megatrend investing has become more readily available Thematic ETFs are a new arrival in Australia and have become a popular tool for investors Thematic ETFs work like the familiar ETFs and index funds: they follow indexes. However, the indexes they track are devised specifically to target megatrends - They can in some instances be built by research houses or consultancies with specialist knowledge of a megatrend. How to select a thematic ETF - When selecting thematic ETFs, investors need to ask a series of questions. First and foremost is about the megatrend the ETF aims to target. Do investors find the megatrend convincing? How sustainable is the growth? And what does the evidence and data say about the theme? You can select an EFT for each specific megatrend – AI to demographics – so do you purchase one, or split between each? Secondly, investors must ask how the thematic ETF targets the megatrend. Does a thematic ETF offer true to label exposure to this megatrend? How does it go about identifying the companies driving a trend? How are they weighted when they are purchased? What is the overlap between this fund and any other funds or ETFs an investor might already have? A good thematic ETF should give true to label exposure, have a process for picking the right companies, and not hug a famous benchmark.   In summary – these investment trends can provide additional growth for the future – but only if the trend continues  Getting the right selection is important – historically this has been hard for an individual to achieve – but in recent times with the increase of professional managers providing these services through ETFs – accessibility has increased – but the issue comes back to identifying the correct megatrend and then relying on the ETF to purchase the correct companies to capitalise on this trend  A google search can give you a list – let you come up with you own decisions – this isnt advice – but some of the major providers are ETF securities, Blackrock with ishares and statestreet are just to name a few reputable providers to look at Thank you for listening to today's episode. If you want to get in contact you can do so here:

    The economics of the Olympics – A golden opportunity or a bronze bust?

    Play Episode Listen Later Aug 16, 2021 25:22

    Welcome to Finance and Fury. As you might have seen, Brisbane has won the bid for the 2032 Olympics – but is this a good thing for the SEQ economy and the people living in it? in this episode we will have a look at the economics of the Olympics – we will Look at the costs and benefits of hosting the games – to see if firstly Brisbane/QLD is going to benefit – and if there is economic gain for being the host –– Lots to unpack here – lets get into it   Introduction - The Olympics have evolved dramatically over time  From going all the way back to the Ancient Greek times – to the first modern games which were held in 1896 Over time – like many things – Olympics became more commercialised – as over the past 60 years, both the costs of hosting the games and the revenue potentials have grown rapidly – but it seems like the costs have growth at a greater rate than the revenues - sparking controversy over hosting the games – as to whether it is of any benefit to the host city A growing number of economists argue that both the short- and long-term benefits of hosting the games are at best exaggerated and at worst non-existent, leaving many host countries with large debts and maintenance liabilities – so is this true? And if so, what does this mean for QLD and Australia at large I've got the data from a few studies – but the main one we will be looking at is – “Going for the Gold: The Economics of the Olympics” – link in the show notes at  Costs Incurred When Hosting the Olympics On the cost side - there are three major categories – 1) general infrastructure such as transportation and housing to accommodate athletes and fans – 2) specific sports infrastructure required for competition venues – 3) and operational costs, including general administration as well as the opening and closing ceremony and security. General Infrastructure – One of the major expenses is the general infrastructure to accommodate the anticipated wave of tourists and athletes that descend upon the chosen city - cities commonly need to add roads, build or enhance airports, and construct rail lines to accommodate the large influx of people as well as build an Olympic Village to host the athletes The International Olympic Committee (IOC) requires that the host city for the Summer Games have a minimum of 40,000 hotel rooms available for spectators and an Olympic Village capable of housing 15,000 athletes and officials. Event Infrastructure - The Olympics also require spending on specialized sports infrastructure. Because of the somewhat obscure nature of many of the events, most cities do not have the facilities in place to host all of the competitions – Think about some of the events, from cycling, needing a velodrome to skateboarding which has been recently added – there are now 41 different sports, of which there are about 340 events all needing different facilities – all of these events and sports need tailored spaces to facilitate the events Additional Expenses - Once the facilities are in place, the Games require spending for operations including event management, transporting and accommodating the athletes, as well as the opening and closing ceremonies, and security So, what does this all cost? An accurate financial accounting of Olympic expenditures in various cities is very hard to find Firstly - It can be difficult to disentangle spending on Olympic building projects from planned infrastructure improvements that might not be attributable directly to the games – such as the Brisbane Airport getting a second runway Secondly – many of the costs are incurred behind closed doors and never fully disclosed – As an example - Submitting a bid to the IOC to host the Olympics can costs millions of dollars. Cities typically spend $50 million to $100 million in fees for consultants, event organizers, and travel related to hosting duties – as an example - Tokyo lost approximately $150 million on its bid for the 2016 Olympics and spent approximately $75 million on its successful 2020 bid But these costs are private due to reforms taken by the IOC – The people of a city don't get a say as much anymore as to whether they wish to host the Olympics – the public used to in plebiscites but in many cases, people voted to not host the games – so what the IOC has done in response is to introduce a reform, one of which is putting all the bidding behind closed doors. They're sick and tired of being embarrassed by cities dropping out. So, the process is now secretive. What are the Benefits of Hosting the Olympics – There are some major categories of benefits that exist in the short term and long term: the infrastructure and employment in the lead up, benefits of tourist spending during the Games; the long-run benefits or the “Olympic legacy” which might include improvements in infrastructure, foreign investment, or tourism after the Games – but also intangible benefits such as the “feel-good effect” or civic pride Short run benefits – Employment, Infrastructure and revenues and the intangibles Employment and spending in pre-Olympics phase - Any large public works project such as the Olympics can lead to a short-run increase in economic activity in the run-up to the opening – but these are dependent on the level of slack in a region's labour and capital markets (i.e. if there is higher levels of unemployment) – and the GDP figures can be inflated by expansionary fiscal policy (i.e. through government expenditure) Many Government forecasts show that the short-term benefits in revenues are higher than the costs of the games - However - these before-the-Games predictions are rarely matched by reality when economists look back at the data the studies show actual economic impacts that are either near-zero or a fraction of that predicted prior to the event. Nearly all of the analyses follow the same pattern. Researchers collect any type of regional economic data that is readily available such as employment, personal income, GDP, tax collections, or tourism figures, and then analyze the data before, during, and after the Olympics in search of any changes that occur either during the event or in the preparation stages – their findings are that there is no real changes I won't go through all the numbers for each of the games – but there can be an initial increase in employment for jobs whilst the construction is going on – but these drop off soon after these works have been completed – so it is a temporary boost at best But this is only really a benefit when employment conditions are considered ‘sack' – the construction and infrastructure industry within Australia is not hurting for work – from clients I speak to in this sector, this is the busiest they have ever been – if things continue then these jobs won't be new jobs – but a re-allocation of existing jobs – therefore little economic benefits will be created – this has been the case in many of the previous games as well – those working on the construction were already employed – the unemployment numbers didn't reduce – due to desire and skills – if you are someone who is unemployed in the hospitality or business sector, are you going to all of a sudden go out and get qualified in contribution and apply for a role in this sector for a few years whilst things are being built for the games? The answer is likely – no! Also – the economic gains through realised profits are concentrated to the construction, hotels, and hospitality industries – many of these can be international companies – so the money flows out of the nation The major potential benefits comes in the form that any basic infrastructure improvements have the greater potential to continue benefiting the cities into the future – such as transportation benefits – Plus - Whatever the bill in the end is - half of the costs are covered by the Federal government and the rest from the state – So if QLD upgrades roads and transportation, the Federal Government covers half the costs initial revenues during the games – These are broadly classified into Broadcasting rights, tourism, sponsorship, ticketing and licensing sponsors, media, athletes, and spectators typically visit a host city for six months before and six months after the Olympics, which brings in additional revenue – plus the influx of people that come into the country for the games - But who gets this revenue? These are split between the IOC and the host city – television rights have represented nearly half of total revenues of the games, with the IOC sharing around 30% with 70% going to the local Organizing Committees. Revenues from international sponsors are split between the IOC and the Organizing Committees, while ticket revenues, domestic sponsorships, and licensing fees are kept by the host city. There is no doubt that money is made through hosting the games – but the question is whether these revenues make up the money spent on the games – because otherwise the state is left with larger debts to service as well as potentially unused facilities costing further maintenance costs, meaning more debt – and QLD already has pretty large debts Another form of economic boon that is advertised is tourism for the economy at large – but is this level of tourism an increase to the normal levels? Tourism - the “crowding out effect” occurs in relation to cities hosting the Olympics – this is when the crowds and congestion associated with a mega-event dissuades other regular tourists or business travellers from visiting the host region – Every host country has seen a significant drop in tourists in the year that the Olympics are being hosted, nullifying any effects that the influx of people that Olympics may have brought with it – regular tourists avoid the area This can bring up another major failing of standard before-the-fact economic impact analysis in regards to tourism – this is the assumption of the multiplier for expenditures – Someone going to the Olympics may have less of a multiplier than a regular tourist – Costs spent on tickets for travel, accommodation and the games are high – accommodation prices increase as well as travel tickets – leaving less to be spent elsewhere Intangibles - While spending directly associated with the Olympics is typically insufficient to cover the costs of staging the Games, short-run intangible benefits must also be considered. Host cities frequently experience a “feel-good effect” both in the run-up to and in the wake of mega-events Long run benefits - First, the Games might leave a legacy of sporting facilities that can be used by future generations. Second, investments in general infrastructure can provide long-run returns and improve the liveability of host cities. A positive legacy of sporting facilities is the least promising of these claims - due to the nature of the sporting events sponsored by the Olympics, host cities are often left with specialized sports infrastructure that has little use beyond the Games, so that in addition to the initial construction costs, cities may be faced with heavy long-term expenses for the maintenance of “white elephants.” Long run issues – Many of these sites are going to be white elephants - The reason why they didn't exist before the Olympics is because there was no economically viable use for them – so once this Olympics ends, this factor doesn't change - Many of the venues from the Athens Games in 2004 have fallen into disrepair. Beijing's iconic “Bird's Nest” Stadium has rarely been used since 2008 and has been partially converted into apartments. General infrastructure improvements clearly have the potential for better returns if they are implemented well – but there is always the issue of the athletes' villages – in most cases these are converted into another use after the games – I have stayed at the Whistler Olympic Village accommodation as it was converted into a hostel – this has been the case with many Olympic villages, where they are converted into dormitories for universities, hostels or other accommodation sites.   Let's look at the estimates for the Brisbane games and compare this to the previous games – The Brisbane bid documents forecast most of the Games income – these are all in 2032 Dollars – the revenue will come from ticket sales of around $1.2 billion, domestic sponsorship of $1.5 billion, broadcasting rights of around $800m, and the IOC would contribute another $900 million – Including other Revenues the total is estimated to be $4.5bn AUD The bid predicts economic benefits of hosting of around $17 billion nationally, with about $8 billion of that for Queensland – This is a pretty staggering estimate – and is likely using some pretty generous assumptions – remember this is against an estimated cost budget of around $5bn The real issue is the cost estimates - Past Games have shown that the final budget for staging the greatest show on earth is many times more than originally planned- The budget has ballooned to US$15.4 billion, twice its winning bid of US$7.5 billion in 2013. And it could be more – audits by the Japanese government are pinning the figure at more than US$25bn to $30bn – there were additional costs due to the delays, but these are estimated to be around $3bn – the major issue for them is the lack of ticket sales and tourism – leading to one of the biggest losses for hosting the Olympics Is Tokyo a stand out in overspending? Looking at past games – Athens 2004 – Cost estimate of $3bn, spent $16bn, Beijing 2008 Cost estimate of $20bn and spent $45bn (most ever), London 2012 - Cost estimate of $5bn and spent $18bn, Rio 2016 - Cost estimate of $14bn and cost $20bn (smallest blowout) – Tokyo - Cost estimate of $7.5bn then spent at least $25bn Minimum blowout of 42%, maximum of 433% - average of around 2.5 times for these games – Going back to Every Olympics since 1960 has run over budget, at an average of 172% in inflation-adjusted terms Why do we expect the QLD Government to be any different? May see a cost blowout from the original bid to be around the $13bn mark – The one saving grace is that Brisbane's bid, similar to that of the upcoming Paris and Los Angeles Summer Olympics in 2024 and 2028 respectively, will focus on reusing existing venues, refurbishing existing sites and using temporary venues where possible (i.e. ones to be destroyed or removed after the games are done). For south-east Queensland, that means using a lot of the venues established for use hosting the Commonwealth Games in 2018 – also instead of the white elephants of Athens and Rio, the hope is that any venue built will also be used down the track – but this is still only a hope – any newly constructed venue is likely to be underutilised   The Bottom Line Hosting the Olympics tends to result in severe economic deficiencies for cities – there are some exemptions however If a city already has all of the infrastructure to host a games and doesn't need to outlay any capital – then the costs will be negligible compared to the revenues – however, as has been the trend, cities selected have all needed to increased their infrastructure and facilities to host an Olympics Therefore - The economic impact of hosting the Olympics tends to be less positive than anticipated - as most cities have ended up falling massively in debt after hosting the games – and many are left with needless facilities that unless they can be repurposed, end up costing the tax payer on an ongoing basis This begs the question - If the Olympic Games tend to offer only a low chance of providing host cities with positive net benefits, why do cities keep lining up to host these events? First, even if the overall effect of holding the Games is typically negative, large projects will still create winners and losers - most bid to host the games are spearheaded by leaders in the heavy construction and hospitality industries – which are the two sectors of the economy that stood the most to gain from the city hosting the Olympics. Second, economic concerns may only play a small role in a country's decision whether or not to stage the Olympics. The desire to host the Games may be driven by the egos of a country's leaders or as a demonstration of a country's political and economic power. As an example - is difficult to explain Russia's $51 billion expenditure on the 2014 Sochi Winter Olympic Games or China's $45 billion spend in the 2008 Beijing Summer Olympics Until you look at these are countries where the government is not accountable to voters or taxpayers, it is quite possible for the government to engage in wasteful spending that enriches a small group of private industrialists or government leaders without repercussions This can also be the case for democratic states that have an disengaged voting base The best situation for a nation the benefit from hosting the games is that the city is a large developed area with a high demand for sports and already existing facilities and accommodation – therefore the costs can be kept to a minimum and the benefits can be in the form of new revenues – If a city is relatively small – such as Brisbane – then the games in the long term can be a total waste Going for the Gold: The Economics of the Olympics - Thank you for listening to today's episode. If you want to get in contact you can do so here:

    What affects demand and prices of property in Australia?

    Play Episode Listen Later Aug 9, 2021 24:02

    Welcome to Finance and Fury. In this week's episode, we will be looking at the demand for property in Australia. If you haven't listened to last week's episode – it may be worthwhile – discussed supply of property in Australia – this week we will be focusing on demand – which in conjunction with supply = the price of property When looking at property price movements – there is an equation to crack – low supply and high demand = price gain e where has limited supply but lots of demand is likely to see some rise in the property price over the medium to long term the reverse is true – if you have areas with high levels of supply – or the potential for supply to increase over time at a capacity beyond demand – then prices may not rise and at worse, actually fall. As part of this equation – it is important to look at not what is happening now, but what is likely to happen in the future – If you are looking at what is happening now – then you will be buying into a market based around current dynamics – which may not hold up in the future – As an example - somewhere with limited supply now, but currently has very high levels of demand is likely to already be very pricey – the issue with buying something that is expensive is the further upside capacity that the property may have can be limited – but let's say that in the future demand stays high, but all of a sudden supply catches up This is often the case if it is possible – due to developers wanting to get in on the high demand So, if you have inner city areas with high demand – then developers are incentivised to develop this region and therefore -supply will increase – this can do so at a greater rate then other areas if there are lots of infill or greyfield sites, which we covered in last week's episode   Demand for property – look at what are the drivers of demand, current state of demand and how to identify areas that will be in demand in the future This comes from people and their wants and need – peoples demand is represented in property in the form of how many dollars someone is willing to purchase a property for – but this one output (of how many dollars people are willing to purchase a property for) has many different inputs – Desire and demographics – The number of Buyers and where are people demanding property – The number of buyers comes in two forms – population growth and relocations within a nation If population growth is high and people are relocating to certain areas – this can manifest in higher demand Centre for Population still expects Australia's population to grow – but it is likely to be 4% smaller — or 1.1 million fewer people — by 30 June, 2031 due to boarders being closed Where people want to live can be very subjective – as people have different desires – but often this will be in a close proximity to work, or retirement lifestyle living, as well as facilities like shops, schools and transportation Desire can also be influenced by emotion – when emotions run hot, in demanded areas – can see FOMO There has been a shift - Looking at demand through a lense of demographic demand - many people have had a chance to re-evaluate their life circumstances over the past 18 months - Offices were shut and remote working took over – inner city retail and hospitality has been dramatically altered - moving forward people may work from home at a greater rate and not be as drawn into cities This means gone are the days where our ‘home' was simply the place we rest our heads and enjoy some downtime between work and our social lives – If you can leave your home and be within walking distance of, or a short trip to, a great shopping strip, your favourite coffee shop, amenities, the beach, a great park That's why choosing the right neighborhood may become even more important – as the saying goes, location, location, location - This is key because it is estimated that 80% of a property's performance is dependent on the location and its neighbourhood. The more liveable a neighbourhood is – the higher the chance of capital growth – but again, only if supply cannot be replicated Beyond the demographics of property – another very important component of demand comes in the form of affordability – how much people can actually afford – if the population has no money, or cannot borrow funds to put towards a purchase, then the price demanded will be lower interest rates are at historic lows – this technically means that housing affordability per $1 is as cheap as it ever has been Remember that this does not mean that properties are cheap by any sense of any metrics – it simply means that for every $1 that you borrow, it is now the cheapest that it has historically been due to low interest rates So you can borrow more dollars and you can afford to pay back this balance due to low interest rates – however it isn't really his simple – as the principal component of the loan repayment also increase The RBA has declared that the interest rate will not increase until unemployment is back to within its preferred range of around 4.5% and inflation is back within a normal band – which may be 2024 based around their forward guidance Demand in the form of affordability can always be viewed as an aggregate – when talking about demand for property – it is important to look at what is in demand and where – as these areas can hold up better if interest rates were to rise As an example, lets say, using some hypothetical numbers, that overall demand declined in NSW, QLD and VIC by around 10% – but what does this mean? That is where it is important to break these numbers down Did demand for apartments and houses decline at the same rate? Or did apartments go down by 20% whilst homes only went down by 5%? Looking at Sydney as an example - Demand for units has increased the most over the past year, with demand for houses broadly flat – why? An influx of first-home buyers, as well and investors coming back into the market in 2021, has contributed to the increase in interest for units When looking at a measure of demand - auction clearance rates are a decent measure to gauge the human emotion Sydney – 79.1%, Melbourne – 77.6%, Brisbane – 81.6%, Adelaide – 89.9% - these are all good measures – but looking forward – However - in many areas – apartments will underperform houses – even if they are in slightly higher demand – mainly due to supply as we discussed in last week's episode – A report by the federal government's National Housing Finance and Investment Corporation (NHFIC) predictednew housing supply would exceed new demand by about 127,000 dwellings in 2021, and 68,000 dwellings in 2022, with Sydney and Melbourne to have the largest excess supply of housing stock – mostly coming from apartment developments Moving forward some areas will strongly outperform others - How do you identify these locations – i.e. What makes some locations more desirable than others? Physical location – locations that are gentrifying and are expected to become good neighbourhoods due to their lifestyle locations This means destination suburbs where there is a wide range of amenities that are within walking distance or a short drive are likely to outperform in the future. At the same time, many of these suburbs will be undergoing gentrification – these will be suburbs where incomes are growing, which translates into people's ability to afford higher levels in prices A good neighbourhood means different things to different people, but there are some key factors that help to determine which locations have the potential to grow in value faster in the future. Generally, a good neighbourhood is determined by the physical location, suburb character, and its close proximity to amenities such as a shopping strip, park, coffee shops, education, and even some jobs. In planning circles, this concept is known as the ‘20-minute neighbourhood'. Many inner suburbs of Australia's capital cities and parts of their middle suburbs already meet the 20-minute neighbourhood tests, but very few outer suburbs do because there is a lower developmental density, less diversity in its community, and less access to public transport. So what to watch out for is up and coming neighbourhoods – those that are likely to go through additional population density over the next 10 years – which is the key driver for more amenities being places in – i.e. shopping centres, restaurants, gyms and transportation Where the overall price comes into it - Supply and demand combined needs to be accounted for As previously mentioned - Rising property prices are the result of Supply and Demand coming together When supply is higher than demand – it is considered a buyers' market – sellers must compete by offering lower prices to attract buyers When demand is higher than supply – it is considered a sellers' market – as buyers now must compete by offering higher buyers Demand looking forward – For the last few decades continued strong population growth and declining interest rates has been a key driver of demand Australia's population has been growing by around 360,000 people each year – this translates into around 180,000 new dwellings needing to be built each year to accommodate all the new households However - 60% of this growth comes from immigration - so in the short-term population growth will fall with boarders shut But Australia's planners think that our population will reach 40m people in the next 30 years – so overall population growth will still be one of the highest in the world Home prices rather hot at the moment – and this may slow down over the next few years – however auction clearance rates remain high and emotions are running high at the moment - with FOMO having become a key driver of property price growth finance approvals are also are at record levels – showing that more people are looking at getting into property at the moment due to low interest rates – but if rates go back up then these approval levels may start to decline For Supply – the concentration of 85% of the population in 9-10 cities has helped condense the new supply coming to market There is no more land supply to add to the most desirable areas to live in as these are currently built out – the only increase in supply in these inner-city suburbs will come in the form of apartments – however – unless you can afford a property for $1.5m + then buying a home in one of these areas may be outside of your price range – therefore you may need to look at outer lying suburbs that are expected to go through high levels of population growth with a limited supply of land – i.e. already built out Australian house price forecasts - Price movements – for 2022 and 2023 – from core logic and Westpac economics – these are just forecasts – there is very small chance they are going to be exactly accurate Sydney – 4% then -6%, Melbourne – 6% then -6%, Brisbane – 8% then -1%, Perth – 4% then -1% and Adelaide – 6% then -2% = so for Australia wide – gain 5% in price then see a reduction of prices in 2023 by 5% It is expected that more expensive areas will outperform – in nominal terms – The current property cycle was initially characterised by all segments of the market rising – other than inner-city high-rise apartments – but some areas have risen faster than others – as the high end of the market has lead growth in property values Looking at some of the data from Corelogic – they break property into 3 tiers – high, mid and low - the high tier is the top 25% of property values in any given region, with mid being 50% of dwelling values and low being the lower 25% Based around these number – the top tier dwelling values are around $1m+ In the recent bull run on property - The top tier saw prices go up by 1.8 times the mid and 2.25 times the low tier property when measures as a percentage – so if the low tier increases by 1%, then the top tier would have increased by 2.25% This is due to many of the factors previously mentioned – areas already built out and in high demand will be more expensive already – but they can see higher levels of capital growth for houses – not apartments – but also for people wishing to upgrade in housing Those already in the top tier were likely not looking to upgrade (i.e. trade in property) – so lower supply of these properties – lead to property price gains Add on the fact that interest rates have been low – allowed for additional increase Summary – it is impossible to tell exactly what the future of property prices has in store – many variables – but you can get a better idea about price movements by focusing on the supply and demand potentials for property - If it is a PPR purchase – then a greater level of emotional attachment can occur with this purchase – if it is the right property for you for the long term, you can afford the debt repayments, even if interest rates rise and you have a decent level of equity for the property (20%) – then buying into a market that has seen price gains may be the correct decision If you are purchasing a property for investment purposes – or to hope for capital growth over the years before trying to upgrade properties – then you can look for properties in areas that you may not want to live due to proximity – but others may         If we are looking at investments – ideally – look for areas which have seen supply cap out but demand yet pick up are potentially areas where prices can rise – this will differ from city to city, suburb to suburb– every city will have different supply and demand characteristics Also - within cities you will see the breakdown of home versus apartments – as we discussed last week, there are different breakdowns between each of these for what the historical average supply has been and where this supply is likely to come from What to avoid would be apartments in suburbs surrounding CBDs – i.e. 10kms out from the CBD Thank you for listening to today's episode. If you want to get in contact you can do so here:

    The future of property supply in Australia

    Play Episode Listen Later Aug 2, 2021 20:46

    Welcome to Finance and Fury. In this episode we look at the future of the supply of property in Australia. We will talk about the availability of land in Australia, look at the population density and supply of developments, as well as what the future supply has in store – assuming that the demand stays constant, then the areas with under supply will see price gains – those with supply abundance will see price stagnation Australia is a unique country – outside of places like Antarctica, or Greenland with massive land masses but with relativity greater areas of unliveable space – compared to many other nations, we have a high rate of urbanisation with high levels of unused land Looking at the land use in Australia – Area KM2 and portion of Australia as a % Land for Intensive uses (mainly urban) 16,822  0.22% Rural residential 9,491    0.12% Australia's population is estimated to be 25.5m - of this population around 86% of people are living in urban areas – This is fairly similar to many other western nations – US is about 83%, UK 84%, France 81% - then you have nations like Singapore or HK – sitting at 100% What is different is the portion of the land that goes towards housing this urban population – US have 3% of the nations land that houses this urban population, and in the UK it is 5% - remember that Australia is 0.22% - or 13.6 and 22.7 times greater respectively So in Australia - Using some simple math – Just under 22m people are living in 0.22% of the nations land mass There are some major reasons for this – First - Large portions of Australia are rather inhabitable - 18% of the Australian mainland is considered to be desert, but about 35% of the Australian continent receives so little rain that large population centres never sprang up there – Fresh water is always important, but also rainfall for vegetation for food and livestock – apart from Antarctica, Australia is the driest continent on earth – so much of our land has reduced liveability But when accounting for the inhabitable land – assuming it is 35% of the continent – then this still means that the land use for urban population is 0.34% - or 10 times lower than the US Secondly - The period of settlement of Australia – focused on the coast and major harbours or river inflows Over time – major cities sprung up – Sydney, Melbourne, Brisbane, Canberra, Adelaide, Perth – but not in the same manner as other nations that have had hundreds of additional years of development in a different technological era – where the population was given a greater chance to sprawl before technology made urbanisation easier – Urbanisation is only possible in developed countries due to technology Transportation and infrastructure, as well as water and food supplies used to be the major issues for having large sprawling cities Transportation and infrastructure – cars, trains, buses, roads – sewage and power – all important to house millions of people in a dense urban area Water and food – the ability for people to live in cities is a hard logistical task - this does come back to transportation and infrastructure – how do you produce enough food and provide enough fresh water to people in the millions – but then you need to transport this into city centres – just in time supply chains Because Australia was starting to grow in population when these problems had mostly been solved – there was no need for population sprawl like in many other nations where the burden needed to be spread out before technology and innovation took over – When comparing Australia to other nations with larger levels of land supply – this starts to become obvious – Big cities – London makes up 13.5% of the UK population, or New York making up 2.5% of the US population - but Sydney makes up 21% of the population of Australia This limited supply of land surrounding these major cities when accounting for demand is a large part of why the price of property in London, New York and Sydney is higher relative to many other cities in these respective nations Where does this leave us as a nation when it comes to property supply in the future – We have a massive potential to achieve property affordability in Australia when compared to a nation like Singapore – but not in a practical way based around the way that we live, or want to live If every person living in cities moved to rural areas, we would see more of a normalisation of property prices i.e. the price of rural properties would rise, whilst CBD prices would decline – on average property could become more affordable - But as previously mentioned – this is not how many people want to live – most people need to be close to their place of employment or alternatively, wish to have the lifestyle that a bigger city affords – therefore, people wish to live close to cities – hence to help with population growth and demand for property, additional supply needs to become available When looking at the property supply development – what are the options to increase the supply of land? more realistic expectations and what town planning is likely to focus on is considered grayfield, greenfield brownfield and infill development – Grayfield land is economically obsolescent, outdated, failing, or underused real estate assets or land. name coming from the "sea" of empty asphalt concrete that often accompanies these sites – we all know these types of areas – run down places with lots of older industrial sites/sheds that has seen prices go up Many of these areas used to be formerly-viable retail and commercial shopping sites but have suffered from lack of reinvestment and have been "outclassed" by larger, better-designed, better-anchored malls or shopping sites - major tenants have vacated the premises leaving behind empty shells – or they are currently rented but the owners offer large prices to buy up these premises Similar to greyfield – we have Infill development - within an urban community, it is the construction on any undeveloped land that is not to be considered on the urban margin We all have seen this type of development – a developer buys 2-4 old properties located in an inner-city suburb and puts up 100 units in their place This development could also be called "land recycling" Infill has been promoted as an economical use of existing infrastructure and a remedy for urban sprawl A greenfield is an area of agricultural or forest land, or some other undeveloped site earmarked for commercial development, industrial projects or other construction projects. Around 20% of Australia's land is Nature conservation and other protected areas (includes Indigenous uses) – this area is not going to be available for greenfield – but with the right regulations – many other areas of supply could be opened up When driving outside of cities – you can often see lots of available land – if it has trees on it or is open fields – assuming that it isn't already owned by a private individual – this would be considered greenfield Many housing estates come into existence through greenfield development – but these can take a number of years longer than to infill - master-planned community such as major housing estates can take between 12 and 14 years to complete – this is from the initial developer purchase of the land, to regulatory planning, all the way to the first person moving in So, the options will be between green, greyfield and infill development for city areas Greenfield developments – housing completions – most often in new estates outside of the CBD – in outer lying suburbs – often 30+ minutes' drive to the city centre Greyfield and Infill developments – multi-unit completions – these will be the supply of property within the CBD radius   Areas around Australia – Stats from Urban Development Institute of Australia Sydney – Long run average is around 31k p.a. of new residential market supply Since 2016 – supply has been above the long run average – But this average is broken down between greenfield housing completions and multi-unit completions – at the last update: greenfield housing completions – 8k multi-unit completions – 27k The supply of units to houses is very different – many more apartments being completed Melbourne – Long run average is around 38k p.a. of new residential market supply Since 2016 – supply has been above the long run average – greenfield housing completions – 18k multi-unit completions – 24k Units to houses are closer – more units than houses Brisbane and SEQ – Long run average is around 19k p.a. of new residential market supply Since 2015 – supply has been above the long run average – greenfield housing completions – 11k multi-unit completions – 11k Almost a 50/50 ratio between houses and apartments Adelaide and Perth are similar – both see a fairly even distribution between houses and apartments Like Sydney – the ACT stands out for apartment completions – but the total completions are vastly lower – the long-term average is around 3.8k – of those 800 are greenfield and 3k are apartments Looking at these trends and how to apply these to what this means for Property prices – when demand outstrips supply – prices will rise for property – but when supply outstrips demand – prices will fall This supply can be broken down into houses (both existing and greenfield) as well as apartments (infill) The future of housing property – limited supply close to the CBD - and uncertain demand So in other words - Greenfield and infill will bear the brunt of property availability for major cities moving forward when it comes to homes and apartments However - The closer to the city you get, the higher the probability that it is either greyfield or infill As For apartments – greyfield and infill development will be where the supply of these properties come from For the increase in supply of property in homes, this will come from outer lying suburbs What to look for and what to avoid – purely looking from a supply perspective – Available greenfield and greyfield areas need to be paid attention to For homes – if you are buying a home in an area with a lot of available land surrounding it – then there is a higher chance that you may not see any capital growth for a while until the land is fully developed For Apartments – if you buy an apartment in an area with either a lot of old run down homes, or commercial sites that are looking a little old – there is a chance that many new apartments can spring up around you This equation is more detrimental than for residential properties – as a few residential properties or one commercial property can turn into a hundred+ apartments If you are looking for capital growth – it is best to avoid areas/sites that can be developed with increasing the supply of property – i.e. increasing the residential capacity through multiplying the number of houses from the same land supply This is mainly relevant to apartments – if you have a block of land in an area (with a house on it or not) that it is hard to increase the supply of land – i.e. everything is already built out on – then this can see capital growth Suburbs with limited available land and new houses, i.e. not derelict properties – that are closer to the city and do not have the capacity to be built out – these can rise in value – or at least maintain much of their value – The sector that is unlikely to grow in capital value – assuming demand stays constant – are apartments – the supply can outstrip demand easily compart to greenfield – For greenfield projects – as time goes on, you need to start looking further and further out from the CBD as the land supply gets soaked up However – for greyfield or infill projects – you will find this land often within 5-10km of the CBD – the maths for this exchange doesn't bode well for supply versus demand – think about turning 2-4 properties into 100 – this only works if you own one of the properties being turned into the 100 – as you can command a higher price – but if you own an apartment in the area and now this is turned into one of thousands – then the supply can outstrip demand – which means that there are few people who can demand your property This is just one side to the equation – need to look at demand – which will be covered in next episode Thank you for listening to today's episode. 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    Is the share market at risk of de-risking?

    Play Episode Listen Later Jul 26, 2021 20:12

    Welcome To Finance and Fury. Is the market at risk of de-risking? Bit of a mouthful – but over the past 12 months the share markets has been going on a run with higher flows of capital going to higher risk shares over those that could be considered defensive shares – those with lower historical risks due to the backing of fundamentals, such are earnings In this episode – we look at the cycles of share markets – looking at the longer-term trends of periods of risk taking and periods of risk avoidance – in which prices of different segments of shares can move independently from the overall index price movement – index may be going up but segments of the market can decline in prices As previously mentioned, certain sectors of the market have performed very well over the past 12 months – Tech sectors, financials, commodities and other highly leveraged share sectors have performed well - This has seen segments of the market start to underperform the index in Australia – as a massive chunk of the ASX is made up of the banks and commodity companies – in the US, the upper end of the index is tech companies and financials In Australia - Under performance has occurred in the historically lower risk segments of the ASX – communication services, industrials, utilities, Health Care, even Gold mining companies – whilst these companies are all incorporated in the ASX index, it means that other companies have outperformed by a larger margin If the index is 50/50 split between lower risk and higher risks segments, and the index has performed 20% over the past 12 months – in reality any combination of returns could have occurred to get this aggregate outcome – however – let's say that higher risk shares have provided a 40% return, whilst the lower risk segment have provided 0% returns – then this means the index would have performed by 20% over this timeframe – in hindsight, where would you have wanted to be invested? The lower risk shares, the index, or the higher risk segments of the market? Obviously, the high-risk segment But what about looking forward? Can these higher risk share categories constantly outperform? Markets have cycles – ups and downs – the nature of market volatility – But these ups and downs of the market are viewed as an aggregate of all shares in all sectors when viewed as an index – but what makes up the index? Thousands of individual shares When separating out the underperforming companies to the over performing companies, the ASX has had an incredible return – especially over the past 18 months Growth/Risk companies have returned 70% over 18 months Value shares have returned only 8% over this same time period – this by itself is a below average return, but when compared to growth companies, it is a significant underperformance The prices of shares is based upon the behaviours of the investors in the market – The price responds to inputs – the number of buyers and sellers in the market – which can be broken down further into economic human action which is actuated to what is anticipated Praxeology - is the theory of human action, based on the notion that humans engage in purposeful behaviour, as opposed to reflexive behaviour (like increasing saliva in your mouth when you see food and are hungry) and other unintentional behaviours (like slipping over on ice) People want to make as much money in markets as possible – so when economic dynamics are present – the market is anticipated to respond in a certain manner – therefore, people change their investment positions around this, and the price of these shares change – how much of this is a self-fulfilling prophecy is anyone's guess – regardless, the historical numbers don't lie When it comes to investing – whilst emotions can be the catalyst to your response, which may not be rational or in your best interest, people believe that they are responding with purposeful behaviours when investing – that is to make the most money possible – or to avoid losing money – even if the end result does not work out in this manner – i.e. you end up losing money – you still are acting in a purposeful manner – even though it may not be rational or work out for us in the long term - we have myopic risk aversion built into us epigenetically There is no such thing as perfection – a humans we will always get things wrong – but our behaviours to help avoid further losses in markets is to follow crowds – if everyone is selling and we aren't is there something wrong with us? Do we not know something that they do? Our brains then think that obviously, they know more than us, then this means we also need to sell – which locks in potential losses in the portfolios This is the issue with human behaviours in the market – because the market is millions, if not hundreds of millions of investors participating in the selling and purchasing of securities which are publicly available to anyone So in the end the price of any share comes down to the sentiment of the market – supply and demand – When markets are hot, they are hot – when they are cold, they are cold – this cycle follows human responses to the inputs provided to the market – i.e. all publicly available information which translates into market sentiment But this behaviour translates into both rational and irrational investment behaviours – when greed is prevalent in the market, fundamentals are thrown out the window – therefore risky companies do well – but when sentiment turns, then investors can have the realisation of their precarious positions – want to exist these and seek other unloved investment opportunities Average cycle from 1955 for the S&P500 index – full cycle is around 70 months or just under 6 years – this is the average, some go for 50 months, some for 100 months The share market can be broken down into two share segments – PE expansion companies and EPS Growth companies Remember - When I talk about the market – I am talking about the millions of buyers and sellers that exist – who each are making their own decisions on whether to purchase a security or not Phases of the market cycle – four phases, despair, hope, fundamental and optimism Despair – this is the stage where the market sentiment is basically in despair - investors which make up the market are worried about losing money on their investments, so they are selling – this creates a situation where prices on listed securities decline – when you have an excess in supply of sales orders, the prices will decline – often quickly when not money people are willing to purchase in this period of despair – this cycle normally lasts around 13 months Drawdowns – historically the market has declined by 26% PE Expansion companies have declined by 23% and EPS focused companies declined by 3% So the brunt of the market decline has been due to Growth companies, with value companies seeing lower declines Hope – this is the next phase that the market enters into after the initial despair – that is hope that market returns will become positive once again – but there is little fundamental reasoning for this – lasts on average for around 11 months Therefore the shares that do the best in this period are those that investors are investing in our of hope – i.e. those that do not have much basis in regards to logical reasoning why people should be purchasing them As an example – let's say that a company is expected to grow their earnings 20% p.a. for the next 10 years, this would sound like a great investment – but what if they are starting off at a point of a negative $200m of net earnings – then after costs they are expected to break even in 10 years' time The price of this share going up massively in this period is an example of hope – the hope that the projections of this company become manifest – these is a chance they do not, there is a chance that they do, but investing in a company today that is losing money to see potentially bigger earnings growth in 10+ years is an example of hope – investing out of hope that a company will do well in the future even though it is losing money today – the issue with this is that anything can happen in the market – this company could be out competed and replaced by a competitor – or their costs go up, or revenue growth is now what was estimated – therefore, the investment into this is purely based on hopes of major returns in the future – The more people invest in their period, the greater the overall returns to companies will be – i.e. the more hope there is in the market that we are out of the worst, the better the overall returns because more investors are willing to sink their money into the share market PE expansion companies do really well in this period compared to the market returns – the market returns have been 32% - whilst the PE companies have been 42% - which means the fundamental companies are sitting at a negative 10% returns This creates a situation where if you were investing for fundamentals, you would have been sorely disappointed Fundamental – this is where the market starts to regain some sense of pricing and focus on what matters – earnings and underlying performance of companies Risk is attractive in periods of high hope – but the fundamentals begin to matter more when hope in the market has gone When market fundamentals matter and clearer heads prevail, then the focus on fundamentals become more prevalent in markets The market is still up in this period – at a total level of 34% - but Value companies account for a return of 54%, whilst growth companies are at a -14% This cycle of the market is the longest – at 32 months Optimism – when the market is getting into the late stage of the cycle – when the price gains of the fundamentals companies outstrip the reality, people think that the tough times are over, and that things are looking up for the future - In this cycle – the market tends to move by 25% and last for around 14 months The PE companies grow by 23% of this and the EPS companies grow by only 2% - fundamental companies no longer justify the prices based around their cashflows and the previously unloved PE companies are back in favour Optimism prevails for around a year – before the cycle repeats Then the despair kicks back in and PE companies crash whilst value companies decline as well, but not by the same extent – important to point out that these timeframe have been the average over the past 66 years, doesn't meant that every cycle is the same – some may see much longer periods of despair, like in the GFC, or shorter periods such as at the start of 2020, where despair only lasted 3-4 months instead of 13 – But what is important is understanding the cycles – every cycles timeframe will be different – every returns for each segment will be different in absolute terms – but what will be the same is that when thing are in despair, value companies do better than growth, when hope is present, growth companies do better than value, when fundamentals are important, value companies do best and then in the final stage of optimism, growth companies do well again Certain shares do well in certain cycles – In only two stage of the cycle do fundamentals do well – so 2/4, or 50/50 are fundamental shares outperforming - but it is for the longest period of time that they do so, which makes up around 64% of the cycle Risk and High beta shares do well due to emotions in the market – not realities – they also suffer at the extreme ends – The largest downturn for fundamental companies is -10% during the hope period whilst the market is at an overall positive return – however growth companies lost 23% and 14% in the despair and fundamental period respectively, which underperform the index significantly Where does the market currently stand? It appears that we are still in the hope period – but we may be nearing the end of this stage in the cycle – This means we may be soon be entering into the fundamentals period – timelines are off – but the return comparisons in magnitudes and market cycles are still on point There was a despair period back in march and April of 2020 – hope soon took over, which has lasted for the last 12-18 months – now things are starting to calm down and due to economic realities like inflation and potential interest rate increases, fundamentals are now more in focus When fundamentals become important – however, the timeline will likely be off this time – the growth companies may continue to shoot the lights out – but if the market starts to turn, the things to look out for Value – Assess the expected cash flows and earnings, dividend payments Enterprise value and book value Intangible elements – management and brand Quality – prefer higher quality companies with proven business models (not start ups with no market share or proof of concept for their product) Resilient and financially robust – and have higher operating efficiency Sentiment - An improvement in the expectations Can this relate into higher expected flow through into better earnings and cash flow, dividends – leading to capital growth Risk – are they lower volatility Lower sensitivity to the market (measured by Beta) Or a purchase that allows additional portfolio diversification Summary – Whilst growth companies have outperformed value companies in two of these periods including the current one we are in, not only do value companies have a greater time period being positive, they also avoid the long term declining trends when markets have a downturn From here – there is a high chance that fundamentals, value companies will become in favour with the market What could drive the risk rally further from here is a lowering of the cash rate and a general optimism in markets that the economic reality doesn't match – however this is totally possible – But at some point this trend of hope will fall flat – leaving the currently in vouge share susceptible to a decline The risk rally can continue – but the better place to be in risky assets based around historical data is the non-hope assets – those that have earning backing them, and can provide some basic utility to society Thank you for listening to today's episode. If you want to get in contact you can do so here:

