Europe strengthens

Germany’s DAX respected its new support at 10500. Follow-through above 10800 would confirm the primary up-trend.

DAX

* Target calculation: 10500 + ( 10500 – 9500 ) = 11500

Italy’s FTSE MIB (Milano Italia Borsa) Index remains in a primary down-trend. Breakout above 17000 and the descending trendline, however, would suggest that a base is forming. Rising Twiggs Money Flow highlights buying pressure.

FTSE MIB

The Footsie retreated from resistance at 7000 but short candles and rising Twiggs Money Flow suggest buying pressure. Expect another test of 7000/7100 but resistance is strong. Correction to 6500 would establish a more stable base for further advances.

FTSE 100

* Target calculation: 6500 + ( 6500 – 5900 ) = 7100

Asia pulls back

China’s Shanghai Composite Index retreated below resistance at 3100. Prospects of a primary up-trend have dimmed and further consolidation between 2800 and 3100 is likely.

Shanghai Composite Index

Japan’s Nikkei 225 Index is pretty directionless, retreating from resistance at 17000. Breach of 16000 would warn of another test of primary support at 15000. But a broad base between 15000 and 17000 is likely.

Nikkei 225 Index

India’s BSE Sensex is the most promising, consolidating in a bullish narrow range around 28000. Upward breakout would signal a further advance towards the 2015 high of 30000. Bearish divergence on Twiggs Money Flow warns of long-term selling pressure, however, and downward breakout would warn of a correction to 25000 or 26000.

SENSEX

Oil Industry Shifts From Survival to Growth | Bloomberg

There has been a spike in oil & gas mergers and takeovers in recent months as sellers expectations of a return to $100/barrel oil prices have finally faded.

From Bloomberg:

While crude has recovered, “there seems to be an increasing consensus that oil will not go back to over $100 any time soon,” said Philipp Chladek, a senior industry analyst for BI in London. “So the differing perceptions about the asset values that, next to the volatility, was the main deal-breaker in the past, are gradually converging.”

Light crude prices have rallied from early 2016 lows to test resistance above $50/barrel. December futures retreated from $52/barrel but this does not seem to indicate a reversal. Breakout above $52 would signal a long-term up-trend with a test of resistance around $64/barrel. With slow global growth, however, further consolidation below $52 is more likely.

WTI Light Crude - December 2016

From Tsvetana Paraskova at Oilprice.com:

Earlier this week, the Russian Economy Ministry said that it expected crude oil prices to remain stable at their current range of US$45-50 over the next two years, with a sustainable improvement beginning in late 2017.

The latest rally in prices, according to a statement by the ministry, has “a speculative nature” and will not last long. The Economy Ministry went on to add in the statement that oil fundamentals were moving in line with “basic forecasts”; that is, the market is on its way to rebalancing, with the glut gradually easing. But this process will take time.

Source: Oil Industry Shifts From Survival to Growth – Bloomberg

UK investor Neil Woodford scraps bonuses as it leads to ‘wrong behaviours’

Colin Kruger, CBD:

One of Britain’s most respected investors, Neil Woodford, has scrapped staff bonuses at his investment group, saying it has proved to be “largely ineffective” which can lead to “wrong behaviours” by staff.

“There is little correlation between bonus and performance, and this is backed by widespread academic evidence,” said the firm’s chief executive Craig Newman.

The academic evidence directly cited by the group was even more damning. “Financial incentives are often counterproductive as they encourage gaming, fraud and other dysfunctional behaviours that damage the reputation and culture of the organisation,” said an extract from The Journal of Corporation Law. “They produce the misleading assumption that most people are selfish and self-interested, which in turn erodes trust.”

I hope we see more of this. Large corporations need to wake up to the fact that bonuses are counter-productive. Not only do they encourage “wrong behaviors” among company executives, they also destroy trust within the organization and with shareholders and the public. Share options are simply a variation on the same theme.

Rather encourage staff to become shareholders, with low-interest loans linked to a clause that prevents sale of the shares for a minimum of 5 to 10 years. That gives employees some skin in the game and aligns their interests with shareholders.

Source: UK investor Neil Woodford scraps bonuses as it leads to ‘wrong behaviours’

US equity prices | Bob Doll

Bob Doll’s view on equities:

Equity indices have again hit new records, but we believe fundamental changes may be necessary for prices to continue advancing strongly. Specifically, earnings would have to improve further and/or investor flows would have to turn notably toward stocks. Neither is out of the question, but aren’t likely….

