May 6, 2009
Nothing New Under the Sun
by Victor Davis Hanson
Pajamas Media
The Same Old Equality of Result
Rather than nitpick about Obama’s envisioned brave new world, I think it wiser to see it in the larger context of age-old divides over the nature of Western democratic and liberal society. Nothing that we have seen proposed since January 20 is novel; everything is merely the promise of the past outfitted with a new snazzier veneer of hope and change.
Take his domestic policies. What overarching philosophy seems reflected in raising taxes, borrowing trillions to spend trillions more on new entitlements, creating a new health care bureaucracy, cap-and-trade, allotting trillions more for education, and the expectation of the appointment of more liberal judges?
It’s old…
In a word, it is adherence to the idea of equality of result rather than an equality of opportunity, the age-old debate that goes back to the Greeks. From Aristotle’s Politics and Plato Laws, we learn of the original dilemma: a stable city-state of roughly similar property owners, who vote as equals, and fight as comrades in the phalanx, tragically, but inevitably, soon becomes tragically unequal.
Divide the land up equally to found the polis; give everyone an similarly-size plot (klêros); and then health, luck, brains, accident, strength, ambition, character, and a myriad of other factors, some understandable, some capricious, conspire to create inequality. I agree with Aristotle; I have seen it with families and communities in which equal inheritances soon led to radically different outcomes, as one sibling on rocky ground thrives, while another in deep loam starves; one town with abundant resources goes broke, while another without natural advantages thrives.
As Aristotle saw, some lose, some expand their original homesteads, and suddenly we have Hoi beltistoi and Hoi polloi — and the rallying cry that someone’s liberty to do as he pleases means that egalitarianism of the lowest common denominator becomes impossible.
American vs. French
The notion of freedom then butts up against equality, as if they are as often antithetical as symbiotic. (N.B.: note the French Revolutionary sloganeering of “fraternity” and “egalitarianism” versus the American Revolutionary emphasis on “Give me liberty, or give me death”, “Don’t Tread on Me!”, “All men are created equal” [by opportunity rather than by result]. And note Obama’s references to the French ideal.)
In response, the state has two choices to preserve its original ideal of equality (and we see elements of this further debate voiced in the Old Oligarch, Aristotle, Plato, Hobbes, Hume, etc, as well as in histories of the middle and late Roman Republic).
The Therapeutic
1. The state and culture at large can be coercive to ensure an equality of result — in the modern liberal world by high redistributive taxes, generous means-tested entitlements, inflationary monetary policies to diminish the power of capital (in the ancient world by forbidding the alienability of land, mandating the maximum size of estates, coining cheap bronze/silver coated money in vast amounts, redistribution of property, cancellation of debt, etc.).
Such efforts at commonality are what we are now witnessing with income tax hikes, $1.7 trillion dollar deficits, inflationary federal spending and borrowing, along with huge new entitlements. Its extreme form is the European Union, its extreme, extreme manifestations are the failed -isms and -ologies of the bloody 20th century where authoritarian elites broke the requisite eggs for the omelet of “for the people” and in service to “equality.”
The Tragic
2. Or instead of the therapeutic mode, we get the tragic acceptance of innate inequality combined with the notion of personal responsibility to care for one’s fellow citizen.
That is, in the American version of equality of opportunity, we accept some will always end up poor, some rich, some in-between due to factors both in, and beyond, our control. But rather than sacrifice liberty to use the coercive powers of the state to enforce equality, we set a foundation at the bottom, a safety net to ensure a minimum level of support for the poor, and laws at the top to prevent buccaneering and piratical behavior — in theory.
Then the tragic view accepts that some will be very wealthy, but assumes that the race for individual riches will, first, create greater prosperity for society at large (the much caricatured “trickle down”). And, two, a host of private mechanisms exists to channel individual bounty back for the general welfare: the status; and/or sense of right of giving to non-profits, charities, etc; the shame of living it up to an excessive degree; the patriotic call upon one to invest their riches in the public good; the informal practice of lending and giving to family and friends, etc. In other words, millions risk dying to leave temperate, naturally rich equality of result Mexico to enter the once equality of opportunity United States.
Been There, Done That
It seems to me that on three occasions during the last seventy-five years we have someone who really did believe in the therapeutic, equality of result — FDR, LBJ, and Jimmy Carter (Truman, JFK and Clinton proved to be centrists in comparison).
FDR had the rhetorical gifts and personal genius to implement such an agenda; LBJ and Carter tried, but were inept and poor messengers. And now we have a fourth avatar, who, given the current alignment of the planets, has a real chance to complete the FDR mandate — not in the dark days of the Great Depression replete with real want and starvation, but in a recession during the greatest age of affluence in the history of civilization — making both success and failure obsolete, and turning us into a sort of egalitarian polis much like Sweden or France.
I Don’t Owe You Any More
Turn on the radio: ads blare out how to renounce mortgage debt; get out of maxed out credit-cards; short the IRS; be eligible for a subsidized government loan, or new entitlement. Other ‘buy gold’ ads warn: plenty of danger, but no money in passbook accounts, stocks, real estate, as the debtor gains on the creditor, and capital earns little in comparison to protected salaries. To match a $100,000 government salary (as an upper-level bureaucrat), the despised capitalist, at a 2% interest payout on his stash, would need $5 million in accumulated cash: advantage bureaucrat.
