Terry Smith Straight Talking

Austerity v Growth

2012-05-18T16:29:45+01:00

I have appeared recently on Newsnight, ITV News and BBC News talking about the debate over austerity v growth.

I also appeared on Robert Peston’s BBC2 programme about the Eurozone crisis - The Great Euro Crash.

These appearances were prompted by the Eurozone crisis coming back into focus, and in particular by a period of a week in which the Dutch government fell; elections in Greece failed to produce a government, and in particular failed to produce a consensus which supported the austerity measures which Greece had agreed to as part of its last bailout deal; and the socialist candidate Francois Hollande defeated the incumbent Nicholas Sarkozy to become President of France. Clearly the electorates are rejecting austerity. It has now led David Cameron to start making supportive noises about Monsieur Hollande’s call for policies to support growth. It seems strange to scramble to align oneself with a soundbite. But then I’m not a politician.

The appearances were also a result of the publication of the latest piece of research by my colleague Dr Tim Morgan – Blowing the Whistle on UK Austerity.

Tim’s research explodes the myth that the UK economy is struggling under the impact of government spending cuts. Government spending was cut by just 1.5% in 2011-12 and is only planned to fall by 5-6% by 2016-17 (so far away, who cares?). It is still over £20bn higher than government expenditure in 2008-09 under Labour. More worryingly, it is 50% higher in real terms than it was 10 years ago. As Tim succinctly puts it: what is it that the government wasn’t supplying ten years ago that we now cannot live without? The answer of course is nothing. Expenditure can be radically reduced and needs to be if there is to be any chance of closing the deficit which is currently running at over £120bn per annum and adding to the national debt which is already too high.

Such a miniscule cut did not send the UK economy back into recession-it never exited in reality (see below about the size of the stimulus which has been applied just to get it to stand still).

My stance is clear and it has been so since the onset of the financial crisis and the Eurozone crisis:

1. The debate between those who propose policies designed to promote growth and those who see the need for austerity is a sterile one for a number of reasons.

The simplest reason is that we are going to get austerity whatever people want. There is simply no source of additional money to spend to stimulate growth. The bond markets have had enough of governments who continually run unsustainable deficits. You cannot borrow your way out of a debt crisis.

Additional deficit spending funded by increased borrowing would not produce the desired result even if it were possible. So far the UK economy has been the recipient of £500bn of deficit spending, £325bn of Quantitative Easing and interest rates have been at a 300 year low for over three years. These so-called Keynesian measures (I say “so-called” because most of their proponents seem to me to have about as much grasp of Keynesian economics as they do the topography of the far side of the Moon) have not managed to get the economy growing so far, and they will not. The velocity of circulation of money has slowed-people want to pay down debt where they can. The government is also an incredibly inefficient spender (unsurprisingly as it’s not their money)-in the years prior to the recession it borrowed £2.18 for every £1 of growth. As Einstein said, to keep repeating the same actions whilst expecting a different outcome is a definition of insanity.

2. The only way to generate growth is to cut the size of public spending sufficiently to allow for tax cuts. Individuals and companies are much more efficient at spending the money they earn than the government is on their behalf, so better to leave more of it in their hands.

Yes, I do have a plan for exactly where to make the cuts.

3. With regard to the Eurozone I first predicted that Greece would leave in April 2010. I have not changed my mind.

There have been no fundamental solutions applied to correct the problems of the Eurozone. You cannot solve a problem of solvency and lack of competitiveness with liquidity and rhetoric. If you could, it would have been solved long ago.

When Greece leaves, the crisis will roll on into Portugal (I know it’s a small country but everyone seems to have forgotten them) followed by Spain, Italy, Ireland and ultimately France. Yes, the horrible truth is that financially France is a peripheral country, one of the PIIGS.

The Euro is doomed

2012-05-14T15:26:42+01:00

I was surprised to see the headline in Friday’s Financial Times “Seven days which shook Europe” looking back over the fall of the Dutch government, the election of Francois Hollande in France and the Greek elections. As I have been predicting for more than a year that Greece will leave the Euro and that this will produce a domino effect which will probably see Portugal, Spain and Italy follow suit, I am surprised that anyone could be surprised by these events. But then I suppose I don’t spend my life swallowing a diet of PR spin from the Eurozone “elite” and their acolytes.

As ever, people are looking in the wrong place for the source of trouble. All eyes have been on the bond market, whereas they should now be on bank deposits as most Greek bonds are now in official and/or local hands so the bond market is no longer playing a central role in the Greek tragedy/farce. There is an old saying that a currency can endure despite a lack of faith in it from foreign investors, but not when it is rejected by its own population (see Argentina in 2001 for details). Greece’s bank deposits have been fleeing its banking system as its citizens fear that they will wake up one day soon and discover that they are New Drachma deposits rather than Euros. When this happens, the €3 trillion of deposits in Italian and Spanish banks are going to try to do the same. This will represent a tsunami which no amount of Eurozone spin can prevent and which will require drastic action - like exchange controls.