Source: Weekly Investment Commentary from Bob Doll | Nuveen

Beware of recency bias

Every the year the 2016 Russell Investments/ASX Long-term Investing Report provides an invaluable summary of before and after-tax returns on various asset classes for Australian investors, over 10 and 20 years.

Naive investors are likely to automatically pursue the asset classes that offer the highest yields. Recent performance is more likely to attract our attention than more stable longer-term performance. Josh Brown highlighted last year that mutual funds that attracted the most new investment tended to underperform funds that attracted the least new inflows. I suspect that the same applies to asset classes.

If we consider each of the asset classes highlighted, it is clear that performance over the next 10 years is likely to be substantially different from the last decade.

Australian Asset Classes 10-year Performance to 31 December 2015

Source: 2016 Russell Investments/ASX Long-term Investing Report

Australian Shares

Australian Shares endured a (hopefully) once-in-a-lifetime financial crisis in 2008. 10-Year performance is going to look a lot different in two years time (20-years is 8.7% p.a.). Prices of Defensive stocks, on the other hand, have since been inflated by record low interest rates.

Residential Property

Residential property prices boomed on the back of low interest rates and an influx of offshore investors. But growth is now slowing.

RBA: Australian Housing Growth

Listed Property

REITS were smashed in 2008 (20-years is 7.7% p.a.). But before contrarians leap into this sector they should consider the impact of low interest rates, with many trading at substantial premiums to net asset value.

Bonds & Cash

Low interest rates again are likely to impact future returns.

Global Shares

Global Shares also weathered the 2008 financial crisis (20-year performance (unhedged) is 6.4% p.a.). Subsequent low interest rates had the greatest impact on Defensives, while Growth & Cyclicals trade at more conservative PEs.

I won’t go through the rest of the classes, but there doesn’t seem to be many attractive alternatives. It may be a case of settling for the cleanest dirty shirt, and the least smelly pair of socks, in the laundry basket.

Defensive PE at a dangerous high

Low interest rates and the accompanying search for yield have driven the forward Price-Earnings ratio for Defensives to a 20-year high. This is likely to reverse when (not if) rates eventually rise. Cyclicals and Growth, however, still look reasonable.

Economists Turn a Blind Eye to Historical Data | Bloomberg View

Barry Ritholz explains where many economists are going wrong when comparing the current recovery to previous recessions:

Why are so many economists, journalists and asset managers using the wrong history for their analysis? In a word: context. As I have been pointing out for nearly a decade (see here, here and here), most are looking at the wrong data set to analyze and compare this recovery to prior ones, using post-World War II recession recoveries as their frame of reference. The proper frame of reference, as Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard University explained in 2008, are debt-induced financial crises…..

Why is there such a difference between economic recoveries? The defining characteristic of any recovery from a credit crisis is ongoing debt deleveraging, meaning that households, companies and governments are primarily using any economic gains in income or borrowing costs to reduce their debt. Low rates are not being used to buy homes, but rather to refinance existing obligations. Hence, the entire current post-crisis period has seen only mediocre retail sales gains and slow GDP growth. Reinhart and Rogoff observed that, while rarer, post-credit-crisis recoveries are weaker, more protracted and much more painful.

There is normally only one credit crisis per generation. They take a long time to fade from memory. And recoveries are slow and protracted. Which is why we should insist that steps are taken to prevent rapid debt growth and a long-term repeat of the 2008 disaster. Increasing bank capital requirements and targeting nominal GDP growth (as suggested by market monetarists) are two important bulwarks against future credit crises.

Source: Economists Turn a Blind Eye to Historical Data – Bloomberg View

Lies Politicians Tell Us | Hoover Institution

Great insights from Allan H. Meltzer at the Hoover Institution:

Most of us learn at some point that politicians tell lies. We expect them to stop once they hold office or to face the consequences. In the past, politicians that violated the public trust resigned, most notably President Richard Nixon. Other lesser officials have also been punished for abusing public trust. No longer. In campaigns, and in office, politicians and their aides or supporters deliberately lie about matters of importance.

