Tag Archives: Banks

article 3 months old

The Overnight Report: Europe Stressed

By Greg Peel

The Dow closed down 94 points or 0.8% while the S&P lost 0.8% to 1305 and the Nasdaq dropped 0.9%.

As noted in yesterday's Monday Report, the European Banking Authority has conducted stress tests on 90 European banks and found only eight have failed, suggesting more capital will be required under the test's heightened debt crisis scenario. However, markets were critical that the tests were too benign and that the parameters had been set before the Italian blow-out and before talk of Greek partial default.

For example, the EBA's test assumed a write-down of Greek sovereign debt of only 15% while the credit default swap market has Greek debt trading at 50 cents in the dollar, or a 50% write-down. So over the weekend the world's large investment banks, including Goldman Sachs, SocGen and others, conducted their own stress tests based on the now disclosed information.

Factoring in greater losses on peripheral debt, Goldmans suggested 18 banks would fail. Add in a 10% write-down of Spanish and Italian debt and 27 banks fail. Other houses used other combinations of parameters for their own tests and the bottom line is all concluded that many more European banks would need more capital, with results ranging from E26bn to E80bn in total. 

What's more, the disclosed information revealed not just the level of sovereign debt held by banks, but the significant level of interwoven private sector loans. What has really irked the market the most is that were the European officials serious about resolving the debt crisis, and not just trying to make light as they have done ever since early 2010, then European banks would already be raising fresh capital and disaster may by now have been averted. Disaster is not yet upon us, but European bank shares have been falling steadily all year, accelerating this month, and last night were down substantially once more. To raise capital now is to face significant shareholder dilution.

Euro officials will meet on Thursday to discuss suggestions of a partial Greek default, as well as consider the wider contagion issue. At this stage all parties seem resigned to partial defaults but the ECB stands unhelpfully rigid, continually noting that it can't hold even partially defaulted debt as collateral. At this stage, a resolution still seems some way away, and in the meantime the global financial markets, and the world, are becoming increasingly angry at the failure of US politicians to reach a debt ceiling and budget cut agreement.

The critical word there is “politicians”. When it's all said and done, the EU GDP is sufficiently large to cope with resolving all of the eurozone's debt issues without too much difficulty, and the US can always just print money like it always has. China may not like it, but then China wants a resolution too. But all across Europe, and in the US, the stumbling block for debt resolution is not finance, but politics. The world's fate is not in the hands of what were once revered statesmen, but in the hands of the self-serving, incompetent, unintelligent, career-focused electoral suck-ups that dominate parliaments all over the globe.

With the collective global value of fiat currency continuing to sink into the sunset, last night gold hit a new psychological, blue-sky benchmark at 1600. It's up US$11.00 to US$1605.10/oz. Silver rose 3% to US$40.55/oz.

Given the debt problems on both sides of the Atlantic, there was little relative move in the EUR-USD. The dollar still came out a winner on its index, rising 0.3% to 75.37, but the safe haven du jour is the Swiss franc, and even the yen is seen as a better bet. The fate of the Aussie has been more parochial of late, but it's down 0.3% at US$1.0608.

At present, real commodities are playing a waiting game. Brent crude was down US$1.21 to US$116.05/bbl in its new September delivery front month, while West Texas lost US$1.09 to US$96.15/bbl. Base metals were yet again mixed on small moves.

The financial sector dominated the drop on Wall Street last night, sending the Dow down 180 points by midday. At that point buyers were unearthed, leading to a less drastic close. Tonight is a big night for US corporate earnings in a season that is now being overshadowed by pan-Atlantic debt issues. Bank of America (Dow), Goldman Sachs and Wells Fargo all report tonight, along with big techs Apple and Yahoo and big consumer staples Coca-Cola (Dow) and Johnson & Johnson (Dow) to provide a broad spectrum assessment.

IBM reported after the bell this morning, beating on earnings and revenue and on next quarter guidance. Its shares are up 1.8% in the after-market.

The SPI Overnight fell 22 points or 0.5%.

The RBA will release the minutes of its July policy meeting today which will be closely scrutinised in light of the first economist back-flips on rate expectations. Bear in mind the July meeting pre-dates Italy joining the fray, as well as the very weak consumer and business sentiment data in Australia and the big profit downgrades now flowing from the retail sector. 

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article 3 months old

The Overnight Report: Did I Say QE3?

By Greg Peel

The Dow closed down 54 points or 0.4% while the S&P lost 0.7% to 1308 and the Nasdaq plunged 1.2%.

Shocked into action by this week's major escalation of the European crisis which has brought Italy into the frame, the well-respected Italian finance minister has since rallied the troops, brought forward emergency discussions, and last night the Italian parliament passed an austerity package aimed at budget cuts and, more specifically, appeasing global markets.

Not only was the vote on the bill brought right forward from the end of August, the size of the package was double that originally flagged. The government then went out and successfully auctioned E1.25bn of five-year bonds at a yield of 4.93%. The cost is about 1% higher than the last equivalent auction in June, but the market bought them nevertheless, further easing fears that Europe's third largest economy is next.

It was enough to afford Wall Street a more positive mood at last night's open, and enthusiasm grew as major US bank JP Morgan Chase (Dow) posted a well received earnings report. JPM brought back provisions, increased revenues with some actual commercial lending, and over the quarter bought back US$3.5bn of stock to boost shareholder value. The bank's shares finished up 1.8%.

It was enough to have the Dow up 90 points by 10.30am, but then Uncle Ben had to go and open his mouth.

I don't know about you, by I interpreted Fed chairman Ben Bernanke's comments to Congress on Wednesday night as suggesting that QE3 stands ready to be implemented were the US recovery to continue to be slow and were deflation to threaten once more. Other words, it ain't going to happen tomorrow but if things don't improve down the track, well, we'll just have to do what we have to do.

Apparently Wall Street didn't quite see it that way though, assuming, for some reason, that QE3 would be fired up some time next week. So when Bernanke qualified his earlier statement last night, in his ongoing testimony, Wall Street turned and fled. The chairman had pointed out that the Fed still anticipated improvement in the second half, and were inflation expectations to increase then QE3 would be kept in its box.

As I said yesterday, we're now back in this tedious “bad is good and good is bad” mode. From here on, Wall Street will almost be willing the jobs numbers to be weak.

