My Say
'QUE SERA, SERA'- My Say No 39
25-01-2009 14:33:23
"Confidence is in remarkably short supply. Investors lack it. Businesses and consumers appear to have lost it completely. Governments are still searching for it in vain." (AFR 16th January 2009)
All this talk of a 'financial crisis' when in fact it is a crisis of confidence. The surprise with which current events have been received has exacerbated this collapse in confidence. After all, if we had known it was coming we could have avoided it. Governments can slash interest rates to zero and throw obscene amounts of money at it but they are all financial fixes. These blunt instruments will not help the delicate flower of confidence to blossom.
I am presently enjoying one of my Christmas presents; a book titled "The Black Swan". Rather than ornithology, this book is about 'The Impact of Highly Improbable Events'. Quite a fitting read in light of the current events. This quote from the prologue will explain the connection.
"Before the discovery of Australia, people in the old world were convinced that ALL swans were white, an unassailable belief as it seemed completely confirmed by empirical evidence. The sighting of the first black swan might have been an interesting surprise for a few ornithologists (and others extremely concerned with the colouring of birds) but that is not where the significance of the story lies. It illustrates a severe limitation to our learning from observations or experience and the fragility of our knowledge. One single observation can invalidate a general statement derived from millennia of confirmatory sightings of 'millions' of white swans. All you need is one single (and I'm told quite ugly) black bird."
In the book, the author defines a "Black Swan" event as having the following three attributes. First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries extreme impact. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence AFTER the fact making it explainable and predictable.
Like most 'Black Swan' financial events, all the causes of the current mess have become topics for broad discussion only after the wheels started to fall off. The bursting of past financial bubbles are now being hauled out and dusted off as confirmatory 'sightings'. They are also being used and abused in an attempt to give some scale to the magnitude of what is happening.
As a result of reading this book I am now a little afraid to make any prognostications regarding the future using history as a guide; however, let us be brave (or stupid)! I propose a potential black 'gosling': The world will not come to an end just yet!
Admittedly, it will feel like it for many as individuals, corporations and governments are all punished for the reckless behaviour displayed in the last 10-20 years. Sadly, many of us will be caught in the inevitable maelstrom.
Pondering the earth shattering forecast I have just made I was prompted to pull another book off the shelf and browse. It is a volume I have mentioned in previous articles titled, "The Fortune Sellers". The author, William Sherden, claims that the title of 'second oldest profession', whilst usually applied to lawyers or consultants, rightfully belongs to the prognosticators.
When he wrote the book in 1998 he noted that the prediction industry (which attracts some of the best and brightest minds) showered us with information at a cost of $200 billion. Despite these huge costs, they routinely failed to predict the major events (Black Swans) that shape our world.
He does however highlight the surprising number of prediction 'hits' achieved by those that forecast often: Luck then plays a huge role in the outcomes. He goes on to point out that one of the biggest challenges in assessing the validity of a prediction (yours or someone elses) is to question whether our own judgment about the prediction is clouded by personal beliefs and predispositions.
Is our belief in a prediction a function of hearing what we want to hear? For example, the chronic pessimist is much more likely to believe an economist who issues a negative forecast. How many times have you read an email/article forwarded by a friend and then felt compelled to quote it at the next social gathering: How many times have you been subjected to the same thing?
As I mentioned in a previous newsletter, it is only after the event that those clever people who apparently foresaw current events will rise above the crowd. The media and the web are already wheeling out the hopeful contenders all claiming to have foreseen this downturn. They will be lauded for their soothsaying skills until it is discovered that they don't have any and will then sink into the obscurity ultimately enjoyed by most fortune sellers.
Using past events and apparently observed cycles to forecast the future is called Determinism. As the human race is erratic in behaviour, determinist economic forecasting is a poor guide to the future. To sum up; I haven't a clue where this will all end up; behavioural finance rules OK!
At a more practical level, I am indebted to a colleague at MLC for his speedy work in applying our arcane formulae to create the charts I so enjoy. The 'Mothership' chart below is the first of two I wish to discuss. It is now apparent the extent to which the mismanagement and neglect of the authorities and the stupidity and greed of corporations and individuals has damaged perceptions and thus finances globally.
The valuation on the right hand scale has dropped almost 50% since October last year. Interestingly, it is almost identical to the amount by which the sharemarket fell in 1987. The reason the current drop in this chart appears so dramatic in comparison to 1987 is that an arithmetic scale distorts the relativities the longer the time period covered. I discussed this topic and the use of log scales in a previous edition so I'm not going to go over old ground.
Turning to the income in this first chart; this has increased fractionally. As I foreshadowed in my last newsletter, the real test of the strength of dividends is coming. Lest I be accused of ignoring a possible 'Black Swan' I want to alert readers to the strong possibility that we will see a decline in dividends in aggregate as industry comes to grips with the downturn that was never going to affect Australia!
