U.S. Government Goes Insane

That's what it feels like. Bears won't be happy. UK stock market is up 9.3% at this moment.

In other news, I went to pick up my Mac laptop but when I got it home I found it hadn't actually been fixed at all. It's been lying in the storeroom at the Canberra City store for the last two weeks I think. In fact they didn't know where it was at first and phoned up all the other stores to see if it had accidentally been sent there. Outrageous.

I didn't hear anything on the outcome of my margin call. At least closing prices in Australia will have been a bit higher today. It's a shame that they decided to downgrade EBB and EBI and force me into selling something. I guess I should never be near the margin limit in case something of that sort happens in the future.

A Sensible Housing Crisis Proposal

For a change, someone is proposing a pretty sensible initiative in the housing market. The Australian Federal government will give tax breaks worth $8,000 per apartment per year for a decade to developers who build rental apartments and rent them for 20% below the market rent to qualifying low income people. This is a sensible move to alleviate the housing shortage in Australia, because it increases the supply of housing rather than increasing demand. Most schemes, like the proposed housing savings accounts, just given people more money to bid for the existing housing stock, which solves nothing. But unfortunately this new scheme does make things more complex and increases transaction costs. So it's not perfect by a long stretch.

Clearly, the Australian tax and maybe regulation system works against developers constructing rental accommodation or institutions and wealthy individuals managing apartment complexes. There are essentially no unfurnished rental apartment complexes in Australia. We have a rental market but it is almost entirely single houses and single apartments (condos in American). Institutions do own property, but it is mostly commercial, retail, and industrial. None is regular residential. (Senior housing does seem viable). One reason is that the effective rate of state land tax increases as you own more property - it's progressive (owner occupiers and agriculture don't pay land tax). I haven't uncovered all the other reasons, but the tax review makes clear that property taxes are relatively high in Australia. Ideally, the tax review will remove some of the distortions in the tax system that discriminate against institutional ownership of rental property. That would help significantly.

P.S. The Australian "housing crisis" is an issue of way high house prices and a very tight rental market. Basically a shortage of housing. At least where anyone wants to live. It's ironic that Australia has the second lowest population density of any country with more than 1 million population. Mongolia has the lowest density.

U.S. Clearly in Recession

For anyone out there who still thinks the U.S. is not in recession this chart pretty clearly refutes that view. It's a view only held by some business economists anyway, I think. U.S. GDP increased by more than 3% y.o.y. in the second quarter of this year. But GDP growth is only one of the factors that the National Bureau of Economic Research takes into account in declaring recessions. The chart shows that in terms of unemployment the U.S. is now clearly in recession. The recent upward trend clearly broke the previous downtrend in terms of any signal to noise test you'd want to construct. And upward trend defines an unemployment recession. This isn't a case of some indicator that is coincident with recessions. I've seen a lot of those charts with commentary that says "in 8 out of the 9 last recessions this indicator rose ". Which isn't much of a statistical sample. I don't think this chart is that kind of an example.

How Come Australia Has Less Government Spending than the US and Has Free Healthcare for All?

Following up from my comments on this post of Madame X, I thought I'd have another go at comparing Australian and US government spending:



As you can see from the chart, Australia spends less as a share of GDP than the US does. Only Korea and Switzerland spend less than Australia among the OECD countries for which there is data. Australian government revenue is slightly higher as a share of GDP than the US, because we have a budget surplus whereas the US has a large deficit. But we have more or less free healthcare for all, while the US does not. Australia encourages people to get private health insurance through tax incentives, and around 35% of people do have private healthcare. This makes free healthcare easier to provide than in other OECD countries where there is less private insurance. So how does Australia achieve universal healthcare when the US does not? Here are some suggestions:

1. Our defence budget is smaller. Also we have far fewer people in prison. The US has 4.5 times as many prisoners per capita as Australia.

2. Because we run surpluses our government has net assets rather than net debt. So we don't have to pay any net interest on the non-existent national debt. There are government bonds outstanding just to keep the market open.

