20 questions every investor wants answered

It’s not the easiest time to be an investor but it is a time that great fortunes can be made by those skilful enough to capitalise on the massive discounts and price anomalies now appearing across the investment market.

Last week, members of the Eureka Report team, including Alan Kohler, Robert Gottliebsen, Tom Elliott and James Kirby, headed to the Investment Expo. Here are some of the more common questions put to them by worried investors.

1. Why has the Australian sharemarket fallen further than Wall Street?

Robert Gottliebsen: The Australian market is dominated by resources and bank stocks and does not have enough industrials such as CSL and Telstra. Resources were hit hard by the forced hedge fund selling of commodities, the Australian dollar and mining shares. In addition, there are fears about the economy in China. Australia’s banks have been caught up in the global re-rating of banking stocks and the fact that they normally suffer in any downturn.

2. Is it a good strategy to buy bank shares and rise out the slump while getting a 9% yield? Even if the dividend falls, it will still be better than bank deposits.

Alan Kohler: Some banks will have increased bad debts and will struggle to hold their dividend but they have eliminated most of their competitors, so in the long term they should do well.

James Kirby: You have to remember that bank yields are based on the expectation that banks will not cut their dividends. Now nobody is saying they are going to cut, but Mike Smith of ANZ has raised the idea that dividends may have to be cut. He is saying that could be seen as “softening up” investors for a cut in dividends in the future.

3. How are hedge funds coping with the ban on short-selling?

Robert Gottliebsen: Many hedge funds have redeemable equity, and large redemptions were due in November. Most have gearing of four or five times equity. They had many strategies but in the past year; some of the more successful had been focused on commodities, Australian dollar securities and mining shares. They also invested large sums in the US sharemarket. Along with margin borrowed shareholders, they have been enormous sellers in the past month.

Tom Elliott: I think those hedge funds that have limited their risks and have a strategy that can work in a bear market will survive, although they may be small because of the general exodus.

4. Whose fault is the crash, and what should have been done?

Robert Gottliebsen: Don’t eliminate the public. They told their advisers that unless they performed they would be sacked. That instruction went down the line and sometimes led to people getting top jobs in funds because they were prepared to take big risks. We all share part of the blame.

5. Why did the US market not fall as hard as the Australian market?

James Kirby: The US market (S&P200) is down about 25% over the last year and we are down more than 40%. It looks unfair and there is something of a flight to the safety of US assets. More important is that the Australian market is terribly exposed to banks and commodities, the US market is much deeper with companies like Procter & Gamble, or Microsoft and Coca-Cola giving more balance – it may explain why Wall Street has held up better.

6. What is the outlook for the residential housing market?

James Kirby: Not everyone is pessimistic about housing; rates are coming down, there is a housing stock shortage, immigration levels remain high by long-term standards and there is evidence already that the Rudd Government’s bolstering of the First-Home Owner’s Grant is having a positive effect, with a jump in registrations of interest in “black spots”, such as Sydney’s western suburbs.

Robert Gottliebsen: I have seen every share crash since 1960 and every time property has followed, albeit that in 1987 it took two years. What happens is that buyers lose their jobs or have lower income; banks take a much tougher line on their lending terms and the economic downturn causes forced sales of property.

After a big share fall, for the property market to fall is like night following day. Commercial property is falling because superannuation investors are cutting back exposure. The most vulnerable area of the housing market is expensive houses and holiday houses.

7. Why is gold not going up?

Alan Kohler: In fact, gold has been fairly strong in Australian-dollar terms. But more broadly, it has been reasonably good as investment for the past year but it has not really rallied in the way its true believers might have expected. Working against any serious rally for gold is the fact that the US dollar has strengthened throughout this crisis. Investors are going back into US dollars and that has put a lid on the gold price appreciation.

8. Will the US decline now, and will China become the dominant country in the world?

Alan Kohler: I am sceptical that things will play out quite so simply. There are negatives for the US and negatives for China, too; it is unlikely that we would have a perfect switch in the superpower financial status of the US and China.

9. How do you pick a company that might be taken over?

James Kirby: Many takeovers are not a big surprise when they are announced. If you read the financial media very closely, there are always companies that stand out as screaming takeover targets. Adelaide Bank was obviously so; similarly gas stocks such as Origin and Queensland Gas. At the moment Foster’s is a very obvious takeover target.

Tom Elliott: You do not have to pick a takeover at the start; there is ample evidence that you can make money on a takeover situation after the initial bid has been announced. The majority of takeover bids are successful.

