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Friday, August 26, 2011

S Korea's consumers edge towards debt precipice

Published August 26, 2011

Household debt burden exceeds that of US before sub-prime crisis

(SEOUL) If thrift is an Asian virtue, then it is one that South Koreans are notably lacking: each adult has almost five credit cards on average and the household debt burden exceeds that of the United States before the sub-prime crisis.

With the growing risk of a global double-dip recession hitting exports from Asia's fourth largest economy, consumer spending has been key to economic growth.

But household borrowing has propped up that spending. With debt far above levels that triggered a credit-card crisis eight years ago, it is now perhaps the biggest risk that Korea faces and one that the government is loath to tackle ahead of elections next year.

Alongside the mainstream banks, there has been robust growth from kerb market lenders. One even advertises that it will transfer funds after an 11-second procedure on a smartphone.

Official data shows that loans from these secondary lenders grew almost 10 per cent in 2010 to 7.5 trillion won (S$8.3 billion) as they tapped into insatiable demand from students, housewives and office workers.

Household debt 'is really serious and getting more so day by day', said Hong Hee-deok, a lawmaker with the opposition Democratic Labor Party. 'Many people now have to borrow more to pay interest, and those who can't see their debt principle snowballing each day. If not dealt with quickly, I think this could cause troubles that may lead to another sovereign crisis,' he warned.

Private economists are not that worried. True, any talk of the high consumer indebtedness is a blast from the past for those familiar with the 2003 credit card crisis in which millions defaulted and the central bank was compelled to inject funds into a tense bond market.

But it is premature to anticipate a 2003-like endgame, said Frederic Neumann, co-head of Asian Economics Research at HSBC in Hong Kong. 'Should household debt growth remain high for a long time, this would inevitably raise risks for financial stability. But, for the time being, this is not on the horizon.'

Korean household debt reached 155 per cent of disposable income in 2010, exceeding the 138 per cent recorded in the US at the outset of the sub-prime crisis, said Erik Lueth, an economist at Royal Bank of Scotland in Hong Kong.

For some Koreans, the debt burden has already become unsustainable. Kim, a shoe polisher working in central Seoul who declined to give his first name, said credit troubles contributed to the failure of his marriage and he was struggling to pay off his debts.

'One of my customers from Chohung Bank one day told me I can get a card easily and indeed came back later with a gold card issued for me. It was all because of the card that my life has collapsed thereafter,' he explained.

South Korea has been bitten by debt before. In 1997, heavy company borrowing triggered a near sovereign insolvency, but companies have cut debts close to 100 per cent of equity from 425 per cent at that time. The government also has strong finances.

Concerns that another global recession will hit exporters hard may also be overblown. Exports to the most vulnerable economies, the US and Europe, have fallen to 25 per cent of the total from nearly 40 per cent in 1997 as Korean companies have tapped into fast-growing markets like China.

That leaves household debt as the biggest risk and, so far, government action has been muted.

It says the bulk of household debts are owed by rich people and relatively well covered with collateral, and points out that loans from banks or conventional financial institutions are relatively sound, with delinquency ratios staying below one per cent for banks and below 2 per cent for credit card loans.

In June, it asked lenders to cap overall lending growth below the nominal economic growth rate of around 7-8 per cent annually, in addition to an earlier policy of limiting lending growth to below deposit growth.

'The measures were not aimed at reducing the total amount of loans, but I think they were the best option available to the government to curb debt growth while minimising the impact on economic growth,' said Lee Sang-jae, chief economist at Hyundai Securities in Seoul.

Indeed, the heavy debt servicing burden at households has become the single biggest factor affecting economic and financial policymaking in South Korea.

The Bank of Korea's reluctance to raise rates lock-step with rising inflation seems to be directly related to the debt situation, either for fear it may trigger a wave of defaults or that it will rein in spending. A percentage point increase in interest rates could, in theory, take about US$8 billion off Korean private consumption.

While Korea has won plaudits for its response to surging global capital flows and its leadership role in the Group of 20 nations' response to the fallout from the US credit crisis, it appears to have forgotten lessons from financial meltdowns.

In the wake of the 1997-1998 Asian financial crisis, Seoul encouraged banks to issue as many credit cards as possible so as to boost consumer spending, and by 2002 the number of cards in circulation surged 2.7 times to 105 million.

By the time the inevitable crisis came, Koreans had an average 4.6 cards per adult and a whopping US$100 billion in debt on them. The average ratio of debt to disposable income for households hit 108 per cent in 2002, right before the credit-card crisis broke out. Millions of defaults ensued and the government was forced to step in and bail out the country's then largest issuer, LG Card.

Card-ownership levels dropped to as low as 3.5 per adult in 2005, but have surged again to stand at nearly five per adult at the end of March this year, according to official data, as Koreans use them to pay for everything from coffee to luxury cars. -- Reuters

Advice for newly-formed households

26 August 2011
Colin Tan

In a weekend feature article, prospective buyers of homes - both for own occupation and for investment - got a huge dose of advice from property experts, consultants and even developers. Much of the advice was not new but there were many good reminders amid the volatile and uncertain economic environment - both locally and globally.

However, the needs of newly-formed households were not addressed as most had assumed that the majority in this group do not really have a choice but to apply for new public housing flats.

But in case you are one of those new households in a dilemma as to what you should do because you have a choice, I would say: Go for new public housing flats if you qualify, even if you can afford better. After all, it is every citizen's entitlement to subsidised housing. Why buy a private unit that is not subsidised?

And unless your housing needs leave you with no choice, avoid buying HDB resale flats as prices today are determined by a very unusual set of market circumstances - a combination of a severe supply crunch and a wayward price spiral in the private housing market. With sounder housing policies being put in place, such a scenario would not likely happen again for a very long time.

For all households, affordability should be a top concern. You do not want to spend your whole life working to pay off your mortgage or have your chances of upgrading minimised. Remember, HDB resale flat prices are at their highest now. Yes, they may continue to rise for a bit more due to the current supply crunch - but what after that?

Also in my opinion, the current prices are unsustainable. The majority of new households just cannot afford them, which is why the HDB is selling a lot more new flats - 25,000 units this year and another 25,000 in the next. Leave the market to those who do not have a choice. The premium factor for resale flats today may also negate whatever CPF housing grant you may be receiving.

With the recent raising of the household income ceiling to S$12,000 per month for Executive Condominium (EC) units, more households now qualify for them. If you are one of those thinking of EC apartments as your first buy, do remember that the units are priced to achieve a profit and at a level that the market can bear. Under the current market conditions, who do you think has the upper hand? Moreover, you are competing with the sandwiched class who have no choice but to apply for ECs.

If you are thinking of the investment potential of your first buy and you want to buy something other than new HDB flats, you would be wise to set this thought aside in the current economic environment. It is already difficult to arrive at a "correct" choice in a stable market, what more when the present environment is in such a turmoil.

Nobody can predict the future. When you consider the investment potential of a purchase, you are actually gambling. You are taking a position on the market - that it will continue to rise in the future. It was less of a gamble in the past as Singapore - or the world for that matter - was a lot less complex than it is today.

Most new households are not sophisticated in that they do not follow the developments in the housing market closely. But those who do may be worried about the oversupply of HDB resale flats some seven to eight years down the road. This is because the 50,000 HDB flats sold this year and the next will mature then. Will resale prices be depressed then?

Anything can happen between now and then to drastically alter the market scenario. Nevertheless, with more selling their units, you can expect prices to be softer. And if there is no support from HDB upgraders, mass market private prices will have to come down to link the two markets again.

If you think about it, it is not really a negative situation to sell low and buy low when upgrading. In fact, it is the ideal situation. The loan quantum needed is actually smaller to sell lower and buy lower by, say 10 per cent, than to sell higher and buy higher by 10 per cent. Work it out yourself.

The writer is head of research & consultancy at Chesterton Suntec International.

History does not repeat itself but it does rhyme

26 August 2011
Tan Chin Keong

The Singapore residential property market has recently exhibited pricing anomalies that remind us of the conditions prevalent during the last market peak in 2007. Back then, exuberant market conditions as well as their own ingenuity allowed property developers to sell some large luxury residential units at a higher price per sq ft (psf) than the smaller units in the same project.

This time, history did not repeat itself but what we have now sure sounds like a rhyme.

In October 2007, a 5,048 sq ft penthouse unit at Orchard Residences sold for a then-record price of S$5,600 per sq ft - significantly higher than the project's average price of around S$3,300 psf based on caveats lodged by purchasers. Other developers held auctions for their penthouse units in hopes of achieving a higher per-square-foot selling price - and they largely succeeded.

That was a pricing anomaly, as small units are normally sold at a higher price per sq ft than larger units (similar to retail versus bulk prices in consumer items). In hindsight, this anomaly turned out to be a warning sign indicating the market's over-exuberance, as residential property prices subsequently fell by an average of 25 per cent in 2008 and the first half of 2009.

Fast-forward four years to today - we are now facing a different form of pricing anomaly.

With the rising popularity of small "shoebox" units as I highlighted in this column last month ("Shoebox trend a boon for developers and retailers," July 15), the pricing pendulum seems to have swung to the other extreme.

Based on caveats lodged on some recent residential property launches, shoebox units are currently selling at a large price-per-sq-ft premium of 30 to 80 per cent over three- to four-room units in the same project.

For example, The Lakefront Residences, a popular project launched in the Jurong Lakeside precinct late last year, saw its small units sold at around 80 per cent price premium to the larger units. According to the caveats on the project, shoebox units of less than 600 sq ft sold at an average of around S$1,300 psf, well above the average S$700 psf price for the larger units with floor space of more than 1,500 sq ft.

While I have said that smaller units should be sold at a higher price per sq ft, a premium of around 80 per cent does seem like an anomaly to me.