3. Retirement benefits are means tested and less generous than average US social security benefits. Whereas the US gives more retirement and unemployment benefits to people with previously higher incomes, Australia does the opposite. Over time retirees will be more and more self-funded due to compulsory superannuation saving in Australia. Since 1992, employers have been required to put at least 9% of salary into a superannuation fund - the equivalent of a 401k. It's much harder to get the money out before retirement too.

4. Our medical care is much cheaper than the US. Reasons include the high level of litgation and consequent insurance and overtreatment in the US and price discrimination by drug companies due to the fragmented nature of demand for drugs in the US. Doctors earn less in Australia.

So, in order to get "socialised medicine" you don't need "socialist" levels of government spending ;)

Why is "The Motley Fool" Still in Business?

I've always wondered how "The Motley Fool" remains in business since the 2000-2002 bear market. Many of the companies they praised in the late 1990s bull market as "breaking the rules" ended up crashing and burning. The model seemed totally broken. And then there was the nonsensical strategy called "The Foolish Four". Most of their comments that I read either state the obvious or seem to lack the relevant context. When I saw their headline: "Buyout or Sellout?" under the headlines for PeopleSupport, I was hopeful that someone else was outraged by this takeover. Don't know why I gave them the benefit of the doubt. They rated PeopleSupport highly but were really happy about the buyout. They completely omitted any reference to the previous $17 buyout that was rejected by management.

As I was thinking about how useless TMF is, someone pointed out to me two adjoining Motley Fool stories about Capital One Financial with diametrically opposing conclusions. Either Capital One Financial is a huge value trap that should be avoided or a low-rated stock that deserves your support. Certainly amusing, not very educational, and definitely not enriching.

In more positive takeover news, Newscorp raised their takeover offer for NDS to $63. That's a nice gesture with no other competition to buy out the company!

Most Frustrating Market in Seventy Years

At least it's not just me having a hard time trading. And Bespoke provides evidence that it is the most frustrating market in 70 years. Someone should run this for the entire history of the Dow Jones Industrials...

Worst Since the Great Depression

There is a lot of talk that this is the worst June for the Dow since the Great Depression and the worst month since the 2000-02 bear market. I haven't run the numbers in a while, or posted that much, as they are so bad, but clearly this is my worst month since the 2000-02 bear market. I didn't bet on such a major retracement in the indices - about a 50% retracement of the March-May rally in the NDX, a new bear market low for the Dow, and a pretty much 100% retracement for the SPX. I've been trading on the wrong side of the market for the whole month, somehow, despite this, my trading result should be a little positive unless something real bad happens on Monday but that is offset by horrible investment returns. Friday night in the US my trading positions did go in my direction as the market reversed to the upside in reaction to a collapse in the oil price from a new all time high. The price of oil really drives the US stock market now, second by second. We are going to need to see a substantial fall in the oil price to get any rally going in stocks. I think that's possible. Recent highs in oil seem weaker as they are being made on lower volume etc.

On another positive note, after the close Friday, News Corp announced that it plans to privatise NDS at $60 per share. I currently have 100 shares. My brother is employed by NDS, which is how I heard about it in the first place. It's always been a bit hard to understand why the company was public given the overwhelming majority stake News Corp held. One excuse I heard was that it was to provide incentive options to staff who owned many of the remaining shares. Also, I've not yet seen any explanation as to why News Corp wants to take the company private now.

Another similarity with 1990-91

Record levels of bearishness. As I write, oil just spiked to a new all time high. Seems to me this was a reaction to a bad Empire State Report (NY Fed report on NYS economy) which caused US bonds to rise and therefore the USD to fall. This started a rise in the oil price that then set off a cascade of stop losses at $137, $138, and $139. At least that's what the charts look like... Dow Jones commented on the price spike but didn't report any news except the Saudi decision to raise output which was already known and bearish for the oil price.

Why Doesn't Australia Give More Incentives to Give to Charity?

We made some donations to help with the recovery from the Sichuan Earthquake. Half the money we gave through San Diego Zoo to help the Wolong Panda Reserve (both of us have been at different times to San Diego Zoo where there are both pandas and koalas). The other half we gave to the Australian Red Cross. We thought about giving money to this charity but contributions to it are not tax deductible while those to the Australian Red Cross are. Americans are used to being able to claim a tax deduction for a contribution to any non-profit. Here, charities must either be named in the Act of Parliament or meet very strict criteria. The Charles Foundation has chosen not to pursue tax deductible status even though it is an Australia based charity. Needless to say pretty much all foreign charities, including San Diego Zoo, are not eligible for tax deductibility in Australia.

I first became aware of these complications when I ran a small Australian non-profit - an academic society - we explored getting tax-deductible status - but it was just a non-starter. I think this discriminates in favor of large established charities - you can take a deduction for a contribution to an Australian university, but not to the educational efforts of our fledging academic society.

There are other strange restrictions on the tax deductibility of giving. In the US, giving appreciated assets to charities is really big. Buy a house for $1,000,000 and let its value rise to say $3,000,000. Leave it in your will to charity and your estate takes a $3,000,000 deduction against the value of the estate for estate tax purposes. In Australia, you can't donate property to charity if you've owned it for more than 12 months! We don't have an inheritance tax here either which also discourages giving (though I'm not a fan of inheritance taxes :) - though requiring people to give 10% of an inheritance to charity or pay an equivalent tax might be a good idea). Actually if the heirs donate the house within 12 months they'll be able to claim a $3,000,000 deduction in Australia but if they wait too long, they'll have to sell it, pay 23.25% tax on the $2 million gain (the top long-term CGT rate - unless they go and live in the house which will make the sale tax free) and then donate the remaining cash to charity, which they will be able to claim a deduction for. In the case of shares, you must hold them for 12 months or more (how weird is that?)... so a Warren Buffett could donate shares to charity and claim a massive deduction against his other income but not real estate or art works etc.

So it's not surprising that the U.S. has the highest level of charitable giving per capita in the world (which somewhat mitigates its low level of official foreign aid) and Australia a much lower level, though still ahead of many other developed economies.

Well, I don't know the answer to the question in the title, except that the government seems to trust people less on this here than the U.S. government does. Maybe it's due to the more secular nature of Australian society? After reviewing the tax deductions available for charitable giving in other countries, Australia is actually pretty generous compared to many.

A tip, donate in the name of the partner with the highest marginal tax rate if you are part of a couple. Don't donate as a couple if your tax rates differ.

Potential Changes (Yet Again) to Superannuation

Gottliebson has some interesting insights on the upcoming Australian tax review. I think it makes sense that "salary sacrificing" of superannuation contributions will be ended. What does this mean? At the moment contributions to super (=retirement account) are taxed at 15% up to a limit of $A50k per year. Above that you can make "undeducted contributions". Earnings in the fund are taxed at 15% (10% for capital gains). Payouts are tax free (and this is out of bounds for the review) and if you convert your account to a pension then the earnings of the fund from then on are tax free too. Eliminating the concessional rate of tax on contributions has two effects (apart from raising revenue for tax cuts elsewhere):

1. It makes the super system simpler by abolishing concessional and non-concessional contributions.

2. Currently people in the 15% tax band get no gain from this concession. Labor will eliminate another middle class welfare expenditure.

By carrying out this reform Australia will have gone from a system several years ago that gave concessions on contributions and superannuation earnings and taxed payouts heavily, to one that taxes payouts lightly if at all and gives no concessions on contributions and only some on earnings. In other words, from an approximation of a 401k to an approximation to a Roth IRA. The US Congress likes Roth IRAs because they bring tax revenue forward to the present. The Australian Treasury, whose head is heading the enquiry, likely feels the same way.

