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    Seed Weekly - The Year That Was

    As we approach the end of 2013, it has proven to be a very good year for investors around the world.

    This was, however, not necessarily apparent at the start of the year, especially if one considered the prevailing news headlines of the day. We have looked back at some of the major financial news items through the year.

    Towards the end of 2012, the global financial markets were fixated with the so called Fiscal Cliff. This was the end of previously enacted US tax laws, which ended in December 2012 and would have had an estimated $ 600bn impact on the US economy. A last minute resolution was passed that saw some modification of benefits. The US Senate passes the American Taxpayer Relief Act of 2012 as partial resolution to avert the ‘fiscal cliff’.

    In January the newly elected Japanese Prime Minister, Shinzo Abe, announced a campaign of additional fiscal stimulus. This followed two decades of lacklustre growth and deflation since the early 1990’s. The mere announcement of the large step up in new monetary creation had the desired effect of weakening the yen against other currencies and boosting share prices on the Japanese stock market.

    In February there was focus again on US budget cuts from March, known as budget sequestration and the possible impact on the economy.

    In March it was noted that the both the announcement and the tone from the US Federal Reserve kept the expansionary monetary policy in place with the target federal funds rate at 0.25% and the open ended $ 85bn per month asset purchase program.

    Also in March, at the opening of the National People’s Congress, Chinese Premier, Wen Jiabao, announced that the government had set a new target growth rate of 7.5% per annum. This was the most conservative growth rate from this country since 2004. However, even at this level China continues to grow and for the 3rd quarter announced annual GDP growth of 7.8%.

    Quarter 1 saw GDP in the US rise to 2.8% annualised, led by consumer spending. At the same time the economic growth outlook for Eurozone countries remained very weak. This level of growth has remained in place for quarter 3.

    In May, the European Central Bank reduced its main policy rate by 0.25% and said that it was committed to keep policy accommodative “for as long as needed”, while the US Federal Reserve hinted in its minutes that tapering of its enormous asset purchases (read printing to buy its own bonds), may start to commence mid 2013. This had an immediate negative impact on global markets as the US 10 year bond yield moved up from around 1.95% to 2.97% in September.

    As a consequence of the “tapering talk”, June saw the start of global currencies declining relative to the US dollar. The “risker” currencies were hardest hit, including the rand, but all emerging market currencies and also members of the G10 like the Australian dollar, Norwegian Krone, Swedish Krona and Canadian dollar, fell relative to the US dollar.

    The US treasury reached their ceiling on borrowings in September, and following disagreement as to the terms of raising the debt limit, the US Government went into a partial shutdown on 1 October. An act was passed on 16 October agreeing to fund the government to mid-January 2014 and suspending the debt ceiling to 7 February 2014. Ultimately the problem is merely postponed.

    Against this backdrop of mixed economic news, the stock markets have been on a tear in 2013. So far as we near the end of November, the Dow is up 22.6%, the S&P500 up 26% - both at new highs - and the technology laden Nasdaq up 32%.

    The MSCI World Index is up 21.3%, while the Nikkei 225 index is up 49% in yen terms and 27% in US dollar terms. This follows 2012, where unprecedented central bank monetary stimulus saw the biggest rise in prices of global shares since 2009. In 2012 the MSCI All Country World index rose by 16.9%.

    Above is the chart of the MSCI World Index. While no one knows exactly where global equity markets will end in 2014, what we do know is that a preponderance of negative news is no hindrance for prices.

    Kind regards,

    Ian de Lange

    021 914 4966

    Permalink2013-11-26, 16:15:23, by Mike Email , Leave a comment

    Seed Weekly - Equity Market Returns

    One of the main tools used at Seed to determine whether the local equity market is expensive or not is the ALSI’s historical PE ratio. We have seen that, over time, a low starting PE ratio has typically resulted in excellent returns to investors over a 5 year period, while a high starting PE has typically resulted in relatively poor 5 year returns.

    Chart 1 below demonstrates this relationship, with each blue dot indicating a starting PE level and subsequent 5 year return (annualised). From this chart one can see the relationship between starting PE and subsequent return and that the market is currently extremely expensive.

    Chart 1: Starting ALSI PE v Subsequent 5 Year Return

    The logical (often rhetorical) question that we get asked after showing this information to clients or other investment professionals is, “I guess that means that you expect a significant market correction sooner rather than later?”

    Intuitively we’d typically agree with this statement, but we delved a little deeper into what’s happened in the past in expensive markets (i.e. when the starting PE of the ALSI was above 17). It was interesting to note that on a 12 month horizon, investors had a similar chance of losing capital when the market was expensive (i.e. PE above 17) as across all market conditions (all observations). Chart 2 below indicates this phenomenon.

    Chart 2: 12 Month ALSI Returns – Various Criteria

    This analysis indicates that investors into local equity should expect negative 12 month returns approximately 1 in every 5 years if they don’t take heed of starting valuations. When the market is expensive (PE above 17), this ratio is similar. What is interesting is that when markets are expensive, the probability of good returns (i.e. in excess of 20% pa) falls right down to approximately 10%, compared to a 50% probability over all periods in the analysis (322 observations).

    Chart 2 also indicates the power of investing when the market is cheap (i.e. PE below 10). In these periods investors have received a 12 month return below 10% less than 10% of the time compared to returns in excess of 20% (over 12 months) in 80% of the observed periods.

