Thursday, September 30, 2010

Some random thoughts on America's tax debate

Todd Henderson's badly written piece about the effects of tax increases proposed on America's "wealthy" and the comments that followed made for reading that was both entertaining and depressing.

There's not much to add to the extensive criticism of Mr Henderson or the very limited support he has received. However, a few random thoughts:

1. like many other developed countries, America is living beyond its means. History has shown that no country can continue to spend more than it earns indefinitely. Sooner or later there will be adverse consequences. At a federal or other government level, there are only three ways to deal with the issue - tax increases, spending cuts or asset sales. Most likely, all three will be needed. So far we've seen a lot of rhetoric and not much action to address the issue;

2. the word "fair" has no place in the debate. It is a subjective term and what is, or is not, "fair" will depend on your perspective;

3. higher taxes have consequences. A person faced with a higher tax bill will either save less, spend less or borrow to maintain spending. Spending less has a negative impact on the goods and services being purchased or charities supported - which will be a negative for the economy and tax receipts from the businesses involved. This does not mean that higher taxes are not appropriate or are not needed, only that higher taxes are not a free lunch for everyone other than those paying the additional taxes;

4. America already taxes wealth. Taxes on dividends are, in reality, a wealth tax - the company has already paid tax on the earnings (profit) and paying a dividend is merely transferring part of those tax paid earnings to the real beneficial owner. Taxing those earnings again is a tax on wealth. The same can be said for capital gains taxes (at least in part). To the extent that capital gains reflect an increase in value arising from tax paid profits being retained by the company, the capital gains tax is a tax on wealth. Likewise, a reintroduction of estate duty will be a tax on (tax paid) wealth;

5. too much of the debate over America's deficit and debt problems is resembling class warfare for my liking. One of the problems America faces is that the number of people paying meaningful amounts of tax is much smaller than the number of benefiting from taxpayer funded support. While this can be taken as evidence of growing income/wealth inequality, it also has other implications. Everyone wants someone else to bear the burden and will support proposals that have that effect, either through public debate or at the ballot box. This is not a healthy situation as the resulting proposals and actions too often end up being an exercise of power by a majority over a minority. It also isn't an answer as the the number of "wealthy" people represent a sufficiently small minority that no amount of tax increases on them is going to come even close to addressing the underlying problem;

6. if Mr Henderson's writing is indicative of his teaching standards, I don't want him teaching my children.

With the exception of item #6, these issues are not unique to America. Many other countries face similar issues. Few countries are dealing with them in an effective manner.

Wednesday, September 29, 2010

Does luck really matter?

Yahoo carried this article on the role of luck in successfully retiring.

The article makes valid points that the time at which you start saving and investing and the time you retire have a material impact on the success of your financial plan. This is not exactly new. Sam Savage (among others) has made this point before.

While the effect of return on investments in the early years of retirement (in particular) can have a dramatic effect on the success of a financial plan, I disagree with the notion that luck has any bearing on the matter because, while we cannot control the markets, we can control our own actions.

In very simple terms the risk of bad "luck" derailing a financial plan can be addressed through proper planning over the life of the plan:

1. reduce equity exposure when values are materially above historical averages - you may miss the end of a bull market but you will also miss the fall in values afterwards and you are cashed up ready to pounce when values get cheaper again;

2. increase equity exposure when values are materially below historical averages and are cheap in absolute terms - sure markets can go down further but history suggests that buying in times of adversity will pay off, it's merely a question of how long you have to wait;

3. plan on retiring a few years earlier. Not only do you have the possibility of spending a few extra years on the golf course if things go well, but you have the flexibility to keep working if things go badly or you want a bit more security.

Points #1 and #2 apply to any asset class, not only equities.

Is it that easy? Possibly not. It requires standing aside from the market when others are boasting about how much money they have made and jumping in when the financial media is spending most of its time showcasing the prophets of doom. It also requires the discipline to save at a higher rate. But if you can manage these three things, at least this component of the luck element can be managed.