Even so, I'm not inclined to add any extra money to Snork Maiden's superannuation and lock it up for the next few decades!

Australian and U.S. Federal Budgets

There were some great charts on the growth of tax revenues and spending in the last few decades in Australia in Saturday's Australian Financial Review. Unfortunately, their website has high subscription fees and I couldn't find similar charts elsewhere on the web. The bottom line was that despite the Australian government's constant attempts to cut tax more and more tax revenue per person has kept piling in since the mid-1990s. Anyway, in response the government has spent more and more, while maintaining a small surplus. In honor of Tuesday's upcoming Australian Commonwealth (Federal) budget I present the following comparison of the breakdown of the US and Australian federal budgets:

Australia


United States


Two big differences are in: interest payments - Australia effectively pays none as it has little government debt any more and defence where the US spends 19% and Australia 8%. Interestingly, the US spends more of its budget on health - 23.1% in total than Australia does, 18% despite there being free public health care available for all without private coverage in Australia (around 35% or so have private health care). Australia though spends more on all social security and welfare, 41%, though Australia only spends about 13% on the "age pension" while the US spends 20% on social security (almost as much goes to "families with children" as to the old in Australia) . Education is much higher in the Australian budget, not surprisingly given the almost complete absence of private universities and more centralized education system.

The Best Market-Timers are Bullish

The best market-timers are bullish on average and the worst are bearish on average currently. Yes, some market-timing gurus do beat the market. And those ones are currently bullish. However, they are fewer in number than all those bearish commentators out there who generally don't beat the market. So what does that tell you? :)

Today the Australian market was down. The only catalyst I could find was Brambles (BXB.AX) saying that Walmart might reduce its contract or something. Gold remained strong, oil remained strong. The Japanese and Hong Kong markets were up and U.S. futures, especially of the Q variety were strongly up following Google's earnings announcement, which I got up before 6am this morning Australian time to follow (just wish I had more GOOG :)). Given all this, I didn't see much risk in buying some SPI (ASX 200 Index) call warrants near the bottom today. I plan to sell them Monday either way. My model is pointing down for the Australian market but it looks like another double-peaked stochastic wave is taking shape, which has been pretty common lately. My position is only a fifth of the size of a SPI futures contract. So I feel very little fear trading this in comparison.

Great Article on the British Housing Market:

Great Article on the British Housing Market:. Click on the links. It's nuts that the average two bedroom apartment in inner Canberra costs about £185,000. But they are pretty nice compared to what you probably get for that "lowest price" property in East London mentioned in the article. One of the apartments in the building I grew up in in South London recently sold for £250,000. I remember my parents bought for £4,500 (1966) and sold for about £60,000 in 1995. That was an investment mistake. Would have been much better to rent it out (with an agent managing it).

And in Ireland a one bedroom apartment in a suburb of Dublin for $575,000 (£290,000 or $A620,000). Suddenly, Canberra looks cheap :)

Meanwhile in California:



On another note, Intel's earnings report has boosted the futures up. Maybe wave 3 from the March low is starting?

Babcock and Brown Combat Shorting

I noticed yesterday that Babcock and Brown had set up a new prime broking arrangement with Deutsche Bank. I didn't look into the details though. Apparently it avoids margin calls and does not allow their stock to be lent to other parties (for short-selling). Short-selling is currently very controversial in Australia as in some cases short-selling has pushed stock prices down resulting in margin calls to directors or companies that results in their stock being sold in a cascade effect. This affected Allco and ABC Learning Centres and rumours were that Babcock and Brown was also being targeted. In the US, unless you are a market-maker you have to borrow stock first before short-selling it. Naked short-selling where stock is not borrowed is not approved though ti goes on. In Australia things are reversed. The ASX has a list of approved stocks that can be short-sold - nakedly short sold. You don't need to borrow the stock if it is on the list. This is the only sort of shorting that is reported to the exchange. On the other hand a market has developed where stock is borrowed and short-sold. The reason is that only the biggest companies by capitalization are on the approved naked shorting list. Borrowing to sell short is not regulated and so no-one knows the actual short-interest in smaller Australian stocks and it seems many people are only just waking up to the fact that this going on.

