Harnessing the ETF revolution

Business Times - 24 Jun 2009

MONEY MATTERS

Exchange-traded funds now straddle virtually all asset classes and have become a global phenomenon

By JOSEPH CHONG

GLOBAL equity markets are roughly unchanged year to date. But this statistical calm masks a roller-coaster ride. Stocks fell 30 per cent until the second week of March - before rebounding 40 per cent. It was fear on a grand scale.

During this mayhem, we predicted in our column 'The paradox of thrift, and other thoughts' (BT, Feb 7, 2009) that things would soon sort themselves out.

Looking at big-picture data, we predicted that equities and hard assets such as precious metals and property would do well. So far, so good with our predictions.

Looking at forward indicators, most developed economies will be out of recession in the second half of 2009. This includes even Europe.

However, this recovery will be different from previous ones. The global economic landscape has changed markedly. Investors now need to scrutinise Chinese retail spending and PMI data as closely as they watch figures out of the United States. Ten years ago, few cared what the Chinese consumer spent.

Amid on-going fundamental shifts in the global economy, the money management industry is undergoing significant changes. And one factor behind the changing complexion of the wealth management business is the exchange-traded fund (ETF). Essentially, ETFs are open-end index funds that are listed and traded on exchanges - like stocks.

From the first humble listing in the US in 1993, ETFs now straddle virtually all asset classes - long and short - and have become a global phenomenon. There are currently more than 1,600 ETFs worldwide, with almost US$660 billion in assets. Twenty-five per cent of all trades on the New York Stock Exchange are driven by ETFs.

ETFs are also the choice instrument for macro bets by hedge fund managers. For example, when hedge fund manager John Paulson, the billionaire who made a fortune shorting the US sub-prime market, wanted to bet on gold recently, he did it through an ETF.

During the savage bear market of 2008, ETFs experienced net inflows, while unit trusts experienced net outflows. Indeed, most traditional unit trust managers see ETFs as one of the biggest threats to their business. Just as mutual funds did to bank deposits, ETFs are disintermediating traditional mutual funds as more investors chose to do away with the cost of active stock-picking work. Indeed, the ETF business is one of the main reasons Blackrock coughed up US$13 billion to buy Barclays Global Investors.

And on an infinitely more humble scale, that is why we soft-launched a new portfolio management service on June 1 to harness the global ETF revolution.

Utilising more than 1,000 ETFs traded on 22 exchanges around the world through one consolidated Internet account, we are providing clients with the flexibility to invest long and short in equities, fixed income, commodities and currencies globally. The goal is to achieve absolute returns regardless of market direction.

ETFs allow us to go long and short efficiently, while automatically achieving diversification and avoiding single-stock risks. But while avoiding single-stock risks, the investor can pursue targeted sectors as opportune.

Investment theory and practice show we can eliminate specific risk of individual securities by diversifying broadly, thus only having exposure to market risk - that is, the ups and downs of the market in general. Market risk cannot be diversified away in a long-only portfolio, unlike one that can go short.

Given the expected uneven nature of the recovery and eventual policy tightening by central banks around the world, the flexibility to go short is expected to be very useful.

The following is an example of a long-short strategy from the recent past. At the beginning of 2008, the outlook was poor for the US but benign for the rest of the world. Reflecting this, the US dollar was weak but US exports were growing because the rest of the world was still prosperous. Overall equity valuations in the rest of the world were not expensive.

One would, therefore, expect equities ex-US to outperform US equities, but US government bonds to do well. A typical strategy congruent with this outlook would be to invest in a global equity ETF but short (or eliminate) the US exposure by investing in an inverse US equity ETF.

Exposure to US government bonds would be through a US Treasury ETF with a maturity of around five years, which would be relatively stable. Therefore, the strategy would have been translated into three ETFs:

· iShares S&P Global 100 Index (IOO) - 45 per cent of portfolio.

· Short S&P500 ProShares (SH) - 25 per cent of portfolio.

· iShares Barclays 3-7 Year Treasury Bond (IEI) - 30 per cent of portfolio.

Such a construction would position the portfolio for upside but provide protection on the downside. Despite the most horrendous year for global equities since the 1930s, this simple three-ETF portfolio would have lost only 1.8 per cent at the end of 2008.

Our new portfolio management service built around ETFs gives individuals the flexibility to invest like a hedge fund but at low cost and with real-time transparency.

It gives investors the scope of large institutions - without the need for massive portfolios and outlays. The advent of the Internet technology and the richness of ETF choices have made this possible. Investors and advisers tend to look at events through the lens of their mandate and available instrument choices. Hence, long-only mandates result in a bias to interpret events on the upside, unlike a strategy that can go both long and short - one that is indifferent to market direction.

Psychologically, this has important consequences for portfolio performance. The changing world suddenly looks less frightening when one can make money whether markets are up or down.

It's just a business cycle as usual

Business Times - 12 Aug 2009

MONEY MATTERS

Pushing break-even points down will ensure profits, which will lead to re-investment and re-hiring - and thus growth

By JOSEPH CHONG

I AM gratefully astonished by the very positive response to our last BT contribution of June 24, 2009 - 'Harnessing the ETF revolution'. Searching on Google with the key phrase 'ETF revolution' two days after publication, I was surprised that of 85,000-plus articles listed, 'Harnessing the ETF revolution' was number one, besting similar pieces from far larger media houses such as FOX Business. It remained that way, until the piece was archived a week later. Readers, who wish to access the article can still do so at www.ni.com.sg. Perhaps the marketing experts at SPH may have some thoughts about monetising such articles, instead of archiving them?

Apropos revolutions, the good recent second-quarter announcements from global bellwether companies such as Intel, Apple, ABB and Honda were treated like revolutions in the business media. It is not a revolution - it is the business cycle at work.

We had a financial crisis that precipitated a deep recession. Companies globally reacted swiftly, throttling production and shedding excess inventory, production capacity and excess labour and benefits, thus pushing revenue break-even points down. At micro-level, we saw this in our general insurance business, as companies cut back coverage and benefits. Labour, which is in excess now, has little bargaining power.

Pushing break-even points down is the needed pain for the economy. This will ensure profits, even in a weak revenue environment. Profitability will eventually lead to re-investment and re-hiring - and thus growth. No revolution here, just the business cycle.

Profit announcements have shown other key traits besides cost cuts - better revenue estimates in the second half and margin expansion. This bottom-up perspective is congruent with the macro view that we have had for some time. We knew that revenue would be better going forward from the PMI sub-indices for new orders from the major economies, led by China.

From the macro perspective, we expected margins to improve because of the divergence in CPI and PPI around the world. The PPI, producer price index or a measure of input costs for businesses, has been falling far faster than the CPI, consumer price index or a measure of what businesses charge consumers, in most major economies. When PPI lags CPI, it is normally good news for businesses and the equity markets as it generally signals improving margins.

The accompanying chart shows the trend of CPI less PPI over the past 20 years for the US. Readers will notice that periods when CPI less PPI was positive have correlated with improving corporate margins and healthy equity markets.

We are now entering a sweet spot in the business cycle for equity markets - expanding margins and revenues. Corporate profit growth is back. Throw excess liquidity (M3 minus nominal GDP growth) into the cocktail and that's a recipe for very strong equity markets, as we had predicted in our contrarian call in BT of April 8, 2009 ('No, the recovery isn't a mirage any more'). Readers who want to access the article can still do so on www.ni.com.sg. Indeed, the Shanghai stock market's 90 per cent climb from the bottom could be a precursor for developed markets.

The improving demand picture and corporate profits are also correlated to the performance of the Singapore residential property market. When we stuck our neck out with our bullish contrarian call in BT on Dec 10, 2008 ('A city of two tales') amid widespread fear, we had an internal forecast of 25 per cent upside in 12 months. It looks as if we may have been too conservative.

Even without the expected additional demand generated by the integrated resorts in 2010, annual average take-up has been around 8,100 units since 1995. With the recovering global economy, we should at least see this number in 2010. Unfortunately - or fortunately, if you are an investor - there will be only 5,500 completions in 2010. This shortfall will push the rental vacancy rate down.

I estimate that this will fall from the current 5.9 per cent to below 4.9 per cent. The last time this happened, in early 2007, rents and capital values surged. Unlike in 2006, the cushion of surplus HDB flats is probably no longer there. I say probably because HDB, unlike URA, has yet to publish data on the inventory of unsold flats.

It looks like quite a party for the residential property market in the next 12 months, barring an external shock or government action. It is strange that when the Straits Times Index jumps 80 per cent in five months, no one screams speculation. However, when the residential property market prices begin to turn around (according to most recent URA data), many are calling for a change to the rules and the guillotine for 'speculators' while demanding 'affordable' prices.

What signal are we sending to those brave investors who take risk and prop the market (and banking system) in the despair of the first quarter of this year, when even the government was issuing statements full of gloom? In future, we may find no buyers at any price when things turn down because we acquire a reputation as rule changers. Curb 'speculation' with care. Otherwise, we may regret what we wish for.

The writer is CEO of financial adviser New Independent. He welcomes feedback at josephchong@ni.com.sg. This article is for information only. Readers should seek independent advice before making any investment decisions

Why China is still a buy

Business Times - 31 Jul 2009

By WU ZHIJIAN

THE Chinese equity and property markets have recently been on a roll. The Shanghai A-share market has gone up almost 100 per cent since the beginning of the year, and gained an impressive 17 per cent in the last two weeks.

Housing prices in some cities such as Shanghai, Beijing and Guangzhou have also soared. There is a buying frenzy. It was reported, for instance, that more than 1,000 people queued overnight to compete for about 300 units of a development in Nanjing, pushing the selling price up almost 90 per cent in a single day.