JP Morgan remained the star of the session, easing the fall in the Dow, while the rest of the financial sector and market slid away. Citigroup reports tonight, but analysts are concerned the good result from JPM might have indicated an increase in market share, rather than sector-wide improvement of note. Meanwhile, the tech-laden Nasdaq underperformed as weak commentary from chip makers resonated, and ahead of the after-market release of Google's result.

To add to the weakness, Moody's stuck its head up (seems to love the publicity at the moment) and suggested the US might lose its AAA rating if it couldn't resolve the debt ceiling issue. Well duh. Moody's had already said this once before anyway. But just after lunch, it was announced that the two parties had suddenly reached an agreement on US$1.5 trillion of spending cuts, despite having been seemingly locked in a stalemate on Wednesday.

Wall Street bounced, sending the Dow back up to the flatline from around 50 points down, but then it drifted away again to the close.

The debt ceiling news at least sparked a bit of a sell-off in bonds, with the ten-year yield gaining 7bps to 2.96%. The earlier auction of US$13bn of thirty-year bonds was very popular, albeit foreign central banks bought 38% compared to a 40% running average.

The US dollar had begun the day weaker as the euro rallied on the positive news from Rome and on expectations of QE3. But Bernanke's comments and the supposed breakthrough on the debt ceiling had the US dollar turning around to be up 0.2% at 75.21. Gold thus took a little bit of a breather in rising only US$4.40 to US$1587.00/oz.

Silver was flat, base metals were mixed on small moves, and Brent crude fell US46c to US$118.32/bbl. Disappointment over no immediate QE3 had West Texas tumbling US$2.02 to US$96.03//bl, widening the spread once more to around US$22.

The Aussie was steady at US$1.0722 and the SPI Overnight lost 9 points or 0.2%.

Then after the bell, Google reported. In short, the result completely blew Wall Street analysts off their chairs. Google shares are up a whopping 12% in the after-market which is a substantial move for a company of Google's size. One presumes, ceteris paribus, that this result will give the Nasdaq in particular and all the indices in general a chance at a good start tonight. 

Please note that a vodcast of the sensational new show everyone's talking about around the water cooler -- FNArena's Market Insight -- will be posted on our website later this morning.

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article 3 months old

The Overnight Report: Arrivederci Roma

By Greg Peel

The Dow fell 151 points or 1.2% while the S&P lost 1.8% to 1319 and the Nasdaq dropped 2.0%.

European bank shares were slaughtered last night with some of the biggest names losing 5-10%. Italian banks were at the forefront as rumours escalate that they will fail the upcoming 2011 stress tests imposed by the ECB – speculation denied by the Italian central bank. The Italian stock market fell 4% and contagion losses across the continent's financial sectors saw London lose 1%, Germany 2.5% and France 3%.

The response on Wall Street was straightforward. The Dow opened down 150 points and, on little volume, stayed there. Action in the S&P 500, which is weighted almost 20% to financials, was similar. The Dow held up better than the broader market given the defensive names therein, while the Nasdaq is a riskier index. US bank stocks were all down around 5%. The VIX volatility index jumped 15% to 18.4.

European officials are currently meeting in Brussels and it was Greece, not Italy, that was supposed to be on the agenda. One assumes the agenda has altered slightly. To understand what's suddenly gone wrong, see European Crisis Escalates from yesterday.

The one saving grace about a debt crisis in the eurozone's third largest economy is that the bulk of Italian sovereign debt is held by Italian banks and insurers. In other words unlike Greece, the debt holders of which are mostly French and German banks, Italy's problems are not so likely to lead to eurozone contagion. Indeed, Italy's government debt to GDP level is much lower than that of Greece and the other peripherals. The problem is, nevertheless, that while the percentage is low the euro value amount of debt is significant and Italy has substantial bond rollovers due over the next couple of years.

Last night the yield on the Italian ten-year bond jumped 33 basis points to 5.98% to widen to a 3.3% over the equivalent German bond. The line in the sand is considered to be a 7% yield, after which point Italy's annual GDP will not be sufficient to cover interest payments. Experience shows that once a country's yield reaches 6% the slippery slope of bond vigilante selling will accelerate that country's bond sales down to junk levels. This is what has happened in Greece, where the ten-year yield is in the teens, as well as in Portugal and Ireland.

The Italian crisis comes at the same time eurozone officials, led by Germany, are considering allowing a partial default of Greek debt. This means a voluntary haircut for Greek bond holders but it also means Greece's debt is reduced rather than extended, which was the basis of the earlier French plan. All up it was a night of “Get me out of Europe”, with the ramifications flowing to all global financial sectors irrespective of their direct exposure. For Australian banks, for example, the issue is to what extent the latest crisis will inflate offshore borrowing costs, just as those costs are otherwise close to peaking.

The US Congress may be stuck in a stalemate over America's debt problems, but in a time of European crisis the flight to quality still means buying US bonds. The US ten-year yield last night fell 12bps to 2.92%. Currency wise, the euro is down 1.4% after having traded lower, and having hit an all-time low against the Swiss franc. The US dollar index is up 1.1% to 75.97 and the Aussie is down 1% to US$1.0654.

Such a big move in the US dollar might have impacted dollar gold, except that European buying pushed gold up to record levels against the euro. In dollar terms, gold is up US$10.10 to US$1554.40/oz.

The same can't be said for the real commodities however. Silver had its industrial hat on last night and fell 2.6%. Copper and lead were down 1%, aluminium and zinc down 2% and nickel down 3%. Brent crude fell US$1.09 to US$117.24/bbl while West Texas fell US$1.08 to US$95.13/bbl in a rare coordinated move.

So what happens now? Well, while many in the market had felt that the Greece-Portugal-Ireland issue could be contained, they were worried about the much larger economy of Spain and just didn't want to contemplate Italy. Spain has been dragged in, with the recent ECB rate rise a kick in the teeth to struggling Spanish property owners aside from the contagion issue. Italy is now in the frame, and markets are very nervous. The meeting in Brussels is ongoing, and will move into tonight when EU officials meet with eurozone finance ministers.

For Wall Street, hope still rests with the June quarter earnings season. Earnings forecasts are ambitious but there have been very few guidance downgrades leading into the season despite expectations of such. Alcoa was one company which did downgrade guidance, from an EPS of US36c to US32c and that's exactly what its result was after the bell last night. Alcoa beat on the revenue line but Wall Street wanted a beat in earnings as well. Alcoa shares are down 1% in the after-market and the US earnings season has begun.