A hint of things to come?

Other than this pricing anomaly, another interesting - and potentially foreboding - trend worth highlighting is that in past years, every time the Government introduced significant measures to cool residential property prices, it was followed the next year by an external crisis that triggered a sharp correction in prices.

For example, in May 1996, the Government introduced a capital gains tax to curb residential property price increases. This was followed by the Asian financial crisis in 1997, which triggered a sharp price decline in the market from 1997 to 1998.

Another example is in October 2007, when the Government introduced measures to stop deferred-payment schemes in the residential market. Again, this was followed by an external crisis - the US subprime fiasco of 2008 - that triggered another tumble in the local market. Singapore's residential prices (mainly private properties, as public HDB flat prices held relatively steady due to supply shortage) fell an average of 25 per cent in 2008 and the first half of 2009.

By now, readers will have sensed the uncanny resemblance between the current conditions and those of 1996 and 2007. Over the last 12 months, the Government has introduced a number of harsh measures to cool the residential property market - including sharply higher seller's stamp duties and lower loan-to-value ratios for mortgages - while global macroeconomic conditions have turned increasingly uncertain, especially over the last few weeks.

In addition, the pricing anomaly that we are currently seeing in the form of the huge price premiums commanded by shoebox units also reminds us the over-exuberance we saw in 2007.

However, it is also not all bad news as the uncertain macroeconomic conditions would mean that low interest rates, which have been supportive of residential property prices so far, would stay for a prolonged period.

But if the quote "History doesn't repeat itself, but it does rhyme," is to be believed, then Singapore's residential property market may not be singing as sweet a tune as before.

Tan Chin Keong is an analyst at UBS Wealth Management Research.

Wednesday, August 24, 2011

'Standard' models can't explain crashes

Published August 24, 2011

Professor presents mathematical model for 'jumps', advises investors to decide on investment policy before any crisis, reports GENEVIEVE CUA

AS grave uncertainties roil markets, some in the academe are working to model financial crises and the domino effect that can ensue, as a shock in one major market sparks off turmoil in other markets and assets.

Yacine Ait-Sahalia, director of Bendheim Centre for Finance at Princeton University, presented a mathematical model for 'jumps', a deceptively innocuous term for market shocks or sudden downdrafts such as has been seen in recent weeks and years.

The big question is - how should portfolios be optimised with a view to such shocks?

Speaking to an audience of investment managers this week, Professor Yacine says there is no mechanism in the classical formula to account for sudden market moves. 'We tend to optimise portfolios well for good times when we don't need it, but not for bad times when optimisation will be helpful.'

Prof Yacine is also the Otto A. Hack 1903 Professor of Finance and Economics. He was the guest speaker at a lunch this week, jointly organised by the Centre for Asset Management Research & Investments and the Investment Management Association of Singapore.

'Rebalancing a portfolio is a disciplined way of fighting the worst behavioural instincts which lead you to make major investment mistakes.'

- Prof Yacine

Classical finance assumes a rational market where risk-averse investors allocate assets broadly between a market portfolio and cash, with a view to maximising returns at a given level of risk.

Any number of factors can derail that smoothly functioning assumption, however, as recent years have painfully shown. In a crisis, asset correlations converge, for instance, which means that most risk assets rise and fall together. Investors cease to be rational and turn risk averse at the worst time, selling down assets that have already been beaten down and exacerbating the plunge. All these mean that diversification, which is supposed to shield portfolios from the worst of losses, may well fail at extreme moments.

Prof Yacine's presentation touched on the nature of crises, where a shock in one market appears to raise the probabilility of successive shocks not only in the affected asset class, but also in other asset classes. These crashes, he says, cannot be explained by 'standard' models which tend to see market shocks as discrete and independent events.

Examples of the contagion effect of shocks include the crash in October 2008 where over a space of five trading sessions, the US market dropped 35 per cent, and sparked a slide as well in the Pacific and European markets. The current downturn is yet another instance.

About October 2008, he says: 'This (price fall) was a move you might have expected to see once every few years on average. . . But to have a move like this every day for five days in a row, an event like this (is) very, very unusual - almost impossible under any of the standard models.'

To capture the possible contagion effect of market shocks, Prof Yacine uses a model called 'Hawkes processes', originally used to model epidemics. Under this model, a shock in one region of the world or segment of the market raises the intensity of jumps or shocks occurring, before things eventually 'mean revert' or return to some long-term average level.

What should investors do? There are some who believe that in the long term, asset prices will settle to a long-term average and time will smooth out short-term volatility. The rub of this thinking is that in a vicious downdraft where most asset prices plunge, you could well lose most of your savings, making recovery difficult.

Prof Yacine proposes that instead of classical theory's two-asset portfolio, investors should have basically three assets - an asset that is a long position on market risk; a long/short fund which hedges against 'jump risks', and cash or the money market.

He told reporters after the presentation that investors should basically hold assets that benefit from a flight to quality. These include US Treasuries, yen assets, German bund and gold. Today, a diversified portfolio may already include a modest allocation to gold, and certainly some to bonds.

At times of crisis, investors should rebalance their portfolio, buying more of the hedges against so-called jump risk.

He said: 'Once you see a jump or turbulent times, you need to rebalance, with anticipation that there will be more jumps and that they're not isolated.

'Rebalancing a portfolio is a disciplined way of fighting the worst behavioural instincts which lead you to make major investment mistakes. . . If you force yourself to rebalance, that leads you to buy more of what has dropped in value and sell what has gone up.'

The catch is that investors should decide on their investment policy before any crisis, and stick to it, rather than formulate a policy on the fly. 'It's very difficult to invent yourself a rebalancing policy in the middle of a crisis. You need to have a policy you are comfortable with in good times and are committed to sticking to. That's the key; you need to (do) it automatically. If you think about it, you give a chance for behavioural factors to come into play.'

Another catch is that picking up the 'jump hedges' such as gold or US Treasuries when a crisis hits means you are likely to be buying when prices of those assets have already risen. Gold, for instance, yesterday briefly crossed a record US$1,900 an ounce.

'If you weren't properly hedged at the first jump, you get a chance to re-hedge. Clearly it will be costly to rebalance. The first jump will change the prices of assets, but that's life - there is no free lunch,' Prof Yacine says.

Gold prices will become 'parabolic', says economist

Published August 24, 2011

Analysts studying technical analysis tools say that bullion prices may be set to decline after record rally

(LONDON) Gold's rally to a record above US$1,900 an ounce has pushed the metal to overbought levels according to technical analysis tools, as economist Dennis Gartman said that prices will go 'parabolic'.

Still glittering: Demand for gold pushed holdings in ETPs to a record 2,216.8 tonnes on Aug 8, data compiled by Bloomberg show
Bullion's relative strength index has topped 70 since Aug 5, a signal to some investors who study technical charts that prices may be set to decline. Gold hugged its upper Bollinger band most of this month, which may signal possible resistance, while a moving average convergence/ divergence indicator and Elliot Wave patterns suggest that prices are overextended, said Ross Norman, chief executive officer of London bullion brokerage Sharps Pixley Ltd.

Gold futures climbed as high as US$1,904 an ounce in New York yesterday and is up 16 per cent in August, set for the best monthly gain since 1999. The metal has advanced as concern about debt crises and slower economic growth spurred investors to diversify holdings away from equities and some currencies. The biggest gold-backed exchange-traded product (ETP) surpassed its equities counterpart as the largest by market value, while bullion rose to record prices in euros, British pounds and Swiss francs.

'I think we're overextended in the short term,' Axel Rudolph, a technical strategist at Commerzbank AG here, said by phone. 'I wouldn't be surprised if we were to fail around US$1,900 to US$1,922, and retrace a little bit for a few days or so. It's still very bullish longer term. Longer term, I think US$2,000 will definitely be hit.'

Prices may slip to the Aug 11 high of about US$1,815 if gold stays below US$1,925, which is near a 60-minute point-and-figure target, Mr Rudolph said. The metal may move 'sideways to up' if no decline takes place in the next couple of days, he said.

Still, a weekly close above US$1,900 may push prices to the 'psychological' level of US$2,000, near the 200 per cent extension of the rally from January's low to May's high projected from the May low, one of the levels singled out in so-called Fibonacci analysis, he said. Fibonacci analysis is based on the theory that prices tend to drop or climb by certain percentages after reaching a high or low.

Gold futures for December delivery traded at US$1,901.90 at 5.15 pm on Comex in New York. In London, bullion for immediate delivery gained 2.5 per cent at 10.17 pm, after reaching US$1,900.60. It is up 34 per cent this year and heading for an 11th straight annual gain, the longest winning streak since at least 1920. The metal has outperformed global equities, commodities and Treasuries this year.

'Gold is strong in any and all currency terms, and it is now entering that stage when prices go parabolic,' Mr Gartman said yesterday. 'This will end when it ends; there is really nothing more that can or shall or should be said.'

Speculative demand from investors has pushed the gold market into a 'bubble that is poised to burst', Wells Fargo & Co said in an Aug 15 report. Prices may climb to US$2,000 an ounce by the end of the year, according to the median forecast in a Bloomberg survey of 13 traders and analysts at a conference in Kovalam in South India on Aug 20.

The precious metal's 'rally when by rights a period of consolidation or profit-taking would be expected suggests that gold is either simply not in technical 'mode' and that other external factors are driving us higher, or that we are in a panic phase which inevitably leads to a blow-off at the top', Sharps Pixley's Mr Norman said.

Demand for gold pushed holdings in ETPs to a record 2,216.8 tonnes on Aug 8, data compiled by Bloomberg show. Investors' assets in the products were 2,211.1 tonnes on Aug 19, more than all but four central banks. Central banks are also adding to gold reserves for the first time in a generation.