There are a few explanations for China's asset boom. One is simply liquidity. China's economy seems to be bouncing back since the government announced its 4 trillion yuan (S$846 billion) stimulus plan last year - the biggest in the world.

Broad money, M2 and bank lending in China have been increasing at a pace of about 30 per cent year-on- year, which is more than double the pace of the US. The liquidity provided by the banks was not supposed to go into the stock or property markets, but some of it has done so.

There is thus some concern that the asset market rally is not well supported by fundamentals.

The question, however, is whether China's equity and property markets are still a buy. There are at least three reasons to take a positive view.

Firstly, the Chinese government is unlikely to slow down the quantitative easing before the end of the year. The 4 trillion yuan stimulus plan was initiated only in Q1; it will take at least 4-6 quarters to fully take effect. In fact, the Chinese government has expressed concern in public that the current rebound might only be temporary and there are still considerable risks that the economy could turn down again.

The government has repeatedly confirmed its main target of sustaining a growth rate of 8 per cent in 2009. With such a challenging objective, it is unlikely that the government will let up in its stimulus anytime soon.

Secondly, the asset markets, especially the property market in China, are supported by the actions of local governments. GDP growth plays a critical role in assessing the performance of local governments and therefore there is a vested interest among the provincial and city-level officials to ensure a well supported property market.

In fact, in some of the cities, the real estate sector accounts for more than 35 per cent of the local economy

Thirdly, there is a possibility that the US economy might recover later this year. Timing the US recovery is a tough call, on which economists differ. If the US economy does improve, however, there is a good chance that China's export machine will revive, which will further support its asset market.

Currently, this is not on the cards. But next year could see the revival of China's exports and further increases in asset prices.

Of course, all the above factors do not rule out the fundamental weakness of the Chinese economy in the long run. Any asset bubble fuelled by a liquidity boom, after all, will burst at some point. However, for the next six months at least, China will continue to offer interesting investment opportunities.

The writer is a commentator on China. He runs the website www.chinatells.com

Big earners saving most of their cash: survey

Business Times - 22 Jul 2009

By JOYCE HOOI

FORGET the 'flight to quality' in turbulent times - locals have gone one better and are doing nothing with their money.

After seeing the bottom fall out of financial markets, more high-income earners here are saving most of their cash instead of putting it in investments or insurance.

A Nielsen survey found a 13 per cent spike in the number of high-income respondents who put most of their cash in savings - from 39 per cent of respondents before the financial crisis to 52 per cent after. High-income earners were defined as respondents who earn more than $7,000 a month.

This switch to savings came at the expense of investments, which dropped 7 per cent to 36 per cent.

Insurance also fell out of favour, with only 4 per cent of respondents putting most of their money in it, versus 10 per cent before the crisis, perhaps an unsurprising development given people have less to lose, hence, less to insure, post-crisis.

The trend was replicated across various income groups, though less pronounced. Overall, the number of respondents saving most of their money increased from 54 per cent to 57 per cent.

A global Nielsen survey in April foreshadowed this outcome. 75 per cent of 500 Singaporeans surveyed said they intended to save excess cash. Only a quarter said that they would invest in stocks or mutual funds.

'It is worth noting that in the past several years in which the Nielsen consumer confidence survey has been carried out, Singapore has always been among the three countries with the greatest number of people expressing their intention to save spare cash,' said Joan Koh, executive director of The Nielsen Company Singapore.

'We are definitely a cautious lot who are more comfortable putting our hard-earned money in fixed deposits and saving for a secure tomorrow.'

Winners in the next bull market

Business Times - 22 Jul 2009

The stocks that fare best are found in economically cyclical areas such as the tech, financial services and consumer sectors

(NEW YORK) WHICH investments are most likely to perform best in a bull market? Many investors have turned bullish in recent months, and, based on the stock mutual funds that they're choosing, they evidently think they know the answer.

Since Jan 1, nearly US$30 billion of net new money has poured into funds that invest in speculative emerging-market stocks. In that same period, investors have pulled money out of stock funds focused on the domestic market and developed foreign markets.

At first blush, moving money into emerging markets may seem a smart bet. Since stocks began to rebound in early March, the MSCI Emerging Markets index has soared 63 per cent, compared with a 39 per cent climb for the Standard & Poor's 500 index of domestic shares.

There's just one problem: History shows that asset classes that perform best in one bull market - as emerging-market stocks did in the run-up from 2003 to 2007 - rarely repeat that feat in the next. For example, the foreign-stock boom of the late 1980s gave way, after a brief bear market in 1990, to big gains in financial stocks in the early 90s and then to the surge in technology stocks in the middle to late part of the decade.

Deceptive

Of course, nothing is certain in investing. And emerging-market stocks could wind up bucking historical patterns. Still, market watchers say that it's dangerous to base an investment strategy for an extended bull run on early-stage results. In fact, stocks' behaviour in the first two to five months after a bear market can be quite deceiving. That's because a pattern tends to emerge when the market transitions from bull to bear back to bull again.

James Stack, editor of the InvesTech Market Analyst newsletter, notes that the stocks that tend to lose the most in a bear market are the best performers in the previous bull market. 'But then, coming out of those downturns, very often you'll see those same sectors regain their leadership status,' simply because they fell the most, he said. 'The question is, will that continue? In many cases, it will not.' Consider the last bull-to-bear-to-bull transition. Technology shares were the market's darlings in the late 1990s, during the Internet stock bubble. But after crashing the hardest in the bear market of 2000 to 2002, tech shares looked as if they would pick up where they left off.

In October and November 2002, the first months after that bear market, tech stocks far outpaced the market overall. Tech shares in the S&P 500 gained nearly 43 per cent in less than two months, while the index itself rose a more modest 15 per cent. Yet the tech resurgence proved to be short-lived, as the sector lagged behind the broad market through much of the bull-market period of 2004 to 2006. 'Due to their bear market losses, technology stocks had an easy time rebounding,' Mr Stack noted. 'The problem is, moving forward, considerations like valuation take over. And that's likely what we'll see in this market.'

Already, market strategists are becoming concerned that the emerging-market rally that began in March has gotten ahead of the fundamentals. The MSCI Emerging Markets index, for example, trades at a price-to-earnings ratio of 16.1, which is 25 per cent higher than its average P/E over the last five years.

'I don't think you want to be joining the emerging- markets bandwagon right now,' said Sam Stovall, chief investment strategist at S&P. 'They're trading at valuations that aren't cheap anymore.'

So if emerging markets aren't likely to provide the best returns, which sectors will? The answer will depend largely on what type of recovery is ahead, said Gordon Fowler Jr, chief investment officer at Glenmede, an investment firm in Philadelphia. For example, if a speedy economic rebound is in store, a bet on economically sensitive investments - such as financial shares and emerging-market stocks - could make sense.

But on the other hand, Mr Fowler said, if you believe that even after a recovery, 'the economy will be weak over a sustained period of time and is not going to be driven by American consumption, then I think that leads you to a different group of companies - good growth companies with solid balance sheets'.

And that search would lead investors to two asset classes that led the bull market of the late 1990s: large blue-chip growth stocks, which Mr Fowler says are at reasonably attractive prices, and tech shares, which stand to benefit whether a global recovery is weak or strong. Mr Fowler points out that 'after the last downturn, technology companies got religion and repaired their balance sheets'. In fact, tech companies in the S&P 500 now hold more cash relative to their overall assets than any other sector in the market.

Mr Stovall agrees that tech is likely to be one of the best performers of the next bull market. Historically, he notes, the stocks that fare best in a new bull market are found in economically cyclical areas, which would lead investors to the tech, financial services and consumer discretionary sectors. But given the continuing uncertainty about the health of financial companies and consumer spending in general, he says tech is likely to be the best bet. -- NYT

The rules of trading and investing

Business Times - 08 Jul 2009

MONEY MATTERS

The objective is not to buy low and sell high, but to buy high and to sell higher

By MICHAEL PREISS

AMONG economists and on Wall Street in general there is now an active debate whether the massive stock market rally we saw globally since the mid-March lows is the beginning of a new bull market or whether it is simply a bear market rally that is now running out of steam. Since the March lows some stock markets around the world have risen 30-100 per cent while there was an increasing talk about 'green shoots' and the real economy recovering or at least getting less worse.

As we are entering the second half of 2009, most investors would do well to do a 'reality check' and reconsider their risk exposures and portfolio contents.

Investors are moving in lockstep like never before, driving up stocks, commodities and emerging markets and risking a replay of last year, when they all plunged the most since World War II. The herd mentality threatens to leave investors with no refuge amid signs that the worst US recession since 1958 isn't abating.

The market response to sell stocks now suggests a dose of nerves at the end of one of the best quarters for world stock market returns in history. It took the same nerves to go long and buy in March when everyone or at least most people were maximum bearish among widespread end-of-the-world sentiment.

Evidence on whether the positive economic currents have turned into profits for companies, which will start flowing soon, is needed before the rally can progress further. Stock price gains might be harder to come by as investors search for profit growth to justify the 41 per cent rally in the MSCI World Index. Whatever your view is on the state of the global economy, it pays to consider some truths and rules about trading and investing.

Never, under any circumstance, add to a losing position...ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin! Remember Citibank shares at US$55 less than two years ago, it fell to US$30, when our friends in Abu Dhabi tried to save them with a US$7.8 billion lifeline investment. Many thought Citi was cheap and 'averaged-in' only to see the once largest bank in the world slump to less than US$1.

Trade with an open mind. Still too many people only buy stocks and hope they will rise. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.

The same applies to emerging markets. While fundamentally a lot of the emerging markets offer great long-term potential, short-term several countries look over-bought. So in emerging markets, it seems 'Short-term SHORT, Longer-term LONG' might be the best tactical advise.

Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital, not to mention stress.

The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is 'low'. Please remember Citibank. Nor can we know what price is 'high'. Always remember that sugar once fell from US$1.25/lb to two cent/lb and seemed 'cheap' many times along the way.

In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral. That may seem self-evident; it is not, and it is a lesson learned too late by far too many. 'Markets can remain illogical longer than you or I can remain solvent,' according renowned British economist Maynard Keynes. Illogic often reigns and markets are enormously inefficient despite what the academics believe.

Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds. They shall carry us higher than shall lesser ones.

Try to trade the first day of a gap, for gaps usually indicate violent new action. I have come to respect 'gaps' in my nearly 25 years of watching markets; when they happen (especially in stocks), they are usually very important.

Trading runs in cycles: some good; most bad. Trade large and aggressively when trading well; trade small and modestly when trading poorly. In 'good times', even errors are profitable; in 'bad times' even the most well researched trades go awry. This is the nature of trading; accept it.

To trade successfully, think like a fundamentalist; trade like a technician. It is imperative that we understand the fundamentals driving a trade, but also that we understand the market's technicals. When we do, then, and only then, can we or should we trade.

Respect 'outside reversals' after extended bull or bear runs. Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more 'weekly' and 'monthly' reversals.

Keep your technical systems simple. Complicated systems breed confusion; simplicity breeds clarity. Respect and embrace the very normal 50-62 per cent retracements that take prices back to major trends. If a trade is missed, wait patiently for the market to retrace. Far more often than not, retracements happen just as we are about to give up hope that they shall not.

Bear markets are more violent than are bull markets and so also are their retracements. An understanding of mass psychology is often more important than an understanding of economics. Markets are driven by human beings making human errors and also making superhuman insights.

Be patient with winning trades; be enormously impatient with losing trades. Remember it is quite possible to make large sums trading/investing if we are 'right' only 30 per cent of the time, as long as our losses are small and our profits are large.

The market is the sum total of the wisdom...and the ignorance...of all of those who deal in it; and we dare not argue with the market's wisdom. If we learn nothing more than this we've learned much indeed. Do more of that which is working and less of that which is not: If a market is strong, buy more; if a market is weak, sell more. New highs are to be bought; new lows sold.

The hard trade is often the right trade: If it is easy to sell, don't; and if it is easy to buy, don't. Do the trade that is hard to do and that which the crowd finds objectionable. In mid-march that trade was major bull. Now after the second half and a massive rally, common sense would indicate 'book profits' across the board and move into cash if not out-right short, if you are a tactical trader. In the words of a Chinese saying: 'Fortune favours the brave - and the prepared mind.'

The writer is a Chartered Wealth Manager and can be reached at Michael@michaelpreiss.net

Billion-Dollar Lessons: What You Can Learn from the Most Inexcusable Business Failures of the Last 25 Years

With lessons learned from extensive research into 750 major bankruptcies between 1981 and 2006, including Enron, Conseco, Texaco, Kmart, and Refco, authors Carroll and Mui set out to help corporate management avoid failure from bad strategies. Almost one-half of the failures could have been avoided if the companies had been aware of strategy pitfalls or had become cautious in the face of clear warning signs. The authors describe seven basic strategic failures, including estimating synergy from mergers, which proves to be exaggerated; aggressive use of accounting or financing mechanisms; staying the course in spite of a clear business threat; and riding the wrong technology, which fails. We also learn about the psychological implications of management banding together when something is wrong rather than individuals standing up for what is right and the important benefits of introducing a devil’s advocate into a strategy’s deliberative process. This well-researched book provides valuable insight for corporate executives and investors.

Think before picking up that bargain

Business Times - 11 Jul 2009

SHOW ME THE MONEY

When it comes to large acquisitions and huge outlays, the odds of such acquisitions succeeding are not great

By TEH HOOI LING
SENIOR CORRESPONDENT

ASSETS are still relatively cheap compared with their pre-crisis levels. And companies with fat cash hoards are no doubt tempted to deploy some of this money in the hope of picking up a bargain. But before embarking on any major acquisition, these companies would do well to read the book Billion Dollar Lessons - What You Can Learn from the Most Inexcusable Business Failures of the Last 25 Years by Paul Carroll and Chunka Mui.

Investors, too, will benefit from this book. It will help them work out whether what their investee company is about to do makes strategic sense. They will also have a better understanding of the likelihood of success of the strategy.

In the words of the authors, for executives, 'why spend $500 million and a decade of your life repeating someone else's mistake when you could learn to avoid it by spending a few hours with a $26 book'?

Here is the extent of corporate failures. Between 1981 and 2006, 423 US companies with individual assets of more than US$500 million filed for bankruptcy. Their combined assets at the time of their bankruptcy filings were more than US$1.5 trillion. And their combined annual revenue was almost US$830 billion.

Over those 25 years, the write-offs of 258 publicly traded US companies came to US$380 billion. Sixty-seven companies had combined losses from discontinued operations that totalled almost US$30 billion.

The authors found that the number one cause of failure was misguided strategy - not sloppy execution, poor leadership or bad luck. After eliminating failures that stemmed from poor execution and factors beyond the control of management - such as the 9/11 terrorist attacks - from the remaining cases, the authors identified repeating patterns where failures across multiple industries were variations on a theme. They found the failures tended to be associated with one of seven types of strategy.

One, pursuing non-existent synergy. Companies tend to over-estimate the benefits from a merger. A Bain study found that two-thirds or more of takeovers reduce the value of the acquiring company. And two-thirds of companies routinely fail to achieve all the synergies identified before a takeover. One reason why synergy goals aren't met is that companies don't do detailed work to make sure that the synergies that seem possible can, in fact, be produced.

In 1981, after IBM introduced personal computers to the market, it thought that it would be synergistic to offer software programmes with its hardware. So it started buying small independent software companies. It also hoped that the entrepreneurial spirit of these software companies would rub off on IBM itself. Instead, IBM smothered the software companies. The Big Blue eventually took US$2 billion of losses on software before giving up on the business.

Quaker bought Snapple for US$1.7 billion in 1994. It sold it for $300 million just three years later. In 1996, Union Pacific bought Southern Pacific Rail Corporation because the combined railroads would be the biggest network in the US. But the two railroads' information systems didn't work together. There were so many delays that the federal government declared an emergency and intervened.

Two, aggressive use of financial engineering when structuring deals. Green Tree Financial Corporation, through financial engineering, made trailer-home ownership more accessible to low and middle-income Americans. In 1992, it lent US$1.2 billion. In 1996, it lent four times that amount. The market rewarded Green Tree generously. Its stock jumped 30-fold and its 'profits' surged six-fold between 1991 and 1997. Green Tree's chairman and chief executive took home pay of US$200 million during the boom.

Green Tree's 'financial innovation' was to offer 30-year mortgages instead of the 15-year terms that were standard for trailer homes. The fatal flaw? Trailer homes depreciate and have a life-span of only 10-15 years. On a typical US$50,000 mortgage, after five years the borrower would still owe US$49,000 in principal based on an interest rate of 12-13 per cent. But by then, a trailer home is worth much less than the sum owed. Borrowers are better off defaulting. And many did just that.

But in the intervening years, Green Tree securitised the mortgages, held on to the mortgage-backed securities and booked profits based on its own forecast of defaults and pre-payments. In those earlier years, the more borrowers it found, the higher the profits it recorded. The long-term performance of the loans was of no importance to Green Tree's management. Investment bankers, said the authors, have an acronym for this: IBG YBG, which stands for 'I'll be gone, you'll be gone.' It means that even though there may be long-term problems with a deal, the folks who put it together will have reaped their profits and be long gone.

In 1997, Green Tree's intricate design began to unravel. Defaults and pre-payments started to escalate. In November that year it took a US$190 million pre-tax write-off. Its credit rating was downgraded and it couldn't roll over its short-term debt. Then came a white knight - life and health insurer Conseco. It was attracted by Green Tree's 30 per cent growth rate, and perceived that both companies served and shared the same market and culture.

So Conseco bought Green Tree for US$7.6 billion in 1998 - at US$53 a share, despite the latter's market price of only US$29 a share. To lift sales, Conseco continued to use the Green Tree model, and actually increased the number of loans made after the acquisition. It financed US$6.3 billion in new trailer homes in 1999. The quality of loans was even worse than before the acquisition. Conseco's founding CEO resigned in April 2000. He received a US$72 million severance package. In total, his pay from 1993 to 2000 was US$530 million. Conseco declared bankruptcy in 2002.

Three, buying a string of small companies in a fragmented industry - referred to as roll-ups - to form a behemoth. A Booz Allen study followed 81 roll-ups between 1993 and 2000. Only 11 outperformed the S&P500. 20 were in or near bankruptcy. Many of these failed roll-ups ended in fraud. Part of the problem for roll-ups is that they are searching for efficiencies in the most inhospitable environment imaginable. In the initial years, however, investors do get excited by the perceived rapid growth. Tyco spent US$63 billion acquiring more than 1,000 companies between 1994 and 2001. It tried multiple roll-ups in home-security alarms, special electronic connectors, fire-protection equipment and specialised manufacturing. There was little emphasis on integration. The strategy came apart in 2002. Tyco's market cap sank by $90 billion that year.

Four, stay on a misguided course. This would involve a former dominant player in a declining industry gobbling up its competitors in a bid to increase market share. Paging company Arch Communications bought dozens of paging companies as it tried to achieve scale, even though the writing was on the wall that mobile phones would make pagers obsolete. In mid-1998, Arch paid US$649 million for Mobile Media. From 1999 to 2003, more than two-thirds of people who used pagers gave them up. Arch filed for bankruptcy in December 2001. In another example, Kodak noted the threat of digital cameras but tried hard to protect its fat profit margins in the photo printing business for as long as possible. In the past decade, as digital cameras gained dominance, Kodak lost 75 per cent of its stock market value.

