Sunday, October 05, 2008

I am an investment Guru God

As a somewhat healthy bi-product of my existential crisis I've gained a deeper understanding of several asset classes and investment choices I would otherwise not have made if I hadn't been mired in that ever present question:

"What's the point of it all?"

And as a nice warm up exercise to today's Zine writing adventure I might just do a little market wrap up to try and briefly explain in my terms the very real danger we are all in.

First up cash generally considered the lowest risk (and therefore least profitable) asset class. Cash is in any given market a game of two variables:

1. fixed interest.
2. inflation.

See money isn't just money, put simply if you have $100,000 dollars cash and stick it in the bank and at the end of the year you have $100,000 dollars cash you have usually lost money. Because of inflation.

You see at the start of the year that $100,000 could have bought you a lot of different stuff, like petrol, bread, paddle pops etc. Once the retailers of these items lifts the price though your $100,000 isn't worth as much because it can't buy you all that stuff anymore.

So when you deposit your cash you want it to be at an interest rate that beats inflation.

Healthy inflation is 2% and we haven't had that for years. It's probably safer to say inflation is on average going to be about 4%. So if you get 6% on your deposit and inflation is 4% you are making money.

Now unfortunately a lot of us have ambitions for travel and that's the clincher. As interest rates go up relative to other countries our currency also goes up relative to other currencies. So if the US's interest rate is set by the reserve at 2% and ours is set at 8% a bunch of people will borrow US dollars and stick them in Australian bank accounts to come out 6% ahead.

As they move down our currency collapses. So even though your house may be worth $300,000 still because interest rates went down, it is no longer worth US$300,000 it just lost a lot of value overnight because of the rate relief.

As the interest rate comes down "foreign investors" have less reason to leave there money in your currency as it is worth less to them so they pull out and everything we import gets more expensive as our dollar gets devalued.

Conversely if interest rates do go down, then people can borrow more money to make investments and buy things which puts upwards pressure on inflation.

So having interest rates go down is bad news on every front really. But the ability to borrow money stimulates the economy, because businesses can borrow money and lend money to keep everything going.

So all in all cash isn't a safe investment right now because interest rates are going down and inflation will go up (almost inevitably) cash is only a good investment when interest beats inflation by a clear margin.

So take your money out of cash and put it into an asset class.

Property is the next big one considered lower risk than stocks and at least theoretically lower profit.

Much like all commodities what makes property valuable is buyers. This is an interesting dilemma in Australia, because what makes our economic fundamentals so strong is the China driven resources boom, and what makes China's booming economy so strong is the China financed american customers that no longer really exist.

Anyway back to property, you sell any given house in any given street and a bunch of people turn up to the auction to gawk. Most of those people will be the neighbors wanting to see how much the property sells for to figure out how much their property is worth.

Three or so of the people will be actual serious bidders. Eventually one bidder will bid an amount that the others are not willing to pay for the house.

Then the real estate agent charges 4% of that price, the government charges 10% in stamp duty and X amount in capital gains (with exceptions). The government then searches for ways to spend the money that won't involve upsetting anybody.

The real estate agent then writes everybody in the street to say they are looking for more houses and they write down some amount based on the last sale that would indicate how much the property was worth.

This is the basis of Property profits, letters that tell you hypothetically how much your property is worth.

But it isn't so simple as 'if everybody sold while the market was booming we'd all be rich' this is patently untrue.

If in the initial street instead of one house being sold their were three, or indeed the whole street being sold those three buyers would not have had to bid against eachother. Instead the home owners would have to compete for the customers.

Property may look profitable but most of the time and for most people these are profits that are called 'unrealised' meaning you don't get the profits until you sell.

If everybody realised their profits they would in fact make a loss, because the profit figure the estate agent uses is based on some assumptions about supply and demand.

In a booming market simply, you would be a fool to realise your profits because property is booming, in a busting property market you are a fool to realise your profits because property is busting.

Generally also, the boom represents a departure from value, and here is where an existential crisis comes in handy. If you own an empty house in a booming economy that is a sure sign that the economy doesn't really need your empty house in order to function.