The market capitalisation of the SPDR Gold Trust, the biggest gold-backed ETP, rose to US$76.7 billion on Aug 19, according to the most recent data compiled by Bloomberg. SPDR S&P 500 ETF Trust, which had been the industry's largest ETP since 1993, was at US$74.4 billion.

Bullion's 14-day relative strength index (RSI), last at 83.61, reached 84.96 on Aug 10, the highest level since October, according to data compiled by Bloomberg. Prices fell as much as 7.3 per cent in the week after the gauge was at 84.61 on April 29 and traded in a US$115 range for the next two-and-a-half months.

'You can actually make forecasts, even if it's trading at new all-time highs,' Commerzbank's Mr Rudolph said. 'The problem with gold right now is that in the last three days, it's just accelerated higher - and when it's in this sort of move, it can still continue in fast spikes. It's very difficult to know where the spikes are going to end.' - Bloomberg

When blue chips give you the blues

Published August 24, 2011


Beware - while value-investing may seem easy, human frailty often turns it into 'unconscious speculation'


IN THE third quarter of 2010, a slew of positive economic data was evident in the media. The idea of investing for the long term - by picking Singapore's 'solid' dividend-paying blue-chip stocks - became an attractive proposition in a low-interest-rate environment. Coincidentally, this was also when the Singapore Investor Confidence Index Poll reached a high. From a contrarian perspective, that's when one should worry.

A 'death cross' occurred when the Straits Times Index (STI) fell to 2,797. It's a term used when a security's 50-day moving average price line crosses over its 200-day moving average line from the top, generating a long-term bearish signal which suggests that investors should adjust their bullish view to bearish.

While 12 out of 18 'death crosses' resulted as false signals (whipsaws) over the past 30 years for the STI, investors should still take the bearish signal seriously. Firstly, as a lagging indicator, the signal usually occurs after the STI has fallen by 10 per cent or more, and only to be compounded by further losses if a severe bear emerges. Secondly, six out of the 18 signals resulted in losses ranging from minus 22 per cent to minus 54 per cent. Thirdly, it is worrying that more than 60 per cent of the STI constituents, which are classified as 'blue-chip' stocks, have generated the 'death cross' signal.

More importantly, the 'death cross' has also occurred for various other global markets, increasing the odds of a full-blown bear market.

The definition of an 'investment', as offered by Benjamin Graham in 1934, 'is an operation that promises the safety of principal and satisfaction of return. Operations not meeting these requirements are speculation.'

Contrary to popular belief, Warren Buffett is a great market timer. He plays the game well by raising cash when he cannot find attractively-valued stocks. He waits for opportunities to pick up stocks at fire-sale prices, especially when there's blood in the streets.

The biggest mistake an investor can make is to focus only on the idea of getting stable dividends, with disregard to price. For example, when investors buy blue chips at a high price during the mature stage of an economic cycle, this increases the possibility of seeing their stock value fall 50 per cent or more in the next economic slowdown.

Despite the potential poor risk-adjusted ratio, investors stick to the concept of buying blue-chip stocks as they harbour the hope of capital appreciation which bonds may not match. This does not make sense as corporate bonds can do the job of providing a steady income better without similar risk to equity.

Untrained investors would focus on buying blue chips with the highest reputation, quoting their good management and their ability to continue to deliver profits for the long term as reasons for investing in them. Such investors do not wish to engage in market-timing activities as they equate these to speculation. Therefore, they pay insufficient attention to prices given their assumption that well-chosen blue chips would recover from an economic downturn. Ironically, that is a speculative assumption as many of today's blue chips could become tomorrow's losers.

For example, an investor who bought SGX shares at $14.40 on Oct 2, 2007 would have seen the price fall 53 per cent as at Aug 22, 2011. Assuming dividends reinvested, the loss would be large at minus 46 per cent. Investors who bought stocks like Cosco, NOL and Yangzijiang at their peak in 2007 would still be nursing losses of between minus 50 per cent to minus 84 per cent.

Contrary to popular belief, Warren Buffett, the famous value investor, is a great market timer. He plays the game well by raising cash when he cannot find attractively-valued stocks. He waits for opportunities to pick up stocks at fire-sale prices, especially when there's blood in the streets. As the key to long-term investment success is to first avoid losing big, a true long-term investor should do the same and wait for a market crisis to buy stocks at attractive prices. Then, they can ignore the madness of short-term volatility and sell the stocks when they become overvalued. Over time, this strategy can substantially increase the wealth of investors.

For most investors, professionals included, qualitative factors like good management are difficult to deal with intelligently and such an evaluation can be clouded by an investor's own confirmation bias. Quantitative factors, like the continued ability for a business to deliver steady earnings growth, would need investors to have a considerable amount of investigation and business acumen.

Savvier investors could argue that Singapore stocks are now reasonable, based on their current price ratios and forward-looking evaluations. This requires the calculation of the intrinsic value of a business as determined by its future earnings. However, history has repeatedly shown that during the good times, many analysts become over-optimistic and assume a sustainable earnings trend. In reality, the concept of intrinsic value is arbitrary at best. It is elusive and hard to determine, due to the uncertain future and the irrational market.

In addition, few analysts dare to offer views different from the herd as it is often safer to err with the masses. For an analyst to be wrong alone, it can lead to the demise of his reputation and career. Even if the trend of earnings and intrinsic value can be determined reliably, it does not sufficiently provide a safe basis for investing, especially during a bear market.

Currently, the price-to-book (P/B) ratio for the STI stands at 1.3 times and history has also shown that since 1994, whenever the P/B ratio drops from 1.5 times, its downward momentum would bring it to lower levels. This assigns a high probability that the STI could have more to fall as it just breached its 1.5 times P/B level this month.

Unfortunately, during a mature economic cycle, undervalued blue chips are uncommon and many investors end up investing without sufficient regard to price. Investors should focus on value investing as it helps investors invest better by selecting stocks based on the margin-of-safety principle. This means that one buys undervalued stocks at a price lower than their intrinsic value.

This helps to prioritise the safety of capital while dividends are viewed as of secondary importance. While dividends come in handy as a 'cushion' to effectively lower losses when stock prices fall, dividend yields are lower when blue chips are bought at higher prices. Furthermore, during an economic downturn, companies do slash their dividend payouts to preserve cash holdings. This was true during the last crisis for blue chips like SIA, NOL, SGX, CapitaLand, DBS, UOB and ComfortDelgro, as their earnings fell.

While value-investing may seem easy, human frailty often prevents successful implementation. It is hard to prevent human emotion from corrupting an investment framework. Even if the necessary fundamental analysis is used to scan for value stocks, investors may end up with a handful of stocks from boring industries which are not what he initially deemed as blue chips. More importantly, it is hard to be fearful when others are greedy, and vice versa. It is hard to think independently and go against the herd.

Nevertheless, I hope that this article has helped instil a new level of consciousness to replace unconscious speculation. When the stock market enters a bear phase, extreme fear rather than fundamentals rules the day. Even the bluest of blue-chip value picks can fall by a considerable amount. Dividends are often insufficient to cushion a market bloodbath. How much more refuge can an expensive blue chip provide? Investors who buy stocks at a high premium during a stockmarket high unwittingly end up as 'long-term investors'.

With the current global economic slowdown, coupled with the lingering US and European sovereign debt crisis, the recent market carnage could be the beginning of something worse. Buying blue chips based on dividends alone while ignoring price, potentially deteriorating fundamentals and the economic cycle can be disastrous. It's never too late to avoid unconscious speculation and to invest wisely.

The writer is vice-president & deputy investment head at GYC Financial Advisory

Tuesday, August 23, 2011

The man whose passion is Singapore

by Teo Xuanwei 04:45 AM Aug 23, 2011

Former Deputy Prime Minister Tony Tan gave an almost embarrassed chuckle when this reporter asked whether his old Casio watch - which he has kept for over 30 years - or his battered wallet - from which he fished out S$5 for a street busker - were signs of him being sentimental or frugal.

"It works well, so I don't see any point changing it. I don't believe in changing things so long as they work. I use it until it sort of falls apart," explained Dr Tan, in his trademark matter-of-fact manner.

Dressed casually in slacks and New Balance track shoes, Dr Tan has been meeting Singaporeans from all walks of life and all races, shaking hundreds of hands a day.

Despite being stopped every few steps by Singaporeans wanting to snap a picture with him, the 71-year-old kept up a pace that this 20-something reporter found challenging to keep up with.

Dr Tan's schedule thus far has comprised four to five events each day, starting as early as 8am and ending only at 11pm after a nightly review at his campaign headquarters.

How has he managed to stay in tip-top shape amid a gruelling campaign?

His secret, he says, is his wife.

"My wife looks after me very well. She makes me a lot of chicken soup," he said.

Also his exercise regime of daily 3km jogs, swims and gym workouts is "no longer a matter of enhancement but a matter of maintenance". He added: "I don't think one can (contest the Presidential Elections) half-heartedly. Once you decide to do it, you must be prepared to cover the ground."

When asked about his passion in life, Dr Tan replied without hesitation: "Singapore."

A topic he spoke readily about at length and with passion, sharing his views on a variety of topics such as the complex challenges facing the nation, or the painstaking efforts that went into building the unique socio-political situation that the Singapore society finds itself in.

But when it came to more personal questions - including those about his family - Dr Tan was more circumspect.

"I try to keep the privacy of my family as much as possible," said Dr Tan, who has been a public figure for several decades, after he was elected as a Member of Parliament for Sembawang in 1979 in a by-election. While he retired from politics in 2006, Dr Tan remained in the public eye in his positions at Government organisations such as the National Research Foundation.

Nevertheless, Dr Tan shared with this reporter the three guiding principles of his life: Honesty, having the right motivation to do things and determination.