The real test will be later in the week when the big banks report.

Yesterday in Australia the market was responding first to Friday's weak US jobs report, which according to the futures was worth 40 points down, and, one presumes, offshore selling as a sign of dissatisfaction with a carbon tax. But the Italian news was a story in our zone yesterday, so there were potentially several factors behind the big drop in the ASX 200.

Last night, the SPI Overnight fell 39 points or 0.9%.

The results of the European bank stress tests are due on Friday night. After last year's stress tests, accusations were made by the market that the ECB set the parameters to ensure almost a full pass. If the pass rate is equivalent this year, no doubt the same accusations will fly. But if the Italian banks do pass, then perhaps this latest crisis may just be a storm in a cappuccino. Yet as we know with Europe, just when you think it's safe to go back into the water someone makes another sequel.

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article 3 months old

European Crisis Escalates

- Investors bail out of Italy, fearing implosion
- Spain cops the brunt of the ECB rate rise
- Germany proposes new Greek solution


By Greg Peel

“Pretending that this is just a liquidity crisis will no longer wash. What it will take is a belated recognition by Germany that this crisis is not a morality tale contrasting virtuous, thrifty Teutons with feckless Greco-Latins and Guinness-befuddled Celts but rather a North-South structural crisis caused by the inherent workings of monetary union.”

London Financial Times commentator Ambrose Evans-Pritchard has long been a critic of an ill-conceived eurozone. Germany continues to be reluctant to commit taxpayers funds to bailing out peripheral eurozone economies given their fiscal recklessness as Evans-Pritchard alludes to above. Germany also wants private sector holders of peripheral debt to share in the cost of bail-out, which is a reasonable expectation but has potentially dire ramifications for European financial markets.

Evans-Pritchard is also no fan of the current European Central Bank leadership. The ECB raised its cash rate last week for the second time since the GFC in an effort to attack rising inflation driven by northern eurozone GDP growth, particularly that of Germany. In so doing, the ECB is claiming it can deal with two crises at once – being inflation problems on the one hand and emergency issues regarding peripheral debt on the other – even though policy responses for both are diametrically opposed.

Spain has suffered an extensive property market bust through the credit crisis and GFC, yet by raising its cash rate the ECB is raising the cost of 90% of Spanish mortgages. And where, exactly, is this inflation, Evans-Pritchard asks. Annualised growth in eurozone M1 money supply has fallen from 2.9% in March to 1.2% in May. Broader M3 money supply has grown at only 2.2% over the past three months. In the meantime the Spanish and Italian manufacturing PMIs have fallen into contraction.

According to the IMF, the GDP of Germany was US$3.3trn in 2010 placing it fourth in the world. France (5) came in at US$2.5trn while Greece (32) posted US$305bn, Portugal (38) US$229bn and Ireland (43) US$204bn. Because of the small size of the peripheral economies, many in the market believe there is little to fear from their demise. The collective E273bn of bail-out funds announced to date is minor compared to the full financial resources of the eurozone. But Spain (12) at US$1.4trn and Italy (8) at US$2.1trn are a different matter. As a comparison, Australia (13) slots in behind Spain with US$1.2trn.

The issue is not just one of contagion stemming from a Greek default, even though the potential for a Greek default never seems to go away. Spanish mortgages are one thing, but the world has become very concerned over current developments in Italy.

Tonight EU officials will gather for a crisis meeting in Brussels. They are not calling it a crisis meeting, and reject such a notion, given it is a rescheduled meeting to discuss the proposed 2012 Greek bail-out package and this year's stress tests for European banks. But everyone else is calling it a crisis meeting, with Italy now the primary focus. The officials have insisted Italy is not even on the agenda, but no one believes them.

On Friday, Italian stocks and bonds suffered a significant sell-down. Bank stocks were hardest hit, with Unicredit, Italy's biggest bank, falling 8%. Investors are worried Italian banks may fail this year's round of stress tests which are due for release on July 15 – a fear dismissed by the Italian central bank. The yield on the Italian ten-year bond blew out to 5.28%, edging towards the 5.5-5.7% level beyond which economists suggest Italy would struggle to refinance itself. But Italy's problems are political as well as financial.

Italian prime minister Silvio Berlusconi has ignited a public slanging match with his own finance minister, Guilio Tremonti. The two have disagreed before over austerity packages and tax cuts but Tremonti is held in high regard by global bond traders as a steady hand on the tiller of a ship in stormy seas. Yet on Friday, Berlusconi suggested publicly that Tremonti “is not a team player, and thinks he's a genius and that everybody else is a cretin”.

Imagine Julia Gillard saying that of Wayne Swan, or even Tony Abbot saying that of Joe Hockey. It is little wonder global investors decided Friday was a good day to exit a foundering ship. To make matters worse, Tremonti has been indirectly accused of corruption because he has been living free in a flat owned by a political ally who is up on corruption charges. Resignation rumours are circling, and the Italian press is more than bemused.

“The government ceased to exist months ago,” suggested La Republica, “What other country would allow itself the suicidal luxury of offering cynical markets such a spectacle of political disintegration and institutional decay at a time when Europe is destabilized by Greece's sovereign debt and haunted by contagion?”

Suggestions are growing that eurozone officials are going to have to stop simply fiddling around the edges with Greek bail-outs and start thinking “shock and awe” monetary tactics. The expression arose in late 2007 when the Fed responded to the growing credit crisis with a full 50 basis point cash rate cut. The Fed then had to “shock and awe” more than once, including a 75 point cut in 2008. The ECB's initial response to a growing global credit crisis was to increase its cash rate by 25 points to combat the inflationary impact of soaring oil prices. That move took the ECB rate from 4.0% to 4.25% but pretty soon the ECB was forced to slash down to 1.0% following the GFC.

Such history puts last week's ECB hike to 1.50% from 1.25% in perspective.

If it were up to Evans-Pritchard, rather than raising rates the ECB would provide “half a decade of super-easy money” to weaken the overvalued euro and stave off debt deflation. “Without either, Italy and Spain can only pray for a miracle.”

