Fantastic article on Aussie Banks

A very well presented argument here on why our "safe" banks may not be as safe as everyone thinks.

Whilst I would not be betting that house prices are going to fall 10% to 15% next year as the Credit Suisse report suggests, I would also not bet against it happening. Regardless of what the housing experts say (those with vested interests in talking up house prices - Fairax, News and the very trustworthy real estate agents), houses are not cheap and there is a reasonable risk that there could be a correction.

With baby boomers de-leveraging over the coming years, there are significant headwinds for the housing sector and therefore the banking sector. For those that are believing that the housing corrections that have happened elsewhere around the world cant happen here because it is Australia, then I suggest you rethink you logic.

Our core scenario is that as interest rates continue to fall over the coming year or two, house prices will most likely stagnate. However, we also believe that there is a moderate probability that there could be a correction. It all depends on how high unemployment reaches in the next cycle. I suggest that you should not be investing significant amounts of money in companies that are based on continued low unemployment to maintain their current earnings.

As Buffett says:

"You only know who has been swimming naked when the tide goes out."

I would hazard a guess that we are closer to high tide than low tide in Australia...

Are all equities a good inflation hedge? By Marc Lerner

Are all equities a good inflation hedge?

Zero Hedge has reposted a UBS report entitled ‘Are equities a good inflation hedge?’ The report
investigates this question through a study of historical data of equity performance in various inflationary and deflationary price environments, and concludes:

Indeed, they [equities] provide an appropriate hedge to rising inflation only in a limited number of cases.

1. The trade has to be entered at a low level of inflation. If the trade is started above 4%, the
valuation loss due to declining P/E will dominate and make equities underperform.

2. If inflation increases only moderately. High-single-digit inflation would make the equity valuation
loss dominate other effects.

3. If the investor assumes that inflation will not decline. In that case, the trade would also generate
sub-inflation returns. So an equity hedge comes with increased portfolio risk in cases of deflation.

The main problem with the report’s approach in reaching these conclusions is that it does not attempt at all to focus on the effects price inflation – a sustained, general increase in prices - may have on individual businesses and their earnings. Whilst it does pose some interesting arguments on a macroeconomic level – for example, that higher inflation may lead to higher volatility and hence higher discount rates being applied to cash flows – and provide empirical data to support them, it only in passing mentions that “some price distortions can obviously affect corporate margins”, instead simply presenting the aggregate returns of stocks in general under inflationary and deflationary environments, as if all equities were homogenous. The report can’t see the trees for the forest. But if you are interested in the performance of specific companies in an inflationary environment, rather than a broad equity portfolio such as an index fund, this effect on margins is precisely the crucial issue, and well worth investigating further.

In the near term, the most likely source of price inflation is money printing from central banks, rather
than some other source, such as a supply shock. The effects of such monetary expansion are never even – prices will rise first wherever the new money enters the economy (relative to what they otherwise would have been – a relative price ‘increase’ can still be, in absolute terms, a decrease). If it is used to purchase government bonds, wherever the government spends the money will experience rising prices, if mortgage backed securities are purchased then rising house prices will result. By unevenly distributing the price increases in this manner, money printing can allow the early recipients of the money to benefit at the expense of the latter ones – by the time the money filters through to them, their costs have already increased correspondingly. Therefore, if it can be determined that a company’s output will be purchased directly by the new money flows before they spread through the economy to affect its costs, aggressive margin expansion and high returns to shareholders are likely to be the outcome. Finding such companies, however, is essentially a political question and hence a difficult one to answer accurately, unless you happen to be friends with Ben Bernanke.

More broadly, as the money does move through the economy and affect consumer prices as well as costs, the crucial question becomes whether or not a business can raise its prices to offset, and perhaps even outpace, the increase in its costs. The extent to which different businesses’ costs are affected depends, again, on the way the new money moves through the economy, and will differ in each case. For consumer businesses in particular, however, the question of whether prices can be raised to an appropriate degree takes on an especially interesting psychological dimension – will consumers be willing to pay higher prices? One consideration could be the extent to which the specific business’s customers themselves are in a position to benefit from the increased money flows earlier rather than later – if the business is one that caters to a particular, easily identifiable demographic. Another argument could be made, however, that the absolute value of the price increase is of importance – a 10% increase in the price of a Coke, for example, may not seem like much to most people in terms of the extra amount they have to pay, and hence not affect Coca-Cola’s ability to raise prices in tandem with inflation, whereas a 10% increase in the price of a house or a car could be seen as a serious cost-of-living increase, and hence such purchases may be delayed or cancelled until prices stabilize or fall.

Marc Lerner

These are a few of our favourite things - Google (By our star recruit Marc Lerner)

Our newest recruit Marc Lerner has given an excellent summary on why we are very happy to hold a reasonable allocation of our client's portfolios in Google:


Despite the seeming complexity of the various services it provides – Gmail,
Youtube, and a search engine that is synonymous with finding something on the
internet, in terms of revenue Google is, quite simply, an advertising company,
with advertising accounting for 96% of revenue in 2011. There are two primary
types of advertising businesses the company runs – advertising on Google
websites – for example, the plain text ads on Google search or Youtube ads
before a video, and advertising on Google Network Members’ sites – a network
of affiliate websites that hosts ads relevant to their content contracted through
Google. The former is a far more profitable business model than the latter, as in
the latter Google has to pay a large proportion of its revenue from advertisers
directly on to the Network Members, although interestingly the second model,
by tying the major cost directly to revenues in a variable manner (if advertising
revenue drops, so do the payments to Network Members), in the case of an
economic downturn could help in mitigating the severity of margin contraction,
which has some value in what is essentially a cyclical business. The ads on
Google sites are, however, a larger part of revenue and have been growing faster,
so the more profitable segment of the company is overtaking the less profitable
one.

In a world where the Internet as a source of information is fast taking over
traditional forms of media – newspapers, television and books – Google has
created a near-monopoly in its strongest generator of advertising revenue,
Google Search. The nearest competitor, Microsoft’s Bing, has a market share
that fluctuates around 14-16%, with Yahoo posting similar figures. Neither has
anything like Google’s – a high of 66.8% of the market in June 2012. Nor is either
likely to increase to any extent that rivals Google – at most, possibly taking share
from each other is all these two can reasonably hope for. After all, when you
need to find something online, what do you do? You Google it.