Five, misguided adjacencies. Avon decided its 'culture of caring' qualified it to operate retirement homes. It also bought into a medical equipment rental company. Avon simply did not have the expertise to manage the new acquisitions. In 1988, it took a charge of US$545 million to dismantle its health care business.

Six, investing in a technology without keeping an eye on the alternatives. Motorola's US$5 billion satellite telephone venture Iridium went bankrupt less than a year after it began. Its assets were auctioned for just US$25 million. Motorola had not anticipated the progress that cellular phones would make.

Seven, consolidation in a declining industry. The example of the paging company above would apply here too.

A lot of the cases above involved large acquisitions and huge outlays. The odds of such acquisitions succeeding are not great. Perhaps a viable strategy is the 'string of pearls' approach, as adopted by Olam. With this strategy, acquisition outlay should not exceed 10 per cent of a company's current value. And preferably, acquisitions should be spaced - perhaps one every three years. Yes, growth would be slower. But it is definitely a better alternative than the massive destruction of shareholder value which inevitably will happen when a company tries to acquire many others in a hurry.

Is there still trust in Reits?

Business Times - 11 Jul 2009

Real estate investment trusts do look attractive in the long term at current prices, but investors must choose carefully and diversify their investments accordingly. By Roger Tan

THE Singapore real estate investment trust (S-Reit) sector has grown remarkably since the first Reit - CapitaMall Trust - was listed in July 2002. Between 2006 and 2008 alone, more than 13 Reits were listed, compared with only seven between 2002 and 2005.

Choices of Reits have also expanded. In 2005, investors could only choose between commercial (retail, office or mixed), industrial and logistics Reits. Today, they can find hospitality, healthcare and residential Reits. There are also Reits that own foreign assets.

S-Reit growth in 2006 was mainly driven by increasing speculative interest in the property sector after commercial rents started to rise strongly. The office rental index was up 30.3 per cent in 2006, compared with 12.7 per cent the year before. This was a stark contrast to a 5.6 per cent increase in the shop rental index in 2006. The median monthly rent for central office space at end-2006 was $6.24 per square foot (psf), compared with $4.24 psf in 2005.

Investors' hunger for Reits grew dramatically. The market capitalisation of the Reit sector at the start of 2005 was $9.4 billion - but it hit $16.9 billion in June 2006. Furthermore, only one new Reit - Allco Reit, now known as Fraser Commercial Trust - was listed in the first half of 2006. The increased demand for Reits pushed their unit prices up and dividend yield down. Average dividend yield in January 2005 was around 6.5 per cent, compared with 5.6 per cent in June 2006. This together, with higher Sibor rates, squeezed dividend yield premiums - the difference between dividend yield and three-month Sibor rates - from 5.2 per cent in January 2005 to a low 1.9 per cent in June 2006.

Although office prices rose 17 per cent on the back of higher rents, the increase was more benign than the 30 per cent rise in rents. This resulted in an increase in median annualised rental yields of office properties from 8.1 per cent in 2005 to 9 per cent in 2006. Rental yields of shop space and industrial properties, on the other hand, remained at 7.9 per cent and 5.2 per cent respectively.

The combination of a lower cost of equities and higher rental yields spawned many new Reits between June 2006 and December 2007. Seven new Reits were listed in second half 2006 and another five in 2007. Reits' assets under management (AUM) grew from $13.4 billion in 2005 to $23.2 billion in 2006. In 2008, AUM were $42.5 billion.

Given the increased competition, Reits started to enhance their yields with debt to attract investor interest. The average debt to total asset ratio of the Reit sector rose from 26.3 per cent in January 2006 to 30.7 per cent in June 2007. A few Reits even pushed this ratio above 50 per cent in June 2007.

Reit investors' high hopes of continued price increases started to shake when the first sign of financial turmoil presented itself in July 2007 and Reit prices started to fall. The situation did not improve into 2008. Between June 2007 and December 2008, the S-Reit index fell more than 66 per cent, as opposed to 50 per cent drop in the Straits Times Index. Although Reit prices have recovered 16.8 per cent for the year, they are still 60.3 per cent lower than in June 2007.

High debt ratios employed by Reits became a concern as Reits started to signal that they would face challenges refinancing their loans - and even paying dividends. Loan-to-value ratios increased in 2008 as Reits revalued their assets downwards - adding more concerns over their survival. To improve the strength of their balance sheets, some Reits issued rights in 2008 and 2009.

There are, however, some positive developments from this debacle. First, dividend yield premiums have increased since July 2007. With lower prices, S-Reits now offer dividend yields of around 12.4 per cent, compared with around 7.3 per cent a year ago and 4 per cent in June 2007. Sibor rates have also fallen, from 2.7 per cent in June 2007, to the current 0.7 per cent. Dividend yield premium has thus improved to 11.9 per cent, from just 1.4 per cent two years ago.

Prices of Reits are also at more affordable levels now. For example, the prices of CapitaMall Trust, A-Reit and Mapletree Logistics Trust were at $1.40, $1.59 and $0.56 respectively as at June 30 this year - around half their prices in June 2007.

Most importantly, the good and bad Reits are now easier to differentiate. The lower 'tide' has exposed Reits that have bad assets and have been poorly managed - making investment decisions easier than two years ago.

Unfortunately, uncertainty still lurks in the sector. Although there are now signs that the economy is bottoming, economic recovery will probably be gradual at best. Furthermore, the Singapore economy is dependent on foreign demand, and therefore recovery will lag the developed nations.

Vacancy rates of offices and shops in March 2009 increased to 10.0 per cent and 6.6 per cent respectively from 7.7 per cent and 6.4 per cent a year earlier. Only industrial properties bucked the trend, with the vacancy rate falling from 7.6 per cent to 7 per cent.

Between March 2008 and 2009, rents for office space and industrial property were down 12.9 per cent and 6.5 per cent respectively, while shop space was up a marginal 0.5 per cent.

Even though developers have been holding back new projects, the chances of significantly higher rental and lower vacancy rates this year is not high. Reits may, therefore, have to reduce their dividends.

Reits do look attractive in the long term at current prices, but investors must choose carefully and diversify their investments accordingly. Here are a few important factors to consider:

A Reit's ability to raise funds, especially in times of turmoil, will determine its ability to thrive and survive. This is an important factor. In good times, most Reits will enhance their yields through higher leverage, but only well-managed Reits will be able reduce this leverage in challenging times. Without this ability, badly managed Reits will find it difficult to refinance or raise sufficient equity to repay their loans, putting them in danger of liquidation.

The quality of assets is another important factor, and Reits that own properties beyond just Singapore would be a plus. Too much emphasis has been put on dividends and too little on assets. Investors must bear in mind that they are buying the underlying assets when investing in Reits - the dividends are the result of the ownership and management of the assets.

However, good assets can produce poor returns if poorly managed. The quality of the managers is therefore another important factor. Good managers will continuously enhance the yield of the assets and use an appropriate debt-equity mix at all times. A sudden fall in rental revenue, rental collection issues and below average rental yields are some signs of poor management. Such Reits should be avoided.

Last but not least, investors must check if a counter is a Reit, such as CapitaMall Trust, or a business trust, such as IndiaBulls Property Investment Trust. Business trusts and Reits are created to allow unit holders to receive dividend payments from operating cash flow instead of accounting profit. However, only Reits are required to pay 90 per cent of distributable income to unit holders. There is no such requirement for business trusts. Investors should therefore look closely at what they are picking, to ensure the counter they choose is in line with their investment intention.

The writer is vice-president, SIAS Research

When quality matters more than quantity

Business Times - 10 Jul 2009

By R SIVANITHY

IT IS tempting to call for increased regulation in the aftermath of the collapse of the structured products segment. For sure, more needs to be done to protect the public interest and to ensure investment scandals are minimised. But when it comes to financial instruments and investment recommendations, is more regulation really the answer, or would public interest be better served if regulatory focus is more targeted?

In other words, assuming that the disclosure-based model is to be retained, is the way forward a greater quantity of regulations or just better quality regulation?

The problem with the disclosure model in practice today is not that it is flawed or has to be buttressed with more rules, but that financial intermediaries, brokers and their agents have been allowed to hide behind the 'caveat emptor' maxim and profit from a natural human tendency to read only the headlines and maybe the first few paragraphs of various publications, whether they are research reports, newspapers, prospectuses or advertising brochures.

One of the best (or worst, depending on your point of view) examples of this is the prospectus for Lehman's failed Minibonds. All relevant information relating to the true nature of the product was actually presented within its voluminous tome - that it was, in essence, an insurance policy taken out by Lehman on its US mortgage instrument portfolio, that the attractive annual 5 per cent interest that investors received was, in reality, Lehman's insurance premium and that if any one of the related parties failed during the instrument's life span, all investment money could be lost.

There was even a section deep inside the prospectus which warned that the more banks or financial institutions there were connected to the Minibonds, the greater the risk of loss. Despite all this, investors were cleverly led to believe they were buying a bond-like instrument (which, because of the word 'bond' in the headline, implied some degree of safety) and that the more institutions there were, the greater the diversification benefits and thus the lower the risk.

This was because the cover or first page did not contain any of the investment-critical information about the substantive nature of the instrument. In fact, nowhere was this the case - the instrument's substance could only be deduced by reading various sections which were not juxtaposed together.

If the first page had described in simple terms what exactly everyone was buying into, things would surely had been very different.