He said: "One has to be frank and open about what he wants to do and why he wants to do it ... When you set your mind to do something, you must have the determination to see it through."

During his Presidential candidate broadcast speech last week, Dr Tan shared that he met his wife, Mary, at university. But they could not hold their wedding dinner because of curfews imposed after the deadly riots in 1964. He added in his speech that the couple celebrated their 47th wedding anniversary this month "with our four children, their spouses and five grandchildren".

Towards the end of the interview, this reporter asked his wife what attracted her to him. At this point, Dr Tan turned to his wife and asked, with a hint of child-like nervousness: "Do you want to answer that?" They laughed a little, and then apologised, saying they had to continue their walkabout in Jurong Point shopping mall.

But as Dr Tan turned and started walking away, Mrs Tan whispered: "He's always been a gentleman."

Teo Xuanwei is a senior reporter at Today.

Monday, August 22, 2011

Templeton’s Mobius Sees Stock Markets Rising on Inflation

By Shani Raja and Susan Li
Aug 22, 2011 6:29 PM GMT+0800

Aug. 22 (Bloomberg) -- Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group, talks about the outlook for U.S. Federal Reserve monetary policy and global financial markets. Mobius speaks from Seoul with Susan Li on Bloomberg Television's "First Up." (Source: Bloomberg).

Global stock markets are “bouncing along the bottom” after tumbling 16 percent in the past four weeks, and will start to climb as inflation accelerates, said Templeton Asset Management’s Mark Mobius.

The U.S. Federal Reserve hasn’t given up supporting the economy by printing money and buying more Treasuries, said Mobius, executive chairman of Templeton Asset’s emerging markets group. The firm is buying commodity stocks, expecting raw material prices to rise, he said.

“At this point, I do think we’re bouncing along the bottom,” Mobius, who helps manage about $50 billion, said in a telephone interview with Bloomberg Television today. “For us in equities, it’s particularly good because people will eventually realize that to beat inflation that’s coming as a result of this higher money supply, we’re going to have to be into equities.”

The MSCI World (MXWO) Index of stocks fell last week for a fourth straight week as investors took flight after a deadlock in the U.S. congress brought the government to the brink of default, reports showed the world’s biggest economy is slowing, and concern grew that Europe’s sovereign-debt crisis will spread. The losses triggered speculation Fed Chairman Ben S. Bernanke will this weekend signal a third-round of asset purchases to help sustain a recovery.

Energy and material stocks have been among the three worst performers in the past month in the 10 industry groups tracked by the MSCI Asia-Pacific Index, as a measure of primary metals traded in London and New-York-traded oil futures slumped.

‘An Opportunity’
“It’s been an opportunity,” said Mobius. “With the amount of liquidity coming into the system, commodity prices have to be maintained at higher and higher levels. The trend is very, very clear, and that’s up.”

Mobius told Bloomberg TV Aug. 5 that he doesn’t expect the U.S. to experience a double-dip recession because of the likelihood of further economic stimulus.

The S&P 500 may stage a short-term rally because companies are cashed up and likely to buy back shares at a time when price-to-earnings ratios are low, said economist Andrew Smithers. Investors should sell shares once their holdings gain 10 percent because even after the recent rout, U.S. stocks are about 40 percent above fair value, the president of research company Smithers & Co. said in an e-mail on Aug. 18.

Standard & Poor’s 500 Index companies have about $291 in cash and short-term investments per share, according to data compiled by Bloomberg. That’s the highest since 1998, when Bloomberg data became available.

Volatility to Continue
Economists said reports this week may show U.S. companies ordered less equipment in July, and that the economy grew even less in the second quarter than previously estimated.

“It’s not certain to us what the Federal Reserve can say to calm people’s nerves,” Don Williams, chief investment officer at Platypus Asset Management Ltd. in Sydney, said in a separate Bloomberg Television interview today. “This period of volatility that we’re in has still got a way to play out.”

Global stocks will rise even amid investor concern that Europe’s sovereign debt crisis may be prolonged by German Chancellor Angela Merkel’s resistance to calls for common euro- area bonds, according to Mobius.

The region’s crisis is moving toward a resolution after European Union pledges this year to stabilize the euro-area economy and stave off a Greek default, Mobius said.

“I believe the situation in Europe will get better now that they have a facility to bail out these countries,” he said. “But in the meantime, the loss of confidence has really hit both sides of the Atlantic, and that’s something that’s going to have to wear away as we go forward.”

Mobius said today he remained interested in consumer stocks, as well as equities in emerging markets such as Brazil, China, Thailand, Indonesia and Russia. On Aug. 5, he told Bloomberg TV that emerging economies were in “better shape” than developed nations amid the turmoil roiling global markets.

Saturday, August 20, 2011

The great market panic

Published August 20, 2011


The recent slump in global share prices reflects fears of a recession in the US and Europe, and worries that this will drag down the rest of the world. Are these fears justified?


'I have observed that not the man who hopes when others despair, but the man who despairs when others hope, is admired by a large class of persons as a sage.'
J S Mill

AFTER the events of the last few weeks it's easy to be bearish. After plunging nearly 20 per cent from their highs earlier this year to the lows last week, global share markets have rebounded by around 6 per cent. But markets remain twitchy.

The slump in markets over the last month naturally raises a lot of questions: What's driving it? Are we seeing a re-run of the global financial crisis? What's the risk of a return to recession? Can China save the world again? Have shares bottomed?

Put simply, shares took a tumble on fears of a return to recession in the US and Europe, and worries that this will drag down the rest of the world.

A few months ago we thought that global growth was just going through a temporary soft patch (on the back of Japanese supply chain disruptions and the earlier surge in oil prices) and that even though shares might remain volatile and see further weakness through the September quarter, the trend would remain up as profits continued to rise and global monetary conditions remained easy.

But the events of the last few weeks have called this view into question. Economic data has remained weak and debt crises in the US and Europe are increasing the pressure for more fiscal austerity at a time when growth is fragile.

Political bumbling on both sides of the Atlantic, Standard & Poors' downgrade of America and fears of more downgrades to come have only compounded anxieties. Furthermore, memories of the 2008-09 global financial crisis are still fresh in the minds of investors so the attitude seems to be shoot first and ask questions later.

Are we seeing a re-run of that global financial crisis (GFC)?

It's still early days yet, but our view is that this is very different from the GFC.

Public debt problems have been brewing for some time so exposures should be well known and more transparent. The leverage and complex financial engineering that caused so much trouble in the GFC is not a factor now. Interbank lending markets are much better supported by central banks. Consequently, while interbank lending spreads (the difference between what banks charge to lend to each other and expected official short-term interest rates - i.e. the OIS in the chart) and credit spreads (the difference between corporate and government borrowing rates) are picking up, they remain relatively low.

While it's early days yet, the risk of a complete seizing up in lending markets - including in areas like trade finance that helped spread the GFC to emerging countries - as occurred in late 2008 seems low. However, the recent speculative attacks on French banks and moves by US money market funds to stop lending them US$ funds are worth watching. This is evident in the greater rise in European lending spreads compared to the US in the chart.

What's the risk of a return to global recession?

The risk of recession has increased significantly in Europe and the US. Fiscal austerity is occurring much earlier than is desirable, and recent political wrangling has put public debt problems front and centre in investors' minds and dealt a huge blow to business and consumer confidence.

Europe is probably the biggest risk. It seems to be stuck in an ever worsening cycle of periodic investor panic over debt blowouts, causing more fiscal austerity, causing weaker growth, causing further budget deterioration, causing more market panic, causing more austerity and so on.

This process started in the peripheral countries but now appears to be spreading to Italy and France. A fiscal union is a long way off and won't solve current problems anyway, and the European Central Bank seems unwilling (or unable) to provide monetary relief.

And the US is now starting down the same path with fiscal austerity set to knock up to 2 per cent from growth next year. However, there are several reasons to believe that while the risk of recession in the major industrial countries has increased substantially, it will probably just be avoided:

The fall in oil and commodity prices generally will take pressure off household budgets and business costs;

Cyclical sectors that can push the US economy into recession are already at recession levels, for example, housing;

Longer-term borrowing costs in the US have fallen to extraordinarily low levels and the Federal Reserve is effectively committing to keep them there for two years. This is enabling homeowners to refinance to lower rates;

Near zero returns on cash are making it very difficult for US companies to continue adding to their already record cash stockpiles. The incentive to get out and invest, or at least buy back shares or other companies, is huge;

It's looking increasingly likely the US will head down the path of another round of quantitative easing (i.e. QE3, which involves pumping more cash into the US economy). While one can debate the seeming failure of QE1 and QE2 to spark a strong recovery, the US probably would have been a lot weaker were it not for these actions and at least it seems to have prevented the US from sliding into price deflation.

We put the risk of a return to recession in industrialised countries at 40 per cent - slightly higher in Europe, but slightly lower in the US - with fragile sub-par growth of around one to 1.5 per cent being the most likely outcome at around 60 per cent chance.

Can China save the world again?

This brings us to the emerging world and China. Providing there is no drying up in trade finance, it is likely China and the emerging world will be able to hold up.

Inflationary pressures in China and the rest of the emerging world are already fading on the back of lower oil and food prices, and with growth coming off the boil, this should clear the way for easier monetary policies.

With short-term interest rates having increased over the last two years, there is plenty of scope to cut, unlike in advanced countries.

Second, public debt levels in the emerging world remain low so there is still plenty of room for stimulus if need be. Overall, China is likely to see growth of around 8-9 per cent and emerging countries, around 5.5 per cent, which implies global growth of 3 to 3.5 per cent. This is well below IMF expectations but not disastrous.

Are shares a good buy?