A current challenge that Google is facing is drawing advertising revenue from the
increasing use of smart phones and tablets, rather than traditional computers, to
access the internet. Because of the physical and technological limitations of such
products, this is a difficult task - for example on a mobile screen there are no text
ads on a Google search, presumably simply because there is not enough space.
The extent to which Google can innovate new ways to generate revenue from
this technological space will have a significant impact on the growth it can attain
in future years. However, even if such innovation, which Google is pursuing
aggressively, provides only disappointing results, the core business will likely
continue unaffected insofar as the convenience of using a computer or laptop
ensures that they will never be fully replaced by mobile devices.

Longer-term, there is some risk in online advertising that – legally or illegally –
ad blocking programs that block ads such as Google’s become very widely used.
These already exist – for example here is a free ad blocking extension to Google
Chrome, which claims to be the “world’s most popular browser extension” and
“used by millions of users worldwide”. Most of Google’s advertising revenues
only get paid on a cost-per-click basis, so if this became truly popular as the
general population becomes increasingly tech-savvy, the effect could be very
serious on Google and its Network Members’ revenue, or its costs insofar as
counteractive technology may need to be developed. Leaving this possibility
aside, however, the position that Google has as a search engine ensures it will
have a competitive “moat” around it for years to come.

Marc Lerner

Coin flippers come out to play...

Its that time of the year again when the coin flippers come out of their shell and make ridiculous predictions for the various share market indexes for the next 12 months. Shane Oliver and John Abernethy have both predicted 10% to 15% returns for the market.

I call them coin flippers because the probability of guessing where the index will be in 12 months is not much better than a 50/50 coin toss.

This practice is about as useful as dart board investing. The answer is that no-one knows where the Dow Jones is going to be at the end of 2013 or whether the All Ordinaries is going to be higher or lower.

Shane Oliver's famous call in 2007 that the Australian market would reach 8000 in the next year was a fantastic example of coin flipping.

The regular offenders of the coin flipping calls are the brokerage houses. Once again, it all comes down to incentives. How do these guys get paid? They get paid when you buy and sell shares. If you keep your shares they dont get paid as much, so it is in their interests (not yours) to attempt to make you buy and sell regularly.

There are a large group of people who like to move in an out of the share market as if they know what is going to happen in the next 12 months. This is a very good way to miss out on some of the best returns available.

If stocks you own are over valued, it may be wise to trim your position, but it is not wise to be buying and selling in and out of the market on a regular basis because of a gut feel.

There are sectors of the market we believe are at greater risk than others and for those of you who are able to invest your superannuation with discretion, you have the ability to reduce risk by avoiding these sectors. Mining and housing related sectors of the Australian share market are likely to have greater headwinds over the coming years. We caution those over exposed to these sectors.

A better practice is to ignore the markets and invest in wonderful businesses and hold them for extremely long periods of time. Always keep some powder dry to add to your positions if markets offer irrationally cheap but high return and sustainable businesses.

At Valor Private Wealth, we would like to make a prediction that the share markets in free markets (not "roach motel" markets like China) will gradually grow over the very long term and continue to create wealth as they have for the last century. There will be market corrections one in every 4 or 5 years on average and your portfolios will fluctuate. It is not these market fluctuations that you should worry about, but the long term growth in the value of the businesses you invest in.

Limits to Proctor and Gambles price gouging?

This article here about the "shaving guru" is an obvious example that the cost of the every day razor is getting out of hand.

Proctor and Gamble who owns Gillette have marked up the price of the every day mans de-bearding tool to ridiculous levels and it is driving customers to look for alternatives.

This leads me to question how much growth is left in these big brand consumer product companies like Proctor and Gamble. Is there a limit to their growth?

At what point do these companies price themselves out of the market? I still use Gillette, however I would gladly swap for something that does a similar job for less.

Are any of my readers looking for alternatives? Are you brand loyal regardless of the increased costs?

Does Buffett Style investing work in Australia?

Warren Buffett has said it is far better to "buy a wonderful company at a fair price than a fair company at a wonderful price". He also likes to say his "favourite holding period is forever".

But does this work in Australia?

Australia doesn't have a plethora of global world beating franchises. Our best brands don't come anywhere near making the top 100. Billabong and Qantas are probably our two most recognised global brands and these have not been fantastic investments over the last decade. In the Brand Directory for 2012, we have some brands that have value, but they are not world beating brands, they are local franchises.

So are there any companies in Australia that would tempt Buffett? Yes, but not many.

Buffett generally doesn't invest in cyclical businesses, so this rules out the mining companies.

He likes to invest in a few banks, so maybe some of our banks might make his portfolio. However at their current prices, I would be very surprised if he decided to buy Commonwealth bank trading at 2.4 times book value when he can buy Wells Fargo at 1.2 times book value or Bank of America at 0.5 times book value.

Buffett has been buying more of the US banks recently, but most of his purchases have been after significant pain the the mortgage market. Something we haven't seen here in Australia (yet).

He likes to invest in insurance companies, so would QBE make the list? With QBE's highly geared structure, I would think that Buffett would throw it into the too hard basket.

IAG might pop up on his radar, but they have had a less than stellar record over the last 10 years so it is also unlikely.

Buffett has always liked newspapers since his days as a delivery boy, but with Fairfax destroying capital at an alarming rate, it is probably not a worthy investment. Newscorp is one of the stocks that may be on his radar as the formidable Rupert continually surprises his competitors.

Buffett doesn't invest in telco's so everyones favourite - Telstra, is not going to make the cut.

So with the miners ruled out, the banks likely over priced, the telcos too uncertain and our insurance companies having been poorly run, what is left?

He might like a piece of ARB. The market leading 4 wheel drive company that has grown its shareholders funds well into the double digits for the last decade, however that is looking a bit overpriced at the moment.

Fleetwood is up Buffetts alley. He owns an amazing caravan business in the US. I would guess that Buffett would be worrying about a slowdown in mining affecting Fleetwood's manufactured housing business.

Having invested in financial reporting at rating companies like Moody's, Buffett may take a look at Iress which has a slightly different business, but still a moderately strong moat. Iress has also had a very good run of late and is not looking like it would fit in Buffett's discounted cash flow mental models at present.

Buffett doesn't mind an investment in oil and gas. His Conoco Phillips investment has been one of his worst performers, but he hasn't sold all of it. A company like Origin energy might tickle his fancy with its current price falls, but with the US shale gas revolution and potential LNG exports out of the US, the upside on Australian high cost gas producers might be less than many predict.

Buffett has previously invested in Sanofi-Aventis, so would CSL get some research time? I would think it would. CSL appears to be kicking some goals at present, however with new management in place and a very high valuation, Buffett would probably leave it for another time.