    The freedom in financial freedom

    Play Episode Listen Later Jul 19, 2021 19:20

    Welcome to Finance and Fury. What does your future have in store for you? It is hard to say exactly – so instead, what does your ideal future look like? You might be thinking about next year, the year after that, or 20 to 40 years in the future – Let's say that in regards to this question – think about once you have achieved financial independence – i.e. finished your working life and are retired – where are you, how are you living, what are you doing and how are your funding this? Have you become a grey nomad, are you living by the beach, spending your time playing golf?    This is a big question – if you have never really thought about this before then you probably can't form a good mental image of this without taking the time to think about it – In this case, it may be worthwhile to stop listening now and spend some time to figure this out – if you need help, or some templates, we have some at the website – – register to the members section for free and get all the handouts and tools But if you do have your ideal picture of what your financial independence looks like - Everyone listening to this will be different in what they are picturing – having a different idea about what they want to do in retirement, how much this will cost them, and how they are going to fund this – some people will want $300k p.a. and other will want $50k p.a – I see this in my daily life in advising clients – everyone has different wants and capacities to achieve this This difference is great – everyone has different desires, dreams, things that make them happy – as well as financial recourses to turn their goals into a reality – as an individual, you have the right to choose how you live your life, both now and in retirement But as an individual, your ability to achieve your desired outcome really comes down to your freedom of choice – which comes from the freedom that society allows the individual to have – where the laws of a society are dictated to us by Governmental powers Your freedom to choose what you want to do – your ability to choose where you live, how you travel, what you do with your money are all incredibly important when it comes to determining your own financial freedom You also have the freedom to choose how you will fund this – though business, personal investments, superannuation, property – but all of these are subject to legislative risks – if the government that you live under doesn't allow property rights, or you to own anything, like North Korea, then you are out of luck – you will never have a retirement as the state isn't going to fund your retirement, and you have no capacity to accumulate wealth towards your retirement – as private ownership is outlawed – you work until you die, scraping by every single day in an effort just to feed yourself This is where Freedom is important – if you had no freedom of choice and had to rely on a centralised entity deciding for you, where if the state has the power to give you everything, they also have the power to take everything away from you But this is why we are lucky to live in this country – we have one of the most generous social security schemes in the world – but on top of this we still do have incredibly high levels of investment and financial independence freedoms – this makes me very appreciative when looking around at what is happening in other countries around the world - look around at most other nations in the world – Cubans are protesting in the streets for their freedom – they have been living under communism for decades and want their own self-liberty South Africa turning inwards on itself through rioting which is destroying economic infrastructure which will further exacerbate their economic decline with supply issues of the basics, like food, medicines and energy Or North Korea as previously mentioned, or Venezuela – where 90% of the population lives under severe food shortages – the average population lost around 11kg in 2017 alone – but those at the top live very well – not like an economically free nation, it is purely the politically connected and politicians themselves that live well – due to the centralised nature of the state   What is happening in these countries is a stark reminder that no matter how free or economically powerful a nation once was – there is always the ability for it to slide into decline with governmental central planning – but also how lucky we are to not be living under a completely centrally planned economy There is one simple test to determine where the best countries to live are – look at where people want to move – nobody is trying to emigrate to nations with highly centralised governments – people are trying to flee these nations There has been a common trend through history – the only walls communist/socialist nations have ever had to build are those that are stopping people from leaving – which again limits freedom of movements Freedom to choose is the most important thing for you to be able to achieve your financial independence – But the more power the state is given, the less your freedom of choice inevitably becomes I love freedom – but I have to work within reality – there is no free society – that is basically anarchy where there is no government and no centralised laws – in which case society would fall back onto the non-aggression principle There has never really been a society with no government system – even small tribes acted as mini-monarchy's – with a tribal leader – Based around the current government systems of democracies in most of the developed world – There is a score of the Economic freedom index – done by Australia is one of the highest-ranking countries on this list Property rights are cornerstone of any economic freedom in my POV – i.e. you legal right to own assets This comes down to having a strong legal framework that protect property rights, and a robust rule of law mitigates corruption - When the enforcement of your rights is high, expropriation is highly unusual, and enforcement of contracts is reliable Compared to other third world nations - The judicial system needs to operates independently and impartially and can enforces laws against bribery and corruption effectively when they are discovered Sadly – Australia has been declining in property rights since 2015 – we were at 90 out of 100, but we have dropped down to 81 out of 100 – still very good when compared to many other countries – but this declining trend if it continues means that in 30-40 years, we may be no better off than many other nations currently experiencing economic worries Under a democracy - Your freedom isn't normally reduced significantly overnight – it is done through one piece of legislation by another over years – every new law introduced technically mitigates the individuals' rights – remember there are around 180 new laws and amendments to laws in Australia that occur every year Negative rights, or as the US constitution states, God Given rights – actually date back to the natural rights based around the Greek philosophers works – in the US constitution it is stated as “Life, Liberty and the pursuit of Happiness” – which are seen as inalienable rights which all humans are born with, and which governments are created to protect Instead – the thing that many people are worried about is that it is the governments that are infringing on these rights as opposed to protecting our rights When it comes to your own inalienable rights – I believe that anyone who works and puts the resources needed into themselves should have the right to retire exactly how they wish – if they work towards this then you should be able to achieve your desired goals, but based on your own economic reality This isn't to say that someone who has never work or never invested has the right to retire to a multi-million dollar property on the coast and get $250k p.a. in passive income at the tax payers expenses – but based on my experience, more people have pretty achievable retirement goals - But if someone has done everything right, through planning for this and directing the necessary financial resources to this goal then they should have every right in aching this This boils down to the real issue - getting off the system is almost impossible unless you work at it – if you never worry about where you will be financially in 20-30 years then you may have a problem – where the state determines what you are entitled to But using the system that is in place to better your life through using our economic freedoms shouldn't be taken for granted – it should be something that is taken advantage of and used on a daily basis - My only concern for people being able to achieve that goals over the long term is that property rights are taken away – such as a communist system for anyone to achieve their desired outcome in relation to retirement – they need to own something – otherwise they are living off the state and hence living the lifestyle subscribed to them by the powers that be The issue is that under any state where people aren't allowed to own anything, there is no funding mechanisms for social security – i.e. taxation or a government that can print money without hyperinflation the economy – in other words, not living in a centrally planned economy However – where we currently sit - As long as property rights are retained – there is still a lot of freedom that you can take advantage of – When comparing Australia to countries like Cuba or South Africa, Venezuela, North Korea – is much better off – better take advantage of it and not take it for granted – not taking this for granted is one of the most important points of this whole episode – When people think that they are hard done by, or deserve more – they turn to the entity that can provide them with what they want – in private employment – this is your boss – you ask them for a raise and if you are producing more than your output then you deserve this – however, in a democracy then for those who are not working or willing to allocate a portion of their income towards their futures can turn to the government as the solution to their problems The issue is that the more people rely on the government – the more they give away their own individual freedoms and ability of choice – the more this happens the less freedom the population is given when it comes to achieving their desired goals This episode isn't meant to be as pessimistic as it sounds – because there is a way out of this at the individual levels At the societal level – I have no idea if there is a way around the slow reduction of economic freedoms – democracy is always going to shift towards a system of having greater government controls – the more a government control the more they can promise – governments have something that people want, so they vote them more authority to provide this – it is a cycle of all nations/empires through history – they rise and they fall – this is something that is outside of our individual control But as individuals – we need to come up with our own gameplan – we cannot rely on the government to determine what we need in our daily lives – they have never met us, and as we opened the episode on, everyone's needs are different – hence no one policy or level of social welfare can provide what is needed for the population at large – as this is made up of millions of individuals One of the greatest quotes which hammers home this fact is by Thomas Sowell - "No one will really understand politics until they understand that politicians are not trying to solve our problems.  They are trying to solve their own problems - of which getting elected and re-elected are No. 1 and No. 2.  Whatever is No. 3 is far behind" This is where everything comes back to Creating your own freedom – within the legal framework provided to you by the government - This comes in many forms depending on how you go about this – your ability to gain financial independence, do what you want, is reliant on you - The first step is to Find out how you wish to spend your time – and how much this will cost – if your current lifestyle is what you are comfortable living with, then great – if not, what would it cost you to do what you want? The rest of the planning is centralised around this point of reference – the end target to achieve your retirement goal Then - Focus on what you have property rights over and Get into the game – To break this down further - Look at your goals – lifestyle requirements and passive income requirements Lifestyle – Everyone needs somewhere to live – which comes back to owning a property – This is a big one – property prices are high – the only thing that can bring these down if you don't own property is a major increase in interest rates, but central banks/Governments don't want this to occur – so getting into property has priced many people out of the market – but getting in is still important – if you don't currently own property, set goals to achieve this - Mainly for Self-sufficiency – Passive income – investments and retirement assets – this helps to build your own self-sufficiency to become independent from needing to work or requiring government assistance Financial independence is great – but there are two major issues with this – price inflation and shortages – These go hand in hand in a way – shortages create price inflation, but price inflation creates shortages in what you can afford – which means your passive income and investments don't provide the same level of consumption as they would in today's dollars – normal inflation of 2.5% p.a. should be accounted for anyway – there are tools on the website to help with this – but if inflation is 5% p.a. instead, or there are a few years where inflation reaches 10%+, this can reduce your purchasing power I aim to keep my expenses down to a minimum through becoming food, water and energy independent over the next 5-10 years – this means that we can be less reliant on my financial resources in the worse case event that we suffer a severe economic downturn The end game – what to do in your own life - Focus on high-value priorities and goals – then work out how to get there But the most important part is don't take for granted the freedoms we currently have to build wealth – there is no financial freedom without having freedom in a society Seeing people currently trying to escape nations where there are no economic freedoms is a reminder that we have things pretty good – and that they have a view that they are entitled to the basic freedoms we take for granted – as opposed to thinking that we are entitled to other people's money – which over 50 years could lead to a system where governments are given the power to strip all economic freedoms away from people Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Can investing using environmental, social and governance scores help to outperform the market?

    Play Episode Listen Later Jul 12, 2021 20:50

    Welcome to Finance and Fury - Is ESG investing the way of the future and good for your portfolio? Within the last few years, large publicly listed companies and investment managers investment are really paying attention to what is known as an ESG score – which stands for environmental, social and governance – it is meant to be used as a determinant on the sustainability of investments – the concept of sustainability it is growing in prominence in every sector of the economy, but particularly within institutional investments and publicly listed companies   In this episode – I want to look at what is ESG, how it is determined and scored, and can following this trend and only investing in ESG companies help your bottom line when it comes to long term returns?   To take a step back – society has been moving towards greater levels of sustainability and environmentalism – with this shift – Publicly listed Companies are becoming concerned with where they fit into this – as well as investment managers wishing to purchase these companies if you are a fund manager investing in a weapons manufacturing company, is this an ethical investment based around ESG metrics? If it doesn't score well and your mandate determines that you cannot invest in low scoring companies then this would have to be excluded from your portfolio – even if the world is going to war and Raytheon is about to make a lot of money But from Raytheon's point of view – you want to be considered by professional investment managers to be an ESG company so that that institutional money can flow your way – because if you are cut off from that market, your share prices will suffer and you would be failing your duty as a board member to maximise shareholder value – i.e. providing returns to shareholders So major corporations are becoming very engaged with the parties that provide ESG scores to help not only incentives further investment in their business – but also to help determine from an outside/institutional perspective if the company is worth investing in – as public investors have shown an interest in putting their money where their values are – This has also seen the rise of many managed funds, brokerage firms, and ETF providers offering products that employ ESG criteria as the sole determinant for investment decision making – people want these products so the market is providing to meet this demand – but does following ESG scores as a criteria for an investment strategy actually work for a long term investment strategy?   What is ESG - Environmental, social, and governance criteria are a set of standards for a company's operations Environmental criteria consider how a company performs as a steward of nature - can include a company's energy use, waste and pollution, natural resource conservation, or treatment of animals criteria can also be used in evaluating any environmental risks a company might face and how the company is managing those risks - For example, there may be issues related to a company's ownership of contaminated land, or its disposal of hazardous waste and management of toxic emissions, or its compliance with government environmental regulations Social criteria examines how it manages relationships with employees, suppliers, customers and communities Does it work with suppliers that hold the same values as it claims to hold? Does the company donate a percentage of its profits to the local community or encourage employees to perform volunteer work there? Do the company's working conditions show high regard for its employees' health and safety? Are other stakeholders' interests taken into account? Governance deals with a company's leadership, executive pay, audits, internal controls, and shareholder rights. A big one I have seen is ethics of the company, board composition and transparency – does the company uses accurate and transparent accounting methods and that stockholders are given an opportunity to vote on important issues? Do they have a diverse board, or is it all old white males? Are there any conflicts of interest in their choice of board members, do they use political contributions to obtain unduly favourable treatment, or do they engage in illegal practices? ESG investing is sometimes referred to as sustainable investing, responsible investing, impact investing, or socially responsible investing – however – this is very similar to CSR - Corporate social responsibility   Based around these criteria - an ESG score is calculated – An organisation's ESG score is a numerical measure of how it is perceived to be performing on each of these criteria – Each of the Environmental, social, and governance criteria are given an individual score then it is combined into one The key word in this score is ‘perceived' - An ESG score is calculated based on how an organisation is seen to be performing – that is, how its behaviour relating to ESG issues is reported – not what it is actually doing behind closed doors Just as with the building of corporate reputation, there is a gap between reality and perception. While a business may have a strong policy around carbon emissions and waste reduction, or a system of transparent, performance-based promotion, if that information is not in the public domain, it won't impact its ESG score. Alternatively – if a business has a face value of supporting every social movement whilst enacting policy behind the scenes that is antithetical to these values, then this is not picked up in these scores - ESG scores don't necessarily reflect the internal reality of a company - as ESG scores only measure how corporate behaviours are reported and the face that they put on to the public Therefore, a reality gap exists – and poses a risk – as if you are basing investment decisions purely around an ESG score, then this not meet your investment desires if you are trying to invest in a socially responsible way Let's have a look at a few examples – when comparing the ESG risk scores Disney – they have a wonderful public perception – and own a massive chunk of media and merchandising rights – theme parks, movies with the rights to Marvel, Star Wars, media as well, like ABC in the US – they also have merchandising rights, so many toys are marketed and made – where are they made? Well, it has become apparent that it may be slave labour – through internment camps in China – So – based around the issues with the use of Chinese free labour – how would they rank? Pretty poor you would think - ESG Risk rating is Low based around the official metrics – 14.9 – Actually a lower risk than Netflix – they are given a ranking of 87% by CSRHUB – which is an ESG rating agency Another example – Tesla – Most people would consider this company as very environmentally friendly – good social governance – and is great for society at large – on a score of 0-50 – where 0 is no ESG risks, meaning it is the cleanest company on earth with the best contribution to society and lots of diversity in the board and management – where would you place Tesla – 10? 20? – well it is 31.3 – which is high risk – CSRHUB gives them 38% out of 100% But good news – BWM, or Daimler are all lower – 27.7 and 25.2 - CSRHUB gives Daimler 87% To put this in perspective – BHP has an ESG risk rating of 30.1 – with a 75% rating - so Tesla is a lot lower – even BP Oil got 64% How are these risk scores calculated? Because does it make sense that these companies rank where they do? It comes down to who is doing the scoring - Analysis companies use various calculation processes – but these scores are done at the behest of these companies – If you are a major company, you go to a rating provider, hand over all your information and they come up with a score – some of those scores I mentioned come from Sustainalytics – a subsidiary of Morningstar – one of the worlds top rating agencies - the others come from CSRHUB Due to the individual companies' methodologies – it is actually harder to determine what contributes to an individual score – as these will vary depending on which analytics they employ. Research by State Street showed only a 0.53 correlation between ESG scores for the same subjects between another provider, MSCI's ESG ratings and Subanalytics – therefore there is about a 50% relation between a score on their board, or their environmentalism – so one company that may seem to be an ESG champion on one site, may not be on another This is all due to the fact that ESG scoring is the measurement of perception rather than reality - so ESG data systems can be largely subjective and vary dependent on which company is doing the rating so how does anyone make an accurate investment decision based around these wildly varying metrics? The answer is that you really can't under their current form ESG ratings and scores are often based on voluntary company self-disclosure and partial data. The issue is that most ESG scoring systems from some companies include an analysis from publicly available print and social media content – so if a companies social media profile supports social movements domestically, whilst using slave labour abroad which is not incorporated into the metrics – this company will appear to be a higher rating on ESG than a company that doesn't participate in the same practices, but isn't as active in changing their twitter profile   How does an ESG investing approach help with portfolio returns – Looking at a few examples – Australian iShares ESG fund – Holdings, CBA, CSL, WES, MQG – but then FMG, Transurban, Newcrest, James Hardie – and Xero – so in the top 10, three are mining companies – performance wise this was only created this month – so no data Other Funds – BetaShares has an Australian Sustainability Leaders ETF – 1 year is 17.79%, 3 years is 10.80% The benchmark index of the Nasdaq Future Australian Sustainability Leaders Index – which the BetaShares fund has underperformed by 0.5% at every stage Another Australian Fund is Van Eck - 1 year is 25.02%, 3 years is 10.17% or 5 years of 7.59% In comparison – the ASX300 provided 28% over 1 year, 9.74% over 3 years and 11.2% over 5 years iShares Core MSCI World ex Australia ESG Leaders ETF – Returns of 30% over 1 year, 14% over 3 years and 14.5% over 5 years International index - 28% over 1 year, 14.8% over 3 years and 15% over 5 years There is no clear winner – The indexes have slightly outperformed in the long term Can this be a good investment for the long term – as more people start ESG investing? There could always be the issues of "Bad" companies performing very well and missing out on this – However – due to public perception – A company with a higher ESG score may start to gain more traction in regards to investment inflows – especially from financial services companies such as JPMorgan Chase, Wells Fargo, and Goldman Sachs – and ETF providers in Australia The very nature of more money flowing into highly rated ESG companies could be a long-term investment – not for the actual performance of the companies themselves in fundamental terms – but from a perspective of more money flowing into these companies and hence the prices go up Even for one of the largest investment sectors within Australia - Superannuation funds – Their mandates may limit or eliminate non-socially responsible investing We have seen the divestment from Coal within superannuation funds over the past 12 months – coal companies on the ASX are not faring well – most have seen a decline in prices over the past few years – many saw a loss in EPS recently with coal prices plummeting to $50USD a tonne in July 2020 – but it is back to all time highs at $136USD a tonne – so coal companies may actually rebound quite a bit – but this component of return may not be included in the ESG investing Brings up interesting issues – as a super fund their fiduciary duty is to provide long term returns for the sole purpose of their members retirement - choosing investment strategies based entirely on investments classified under ESG and socially responsible investing score could start to lag markets depending on the score allocated to companies Remember – score can be subjective – large companies with a good social presence and the ability to have great PR In summary – If you are going to be investing only in Large cap companies and using ESG metrics – probably nothing to be gained here – they will all have great ESG scoring based around the metrics and how companies determine these scores – Mid and Small cap companies – these may be left unloved by these types of funds – but this is where a large chunk of capital growth comes from the market – Companies at the top that have a large portion of the market shares have limited capital growth when compared to new companies coming in If you are going to invest – then invest – if you are looking for ESG – don't rely on metrics from companies providing these – decide if a company meets your ethical criteria Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    Is high inflation here to stay?

    Play Episode Listen Later Jul 6, 2021 25:17

    Welcome to Finance and Fury - The big question on many investors minds at the moment is if inflation is going to be transitionary, or something that is going to set into the economic framework for the long haul – maybe not for the next decade, but for the next few years at least – if you listen to Central Bankers, the inflation within the economy is transitionary i.e. going to last a few quarters then revert back to normal, if you listen to investment pundits, it is something that could set into the economy for the long haul – i.e. the next few years – so who is right?   In this episode – we will look at inflation – an often-misunderstood concept – because when talking about higher inflation it is important to focus on what type of inflation is occurring – as well as what is important to the economy – so we will look at the core concept and types of inflation, the current causes of inflationary pressures and try to see if this is something that is just going to be a momentary shock to the economy and your purchasing power, or if it is going to be persistent for the next few years and something that could really affect not only your own wallet – but also financial markets due to an increase in interest rates, and potentially a dramatic one at that if central banks need to combat inflationary effects similar to that of the 1980s.   To start with - It is important to define inflation – as many people have different definitions of inflation and what price increases are actually important to them – I talk to many people about this, it is interesting as people see inflation as something different Now - the very definition of inflation as per the government's measurement of statistics is based around price increases of a basket of goods and services – measured by the consumer price index (CPI) – IMO this is not a great representation – the collection of these statistics can be very biased, based on what is included in the basket and how it is collected – there are 10 baskets in Australia - food, alcohol & tobacco, furnishings, health, transport, recreation, insurance & financial services, housing, education and communication – each of these go through trimming (normalising outliers) as well as hedonics (adjusting for quality increases) – so it is a pure measurement of a price increase and is often an underrepresentation to the actual price increases seen An important point is that housing doesn't represent the costs of your mortgage or the price of buying a home – we will come back to this later – but as an example, the CPI for housing is a negative 0.9% over the past quarter – whilst the price of timber and construction has increase massively over this time period – so take this with a grain of salt What are these price increases, being measured by CPI representing? Goods and services we buy from private companies – which aim to be competitive – a company in a competitive environment won't increase their prices just because money supply has increased – if they do, they will lose business to other competitors – assuming the market is competitive But what creates price increases? Does a company want to charge as much as possible and make a profit? Sure – but what creates a situation where this is not possible? Competition – the more supply on the market allows for competition between distributors, so monopolistic prices cannot be charged (which are always higher than that of a free market economy) Market prices of supply and demand – Particularly at the moment, looking back over the past 18 months – coming from Supply shortages – What have we seen over the past 18 months – small business being shut down – small business has always provided some form of competition in supply – remove this you are left with only an oligopoly of suppliers, especially in the distribution services – on top of this there has also been the issue of direct suppliers, those producing the goods, like farms which have seen shut down – this creates a situation where less competition is present in both the production of goods as well as the supply chains which distribute these goods Also, you have Increase cost to businesses – labour costs of employment have been a major point of contention over the past year since government unemployment benefits kicked in – the best example of this I have seen has been in the US where there is no federally mandated minimum wage – Unemployment benefits equate to around $15USD per hour – so if a business is going to hire someone for $15USD to fill a role, would you take this role if you had to work 9-5, 5 days per week? Do nothing or work full time for the same salary? This brings up the economic cost of your time – say a role was advertising for $17 per hour, would you then work for a benefit of $2 per hour? When compared to not working - probably not – it is the equivalent of trading your time for $2 per hour – a business would need to offer well above market rates to employ people to get the people they need to operate a business – this increases the cost to the business – which leads to an increase in prices being passed through – I have seen some stories from the US where hospitality services like MacDonald's cannot find anyone to work – so they need to offer higher salaries – which results in higher prices of goods provided This beings up the concept of Productivity – for every dollar invested, what is the return in business – if you are spending $1 then as a business owner you hope to see at least $1.01 in return – however with additional costs of labour over the current economic cycle, this reduced this capacity for business owners to turn a profit – due to a situation where businesses were shut down for large chunks of the year, hurting their supply potential, but then when they are allowed to re-open, they are now competing with the government in the form of unemployment benefits – this further compounds the effects of a restricted supply – so assuming demand stays the same, this allows those remaining companies to increases their prices – not only to compensate for the loss of revenues (if they have had any, because large companies have not seen this) – but also to account for the increase costs to the business - On the other hand – you have monetary theory of inflation - which states that the increase in the money supply will lead to an increase in inflation through reducing the purchasing power – the more money there is, the less valuable each dollar is This is true –when the money supply has a limiting factor, such as under the gold standard – i.e. where the increase in the gold supply would lead to inflation through a reduction in the purchasing power of the population directly – as you used to be able to convert your paper money for gold – but also when the monetary supply increase is distributed equally to the population The trouble is that this monetarist theory goes back to monetary systems like the gold standard – where monetary increases which were backed by something decreased the relative value of each dollar, or even ounce of gold – and the financial system wasn't the major recipient of any increase in the monetary supply – then an increase in the money supply would represent a reduction in the purchasing power of the population – take Spain as an example after the gold rush that occurred after looting the Aztecs (and other tribes of south America) – they say that due to their over supply of gold, that prices of things started to increase – well this was due to this gold being distributed amongst the population eventually, first through repayments of debt that the Spanish crown had – which was then siphoned through the hands of the monarch, to nobles to the everyday individuals – so due to the abundance of gold in Spain, the purchasing power of one ounce was now lower – so it did lower their purchasing power – however when looking at today, most of the money supply increase does not end up in our hands and due to the fiat nature of the financial system, an increase in the monetary supply doesn't correlate to an increase inflation rate as it did in the past – especially due to the way it is measured by monetary officials To look at this point further – there has been a massive increase in the money supply occurring since the 1970s – but this got ramped up to a new level from 2009 onwards – the introduction of un-conventual monetary policies like QE increase the base money supply – US saw an increase of their monetary base by 10.58% p.a. for the decade from 2010 to 2020 – did inflation rise by this level the way it is measured? No, it averaged 2% p.a. This shows that the inflation effects were contained through the nature of credit growth – i.e. the increase in lending increasing the price of property and other assets, such as shares This brings up another major point – in particular when it comes to Australia - If inflation is considered to be the reduction in purchasing power of your dollar – then no area of the economy is more prevalent then the property market If you could buy a property 20 years ago for $100,000 and today the same property is selling for over $600,000 with no improvements or renovations – then this is an average inflation rate of 9.4% p.a. over this time period The government statistics do no consider the effects of the monetary expansion through credit growth on inflation of asset prices – this has really hurt the Australia dream – owning a property to get into the game and start to see some equity growth Hence – the inflation to reach this dream has been eroded by almost 9.5% per annum, well beyond the average household's capacity to save – which due to the current ZIRP environment is actually a disincentive to save – i.e. you get 0% interest whilst seeing inflation eat away the real value, let alone the fact that you potentially need to save a further 9.5% p.a. each year for a deposit that you wait If people are looking for correlation of anything when it comes to monetary expansion and increases of prices, it isn't CPI, but credit growth and hence property price increases which have been the most correlated This brings up the biggest question of all – what inflation really matters to you and how is this created? is inflation caused by the money supply increase, devaluing your purchasing power? is inflation the measurement of prices charged by businesses on goods and services, caused by supply and demand? or it is the price increase of assets – essentially devaluing your purchasing power over time? the truth is, that it is a muddied version of all three when it comes to what is important to you and I – they all matter Inflation caused by the money supply increase is seen where this money goes – which over the past 20-30 years has been asset pricing – particularly property but also shares to a lesser extent This has been great if you have been in the game for the past 10-20 years – but if you a new entrant, then you are buying in at the top of the markets in the hope that the same monetary policies continue - but in essence this has created a large barrier to entry – especially for housing But over the past 20 years - Inflation from business price changes have been seen as both deflationary and inflationary – Sectors that have seen less direct government involvement have seen deflation in prices – electronics – but only from non-monopolistic supplies – TVs, fridges, and other electronic goods, clothing, cars – all seen in real terms lower prices – think about buying any of these goods 50 years ago – it was very expensive and you got a worse product – today you get a great product for less in real terms Other sectors that are highly regulated – energy, health, education, housing, insurances – have seen a large increase in prices – but the two have managed to offset each other – so CPI in the way the government measures it hasn't been particularly noticeable In this essence – inflation – the way it is measured and what monetary officials focus on hasn't come from the massive flood of the monetary expansion – the CPI measurements we have seen have come from issues with supply chains – when compared to demand This is why I think the major issue with inflation at the moment has come from supply issues – Many companies being shut down over the past 18 months and not allowed to operate – labour costs increasing – so this needs to be passed on to consumers through price increases Therefore – if lockdowns and the limiting of supply continues – then prices definitely have the capacity to increase further, increasing the inflation measurements – In addition, if governmental support payments like unemployment benefits continue to be generous o the point they are anticompetitive to the free market with other businesses – this will also lead to an increase in the costs of goods due to increased costs of labour – being passed on in the form of an increased price of a good or service – if the world returns back to normal – not the new normal – then the inflation currently seen should subside – even if it does have the capacity to still increase costs in the long term As an example - one high year of inflation is still bad – it is due to the compounding nature of returns – Start with $1 – if inflation is 2.5% p.a – that good will cost $1.28 Now say that inflation of 10% for 1 year leads to that good costing $1.10 – then it reverts back to 2.5% p.a. – in 10 years' time it costs $1.37, which is a reduction of purchasing power by 33% in 10 years' time when compared to inflation just going up by 2.5% p.a. So even transitionary, or one or two years of inflation can be damaging – especially as monetary policy is trying to combat deflationary environments through having low interest rates   So, in conclusion - Is inflation transitionary? – there are indications that broad-based inflation indicators are rising, but nothing is conclusive at this stage if this is going to be anything more than a transitionary effect – but this could always change in the coming months The case for looking at inflation being a long-term trend is usually based around a broad-based phenomenon – where the price of everything is increasing across the board – It is not just one or two sectors of the basket are going up in price – but that the whole economic environment shows a general price increase Think about inflationary episodes in economies around the world in the past and present – Weimar Germany always comes to mind – where the cost of everything was elevated – or today with Venezuela and other south American countries, like Argentina which have struggled with inflation for years – most of this occurred in a different economic environment but also with extreme government controls on supply I would go out on a limb and say that we won't end up in this sort of situation if the economy is allowed to go back to work – the only thing that could lead to this is a massive shock to supply due to further lockdowns or restrictions of business, as well as extensions of the above market rate unemployment benefits Looking at what happened in 2020 - For the first time in decades central banks actually increased money supply well above demand – due to the forced shutdown of economic activity - the economy did not collapse due to lack of liquidity or a credit crunch, but due to the lockdowns and restrictions of supply – this created the major area of inflation we are seeing playing out now: a disproportionate amount of money flowing to risky assets joined by more flows to take overweight positions in scarce assets – in other words - the excess money made investors move from being underweight in commodities to overweight, as commodities are scares resources – creating an abrupt rally So what is the risk? - The history of the economy points to a similar pattern playing out - when money is aggressively printed and with this comes the excuse that there is no inflation – then when inflation rises, central banks and governments tell us that it is transitionary and to not worry – then this transitionary inflationary inflation turns out to be a longer term trend – then government/central banks present themselves as the solution to the problem – From the Government perspective – this involved imposing price controls and restrictive measures on exports – this would be the worst-case scenario – as it would further compound supply shortages due to prices being capped below the costs of production and sale The risk has always been the government responses – a free market can see inflation for periods of time, but this if often corrected as additional supply comes onto the market to soak up the demand But the real risks to markets – Central Bank policy – If inflation is overly persistent in the way that central banks measure this – will they then increase interest rates? This has massive flow throughs to the economy – not only in financial markets by reducing the present value of cash flow valuations of equities – but also increasing the financing costs of property, reducing the price capacity of credit growth, and with this price increases So the major question is: Will central banks tighten policy when government deficits are soaring and even a small increase in sovereign yields can generate a debt crisis? In summary - My thoughts are that inflation, the way it is measured by the government and what influences CB policy responses - shough only be temporary if things are allowed to go back to normal economic activity – but this is the real issue – many small businesses may not come back – which does increase the risk of inflation running away – Inflation in the context of asset price increases through credit growth is likely to continue – but then at some point if interest rates do go back up – it would slow This doesn't mean that the areas that see the monetary expansion effects should be ignored – for example - property has been inflationary –this isn't measured by statisticians and is hence ignored by monetary officials – whilst it is ignored by them, it is still important to you The issue with this is that CBs will let CPI run wild beyond the point of control before responding – but CPI will only run wild if government continue their absolute control over the economy through further economic shutdowns and reduction productivity through unemployment benefits The irony of this is if we actually viewed inflation as the increase of credit growth – rather than the increase of prices selectively edited by central banks – there would have been an increase in interest rates – Due to the largest spending components of most households being property, this could then lead to deflationary pressures as less people are willing to spend in the economy Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    Central Bank Digital Currencies – coming to a wallet near you.

    Play Episode Listen Later Jun 28, 2021 27:14

    Welcome to Finance and Fury. This episode is to look at Central bank digital currencies - Central banks releasing digital currencies is an inevitability at this stage - proof-of-concept programmes are currently in the works across the globe - with more than 80% of central banks looking at digital currencies – The RBA is one of them There is a lot of cover in this topic – we will define a central bank digital currency and go through why central banks are looking at pure digital currencies as an option – We will also look at what is happening in China with their plans for the distribution of the digital yuan – but also look at the alternatives the RBA is looking at   Defining the different forms of currencies in the modern monetary economy – physical and digital Physical money is easy - Think of cash in your wallet – either in notes or coins – this is physical money – when you log into your bank account and see digits on a screen – this could be considered a digital currency – but you can still convert these digits into physical money Digital currency is the name given to the electronic equivalent of physical money or cash when it is issued in a purely digital form Digital currency is managed, stored or exchanged on digital computer systems over the internet. Types of digital currencies include cryptocurrency, virtual currencyand central bank digital currency Under current legislation – you can still convert your digital currency into fiat currency, hence physical – you can withdraw digital forms of money – i.e. exchange BTC for AUD, then withdraw this AUD Currently – the digital representation of your physical money can be used via payments technologies such as online banking and electronic financial transaction point of sale – EFTPOS for short These payment methods are linked to commercial bank accounts in your own name, as well as deposit-taking mobile wallets, and gift, credit or debit cards – most people listening would have most likely used this form of payment – transferring the right to a physical currency digitally A CBDC is different to cryptocurrency – or cryptoassets based around the terminology used in legislative frameworks these are government sanctioned and centralised in their production – exactly like physical money - a cryptocurrency such as BTC or ETH does not – it is decentralised A CBDC would still have a ledger – but this would be centrally controlled and fully integrated into the financial payments system Currently - Every single day - Central banks are issuing conventional digital money to commercial banks that can then be exchanged with cash at par value – you go to an ATM to withdraw digital representations of your dollars for physical ones – the internet revolutionised this in the financial system banks used to have to store more physical currency – or at least a paper entitlement to this – to meet the demand of consumer payments - digital was never a consideration – with the decline in physical currency demand – less economic activity is conducted in this manner – so banks need to hold less physical cash - I remember going to Coles with my grandparents when I was a kid – they would take out cash for their weekly spending and pay in cash for everything – because this was how things were done in their day – today – credit and debit cards have mostly replaced cash payments In the current monetary economy - the RBA actually does issue digital currency to commercial banks through the provision of money into each bank's account within the exchange settlement account (ESA) system — However – there is no major central bank that purely issues digital currency directly to the public Whilst most currency that exists is digitised – it can still be transferred into physical currency Plus – you don't get your digital cash from a central bank – you get it through commercial banks The transfer of the monetary system from a physical currency to a digital one would be a form of a monetary reset - Let's take a step back and look at the previous monetary reset that occurred – Under the gold backed currencies – you could convert your paper money for gold at the equivalent pegged value – until this was banned by Governments on the population – in the US from 1933 – but other Central banks could still convert currency for gold under the Brenton woods system – until 1971 when any form of gold standard was abandoned Think of a Central Bank Digital Currency as a similar process of reducing your financial freedoms – you can currently convert your digital money into physical money – but when the nation adopts a pure digital currency policy, this is no longer possible – no more physical cash – everything is digitised – the same as when the population was no longer allowed to convert the currency for the asset backing it – i.e. gold This brings us to a core component of this episode – the People's Bank of China (PBoC) – which is one of the most prominent central banks globally, aims to be the first major central bank to issue digital currency for use by the general public and business – replacing physical cash This digital yuan will be fully produced and backed directly by the Chinese central government The underlying technology for this is different to the blockchain ledger, and will be controlled by the Chinese government and not distributed across the Chinese financial system - or any other nodes – like a decentralised ledger that crypto operates on   Why do Central Banks – particularly China's want a digital currency? Based around the released papers - it is suggested that the Digital Currency electronic payment system will alleviate the risks to the financial system that are present with both physical money or cryptocurrency transactions – these are anonymous counterfeiting, money laundering and illegal financing This sounds like a great argument if you are a monetary official – on the surface - because under a purely digital currency, monetary regulators can completely monitor digital currency transactions – for them this is a major plus as they will greatly increase their financial and monetary supervision capabilities – but what about for the individual in the economy – who makes up the economy So, Governments and Central Banks want to track every transaction that someone makes – this is firstly in an aim to reduce the black market economy Black market economies emerge to fill in the gaps of an imperfectly legislated economic environment – with tradies in Australia – the 10% discount to pay in cash to avoid GST In other nations that are highly regulated through central planning – black markets emerge to provide goods as well as currencies to fill in a gap – because of limitations of government controls – these sorts of economies exist mostly in communist/socialist economies like Venezuela and North Korea Where there is demand – people will find a way to fill this through providing the supply – whether it be food or drugs – if people want it and the government wont allow it – it will likely find its way onto a black market The black market fills a hole to reduce the inefficiency of the government – allows the economy to function at a greater capacity than it would under a complete governmental control – hence, the introduction of a pure digital CB currency removes this natural phenomenon to help right any wrongs that central planning creates This is particularly relevant in nations which complete central planning – socialist/communist countries like Venezuela and North Korea, or the USSR, China and Cuba in the past – the only way for people to get an allocation of food was often through the black market – but at imperfect prices due to market disruption All of these operate on cash – which cannot be tracked and measured by the government - It actually creates a completely centralised and controlled economy – the monetary authorities may view this as a win – but for the every day individual, this limits their ability to maximise their economic output – the greater limitations occur in situations where economic transactions are limited by government – countries like Australia are relatively free – but in countries like China – this could really reduce the individuals living standards if they are both cut off from cash payments and restricted in the digital payments – The most alarming factor of all of this – especially for China – this relates to their social credit score system – monitoring what you spend your money on – allows them to allocate you a score If you spend too much on alcohol, or if you are hoarding too much cash and not being a productive member of society through investing or spending this, well – you will see your score lower – even if you are friends with an alcoholic – your score will lower – then you save, spending money, cannot travel, find accommodation to live and you become homeless quickly as you are completely cut off – you can also not beg for money This digital Cb currency from China has the added element of being able to piggy back onto what is already an incredibly authoritarian system of control of its population – where if you score is also too low – now you no longer have the right to access this currency and you are shut off – with no method of redemption From an Economic perspective – monetary officials want to create the perfect world – where they can measure spending down to the exact dollar and manipulate the economy through making adjustments to the money supply and interest rates – they can also get a measure on inflation They have been trying to do this for decades but with little effect – think about monetary policy for a minute – the control over interest rates is aiming to control behaviours of individuals that make up the economy – if there are lower interest rates, this based on the rational models that entities like the RBA have, which theorises that a lower interest rate should decrease the incentive to save cash and instead people will spend it – this should then increase inflation and then interest rates can increase over time – but these models aren't perfect – as unintended consequences occur – what happened in practicality is that the lowering of interest rates to help increase inflation resulted in credit growth – i.e. mortgage sizes – where people were borrowing more money – whilst interest rate payments were lower per dollar borrowed, people now had more borrowed dollars – so total interest rates did decrease, but loan repayments for principal increased – resulting in more money flowing into debt repayment – hence less being spent in the economy – therefore the inflation never materialised as hoped Monetary officials think that these models aren't perfect because they don't have complete data – they don't know how much exactly each individual is spending and where they are spending this – plus, inflation is currently measured by around 0.8% of households keeping a manual diary and reporting this back to the ABS – would be much easier to have a direct line to every transaction you make and measure the relative price increases – this equals a completely centralised and controlled monetary system What they never understand is that there I no way to control a complex system like the economy – any model is never going to work as the economy is non-linear – i.e. if you put in $100 to the economy expecting a multiplier of 2 under a linear system – you would get $200 – under a non-linear system you could get $20, -$50, $100 – who knows – inputs do not equal outputs In addition – thin about Welfare payment that governments and central banks can make – a recent proposal was made in limiting spending and transactions to a card where it could only be spent on food or other essential goods – no alcohol or withdrawn as cash to spend on who knows what – this would fulfill this if CB digital currencies came into existence But also – Digital currencies in their pure form are only from CBs to commercial banks – the invention of digital CB currencies allows for the expansion of helicopter monetary policies The payment directly from a CB to your bank account – this is the basis for economic policies such as UBI based around modern monetary theory – MMT So these CB digital currencies allows for a circumvention of fiscal policy – no longer goes a government decide on welfare payments – CBs can directly pay individuals as the commercial banks would no longer be required as a financial intermediary The end result of this is Central Banks increasing their Control over the economy – We already do don't have a free market economy – money is the life blood of any economy – it is what facilitates the exchange system of the economy – but the control of the supply of money and the interest rate control affecting incentives to save or spend has completely destroyed the natural state of the economic and business cycle What is even more telling about the potential implications for us – is when looking at a speech given by the Bank of England's chief economist in 2015 – where CBDC would be the ideal mechanism to implement negative interest rate policies – if you get charged to save, then you would withdraw your cash savings and put it under your mattress – but if this is not possible, you would have no options to either spend or invest the cash Increase spending – from both the population but from a central bank through just issuing more digital currency – as well as economic transfer payments directly to the population – if this doesn't come from a government, and from the creation of the money supply – it isn't technically debt represented on a balance sheet anywhere Under the current economic environment – for governments to spend money they don't have, they get into a deficit and fund this through issuing a bond – with digital currencies directly issued from a CB – no government debt From a central bank's point of view – a digital currency can also reduce the costs involved in handling, maintaining and recycling banknotes and coins throughout financial systems and economies It is true that it does cost money to print dollars and produce coins – There can also be currency shortages - Coin shortage in the US at the moment – the costs go up over time to produce these assets, whilst inflation reduces the real value of the currency I did some maths for Australia – looking at the 20c coin – it weighs 11.3g – and constitutes 75% copper and 25% nickel – well at current market prices this represents around 7c of nickel and 11c of copper – so even the raw materials are worth around 18c – let alone the manufacturing costs – so in producing a 20c coin, the RBA may actually be losing money if commodity prices continue to rise     China is serious about this – they are rolling it out - It will initially be distributed to all commercial banks affiliated with the Chinese central bank such as the Agricultural Bank of China First phase - it is designed as a replacement for China's Reserve Money (M0) – this is the monetary reference to central bank notes and coins – it is essentially the base money supply on which banks can extend the money supply to commercial banks Second Phase - it will be distributed to large fintech companies such as China's Tencent and Alibaba to be used alongside their WeChat Pay and Alipay inhouse payments respectively The first public testing is already going on - in October 2020 - China's central bank issued 10 million yuan ($2 million AUD) of digital currency to 50,000 randomly selected consumers This digital currency is available for transactions across 3,389 retail outlets in Shenzhen Next phases of testing - 4 key cities are going to be the first cities to test the use of the DCEP These cities will be closed economies – where pilot tests and this is testament of digital currencies - Beyond this first stage of domestic integration – China is thinking of internationalising the RMB by offshoring the yuan into Hong Kong and Singapore Multinational foreign firms – companies such as McDonalds and Starbucks will also take part in the DCEP testing alongside local hotels, supermarkets, postal lockers, bakeries, bookstores, gyms   Does this relate to Australia and why would cash disappear? Studies by the Reserve Bank of New Zealand (RBNZ) suggest there are two main reasons why cash could disappear Cost - The relative cost of its use of physical cash compared to digital methods – as we went through earlier in the episode – the major reason to get rid of a fiat cash is if it is worth more than what the value you attribute to it is – i.e. why spend 0.21c to produce a 0.2c coin?   Undesirable outcomes – Central banks think that physical cash has a socially undesirable outcome – i.e. the attractiveness for tax evasion, money laundering and illegal transactions In Australia - large-scale cash transactions have been deemed such a social risk that in 2019 the Currency (Restrictions on the Use of Cash) Bill 2019 was introduced in Federal Parliament to ban cash transactions over $10,000 – this is a step to limit cash How the RBA views this topic on alternative digital payment methods Australia's digital version of the Australian dollar (AUD) will be some way off In 2020 - The Reserve Bank today announced that it is partnering with Commonwealth Bank, National Australia Bank, Perpetual and ConsenSys Software, a blockchain technology company, on a collaborative project to explore the potential use and implications of a wholesale form of central bank digital currency (CBDC) using distributed ledger technology (DLT). This is part of ongoing research at the Reserve Bank on wholesale CBDC. From a central bank/governmental perspective - The benefits have been acknowledged to include improved financial tracking cost reductions from reduced production and general handling of coins and banknotes. In China, Australia and elsewhere, the cashless trend is seen to be strong with both business and consumer habits seen as key drivers in the likely seamless adoption of a DCEP.  China is the first mover – where they are cracking down on crypto assets – as they are implementing their own digital currency - China wants complete control – any nation that implements this also likely wants complete control Be prepared for the next decade of change – as central banks adopt digital money – replacing physical currency Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    Banks and cryptoassets – the first introduction of a regulatory framework.