After sharp falls in share prices and bond yields, shares are good value on several metrics. Price to earnings multiples on global, Asian and Australian shares have fallen to around 10 times, well below long-term averages. And dividend yields have risen sharply compared to bond yields. This means shares only require modest capital growth to provide an attractive return premium versus bonds.

However, while shares may be cheap, it doesn't mean they have bottomed.

The table above focuses on US shares as they set the cyclical direction for shares elsewhere. As can be seen, all US recessions over the last 50 years have been associated with a sharp fall in the US share market. What's more, the low in the share market has always come after the recession has begun (by an average of nine months). Right now, it's hard to argue that a US recession has commenced, but if you believe one is on the way, then US shares are arguably a long way from bottoming. And this means global shares as well.

However, if recession is avoided in favour of just low messy growth, then the downside may be less concerning on, say, a 12-month horizon. For example, with Australian shares providing a grossed up dividend yield of over 6 per cent, assuming profits grow just 4 per cent per annum and share prices move in line with this, then the total return on a medium-term view is around 10 per cent. This is at a time when the bond yield is just 4.5 per cent. Furthermore, bank deposit rates are starting to fall as banks are awash with cash, wholesale interest rates have fallen and credit growth has slowed to just 3 per cent per annum. This means the cash flow from shares is now back above that from bank interest.

For short-term investors, there is a case to remain cautious. For long-term investors, attractive sharemarket yields, low and falling yields on bonds and bank deposits and the likelihood of more monetary stimulus on the way suggest shares may be attractive on a longer-term basis, meaning there is a case to average in over time.

The writer is head of investment strategy and chief economist, AMP Capital Investors

Scarred by a volatile market

Published August 20, 2011


The recent wide swings in the stock market have resulted in investor anxiety that may linger for years


LAST week's record volatility in US stocks ended after four days. The anxiety it instilled among mutual fund investors may linger for years.

Investors, nervous about the volatility and seeming instability of the stock market, pulled a net US$23.5b from US equity funds in the week ended Aug 10
Investors pulled a net US$23.5 billion from US equity funds in the week ended Aug 10, the most since October 2008, when markets were reeling from the collapse a month earlier of Lehman Brothers Holdings Inc, the Investment Company Institute said on Wednesday. The period tracked by the Washington-based trade group included three of the unprecedented four consecutive days in which the Standard & Poor's 500 Index rose or fell by at least 4 per cent.

The roller-coaster ride was unnerving for fund investors who have already endured the bursting of the Internet bubble in 2000, a 57 per cent collapse in the S&P 500 Index from October 2007 to March 2009 and the one-day plunge in May 2010 that briefly erased US$862 billion in value from US shares.

The debacles, combined with falling home prices, unemployment above 9 per cent and a lack of trust in government to bring down spending, may sour individual investors on domestic stock funds for an additional three to five years, according to Andrew Goldberg, a market strategist at JPMorgan Funds in New York.

'You can't keep having bombs, so to speak, go off,' he said in an interview. 'If the second you walk outside another one goes off, you're going to stay inside for longer, and that's what's going on.'

The return of the S&P 500 during the past 10 years has been about 3 per cent including dividends. Investors have experienced 'a far greater degree of volatility than one would expect for such meagre returns', says Morningstar analyst Greggory Warren.

The US$12.2 trillion mutual fund industry has historically been able to count on investors to come back to stocks after a significant selloff. They did so following 'Black Monday' in October 1987, the Asian currency crisis in 1997 and Russia's debt default in 1998. In the year after the 2000-2002 bear market, US equity funds attracted US$130 billion, ICI data show.

Funds that buy domestic stocks lost US$98 billion in 33 straight weeks of withdrawals last year after the 20-minute plunge in May, ICI data show. They've had redemptions of US$74 billion this year. The latest withdrawal streak began in 2007 and didn't end even as stock surged from their March 2009 lows.

'What we have seen this time is a much slower return to risk-taking,' said Francis Kinniry, principal at Vanguard Group Inc in Valley Forge, Pennsylvania, the largest US mutual fund manager. He attributes the difference to falling home prices. In bear markets prior to 2008, residential property values were rising.

'There was significantly more wealth destruction this time around,' he said.

Investors have compensated by shifting some of their money into passively managed index funds and exchange-traded funds that track stock benchmarks, forsaking managers who select the investments they buy and sell.

US stock index funds have posted net deposits every year since 2001, according to Morningstar Inc, a Chicago-based research firm. Investors have similarly poured US$851.5 billion into ETFs for all asset classes from 2001 to July 2011. Unlike mutual funds, ETF trade throughout the day like stocks.

Bond funds also have been winners, adding US$75 billion in deposits this year, while funds that buy non-US stocks took in US$15 billion, according to ICI.

'Over the past couple of years and especially the past couple of weeks, I have heard a large number of clients and acquaintances express fear and dislike for the stock market,' Eitan Tashman, a financial planner in Beverly Hills, California, said. While 'many investors are scared of the volatility and seeming instability of the stock market and would even like to remove their money from the stock market', there are few alternatives, he said.

The post-World War II generation of baby-boomers is the largest group of investors in mutual funds, said Geoff Bobroff, an investment-management consultant in East Greenwich, Rhode Island. As they go into retirement, they might not return to equities after two bear markets and the volatility this year, he said.

'They are already thinking now about their retirement years,' Mr Bobroff said. 'They may be in fixed-income of different flavours, but equities may no longer be on their horizon.'

The recent volatility makes Mark Beller, 42, a physician in Northridge, California, want to put more of his money into real estate. 'The market is so volatile - 1,400 points in a week? Give me a break,' he said. 'I have money to invest, and my portfolio is down about 15 to 20 per cent, so I'm going to wait for it to come back to where I feel comfortable.'

Younger investors aren't replacing their retiring counterparts. Cash holdings are at the highest levels since the record in March 2009, according to an Aug 16 survey by Bank of America Merrill Lynch.

Investors aged 18 to 30 years have the highest cash position of any age group at 30 per cent of their portfolio, MFS Investment Management said in an Aug 8 report. Almost three in five investors cite fear about volatility or needing money someday as a reason they hold high or increasing levels of cash.

'Investors are in cash for a reason and, regardless of time horizon, conventional investing wisdom no longer applies,' William Finnegan, senior managing director of retail marketing at the Boston-based firm, said in the report. 'The Great Recession of 2008 has had a profound and longer-lasting impact on investors' confidence than expected.'

The average investor tends to hold large amounts of cash when the markets are at a low and thus miss out on gains, JPMorgan's Mr Goldberg said. The previous high of cash as a percentage of portfolios was in October 2002, right before the start of a five-year bull market.

'Households had become so conservative that they were sitting on all this cash that should've been seeking out opportunity,' he said. 'To the extent that emotions drive decisions, they're going to get it wrong.'

The return of the S&P 500 during the past 10 years has been about 3 per cent including dividends. Investors have experienced 'a far greater degree of volatility than one would expect for such meagre returns', Greggory Warren, a Morningstar analyst, wrote in a June 29 research note.

Still, not all investors are panicking or leaving the market.

'Generally, they're holding tight, and I've been pleasantly surprised,' Kevin O'Reilly, a financial adviser based in Phoenix, said in an interview. 'I haven't gotten, really, nearly as many calls panicking as I thought I would have.'

US investors may be getting used to the volatility, which isn't necessarily a good thing, said Lee Ann Knight, a financial adviser in Bedford, Massachusetts.

'They may be immune to worrying about it when they should be,' she said. 'What surprised me is that I have had a few phone calls from people wanting to use this opportunity to invest. That's great, that's good, but I feel like I had these conversations for 10 years, and people were like, 'No way, no way'.' -- Bloomberg

Real estate sector in for a correction?

Published August 20, 2011
Show me the money

Where the stock market goes, the property market is likely to go too, maybe with a lag of two quarters


DO we have the making of a perfect storm in the real estate market?

High real estate prices, especially in the public housing market, was one of the hot button issues in the recent general elections. In response, the government vowed to spare no effort in slowing down the price ascent.

Various measures have been implemented to dampen demand. Higher stamp duties and tighter mortgage financing policies are just two of them.

Immigration policy, another hot political potato, has also been tweaked. It is now more difficult to get employment passes, permanent residency (PR) or citizenships in the Lion City. Among the stories I've heard: a Chinese owner of a few businesses in Singapore with a few properties under his name was rejected when he applied for PR or citizenship. Another practically grew up in Singapore, and now in her early 30s, is running a few of her own small enterprises. She too was rejected. A friend was sent by her Taiwanese employer from Penang to Singapore a few months back. Her application for an employment pass was rejected and she's appealing.

Foreigners or new citizens are big sources of demand for housing, be it for purchase or rental purposes. The tightening of immigration policy will further reduce demand for housing.

Given the way the stock market is going, investors who got into the real estate market in the last four to five quarters may have to wait a while more to see any substantial capital gains on their investment.

Meanwhile on the supply side, the Housing and Development Board is cranking up its apparatus to supply what is described as a pent-up demand for public housing. Just this week, the HDB said that it would be launching a record 8,000 flats next month to meet households' demand for public housing. It will launch another 4,000 Build-to-Order (BTO) flats in November, taking this year's total BTO supply to 25,000 units.

Next year, home seekers can look forward to another 25,000 BTO flats and some will even be in sought-after mature estates such as Tampines and Kallang/Whampoa.

'In two years, we'll be building an entire Ang Mo Kio town,' National Development Minister Khaw Boon Wan said. There are around 48,000 dwelling units in Ang Mo Kio.

'That's why I'm so confident that in three years' time, four years' time, when all these units start materialising, whatever pent-up demand of applicants, the problem would have been largely resolved,' he said this week.

Meanwhile on the private property market, the supply is going to be massive as well. As at Q2 2011, there were 57,520 units of uncompleted private residential units. That's some 22 per cent of the current total supply.

