Where are the next global risks?
Investor success has as much to do with the lemons we deal with or avoid, as to with the success we find and hold on to. 
We have seen right here on more then one occasion how some good choices become diluted due to a few bad ones held on to, too long. Yet, if you never encounter a slacker you likely will never have a winner either. As one old astute investor told me once, if you manage to avoid all bad choices it means you are not trying hard enough to achieve above average returns.
When I interviewed in the 1980’s in New York for the job I then got in Chicago, for Morgan Stanley, one of the key question was: “what was your worst investor choice ever -and what did you do about it?” Two good questions in one because if we never have a bad selection we are not realistic investors -and if we don’t do anything about it, it could/will consume us. The crux of the matter is not to just have winners but to deal with the losers which also come our way. I ask myself everyday, what looser we have now which is staring in our face?
I don’t want to go down a long memory lane here as surely I will forget some calls which I’d rather not remember; last year I wrongly chose AJ and PTL due to all the institutional brokerage recommendation and hype around those two at the time. (To be fair I quickly dropped PTL). As stated many months ago I bailed out of AJ as well (at 16.90) and took my looses in due time and this so saved having dead capital in place besides allows to move into better ideas. I realize the real fear is always that we walk away from a winner which just took a correction. You just got to balance the two. In DEMCO’s case, this stock moved down before up (mostly due to the Thai flood news and EU imploding) and those whom cut loss there, or lost the patience, made a big mistake. There is no magic formula but the big difference between these two, as is just one example, is that we lost conviction in some vs. DEMCO where we clearly did not.
Obviously sometimes we make a mistake and later the stock roars back but the point is that often it’s the opposite: where a dud stays a dud and it was right to walk away. For sure there are no clear cut answers to these vexing questions and that is mostly why investor success over time is difficult to achieve. Call it the “dealing with mistakes” syndrome. An investor ever necessity.
It is not just individual stock selections which come to mind but country and sectors as well. This year for example, it was very wise to avoid, coal and gold and commodities.
Many expats happily live in Thailand but for some reasons long ago were convinced by themselves, or so called “Wealth advisors”, not to invest here. “Live here but don’t invest here”, is often the motto -and its proven wrong. Many now feel sorry to sit on all those EURO’s which depreciated or other developed country’s investor choices which under or poorly performed. If you live in a country and your expenses are in that country its wise to have some of your money in that country.
If not it is the inverse of a country which borrows much of its capital in foreign currency….a dangerous path to go down as if that currency increases in value the debt to be repaid is that much more. This can mean bankruptcies. This in fact happened to many people across many different countries. Some good people in Hungary for just one example are sitting on huge financial set backs now because they borrowed Swiss Francs to finance their in Hungary based homes. Most wealth advisors here do not advocate investing in the Thai financial markets because they know near nothing about them and besides want to sell their own commissioned products, like funds and insurance schemes.
So what are the likely investor traps of today? Nobody knows for sure but I ask myself this as well as what are the next likely winners. We can and some of us have to make some guesses. Let’s just say at the outset over the past 5 years: it was wise to avoid EU exposure and the US is not doing much better. While the SET did hit a 16 year high earlier this year, the US Dow Jones is still well below the 14,000 mark it hit in October of 2007, or not even 5 years ago. The AUSSI stock market is down some 50% in the same 5 year time frame but their currency has been firm, at least until now. One has to ask is the AU stock market worrying about something many of us do? Not just a high currency which dents exports but a larger risk, like a housing boom/collapse.
Speaking of Australia, this is one market I am sort of mesmerized with because, while no expert there, I happen to be an AUSSI bear. The AUSSI economy and currency have been buoyant for far too long and my bet is it won’t last. Because I know we have more then a few AUSSI members and the country is in our region, lets take a look why I for one am an AUSSI agnostic, investor wise.
First ask yourselves: in the developing world, what housing bubbles are still out there which have not burst? AU is one of them. There housing prices actually made new highs following the North Atlantic induced great financial crisis of 2008. AU on the surface looks good as it’s a well run (nanny) country with low public debt. Remember the same was true with Ireland and Spain which not so many years ago also had low debt to GDP ratios. However as these saw if you let a housing bubble get out of hand and the government then has to intervene to prop up the banks, then the governments debt ballooned.
