Go Placidly Amid The Noise and Wait

Given the carnage on the markets over the last week or so, it was only a matter of time before the we got some irresponsible media reports.

So far, I give a qualified single thumb up to the media for restraining themselves from the kind of sensationalist and hysterical spectacle we saw during the tech wreck. At no stage have we seen the media, en masse anyway, hinting that everyone should sell up before (paper) losses get too great. At least, in Australia, anyway.

The reasons for this are twofold:

1. The tech wreck ended up as, by and large, a bit of a non-event in this country. We're not a hi-tech country. We weren't subject to mass IPOs of dubious quality floating on the market in the same way that countries like the USA were. Needless to say, those in the media who got a little crazy after the events of 2001 looked like geese, and probably felt a little sheepish afterwards as well.

Enough with the animal insults.

2. The Australian economy is in great shape. Our banks are totally not in need of "guaranteeing" in the same way as what is going on in Europe and North America at the moment. Never mind that, though. Our Federal Government guaranteed them today.

OK. Up until quite recently, we did have a bit of an inflation problem. On top of that, we did have a real estate bubble that, thankfully, appears to have sprung a slow leak thanks to our (still relatively) high interest rates. But in the overall scheme of things, we're doing OK.

We don't have a property price crisis like over in the States, though. Yet.

It did make me wonder though, during the week, when I turned on the news to see that some commentators are now starting to consider the distinct possibility that a housing price slump could hit Australia. I would personally welcome this, however, it could cause some grave havoc.

Consider this: In the 1980's, the median house price was set at around about three times gross household income, based on figures I saw during the week. Now, it appears to be about seven and a half times. In real terms, this is simply too much for most householders to afford, and should ring alarm bells anywhere, in the same way that the USA's foreign debt at around 350% of US GDP is at the moment.

By the end of the week, the massive spin doctoring machine that is the Real Estate guilds in each state had reversed this talk, and were even talking up their industry, with headlines like "Housing Prices Bottoming Out", amongst others.

You have to hand it to the RE guilds. The media is totally in their thrall. Media Watch, a couple of weeks ago focused on the attention that Sydney newspapers paid the sheer spin and dishonest figures that the Real Estate Institute of New South Wales like to put out to support their arguments. Figures that, when compared to those churned out by the Australian Bureau of Statistics, seem totally incredulous. The Daily Telegraph even held up the REINSW as being the "peak body" when it came to these figures.

I'm at the point that when I see a property story on the news, I simply don't believe a word of it if there is even only a one-word quote from anyone associated with these bodies. The fact is, the RE guilds represent real estate agents. They do not present fair figures honestly, and how the media don't see through the rubbish that they put out every week is one of life's little mysteries that we'll never see solved.

But on the whole, the media has been relatively controlled on the stampede for the exits that we're seeing in equity markets at the moment.

I did, this week, see something that made me wince.

Marcus Padley, a stockbroker, and regular columnist for The Age usually writes some insightful articles on finance.

Padley, for those who don't know, possesses a sharp mind and one of the silliest egos in finance this side of the late Rene Rivkin. He writes a tip sheet, which is relatively highly regarded, called "Marcus Today". Obviously, Padley was oblivious to the groans that went on around his office when he decided on that one.

Padley wrote an article in The Age which in my honest opinion, is the stupidest and most irresponsible op-ed piece during a financial crisis that I have ever seen. It was titled, "Take your money and run - it's worthless advice".

Cop a geek at this. Padley writes the following choice quotes:

"If I was still holding stocks, yes I'd still sell them... But I come at it not with an opinion about the direction about the sharemarket, but from a human perspective."

Padley has essentially held out a red rag to the bears and said, "Go on. Sell up. You know that you want to."

"But [don't hold on to your stocks] if you can't afford any more losses and are in pain. The definition of "can't afford" in my book is this, if I had to go home to my wife and tell her our expectations are going to have to be lowered."

(My emphasis)

OK. We're all going to have reduced expectations as a result of this. In Padley's opinion, everyone must sell everything, lock, stock and barrel.

"Who wants to play in a casino? The volatility has reduced the market to a casino. In a casino, no opinion has any value."

Your average investor might just as well give up at this point and shoot craps, because this is what Padley is suggesting that the market is no better than.

This is despite the fact that we know a great deal of market behaviour over the long term, which tilts the odds firmly back in the direction of an investor. Unlike our craps table at the casino, which is rigged against you from the start.

This is just the first third of an article which Padley manages to break every rule in responsible journalism. By essentially saying, "everyone should sell, without question," Padley has crossed the line into Personal Financial Advice territory, and should have the book thrown at him by ASIC.

Elsewhere Padley offers these little gems, which I have paraphrased:

• Avoid losses. Therefore, avoid the market as well. It doesn't matter if you are in it for the long term or not.
• I agree that the herd mentality is good. Stick with it and you can't go wrong.
• Optimism is just that. Even if it backed up by the sheer force of history that suggests that investing for the long term requires a buy and hold approach.