And the alternative is what? Just taking your chances? Buying bonds only - at today's yields? Personally, I would rather make the attempt to deal with the issue than ignore it.

Monday, September 27, 2010

Negative real interest rates

Hong Kong's official CPI for August 2010 showed a year-on-year increase of 3.0%. This means that the weighted basket of items that make up the index increase 3% over the preceding 12 months. If your cost of living went up at the same rate as the CPI, then it costs 3% more to live in Hong Kong today than it did a year ago. (Of course, very few people's personal cost of living will fluctuate at the same rate as CPI.)

This compares with:

1. very close to zero for call and short term bank deposits (HSBC is offering 0.015% for a one month deposit)

2. less than one percent pa to borrow money on a residential mortgage (all my mortgages are currently costing my less than 1% pa)

3. a little bit more than 3% pa for a good quality HKD corporate bond with about 10 years to maturity

Given these factors, I am amazed that the level of deposits held by banks in Hong Kong is so high (especially when non-HKD deposits are taken into account). Why on earth would people would so many people leave so much money sitting in bank accounts losing real value for so long? If the answer is risk aversion, then this behaviour amounts to embracing a small certain loss and sacrificing any possibility of avoiding loss altogether in order to avoid the possibility of a greater loss. While I can understand the wish to avoid a loss, the possibilities that ready cash offers to take advantage of opportunities and the need to have enough cash on hand to meet short term needs, I just do not understand why people would be prepared to adopt loss making behaviour when there are so many other alternatives available.

That said, at one level I am grateful - all that cash sitting in the banks and not being more productively invested is available for people like me to borrow at negative real interest rates.

Friday, September 24, 2010

Magic Holdings sold

As a shareholder in Hua Han (587), I received and took up a small allocation of shares in Magic Holdings (1633) which listed today. Magic Holdings' business and fundamentals looked appealing so I gave some thought to the price at which I would be prepared to buy more. The shares opened at $4.36 which compares to an issue price of $3.30. Since I regarded the issue price as being at the high end of what I was prepared to pay, I sold my small entitlement at an average of HK$4.38. Net of transaction costs, I made a profit of 29%. Sadly, the amounts involved were relatively small.

Wednesday, September 22, 2010

Everybody wants a weak currency

While the logic of having a weak currency to benefit exporters has general acceptance, the reality is that this is a comparative measure - one currency against other currencies and it simply not possible for all countries to have comparatively weak currencies. If one currency falls, others must rise.

In this context, the efforts of central banks to weaken their nations' currencies is getting quite intense. As examples:

1. the US Federal Reserve's asset buying programme has the effect of selling dollars;

2. the European Central Bank's asset buying programme has the effect of selling Euros

3. Japan made a big effort to talk about it's intervention in the currency markets to stem the rise of the yen

4. Brazil and South Korea (among others) have taken action to weaken their local currencies

5. China operates a fixed exchange rate which is widely viewed as making the RMB undervalued.

Not every currency can be weak relative to other currencies. At the moment, the biggest loser in the battle to have a weak currency would appear to be Japan and the biggest winners would appear to be China and some of the major exporters in the Euro zone (e.g. Germany).

Of course a weak currency also has other consequences, including the cost of imports and the impact on inflation.

However, I really have to wonder how it will end when so many major countries are all attempting to have their currencies trade relatively lower than their major trading partners? At the very least, there has to be some basis for arguing that the competition to achieve comparative devaluation of a number of currencies will result in absolute devaluation of paper currencies generally. This would certainly be consistent with the historical track record of paper money (aka fiat currency) depreciating over time. It would also suggest that either inflation or biflation looks more likely than deflation over the longer term.

As an investor, the issue is what are the implications for my portfolio. I continue to believe that cash and low yielding notes and bonds are a poor store of wealth. I have never been a fan of gold (a point on which I concede to being very wrong over the last few years), but do believe that investing in assets which have the potential to appreciate over time at an acceptable rate of return (say a real rate of 3% pa) is critical to long term financial success. From this perspective, competitive devaluation does not change my approach to investments. However, the possibility of seeking greater diversification between asset classes and along geographical lines is something to consider.

