USA Debt Ceiling

By Jason Fittler

At present the US is back in a situation where their debt ceiling needs to be increased.

The current debt ceiling is $16.7 Trillion, back in 1990 it was $3 Trillion by 2000 it was $6 trillion and by 2010 it was at $14.3 Trillion.

Since 1913 the US government has had to approve the debt ceiling. The debt ceiling is the amount up to which the US government can borrow.

Why this is a big issue? The US needs to borrow money to continue to pay for its reforms along with interest on current debt and all current government expenditure.

The Republican’s in the US see this as an opportunity to bring about spending reforms by cutting back on government expenditure, which they consider wasteful. The president however has a number of social reforms which he want to go through as such we have a stale mate.

The key date here is 17/10/2013, at which point the government will start to default on their debt obligations. To put this in terms the ordinary Australian can understand, it is like going back to the bank to borrow money to pay for expenses you have committed to but do not have the money to pay and the bank tells you no.

It could however simply be a storm in a tea cup as not to increase the debt ceiling will cause severe economic pain in the US as services need to start being cut. As such it is widely expected that an agreement will be reached around this date.

But this leads me to the bigger picture.

The US has been using Monterey policy to prop up their economy since the GFC. This activity has been undertaken by the Fed Reserve. The market has been speculating for some time as to when this process will slow or cease.

Back in April 2013 the chairman Ben Bernanke announced that they were considering slowing down Monterey policy, the market started to drop. It was not until May when the chairman corrected his April statements that the markets started to move up again.

The market is expected to fall once again when Monterey policy easing starts, the problem is no one knows when this will happen.

The current debt ceiling crisis for me is an indication that the government in the US need to change spending habits which leads into easing of monetary policy. I do not expect that this will happen in the short-term but if there is a ground zero I think this might be it.

Australia is not isolated on this issue, we also have a debt ceiling problem, which has been well flagged. Our current ceiling of $300 billion is also to be moved up to $350 billion shortly however I doubt we will have the same media coverage as the US. The new government has advised that this will be a short-term increase.

Australia I feel is ahead of the US as far as economic recovery. Our new government is clear that they will cut spending and focus on infrastructure spending which will in turn provide more jobs and build long-term efficiencies for our country.

The road back to surplus will be at least two terms of government but at least we are on the right road. The US is yet to make these changes but I expect it will happen at the next election.

I expect that the Australian market will pull back with the US; mainly due to international investors generally looking to exit all markets while the US get reset.

This would be short-term and provide a good opportunity to get spare cash into our market, which is looking a little fully valued at present.  

Corporate Capital Allocation

By Matthew R Smith (B.Com C.Dec)

I am an owner who takes a very big interest in the companies I own a part of.

What I am about to propose is heresy to legions of income-hungry, dividend fans.

Firstly, what I am not saying is that all companies should retain 100% of their earnings. Funnily enough, there are some companies which should not retain 1 cent of their earnings. Those businesses, the ones with low rates of return on equity (ROE) should in fact distribute all earnings to their owners. However, there are companies that should suspend their dividends and retain all their earnings. My reasons follow.

With the removal of the double taxation and implementation of the imputation system, Australian investors have been lapping up these franked dividends since 1987. This silent protest from Australian investors has been so effective that corporate capital allocation now blindingly follows the mantra to the significant cost of the very investors the mantra seeks to serve.

Business owners will be financially significantly better off if, a company stops paying a dividend and can re-invest earnings at a higher rate of return than owners can elsewhere.

Australian directors which are generally part owners are selling themselves and their other business partners short by paying a dividend at present. The following example demonstrates my rational allocation of corporate capital.

Take a company with $10 per share of book value on its balance sheet. Assuming a return on equity of 20% per annum and assume 50% of earnings are paid out as a dividend, as often is the case in Australia. In the first year, earnings per share will be $2 and the dividend will be $1. The retained $1, which is not paid out as a dividend, increases the equity at the end of the year to $11. In year two the company generates a 20% return on equity, this time on $11 per share of book value, producing $2.20 of earnings.

If we now assume the market chooses to never re-rate this stock from a price/earnings multiple or P/E of 10, you will find that in year one the stock price will equal $20 (P/E of 10 x $2 of earnings). In year two, the share price will be $22 (P/E of 10 x $2.20 of earnings).