AU post the 2008 great global recession kept on growing as its GDP never went negative. Why? Well for the most part because China kept booming and AU more then anything rode the coattails of booming China along with higher commodity prices. Presently, “The Economist House Price Index” shows that AU housing is nearly 63% overvalued. It shows that along with Hong Kong, AU has the highest housing price index. AU (along with Canada) is one of the very few countries which did not see a housing price decline post the 2008 horror. Today AU housing prices are 20% above their rising 5 year averages’ which looks like a bubble to me. China is a distant next being up 14% above their 5 year average and Canada ranks 3rd being 5% up. Unsustainably so, AU gets the top price on that.
The weak link in the AU case is their banking sector. Credit growth in the housing sector after averaging some 20% annually for many years still shows a punchy 7% annual growth of late and its never gone negative. How long is that sustainable?
AU’ banking sector also has the highest loan to deposit ratio in the G20 universe. As of end of 2010, loans of 180 AU$ are made for every 100 AU$ of deposits. The 4 biggest banks the ratio is a bit lower (160) but still higher than any country in Asia! Further, major AU banks get more then 40% of their funding from abroad and roughly half of that is short term! This is dangerous. As such reliance on wholesale funding is always treacherous because it can vanish so very quickly at the merest hint of trouble. Remember, United Kingdom’s “Northern Rock” collapsed, as did many others, due to reliance on shorter term wholesale funding.
Worthy noting again is that AU Banks in general have very high offshore debt as a percentage of total debt. This has been rising from a low 24% in the late 1990’s, to over 40% currently. Its credit ratio to nominal GDP has also been on the sharp increase, from 0.80 to of late around 1.42.
AU banks remain very geared to the domestic economy. They escaped the worst of the financial crisis because they had little exposure to the subprime debt others like the EU succumbed to. But this also means that any trouble in the property market would be catastrophic for them. A grave concern there, as we learned from the US experience, is that reportedly 90% of AU home mortgages are of the variable rate, which means these will move up along with market % changes instantly. Also, fully half of home investors there have interest only mortgages while the number of owner occupiers is a low 30%. (Source WESTPAC). All these attributes are dire warning sign of a potential housing bubble to come.
“Australia is a house of cards. We are confident the bubble will bust and that it will be spectacular, but we do not know what will provide the spark.” Authors of “Endgame” (2011) By John Mauldin and Jonathan Tepper.
The trigger will likely be, or lets say my #1 fear would be the now slowdown in the China, Brazil, Russia and India’s economies which will dent if not end the commodities boom. As it is this which has helped fuel AU for too long. Coal prices globally have dropped considerably this year, so have many other raw commodities beyond just Oil. You take away that fire, which is what mostly had AU perking, and the risk levels there have considerably increased.
The AU stock market makes up less then 4% of total global stock market capitalization and while I don’t have exact up to date numbers on hand so does its currency, i.e. its money traded is rather miniscule as compared to say the big three. US$, EU and YEN. This makes for easy manipulation and so I would not read much into the fact that the AU $ currency rebounded a bit of late. If you look at a 5 year graph on AU$ vs. the Thai Baht currency for example, it sure looks like a long rounding top to me, where this rounding top is just around 32 Baht, per 1 AU$. Rounding tops often show fatigue with an eventual exhaustion.
The same is true vs. the US$ where it shows fatigue rounding-out just above 1 to 1 parity. Lets say if the AU money was a stock graph I would be very scared owning it. Note that while the AU economy held up well during the great financial crisis, its currency did drop some horrifying near 30% vs. the Baht, during some dire months in year 2009. This shows how the AU money is flippantly and so vulnerable to any perceived or otherwise set back. And it’s coming housing bubble which may well set it up for its next volatile move even while none of us can predict when?
I am not shorting AU nor advocating this as the timing is uncertain. I am just painting this bear picture with some facts which keeps me holding that hat firmly on, in being AU cautious. Bull and bears are fighting it out but I would stay away.
Best Regards,
Paul Renaud.
www.thaistocks.com