Honestly, the whole thing almost reads like a parody. If this is Padley's idea of a joke, it's not funny, and he should be hauled over the coals as soon as the moment arises.

On top of this, Padley is a stockbroker. This means that whenever another sale is done, he collects a commission from it. Ka-ching!

Out of 5 stars, I give this disgraceful effort a bitch slap. Padley needs to wake up to himself.

Standard but necessary disclaimer: Only a complete idiot would think that any of this plausibly constituted advice. It's not even vaguely reasonable to consider this to be advice. If you are in any doubt as to the content of this, see a good, independent financial adviser immediately. They do exist.

Brutal carnage!

We've seen a lot of action on the markets in the last few weeks, and I suppose that some of my regular readers are probably wondering, "Hey Dikkii. You've been awfully quiet on this."

And I suppose that I have. The thing is, I'm neither greatly spooked, nor am I greatly interested. I've had more important fish to fry at this point in time, but I have been following at a distance.

So I thought that I'd get my thoughts down on paper and attempt to try to put together some thoughts on the week that we've just had, because it has been a doozy. I'm not about to go the way of the financial media and suggest that the global market slide that we saw represents the death of capitalism, though. This has been some disgraceful irresponsibility coupled with a complete lack of knowledge about what capitalism really is. However it is interesting to note that where chickens have been coming home to roost, this blogger did see some of it coming.

1. The "Death of Capitalism"

This is just plain lazy reporting.

Capitalism is just the interplay between those two non-physical forces, Supply and Demand. Nothing more, and nothing less.

Supply and Demand, in turn represent the twin human emotions of greed and laziness.

Note that I haven't mentioned fear. Fear certainly impacts on Supply and Demand, but it is not an emotion on what they're built. Allow me to demonstrate:

Imagine that you are a buyer of something that we'll call "doo-hickeys". Greed and laziness suggest that you'll be more willing to buy more doo-hickeys when prices are low, rather than when they're high. Or to put it another way, you are susceptible to a good bargain, and you're turned off high prices. This, folks, is how the force of Demand works.

Let's now switch roles, and suggest that you are the manufacturer of the aforementioned doo-hickeys. It's via greed and laziness that you are willing to pump up production when prices are high, rather than when they're low. Essentially, you're paying in doo-hickeys for money, and when you can get more money per doo-hickey, you want to make the most of it. Which really makes Supply a sort of inverse Demand priced in commodities rather than money.

So how does fear impact this?

Essentially, fear attacks in waves. Usually, fear inhabits a small corner of one's mind, and is not sufficient in its own right to interrupt the greed and laziness emotions.

However, every now and then, the amount of fear that is there reaches a critical mass in an individual, and this will override the greed and laziness to the point where they fail to register. This is called panic.

So for a buyer of doo-hickeys who's financially fearful, they're going to not be so keen on buying those doo-hickeys, because the fact that they're parting with actual cash to get those doo-hickeys becomes worrying. They'll be worrying about the re-sale value of those doo-hickeys. They'll be worrying about whether the doo-hickeys are any good. In short, they'll be worrying. Or fearful, if you like.

Fear affects suppliers of those doo-hickeys as well, but in a different way. Remember how I said that Supply is a kind of inverse Demand? Well, imagine that you're seeing less and less dollars per doo-hickey sold. You may eventually start fearing that doo-hickeys will eventually be worth nothing. You might choose to dump your entire stockpile on to the market, as you fear that to delay might result in this stockpile eventually becoming worthless.

And even though prices are falling, you may even choose to ramp up production in the hope that prices fall even further, allowing you to buy some back later on to sell when prices stabilise, allowing you to realise a small profit for them.

You can see, just from these examples, that Supply and Demand morph into almost entirely new animals as a result of the introduction of fear, however at no point do they go away. Fear just causes greed and laziness to take on lesser importance in the whole system.

Fear also seems to throw rational thought out the window.

And so it is with assets as opposed to the commodity that we've called doo-hickeys. Supply and Demand work in almost entirely the exact same way. Except when fear comes along, and then it's panic stations.

Supply and Demand will not go away. They'll just take on a different shape for a while. The same can be said about capitalism - after all, it's really the same thing.

2. Complex financial instruments

A little while back, I bemoaned complex financial instruments, and how they appear to exist only to generate fees for the issuers of them.

Since then, we saw one capital guaranteed product issued by Macquarie Bank hit the wall and announce that under the rules that it operated under, investors would get their money back. In 2013. But no additional returns would be paid.

No returns at all until 2013 is a frightfully long time for your money to be going nowhere.

Elsewhere, outside these complicated little instruments that are designed to prey on investor fear, we have lovely little terms permeating the financial department stores, and catching investing novices and veterans out alike.

