Gavin's Blog

We started the year with five big investment banks. Bear Stearns, Goldman Sachs, Merrill Lynch, Lehman Brothers and Morgan Stanley. Bear fell earlier this year. Now Merrill and Lehman have disappeared in a weekend. Only Goldman and Morgan remain.

How will the market react later today? Dow futures are off by 300 points, the dollar is weakening against the euro and we could be in for a world of hurt throughout the week.

Disclosure: At the time of writing I was long euro v dollar.

The Sunday Tribune had a rather odd article today about commodity ETFs. Eddie Lennon seems to get his facts wrong, or at least misses the point with regard to the advantages ETFs provide:

ETFs are bought and sold on the stock market just like shares. They offer an easy, inexpensive entry to the markets and can be bought through a stockbroker for a standard brokerage fee or from an investment company, preferably for a flat fee. The minimum investment is usually €5,000, but can be as much as €20,000.

ETFs are listed on the stock market like ordinary shares. You can buy and sell them like you do with ordinary shares. They are also priced like ordinary shares. So where does this minimum investment of €5,000 come from? And a maximum? It makes no sense. (Though I guess he may be directing the article at the pensions market specifically) He goes on:

They can also be bought from the likes of Eagle Star, Irish Life, Canada Life and Rabodirect, which have their own commodity-linked investment funds. These companies buy commodities indices on the world’s stock markets.

Eagle Star’s Global Commodities Fund was the top Irish performer in this area over the past year, until last Wednesday. It rose in value by an impressive 48.16%. Next was Irish Life’s Commodities Index Fund, which grew by 20.19% over the same period, followed by Rabodirect’s BlackRock World Gold Fund (up 18.61%), Rabodirect’s BlackRock World Mining Fund (up 12.48%), Canada Life’s Quadrivium Fund (down 12.37%) and Rabodirect’s JPM Global Natural Resources Fund (down 16.79%).

Ah. Now I see. Let’s take the Eagle Star Global Commodities Fund as an example. According to the information in the prior piece, there is a minimum investment level of €5k. But that’s only if you go through one of this firms who are simply reselling ETFs. The one mentioned actually just tracks this. Which traded at $67.80 a share on Friday.

Why would I go through Eagle Star when I can just buy the ETF myself on the market? I could buy one share for $67.80, that’s the real minimum investment level. And the maximum? Well I guess I could theoretically buy all the ETF shares, but that would cost quite a bit of money. Or better yet I could dollar cost average my investment in ETFs, and buy at regular intervals. See here.

Strangely, expense ratios are nowhere mentioned. It is one of the biggest factors for anyone buying ETFs. Vanguard offer some of the lowest.

The Fool has a good roundup on the difference between mutual funds and ETFs.

I suspect all of these firms are simply reselling ETF products and taking a cut for themselves. If you want commodities exposure you would be better advised to avoid all of these firms. Technically the least you can invest is one share, not €5,000.

Just open a cheap online broker account with Firstrade or Zecco and do the buying yourself for next to nothing.

And no matter what you do, either doing it yourself or through one of these firms, you will be dollar exposed since the ETFs are listed on US markets.

The US government is to step in and help out Freddie and Frannie. I guess it was bound to happen after the events of recent weeks, there was really no way to get let these mortgage lenders go under, in IndyMac Bank fashion.

Fannie Mae and Freddie Mac shares plummeted again today as concern mounted that the US government will be forced to take over the beleaguered mortgage finance companies, which some investors fear are at risk of default.

The markets opened two hours ago, and the Dow has already fallen below 11,000. We are now back at 2005 levels.

Educational.

Barbara Dafoe Whitehead has a nice roundup of the US debt mess in the current issue of the American Interest. She has some startling statistics too:

Between 1989 and 2001, credit card debt almost tripled, from $238 billion to $692 billion. By fall of 2007, the amount of revolving consumer credit had reached $937.5 billion, a 7 percent increase over the previous year.

Another interesting statistic is the proportion of lower income people who play state lotteries. Households earning less than $12,400 a year spend $645 a year on the lottery. By comparison, households earning $62k-$124k a year spend $373 a year – proportionately far less.

Interestingly she suggests four pro-thrift ideas. Thrift is, I think, a word almost unknown to Irish people. The concept of thrift has also been lost in the Celtic Tiger malaise. It is worth quoting these four ideas:

Re-establish a public education campaign. During World War II, Americans saved at extraordinarily high rates—about 25 percent on average. This impressive display of thrift and sacrifice was driven primarily by the war, but it also had a more proximate source: The U.S. government, collaborating with civil society leaders, actively stressed the importance of saving for the war effort while also providing a specific new savings tool in the form of war bonds. Perhaps the time is right to re-establish a pro-thrift public education campaign. Similar campaigns to reduce drunk driving and smoking and to encourage seat belt use appear to have had a demonstrable impact on people’s behavior in recent years. Why not thrift?

Challenge “consumer spending” as a main solution to economic problems. Whether it is a national security crisis like 9/11 or worrisome economic news, our leaders in recent years seem increasingly determined to insist on the catchall economic salve of prodigious consumer spending. Hence, for example, the 2008 tax rebate legislation. But this is, at best, partial and misleading advice in a society marked by dangerously high levels of debt and dangerously low levels of saving. Perhaps it is time to balance the message of more spending with a message of more saving and wealth building.

Create a thrift savings plan available to all Americans. Since 1986, the U.S. government’s Thrift Savings Plan (TSP) has permitted Federal employees to build wealth and save for retirement by systematically placing a portion of their earnings into diversified stock-and-bond index funds. These funds are managed by an independent board, with oversight from the public and private sectors. The expense ratios on TSP funds are low (0.06 percent), making them cheaper than similar commercially run funds. Currently, the TSP boasts 3.7 million participants, manages assets of approximately $225 billion, and is widely viewed across the political spectrum as a major success. Federal policymakers and others should consider offering this same wealth-building opportunity to all working Americans.

Build new thrift institutions. New, community-based thrift institutions can stand as attractive alternatives to payday lenders and other anti-thrift institutions. If we are serious about confronting the debt culture, building these new institutions is our most urgent task. They must possess three core traits: Functionally, they must provide opportunities and incentives to save and offer credit at affordable costs for prudent purposes; structurally, they must be broadly democratic and organized as not-for-profit cooperative or mutual organizations; geographically, they must be accessible to low-income Americans.

Re-purpose the lottery. State lotteries are the most egregiously anti-thrift state-run institutions in America. Because lotteries typically enjoy broad support by politicians and the public, it would be hard, if not impossible, to outlaw these operations at present. But it is possible to re-purpose the lottery, at least in part, as a thrift-promoting institution. In every state lottery outlet in the United States, a customer should be able to purchase “savings” tickets as well as lottery tickets. In this way, a comprehensive public apparatus devoted to encouraging everyone to become a bettor would simultaneously become an apparatus devoted to encouraging everyone to become a saver. It ought to be an easy sell: “Every ticket wins!” because, in fact, every single savings ticket would improve the financial well-being of the purchaser.

Incidentally, are there any statistics about our National Lottery? Besides the fact that most of the charity money goes to the constituency of the then Minister for Sport?

Barry Ritholtz poses the question. It’s a good one.

What is the magic about 20%?

What makes this the “official” onset of a bear market? There isn’t any NBER-like group that declares an “official” bear market.

Best as I can figure, the 20% number is a not-quite-a-random number — more than a 10% correction, less than a full blown crash (which for all we know, could be “offically” 30%).

I have no idea who first started bandying about these nice round base ten numbers — but for whatever reason, they seem to have stuck in the public and the press’ imaginations. (Anyone have a better idea where these two figures came from?)

Forget the rather squishy terminology, and consider the following economic, fundamental and technical questions:

• Is the Economy expanding or contracting? Have recent data points been improving or worsening?

• Are corporate earnings getting stronger or weaker? Where are we in the earnings cycle?

• Are stock prices generally rising or falling?

• Are market advances narrow or broad? Is the volume expanding on up days, or on down days?

• Is investor Psychology greedy or fearful?

Rather than focus on terminology, investors should be considering their risk management strategies, what they are doing to preserve capital, and how they are psychologically prepared to deal with what could be an extended downturn.

That matters a whole lot more than whether something is called a bull or bear market…

Wise words indeed.

Ryanair chief executive Michael O’Leary. Um nothing more to add.

For the past several weeks I have been in correspondence with the Revenue in relation to their treatment of various investment instruments. I was particularly interested in more exotic ones like Exchange Traded Notes (ETNs) Futures Contracts, Options Contracts, CFDs and Spreadbetting.

Perhaps the most surprising result of my questions was that Revenue don’t know how to tax ETNs. They said:

Revenue haven’t encountered these products to date so therefore we haven’t expressed an opinion on their tax treatment.

I don’t know which is more surprising, that they haven’t encountered ETNs or that they have not expressed an opinion on their tax treatment. In the US, ETNs are treated for tax purposes as prepaid forward contracts.

For those who don’t know, here is a good general background to ETNs.

I suppose my next question to Revenue would be, if I profit from buying an ETN like the iPath Dow Jones-AIG Commodity Index Total Return ETN, am I liable to any tax whatsoever?

In relation to Futures contracts the position is more clear:

Future contracts, within the meaning of section 607 (of the Consolidated Tax Act), are not chargeable assets. Accordingly capital gains are not chargeable and capital losses are not allowable. Gains on the disposal of future contracts and traded options, within the meaning of section 608 and which are regarded as investments for the purpose of that section, are not chargeable to CGT. Capital gains & losses on the disposal of future contracts and quoted options, other than in the above scenarios, are chargeable in the normal manner.

Similarly, gains and losses which occur in the course of a financial trade are taxable under income tax rules.

In the case of a futures contract dealt in or quoted on a stock exchange or futures exchange, the requirement that the security be delivered will be met if the person by whom the contract is made closes out the contract by
entering into a reciprocal and opposite contract on the exchange and settles through the exchange on a net payment or receipt basis.

In relation to options contracts:

Gains or losses on options contracts arising in the course of a trade are taxable as income.

I take this to mean that if I buy or sell an options contract before options expiry, the gain is classed as income as oppose to a capital gain.

CFDs are liable to CGT, Spreadbetting is not liable, although there could be an income liability if it becomes your primary source of income.

I did a small piece for today’s Irish Examiner on the Motley Fool’s visit to Dublin at the weekend. What a cool bunch of guys.

I think it’s page 17.