Italian GDP has not grown for a decade, notes Evans-Pritchard. Official forecasts suggest 1.1% GDP growth in 2011 but outside forecasts are much weaker. Jefferies Fixed Income has suggested the elephant in the room of the European debt crisis is that Italy's debt payments will explode within three or four years if the average borrowing cost increases by 200-300 basis points. The ten-year yield has pushed up to only 5.3% so far but that's how it started in Greece, which now has two-year bond yield in excess of 20%.

Which brings us to Greece's second bail-out package – the supposed subject of tonight's meeting in Brussels. EU officials have put off and put off a decision on the package, first waiting to see what would transpire from the drama of last week's Greek parliamentary vote with regard to the current package. The reality is that Europe is no closer to an agreement than it ever was.

Germany, the Netherlands, Austria and Finland are all determined, notes Reuters, that banks, insurers, and other private holders of Greek government bonds should bear some of the cost of helping Athens. But the constant stumbling block of “haircut” solutions is that ratings agencies believe they would effectively be a form of default, and the ECB rules do not allow defaulted debt to be held as collateral. At present the ECB is holding Greek debt in exchange for emergency loans.

French banks got together recently and offered up a complex solution that would involve rolling over Greek debt into new thirty-year bonds. Critics have suggested the plan is self-serving and will only add to total Greek debt levels over time. The plan was rejected by Germany, but a German-led consortium of creditor countries has now come up with its own solution.

The Financial Times reports the new strategy, which will be discussed at the meeting tonight, would involve Athens defaulting on part of its debt in return for new bail-out concessions including lower interest rates on loans and a broad-based bond buyback program. The idea is to have both the public and private European sectors taking some of the pain in order to reduce Greece's debt burden. Details are not expected to be agreed upon for another month or so, but the FT's take is that if the strategy were agreed, “it would mark a significant shift in the 18-month struggle to contain eurozone debt”.

The strategy was originally devised by German investors, including Deutsche Bank, and could see private holders buying back as much as 10% of outstanding Greek debt. Given that debt is currently trading below face value, such a buyback would constitute a “haircut” on investments.

The buyback would have to be funded, but the European Commission has long been pushing for the recently agreed upon E440bn eurozone general emergency fund to be used for such a strategy. Funnily enough, the proposal has to date been rejected by Berlin.

So we may now have some progress on the Greek front, as Italy threatens to implode and Spain cops the pain of an ECB rate hike. One assumes that a buyback for a loss, rather than a restructuring as the French banks had offered, would not imply a technical default in the eyes of the ratings agencies, although an EC funded collective buyback may still be deemed a “distress” response and thus a partial default.

Tonight's meeting will indeed be interesting.
 

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article 3 months old

Top Ten Weekly Recommendation, Target Price, Earnings Forecast Changes

 By Chris Shaw

The first full trading week of the new financial year has seen a further increase in positive ratings on Australian equities, the FNArena database showing 14 upgrades for the week against nine downgrades by the eight brokers under daily coverage. Total Buy ratings now stand 53.1% of all recommendations, up from nearly 52.5% last week.

Bank of Queensland ((BOQ)) was a major beneficiary of upgrades, seeing an additional two Buy ratings over the past week as the valuation argument in favour of the stock continues to gain credence. The valuation argument was also made in favour of Westfield Retail as it was upgraded, the stock seen as offering an attractive defensive exposure in the Australian REIT sector.

Westfield Group ((WDC)) also enjoyed upgrades as more analysts in the market accept there is improved value following recent share price underperformance. Revisions to commodity price assumptions sparked upgrades for uranium play Paladin ((PDN)) over the week, while the likes of QBE Insurance ((QBE)), ResMed ((RMD)) and Westpac also saw upgrades.

On the flip side the major downgrade of the week was experienced by Murchison Metals ((MMX)) after the company updated on the progress of the Okajee and port and rail and Jack Hills uranium mine projects. Brokers see a need for a restructuring as the capital costs of development appear beyond Murchison at present.

Changes to commodity price assumptions were behind a downgrade for Gryphon ((GRY)), while the likes of Macquarie Group ((MQG)), Cardno ((CDD)) and Insurance Australia Group ((IAG)) also met with downgrades during the week.

There was little in the way of increases to target prices, which tends to underpin the argument while the market offers a number of value situations there are few obvious catalysts at present. Murchison's issues saw price targets for the company slashed by better than 70%, other reductions being of similar magnitude to the target increases.

Our usual update on earnings estimates is this week absent due to technological problems. Sorry, we couldn't get them fixed in time before today's update. Should be back next week.

 

Total Recommendations
 Recommendation Changes

 

Broker Recommendation Breakup

 

Recommendation

Positive Change Covered by > 2 Brokers

Order Symbol Previous Rating New Rating Change Recs
1 BOQ 0.130 0.500 0.37% 8
2 WRT 0.710 1.000 0.29% 7
3 BTT 0.500 0.670 0.17% 3
4 WDC 0.710 0.860 0.15% 7
5 PDN 0.430 0.570 0.14% 7
6 TSE 0.570 0.710 0.14% 7
7 QBE 0.250 0.380 0.13% 8
8 RMD 0.500 0.630 0.13% 8
9 WBC 0.130 0.250 0.12% 8
10 TEN 0.130 0.250 0.12% 8

Negative Change Covered by > 2 Brokers

Order Symbol Previous Rating New Rating Change Recs
1 MMX 0.330 - 0.670 - 1.00% 3
2 GRY 1.000 0.670 - 0.33% 3
3 CMW 1.000 0.670 - 0.33% 3
4 CDD 0.750 0.500 - 0.25% 4
5 MQG 0.290 0.140 - 0.15% 7
6 IAG 0.750 0.630 - 0.12% 8
7 WOR 0.500 0.430 - 0.07% 7
 

Target Price

Positive Change Covered by > 2 Brokers

Order Symbol Previous Target New Target Change Recs
1 SKI 1.319 1.379 4.55% 8
2 ESG 0.907 0.920 1.43% 4
3 RMD 3.493 3.538 1.29% 8
4 PRY 3.656 3.699 1.18% 8
5 WRT 2.917 2.934 0.58% 7
6 WDC 10.079 10.090 0.11% 7

Negative Change Covered by > 2 Brokers

Order Symbol Previous Target New Target Change Recs
1 MMX 2.100 0.560 - 73.33% 3
2 MQG 39.666 37.523 - 5.40% 7
3 CDD 6.363 6.198 - 2.59% 4
4 WOR 31.608 30.824 - 2.48% 7
5 GRY 2.143 2.093 - 2.33% 3
6 IAG 4.028 3.950 - 1.94% 8
7 CMW 0.775 0.760 - 1.94% 3
8 ABC 3.604 3.535 - 1.91% 8
9 ASX 36.682 35.980 - 1.91% 7
10 BTT 2.960 2.907 - 1.79% 3
 
 

Technical limitations

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article 3 months old

Top Ten Weekly Recommendation, Target Price, Earning Forecast Changes

 By Chris Shaw

Total Buy recommendations on Australian equities have moved even higher this week, the FNArena database now showing nearly 52.5% of all ratings by the eight stockbrokers under daily coverage are Buys. The increase comes despite little sign of any improvement in the outlook for corporate earnings or the broader economy.