This practice of placing the most critical investment information anywhere in the disclosure document but on the first page extends to many other financial market-related areas, such as stockbroking reports.

For example, in a 'buy' on a well-known technology stock listed here, a foreign broker based its recommendation on a long-term forecasting model that peered 18 years into the future. While it is conceivable that there are people today who possess sufficient precognitive powers to be able to foretell what the world would be like in 2027, most reasonable investors would take such claims with plenty of scepticism. No matter though, in a market governed by 'caveat emptor', it should be up to readers to make up their own minds whether to bet their money on such recommendations - provided, of course, all the information is made readily available.

Like the Minibond example, the operative word, of course, is 'readily'. In this case, the long time horizon was only given on the fourth page of the report, while no details of what inputs and assumptions that went into the model were disclosed. In other words, the information was there - but only the bare minimum was presented and even this was not upfront.

This practice of burying important assumptions or data in the inside pages is common in research reports. However, if the authorities are serious about enhancing investors' interests, they should make it compulsory for all investment-critical information to be disclosed on cover sheets in simple, straightforward English. It is a relatively easy idea to grasp and doesn't require much new regulation - simply make investment product sellers state upfront in uncomplicated language what they are peddling and if they don't, make it such that severe sanctions could follow.

This way, quibbling over whether there was mis-selling or misrepresentation would be minimised and sellers (whether they are brokers, underwriters or investment banks) will be forced to cut to the chase and remove superfluous literature that their marketing/legal departments had devised to divert attention away from important risks.

While they're at it, the authorities should also put a stop to the distasteful practice of presenting legal disclaimers and important information in fine, eye-straining print. They should even go so far as to specify minimum font sizes for investment-critical information - admittedly an extreme suggestion but one that's wholly necessary given just how much relevant information sellers tend to hide in minuscule text.

Whatever the steps chosen, the important point to note is that the disclosure-based approach to governance has actually not failed. It has, however, been bypassed or marginalised by clever marketing that relied and capitalised on people not reading beyond the headlines or first page. Since it is difficult to alter human nature and people's reading habits, a much better approach would be to change the rules to suit those habits.

Asian commodity traders vexed by liquidity gap

Business Times - 08 Jul 2009

Dearth of activity during Asian trading hours can lead to erratic swings in prices

(SINGAPORE) The rogue Brent trades that roiled the oil market in the normally placid wee hours last Tuesday have again put a spotlight on the lengthy period of Asian illiquidity for the world's main commodity markets.

The sharp jump in prices and volumes on Brent - and gold's drop two months ago - ultimately had no lasting impact on world prices, but vexed Asian traders who face a constant dilemma: Keep large stop orders out of the market during thin Asian trade to avoid moving prices accidentally, or leave them open in the hope of a burst of liquidity like last week's.

There are several ways to lift liquidity, none of them quick: Find a few brave souls ready to break their routine and make an early market, develop an Asian exchange with compelling local contracts, or wait for China and India to unshackle thriving domestic exchanges to allow outbound trade.

'I think it will be a combination of a few factors; the centre of commodities trade is shifting east more and more, so there will be more demand for liquidity, and I guess there will be some incentives from the exchanges for market makers,' said Roberto Tassinari, a proprietary trader with Saxon Financials.

As global exchanges like the New York Mercantile Exchange and the London Metal Exchange adopted near-24-hour electronic trade over the past decade, they also tried to foster greater activity in the Asian time zone, both to establish their market position and to grow business in the fast-expanding region.

They have largely failed, resulting in global benchmarks for soybeans, oil or copper that are open for trade but nearly dormant for one-third of the day.

'It will take at least five to seven years to have adequate liquidity,' said a Singapore-based industry source who trades global commodities. The best hope, he said, is 'China opening up and moving from a price taker to benchmark setter'.

For now the market may have to live with the risk of the occasional jolt like the one that occurred around 9am Singapore time last Tuesday, when a series of roughly 500-lot bids by a rogue London-based Brent broker at PVM triggered a more than US$2 surge in prices .

The reaction would have been far more muted if the same volumes had gone through during the highly liquid US and European trading periods.

In a single hour more than 11,000 lots of Brent traded, over 10 times the norm for the entirety of the Asia time zone, but about average activity for the main 1000 to 2000 GMT period.

The incident - which PVM says cost it nearly US$10 million and is under investigation - comes just two months after an apparently mistaken sell order for Comex gold futures triggered a sudden US$10 fall in midday Asian trade, a sizeable move that dragged down spot bullion and roiled the market.

While the latest incident is sure to cause a new round of questions about broker trading controls, the more immediate issue for the growing ranks of Asia-based commodity traders is how to protect themselves from erratic, low-liquidity moves.

Some find hope in the growth of local contracts, from the birth of the Dubai Mercantile Exchange's Oman crude oil futures contract two years ago to the ASX's launch of an Australian thermal coal futures contract last week.

Several other exchanges in Singapore are also in the works, some trying to capitalise on strong Indian demand for more venues that sidestep currency controls as well as regulatory risks in a country where the government has been quick to shut down any contract it fears is stoking local prices.

In China, Shanghai copper and Dalian grains contracts have become important global weathervanes for those markets.

When adjusted to compare like for like per-tonne trading volumes, total volume in the Shanghai Futures Exchange copper contract is roughly equivalent to total LME trade, according to Reuters data.

The liquidity gap is acute.

Front-month Nymex crude oil futures traded an average of under 8,000 lots a day from 0000 to 0800 GMT in June; from 1200 to 2000 GMT they traded over 200,000 lots. The two front CBOT soybean contracts Sc2 trade some eight times more in just five hours of Chicago trade than in 12 Asian hours.

Exchanges are unlikely to consider curbing hours to reduce the market's liquidity exposure, although ICE Futures rowed back extended hours over the past two years after concerns about market liquidity and complaints from London brokers who were reluctant to staff desks at all hours.

Ultimately what's needed in the short term is a few more players like Peter Maguire, the managing director of Commodity Warrants Australia, who faced down sceptical traders over the past five years as he sought to fill orders during his daytime.

'We started trading during the day here and people told us nothing was going to get done. But we just put the bid in and it gets hit. In Delaware or Moscow or wherever, somebody is messing around on their Blackberry and sees a good trade.' - Reuters

Goldman may lose millions from code theft

Business Times - 08 Jul 2009

Program can be used to manipulate markets: prosecutor

(NEW YORK) Goldman Sachs Group Inc may lose its investment in a proprietary trading code and millions of dollars from increased competition if software allegedly stolen by a former employee gets into the wrong hands, a prosecutor said.

Sergey Aleynikov, an ex-Goldman Sachs computer programmer, was arrested July 3 after arriving at Liberty International Airport in Newark, New Jersey, US officials said. Aleynikov, 39, who has dual American and Russian citizenship, is charged in a criminal complaint with stealing the trading software.

At a court appearance on July 4 in Manhattan, Assistant US Attorney Joseph Facciponti told a federal judge that Aleynikov's alleged theft poses a risk to US markets.

Aleynikov transferred the code, which is worth millions of dollars, to a computer server in Germany, and others may have had access to it, Mr Facciponti said, adding that New York-based Goldman Sachs may be harmed if the software is disseminated.

'The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways,' Mr Facciponti said, according to a recording of the hearing made public yesterday.

'The copy in Germany is still out there, and we at this time do not know who else has access to it.' The prosecutor added: 'Once it is out there, anybody will be able to use this, and their market share will be adversely affected.'

The proprietary code lets the firm do 'sophisticated, high-speed and high- volume trades on various stock and commodities markets', prosecutors said in court papers. The trades generate 'many millions of dollars' each year.

Defence attorney Sabrina Shroff said in court that the government's allegations are 'preposterous'. The firm was aware that Aleynikov, who is the father of three young girls, was downloading programs to his personal computer to do work at home and that he has not disseminated the code, the lawyer said.

'If Goldman Sachs cannot possibly protect this kind of proprietary information that the government wants you to think is worth the entire United States market, one has to question how they plan to accommodate every other breach,' she said.

Michael DuVally, a spokesman for Goldman Sachs in New York, declined to comment.

US Magistrate Judge Mark Fox ordered Aleynikov, who earned US$400,000 a year, to be held on US$750,000 bail, after prosecutors claimed that he posed a threat to the community. Aleynikov planned to earn three times his salary by joining a start-up company and engaging in high-volume automated trading, prosecutors said. He posted bail on Monday and was released.

He did not speak at the hearing, except to say that he understood the conditions of his bail.

'Someone stealing that code is basically stealing the way that Goldman Sachs makes money in the equity marketplace,' said Larry Tabb, founder of Tabb Group, a financial market research and advisory firm.

'The more sophisticated market makers - and Goldman is one of them - spend significant amounts of money developing software that's extremely fast and can analyse different execution strategies so they can be the first one to make a decision.' Someone could use the code 'to implement the same strategies and maybe on certain stocks they can be faster and, in effect, take away money that would normally be Goldman's', Mr Tabb said in a phone interview.

'The second thing that they can do is actually analyse the code so that they know what Goldman's going to do before Goldman does it and kind of reverse engineer Goldman's strategies and make money basically at the expense of Goldman.'

Aleynikov spent four hours with a Federal Bureau of Investigation agent after his July 3 arrest, Ms Shroff said. He told the agent that he had done nothing wrong, authorised prosecutors to seize his personal computers, and said that he did not know that the server he was using was in Germany, she said. -- Bloomberg

The cane whistles, but does it really hurt?

Business Times - 08 Jul 2009

COMMENTARY

MAS bans won't affect FIs much and it shouldn't gloss over deeper issues

By WONG WEI KONG

IT is a pity that what seems so tough is really just a slap on the wrist.

