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Virtually everything that’s being said in the media re the global economic picture is either untrue or irrelevant when it comes to growing or protecting your wealth.  Therefore, as almost always, you can feel very safe ignoring it.  We will continue to monitor the important things but rarely has the path ahead been more clear and promising.  The next few years will undoubtedly be very good.  In the meantime, the real rules of wealth still apply.
Whilst I had promised last month to look at the Truth behind the Aussie sharemarket’s apparent out-performance for the decade 2000-2010, I’ve decided to push this back in the wake of continuing and increasing media hype over European Debt and, more recently the US debt ceiling.

Given the relative potential complexity of this topic and the different levels of detail our clients appreciate, I’ve chopped this into a couple of sections.  That way no matter what your desire for detail you will hopefully be well satisfied without having to wade through unnecessary graphs and text.  As always, if you find you’d like more information please comment below.

The Short Version

The problem with News is it doesn’t stay new.  Therefore if you’re selling news (or using news to sell advertising) then you have to keep coming up with “new” news.  When you combine this problem with competition (within and across mediums, e.g. TV, papers, internet etc), you have a major struggle just to be heard.  Therefore those who sell “news” need to make sure their news is more “appealing” than their competitors.  This means just reporting the facts is no longer an option[1].

Virtually everything that’s being said in the media re the global economic picture is either untrue or irrelevant when it comes to growing or protecting your wealth.  Therefore, as almost always, you can feel very safe ignoring it.  We will continue to monitor the important things but rarely has the path ahead been more clear and promising.  The next few years will undoubtedly be very good.  In the meantime, the real rules of wealth still apply – focus on your real balance sheet and things you can control and influence.  Ignore the seductive but irrelevant distractions of “Portfolio Value” and “Economic data”.

If you‘d like to hear someone smarter than me explain this is relatively simple terms, check out Magellan’s CEO Hamish Douglass on Inside Business. Inside Business Interview – Sunday, 24th July 2011.  Hamish is one of the most cautious investment managers I’ve ever met[2] so when he’s fairly relaxed, I sleep like a baby.  Similarly the idea that that US debt is passing some magical level against GDP actually matters is well covered by Robert Shiller here: http://www.project-syndicate.org/commentary/shiller78/English

After all what really matters is company earnings growth and the outlook is very good indeed with almost unprecedented levels of cash and record low debt around the world.  It’s earnings growth NOT economic growth that drives returns, contrary to what most “market economists” or other “financial experts” try to suggest.  Economic (GDP) growth in fact has no correlation to investment returns (see graphs below).

Whilst portfolio value seems like an important measure, it’s really only an outcome of other measures which in the short-term aren’t that relevant and beyond your control.

For more detail see the following sections in this month’s 20c which you will receive in the next few days:

  •  “Nothing to Worry About” – In more detail – A look at what actually investment drives returns
  • “You lose on the way up, not on the way down” –A graphical and mathematical look at why sitting on the sidelines is so dangerous and what it can really cost you.  This also includes a look the Dalbar study which for the last 17 years has compared the actual returns of investors in the US compared with the market return.
  • “Why do you think what you think?” – What are our real sources of information and do we listen mostly to the most accurate source or the most vocal?

So What’s going on?

Whilst I covered the US in May’s article “The US Truth– Economic Basket Case or Media Beat Up?”, I appreciate that May was a little while ago and the relentless media focus has perhaps got some people a little more worried.

What’s Changed Since May?

Well actually a fair bit.  Greece is still broke but as of last week the various stakeholders began to outline who pays for the mess the Greeks got into.  Until now, all that had happened in Europe is the problem had been postponed.  Two things had to happen for the European situation to move on. Firstly the Greeks (and others) had to get serious about balancing their budgets so the problem isn’t likely to reoccur (at least in the short-term).

Secondly the existing debt needed to be “restructured” ie some actual default needs to be recorded in some way so that the amount owing has some hope of being repaid.  In reality, there no point doing this until the various governments balance their budgets and the problem stops getting worse. No point writing off some debt now only to have to revisit in another 12 months.

With last week’s announcements we’ve now got some detail on how this might occur, essentially a “bond swap” to occur.  Without going into the detail, this is simply a “selective default” which means the process can occur in a more orderly fashion without major disruption to credit markets or any country’s solvency.

Rest assured the media message would not change until these two things happen.  The fact is we have known this for over 12 months now so whilst the detail is finally emerging, the actual outcome is ultimately somewhat irrelevant for those not invested in European Bonds.

But what if they don’t fix it?

Anything’s possible but let’s consider the balance of probability and most importantly, the motivations of the main players.  Governments, regulators and Central Banks – one way or another these are essentially elected positions and therefore retaining your job (and perhaps more importantly power) is based on the ability to remain popular.  Whilst I may be quick to blast elected officials for their poll driven decisions, the fact remains that if you’re not in charge you have no power.  Therefore when it comes down to it, there’s nothing to be gained in letting otherwise manageable problems get out of hand.

This doesn’t mean however you should lie down or just “take one for the team”. No Public Official wants to be seen to be putting taxpayers on the hook at the expense of those who simply lent money they shouldn’t have.  Faced with the choice though (as they ultimately will), these Public Officials will do what’s needed because otherwise their careers are over.  In any battle or negotiation, I always back self-interest.

Therefore we remain alert to the goings on in Europe, but I’m sleeping very well and the messages currently being blasted by the media whilst not technically untrue, are more the stuff of Dan Brown novels than reality.  The announcements last week are the predictable first signs of this beginning.

But what about the US – what if they default?

In short, for the same reasons outlined above, they won’t.  If the doomsday scenario were to occur just because Congress neglected to pass a bill increasing their credit card, what do you think the public reaction would be?  Come November 2013 anyone who was complicit in this would be out of a job.  Given how hard they fight to get and keep these jobs and the money they spend doing so, is it really likely they would throw it all away on this relatively minor issue?  Again I back self interest.

The only reason they haven’t acted to already is political opportunism.  It is nothing more than a game of chicken in which both sides want to be seen to give the least amount of ground.  Given their relative positions they will find a deal they can both sell as a win and the media will move on.  When it comes to changing their mind rapidly and violently, politicians are more than capable – just think Julia’s Carbon Tax or John Howard’s GST promise.  They can and they will.

As to how they get back on track from here that was outlined in May’s article so I won’t repeat it here, suffice to say it isn’t actually that hard.  Given the US unemployment rate there also remains significant upside for their economy before problems are likely to occur.  Our own Reserve Bank would love to have that much “capacity”.

[1] For a great piece on just how fear can be used to distort our perspective, see the shark attacks section in Superfreakonomics by Steven Levitt and Stephen Dubner
[2] A very active manager not afraid to react to protect capital, last year Hamish’s fund increased cash holdings to 30% and he famously sold out of US financials weeks before the GFC.
Matt Battye

Matt Battye

CEO, Financial Adviser

Analysing what can seem to be like complex issues, Matt is effective in using analogies to better explain scenarios and truths to the rest of us. This is what Matt enjoys – educating clients on the truths and debunking the commonly held (wrong) view.

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