….The Obama administration lied to change a major foreign policy issue. Other lies are about less important but not unimportant issues. The French economist Thomas Piketty claimed that capitalism squeezes the middle and lower classes to favor the rich. Piketty’s book Capital in the Twenty-First Century and other studies that followed supported that argument by relying on deceptive data—specifically, income before taxes and transfers. Critics pointed out that the case is much weaker if income after taxes and transfers is used, as it should be. That’s much closer to the receipts that people have. And the differences are large. Transfers that are not part of income before taxes amount to more than $1 billion annually. The top 20 percent of taxpayers paid 84 percent of all income taxes in recent years. And the derided top 1 percent paid 23.5 percent of the income tax.The failure to use income after taxes and transfers cannot be accidental. It seems to be a deliberate attempt to mislead the public. And it is not the only misuse of data. Much of the recent large rise in the income received by the top 1 or 10 percent results from the Federal Reserve’s policy of lowering interest rates and raising housing and stock prices.

…..Hillary Clinton proclaims almost daily that women receive only 78 percent of the income that men receive. Her message is so misleading as to be dishonest. The 78 percent number is the ratio of women’s to men’s median pay. It does not adjust for occupational and other differences in the work that men and women do. For example, skilled neurosurgeons and football, baseball, and basketball stars are men. Domestic workers and hospital cleaning crews are mainly women. A recent paper by Diana Furchtgott-Roth summarized studies at Cornell and other quality economic departments. When adjustment for occupational differences are considered, the ratio is 92 or 94 percent, not the advertised 78 percent. And the remaining difference may not be due to discrimination. Differences in time in the work force, hours worked, and other factors may play a role.

….These are just a few examples of lies and misleading statements that we encounter every day. Clinton lies frequently and Trump shouts a falsehood a day—and probably more—as a major part of his campaign. This is not what citizens of a free country should expect and demand.

….Free societies require truth and honesty.

Worth reading the entire article at: Lies Politicians Tell Us | Hoover Institution

Hat tip to David Kotok.

ASIC review of investment banks shows poor practice

From Sarah Danckert:

The ASIC review of investments banks found that not only do the heavyweights of Australia’s financial system have difficulty in managing their conflicts of interest they also financially reward staff for potentially conflicted behaviour.

…..So ugly is the result the Australian Securities and Investments Commission has warned the people often known as the smartest men and women in the room it will take action against the culprits if the poor behaviour continues.

……Managing conflicts of interest are crucial for investment banks because often one part of the bank is advising on an asset sale or an initial public offering while the bank’s research arm is producing research for the investment banks’ investor clients about the quality of the assets or the IPO.

….ASIC said it had also found “instances of remuneration structures where research remuneration decisions, including discretionary bonuses, took into account research analyst involvement in marketing corporate transactions”.

The review also found “instances with mid-sized firms where research reports on a company were authored by the corporate advisory team that advised the company on a capital-raising transaction or had an ongoing corporate advisory mandate”.

Results of the review come as no surprise. When there is a conflict between profits with multi-million dollar bonuses and independence the outcome should be obvious.

Having worked in the industry, I believe that the only way to achieve independence is to separate investment banks from research houses, with no financial linkage. A professional body for research houses would ensure independence in much the same way as the auditing profession. There is no better way of enforcing good behavior than the threat of censure from a professional body that has the power to prevent its members from practicing.

Source: ASIC review of investment banks post UBS-Baird government run-in shows poor practice

US Light Vehicle Sales disappointing

June US Light Vehicle Sales came in at a disappointing seasonally adjusted annual rate of 16.689 million vehicles. Light vehicle sales, an important barometer of consumer confidence, have been trending lower since November 2015. Further falls would be cause for concern.

Light Vehicle Sales

CEOs Are Paid Fortunes Just to Be Average | Bloomberg View

From Barry Ritholtz:

Verizon’s purchase of Yahoo! for $4.83 billion, while an interesting exercise in combining content, networks and mobile services, highlights the broken norms for paying executives of U.S. corporations…….Yahoo Chief Executive Officer Marissa Mayer will walk away with more than $200 million for doing little more than keeping the seat warm for the past four years.

Research has shown that external influences account for the majority of a given company’s share price. A rule of thumb is that the company itself is only responsible for about a third of its price movement. The market gets credit for about 40 percent, while the performance of the company’s industry drives another 30 percent.

There are of course exceptions. Apple’s incredible share run-up on the iPod, iPhone and iPad is hard to match.

….Share price isn’t a very precise way of compensating for value delivered. Indeed, share price may be one of the worst ways to judge an executive’s performance….

There should be ….. reform in corporate pay policies; executives who deliver returns that match the market or industry should be compensated like low-cost service providers. It’s long past due that this happens.

Barry raises an interesting point. Why not pay executives for outperformance, above the market, in the same way that fund managers are paid performance fees for outperforming the index?