Some of the demand for this supply is likely to be siphoned off to the public housing market. Prime Minister Lee Hsien Loong announced over the weekend the raising of the income ceiling for those who qualify to buy HDB flats. So this group, who might otherwise buy private properties, now has the option to buy the cheaper public housing flats.

All these plans of course were made when the property market was still strong, and the global equity markets showed some semblance of stability.

The picture appeared to have changed drastically in the last two weeks, although the sudden change in sentiment can be said to be rather intriguing.

As a seasoned portfolio manager put it: 'This current sell-off is rather strange. The market knows about the sovereign debt issues in Europe and the US. The US debt ceiling issue had been hogging the headlines for months. I can't figure out the trigger for the sell-off that we have now. In 2008, nobody expected Lehman Brothers to collapse. So the panic then was understandable.'

Anyway, that's what we have today. Fear is back in the market. And where the stock market goes, so too the property market, maybe with a lag of two quarters.

From the first chart, you can see that a sustained decline in stock market will almost certainly result in the softening of the property market.

In addition, the stock market is also a leading indicator of the economy. If indeed the decline we are seeing is a harbinger of tough economic times ahead, then buyers will be more cirscumspect in deciding to part with their cash to buying big ticket items.

But of course the property market is not likely to decline in the same degree as the stock market. From its recent peak in October 2007 to its trough in March 2009, the Singapore stock market plunged by some 60 per cent.

The private residential property index meanwhile fell by about 25 per cent from the second quarter of 2008 to a low in the second quarter of 2009. That's a brief decline of just a year. But a 25 per cent decline in the property price is more than enough to wipe out 100 per cent of the equity an investor might have in his or her property.

Interestingly since then, the property index has risen above its 2008 peak - by about 14 per cent based on the Q2 2011 numbers. On the other hand, the stock market, as at Aug 1 before the sell-off in the last two weeks, was still 10 per cent below its 2007 peak.

So, might we see a bigger correction in the property market this time round? Again, it all hinges on how bad the bloodbath in the stock market is going to be, and its implication on the real economy. If the worst comes to pass, then the outlook for the property market is definitely less than rosy.

Meanwhile, I just want to update a chart I did two months back. It showed the total return for investment properties bought in the various periods and held till end 2010. I forgot to total up the rental income earned throughout the years in my previous calculation.

In the new chart, you can see that with the exception of those bought in 2008, private residential properties have yielded positive return for investors who bought any time since 1999.

The thing is, given the way the stock market is going, investors who got into the real estate market in the last four to five quarters may have to wait a while more to see any substantial capital gains on their investment.

So property investment, like in any other investment, is just as much about timing, timing, timing.

Just to recap, for the second chart, the return for the property investment includes price appreciation and rental income. The assumption is that the property investor bought into the market at various points in the past 12 years and held on till end 2010. Calculations are based on a 100 sq metre condominium.

The purchase price of the property is raised by 8 per cent to account for the various fees, and likewise the selling price was reduced by 2 per cent. Deducted from the capital appreciation are the interest charges paid to the bank during the holding period of the property.

Interest rates are pegged at 1.5 percentage points above one-year interbank rates. Meanwhile, rental income is net of management fees. The rental cash flow is then further reduced by 15 per cent to account for property tax and rental income tax.

The writer is a CFA charterholder

Crash? You ain't seen nothing yet: analysts

$21 billion wiped off Singapore market - but observers say stocks could fall another 20-30% before hitting bottom

Published on 20 August 2011

THE bloodletting which wiped some $21 billion off the Singapore market yesterday could be the beginning of a selldown which could lop another 30 per cent off the value of stocks here.

That seems to be the view of some analysts and strategists following a rampage which dragged the Straits Times Index (STI) down 3.2 per cent or 91.33 points to 2,733.63 points yesterday - its lowest in 15 months.

'What we are seeing is a perfect storm - a confluence of negative factors,' said Prabodh Agrawal, CEO of Singapore-based IIFL Institutional Equities.

'Despite the selldowns we are now seeing, most blue chips and bellwethers here are still trading at just below their long- term price-book levels. During the last recession, they were trading at about two standard deviations below their long-term average. If we assume the same numbers and circumstances, stocks could fall another 20-30 per cent from current levels.'

The selldowns here and across the Asia Pacific region came on the heels of similar overnight savaging of Wall Street and European markets following more disappointing US economic data and intensifying concerns about a potential global economic recession triggered by the European sovereign debt crisis and a sharp US economic slump.

The dive across Asian bourses followed 3-5 per cent plunges in the US and Europe. And the selldown intensified as Wall Street futures remained deep in the red and Europe opened sharply lower again yesterday.

In Tokyo the Nikkei 225 gave up 2.51 per cent to 8,719.24, while Hong Kong's Hang Seng lost 3.08 per cent to 19,399.9 and Sydney's ASX200 dived 3.51 per cent to 4,101.90.

In Singapore, with yesterday's plunge, some $117 billion has been lopped off the value of Singapore equities this month alone.

And technical analysts see more downside. Kim Eng Securities' technical charts suggest a potential low at 2,350 points - a whopping 14 per cent under current levels.

'Based on the weekly chart trends, our chartist sees the STI trading within the 2,600-2,680 area in the short term, which coincides with the 50 per cent Fibonacci level,' it said in a note yesterday. 'The index could further correct downwards to the 2,350-2,420 area if this support area is broken.'

But many analysts also point out that medium-term fundamentals-wise, many stocks are turning attractive and thus providing opportunities for bottom-fishing.

Melvyn Boey, head of research and strategy for Asean, Bank of America/Merrill Lynch, added that although there's a looming crisis in the West, this region's fundamentals are intact.

'Asean, and especially Singapore, remain vulnerable to the impact of a global recession,' Mr Boey said.

'But, that said, South-east Asia's fundamentals are a lot stronger today than five or 10 years ago. Investors should look at stocks of companies with revenue growth, pricing power, cashflow and strong overall fundamentals to ride through the recession.'

Mr Boey added that while a recession seemed imminent, the down-cycles were getting shorter and tighter.

In short, the recovery could be as swift as the slide is brutal. So stick to fundamentals.

On the other hand, Mr Agrawal was more circumspect. 'The 2008/09 crisis lasted only four quarters because governments and central bankers were able to act aggressively and in concert to recapitalise distressed asset markets. Today, government balance sheets are in poor shape, thus diminishing their ability to act as aggressively,' he said.

Mr Agrawal noted that the intervention in 2008/09 had reflated the asset markets, but not the economies concerned. He now sees a potential for several rounds of continuous deleveraging dragging all asset markets - equities, commodities and property - further southwards. In Singapore, he cautions against jumping back into stocks too early.

But then, asset markets - especially equities - could get another reflation if US Federal Reserve chairman Ben Bernanke unveils a new stimulus package or 'QE3' at next Friday's Jackson Hole meeting.

Wednesday, August 17, 2011

Is capitalism doomed?

17 August 2011
Nouriel Roubini

The massive volatility and sharp equity-price correction now hitting global financial markets signal that most advanced economies are on the brink of a double-dip recession.

A financial and economic crisis caused by too much private-sector debt and leverage led to a massive re-leveraging of the public sector in order to prevent Great Depression 2.0. But the subsequent recovery has been anaemic and sub-par in most advanced economies given painful de-leveraging.

Now a combination of high oil and commodity prices, turmoil in the Middle East, Japan's earthquake and tsunami, euro zone debt crises, and America's fiscal problems (and now its rating downgrade) have led to a massive increase in risk aversion.

Economically, the United States, the euro zone, the United Kingdom and Japan are all idling. Even fast-growing emerging markets (China, emerging Asia and Latin America), and export-oriented economies that rely on these markets (Germany and resource-rich Australia), are experiencing sharp slowdowns.

Until last year, policymakers could always produce a new rabbit from their hat to reflate asset prices and trigger economic recovery. Fiscal stimulus, near-zero interest rates, two rounds of "quantitative easing", ring-fencing of bad debt, and trillions of dollars in bailouts and liquidity provision for banks and financial institutions: Officials tried them all. Now they have run out of rabbits.

Fiscal policy currently is a drag on economic growth in both the euro zone and the UK. Even in the US, state and local governments, and now the federal government, are cutting expenditure and reducing transfer payments. Soon enough, they will be raising taxes.

Another round of bank bailouts is politically unacceptable and economically unfeasible: Most governments, especially in Europe, are so distressed that bailouts are unaffordable; indeed, their sovereign risk is actually fuelling concern about the health of Europe's banks, which hold most of the increasingly shaky government paper.

Nor could monetary policy help very much. Quantitative easing is constrained by above-target inflation in the euro zone and UK. The US Federal Reserve will likely start a third round of quantitative easing (QE3), but it will be too little too late. Last year's US$600 billion (S$721.61 billion) QE2 and US$1 trillion in tax cuts and transfers delivered growth of barely 3 per cent for one quarter. Then growth slumped to below 1 per cent in the first half of this year. QE3 will be much smaller, and will do much less to reflate asset prices and restore growth.

Currency depreciation is not a feasible option for all advanced economies: They all need a weaker currency and better trade balance to restore growth, but they all cannot have it at the same time. So relying on exchange rates to influence trade balances is a zero-sum game. Currency wars are thus on the horizon, with Japan and Switzerland engaging in early battles to weaken their exchange rates. Others will soon follow.

Meanwhile, in the euro zone, Italy and Spain are now at risk of losing market access, with financial pressures now mounting on France, too. But Italy and Spain are both too big to fail and too big to be bailed out. For now, the European Central Bank will purchase some of their bonds as a bridge to the euro zone's new European Financial Stabilisation Facility. But, if Italy and/or Spain lose market access, the EFSF's �440 billion (S$762.5 billion) war chest could be depleted by the end of this year or early next year.

