This recent rally in world markets have taken respective stock markets to new highs. However, the trajectory of the climb is indeed worrying. RSI is entering overbought territory on the Weekly SP500 charts. ADX is cutting the +DI soon. In my opinion we should be anticipating a correction for the first quarter of next year. Happy holidays to all.
Found this somewhere, nice to see for a while but after that you realise the sad fact of life.
By George Friedman
In an action aimed at ending more than a year of political instability, the Thai military staged a coup Sept. 19, stripping then-Prime Minister Thaksin Shinawatra of his office. Unlike in most countries, coups in Thailand — though relatively common — are not particularly disruptive. In fact, they tend to function as safety valves whenever the civilian government begins to break down. As such, while most observers — including Washington and Wall Street — watched with a wary eye, they withheld judgment and indulged in calming platitudes that Bangkok should soon get back to whatever Thais consider “normal.” No firms were nationalized, no opposition (or former government) officials were shot, and life more or less went on.
In fact, outsiders’ votes of confidence in the Thai system were so firm that investors — after a few-week retreat — came back in droves as technocrat after technocrat was appointed to positions of economic importance. The Bank of Thailand (BoT), the country’s central bank, estimates the net investment inflows in November were steady at $300 million — a respectable level for a country of Thailand’s size. By December, however, the inflows had reached $950 million, a level far above Thailand’s ability to handle safely.
The Thai government feared that such inflows were “hot money,” cash placed by investors looking to make a quick buck by betting on short-term changes in stocks, bonds or other investments. Of late such hot money has been particularly active because of the falling dollar. If a foreigner uses U.S. dollars to invest in a Thai asset that increases by 10 percent, and then the Thai baht increases versus the U.S. dollar by 10 percent (as the baht has done since mid-October), then the net gain is more than 20 percent in a very short period of time.
Of course that gain is only realized if the money is pulled out of Thailand as fast as it was put in. Neoliberal economists claim that allowing such strategies room to function encourages the most efficient use of capital, and in the long run vastly benefits countries by giving them both more access to capital and experience in dealing with foreign financing. Those on the receiving end of such capital inflows and outflows complain of the volatility caused by such flows, as well as the artificially inflated currencies that they cause, reducing the competitiveness of a country’s exports. Both are right. Thailand’s until-now commitment to weathering such flows has made it among Asia’s healthiest, most dynamic and flexible economies — and its currency is at a nine-year high.
In order to reduce Thailand’s vulnerability to what Bangkok feared would be an eventual outsurge of capital, it sought to crimp the insurge.
So on Dec. 19 the Thai Finance Ministry announced the implementation of a “lock-up” program to limit capital flows into the Thai economy. Under the program, 30 percent of all investment dollars would be forcibly deposited into a non-interest-bearing account with the BoT, with the investor free to invest the 70 percent at his or her whim. Should the investor withdraw the funds before one year has passed, the BoT would refund only two-thirds of the money in the lock-in account. In essence, investors would be denied access to three-tenths of their monies and be subject to a new 10 percent tax should their investments prove short in duration. Officials further added that should this policy not achieve their goal of slowing inward hot money flows, they would not hesitate to take more “aggressive” action.
Investors immediately panicked.
The Thai stock market plunged at opening by 10 percent, which triggered a trading suspension. The decline renewed once trading reopened half an hour later with the exchange ending 15 percent down for the day, its largest single-day drop ever. The government quickly amended the policy after market closing so that it now applies only to bonds.
On the upside, the Thais have most certainly gotten their point across and only the bravest (or most stupid) of daredevil traders are now going to be seeking to play the market in the way they were before Dec. 19. One goal of the policy — weakening the baht — has also been achieved (albeit perhaps a touch too well).
The downside is clearly a bit more comprehensive. Thailand has severely damaged its reputation for being a well-run economy that shies away from investor-unfriendly actions, and in two ways. First and most obvious, even during the depths of the 1997-1998 financial crisis, Thailand never adopted a policy as restrictive as this.
Second, the policy was not just restrictive, it was ham-handed.
It is not so much that investors do not like to be told what to do with their money, but that this policy was not particularly well thought out. During the financial crisis, a number of states adopted a number of policies in attempts to cope. The most successful by far was in Malaysia, which pegged its currency to the dollar and enacted strict capital controls that prevent speculators from removing their gains until a great deal of time had passed. That offended market purists, but completely squeezed all but long-term investors out of the market.
On Dec. 19 Thailand went about it backward. Instead of restricting capital outflows, it hijacked capital inflows. Put another way, not only did it adopt a policy designed to spook a certain class of investor (speculators), it did not do it in a way that would prevent others from running. So sure, the Thais achieved their goal, but exposed themselves to a great deal of unnecessary collateral damage in the process.
That has created a double hit to market confidence in the Thai authorities, injecting immense doubt into the heretofore dominant belief that recently elevated technocrats such as Finance Minister and former BoT Governor Pridiyathorn Devakula and current BoT Governor Tarisa Watanagase have some clue as to what they were doing.
What these two policymakers do next is of critical importance. If much-needed unified statements of explanatory calm flow forth from Bangkok before and during the opening of trading Dec. 20, then the lock-in policy probably will be filed away in Thailand’s “never-do-this-again” file, the lesson will be learned, investors will mellow and life will go on.