During the week there were 16 upgrades compared to just seven downgrades, which is a continuation of the recent trend and suggests the valuation argument remains favourable for many companies.

Orica ((ORI)) received an upgrade to a Buy rating given an improved balance sheet has the company in good financial shape and earnings growth suggests value. Westfield Retail ((WRT)) also saw an upgrade to Overweight from Underweight, the argument being the stock offers defensive earnings and there is scope for June 2011 NTA to surprise to the upside.

Seven Group Holdings ((SVW)) was also upgraded and saw increases in price target, this being the result of changes in analysts covering the stock. Valuation arguments support the upgrades to Kathmandu ((KMD)), Paladin ((PDN)), AGL Energy ((AGK)), CSL ((CSL)) and Sonic Health ((SHL)), while an improved outlook given a competitors strong quarterly result was behind the upgrade for Sims Group ((SGM)).

Among the downgrades are Cochlear ((COH)), this given the combination of a high multiple and a slowing in earnings growth expectations. Generally weak trading conditions or valuation issues are behind the downgrades for Macquarie Airports ((MAP)), Macquarie Group ((MQG)) and ResMed ((RMD)).

While MAp saw a ratings downgrade there was also an increase in price target, this reflecting the potential for a proposed asset swap involving the company to deliver a positive valuation result for shareholders.

Positive initiations of coverage on Austbrokers ((AUB)) and Lynas ((LYC)) saw increases in consensus price targets for the two stocks in the database, while Orica and Westfield Retail also enjoyed price target increases associated with the upgrades in ratings.

The consensus target for Boart Longyear ((BLY)) fell after an initiation of coverage added a target below the previous consensus, while Ten Network ((TEN)) similarly saw a cut in target given ongoing evidence of weakness in advertising markets.

With fresh eyes looking at Seven Group the company enjoyed the largest increase in earnings estimates during the week, while the likes of CSR ((CSR)), Spark Infrastructure ((SKI)) and SP Ausnet ((SPN)) also saw changes to estimates as did Lynas, MAp and McMillan Shakespeare ((MMS)).

Resource stock Energy Resources of Australia ((ERA)) and refiner Caltex ((CTX)) were hit with the largest cuts to earnings forecasts during the week, while others to see numbers lowered by around 4.0% or more were Macquarie Group, Rio Tinto ((RIO)) and Aquila Resources ((AQA)). More modest cuts were made to estimates for Tabcorp ((TAH)), Qantas ((QAN)), BHP Billiton ((BHP)), Atlas Iron ((AGO)) and Blackmores ((BKL)).

 

 

 

Total Recommendations
 Recommendation Changes

 

Broker Recommendation Breakup

 

Recommendation

Positive Change Covered by > 2 Brokers

Order Symbol Previous Rating New Rating Change Recs
1 ORI 0.130 0.500 0.37% 8
2 WRT 0.710 1.000 0.29% 7
3 SVW 0.600 0.800 0.20% 5
4 KMD 0.800 1.000 0.20% 5
5 LYC 0.330 0.500 0.17% 4
6 SGM 0.430 0.570 0.14% 7
7 PDN 0.290 0.430 0.14% 7
8 AGK 0.750 0.880 0.13% 8
9 CSL 0.250 0.380 0.13% 8
10 SHL 0.500 0.630 0.13% 8

Negative Change Covered by > 2 Brokers

Order Symbol Previous Rating New Rating Change Recs
1 MAP 0.830 0.670 - 0.16% 6
2 MQG 0.290 0.140 - 0.15% 7
3 RMD 0.630 0.500 - 0.13% 8
4 BLY 0.860 0.750 - 0.11% 8
5 COH - 0.250 - 0.290 - 0.04% 7
 

Target Price

Positive Change Covered by > 2 Brokers

Order Symbol Previous Target New Target Change Recs
1 AAX 3.336 3.545 6.26% 4
2 TAH 3.110 3.275 5.31% 8
3 SVW 9.710 9.940 2.37% 5
4 MAP 3.487 3.555 1.95% 6
5 ORI 28.104 28.441 1.20% 8
6 AUB 6.570 6.638 1.04% 4
7 KMD 2.133 2.153 0.94% 5
8 SHL 13.253 13.371 0.89% 8
9 LYC 2.383 2.400 0.71% 4
10 WRT 2.917 2.934 0.58% 7

Negative Change Covered by > 2 Brokers

Order Symbol Previous Target New Target Change Recs
1 PDN 4.337 4.130 - 4.77% 7
2 MQG 39.666 38.094 - 3.96% 7
3 BLY 5.197 5.106 - 1.75% 8
4 TEN 1.319 1.306 - 0.99% 8
 

Earning Forecast

Positive Change Covered by > 2 Brokers

Order Symbol Previous EF New EF Change Recs
1 SVW 70.380 75.220 4.80% 5
2 CSR 24.125 25.950 1.80% 8
3 SKI 7.950 8.588 0.60% 7
4 SPN 8.250 8.488 0.20% 8
5 MMS 61.420 61.647 0.20% 3
6 LYC - 2.200 - 1.975 0.20% 4
7 MAP 8.459 8.659 0.20% 6
8 CSL 177.263 177.388 0.10% 8
9 SEK 29.725 29.825 0.10% 8
10 NHF 12.175 12.275 0.10% 3