But there is another issue related to stock options. Executives are betting with other people’s money. If the bet comes off and the stock outperforms, they cash in their share options. If the bet doesn’t come off, the shareholders suffer and the executives walk away scot-free. They will be more inclined to take risks if they have no skin in the game.

The investment bank I worked for in the nineties had a far more sensible approach. Executives were loaned large amounts at attractive interest rates for the purpose of buying shares in the company. When the stock price rose they became extremely wealthy. But if the price had fallen, they were accountable for the loan. It certainly made executives more risk-averse — they thought and acted like shareholders. Not a bad idea in the banking industry.

Source: CEOs Are Paid Fortunes Just to Be Average – Bloomberg View

Privatisation has damaged the economy, says ACCC chief

In a blistering attack on decades of common government practice, Australian Competition and Consumer Commission chairman Rod Sims said the sale of ports and electricity infrastructure and the opening of vocational education to private companies had caused him and the public to lose faith in privatisation and deregulation.

“I’ve been a very strong advocate of privatisation for probably 30 years; I believe it enhances economic efficiency,” Mr Sims told the Melbourne Economic Forum on Tuesday. “I’m now almost at the point of opposing privatisation because it’s been done to boost proceeds, it’s been done to boost asset sales and I think it’s severely damaging our economy.”

Mr Sims said privatising ports, including Port Botany and Port Kembla in NSW, which were privatised together, and the Port of Melbourne, which came with conditions restricting competition from other ports, were examples where monopolies had been created without suitable regulation to control how much they could then charge users……

Deregulating the electricity market and selling poles and wires in Queensland and NSW, meanwhile, had seen power prices almost double there over five years, he said.

I have also been a strong advocate of privatising state assets, but Rod Sims raises some important concerns that need to be addressed.

There is a strong trend in capitalist economies away from free enterprise and towards privatised “monopolies”. Investors place a great deal of emphasis when evaluating stocks on a company’s “economic moat” or competitive advantage. Both of which imply the ability to restrict competition. While this may maximize revenue for the individual economic unit, it is harmful for the economy as a whole.

Which brings me back to Mr Sims’ point. Higher prices paid for infrastructure services destroy the competitiveness of the economy as a whole, with profound implications for exports and productivity.

Source: Privatisation has damaged the economy, says ACCC chief

The Cancer of Advocacy Journalism

From John Schindler, formerly a professor of national security affairs at the U.S. Naval War College, where he taught courses on security, strategy, intelligence, terrorism, and military history. Before joining the NWC faculty, he spent nearly a decade with the National Security Agency as an intelligence analyst and counterintelligence officer.

Over the last week, the American media has begun, belatedly, to examine a story in Rolling Stone magazine last month which asserted that a horrific gang rape occurred at the University of Virginia, at a named fraternity. The story was light on specifics, not naming the victim or the perpetrators except in vague terms, but its depiction of gang rape was vivid and hard to forget.

I have no expertise in such matters, but my old counterintelligence sense told me that a lot of this didn’t add up……

Source: The Cancer of Advocacy Journalism

How to Survive & Profit in Today’s Markets

We have observed over a number of years that many investors follow an erratic path to trading/investing. Without clear objectives, they jump from one system to another, and one time frame to another, with no plan or process.

This is attributable to lack of a solid foundation. A deep understanding of the basics of technical analysis, how markets work, and how to manage investment risk — together with confidence in your ability — are all essential to manage your investments effectively.

The biggest risk you take is investing in the stock market without a solid understanding of how it works.

I have enlisted the help of Tony Porter to present training courses for Incredible Charts. Tony is an experienced investment manager with whom I have collaborated for some time. We are on the same wave-length when it comes to Technical Analysis and Trading.

How to Survive & Profit in Today’s Markets is not an A to Z of Technical Analysis, nor of Technical Indicators. We bypass a lot of conventional thinking and focus on core skills — technical analysis, fundamental analysis, macroeconomics, trade management, money management, and self-discipline — needed to survive and profit in today’s markets.

Colin Twiggs & Tony Porter

Colin Twiggs & Tony Porter

The course is run in two parts, each of 6 weeks duration, and will be conducted through printed notes, online exercises and weekly online seminars run by Tony and/or myself.

You will find details at How to Survive & Profit in Today’s Markets.

Register Your Interest

Numbers are limited to 12 per course, and we need to contact participants to arrange course scheduling.
So please register your interest early.

Yours Sincerely,

Colin Twiggs

 

The expectations of life depend upon diligence; the craftsman that would perfect his work must first sharpen his tools.