If tomorrow’s news is silence — or, worse, confusion — then Thailand has two issues to deal with.
First, the world will find out just how much Thailand has grown since its problems in 1997, because eight years of progress would be up for grabs. It is true that Thailand has come a long way since then. Its economy has doubled, the problem is now currency strength and not currency weakness, and the financial system that contributed to the crisis’ severity is largely gone. But Thailand remains dependent on foreign capital — and the owners of that capital are spooked. Contagion ? la 1997 is not likely because, like Thailand, most of the region’s states (with Indonesia the notable exception) are far stronger now than then. Investors, however, have a herd mentality and a mass exodus from Southeast Asia can hardly be ruled out. After all, the Hong Kong, Indian, Indonesian, Malaysian, Philippine and South Korean markets all took their cues from Thailand on Dec. 19 and went nowhere but down.
Second, Thailand’s reputation as a solid economy with questionable politics would change to a reputation of questionability on both scores. Investors did not bolt after the Sept. 19 coup because there was trust that the Thais — not to be confused with the Thai government pre- or post-coup — were levelheaded enough to keep their money separate from their politics. Should the events of Dec. 19 not prove a mere hiccup, then coups will mean the same thing in Thailand that they mean everywhere else.
This article analyzes the question of whether return on equity (ROE) or return on capital (ROC) is the better guide to performance of an investment.
We’ll start with an example. Two brothers, Abe and Zac, both inherited $10,000 and each decided to start a photocopy business. After one year, Apple, the company started by Abe, had an after-tax profit of $4,000. The profit from Zebra, Zac’s company, was only $3,000. Who was the better manager? I.e., who provided a better return? For simplicity, suppose that at the end of the year, the equity in the companies had not changed. This means that the return on equity for Apple was 40% while for Zebra it was 30%. Clearly Abe did better? Or did he?
There is a little more to the story. When they started their companies, Abe took out a long-term loan of $10,000 and Zac took out a similar loan for $2,000. Since capital is defined as equity plus
long-term debt, the capital for the two companies is calculated as $20,000 and $12,000. Calculating the return on capital for Apple and Zebra gives 20% (= 4,000 / 20,000) for the first company and 25% (= 3,000 / 12,000) for the second company.
So for this measure of management, Zac did better than Abe. Who would you invest with?
Perhaps neither. But suppose that the same benefactor who left money to Abe and Zac, also left you $100 with the stipulation that you had to invest in the company belonging to one or other of the brothers. Who would it be?
Most analysts, once they have finished talking about earnings per share, move to return on equity. For public companies, it is usually stated along the lines that equity is what is left on the balance sheet after all the liabilities have been taken care of. As a shareholder, equity represents your money and so it makes good sense to know how well management is doing with it. To know this, the argument goes, look at return on equity.
Let’s have a look at your $100. If you loan it to Abe, then his capital is now $20,100. He now has $20,100 to use for his business. Assuming that he can continue to get the same return, he will make 20% on your $100. On the other hand, if you loan it to Zac, he will make 25% on your money. From this perspective, Zac is the better manager since he can generate 25% on each extra dollar whereas Abe can only generate 20%.
The bottom line is that both ratios are important and tell you slightly different things. One way to think about them is that return on equity indicates how well a company is doing with the money it has now, whereas return on capital indicates how well it will do with further capital.
But, just as you had to choose between investing with Abe or Zac, if I had to choose between knowing return on equity or return on capital, I would choose the latter. As I said, it gives you a better idea of what a company can achieve with its profits and how fast its earnings are likely to grow. Of course, if long-term debt is small, then there is little difference between the two ratios.
Warren Buffett (the famous investor) is well known for achieving an average annual return of almost 30 percent over the past 45 years. Books and articles about him all say that he places great reliance on return on equity. In fact, I have never seen anyone even mention that he uses return on capital. Nevertheless, a scrutiny of a book The Essays of Warren Buffett and Buffett’s Letters to Shareholders in the annual reports of his company, Berkshire Hathaway, convinces me that he relies primarily on return on capital. For example, in one annual report he wrote,”To evaluate [economic performance], we must know how much total capital—debt and equity—was needed to produce these earnings.” When he mentions return on equity, generally it is with the proviso that debt is minimal.
If your data source does not give you return on capital for a company, then it is easy enough to calculate it from return on equity. The two basic ways that long-term debt is expressed are as long-term debt to equity DTE and as long-term debt to capital DTC. (DTC is also referred to as the capitalization ratio.) In the first case, return on capital ROC is calculated from return on equity ROE by
ROC = ROE / (1 + DTE),
and in the second case by:
ROC = ROE * (1 – DTC)
For example, in the case of Abe, we saw DTE = 10,000 / 10,000 = 1 and ROE = 40% so that, according to the first formula, ROC = 40% / ( 1 + 1) = 20%. Similarly, DTC = 10,000 / 20,000 = 0.5 so that by the second formula, ROC = 40% (1 – 0.5) = 20%. You might like to check your understanding of this by repeating the calculations with the results for Zac’s company.
If you compare return on equity against return on capital for a company like General Motors with that of a company like Gillette, you’ll see one of the reasons why Buffett includes the latter company in his portfolio and not the former.
For more articles, analyses, and insights into today’s financial markets from John Price, visit his web site.