Negative Change Covered by > 2 Brokers

Order Symbol Previous EF New EF Change Recs
1 ERA - 7.175 - 14.950 - 7.80% 8
2 CTX 114.550 108.050 - 6.50% 6
3 MQG 349.500 344.071 - 5.40% 7
4 RIO 1030.422 1026.386 - 4.00% 8
5 AQA - 4.050 - 7.750 - 3.70% 4
6 TAH 66.900 64.850 - 2.10% 8
7 QAN 18.950 17.150 - 1.80% 8
8 BHP 411.961 410.211 - 1.80% 8
9 AGO 23.886 22.771 - 1.10% 7
10 BKL 160.533 159.667 - 0.90% 3
 

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article 3 months old

Australian Banks Revisited

By Greg Peel

FNArena last reviewed the current consensus standings for the Big Four Aussie banks in early May in the wake of the first half result season for Westpac ((WBC)), ANZ ((ANZ)) and National ((NAB)). At the time the ASX 200 had already fallen by just under half of what this latest Greek-inspired correction has ultimately wrought, being a total of 9% from the April peak of 4971 to yesterday's close of 4529. Pedants might suggest a market has to fall 10% before being “officially” called a correction, but FNArena considers such trivia to be a load of rubbish.

Of course the “Sell in May” correction has not only been a result of Groundhog Day Greece but also of weak US economic data and the pending end of QE2, the immediate impact of the Japanese earthquake, Chinese tightening to fight inflation, and, peculiar to Australia, the ongoing currency impact and the negative March quarter GDP. So if we assume the Greek story will once again fade for now, we're not necessarily out of the woods just yet.

There is nevertheless a popular view that the second half of 2011 will be more positive for the global economy, with Greece resolution one matter but expectations of easing Chinese inflation growth, a swift Japanese rebound, and solid US corporate earnings forecasts for the June quarter being catalysts. Then there's always history – the “Sell in May” impact usually loses momentum around July-August.

In Australia the RBA remains hawkish with investment in the resources sector outweighing a weak economy elsewhere, such that a rate rise is expected by economists in August. The June quarter GDP will show a bounce out of the disaster-ridden March quarter mire but may yet show another negative result, in which case the same people who wait for a 10% pullback to declare “correction” will be quick to declare “recession”. Oh God, I can just hear Joe Hockey now. But this label, too, is a load of rubbish. Australia is already in as good as a recession everywhere expect for the resources sector, and we may yet see a positive GDP result for June anyway.

The problem for banks, however, is that mortgage demand is not being driven by miners who are either living in demountables or buying property for cash. On the home loan front, Citi best summed it up in a report last week by suggesting, “Volume growth is expected to be lower because of the rising interest rate burden for rate sensitive customers, a general consumer interest in deleveraging, falling real estate volumes, and widespread softening in real estate prices”. A Macquarie report this week adds, “Similarly business investment intentions outside the mining sector remain extremely weak meaning business lending is likely to remain weak for the foreseeable future as well”.

And that is the situation Australia's banks find themselves in as we wrap up what is for most FY11, albeit only CBA accounts on a June basis while the other three have a September year-end.

In the May Australian Bank Earnings Review, ANZ lost its position as the number one preference by broker consensus as the bank's margin premium due to Asian deposits began to narrow. NAB took ANZ's place after a strong mortgage performance fuelled by its nauseating ad campaign, and signs of stability in its UK and toxic asset positions. CBA and Westpac are already loaded with mortgages so weak business lending kept brokers subdued. CBA was seen to be close to fair value based on its perennial “big bank” premium while Westpac (which is actually “bigger” but coping with a risky St George franchise) was seen to offer the least value after a decent relative share price run, and as such scored no Buy ratings

Bear in mind that when global credit fears re-emerge it's always the smaller ANZ and NAB which cop the biggest hiding from nervous investors.

This was the state of play in May:

Moving on to our end-June summation, Macquarie notes FY11 sector growth will come in around 5% but the analysts suggest this looks like a cyclical low. Citi analysts have nevertheless cut their system loan growth assumption for FY12 to 4% from 6%, noting that Australian “interest in purchasing real estate and shares” (which is probably sourced from Westpac's regular consumer confidence surveys) has fallen to a 15-year low.

All sound pretty dour really, if you're an Australian bank investor.

But actually, it's not. For one thing, consumer frugality has meant ongoing strong deposit growth which takes the pressure off expensive offshore funding and hence alleviates the margin squeeze analysts would otherwise have expected. Banks would still rather write more business, but higher deposit levels are a concession in the meantime and help satisfy capital requirements under the new Basel III rules.

What this means is that Citi, having dropped its FY12 loan growth forecast to 4% from 6%, has only reduced its sector earnings forecast by 1% on the deposit-side balance. Citi is not alone, for despite ratings changes amongst the FNArena database brokers, consensus price targets have barely changed from May to now:

The most notable change here is that Westpac has scored two upgrades to Buy from Hold in the interim, moving it into equal third position with CBA. Clearly Westpac shares have suffered a pullback over the past six weeks but what is noticeable is its forecast yield numbers. At this level, broker consensus has Westpac yielding 7.0% in FY11, fully franked, and 7.4% in FY12. By contrast, ANZ is offering 6.5% and 7.0% and NAB 6.8% and 7.4%, while CBA is offering 6.7% for FY12 (with FY11 ending today).

BA-Merrill Lynch also notes Westpac was, again, the only major to record positive net retail fund flows in the March quarter.

After tax yields of around 7% for the safest banks in the world (in many an opinion) are not to be sniffed at, particularly given the banks will be at the forefront of any second half stock market rally, were that to occur. Macquarie thinks it will.

Macquarie notes that the RBA's hawkish stance – that which is keeping potential borrowers on the sidelines and driving others to pay down debt – is a reflection of cost-push inflation caused by “supernormal strength” in the Chinese economy. Economists are expecting China's inflation growth problem to ease in the second half, and Premier Wen concurs, and as such result in a more stable outlook for RBA rates. This would have positive implications for domestic asset growth, Macquarie suggests, as would the resolution of other global uncertainties such as European debt and slowing US growth.

The second half should also see another little boost in the form of our friends across the ditch.

While the connection to New Zealand is somewhat obvious for ANZ, RBS analysts remind us that Big Four earnings in the first half saw contributions from New Zealand of between 6% and 16%. With post-quake rebuilding efforts now underway, and both fiscal and monetary stimulus being provided by the NZ government and RBNZ respectively, RBS suggests the recovery in NZ loan growth should begin to gain traction in the second half. At the same time, direct quake-related losses for the Big Four should be minimal, just as they were unsubstantial in the wake of the Queensland floods.