Woolworths is a wonderful business that Buffett would also probably invest in, however his recent purchases in Walmart at 10 times earnings and Tesco at 8 times earnings make investing in  Woolworths at 20 times earnings an unlikely prospect.

Buffett recently bought Burlington railway. So would QR be on his radar? It might, however with Burlington earning twice the return on equity and significantly lower debt that QR does, he would probably let that one slide.

So if Buffett was located in Australia, he would have a difficult time using his investment philosophy to fill a portfolio of Australian stocks.

Michael Pettis article

Another fantastic article on China's difficult road ahead from Michael Pettis.

At Valor Private Wealth, we have not seen any evidence that China is doing anything more than talk about reforms in their economy.

Building empty buildings and infrastructure is not the panacea for all growth problems. It is extremely difficult to turn the ship around and reduce fixed asset investment and at the same time increase consumer spending.

We still believe we are in the eye of the storm in China's fixed asset slowdown. At some stage the debt binge becomes unmanageable and the party ends. And this has been one hell of a party!!!

Many mainstream journalists and fund managers are buying back into the story that China will resume 8% plus growth for decades on end. We dont believe the hype and are still very worried that there is more pain to come.

More Chinese Accounting issues

The SEC are working hard but are hitting road blocks and seem to be having difficulty in dealing with the Chinese when looking into the accounting issues of a number of companies. The Chinese are further blocking access to many of these companies documents and not playing fair.

It astounds me that people are still investing in these Chinese foreign listed entities. The level of accounting irregularities is perverse and yet professional investors are still putting their money into the black hole of Chinese foreign listed entities.

When trust fails in markets, the systems can break down. The Chinese need to ensure they dont break the trust of western investors.

It will be interesting to see the outcome of the coming months of SEC probing.

Should the bank shares be rising as house prices fall?

I have seen numerous portfolios of clients who come to me with 40% and even 50% invested in Australian bank shares.

With house prices across the entire globe falling and bank shares (apart from the Aussie ones) having fallen 80% or 90% and numerous failures, why do Australians persist with the notion that investing almost half your capital in these grotesquely geared entities is considered a safe practice?

The above average intelligence guys at the Intelligent Investor wrote in the back of one of their recent newsletters that they believe a maximum allocation of 10% of a portfolio should be invested in the Australian banks. I completely agree. Although at Valor Private Wealth, we believe that the Australian banks have limited upside and potentially large downside and this is not the kind of investment we feel comfortable owning for our clients, so our current weighting to Australian banks is 0%.

The capital requirements of the banks are about to come under closer scrutiny over the coming months with Basel III. There is talk of some of the enormous off balance sheet derivatives being required to be brought onto the balance sheet. I have spent countless hours attempting to work through this issue, however as the reporting for these instruments is still quite opaque, any work done has limited application. When the derivatives listed in the banks are in the trillions for each bank, small movements  can have enormous affects. The vast majority of these instruments are simply hedges, however as seen with the JP Morgan losses of late, trading losses can be large.

One of the biggest concerns is the accounting of capital for the banks. With house prices rising over the last decade around Australia, there has not been any issues, however since October 2010, house prices have begun a gradual retreat and if this continues, the banks could prove to be swimming naked when the tide goes out. Westpac and Commonwealth have the highest proportion of residential mortgages at about 2/3 of their book, whilst ANZ and NAB are holding approximately 55% and 50% respectively. The ugly girl at the dance (NAB), who has been a stellar under performer may actually be the least worse bank!

So the latest reports of house prices continuing to fall why are the bank shares rising? Deep T from Macro Investor has highlighted the risks to the banks with continued house price falls. In reality, the banks are a levered bet on house prices in Australia. If the market was rational, then the bank shares should move at a greater rate than the house price falls or rises. This was definitely the case when house prices were going up, but there appears to be a disconnect with house prices falling 5% year on year nationally and bank shares rising approximately 15%.

In a situation of continued house price declines, it is the LMI (lenders mortgage insurance) insurers that are most at risk. QBE and Genworth could shoulder enormous losses, many times their current capital, if house prices fall in a similar fashion to what has happened around the globe. This is something I would suggest is not a negligible probability. Once again, there is very little data about the current LVR profile of these highly geared insurers. In the last QBE annual report, the word LMI only popped up twice. For what I see as one of their largest risks, mentioning the word twice is not what I call keeping investors up to date.

Could a higher dollar lead to a lower dollar?

With the recent further rise in the Australian dollar against a continued slowdown in China and growing fears about a resource investment cliff, I am beginning to see the prospects of a higher Australian dollar leading to an increasingly uncompetitive position in Australia. This inability to compete due to higher wages, lower returns for exporters, cost to inbound travelers may slow the Australian economy leading to lower interest rates and then a lower Australian dollar.

The question is how high does the Australian dollar need to go before it bites itself in its own bottom?

With the general consensus that our LNG boom may not be the saviour it is expected to be due to the shale gas boom the the US, people are beginning to understand how our persistently high Australian dollar is sending future growth prospects away from Australia.

Our general view at Valor Private Wealth is that interest rates will continue to fall over the coming year and possible the year after that and along with it the dollar will lose its shine as the interest rate differential reduces. There is likely to be a tipping point where the current flow of money into Australian dollars reverses. Where that tipping point sits is unknown, however when it turns, it is likely to be a sharp reversal similar to 2008.

The Fiscal Cliff and Investing

The Fiscal Cliff is a potential problem for the US. The issue is real. Whether or not it should be up for debate is another question.

The US does need to fix its government finances, but they are not unfixable problems.

But how does the Fiscal Cliff affect long term investments?

If the US goes past its deadline, will Coke sell less cans of Coke over the next 10 years because of a deadline to agree on some tax and budget cut issues? Probably not.

Will less people "Google"something and click on the adds next to the search engine? Probably not.

Will the excess houses in the US that are being mopped up over the next few years all of a sudden not continue to reduce the supply? Probably not.

Will the shale gas revolution grind to a halt and stop the US drive toward energy independence at some stage over the next 5 to 10 years? Probably not.

Will sentiment increase the share market volatility? Likely so.

So if the Fiscal Cliff is unlikely to make a dent in the worlds best businesses, then does it provide a good opportunity to add to these businesses at reasonable prices? Likely so.

Both Jim Chanos and Warren Buffett have recently stated that the Fiscal Cliff is not changing how they approach their long term investment philosophies and I recommend that you do the same.

China Recovery Unsustainable

Another great article from Macroinvestor outlining the recent appearance of a recovery in China.

The HSBC PMI data came out in expansionary for the first time in 13 months.

I must agree with the FT Alphaville's comments on Nomura's analysis that it is unlikely that the recovery in China is sustainable. If your problem is building empty offices, apartments, shopping centers and other infrastructure, then it is not sustainable to build more empty offices, apartments, shopping centers to fix the problem.

At some stage, China is going to have to take the bitter pill. The current leadership change appears to have delayed that difficult transition from fixed asset growth to more balanced growth, but the more they delay it, the more difficult it becomes...

Does Xi and his team have what it takes to turn the behemoth around? Do they have the ability to stop corruption from eating the country from the inside out? Or as Hu Jintao described it "kill the party and ruin the country"...

Deflation to continue?

A good article here by Stephen Koukoulas regarding the low inflation environment we are currently in.

The most important point is in the last paragraph. It states that "inflation will be staying too low despite the best efforts of the G7 central banks to kick it higher".

When central bankers have their backs against the wall with a choice of inflation or deflation, it is a good bet that they will strive for inflation every time. Whilst no one knows if or when inflation might kick it, it is not wise to invest your hard earned savings on the assumption that it is not around the corner.

Those holding too much cash or low yielding bonds when inflation rears its ugly head should get their rubber duckies out because they could take a bath.

Housing Recovery?

A very well weighted argument for both cases of the housing recovery from Matthew Kidman here.

I am not going to comment on which way I think the housing market is headed, because I dont know and no one really does. (I am slightly more bearish than Matthew Kidman though). What I do know is that there are an enormous number of people betting the majority of their retirement savings on a sustained recovery in Australian real estate. People with highly geared investment properties who are in their 50's, retiree's with 30%, 40% and even 50% of their superannuation in Australian bank shares and the countless number of baby boomers who are planning to downsize and use the current equity in their houses to supplement their super.

Whilst all of these strategies may pan out, they are not as guaranteed bets as those who are relying on them believe they are. If the loss of confidence in high indebted nations that the rest of the western world are experiencing invade our shores, then these residential property dependent strategies could make a serious dent in many peoples retirement dreams.

Our view is that to place such a large bet on the sustained recovery in the Australian residential market is to bet that unemployment will remain at extremely low levels for many years to come. We believe that betting that unemployment will remain at five and a half percent for the foreseeable future is not rational. The history of the last hundred years suggest that a cycle in Australia should average every 8 years or so. Just because we haven't had a cycle since the early 1990's does not mean we should base our investment strategies on one not occurring. 

The raw numbers are not in the favour of those with heavily weighted bets on the recovery. Enormous mortgage debt to GDP up there with the worst in the world, a mining investment boom coming off its peak in the next few years and the baby boomers retiring does not suggest we are expecting a boom any time soon. Having said that, if interest rates continue to fall, there may be some "hot" money flowing into the markets.

My travels around the world as an international pilot allows me to compare average housing costs in different cities and countries. Australia really does have some crazy prices when compared to other fantastic cities with larger populations. This disparity in prices may be purely due to the hot Australian dollar, but I am not sure that this is the only factor creating the difference in value for money.

With some fantastic assets on sale in the rest of the world, now is the time to diversify your risk from the scenario that Australian residential housing does not have a sustained recovery that many people are so dependent on.

Ice Cream for Breakfast

Warren Buffett eats ice cream for breakfast and doesn't have an email account...

Interesting new series from CNBC.

Betting on something worth betting on...

Yesterdays "Race that Stops a Nation" was exciting.

Unfortunately I find it difficult to throw away money on this kind of venture. I have previously put down a few bucks just to have a bit of fun, but with a race so open that almost anyone could win, it is not the kind of odds I prefer to play with.

The key point I wanted to make in todays blog is that betting on the horses is not much different from the way many professional punters/ investors invest their clients hard earned money.

The majority of professional investors have a very myopic view on managing money. They generally dont think past the next 12 months when investing. This can be seen by the turnover of managed funds portfolios often around the 100% per annum range.

This hyper activity is crazy.

Betting on what a stock is going to do in the next 12 months does not give very good odds. Even the best betters can't get much more than 50/50 odds. If you ask a bunch of fund managers whether BHP will be higher in 12 months time, the answers would vary wildly because no one really knows!!

Compare this with the probability of Coke (KO) selling more Coca-Cola's and putting the price up over the next 5, 10 and 15 years. The probability of this is unbelievably high.

The secret to investing is to wait until the very high probability companies are trading in a range that is worth betting on and then hold them for a very long time. This doesnt happen often.

As Buffett eloquently said:

     The market is designed to transfer money from the active to the patient

When investing, you are looking for horses that win year after year. For decades at a time. Put a punt on when they have a bad race one year because it is more than likely just one bad race.

Walmart was a good example of this. Recently Walmart had the Mexican corruption scandal. Was this terrible offense going to affect the earnings of Walmart significantly over a 5, 10 and 15 year period? Probably not. This gave investors an opportunity to place their bets on a winning horse with fantastic odds that had one bad race.

Many people see the market volatility and get worried about the risks of the ups and downs. When you look through the noise and just see the wonderful companies working hard to grow their earnings over time, you realise that most of the noise in the market is the "punters" (often professional investors) who are betting on very average short term odds.

For those that ventured to their local pub yesterday to watch the race, you may have noticed that the scene looked not dissimilar to the stock market floors of decades ago. People throwing down bets and shouting at screens. The reason for this is because the majority of the market is just punting on short term odds which as a general rule is not an overly productive pastime.

Accounts Receivable...

If the figures are correct in this article from the Diplomat, then those hoping for a turn around in China in the fourth quarter may be in for a shock. Then again, I wouldn't hang my hat on any accounts out of the "Roach Motel" giving accurate figures.

Bond Bubble???

The global search for yield has driven the safer end of the bond market the historic lows, but the middle to lower end of the bond market is having money thrown at it too.

These do not appear to be rational allocations of capital in a world where Helicopter Ben and Super Mario have outlined their preference for inflation rather than deflation during their reign.

Lardy vs Pettis

Here is a fantastic letter from both camps on Chinese growth.

Most know which side Valor Private Wealth is on, but it is important to note that we spend considerable amounts of time looking at the other side of the argument.

Many of our new readers may think that Valor has a large exposure attempting to profit from a slowing China. We believe that China has some difficult rebalancing years ahead, but we prefer to invest in wonderful businesses that can grow their owner earnings over the next few decades. Our main goal is to attempt to remove as much risk from our clients portfolios from a China slowdown and the only upside we expect is a potential fall in the Australian Dollar or our international holdings.

Our position is that owning cyclical businesses that are closer to the top of their cycle than the bottom is not a sure path to wealth and can destroy capital faster than most predict when margin contraction occurs.

Completely in control

The general consensus is that the ruling elite in China have complete control of their economy and can manufacture a soft landing regardless of the imbalances that appear quite obvious.

The amazing insights into the hidden world of the leading men of the Communist Party by John Garnaut shows they are having trouble controlling the infighting in the party, let alone the finer workings of a $7trillion economy.

The best from our portfolios

As a suggestion from a good friend, I have decided to give some insights into how we manage our portfolios.

The suggestion he made was to provide a few examples of our best stocks over the last few years.

As with every bit of advice I discuss on this blog, it is general advice and has not taken into consideration any persons financial objectives, goals or risk attitude. If you are looking for specific advice on your portfolios, we believe we have a respectable track record at Valor, so give us a call on 02 8013 5205 and we can get together to see if we can help you.

Here are our portfolios best stocks over the last few years: (Stocks we previously bought, but are not necessarily in the buying range anymore) (We have bought at different prices for clients so the average buy price can vary.)

Magellan Financial Group

Magellan Financial Group has had a fantastic couple of years. Their funds under management has grown from approximately $400 million a few years ago to $4.5 Billion today. This growth combined with a slower growth in costs has seen earnings double approximately ever 6 months for the last few halves. There are very few companies that can boast returns similar to Magellan.

Hamish Douglass and Chris Mackay are very capable in both the attributes a fund manager requires; marketing and skill at allocating capital. There are countless fund managers who fit the first trait, a few who fit the second trait, but very few who combine both talents to draw in enormous inflows of investor money.

Fund management businesses are inherently risky businesses. When they are out of favour, the financial planners can exit their clients funds at an extremely rapid pace. For this reason, we always limit these types of businesses to very low single digit percentages of our clients portfolios. If we can find four or five above average fund managers over the years, this group of businesses should hold quite favourable economics when compared to the average market return.

We began buying Magellan at $1.25 and have held the stock to its current share price. We intend to start trimming our position not much higher than the current price.

Google

Google is the dominant force in online advertising. Their commanding position in the market is yet to reveal a worthy challenger and is going from strength to strength.

Whenever a company's product becomes part of everyday vernacular, it is likely that products brand is entrenched in society. Google is an everyday word and it will be enormously difficult for Yahoo or Microsoft or any competitor to knock it off its perch any time soon. The day is hear someone say they are going to "Bing" something to look it up on the internet is the day I begin to question our Google holding. The growth in tablet and mobile search may slow profit growth as cost per click is substantially lower, however we believe there is still significant upside from the current position.

Many online businesses may be less than a decade old and so it may appear difficult to judge how deep and wide their moats are in such an infant industry. We do see many changes in this industry over the next few decades. This is very different to the car industry where cars are not dissimilar to cars from 10 years ago and are likely to be fairly similar in another 10 years with perhaps slightly different engines or power plants. The 20% time for Google employees should see Google at the forefront of the industry in many areas. This one point will likely keep Google's moat wider than its competitors as one of the dominant players for many years to come.

We purchased our Google shares for our clients around the $560 to $580 per share. Its latest pullback is returning its valuation to a more attractive range and with 45% growth in revenue in the last year, we believe there is plenty of growth ahead.

Walmart

Walmart has been a stellar performer for our clients climbing approximately 50% to its current share price from our purchase price of approximately $52.

For those that have wandered around a Walmart in the US, they will understand the commanding position this retailer holds over the competition. The prices are astoundingly cheap. For a company that has grown at high single digit rates throughout the GFC, we were very confident when we were purchasing the business at around 10 times earnings that we were getting one of the worlds best businesses on sale. The property portfolio of Walmart is worth approximately $60 billion which complements their retail operations.

The risk from online and competitors is not insignificant, however the management at Walmart led by Mike Duke appear to be cognisant of the risks and are taking steps to ensure the Walmart moat is both wide and deep for many years to come.

The 50% price rise has us less excited about significant future gains, however is not enough to warrant us selling our position.

Asia in decline according to Buffett

At Valor Private Wealth, we have been positioned for the last 18 months expecting a lost decade in Europe, a slowing China and a recovering US.

As Warren Buffett describes in his latest interview on CNBC, our predictions are beginning to transpire as expected.

Whilst we have macro views on the economy, we prefer to invest in wonderful businesses that have the ability to create their own economics. Our strategy is paying off, with well above average returns over the last few years.

Demographics in China

There is still a belief that the current slowdown in China is temporary and after this short hiccup, most believe that China will continue onto over taking the US as the dominant economy at some stage in the next few decades. Looking at the demographic trends and I am not so sure.

Whist Harry S Dent makes some absurd predictions and I dont follow his tea leaf forecasts, his work on demographics and the effect on the economy has some merit. China has some potentially disastrous demographic trends due to the one child policy which will likely detract from future growth more than many predict.

The property bubble over the last few years has been compounded by the fact that for a young male you have had great difficulty in wooing a wife without owning an apartment. Looking at the one child policy which started in 1979 (one year after I was born) and mirroring that to the average age for males to marry (approximately age 32) and it is obvious we are at a junction point. The number of single child males that are to marry in the future will be fewer and so there is likely to be less pressure for buying apartments to marry.

With an aging population in a society with virtually no safety net and fewer children and grandchildren to look after the elderly, it becomes apparent that there are some very challenging demographic trends.

The worlds factory has had an abundance of young workers to chose from over the last decade, however as that workforce ages, will the older workers demand higher wages and better conditions? Will this make the marginal returns of many Chinese exporters uneconomic? What industries will China have to develop as the wages rise to counteract the more marginal operations of the manufacturing enterprises? Can they overcome these issues?

When I was in Guangzhou earlier this year I noticed a disproportionate number of younger people on the trains and wandering around the city. My Chinese friend explained to me that many of these migrant workers come from the countryside to work in the factories. What happens in the future when this flow of migrant workers slows?

Economic forecasting using demographics is no where near an accurate science, but for those investing in Australia in companies which rely on China's miracle economy, I would suggest that they look further into the risks they are taking over the medium term. The potential downside for these investments is larger than most would acknowledge. As Buffett always says:

Rule Number 1: Dont lose money
Rule Number 2: Dont forget rule number one.

When making investments in cyclical companies based on China's endless economic growth, I do not believe you are ensuring you meet these two simple rules.

Chinese Accounting

Jim Chanos aptly described the collective group of Hong Kong listed Chinese Shares as a "roach motel", suggesting that almost all of theses shares had accounting irregularities.