Frankly, people should fucking well go to gaol for Collateralised Debt Obligations, because these little bastards were designed to mislead. How the fuckety fuck can one bundle up a bunch of bad loans as an AAA-rated security I'll never know.

In Australia, we had all these capital guaranteed funds out there that were marketed a bit like this:

You could earn as much as 20%* (*based on market performance). What's more, we'll capital guarantee them, so if they haven't performed in ten years, you'll get your money back.

Investors now are pretty much locked into things that will now look only as good as what they paid for them in the first place. Which makes only the capital guarantee worth something - the representations on returns were something that should have never appeared in print to begin with.

Contracts For Difference - oh these are going to be fun. I'll come back to these a little further on, but I suspect that we're going to hear a lot about these in the months to come.

Look. The upshot of all this is this: If you can't get your head around how a particular financial product works, then for heaven's sake stay away from it.

3. Derivatives, Sub-Prime Loans and the US Housing Price Crisis

In March 2007, I made a throwaway comment in answer to a comment left by Einzige at this blog that we were yet to see the effects of the US housing price crisis.

I was not looking into a crystal ball, people. I was reading newspapers and watching TV, and if people were talking about it back then, then we knew that there was a problem.

Fast forward to September 2008 and we know now where this has lead. Sub-prime loans have basically now brought down nearly the entire US financial system thanks to an oversupply of housing and a sudden rise in interest rates. Is Alan Greenspan to blame?

Hardly, at least in the first instance. What is to blame is a banking sector that assumed that property prices never go down.

Property prices, just like shares, derivatives and commodities go down sometimes. Can you believe that?

Warren Buffett made the bold assertion back in 2002 that the sudden explosion in derivatives was playing with fire. Why, oh why, can't anyone see that if Buffett, the closest we have to evidence of minor deities, is critical of something then it must be bad?

I mean really. Did Orange County, California file for bankruptcy for nothing?

Hmm. Contracts For Difference. Why did that thought just pop into my head again?

4. Freddie, Fannie, Lehman and AIG.

This month has seen bailouts on an unprecedented scale.

Companies should not be being bailed out. Companies should not be so big that they need to be bailed out by governments.

If there is near total domination of a market by a particular company, this is bad. Back in the early part of this century, Standard Oil was broken up. It was too big to allow the market to operate effectively.

We haven't learnt anything from that. In financial planning, a lot is made of diversifying your investments in order to spread your risk. And granted, Standard wasn't about to go down, but no one benefits from this degree of market dominance.

Economies should also learn from this. How the hell could the US mortgage sector be dominated (I nearly wrote "denominated") by just two companies? Just like investors, economies need to spread their risk.

In Australia, banking is dominated by four companies. Five if you count St George Bank, but it's about to be consumed by Westpac, so really, it only is just four.

Once again, this lot are bleating about being allowed to merge further. This certainly shouldn't be allowed. "But it allows us to build scale in order to become globally competitive," they say.

"Go out and build scale in the rest of the world," I say, "You'll have to eventually."

A free market might be about letting companies build this kind of dominance over time. "Free market economics" also suggests that companies genuinely want to pay tax voluntarily, rather than being made to do so. I think you know where I'm going with this.

5. Stock borrowing and short selling

It's been argued that eventually, short-selling en masse will cause even respectable firms to be completely frozen out.

I applaud the efforts of some countries this week in banning the practice.

In Australia, naked shorts were banned. Rather than something out of Benny Hill, this now means that you cannot sell shares that you don't have. In other words, you will now have to borrow them or, gasp, buy them first.

I'm not actually sure how much naked shorting was going on. It must have been quite a bit because on Friday, the market reacted as though share prices had had a bomb fuse lit underneath them. In any event, I'm not sure that hedge funds are solely to blame.

Let's talk Contracts For Difference. Or CFDs, if you like.

In the early noughties, these were introduced on to the market as a mechanism for "spread betting" on the market. You could go long or short, and in later versions, you can now trade them on the market, rather then selling them back to an intermediary and you can get paid dividends on CFDs that you own if a dividend gets paid on the underlying security.

How do the intermediaries who underwrite the CFDs do it? Well, one would expect that they dabble in the market themselves.

And if there are suddenly a lot of their clientele shorting BNB, doesn't the underwriting institution have to short BNB as well?

What I'd really like to know is this: How many short positions on close of business Friday hadn't been closed out when the ban on naked shorts went through? And how are brokers, in the short term, anyway, going to police the ban?

Folks, we are going to see more carnage hit the markets in a big, ugly and undignified way. And even though we consider ourselves immune in Australia, we're certainly not.

I plan to be getting in and cleaning up on the mess that's left behind. But I don't mean fixing it.

Disclosure: This blogger owns shares in Macquarie Group Limited.

Standard but necessary disclaimer: This is not advice. Only a complete idiot would think that any of this constituted advice. It's not even vaguely reasonable to consider this to be advice. If you are in any doubt as to the content of this, see a good, independent financial adviser immediately. They do exist.