Ironies Galore
Obama rather brilliantly counts on two great constituencies (other than the professional Ivy League technocracy whose responsibility is to figure out how to borrow and tax the money, lavish it on constituencies, and do rather well themselves as government overseers). One is the hyper-rich, the Kerrys, the Soroses, the Gateses, and their appendages in universities, government, foundations, and the media. These power players either make enough to be unconcerned with high taxation, or are so well connected politically (cf. the machinations of a Daschle, Dodd, Geithner, Rangel) that the coercive state rules simply do not apply.
Instead the hyper-wealthy receive a sort of psychic gratification in helping the ‘poor’, and romanticizing the underprivileged, thereby alleviating the guilt of being blessed, and at relatively small cost — and so they quite enthusiastically support the equality of result state.
Again, the poor present no challenge, offer no threat to the hyper — wealthy, but are thankful client recipients of ensured government largess. In contrast, the fellow elites have the necessary taste and education to satisfy the demands of aristocratic society.
And The Upper Middle Class?
But those in between, and especially those of the upper-middle class — the hardware store owner, the dentist, the paving contractor, the successful restaurateur, the real estate agent? These grasping who wish and aspire and may reach a mythical $250,000 salary some day (again, the threshold where one becomes the hated “they”), well now, they are not poor, need no government or private help, and offer no psychological alleviation of guilt to the elite. Romanticize a gardener or farm worker, or even clerk or teacher, but how does one mythologize a successful optometrist or insurance agent?
And yet they are not usually sophisticated in the snobbish sense, not opera-goers, not familiar with museums, not symphony buffs. Their children don’t necessarily attend Stanford or Harvard. In other words, they are near-to-wells, wannabes, without requisite culture, deserving of neither cultural awe and acceptance nor noblesse oblige.
A leftist elitist would always prefer the dubious (and now upscale, tax avoiding) huckster Al Sharpton, Tawana Brawley and all, to Sarah Palin, former mayor of Wasilla and Idaho University graduate. Joe the Plumber, the Cuban upper-middle class of Miami, the local talk show host, anyone who wants to get ahead, but shows so visibly the scars of the struggle to do so, lacks the refinement and taste of the more affluent, yet is in the crosshairs of the Obama revolution.
The only impediment to our new polis? There are not simply enough of these entrepreneurial dinosaurs to pay the taxes to feed the new $3.6 trillion annual beast. One can take all the income of the $250,000 “them”, and there won’t be enough to pay down the $9 trillion in new debt.
In short, Bush = lower taxes, more spending, and more debt; Clinton = higher taxes, more spending, and less debt; Obama = more taxes, more spending, and a lot more debt — and the same old dream that we can make everyone equal in the end — or else!
©2009 Victor Davis Hanson
Sunday, May 10, 2009
Friday, April 10, 2009
The Key to Personal Freedom
Due to rising unemployment and the sharp contraction in the economy, personal bankruptcies are hitting record levels, up more than 50% from a year ago.
There is another factor here too, of course. Millions overreached.
In some ways, this is understandable. It's natural to want to improve our circumstances, enjoy the best life has to offer and "go for the gusto."
Without moderation, however, our wants have no natural limits.
True, some of us have fewer desires than others. Yet conservative spenders don't necessarily lack ambition, imagination or even money. More often than not, they have spent years cultivating an attitude of restraint.
Freedom, after all, is not the absence of responsibility. It is the absence of restraints imposed by others. To be truly free, however, we must generally impose severe restraints on ourselves.
That often means delayed gratification... or settling for less... or simply doing without.
This is bitter medicine to the thousands of consumers who hang on to their material desires like caterpillars to a cabbage leaf. Especially when the media glamorizes the materialistic lifestyle, their neighbors - who may be two payments from the edge - are living high, and advertisers bombard them daily with subtle - and not-so-subtle - messages meant to stir their cravings.
There is a reliable defense, however. And it begins with your frame of mind.
If you or someone in your family suffers from the "urge to splurge," here are four steps to help reclaim your personal freedom - and, perhaps, your credit rating:
1. Recognize that we are wired to feel dissatisfied with our circumstances. It's in our genes. An early human who was content with what he had - who spent his days lazing on the African savannah admiring the clouds and thinking "ahh, life is good" - was far less likely to survive and reproduce than his neighbor who spent every waking moment trying to gain some advantage.
2. Understand the psychology of desire. We all tend to "miswant" - to want things we don't really need and won't appreciate once we acquire them. Remember how your last major purchase failed to "do it for you" and you're less likely to believe that this time will be any different.
3. Stop regarding life as an ongoing competition for social status. Opt out of the game - even if everyone else seems to be playing it - and you can't be controlled or disappointed by the opinions of others. Do work you enjoy, even if it's lower paying. Spend your time and money collecting great memories rather than more stuff.
4. Instead of focusing on what you want, try appreciating what you already have. Nothing cures your craving for the next bauble like the thought of losing your partner, your children, your health, or the things you already own.
In "On Desire: Why We Want What We Want," William B. Irvine argues that many of us lack "a sense that we are lucky to be living whatever life we happen to be living - that despite our circumstances, no key ingredient of happiness is missing. With this sense comes a diminished level of anxiety; we no longer need to obsess over the things - a new car, a bigger house, a firmer abdomen - that we mistakenly believe will bring lasting happiness if only we can obtain them. Most importantly, if we master desire, to the extent possible to do so, we will no longer daydream about living the life someone else is living; instead, we will embrace our own life and live it to the fullest."
Sounds simple enough. Yet we face a powerful headwind.
Modern culture and our own heritage have programmed us to want ceaselessly, spend liberally and compete for resources in order to keep up with the Joneses. Millions today suffer from so-called "status anxiety."
Their prison, however, is entirely self-imposed. Unbeknownst to most of them, the key is right between their ears.
Any of us can make the conscious choice to turn our backs on the consumptive lifestyle and live simply, happily and with dignity.
Idealistic? Perhaps. But then freedom often is.
There is another factor here too, of course. Millions overreached.
In some ways, this is understandable. It's natural to want to improve our circumstances, enjoy the best life has to offer and "go for the gusto."
Without moderation, however, our wants have no natural limits.
True, some of us have fewer desires than others. Yet conservative spenders don't necessarily lack ambition, imagination or even money. More often than not, they have spent years cultivating an attitude of restraint.
Freedom, after all, is not the absence of responsibility. It is the absence of restraints imposed by others. To be truly free, however, we must generally impose severe restraints on ourselves.
That often means delayed gratification... or settling for less... or simply doing without.
This is bitter medicine to the thousands of consumers who hang on to their material desires like caterpillars to a cabbage leaf. Especially when the media glamorizes the materialistic lifestyle, their neighbors - who may be two payments from the edge - are living high, and advertisers bombard them daily with subtle - and not-so-subtle - messages meant to stir their cravings.
There is a reliable defense, however. And it begins with your frame of mind.
If you or someone in your family suffers from the "urge to splurge," here are four steps to help reclaim your personal freedom - and, perhaps, your credit rating:
1. Recognize that we are wired to feel dissatisfied with our circumstances. It's in our genes. An early human who was content with what he had - who spent his days lazing on the African savannah admiring the clouds and thinking "ahh, life is good" - was far less likely to survive and reproduce than his neighbor who spent every waking moment trying to gain some advantage.
2. Understand the psychology of desire. We all tend to "miswant" - to want things we don't really need and won't appreciate once we acquire them. Remember how your last major purchase failed to "do it for you" and you're less likely to believe that this time will be any different.
3. Stop regarding life as an ongoing competition for social status. Opt out of the game - even if everyone else seems to be playing it - and you can't be controlled or disappointed by the opinions of others. Do work you enjoy, even if it's lower paying. Spend your time and money collecting great memories rather than more stuff.
4. Instead of focusing on what you want, try appreciating what you already have. Nothing cures your craving for the next bauble like the thought of losing your partner, your children, your health, or the things you already own.
In "On Desire: Why We Want What We Want," William B. Irvine argues that many of us lack "a sense that we are lucky to be living whatever life we happen to be living - that despite our circumstances, no key ingredient of happiness is missing. With this sense comes a diminished level of anxiety; we no longer need to obsess over the things - a new car, a bigger house, a firmer abdomen - that we mistakenly believe will bring lasting happiness if only we can obtain them. Most importantly, if we master desire, to the extent possible to do so, we will no longer daydream about living the life someone else is living; instead, we will embrace our own life and live it to the fullest."
Sounds simple enough. Yet we face a powerful headwind.
Modern culture and our own heritage have programmed us to want ceaselessly, spend liberally and compete for resources in order to keep up with the Joneses. Millions today suffer from so-called "status anxiety."
Their prison, however, is entirely self-imposed. Unbeknownst to most of them, the key is right between their ears.
Any of us can make the conscious choice to turn our backs on the consumptive lifestyle and live simply, happily and with dignity.
Idealistic? Perhaps. But then freedom often is.
Monday, February 16, 2009
Investing and the Use of Leverage
Investing and the Use of Leverage
Many investors see the current bear market and economic slowdown as a reason to sell stocks. We believe the opposite action should be taken and that investors may think about using leverage to increase their potential net worth. Here’s why:
The current situation for real estate, bonds and equities
In Canada, the real estate market has been buoyant these past several years and has begun to slow as prices have levelled off. People who wanted to purchase a home have done so and they are probably content to stay in that residence for the next 10-15 years. Therefore, the real estate market is not as appealing an investment as it once was. We think that future returns should continue to be decent but are unlikely to mirror those of the past decade.
We believe that the bond market, perceived to be a safe haven from a collapsing U.S. economy, is now overbought. That’s because real returns (after tax and inflation) are now negative.
Currently, the 10-year Government of Canada bond yield is 3.4%. After 50% tax (interest income) and inflation (2.25%), the real return is –0.55%. This means that investor spending power against tax and inflation is falling, not growing.
As a result, we believe there’s more risk inherent in the bond market and that risk could increase if the U.S. Federal Reserve Board quickly raises rates once the financial sector stabilizes – an increase in interest rates causes bond prices to fall.
Equities, meanwhile, have been in a bear market (down 20% or more from the market peak last October) as the economy has entered a contraction phase of slower or even negative growth. But this economic phase should not last forever. We think there’s a tremendous opportunity for growth in the equity market.
The opportunity in equities
While stock market corrections are unsettling, investors must understand that four things remain static, even in a bear market:
1) Stock prices will fall in a bear market but the capital is not lost unless it is sold. It’s more important for investors to remember that they are making an investment in a business with an expectation of a payback on that capital over time, usually through a combination of dividend payments and price appreciation.
2) If the financial health of the company is solid, dividends should continue to be paid, giving investors income to buy more shares at cheaper prices, waiting for the day when the stock market recovers.
3) As dividends rise, stock prices ultimately follow.
Consider a stock that trades at $20, pays a $1 dividend and yields 5% ($1 divided by $20). If the dividend subsequently rises $0.20 a year for five years to $2:
At $20, the yield will be 10%. Given such a high yield, investors would be attracted to buy that asset. For the stock to return to its previous 5% yield, the share price would have to rise to $40, eventually earning a positive capital return for the investor in addition to their growing income stream.
4) A “slingshot effect” usually occurs and the market rebounds before investors recognize it. Just before the U.S. invaded Iraq, the stock market reached its last low on March 11, 2003. Nobody wanted to own equities then because the fear of war tends to wreak havoc on economies, causing markets to tumble.
It wasn’t until 2005 that many investors felt comfortable enough to buy equities again. Unfortunately, this was a huge missed opportunity. The “slingshot effect” in this case was a 45% stock market decline from 2000 to 2002 followed by a 50% rally from 2003 to 2005.
Those investors who stayed in equities and used the market decline as an opportunity to buy more stocks, earned better-than-average returns when the market recovered.
We believe that opportunity has re-surfaced in the stock market.
1) Some dividend yields are as high now as they have been in 35 years.
2) If there is another 20% drop in the market, price-earnings ratios would be at their lowest since 1975, a period that signalled the beginning of the greatest bull market of the 1980s and 1990s.
3) Globalization has given corporations a chance to sell into greater and more diverse markets, especially in emerging markets where per capita incomes have risen much faster than in the more mature G7 countries.
There are generally three stages in a bear market:
• The first - when just a few prudent investors recognize that, despite the prevailing bullishness, things won’t always be rosy,
• The second - when most investors recognize things are deteriorating, and
• The third - when everyone is convinced things can only get worse.
Certainly we’re well into the second of these three stages. There’s been lots of bad news and many write-offs. More and more people recognize the dangers inherent in things like innovation, leverage, derivatives, counterparty risk and mark-to-market accounting. And increasingly the problems seem unsolvable.
One of these days, though, we’ll reach the third stage, and the herd will give up on a market turnaround. And unless the financial world really does end, we’re likely to encounter the investment opportunities of a lifetime.
What is leverage?
Leverage is the action of taking the value of an asset or the steady income stream of a salary and borrowing against it. For example, individuals can take out an investment loan based on a percentage of the equity in their house - the difference between the appraised value of the house and any mortgage outstanding.
Another way is to borrow against your annual income. If you have consistent earnings, the bank will lend you a percentage of your annual income based on your ability to pay, net of all other expenses.
The purpose of leverage is to have more capital available to earn a greater return over time than if you just had a small amount of cash savings to invest.
It’s even more attractive because the government allows you to deduct a portion of the interest paid on your income tax return.
For example, if you own a house worth $600,000 and the mortgage has just been paid off, the bank may lend you up to 80% of the appraised value of the house in the form of an investment loan, or $480,000.
With the loan, you now have over $1 million of total assets that can grow and compound over time.
Given that interest rates continue to trend lower, the low cost of capital is making it attractive to use leverage through an investment loan.
For Canadian investors, the Bank of Canada is expected to keep pace with the Fed and reduce interest rates. This should lower the prime rate offered by the banks.
For example, if you take out a loan at 6%, the after-tax cost of capital would be roughly 3%. If that capital is invested in a stock that yields greater than 3% after-tax, the interest can be covered by the dividend income and the residual amount can grow through time and compounding to an amount greater than the loan.
What rules should be followed when using leverage?
While leverage helps capital grow over time, there is a downside. That occurs if the investment falls during the period of the loan. If the investment went to zero, there would be no capital growth but the debt would still have to be serviced.
That’s why it’s important to use some disciplined rules if you decide to use leverage:
1) Buy only dividend-paying stocks.
These companies should be more mature (large-cap, blue chip names) and have a proven track record of annually raising dividends.
Another benefit of dividend-paying stocks is that the yield should help set a floor as to how low the stock price may go, relative to current bond yields.
Non-dividend-paying stocks have no guarantees of growth. Unlike dividend payers, their share prices will be determined by their earnings. If the earnings disappear, the share prices will plummet.
2) The holding period should be 10-15 years.
Using leverage isn’t a get-rich-quick scheme. When buying stocks (with or without leverage), it’s important to let the companies grow through economic cycles.
This becomes clear if you leveraged at the worst possible time in the market, such as when the technology bubble burst in 2000. For anyone leveraging their portfolios in 2000-2001, a significant amount of time was needed for the investments to increase in value.
3) Borrow only what you can afford to pay monthly.
Do not extend yourself by borrowing too much. Decide first how much you can afford monthly to pay on the loan. The bank can then determine how much they will lend you.
4) If you currently have a mortgage, don’t leverage further.
Your mortgage is the highest after-tax cost you will face in your lifetime. It is more important to pay off this debt as soon as possible. Once the mortgage is paid, you can then decide if you wish to leverage the equity in the house in the form of an investment loan. A simple method is to borrow an amount that makes the monthly payments similar to your previous mortgage payments.
5) Retirees should not leverage.
During retirement, it is essential to be debt-free. Using leverage would be a dangerous strategy because there is no guaranteed income stream like a salary and bad investments could wipe out your retirement nest egg or worse, force you back to work.
6) The new Tax Free Savings Accounts – TFSAs may be an attractive use of leverage.
These accounts were introduced in the recent federal budget and should begin in 2009. The guidelines are that individuals may put $5,000 annually into this tax shelter. Because there is no tax liability and funds may be withdrawn without penalty, the after-tax cost of using leverage would be minimized.
For investors who can afford to leverage, who have the time-horizon to use it and who understand the inherent risks behind the strategy, we believe this may be an ideal time to do so.
Many investors see the current bear market and economic slowdown as a reason to sell stocks. We believe the opposite action should be taken and that investors may think about using leverage to increase their potential net worth. Here’s why:
The current situation for real estate, bonds and equities
In Canada, the real estate market has been buoyant these past several years and has begun to slow as prices have levelled off. People who wanted to purchase a home have done so and they are probably content to stay in that residence for the next 10-15 years. Therefore, the real estate market is not as appealing an investment as it once was. We think that future returns should continue to be decent but are unlikely to mirror those of the past decade.
We believe that the bond market, perceived to be a safe haven from a collapsing U.S. economy, is now overbought. That’s because real returns (after tax and inflation) are now negative.
Currently, the 10-year Government of Canada bond yield is 3.4%. After 50% tax (interest income) and inflation (2.25%), the real return is –0.55%. This means that investor spending power against tax and inflation is falling, not growing.
As a result, we believe there’s more risk inherent in the bond market and that risk could increase if the U.S. Federal Reserve Board quickly raises rates once the financial sector stabilizes – an increase in interest rates causes bond prices to fall.
Equities, meanwhile, have been in a bear market (down 20% or more from the market peak last October) as the economy has entered a contraction phase of slower or even negative growth. But this economic phase should not last forever. We think there’s a tremendous opportunity for growth in the equity market.
The opportunity in equities
While stock market corrections are unsettling, investors must understand that four things remain static, even in a bear market:
1) Stock prices will fall in a bear market but the capital is not lost unless it is sold. It’s more important for investors to remember that they are making an investment in a business with an expectation of a payback on that capital over time, usually through a combination of dividend payments and price appreciation.
2) If the financial health of the company is solid, dividends should continue to be paid, giving investors income to buy more shares at cheaper prices, waiting for the day when the stock market recovers.
3) As dividends rise, stock prices ultimately follow.
Consider a stock that trades at $20, pays a $1 dividend and yields 5% ($1 divided by $20). If the dividend subsequently rises $0.20 a year for five years to $2:
At $20, the yield will be 10%. Given such a high yield, investors would be attracted to buy that asset. For the stock to return to its previous 5% yield, the share price would have to rise to $40, eventually earning a positive capital return for the investor in addition to their growing income stream.
4) A “slingshot effect” usually occurs and the market rebounds before investors recognize it. Just before the U.S. invaded Iraq, the stock market reached its last low on March 11, 2003. Nobody wanted to own equities then because the fear of war tends to wreak havoc on economies, causing markets to tumble.
It wasn’t until 2005 that many investors felt comfortable enough to buy equities again. Unfortunately, this was a huge missed opportunity. The “slingshot effect” in this case was a 45% stock market decline from 2000 to 2002 followed by a 50% rally from 2003 to 2005.
Those investors who stayed in equities and used the market decline as an opportunity to buy more stocks, earned better-than-average returns when the market recovered.
We believe that opportunity has re-surfaced in the stock market.
1) Some dividend yields are as high now as they have been in 35 years.
2) If there is another 20% drop in the market, price-earnings ratios would be at their lowest since 1975, a period that signalled the beginning of the greatest bull market of the 1980s and 1990s.
3) Globalization has given corporations a chance to sell into greater and more diverse markets, especially in emerging markets where per capita incomes have risen much faster than in the more mature G7 countries.
There are generally three stages in a bear market:
• The first - when just a few prudent investors recognize that, despite the prevailing bullishness, things won’t always be rosy,
• The second - when most investors recognize things are deteriorating, and
• The third - when everyone is convinced things can only get worse.
Certainly we’re well into the second of these three stages. There’s been lots of bad news and many write-offs. More and more people recognize the dangers inherent in things like innovation, leverage, derivatives, counterparty risk and mark-to-market accounting. And increasingly the problems seem unsolvable.
One of these days, though, we’ll reach the third stage, and the herd will give up on a market turnaround. And unless the financial world really does end, we’re likely to encounter the investment opportunities of a lifetime.
What is leverage?
Leverage is the action of taking the value of an asset or the steady income stream of a salary and borrowing against it. For example, individuals can take out an investment loan based on a percentage of the equity in their house - the difference between the appraised value of the house and any mortgage outstanding.
Another way is to borrow against your annual income. If you have consistent earnings, the bank will lend you a percentage of your annual income based on your ability to pay, net of all other expenses.
The purpose of leverage is to have more capital available to earn a greater return over time than if you just had a small amount of cash savings to invest.
It’s even more attractive because the government allows you to deduct a portion of the interest paid on your income tax return.
For example, if you own a house worth $600,000 and the mortgage has just been paid off, the bank may lend you up to 80% of the appraised value of the house in the form of an investment loan, or $480,000.
With the loan, you now have over $1 million of total assets that can grow and compound over time.
Given that interest rates continue to trend lower, the low cost of capital is making it attractive to use leverage through an investment loan.
For Canadian investors, the Bank of Canada is expected to keep pace with the Fed and reduce interest rates. This should lower the prime rate offered by the banks.
For example, if you take out a loan at 6%, the after-tax cost of capital would be roughly 3%. If that capital is invested in a stock that yields greater than 3% after-tax, the interest can be covered by the dividend income and the residual amount can grow through time and compounding to an amount greater than the loan.
What rules should be followed when using leverage?
While leverage helps capital grow over time, there is a downside. That occurs if the investment falls during the period of the loan. If the investment went to zero, there would be no capital growth but the debt would still have to be serviced.
That’s why it’s important to use some disciplined rules if you decide to use leverage:
1) Buy only dividend-paying stocks.
These companies should be more mature (large-cap, blue chip names) and have a proven track record of annually raising dividends.
Another benefit of dividend-paying stocks is that the yield should help set a floor as to how low the stock price may go, relative to current bond yields.
Non-dividend-paying stocks have no guarantees of growth. Unlike dividend payers, their share prices will be determined by their earnings. If the earnings disappear, the share prices will plummet.
2) The holding period should be 10-15 years.
Using leverage isn’t a get-rich-quick scheme. When buying stocks (with or without leverage), it’s important to let the companies grow through economic cycles.
This becomes clear if you leveraged at the worst possible time in the market, such as when the technology bubble burst in 2000. For anyone leveraging their portfolios in 2000-2001, a significant amount of time was needed for the investments to increase in value.
3) Borrow only what you can afford to pay monthly.
Do not extend yourself by borrowing too much. Decide first how much you can afford monthly to pay on the loan. The bank can then determine how much they will lend you.
4) If you currently have a mortgage, don’t leverage further.
Your mortgage is the highest after-tax cost you will face in your lifetime. It is more important to pay off this debt as soon as possible. Once the mortgage is paid, you can then decide if you wish to leverage the equity in the house in the form of an investment loan. A simple method is to borrow an amount that makes the monthly payments similar to your previous mortgage payments.
5) Retirees should not leverage.
During retirement, it is essential to be debt-free. Using leverage would be a dangerous strategy because there is no guaranteed income stream like a salary and bad investments could wipe out your retirement nest egg or worse, force you back to work.
6) The new Tax Free Savings Accounts – TFSAs may be an attractive use of leverage.
These accounts were introduced in the recent federal budget and should begin in 2009. The guidelines are that individuals may put $5,000 annually into this tax shelter. Because there is no tax liability and funds may be withdrawn without penalty, the after-tax cost of using leverage would be minimized.
For investors who can afford to leverage, who have the time-horizon to use it and who understand the inherent risks behind the strategy, we believe this may be an ideal time to do so.
An Investor Receiving Dividends Can Choose What to do With the Money
Dividends - Asymmetric Information
January was a poor month for markets across the globe with most major indexes falling between 5 and 7 percent. The period from September to January has been one of the most volatile on record and the gloomy economic news continues unabated. However, during this period of gloom and turbulence no less than 15 of our holdings increased their dividends. Clearly some corporations are capable of coping with the current economic environment, and are optimistic about their long-term prospects. Dividend increases should not be taken lightly and are a powerful signal of management's view of the future.
Unless management is confident of a business's long-term prospects they would not commit to paying out cash. Based on the current news one could argue that conserving cash might be the way to go, but dividend increases speak to long-term prospects. This is a case of asymmetric information - management might know more about the business outlook than the market or investors. To quantify the impact of dividends on long-term returns consider that a full 2/3rds of long-term equity returns have come from dividends and dividend reinvestment. Look at this decade to date. Dividends paid to investors have added a full 10% to market returns since January 1, 2000 compared to simple price appreciation. Dividends may seem small, but over long periods they add up to a significant amount.
Dividends may seem quaint in this day and age. Any finance textbook demonstrates that an investor should be indifferent between receiving dividends and having a corporation buy back its own stock. Here is how this equivalency is supposed to work.
Companies buy back stock thereby reducing the number of shares outstanding. As a direct result, earnings per share increase, and all else equal (meaning the p/e ratio remains the same), the price of the stock goes up and presto, there is your dividend. If an investor actually wants cash, then they just sell a portion of their holdings.
But if the last few months have shown us anything it is that what is supposed to work in theory does not always work in practice. We have a couple of issues with this view of returning money to shareholders through stock buybacks. First, is one of control.
An investor receiving dividends can choose what to do with the money; save it, reinvest in other companies or buy more of the corporations stock. But make no mistake about it- the control is in the hands of the investor. In contrast share buybacks are controlled by the corporation. They are not scheduled to occur on a quarterly basis and can be terminated at any time.
In fact, most announced buybacks are never completed. Contrast the ease with which buybacks can be announced, delayed or terminated with cash dividends. To suspend a cash dividend is the last thing management will consider and can sometimes indicate a serious problem at the corporation.
Second, dividends impose a capital discipline on corporations. To maintain a dividend commitment a corporation must remain focused on cash generation. Moreover, it curtails the potential for cash to be put in marginal or risky ventures.
Dividends represent a commitment to long-term shareholders. Finally, dividends encourage and reward long-term ownership. The concept of owning a company is all but lost on many investors. Indeed as the average mutual fund portfolio turnover reaches 120% per year (average holding time of 10 months) portfolio managers are just speculating on the price rather than buying solid businesses as a long-term investment. It is not surprising that turnover is one of the best predictors of performance - the higher the turnover, the lower the performance.
Dividends are an important driver of investment performance and increasing dividends are a powerful signal about future prospects. Through your Toron portfolio you are an investor in businesses for the long term and not a speculator about where the next quarter's price will be. This discipline will help grow your portfolio over the long haul.
Arthur Heinmaa, CFA Managing Partner
January was a poor month for markets across the globe with most major indexes falling between 5 and 7 percent. The period from September to January has been one of the most volatile on record and the gloomy economic news continues unabated. However, during this period of gloom and turbulence no less than 15 of our holdings increased their dividends. Clearly some corporations are capable of coping with the current economic environment, and are optimistic about their long-term prospects. Dividend increases should not be taken lightly and are a powerful signal of management's view of the future.
Unless management is confident of a business's long-term prospects they would not commit to paying out cash. Based on the current news one could argue that conserving cash might be the way to go, but dividend increases speak to long-term prospects. This is a case of asymmetric information - management might know more about the business outlook than the market or investors. To quantify the impact of dividends on long-term returns consider that a full 2/3rds of long-term equity returns have come from dividends and dividend reinvestment. Look at this decade to date. Dividends paid to investors have added a full 10% to market returns since January 1, 2000 compared to simple price appreciation. Dividends may seem small, but over long periods they add up to a significant amount.
Dividends may seem quaint in this day and age. Any finance textbook demonstrates that an investor should be indifferent between receiving dividends and having a corporation buy back its own stock. Here is how this equivalency is supposed to work.
Companies buy back stock thereby reducing the number of shares outstanding. As a direct result, earnings per share increase, and all else equal (meaning the p/e ratio remains the same), the price of the stock goes up and presto, there is your dividend. If an investor actually wants cash, then they just sell a portion of their holdings.
But if the last few months have shown us anything it is that what is supposed to work in theory does not always work in practice. We have a couple of issues with this view of returning money to shareholders through stock buybacks. First, is one of control.
An investor receiving dividends can choose what to do with the money; save it, reinvest in other companies or buy more of the corporations stock. But make no mistake about it- the control is in the hands of the investor. In contrast share buybacks are controlled by the corporation. They are not scheduled to occur on a quarterly basis and can be terminated at any time.
In fact, most announced buybacks are never completed. Contrast the ease with which buybacks can be announced, delayed or terminated with cash dividends. To suspend a cash dividend is the last thing management will consider and can sometimes indicate a serious problem at the corporation.
Second, dividends impose a capital discipline on corporations. To maintain a dividend commitment a corporation must remain focused on cash generation. Moreover, it curtails the potential for cash to be put in marginal or risky ventures.
Dividends represent a commitment to long-term shareholders. Finally, dividends encourage and reward long-term ownership. The concept of owning a company is all but lost on many investors. Indeed as the average mutual fund portfolio turnover reaches 120% per year (average holding time of 10 months) portfolio managers are just speculating on the price rather than buying solid businesses as a long-term investment. It is not surprising that turnover is one of the best predictors of performance - the higher the turnover, the lower the performance.
Dividends are an important driver of investment performance and increasing dividends are a powerful signal about future prospects. Through your Toron portfolio you are an investor in businesses for the long term and not a speculator about where the next quarter's price will be. This discipline will help grow your portfolio over the long haul.
Arthur Heinmaa, CFA Managing Partner
Thursday, February 12, 2009
How They Took Down the Price of Oil
I figured out how they took down oil.....it went like this.....