Then, unless the EFSF pot were tripled - a move that Germany would resist - the only option left would become an orderly but coercive restructuring of Italian and Spanish debt, as has happened in Greece. Coercive restructuring of insolvent banks' unsecured debt would be next. So, although the process of de-leveraging has barely started, debt reductions will become necessary if countries cannot grow or save or inflate themselves out of their debt problems.

So Karl Marx, it seems, was partly right in arguing that globalisation, financial intermediation run amok, and redistribution of income and wealth from labour to capital could lead capitalism to self-destruct (though his view that socialism would be better has proven wrong). Firms are cutting jobs because there is not enough final demand. But cutting jobs reduces labour income, increases inequality and reduces final demand.

Recent popular demonstrations, from the Middle East to Israel to the UK, and rising popular anger in China - and soon enough in other advanced economies and emerging markets - are all driven by the same issues and tensions: Growing inequality, poverty, unemployment and hopelessness. Even the world's middle classes are feeling the squeeze of falling incomes and opportunities.

To enable market-oriented economies to operate as they should and can, we need to return to the right balance between markets and provision of public goods. That means moving away from both the Anglo-Saxon model of laissez-faire and voodoo economics and the continental European model of deficit-driven welfare states. Both are broken.

The right balance today requires creating jobs partly through additional fiscal stimulus aimed at productive infrastructure investment. It also requires more progressive taxation; more short-term fiscal stimulus with medium- and long-term fiscal discipline; lender-of-last-resort support by monetary authorities to prevent ruinous runs on banks; reduction of the debt burden for insolvent households and other distressed economic agents; and stricter supervision and regulation of a financial system run amok; breaking up too-big-to-fail banks and oligopolistic trusts.

Over time, advanced economies will need to invest in human capital, skills and social safety nets to increase productivity and enable workers to compete, be flexible and thrive in a globalised economy. The alternative is - like in the 1930s - unending stagnation, depression, currency and trade wars, capital controls, financial crisis, sovereign insolvencies, and massive social and political instability.

Nouriel Roubini is chairman of Roubini Global Economics, professor of Economics at the Stern School of Business, New York University, and co-author of the book Crisis Economics.

Skinning the cat called stock market volatility

Published August 17, 2011

Strategies for minimising loss range from the simple collar to futures and structured notes


THE stock market in the last week has been the very definition of volatile, up one day, down the next, then up again the day after. But while most investors care about volatility only when markets go down and their portfolio loses value, volatility works both ways. And smart investors are figuring out ways to smooth out the peaks and valleys.

Tony Roth, head of wealth management strategies at UBS Wealth Management, said that he considered volatility a fourth asset class, after stocks, bonds and alternative investments such as real estate and hedge funds. And he advises the firm's wealthiest clients to factor it into their portfolio even in good times. 'You're competing in a market with high-speed and hedge fund traders, and they have volatility strategies as a source of returns,' Mr Roth said. 'If you're not developing your own strategy for dealing with volatility, you're at a structural disadvantage on the playing field we call financial markets.'

While thinking of volatility as an investment may seem as odd as buying air rights for development once did (or still does), devising strategies that limit the highs and lows in the global economy are becoming increasingly common. They generally fall into two categories: strategies that look to profit from volatile markets and those that try to cushion a portfolio from those wild swings.

What has changed is that many of these strategies are no longer available only to the most sophisticated investors. (Some of them certainly got a lot more expensive this week.) Two of the strategies I discuss below are accessible to investors with even modest portfolios, and two are for wealthier investors, but they show just how much control people can now exert on their returns.

Here's a look at the strategies aimed at giving investors more control over their returns, although, of course, there are some risks.

The simplest volatility strategy is combining two types of options to create a range a stock or an index will trade in. This is done by selling a call option, which allows the buyer of that call to purchase shares at a set price, and then buying a put option, which allows the person who owns the shares to force someone else to buy them if they fall to a certain level.

Take United Parcel Service, which was hovering around US$63 a share on Monday, the first day of trading after Standard & Poor's downgraded the United States' credit rating. Tyler Vernon, chief investment officer of Biltmore Capital Advisors, which manages US$600 million for wealthy families, said that an investor could have sold a call option at US$65 a share for US$2.50 and for the same amount bought a put option at US$60. The costs would cancel each other out and the investor would have created what is called a collar around the stock.

'With volatility kicking up, this is a strategy that more sophisticated investors are taking advantage of,' Mr Vernon said. 'They're okay giving up the upside after seeing markets fall down by hundreds of points every day.'

Of course, the investor may not get the gains if the UPS stock rises above US$65 before the collar expires. But Mr Vernon said that this was a risk most clients were willing to take. 'They're having flashbacks to 2008 at this point, so that's not a bad deal.'

Futures contracts

A slightly more complex but relatively inexpensive way to manage losses is to buy futures contracts that bet an index will fall in value.

Mark Coffelt, who manages the Empiric Core Equity Fund, said that he hedged the entire US$50 million portfolio this week by buying 702 contracts that bet the Russell 2000 index, which tracks small-cap stocks, would fall in value. They cost just US$1,400. While the equities in the portfolio still fell in value, the futures contract limited the overall losses. 'Our hedges picked up US$2.5 million' the previous week, Mr Coffelt said. 'Hedging has helped us tremendously this year. It has not accounted for all the gains, but it sure has reduced some of the losses.'

A big advantage of this strategy is that the markets for futures, particularly with currencies, are easy to trade in and out of. But they require restraint.

'If everything turns around quickly, we're going to lose money, unquestionably,' said David Kavanagh, president of Grant Park Funds, which has just under US$1 billion in a managed futures strategy. 'I can't emphasise the disciplined nature enough. There is always an exit strategy.'

He said that once he took a view on an index, he would look to buy the futures contract that was the most liquid, whether it lasted one month or six.

Structured notes

With structured notes, a bank can pretty much create any trading range that clients want through a combination of financial products, including options and derivatives. But these notes are highly complicated, generally illiquid and carry the risk of the firm that created them.

This was an issue when Lehman Brothers went bankrupt in 2008. The firm had sold billions of dollars of structured notes that lost their value when the firm collapsed.

But investors who are comfortable with the firm creating these notes can virtually determine how much economic risk they are comfortable with by using a simple formula: the more appreciation they give up, the more they can protect themselves from losses.

JPMorgan Private Bank is selling one-year notes that offer what Joe Kenney, US head of investments at the bank, called 'contingent protection'. They have been structured to give a client as much as 20 per cent gains and protect losses down to 20 per cent.

On the plus side, the notes pay a guaranteed 8 3/4 per cent return even if the market does not rise that much. The downside is that if the losses are greater than 20 per cent, the protection expires, and the investor gets all the losses. A relatively new strategy relies on publicly traded options and exchange-traded funds to create the same effect as a structured note without the credit risk of a bank.

Mitchell Eichen, president of the MDE Group, which pioneered its 'planned return strategy' in 2009, said that the strategy was meant to protect against the first 12 per cent of losses - with any additional losses starting at that point - and to double the market gains up to a cap of 8-12 per cent. Now, some US$275 million of the US$1.3 billion the firm manages is in this strategy.

Tax factor

One advantage is its transparency: All the parts that create the band are held in a separate account for each investor, with Fidelity as the custodian. Another is that the firm is putting together new offerings monthly in the hope that this product will become like a laddered bond portfolio for its clients.

Philip M Gross, a retired engineer who had worked at Warner Lambert and General Electric, said that he had about 15 per cent of his money in MDE's planned-return strategy and was adding to it. 'If I thought the market was going straight up over the next three years, I wouldn't do this,' he said. 'But this is a practical approach.'

The one caveat with this and many of the other strategies is how they are taxed. They are often at the higher short-term capital gains rate or some mix of short and long-term gains. But taxes are the last thing on Mr Gross' mind, after the market crashes in 2000 and 2008. 'I'm not sure if I'm ever going to use all my capital losses,' he said. 'I realise intellectually that's a dumb answer, but it's a practical answer.'

Given that volatility is a practical problem right now, that may be good enough. -- NYT

Living in a more volatile world

Published August 17, 2011

These days, 'risk free' and 'Treasuries' are no longer interchangeable terms


IT'S been dizzying. The markets have been swinging madly up and down - mainly down for equities, as anyone in the stock market knows too well. How bad has it been? Despite brief rallies, the Standard & Poor's 500-stock index has fallen more than 13 per cent from its May peak. For four consecutive days, the index moved up or down by at least 4 per cent, the first time that's happened.

In a steadily rising market, investing may be a pleasant pastime, like knitting or chess or antique-collecting. Lately, it's been a blood sport. William Butler Yeats captured the feeling nicely: Things fall apart; the centre cannot hold; Mere anarchy is loosed upon the world.

There are prosaic explanations for the gyrations that have been unmooring the financial markets. Start with the unseemly squabbling over the debt ceiling in the United States, and the inability of politicians in Washington to come to grips with the nation's growing debt load.

Then there's the parallel debt crisis in Europe, which has exposed fissures in the European Union and vulnerability among its major banks. Behind all of that is a sagging global economy - highlighted, in the United States, by a moribund housing market and painfully high unemployment.

A grain of sand too much

'The distinction between developed and emerging markets has blurred and will require a fundamental rethinking.'

- Aswath Damodaran,
finance professor at New York University

While these issues aren't new, the accretion of them all is like 'adding grains of sand to a mound on the beach', said Mohamed El-Erian, chief executive of Pimco, the world's biggest bond manager. 'For a while, you add sand and nothing much happens,' he said. 'Then with just a few extra grains, the structure starts to shift.'