So the Monetary Authority of Singapore (MAS) has banned 10 financial institutions (FIs) from selling structured notes for periods ranging between six months and two years for mis-selling products linked to collapsed US bank Lehman Brothers.

The offending banks on the list are all established names: ABN-Amro, DBS Bank, Maybank, DMG and Partners Securities, UOB Kay Hian, CIMB, Kim Eng Securities, OCBC Securities, Phillip Securities as well as Hong Leong Finance. These were names that many investors instinctively trusted - but, as the MAS findings show, it was a trust that was grossly misplaced.

On the surface, the MAS ban, following approximately seven months of investigations, appears to be appropriate punishment. But it really rings hollow, because it isn't going to hurt the FIs very much. The fact is that the whole structured products market has vanished - the financial crisis and the structured notes fiasco have seen to that. Even without the ban, these FIs weren't selling any structured notes.

This will be cold comfort to the 10,000 or so investors who suffered from the mis-selling, some of whom will never fully recover from the blow. And it isn't satisfactory, given the serious lapses at the FIs. The list of shortcomings makes for shocking reading: risk profile questionnaires that were wrongly scored; risk profile scoring systems that did not allocate numerical scores; wrong classifications of products, and relationship managers (RMs) and representatives who refused to attend the pre-requisite training. And all the FIs get, so far at least, is a ban on doing a business that doesn't exist anymore.

If a ban really means nothing, the MAS should have imposed fines, big fines, that will hurt the FIs. If it does not want to collect fines, it should have considered pushing the FIs to compensate, more than what they have done, the investors who are seeking redress. Of course, the FIs will say they're suffering reputational damage, but that's already a fact, and that is well deserved.

Oversight and processes

There's another point worth making. Apart from investigations into FI-wide issues, the MAS is concurrently looking into specific cases 'where individuals involved in the sale and marketing of the notes may have departed from the relevant regulatory standards'. Inquiries are ongoing and any regulatory action taken against individuals will be published in due course, the central bank said.

While it remains to be seen what the MAS will do in this respect, it will be a pity if any subsequent action taken is only against the RMs and representatives actually selling the products on the ground. The nature of the lapses identified by the MAS suggests a failure in oversight and processes, which really points the finger at senior executives, and they shouldn't escape responsibility.

And what about the MAS' own role? Dare we suggest that if the sub-prime fiasco hadn't happened and Lehman hadn't collapsed, the mis-selling would have continued merrily and no one would be the wiser? How closely did the central bank supervise the banks when it came to the sale of structured products before the crisis? Liberalising the market is good, but if not implemented properly, the costs, as proven now, are enormous. The MAS itself should be deriving lessons from the whole affair.

Time to win back trust

The industry will respond to this as it usually does. Indeed, the Association of Banks in Singapore (ABS) immediately announced that its member banks are putting in place a series of measures to further protect the interests of consumers who buy investment products, with the measures covering a range of governance and assurance processes, training and compensation of sales personnel, consumer education and enhancements to the sales process. Investors will take all this with a pinch of salt. Weren't there such protestations before?

Forget expansion - winning back trust should be the biggest priority for banks and financial institutions.

Inside the Goldman money machine

Business Times - 07 Jul 2009

Ex-employee charged with stealing secret computer codes that help the firm generate millions of dollars in profits each year

By MATTHEW GOLDSTEIN

DID someone try to steal Goldman Sachs' secret sauce? While most people in the United States were celebrating the Fourth of July holiday, a Russian immigrant living in New Jersey was being held on federal charges of stealing secret computer trading codes from a major New York-based financial institution. Authorities did not identify the firm, but sources say that institution is none other than Goldman Sachs.

The charges, if proven, are significant because the codes that the accused, Sergey Aleynikov, allegedly tried to steal are the secret sauce to Goldman's automated stock and commodities trading business. Federal authorities contend that the computer codes and related-trading files that Aleynikov uploaded to a German-based website help this major financial institution generate millions of dollars in profits each year.

The platform is one of the things that gives Goldman an advantage over the competition when it comes to the rapid-fire trading of stocks and commodities. Federal authorities say the platform quickly processes rapid developments in the markets and using secret mathematical formulas, allows the firm to make highly-profitable automated trades.

The criminal case has the potential to shed light on the inner workings of an important profit centre for Goldman and other Wall Street firms. The charges also raise serious questions about the safeguards that Wall Street firms deploy to protect these costly- to-build proprietary trading systems.

The criminal case began to unfold on the evening of July 3, when Aleynikov was arrested by FBI agents at Newark Airport after returning from Chicago. Aleynikov apparently had just started work with another big firm in Chicago after leaving his previous employer in New York in early June. It appears that the financial institution allegedly victimised by Aleynikov had alerted federal authorities that its former employee might be up to no good.

On July 4, Aleynikov was processed on a 'theft of trade secrets charge' in a criminal complaint. As of Sunday morning, he was still being held at the Metropolitan Correction Center in Brooklyn.

A Goldman spokesman declined to comment on the incident. Calls to Aleynikov's home in New Jersey, which he shares with his wife, were not returned. A spokesman for the United States Attorney's Office in Manhattan did not comment.

The Federal Bureau of Investigation, in charging Aleynikov, says he began working for the major financial institution in May 2007 as a computer programmer and left in early June. That matches the description of a man named Serge Aleynikov on the social networking site LinkedIn (the difference in spelling of the first name could not be immediately explained).

Ballroom dancer

The biographical information for Aleynikov on LinkedIn says he joined Goldman in May 2007 and was vice-president for equity strategy. The bio says he was responsible for 'development of a distributed real-time co-located high-frequency trading platform'.

The case against Aleynikov may explain why the New York Stock Exchange moved quickly last week to stop reporting program stock trading for its most active firms. Goldman was often at the top of the chart - far ahead of its competitors.

It's possible Goldman had asked the NYSE to stop reporting the number after it discovered that someone may have infiltrated the proprietary computer codes it uses.

Here's the way the criminal complaint describes the Goldman trading platform: 'The Financial Institution has devoted substantial resources to developing and maintaining a computer platform that allows the Financial Institution to engage in sophisticated high-speed, and high-volume, trades on various stock and commodities markets. Among other things, the platform is capable of quickly obtaining and processing information regarding rapid developments in these markets.'

Federal authorities appear to believe Aleynikov may have had help. The German website that he is accused of uploading the stolen information to is registered to a person in London.

While the case is still unfolding, there is more information to unearth about Aleynikov. For instance, it appears that he and his wife are competitive ballroom dancers - there are videos of them on YouTube.com.

Many questions remain. Which Chicago firm hired Aleynikov? The job he took in Chicago, according to the criminal complaint, paid nearly three times more than his US$400,000 salary at Goldman.

Also there's more to learn about anyone who might have been helping him and the fallout the case may have for Goldman.

When he was arrested, Aleynikov told the FBI he 'only intended to collect 'open source' files on which he had worked, but later realised that he had obtained more files than he intended'. Quick, get this guy a good lawyer.

One question investors need to ask is whether this incident will have any impact on Goldman's second-quarter earnings.

The alleged wrongdoing by Aleynikov took place at the beginning of June - although it's not clear if it had any material impact on automated trading. -- Reuters

Matthew Goldstein is a Reuters columnist. The views expressed are his own.

New KL index makes debut in tepid market

Factors expected to drive market returns in 10-15 years

Business Times - 06 Jul 2009

By OH BOON PING

LONG-TERM trends seldom change and, therefore, sustainable structural factors will continue to drive market returns over the longer term, according to fund manager Schroder Investment Management. In particular, the fund house said that the major investment themes that should dominate in the next 10 to 15 years are social demographics, climate change and a capital investment 'super cycle'.

'It helps us to understand what will come into focus a few years later and stay ahead of the market,' said Adam Farstrup from the firm's global equities team.

In terms of social demographics, the global population is forecast to grow from the present six billion to nine billion by 2050 - 86 per cent of whom will live in emerging markets, Mr Farstrup said.

More importantly, China has an ageing population problem due to its one-child policy, while Japan's population could shrink by half in 2100 - meaning the healthcare sector provides interesting opportunities going forward.

In addition, Asian consumers now have the spending power to drive healthcare demand as wealth capital appears to be shifting away from the West to this region.

As for climate change, Schroders sees a concerted effort worldwide to develop fuel-efficient technologies, especially in Asia where economies could be hit hard by changes in weather conditions. Based on estimates, the total cost of climate change may reach some 6.7 per cent of GDP in major South-east Asian countries by the end of this century.

This is set to provide new investment opportunities, and Schroders is positive about the wind power segment, compared with other sources of clean energy, due to its lower cost of power generation. Auto companies and property developers with fuel-efficient technologies should also benefit from the 'green' movement.

Meanwhile, the strong growth seen in newly industrialising countries and the urgent need to replace ageing infrastructure in developed markets will translate into a dramatic increase in capital investments and spending. Coupled with strong population growth and urbanisation, this will benefit players in the utilities, transportation and energy space.