Monday, September 20, 2010

Financial house keeping update

Of the items on my financial house keeping list:

1. all management fees for our properties are now on auto-pay. I will still have to pay the fees for September and, for one property, October manually but the end is in sight;

2. of the four trivial investments in Australia and New Zealand, two have been sold, one is subject to an executed limit order (it seldom trades) and the fourth requires me to dig out a shareholder identification number which, for some reason, is different to all my other shares;

3. the two trivial investments in ETCs remain unactioned. I need to reactivate the dormant account before I can do anything with them;

4. the idle cash sitting in Australia has been transferred to my broker where it can earn interest in a money market account;

5. I have not taken any action on the idle HKD sitting in my company's account in Hong Kong. I have several leases falling due between September 2010 and March 2011 as well as a raft of incoming repair bills and would like to maintain a larger than usual float until I am past the vacancy risk.

Saturday, September 18, 2010

How not to cool an over heated market

The Hong Kong government has been considering ways in which to address the growing sandwich class - the group of middle class people whose incomes are too high to qualify for public housing programmes but who are struggling to save a a deposit to buy a home without assistance.

Most of the ideas which have been put forward for discussion are either silly or morally inappropriate. They also demonstrate that a lot of people (including sections of the media) have learned absolutely nothing from America's housing problems.

it all comes down to supply and demand. If you want to make housing more affordable, you either need to increase the supply or reduce the demand. Many of the proposals focus on providing people with either a taxpayer funded subsidised entry to the housing market (e.g. a first home buyer grant) or some other form of financial assistance (e.g. buy to rent programmes). There are two major issues with these proposals.

The first is that they represent a transfer of wealth from an already very narrow tax base to an already too large pool of people who take support from that very narrow tax base. While there is a legitimate case for providing support to people who cannot afford housing at all, there is no legitimate case for the taxpayer to be required to upgrade the financial position of people who are able to support themselves.

The second issue is that these forms of financial support have the effect of increasing demand. You don't need an advanced degree in economics to understand that increasing demand is likely to put upward pressure on property prices making the situation even worse.

If the government does introduce a buy to let scheme or a first home buyer grant, I suspect I would not be the only investor who would consider buying some of the properties in the target price range (HK$2-3 million) in anticipation that the increased demand would lift prices. After all, I might as well get some benefit from how the government spends my tax dollars.

Friday, September 10, 2010

RMB bonds - are they worth it?

Bond issues denominated in RMB have been very popular. In fact bond issues are popular generally. There are no shortage of stories about investors pulling out of stocks to invest in bonds. I put some relatively small sums into a few RMB issues over the last two years and a slightly larger sum into HSBC's 6.8% due 2038. The latter has been a good investment and the former haven't done me any harm.

The latest "hot" offering is by BOCHK which is offering two tranches by way of public offer - Tranche A due in 2012 paying 2.65% and Tranche B due in 2013 paying 2.9%.

Should I buy these bonds?

Looking at the Tranche B issue, the annual yield is less than a lot of stocks pay (including the dividend on BOC's own shares). The only real case for buying on yield is that the bonds are of sufficiently short duration to be viewed as an alternative for cash. If I had meaningful amounts of RMB, I would be happy exchanging bank deposits paying zero for bonds paying 2.9%.

Since I don't have meaningful amounts of RMB sitting around, the comparison between RMB bank deposits and the RMB bonds is not valid for me. I have to compare the HKD cash that I would convert to RMB with other things I could put those HKD into.

