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.