    Play Episode Listen Later Jun 21, 2021 27:56

    Welcome to Finance and Fury. This episode we will continue looking at the crypto markets. In particular, we focus on the regulatory frameworks that have been released by the Bank for international settlements, BIS for short. One division of the BIS - the Basel Committee on Banking Supervision - released a consultation paper this month to provide a framework to every nation's regulator of financial institutions on how to treat cryptocurrencies - Now – the Basel Committee on Banking Supervision is the world's most powerful regulator of banking standards and rules – it gets to decide what capital adequacy banks should focus on, as well as what assets should be classified as capital – if you have been listening for a while, you would have heard me mention this group – they are who APRA, who regulates superfunds and banks in Aus take their directions from So this recent release is meant to provide the framework for banks on how to treat different forms of cryptocurrency on their balance sheets - if they wish to start purchasing crypto The big question of this episode is if this is a major win for cryptocurrencies, as it was initially treated as purely based around market price reactions, or is this something that could actually damage the crypto markets through a financial system takeover? Firstly, it is important to note that this paper does not refer to crypto as a currency – such as the name cryptocurrency would imply – instead, they call them cryptoassets – implying that these are assets for banks or for the financial system to hold or trade these as assets – this off the bat could be viewed as an implied intent, where in the BIS's view, existing cryptos will never be treated as a currency in the mainstream – but I wanted to mention this as I will be using the term cryptoasset throughout most of this episode when it is in relation to this prudential paper – please forgive me in advance as cryptoassets will be mentioned a lot Another important point is that this report specifically states that central bank digital currencies will not fall under this legislative framework – which also implies that this is a serious option that they are looking at and will fall under a different legislative framework – as an actual currency, not a crypto asset – which we will come back to next week Start with the introduction to the BIS report – The BIS have noted that over the past few years, they have seen rapid growth in cryptoassets – with market capitalisation of these assets rising – sitting at an estimated $1.5 trillion But while the cryptoasset market remains small relative to the size of the global financial system – there continues to be rapid developments, with increased attention from a broad range of stakeholders – these stakeholders are some investment banks, since banks like JPM, Goldman and Citi have already launched their own crypto-focused businesses – I find it hard to believe that the BIS would view individuals as stakeholders In this report the BIS brings up the normal rage of concerns with Cryptoassets – including consumer protection, money laundering and terrorist financing, as well as their carbon footprint from the electricity usage But the big point of concern they focus on is that, quote: “The Committee is of the view that the growth of cryptoassets and related services has the potential to raise financial stability concerns and increase risks faced by banks.” In other words, crypto can be destabilising on the financial system – anything that provides some potential competition is destabilising if you are used to monopoly controls – this happens in all aspects of commerce – if you have a monopoly business operating who can fix prices and provide poor services, then a competitor appears, this is destabilising for your business practices, you will lose customers – so what to do? In most cases they simply buy out the competitor or have them shut down If banks were to start trading crypto using derivatives, then this could also pose a risk to the financial system The report also mentions that certain cryptoassets have exhibited a high degree of volatility, and could present risks for banks as exposures increases – these risks include liquidity risk; credit risk; market risk; operational risk (which include fraud and cyber risks); money laundering / terrorist financing risk; and legal and reputation risks – this basically ticks all the risk boxes beyond political/legislative risk – but to the BIS this isn't a concern, as they impose these risks on the market To that end, the BIS Committee has taken steps to address these risks through producing this legislative framework – and they first started looking at this over two years ago, back in March 2019 – where the Committee published an article on the risks associated with cryptoassets – then in December 2019, the Committee published a discussion paper seeking views of stakeholders on a range of issues related to the prudential treatment of cryptoassets – remember stakeholders are entities with direct connections to the BIS – i.e. Central Banks and megabanks It is important to note that mega banks like JPM, Goldman and Citi group are very interest in securitising crypto – anything that can be securities to make a profit off is a bonus in their eyes – remember in the mid-2000s they were creating synthetic contracts off collateral debt obligations – i.e. peoples mortgages to try and made more money than simply what the interest payments could provide to a commercial bank   How does this legislative framework treat cryptocurrencies – or cryptoassets as the BIS refers to them – I won't be covering the minute details for the sake of time, as this report is 20 something pages long – but if you are interested the links will be in the show notes at – or you can look up Prudential treatment of cryptoasset exposures – but I will be covering the higher level implications of this framework Cryptoassets are defined as private digital assets that depend primarily on cryptography and distributed ledger or similar technology – these digital assets are a digital representation of value, which can be used for payment or investment purposes The prudential treatment of cryptoassets has been guided by three general principles: Same risk, same activity, same treatment: a cryptoasset that provides equivalent economic functions and poses the same risks compared with a “traditional asset” should be subject to the same capital, liquidity and other requirements as the traditional asset. The prudential treatment should, however, account for any additional risks arising from cryptoasset exposures relative to traditional assets. Simplicity: The design of the prudential treatment of cryptoassets should be simple. Cryptoassets are currently a relatively small asset class for banks. As the market, technologies and related services of cryptoassets are still evolving, there is merit in starting with a simple and cautious treatment that could, in principle, be revisited in the future depending on the evolution of cryptoassets. Minimum standards: Any Committee-specified prudential treatment of cryptoassets would constitute a minimum standard for internationally active banks. Jurisdictions would be free to apply additional and/or more conservative measures if warranted. As such, jurisdictions that prohibit their banks from having any exposures to cryptoassets would be deemed compliant with a global prudential standard This is an important point – as the framework is the minimum standards that need to be applied – if a regulator wishes to go above and beyond, or even ban banks for holding crypto, that is well within their rights and would be deemed compliant   In essence – what these principles do – assuming a bank is allowed to trade crypto - is break it down into groups of assets – Group 1 (broken down into A and B) and then Group 2 Group 1 cryptoassets – these fulfil a set of classification conditions and as such are eligible for treatment under the existing Basel Framework (with some modifications and additional guidance). These include certain tokenised traditional assets and stablecoins Group 1 cryptoassets will be subject to at least equivalent risk-based capital requirements based on the risk weights of underlying exposures as set out in the existing Basel capital framework. The cryptoasset either is a tokenised traditional asset or has a stabilisation mechanism that is effective at all times in linking its value to an underlying traditional asset or a pool of traditional assets. In the case of underlying physical assets, they must verify that these assets are stored and managed appropriately All cryptoasset arrangements must ensure full transferability and settlement finality at all times. In addition, cryptoassets with stabilisation mechanisms must ensure full redeemability (ie the ability to exchange cryptoassets for cash, bonds, commodities, equities or other traditional assets) at all times. Group 2 cryptoassets – are those, such as bitcoin, that do not fulfil the classification conditions. Since these pose additional and higher risks, they would be subject to a new conservative prudential treatment These coins are the ones that people would be more familiar with – such as BTC, ETH, ripple, really any coin that isn't a stable coin or a tokenized version of an asset like a share, bond, commodity or currency Each of these groups therefore have different Capital requirements for each banks reserve requirement - Similar to activities related to traditional assets that the banks hold, such as loans, bank activity related to cryptoassets will increase the operational risk charge to a bank within the Basel framework – due to cryptoassets being new and rapidly evolving, there is potentially an increased likelihood that they pose unanticipated operational risks in most cases to the banking system – this is basically saying that they don't know the true risks to the financial system if banks start trading crypto Group 1 cryptoassets will be subject to the requirements set out in the Basel Framework for a normal asset that the banks hold – group 1 is broken up into two categories depending on the classification of the asset Group 1a cryptoassets: tokenised traditional assets – i.e Tokenised traditional assets use an alternative way of recording ownership of traditional assets through the use of cryptography - may be treated as equivalent to a traditional asset for the purpose of calculating minimum capital requirements for credit and market risk - In practice this means that a tokenised cryptoasset is treated the same as - Bonds, loans, commodities, deposits and equities in regards to capital adequacy requirements This is because this form of cryptoasset must confer the same level of legal rights as ownership of these traditional forms of financing, eg rights to cash flows, claims in insolvency etc. For example, a tokenised corporate bond held in the banking book will be subject to the same risk weight as the non-tokenised corporate bond held in the banking book. Similarly, if a bank holds a derivative on a tokenised asset, it will be reflected in the market risk charge in the same way as a derivative on the non-tokenised asset – so in the banks eyes there is no difference in holding a bond or a tokenised version of the bond so – a tokenised cyptoasset can be recognised as collateral for the purposes of credit risk mitigation if it falls within the framework Group 1b cryptoassets: cryptoassets with stabilisation mechanisms that seek to link the value of a cryptoasset to the value of a traditional asset or a pool of traditional assets through a stabilisation mechanism. Cryptoassets under this category must be redeemable for underlying traditional asset(s) (eg cash, bonds, commodities, equities) – things like a stablecoin – so whilst not a tokenised version of the asset, its value is linked to the underlying asset, therefore it is treated relatively similar – however Group 2 cryptoassets – are those that pose unique risks compared with Group 1 - as such are subject to the newly prescribed capital requirement – these are coins like BTC and ETH – anything that doesn't have a tether to the value A risk weight of 1250% is applied to the greater of the absolute value of the aggregate long positions and the absolute value of the aggregate short positions to which the bank is exposed. A 1250 percent risk-weight is the equivalent in banking terminology to a 100% capital requirement So for bitcoin and Ethereum - this would require banks to hold $1 dollar for every $1 in "exposure" to those assets This is in line with the toughest standards for banks' exposures on riskier assets, such as illiquid shares or junk bonds - So if the bank has a $100 exposure in bitcoin this would result in a minimum capital requirement of $100 This also applies to cryptoasset derivatives positions with the potential maximum loss value under a RWA formula – This can be a bit of an issue for the derivative markets – as the RWA is often not the total loss based around the value of the trade, but the cost of the derivative contract – which is often many times smaller – as you are paying for a premium So in summary – if the assets are a tokenised version of an asset, or use an asset as an anchor for their value, then the banks can hold these and it can be treated as part of their capital requirements under the existing Basel III requirements – so banks can use this as part of CAR to against their RWA – under Basel III – you need to hold 8% of your RWA – which in Aus is calculated as 35% of your loans   My take on all of this This could be good news for crypto markets, as they now may see greater recognition by the most powerful financial institution on earth when it comes to providing direction on regulatory frameworks Or, it could be that the financial system sees another way to make some money – so why not take the plunge? There is nothing inheritably wrong with making money – but the way that banks do this, especially in the US is different from you or I purchasing crypto The issue with this is the structure of the financial system – as these banks are TBTF If you buy one BTC for $50k and it drops down to $10k, you have lost $40k which sucks – you will likely feel bad – but you can hold onto this and hope the price recovers But the way a bank like JPM or Goldmans make these trading positions is normally though the use of derivatives on these assets – they only put up a fraction of the funds and cannot simply hold if the prices decline – because of counter party risk – as each bank tries to get out of a position at one point of time – this can create major issues -financial system collapse – If you go bankrupt – then too bad – if a bank goes bankrupt – this becomes your problem – as banks will get bailed out – remember, they are Too big to fail The BIS notes that the extreme price volatility of some of these assets – particularly those in group 2 – have unproven track record of liquidity will make it challenging to hedge positions when providing derivative instruments or when manufacturing investment products that reference crypto assets There are any number of ways that this can explode in the future – here are just three I can think of off the top of my head One – Requirements for additional dollars or bonds to be printed to absorb the increase in the RWA for any bank holding category 2 of the crypto assets – Say BTC does go to $500k - Banks need to increase cash they hold if prices rise – banks don't hold much cash relative to their overall asset and liability position – the balance sheet of banks is basically neutral – they have the same amount of liabilities as assets – so if the price of cryptos increases massively, then banks would need to have central banks expand the money supply further for them to maintain their CAR requirements Reminds me a little bit of the Mississippi bubble – the price of assets increases to the point that people want to cash out – but not for a worthless form of conversion such as the paper money being issued – if cash like the USD continues to be expanded at its current pace – people could request alternative assets destabilising the financial system - could create a major issue down the road Two – asset bubble through bank speculation and derivative practices – The GFC period was bad enough when you have banks speculating on newly created assets – whilst mortgages have been around for hundreds of years, the CDOs were relatively new – Through entering into crypto – banks are entering into a new territory of pure speculation – the buying and selling of cryptoassets by itself isn't the issue – but the speculative practice of derivates and who knows what else they come up with in the years to come could become a major issue for the stability of the financial system – could both collapse crypto markets as well as shares and bonds if economic confidence gets hit Three – Additional risks, such as AML issues – if the banks do not act in good faith, because to be honest they do not have a good history of this – there could be a call by regulators for additional crack downs on crypto So in summary – this legislation Creates a two tiered system for Cryptos – and opens the door for the largest financial entities to begin speculating on what is already a volatile asset For the two tiers - one is seen as good as the assets underlying it - The other – is seen as a very risky asset class So we may also see the rise of tokenised assets and a new wave of how the economy works In addition – it means that you will now be competing with the most sophisticated traders on earth – complex computer algorithms dictating market prices could see larger swings in volatility It goes without say that governments are increasingly focused on issues surrounding cryptocurrencies – especially with some central banks exploring digital currencies – this even came up in the recent G7 meetings this month So we will finish off the crypto series next episode looking at China's Central bank digital currency Thank you for listening to today's episode. 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    El Salvador and Bitcoin - a match made in heaven?

    Play Episode Listen Later Jun 14, 2021 23:30

    Welcome to Finance and Fury. This episode we will continue to look at what is happening in crypto markets. After last episode, we are starting a bit of a mini-series on crypto and digital currencies. This wasn't originally intended but I have been doing more of a deep dive into this topic and there has been some timely news articles that I want to cover. In this series, we will look at a few factors in relation to the crypto markets. Mainly governmental and financial institutional adoption of mainstream cryptocurrencies, like BTC. This series will cover the topics of firstly, el Salvador and other potential Latin American countries accepting BTC as legal tender, then Basel Regulations updates on banks/financial institutions accepting cryptos as assets and the implications this has on markets, and then to finish things off, China rolling out a digital currency that has been in the works since 2014. This may change over the weeks if I uncover any more interesting topics, but at this stage, this is the gameplan. But in today's episode – we will be following on from last week's episode where I give my personal thoughts on crypto currencies I mentioned last week that a few small nations may accept and adopt BTC – good timing – on the same day the episode was released - news that El Salvador was proposing the acceptance of BTC as legal tender came out – in the meantime, this has passed into legislation – so we will start the mini-series looking at this development   Now - El Salvador has become the first nation to formally adopt a cryptocurrency as legal tender and a handful of other Latin American leaders have indicated that they would follow suit – such as Paraguay and Panama  Does this really mark a change in bitcoin's reputation and acceptance on the global stage? Yes and no – Yes for developing/3rd world nations reliant on the US dollar and remittance, but no for any major economy who are standing firm on their own domestic fiat currencies or proposed central bank digital currencies Why has El Salvador made this decision? It isn't as simple as them being the first adopter in a global trend - Let's look at why – as it comes down to the make up of these economies as well as their reliance on not only remittances – El Salvador – small Latin American country wedged between Guatemala and Honduras – the last time there was this much buzz around this region was the football war of 1969, which was fought over a few issues but was accelerated by the FIFA 1970 qualifying matches – but it is a small country with around 7m people living in it But it is considered 3rd world – GDP per capita of $4k v Aus at $55k They are also heavily reliant on the USD – which is another legal tender in the country This is a problem for them as they are a net importer of goods – which means they can run out of USD – in other countries, you can just print more money – but El Salvador cannot do this Like many other Latin American nations - El Salvador's economy is heavily dependent upon remittances – this is a term for funds sent home by citizens working abroad – i.e., an El Salvadorian works in the US and sends money home to family members – then this is remittance Remittances totalled over 20% of their GDP output in 2019 – and had only been growing over time – the economy in El Salvador has been struggling for years – their domestic economic output has struggled due to their internal economic issues, so they have become more reliant on external factors, such as the reliance on inflows of USD into the country to spend – they have also had some major political issues as well which we will come back to later in the episode The Governments move to adopt BTC is a very smart one from their president – when it comes to trying to maximise the remittance levels as well as potentially increase the crypto mining in the country – it works to achieve both ends Currently, remittances are delivered by money transfer services companies like Western Union – these are centralised and highly regulated under financial service regulations – this can be complicated between boarders – some nations disallow the transfer between boarders due to money laundering and counter terrorism financing laws Then to actually make the transfer happen through a money transfer service when it is permitted, it requires an in-person visit to an office and proof of identity for both the sender and receiver In El Salvador - there are around 500 Western Union offices across the country – but most of these are located in populated areas – so some of the poorer individuals living in rural areas of the nation can have limited access Let's have a look at the current state of financial services in El Salvador - around 70% of the population is considered to be unbanked – this means that they lack access to a basic bank account – which is an issue for anyone wishing to save or conduct online commerce – this is why physical cash transactions are facilitated through money transfer services – who needs a bank account when your withdrawals are coming from these services? In addition – due to the governmental history and political risk of the country – many people don't trust financial institutions – let alone have the capabilities to establish a bank account Now – lets contrast this to say a BTC transfer – these allow anyone with a mobile phone and internet access to send or receive funds - Also - BTC could be spent directly on goods and services, just as the US dollar is in El Salvador – all can be done though a wallet – so rather than someone going to Western Union and getting acceptance of the USD transferred to them, then withdraw the cash and then go spend this at their local store, they can simply be transferred BTC and then spend this on goods and services directly at a vendor it does sound a lot easier, doesn't it? – but this is from a first world western perspective – which we will come back to in a minute But first – let's have a look at how this could be great for El Salvador in the interim – If BTC prices continue to rise over time – and the population continue to accumulate more BTC in their wallets – then the prices of goods and services will become deflationary for them – i.e. they can afford to purchase more goods or services for the same amount of BTC As many crypto analysts suggest the price of bitcoin will rise over time – and let's assume that it does – anyone in El Salvador that has BTC stored in their wallets can now afford more goods and services, especially whilst other goods and services are being pegged to the USD – This could potentially create an increase in wealth a consumption power by any lucky Salvadorians who has acquired and holds bitcoin if prices continue to rise If you invest 3 BTC in the country, you can also become a citizen So additional wealth and investment may come into the country Mitigation of environmental concerns around the electricity consumption of cryptocurrency – El Salvador has a large geothermal capacity – Geothermalpower in El Salvador represents 25% of the country's total electricity production and is one of the top ten geothermal energy producers in the world However – they are currently an energy net importer – and it isn't cheap electricity prices So, if the government, or private energy providers invests in further geothermal capacity, then the Government invites mining syndicates to set up in the country to mine crypto at a low electricity cost – could provide a cost-effective method of accumulating coins – plus they can tax it – to help generate more government revenues – this could be a major plus to their economy – but this would take years to implement This all sounds great – and any market innovations and adaptions in my book is something in the right direction – but is that what is going on here? Important to take a step back and think about the functional economy within El Salvador and the use of BTC – as a 3rd world economy - for those of us in the 1st world – we cannot really appreciate what daily life is like to operate in an economy like El Salvador For a functional BTC exchange to emerge – it requires the internet - Recipients of bitcoin realise their funds by connecting to the internet Does El Salvador have wide spread internet access in the country and is this the major method of transaction between consumer and vendor? – World Bank has the data on this –as of 3 years ago, only 34% of the country was using the internet or had access to the internet This right away may seem to be a problem – unless this government program is to give all of the rural or poor population a phone with internet capabilities – how are they going to function under BTC as a monetary exchange? Would be different if this was done in Aus – where around 95% have regular use to the internet – but in a nation without the very infrastructure to help facilitate this adoption, there is a major bottleneck Another major issue is that is appears that businesses are being forced to accept BTC – I am not a fan of this – I personally think it goes against the very core concept of crypto – that is should be voluntarily adopted and based around individual liberty – i.e. to get away from government control and oppression that the monetary system has paced on the population – now a government policy forces all vendors/suppliers in the country to accept BTC Based around the legislation translations I have seen – relying on translation, I cannot speak Spanish – but the government acceptance of BTC as a legal tender requires every single commerce transaction to have to option to be conducted in BTC If they breach this – they are now breaching the nations commerce regulations and suffer consequences It is essentially the equivalent of you going to the farmers markets and wanting to pay in BTC – but they don't have the capabilities to accept this form of payment – I go to a farmers market and around half of the vendors only accept cash – rather than me paying on bank card or credit card – but this is okay – as it is all still AUD – it is just the method of payment which differs – With BTC – there is currently no physical widespread payment mechanism for this – if a merchant doesn't have internet, how does this affect their business? It is a big question – and one that the economy of El Salvador has been given very little time to adjust to – remember – we are not talking about a first world nation – that has the capacity to access internet and sign up to wallets if need be overnight   I personally have never been to El Salvador – but I have been to many other 3rd world nations –and the cultural acceptance of certain technologies and pace of adaption that first world nations have shown shouldn't be projected on any other nation Many of these nations do thing in their own time – and the approach of ‘if it isn't broke don't fix it' can apply to many situation – so the very fact that the government may try to force your local street side vendor in El Salvador, who may not have access to the internet themselves to adopt and accept BTC overnight, let alone within the next 5 years may be a big challenge May put additional stressors on the population and hence the economy Another major issue is the volatility of BTC – I mentioned earlier in the episode that if BTC can continue to appreciate in value, then the price effect will be deflationary, assuming goods and services continue to be prices relative to USD This is where Adopting bitcoin as legal tender is not without its downsides – what is BTC all of a sudden decline in value by a substantial margin – this would have the opposite effect – through reducing the purchasing power of those holding BTC – creating an inflationary pressure BTC can be rather volatile – as an example – at the time of putting this episode together – the price of one BTC if $46k AUD, or $35.7k USD – this represents a decline of roughly 45% from the April high this year Volatility in purchasing power can be an issue – as it affects the individual's ability to make consumption decisions – if you purchasing power can easily change by 10% +/- per day then this can create major uncertainty when it comes to make purchasing decisions, as well as selling decision – Now imagine that someone in El Salvador had received all their savings through remittance in the form of BTC – then over a month the price declined by 45% - this means they have almost half the ability to spend – so what do they do? Can create economic cycles within El Salvador – if BTC crashes – then purchasing power is less – so people won't spend anything for a month or two – and wait and hope until prices rise - if the price does, then you may see a massive spike in consumption, with which supply cannot keep pace, then you get inflationary pressures in USD terms, then if this cycle continues, you may start to see the purchasing power of the BTC decline even further So there are some untested areas of the economy with this case study for a small nation adopting a crypto currency My personal views – I may be completely off – but BTC being accepted as legal tender by the government may simply be a policy that benefits the upper classes of El Salvador more so than many of the poorer individuals who rely on remittance – those with money who are politically connected and already have internet access – such as cartels and political officials, corrupt or not – rather than the poor farmer trying to sell their goods on the street – this take may be cynical of me and I may be missing a major factor of this policy here – but based around the historical behaviour of the El Salvadorian government, as well as the capacity for the average population to accept BTC as a method of payment due to limited internet access, it makes sense to me at lease When you look at El Salvador or many other tiny Latin American nations – historically many of these countries are run as either a banana republic or as a narco-state – where there is an embedded relationship of corruption Who does this policy help? When you look at the fact that the majority of the poor don't have access to the internet and will still be reliant on remittance from money exchange services – it may not be them The very lack of an internet connection in the nation stifles the adoption of the policy – plus puts a major political risk on businesses who are now required to fund to cost of getting a device and internet access to accept BTC payments But from my 1,000 foot view – take this with a grain of salt – as I am providing an analytical assessment without ever setting foot in the country or talking to the population – but the majority of the poor who cannot afford internet connections or smart phones may be left in the dust But those who have internet connections and have large amounts of capital to move can really benefit - Look at the current president and his actions – this is based on news stories, so no idea if they are true or not - The President wanted to secure a $109m loan from the US to militarise their police -the plan was opposed by both opposition parties who had the majority – game over right? Well - he ordered soldiers into the Legislative Assembly to help incentivise legislators to approve the loan until it passed in his favour He has also been accused of negotiating a deal with MS13, the most powerful gang in the country to provide less strict prison conditions if they can lower the number of public murders Gang presence is huge – MS13 and MS 18 are the largest crime syndicates in the country who are responsible for drug and human trafficking trades Who has the most money to flow into El Salvador – a group of local farmers, or a massive criminal network like MS13 This isn't a justification to ban crypto like BTC, as no other currency on earth has seen more criminal deal committed in it than the USD – In summary – If this was a move where all major governments/monetary authorities were going to look at the same process, then this would be great news – but it is in reality a minor occurrence – as the capability to directly accept BTC for commence is lacking in the country, beyond those wealthy elite or drug cartels already set up for this but I hope it just helps to show a different side to the title that most people have read, showing that BTC is being accepted by El Salvador – as there is more to the story once you dig a little deeper I may be wrong, the internet connection and adoption by the local population may occur overnight, but time will tell – Next week – we will look at the evolution of the banking system in relation to crypto – in particular the Basel Committee views on the subject and their recently released guidance to banks around the world on how to treat crypto Thank you for listening to today's episode. 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    My thoughts on cryptocurrencies: the ups and downs of an unregulated market.

    Play Episode Listen Later Jun 7, 2021 25:22

    Welcome to Finance and Fury. This episode we will look at crypto markets as there is a fair amount of noise being generated in this space at the moment. Just a heads up that this will be a bit of a longer episode as there is a lot to unpack. I have made my position on crypto markets fairly obvious in the past – if you haven't listened to any of those episodes, I will provide a bit of a summary of where I stand in relation to cryptocurrencies – and whilst markets price dynamics has changed substantially over the past 3 years – my position hasn't As an overview – I am not for or against them – many people have been able to create wealth through trading crypto – and all the power to them – this is great If people can successfully trade coins profitably, then this is fantastic – cryptos offer an alternative form of monetary conversion beyond traditional asset classes First – I have to explain my overall view when it comes to crypto - I like the concept of the blockchain – I also like the concept of cryptocurrencies like BTC – When it comes to the money supply and particularly the control of the money supply – I think they free market should be responsible for this – creating competition for money and with this interest rates changes based around demand and supply dynamics – Where we currently sit is a complete centrally planned money supply based around what a central authority deems as appropriate as not only the cost of money (being the interest rate) but also what the devaluation of this currency should be each year (which is the inflation rate) Put into this perspective – fiat cash is not a great medium of exchange for the population/economy – You are essentially guaranteed to lose money in real terms after record low interest rates minus inflation expectations – but it is great for those that provide the fiat but does this mean I am converting fiat money into these cryptocurrencies – well, no. If people do, then all the power to them – I hope the cryptocurrencies that people are buying can grow in prices at an accelerated pace – I personally have nothing against the crypto markets - But I haven't bought any? Well – there are a number of reasons – but the major one is Legislative risk – As we will look at in this episode – there is a massive potential for crypto markets to accumulate additional money flows – in other words – additional funds are available to purchase cryptos like BTC, ETH, or one of the other 4,000 currencies Everything else being equal – where legislation stays the same, and the interest from the population still continues to rise at the same level as is the current trend - There is potential for cryptos to go in up in value – and go up in value by a large margin – Taking this view – it is a numbers game – if most people in the world don't own any BTC but are interested in buying some, and convert AUD, USD, or other currencies for these cryptos, then the prices will go up – purely based around the numbers who don't currently own crypto - This is the potential major upside for markets – let assume that there are no governments, or central bank controlled fiats – and that these entities even if they did exist have no interest in controlling the money supply – crypto has a lot of upside to it and would probably be the new medium of exchange people would use recently released report on the State of the Crypto Marketfrom Gemini - they polled 3,000 U.S. adults, ages 18 to 65 with $40,000 or more in household income This survey included 921 current cryptocurrency owners and 1,697 consumers who were interested in learning more about cryptocurrency Now – this survey sample size is small – but they have extrapolated this data and estimated that roughly 14% of the U.S. population owns cryptocurrency This number is actually fairly consistent with other estimates from surveys conducted - This translates to 21.2 million U.S. adults who own cryptocurrency – but based around interest in this subject - This number is expected to double over 2021 – going to 42m US adults – let alone the rest of the global population There is currently a large demographic of the population who could be considered crypto-curious – these people would be those who do not currently own cryptocurrency but have indicated that they may wish to purchase some crypto soon This group is significant in size – based around the current market demographics – has the potential to include 63% of U.S. adult population This doesn't mean that every person in this group will buy crypto – but let's say that even 30% do, well this is still a large increase from the current ownership demographic- with this comes additional money flow – hence, more potential to increase the price of BTC If everyone who is curious about buying cryptos, this is fairly bullish - so assuming that everything else stays the same in sentiment – where these individuals are still bullish for crypto, hence why they are looking to purchase – then prices have the potential to rise – the more people buy over sell, the more prices rise Beyond these survey results – it is becoming clear that crypto awareness is spreading – and the hope for acceptance is becoming more and more mainstream – this is promising for the future of crypto's growth general knowledge about cryptocurrency seems to mirror what we hear in the news - Bitcoin is almost synonymous with crypto - few people are familiar with other coins – almost everyone interested in crypto has heard of BTC – but only about one third has heard of ETC   Based around demographic trends - more than a quarter (26%) of current owners first acquired crypto in the last year - and 68% individuals have purchased crypto for the first time within the last two years shows crypto is starting to receive a widespread interest and it is growing fast – helping to push prices up While new cryptocurrencies emerge nearly every day, bitcoin still reigns supreme as not only the coin most people have heard of, but also the coin most crypto holders own Nearly 9 in 10 current crypto owners currently own or have owned bitcoin (87%) Compare this to bitcoin cash at 22% and litecoin at 21% The large majority of current crypto owners say they buy and hold crypto for its long-term investment potential. More than two-thirds (69%) buy and hold, compared to the 36% who actively buy and sell as a means to achieve profits and the 27% who actively use it to make purchases on the internet. All of this is very interesting – as prices for anything are determined by those looking to buy or sell – say a few million people with $100s of millions of dollars are looking to enter crypto markets – where the majority of these people are focusing on BTC – then this technically should mean that BTC prices are set to rise over the next few years – and they very may well - But – the thing I am wary of is the legislative risk – this is the major thing that has made me personally avoid the crypto currency markets – again, I love myself a free market – and the blockchain with some particular cryptos are something that the libertarian inside of me really loves – but the libertarian inside of me also understands how governments act – in regards to their historical behaviours as well as the primary purpose of a monetary economy For those who aren't familiar – we live in a monetary economy – i.e. we exchange a fait currency for a good or service – in the past, there have existed barter economies – when we exchange goods with one another directly – but then due to convenience – the market adapted to a monetary economy – where people started exchanging gold/silver or gold/silver backed IOUs as a medium of exchange – this was all conducted in a private manner and was working well why is this important for a government? A monetary economy is so much easier to collect taxes on – the government doesn't want to collect 10 of your cows in annual income tax, they would prefer to take say 30% on average of your gross income – so the very early private monetary economies were taken over by state at the time – they effectively disallowed the use of privately minted coins with that which contained their own markings This can occur with any medium of exchange - in the modern era this has been the gold standard, then fiat currency – which is granted legislative power as being the only currency that can be accepted to pay taxes or debts – fiat currencies have a monopoly of force behind them if you sell BTC and make a capital gains, you have to pay this tax in AUD – not in BTC to the Gov – If you do not disclose this capital gain – and the government finds out about this through their reporting entities like AUSTRAC – then they have a monopoly of force to make you pay – ignore them for long enough, you can have an arrest warrant issued in your name and then police with guns are legally required to reprimand you until you pay what is owed When it comes to any monetary economy – under the prevailing thought - a centralised currency is required by the powers that be to accept taxes as well as the repayment of debts – it makes thing simple for them Think of your PAYG – you have a chunk of your fiat currency (AUD for most people listening) taken out of your pay cycle – Lets use a thought experiment – lets say that AUD is replaced with BTC – the reporting and control of this currency is outside of the governments hands – this is actually no good for governments under the current system for them to collect taxes or guarantee that they have a never ending supply of debt they can issue They not only need complete oversight and visibility of the going on with this currency (so they get their taxes) – but control of the supply to fund never ending fiscal deficits But the bigger issue for them is the limited supply of certain cryptos – like BTC – Hard to continue to print, or increase the monetary supply of a currency – Technically this isn't so much of an issue – as you just devalue the price mechanics – similar to how the price of gold was controlled by a central bank when this was the backing of money – you can artificially increase the money supply if you increase the price of gold from $15 an ounce to $35 – same amount of gold but now it is worth far more – even the romans devalued their coins by reducing the amount of silver in them But the major governments as it currently stands is not interested in adopting any existing cryptos – they are more interested in central bank issued digital currencies Some smaller governments around the world may chose to accept it – but the major governments won't Digital coins - What form these take is anyone's guess – China is currently looking at a gold backed stable coin – hence why they seem to be hoarding physical gold – and why they are starting to crack down on crypto access and miners But when it comes to governments and the adoption of a particular medium exchange – they do not like competition – when gold was the backing for money the governments made this illegal for individuals to own – unless it was in jewellery or collectable form – so if central banks are looking at their own form of digital coins – and if cryptos are seen as competition – which are a destabilising factor to the monetary economy – what are governments likely to try and do to competing digital currencies/cryptos? Competing cryptos are considered deflationary by monetary officials - rather than AUD being spent in the economy for GDP it is being converted to BTC – creating a deflationary effect on the AUD – requiring more to be printed to try and boost GDP Can the government ban crypto? Can they outright ban BTC, or ETH or ripple – well no – due to the nature of the blockchain it is going to be very hard, if not possible for a single government to ban the existence of a crypto But let's take a step back – what do governments control – regulation of fiat currencies – control over ADIs – i.e. banks – in the modern financial era they have a never before seen control over this sector of the financial markets – from not only the supply of money, but from what you can use your own cash for i.e. cash restriction bill – limiting how much cash a private business can accept as payment for their services – which is open ended with restrictions – it is simply up the government to change their mind Much of the bullish behaviour of BTC has come from the expectation, or hope that many large multinational companies will accept currencies like BTC as payment – Has created a major bullish sentiment in crypto – saw the price go from $20k AUD to $85K per BTC – many other major crypto currencies followed suit- expectation that major companies like TSLA would accept payment is good news – and it is good news – until they turned around and reneged on this Also, other companies like Mastercard and BPAY said they are going to accept transfers and payments in cryptos like BTC – but lets look at their business/profit motives for a minute – if their business model is to make a percentage split on money spent through their chain, wouldn't it make sense to adopt as many different methods as possible to make as much money as possible? so this adoption from companies like Mastercard may not be because they see BTC taking over fiat currency, but simply another way to make additional revenues But negative news surrounding this space – such as tweets from Elon Musk and news from the Chinese Government have created a negative sentiment for cryptos like BTC – saw a 50% decline in prices This is where it is important to look at what governments have control over China cannot ban the existence of BTC – but they can ban any financial intermediary from accepting a conversion from BTC to RMB – effectively controlling the flow of currency into crypto or vice versa Say you have a wallet and you are looking to get your BTC out into RMB in your own bank account – well China as the monopoly controller of these financial institutions can decline this transaction – You are still left with options – P2P conversions for other crypto currencies – or set up a new bank account offshore and convert your coins into another currency – which can then be converted back to RMB But let's say that the US follows suit, or Aus – and slowly as part of a G20 agenda – no financial institutions across this jurisdiction are willing to convert any funds from a crypto wallet into any major fiat currencies – well, this is a major risk – it may never happen – but this all depends on the willingness of governments, not their ability – they have the ability but are rather slow at getting anything done – which the major concern that I have when it comes to these markets in their current form The way I view it is that crypto markets are being allowed to exist by the powers that be, as in their current state they pose no risk – central bank and fiscal mandates are to ensure financial stability – if all of a sudden, they deem that say BTC is creating issues with financial stability, either through consumer protection excuses or through deflationary pressures where fiat currency is being converted to crypto rather than being spent within the economy – well, daddy government may start paying more attention to their methods of controlling/regulating these markets Plus – what makes the crypto markets great in the eyes of many, makes it a money-making playground for others – such as the billionaires or whales within the market As an example – say I am an eccentric billionaire – and I dump $5m into some alt coin – more or less a meme coin like poocoin (real thing) – then I promote it and get other people to buy it, saying that it is going to go up in price – many other people start you buy and the price goes up by 2,000% very quickly through a self-fulfilling prophecy – I then sell my position and take profits – then I reinvest into another coin – promote this via twitter telling people that it is the next big thing and to invest all of their money – then I make a further 2,000% on this coin – and repeat this behaviour – I can make a lot of money – especially if people respect my public profile and I can reach enough people Now – this type of behaviour is commonly referred to a pump and dump scheme – you promote something where others then invest into it and it push the price up – I as a smart person know that the prices the current asset that I am promoting is not worth what it is trading it, so I sell – and take my profits – this is technically illegal on markets that are regulated by entities such as the SEC or ASIC – goes against market integrity rules – But for unregulated markets – this is fully legal – The unregulated crypto market is rife with market manipulation – and technically I see nothing wrong with this – I prefer an environment of buyer beware - it helps to create a more aware population – but when most of the population is used to the concept that some arbitrary rule or regulation will save them from these schemes – it can lead to undesired outcomes – where people lose money – But this sort of pump and dump is the day-to-day occurrence within crypto markets – Whilst it is not good for anyone duped by these schemes – this is the smallest risk that these markets face and markets will adapt over time – people will start paying less attention to what Elon Musk has to say and no longer respond to his signals - But this sort of behaviour can also bring is a large risk from a legislative perspective – this is consumer protection – that governments need to get in involved and treat cryptos as securities, falling under their legislative branch So in summary – if people are making money from Crypto – that is awesome – I would prefer some form of naturally adopted medium of exchange that it outside of government or central bank control – to help maintain purchasing power This is where the blockchain has a lot of promise – but I also know that the government and monetary authorities don't like anyone else playing with their toys This is the same position I have had for the past 3 years when it comes to each any every single coin – The prices may go up and down – but what are those prices measured in? Aus, USD, - and when governments bring in their own digital currencies, competing coins may be deemed too much of a risk So for me personally –prices have the potential to go up of crypto as more and more people adopt this – through converting their fiat for crypto – But as a store of value for the very long term – and as something that can provide me value through an investment – it is something I am not interested in I may be wrong – governments may change their minds and completely ignore crypto markets – but I am not willing to take that chance Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    Printing an unbacked currency to avoid asset price declines. What could go wrong?

    Play Episode Listen Later May 31, 2021 24:41

    Welcome to Finance and Fury. This week we will be looking at the Mississippi bubble. I find it a very interesting story of speculation and devaluation – creating a situation of loss of confidence in an early form of fiat currencies –– Lessons to learn from this – I get asked the question a fair bit – what happens to the value of every asset when denominated in fiat currency if fiat currency fails – and it is a good question - But in this instance the Mississippi Company bubble can help to provide some direction for an answer when it comes to what happens when people are no longer willing to sell assets in exchange for a fiat currency – This story is similar to the south sea bubble episode I did – the Mississippi bubble can actually be confused as the South Sea bubble as the collapse occurred in the same year - during this period many millionaires would be created – and the French actually came up with the term millionaire a result of his most famous scheme – but these millionaires didn’t last long But the Mississippi bubble is actually more of a currency blunder than a true speculative bubble like the SS bubble – this is where the MB has an additional element to it – that it collapsed the confidence in the very currency used to finance the purchase of shares in this venture through the bubble prices of the assets The term bubble in the world of finance is normally applied to a situation when unusually rapid increase in prices of some financial commodity occurs – can occur in shares, real estate, orange juice, crypt, tulips – anything that has a price and people are willing to speculate on can enter a bubble – but a bubble isn’t technically a bubble until the initial rapid increase in price is then followed by an equally rapid collapse in prices Is something in a bubble if the prices go up 1,000% - it may be, but if the price never comes back down then it moves from being in bubble territory to the new status quo The price movements depend mostly on people’s perceptions – the money flow – if people think something is worth a lot or think the price will go up further – they will buy The perception is what fuels a bubble – the reality or a breaking in the perception is what causes it to come back to earth – if that reality never sets back in – or the perception meets or creates the new reality – a bubble never has to pop – but sometimes some exogenous force can piece the reality that perception has created – this is the same element with most famous price bubbles Has a lot to do with the modern monetary and financial system   Let’s start with looking at the history to the lead up to the MSB – We start in 1715 France – where the French monarchy was essentially insolvent – therefore the nation was insolvent (i.e. bankrupt) The French government had spent a lot of money in the many anglo-french wars – most recently on the war of the Spanish succession This is before fiat currency could finance budget deficits – gold and silver were money – if you ran out of these commodities or other nations to lend these to you, then you were in trouble taxes were raised to extremely high levels on the french population but the hole that warfare left in the French treasury was too deep So – what happens to nations when they can’t pay back their debts? France began to default on its outstanding debt and people feared for the future of the nation – if you have no money you have army, i.e. no protection from the English or Hapsburgs if they decide to march an army into your nation This was also the time of colonisation - the French controlled the colony of Louisiana which was a vast settlement in the interior of North America – think of the US today – this area was most of Montana, North and South Dakota, Nebraska, Iowa, Wyoming, Kansas, Missouri, Arkansas, Oklahoma, some of Texas and Colorado and Louisiana - France was the first European country to settle this area of North America (1699-1763) – so they ended up with almost 1/3rd of the current US geographic boarders This land mass was much larger than France – but on top of this the French knew little about it – let alone where it was – this was before the days of google earth But many had heard the rumour that this land was rich in silver and gold – which was the currency   Enter John Law – was a Scottish financier born in Edinburgh and had talents in both gambling and finance Law was a Scottish exile he killed a man in a duel and fled to France in 1714 – at this time he renewed his acquaintance with the nephew of King Louis XIV, the Duke of Orleans The duke became Regent of France after the king's death in 1715 – under old monarchy rule – a regency was when the rightful ruler (i.e. the male child of the king) was below the rightful age to commence rule – normally at the age of 15-16 – so the regent - served as ruler while the rightful heir to the throne matured – which at this time was five-year-old Louis XV So John Law and the Duke of Orleans got talking – the Duke was looking for some solution to their solvency problems – whilst John Law was a bit of a gambler and was well versed in finance – match made in heaven Law thought it was the unpredictable and limited supply of gold and silver that was slowing the economy rather than France having a true economic problem of spending more than it could afford Law thought that by switching to a paper backed currency - more currency could be issued and trade would speed up – similar to a multiplier effect theory financed through fiat debt – i.e. the more money that you print and introduce into the economy, the more that people will spend and based around velocity, the greater the GDP output May 1716 – Law – who was the Controller General of Finances of France created the Banque Générale Privée = "General Private Bank" It was the first financial institution in France to develop the use of paper money It was a private bank, but three-quarters of the capital consisted of government bills and government-accepted notes – issued by the French Government The paper notes would be supported by the bank's assets of gold and silver and would circulate as a medium of exchange Paper money was a new concept for the French; money to them was silver and gold. Law believed that paper notes would increase the money in circulation, which, in turn, would increase commerce. However, the catch was that you could only deposit gold or silver, and withdraw in paper Now – Enter the Mississippi Company - founded 1684 – it was actually named the Company of the West from 1717, and the Company of the Indies from 1719 – but I will be referring to it as the Mississippi company This was a corporation holding a business monopolyin French colonies in North America and the West Indies – which the French held a large territory of – Under the monopoly agreements this company was the sole provider for any trade in their regions August 1717 - Law decided to expand his banking empire by acquiring the Mississippi Company How would this help the Government finance? The scheme to finance the initial operations of the Mississippi Company was simple. Law would raise the money by selling shares in the company for cash as well as for state bonds – the more state bonds that could be sold – the more France could get their way out of debt issues in the short term (debtors come knocking at the door – well they can now convert their debts for shares in this new promising company) Law accepted a low interest rate on the bonds which helped French finances while promising the company a more secure cash flow Also - the lure of the promised trade goods out of the monopoly company – i.e. gold and silver and furs brought out many eager investors in the Mississippi Company.  It turns out that the Mississippi Company was a small part of a much grander empire Law was trying to create The next year in September 1718 - the company acquired the monopoly in tobacco trading with Africa. He also expanded the taxation rights over the colonies under the monopoly charter. He also obtained control of the companies trading with China and the East Indies January 1719 - Law's Bank Generale was taken over by the French government and renamed the Bank Royale - but Law remained in charge But this had a massive shift in confidence for those looking to invest - the crown was now the guarantor of all bank's note issue In effect – with this move - Law now controlled all trade with France and the rest of the world outside of Europe as well as having the guarantee of the French Government from defaults Under the French Governments ownership, but Laws control - The company next purchased the right to mint new coins for France and by October the same year it had purchased the right to collect most French taxes In effect - Law now controlled all of France's finance, taxation collection and money creation - He controlled the company that handled all of France's foreign trade and colonial development – this was Europe's most successful conglomerate – as confidence was high But all of these acquisitions over the years and to receive these privileges weren’t free – to buy the rights to collect taxes, rights to mint coins, rights of trade – these had to be paid for - these activities and privileges were paid by issuing additional shares in the company What is going on with the Mississippi Company share piece? – well it rose dramatically as Law's empire expanded Shares in the Mississippi Company started at around 500 livres per share in January 1719 (the livres was the French unit of account at the time). By December 1719, share prices had reached 10,000 livres, an increase of 1,900% in just under a year. The market became so seductive that people from the working class began investing whatever small sums they could scrape together. New millionaires were commonplace and wealth was booming – times seemed good – at the surface level As the stock price shot up - the amount of cash needed to buy Mississippi shares meant more money had to be printed to meet new demands – as shares were purchased using government debts or paper money This was the weak spot in Law's scheme – as he had a never-ending willingness to issue more bank notes to fund purchases of shares in the company Markets reached their peak in early 1720 – but prices began falling in January 1720 as some investors sold shares to turn capital gains into gold coin – normal profit taking behaviours – making almost 2,000% from a gain – but any sell off spelt disaster for Law – as if people wanted to convert the funds for gold or silver, there wasn’t enough to cover a large sell down To stop the sell-off - Law restricted any payment in gold that was more than 100 livres In Response to this the paper notes of the Bank Royale were made legal tender, which meant that they could be used to pay taxes and settle most debts – essentially the form of money that would emerge under Brenton woods era of monetary policy Law and the Bank Royale needed people to accept paper notes rather than gold – so the bank subsequently promised to exchange its notes for shares in the company at the going market price of 10,000 livres – to todays POV – this doesn’t seem like much – but what it effectively did when money was in somewhat of a limited supply was double the money supply overnight – you had the paper currency in circulation – but now you also had to account for the market cap of the Mississippi company shares It is not surprising then that inflation started to take off – where inflation reached a monthly rate of 23% in January 1720 – in the same month This effectively devalued the shares in the company – but this practice would continue in several stages during 1720 – as the value of bank notes was reduced to 50 percent of their face value with inflation By September 1720 the price of shares in the company had fallen to 2,000 livres and to 1,000 by December In the end – the fall in the price of the MC shares allowed others to take control of the company by confiscating the shares of investors who could not prove they had actually paid for their shares with real assets rather than credit – remember credit is seen as paying for the shares with government bonds (i.e. debt) or paper money By September 1721 share prices had dropped to 500 livres, where they had been at the beginning – a loss of 95% of the value   So, what went wrong – and what can we learn from this   Obviously, the financial world between now and 300 years ago are different – but people and their behaviours are relatively similar Back in 1720 - people wanted gold and silver when they took profits from the sale of the MC - But Law capped redemption in gold and silver to avoid depleting his reserves - This removed France's paper currency from the gold and silver standard and put it on the Mississippi Company share price standard – while at the same time increasing the money supply by the market cap of the MC – then because the amount of paper currency afloat was now many times the actual reserves of gold and silver and hyperinflation set in People want a medium of exchange that they see as valuable – at some point in 1720 – people started to view the paper currency of the Royal bank as worthless when compared to gold or silver Because it technically was – this paper currency was meant to be backed by gold and silver – but it wasn’t to the extent it should have been The solution from the Royal Bank was the continue to print unbacked livres to inflate and support the collapsing Mississippi bubble Between then and now - It isn’t an exact comparison – but CBs today are providing a service that John Law with the MV company were doing Printing additional unbacked currency to help maintain the value of financial assets – mostly in the debt markets – but also in the share and property markets by keeping interest rates low to zero Our whole financial system is confidence based – confidence backs everything and it is the thing that holds the whole modern system together – if people no longer have any confidence that the value of something will maintain its current price – then they sell – the prices go down, then more people lose confidence, then these people sell, then more people lose confidence, then they sell – and so on – and in the modern economy – this happens quickly Think about Government bonds and the debt markets – if every holder of government debt were to sell in an instant – this would create a massive market decline Many central banks are expanding their balance sheets by buying government debts, companies – both equity and debt – which essentially have a monopoly on a lot of the market in their ownership For investors beyond this - Why don’t they sell? Because they have the confidence that Governments/Central banks will continue to provide QE – printing additional funds – increasing the money on unbacked dollars to help maintain the prices of government debt But this story of John Law and the Mississippi Company is as intriguing as it shows the issues that the monopoly powers have over the control of currency Especially when that currency is what is used to pay taxes, debts and buy goods and services Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    Signs of financial instability: How inflation and rising bond yields affects fiat currencies and what this means for financial markets.

    Play Episode Listen Later May 24, 2021 24:04

    Welcome to Finance and Fury. Today, signs of financial instability that are emerging in markets – why are inflation and rising bond yields affecting fiat currencies – and what this means for markets – modern economy is interconnected and complex – so do my best to break these all down There is a growing recognition that price inflation has the potential to increase significantly in the near future It has already increased significantly in certain areas – timber/wood, food, and petrol especially in the US with the hacking of colonial pipeline The official estimates state that this inflation will be a temporary phenomenon – with it reverting back to limited to an average of 2% p.a. But the markets are more worried about the fact that this may not be a transitional phase in the short term, but that inflation is going to linger for years – hence there is increasing speculation about the need for interest rates to rise – creating further uncertainty in markets and sectors starting to de-risk from growth shares For those who are familiar with monetary policy – if inflation is above the mandate of CBs policy, increases of interest rates are the typical response It is something that hasn’t really been seen since the 80s – but markets could panic that this is going to occur and with this – the growth companies that are relying on the lack of discounting of their cashflows in propping up their valuations could come crashing back to earth – specifically the tech sector of the market Where the probability of interest rates being increased is being reflected in the bond yield – in the US – the yield on 10-year Treasuries has more than doubled over the last year, Australia and most of the world is seeing the same phenomenon – all of this is occurring whilst QE is occurring to held artificially lower yields through buying up the additional supply of government bonds on the secondary market – who knows how high the yields would have spiked without QE Historically – and working in a world where fundamentals matter - equity markets have continued to rise during an initial increase in bond yields But Financial markets have become dislocated from fundamental realities – they are now more vulnerable to a change in sentiment – driven from central bank policy – this all requires a revision to fundamental theory – with an updated view to look at what the driving factors are of markets at this stage of the economic cycle Yields rising, or inflation peaking technically should have no effect on equity markets – but it is what economic responses that they point towards that do – in the modern era – CB policy and investor behaviour in response If a central bank changes their mind on interest rate policies – or how much to expand their balance sheet by through QE purchases – markets will react more than they would have historically to something like inflation kicking in – they are reacting to what a central bank will do in response to inflation – not the inflation This is because equity markets are purely driven more by money flows– i.e. money flowing in or out of share – buying and selling – which is the demand of the share market – if it is demanded, then people will buy more, money will flow into the markets, pushing up prices – the reverse is true Money flows can occur in a few forms – in response to the perception about the economy CBs - from policy like QE who are worried about rising yields on government debt Inflation rates and employment concerns – leading to changes in Interest rates - The perceived economic prospects – will GDP be strong, will companies have good profits When looking at some of the current economic prospects - commodity prices are soaring, and supply chains remain disrupted – both of these can lead to supply issues and inflation in prices of goods and services Commodities – inputs to goods and services – when their prices go up, it is passed on to consumers – Supply chains – when they are disrupted it lowers the supply of goods, and if demand stays the same then prices go up Even directly for consumers - oil prices go to petrol – coal, gas – go to power bills These factors on top of the expansions of money supply – which is expected to continue in the future – inflation rates have the potential to spike – if these are not simply transitionary through one or two quarters - higher interest rates may be brought in – which with the amount of debt and additional money supply – threaten to destabilise both financial markets and fiat currencies. For financial markets - The reality is – if interest rates rise – the money flows into assets can reduce – creating a limited price growth and if anything – a price decline For Fiat currencies – all currencies are debt – every dollar is an IOU to a central bank – with inflation, the value of these fiat currencies declines for the person holding it – so inflation for savers in a world where interest rates are zero People are converting their money for dogecoin – this says a lot about the state of the current fiat markets The concerns are that the money flows will cease – CBs will stop printing as much as a response to increase interest rates – So in effect - an interest rate rises will lead to less money supply flowing into assets such as shares and affect existing borrowers This would have dramatic effects on the property markets The interesting thing with markets is what is known or predicted is typically priced in – if an increase in interest rates is known before it takes effect – markets would have already priced this in This being said – what is not expected is what shocks markets – What shocks markets can be in the form of changes in expectations – for instance, inflation is expected – but CBs have said that interest rates will be on hold – Markets are hedging their bets – investors are starting to sell off some of the overpriced growth companies in the market – companies like TSLA – slowly being sold down But Public participation in equity markets is at an all-time high, not just through direct holdings but through passive index tracking funds and the like So the real risks to the markets at this stage of the cycle is that money flows will dry up thanks to responses to monetary policy – this will then spook investors – There will be an inevitable cyclical switch from greed for profits to fear of loss that defines the divide between bull and bear markets The bond market is pointing towards a bear market - considering the effect on market relationships as over many investing cycles it has been observed that bond prices conventionally top out before equities – it is a very reliable warning sign But today we see that there is a relationship between declining bond prices and rising equities The increase in bond yields will affect the cycle of money flow – Looking back – one of the largest debt markets - the 10-year US Treasury bond – saw its yield fall to 0.48% in March 2020 – this is when deflationary fears were around – then the S&P 500 index fell by 32% and commodity prices were collapsing due to demand fears The Fed and global CBs then did what they have always does in these conditions - cut interest rates to the minimum possible (zero this time) and it flooded markets with money ($120bn in QE every month in the US) Over the past year - equity markets recovered fully and have gone on to new highs and commodity prices are now rising strongly But the money supply isn’t being reduce in response – it has continued and is likely to continue - the expansion of base money by central banks is huge - From the beginning of March 2020 base money in the US, the world currency reserve has grown by 69% - this is an incredibility large increase – and it has been rapid – 12 months - likely behind rising commodity prices in part as the purchasing power of the dollar in international markets is falling – as most commodities are based on the global reserve – the USD When the outlook for the purchasing power of a fiat currency falls, all holders expect compensation in the form of higher interest rates or prices – this is inflation after all – the real value of $1 is less when there are now almost 70% more USD – due to time preferences – the expectation is that the currency will buy less tomorrow than it does today. When looking at CPI and bond yields – if we look at the official targets of inflation, at 2.5% - the dollar’s purchasing power should sink to 97.5 cents on the dollar in 12 months if it is accurate – so the yield on the ten-year UST should be at least 2.56% to compensate this - otherwise new buyers face immediate losses – but it isn’t which shows a concern for markets as if inflation is going to go up, investors in debt markets will lose out – which is why QE is needed – You will never hear a CB, like the Fed admit the erosion of the currency they manage – but it is happening It is only a matter of time before holders of all fiat currencies slowly realise these issues one at a time – further eroding the confidence in the dollar and other fiat currencies – this can fuel further money flow out of the dollar – into assets And as has been seen - commodities have soared in price along with other inflation hedges, such as cryptocurrencies, equities and residential property. Other than the purchasing power of currencies, prices of fixed interest bonds have fallen, which is why their yields have risen. What risks are there to markets with a collapse of the value of Fiat For several decades successive – going back to the times of Alan Greenspan – Cb officials have admitted that a rising share market is central to monetary policy – they believe that it creates the wealth effect and economic confidence This has been evident from CB policy – especially last year – but these policies to prop up equity and property markets is always going to address any financial or economic collapse by inflationary means – through the money flow – coming from an increase in the money supply But this in turn creates a real devaluation of the dollar through inflation - the valuation basis for equity markets will shift - undermining prices based around low to no inflation expectation Even if the Fed tries to offset a decline in prices as markets start to price in inflation – Creating higher yields for bonds and greater preference for present values in cashflows today rather than in the future for equities – if the solution is to increase QE to feed more cash into bonds and equities – they are chasing their own tail and at some point, it will be impossible to offset the valuation effect Equities will almost certainly succumb to an interest rate shock at some point. At the same time, the increase in bond yields will undermine government finances. In these conditions the Fed will be trapped - it cannot let bond and equity prices slide - investment sentiment would turn deeply negative creating further sell offs and further price declines- but nor can it stand back and let markets sort themselves out, because of the record levels of corporate and other debt which would become impossible to refinance But nor can it just print money in order to rescue everything, because the dollar will be further undermined and start to become even more worthless - That leaves it with only one alternative left to pursue, albeit with the greatest reluctance. And that is to raise interest rates — substantially From this earlier precedent – the central banks have made the choice to increase interest rates over printing more money – but only when confidence in the dollar is low – you don’t want to lose all confidence in the dollar – or your currency – get a hyperinflation event – so to save the currency at some point interest rate increases would be needed But today – almost every economy is loaded up with debt, much of which is unproductive. A sharp rise in interest rates to contain price inflation would drive the world’s economy into a humungous debt-induced slump – also government borrowing is already out of control – especially in countries like Japan and the US Whilst it would create a massive downturn in prices – it may be what is needed. We aren’t at this point just yet – but there are some consequences of rising bond yields – that is that they can bring a rapid shift from overtly bullish assumptions to a more considered bearish outlook Where instead of bad and inflationary policies being tolerated or even demanded by investors, their thinking turns on a dime to a fear of anything and everything Under these conditions - every turn of the central management of economic outcomes only makes things worse Such is the violence of market imbalances that plague the financial world with central banking environment – where under their control financial markets can face a rapid decline if major inflation spikes due to the artificial controls on money – through increasing the money supply and keeping interest rates near 0% In this environment – alternative assets can do very well – commodities, physical previous metals – and beyond speculation – this may be why many crypto markets started to rise over the past 12 months – people are looking for anywhere to put their money beyond fiat currencies or debts denominated in those currencies Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    How do you both manage and protect your wealth in times of war?

    Play Episode Listen Later May 17, 2021 20:25

    Welcome to Finance and Fury. This episode is a little outside of the box, the topic comes from a listener, Mario. He asked the question of how does someone both manage and protect their wealth in times of war? and are there actual strategies that one can implement if a war was to break out? So, in this episode we will look at if there are strategies that are implemented as part of managing a portfolio to safeguard against the impacts war has on share markets and other asset classes.   Before we get into that – there are some things to consider when looking at this topic – Wars are not all built the same – you can have civil war, boarder conflicts, or even major conflicts like a world war – since WW2 there has also been the potential for a full-scale nuclear war – leasing to a mad max/fallout post-apocalyptic world scenario There are always wars going on – 3 wars saw 10k more combat related deaths last year, 14 with 1k to 10k, 33 other conflicts The major consideration out of all of these - is your country affected? Countries ravaged by war suffer severe losses – in terms of life, disruption of resources, occupations Times have changed – Switzerland used to be considered an independent country – but now the world is interconnected in a way that would seem foreign to those living in through the times of WW1 and 2 Wealth has changed – used to be mostly physical – and financial contracts have changed Back in WW1 or wars before - Those who offloaded wealth – nazis with physical wealth – to avoid it being confiscated – would do so in a physical manner Gold, artwork – this would be transferred to neutral countries like Switzerland   Whilst wars are awful – one piece of good news is that you probably don’t need to worry about most investments if a war breaks out – especially long term This is assuming that it is a similar style of war that we have seen – if it is a major form of conflict – say the US and the West versus China and Russia – in a nuclear fallout situation – the best investment would be in your own survival – making sure you have your own food, water and power sources – But the good news - if there can be any when wars are declared – is that most financial markets tend to not be negatively affected in the long term Markets don’t deal well with uncertainty well – if a major conflict were to erupt with major uncertainty, then the share markets may drop – but markets have seen many conflicts The major wars that affect financial markets have been financial wars – been raging since 2009/10 – with currency wars – but lets say a hot war breaks out – what are the safest asset classes to be in and how should you manage your funds   Asset classes to look at – Defensive assets such as bonds are not that safe in times of war – this is because Bonds generally underperformed during times of war – this is for two reasons war tends to be inflationary – you see massive supply shocks, increasing prices - bonds do not like inflation most bonds pay a fixed income and have a nominal face value to be paid back at maturity – hence their value dwindle when inflation rises – so inflation will traditionally drive the price of the bond lower to compensate for this factor governments tend to borrow more during wartime – creating more supply of debt which again tends to drive prices down Historically this has been an issue - but with CBs and QE – this isn’t as much of a concern, as long as QE were to increase to soak up any surplus supply – which would depend on the country How well the debt markets go really does depends on who is the likely victor of a war is – Bonds are debt issued by either governments or companies – if a war was to break out and a nations government gets overrun and its domestic companies get destroyed in their output – both see their ability to honour their debts being diminished – making the asset worthless – markets would respond poorly to this – so the price of the bonds would become almost worthless US bonds have historically been the favoured destination for investors since WWII – considered a global superpower – if a war breaks out tomorrow - the US will be the likely winner – not talking about their failed ‘nation building’ wars – like in Iraq and Afghanistan – there is really no winning those wars Looking at the losers of the war - Germany, Japan, Italy - fixed income had severely negative returns - German bill investors lost everything in 1923 Going back further - German bonds investors lost over 92% in real terms after World War I. Admittedly inflation was virulent in a war-torn world, and fixed income is not the place to be in such an environment. In the chaotic, disorderly environment of the war years in the Loser nations, you can't sell bonds or cash in bills any more that you can trade stocks. So in most cases – if wars break out there is little upsides to bond markets – they can fail at their defensive purpose, and also provide lower returns   Shares – these actually can perform rather well through longer periods of wars a review of market reactions during the major wars between 1926 and 2013 shows that the impact of war on US stocks were largely positive – WWII, the Korean War, Vietnam and the first Gulf War were all periods in which "both large-cap and small-cap stocks outperformed" their long-run averages more surprisingly still, volatility did not take off - indeed, markets experienced lower volatility than normal – in a sad way, markets may have become accustomed to war Share markets have largely shrugged off past geopolitical conflicts – they can initially see some volatility or losses – but recover rather quickly - Why would this be the case? As serious as wars get – you need to ask yourself how likely any wars are to have to have a material impact on the major economies of the world – with this flowing into affecting the fundamentals of corporate profits of the companies listed on the markets – most major markets have been affected by wars due to this reason – the companies are untouched by modern day conflicts Plus the U.S. has spent an estimated $6.4 trillion on wars post 9/11 - it appears willing to keep spending if things escalate – this is money flowing into companies that run the war machine – so it helps to boost markets Looking at history - From the start of WWII until it ended in late 1945 – the US market was up a total of 50% - more than 7% per year over the 6 year timeframe When including WW1 from 1914 to 1918, just under 4 years - U.S. stock market was up a combined 115% over this 10 year period Beyond the tragic loss of life – the US economy was largely unaffected – it saw a ramping up with many companies and resources being reassigned to the war machine It is in periods of major uncertainty where the share market suffers the most when there is a pre-war phase – i.e. there is an increase in the likelihood of war breaking out – this tends to decrease share prices - but the ultimate outbreak of a war increases them – interestingly – markets can predict, or determine the outcome of wars – as some examples Japan's market peaked in 1942 – as up until this point they were winning on all major fronts – technically controlled the largest geographical span of control of battles in human history – most of this was across water – but it was an immense theatre of war the US market turned around after the Battle of Midway in late May of 1943 – first major win by the US after getting beaten time and again by the initially superior Japanese fleet that the British stock market bottomed at the time of the Battle of Britain in 1940 – major air conflict between the RAF ad the Luftwaffe – which the RAF ended up winning the German market reached its high-water mark in December 1941 - about 6 months after operation Barbarossa began (the German offensive on Russia) as it became clear that the casualties and likelihood of compete victory was in doubt But in cases when a war starts as a surprise - the outbreak of a war decreases share prices due to the initial uncertainty shocks this phenomenon can be called "the war puzzle" - but there is no clear one explanation why share increase significantly once war breaks out after a prelude - As an example - Iraq war – in the lead up to this war after 9/11 – The ASX fell by around 22% - but then investors were encouraged by the start of military action when it finally happened in 2003 – because it removed the uncertainty that had plagued markets up until then In essence how long a war goes for, what sort of damage is done, and what is priced in before it happens all play a role before investors refocus on the main drivers of financial markets - the economy and earnings. Over the past 100 years - markets have been conditioned not to overreact to political and geopolitical shocks for two reasons There is the belief that there would be no significant subsequent intensification of the initial shock beyond what has already been priced in central banks stood ready and able to repress financial volatility – i.e. print the way out of trouble Investors should technically be buying the dips Gold - one safe haven that does do well in times of war is gold Gold has been a good hedge against geopolitical upheaval and uncertainty Looking at the history of Europe during World War II indicates gold and jewellery work fairly well to protect a small amount of a wealth – because back then this was purely what you could carry on your person - but there were risks to this - conquerors demand the physical assets - and your bank will give it to them – back then people would try to take their wealth with them – but now things are different – as you can have paper gold in the form of ETFs -   If you have physical gold this is probably better – as long as it is stored in a secure location on your own property and assuming that an occupying force isn’t knocking down your door But when times are uncertain – gold can go well as a hedge to the initial shocks the share market can suffer from the build up to wars Summary - But what are the takeaway lessons? For protecting wealth and getting positive returns in times of wars – the share market has been a better bet than bonds Gold can also provide a good hedge – also, I would guess that some crypto markets would do well also – hard for one single nation to confiscate a global market Over the long run, equities are the place to be — even in countries that are losing a war, because historically, even they have managed to beat inflation However - even in the countries on the winning side - money invested in equities should be diversified - no company has ever had a sustainable, forever competitive advantage The historical records indicates that equities over the long run in relation to war are highly likely to earn a return well in excess of the inflation rates as well as provide a positive return during the period a war is occurring Share in a stable country have a higher degree of certainty and can achieve a long-term better real return over the countries that may be the losers of any wars It is always good to diversify – if you are really worried about a war coming to Australia’s shores – shares can work better than bonds – if you are worried about a nuclear winter – then any financial investment is likely to do you little good – better to start building a bunker and buying some MRE Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    The Federal Budget: How will you be affected and will the proposals benefit you?

    Play Episode Listen Later May 13, 2021 21:18

    Welcome to Finance and Fury. This episode we’ll be talking about latest federal budget that was announced this week - and the implications this will have for individual There were many announcements in the budget – few good things like the reduced tax on innovated products – but we will be focusing on individuals Many of these announced changes haven’t passed legislation yet – but very likely they will – the budget for individuals focused on taxation, superannuation and housing Personal Income Tax cuts – not too much has changed here The Government continues its Personal Income Tax Plan with the announcement of a number of measures targeted towards low and middle-income earners – the changes to the tax rates is still expected to continue as planned The aim of this is to provide immediate relief to individuals and support economic recovery by boosting consumer spending Comes from the demand side of economics – allowing people additional income to spend more within the economy to boost GDP – as the majority of our GDP comes from consumer spending, allowing people to keep most of their own money can assist with GDP – but it does depend on how the money is spent Retaining the low- and middle-income tax offset for another year The low and middle income tax offset (LMITO) was a temporary measure introduced – but this has been extended for a further financial year to the 2021-22 income year. The LMITO provides a reduction in tax of up to $1,080 for those earning less than $90,000 and will be received on assessment after individuals lodge their tax return- basically it means you get an extra $1,080 back at tax time – it starts to reduce once you exceed the threshold – but it is still more money in you pockets It is estimated that more than 10 million low and middle-income earners are expected to benefit from the extended tax cut Save the Australian population $7.8 billion in tax - the government expects the extra cash will flow towards businesses, encouraging more employment or investment – boosting GDP by around $4.5 billion in 2022-23 Right away here there is something that stands out – that they don’t expect all of these funds to be actually spent – consider the concept of the multiplier effect – where $1 within the economy should lead to more in an increase in GDP – granted that this can take more than a year to potentially materialise – but 42% is expected to be retained by individuals Self-education expense deductions The Government will also remove the exclusion for the first $250 deduction for prescribed courses of education. The first $250 of expenses relating to prescribed course education is currently not deductible. The measure aims to reduce compliance costs for individuals claiming self-education expenses. This is another minor change – but at least if you are taking a course to further your income capacity in your current job you can claim the full amount of your education costs Superannuation – Superannuation guarantee increase – this isn’t specifically a part of this budget as it was meant to occur a number of years ago – but the increase in SG is occurring from 1 July to 10% The superannuation guarantee refers to the minimum percentage of earnings an employer needs to pay into their employee’s superannuation fund. The superannuation guarantee is currently 9.5%, but will increase on 1 July 2021 to 10% Can provide an additional boost to individuals superannuation – but might have some unintended consequences An individual’s superannuation balance is expected to benefit all things being equal – i.e. same wage levels and wage growth – but SG is based around wages Most employers look at total package – what will it cost to employ someone– wages plus SG and any other benefits – Wages of $80k used to have $7,600 of SG on them – total package of $87,600 Now an employer either needs to find an additional $400 per employee or reduce any wage rises by $400 – as the new SG is $8k – this doesn’t sound like a great amount in the grand scheme of things – and that is correct – but an employer with 1,000 employees now need to find an additional $400k for this – and this is just the first of the planned increases – meant to increase to 12% - or for someone on $80k this is $9,600 or an extra $2k p.a. This equates to $200k for a medium employer with 100 employees, or $2m for a larger company with 1,000 employees there are pros and cons to this Pros are that at least people are forced to have savings for retirement Examples – someone starting off their career with $50k income – works for 30 years and gets wage growth of 3.5% p.a. on average – assuming super gets 8% return p.a. 5% - $827k in super 12% - $1.044m in super or $217k more The CC cap will be increased as well to $27,500 – this is another change that was already on the cards – but is coming into effect 1 July – the CC cap will increase by $2,500 This means that people can salary sacrifice an additional amount each financial year This is a benefit – allows people more room to SS more into superannuation – this is good as the changes over the years have been to reduce the CC cap – even though over time with the devaluation of the dollar and inflationary pressures, it should have been going up initially this was an unlimited cap – then $150k, then $50k when I started in the industry, then got brought down to $25k. Superannuation Guarantee Eligibility Threshold removed The Government is proposing to remove the $450 per month minimum income threshold which determines whether employees have to be paid the superannuation guarantee by their employer. Currently, where employees are paid $450 or more (before tax) in a calendar month, superannuation guarantee is payable on those wages. This threshold was introduced to prevent the administrative burden of facilitating the superannuation guarantee for employers with employees in casual employment arrangements.    This proposed measure will ensure lower income earners are not missing out on the benefit of having superannuation accrue for their retirement. In particular, an estimated 300,000 individuals would currently be eligible to receive these additional superannuation guarantee payments So the minimum monthly income threshold of $450 before super guarantee contributions are payable by employers will be abolished - given SuperStream and Single Touch Payroll exist, the admin burden has been lessened slightly – but one thing to watch out for if you are a casual worker is to make sure you track your super payments – make sure you have the one fund First Home Super Saver Scheme (FHSSS) changes aimed to increase uptake In the latest change to the scheme, the maximum releasable amount of voluntary concessional and non-concessional contributions has been increased from $30,000 to $50,000. Voluntary contributions made from 1 July 2017 up to the existing limit of $15,000 per annum will apply towards the total amount able to be released. This increase will apply from the start of the first financial year after Royal Assent, expected to occur by 1 July 2022. The increased cap will ensure the FHSSS continues to help first home buyers raising a deposit more quickly, primarily through the special tax treatment of super and associated investment earnings. Self Managed Superannuation Funds (SMSFs) & residency SMSFs have long been disadvantaged from a tax perspective where SMSF members are absent from Australia for extended periods of time. In this budget the Government proposes to relax the rules such that the SMSF and members now only need to meet two rules to be eligible for concessional tax treatment: The fund must be established in Australia or hold an asset in Australia The members cannot be temporarily absent from Australia for more than five years. Other changes that affect older Australians The Work Test has been proposed to be abolished - From 1 July 2022 Australians will no longer need to meet the work test to be eligible to make non-concessional superannuation contributions and receive salary sacrifice contributions after reaching preservation age The old rules were that anyone over the age of 65 would need to meet a work test to contribute to superannuation – make a non-concessional contribution or salary sacrifice contribution Individuals aged 67-74 years will still have to meet the work test to make personal deductible contributions The worst test is that you are working at least 40 hours in a 30 day consecutive period Downsizer contributions - From 1 July 2022, Australians over 60 years of age will be eligible to make downsizer contributions. Previously the downsizer contribution was limited to Australians over age 65. The other eligibility criteria for the downsizer contribution remain unchanged. Housing  The government has established a new Family Home Guarantee, which will be awarded to 10,000 families with single parents, allowing them to build a new home or purchase an existing home with a 2 per cent deposit The Family Home Guarantee is set to allow single parents to purchase a property with a deposit as low as 2%, with the government guaranteeing the remaining 18%. Applicants can either build a new home or purchase an existing home. Usually, home buyers would need to save up at least a 20% deposit, or take out lenders mortgage insurance (LMI) which can leave them thousands of dollars out of pocket. The Family Home Guarantee is limited to 10,000 places. However, this will be spread out over four financial years – which equates to 2,500 spots per year - The Federal Government says about 125,000 single parents will be eligible for the scheme. That means only 8% of eligible families would benefit from the measure over the four-year period – or 2% per year Eligibility for the Family Home Guarantee - Single parents with dependants who earn up to $125,000 per year - must also be Australian citizens and at least 18 years old. The scheme is open to first home buyers as well as those who have previously owned a home. The New Home Guarantee - An extra 10,000 places in the New Home Guarantee scheme will be added for 2021-22 This is similar to the family home guarantee – as the government guarantees the remaining 15% of the deposit value – so it can help to support first home buyers in building a new dwelling or to purchase a newly constructed The New Home Guarantee scheme helps first home owners build or purchase a new home with a deposit as low as 5 per cent. But that means existing properties are not eligible for the scheme, which limits the opportunities for prospective first home owners living and working in capital cities or built-up areas. With these measures as well as the FHSSS – can help people get into property But the thing to watch out for is that you are getting either a 98% loan or a 95% loan – In both cases the government is guaranteeing the remaining 18% and 15% level of funds that would be needed to make up the 20% deposit to avoid LMI – but I don’t believe that they are putting up the capital for you as a deposit – As an example – buying a $600k property – normally you need $120k as a deposit With the FHG – you need $12k – plus stamp duty (depending on if you are eligible to get any concessions on this depending on the state you live in) – But means you have a $588k loan So your repayments will be higher and you will still need to prove that you can afford your loan repayments with the bank With a 20% deposit at 2.8% = $1,972 p.m. in repayments, with 2% = $2,416 p.m. = extra $5,328 p.a. Other consideration is that if prices go down slightly, you would be left with more debt than property value – so you may be trapped in the property and cant sell unless you are willing to take the loss and come up with the funds to repay the bank HomeBuilder – 12-month extension of the HomeBuilder construction commencement period for existing applicants This was the $25k for new home construction or renovations above $150k – there has been massive delays in the building industry so the extension is in hopes that people where were expecting it won’t miss out Summary: Budget for individuals does have some small improvements for individuals Extension for income tax offsets Additional superannuation for employees Additional foothold in the door for property – but can come at some risks to be aware of Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    Announcement: Delay of episode until after the 2021 Federal budget

    Play Episode Listen Later May 10, 2021 0:47

    How to minimise market timing risk for your investment strategy.

    Play Episode Listen Later May 4, 2021 21:39

    Welcome to Finance and Fury. There are concerns at the moment when it comes to investing – and that is that markets are at their all-time highs – concerns aren’t that markets continue to go to new all-time highs, but that the market falls through in the short term – what goes up must come down – the major concerns are around how far this may go down This episode – want to go through how to minimise timing risks – in other words, how to still invest now and if you see the market go down, minimise any loss but also take the opportunity to profit out of this situation To understand this concept and market timing risks – need to understand the concept of probability – which comes back to market timing risks - I get the question a lot - Is it a good time to invest at the moment? This is at the core of timing risks - the speculation that an investor enters into when trying to buy or sell an investment based on future price predictions – fer examples - I think the market is going to go up so I go all in, but then it doesn’t – or I think the market will go down so I hold off, but then it goes up and I miss out - is now a good time to invest an important question – depends on what type of assets you are talking about and how you are going about investing – I always think that it is a great time to invest now – if you are talking about your expected position in 10 years time – it is about the time you spend in the market, not trying to time the market If you invest $100k today in an index fund, the probability that you would be in a positive position in 10 years’ time should be a sure thing, based on past performance – future performance shouldn’t be determined by past performance – but lets think about the market make up for a minute What is an index – a basket of shares – ASX300 is the top 300 companies listed on the ASX by market cap – you are buying a large chunk of companies in the large cap – but also 250 companies that may rise to be the top performers – overall, these companies should perform positively over the long term – there will be companies that do not, but the majority of the index should rise, and your position in underperforming companies should reduce as the winners take their place – it is all about probability – spreading your risk out amongst many companies to minimise the probability of loss Probability - the branch of mathematics concerning numerical descriptions – i.e. how likely an event is to occur - The probability of an event is a number between 0 and 1 - roughly speaking, 0 indicates an event that is impossible to occur, whilst 1 indicates certainty Flip a coin – you have a probability of getting heads or tails – 50/50 – Flip a coin twice – you have a 25% change of getting 2 head in a row – flip it 10 times, have a 0.1% change of getting all heads – so flip a coin 1,000 times you may see this occur Experience in the market – shows that there is always a probability of losses – but this can be minimised when investing well and implementing strategies if you are concerned about losses in the short term But – it brings up an important point of probability in markets – What is the probability that you invest now and are in a positive position tomorrow, or the next month, or the following? It all depends on timing – which can really be best boiled down in probability to luck in the short term – do you finally pull the trigger today, tomorrow, or next month? A lot of people talk about luck when it comes to investments – wrong way to think about it – Luck – when investing you make your own luck – if you haven’t invested in the first place then you see the market go up – this isn’t lucky – but if you hold off investing and see the market crash – is this a turn for the better? Or a lucky situation? Technically it is – but all of these situations are viewed on a short-term time horizon – Long term - You make your own luck – you either invest for your future or you don’t – those who say that others are lucky because their made money investing are often those who have never invested In the short term – it is anyone’s guess what markets will really do – In the short term, I am talking about day to day - month to month, or even sometimes, year to year – but what about decade to decade? It becomes very hard to be unlucky with investing when your time horizon extends out to 10 years markets have a tendency to increase in value over time – the increase in value through a long term time horizon decreases the risks for short term investing But what about the short term? Here is where things get more interesting - Lets have a look at the numbers and probability – in particular, lets look at the ASX index for investing – One good illustration of this point is the holding periods that were positive – from investing from day one and waiting – for these figures we are looking at the ASX index, probabilities differ if you select one individual share, or even 5 individual shares – but for the index 1 day (the next day) – 54% that you were positive or 46% that you were negative – very close to flipping a coin 1 month – 62% chance that you were positive – so there is a higher probability that after a months’ time, you will have a positive return There is a higher probability that you are still in a positive position – but there is a 38% chance that the investment would be at a lower value 1 year – 78% - now we are getting into the positive territory that if you invested 12 months ago, you have a 22% chance of having a negative return – about 1 in 5 – so every 5 years on average you may invest and see a negative return – but looking at the longer term 3 years – 91% that you are positive – so if you invest and see the market drop day 1 after you invest, and this continues to be a market crash, you have a 9% chance that you are still at a loss – this assumes that you didn’t invest anything further at the lower points of the market to recoup your losses 5 years, 10 years – 100% - beyond 10 years – 100% - for 15, 20, 30 years Out of all of these, that these probabilities don’t mention is the level of positive returns - Going long term – looking at the past 120 years – or since 1900 from the federation of Australia History of the markets – ASX in particular – average returns of around 13.2% p.a. – so if you have held investments in the index for 120 years – which in reality no individual could manage – you have 0% chance of loss – and a better compounding return rate that warren buffet There have historically been periods where the market has been flat for a number of years – especially in real terms – i.e. after inflation 1914-1921 – market had a flat real return – period of 7 years 1929-1932 – flat real return of 3 years 1937-1944 and 1951-1958 both saw periods where the real returns were flat for 7 tears Largest stretch was 1970 to 1985 – 15 years without a real return – but inflation was in double digits More recently – the market was flat in real term for about 8 years, from 2009 to 2017 But markets have changed over time – what drives markets is different – Looking back – the periods of time that markets have underperformed, or been flat long term follow economic recessions/depressions – why? Markets were behaving rationally for their time – differences to today no endless liquidity injections – money was relatively finite before endless liquidity from CBs – Looking at the market since 1970s- when fiat came into existence bull markets and bear markets – Average bull market – 46 months – return of 130.1% Average bear market – 13 months – return of -35.8% So your probability of losses are still smaller than the gains from investing when viewed in the long term But capital preservation is important – lose 50% of your investment, have to make 100% on the positive to get back to your original position   There is no way to completely remove risk from investing – even cash technically has a risk to it – counter party risks of the banks - But there are Strategies to reducing timing risks – volatility - The first and easiest is behavioural – if you own investments – and the market go down – don’t sell This one is very simple – but effective – if you buy investments and the market declines – don’t sell This can be very hard – humans are risk adverse by nature – we have myopic risk aversion But if you remember that if you hold long term, you should be at least back to your original position in 5 years at the very worst case Often the feelings of wanting to sell occur right around the bottom of the market – you see a major loss and worry about markets going down further? Guess what? Most people who have funds invested feel this same way – some feel it at 10% loss, some at 20%, some at 50% - but at some point those who feel the fear start to be outweighed by those who get greedy and the markets recover Timing risk comes from trying to guess what the market will do in the short term The worst thing to do is sell – because how do you know when to get back in? The hardest part of selling is then getting the guts to then put your own money back into an investment that has caused you loss – which financially has hurt you – this financial hurt can linger worse than a physical pain – cut yourself, it will heal in a week or so, but the painful feelings of financial loss can linger far beyond this point – this affects your future behaviours – you would be less likely to invest again – past experiences affect future decisions – heuristics of human beings – one bad experience can ingrain a bias to avoid repeating this – hence you don’t ever actually want to invest again – so you never do and you miss the rebounds in the market and the long term performance this can provide Remedy to this is to Buy more – when markets go down, buying more can help avoid long term losses – but it takes some guts to put money into investments that appear to be declining in value – but if the only reason that they are going down is that everyone is selling, which has nothing to do with the underlying performance of the investments – then investing is basically picking up a bargain but sometimes you don’t have any capital left, to avoid this, another strategy can work DCA – dollar cost averaging is about breaking up timing risks – done full episodes on this strategy – last one was about 5 months ago Check out the episode “Dollar cost averaging - how and when can this best be used for investment purposes” But in summary – if you have $100k to invest now, and are worried about short term capital losses, then you can invest $40k now and the remainder over a number of months - $20k over 3 months, $15k over 4 months, or $12k over 5 months, or even invest $20k over 5 months – no one right way about it, depends on individual preference and investments being selected What is important is that the probabilities are being averaged – DCA – stands for cost averaging, costs are the prices of the market – buying the average price of the market over the time period you are investing – which comes back to probability ABI – Always be investing – done through Monthly investments If you don’t need the funds for years then market declines can provide an opportunity – shouldn’t be viewed as a painful experience, if you know markets will recover at some point – instead view it as an opportunity Deploying spare cashflow – keep investing in down markets, if you can afford to invest more, then do it Diversification – process of spreading your risk out – many people think this refers to buying say an index – of having 300 shares on the ASX – or a few thousand international shares – this is a method of diversification, but it doesn’t save you from a systemic market collapse – where all markets are crashing – real diversification comes through investing in asset classes which can preserve capital, or even gain in value when another is declining Strategy: Initially – invest in other asset classes - and rebalance over time – Diversification helps to minimise downturns in the short term through being in uncorrelated assets, or assets that have low levels of correlations Investing between asset classes – bonds, credit, alternatives, gold, etc. – but many people don’t want to own these investments long term Bonds – a lot of people I speak to don’t want to be in bonds if they have a 30+ investment time horizon, and I completely understand this – personally I don’t hold defensive investments like bonds – But they can provide a capital hedge against going fully into the share market – and aim is to get a better return than cash What you can do, is if markets decline then use your defensive funds to rebalance into the undervalued assets If shares go down, and bonds and gold go up, use those assets to buy back into shares – buying more of the assets Summary – Markets rise and fall – long term – you aim to get positive returns Short term – i.e. 1 year, it is anyone’s guess Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    Will the proposed Stamp Duty reforms make property more affordable?