This is like owning a restaurant that nobody eats at. Its a bad business, however thanks to terms like 'capital apreciation' and 'unrealised profits' people can think it is a good business, and failing empty buildings can be in steep demand.

This is generally what has tipped off recessions in the world.

Which brings us to stocks, stocks are my second favorite investment. That said stocks are not like cash or property or art whose value reflect the market generally - stocks are a whole bunch of businesses.

Each business you can own a part of. The part you own represents a share of the entitlement to the profits. The more profits a company makes the more you get but also the higher the price of the share.

To over simplify you simply look for P/E ratio's below one dollar. This means that for every dollar spent owning the company the company earns more money.

Taking it a step further you take the whole business apart to try and see whether it will be a better company in the future, then the price offered now may be even more of a bargain.

But it's really too complicated to talk about it all out.

Basically business is all about adding value, so you take something that needs to be done and you try and do it to the highest standard at the lowest cost possible.

And this brings me to my final legal loophole that I think makes my investment advice the best ever.

In Australia it is illegal to kill anyone already alive. Now whilst many old people will soon die anyway, it also means very young people statistically speaking have a long future ahead of them.

Since they are going to be alive anyway we may as well increase the value of the individual being alive. Whilst it is hard to make someone taller or stronger or able to shoot laser beams out of their eyes you can get a sizeable return on education.

Furthermore education whilst offering returns (around 7:1 on every dollar invested apparantly) is very expensive it's hard for other countries to compete with an educated one.

One of the most straightforward and most monopolistic investments one could ever make is in education.

Now to look at the plight of the world today, we have to look at the plight of baby boomers and the concept of superannuation.

See a ways back someone with foresight said 'What a tax burden this huge generation of people will be to sustain on a pension, if only there were a way they could self fund their retirement' and so was born the concept of self funded retirement.

So most of these people who wouldn't have saved money themselves had the government force their employers to put away money for them.

Then years past and as soon as they got their hands on their own money most of them bought property. Property above and beyond what was actually needed.

Especially in california. And then because there was so much demand for property, property prices skyrocketed. Everyone was theoretically making lots of money, so long as people were willing to buy at ever increasing prices.

To facilitate this banks started lending money to 'help' people get a foothold in the property market abolishing such requirements as the need for people to be able to prove their stated income.

Eventually a bunch of people got laid off and couldn't repay their loans anymore which in the meantime had been sold to banks all around the world.

This created a credit crunch which in turn meant banks not fully knowing how exposed they were to bad property investments couldn't lend money to businesses anymore. Businesses in turn found their customers desperately trying to make payments on houses with 'negative equity' were no longer finding a need for 'Calvin Klein' baby glasses and other material excesses the economy had increasingly based itself on.

Thus more people got laid off and the problem compounded.

To keep liquidity going interest rates in America had to be left at 1%, causing the US dollar to tumble. This pissed off Russians, Chinese and Japanese governments who held huge reserves in US dollars.

The US was trapped. In turn China stopped lending money to the US which meant that US consumers could no longer buy Chinese goods with the money leant to them by China.

In effect China was just as guilty as US mortgage brokers at trying to amplify their profits by leveraging thier investment in the US economy.

Once China's bubble bursts (on account of losing their richest customers) and their currency appreciates at the speed of light it is game over for Australia's resources boom.

Property in mining towns will collapse, along with a whole bunch of contracts currently propping up the economy.

The layoffs will have a knock on effect on the banks lending money to a bunch of these people.

In turn the over exposed self funded retirees will try to relize the profits locked up in real estate, flooding the market with a glut of houses nobody ever needed apart from the need to make imaginary profits. They will be ruined and back on the pension.

Except heaps of people will also be out of work because the resources boom is over before it began.

Manufacturing jobs will have moved offshore, and the services sector will collapse because services are a luxury that serve industries like resources and manufacturing.

Whereas if we had just instead of going for self funded retirement, built a phenomenal education system (which would not resemble our education system at all) we would probably have all the best jobs and companies and industries in the world, and it wouldn't matter if there was a huge tax burden on the current working population because they would be paying dividends on the investment in their education.

Aren't I a genius.

No comments: