Rob Coyte's Blog

It provides a comprehensive and interesting overview albeit in a relative short period of time and I thoroughly recommend you either watch the DVD or read the book.

Through looking at the history of money the overall conclusion is that we never learn from history when it comes to issues concerning money. Given the current financial crisis it provides a look at how we got here and indeed a much needed perspective.

Some of the interesting stories include the establishment of the first limited liability company in 1602 by the Dutch and how they fought wars to protect their interests. Niall takes a close look at the first stock market bubble “The Mississippi Bubble” caused by a Scots man John law, a convicted murderer and a compulsive gambler. This was basically a Ponzi scheme, named after an Italian American Charles Ponzi, which has remerged recently by the former Wall Street legend Bernie Madoff that has lost tens of Billions. He looks at the dubious business and accounting practices of Enron and its subsequent collapse from being the darling of wall street. He draws the parallel between this financial disaster and the “Mississippi Bubble” some three hundred years earlier. He talks about the modern day fraudulent practices and the “cooking of the books” and the dishonest actions of the directors and senior management led by Ken Lay. Most of the deception incurred by Enron was by their methods of “hiding debt” off balance sheet and such practices have been picked up by other executives in the western world to lead to today’s financial crisis.

He looks at stock markets booms and crashes and the “herd mentality” that investors demonstrate to cause such huge over reactions, from the overly optimistic to the overly pessimistic, indeed greed to fear. Probably one of the most famous descriptions of this was by former Federal Reserve Governor Alan Greenspan who called it “irrational exuberance”.

He looks at the fallacy of “Safe as Houses” and how investors at their own peril take the view that property never goes down. Whether this be it investors or owners in real estate itself or indeed to lenders that lend money against property. Niall says “No amount of financial alchemy can turn little suburban boxes into treasure chests with roofs”. From individual circumstances such as the losses incurred by the 2nd Duke of Buckley who lost his immense wealth in property spanning more than 67,000 acres in England, Ireland and Jamaica, or collectively such as The Great Depression which saw US property prices plunge as people became unemployed and could not afford their mortgages.  Other examples include the  1960’s Savings and Loans crisis which saw US property values collapse, in the UK property prices fell by 18% between 1989-1995, and then the big one in 1990 the Japan property market collapsed by 75%.

From the very first bankers, the Loan sharks who inflicted physical injury for non payments, they have never behaved well.  Ever since deregulation of the banking sector it has definitely been a case of “caveat emptor” or “Buyer Beware”. In 1984 in Dallas, Texas The Empire Savings and Loan scandal in Texas where the bank scammed investors for by raising deposits to then fund borrowings for lenders so they can buy worthless property at highly inflated prices with a developer they were in business with. This scam cost $153 Billion which was a bill put by the tax payer but this amount was going to be miniscule compared to the crisis 20 years away. The “Sub Prime” collapse which has caused global financial dysfunction as a result of banks lending people with no incomes loans to buy houses. The banks packaged these loans (securitised them) and the sold them off (for a fee) to investors all around the world. When the loans were seen as bad due to rising interest rates or declining property prices the chaos followed.

Probably one of the most fascinating aspects I felt of the series was how invariably the powerful have fallen. This is no more evident by the fall of Lehman Brothers, Bear Sterns and Merrill Lynch in the latest crisis.

Niall also looks at globalisation and the over reliance of the developed world on having their spending being funded (borrow money) by what were considered the “Emerging Markets” lead by the rising giant China.

A company's share price is an extremely volatile beast. In most case the underlying profits of companies are fairly steady and consistent with good companies growing profits over time. Whilst there may be changes to profit from year to year depending on the operational performance of the company these variances are usually nowhere near as volatile as share price movements. For example the bank share prices at their worst halved but underlying profit has only decreased say 5-10%.
 
Given short term profit uncertainity companies may cut dividends or distributions so as to ensure they have enough cash remaining inside the company to not only meet their current expenses but fund future investments and projects. A lot of companies with high debt levels are also getting pressure from their banks to reduce the level of their debts which means they need to retain cash to repay these loans. In the past some shares have been paying higher dividends and distributions than actual cash earnings obviously this cant be maintained indefintely.
 
Whilst any changes to dividends or distribution effects the investors personal cashflow it is in the investors interests to ensure that the financial security of the company is maintained. Such changes are usually only short term fixes and if the company has longer term issues they then raise cash by either selling core assets or raising additional capital from investors.

Over the last decade no doubt the story has been China, India and other emerging nations and I agree with the fundamentals  behind this story and these areas will provide outstanding opportunities over the next 20-30 years.

In the last 5 years we have seen a commodity boom (up until recently) as a result of this China story. However, it must be kept in mind that in the decade previous there was a massive underinvestment in resources due to low commodity prices which stifled investment in projects. Then China’s explosion in demand for these commodities saw a massive undersupply which lead to a boom in commodity prices and profits for those fortunate enough to be able to dig them out of the ground. However, with higher prices and increased profits this encouraged existing players to develop more projects and even new players to come into the game, Andrew Forest and the Fortescue Metals Group is a good example of this. Once these new projects come online the supply increases dramatically and any disruption to demand will see the prices and profit margins fall just as quick, this has been the concern over the last 12 months. China is now holding out in its negotiations with regards to iron ore pricing as they want reductions in price of some 30-40% in contrast to the year before where the iron ore companies demanded huge price increases as demand was greater than what could be supplied.

Another example of late has been the Perth Office market where vacancies have risen from a record low of 0.3 percent last June to about 6 percent. You could not get space in Perth which meant high rents for landlords and this encouraged massive investment in the construction of new buildings. To maintain the financial returns, rents need to be maintained at current levels which means that all the new supply needs to be absorbed by companies demanding space. The above reversal of the commodities boom has proven to be the undoing of the Perth property market with demand now decreasing in a period where supply has risen sharply. Lee Walker, at Sydney-based forecaster BIS Shrapnel said vacancies in Perth will jump to 16 percent by mid-2010, peaking in 2013, with average prime rents dropping to A$360 ($286) per square meter from current price of A$720 now.

As investors we need to be taking long term views and we need to understand the fundamentals of our assets. Market movements are usually a result of short term sentiment which changes more frequently than Melbourne weather. History is full of examples of markets getting carried away with “this time it’s different” . Booms never last neither do busts. We tend to place little emphasis on sentiment in making strategic decisions as it usual leads to the destruction of long term wealth not the creation of it.

So if the funding costs are now being reduced for Banks why are our interest rates going up?

Banks have been accused of not passing on these reductions and as a consequence this will improve their own profit margins. It is thought they are doing this to protect themselves from increases in losses from bad debts as the economy slows. The banks will be generating greater profits as a result of the margin expansion, in a time when their competition has been greatly reduced, which in turn will give them more capital making the a safer “financial” proposition. In short as we have been saying over the last 12-18 months the Australian banks are going to be big winners as a result of the credit crisis.

So the funding crisis is over, but until the banks start lending money to businesses and individuals on reasonable terms the credit crunch is not yet over.

As per previous blog you are running out of time to undertake your tax planning strategies for this financial year. We covered a number of simple strategies in our previous newsletter which can be found on the website here.
 
It is imperative that you act before the end of the financial year because after that its too late.
 
Please contact our office to ensure that you are approrpiately positioned for the end of financial year.

Keep in mind that our first Client Rewards offer is closing 30 June, so for those holding out until the last minute - don't miss this opportunity to win one of three fantastic gift vouchers from Red Balloon Days.