There has been one significant change in the structure of markets recently, he said. It was partly symbolic, but still disturbing: the Standard & Poor's downgrading of the sovereign debt of the United States. Why is this so important? It's because 'AAA' United States Treasury bonds have been the linch-pin of the global financial system, and the centre of myriad calculations in business, portfolio construction and capital markets.

In this context, Mr El-Erian said, the downgrade represents a wide perception of instability in the world's financial structure. 'We lived in a world in which 'risk free' and United States Treasuries were interchangeable terms,' he said, 'a world in which it was assumed that the United States would safeguard its pristine AAA rating, and protect the dollar, the world's reserve currency'. Now, for many around the planet, the world's core seems much less solid.

Blurring distinction

Aswath Damodaran, a finance professor at New York University, said that the true rate for a 'risk-free investment', which had been assumed to be the 10-year Treasury yield, now needs to be 'approximated', a procedure heretofore required for emerging markets. 'The distinction between developed and emerging markets has blurred,' he said, 'and will require a fundamental rethinking.'

Eugene Fama, a finance professor at the University of Chicago, said that S&P's move was 'a non-event in itself, because it merely reflected a view that was already well understood by the markets'. But, he added, it reflected 'a great deal of pessimism out there, a great deal of uncertainty' over whether Western governments would resolve their fiscal dilemmas. 'Capitalism itself is under duress,' he said.

Prof Fama, a leading theoretician of efficient markets, said that the current volatility 'is exactly what you'd expect when efficient markets are confronted by massive uncertainty'. Not that the Treasuries have been supplanted by another putative risk-free security. In the current crisis, Treasuries have been very much in demand. Their prices have soared, and yields, which move in the opposite direction, have plummeted. Thanks in part to a Federal Reserve pledge last week to keep rates low until at least 2013, the 10-year note fell Friday to 2.25 per cent.

Summer dip

Scott Minerd, chief investment officer at Guggenheim Partners, predicted correctly in May that the 10-year Treasury yield would dip below 2.5 per cent over the summer as the economy weakened and investors sought a haven from greater distress in Europe.

Now, he says, long-term government bond yields are likely to remain very low for several years, and the Fed is likely to ease monetary conditions further.

There is more risk in the global financial system, he says, but for canny investors, it has created a 'phenomenally good time to buy'. He sees bargains in stocks as well as in municipal bonds. Over the long haul, he said, he's also bullish on gold, but added that 'its recent parabolic rise will lead to a correction, so this isn't the time to buy it'.

If the US economy doesn't lurch into recession, and if corporate earnings stay strong, then stocks are far better priced than government bonds, said Tad Rivelle, chief investment officer for fixed income at TCW. For a while last week, the 10-year Treasury yield dropped below the dividend yield on the S&P 500, a rare occurrence, according to Birinyi Associates, a research firm. It also happened in the 2008-09 financial crisis, presaging the stock market bottom of March 2009.

While there will be opportunities for astute investors, Mr El-Erian said that in addition to a 'new normal' of slow economic growth and high unemployment, we must now also grapple with a weakening of the financial system's core. 'We will be living in a more volatile world,' he said. -- NYT

Buy-and-hold approach untenable today: Lipper

Published August 17, 2011

Analyst says it's difficult to justify a passive stance in current conditions


BUY and hold investing is increasingly 'untenable' in today's volatile environment, says Lipper senior research analyst (Asean) Rajeev Baddepudi.

In a briefing on the second quarter performance of funds in the CPF Investment Scheme, he said a buy-and-hold approach may have been rewarding more than 10 years ago. But that is not the case today.

'Between 1999 and 2011, in any three-year period there is a likelihood of (a fund) dropping in value to where it started . . .

'What will assist in a long term strategy is to focus on choosing the right fund to diversify with and generate absolute returns.'

He added: 'It's not about long term or short term (holding period) but about passive or active. It's difficult to justify a passive approach in the current market conditions.'

In the six months to end-June, CPFIS-included funds overall lost 1.89 per cent on average.

Bond funds generated the highest return of 1.83 per cent; equity funds lost 2.94 per cent. Mixed asset funds recorded a marginal loss of 0.78 per cent.

Over 12 months, the average return of a CPFIS-included fund was 7.74 per cent, and 2.4 per cent over 36 months.

In a statement, Lipper said its analysts were 'cautiously positive' about the second half.

Mr Baddepudi advocates the use of 'Lipper Leader' ratings in the choice of funds.

This method of rating ranks funds against their peer group based on four metrics - total return, consistent return, capital preservation and expense.

The ratings are subject to change every month, and are not predictive of future performance. According to Lipper literature, the ratings 'do provide context and perspective for making knowledgeable fund decisions'.

Based on some 310 funds in the CPFIS menu, for instance, 27 funds are both Lipper Leaders in terms of preservation and consistent return over a three year period. Only one fund is Lipper Leader in all four metrics. This is the APS Alpha fund.

Based on a three-year period, the top unit trust sectors in terms of their information ratio - a measure risk adjusted return - are equity (Asia Pacific) small and mid cap funds, Malaysian equity and Singapore equity.

Among ILPs, the top sectors are Singapore equity, information technology funds, and European equity.

Meanwhile, preliminary data on fund flows shows a net inflow of just under $2 billion into funds here in the first half. Most of the inflow has gone into bond funds.

This is not surprising as the second quarter saw a spike in risk aversion, with investors preferring safe haven assets.

The Citigroup World Government Bond Index rose 3.32 per cent in the quarter and the Citigroup High Yield Market Index gained 0.93 per cent.

Lipper analysts say the outlook for the second half is 'cautiously positive'.

Investors are waiting to see how key economic indicators and events unfold. These include the events concerning the Eurozone debt crisis, and the policy debate over inflation versus growth in growing economies.

Tuesday, August 16, 2011

Dead Cat Bounce

Are we seeing a repeat of 2008?

Stop coddling the super-rich

16 August 2011
Warren Buffett

Our leaders have asked for "shared sacrifice". But when they did the asking, they spared me. I checked with my mega-rich friends to learn what pain they were expecting. They, too, were left untouched.

While the poor and middle class fight for us in Afghanistan and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks. Some of us are investment managers who earn billions from our daily labours but are allowed to classify our income as "carried interest", thereby getting a bargain 15-per-cent tax rate. Others own stock index futures for 10 minutes and have 60 per cent of their gain taxed at 15 per cent, as if they had been long-term investors.

These and other blessings are showered upon us by legislators in Washington who feel compelled to protect us, much as if we were spotted owls or some other endangered species. It is nice to have friends in high places.

Last year, my federal tax bill - the income tax I paid, as well as payroll taxes paid by me and on my behalf - was US$6,938,744 (S$8.37 million). That sounds like a lot of money. But what I paid was only 17.4 per cent of my taxable income - and that is actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 per cent to 41 per cent and averaged 36 per cent.

If you make money with money, as some of my super-rich friends do, your percentage may be a bit lower than mine. But if you earn money from a job, your percentage will surely exceed mine - most likely by a lot.

To understand why, you need to examine the sources of government revenue. Last year, about 80 per cent of these revenues came from personal income taxes and payroll taxes. The mega-rich pay income taxes at a rate of 15 per cent on most of their earnings but pay practically nothing in payroll taxes.

It is a different story for the middle class: Typically, they fall into the 15-per-cent and 25-per-cent income tax brackets and then are hit with heavy payroll taxes to boot.

Back in the '80s and '90s, tax rates for the rich were far higher and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.

I did not refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone - not even when capital gains rates were 39.9 per cent in 1976-77 - shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money and potential taxes have never scared them off.

And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what has happened since then: Lower tax rates and far lower job creation.


Since 1992, the Internal Revenue Service has compiled data from the returns of the 400 Americans reporting the largest income. In 1992, the top 400 had aggregate taxable income of US$16.9 billion and paid federal taxes of 29.2 per cent on that sum. In 2008, the aggregate income of the highest 400 had soared to US$90.9 billion - a staggering US$227.4 million on average - but the rate paid had fallen to 21.5 per cent.

The taxes I refer to here include only federal income tax but you can be sure that any payroll tax for the 400 was inconsequential compared to income. In fact, 88 of the 400 in 2008 reported no wages at all, though every one of them reported capital gains. Some of my brethren may shun work but they all like to invest. (I can relate to that.)

I know well many of the mega-rich and, by and large, they are very decent people. They love America and appreciate the opportunity this country has given them. Many have joined the Giving Pledge, promising to give most of their wealth to philanthropy. Most would not mind being told to pay more in taxes as well, particularly when so many of their fellow citizens are truly suffering.

Twelve members of Congress will soon take on the crucial job of rearranging our country's finances. They have been instructed to devise a plan that reduces the 10-year deficit by at least US$1.5 trillion. It is vital, however, that they achieve far more than that.

Americans are rapidly losing faith in the ability of Congress to deal with our country's fiscal problems. Only action that is immediate, real and very substantial will prevent that doubt from morphing into hopelessness. That feeling can create its own reality.

Job one for the 12 is to pare down some future promises that even a rich America cannot fulfil. Big money must be saved here. The 12 should then turn to the issue of revenues. I would leave rates for 99.7 per cent of taxpayers unchanged and continue the current 2-percentage-point reduction in the employee contribution to the payroll tax. This cut helps the poor and the middle class, who need every break they can get.

But for those making more than US$1 million - there were 236,883 such households in 2009 - I would raise rates immediately on taxable income in excess of US$1 million, including, of course, dividends and capital gains. And for those who make US$10 million or more - there were 8,274 in 2009 - I would suggest an additional increase in rate.

My friends and I have been coddled long enough by a billionaire-friendly Congress. It is time for our government to get serious about shared sacrifice.

Warren Buffett is the chairman and chief executive of Berkshire Hathaway.