    Play Episode Listen Later Apr 26, 2021 26:15

    Welcome to Finance and Fury. A few weeks ago we went through the NZ government tasking the RBNZ with looking at property prices with monetary policy. in that episode, we went through why it probably isn’t going to really work well – politically the perception is that the Government is trying – but for the CB to make housing affordable through monetary policy, their only real recourse is to increase interest rates which would potentially put many households into default – leaving to an oversupply in property and property prices dropping – but this may not actually create ‘affordability’ – it would create people who have declared bankruptcy, who then have a hard time getting another loan, plus it may lower the household incomes – affordability of property is the price of property measured against the average household income what was mentioned in this episode is that the central bank has basically said as much – and would refer back policy tips for governments to try and implement – this is the other end of the spectrum on the fiscal policy side – such as changes to the taxation system – this brings us back to today’s topic – and this is one of the proposals that the NSW government has when looking at property affordability – Major changes may be coming down the pike in NSW for stamp duty reforms – may set the example for other states to follow This episode – we will look at the proposal to remove stamp duty and replace this with a form of property tax – in other words, pay less upfront tax and replace this with an ongoing tax We will also look at some examples of how this would work Most of the information from this episode is from the consultation papers, bot with NSW treasury and a few private To start with - this proposal is nothing new – one paper I was looking at went back to 1996, another to 2016 – Because if anyone was politically/policy aware back in around the 2000s – the proposal was that with the introduction of GST at the federal level, it was meant to be the replacement of stamp duty charged by the states – so the GST gets introduced, then the states remove stamp duty As is with governments – don’t like to forego revenues – so GST was a double win for the states – keep collecting stamp duty and then get a distribution from the federal level through GST – which is distributed between the states Before we get into the details of this proposal – let’s start at the beginning - What is stamp duty – Tax you pay on the transfer of an asset – stamp duty is triggered by a property transaction and levied on the sale price Stamp duty is also referred as a transfer duty, as it is a transaction-based tax paid on the transfer of property, both residential and commercial. The tax is paid by the purchaser of the property, based on the sale price – includes the price of the land and the building on it – essentially the market value Stamp duty has a progressive tax structure - the tax rate increases as the purchase price increases. first introduced in England back in 1694 under an act to help raise revenue to fight against the French towards the end of the Nine years’ war As an English colony this tradition carried – NSW introduced Stamp Duty 1865 Stamp duty makes up a large chunk of every states revenues – NSW has a revenue of just under $32b Transfer duty - $8bn or 25% of the total revenue, land tax was about $4.6bn or 14.4% - but in total the NSW government makes around 40% of their revenues from property, in the form of transfers or ongoing land tax – note that this land tax is not rates – which are levied and collected by the local councils Interesting – one paper I looked at called Fundamental principles of stamp duty – had the revenues of NSW back in 1995 - $2.6bn was the stamp duty collection – but this made up around 43% of the state’s revenue back then – today this tax, whilst it has increased by $5.4bn, makes up about 18% less as a share of the total revenue - additional taxes have been introduced since, such as on gambling, other state levies, which have helped to reduce the portion NSW has some history in reforming Stamp Duty - From 1 July 2016, the NSW government abolished transfer duty on the sale of business assets, including intellectual property, goodwill and statutory licences.   Why is NSW looking at this proposal – The major reason is that over the past 156 years, stamp duty on property has become a large upfront barrier to entry to getting into the property market – not only getting into the property market, but moving from a current property into a new one - Since the 1990s - Property prices have grown, especially around the greater Sydney area – but on top of this, the tax rate of stamp duty has also grown – creating a compounding effect of the barrier to entry for property Initially the stamp duty rate was 0.5% - but on average now it is around 4% in NSW based on the average property price – it is a tried system – but on average it is about 4% - increase of about 8 times In the past 30 years, the average earnings over households in NSW have trebled, but the average house prices have increased around five times, and average stamp duty on dwellings has increased more than seven times – there is a problem here – With the compounding factors of higher prices, requiring more of a deposit savings, as well as costs to stamp duty, homeownership has declined, from around 70% in the 1990s to around 64% today To get into the property market – you have to personally cover the stamp duty – save for your 20% plus the stamp duty costs One of the studies done has estimated that stamp duty can add 2.5 years for an average worker to save enough to get into the property market – this is based on the average household saving 15% of their income on a deposit Goes without say that stamp duty has massively increases the transaction costs for getting into property – In 2009 NSW stamp duty revenue was 137% of the ABS measure of ownership transfer costs. By 2018, stamp duty was 384% of ownership transfer costs Economists also suggest that stamp duty can also hurt economic spending for the population - A review of nine recent studies of the Australian tax system indicates that each additional dollar of residential stamp duty revenue lowers living standards by about 90 cents. For stamp duty on commercial property, the impact is even higher, with an economic cost of $1.00 for every dollar of revenue raised. So, on average, almost every dollar raised in stamp duty has 100% economic cost – reducing consumer spending and GDP   But let’s be clear – the Government are not acting purely out of the goodness of their hearts for this change – they are looking to replace an upfront tax with an ongoing tax – in the form of a property tax We already have a Land tax - which is an annual tax paid on the ‘unimproved’ value of land We also already have rates – which is also based upon the unimproved value of land – however at the moment – land tax isn’t paid by many people in NSW – the numbers: For stamp duty – figure of about $8bn at the state level, with an average rates bill of $1,050 in NSW and 3m households, revenues by the councils of about $3.2bn, but for land tax there is a $4.7 billion revenue that is generated from about 180,000 land tax payers – this is an average annual land tax bill of about $26,000 per tax payer Focusing on properties, rather than the people who pay land tax, about 260,000 out of 3 million residential properties in NSW (about 8.5 per cent) are subject to land tax - then among commercial properties only about a quarter are subject to land tax a smaller number of people pay land tax – why? It has a high tax-free threshold, and there are many large exemptions, including the principal place of residence and farms. This new property tax will not be land tax, or replace land tax or rates – it will be on top of these There will be some changes compared to land tax as it currently stands - The property tax would apply to each individual property, unlike land tax which is based on an owner’s aggregate value of landholdings But here is where the proposal is looking at two options – Tax based on the unimproved land values – which is how council rates are determined Property tax based on the market value of property – including the value of the land, buildings and improvements Is similar to rates vs stamp duty – rates are based upon the current unimproved land value – stamp duty is based on the market value of sale – I think it will likely be based on the unimproved land value – the council already does this each year – takes more work to try and calculate the market value – plus, it may cost too much on an ongoing basis It is estimated that the economic benefit of the reform would be approximately halved if the property tax were based on market values instead of unimproved land values. The reform framework – Buyers will be given a choice of which tax to pay – anyone buying a new property will be able to do the sums themselves Pay upfront or pay on an ongoing basis Pros and cons for each situation – if you plan to move homes regularly, or live somewhere for a few years before upscaling, it may make more sense to take the annual tax rather than paying for stamp duty -or if you plan to buy your forever home where you will live in it for decades, it may be actually cheaper Property tax will be an annual tax on land value – the tax structure will likely be similar to rates, where it is based on the land value There will be a fixed amount plus a rate applied to the unimproved land value of an individual property The rates – depends on the type of property – four types, owner-occupied residential property, investment property, primary production (farmland) and commercial – All of these properties need to currently pay stamp duty if they are purchases – but only investment properties or commercial properties are liable to pay land tax, if they are above the minimum threshold – what are the rates: Owner occupied: $500 + 0.3% of the unimproved land value Investment property: $1,500 + 1% of the unimproved land value Farmland: $0 + 0.3% of the unimproved land value Commercial property: $0 + 2.6% of the unimproved land value If you are not buying a new property, there is no change to your current situation If you already own a property and have paid stamp duty, then you will not have to pay the potential property tax There will be window in which new purchases of property can make a choice, to receive a rebate of their stamp duty and to pay the ongoing property tax First time home buyers – the existing stamp duty concessions for FHB could be replaced with a grant of up to $25k   Looking at some examples – In 2020, the average unimproved land value for residential property across all of NSW is around $437,500 Using the indicative property tax rates, the average residential property in NSW would be subject to an owner-occupied property tax of $1,812 per annum For metropolitan NSW the average residential land value is around $630,400 - corresponding owner-occupied property tax would be $2,391 per annum In comparison – let’s say there is 40% premium for the total values – taking the market values to $612,500 and $882,560 respectively – Stamp duty on these properties would be $22,897 and $35,052 – this represents paying for 12.6 years and 14.6 years upfront in stamp duty when compared to the ongoing tax for that is estimated The other thing to consider is that over the years, the unimproved land value of the property is likely to rise – hence the present value of stamp duty may not seem as bad Assuming that the average land value grows by 3% p.a. – takes the break evens down to 11 years and 13 years – so shaves about 1 and a bit years off – but they key consideration is the long term holding of a property If you plan to own the property for 20+ years, or retire into it – it may actually be better to still pay for the stamp duty Investment property – Say you buy a residential investment property in metropolitan NSW – the fixed fee plus 1% is about $7,804 p.a. – the stamp duty payable on property at the market rate = $35,052 – about 4.5 years of the annual ongoing tax Effects on investment property – make it less viable form a cashflow perspective – additional costs – rates, land tax, annual tax – rents would need to go up to cover this   Will this do any good? The government has forecasts that in the medium term, the property tax would create a revenue neutral situation – Currently, there are about 200,000 property transactions each year paying stamp duty. A long-run transition to a system where around 3.5 million properties pay an annual property tax would allow the Government to recover the revenue lost in the early years. From an economic perspective - Based on the current model, the proposed reforms could inject $11 billion back into the economy over the first four years, putting money back into the pockets of the people of NSW However – this may actually have a long term negative effect on consumer spending – when accounting for the increasd ongoing costs for households for holding property, this may initially inject $11bn in the economy over 4 years, but what about the annual opportunity cost for the money going into this ongoing property tax? Issue with models, impossible to accurately predict anything – especially when considering that it is all assumptions based and assuming that the money saved on stamp duty will be spent in the economy – as opposed to going towards a deposit or helping to cover the debt One big assumption is that the removal of stamp duty is that it has the capacity to increase household turnover – reducing the upfront transaction costs The Reserve Bank has noted housing turnover is positively related with household retail spending, particularly on durable goods such as furniture, home appliances and electrical or electronic devices, and renovation activity as new owners might choose to modify homes to suit their needs or existing owners add value before listing From an affordability point of view – trading the here and now for ongoing costs Residential – need to consider the pros and cons For investments – it may be better in some cases if the property is going to be long term hold – to pay stamp duty In summary – the NSW Government views - Stamp duty is an inefficient and volatile tax that puts a barrier to entry for people getting into the property market Thank you for listening to today's episode. If you want to get in contact you can do so here: 

    How do you change your investment strategy over time as the portfolio value increases?

    Play Episode Listen Later Apr 19, 2021 24:26

    Welcome to Finance and Fury. This week the topic is from a listener, Gabriel. That is “how do you change your investment strategy over time as the portfolio value increases? more specifically, how do you see someone building a growth portfolio starting with $10,000 and what would they change when they get to $100,000? What about $1,000,000?” This is a great topic, thank you for suggesting it. Everyone is different- no one right way to go about this – I have clients invested in a similar manner with $300k to $2m – because it is the right option to meet there needs – the only difference is how much is invested in each of the types of investments that make up their portfolios I also have clients with vastly different allocations – but again, this is depending on your needs Some want long term leveraged growth, so we looked at property or geared share funds there are some factors that can be used to help determine where someone should invest – which helps to determine an investment strategy based around the level of funds invested But the best thing to do is look at the end picture – where do you want to be – and build towards that This will help to answer this question better – to answer ‘what changes should be made once you have accumulated $100k or $1m’, the focus should be more so on what do you need your $100k or $1m to do for you To explain this further – say your end goal is to have a passive income of $50k p.a. - $1m in todays dollars - can fairly comfortably achieve this – but only if the assets generate an income yield of 5% Obviously with cost-of-living increases over the years the nominal value you will need is greater It is great to have $1m, but if this is in cash and you need an income, you are out of luck, as well as if you were invested in one single share that doesn’t pay an income, or even gold This is why having goals-based investing helps to determine this question Goals – to help work this out – for long term investment goals, there are considerations to help determine the investment strategy: Return needs – what returns do you need out of your investment? Returns have two components – growth and income – add these together and you get your total return Different assets have different return profiles – some are purely growth, others purely income They also have different factors that affect each of these returns – leverage on property, income of cash versus FF dividend paying shares at the moment Risk mitigation – do you need to protect your downside? If you are starting off with $10k – you would still probably need to protect from absolute losses. If you have $1m and are looking to retire, you might want to do this also, but is much easier to do with $1m compared to $10k: how can this be done? Diversification – ways to minimise your risk, in terms of volatility is to spread the risk out Risks – absolute and speculative – in other words, what is your risk of losing everything versus seeing some downwards price movements that are a natural part of any growth investment? Using the example above, if you buy one share with your $10k, the risks might be high for both speculative and absolute losses Now use your $1m to buy 100 companies at $10k a pop – your volatility will go down and so will the absolute loss potential Now – buy a property for $400k and use the remaining to buy shares – at $10k a pop then Now – buy a property for $400k, $550k of shares and $50k of gold – the volatility of your overall portfolio will decline further Defensive allocations versus growth components – Defensive assets Both of these factors will change over time as well – as you grow additional wealth, you can start to invest in some defensive assets to help secure your position, as well as purchasing additional assets as part of diversification The costs of the ongoing strategy – Different investment have different costs to them Looking at the strategy of buying 100 shares, that would cost you $995 with a brokerage platform like selfwealth – not too bad – makes up 0.1% as a transaction cost But now say you have $10k and want to buy 100 shares for the same diversification – at $100 each, cost you almost 10% of your invested assets to just get into the market Changes to a portfolio – CGT costs from rebalancing Also – depending on How are you going to accumulate the wealth over time can help to determine where to invest – Monthly investing, or saving up and making lump sum investments, or debt repayment and refinancing for equity releases from property All of these combined can help to work out the correct investment strategy – but remember the key factor is the end picture – what these investments need to be able to do for you. This helps to determine: What types of investments to purchase: shares, etfs, LICs, managed funds, property, gold, BTC How they should be purchased – directly, on a platform, personally or inside of a trust Also – as a quick note – any changes to investment strategies don’t necessarily mean a change the existing investment allocation, but start investing in additional assets   Now that that is out of the way - Let’s have a look at some examples to go through this   Starting out – options for a $10k investments When starting out with $10k – your options are limited due to the capital size – Not like you can buy an investment property with this – or purchase a managed fund directly due to minimums with investors Your options are likely limited to either a share, ETF or LIC or managed funds held on a platform to avoid the minimum Coming back to goals – if you aim is to work your way to $1m to help generate a passive income, what investment can work: Looking at the considerations Returns needs – depends on your timeframe – but if it is long term, you can generally focus on a good allocation to growth, with any income on top being reinvested in the portfolio Risk mitigation – This is probably one of the hardest parts when starting with $10k Direct shares are probably not the best option Costs for the strategy – share purchases would have the brokerage costs – ETFs, LICs have the brokerage and indirect MERs, platforms for managed funds would have administration costs and MERs for the funds Investment options – not investment advice – Can use some ETF index funds like Vanguard Diversified High Growth Index ETF (VDHG) – has 7 index funds inside of it – so rather than buying the individual funds, can just buy the one to save on some brokerage This initial step seems relatively simple – for purchasing an initial investment – the big question is how are you are going to build your wealth - Say you invest $10k in the index, over 10 years the average return is around 9% = $23,673 assuming that you personally cover the distribution tax and that the gross income is reinvested In 20 years, with the same assumptions, you would reach $56k, in 30 years, around $133k – so it is likely that you will need to put your own financial resources towards this end investment goal, in the form of monthly savings or accumulated savings in one lump sum Along the way – if you accumulate another level of savings, say another $10k, you can start investing this but also start spreading the investment allocation out – Technically – to reach $100k in a timely manner – in 10 years, your additional investments would likely be required Not comes the important question – where to invest these funds? It depends – if you are already holding assets that meet your long-term goals – i.e. passive income levels, then technically do you need to change anything? But if you invest $10k in a multi-asset index fund initially and want to make monthly investment of $2k p.m. for the next 20 years, this would technically reach $1.4m However – you would simply have this one ETF – and be paying $9.95 each month in brokerage, or 0.5% in transaction costs – if this ETF meets your needs of distributions, for these funds it has been close to 5% p.a. then this may be a simple strategy but in the end effective I hope this is starting to make sense – there is no one right way to go it – it is important to focus on what you need – changing a portfolio as it grows in value for the sake of changing it may not lead to a better result What having $1m in invested assets allows you to do is have a greater range of potential investment allocations without breaking the bank Technically you could split this $1m up between the VDHG funds underlying investments, so buy Vas at 36%, and so on until you replicate what this ETF is made up of – or just buy VDHG The more you have simply allows you to expand into other asset classes with higher cost barriers to entry – like property, with stamp duty as an example as well as deposit requirements   In summary – there is no one right strategy for everyone – because it all depends on what you need out of your investments Hence, first figure out what investments will help you to meet your goals – both in the interim and long term – because I have often found that they are similar In the interim you want to have a good return – The one thing to do is rebalance over the years – rather than buying purely high growth investments, can start to diversify into other asset classes as a hedge – this is for those who are more risk adverse Considerations along the way to help determine the investment strategy Return needs – Say you need long term growth with returns of 8%+ p.a. Risk mitigation – Defensive allocations – you don’t need any Diversification What would you change when you get to $1m? Hopefully nothing – beyond making some additional investments on top of what I already held This is the way I have set up my investments – have about 20 direct shares, a few index ETFs, 4 LICs, portfolio of 12 managed funds – I simply keep adding to my investments over the years When I started when I was 15 – I only had 2 shares – NAB and TLS not the best long-term investments, but have made many additional ones over the years Why I don’t like major rebalancing - Major cons with selling down a full $1m portfolio and repurchasing something else is GCT and transaction costs Instead - Along the way you want to be able to manage the allocation to fine tune this to where you need it to be But this is done through investing with your end goal in mind Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Should Central Banks be tasked with housing affordability?

    Play Episode Listen Later Apr 15, 2021 20:20

    Welcome to Finance and Fury. Firstly, sorry for the delay in episode, been over a week now – daughter was born last week, so been pretty busy helping care for her and trying to find a time to record in between work – should be back to normal from next week Interesting episode today – as one central bank in particular has now been tasked with the problem of housing affordability – This is the New Zealand central bank (RBNZ) – Can Central banks make property more affordable? If you are familiar with CBs – you would be familiar with the mandates that they get from the government – it is generally to keep annual inflation between a target range (1 and 3% for the RBNZ) and to also support maximum sustainable employment – trying to help job growth But in February 2021 - the NZ government formally added a clause to the RBNZ’s mandate, instructing it to consider housing prices in making monetary policy decisions The change has drawn attention – firstly, what this actually means from a policy decision point of view? Interesting – as it has the potential for governments to extend further into CB policy but also – goes in a contrary manner to the prime mandate of CBs - NZ has a history in being a canary down a coal mine - In 1989 it was the first to commit to a specific target for consumer price inflation – inflation target - target helped to lower self-fulfilling expectation of endless price rises that was occurring across most western economies in the late 70s and into the 80s From 1989 to 1991 - inflation fell from 8% to 2% - Soon after, most central banks had adopted targets Why extend the mandate to consider housing prices? The western world we have been experiencing inflation for years since the targets were brought out – not talking about CPI Today the runaway inflation rates are essentially asset price inflation consumer prices have been held in check by globalisation and automation – if anything deflationary fears have existed in regards to this – which is why interest rates have been reduced and, in the process, created easy money – but this easy money has been driving up the price of assets such as shares, bonds and housing Like many western nations - Home prices have risen steadily in the pandemic, and in 12 months through to the end of January were up 20% The price of a typical Auckland home gone to $720,000 Inflation targets were brought out to reduce inflation below this level of price growth In NZ – The prime minister made campaign promises to provide affordable housing – so she has tasked the CB to consider the effects on housing as their policies have helped to push homes beyond reach for the lower to middle economic class – which includes younger first-time home buyers This isn’t only in New Zealand – in western nations, homes are considered “unaffordable” (more than three times median family income) in more than 90% of cities The $220tn global housing market is more than twice the size of the global stock market – but the housing market has much additional debt – so the risks of falling prices are compounded by failed mortgages and defaults – making economic downturns worse I do find that there is some bit of irony of this policy - New Zealand’s was the first CB with the inflation target – hence, interest rates became a tool to be moved to combat inflation – higher rates for higher inflation, lower rates for lower inflation – this monetary tool initially got inflation in line but over recent years, the inflation rate is below the target rage in many countries (in has been for 4 years in Aus, but not in NZ at the moment) – to help this and to try and stimulate the economy – rates keep getting lowered We are in an era of ultra-low interest rates which may be the inevitable destiny of monetary policy – but whilst CPI was declining, asset price inflation has been on the rise at massive compounding rates over the past few decades as an order of consequences from this - inflates the value of the assets beyond what they might “reasonably” be worth if interstress rates were a flat 5%. Governments worldwide have come to embrace easy money as a way to finance social programs and deficit spending, needing QE to make sure bond yields don’t go through the roof – but this has created a negative effect on financial stability and housing affordability.   Now the big question - Can central banks really make houses cheaper? Technically – yes – all it needs to do is increase interest rates massively to the point it puts a downwards pressure on property – but this would have some major downsides that are too great to justify this type of policy This becomes clear when considering the extent of monetary policy tightening that would be required to reliably control asset prices - Research from the San Francisco Fed found that it would have taken 8% of monetary tightening between 2002 and 2006 to completely avoid the housing bubble that preceded the 2007-2009 global financial crisis - For context, the federal funds rate has not been at this level since October 1990 – now that rates are near 0% in most countries, this would require a massive increase This move by the NZ governments move may not slow the housing boom soon – mainly due to the supply-and-demand dynamics being too strong Demand – low interest rates and lots of people wanting to live in major cities like Auckland Supply – Have a pretty urbanised country – technically not as urbanised as Australia The RBNZ has said that “they will have to take into account the Government’s objective to support more sustainable house prices, including by dampening investor demand for existing housing stock to help improve affordability for first-home buyers.” Monetary policy is unlikely to be the critical tool to ease New Zealand’s home prices – it could be, but it likely won’t be without abandoning their long running mandate of having an inflation rate of 1-3% and having full employment If rates are made tighter (in other words increased) the housing market could be dropped in price - but the entire economy could suffer. If growth slows and unemployment rises, it’s likely the price of homes will go down, but is that really what New Zealand policymakers want? Also – consider the term ‘affordable’ for a second – homes are considered affordable based against the metric of a household’s income – if an economic slump occurs and employment drops, reducing the median household income by 30%, but in the process, you see a 30% decline in housing prices, is this really a more affordable situation?   This brings up another important question – should central banks consider the impact of their policies on hard assets, like property? In making monetary policy, central banks generally focus on the prices of goods and services – which is CPI - but there are occasional calls for them to pay more attention to prices of assets, such as houses or the stock market This debate is not new – in the early 2000s it was actually a topic of global discussion by the Centre for Economic policy research – done by the Geneva Report on the World Economy called Asset Prices and Central Bank Policy This looked at the use of interest rates as a tool to pop asset bubbles However – this was shouted down - in 2002, future Fed Chair Ben Bernanke argued that it was crucial to use the right tool for the job when making policy. “As a general rule, the Fed will do best by focusing its monetary policy instruments on achieving its macro goal – price stability and maximum sustainable employment – while using its regulatory, supervisory, and lender-of-last resort powers to help ensure financial stability.” In the same 2002 speech, Bernanke directly addressed the idea that the Fed should meddle directly with asset prices: “I think for the Fed to be an ‘arbiter of security speculation or values’ is neither desirable nor feasible.” Sounds funny today – but this is going back almost 20 years ago – before the days of QE or SPVs that buy corporate debt or ETFs in shares But the very nature of a CBs mandated goals of full employment and price stability come with the flow on effects on housing, shares and the bond markets – you cannot expect to move interest rates without having an affect on these assets – so through not considering this factor has led to runaway prices However – now that the mandate given to the RBNZ from the Finance Minister appears to have a different priority - Rather than describing house prices as a potential threat to financial stability, the government mandate asks the RBNZ to consider the impacts of its policy decisions on housing affordability The RBNZ central bank officals came out against this – they are sceptical about the use of interest rates and instead prefer a macroprudential toolkit as opposed to trying to reduce housing prices for first-time buyers – as they believe this goal is better met by increasing the supply of houses and targeted fiscal policy Similar in the US - Federal Reserve Chair Jay Powell also thinks that using interest rates to deal with asset price bubbles is dangerous - prefers to turn to macroprudential tools for that purpose – in plain English, this means financial regulation from the governments end that aims to mitigate risk to the financial system – so it may mean that additional controls on lending are needed, or changes to deductibility on property – but this is unpopular for governments In a January 2021 Powell said, “We don’t actually understand the tradeoff between if you raise interest rates and thereby tighten financial conditions and reduce economic activity now in order to address asset bubbles and things like that—will that even help? Will it actually cause more damage, or will it help? So I think that’s unresolved. And I think it’s something we look at as not theoretically ruled out, but not something we’ve ever done and not something we would plan to do.” It seems like the government and CBs are trying to pass the buck to one another RBNZ – “We will be considering our financial stability policy settings via our prudential tools – like loan-to-value ratios, bank stress testing, and capital requirements – against particular types of mortgage lending. This is done with a view to moderating housing demand, particularly from investors, to best ensure house price sustainability.” But this is a recommendation that they can make to the Government to then implement -   Looking at some of these other government-controlled factors outside the central bank’s In many developed economies, house prices are as affected by land-use regulations that limit the size and style of homes that can be built, which create artificial housing scarcity that in turn drives up prices - A 2017 New Zealand government study found that rules around building could account for 15% to 56% of a home’s cost depending on the area Also – things like taxes, with stamp duties are increasing the costs of housing – will cover this in another episode soon, as NSW is looking to replace stamp duty with an ongoing tax Directing central bankers to pay attention to the economic metrics of everyday life is always a good idea. But the problem of housing affordability is too complex to solve by tweaking interest rates alone In summary – this policy from the Government of tasking CB to deal with it is smart – smart from a political stand point – when you campaign on affordable housing and the markets go up – then you need a scape goat Technically - NZ Government has selected the correct scape goat – but are still passing the buck I personally don’t think it will amount to much – the CBs power would be to increase rates, and crash the housing market – which may make homes unaffordable if the median wage gets hit in the process I mean, to lower property prices is simple – increase interest rates to 10% - people will default, be forced out of their homes and there will be a massive oversupply of property, pushing prices down – is that good for anyone? If you don’t own property, it may not be – as with this style of collapse also comes a wider spread economic collapse – if you are starting in your career, job opportunities may not exist, which could delay your home ownership journey further So the NZ CBs have said that they will monitor the situation but in effect, have passed the buck back to the government and fiscal policy It may hopefully bring more awareness to the issues that CBs play on our everyday lives – but as far as having an effect, it is a catch 22 – either way, it is an interesting development that may also spread to other CBS Thank you for listening to today's episode. If you want to get in contact you can do so here:

    The lessons from the Nifty Fifty. Are we repeating the same mistakes of the past?

    Play Episode Listen Later Mar 29, 2021 24:19

    Welcome to Finance and Fury. Today’s episode is lessons from the nifty fifties – bit of a history lesson as well as looking back to lessons that can be learnt from this, to help not make mistakes of the past. This is a particular bubble and market correct that most people wouldn’t be familiar with – especially when compared to the 1929, 1989, or 2008 crashes which were more world wide or a complete systematic risk This mini-bubble occurred in the US back in the 1970s – the term Nifty Fifty is an informal designation that was given for fifty popular large-cap stocks on the NYSE These shares were particularly popular in purchases between the 1960s and early 1970s This basket of shares was widely regarded as solid buy and hold growth stocks – they were essentially Blue-chip stocks - your large companies that were considered lower risk The group included names like Revlon, Procter & Gamble, Philip Morris, Pepsi, Pfizer, Merck & Co, Eli Lilly, Coca-Cola, IBM, Gillette, Wal-Mart, Disney, Eastman-Kodak, Xerox and Polaroid – a lot of these are still household-names today, although some, like Eastman-Kodak are no more Some academics credit these fifty shares as being the primary reason the US had a bull market of the between the 60s and early 1970s – But this then turned into a subsequent crash and underperformance of the market through the rest of the 70s and into the early 1980s It is interesting – because when you look at a market/index – depending on the weighted allocation of a basket of shares – the performance of the top 50 large shares on an index that has thousands of shares listed on it is more important than all of the other shares combined As an example – think about the ASX – the top 50 companies make up between 70- 75% of the market cap of the index If these shares have a negative 10% return, but the remaining 2,700 shares have a positive 10% return, results in a negative 5% return to the index – due the weighting of the index – where what is most important is that the companies that make up the most of it perform well Where this gets even more concentrated is on an index like the NASDAQ –55% of the index weighting is held in 10 companies – Apple, Microsoft, Amazon, Tesla, FB, Alphabet A & C, Nvidia, paypal and comcast NASDAQ has done pretty well over the past 10 years – thanks to the rise of companies like Apple, amazon and tesla – Similar dynamics were playing out back in the 60s – thanks to a handful of shares -the NYSE rose significantly We will go through what happened in detail – but it is an example of what may occur following a period during which many new investors start joining the markets, which are then influenced by a positive market sentiment, providing a feedback from further positive returns, ignoring fundamental market valuation metrics in the short term – then a trigger catalysis occurs and the house of cards crashes down   Starting at the beginning - the most common characteristic by the companies in the nifty fifty could be described as investor optimism -   Looking back in time on the Go-Go Years The 1960s were buoyant years for the US economy and stock market. From the mid-60s the term ‘go-go’ was used to describe an aggressive way of operating in the stock market, which involved trading for quick profits. Many of these companies were either providing solid earnings growth, or there was the expectations of solid earnings growth in the future This attracted a lot of attention and new Investors came to the market This is actually a key feature of the 1960s that could be easily overlooked – and that is that there was a massive increase in the number of investors in the US stock market Seven times as many Americans held shares by the end of the 1960s when compared to 20-30 years earlier - In the summer of 1970, the US Stock Exchange unveiled a survey showing the country had over 30 million shareholders – population of 200m – so 15% of the population – but it was previously only 4.3m when the population was closer to 150m – which is 3% of the population Chicken or the egg situation – was the rising market the reason for new investors, or were new investors the reasons markets were rising Probably a bit of both – whilst throwing in there the population growth and increased in accessibility to the market As a population grows – there are more people who can invest – as the access to invest increases, the number of people invested will also rise – but what incentivises these people to invest is to generate wealth – so a rising market can expediate these factors One of the major factors in this which shouldn’t be overlooked was the increase in access to the market that occurred in the 1960s due to innovation The decade saw the rise of the professional fund manager - It was the period in which managed funds started to be established and saw large fund inflows – by the mid-60s managed funds accounted for around a quarter of all transactions in the market and this only rose over the next 10 years Back in the 1960s – the influx of new investors had only ever experienced a prolonged bull market, another factor sustaining the bubble in the Nifty Fifty. Either way – what materialised by the 1970s is that each of the large cap shares started to carry extraordinarily high price–earnings ratios – a PE of 50x was relatively normal - far above the long-term market average The group included names like Revlon, Procter & Gamble, Philip Morris, Pepsi, Pfizer, Merck & Co, Eli Lilly, Coca-Cola, IBM, Gillette, Wal-Mart, Disney, Eastman-Kodak, Xerox and Polaroid – a lot of these are still household-names today, although some, like Eastman-Kodak are no more What was said by many investors back in the 1960s is that these shares should be bought and never sold - became the majority holdings in many institutional investor’s portfolio (managed funds) as well as in personal portfolios But then the issues started to emerge – the major problem was the Price/Earnings ratios being sustainable in the long term The price/earnings (PE) ratio is a valuation measure which compares the market price of a company to its earnings per share – you take the price and divide by the EPS The PEs of some of the Nifty Fifty moved into stratospheric territory as the 1960s progressed. By the early 1970s, the highest rated companies, darlings of the market, were trading on stunning valuations: Johnson & Johnson (57.1x), McDonald’s Corp (71.0x), Disney (71.2x), Baxter Labs (71.4x), International Flavours & Fragrances (69.1x), Avon Products (61.2x), Polaroid Corp (94.8x) and MGIC Investment Corp (68.5x). We might compare these valuations with those of the top holdings in the NASDAQ – Amazon is about 76x, Tesla is at about 1,000x, NVIDIA is about 76x, with the rest of the between 30-40 PE Some of these valuations are around the same – but some like Tesla exceed it to the extreme Enter the bear market of 1970s The long bear market of the 1970s which started to emerge – triggered by the 1973–74 stock market crash– this was a rather long one as it lasted until 1982 before markets started to recover – The issue with a very large segment of the market cap – concentrated in a few companies with very high PEs makes the market more fragile – If a market correction occurs, the companies that are overvalued can be sold off harder and faster – the crash in 1973 caused valuations of the nifty fifty to fall to low levels along with the rest of the market, with most of these stocks under-performing the broader market averages Similar to the rise of the market – if the largest segment of the market is overvalued and crashes – then this can drag down the whole index These shares didn’t all fall in tandem though - they were dropping one by one - some of the share price declines to 1974 lows were huge: Xerox (-71%), Avon (-86%) and Polaroid (-91%). The vulnerability of highly-rated companies to rising risk aversion was revealed – due to them starting on massive valuations in the first place There is one notable exception to this group – and that was Wal-Mart – which is the best performing stock on the list – has provided a compounded annualized return over a 29-year period of 29.65%.   But what happened to create such a drop in this segment of the market? It had been a long party for investors which had to come to an end – but there was no one cause – there was political instability with Nixon and Watergate, profit taking for investors, rising inflation I think one of the biggest contributors were rising interest rates, the end of the Bretton Woods monetary system and valuing growth – I’ve talked about the importance of interest rates and the yields on 10 year government bonds in previous episodes – this actually relates to one of the leading contributors for the market correction interest rates and discounting – the yields on the risk-free rate on a 10-year treasury – Say you have a company earning $100 today, but is forecasted to earn $200 in 10 years’ time When the risk-free rate is low – the discounting to present value for cashflows isn’t as severe – so why not hold out for that higher earnings in the future – but when the risk-free rate is higher, and discounting is higher as well – you start to care more about the cashflows today – in present value Take this example further – if the RF rate is 1% - and you have one company earning $100 today, but isn’t going to grow, versus another company earning $2, but is expected to grow at an earnings rate of 50% p.a. (which is huge for constant growth) – in 15 years’ time, which would have had the best free cashflow in PV? The company earning $2 today is worth around $2,303 of PV in cashflow, the company earning $100 is worth $1,386 – so the growth company is worth much more – but if the RF rate is 10.5% - they have the same PV in cashflow over a 15-year period Looking back on the risk-free rates – in the 1963 – 4% then started to rise, 1967 – went to 5.1%, 1969 – 6.7%, 1970 – 7.4%, 1975 – 8%, 1980 – 11.4% A lot of this had to do with the change in monetary system – and rampart inflation, so rates were pushed up to help combat this But had the effect of the valuation of companies starting to drop due to the discounting methods – so if you are a predicted growth company with a massive PE today – it isn’t good news for you Hindsight is 20/20 – and looking back, common sense suggests that many of these Nifty Fifty companies were in a classic investment bubble due to the investment flows and huge PEs - driven by what drives most bubbles - strong economic growth forecasts and plentiful liquidity (or money flowing into these companies) – pushes up valuations to unsustainable levels over the short-term This example does help to point out unrealistic investor expectations – and that nobody knows the future – what is the best company today may fall over tomorrow – people in the 50s and 60s probably though that polaroid was going to be the next big thing for decades to come – and it was – which is why it made the list – today it is a defunct company that filed for bankruptcy over 15 years ago and has been passed around in the private world, constantly losing valuation along the way Or even Xerox – Didn’t go bankrupt but has the same price today as it did in 1980. What to do with this information – these examples do help to highlight the dangers of a long, late-cycle bubble for equity investors – as there are some similarities to markets today – New investors – similar to the 1960s increasing the access to markets - the increase of Index funds and ETF access over the past decade has had a similar effect, but magnified – this has been magnified by the internet, the increase in technology allowing increased access to equities Back in 1970 – 15% of the population owned shares in the US – today it is 55% The average wealth has also increased – so the amount of money through all of these compounding factors – i.e. more people investing with greater sums of money has had a positive inflationary pressure on markets New investors have only known positive markets – increases the level of exuberance in markets Looking at listings – so many new ETFs coming to the market – we have only really known a bull market since 2012 – have been some corrections – but the markets ended up with positive years People jump into them without even thinking or without any knowledge of historical performance of the underlying companies Market valuations – these are very high at the moment and concentrated in many well know large cap shares which are considered house hold names, or long term buy and holds – but there are some risks to this Interest rates - Current interest rates - estimated to be around 0.9% for the risk-free rate In 2018 – was about 2.9%, in 2001 – was 5% - has the capacity to increase valuations for companies not currently earning anything but may someday through the roof – but still – the PEs in some companies listed on the market are 0 or negative If RF rates do go back up - Markets will start to care more about current income/cashflow in present value cashflow when the risk-free rates rise – covered this last week on the case for value shares Technology and adaption – many competitors may come out and what is natural in business cycles – when companies get too big, it becomes hard for them to adapt Even high-quality businesses can be poor investments if they are bought at extended valuations – like with a house – you can have a very nice house – but if you pay twice the market valuation – it may take you decades to get your money back if you were to sell Buying a great company at a fair price is better than a great company at a massive price In financial markets – there should always be a focus on capital preservation - consider the potential downside of any investment In my view – one of the best ways to do this in the current market is to not hold purely large cap companies – nature of markets over time to replace market leaders – Still focus on investing for the long term – whilst many of the nifty fifty crashed in the 70s due to their extreme levels of overvaluation - if you had continued to hold stocks such as Walmart, Coca-Cola or McDonald’s, from the 1970s peak until the present day - you would have still made decent returns But as always – important to diversify property – and not pay more than a company is worth – and take advantage of downturns Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Is it time to start investing using a value strategy?

    Play Episode Listen Later Mar 22, 2021 22:00

    Welcome to Finance and Fury. Time for value? Looking at the value rotation occurring within the share market A value rotation is a term used to describe a shift in investment behaviour – where investors start favouring value shares instead of growth shares Previous episode – inflation expectations and what is occurring to bond yields – did an episode a while back on why growth shares have been beating value – however a rotation may be occurring – where value investing may start catching up in performance Value investing – buying undervalued companies based around their intrinsic or book value – essentially involves buying beaten-up or unloved shares Over the past half decade – growth shares have been in high demand – hence they have seen their prices go up – blowing metrics like PE ratios through the roof – but this has left large segments of the market untouched and undervalued compared to their growth counterparts Over the past three months – essentially since the start of the year – the mood of the market has shifted dramatically – which may be pointing towards growth shares falling out of favour This is because the prices of many large growth companies have been falling from their previous highs Looking back on the past 3 months – the best performing investment have been the US Russell 2000 mid cap index at a 35% return since the start of the year, so under 3 months in reality – EU shares have also done well – with returns on average of 20% over this time period However – tech has started to lag behind – the returns for this traditionally growth basket of shares is sitting at 15% - this is still phenomenal though – a 15% return in 2.5 months is a good result But why the lag? This group of shares was the cream of the crop – and in the words of House of Pain – rose to the top – so is it that the rest of the market is now just playing catch up, or is there really a value rotation going on? Well – yes – there has been a rotation from growth shares into value companies – hence this lag in tech companies in the past 2.5 months – but the key question is ‘Will this continue?’ or in other words, was this movement just a chance to buy neglected shares within the market, pushing up demand and their prices, or the emergence of a longer-term trend? And if so, for how much longer? So, in this episode, we will be trying to answer this as well as what would drive the rotation going forward? To do this – we need to look at the state of the market and forecasts - Strong economic growth predicted in 2021 – and beyond the global economy looks set to boom in 2021 – this has been due to the anticipation of the initial hit of stimulus – Think of it as energy being introduced into a system – if you have a lot of glucose, or sugar, you can get a bit of an energy high – but this energy can soon burn out When looking at the underpinnings of growth predictions in 2021 At the moment, massive levels of fiscal and monetary stimulus have been brought to bear on the global economy Levels as a percentage of GDP not really seen since the world wars in government spending – but what is different is that governments are already starting off at a very high debt to GDP level – based around economic theory, technically has less bang for your buck Looking at the US – post WW1 – there was debt of around $17bn, 16% of GDP – then by the start of the great recession and the introductions of the New Deals by FDR – this rose to about 42%, or $40bn, by the end of WW2 was sitting at about $270bn, or 118% GDP By 2020 – debt was $23 trillion and 110% of GDP – now it has jumped to $27 trillion as an estimate and 136% of GDP Now, the US is about to enact a US$1.9 trillion package on the heels of the US$900 billion program just passed in December last year – will mention that the majority of these packages have nothing to do with relief for Covid affected businesses or people – but the market has responded positively On top of this, the Federal Reserve did as much quantitative easing in six months last year as it did over the initial six years from its implementation in the post-GFC measures – i.e. from late 2008 through to end of 2014 Other countries across the globe have also been aggressive with their policy stimulus in 2020 – in Aus we have gone from 46% debt to GDP to an estimated 70% Australia has started to engage in QE – and this is beginning to ramp up as well to help keep bond yields in the target range close to the cash rate of 0.1% The result – investors and markets became bullish – this has become well known – growth shares did very well based around lowering interest rates, funding costs, and lower inflation The outlook for 2021 is considered to be strong – there is a consensus view amongst economists – so take that with a grain of salt - what is now more critical is whether this strong growth momentum can continue beyond this year once the stimulus expectations are priced into the market – then, how strong will growth be in 2022, 2023 and beyond? Because what will happen post 2021 once the initial stimulus hit fades - or when the sugar high of the stimulus begins to fade? What will be left to drive the global economy forward from 2022 onwards? It is always possible that MMT emerges further and regular deficit funded stimulus becomes the norm – but this factor is unknown – so are there any signs of real economic recovery? If so – and importantly for this episodes topic - how would markets behave? To best answer the question of a value rotation – look at if the growth frenzy is likely to continue and if not, value may be in the markets favour Thinking about this – one of the big drivers for growth has been the lowering of interest rates and positive reaction to additional stimulus – But with the yield curves starting to steepen, this has been pointing to the potential for increasing interest rates in the future – beyond 2024 – but markets are forward looking – trying to price in all future events today When interest rates change - in theory at least, the way companies are valued changes – as mentioned in previous episodes – this rate is heavily tied to the discount rate which is used to get the present value of a companies future cashflows – I.e. what are the profits of a company worth today The lower the discount rate – the less a dollar today is worth compared to a dollar tomorrow – so if a company is a traditional value business – with solid cashflow performance and profit stability/predictability today – the less this is worth to markets - so if you are a growth company if you don’t have any dollars today, the market doesn’t care as much The higher the discount rate - the more a dollar today is worth more than a dollar tomorrow – so the fair value of a company should in theory reflect their profits today more so than their profits tomorrow Therefore – the higher the discount rates, the more a company with strong fundamentals should be worth – indeed - over the past few months as the yield curve has steepened - we have seen value shares have started to outperform growth the lowering of interest rates may not be possible from here, and yields on the RF may continue to rise further – so can value do better? To look at this – there are a few primary factors that are coming together which could help to provide continued momentum towards value companies once the initial "sugar rush" stimulus wears off. Those factors are as follows: Households have paid down considerable levels of debt in 2020, have higher savings, and have a greater capacity to spend US credit card balances are down US$120 billion from their peak at the end of 2019 – potentially frees up borrowing capacity which can be tapped into to drive further consumption growth – but also frees up cashflow that goes towards debt instead of consumption looking at households and consumers - in most countries savings rates have gone up significantly – natural response In the UK - Q2’s household savings ratio was 26.5% - almost twice its highest peak in the past 50 years – next quarter it had dropped but still around 16.5% - estimated that the extra cash in their bank accounts is around 7.7% of GDP In the US - equivalent figure is approx. $2.3 trillion or around 11% of GDP – more than doubled in 2020 In Australia – jumped to 22% by July 2020 but has declined to 12% approximately last quarter This technically means that there is less spending going on – if savings rates are up – but as confidence comes back to consumers, and job security increases, saving rates may decline further and help economic growth Especially if interest/cash rates remain low – no incentive to save beyond the concerns of losing an income So real economic growth may emerge, as more businesses are allowed to open and operate again As the economy’s confidence normalises – can be expect the Western consumer will resume their high marginal propensity to spend That effect, coupled with falling household savings ratios has the potential to provide a strong underpinning to consumption growth through a multiplier effect The trend of house price growth may remain strong – increasing equity and the wealth effect Housing markets have maintained prices and grown through 2020 – due to lowering supply – less houses being listed in conjunction with lowering interest rates, increasing borrowing capacities - After an initial one- to two-month wobble in house prices at the height of the lockdown - most countries’ prices resumed a strong upward trend for the remainder of 2020 This price growth reflects monetary looseness, i.e. the lowering of interest rates, increased liquidity in debt markets and other demographic factors – being in lock down and wanting more space – spreading out as if you are working from home, you don’t want a roommate walking behind you in the nude on zoom Economists believe that the uptrend in house prices has been historically associated with the wealth effect – where the more people feel wealthy and have access to equity (through a withdrawal from what is in their houses) – this can support strong consumption growth – in 2020 home equity withdrawal has picked up sharply – but it depends on where this money is spent Also as another note – there are mixed theories on the Wealth effect – in theory it should work, but it doesn’t show any causal relationship Either way – the underpinning of an increasing yield curve, repayment of debts, ability for additional spending and a strong housing market these can point towards some better growth in the markets – plus, global monetary policy should remain loose for a while yet – forward guidance that cash rates will essentially be 0% for the next 3 years The major concerns for markets at the moment are the removal of monetary accommodation later this year – the CBs will be walking on eggs shells when it comes to removing monetary measures Looking at the end effects on markets - If all of these factors play out – there is likely going to be a structural shift into value and cyclical shares This expectation can be backed up by the relative valuation between the growth and value indexes – showing the relative valuation premium of growth over value stocks Going back to 1970s – the premium in price that you are paying for a growth company is at the highest it has been by a narrow margin – the next two were the dot com bubble and the nifty-fifty bubble – that has a lot of similarities – probably do an episode on this DotCom bubble – paying about a 45% premium for growth, about that in 1975 but close to 58% today – looking at the forward PEs – sitting at about 47% today, which matches the dot com bubble – but not quite as high as the nifty-fifty bubble Risks and downsides - Naturally – there will always be multiple risks investing on shares and betting on one outcome over another The major risks to the market at this stage are downgrades in Central Banks intervention in markets – especially the Fes given the high valuations in many sectors of the equity markets The S&P500 is on a 12m forward PE ratio of approximately 23x – only been surpassed during the Dot com bubble not just the US market which is expensive – around 30 indexes across the globe that are in their top quartile valuation range - Brazil, India and the Australian markets At this stage – liquidity with QE has been a key driver of high valuations – but this may also lead into additional inflation which could require CBs to act – but regardless – if markets crash, being in the value companies may be the place to be  Summary At this stage of the market cycle - investors probably shouldn’t be paying as much of a premium for growth because it could be likely that the valuation gap between growth and value shares is on the move to close - I always have growth and value – in different segments across different markets – but if you are concerned about market downturns – value is the way to go – opportunity to buy into the undervalued companies Plus – can help to limit downside risks – look at the nifty fifty bubble from the 70s to see why Thank you for listening to today's episode. If you want to get in contact you can do so here:

    When bond yields start to rise, what happens to the price of gold and shares?