Whilst we await these events, herewith a piece of research which tells you why the Euro was doomed from the outset:

Return on Capital Employed

2012-04-23T09:34:38+01:00

Today's Financial Times carries a letter from me about the subject of how to measure managerial performance.

This is a matter which has attracted a lot of attention as a result of the debate about executive pay. Having a yardstick of company performance which aligns the rewards for managers with the interest of investors is vital to this debate.

I have been amazed by the poor quality of the debate and the work on managerial incentives. Probably the most commonly used measure of fundamental performance is growth in Earnings Per Share or EPS. This is garbage: it takes no account of the amount of shareholders' capital employed to achieve that growth. This is a mistake that a novice investor choosing a bank savings account would avoid.

I was therefore pleased but slightly irritated to read that the Association of British Insurers, one of the trade associations which seeks to represent the interests of insurance investors, and which has expressed many views on executive pay, has said that growth in EPS may not be a suitable measure for this purpose. Neither is Total Shareholder Return, another commonly used measure, or even Return on Equity or ROE as it can be distorted by leverage or debt gearing. They are beginning to recommend Return on Capital Employed or ROCE. So are some institutional investors.

What is galling about this is that not only have I been saying that for about 20 years, but Warren Buffett said it in his 1979 Chairman's letter for Berkshire Hathaway. It has taken these self-appointed guardians of investors' interests a mere 33 years to catch up.

The next concept they may need to study is asset life or the duration of those returns. At their present rate of progress we can expect a result is 2045.

Buffoonery.

ETFs: safe, transparent and low cost?

2012-04-13T12:28:15+01:00

If you read the outpouring of defensive pronouncements from the ETF racket, sorry industry, that’s what you would be led to believe.

Well compare and contrast these views with the article in today’s Financial Times.

“Exchange traded industry shows fractures”

http://www.ft.com/cms/s/0/a851a584-84b5-11e1-a3c5-00144feab49a.html#axzz1ruyydFYP

Here are a few points to note from the article:

1.‘Last month the TVIX, an ETN marketed by VelocityShares, diverged dramatically from the volatility index it was meant to be tracking. Its issuer, Credit Suisse, had suspended the creation of new units due to its own internal risk limits, inhibiting the market from keeping the note’s value in check.’

So an ETF has diverged materially for the index it was meant to be tracking. I thought that wasn’t supposed to be possible according to their apologists.

2.‘It is still a good illustration of the hidden benefits that many big banks can reap from the alphabet soup of exchange-traded products that they host on behalf of big and small investors.

Importantly, say analysts, banks generate more than just basic management fees from exchange traded products, which have grown over the past dozen years into a $1.8tn market sold to both big and small investors.’

How does that fit with them allegedly being low cost?

3.‘The products can help banks fund their own vast portfolios of securities tand trading positions, or be used to offset the risks they incur from their daily business.

Adam Sussman, partner and director of research at Tabb Group, a financial industry consultancy says: “It’s just a very effective tool for them to recycle risk or manage liquidity.”’

Hold on a moment, these products are not formulated to give investors access to supposedly low risk, low cost investment, they are designed to help banks lay off their positions!

‘In doing so, the two companies have shone a spotlight on the use of ETNs as a vehicle for “recycling risk”. That involves banks using an ETN to offset positions they incur through various businesses. The more a bank can match such risks internally, the more money it saves – and may even make.

Providing such volatility-related products may be particularly attractive for banks, analysts say, because they can be especially useful in helping to offset one of the biggest risks they can incur in recent markets, so-called correlation risk. Correlation, when markets for various securities move in tandem with each other, can be difficult for big banks to hedge.

“Correlation, can be ‘recycled’, meaning repackaged and sold as a separate product,” JPMorgan analyst Kian Abouhossein wrote in a 2010 note on the future of the global investment banking industry.'

4. ‘Little is still known about ETN counterparts. ETN issuers stress the notes are openly marketed as unsecured debt obligations that expose buyers to the credit risk of the issuing bank.’

Just what you need as an investor to be exposed to the credit risk of a bank.

I have said it before and I will say it again: if you want an index fund buy exactly that, not an ETF.

Climate change: what consensus?

2012-04-12T09:00:00+01:00

49 former NASA scientists and astronauts sent a letter to NASA Administrator Charles Bolden last week admonishing the agency for it's role in advocating a high degree of certainty that man-made CO2 is a major cause of climate change while neglecting empirical evidence that calls the theory into question. The group, which includes seven Apollo astronauts and two former directors of NASA’s Johnson Space Center in Houston, are dismayed over the failure of NASA, and specifically the Goddard Institute For Space Studies (GISS), to make an objective assessment of all available scientific data on climate change. They charge that NASA is relying too heavily on complex climate models that have proven scientifically inadequate in predicting climate only one or two decades in advance.

http://wattsupwiththat.com/2012/04/10/hansen-and-schmidt-of-nasa-giss-under-fire-engineers-scientists-astronauts-ask-nasa-administration-to-look-at-emprical-evidence-rather-than-climate-models/