My good friend John Hempton has also demonstrated in extreme detail how Focus Media just cant be taken seriously with their fairy-tale accounting along with numerous other Chinese companies listed on foreign exchanges.

And now Paul Gillis has produced a powerful work on the VIE's (Variable Interest Entities) for Asianomics that politely argues how the structure just doesnt work any more. (Did it ever work?)

For those that believe in the China miracle, I would suggest you take a long hard look into the accounting of Chinese companies. The prolific number of frauds and accounting irregularities that are in the Chinese foreign listed companies is creating a trust gap.

The world economic system is built on trust. If there is a failure of trust in the economic systems, then capital flows can break down. Whilst China just recently overtook US as the highest country for FDI (foreign direct investment), I would suggest that further accounting scandals and frauds could turn this capital flow on its head very quickly.

What happens in this space over the next few months and years could be very interesting. So far very little has been done by the Chinese to attempt to fix these issues. Any further deterioration in trust does not bode well for the Aussies betting on the permanent China growth story.

Our second largest trading partner is not in great shape either...

If there wasnt enough to worry about with the Chinese slowdown, then a debt crisis in Japan should be enough to keep the Aussie bulls at bay. As our second largest trading partner, Japan still pays a significant part in Australia's economy.

Whilst Japan shouldering the largest government debt in the world may be nothing to worry about, when it is combined with slowing exports to China, you have a recipe for potential pain ahead.

Nothing may come in a military sense of the territorial spat between China and Japan over a small group of islands, but the silent economic patriotism is definitely having a marked affect.

But yet there appears to be some greedy souls pouring back into Aussie banks and miners leading to a run on the All Ords over the last few months.

I think we are in the eye of the storm. Perhaps the storm hasn't even started yet.. Caveat Emptor!!!

Has China Bottomed

There are numerous theories around that are suggesting that China has managed this slowdown extremely well and that their economy is bottoming now and in the fourth quarter. It is quite amazing how 9 guys (about to go to 7 guys) can get together and control a $7.5 Trillion economy with such precision.

Is that all there is to the China slowdown? Or are the numbers being massaged to make it look pretty for the handover of power?

I am not so sure this is the bottoming of the Chinese slowdown

The bigger the party, the bigger the hangover. (I should know this because I had my bucks party last weekend!!!)

China's fixed asset boom has no parallels. I would highly doubt that a country that is so "unbalanced, uncoordinated and unstable" as stated by its leader is able to have a such a short period of lower growth and all of a sudden start building empty buildings, empty apartments, empty offices, empty bridges, empty airports and empty trains at the rate it was during the 2009 to 2011 period. With the capital outflows out of China, it would seem that investors are not so convinced in the China economic miracle story anymore.

As BHP boldly stated last week that China has reached peak steel consumption, this suggests that there is going to be slower growth ahead.

Only time will tell, however I would suggest that those with their finger on the pulse like Michael Pettis, Jim Chanos and Patrick Chovanec have a higher probability of being right than those who didnt even see any slowdown coming.

A Tribute to Al Ueltschi

I had the pleasure of meeting Al Uultschi through Bob Miles at one of the many Value Investors Conference's that I have attended.

Al has been an inspiration to me over the years in the way that he was also an international pilot and business owner at the same time.

He gave me some very encouraging words of advice and I will always remember him fondly.

His contributions to sight impaired through his founding of Orbis is a testament to his nature.

Today is the passing of a wonderful human being.

Having a Command Economy does not solve all issues

Many people still believe that because China is a command economy, that they can fix any problem they face due to stricter policy control.

It all comes down to incentives and unfortunately the incentives in the Chinese economy are leading to very poor investment decisions.

The government have lured numerous industries into running at a loss because of the failed policies. Whilst the industries have grown, they have grown unprofitably. Much of the infrastructure that has been built in the 4 Trillion Yuan stimulus is expected to not return enough to pay the debt load leading to the enormous roll over of local government debt.

I think the latest reports of the solar industry illustrate how backward the Chinese economy is and why we believe that there is still a way to go on the downside in the rebalancing of their economy.

We continue to fear significant downside in the Chinese economy and the flow on effects for Australia could lead to an extended period of less than acceptable returns.

Finding it harder to find value

Due to the latest market increases, fewer and fewer of our favourite companies are at or below what we consider to be fair value, however fair value can depend on where we think inflation (or deflation) will average over the next decade.

Ben Bernanke has lit a match close to an open flame which has the potential to ignite. Whilst we are still worried about anemic economic growth in the western world after some spectacular asset bubbles and corresponding debt, the more the central bankers promise, the greater the threat of inflation.

With a recovering housing market in the US, soft commodities hitting highs and a sense of confidence returning thanks to Super Mario and Booster Ben, we may see inflation rear its ugly head at some stage over the next few years. I would suspect that this is what the central governments are trying to induce to inflate away the enormous debts (but would never admit), but they should be careful for what they wish for.

For those that need to live off their capital for the rest of their lives, having a large majority of your money in "safe" assets such as cash and bonds may actually destroy capital at a faster rate than you could imagine. Double digit inflation like in the 70's can eat away at your capital extremely quickly if you are in low to mid single digit fixed return assets.


For those thinking all shares have inflation protection, I must stress that this is blind faith.

During times of high inflation, having pricing power in a business is paramount and very few businesses posses this quality.

Capital intensive infrastructure businesses can hold some inflation protection as it becomes more expensive to replace the capital assets than it is to hold existing assets. Regulation of these assets can take a bit of shine off this protection.


No one knows the future, however you should always attempt to prepare for the worst and hope for the best...

Are SMSF's under exposed to international stocks?

Looking at the data from the SMSF review newsletter that I receive, they state that:

471,388 SMSFs in existence
901,285 SMSF members
$438 billion in assets
29.9% is in listed shares
30.5% is in cash and term deposits
15.1% is in direct property

The latest information I could find regarding direct international shares was that less than 1% of SMSF's total investments were in direct international shares and only approximately 8% of SMSF assets were available for other investments of which international exposure was in that basket.

Are the SMSF's investing too much in Australia which is such a small part of the world economy and is highly exposed to just digging holes and reselling over priced houses?

Perhaps due to the fact that I travel the world with my job as a international pilot, I see a very narrow focus of the typical Australian investor, professional or amateur.

I worry that the average SMSF which generally holds large amounts in banking stocks, some big miners and a good proportion in cash may underperform the average industry fund over the next few years. The industry funds generally have a higher international exposure and if our housing market slows, China slows and cash rates reduce to lower single digits then the average "punter" SMSF may struggle to keep up.