    From this (admittedly simple) analysis we can conclude that while we don’t think there’s a heightened chance of a market crash when compared to history, investors should brace themselves for the high probability of sub optimal returns over the next 12 months. Investors should also be aware that should there be a fall in markets, it is highly likely that it will be larger than a typical correction.

    As a result of this, and other, analysis the asset allocation Funds that Seed manages (namely Seed Flexible Fund and Seed Absolute Return Fund) are currently conservatively positioned, using local equity as a measure, compared to historical and strategic weightings.

    Take care,

    Mike Browne

    021 914 4966

    Permalink2013-11-19, 09:58:41, by Mike Email , Leave a comment

    Seed Weekly - Value Investing the Buffett Way: 1987 – 1991

    This is the third part in a series looking at Berkshire Hathaway’s annual reports. In it, Warren Buffett continues to demonstrate his simplistic approach of looking at Berkshire’s investment portfolio. Although asserting that the market is less attractive than the previous two decades, Berkshire’s managers have produced extraordinary results by doing rather ordinary things - but doing them exceptionally well.

    The best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago. Most sell non-sexy products or services in much the same manner as they did ten years ago (albeit in larger quantities, or at higher prices, or both). They may be making the most of an already strong business franchise, or concentrating on a single winning business theme.

    Mr Buffett approaches a purchase as if it’s a private business. He advises that when investing, one should view oneself as a business analyst (and not solely as a market, macroeconomic, or security analyst). He looks for outstanding businesses at a sensible price rather than mediocre businesses at a bargain price. Buffett concentrates his investments in a few companies that are understood well. He does not have in mind any time or price for sale, instead he’s willing to hold a company indefinitely, granted that he expects the business to increase in intrinsic value at a satisfactory rate. He mentions that a stock is not necessarily an intelligent purchase purely because it is unpopular – i.e. being contrarian for the sake of it.

    Mr Buffett states that declining share prices benefit investors, and rising prices hurt investors. “The most common cause of low prices is pessimism - sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer.” One should always be well positioned for prospective investments. “If you want to shoot rare, fast-moving elephants, you should always carry a loaded gun.” During 1989 Mr Buffett increased his holdings in Coca Cola.

    Mr Buffett is not weary of missing out on some company that depends upon an esoteric invention (Xerox), high-technology (Apple), or brilliant merchandising (Wal-Mart). Exotic sounding businesses that hold out the promise of feverish change generally trade at the highest PE ratios. That prospect lets investors fantasise about future profitability rather than facing today's business realities. Mr Buffett notes that, “We will never develop the competence to spot such businesses early. Instead I refer to business situations that Charlie and I can understand and that seem clearly attractive - but in which we nevertheless end up sucking our thumbs rather than buying.”

    A significant portion of Berkshires earnings were given to charity. During November 1988, Berkshire’s shares listed on the New York Stock Exchange. Mr Buffett’s wish was to attract long-term owners who, at the time of purchase, had no timetable or price target for sale but plan instead to stay with Berkshire indefinitely. Long term investors have been handsomely rewarded.

    Kind regards,

    Lourens Rabé

    021 914 4966

    Permalink2013-11-12, 10:29:48, by Mike Email , Leave a comment

    Seed Weekly - The Cash Safety Trap

    The move from defined benefit funds to defined contribution funds and the subsequent transfer of pre and post retirement investment risk to the retiree, has created some very interesting scenarios for retirement funds members both approaching retirement and in their post retirement phase.

    I have seen a number of “life stage” retirement portfolios which change the investment risk as a member nears retirement. Whilst the rationale is sound to a degree, those members who are planning to use investment linked living annuities rather than purchasing a guaranteed annuity need to be very careful of moving their entire investment amount to cash a couple of years before retirement. The reason why this happens is that it is assumed that people nearing retirement should not be exposed to capital volatility. Whilst this may be true for people purchasing a guaranteed annuity from an insurance company, this rationale ignores the fact that members transferring to a living annuity often have a thirty year plus time horizon for their investment. A recent presentation by Prescient graphically illustrated this example.

    In this example we had a fund member (Mr Cash) who transferred all of his assets into cash three years before retiring in June 2008. Anybody who has had any exposure to equity markets will realize that our poor member’s retirement date was just before the biggest market crash in many years. The graph above also shows an example of a member (Mr Balanced) who stayed in a generic balanced fund (which can have exposure of up to 75% in equities) this is totally contrary to conventional wisdom on retirement funds. Our two members left their investment portfolios as is when transferring to a living annuity.

    At retirement date Mr Balanced, who had invested in the generic balanced fund, had approximately R 600 000 more capital than Mr Cash and was feeling very smug. A month or so later he was feeling suicidal and Mr Cash felt that he had made the correct decision. Unfortunately, what normally would happen now is that Mr Balanced would say he cannot afford to stay in the balanced fund because “we are going to have a double dip” and he is going to lose all the money that he had saved for his retirement, he wants to switch into cash to be like Mr Cash (safe and steady). If he listened to his financial advisor (we will assume that he wasn’t feeling suicidal as well) and stayed in his balanced portfolio, three years later he would be substantially better off than Mr Cash.

    The problem with long term cash investments, is that whilst you do not see much capital volatility, you are almost guaranteed to lose money in real terms in the long run. The graph illustrates that using absolute return or more flexible balanced funds will reduce this volatility but illustrates the point graphically that if you are going to be using an investment linked living annuity you can’t afford to be in cash type portfolios either before retirement or after retirement.

    Kind regards,

    Barry Hugo

    021 914 4966

    Permalink2013-11-05, 10:08:39, by Mike Email , Leave a comment