So while the Big Four were looking unexciting as investments back at the April highs, at which time most analysts were declaring “fair value”, today the story is somewhat different following the correction. One need only look at consensus price targets from May to now in the tables above – they've barely moved as noted. What have moved, however, are the upside to target measures, which are now quite substantial. In other words, analysts don't see any impact of note to the Big Four from those global factors behind the correction.

Unfortunately the same can't be said for Australia's poor old investment bank, which was once the envy of the world. With the GFC bringing Macquarie Group's ((MQG)) fund model to an end, the bank must now rely on fees and profits from financial market trading and M&A activity, and yet another global market scare has meant those numbers are still nowhere near to returning to “normal”.

Deutsche Bank believes Macquarie is now looking cheap from a fundamental point of view given the analysts' expectation the group can again boast return on equity levels of 15-20% some time in the future, but right at the moment it seems a fairly distant dream. With talented staff finding better offers elsewhere the once superior Macquarie franchise has become tainted, and the credit ratings agencies are circling on a sniff of blood.

Deutsche this morning slashed its 12-month price target for MQG to $33 from $44 and downgraded to Hold. The thousandaires factory now has a Buy/Hold/Sell ratio of 2/4/1.
 

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article 3 months old

European Sovereign Debt Contagion Continues to Spread

By Tony D’Altorio, Investment U Research
Wednesday, June 29, 2011

Surely, many American investors are bewildered by what’s going on in Europe.

They must thinking to themselves: “Greece, Ireland and Portugal are such small parts of the European economy, what’s the big deal?”

True enough… but the problem isn’t the Greek or Irish economies. The problem centers on their sovereign debt and whether that debt can ever be paid back to their creditors.

And who are Greece’s creditors? Mainly European banks. Banks all across Europe are stuffed to the gills with this paper, which in Greece’s case, is trading at about $0.50 to $0.55 on the dollar.

If European banks are forced to realize these losses, they’ll have insufficient capital to function. They would then need to conduct capital-raising operations from reluctant investors. Or need huge bailouts from European governments, which can’t afford it, in a kind of a vicious circle.

If the contagion spreads to the sovereign debt of larger countries, such as Spain and Italy, the very real fear is that the entire European banking system would become insolvent.

A quick look at the bond markets shows that the contagion has spread from Greece…

- Irish and Portuguese 10-year bonds are yielding over 11 percent.
- Italian and Spanish yields were treading water for most of this year.

But now there are signs that their yields are breaking out to the upside. In fact, the 10-year Spanish bond yield has risen to an 11-year high at 5.66%.

Moody’s Downgrades France’s Three Biggest Banks

These interest rate moves may have prompted the credit ratings agency Moody’s to try to get ahead of the curve last week.

Moody’s said it may downgrade the credit ratings of France’s three biggest banks: BNP Paribas (OTC: BNPQY.PK), Credit Agricole (OTC: CRARY.PK) and Societe Generale (OTC: SCGLY.PK).

Moody’s cited the banks’ large exposure to Greek debt as the reason. French banks are major creditors to Greece, with $53 billion in overall net exposure to Greek public and private debt, according to the latest figures from the Bank for International Settlement.

For example, BNP Paribas had five billion euros in exposure to Greek debt at the end of 2010. Societe Generale had 2.5 billion euros in net exposure to Greek government bonds.

In addition to sovereign debt exposure, Credit Agricole and Societe Generale hold majority stakes in local Greek banks.

- Societe Generale’s 54-percent stake in Geniki Bank gives it 3.4 billion euros worth of loan exposure in Greece.
- Credit Agricole’s Emporiki Bank had $30.1 billion in outstanding net loans at the end of March.

Investors – Watch Out for Spain and Italy…

There are legitimate concerns that any sort of restructuring of Greek debt will adversely affect European banks and the European financial system. The entire conglomerate may be at risk, as was the U.S. financial structure when Lehman Brothers collapsed in 2008.
Greece, Ireland and Portugal will most likely not bring down the European financial system. But a default or restructuring of their debt will be unpleasant for European banks.

But it’s not catastrophic. They should be able to be successfully re-capitalized and continue to be solvent.

What investors need to look out for is Spain and Italy. These are much larger economies and the exposure to their debt is much larger. Problems in these two countries will make the current difficulties look like a walk in the park.

That’s where American investors who are concerned about the turmoil in Europe need to focus. Keep an eye on the 10-year bond yields in Spain and Italy. If they break out sharply to the upside, look out… rough seas ahead.

Good investing,

Tony D’Altorio

Reprinted with permission of the publisher. The above story can be read on the website www.investmentU.com. The direct link is: http://www.investmentu.com/2011/June/european-sovereign-debt-spreads.html

Nothing published by Investment U should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Investment U should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Views expressed are not FNArena's (see our disclaimer).

article 3 months old

The Overnight Report: Almost There

By Greg Peel

The Dow closed up 72 points or 0.6% while the S&P gained 0.8% to 1307 and the Nasdaq added 0.4%.

The 1300 level in the S&P 500 did not provide much resistance as Wall Street rallied for the third session in a row, fuelled by the Greek parliament's 155-138 vote to pass the austerity bill in principle amidst violent riots in Athens. Tonight each element of the package must be individually voted on but last night's win suggests it should be academic from here.

Not unsurprisingly, the vote announcement was first met with some selling from the “sell the fact” brigade. Wall Street had already put in its best two-day move since February on anticipation of a positive result. But the buyers quickly won out once more in a session peppered with various snippets of positive global news.

Yesterday's Asian session saw the release of the Japanese industrial production number for May which showed a 5.7% gain. A positive number was always expected but this represents the biggest monthly jump in 50 years, led by Japanese automakers coming back on line with a vengeance after the tsunami. The result provides concrete support to those who have long been touting the global economic impact of a recovering Japan, and while the magnitude of the May number is unlikely to be repeated, markets can feel confident that the Japanese recovery has begun. The release helped the ASX 200 to a solid gain yesterday.

Economists had expected May US pending home sales to show a 3% gain so an 8.2% jump was met with much enthusiasm, coming off the back of yesterday's surprisingly robust rise in the Case-Shiller house price index. Is the US housing double-dip now over? Well these are spring season numbers so it's a bit too early to get carried away. Wall Street was happy to take it nonetheless.