    Play Episode Listen Later Mar 15, 2021 24:19

    Welcome to Finance and Fury. In the last episode I went through the bond market and how inflation expectations being on the rise are having their effects, yield curves starting to steepen. So what will happen to other asset classes? In this episode we will look at this question. If the trend of nominal yields continues, what will be the effects on different asset classes, cash, shares and gold? Before we get into that – quick recap that when talking about yields, it is the returns on bonds expressed as a percentage bond yields are inversely related to the bond prices. The lower the price, the higher the yield, and vice versa Bond yields have been declining since 1982 in a long-term trend – as they were nearing zero, could continue into the negative long term or reverse course – 10-year Treasury yields have fallen from 15.8% 40 years ago There are fears that due to the economic recovery plans for every nation being printing money for stimulus measures – that this could lead to an inflation outbreak – hence, this recently led to a rise in bond yields Happened in most countries – in the US the yield on 10-year bonds were 0.91% at the start of the year – in a matter of a two months they went to 1.49% then 1.61% before declining to 1.42% The Australian 10-year rate jumped to 1.93% and this spooked the share markets Also, important to understand the nature of money flows – and that is that different asset classes compete for your money, as well as institutional money That is where the yields on bonds (i.e. the returns) can affect other investments prices by competing for investors money – supply and demand – if more money flows into one asset class in the expectation of additional returns over another – that is additional demand – so if the supply stays the same, prices should naturally go up Bonds can be seen as a safe harbour – but if bond have a negative yield, people may hold cash for 0% interest rates or Gold instead – so currencies can move or the price of gold also move if people are selling bonds and reinvesting in another safe harbour When making an investment decision – there is always an opportunity cost – i.e. what you forego in not choosing the next best alternative - the opportunity cost of an asset is what you give up by owning it – so the OC for investing in shares could be the yield on a bond – which may be dependent on the risk or return profiles of an investor However – there has been an increase in the amount of money supply – increasing the amount of money that can flow – the increase in the money supply has been flowing into bonds initially through QE – this can then be used for the reinvestment into other assets – where the money flows could be based around incentives of returns This is part of the theory as to why QE can lift share prices as well – super funds or other institutional investors selling their bonds in the secondary market to CBs and then using their new found cash to repurchase other asset classes policymakers have distorted traditional free markets – the efficient allocation of scarce resources   To start looking at asset classes - Quickly go through the dollar, or cash in general No surprise to anyone that the real value of cash is generally declining – the additional supply of money naturally devalues cash in each domestic country depending on what is happening to the supply Between countries - There are a million things that can affect currency exchange rates – interest rates, net exports, but the big thing for the value of money that is relevant to this episode is specifically inflation – Cash is used as a Medium of exchange – exchange for goods, services, but also as savings or an investment – holding cash has an opportunity cost – it is actually rather costly to hold cash in real terms if inflation does materialise – imagine getting an interest return of 0.5% if inflation is 3% - negative yield on the money of -2.5% p.a. Central banks have essentially put a cap on interest rates for a number of years – in most countries they say that interest rates wont rise for 3 years - at the same time as rising inflation expectations means that there is an asymmetric risk to the downside in real interest returns All the new stimulus and associated dollar printing by the Fed and other CBs does not bode well for the cash’s future - The major thing with dollars is that they will lose their real value – this then in turn incentivises the disposal of this cash into alternative holding vehicles – why save money if you know it is going to lose value – better to buy something with it   Relationship between yields and gold The historical data does not confirm that there is any positive relationship between gold and the bond market – over some time periods there is a strong correlation in price movements, some other times there isn’t 1970s - the price of gold was rising and bond prices were falling while rates were increasing rapidily 1980s onwards - there has been a long upward trend in bond prices – with declining yields – through this period there was no relation to the changes in the price of the gold market – gold had a bear market in the 1980s and some of the 90s, then went through a bull market in the 2000s There have been times that a negative correlation between nominal bond yields and Gold can be measured in the short term – seen some measurements that it is currently -0.80% - fairly minimal This is all on the nominal level – however there is a stronger relationship between bonds and gold – that is on the real yields what really matters for gold are the real yield rates - not nominal yields – this is because high and accelerating inflation rates affect gold and bonds differently – this relationship can be seen over the past 20 years – where the price of gold moves in relation to the real yield on a 10 year bond From early 2000s – gold prices were rising, as real yields started to decline as inflation picked up By Jan 2013 – real yields had hit their bottom at -1% and hold had topped out at around $1,800 USD an ounce Between then and Jan 2019, real yields started to rise and gold prices went down – until the start of Jan when real yields started to drop – going down to -1% again and gold topping $1,800 USD an ounce So there is a negative relationship with real yield rates on bonds – the nominal rates minus inflation From an understanding point of view – there is likely no one cause for this – but if both bonds and gold are seen as a safe harbour and inflation is materialising and the real yields on bonds are going down or are negative – then investors may simply be buying gold instead of bonds If inflation expectations continue to rise and nominal yields on bonds remain controlled by QE policy - Gold miners and gold may do well – especially if additional stimulus on steroids makes matters worse with real yields – or if nominal rates don’t go up due to QE keeping them low by buying – keeping prices artificially high compared to a market outcome – whilst at the same time seeing run away inflation In this scenario – real yields will drop and gold would likely go up – and miners lag behind in prices but also increase   Shares – effect of on the risk free assets (done in past episode) Historically – shares have done well when the economy is booming Logic behind this - When people are spending money and making more purchases within the economy, the companies selling the goods and services will receive higher earnings thanks to higher demand – this then increases their balance sheets and investors feel confident – they invest either off positive results or the expectation of these – then the price of the shares go up as more money flows into the market But how did risk assets such as shares do when rates are rising along with inflation expectations? That is where with a booming economy, inflation can also materialise But one of the best ways to beat inflation over the long term is to buy share If an investor owns bonds – they would ideally want to sell these and buy shares when the economy is doing well and inflation is present and rising With bonds – if they are non-inflationary linked – say you have a 10y bond issued at $100, but in 10 years you get $100 back in nominal terms, if inflation was 2.5% p.a. then the real value of that bond is around $78 So, if the real yield has been close to 0% over this time period as well – you have effectively lost money This is where the opportunity cost comes in – would you prefer to participate in the share market for positive returns or hold a safe harbour asset which may lose funds in real terms? However – if the economy were to slow with consumers purchasing less and corporate profits falling – this can turn into a declining share market – investors may try and time the market and prefer to now purchase bonds – seen as the safe asset and get the regular interest payments guaranteed by bonds This safety of an asset class can also affect valuation due to bonds being the RF asset When valuing equities – in the CAPM calculations - investors add the equity risk premium they seek to a risk-free rate to compute the expected rate of return In this calculation – the RFR is the 10-year bond yield – this is why long-term bond yields can matter to equities As theoretically - given that a bond yield is the risk-free rate, a higher bond yield can be bad for equities and vice versa – as the excess returns may not justify the excess returns As the 10y bond yields also reflect the growth and inflation mix in the economy – if these are on the rise it generally means the economy is growing Looking historically - There have been many occurrences real yields on bonds rising as well as returns on the share market – happened during 1997-99, 2004-06 and 2016-18 However – what happened in 2000, 2008, end of 2018 – the markets went through corrections Look at the average weekly returns for the MSCI index since 2000 If inflation is rising and real yields on bonds are rising – then the MSCI average weekly return is 1.2% If inflation is falling and the real yields are also falling – then returns have been negative 1.3% If they are neutral – with inflation not moving and real yields staying the sale – the returns have been 0.2% The important thing about this relationship – is that when inflation is rising – the share markets performance is positive across the board – however the degree of the positive returns seems related to the real yields on bonds If real yields are falling – then the positive returns are 0.7% - compared to 1.2% if real yields are either neutral or rising Also – if inflation is falling, then shares also perform negatively What can be inferred from this – is that rising inflation expectations can lead people to invest more into the market Everyone would have a different reason to invest – so to pinpoint one cause for a rising market is hard – could be due to not wanting to lose value of your cash in real terms, or to participate in an already rising market However - historical equity and bond performance has been better when yields are rising rather than falling, but especially when this occurs along with rising inflation expectations – which is what is occurring now when risk assets such as shares fall sharply – these have been mostly around fears of policy tightening or late in the economic cycle – both of which aren’t on the table at the moment based around what wall street are betting on Where could we be wrong - Higher real yields with declining inflation expectations would likely create lower performances in shares - so would an increase in real yields if it is driven by fears about the removal Central banking policies that are keeping rates low  - but this outcome is not likely at this stage So in summary If inflation continues to rise – then the worse asset class to be in would be cash Both gold and the share market can do well when inflation is rising and real yields are staying the same Remember that real yields on bonds are rising – but they didn’t rise at the same pace at nominal rates But it doesn’t matter – historically, if real yields rise by any rate whilst inflation is also rising – both bonds and shares have a positive performance – shares by a greater rate However these metrics point towards a rising market – but what goes up can come down – this is where rising yields – if it spreads through corporate debts can lead to additional funding pressures on companies in the share market – many companies in the tech basket that aren’t profitable at this stage So investing in gold or shares can go well in this environment – but there are corrections on the way – so it is important to be invested appropriately in quality companies and diversified within and across asset classes Thank you for listening to today's episode. 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    Why are yields rising in the bond markets despite the RBA’s best efforts?

    Play Episode Listen Later Mar 8, 2021 19:13

    Welcome to Finance and Fury. This episode we will be looking at what is happening in the bond market, how the RBA is struggling to maintain their targets on bond yields for 3y and 10 year - as well as some of its implications on the debt markets and government. What is going on? over the last few weeks there has been a surprise to the markets – the emergence of a higher 10-year rates on government bonds – the rates went up about 0.45% in Feb and 0.55% since the start of the year This was pretty surprising but it actually does make sense in a way – why? To start with – all we have to do is look what has occurred over the past year – Looking back on 2020 there was an unprecedented level of stimulus policies - both fiscal and monetary – QE, corporate bond purchases, ZIRP, stimulus payments The RBA announced on Feb 1 that they were doing an extension to its QE program that they started last year by a further A$100 billion - They have also said it doesn’t expect to increase interest rates until 2024 Both of these are in pursuit of the central bank's yield curve control – as the RBA is trying to target the three-year yield rate at 0.10% The same day as the QE extension announcement, the RBA purchased A$3BN in three-year government bonds This was done in the secondary market and completed on Thursday last week - $3bn might not sound like a lot in the modern era of trillion-dollar stimulus measures - triple the normal amount – the yield on the April 2024 bonds (maturity of the 3-year bonds) declined slightly from 0.13% to 0.125% - decline of about 4% - but then yields soon jumped up to 0.14% before reverting back to their original yield of 0.13% - but remember they are trying to target a yield of 0.1% The RBA is in scramble mode to try and control the yields – through their methods of the Yield Curve Control target of 0.10% on the 3Y Why are they trying to keep rates low? Government funding costs – if you are deficit spending on billions of dollars, the difference between 0.1% and 0.2% is huge The RBAs success and their credibility are starting to fall short on their target - A$3BN of additional QE proved insufficient to get the yield down to the target – as the 3Y Australian bond rate is still at 0.13% - 3bps above It is starting to appear that the RBA's Yield Curve Control is failing as the market is pressuring the central bank's commitment to the point of failure – Free market of bonds – not huge selling of local government bonds in recent days, but there was not a lot of buying. When there is less demand for bonds, bond prices fall and yields rise. So to try and keep yields low – there needs to be more demand which can artificially be created by extensions on QE – or central banks buying back bonds on the secondary market To date though - RBA had been unsuccessful in lowering yields to the levels they want – they have certainly lowered bond yields – but these are still above what they are hoping at the short and long end of the curve – i.e. the 3y and 10y bonds There is naturally an upward pressure on market interest rates – so unless the RBA can get this under control – this will flow through into making it more expensive for Government to borrow – as well as companies to borrow over a 3-to-10-year timeframe This probably won’t affect you or I with mortgage rates – these are not priced off the long-term, 10-year bond yields – the rba cash rate is what matters more to mortgage rates But the Aus governments 10-year borrowing cost has jumped to 1.72% – a doubling of the yield since the RBA officially unveiled its QE program last November This upwards yield is ideal for investors, but not for the government – could threatened to unravel the local bond market – issue with compounding debts at higher yields is that at maturity, more bonds need to be issued to cover the payment, think of a balance transfer but every time the interest rates outside of the grace period starts to increase – compounding the risks that is why the RBA took emergency steps to show markets who's boss with the increase in bond purchases – beyond the 3 year bonds, they will take aim at the longer-term debt the RBA said it is buying A$4BN of longer-dated bonds which is twice the usual amount   However – similar to the 3y yields, the RBA may sit back and watch as their policy has less and less impact in controlling the yields of government debts, as they purchase more and more the RBA now owns $18.5 billion of the $33 billion April 2024 bond – 3y bonds issued As previously mentioned, The RBA have said they don’t expect the cash rate to rise until at least 2024 – but the bond markets are challenging this idea as well - The market is pricing in a jump in rates - with the yield on the November 2024 bond blowing out to 0.36% This has lifted Aus bond rates quite a bit higher than US yields and that means that there will be probably more demand and more buying of Australian bonds - pushing up the Australian dollar The rising AUD also puts pressure on the local economy, and stability of exports in a recovering economy – which puts pressure on the RBA as well to further control interest rate expectations What can the RBA do? They might need to intervene at the longer-end of bond maturity - with more QE because otherwise over focusing on the short term can have spill over effects in the currency market and start to impact other financial markets – like the share market At the end of the day, the RBA have just one solution - to step in and buy more and more bonds with further QE Why is all of this occurring? Why can’t the RBA simply click their fingers and hit their desired targets? Has to do with something else the RBA targets as their primary purpose on monetary policy – inflation targets – something else that central banks are having trouble in achieving as well Due to the monetary and fiscal policy measures - inflation expectations are beginning to rise – gradually initially – but with front-end interest rates almost guaranteed to be zero by the Fed and other central banks – the nominal yield curve started to steepen and assets that attract risk, such as shares entered into a strong rally bond traders are beginning to observe higher levels of inflation across the board – therefore, they think it is only a matter of time before Australia yields go up – why yields are trading above targets To continue looking at this further – to understand why yields are rising requires looking at the relationship of nominal yields, inflation expectations and real yields.  Because higher real yields along with rising inflation expectations can clearly create an environment where nominal yields are rising for good reasons But the real yields remained depressed through 2020 – real returns are nominal minus inflation – this was at the same time that there were deflationary pressures – the tides are turning at the start of this year – and inflation trades can be seen everywhere Looking at the real rates - the composition of the nominal 0.55% increase in the 10-year yields since the beginning of 2021, about 0.20% is from higher inflation expectations and 0.35% is from higher real yields – this has been reflected in the equity markets as well Yields – nominal versus real. Real yields = nominal bond yields minus inflation – these have soared recently The 10-Year real yield has risen 40BP – gone from -1.06% two weeks ago to -0.67% last week – this negative real yield is the highest it has been in 8 months So is this due to inflation moving or nominal rates? Both - inflation expectations have risen, but nominal bond yields have tripled – gone from 0.50% in August last year to around 1.50% At this stage – this rise in nominal rates is the major reason for why real yields are soaring But inflation expectations are beginning to rise at a greater rate – looking at supply shocks coupled with fiscal stimulus plans in the US and worldwide – in the figures of trillions of dollars that are being financed by the government issuing bonds – inflation is expected to follow – whether it does or not, time will tell But if inflation does materialise – CBs have another policy response – increase interest rates – this is what is being priced into yields for bonds longer term – where there is an upwards pressure on yields Interest rate relationship to bond prices – rates go up, then the price of bonds goes down, pushing yields up So the expectation of inflation and the response by CBs is putting pressure on the nominal rates But without constant central bank intervention - the huge increase in bond issuance to finance more and more stimulus spending would naturally push yields even higher – prices go down so yields go up – supply and demand 101 So to avoid governments going insolvent based on the annual interest cost alone, CBs have no choice but to constantly increase their QE programs – either that or collapse the debt markets Also, in basic economics - real yields and inflation expectations rise together when investors expect a stronger, sustained economic recovery – From what economists expect in regards to economic recovery through looking at the data - this process has already begun and an improvement in economic data would then encourage real yields to make nominal yields go up One bit of supporting evidence in this is the increase in commodity prices: iron ore prices have gone beyond $US175 a tonne - the highest level in a decade – this has also contributed to upward pressure on the local exchange rate over the past few months, but is also a big reason for the higher yields in bonds So how high could bond yields go – helps to look long term – looking at the 30-year bonds There is a monthly chart for the 30-Year Treasury Yield that shows that every time the yields exceeded its 100-Month Moving Average, the yields reverted back – this relationship is incredibly reliable - The yields are currently heading back up – the 100-month moving average is currently around 2.75% - current yields are at 2.32% - so if history repeats itself, the yield may go to 2.75-3.00% and then down again This relationship may be due to two reasons – self-fulfilling prophecy where traders can take adventive of this, as well as central banks implementing a Yield Curve Control policy – as they can drive down yields by buying treasury bonds across different maturities No surprise that to implement this means that CBs would need to print more money to buy back bonds from the secondary market   Summary – Yields are on the rise in government debt – as the 10-year bonds are the risk free assets in financial markets, this could have spill over effects into financial markets – shares could soar in relation to the central bank panic and if QE ramps up further But for the next few years, if not longer, CBs will be doing everything in their power to try and target low yields for debt Inflation expectations and in response, interest rate increases are being prices in and also pushing up bond yields Help to avoid governments being in financial stress Next episode – look at the flow on effects to sectors of financial markets, the dollar, shares, and commodities Thank you for listening to today's episode. 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    Are sectors of the US share market in financial bubble territory?

    Play Episode Listen Later Mar 1, 2021 22:44

    Welcome to Finance and Fury. Are sectors of the share market in a bubble, one in particular that comes to mind would be the US tech sector. There have been many bubbles in financial markets throughout history – if enough excitement is generated around some new asset, or commodity that is seen as the next big thing and everyone starts buying – bubbles can emerge in prices covered some of them, south sea bubble, tulip mania – one that may be the most similar is the dotcom bubble – But how exactly is a bubble designed? And what metrics can be used to measure this The traditional definition of an economic bubble – “An economic bubble or asset bubble is a situation in which asset prices appear to be based on implausible or inconsistent views about the future. It could also be described as trade in an asset at a price or price range that strongly exceeds the asset's intrinsic value.” However – the intrinsic value – or fair value of an asset can be fairly subjective – especially for new or emerging companies or assets As an example – think about CBA for a minute – the fair value should be one of the easiest to calculate as far as shares go – underlying earnings are well known – forecasts also pretty easy based on the business model and the availability of their financials and stability in their results meeting market expectations Many analysists cover it – the price tends to be around what the fair value is estimated to be – the fair value between brokers ranges from $78 to $90 – and so the price ranges between these – currently trading at $82 There isn’t much growth estimated in CBA – what about tech companies – or emerging businesses that are forecasted to have massive growth? This is when bubbles can emerge – nobody wants to miss out on the potential growth in the future – so everyone jumps in today – pushing up the price to what may be fair value in 10 to 20 years But some companies can get to the point where they are still losing money – have many competitors – don’t have market share – but yet they are trading as the next big thing – which they well may be – but it is speculation – One company in a whole market doing this isn’t a bubble – this happens all the time – you get some companies go up 1,000% - before crashing back down to earth But when a whole sector of the market – or the whole market in general is trading at a massive forward PE – this could be starting to look like a bubble territory I was reading an article that ray dalio published – about how he has a “bubble indicator” that helps to give perspective on each market What is the bubble indicator - What I mean by a bubble is an unsustainably high price, and how I measure it is with the following six measures. How high are prices relative to traditional measures?  - The current read on this price gauge for US equities is around the 82nd percentile, shy of what we saw in the 1929 and 2000 bubbles. Traditional measures are estimates like PE, yields and future earnings.   Are prices discounting unsustainable conditions? - This measure calculates the earnings growth rate that is required to produce equity returns in excess of bond returns – this looks at the fundamentals of a company based around the discounting rates – i.e. a 10y gov bond. Currently this indicator is around the 77th percentile for the aggregate market. This indicator shows that while stock prices in aggregate are high in relation to the absolute returns they are to provide, they are not extremely high in relation to their bond market competitors. In both 1929 and 2000 this measure was at the 100 percentile- interesting about this is that the real returns on bonds change with inflation expectations as well   How many new buyers (i.e., those who weren’t previously in the market) have entered the market? - A rush of new entrants attracted by rising prices is often indicative of a bubble. That is because they are typically entering the market because it is hot and don’t want to miss out. Many new buyers don’t have any experience with markets (hence new buyers) – so the warning signs of a company being overpriced can be missed. This was the case in both the 1929 and 2000 equity bubbles. This gauge has reached the 95th percentile recently due to the flood of new retail investors into the most popular stocks, which by other measures also appear to be in a bubble.   How broadly bullish is sentiment? - The more bullish the sentiment, the more people have already invested, so the less likely they will invest more and the more likely that they will sell. The aggregate market sentiment gauge is sitting at around the 85th percentile. Once again, it is heavily concentrated in the “bubble stocks” rather than most stocks.   Also - IPOs have been exceptionally hot—the hottest since the 2000 bubble.   The current IPO pace has been brought about by the sentiment previously mentioned, as well as the SPAC boom - special purpose acquisition company (SPAC) is a corporation formed for the sole purpose of raising investment capital through an initial public offering (IPO). these acquisition companies have lower regulatory hurdles and greater flexibility to bring more speculative companies into the public markets.   Are purchases being financed by high leverage? - Leveraged purchases make the underpinnings of the buying weaker and more vulnerable to forced selling in a downturn. The leverage gauge in the US market, which looks at the leverage dynamics across all the key players and treats option positions as a form of leverage, is now showing a read just shy of the 80th percentile. So there is high level of leverage being deployed by the retail segment (using options) in “bubble stocks,” while there is much less leveraging by other investors and in non-bubble stocks. Volume in single-stock call options is at record highs. Retail purchases of options have been the big contributor to this surge. Outside the retail sector we aren’t seeing excessive leveraged buying.   Have buyers made exceptionally extended forward purchases (e.g., built inventory, contracted forward purchases, etc.) to speculate or protect themselves against future price gains? - One perspective on whether expectations have become overly optimistic comes from looking at forward purchases. We apply this gauge to all markets and find it particularly helpful in commodity and real estate markets where forward purchases are most clear. In the equity markets we look at indicators like capital expenditure—whether businesses (and, to a lesser extent, the government) are investing a lot or a little in infrastructure, factories, etc. It reflects whether businesses are extrapolating current demand into strong demand growth going forward. This gauge is the weakest across all our bubble gauges, pulling down the aggregate read. Today aggregate corporate capex has fallen in line with the virus-driven hit to demand, while certain digital economy players have managed to maintain their levels of investment.   What to take away from this - Each of these six indicators influences is measured using a number of stats that are combined into gauges – these indicators are simply estimates as well - they are combined into aggregate indices by security and then for the market as a whole. Ray has put similar data into the market since 1910 – how does the market stack up? 1920s Dotcom 2007 US market today US market - tech Comparing the share of US companies that these measures indicate being in a bubble - It is about 5% of the top 1,000 companies in the US, which is about half of what was seen at the peak of the tech bubble. The number is smaller for the S&P 500 as several of the most bubbly companies are not part of that index. However – these bubble shares – or the 50 companies in the US – have had good performance – especially when compared to the rest of the top 500 companies.  50 in bubble – 350% returns over past year Rest 25% returns Conclusion – What to take away from all of this – firstly, these gauges are not perfectly accurate - Even if you were timing tops and bottoms based on what neighbourhood share are in - there is nothing precise about this. it is tough to pick the levels and timing of tops and bottoms based on it. May seem like some things point towards bubble – but doesn’t mean it can’t continue up – that is the problem with anything in a bubble – the ride can continue – Or prices can falter out Whilst many tech companies do seem overvalued and in a bubble territory due to traditional pricing metrics – there can be some fundamental reasons why Quest for yields and real returns – Store of value if cash is being devalued - so with new entrants and many market participants having familiarity with certain companies – such as big tech businesses – they invest into them If you are worried about a crash in prices – then either invest a small amount into an index or avoid companies that appear overvalued – well beyond normal growth share metrics – like PEs in the 50s - Next week – look at the risks of rising yields – many tech companies are non-profitable – what happens when yields on their corporate debt starts to rise? Thank you for listening to today's episode. 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    Investing in infrastructure as part of a wealth accumulation strategy.

    Play Episode Listen Later Feb 22, 2021 26:02

    Welcome to Finance and Fury.  This episode will looking at infrastructure as an asset class, to see if it can help to provide some diversification for portfolios and decent moving forward. Infrastructure – physical assets that provide services that are essential for us to live our lives. The aim is to invest in assets that if the market booms or busts, it provides some diversification to traditional asset classes. Traditional Asset classes – Defensive – Cash, Fixed interest (gov, corporate bonds, credit) Growth – Property, Shares – Australian or international Where does infrastructure sit – still in the growth category - In my view – can help to provide a real asset can play a role in an investment portfolio – two component for reasons to invest in infrastructure Diversification – infrastructure allows an investment in lower correlation to other asset classes – however, depending on the type on investment purchased, some may have “higher beta and therefore less diversifying” Real use – value – investment in areas that we generally interact with these essential services every single day, gas, water, electricity, transport Traditional infrastructure Transport – seaports, airports, major roads, bridges, tunnels Utilities – Power generation, energy distribution and storage, water, sewage Renewable energy – big asset class moving forward Communication – network towers, satellites, phone networks Infrastructure at the moment is potentially undervalued due to not seeing the same rebound as many other growth investments over the past 6 months – oil prices also went down – the year returns haven’t been great – effects are cyclical - there may be an opportunity today from a pricing perspective - the market has marked down real assets and infrastructure at the moment - Lot of money being spent on infrastructure – there is a major need in developed economies for revamping of aging infrastructure, and for new infrastructure projects In addition - emerging markets which have their economies growing as well as their population’s wealth increasing, the demand for more and better infrastructure continues to rise But government budget pressures have been affecting their ability and willingness to fund infrastructure projects, creating more opportunities for private capital in the asset class – however, with the invention of green bonds as well as cash rates for funding being close to zero, this could increase the amount of money available to fund projects Benefits – Predictability of cashflow - Infrastructure assets usually have a pretty high level of visibility and security when it comes to their future cash flows. When talking to fund managers, they say that they look for projects that almost have guaranteed revenues – those that are underpinned by regulation or long-term contracts with highly creditworthy counterparties - such as governments – compare this to other companies where their cashflows are not as secure – the valuations can be hard However – most infrastructure could be considered to be a Public Private Partnerships - where the public sector partners with a private sector company - The private sector company develops, constructs, finances, operates and maintains the infrastructure, and the public sector pays for those services -the concessions for the assets are often granted over lengthy contractual periods, which can be over 30 years – so the cashflows can be relatively secure Also – they have Inflation-linked revenues - The revenues that infrastructure assets earn are often linked to inflation - rates of return set by regulators frequently linked to future inflation expectations in in a long-term contract. A competitive advantage – A lot of the time, infrastructure assets have a form of a monopoly in the services that they provide – or in other cases, they operate in markets with high barriers to entry  Therefore, the assets cannot be easily replicated and often remain free of the competitive pressures confronting more traditional organisations – so again, the risks that an established project all of a sudden has a new up coming competition are very low – helping to reduce uncertainty risks The Essential nature of infrastructure and correlation – People tend to use these essential services on a daily basis and that utilisation (and returns) can often depend less on the economic climate at a point in time than other investments - Because of that essential character, economic factors often have less of an influence on infrastructure assets than on numerous other businesses, which can assist in delivering stable returns through market cycles infrastructure as an asset class, particularly unlisted infrastructure, has historically demonstrated low levels of correlation with other growth asset classes – can help to reduce volatility of a portfolio The risks of infrastructure Too much leverage and interest rates Debt and the cost of that debt can be a big factor in the future performance of a project – Technically – with interest low or falling – the cost of debt declines – this means the costs of capital also decline in the valuation of projects – This means that the values of the project increase – but the opposite is true, if interest rates rise, then the valuations can also decline on average, most infrastructure stocks have higher debt to equity or gearing levels than the average stock and therefore are more vulnerable to interest rate rises.  Greenfield risk – this is a major risk for new projects – where the estimates don’t stack up to reality – an example of this would be a toll road at the beginning of its life, when it has the most uncertainty - what traffic levels of the road will really be like remains to be seen. Tolls may have been set, but again, sufficient usage of the new road is essential – there can be too much uncertainty which can be dangerous You can also have Construction risks, delay risks and cost blowouts - Example – The Queensland Government contracted BrisConnections to run its Airportlink Project, which opened to the public in 2012. Initial forecasts were for the 6.7km tunnel, linking Brisbane Airport with the CBD, to carry 170,000 vehicles per day.  Six months after opening, there were only 50,000 vehicles using the road and BrisConnections went into receivership. The roadway was eventually sold for $2 billion to Transurban, despite having cost $4.8 billion to construct. Many retail investors who invested in the initial public offer at $1.00 lost most of their money when the shares plunged to $0.001 within months. Further, the shares were structured as instalment warrants carrying a further two instalments of $1 each. People who thought they were being canny traders, picking up a bargain, suddenly found that for each $1,000 they invested, they incurred a $2 million liability. Lesson – investing in early infrastructure projects is very risky – especially if there aren’t government guarantees on the returns Management and ESG factors - while real assets like infrastructure can be fairly low risk, this can be negated by the people that run them – the same with any company When looking at infrastructure businesses - It might be the case that too much risk is taken on, a white elephant is built, or the capital structure is not right and there is too much leverage. The human element is very important to assess as the humans are the ones making the decisions on what to build based around assumptions – if enough mis management occurs, a company can lose its licence to operate an infrastructure asset if the asset is not well managed.  In Italy – Autostrade is a company that controls the roads forming the Italian system of motorways - currently at risk of having its motorway concessions revoked because of the collapse of a 200-metre section of a bridge in the city of Genoa in August 2018 Currency risk - When investing in global infrastructure assets, currency risk is introduced into the equation and This can affect the returns of an investment due to changes in currency exchange rates   Infrastructure performance - infrastructure has done well over the years depending on the sectors invested in Pretty strong returns have been achieved by a blended allocation of property and infrastructure International infrastructure fund – 10.32% over 10 years – invested for 7 years with a return of about 9% - off the back of a 1-year return of -16.41% Over the same timeframe – ASX index – 7.66% return for 10 years, but the 1 year returns are only negative 2.6% Obviously past performance isn’t an indicator of future performance Looking forward for returns – Comes from demand factors – who is going to use the assets? And will they actually be used. With this in mind: should concentrate on owning infrastructure in high population growth areas - does not make sense to add infrastructure in regions where there are less customers each year because populations are going backwards – an example would be Japan - a toll road project where there is no pricing power because it is difficult to raise tolls in this situation. The best infrastructure plays are those where there is exposure to high population areas and urbanisation – happening in many developing countries Important to research the investments if you are considering it – as some managers do have big weightings to Europe, with regions with less population growth – but some of them have the cash cow of governments funding these projects   Investing in infrastructure - Accessing infrastructure – your options – this is not advice but the general methods to access it Listed – This is purchasing shares that are listed that deal in infrastructure – an example would be Transurban or Sydney Airport Another option is to purchase managed funds that deal with infrastructure – I have a mix of both – international I do through managed funds Unlisted – this is a little harder to get The risks here are similar to property trusts – illiquid nature The correlation question – listed infrastructure can be heavily correlated to the equity market – makes sense as it is listed on the equity market However – it does provide some measure of diversification – different shares in different sectors – But when the market falls – all shares take a ride down Conclusion – Infrastructure investment offers the opportunity to invest funds into assets that play an integral role in daily life – when looking at investments for the long term – confidence is important – what are people still going to be using and demanding as a product in 10 to 15 years? Then, what companies are in a position to be providing these above competitors The benefits of infrastructure investments are predictability of cash flows, the longevity of assets, and comparatively less volatility of a portfolio overall than going purely into Australian shares There are also risks associated with infrastructure investments however - might involve higher debt to equity or gearing levels compared to other assets, ESG factors and with global infrastructure, currency risk that needs to be considered. Additionally, greenfield risks might deter some investors from investing in infrastructure projects at the start of their lives. As is true for all investments and strategies – you need to take careful consideration of if infrastructure is appropriate for you.  Thank you for listening to today's episode. If you want to get in contact you can do so here:

    What is stakeholder theory and what does it mean for capital markets and investments?

    Play Episode Listen Later Feb 15, 2021 25:04

    Welcome to Finance and Fury. What is stakeholder theory and what does it mean for capital markets and investments? World Economic Forum annual agenda occurred a few weeks ago. One year ago, the World Economic Forum launched a new ‘Davos Manifesto’ in support of stakeholder capitalism – this year – stakeholder capitalism, or stakeholder theory was at the forefront of many of the agenda’s What is stakeholder theory – like many things, the definition has changed over time – Originally - Stakeholder Theory is a concept from R. Edward Freeman (American Philosopher and Professor) when he introduced it in 1984 – it was a theory of organisational management and business ethics – aimed to address morals and values in managing an organisation - The theory argues that a firm should create value for all stakeholders, not just shareholders Since the 1980s - there has been a massive rise in the theory – as well as an expansion on what is defined within the term value and who is considered a stakeholder From R. Edward Freeman - “The 21st Century is one of “Managing for Stakeholders.” The task of executives is to create as much value as possible for stakeholders without resorting to tradeoffs. Great companies endure because they manage to get stakeholder interests aligned in the same direction.” The issue with this is the concept of providing value without resorting to tradeoffs – is this actually possible? Individuals and companies have to make decisions every day – with every decision there is an opportunity cost – and likely a tradeoff Today - Stakeholder theory is closer to a version of corporate social justice – or in other words, the concept of equity in the world and a merging of company’s responsibility for communities (who are technically non-stake holders) To explain this further – Equity (in the non-financial sense) is about outcomes – the fairness of an outcome - is not equality of opportunity – but equality of outcomes unlike equality of opportunity – equity actually requires the different treatment of individuals and different distribution of resources to get to an equitable outcome – if you have $10,000 in shares but your friend doesn’t, that isn’t equitable, you should technically both have $5,000 – if you earn $100,000 but your neighbour only earns $50,000 – that isn’t equitable This is one of the big changes in stakeholder theory – that is the growing support in calls for equity – Under this theory business firms should entertain all kinds of noneconomic goals and outcomes. No longer may owners simply concern themselves with profit or loss, but instead must consider the broader societal implications of everything their business does. Social media has really helped to accelerate this – when looking at the online presence of massive companies – it is all about cultivating an image of social responsibility – PR teams working around the clock to support any cause that is in vogue – Whether corporate leaders concern themselves with social justice out of genuine desire or merely to avoid backlash is an open question – to find an answer it helps to look at what a company does versus what picture they have on Under the original conception of stakeholder theory - businesses have four primary elements when it comes to stakeholders - namely owners, managers, employees (or suppliers), and customers All four have skin in the game – they either have invested money in the company, are employed by the company, require the company to buy their goods/services or in turn, buy this companies goods and services – at every stage each of these elements has their own money or income is involved in the decision-making process – Each of these individuals are making tradeoffs – making decisions based around what they believe will provide them the greatest value Owners/Investors – tradeoff in that they could have invested money elsewhere – but do so as they see value in investing in the company Managers/employees – trading their time/effort for an income – the income needs to provide a value – i.e. enough to compensate for time Customers – have to see a value in what they are buying to exchange money Value itself – think about the value that a company can provide – even a small one – provides wealth to the owners – but based on the value it can provide to the other key stake holders Today - stakeholder theory argues that there are other parties involved, including governmental bodies, political groups, trade unions, communities, financiers, suppliers, employees, and customers – extension to include governmental bodies, political groups, trade associations and unions and communities – which means every person on earth WEF agenda this year: “It is also a system where companies, government, civil society and international organizations are recognized as equal partners, and where they all pursue a common goal: the well-being of people and the planet. It would prevent economic inequality to get out of hand in the way that it did.” The difference is that those who are not stakeholders – or have no skin the in game now have power over companies’ business practices This notion of stakeholders actually inverts the original concept - grants a new degree of power over private businesses to those who take no risks and provide no benefit – no trade offs and provide no value Going back to value – if someone who has no skin in the game starts to determine company decisions – is this good for the value that this company provides? To employees, who require a company turn a profit to remain employed, to shareholders, who require a company to perform well long term, also generating profits to make money? To suggest that the general public or society at large ought to be a de factopartner in any business, based on the interconnected nature of any economy, actually starts to undermine the very concept of private ownership – which is the bedrock of any functional economy This new wave of stakeholder capitalism starts to imply collectivism as insists everyone in society has the right to an interest in what companies do - and not only with respect to their profits, but even their business practices and mission remember, this concept is being pushed from the same organisation that produces works that state: “Welcome to the year 2030. I Own Nothing, Have No Privacy And Life Has Never Been Better. Welcome to my city - or should I say, "our city". I don't own anything. I don't own a car. I don't own a house. I don't own any appliances or any clothes. It might seem odd to you, but it makes perfect sense for us in this city. Everything you considered a product, has now become a service.” If this is sounding slightly familiar - Societal ownership of business firms have traditionally taken a few prominent forms – socialism and communism Similar to R. Edward Freeman, another philosopher came up with an economic theory on value and tradeoffs in Das Kapital in 1867 – over the years it morphed and changed and then with its implementation – about 40-50 years later once it had gained traction in society – we know how well that turned out for the economies that implemented it Socialism is increasingly popular – using the terms of equity and stakeholders seems to be blurring the distinction between private companies, property ownership and state (governments) – this is the merging of economic means and the political means However - equity and stakeholder movements do not represent outright socialism or communism – there will still be a share market where we can purchase companies that still have profits and losses – but it is an evolution in the system – where the uneconomic decisions can be further made from non-stake holders – like Governmental organisations like the UN – which further distort the nature of a free market Economic decisions require the concepts of trade-offs – however – there are some entities that seem to be unfamiliar with this concept Calls for stakeholder theory are coming from Government entities – like the UN and EU – Government entities aren’t known for economic trade-offs – lack of consequences when compared to a free market – when it isn’t your money or you have no skin in the game – i.e. your decisions don’t affect your outcome, just that of others – UN is pushing stakeholder theory as part of the great reset The European Commission (executive branch of the European Union, responsible for proposing legislation, implementing decisions) recently released a sustainable corporate governance report claiming to find a problem with publicly listed companies due to the investor-driven behaviours of these companies – they are proposing that power be shifted in EU-listed firms to other stakeholders – so stakeholder theory isn’t just some fringe thought anymore Harvard Business review went through this and found that the EUs reports were deeply flawed. And its proposed policies would actually reduce businesses sustainability in the EU What the EU claims is that there is a rising level in gross shareholder payouts, dividends and repurchases and declining levels of investment – in other words, firms are increasingly showering cash on shareholders, stripping the company of assets that could be used for long-term value creation – investment in green projects Without going through all the numbers – this report relied on a cherry-picked sample of public firms. An analysis of all EU-listed firms reveals that both capital expenditures (CAPEX) and research and development (R&D) increased during the period covered by the report However - The EU report implies that investment might be higher had shareholder payouts been lower. But cash balances grew by nearly 40% over the last decade, from €712 to €973 billion This could actually suggest that investments by EU public firms is limited by the lack of additional opportunity, not by a lack of available cash With board decisions – profits have two primary purposes – to be retained – for R&D and other CAPEX, or to be paid out to shareholders – the decision on how much should be paid out comes back to the expect rate of return (IRR) of a project versus the benefit to shareholders – i.e. if a company invests $1bn that may boost share price by 3%, versus paying out shareholders where this payout represents a return of 4%, better to go with the 4% Not only does the report fail to show that EU businesses are misgoverned, it also makes proposals that would actually put these businesses at risk As part of the stakeholder theme – the report recommends an EU-wide reformulation of directors’ duties to include a broad and ill-defined range of considerations – i.e. representing the interests of the “global environment” and “society at large.” These duties would be enforced by non-investor stakeholders bringing suits in court. The effect of implementing such proposals would be corporate destruction - any board decision could be legally challenged by some entity with no skin in the game claiming a violation of directors’ almost boundary-less duties – board members and directors will freeze any decision making without having consent from entities like the EU or the courts that they would need to defend themselves through – bad PR can destroy profits as well a legal payout – however – I believe the report makes the directors personally Ask yourself - How will these firms compete with Chinese firms? Conducting business through an EU-listed firm will simply no longer be sustainable. Firms will go private, or seek to avoid these rules by domiciling and listing elsewhere - Decreases the investment opportunities for us, as more and more companies will de-list The primary reason of being a listed company – i.e. to raise capital – would be gone, why would investors make the decision, or trade off to invest their funds in a company with an EU mandated fiduciary duty – that requires them to only deploy funds to benefit the global environment or society at large Remember – the definitions of what this benefit or value is would be defined by governments – we tend to have different definitions on what is valuable of us – which is why choice in a free market is important In addition – returns could decline – could force directors to cut back on dividends and invest more internally – even if this isn’t the best investment decision and the money is mis-spent – just to avoid being called a short-term focused director In Summary - stakeholder theory means that companies would have a duty to make uneconomic decisions as opposed to trying to maximise value to those who are real stakeholders – or those with skin in the game Under stakeholder theory - broader societal interests, not real value to shareholders, employees or customers must be considered - these societal interests can be real or imagined based around public perception – leading to further uneconomic consequences So, companies would need to invest in supposedly green but inevitably less efficient technology or others causes that have the most current attention, which may not be the optimal economic decision - These actions may in fact provide long-term benefits from a positive public image to a company, but they do not directly increase share prices or dividends It also undermines the purpose of capital markets – raising capital as well as price discovery Markers help investors and businesses to allocate capital to its best and highest uses - however this is imperfect and has hazards – which do get criticised – but if you get in the ring, you might get punched But if a company does not wish to subject itself to director mandates for stakeholder value or public campaigns – they will start to take themselves private Markets and companies as they stand are imperfect because humans are imperfect – there is no perfect system to get the perfect outcomes - But the alternative is nothing less than creeping socialism by another name The ideal economy of the EU/UN is outlined in their SDGs - Does increase the equitable nature of the mega-corporations – where you have a handful of companies that provides the world their needs – one specialises in each sector of the market – to a point they can force equity and not have to listen to the real stakeholders anymore – but the non-stake holders This in turn, then reduces the outcomes to the individuals that make up the real economy – companies making non-economic decisions – hurts economic output at optimal levels – All companies are not built alike – I am critical of mega-companies – those that act in anti-competitive behaviours – but I have the feeling that these companies will do just fine under any stakeholder theory – it would be smaller companies and those people working for them, or using their goods that suffer I’m not saying that companies should destroy the environment and shouldn’t care about their contribution to society – most companies indirectly do benefit society and us in our day to day lives – they provide value to us in goods and services, they employ people, they can make people wealthy through investments – you simply need to participate to reap the rewards But to completely revamp the concept of companies could lead to a much worse economic outcome for us – but not the people pushing this Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Market integrity, disruptions, innovations and the fallout of Wall Street versus retail traders.