10. Is Babcock & Brown a bargain?

Tom Elliott: Babcock & Brown is really now what we used to call a “penny dreadful”. The theory says that if you buy something that is extremely cheap, say one cent, it would only have to move to two cents and you would have doubled your money. But for most stricken stocks it just does not happen. This is a very speculative area.
11. What is the outlook for environmental investing?

Alan Kohler: I know we are in a very difficult phase of the market, but there are huge changes occurring in the economy around climate change and carbon trading, and you only have to get a series of mandated changes from the Government and certain areas will do very well. For example, there are only two glass makers in Australia and they are both owned by CSR. If there are moves toward double-glazed windows – especially if that move is mandated – then that division of CSR will do very well indeed.

12. Will BHP Billiton be successful in its takeover bid for Rio Tinto?

Tom Elliott: Yes, I believe it will, there are some more regulatory hurdles, especially the European Union. But I think the circumstances are changing and the pressure is accumulating daily on Rio to open negotiations with BHP. Rio is still trading a very good discount to the bid.

13. How do CDS swaps work and should we worried about them?

Alan Kohler: Credit default swaps are relatively obscure traded financial instruments that indicate the willingness of banks to lend to each other. They came into the news in recent weeks because as the international banking crisis deepened, the CDS swap rate attributed to some banks jumped sharply to levels rarely seen.

It was a soaring CDS swap rate at the crippled US investment bank Lehman Brothers that alerted traders to the urgent, and ultimately irreparable problems faced by the bank. Although defined as a “derivative contract between two counterparties”, it’s really just betting; traders betting that banks will go under. In effect the CDS swap rate is an indication of the possibility a bank may default on another bank… that’s why it matters so much at a time of crisis.

14. What is happening with the bidding for the Government’s broadband project?

Alan Kohler: Telecom NZ has pulled out of the Terria consortium, and there are rumours of other members of the consortium getting concerned. It does not look like it will be much of a bidding war at this stage; Telstra might be the only bidder.

Robert Gottliebsen: It looks to me as if Telstra is the only one that can build it in the light of the tight global money conditions. If the Government wants the project, it must take Telstra’s terms. If I am right, and Singapore Telecom may surprise me, then it’s very good news for Telstra long-term.

15. Could the Australia index fall to 2800 points and wipe out all the gains of the bull market?

Robert Gottliebsen: We are seeing a massive deleveraging of the market both via hedge funds and via investment banks and brokers selling their long portions, which had been funded by borrowed money. Hedge funds need money to meet redemptions. Most sharemarket slumps end with a “day of no hope”. If we saw it fall to 2800, that would be a huge decline and would represent a magnificent buying opportunity. Given that this market is about deleveraging – plus some fear – nothing can be ruled out, but that would be a bigger fall than I anticipate.

16. How will the US fund the bailout?

Alan Kohler: By borrowing from China, Japan, the rest of Asia plus the Middle East. It’s the ability and willingness of Asian countries to keep sending money to the US that props the system, but in many ways they are locked in.

17. Is there value in property trusts?

James Kirby: There may well be value. Big trusts such as GPT are raising money at a 50% discount right now. On anyone’s numbers, there appears to be value at the stronger trusts such as Stockland or maybe even Westfield, but anyone going into these situations will have to able to take early losses.

18. What about Macquarie Cash Management Trust?

Robert Gottliebsen: Macquarie is investing its cash management trust fund in government-guaranteed securities and if they do that (and I am sure they will) there will be no risk. Gold is being hit by leveraging and by the strength of the US dollar. Gold is a hedge against a massive sell-off of the US dollar.

19. Where are the opportunities?

Robert Gottliebsen: In a strange way I am excited by the prospect of a sharemarket that becomes like a jewellery shop, with value at every corner created by the massive forced selling we are currently seeing. The opportunities are for long-term investors only.

The opportunity areas I see are banks, top miners and sound but depressed property trusts. Banks have lost their competitors; the miners face lower prices for some time and their value depends on China holding at 8% growth rates. I think they will, or go very close to it. We are likely to see lower interest rates so that next year, with new profit guidelines in the light of the downturn, there will be many yield opportunities including property trusts and infrastructure assets.

20. Have the property trusts performed any worse than stocks generally?

James Kirby: Yes, they have. In the year to 30 September the ASX Accumulation index was down by about 28%, but the Listed Property Trust Accumulation index was down about 40% – and even at that the index was held up to some degree by Westfield, the biggest trust of all, which was only down by 18%.

This article first appeared on Eureka Report