I have thus included a second chart which shows industrial dividend growth over the last 45 years. The two noteworthy periods are '72-'73 and '90 - '92 when dividends were reduced. This is a reminder that there are no 'dead certs' in the investment world. I had commented in the last newsletter about the possibility of dividends being lower in the future and the odds of this happening are shortening by the day. I also indicated the practical steps we personally will take to handle this eventuality.
In considering the second of these two charts it is worth looking in more detail at the two periods where dividends declined substantially. If we consider the '72-'73 period first. Let us assume you had been invested for a short time prior to the downturn, say, January 1967. For the sake of simplicity let's also assume your dividend income in that year was $1000. In 1968 your income would have risen to $1090, 1969 to $1145, 1970 to $1247 and 1971 to $1322.
In 1972 your income would have declined by approximately 6% to $1242 followed by another reduction of approximately 4% in 1973 reducing it to $1192. However, for those investing in 1971 with a notional initial income of $1000, they would have seen their income decline to $902 over the same period.
If we now look at the period '90-'92 and make the same rough calculations. Again, let us assume that we have invested a few years previous, say January 1985 and your income that year was $1000. In 1986 your income would have risen to $1130, in 1987 to $1490, in 1988 to $1924 and in 1989 to $2424.
As the recession 'we had to have' began to bite your income would have dropped in 1990 to $2206, in 1991 it dropped again to $1588 and in 1992 it dropped further to $1445. For the investor entering the year directly before the declines in dividends, their initial $1000 income would have reduced to $910 in 1990, $646 in 1991 and to $588 in 1992. The consolation was that the income had recovered steadily and was back over $1000 by 1997.
A couple of points should be made here. Firstly, I have assumed a relatively stable portfolio. For traders, their result may be nothing like this. Secondly, the unusually steep rise in dividends in '87, '88 and '89 were a function of two things; the introduction of dividend imputation in June 1987 and two consecutive cuts in corporation tax in the years '88 and '89.
Whilst we do not have similar changes to cushion the possible reduction in dividends now facing us we can draw some comfort from the 7 years of strong dividend growth leading up to the potential crunch.
For those who have been in the market, the notional $1000 of dividends from 1999 would now be worth over $2400p.a; a not untidy increase! A positive result from current events assumes that people are able or willing to reduce their spending/lifestyle to match their potentially straitened circumstances.
All well and good for the long term investors who should be able to ride this out; for those recent entrants I have little comfort: The lifeboat is full, here is a life jacket and good luck!
Whilst I am p****d off by the events that have led to this, it will not be the end of the world. My apparently sanguine approach has been heightened in the last few weeks by a recent funeral. It was with sadness that last week I received news of the sudden death of Gary Somerville. This name won't mean much to most but for readers of my book you will recognise him by his pseudonym Roger, in the final chapter of my book. He died on the 19th January aged 87.
His extraordinary character was recognised at the funeral by the huge number of people who attended and the heartfelt eulogies from many. Many of you financial advisors may remember my quoting him often at public seminars.
He has always been a great source of inspiration to me and I will miss our chats over afternoon tea. For those wondering what all this is about, a quick recap. Gary was a ledger clerk at Perpetual Trustees for 42 years. He retired in 1980 and invested his modest life savings in shares. Needless to say, as a result of this and his hands - off approach to his portfolio, he became a multi millionaire and subsequently earnt more income in his retirement than he did in 42 years of working. He is a tribute to the potential available to us all.
Whilst the capital of Gary's portfolio has been hit like everyone elses, and the dividend income may decline, the modest lifestyle Gary and his wife enjoyed means that his widow will still have an enormous margin to soak up any dividend reductions. Knowing them both, I have no doubt that Gary would have felt justifiably pleased leaving his beloved partner of 62 years with complete financial security.
I will leave the final words to William Sherden, author of "The Fortune Sellers".
Paradoxically, our future lives are more influenceable than predictable. Although one can never know how one's life will evolve, it is surely possible to influence the evolution of one's life to achieve certain aims. If there is something to be gained by heeding the message, "What shall be, shall be," it is that we should not take ourselves so seriously in the light of the fact that our futures will be filled with uncertainty and, in large part, shaped by chance events and luck. In spite of that, we can choose to lead lives that are flexibly adaptable to unforeseen changes, and ambitious and motivated individuals can influence their futures by striving to make things happen."
Please note; the next Sydney University course is scheduled for 28th February. For further information paste this link into your web browser https://www.motivatedmoney.com.au/presentations.php or go to the "Upcoming presentations" button on my website. It is a full day (Saturday) session and great fun.