Conversely, the average SMSF is usually less exposed to the chronically low bond yields currently seen around the world.

Whilst Aussie government bonds may still have some upside, the average global government bond is very much as Buffett described "return free risk". The lack of exposure to these overpriced bonds may cushion the SMSF sector compared to the average industry fund which probably holds higher amounts of these significantly overpriced assets.

Update on Housing Market

John Edwards from Residex always gives a good view on what is happening in the residential housing market in the short term.

He mentions that the markets are fragile and affected by news from Europe and around the world. In translation, does this mean that houses are still significantly overvalued and people are worried that if they borrow the enormous amount of money that they need to buy, then they may have issues paying it off in the future?

Surely if people were buying houses without excessive leverage, then they would be far less affected by external signals.

The fall in interest rates does not appear to have given the housing market a kick start, but rather dampened the losses. Perhaps a few more interest rate cuts will give the market the kick it wants, but may not need.

Anecdotally, I still see numerous people with what I consider ridiculous mortgages. I still believe that the old conservative maximum of two and a half times your income is the most you should borrow. This is very far from the minds of people who sometimes borrow up to seven times their incomes.

Those that are borrowing enormous amounts of money to buy a house at the present time, I caution you to be on the conservative side and ignore what the maximum amounts the banks will lend you.

I worry about Australia and our very pricy houses in the event that unemployment rises due to a significant slowdown in the mining sector. 

Brilliant summary of Chinese problems

Professor Patrick Chovanec is one of the more informed Chinese economic experts.

His latest CNN video is a wonderful summary of the Chinese conundrum of debt and growth. 

The GDP dartboard in China..

With the raft of downgrades coming after the bad news out on the weekend in China, the geniuses of our top banking economists are changing their tune again. I always love a 12 month forecast that changes every 3 months.

These are the same economists who only a year ago said that there would not be any landing at all in China, soft of hard and China would continue to grow at high single digit rates for years. The RBA is still in denial suggesting that China will continue to build empty buildings until the 2030's.

My prediction is that China will massage any GDP figure no matter how bad the economy is to ensure it makes the 7.5% GDP growth that the government forecast.

Electricity figures could fall, exports could continue to slow, consumption could slow further and the GDP will still come out at 7.5%... 

Brewing under the surface

A very well written article here outlining the political risks to China's future.

Whilst I agree that there is a risk of a revolution, there would have to be a large scale disgust with the leadership in China, which at present doesn't seem likely.

From my many trips to China, I have formed the opinion that the locals are quite patriotic even in the face of mass scale corruption, controlled existence and very limited political voice. I would suspect that it would take more than a few Bo Xilai scandals to move the people to unrest.

The Chinese governments prime objective is to keep their power. This will mean keeping low unemployment regardless of a slowing economy, tight censorship and continued propaganda. The former ministers of railway and current ministers of local provinces are multi billionaires. They will stop at nothing to keep their power, they will even murder to keep their positions. Whilst the Russian economy crashed in the late 90's the power still remains in the corrupt elite. I would not bet against the Chinese Communist party keeping their power.

Chances of Chinese stimulus diminishing

With anecdotal evidence such as todays WSJ article, the chances of a substantial Chinese stimulus get smaller by the day...

Still bubbling away...

Here I was thinking people were coming to their senses in the Aussie property market with the falls over the last few years and then this...

I would not want to know what the rental yield on this one would be. Less than 2%?

Maybe the property spruikers will prove correct and the laws of compound interest can be rewritten allowing house prices to double every 7-10 years!!!

If that is the case, then the geniuses who paid $1.9 for a 1 bedroom apartment here will be able to sell their 1 bedroom apartment for $3.8 million in 2019 or $7.6 million in 2026 and then maybe when China has taken every bit of iron ore out of the ground in Africa, Brazil and Australia after 21 years of boom as predicted by the RBA then someone will come along and pay $15.2 million for one of these 70 square meter apartments in 2033.

Stranger things have happened and if China keeps building at the rate that they have, then they will have an enough for four office spaces for every man woman and child in China by this time!!!

Perhaps if we have 1970's style inflation for 20 years, then these apartments may look good value.

Whilst I do think that inflation may be higher in the future, I wouldn't bet the house (or small apartment) on this. 

Tale of Two Markets

Shanghai index versus the Dow

When you are comparing the best companies in the world to the worlds factory and building empty buildings, I know which one I would bet on...

China Quarantine

With much of China's excesses being driven by internal forces due to their enormous stimulus, how much of its problems from these excesses will be quarantined to China and the commodities export countries?

Will a hard landing in China significantly affect a US recovery?

At Valor Private Wealth, we believe that the forces of a housing recovery will be stronger than the headwinds from a significant slowdown in China leading to continued moderate growth in the US.

Our investments are reflected in this manner with significant holdings in US based companies including US banks and housing related companies.

We have our largest holding in Berkshire Hathaway as we believe that their earnings will recover quite strongly with better results from Clayton manufactured homes, Benjamin Moore paints and Shaw industries carpets. Add this to the downside protection of Buffett's buy back promise and you have a good recipe for limited downside and quite reasonable upside.

Whilst I have been seen to be quite negative on Australian mining and housing for the last 18 months and believe that we are just at the beginning of what could be a very rough patch for Australia, I am very confident that at some stage in the next few years, the US economy will begin to recover stronger than most expect as housing construction and the flow on effects return to more normal growth levels.

In the meantime, the politicians in the US are likely to have asinine arguments about debt ceilings and cause irrational markets to remain choppy. This stimulus junkies will be holding out for their next hit and if it doesnt come when they expect, their impatience could put some pressure on markets in the short term.

Coffins Corner

China is in "coffins corner".

Coffins Corner is a place you don't want to be when flying an aircraft. It is caused by flying much higher than your optimum altitude. If you fly any faster, you get an over speed condition often with high speed buffet, and if you fly any slower you stall.

China has been flying much higher than their optimum altitude quite a few years now.

If China stimulates, they could cause an overspeed and will likely crash the economy in a few years. If they slow down, they could cause instability due to deflation as explained by John Hempton in his brilliant Kleptocracy blog.

At Valor, we are not expecting China to stimulate in a similar manner to their 4 Trillion Yuan previous injection, but we are keeping a very close watch on this.

I would suspect that Twiggy Forrest is awake at nights praying for his $100 a tonne iron ore price and a significant stimulus very soon. I would think it is a low probability that Twiggy gets his wish.

More Promises...

Another promise from Wen about buying more European debt.

I suspect that China's own debt problems will severely limit any debt purchases in Europe.