Substantial shareholder / Director transactions

1. Raffles Education: Chew Hua Seng bought 80,000,000 shares @ $0.38 on 2 Apr 09.
2. Raffles Education: Chew Hua Seng bought 4,000,000 shares @ $0.41 on 3 Apr 09.
3. Raffles Education: Chung Gim Lian bought 4,000,000 shares on 3 Apr 09.
4. Raffles Education: Chew Hua Seng bought 2,000,000 shares @ $0.46 on 7 May 09.
5. Raffles Education: Chew Hua Seng bought 1,000,000 shares @ $0.53 on 25 May 09.
6. Raffles Education: Chew Hua Seng bought 160,000,000 shares @ $0.64 on 18 Jun 09.
7. SPH: Tony Tan bought 50,000 shares @ $2.65 on 20 Feb 09.
8. SPH: Share Buy-back @ $4.1942 on 22 Jan 08.
9. Comfort Delgro: Chairman bought 300,000 shares @ $1.28 in June 09.
10. Comfort Delgro: Chairman bought 100,000 shares @ $1.26 on 18 Feb 09.
11. Comfort Delgro: Chairman bought 100,000 shares @ $1.29 on 17 Feb 09.
12. Comfort Delgro: Chairman bought 100,000 shares @ $1.30 on 13 Feb 09.
13. Keppel Land: CEO & MD bought 387,000 shares @ $1.77 on 24 Apr 09 (first purchase since 1994). He sold 626,000 shares @ avg of $8.10 in Nov 07 and 20,000 shares @ $2.49 in 1994.
14. K-REIT: Director bought 100,000 shares (first trade since appt in 2001) @ $0.67 on 27 Apr 09.
15. SMRT: Non-exec Chairman Choo Chiau Beng bought 100,000 shares @ $0.58 in Aug 03.
16. SMRT: Non-exec Chairman Choo Chiau Beng bought 200,000 shares @ $1.54 on 4 May 09.
17. STEng: Aberdeen Asset Mgr Ltd bought 151.5 Mil shares @ $2.39 on 26 May 09.
18. STEng: Aberdeen Asset Mgt Asia bought 28.6 Mil shares @ unspecified price on 25 May 09.
19. UOL: Share Buy-back 3,790,000 Mil shares @ $3.25 in Jun 09.
20. UOBKayHian: Chairman buys @ $1.74 on 22 Jan 08.
21. SembCorp Marine: Share Buy-back @ $3.59 between 25 Feb to 7 Mar 08.

How to avoid the dash to trash

Business Times - 20 Jun 2009

SHOW ME THE MONEY

In the current fickle market, here's a way to find stocks that are potentially good long or buying candidates

By TEH HOOI LING SENIOR CORRESPONDENT

BACK in May 2008 - it seems so long ago - James Montier of Societe Generale wrote a global strategy report titled Joining the Dark Side: Pirates, Spies and Short Sellers. He screened stocks for three characteristics: a high price-to-sales ratio; deteriorating fundamentals (as measured by a low Piotroski F-score - I'll elaborate later); and poor capital discipline (as measured by high total asset growth).

'Each of these characteristics is a telling sign - but when combined, they become even more potent,' Mr Montier wrote.

According to him, over the period 1985-2007, a portfolio of such European stocks rebalanced annually would have declined more than 6 per cent per annum in absolute terms; in comparison, the general market was rising 13 per cent per annum. The basket of stocks suffered absolute negative returns in 10 out of 22 years. It underperformed the index in 18 of the 22 years. Similar findings hold for the US, Mr Montier said.

However, in the few years leading up to 2008, this strategy totally backfired. The basket of stocks that one was supposed to short, based on the above criteria, actually outperformed the general market. 'This attests to the extreme nature of the dash to trash that we had witnessed,' said Mr Montier.

In any case, in May last year he ran the screen and saw a record number of stocks passing the criteria for the short basket. Generally, such a screen would yield 20 stocks in European markets. But when he looked, the number of stocks totalled 100. In the US, the typical average number would be 30 stocks; last year, however, it was 174. 'The opportunities are on the short, not the long side, currently,' concluded Mr Montier. 'Perhaps it is time to join the dark side.'

Events have indeed proved him right. Now that prices have corrected significantly - despite the sharp rebound in the last three months, equity prices are still some 30 per cent below the levels in May 2008 - and the economy is supposed to be on the mend, perhaps we could try to do the reverse of what he has done to see what names we come up with as potentially good long or buying candidates.

First, let's go through the criteria. The first one for Mr Montier is valuation. From a short-seller's perspective, the most useful valuation measure is price-to-sales. According to Mr Montier, high price-to-sales stocks allow investors to hone in on counters that have lost touch with reality.

Here's what Scott McNealy, then CEO of Sun Microsystems, apparently said in 2002: 'Two years ago, we were selling at 10 times revenue when we were at US$64. At 10 times revenue, to give you a 10-year payback, I have to pay you 100 per cent of revenue for 10 straight years in dividends. That assumes I can get that by my shareholders.

'That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes.

'And that assumes that with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at US$64?'

With that first criterion, I went to the Bloomberg terminal and downloaded all Singapore-listed stocks and their price-to-sales ratios. SingTel is trading at just over three times its revenue, Wilmar at 0.78 , DBS Group at 2.1 and CapitaLand at 4.6.

Singapore Airlines and Keppel Corp are both trading at less than their revenue - 0.93 and 0.84 times respectively.

The company that stands out from the rest of the big-cap stocks is Singapore Exchange (SGX). Its market capitalisation is a whopping 12.5 times its revenue. But the thing is, SGX raked in a net earnings margin of 62 per cent. So its price-to-earnings multiple is a more palatable 15 times. So for 'buy' candidates, the better measure would be price-to-earnings ratio, or my favourite, price-to-book (P/B) ratio - the lower the better. For the record, Mr Montier's short screen is for companies with price-to-sales ratios of more than one.

The second characteristic Mr Montier uses to sieve stocks to short is deteriorating fundamentals.

Here, he uses Joseph Piotroski's F-score. There are nine measures that relate to a company's profitability, the health of its balance sheet and its operating efficiency that one looks at to arrive at the F-score. The checklist is:

• positive net earnings;
• positive cash flow from operations;
• increasing return on assets (ROA);
• higher operating cash flow relative to net income;
• decreasing long-term debt as a proportion of total assets;
• increasing current ratio;
• stable or decreasing number of shares outstanding;
• increasing asset turnover; and
• increasing gross margins.

If the answer is yes for each item on the checklist, the score is one; no, and the score is zero. Companies with improving fundamentals will have higher F-scores (seven to nine), and those with deteriorating fundamentals will have low F-scores (below three).

Piotroski's strategy calls for buying a company with the requisite low P/B ratio and an F-score of eight or nine. Piotroski's research shows that low P/B stocks with high rankings are less likely to go bankrupt or to fall drastically in price than those with low rankings. This provides a greater safety margin.

Mr Montier's final criterion is capital discipline. Companies that have grown their total assets by more than a double-digit percentage will pass through his short screen.
So let's say our 'buy' criteria should be companies with price-to-sales of below 1.2 times, Piotroski F-score of more than seven and total asset growth of less than 20 per cent from a year ago.

The lone stock the screening process spits out is Singapore Petroleum Corp. Its market cap is less than half of its sales, and its Piotroski F-score is seven. And it didn't have a big asset growth in the year just ended; in fact, its asset base shrank 22 per cent. But arguably, investing in a depressed market may yield long-term rewards.

According to the Bloomberg screen, other stocks that come close to meeting the criteria (although not quite all of them) include SembCorp Marine, Keppel Corp, Cosco, Venture, SembCorp Industries, Yangzijiang, Noble Group and Thail Beverage. Readers, of course, are advised to verify for themselves if these stocks do indeed meet the criteria - and to decide if they deem the criteria sound enough, to begin with.

Build cushion against the return of inflation

Business Times - 17 Jun 2009

(NEW YORK) As the American government continues to pump money into the economy, many investors have started to worry that inflation is inevitable.

Most economists don't expect inflation to arrive anytime soon. But nobody really knows when it will appear or how corrosive its effects will be. In the meantime, financial planners are suggesting that investors make sure that their portfolios are well positioned to withstand any impact on their hard-earned money - before it's too late.

'There are a lot of people who are worried about rising deficits and the prospect of a falling dollar, and all of these things will put upward pressure on inflation,' said Alan Gayle, senior investment strategist at RidgeWorth Investments.

'We don't see inflation as a problem this year and even perhaps for 2010, but it is a factor that investors should try and incorporate in their portfolios as they go forward.'

That doesn't mean making a radical overhaul to your investment portfolio unless, of course, it wasn't well diversified to begin with - or if all of your money is sitting in cash or low-yielding Treasuries with no long-term plan. (If that's the case, you may want to seek professional advice.) What many financial planners are recommending, however, is incorporating some classic inflation hedges - some inflation-protected securities, maybe, or some commodities, while making sure your fixed-income investments have relatively short maturities.

For the short term, investment experts agree, deflation is more probable, with unemployment still climbing and the economy still mired in a recession. There's talk of 'green shoots', but most everyone agrees that an earnest recovery is a long way off.

Still, inflation can quietly sneak up on you, and at that point it will be more expensive - or less effective - to get the inflation protection you need. It's especially rough on people who live on fixed incomes, notably retirees, many of whom have already suffered painful losses in their portfolios.

'The problem is if you wait until we are actually in it,' said Chuck Roberson, a financial planner with Modera Wealth Management in Old Tappan, New Jersey, 'it will be too late or the strategies won't work as well.'

What follows are some of the most common strategies to inflation-proof your portfolio:

Review your mix

The inherent characteristics of a well-diversified portfolio - including a healthy dose of stocks - will help withstand inflation.

If, for instance, your investments are split between domestic and foreign markets, which they should be, you already have a built-in hedge against the dollar and the American economy. Some financial professionals have added a diversified basket of foreign bonds to their fixed-income allocations. Others are hopeful about a recovery in Asia, so they are adding more money to Asian-based funds (minus Japan), while some planners have slightly increased their ratio of international to domestic stock funds.

Shorten up

Several financial planners recommend shorter-term fixed-income investments or, at the least, making sure your bond investments aren't heavily tilted towards long maturities, because they are most affected by rising interest rates. (Newer bonds issued at the higher, prevailing rates make existing issues less valuable. So when interest rates rise, bond prices tend to fall. Bond funds and investors who hold securities with shorter maturities have the opportunity to reinvest at higher rates more quickly.)

'Fixed income is a disaster in inflationary times,' said Steve Podnos, a financial planner in Merritt Island, Florida, who has been keeping his clients' fixed-income money in short-term, high-quality bonds funds like the Vanguard Short-Term Bond Index Fund. 'You are giving up a couple of percentage points of income per year but inflation can do harm in terms of declining asset values.'

For clients with at least US$250,000 to invest in bonds, Gordon Bernhardt, a financial planner in McLean, Virginia, builds a bond ladder, spreading money evenly across a portfolio of bonds that mature at regular, but staggered, intervals. This enables you to replace maturing bonds with bonds that offer higher yields.

TIPS

Treasury Inflation-Protected Securities, or TIPS, guard against inflation because the principal increases with inflation (but decreases with deflation), in tandem with the Consumer Price Index.

Investors can either buy the securities directly, or purchase a TIPS mutual fund or exchange-traded fund. If you hold TIPS directly, you will receive the adjusted principal, or your original investment, whichever is greater, when the TIPS mature. Interest payments also rise or fall with the movement of prices.

While the allocation to TIPS will vary on a person's circumstances and goals, Scott Dauenhauer of Meridian Wealth Management has about 20 per cent of his clients' fixed-income allocation in TIPS.

It is best to keep TIPS and TIPS funds in tax-deferred accounts like an IRA because you'll be taxed on the amount your principal increases - even though you don't receive it until the TIPS matures.

With mutual funds, those adjustments are distributed (and taxable) to investors each year as well.

Commodities

Commodity investments tend to perform well when there's inflation because rising prices usually mean a stronger economy at home (or elsewhere in the world). That, in turn, leads to increasing demand for raw materials to meet rising production and consumer needs. Don't be tempted to make individual bets on oil or gold, planners say. Instead, buy a diversified basket of commodities that tracks a major index like the Dow Jones-UBS Commodity Index from a low-cost fund or exchange-traded fund provider.

Investors have to determine what allocations are best for them, but planners said they would invest anywhere from 3 to 10 per cent of a portfolio in commodities. Given commodities' volatility, investors need to rebalance their portfolio periodically to make sure their position doesn't balloon. These investments are also best kept in a tax-deferred account.

Real estate

Real estate can also be a good way to hedge against inflation. Real estate investment trusts (Reits), which invest and own commercial and residential properties, are an easy way to gain access. Not surprisingly, Reits, which are required to distribute most of their income (generally from rent rolls) to shareholders, have been battered in the downturn. But they have shown signs of hitting bottom, and Mr Gayle said it might be a good time to start building a position.

'But while it is an inflation hedge, it is a leveraged inflation hedge,' he added. 'Debt and access to debt influence the real estate market very significantly,' he said, 'so that should be further down the list' of inflation protectors.

Investors with a higher net worth may consider foreclosures, as long as they have done their homework. 'If inflation does come back, hard assets like real estate will start to move,' said Marc Schindler of Pivot Point Advisors. But you need to have a 5-10-year time horizon and you don't want to invest more than 25 per cent of your net worth in real estate, he added. Still, he said, 'if you are able to buy at a huge discount to market through foreclosure or other means, it will be a wise investment'. -- NYT

Learning from long experience

Business Times - 13 Jun 2009

SHOW ME THE MONEY

In the market since 1966, Trader Vic shares his expert views about market moves over the past several decades

By TEH HOOI LING, SENIOR CORRESPONDENT

IN this Internet age, youthful energy is valued much more than experience. But in many fields - and particularly fund management - I think there is no substitute for experience and the opportunity to learn human and market nature over a long period of time. That's the reason I regard most young hotshot fund managers with some scepticism, unless they have shown themselves to be really old souls.

This week I met a trader who has been in the market since 1966. And what he says makes a lot of sense. Victor Sperandeo started working on Wall Street at the tender age of 20. Asked why he chose trading as a career, he said he has always been a numbers man. When he was young he used to play cards with other teenagers in back alleys. 'We played poker once or twice a week, and I made a living - a small one - doing that. I won by studying the odds, they are easy to measure and think about. So I decided to build my career around statistics.'

When he was looking for work in The New York Times Classifieds in 1965, the three highest-paying jobs were physicist, biochemist and a trader. He opted to be a trader. And he's still at it more than 40 years later.

Mr Sperandeo - nicknamed 'Trader Vic' by Barron's in an article in 1987 - was in Singapore this week to launch the Trader Vic Index (TVI) in partnership with the Royal Bank of Scotland. The TVI is a rules-based, long/short index that comprises a diversified basket of 24 futures contracts spread across three asset classes: physical commodities, global currencies and US interest rates.

Market wisdom

Mr Sperandeo thinks there are so many things going on around the world that sound fundamental analysis is out of the question, especially in commodities. 'You can't know everything that's happening,' he says. 'All you can do is follow the trend with some reason. And sell it when it turns.

'It's very difficult to make money if you are a fundamental investor in commodities. You don't go anywhere if you don't trade commodities - they always come down.'

For example, corn was trading at US$0.80 a bushel in January 1930. Now it's at US$4.41. In almost 80 years, its compounded annual return has been only 2.1 per cent.

Here's another reason why fundamental analysis doesn't help predict commodity prices. Say an analyst has studied demand and supply of soya bean for three months and comes to the conclusion that there is going to be oversupply. He shorts soya-bean contracts. But soon after he does this, the tides in some oceans shift. As a result, the supply of, say, anchovies, which are used as feed by farmers in Japan, falls sharply. So the farmers turned to soya bean as alternative feed.

Consequently, demand for soya bean shoots up. 'Nobody knows why the tides shift,' says Mr Sperandeo. 'They just do. So this guy is sitting on his short position, and has no idea why he is losing money despite his three months of research telling him the price of soya bean should come down.'

Moving averages

Different commodities have their own price cycles. So traders who want to identify a trend should look at different moving averages. Too short (a moving average period used), you get whipsawed. Too long, you can't make money, says Trader Vic.

For example, precious metals are very volatile. People trade gold using a lot of leverage. That causes violent price movements in the short term. The moving average one should use for precious metals is 12 months, says Mr Sperandeo.

For crude oil, he uses the six-month moving average. For grain, he looks at the four-month moving average to coincide with planting seasons. And for Treasury notes he uses the 10-month moving average. 'Once the government starts to tighten or loosen the monetary environment, they don't change course so soon,' he says.

Also, different moving averages are used for different currencies. They range from four to 12 months. For stock markets, 200-day moving averages are used. And all moving averages are exponentially weighted, which means more recent data has a bigger influence on the calculated average. A price that rises above an upward sloping moving average line is on an upward trend, and one that falls below is on a down trend.

Trader Vic sees a lot of similarities between the current equity market and that in 1938. Between March 1937 and March 1938, the Dow Jones Industrial Index fell about 50 per cent. The legacy of the Great Depression, war fear and Wall Street scandals contributed to the crash. That period of decline was remarkably similar to the stock-market crash in the fall of 2008, says Trader Vic. Back in the 1930s the market bottomed around April 1938, then staged a 60 per cent rally in about three months. It consolidated for another three months before a spurt towards the end of the year sent the index up a further 15 per cent.

In 1939, there was a correction in January, followed by a rebound. Then in the second half of March, there was a steep descent that took the index down 20 per cent in a month.

Mr Sperandeo thinks the path of stock markets today will resemble that of 1937-1939. 'We are going through a consolidation phase now, and heading towards the good news of GDP not contracting as drastically as the last quarter of 2008, so there's likely to be a rally towards the end of this year,' he says. But by next year, if no new stimulus package is introduced, the rally is unlikely to sustain and stock markets will plunge. Still, prices won't revisit the lows of the previous 18 months.

Although a year-end rally is expected, Trader Vic says he won't buy equities now. 'Rallies are like humans. Only 5 per cent of rallies go up 40 per cent without a correction. Getting into the market now is like buying an 80-year-old man. Yes, he can live to 85. But if you buy a 21-year-old, you have better insurance.' Trader Vic will buy the Hong Kong and Singapore markets if there is a 10 per cent correction.

In the current environment, he reckons gold is the best investment in the next one to three years. 'I don't know any scenario that can make it go down,' he says. 'It's going in one direction that's consistent in the long run.' He is also a big bull on other commodities.

There are known and unknown risks for stocks, he says. For example, Israel may attack Iran at any time. The current Israeli Prime Minister, Benjamin Netanyahu, is very aggressive. 'So what I do is, I long crude oil contracts every Friday and close the trades on Monday. The last time Israel attacked Iran was on a Saturday. If they ever attack, crude oil will double overnight.'

Then there are Pakistan and North Korea. 'Markets don't discount wars. There's no self-interest for fund managers to sell in anticipation of a war,' says Mr Sperandeo. 'If they did, and the war didn't happen, they would underperform their peers. But if they didn't, and the war erupted, everyone's portfolio would be hit. He would be no worse off.'

By following trends, the TVI has chalked up some pretty impressive returns in close to 20 years. Between July 1990 and May 2009, the annualised return was 13 per cent, with a maximum annual decline of 10.6 per cent. This compared with MSCI World equities index's 5.1 per cent annual return and its maximum drawdown of -54 per cent. On a rolling 12-month basis, the TVI made money 98.1 per cent of the time.

The world after the current crisis will be one in which companies make less money and enjoy slower growth because of de-leveraging. In this kind of environment, the smart thing to do is 'not to be an investor but be a trader, as the US will not repeat its stock-market performance of the mid-1990s for some time', says Mr Sperandeo.