Anyway, I hope this move helps the stock prices of Babcock and Brown related stocks such as EBB.

Wealth Much More Evenly Distributed in Australia

Wealth appears to be much more evenly distributed in Australia than the US. The lowest 10% of households have a median net worth of $A175k, which is greater than the US median for all households (around $US100k). I think the Australian figures include cars and household effects which pushes the numbers up a little. One important factor is probably compulsory superannuation - employers must contribute at least 9% of salary towards a retirement account and cashing those accounts out before age 60 or so is near impossible. The median for all households is $A340k and for the top 10% $A975k. This probably places us ($A470k) a little lower in the continuum than we would be in the U.S. According to recent taxation data we live in the 8th richest (out of 26 in terms of income) district of the Australian Capital Territory. About where we fall in the national net worth spectrum too.

Are Professors Better Market-Timers?

I showed in a previous post that many of the investors in the TFS Market Neutral Fund were poor market timers. I just received the CREF Annual Report, which also contains data that is useful for assessing market timing, though not at the same level of detail. The following table gives the distribution across funds and asset classes of the CREF and TIAA Real Estate variable annuities (similar to mutual funds in this case). I've estimated the holdings of the TIAA Real Estate based on data for September 30th, 2007 and projecting that the growth rate of assets in the fourth quarter was equal to that in the first three quarters of the year:

CREF also has regular mutual funds available under some retirement plans though their assets are still small. There is also the massive TIAA Traditional Account which is a kind of life insurance annuity. It's assets are just as big as those of the CREF variable annuity scheme.

At the end of 2002 the investors held 82% of their assets in stocks, 9% in bonds, 6% in cash and 3% in real estate. 2003 was a strong year or stocks and not surprisingly the allocation to stocks rose but in subsequent years of the bull market the stock allocation was gradually reduced. This might be evidence of rebalancing following the 2003 run up. In 2007 there was a sharper reduction in stocks. I'd have to dig into the quarterly data to find out whether this occurred in the first or second half of the year. It could represent either good or bad market timing. 2008's allocation will be interesting. Assets were reallocated across the spectrum but the real estate fund which was performing well through the end of 2007 was the greatest beneficiary. Stocks and real estate performed about as well as each other in 2006. Therefore, there was a clear reallocation to real estate in the year. So far putting money into the real estate fund has proven very worthwhile. It has only had one minorly negative month since October 2002 returned an average of 0.9% per month over the period with a Sharpe Ratio of 4.08. So it's hard to say whether investors are "chasing returns" or appreciating quality when they see it.

Within the equities category funds have been shifted towards global equities fund (50/50 US and foreign shares) from the massive "Stock Fund". CREF's Growth and Equity Index funds have underperformed the Stock Fund and have not seen big shifts towards them. Foreign stocks outperformed US stocks throughout this period. Looking deeper into the accounts, while investors continued to pay premia into the Global Equities fund through 2007 at a fairly constant rate, the fund saw big switches into it in 2006 and much smaller switches out in 2007. Again I don't know in which half of the year these occurred.

In conclusion the professors and other education workers invested in the TIAA-CREF accounts do not seem to be too bad at market-timing and rebalancing. There is a little evidence of return chasing but also of rebalancing. In any case, no movements as dramatic as in the TFS Capital Market Neutral Fund.