Sorry Angela, I think you might be on your own with this one. Roll out the printing presses...

Where is the money going to come from?

With the tug of war between returning to surplus to keep the ratings agencies happy and stimulating the economy in what we believe is a coming downturn, the question for future tax revenues starts to come into question. Ken Henry's mining tax should have been introduced many years ago, however the power of the mining companies was enough to bring down a prime minister over this issue.

Where will the tax revenues come from when China is not building empty buildings?

Will they tax super over 60 at some stage over the next decade or so? I am not so sure this is out of the question.

With an aging population requiring higher medical expenses and a lower working population percentage in the future, Abbott's fantasy idea that we can have a Howard style era is just that, fantasy. 

Aviation Safety

For some bizarre reason, the finance world likes to make all in bets. They use leverage to back themselves into corners and reduce their possible outcomes.

Aviation has developed over the years to avoid this kind of practice. In every commercial aircraft, multiple systems are in place to compensate for the unknowns. There is redundancy.

Warren Buffett talks about risk in a similar way to Aviation safety risk. He always looks to have a minimum amount of cash on hand to handle any unknowns.

As an international pilot, I spend numerous hours per year in a simulator working through different scenarios that could affect an aircraft. Luckily most of these scenarios will never happen in my career, however this does not mean we are not trained to be ready for them if they happen.

Whilst the system of the world of finance may be slightly more complex than the systems in an airplane, the strategies to prepare for the unknowns should be similar. Sadly, they are not.

Whilst our Reserve Bank and political leaders might attempt to con us that we do not have a housing bubble and China is not going to have a hard landing, they should not be complacent in their modeling of the effects of an extended slowdown in China and subsequent housing slowdown may create. This is their job. Not to sit in their big leather chairs and ignore the risks, but to think of all the risks and attempt to build in redundancy into the systems.

They may be doing this in the background without our knowledge, however housing busts and the surprise they caused to politicians and economists in the USA and around the globe have proven that this is unlikely.

The work of economists and finance professionals in todays world is not much better than the effectiveness of 18th century doctors and the technique of bloodletting to cure disease. 

When will it pop?

Breathe in as much air as you can. Then when you think your lungs are full, try breath in some more.

This is a similar problem China is facing at present. They have breathed in as much debt as they can, but popular thought is that they can continue breathing in as much debt as they like to keep the economy ticking along at high single digit rates, albeit with a soft slowdown to 7.5% this year.

Whilst they may be able to stimulate in the short term, it would likely cause greater imbalances over the medium to longer term as the majority of any stimulus would continue to be channeled to inefficient government directed fixed asset investment.

There is a great article here from Zarathustra about the loan issues China faces over the next few years...

Ignoring Fundamentals

I usually dont worry too much about short term moves in the markets as they can be quite irrational but current trends are puzzling me.

Iron ore has fallen significantly lately but yet the big miners BHP and RIO are going up? (See http://www.macrobusiness.com.au/2012/08/ore-swaps-bust-the-ton/)

Who is crazy enough to buy these companies when the fundamentals are heading in the opposite direction to where you would want them to go?

Are they betting on a bigger than 4 Trillion Yuan stimulus in China? I am not confident that the Chinese will introduce a stimulus equal to or larger than the previous 2009 injection. Without a large stimulus, I would suspect that there is a continual decline in commodities over the next few years heading toward longer term averages.

I suspect that China will stimulate, but at a level that they believe will stop the rot rather than ignite another boom. They have shown they are keen to keep the pressure on property prices in the larger cities and I expect this to continue in an attempt to stop a reflation of the bubble.

The fragility of the Chinese banking system, the potential for numerous de-listings of Chinese companies in the US and a capital outflow are just some of the risks to the Chinese economy in the near to medium term. I would suggest that it may be difficult for the Chinese to get past this coming speed hump without meaningful slowdown. You need to contend with these issues when buying the mining stocks at present.

Caveat emptor!

Belief in China's command economy to solve all problems when it is the command economy that caused the problem is a dangerous paradigm.  

Strange Strange World...

Strange Strange World...

We live in a world where bond yields are negative, Australian Banks are worth more than some of the largest American banks and Australian mining companies are trading at 3 to 6 times their book values at a point closer to the top of the cycle than the bottom.

Unfortunately all of the above scenarios may not work out too well for those that are placing their faith in the concept that the world will permanently be in this current situation.

My first ever blog post...

I am not sure if this is going to be a regular thing our just a way to get through to existing and future clients in the most efficient manner, but here it is...

In Search of Yield

The dangerous game of hunting for yield could lead to less than desirous results for investors who don't understand the economics of the businesses they invest in.

The banks are not "safe as houses" and those grabbing for yield could be in for a rough ride.

With one of the highest mortgage debt to GDP ratios in the world, Australia does not have a significant upside in our ability to borrow more for housing. This combined with a huge reliance on overseas funding puts our banks in a less than stable position over the next 5 to 10 years. If unemployment follows a pattern similar to any of the previous cycles in history, then it is unlikely to remain steady at low 5% range for ever. At some stage, rising unemployment with enormous mortgage debt becomes a problem. It may not be this year or next year, but a cyclical turning point is likely at some stage and those holding bank shares may not get their "utility like" returns (http://www.macrobusiness.com.au/2012/08/bank-gloomsters-are-from-mars/).

Anecdotally, I am speaking to clients, friends and family who have mortgages that take my breath away at 5,6 and even 7 times their incomes. Whilst they have previously had a bit of a buffer in the equity in the house, the house price falls of the last few years is slowly eating away at their margin of safety.

"Be fearful when others are greedy and greedy when others are fearful." (Buffett)  When the market capitilisation of Commonwealth Bank is more than the market capitilisation of Bank of America or Citigroup, I know which company I would be more fearful of owning.

Aussie Dollar

The mining stocks and Australian dollar are confusing me at present. I am not sure if I am missing something, but the recent "real data" coming from China is pointing to a significant slowdown. With electricity figures running at a negative year on year growth for the first time in a while, I would suspect that China is in the early to middle stages of a hard landing. There is likely more of a slowdown coming.

Having traveled to China dozens of times in the last 15 years, I am very suspect of the reported news that eventually hits our papers. You need to scratch under the surface to really understand what is going on in their economy. Half of the Chinese figures are so ridiculous that it makes them laughable.

In the short term, things can be irrational and the latest movements of the Australian Dollar and mining stocks are missing the point that no economy in history has had a smooth transition from an investment based economy to a consumption based economy and I doubt that China has rewritten the laws of economics.