    Play Episode Listen Later Feb 8, 2021 24:01

    Welcome to Finance and Fury. In this episode, we are going to look at some of the potential fallouts from the GameStop saga – looking at market disruptions, market integrity and the ongoing implications of potential regulation changes If you want an overview of this – check out last Mondays episode. But in short - Gamers are good at playing games – when they know the rules The rules of the financial game are starting to be more understood by people online - Some people on reddit were paying attention to the Form 13F filings in the US for hedge funds – have to be lodged each quarter– saw that GME was heavily shorted by a few funds, The one firm that received the most attention, Melvin Capital had heavy short positions The price of GME has come back down a fair bit from its high point last week, was sitting at around $60 on Friday last week – but there was a gradual increase from around $18 at the start of Jan to around the last week of Jan – when the price started to sky rocket – went up over $400 – triggered a short squeeze where funds were trying to get out of their short positions by buying back the shares – but there either went enough shares, pushing prices up further or you had to accept a massive loss Even buying the shares back at $60 would still result in a big loss – most got into the short positions between $4 and $10 There are some estimates – hard to get a total for all the funds that lost money – but Losses total losses were estimated to be around $70bn from short positions within the hedge fund community – Melvin Capital lost around $13bn of their capital – loss of around 53% in the fund So in this episode – I want to go through the nature of this market disruption, and the greater implications of this – from the market integrity point of view as well as potential regulatory responses   To start with – discuss the nature of Market disruptions – through innovations One view that I have about this whole saga is that the disruptions are due to innovations – both human and technological It is a bit of a paradigm shift – humans are adaptive creatures – if a group of online investors managed to push up the price of a company, where some made some decent money, while causing massive losses to institutions, what is to stop this from happening again? When looking at the evolution of humans and technology, it can help to paint a picture of what may happen next in financial markets – the basic trend occurs as follows: Disruptive companies or trends start- normally start small or at the low end of a market – these start out with a focused/niche group Existing powers that be (companies or groups in the social dynamic) ignore this new competition – mainly because it is small – so either poses no threat to the loss of customers or there aren’t enough people to affect change Over time successful trends or disruptor climb the value chain – with companies, they offering better products and services, with social groups, it also provides value – community or prestige Eventually – these disruptors grow to a point of being legitimate competition - the existing powers that be either fail or adopt the disruptor’s models, and the whole cycle starts over again Much more to this cycle – but when viewing the recent rise in retail trading through this model – it is following a pretty classic disruption model The emerging disruptive trend in markets – coming from retail investors in combination with technology – have access to low/no cost trading platforms as well as chat sites/social media that binds them together – so they can move trades as one They have been overlooked by the powers that be – relatively small -but when taken at the aggregate level, especially now with stimulus checks coming in – they each have an additional $2k ($1,400 more coming on top of the initial $600) As a group – the common knowledge of gambling and gaming is relatively strong Therefore, it is pretty easy to assume that this style of behaviour will grow and have further influence on financial markets  The big lesson about disruption – is that once the ball gets going, it rarely stops – unless diverted – which is where ‘market integrity’ will come into this -   If this does continue – what are the risks of short squeeze a large credit shock can traverse through the market - how can last few weeks squeeze activity affects the rest of the (institutional) market? It all comes down to the leveraged nature of trades Aside from a broker/hedge fund not being able to meet margins calls or close out a position - most of the hedge fund industry is financed – in doing so, its beta is close to 1 from their net exposure x leverage In other works - if your (long-short) exposure is just 10% of gross values but you are levered 10x then your ultimate NAV beta is still about 1 Trouble is - even the largest brokers will only allocate so much 'regulatory capital' towards Prime Brokerage; after which they will raise the cost of financing Morgan Stanley and Goldman (the two largest shops in the space) are in a much, much better position than in 2008 - but when more stocks get squeezed, they will raise financing costs to allocate precious capital - they will cap risk to the hedge fund and new trades will become impossible to put on if gross positions exposure exceeds risk adjusted limit If this were to cascade – hedge funds need to cover their position – through selling up long positions to cover the short ones - the first thing sold is the highest P/E (likely highest beta / momentum factor risk) exposure Now – Melvin was a pretty small fund in the scheme of things – but if a fund 10x the size of Melvin was to find themselves in this position – things could become worse – losing 53% of their capital in one trade, then follows the redemptions from existing investors - If these were to cascade, then the Fed will have to step in, and call the prime brokers and relax regulatory standards Things are heating up - the most heavily-shorted stocks have risen by 98% in the past three months, outstripping major short squeezes in 2000 and 2009 US equity long/short fund returned -7% this week and has returned -6% YTD. Over the past few decades there have been a number of short squeezes in the US equity market – what is different this time is that it has been an extreme case in a few specific companies   In the last three months – when looking at a basket of top 50 shares with market caps above $1 billion and the largest short interest as a share of float in the Russell 3000 index – these companies have rallied by 98% - This week the basket’s trailing 5-, 10-, and 21-day returns registered as the largest on record. most shorted stocks took place even though aggregate short interest was near a record low – this is different as well because historically, "major short squeezes have typically taken place as aggregate short interest declined from elevated levels In contrast, the recent short squeeze has been driven by concentrated short positions in smaller companies, many of which had lagged dramatically and were perceived by most investors to be in secular decline" Bankers at Goldman sacs believe this could be an issue – one stated "this week demonstrated that unsustainable excess in one small part of the market has the potential to tip a row of dominoes and create broader turmoil." They went on to say "the retail trading boom can continue" as "an abundance of US household cash should continue to fuel the trading boom" with more than 50% of the $5 trillion in money market mutual funds owned by households and is $1 trillion greater than before the pandemic, what happens in the coming week - i.e., if the short squeeze persists - could have profound implications for the future of capital markets   This is where we come back to the concept of market integrity and systemic risks– which regulators are meant to be responsible for What is market integrity? Well, it is one of the main objectives of securities regulators – in the US, the SEC, in Australia, ASIC - a rough definition it to protect the integrity or fairness of the markets This, together with protecting investors, improving the efficiency of markets, and protecting the markets from systemic risk, form the four fundamental goals of securities regulation Such narrow definitions of market integrity conceptually link it to market efficiency - in that a market of high integrity should also be efficient because prices will reflect their fundamental value – there are a few definitions Michael Aitken has defined market integrity, in part, as “the extent to which market participants engage in prohibited trading behaviours.” Hersh Shefrin and Meir Statman (1) freedom from coercion (people enter transactions voluntarily and are not coerced into or prevented from entering transactions); (2) freedom from misrepresentation (people are entitled to rely on information which is disclosed); (3) information (people are entitled to equal access to a particular set of information); (5) freedom from impulse (people are protected from possible imperfect decisions); (6) efficient prices (people are entitled to prices that they perceive to be efficient in that intervention is permitted to correct imbalances); and (7) equal bargaining power (people have equal power in negotiations leading to transactions). Here is where things can get murky – who defines what fair/efficient prices should be? What is an efficient price? Sure, GME at over $400 isn’t an efficient price, but are Afterpay or Tesla trading at their efficient price? What about freedom from impulse? To implement this, this could be what Robinhood did, limit/restrict buys – not letting people buy companies based around what is determined impulse The next element is regulators protecting the market from Systemic risk is the possibility that an event at the company level could trigger severe instability or collapse an entire industry or economy These definitions, or rules are contradictory – regulators have four major functions - protecting market integrity, protecting investors, improving the efficiency of markets, and protecting the markets from systemic risk Based around protecting investors, this could mean the limitation of investors rights – the banning of the trades in a company should be something that the SEC should look into – reduces the integrity and efficiency and competitiveness of a market – stacks everything on one side The issue with the regulations is that it is based on projections from one side – the financial systems – i.e. hedge funds and politicians – to help protect from this happening again, they may restrict the free market When looking at the options for Regulations – it may be as simple as tech censorship – discord banned WSB for a short time – may see the pressure of the Government on either trading firms or social media sites to reduce the coordination of traders One of the more likely outcomes will be that there will be some Scapegoats to scare the public from doing this again – already found one or two – similar to what happened in the US back in 2010 – what can get them is that some of these people on reddit trading have securities licences in the US they will once again find a small-time trader to scapegoat, regardless of whether their actions actually had a major impact on the market volatility in question Still an ongoing issue – but time will tell how this plays out – it may turn out that nothing may come from this – at the very least, the US/SEC/Regulators and committee members like Maxine Walters may just get a few scape goats from this movement fined/banned from trading or jailed – But if the trend continues of retail traders buying shares and shorting – further action may be deemed necessary by governments/regulators – to protect market integrity as they see it Whatever the governmental response is – it will take a while to legislate – maybe a few years – but if a market crash occurs out of this – the blame will be placed on redditors – not the short sellers or the people betting against a share with other peoples money – just those going long with their own money Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Welcome to GameStop: may we take your order?

    Play Episode Listen Later Feb 1, 2021 27:45

    Welcome to Finance and Fury. In this episode, we're going to cover the GameStop saga. It's still ongoing at the time of recording this, so new information may be out by the time you listen. I wasn’t going to cover this topic – I saw this first pop up either Monday or Tuesday last week – looked like a funny story – retail traders sticking it to hedge funds – but has evolved over the last week to something much more – and has been making headlines everywhere – in this episode – want to give a quick recap about what is going on, between the initial rise of the GME shares, the market interference by Robinhood, why this went on and the greater market implications, looking at short selling and hedge funds in general – so lots to covers   To start with – what is the GME story - GameStop – GME – brick and mortar game retailer – owns EB games GME price history – Over the years brick and mortar retails have lagged behind – Steam, amazon, many online gaming services – Back in 2013 the price was around $50 USD – by the end of 2015 – trended down to $35, 2017 was in the $20s, then by the start of 2020, was around $4 – then with the lockdowns – many people thought this would be the final nail in the coffin – go the way of blockbuster – Many things have happened since them that are positive for the company – new billionaire investors/board members who have come aboard with expertise in e-commerce – which is where gamestop needs to head to survive – then new PS5 and Xbox came out – prices started to go up – but funds stared to double down on shorting positions – So by the start of 2021 – there were around 71 million short positions taken – to put this into perspective – GME only has around 70 million shares – but around 20% of these shares are owned by insiders (CEOs, board members, etc.) – on top of this – managed funds and indexes own a large chunk as well – this takes the number of available for trade down to around maybe 30 – 40 million Short selling – if you think the price of a company is too high or is going to go down – or is already trending downwards – you profit off this through ‘shorting the share’ You borrow the share off a broker or market maker – you then sell that share – taking the cash – you then wait – and if the price goes down – you buy the share back at a lower price, return that share from the lender and make a profit in the difference – As an example – Share A is trading at $2, I think it will go down – so I log into my brokerage account and apply for a shorting position – some fund which wants to hold this company for a while will then lend me this share, I sell it – then a few weeks later the price goes to $1 – I buy this share, return it to the fund and make a profit of $1 However – the net profit will technically be minus the borrowing costs – this is what can make this trade very risky – the fee to do this may normally be a few percentage points to the lower end of 1% - for some large companies is about 0.5% - so off this trade I will pay $0.1 so have made a $0.9 profit – still not bad But - Say you short a share – and the price goes up – well, why not just hold on for a long time and wait, hope and pray that the price comes back down at some point? Well – because you have to pay an ongoing fee for this – the fee is dependent on a number of factors and will change over time – but lets just say, that if the prices goes up – this fee gets larger This makes shorting closer to gambling in the short term that you are correct on your position - That is what shorting is in a nutshell – So as a quick recap - hedge funds were shorting GME – price started to go up – the hedge funds doubled down to the point there were around twice the number of shorted positions to available for purchase shares – People on Wallstreetbets realised this – companies like Melvin capital management was going to short on GME – Wallsteetbets – subreddit – has about 2 million members – but has a wider reach in the investor community People in these forums investors online on reddit decided to put a squeeze onto these firms – These investors banded together and started to buy these shares Market cap at around $4 per share is $280m – went to around $1.4bn at $20 per share - so if you get 2 million people are they each buy a few shares, say $200 worth each on a nil brokerage platform like Robinhood – then that is $400 million flowing into this share – If they then buy all the available shares – so 25-30m in total and hold onto these – pushing the price went up massively in a short space of time and limiting the supply of shares to buy back to exit the short positions – this triggered a short squeeze – Short squeeze is where people with a short position desperately try to buy the shares back to exit the position – they will still lose money but hope to cut their losses But when there aren’t enough shares to go around – the price goes up massively – This is what happened – price had a gradual increase – from Aug when the good news was coming out – price went from $4 to about $19 at the start of the year – then from the 20th of Jan – about a week and a half ago – started to sky rocket – hit $470 at the peak a week later on the 27th/28th of Jan – Over this time though - The process is borrowing the shares – hence the fees went up on the share – so if you find yourself in this position, you have to cover the costs in the differential – funds lost billions – ended up in This is where the story takes another turn – some of the trading platforms that investors were using to purchase GME, and a few of the other shorted positions restricted the trading of these shares on the 28th – Robinhood – restricted people from trading GameStop – well, not selling, only buying were restricted Not just Robinhood – E*Trade and WeBull, and a few other platforms restricted trades as well Not just on game stop – AMC, blackberry – and 10 other companies that were also heavily shorted They lifted this ban pretty quickly - On January 28 – same day as the banning - a class-action lawsuit against Robinhood for alleged market manipulation was filed in the Southern District of New York. The lawsuit alleges that the app “purposefully, willfully, and knowingly removing the stock ‘GME’ from its trading platform in the midst of an unprecedented stock rise [...] deprived retail investors of the ability to invest in the open-market and manipulating the open-market.” Later that day, the company announced that it would reallow limited buys of the stocks on January 29 However - limited number of purchases available - Limited it where if you already owned shares in GME you couldn’t buy any more, but if you were a new purchaser – limited to 5 shares – this then got updated to 2 shares – So you could own 2 shares in total as a new purchaser – but then this got updated again - Robinhood’s list has grown, with 50 stocks now considered volatile and thus with limits. Most of the stocks are now limited to holdings of one single share – GME and AMC included Who is Robinhood and why would they do this? Robinhood is a brokerage platform – they don’t execute the trades for buying and selling – Robinhood is meant to be for the everyday retail trader – the same people who were doing the buying of GME – so making this decision could sink their clientele – and they have received some very bad press – But there is more to the story – First - they don’t charge any commissions on this – market themselves as the anti-wall street – not charging commissions – so if you don’t pay them, are you really the customer? Robinhood – technically works for larger brokerage firms and market makers – Robinhood doesn’t actually execute the trades – they take it to a market maker – another large brokerage firm – who then in turn are the ones executing the trades – this practice can be called front running – where the market makers can get into a share and then sell it back to you for a slightly higher price if you are looking to buy Robinhood gets paid for this – as they are essentially selling your data to hedge funds – then wall street can use this data to trade – if lots of buys are coming in, they know the price is going up, put positions on – plug into algorithm – the price differences will be so small that it isn’t that noticeable – but if a company can make $0.1 per share and sell millions in a day, that is a decent profit for almost nothing Going back to September 2020 - Robinhood was under SEC investigation for failing to fully disclose selling clients' orders to high-speed trading firms - Robinhood paid $65 million to settle the SEC investigation on December 2020 Think of FB – you aren’t the customer if it is a free product – you technically are the product Why would Robinhood restrict the trades on so many companies? We don’t know for sure – but following the links Likely some major pressure from wall street – who robinhood needs to work with and is who pays it – remember the retail trader pays nothing in commissions– market makers (the ones losing from short trade positions) are the ones who pays Robinhood – Their largest hedge fund that purchases buy order flows from robinhood is Citadel group – which is a hedge fund that buys the order flows from Robinhood – makes up around 60% of their purchases – so either pressure was placed on them, or these major hedge funds refused to take any buy order flows from the trades at robinhood – However – citadel is an investor in Melvin capital – which is the hedge fund losing the most money – at least publicly - on the short positions – was one of the two first that provided $2.75 billion USD after Melvin’s loss on the short squeeze position – the other is point72 This leads to some speculation that this is the reason as to why robinhood ceased trade – both Melvin and Robinhood have denied these claims – so who knows – Other explanation – is the leveraged nature of trades possible on Robinhood’s platform – as an investor – you can borrow funds to invest – RH have LOCs from large investment banks – like JP Morgan – Robinhood faced backlash in June 2020 after a 20 year old student committed suicide after seeing a negative cash balance of U.S. $730,000 in his Robinhood margin trading account – you can also trade options on leverage – this has been restricted heavily from the early days So the other explanation is that due to GME prices going up massively –Robinhood could have been trying to protect people – or themselves from lots of leveraged losses – if the price of GME goes back from around $325 to $20 – which would be a 94% loss What are the implications of this The banning of trades – what happened to the price? what happens? Prices drop They resumed limited buys a day or two later – but the price dipped – either profit taking or the intended outcome – then went back up a bit – went from the peak at the market open on the 28th of $470 to $197 by market close – the next day when limited trades were available price went up to $380 – but is back to $325 as of the Friday close - Either way – this has really shown a lot of the public that Wallstreet hates outsiders – It is okay for them to affect market prices, gambling and lose funds, then get bailed out – but if the public does it and makes them look stupid – then look out – they have massive companies, billions of funds and government officials to help – The media for the most part is spinning this as some autists online are manipulating the market – destroying market integrity – hence the need for additional regulations to help protect unwearying investors for stumbling into these shares of GME at $325 - Shorting shares and market manipulations – does it have a point in the markets? it isn’t unheard of for some investors to spread some doom and gloom information on a share they have a short position in – What is the point of short selling – profiting from a market decline – or a decline in the price of a share Beyond this – does it have a point - in theory – to create an efficient market – but that is where standard selling come into it – demand and supply of shares through buying and selling – Shorting shares is a method of profit maximisation - Has been banned in the past – post GFC – speculated to have increased the downturn – Self fulfilling prophecies of creating additional downside It is easier to make people afraid than hopeful about a company – this is where Hedge funds – seem to market manipulate in their own ways – Example – in march of 2020 – markets were going into panic mode – Bill Ackman – hedge fund billionaire went on CNBC ‘our economy may be done, dead and not coming back’ – “Hell is coming – America will end as we know it” – this was on March 18th Predicted that many companies were going to $0 – Hilton hotels as well as the majority of other hotel companies Got out of his short positions a few weeks later from spreading this message and then bought into the companies he was saying were going to $0 using the profits from his short positions - So why then did you buy it a few weeks later if he actually believed what he was saying? What is different – hedge funds have a lot of power – over the media, over politicians and regulators   Regulators won’t fight against it if it is done from the financial institutions – but may against retail traders Head of Treasury – Janet Yellen – was head of Fed for years – used to market manipulation from working at the biggest manipulator in history – the Fed She received $800k from Citadel group in speaking fees in 2019 and 2020 – plus many other fees over the years The point is, these speaking fees probably aren’t due to her being a talented public speaker – but it may be for some inside information In 1988 Executive Order 12631 established the President's Working Group on Financial Markets. The Working Group is chaired by the Secretary of the Treasury and includes the Chairman of the SEC, the Chairman of the Federal Reserve and the Chairman of the Commodity Futures Trading Commission. The goal of the Working Group is to enhance the integrity, efficiency, orderliness, and competitiveness of the financial markets while maintaining investor confidence Based around their own charter – the banning of the trades in a company should be something that the SEC should look into – reduces the integrity and efficiency and competitiveness of a market – stacks everything on one side But when it comes to this – we will likely hear crickets – If anything – over the years this practice of restricting trades may become more prevalent – especially if more brokerage accounts adopt the robinhood method Still an ongoing issue – but time will tell how this plays out – but there may be an ongoing issue moving forward – This movement of shorting the markets – silver may be the next target of a short squeeze – may cover this in the next episode – market integrity Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Investing in Asian markets.

    Play Episode Listen Later Jan 25, 2021 24:38

    Welcome to Finance and Fury. This episode on about how to invest in Asian markets and how to avoid some of the biggest pitfalls in these markets – I have covered the Aus market, and the US market in detail, but haven’t covered much on a giant portion of investments that are available – that is Asian markets Why would you want to invest? Number of people in this region is around 4 to 4.5 billion people – or over 50% of the world population Along with this – comes the companies that provides goods and services to these individuals Has the potential for market returns – how? Companies performances are based off supply and demand - Diversification – considered emerging markets – has growth potential that isn’t as correlated to issues in the west   Countries – and their respective markets – go through the list – some of the market caps may be a little old - hard to get up to the minute data on these Tokyo Stock Exchange – Japan - June 2020, the exchange had over 3,700 listed companies, with a combined market capitalization of greater than $5.6 trillion Shanghai Stock Exchange – China – around $6.72 trillion – maybe around 1,200 companies (hard to get estimates) Shenzhen Stock Exchange – China - $3 trillion market cap - maybe around 1,700 companies (hard to get estimates) Other nations close to China – HK, Taiwan Hong Kong Stock Exchange – Hongkong - Market capitalisation was $6.5 trillion at the end of December 2020 – 2,600 shares Makes sense that this is around the same size as the Chinese markets – go through why in a minute Taiwan Exchange – Taiwan – $1.5 trillion, 900 listed companies Singapore Exchange – Singapore - $650 billion – 700 listed companies Bombay Stock Exchange – India - $2.5 trillion market cap, with 5,500 listed companies National Stock Exchange – India - $2.5 trillion, 2,000 listed companies Korea Exchange - South Korea - $2.1 trillion market cap, with 2,400 listed companies The Stock Exchange of Thailand – Thailand - $500 billion, 600 listed companies Indonesia Stock Exchange – Indonesia, Jakarta - $600 billion, 700 listed companies   These have been some of the bigger ones – there are plenty more – but in the interest of time – move on But in total – out of these markets – there is a market cap of just under $32 trillion and 22,000 listed companies available for purchase – As comparison - Australia’s market cap is around $1.6 trillion USD, with around 2,400 listed companies – so these Asian markets have a market cap around 20 times larger and 9 times the number of companies Some of the growth potentials over the past few decades may look huge as well - China – probably one of the biggest rises in economic growth and wealth in human history – opening up their free markets – anyone would be crazy to not invest in the Chinese market, right?   However – it isn’t all rosy – Within the Asian markets – there can be many pitfalls – to start with – China is a good example – and how companies that surround China can also be filled with landmines of companies – to start with – a simple explanation of the problem would be to say that China’s listing process on the exchange is over regulated and then beyond this, it is not regulated enough – that is where out of all the markets mentioned above – china stands out for one major reason Stock exchanges around the world are mostly non-government companies – they are a market place provider – exchange in shares – Think of these companies as a service providing company – allowing you to buy and sell shares through an exchange – brokerage accounts allow for the transactions to take place – but the exchange itself allows for market pricing – where all brokers, i.e. buyers and sellers can come together As an example – the New York stock exchange, or the ASX – all regular companies – all ironically listed on their respective exchanges that they provide these services for – you can buy ASX shares on the ASX In china however – the Shanghai stock exchange is a government agency – the government sees this as a public service which they wish to handle – in theory they are a communist country – in my view, this is only in name – closer to some form of authoritarian country that is not as far left as communism on the economic scale – In relation to their share market – this does creates a few issues – The CCP has control over what companies get listed and those that don’t – these companies can earn profits – which is why I don’t think that China is communist in anything but name There are high levels for barriers to entry to markets in general – there are requirements on listing in every country – If you want to list on any market in the world – each exchange – i.e. the company that is providing the exchange service as well as the regulator, say for instance the ASX and ASIC – they have their set rules that you need to follow to be eligible to be listed – meet a certain market cap, conduct an audit service – Have a third party – normally an investment banks do book builds to work out the price of listing and the number of shares – for which they get compensated However – if the numbers don’t stack up, the ASX or this investment bank are liable – both financially through a failed issue (where nobody buys all of the shares available) or legally from ASIC In China – the government makes the rules – they determine which companies are eligible to list or not - However – their control goes beyond the listing process, if you as an individual want to buy shares in China – you have to meet the Governments rules – Not like buying shares on the ASX of in the US or most other markets – I can jump online right now and buy some ASX shares, or shares in the UK, or any other market – but the criteria in China is as follows: Foreigners with a permanent china residence card or work in china Foreign employees of a listed A-Share company who currently lives in China or abroad, as long as participating in the companies equity incentives Or be the owner of a corporation that does business globally or in china Lets just say – the vast majority of people listening won’t meet these requirements – plus Have to go through background checks and no voting powers – don’t want foreign influence – smart in one way – they are familiar with subversion tactics, having engaged in them for decades on other nations – so don’t want the same things to occur against them – but this is limiting the markets capability – of its primary function – rising capital from a wide pool of investors – for this – china probably doesn’t care though Many of the largest companies listed on the market are state owned for the majority – in other words, the majority of shares i.e. more than 51% are owned by some arm or department of the CCP So you are limited from actually investing in China – but this being said – would you even want to invest in China? This market isn’t great as raising capital as previously mentioned – when thinking about supply and demand – if there is a limited capacity of demand – then the price growth potential can be limited – and it is a wild ride Reached its peak 2008, at about 6,000 points, then crashed down to below 2,000, went through another rise in 2015 to 4,600 points before crashing, today is about 3,600 points Can see many large companies in china listing overseas – like Jack Ma with Alibaba – wider access to funding - If you look at the market – most of the companies are state owned companies that have a small portion of equity i.e. shares that an individual can hold Because their main point is state owned and to provide a service, the performance can be lacking Especially when comparing the GDP growth compared to the share market growth Issues with the markets in China and by extension, some other parts of Asia, you don’t know what you are getting Example – looking at the number one company on the shanghai market – it is number one in market cap by a long way - $2.2 trillion RMB/Yuan ($340 million USD) - In comparison – the Industrial and Commercial Bank of China $1.3 trillion RMB ($200m USD) Probably going to butcher the pronunciation – but this number one company is called Kweichow Moutai Co., Ltd. is a partial publicly traded, partial state-owned enterprise in China – state owns around 65% of the company specializing in the production and sales of the liquor Maotai baijiu, together with the production and sale of beverage, food and packaging material, development of anti-counterfeiting technology, and research and development of relevant information technology products The revenues of the company were around $85 billion – but there isn’t a verification process – they are Audited by some Chinese public accountants – the numbers may be accurate – and likely are But there is an issue with the under regulation of existing investments – especially those down the pecking order but also those listen in other markets around Asia that also don’t require a big 4 accounting firm to do public audits – like we do in Aus Spoken to a few fund managers who have funds investing in china – they tell some great stories Some companies have completely fake operations – not How does this happen – mergers – technically called a reverse merger – If a company is listed on a market – say in Taiwan – which is considered a freer market – someone in china could set up a false company, with fictitious numbers – nobody is going to check – complete a merger, or buy out 51% of the existing company on another market – you avoid the auditing rules and now you can sell any of the assets held by the company that you bought out Names of the company can change, then the investment can be pumped and dumped – a boiler room – This being said – there are plenty of good quality companies with lots of growth potential in other nations outside of China – but how to avoid the trap of buying a remerged company – and how do you access quality investments in Asia - Depends on how you want to access these investment – now this isnt advice – have to take into account if these investments are in your own best interest But you can access Asian markets through – ETF or managed funds – The question remains - Index versus Active – the index of some of these countries does have some issues Korean market – over 25% of the index is in one company – Samsung Wouldn’t purchase the Chinese market indexes Active – depending on nation – many managed funds out there – ones that focus on emerging markets Advantages of active – can do the research – go into the companies and verify the ownership and the services being provided are real and aren’t just on paper Can be selective in the shares – as well as markets – can be filled with dud companies The option to avoid government controlled markets – most of these are also ex Japan (or exclude Japan) – the BOJ owns around $450 billion of shares on the Japanese market - I have a decent chunk of funds invested in Asian markets – mainly in active managed funds – For those looking to invest – avoid some of the pitfalls – active managers – finding the right active manager can be hard Thank you for listening to today's episode. If you want to get in contact you can do so here:

    How to build a positive wealth mindset on your road to financial independence.

    Play Episode Listen Later Jan 18, 2021 19:24

    Welcome to Finance and Fury. Positive wealth mindset, or a growth mindset for your finances To start with – lets imagine that you’ve hit the lotto jackpot! Say you win $20m – it is a lot of money – enough for any person to reasonably retire on So, now that you may be able to be considered FI - what are you doing with your time? Where are you living? And how are you living your life? This might be pretty hard to actually think about for some people - it depends on much time you’ve actually spent thinking about it before If you had $20m of financial resources at your disposal - how would you spend your time? and what would you do? and would all your problems be solved? For a lot of people – these aren’t the focus when it comes to fantasising about winning the lotto – it is on how this $20m would be spent The same goes for FI in general – the focus can be solely on the target of what we need to retire – and not on the rest of the picture – what we will be doing – This is where having a mindset not only to focus on personal growth but also financial growth is very important Going back to the lotto winner - With $20m – if you invested the full balance – you could reasonably generate around $1m of passive income p.a. (assuming 5%) – after taxes – may be closer to $524k of income (not assuming any trust structures are implemented) Does this now mean that this individual is now financially independent? FI is a two-sided problem to tackle First - it doesn’t really matter how much money you have, it more so matters how you much you need to have - what would you do with your independence? And how much would that cost? This first focus is about defining what independence actually is. And that’s an issue to really tackle because if you are just aiming for that million-dollars-a-year of income, and it’s only going to cost you $80,000 then financial independence is almost something that may never be achieved - if you think it’s a million dollars a year This brings in the second part - how much you actually have – or believe that you can have – back to the economic problem – finite resources for the potential of unlimited wants These unlimited wants can get in our way – and cloud our mindset when it comes to FI and wealth Very easy these days with social media and the internet – can see how the top 1% of the 1% live Money provides ability to have independence but creating a picture of what your independence looks like is the best place to start – which is all about having the right mindset in place A trap that a lot of people can fall into when winning the lotto is not being in a wealth mindset when they win the money – think of it as a money maturity – if you have been able to accumulate $3m over time, then getting another $3m lump sum likely means you have the right mindset and knowledge to deal with these additional funds Examples of people who win the lotto - you get a lot of money meeting all your goals for financial independence – if you win $20m you’ve likely got all the FI - but that’s a lot of responsibility in your hands in one day. unless you’ve got the habits formed around money and really fully prepared for receiving that level of responsibility, it can actually go pretty wrong without a plan. It’s actually almost impossible to prepare for - so last minute - to get such a large level of funds and to actually change your mindset and be ready to reach that financial independence If you are going from being broke to now having $20m at your disposal – this can create a very uncomfortable feeling – we are hedonic and revert back to our normal state of being – for someone without money – and if this is their mindset – then their subconscious thoughts can turn into actions to try and get rid of this money as soon as possible Our mindset can be our best friend - or our worst enemy I’m sure many people out there are familiar with the potential for our own self-limiting beliefs – we can be our own worst enemies Our tendencies for obsession or Rumination can get in the way of focusing on the positives or what we can achieve – Rumination is from our brains focusing on one bad factor and repeating this to ourselves - Has your head ever been filled with one single thought that just keep repeating? These tend not to be good things - tend to be sad or dark – regrets that we have – rumination is a cycle where we focus on the bad more than we do the good If this becomes engrained, this habit can be dangerous – the more we focus on the bad the more we continue to focus on the bad The issue is that we can’t just turn it off – and tell ourselves to stop thinking about the bad side of things – or what we might fail at or have failed at financially Ironic process theory - White bear or pink elephant - Trying to avoid thinking about it makes you want to think about it more. If you are constantly thinking about the bad financial decisions you have made – can lead to further self limiting beliefs – which translate into actions that turn our lives into a self fulfilling prophecy We think we cant do something, then we don’t do it, so we never achieve the thing that we thought we couldn’t do   However – our mindsets can be our best friend – There’s lots of research out there on an individual’s attitude and mindset to their achievements – Sports stars – spend time visualising about what they will achieve in their respective sports Carol Dweck coined the terms fixed mindset and growth mindset  Came from studying students' attitudes about failure - some students rebounded while other students seemed devastated by even the smallest setbacks When students believe they can get smarter, they understand that effort makes them stronger. Therefore they put in extra time and effort, and that leads to higher achievement. Looking at the wiring in the brain and studies in neuroscience – they show us that the brain very malleable The process of this malleability could probably be best called brain plasticity – that is, how the connectivity between neurons in our brains can change with experience and thoughts With practice - neural networks can grow new connections, strengthen existing ones, and build insulation that speeds transmission of impulses – think of walking – you probably don’t have to even think about walking, your brain just does it – but when you were an infant you needed to learn from scratch – people with spinal cord or brain injuries need to relearn this – comes from the repeated practice of walking – over time you don’t need to think about it There is a link between mindsets and achievement - if you believe your brain can grow - you behave differently – the same is for anything in your own life – If you don’t believe that you can lose weight – what actions will you take to lose weight? If you don’t believe that you can accumulate wealth and retire FI – then what actions will you take?   Begs the question – how can we change our mindsets? One way is to identify where you may have fixed mindset tendencies so that you can work to become more growth minded. Visualisation – having something to focus towards – Goals form part of this – but knowing exactly what you want your life to look like – and focusing on this – either with physical pictures or mental picture – regularly focusing on this – helps to cement an idea about what you are working towards – But you need to believe that it is achievable Affirmations – repeating to yourself – make it a daily habit – How to make yourself believe that you can be FI and accumulate wealth – which in turn can change your actions – Tell yourself this very thing – affirmations are powerful – opposite to ruminations – as opposed to focusing on negative – train yourself to focus on the positive – and what you want to achieve – if you are down – keep repeating to yourself you are happy and positive and believe it - need to regain control over your mindset which will determine your behaviours in responses to the event. The first question should be “what can be done to get the best outcome?”. Equation: Event + Response = Outcome It is important to change your responses if your current ones aren’t getting you the outcomes you are after. If you continue the same behaviour (responses) then you get the same results. This is the process of learning through failure You can’t control the event, but you can control your response which leads to a better outcome. taking 100% responsibility makes life simpler. If you accept that you have 100% responsibility, therefore control you can become the master of your own success - the world doesn’t owe you anything, you have to create it! Give up complaining! We are all guilty of complaining, either voicing complaints to others or mumbling them to ourselves. The truth is that we complain about events that we know can yield a better outcome than our current situation. We don’t complain about things that just exist. For instance, we don’t complain about gravity being gravity. To give up complaining, change is needed in your response. We normally don’t though as changing a response can be uncomfortable. People may judge you but who cares? It will take effort but it is worth it! Complaining is pointless in most situations as we normally complain to the wrong people anyway. You will complain about your partner to your friends, about your boss to other employees. We never talk to the person we have the issues with – also is similar to rumination – focusing on the negative Instead of complaining – focus on a positive affirmation The main thing is to first – believe that you can do it – does sound corny, but it is the cornerstone to building a positive wealth mindset – In summary – You can be your own best friend or worst enemy – what you think about and focus on can become a reality So why not focus on what you want to achieve and tell yourself you can achieve it Then let your actions do the talking through forming positive actions and habits to get you towards your goals Thank you for listening to today's episode. If you want to get in contact you can do so here:

    How to avoid financial distractions and hack spending habits.

    Play Episode Listen Later Jan 11, 2021 22:35

    Welcome to Finance and Fury, I hope you are all going well. Today we will be going through how to avoid financial distractions. This episode is a little bit of a follow up from the previous - as one of the comments I made was a little oversimplified – that was that if you simply spending less and invest these funds – you can achieve more in your financial future – It is not as easy as it sounds – it is very easy to say to someone spend less and invest more – but to actually achieve this as part of a goal can be almost impossible without the right tools to reduce discretionary or non-essential spending So in this episode – we will outline some of the core reasons behind spending habits and some ways to hopefully hack these in your own lives to help reduce needless spending and instead redirect these funds into towards your financial futures When I talk about spending - Not talking about needed or essential spending- but those additional spending items that can be made on impulse rather than as part of a plan This whole episode comes back to the economic question – of having finite recourses – but yet unlimited wants – but the real issue is the wants that we don’t know we want until we want them – bit of a mouthful – however: the age of the internet and social media marketing has really redefined wants Think about the availability to promotions that we have to put up with – advertising everywhere and the temptation to purchase at out fingertips Facebook, instragram, amazon, ebay – all have massive market places – has increased our access to the offers put on place on an exponential scale – Before the internet – you would need to go into a local store and be tempted to buy something Concept of window shopping – looking through the window which provided a trigger and temptation – but now that window is right in your own home or wherever you are with your phone – that black mirror of a smart phone has become the new window shopping and with this – the temptation to buy has increased at an incredible rate – as now – rather than you needing to be in front of a specifics shops window – which you would physically have to travel to and be limited in choice to what that window contained – now any store across the globe is in your hands at any time of the day, on any day of the week access to technology is a great thing – when used correctly – however – marketers and social media companies know how to manipulate people very well through cues and reward triggers we are pre-disposed towards that fuel addictive purchasing habits Hence - In the modern era – our wants can definitely outweigh our resources – creating additional problems or barriers to the economic question But at the same time – we have been the wealthiest any societies have ever known on average – but our resources can be sapped by up in some pretty tricky ways – leaving us no better off long term -   So in this episode – want to lay out a game plan and strategy to help curb some spending habits and instead redirect spending to your long term self-prosperity The first step is understanding Distractions and temptations Story of Tantalus – ancient Greek story - most famous for his eternal punishment - he was made to stand in a pool of water beneath a fruit tree with low branches, with the fruit ever eluding his grasp The catch was that if he reached for the fruit – it would rise out of his reach – but at the same time - the water he was standing in would always receding before he could take a drink – so he was condemned to the afterlife – to be always hungry and always thirsty – hence – his economic problems were never being met But we are different from tantalus – we are not dead – someone who is dead technically doesn’t need food – unless they are a zombie searching for brains But we can learn from Tantalus and his temptations – is very similar to our modern situation – for the vast majority of the population – we may not need the things we crave – but yet still crave them – for tantalus – it was food and water – but he was dead – hence he didn’t need these things – but still was triggered to yearn for these items – for us it may be a new TV or computer, or a new piece of clothing or any item that technically we can go without – due to social conditioning through social programming from advertising or other impulse triggers – we can crave these items and trick ourselves into thinking we need them If you care about your financial future – you need to become less distracted or tempted from the temptation of purchases Easier said than done - We all have temptations - mine are computer games For me – I love strategy games – either RTS or grand strategy games –Games are addictive for me – but why? Well - get to progress in an online world gives same feeling as doing it in real life - Also competition – beating others – I can build an empire and thrive online I think I have a special kind of autism that helps with repetitive tasks – but I got good at these games – gave a feeling of accomplishment and at the same time – provided a strong distraction from doing other things that I needed to do Buying things does this as well. Not about the item we are buying most of the time – or what that thing physically gives us - but the escape – to distract and help to meet the feeling of achieving something This comes back to greater aspect of distraction and temptation – is that for me – games provide something that is rather easy for me to control and at the same time – relatively easy to succeed at – especially when compared to things in the real world Something we can control and succeed at can provide a powerful distraction to our own lives – why bother work at something hard in our own lives when we can turn this time and energy into something online – or to purchase something to provide the same feelings If a goal is too great a goal – and you don’t think you can reach goal then why not play some games or buy some items on amazon and succeed at something else – provides the same sort of reward pattern without providing the long term actual reward that would benefit us the most As an example – when I was at uni – I could easily play 10 hours a day on an MMORPG – imagine that I continued this to this day – instead of ceasing this activity and instead using this time to start a business and build this to help people with financial advice – I may be living at home still – still playing games – I might be great at online games but I may be a total wreck in my own personal life – but if I was committed to games instead, would this really matter if I was just chasing the feeling of achieving something? This all comes back to Escapism – escaping the harder tasks of life – at uni – instead of studying – why not play games? Uni was relatively easy to get 5s and 6s in a lot of courses – so why devote any time into getting 7s? But this habit of playing games instead of studying (outside of the hours that I was working) was the path of least resistance – help me fill a role and feel like I was achieving something else – in other words – escapism – Spending habits can also be escapism – if you feel like you want to be financially independent and rich – well why not spend some coin now and act like you are FI and rich – even though it might be on a CC – you still get that same escapism feeling now – without actually having to work towards – the temptation of spending itself can provide the very feeling or outcome that our long-term goal does This can be a dangerous form of escapism if you don’t fully understand it – I was luck enough to realise I was wasting my life on games during the uni days and kick that habit before getting into my full time working career But if a spending habit lingers with you through your working life – this can be a massive drain on your financial recourse – which back ‘to the economic problem – means you have less to achieve your long term wants – as you are meeting a short term outcome which is draining your longer term financial future   Understanding the root causes of spending habits – being discontent If something stops discomfort or the feeling of being discontent – and instead allows you to feel a small amount of control in your own life, it can control you. Being discontent is good. We are hardwired for this. It provides motivation to do more. But with more options to satiate the feeling of being discontent – can create a habit to spend to avoid this – one of the major factors that we need to be aware of that is driving spending habits – that is the need to feel satisfied and to not feel discomfort But We should feel uncomfortable with ourselves – Being uncomfortable is actually a good thing – many people like to avoid boredom – or the feeling of lacking in themselves – understandable – nobody wants to feel uncomfortable – but at the same time – we are hard wired to do this – it is what drives us forward as a specie to improve – We are also hardwired in habits through the cue – action – reward sequence – so the aim of a strategy to change behaviours is to track the cue, or trigger, change the action and receive a reward that benefits you long term Strategies – no one right way to go about this – the first major step is understanding why behaviours and habits form– from there, there are some options: Step 1. What is the cue or trigger. Is it a diversion from difficult work. Or a feeling of not being satisfied? Something generally triggers spending behaviours – the first major step is looking around and where you are and what you are doing? Is it scrolling online, or at work, or being bored and feeling unsatisfied? Is it at some shops? This can be hard to do initially – most of this occurs subconsciously – have to make it a mental focus to pay attention as opposed to letting the part of our lizard brains take over Step 2. Write down the trigger. Track the sensations – start a journal – this helps people to become more aware Being aware of what is a trigger for spending habits is the key – as you can be aware of your surroundings and how they affect your focus and thought patterns – knowing what, when and where then allows you to actively change your behaviours and actions Step 3. Change the action – your actions are what you can control – hard to turn off the triggers – but once you know the triggers – and one pops up – if you are aware of this – you can then aim to change an action These actions will depend on what the situation calls for – if it is making a spending decision – wait a day or so If it is scrolling through amazon or an online shopping platform – hold off for 10mins or an hour before instantly clicking – take some time to reflect - If you think about spending or buying – it can be hard to distract yourself – ironic process theory - explain this more in another episode about a positive wealth mindset Step 4. Change your reward – this is personalised to the individual but at the core can be avoiding the feeling of discomfort Options - Put 5 into a savings account if you have done well and held out from spending – or put the equivalent value of the item off on a credit card - Could be as easy as positive self-talk – or tracking goals and ticking off a goal of spending less In summary - A lot of needless spending habits come from a subconscious root – either wanting to feel in control, as a distraction from being uncomfortable – If you then use purchasing more things to satiate these feelings – and that you might think that you need these items – then that’s fine – but it will come at the expense of diverting resources towards items that have diminishing marginal returns – due to hedonic adaption - As opposed to those with compounding returns if you harness these feelings and put it towards achieving something positive long term – like saving additional funds, investing or paying off debt – once your brain is rewired – can still avoid that feeling of discomfort as you are moving towards achieving goals If it is part of your spending plans – then spend it – but if it is spontaneous – you can aim to minimise these spending patterns by changing the cue, action reward sequences by tracking the cues and being aware of the triggers, changing the action and then providing yourself a positive reward towards achieving goals Thank you for listening to today's episode. If you want to get in contact you can do so here:

    How to achieve your new year financial goals through turning them into daily habits.

    Play Episode Listen Later Jan 4, 2021 20:40

    Welcome to the Finance and Fury and the new year, 2021. Hope the start to the year has been good for you all – as in this episode we will be looking at how to work on your financial goals through the year through turning these into daily habits Last episode - Stared off with a question; looking back on the year, are you in a better or worse financial position? We also went through some foundations on setting goals – but importantly – narrowing these down to 3 major goals that are of your top priority The reason for narrowing this down is due to the topic of todays episode – that is actioning them You can set all the goals in the world – but to be in a better financial position this time next year – you need to be able to implement these – through taking some action based around the plans that you set – to make sure you’re always moving forward.   Time can be broken down into the following: Past – What has gone on – All of your life events to this point Dictates a few things – Behaviours and habits We all have habits creep in over time – Positive feedbacks Positive feedbacks can be a negative outcome for us long term – if you take heroin – that is a positive feedback based on your neurochemistry – but the more you do the more your life may not end up in a positive place But like any addiction – you can form good habits as well – through doing a few small positive things that form feedbacks as a reward system over time Present – The now – What are you doing? Most people financial security comes from income from employment What happens if this was to go today? Is there enough to survive? This is where setting goals and having actions are what you do in the present – But undoing some bad habits may be needed in the now All in an effort to get a better future Future – This is where you want to be – which is why you need goals to know want to achieve, as this needs to be defined Plans and Goals Start With the one goal – breaking it down SMART – or What, How and why? Implement it and adjust along the way – Over time (30 – 90 days depending) it will become a habit Then implement the next goal on the list Your future is determined by your actions from now up until that point All three time phases are important – understanding your past behaviours – as these determine your current position – then planning for the future and taking action now   The long term can be negotiated with But if you hit the future are aren’t where you want to be, where does that leave you? That is where further self doubt kicks in – Unrealised expectations   Not many people stick to new year goals – Why? there can be too many, normally people thing this is good, to have a lot of goals But if these are similar to last year and you didn’t make it, why might that be? Hard to go from 0 to 100 overnight – Inertia – something continues in its existing state (rest or in motion) unless it is changed by external force Hard to start a train and get it to top speed – takes a while Same for us – once we get set in our ways – very hard to change them If you have been in an investing mindset – or a mindset to So from your top 3 goals – select just one – the most important to you now and set a timeline to be on the road to achieving this over the next 30-90 days – Be it cutting back on spending, monthly saving or investing, etc. Then once the habits for this goal are in place – move on to the next   But if you are Looking to start – even with the first goal – Finding Motivation is not a good concept to look towards - What people search for is a moment of inspiration to get the ball rolling It rarely if ever comes – Why? Motivation comes from a positive feedback loop – do something good, dopamine is released in the brain, you then want to do this again We are creatures of habit – and we form habits from feedback loops of receiving dopamine – every addict has this feedback loop – heroin, alcohol – but you can use this to harness motivation as well Think about it, you don’t need to find motivation to indulge in anything – Because your brain is wired to give positive feedback when you do these things you already like. If someone is an alcoholic then they may go out of their way to get a drink – there can be justifications made behind actions – but at the end of the day they will beg, scape or steal to get a drink - Part of the problem - bad things compound as well So as how do you motivate yourself to invest or achieve a goal, be it financial or not? Finding a spark of motivation probably wont work If you wait for moment of inspiration to get the ball rolling you may be waiting a long time. It’s because motivation comes from a positive feedback loop – you work towards something that is meaningful to you – then dopamine is released in the brain, you then want to do this again Small action = dopamine = want to do larger actions All about starting small – if your goal is to save $2k per month, but you are currently spending more than you earn and are in CC debt from buying lots of things or going out all the time – The first step would be to look at this behaviour pattern – why are you spending? A lot of the time it has come from that same habitual behaviour to get a good feeling – You have to examine this and then turn it around – aim to save $100 per week at first – set up a new account and start the process of rewiring your brain – an addict has a very hard time going cold turkey – you need to wire your brain to get good feelings of hitting your goals consistently Keep a list – or a journal to track your progress – each month – tick off accomplishments in the right direction Motivation to just say you will save $2k p.m. from the get go could be lying to yourself, as in the here and now there will always be something better to spend your money on than your future security and financial independence. Like things that achieve instant gratification This comes back to goals – having each of the goals set in stone – allows you to break these down into achievable chunks If you have a goal to save $100k for a home deposit in 4 years’ time – that is great – but start breaking each goal down into achievable bit size pieces - $100k in 4 years seems a lot bigger than $480 per week for 208 weeks Saying you want to have $100k of passive income by the time you are 60 seems like a big goal – but if it just takes an additional $200 per week to be SS into super to get you these (on top of your existing super funds) – then these things start to become more achievable – Which is the whole point of reaching any goal – making it seem achievable to you What you can do to get ahead now - How to start? Sometimes there can be too many things to change at once Start small – Pick one thing What is one financial behaviour you would change? Small action = dopamine = larger actions. The best way to get over Slumps – little momentum to start and it takes off. Once you get enough of a craving for the feeling of saving/investing, it is hard to stop Remember: Almost impossible to go from 0 to 100 - Train – Starts off slowly, but then don’t get in its way once going. Implement it and adjust along the way. Over time (30 – 90 days depending on the goal) it will become a habit. Then implement the next goal on the list That is the process to improvement – one small things at a time. Financial habits are built through the positive feedback of cue, action, reward. These decisions years ago have improved my position now. That is the relationship with good habits – Keep improving slowly over time Pareto distribution – 80/20 rule. 20% who have 80%, they have been able to grow good habits, compounding effects It is as simple as investing and waiting - $20k today would be $80k in 14 years at 10% p.a.     What is one thing that you can do to better the future self? Starting sooner rather than later – There wont be much joy in starting initially – starting is the hardest part – but know that it gets easier as your goals turn into habits that give you a positive feedback over time - ‘all good things comes to those who wait’ – means that if you wait it out and just start at one thing, keep at it, you will start getting the motivation to keep going, and increase speed. Thanks for listening everyone! I hope you all can make a small change. Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Creating new year financial plans to turn into financial actions.