If one accepts the often voiced opinion that the RMB is undervalued against the HKD (which is pegged to the USD) and arbitrarily assume that the RMB will appreciate by 20% over the three year life of the bonds then the total return is 2.9+2.9+2.9+20 = 28.7% less the FX conversion spread and bank charges on the receipt of each semi annual interest payment. There is no compounding of the interest received given that deposit rates are near enough to zero. This is is roughly 8.4% compound p.a. (depending on fees and spread) which is a very decent rate of return - if the FX appreciation actually happens (a point on which I am agnostic). As alternatives, one can find no shortage of shares listed in Hong Kong with higher yields and the potential for capital gains which may or may not be larger than the potential for appreciation of the RMB. There is no certainty that the RMB will appreciate against the HKD by 20% - or at all.

Of course, there is less downside risk investing in bonds than in equities. Safety favours the bonds.

Lastly, buying some more bonds would make my portfolio more diversified which would not be a bad thing.

In the end, it is unlikely that I will buy these bonds (at least not in any great quantity). If I can buy equities with better yields (which have the potential to grow) and which have the potential for greater appreciation, then I will take that over the relative safety of bonds and the more limited potential for currency appreciation.

Note: once I retire I will allocate a part of my investments to cash and short term interest bearing products. At that time the case for short dated bonds like this becomes stronger.

Thursday, September 09, 2010

Some overdue financial house keeping

One of the things which has been on my "to do" list for a long time is cleaning up some very small matters, some of which should have been dealt with a long time ago. I have finally kicked myself into action and begin the process. Here is the list:

1. Auto-pays to implement: I have three properties in Hong Kong where the management fees are not on auto-pay. This means I have to sit down and manually transfer funds or write a cheque each month. My previous attempts to get these three payments on auto-pay failed. One management company acknowledged receipt of the bank instruction but failed to do anything with it - and then had the cheek to send me an overdue notice. For the other two properties, the management company sent me the wrong forms which I have successfully sat on since early this year;

2. Trivial investments to sell #1: I have very small parcels of shares in four companies listed in Australia or New Zealand. Two of the shares were allocations by insurance companies, one was a spin off from another company I held shares in and the fourth is a company which has teetered on the verge of insolvency for a long time (and serves as a hard lesson about the need to cut losses when things start to go wrong). I will sell all of these. For at least one of the shares, this will require reactivation of a dormant account with a local broker;

3. Trivial investments to sell #2: a couple of years ago I made some small investments in commodity ETCs. The amounts are not meaningful. I need to either dispose of these or increase the investment to a meaningful amount. In either case, the account is now dormant and needs to be reactivated;

4. Idle cash #1: I have some cash sitting in a bank account in Australia earning zero. It's not a lot but I will be sending this to a broker for future investment;

5. Idle cash #2: one of the Hong Kong accounts into which my tenants pay rent and I use to pay mortgage balances has built up to a modest sum. Absent any better ideas, at the very least I should make a partial early repayment of one of my mortgages. Around 1% (being the cost of the mortgage) is better than zero and it will either improve cash flow or reduce the term of the mortgage by a meaningful amount.

I have set myself a goal of getting all of these resolved by the end of November. Reactivating the dormant accounts will take the longest.

Wednesday, September 08, 2010

Vodone purchased

This morning I added handset manufacturer Vodone (82) to the private portfolio paying HK$2.36 per share. At first glance the stock appears rather expensive, selling on a trailing PE of around 44x. However, this is misleading. A crude annualisation of interim result, drops the PE for the current year to around 26x (which is still expensive). However, revenues and earnings are expected to increase significantly following the completion of a recently announced acquisition of a mobile handset design house (Shenzhen Tastech) through a JV.

The balance sheet is clean with no material debt as at the last accounts date.

The decoupled property world

A selection of headlines and quotes from today's SCMP Property Post show just how much divergence there is in property markets around the world:

Hong Kong: "fierce bidding at land auctions shows developers are expecting the market will maintain its [upwards] momentum"

Thailand: "Huge demand sustains Bangkok boom"

Singapore: "Singapore prices to keep rising"

Malaysia: "Property mania brewing in Malaysia"

Canada: "Canada's cooling market may avoid crash"

United States: "US faces grim choice over owners as home sales and prices plummet"

Britain: "British prices fall quicker than expected and building slows"

It's also fair to say that the markets which are experiencing property price increases are those where the governments have spending under control to a far greater degree than those which are suffering. Of course, there are other factors at work as well.