In year one, you will receive a $1 dividend, and in year two a capital gain of $2 for a total return of 15% ($1 div + $2 gain = $3 / $20 share price = 15%) but had the dividend not been paid, retained earnings would have been $2 and the beginning equity in year two would have been $12.

A 20% ROE, on the newer higher equity of $12 would correspond to earnings per share of $2.40 in year two. If the P/E remains at 10 times earnings the share price would be trading at $24. The owners would have received a 20% return ($0 div + $4 gain = $4 / $20 share price = 20%).

By following the mantra that seeks to serve, the owners have robbed themselves of $2 in capital gains.

For many years, it has been investment hoodoo-guru that as you attain a senior’s card, your portfolio should lean increasingly towards income and clear itself of growth. Unfortunately, the majority of Australian companies irrespective of their returns on equity have been obliged to adhere to the irrationality of flawed financial advice for far too long.

I simply wish to see that business owners don’t miss out as a result and see that dividends are suspended until the Return on Equity equals a company’s weighted average cost of capital.

Kind regards,

Matthew R Smith (B.Com C.Dec)
Private Client Adviser | Authorised Representative: 327 246
RBS Morgans Limited | ABN 49 010 669 726 | AFSL 235410
Unit 3 69 Eyre Street North Ward QLD 4810
PO Box 1663 Townsville QLD 4810
Direct: 07 4771 4577
Email: [email protected]
Level 1 Candidate for the CFA Program

Panic and Lose Money (29-Jan-08)

By Jason Fittler
Why is it that people panic?  People panic in many different situations and I am yet to hear a story where panic actually did some good. So why do we do it?

Between 01/11/2007 and 21/01/2008 our stock market lost 23.5%, this is a large loss and certainly something to be concerned about. A lot of people lost a lot of money but the losses were compounded by three factors: panic, greed and ignorance. I am pleased to say that during these events our clients were not influenced by any of the above factors. The most common comment I received from friends and family was “You must have had a busy week”, in fact no, my week was like most others.  I am proud to say our clients understand the markets and most were looking to take this opportunity to buy good quality shares at a discount.

Let’s take a look at the above three factors and what part they played in recent market events.

Greed

Global V Domestic Equities

By Jason Fittler

"I believe that it is time for Australian investors to start to increase the allocation of international shares in their equities portfolio. At present the best way to do this is through Listed Investment Companies (LIC) which invest in the international market companies such as Platinum Capital and Hunter Hall."

Most of us have the majority of our investments both within super and outside of super in Australian Equities, whether this is through buying direct shares of managed funds. This is a sound strategy and below I will discuss a number of reasons as to why, however, given that the world is shrinking and technology has allowed us to travel the world at the click of button we need to reassess how we invest and more importantly where we invest our money.

Investing in other countries is becoming easier and will be a normal part of business in the next 5-10 years. As such there is a strong argument to start looking to increase your exposure to international shares.

Australia is only around 2% of the world stock market.  Having most of your portfolio exposed only to Australia can mean that your portfolio is overweight Australia.

Shorting the Market

By Jason Fittler

Most people’s view of the stock market is you only make money when the market is rising, in fact you can make money when the market is falling as well.

You may have heard the term to “go long” or “go short” the market, ever wondered what this means.

“Go long” this is a term we use when we are bullish or positive on the market, it means that we are buying shares with the view that in the short term process and the market will go up.

“Go Short”
this is a term we use when we are bearish or negative on the market, we believe that the market will go down so in order to make money in such a situation we go short.

Clear as mud, going long is easy to understand as you buy share at a lower price then wait until they get higher sell and make a profit. But how do you make money when the market is falling.

When the market is falling to “go short” you can do one of two things:

Where Do The Terms “Bull Market” and “Bear Market” Come From?


The terms go back more than two centuries, to when middlemen called bearskin jobbers would sell the skins of bears not yet caught, and then wait for the market price to drop before buying the skins from trappers, pocketing the difference. Thus a bear market has falling prices, and is favorable to bearskin jobbers and modern-day short sellers. Because bull and bearbaiting were popular sports at the time, bull market came to mean the opposite: a market with rising prices. Now see if your accountant knew that.