    Play Episode Listen Later Dec 28, 2020 16:51

    Welcome to Finance and Fury. I hope you all had a good Christmas – if you are like me might be a few kg heavier. This episode – be looking at making new year plans – new years is upon us – many people have new years resolutions. To start with - looking back on the year, are you in a better or worse financial position – been a tough year for a lot of people But in todays episode - how to be in a better financial position this time next year Going to look at how you can always be ahead on finances compared to last – through planning and then next episode is about how to act on those decisions Because - like compounding of investment returns over the years, the little things you do in your own personal life compound over time as well This can occur in both directions – both backwards and forwards   What are your financial goals for this year? Or new year resolutions? Maybe you haven’t thought about them yet – the new year may be a few days away – or already occurred by the time you listen to this – either way - By the end of this episode you should hopefully be able to think of at least 3 and something to put in place to help improve your financial life Now - Financial goals are related to ‘what you need money for’. Many goals may relate to your personal life - Most people have goals that related to other goals outside of their finances When looking at financial goals – these will also vary between individual to individual – broken down between short and long term Short term goals, this could be saving for a deposit on a home, getting out of debt, or saving for a holiday Long term goals, I find that these are mainly around financial independence, or things that take a long time to achieve like a passive income. I meet a lot of people with goals – but most of the time these are conceptions about what they would like to achieve – not technically a concrete goal There is a difference between saying that you want to retire financially independently – versus saying that you will retire at the age of 60 with $100,000 of after tax income derived from a portfolio of shares, superannuation and an investment property Even this can be broken down further – with an allocation to each – where the IP will generate $20k after costs, the shares $15k with FC to offset the tax and the remaining $65k coming from super To achieve this though – you need to get down into the nitty gritty details But like most things – this doesn’t happen overnight – can’t just click your fingers and be in this position out of hopes and wishes – some work needs to be put into it But the first stage is planning – planning on what you want and how you are going to get it – The first stage of planning is clarifying what you want – which comes back to goals Looking in the short term – and relating to this episode – it may all be about being in a better position in 12 months’ time compared to where you are today – but What does this look like? What you can do – In general terms – there are categories which most fall Reduce tax, save money, build wealth – start investing, Increase income – Salary, investments Hard to generalise these things – but at the same time – each of these are simply a wish list – not actual goals – hence why setting goals around these is important If you wish to reduce your tax – by how much – and is it possible – then how will you achieve this? Of if you wish to build additional wealth – by what mechanism will you achieve this by?   So - What are your financial goals? Not many people stick to new year’s goals. There can be too many, normally people think this is good to have a lot of goals But it can be a determinate – too many goals can create information overload, decision fatigue and many other psychological conditions where the easiest solution it to just do nothing different We are creature of habit – hard to implement 20 different changes to our behaviours overnight Hence – why every year, or every month – it is a building process – to create a better you – someone who every month is more on track to achieving financial goals Our wants – in other words – out idea about the wish list of goals that we may have – can be infinite – but this is simply a wish list – not actual goals Goals need to be things that you actually want to achieve and are willing to sacrifice to get there Hence why limiting these at the initial stage to a few key goals is important - The real issue is the follow through It’s hard to go from 0 to 100 overnight, it’s a lack of inertia. Something continues in its existing state (rest or in motion) unless it is changed by an external force So as an Example: say you have 10 goals down now, and they are all new things that you wish to implement in the new year Invest in shares, reduce your tax, buy your first house property, generate $50k of income of passive income in 15 years from investments, provide for your kid’s education, buy an investment property, then buy another investment property, protect your wealth with insurances Well – Where do you start? And how? Most of these will be using resources at the sacrifice of another – the economic problem is satisfying the potentially unlimited wants with finite resources After spending hours trying to figure the solutions for each of these wish lists items - Information overload sets in and you go back to your old ways pretty quickly – kick back to old habits doing what you are currently doing – as it is safe, familiar and easy – we are creatures of habit If you are just starting out pick 3 items from this wish list for the year at maximum. To do so – you need to prioritise – to help with this – identify if they are short term or part of longer-term goal? What is the most important to you in the here and now? Then comes the time to clarify on these wish list items – and turn them into actual goals –   How to start? It is all about starting small, and picking one thing at a time – such as what is one financial behaviour you would change? Or what is the most important goal that you have? To help clarify this – think about your Future self – what could you do today – or what is one thing that you could implement to be able to help you be in a better financial position next year? This is where goals come back in to it. What you want to achieve needs to be defined. Plus, is the goal going to help achieve this? With the one goal, breaking it down in the simple SMART terms – this is a bit of a cliché with it comes to setting goals – but it does really help: SMART – Specific – do you have an actual number in mind – and how you will achieve this? (simple, sensible, significant) Measurable – what is the number and how much will you need to direct towards this goal – also is it meaningful and motivating Achievable – is everyone on the same page - agreed, attainable Relevant – but also realistic and resourced Time bound – when do you want to achieve this goal by – beyond measurable and specific – this is very important – as it set limits to when you need to achieve the goal by – hence – determines the amount and how this can be achieved – either through lump sum investments as well as monthly contributions g. Example: If you wish to have a passive income of $100k in 30 years – and you need to put away $2k p.a. to get there but don’t have the spare income - How will you first save enough already - cut spending/increase income? But then what will you invest in – once this is determined – relatively easy Plus consider if this will this hurt another goal? – like short term goals – if you wanted to buy a house But it is important to determine how much do you need? By when? How are you going to do it? Put it down for each goal that you have, the answers to those 3 questions – but remember to prioritise to each of these goals   My process For me a financial goal isn’t set unless it has a yes answer to the following: Will it put me in a better financial position? What does ‘better’ look like? It varies depending on the goals Better can be a very subjective term – better by $1? Or better by actually meeting the financial goal Simple measurements depending on your goal Will it move you closer to your individual goals? And will it do so to meet your timeframe? If you are new to all of this, and haven’t a listen to previous episodes on how to work this out – members section on the podcast – free to join and there are tools in there to help work this out But ongoing work is needed – you can set your goals – make them a habit – but this needs to continue until you reach your goal Hence – a good question to ask is - Will it close the gap (every year)? There are categories which most goals fall into which are either: Building wealth: Investments or in a business Increasing income: Salary, investments and business Break down further, like reducing taxes, reducing debts, etc. to increase income To help work out goals – there are workbooks on the financeandfury website.  Got your goal: Looking to implementing it – go more into this next week - Such as how do you motivate yourself to invest? Finding motivation is a rubbish concept as a place to start So in summary – To help determine you goals – ask yourself - What is one thing that you can do to better the future self? Starting sooner rather than later allows you to do a negotiation with your future. Think of it as time travelling. What are your three financial goals? How much, by when, and how will you get it done? Will your actions help achieve the goal? What strategies do you need to implement? Thanks for listening everyone! I hope this episode helped break down some steps. If you want to get in contact you can do so here: 

    What is momentum investing and can this be the best investment strategy in a world where fundamentals mean little?

    Play Episode Listen Later Dec 21, 2020 18:55

    Welcome to Finance and Fury. This episode is about what is momentum investing and can this be the best investment strategy in a world where fundamentals mean nothing?   Over the past few years – value managers – or those that try to estimate the fair value of a company and base their purchasing decisions around this have struggled to provide alpha – Alpha is the returns above the benchmark – or the index – and those active managers trying to provide value through buying undervalued companies – or those that have had short term losses – so their prices are below their fair valuations – have failed to see the rebound in prices expected from following this strategy So returns have been minimal One alternative strategy which has provided better returns over the past few year on average has seemed to be buy those companies not based around fundamentals but with momentum – i.e. what others are buying and hold these for a while to ride the wave up   What is momentum investing - is a system of buying shares that have had high returns over the past three to twelve months, and selling those that have had poor returns over the same period – Seems antithetical to the age old saying of buy low and sell high – as here you are looking at a strategy that is selling low or buying high – based around the returns over a 3 – 12-month time frame – Now – there is no single consensus that exists about the validity of this strategy – but recently it has been a viable strategy for a handful of shares – At large - economists have trouble reconciling this phenomenon – I am someone in this same boat – For standard market theory - when using something like the efficient-market hypothesis – momentum strategies shouldn’t be able to provide much in the way of alpha – however there are two main hypotheses have been used to explain this effect in terms of an efficient market - The first - it is assumed that momentum investors bear significant risk for assuming this strategy, and, therefore, the high returns are a compensation for the risk – in other words – more risk, more reward However – at the same time - Momentum strategies often involve disproportionately trading in shares that have a high bid-ask spreads – everyone is trying to get into them so the buyers have to buy above a price what they may otherwise wish so it is important to take transactions costs into account when evaluating momentum profitability The second theory assumes that momentum investors are exploiting behavioural shortcomings in other investors, such as investor herding, investor overreaction and confirmation bias - Hence – from this theory – there is a greater downside – that through buying into a share that has risen significantly over the past 3-12 months may result in greater long-term losses – Reminder – that there are plenty examples of this – A2M is one – others in the market – but those companies that seem to be having a massive rise in prices (which does result in returns) off speculation – what can eventually fall apart Looking back in time – the history - Richard Driehaus is sometimes considered the father of momentum investing – similar to how Benjamin graham is considered the grandfather of value investing but the strategy can be traced back before Driehaus – and in the previous market participants view - this strategy takes exception with the old stock market adage of buying low and selling high. According to Driehaus, "far more money is made buying high and selling at even higher prices." There are some reasons as to why momentum may become more of a viable strategy to trade moving forward Over the years though – technology has improved – so has the availability to trade – In the past – going back 30 years, especially before the internet – only professional investors, or those with access to brokers or other professional investors guiding the way could generally buy shares – and back then – with these gate keepers leading the way - buying a company with a negative -100X PE may be considered crazy - But from the late 2000s - computer and networking speeds increase each year, there were many sub-variants of momentum investing being deployed in the markets by computer driven models – not only from within broker models but from without – as access to trading became available to everyone Some of these operate on a very small-time scale, such as high-frequency trading, which often execute dozens or even hundreds of trades per second So not only is it that more people can now buy shares – but computers and algorithmic trading can occur – for an AI – they may not care about fundamentals at all – if the price growth is there through momentum – they will jump in as well – pushing up prices further So this increase in access and technology may have given a rise to momentum investing – essentially every one has access to jumping on any bandwagon of shares Although this is a re-emergence of an investing style that was prevalent in the 1990s – just a side note - that ETFs for this style of momentum investing began trading in 2015 So a lot of shares that are in the top of an index – or in a index in general – have a ride up as people are buying the index – if you buy the VAS – you are buying 10% of CSL – so if 10,000 people buy VAS – all putting down a few thousand – at an average of $5k – that is an easy $5m to the market cap But on top of this – momentum specific ETFs are now available But there are some studies conducted on the specific advantage of following a trend - Looking back at the historical precedence that point towards to value of momentum investing – few studies looking at this strategy give average returns of 1% per month for the following 3–12 months when back testing data This finding has been confirmed by many other academic studies, some even going back to the 19th century But it is important to note – that turnover tends to be high for momentum strategies – or in other worlds high levels of buying and selling the investing – so it isn’t a buy and hold strategy if it is to work out well as these studies have anticipated So this high level of turnover has the potential to reduce the net returns of a momentum strategy This can go even further – as if you account for transaction costs as well as capital gains taxes – these can wipe out momentum profits There is another empirical study of this strategy covering over a century of data showed just how consistently well it performs – this was done by London Business School researchers  Dimson,  Marshand Staunton – looked back at market performance since 1900 - They constructed investment portfolios by selecting 20 top performing shares in the previous 12 months from among UK’s 100 largest publicly trading firms, and compared their performance to portfolios of 20 worst performers, re-calculating the portfolios every month. They found that lowest-performing stocks would have turned £1 invested in 1900 into £49 by 2009. By contrast, the top performers would have turned £1 into £2.3 million, a 10.3% difference in compound annual rate of return This is all well and good when back testing data – as you know what the best performing shares have been In a 2014 study called 'fact, fiction, and momentum investing' - 10 issues with regards to momentum investing, including transaction costs were identified – don’t have time to cover this fully -if you are interested would suggest going and checking this out - Does point out some downsides – such as the performance of momentum shares – epically that occur with occasional as large market crashes One example of this is in 2009, momentum style shares experienced a crash of -73.42% in three months from the initial crash – This downside risk of momentum can be reduced with a so called 'residual momentum' strategy in which only the stock specific part of momentum is used – where you buy a specific share that has momentum whilst allocating the rest of your portfolio based around fundamentals A momentum strategy can also be applied across industries and across markets to individual specific shares - Lets look at one example of this – and maybe the best example of the past few years – Tesla – I have been sceptical of TSLAs price rise over the years – that is because there has been little in term of fundamentals to give rise to these price increases They get positive cashflows from selling government credits – there is also a lot of speculation that they will make up a decent chunk of the car market share in the future - But - tsla and the power of momentum investing have proven to be a great investment – requiring no actual thought but simply following a trend – the more you think about it – the more TSLA looks like a sell – or a short sell when framing this decision based around fundamentals – but simply buying into this trend as part of a momentum strategy wouldn’t have provided a dependent return – but again – the fundamentals aren’t there to justify their current prices - In comparison - Last week Tesla’s market cap was siting at around $606 billion USD – this now has surpassed that of Toyota, General Motors, Daimler, VolksWagen, BMW, Honda and Ford combined – which are sitting at around $578.2 billion Obviously – TSLA should produce more cars and revenues than all of the above – but - Where does Tesla rank compared to other auto companies – VW, Toyota, Daimler – top 3 – top two around 10.5m cars each year – TLS made 380k cars a year This yet again underscores the power of market trends and the momentum investing strategy Comparing the returns over the past 10 years – the S&P500 has had a cumulative return of around 300% Overall though – car manufacturers have lagged this return If you invested $1 in Toyota – you would have $2 today – Ford – investment would be $0.5 – the others are about even – Investing in TSLA would have given you $120 – which is a huge return in comparison But when comparing a purchase into TSLA versus Toyota - Tesla’s valuation would be hard to justify these returns based around any rational basis – however - the undeniable reality is that Tesla has massively outperformed it peers – a trend that’s held throughout the past decade   Looking at the power of momentum investing – which is the power of a trend   There is a recurring theme within markets – in particular with some companies and their performances - that markets move in trends When trends get going - they can blow out any notions about rational valuation So Momentum investing, a variant of trend following, seeks to systematically pick such ascendant stocks and hold them for as long as they outperform. The benefit of a trend follower and momentum investor is that you don’t need exert yourself to determine the right valuations at which to buy or sell assets the market through the trend communicate to us which assets are in favour and which are not It may seem very simplistic - but with CBs having injecting liquidity and cash rates being so low – there is evidence supporting this approach Momentum investing can work – but it – requires some specific selection - if you systematically picked the best performing shares and invested in them regardless of what you thought about the companies in question, their valuation, products or management teams – that is momentum investing Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Vanguard’s plans to disrupt the Australian superannuation industry.

    Play Episode Listen Later Dec 14, 2020 17:27

    Welcome to Finance and Fury – Vanguard bringing in some disruption to Australian markets - If you haven’t heard of them – Vanguard are the world's second biggest asset manager – dealing in index funds and ETFs Vanguard – have almost $9 trillion of funds under management world wide company's incredible rise since being founded in 1974 by investor Jack Bogle – providing low cost access to indexes – originally with managed funds but recently been branching out into ETFs But they have recently been branching out into platform services on top of asset management – little while ago - came out with the Vanguard personal investor platform Low cost account to access Vanguard investments - an Account Fee of 0.20% per annum, based on the total portfolio value of your account, including any cash held, capped at $600 per annum, per account A lot of the wholesale funds have high minimum buy ins – about $500k in some cases – so going through a platform gets around this – was third party platforms but Van have come out with their own Now they are is gearing up to disrupt Australia’s superannuation industry – this is a pretty big play from such a behemoth as Vanguard It all started when they announced that they will return tens of billions of dollars it now invests on behalf of super funds They are ceasing managing bespoke investments for Australia's superannuation funds – trustees outsource the investment management of the underlying assets – especially for index fund investments All as Van prepares for a disruptive second push into superannuation – first was taking over management of funds – not be direct super providers seeks to manage super accounts directly with potentially lower admin and investment fees This is big for vanguard – it is a lot of sacrifice initially to make what they likely estimate to be better fees long term Vanguard abandon up to $100 billion in investment mandates from third-party fund managers – this has been a core part of its Australian strategy since entering the market 20 years ago – manage the investments of super funds Now they want to enter the market directly and similar to the VPI platform, offer super as well Van is the second largest holder of mandates from not-for-profit funds in Aus – pretty much the industry superannuation sector The fact they have given this up – good indication of how seriously they are taking this push into the Australian super market One of the main reasons to do this and abandon their management of other super funds investments is to avoid any conflict of interest - if Vanguard to push ahead with its plans to launch an APRA retail super fund while managing the money of competitors Whilst they likely wouldn’t do it on purpose – but if their competitors underperformed on the money that they were managing compared to their in house assets – raise some questions They have some history with super – It previously launched a super fund shortly after entering the Australian market, but transferred the management of it to National Australia Bank's MLC Wealth business in 2012. Some additional competition is needed – the trend over the years and what will occur in the future is a consolidation of super funds – so less competition – has its benefits – covered this in an episode a little while back - But the Aus super sector is sitting at about $3 trillion of FUM – and this is likely to continue to climb massively – Not likely to be any time soon that they come into super – may take them a year or two – if not more – It is a rather comprehensive process of applying for a superannuation licence and entering the market At last publication – Van said it was "tracking well" - with an intended launch date of mid-2021 for its retail superannuation product – but this could be delayed slightly – but still within the next year to two – but it still is a lengthy process – few reasons: Firstly – they cant easily abandon the super industry - Vanguard Australia managing director said - would not be "abrupt", giving clients up to 24 months to find another manager or bring investment functions in-house So super funds and other investment managers have 2 years to try and replace Vanguard – they have a fiduciary duty – cant just walk away Secondly – lots of due diligence and compliance that needs to be accounted for – government agencies like APRA don’t work that quickly – so this may take a bit of time However – they will try and ramp up their direct service offerings – The managing director said - "We will push hard into the strategy of improving outcomes for individual investors, whether that is through a direct relationship or a financial intermediary, typically a like-minded adviser," It plans to stop providing portfolio services to third-party institutional investors, but continue to offer off-the-shelf pooled investments like Van managed funds or ETFs to investors Again – this is a big initial sacrifice for them to make - Institutional mandates and the fees they make from this have formed a large part of Vanguard's Australian revenue over the two decades Estimates show that these mandates account for $50 billion of Vanguard's total $160 billion in domestic assets under management But while a significant part of the strategy until now, the local boss said the business of customising and running bespoke portfolios for institutional clients was a global outlier. It’s going to give the industry funds some well-deserved and true to label competition They are the second biggest manager in the world – low cost, economies of scale – access to research and the infrastructure They have are a commercial heavy hitter – have a big brand name to attract attention and lots of market research - They understand customer lifecycle management and could pretty easily provide a MySuper alternative plus they are cheaper – likely have a lot admin and low ongoing MER/IRC – Van multi index is around 0.29% - compared to the MERs for a lot of industry funds – 0.6-0.8% for similar allocations They spokesperson said that this shift was strategic – I am excited about it – they have been moving in the right direction for a while – and working with advisers and not against them Vanguard's Australian direct-to-consumer push is also escalating – as an example - the Personal Investor portal that was launched in April - now has around 10k investors signed up to it, with growth of about 2000 since late August - The low-cost investment platform provides free trades on in-house Vanguard ETFs – and access to their wholesale managed funds without having to meet the minimum investments One of the most successful strategies that they have is support from advisers - Vanguard's retreat from institutional client work is also an indication of the lucrative rapport it has developed with Australia's financial advisers over its 20 years operating in the country. according to managing director - It now counts 12,500 Australian financial advisers as clients which represents an incredible 57 per cent penetration rate in the industry. Given their fractured relationship with the industry super lobby, which has criticised independent financial advisers for decades and warned consumers against using their services, some advisers welcomed the retreat Vanguard developed the term "adviser alpha", which has become an influential concept in practice management for financial advisers. It refers to the value of financial advice being in client relationships rather than investment management and returns. Just something to watch out for – may be a trend – Aus super industry could have distribution in the future – Google super, Amazon super, Apple super – etc. – larger brands are thinking of branching out – many years off – and time will tell – but we know that Van is coming out with their own super soon which depending on the fees – may be an option. Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Checking if your superannuation is appropriately invested for you.

    Play Episode Listen Later Dec 7, 2020 23:14

    Welcome to Finance and Fury. Today we’ll look at how to get the right investments in super. Because super funds take care of it for people – a lot of people don’t pay attention – so in this episode want to explain what to look for and how to help determine if your investments in super are appropriate – Not advice – seek advice if you are unsure What is super? Most people think of superannuation as just something your employer pay in to so that when you turn 60 you can access it. Even though your employer pays into super, that is your money! 9.5% on average don’t care and why would you right? out of sight, out of mind and decades away from becoming relevant. Technically – superannuation is just a vehicle for investments that are held in a concessionally taxed environment Like having an investment account that pays only a 15% tax rate on income when compared to your marginal tax rate The only downside – is the preservation rules – where you can access it if you desperately need the funds   There are different types of accounts that allow access to different investment options Super is a vehicle to invest funds for retirement – A car is a vehicle You can get a Mazda, or Mercedes but the aim is to get you from point a to b! Like cars there are different types of super accounts with different features What are your options: Retail – A Master Trust is a superannuation fund in which a large number of members deposit their money. The trustee of the Master Trust pools the money together and purchases interests in the underlying investments, typically managed funds. The value of the investments of each member incorporates the fees, franking credits and some taxes from the underlying investments. WRAP account – External super trustee but you have control over investment decisions You get a cash account Then you select third party investments – Managed funds, Direct Shares, LICs, ETFs Industry Industry super funds are multi-employer funds (employer associations and unions). Investments - limited to around 10 multi-sector investment options (eg. Growth, Conservative, Balanced) – as well as single sector investments – in an asset class Regardless of the type of account that you have - The real cost of super is opportunity cost – doing nothing now will hurt long term - Any problem ignored long enough will grow – until it is too late Pay attention and make it work – don’t regret the future That is why setting up the correct investments and paying at least some attention is very important Again – the core concept for investments in super is that it is a Tax effective investment account – if you are investing for the long term, why not use? Comparison - Same investment of 10% p.a.: Compounding returns of 8.5% p.a. vs 6.1% p.a. $20,000 over 30 years = $231k vs $118k – or almost double the money   Superannuation investments- Will be looking at the industry fund sector – what most people have and have covered WRAP accounts in another episodes: “What types of superannuation accounts allow you to control your investments?” Industry super funds – Not a lot of transparency but it is getting better – so it can be hard to actually know where the funds are invested – For shares – there is transparency – other investments like property, infrastructure, alternatives – harder to know Investments - Depends on account. Mostly - Premix – Conservative to high growth – Based around the asset classes that are invested in – cash, FI, property, infrastructure, shares, alternatives How much to each asset class will determine the classification – 100-90% to growth – probably the most growth pre-mixed option the super funds have The default used to be Balanced – but for someone who has 30+ years of investments ahead = might not be correct. normally a lifecycle strategy – as per your age and account balance Below the age of 40 – you might be in a higher growth investment – then after 40 they start to scale you back – This might not be appropriate – you might be in your 40s and still want to be a higher growth investor Also – most have single asset class investment options – shares, bonds, property, etc. These can be used to help beef up or reduce the allocation to asset classes Example – if the pre-mixed options don’t have enough growth – then you can select some additional share allocations – say 80% to their growth option and then 20% split between Aus and Int shares Considerations when determining the right investments for super - Time horizons and goals based investing – investing is a long-term game – super can be even longer – due to the preservation rules – The longer the time frame – the longer you have to recover from any volatility losses Hence - Time in the market becomes a thing– the longer you have the funds invested, the greater your long term returns could be – Trying to guess markets and switch from high growth to cash and back again can result in lower long term returns – so keeping your super appropriately invested based around your goals in important - Super contributions - Higher levels of volatility can be good for regular conts If your super isn’t getting any contributions – may be better to have slightly less volatility – Regular investments with high level of volatility can help you buy additional investments when funds prices are low Combining all factors makes for a strong performance – the bedrock is the returns from the investment How to make the decision – Compare how industry funds invest money now – But checking on the growth to defensive ratios is the first step Would help to go onto your funds website and see how they have invested your funds – double check that you are in an option that might be appropriate for you Can see how much the investment ranges on the asset classes – the funds normally have their investment objectives and risk metrics Investment objectives - + a percentage above the cash rate or inflation Risk – volatility levels and time frames to be invested for Remember – your goals and objectives could be different – you might have a Long term focus – Allocations can likely changes over time – if you are in your 50s to 60s – probably better to have less volatility approaching retirement Other considerations - Check your costs – Some accounts are higher than others – but it depends on what you get for what you pay Admin fees: Flat fees and percentage fees – For flat fees – some accounts have $0 and some have a Standard is about $78 which is good for lower balances One I am with is $175, but worth it. Any managed fund I want, any direct share (Aus or Int) You can have no flat fee – but % admin fees – these do range as well 0.1% to 0.16% - These are for industry funds – pretty standard - Where these is a variation - Investment fees (MER/ICR) – these can be hidden The higher the MER – the lower the net returns depending on investment strategy But the higher the MER – the greater the potential returns – Higher growth have higher MERs in general – looking at a few options – you can have MERs of 0.35% or 0.8% - but this is the difference between a conservative option that has mostly cash (which has a low to no IRC/MER fee) – So whilst the MER is much lower for conservative – the long term returns can be a few percentage points lower even at the lower costs Where it can matter is between platforms - if two funds invest identically – but one has a 0.5% versus a 1% ICR/MER – then that is what can lower your returns potentials - Don’t get caught out Focus shouldn’t just be on the percentage costs but what you get for your money What to do to make sure you make the most out of it? Pay attention – get the right investments Cars: You can have a Ferrari but if the driver (investments inside the account) is awful, the car may crash! Not getting to point B! Make sure your contributions are going in there Treat it like your own, cause it is – If you think you don’t have any investments, well you do in your super Check out the websites for super funds – look at the investment options Check out that you have a good investment compared to what your goals are Thank you for listening to today's episode. If you want to get in contact you can do so here:

    A quick announcement about episodes for the rest of the year

    Play Episode Listen Later Dec 2, 2020 0:56

    Hi and welcome to Finance and Fury. Just a quick announcement today. Only going to be doing Finance and Fury Monday episodes for the rest of the year. There is a lot going on with work and life in general and I just need to cut back a bit on the episodes. Had to make a decision on which episodes to cut out, so will still be doing the Monday episodes focusing on personal finance. If you send a question through – might not be answered for a little while Just wanted to let you know Speak to you next week for the Monday episode.

    How to use your own home as part of a wealth accumulation strategy.

    Play Episode Listen Later Nov 30, 2020 23:26

    Welcome to Finance and Fury. This episode will be about using your own home as part of a wealth accumulation strategy Some strategies that I plan to do First – what is a home – a lifestyle asset – is still technically an asset as it has a value – as long as someone else is willing to buy it off you I personally have never really seen a home as a financial asset - it technically losses you cashflow when it has a mortgage – and even when it doesn’t from a mortgage if this has been repaid – with rates, body corporate, ongoing maintenance costs for upkeep on the property Classification – Can you live off it? anything that doesn’t make you a passive income but instead loses you cashflow cant be used for financial independence Property ownership is expensive – mortgage is normally the biggest expense – PI loans eat a lot of cashflow – but the P component can be treated as forced savings that you can’t use But does decrease your I payments over the long term However – whilst your own home is a lifestyle asset – it still has wealth/equity in it - What is home equity?  Wealth inside of your property - Most homeowners build this over time with debt repayment as well as property price growth - which is calculated as the total value of your home minus your home loan. The equity in your home increases as you continue to pay down your loan. And if your property’s value increases, your equity also increases. Not advice but a strategy – Create a separate loan facility as an investment loan to release this equity for investment purposes – Debt – Leverage – Borrowing money to invest – Agree or not - $100k is more than $50k? – it is – Borrowing to invest allows you to Increase value of what is invested Technically your net wealth hasn’t increased initially – but over time this ideally can change Returns come in percentages – the greater the level invested - greater nominal returns at same percentages We are locked into same percentages for ASX – Different values Rich getting richer – more to increase at same percentages Does debt go up with inflation in value? No, you pay interest instead Why you borrow to invest in something that grows, not keep in bank account. Time goes on, your investment increases, debt doesn’t. Borrowing funds to invest is a strategy known as leveraging. Good Debt – If you borrow to produce an income, normally deductible interest. Plus if you invest in something that grows, you should have a higher total return over the long term than what Bad Debt – this is the PPR loan - principle of increasing the size of an investment expected to get long term capital growth. Leverage works better from growth and not cash flow. Having it is neutral cashflow position to slightly positive is the aim to maximise leverage – especially for property Pay back loan - Lower LVR = Lower multiple of growth, but lower repayments for cashflow. Increase loan with value = Increasing multiple of growth, but higher repayments.   How it works when investing outside of property Options Home equity - Borrowing equity to buy shares, or managed funds Debt recycling – borrowing more each year and using the income from investments to pay down bad debt How to start Example: Property – Initial purchase and building equity   Utilise equity of $100,000 to purchase a property for $500,000 Borrowed funds – LVR 80%. Three years - 8% growth return = $40,000. Growth return on the equity of 80% - $32,000 in available equity In addition – you will have repaid some of the loan - $375k in value by this stage as well with standard monthly PI repayments – ($25k) - so in total there would be $57k of equity available Next step – deciding on how much to utilise of this and how to invest it - May not be worth it to borrow the full amount again – Taking the property back up to 80% loan may just cost you additional cashflow – Interest payments – Have to repay interest on the borrowings. The borrowing of funds against a property for investment purposes. The process involves having the home revalued – so the valuation may not have additional equity How to invest and where to invest – How to invest the funds – lump sum, DCA, or monthly investments – example of these options Lump sum – putting the $57k into the market at one time DCA – breaking up the investments for 5 months - $11,400 p.m. Doing monthly investments moving forward from the account - $2k p.m. for just under 2.5 years Aim is to try to minimise risks and maximise possible return – as the funds are borrowed, want to take some additional conservative approaches – such as DCA - Where to invest the funds – want to be diversified This is just a home equity investment strategy – taking it to the next level – it would be a debt recycling strategy Debt recycling works similar to the home equity release for investments – but you do this every year Involves refinancing and increasing the size of the investment loan each year and investing the funds In the previous example – PPR loan would be $365k – so a further $10k of debt repaid – this could then be released in the second loan and investing the funds   Example – Your property of 500 has grown to 700, your mortgage at 450k. If the value is $700,000 and the current loan is $450,000, $110,000 can be borrowed to a LVR of 80%. Initially $30,000 is invested with monthly investments of $3,000 established.   Worth it to leverage? Hurdle rate - the minimum rate that you expect to earn when investing. When borrowing to invest, your hurdle rate will be the cost of borrowing the funds (interest payments).   Downsizing risks - Where it goes wrong Wrong investments Shares or managed funds? No liquidity, or not reducing investment time risk - DCA Disposable cash flows low – job security Panic selling or being forced to sell Buffer account – lower LVR or surplus cash My plan – spend the next 12 months paying down additional debt – borrow – then invest those funds in a portfolio of managed funds over a 3-5 month period – do this again for 5 years – ideally – in 10 years time there will be no bad debt – only investment debt – depending on interest rates – either redirect investment income to pay down loan – or reinvest still - Summary Leverage for growth Risks can be worth it if done correctly. Thank you for listening to today's episode. If you want to get in contact you can do so here:

    Would a one world currency actually work?

    Play Episode Listen Later Nov 27, 2020 24:10

    Welcome to Finance and Fury, the Furious Friday edition.  In this episode we will look at the concept of a one world currency and if one single currency could actually work for the world? There has been an increased level of discussion around this topic over the past few years – especially with central banks looking to adopt digital forms of currencies over the next few years However – these are based on the individual country’s central banks - There are about 195 countries – depends on who you ask – but working off the UN numbers – there are 195 At the same time - There are 180 currenciesrecognized as legal tender in United Nations (UN) member states Abut 15 of these UN recognised nations use some other nations currency already as their legal tender – like the USD as the global reserve currency However - excluding the pegged (fixed exchange rate) currencies of the 180 – which there are about 50 – which also peg themselves to the USD - there are only 130 currencies which are independent or pegged to a currency basket In other words, there are free-floating exchanges – with exchange rates between different currencies – If you want to learn more about this – if you haven’t listened did an episode called: Looking at the factors behind the AUD/USD exchange rate movements. However – In the current financial system - these currencies are a digital form of fiat currency – This doesn’t include alternative medium of exchanges that have been used and are currently used – like gold – or crypto – Technically – a medium of exchange is anything that can be used in an economic transaction as long as someone will take it – it can technically be treated as a medium of exchange But the major forms of what is referred to as Currency is meant to be the legal tender that makes trade possible – in other words – what governments allow us to use within our domestic boarders These forms of currencies are meant to make transactions easier within the economy – and for everyone within the economy – which is us If you are in Australia – you will use AUD to buy goods or services – if you are in the US – USD, if you are in Germany, you will use the EUR But is having 180 currencies of which 130 are floating exchanges complicating matters? If you wanted to travel to Europe – you can’t use AUD to buy goods or services – have to transfer AUD to EUR – vice versa this begs the question - Wouldn’t a one world currency be best? 180 different currencies with foreign exchange rates for each can and does increase the complexity of an already complex international economy So, wouldn’t replacing all of these currencies with just one global currency be the optimal solution? This line of thinking was the whole point behind the implantation of having a Euro in the first place – A single currency zone to make it easier to travel and do cross boarder trade it isn’t just about ease or simplicity for travel or trade – but was about minimising transaction costs – Banks charge costs and services – there are also risks involved with currency exchange risks which we will come back to in a minute So why not expand this concept further – beyond simply just being implemented in the EU – why not do it worldwide? Some at central banking communities as well as think tanks think so – Mark Carney, Bank of England governor, has proposed the creation of a global digital currency as a way of stabilising global financial systems and protecting international economies from trade and currency wars He has made these viewpoints widely known - Speaking at a US Federal Reserve conference - Carney said that a “Synthetic Hegemonic Currency” (SHC) governed by the public sector (governments) and backed by a number of central bank digital currencies could replace the US dollar as the global reserve currency, and that this would be preferable to the alternatives, such as the Chinese Yuan/Renminbi World already has a reserve currency = USD – maybe not for long – SDR (special drawing right) is essentially a SHC A global currency wouldn’t just be implemented overnight – it would have stages and steps – have to get a cashless society – then have digital central bank currencies – then use these as a basket of currencies to replace the global reserve – like the SDR – then eventually – unlike currently where an SDR can only be used by monetary officials – it may be implemented and used by the public at large  This sounds very nice in theory – I mean - Why not have one currency that everyone in the world works off? First – lets have a look at money actually is - In The Wealth of Nations, Adam Smith defines money by the roles it plays in society – there are three primary roles that it plays A store of value with which to transfer purchasing power from today to some future time – it retains its value - A medium of exchange with which to make payments for goods and services – i.e. people will accept it for providing physical goods or services A unit of account with which to measure the value of a particular good, service, saving or loan – i.e. it is divisible – or in other words- we all know the value of a $50 bill But these functions of money operate in a hierarchy There are many assets that people view as stores of value – like an investment, or property like a family home — that are not used as media of exchange At the same time – you can have an asset that can only act as a medium of exchange if at least two people are prepared to treat it as a store of value And for an asset to be considered a unit of account, it must be able to be used as a medium of exchange across a variety of transactions over time between several people – 1 house is not worth 1 other house – they will likely be different These levels of hierarchy really just point to the reality that money is a social convention that is enforced by the monetary officials by fiat – or government decree History of money – Humanity has evolved over time – from a very basic barter system to gold coins, to gold backed currency, to fiat currency to the modern era – where the majority of transactions are done digitally, or electronically – But these evolutions in monetary systems have undoubtably increased the ease of trade – as well as the possible amount of trade that can occur Image that we were back in bartering times – and you wanted to buy a pack of gum from the super market – should be less than $1 – if you have an apple – might be okay to do – but what if you only have a cow – that cow is worth much more Now imagine that you wanted to buy some goods that only another nation could produce – trying to send a cow across the world may actually cost more than the good you are purchasing itself – like some clothes off amazon But in addition – this barter or exchange of physical goods system created a situation where it was hard to store wealth in physical commodities – as many of these were perishable – be it apples, or cows or goats – created problems – perishable – may not lost a trip and have limited lifespans – you can’t save a bushel of apples for retirement This system did work okay in small communities – but on a global scale – there is a natural increase in the difficulties in carrying out an economic transaction – these difficulties are normally referred to as frictions in an economic sense Hence – global currencies are being looked at by monetary officials - And technically – global currencies aren’t a new thing – think about gold – it was universally accepted as a medium of exchange But this also had its complexities – or frictions – you had to transport the gold – which can be heavy and can be stolen there may be some pros to a global digital currency – ease of transactions – not having to worry about transaction costs for one - One of the best ways is to look at the previously and currently used systems – Examples of the EU – the single currency arrangements were established formally in 1999 – risks of dealing with foreign currency can be significant – due to currency spreads – Let’s look at a situation before this – Germany and France – say that Germany wants to produce some car parts and France is going to be exporting power to the German car plans – lets say that the deutschmark is the same as a franc – 1 to 1 – so the costs of power for the plant are the cost base for the production of the car parts – but now Germany goes through some economic shock – drops the deutschmark to be 1 to 0.75 franc - now – it is more expensive to produce car parts – then have to sell to France or other nations at a greater price – pushing up the costs for other nations but also making German cars less competitive – so someone might buy Italian cars instead The EU created a situation where this additional concern was removed – this was pretty nig as foreign exchange risks are a part of an international economy So – beyond these eases of transactions and travel – what may be some downsides to these policies – as there are some major issues with a one world currency system – many of these can be seen with the EU as well Monetary control – and monetary policy - If you have a one world currency – who is in charge of this? Who determines the money supply, and what the interest rates should be? Looking at the economies of Greece compared to Germany is an example – Germany is a very stable county economically – Greece is not so much – Greece has gone through some debt issues – technically – nobody wants to lend to them as they are at a massive risk of defaulting – so if you are a Greek company or the government – looking to finance projects – you may normally be in trouble – however – the economic functions of bonds and FI have a solution to this – you get compensated more through higher yields on debts So if someone is going to be looking for investment – say the German government – and they are looking for lenders – they are economically secure – but the money is gong to be lent in euro – regardless of – the risk – the only return is now in coupon payments of debt So nations like Greece – which aren’t as secure – as Germany – all the debts are being issued in EUR – what happens then if Greece defaults? Creates a massive shock in the EU – saw this in the post GFC era – the EUR and global economy went through a massive shock – for a country that made up 2% of the EU economy So this form of monetary system – having every nations interconnected creates an increased fragility for the globe – rather than having individual floating currencies – where the collapse can be semi-contained to that one nation – all nations on earth have to soak up the losses – however – you may not know it is going on if everything I priced in the one world currency – it may just be represented in inflationary pressures Trade – may create a beggar thy neighbour situation without even manipulating the currency If a country is struggling economically – then its currency should depreciate – this in turn makes it more competitive - This means it is cheaper to travel to or to purchase goods from – this is what should have happened to many EU nations – like Greece – where they could set their own interest rates and have their currency depreciate to attract investment or trade – however under the EUR – they couldn’t – so the road for economic recovery is very limited for them - Floating currencies tend to stabilise over time Imagine that the whole world is on this system – it would eventually create economic ruin for most of the world – with a few winners – like in the EU – Germany and France are doing okay out of the system – Greece, Slovakia, Czechia and Hungary as just a few – not so much Biggest question – who would control it? BIS or IMF? In most countries the currency is controlled by the central banks and the government – one controls the supply and the cost and the over enforces its use This wouldn’t be allowed under an international system – there would need to be a one world system of control of the currency and enforcement Why? Well what stops every country on earth printing trillions of dollars if this isn’t in place? With individual currencies this punishes the nation – devaluation of their currency – if it can’t keep up with the demand for their currency But if the currency is the only one that can be demanded – then what is to stop each nation – especially the poorer nations from printing all the money – it becomes a race to the bottom for everyone – the whole world may become a hyperinflated mess This leaves the other option – that one central power – like the BIS controls the printing of money – or the growth of credit – However – this has major downsides – What happened under the gold standard? Well nations would hoard wealth - System of mercantilism – countries hoard the money as a store of power – The idea that countries could achieve additional wealth through exporting more than it imports – in other words – current accounts of a country would increase and that nations wealth – in an economic sense would also increase So a country trying to game the system may be incentivised to limit imports and maximise exports - be it natural recourses – or food However – the real-world implications of this may be dire for the population Sure – economists and the politicians may be able to point to budget numbers – But it may create shortages of goods and services for the nation – especially in a world that is so reliant on other nations for goods and services The end result may be a restriction of trade – would hurt the world economy – which at the end of the day is us Also – what about the other rules and regulations that may come along with this Monetary policy - In the EU – the ECB controls the currency’s interest rate The other issue is who is in control of the policies – think about nation to nation interests If the head of the currency was someone who was Aus – would they do things that may be unfair to someone in south America Fiscal or trade policy – trying control the economic activity of each nation to avoid a situation like currency hoarding Where we stand at the moment - many nations are moving towards a cashless society or a pure digital currency style monetary of system – I personally think this is bad – a one world currency is a long way off at this stage – but it doesn’t mean that many monetary officials don’t have there eyes set on this down the road in the next 10+ years At this stage it is not possible to do – in 10 years once the SDR is likely to be the reserve currency and most nations currencies are purely cashless – it becomes more possible - but it may not provide much in the ways of benefits – To have any benefit - The assumptions are that it is administered responsibly – that is a huge assumption – one that is almost laughable when looking at how a single nations currency is administered – between the cost of the cash rate and the amount of the money supply – now expand this by an order of magnitude of 195 – not just timing it by 195 – but to the power of 195 – as the complexity of the world economic system is enormous But in short – I think this would be a bad idea to implement – just my two cents – as greater controls over the economy often don’t lead to the intended outcomes Thank you for listening to today's episode. If you want to get in contact you can do so here:

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