Monday, September 06, 2010

A series of repairs and some leases up for renewal

After a relatively charmed run, in the last few weeks I have been hit by a series of repair bills:

1. replacing two airconditioning units

2. replacing a hot water cylinder

3. fixing a broken water pipe that was leaking into the common areas

4. cleaning four airconditioning units

5. a leak in the kitchen - source unknown

I have already paid for #1 and #4 and expect to pay the rest this month.

I also have two leases expiring soon - one at the end of September and the other in late October. Both tenants are looking at alternatives so the possibility of some vacancies is there which would bring to an end a very long series of months with positive cash flow. One of the tenants who is looking at other properties to rent has asked for an extension for a "month or two" which I have refused. I either want them to be out by the end of October or to commit to remaining in place until at least the end of March - finding tenants around Christmas time and around Chinese New Year has, in the past, been problematic. If I must have a vacancy, I would prefer a short one.

Another small speculation

On Friday I purchased a few shares in Midland IC&I (489) at HK$0.05. I sold the shares this morning at HK$0.05, netting a profit after expenses of around 1.5%. Given the small amount of money involved, the gain will just about cover my lunches for this week. Fun, but hardly of any financial significance.

Friday, September 03, 2010

A small day trade

I executed a small day trade, buying Solartech (1166) at HK$0.02 on Wednesday and selling it on Thursday morning at HK$0.021 for a profit after transaction costs of 3.2%. OK, this was only a very small amount of money, but the profit was still enough to cover my lunches for this week. Needless to say, I have no intention of committing more than relatively trivial sums to this sort of speculation.

Incidentally, if I had sold a few hours later on Thursday when the shares were trading at HK$0.023 and HK$0.024, the profit would have been much more impressive (12-17%).

Another nomination for "death of equities" headline

This article from USA Todayhas been picked up by a few bloggers.

While the article itself is not completely unbalanced (the quotes from Jim Paulsen give one view on what it would take to set off the next bull market), the most interesting (and depressing) reading was in the comments. The degree of negativity was enormous: repeated allegations of the market being rigged by the "big guys", allegations that the regulators do nothing to "protect the little guy" etc etc etc. The sentiment was either that people would never invest in stocks again or would only invest when things were better - overwhelmingly so. I really struggle to understand why people would prefer to invest "when things are better" - that amounts to a statement that people would rather pay higher prices than lower prices which defies all common sense.

While it will always be true that prices can go lower and it is very true that the American economy has some very serious issues (government debt, deficits, consumer debt, regulation that is strangling the small businesses that drive job creation, a misplaced entitlement mentality and a lack of political will to do anything to resolve these and other problems), it is also true that America has a great record of dealing with economic adversity.

Looking at a few facts - on both a trailing and a forward looking basis, American stocks are trading at below their long run averages, there are many world class companies with very strong balance sheets that are selling at prices which (IMHO) are attractive on a valuation basis and Americans also have the ability to invest in the world's lowest cost index tracking funds. I wish Vanguard would let me invest with them.

Looking at the alternatives, bonds are selling at very low yields. You have to get a fair distance out along the yield curve to match inflation and even further if you have to pay tax on the interest income. Bonds have done well but yields are now well below equity earnings yields. Real estate would have to be attractive given the number of forced sales going on (but clearly involves a lot of homework and more work generally than other investments). Bullion has also done very well but is more speculative given that the price largely depends on sentiment and there is an absence of valuation parameters which can be applied.

Historically, going against the crowd and investing in the most unwanted asset class has often turned out to be a sound move.

None of this is to say that equity prices cannot go lower. They can. But given current sentiment and current valuations and a willingness to ride out the volatility that is inherent in the equity markets (for years if necessary), equities look a pretty good bet at the moment.

Of course, since I am heavily invested in equities perhaps my perception is less than fully objective.