Evidence on Market Timing

Following up on my recent post on market timing, I thought I'd give you some evidence of the real-world market-timing abilities of mutual fund investors from the latest semi-annual report of the TFS Capital mutual funds. The data can be found on page 33 in the table "Statements of Changes in Net Assets". I've computed the average price per share data:



Bear in mind that one would think these investors are somewhat sophisticated as this is a market neutral mutual fund, which is a little esoteric. In the year up to June 30th, 2007 shares issued by the fund exceeded shares redeemed by investors by around a 20:1 ratio (13.4 million issued, 740,000 redeemed). The average price of shares issued did exceed the price of those redeemed but giving the benefit of the doubt, maybe the redeemers had bought shares earlier in the period or in previous years. A 2% fee is imposed on redemptions within 6 months of purchase. Redemption fees totalled 0.85% of the value of redemptions so more than 40% of sellers had bought within 6 months of selling. Based on that the average seller made little or no money on their investment.

Things changed dramatically after June 30th. The fund suffered a big loss in August:



though it has recovered nicely since then, especially when compared to the broader market. Including the dividend of 41 cents per share paid in December the fund is near its July 2007 high.

However, masses of investors rushed for the exits. Redemptions exceeded new issuance by a 2:1 margin in the second half of 2007. Redemption fees totalled 1.4% of the value of shares redeemed, so most sellers had bought in the last 6 months. The difference between the average price of shares issued and redeemed was $1.00 - buy high sell low! As you can see from the chart, prices averaged much more than $13.48 in the second half of 2007. Most people who sold, sold right near the bottom.

So the average investor, and even the somewhat more sophisticated investor, is a terrible market timer. As I commented at the time it made more sense to invest in funds such as this one in the second half of 2007 rather than sell out.

Time and Class

Social class is a tricky concept to get a handle on. For one thing, class definitions vary quite a bit around the world. The "middle class" starts at a higher level of income and education in Britain and Australia, where most people define themselves as working class, than it does in the United States, where the majority identify as middle class. It's clearly not just a question of income or net worth, or education, though all those are correlated with it. Maybe it is a question of time. Once I read that the working class is mainly concerned with the present (making ends meet and enjoying the moment), the middle class with the future (studying, saving, getting ahead), and the upper class with the past (ancestry etc.). That's certainly true to some degree. Today I read about Edward Banfield who put it in terms of "time preference" a standard economic concept. Basically, someone with a high time preference discounts the future at a steep rate. It makes sense that working class discount rates would be much higher than middle class ones. Not only is this seen in the behavior mentioned above but in the interest rates available - e.g. comparing payday loans with mortgage rates. Someone born in a working class background who develops a low discount rate will be more prepared to save time and money towards getting educated and moving to the middle class. Of course a lot of people will try and fail for whatever reason, so I'm not saying people are poor because their discount rate is too high. But comparing samples of "working class" and "class people" the average would differ in this way. Some people remain poor because they haven't learned to lower their discount rate and others because circumstances have gotten in the way of using this positive character trait.

An interesting hypothesis then is: "Is the discount rate of the upper class, even lower than that of the middle class?". This paper hypothesizes that the aristocracy and peasant class in early industrial Britain both had high discount rates while the emerging middle class did not. And that this lead to the decline of the traditional aristocracy. Of course, the paper is pure theory (speculation) with no data to back the idea. Maybe instead someone who can preserve inherited wealth and cares about dynastic succession, might have an even lower discount rate than the middle class saver and learner?

Recession is Local Too

USA Today has a nice map of economic conditions across the US - I've see a similar map somewhere else recently. Some parts of the US economy are doing fine, others are clearly in recession, which is one reason why it is hard to say whether the country as a whole is in recession and maybe if it is the recession could be mild?

Looks Like We're Going Down Again

This would be wave 3 of 5 in my Elliott Wave count. It arrived a couple of days earlier than I expected. I sold NNDS, BWLD, and RICK (NNDS and BWLD for gains and RICK at a loss). I also sold short LAZ. My US portfolio now consists of the following:

AAPL
BRK.B
BTF
FF
FLIP.OB
HCBK
HSGFX
LAZ (short)
LTR
LUK
NCT
PSPT
SAFT
TFSMX

I didn't feel confident enough to add more short positions into options expiry on Friday, which I had thought would be a positive event for stocks due to the number of outstanding puts.