~ The Analects of Confucius

The Italian bank crisis – the one graph version | The Market Monetarist

I love Lars Christensen’s work. Simple but elegant. This is a bit wonkish for an investment blog but he makes a very important point which applies to far more than just Italy.

Today I was interviewed by a Danish journalist about the Italian banking crisis….. He asked me a very good question that I think is highly relevant for understanding not only the Italian banking crisis, but the Great Recession in general.

The question was: “Lars, why is there an Italian banking crisis – after all they did NOT have a property markets bubble?”

That – my regular readers will realise – made me very happy because I could answer that the crisis had little to do with what happened before 2008 and rather was about monetary policy failure and in the case of the euro zone also why it is not an optimal currency area.

Said, in another way I repeated my view that the Italian banking crisis essentially is a consequence of too weak nominal GDP growth in Italy. As a consequence of Italy’s structural problems the country should have a significantly weaker “lira”, but given the fact that Italy is in the euro area the country instead gets far too tight monetary conditions and consequently since 2008 nominal GDP has fallen massively below the pre-crisis trend.

That is the cause of the sharp rise in non-performing loans and bad debt since 2008. The graph below clearly illustrates that.

I think it is pretty clear that had nominal GDP growth not fallen this sharply since 2008 then we wouldn’t be talking about an Italian banking crisis today. There was no Italian “bubble” prior to 2008 and there are no signs that Italian banks have been particularly irresponsible, but even the most conservative banks will get into trouble when nominal GDP drops 25% below the pre-crisis trend.

Market monetarists advocate that central banks should maintain smooth monetary growth consistent with a nominal GDP target. Current central bank response is lagged because they have to wait for inflation and employment numbers — which is about as effective as driving your car down the highway while looking in the rear view mirror to see where you are headed. Even then, they focus on the wrong numbers, inflation and employment, when the root cause is monetary growth and nominal GDP.

Source: The Italian bank crisis – the one graph version | The Market Monetarist

Major banks’ credit rating outlook cut to ‘negative’

From Clancy Yeates:

Australia’s banks face the threat of higher funding costs, after Standard & Poor’s downgraded the big four’s credit rating outlook to “negative”, a direct result of its action on the government’s top-notch rating.

….the banks’ credit ratings are automatically raised by two notches because S&P assumes they would receive government support in times of financial stress. Action on the government’s rating therefore tends to flow directly into the banks’ ratings.

“The negative outlooks on these banks reflect our view that the ratings benefit from government support and that we would expect to downgrade these entities if we lower the long-term local currency sovereign credit rating on Australia,” Standard & Poor’s said.

While the warning does not reflect changes in the banks’ financial performance, analysts say that if it leads to a downgrade in the actual credit rating of banks, it could push up bank funding costs all the same.

….”While Australian banks enjoy relatively high credit ratings and are deemed to be in the top quartile of global capital requirements, the frequent use of offshore wholesale funding markets is likely to result in higher funding costs.”

The big four raise about 30 per cent of their funding by issuing bonds in wholesale funding markets, so the cost of this debt can have a significant influence on the sector…..

To avoid moral hazard, with banks taking unnecessary risk at the taxpayer’s expense — a case of heads I win, tails you lose — Treasury and the RBA should commit themselves to the Swedish example. Banks that require rescue should forfeit control of their assets by issue of a controlling equity stake to the government. That would significantly curtail management and shareholders’ willingness to take unnecessary risks. And create a strong incentive to increase capital buffers. Not just to comply with APRA rules, but to make their businesses as bullet-proof as possible. Conservatively-run banks would be a major asset to the economy.

What APRA needs to focus on is instilling the right culture in banks. Rather than management focused on incentives to grow the business, there should be more emphasis on protecting the business and ensuring its long-term survival.

Source: Major banks’ credit rating outlook cut to ‘negative’

ASX 200: Banks weigh on the index

The ASX 200 encountered resistance at 5300 and is likely to test support at 4900/5000, with breach of the lower trend channel and declining 13-week Money Flow warning of selling pressure. Breach of support at the recent low of 5050 would confirm.

ASX 200

The Banks are weighing on the index, with APRA warning of further capital increases and concerns over a slowing housing market, particularly apartments. The ASX 300 Banks Index is testing primary support at 7200. Breach would offer a target of 6400*. Weakness in this sector is likely to affect the entire market.

ASX 300 Banks

* Target calculation: 7200 – ( 8000 – 7200 ) = 6400