1) They wanted to desperately take down the price of light sweet crude because its a bench mark for all pricing
2) There was (is) a shortage of light oil but a glut of heavy
3) so they pump light sweet to cushing from the SPR and replace it with heavy sour
4) The EIA week reports no change in SPR levels but Cushing is full of light sweet
5) Market concludes there is a glut of light sweet and they are right but for the wrong reasons
6) Don Coxe was right about the deliberate take down in oil
7) I just figured out how they did it
see
http://news.goldseek.com/GoldSeek/1234386901.php
I am a genius (but a broke one)
1) They wanted to desperately take down the price of light sweet crude because its a bench mark for all pricing
2) There was (is) a shortage of light oil but a glut of heavy
3) so they pump light sweet to cushing from the SPR and replace it with heavy sour
4) The EIA week reports no change in SPR levels but Cushing is full of light sweet
5) Market concludes there is a glut of light sweet and they are right but for the wrong reasons
6) Don Coxe was right about the deliberate take down in oil
7) I just figured out how they did it
see
http://news.goldseek.com/GoldSeek/1234386901.php
I am a genius (but a broke one)
Sunday, January 4, 2009
Ten Surprises for 2009
These are my Ten Surprises for 2009
1) Oil Trades above $140 per Barrell
2) Oil Trades below $30 per Barrell
3) GM merges with Chrysler
4) Italy leaves the Euro and returns to the Lira
5) British Pound trades Below $1 US
6) Natural Gas Price trades below $4 per MMBTU
7) Iran's government Falls
8) Cuba elects its first President as a democracy
9) The Canadian Dollar reaches parity with the US$
10)All major stock Indexes in North America break the 2008 lows
1) Oil Trades above $140 per Barrell
2) Oil Trades below $30 per Barrell
3) GM merges with Chrysler
4) Italy leaves the Euro and returns to the Lira
5) British Pound trades Below $1 US
6) Natural Gas Price trades below $4 per MMBTU
7) Iran's government Falls
8) Cuba elects its first President as a democracy
9) The Canadian Dollar reaches parity with the US$
10)All major stock Indexes in North America break the 2008 lows
Tuesday, December 30, 2008
Don Coxe Indicators
Don Coxe Indicators
In the November Basic Points, Don Coxe had four indicators to gauge when "Mama bear is done her worst".
1) TED Spread: "We suspect if it breaks 150 and stays there for at least a week, the financial crisis part of this drama, while not humdrum, will no longer command center stage".
The TED Spread is currently at 132 and has been under 150 for pretty close to a week (if not already a week).
2) The bank stock index continues to outperform the S&P.
1 Month: S&P -3%, BKX -13%
3)The VIX Index Retreats
Currently at 43.
Month Ago: 60
4) The YEN and the U.S Dollar Decline
US Dollar index currently at: 80.5
Month Ago US Dollar Index: 83.5
JPYUSD currently at: 90.5 (Yen has strengthened)
JPYUSD Month Ago: 93
In the November Basic Points, Don Coxe had four indicators to gauge when "Mama bear is done her worst".
1) TED Spread: "We suspect if it breaks 150 and stays there for at least a week, the financial crisis part of this drama, while not humdrum, will no longer command center stage".
The TED Spread is currently at 132 and has been under 150 for pretty close to a week (if not already a week).
2) The bank stock index continues to outperform the S&P.
1 Month: S&P -3%, BKX -13%
3)The VIX Index Retreats
Currently at 43.
Month Ago: 60
4) The YEN and the U.S Dollar Decline
US Dollar index currently at: 80.5
Month Ago US Dollar Index: 83.5
JPYUSD currently at: 90.5 (Yen has strengthened)
JPYUSD Month Ago: 93
Saturday, November 29, 2008
The End of the Finance Economy - I Hope
For what is ‘normal’? Were the decades of the 1990’s and 2000’s, which witnessed unprecedented prosperity in the financial sector, normal? Logic dictates that the answer is no. There was “too much finance”. So much so that the financial system was a farce.
The financial sector became far too large in relation to the real economy. The compensation of those who worked in the financial sector became increasingly disproportionate, and abhorrently so, relative to the wages being earned in the real economy making real things. Too many financial instruments were being derived on other financial instruments, becoming too far removed from anything that even remotely resembled real assets or real economic activity.
These were abnormal times, and were therefore unsustainable times. The heyday of finance was nothing more than a pyramid scheme, only viable until it was unable to reel in the last sucker.
The world has finally come to the realization that pushing paper to other paper pushers for the sake of paper pushing doesn’t, in fact, constitute real value-added economic activity. The myth of the financial system as an unbridled source of wealth has been exposed.
The financial sector became far too large in relation to the real economy. The compensation of those who worked in the financial sector became increasingly disproportionate, and abhorrently so, relative to the wages being earned in the real economy making real things. Too many financial instruments were being derived on other financial instruments, becoming too far removed from anything that even remotely resembled real assets or real economic activity.
These were abnormal times, and were therefore unsustainable times. The heyday of finance was nothing more than a pyramid scheme, only viable until it was unable to reel in the last sucker.
The world has finally come to the realization that pushing paper to other paper pushers for the sake of paper pushing doesn’t, in fact, constitute real value-added economic activity. The myth of the financial system as an unbridled source of wealth has been exposed.
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