Last night Bank of America agreed to pay an US$8.5bn settlement to customers screwed over in the mortgage crisis, marking the biggest such settlement in history. It's a decent slug for BofA but represents positive news given Wall Street had anticipated the worst and now the uncertainty is removed. BofA shares are down 23% in 12 months but last night jumped 3% in a generally positive session for the financials.

Late in the session the Fed announced that debit card swipe fees would be capped at US21c, which represents a compromise between the current US44c the banks have enjoyed and the US12c originally touted and backed by retailers. Shares in both Visa and Mastercard quickly went into limit-up trading halts before Visa closed up 15% and Mastercard 11%.

Energy stocks were on a flyer again last night as Brent crude shot up US$3.52 to US$112.50/bbl on the positive Greek vote. Critics of last week's IEA release from the global Strategic Petroleum Reserve at a time when oil was already weaker have been vindicated given oil is now back above the price it fell from on the announcement. Rightly or wrong, the 60m barrel release is not substantial. West Texas rose US$2.18 to US$95.07/bbl.

The dam finally broke to the upside last night on the LME after several sessions of uncertain limbo. Copper led the charge by breaching its recent range and jumping 2.5%. Aluminium gained 0.5% and the others all put in 1-2% rallies.

Commodity prices were assisted by the inevitable rally in the euro – now above US$1.44 – which in turn led to a 0.5% drop in the US dollar index. And the world's favourite commodity currency has had a rocket attached these past two sessions, with last night showing a 1.3% gain to US$1.0681.

Gold met one of those push me-pull you situations, with dollar weakness and recent weakness in the metal itself overcoming the supposed reduction in sovereign risk stemming from the Greek vote. It finished up US$10.50 to US$1511.80/oz while silver surged 3%.

Over in the US bond market, the approaching expiry of QE2 and relief from Greece meant another big sell-off. The US Treasury again struggled to get its auction away, this time US$29bn of seven-year notes, and foreign central banks bought only 32% compared to a running average of 56%. The benchmark ten-year yield jumped another 9bps to 3.12% to mark a rise of nearly 30bps in three auction sessions.

The SPI Overnight gained 31 points or 0.7%.

So what now for Greece? Well apart from still having to vote on the individual components of the austerity bill tonight, in theory Greece will get the E12bn tranche of the 2011 bail-out fund of E110bn which will carry it through to August. While that implies we have to go through this all again one presumes the next tranche will be more of a formality once the new austerity package is in implementation mode. In the meantime, the usual suspects still have to agree on the new 2012 bail-out fund and knowing the Europeans there will no doubt yet be much dithering and deliberating, grandstanding and politicking before we get to that point. Given Germany has backed down on haircuts, French banks have offered to take haircuts of a sort, and the ECB seems determined to raise its cash rate in July, a resolution seems likely.

If this truly is a Groundhog year, Greece will now go out of the spotlight and contagion fears will wane until we'll all meet again around February 2012 and say “Omigod, Greece is about to default!” for the third time. 

And if it's a Groundhog year we should see a second half rally, except that last year's rally had QE2 behind it. The S&P 500 closed at 1030 on June 30, 2010, so it's up 27% while the ASX 200 closed at 4301 so, pending today's trade, it's up a whopping 5%. Gotta love that Aussie.

And let's not forget that the last three sessions on Wall Street have been all about end of quarter window dressing with confidence provided by Greece, albeit ASIC is now vigilant about such activity in Australia which should keep fund managers here a bit more real.

Rudi will not be making his regular appearance on Sky Business today but fear not, for I will be joining the Business View panel tomorrow at 2pm. 

[Note: All paying members at FNArena are being reminded they can set an email alert specifically for The Overnight Report. Go to Portfolio and Alerts in the Cockpit and tick the box in front of The Overnight Report. You will receive an email alert every time a new Overnight Report has been published on the website.]

article 3 months old

Why Money Managers Fail To Beat the Market

By Alexander Green, Investment U’s Chief Investment Strategist
Monday, June 27, 2011: Issue #1543

Here are three easy ways to beat the market: Deception, irrelevance and bad math.

Perhaps some explanation is in order…

It’s a well-known fact that three out of four investment professionals fail to beat an unmanaged index each year. Over the long term, the percentage is much greater.

Yet everywhere you go, investment advisors claim they’re generating superior results. It’s a bit confounding. So let’s take a closer look…

Why Money Managers Fail to Beat the Market

Most money managers fail to beat the market for a number of reasons.

- Some, quite frankly, are inexperienced or inept.
- Others, being human, make mistakes.
- Some find it impossible to beat the market after charging substantial fees.
- And most operate at a disadvantage because they must keep substantial cash on hand to meet redemptions. (And cash is a notoriously poor performer.)

Yet despite these headwinds, many money managers – perhaps most – still claim that they’re beating the market. Are they lying? You be the judge…

Beating the Market’s Isn’t Arithmetic… It’s Geometry…

I once attended a conference where the speaker – a local money manager – claimed that his managed accounts had averaged a 25-percent annual return over the previous two years, an impressive number during a difficult period.
But a member of the audience took issue with his claim. “I invested $200,000 with you two years ago,” he said. “And while you did double my money the first year, the account lost half its value the next. I’m now back to $200,000. So how can you claim a 25-percent annual return?”

Without missing a beat, the speaker wrote out the calculation on the overhead. He showed that when you subtract the 50-percent loss the second year from the 100-percent gain the first, you end up with a 50-percent return. And 50 percent divided by two years is a 25-percent average annual return.

This left many in the audience scratching their heads. He was correctly determining the arithmetic average, a meaningless calculation when negative numbers are involved. What all investors should be interested in – indeed what the SEC now requires funds and registered reps to provide in their literature – is the average annual geometric (or compounded) return. What the money manager was saying, strictly speaking, was true. But it was also meaningless and misleading.

Excluding Dividends and Outperforming the Wrong Benchmarks

Other managers boast of beating the market in a less audacious but still erroneous way: They understate the market’s performance by leaving out dividends.

For example, over the last decade, the S&P 500 has averaged just 0.7 percent annually without dividends. But with dividends it has returned 2.81 percent annually. That’s still no great shakes, but easier for brokers and money managers to beat.

How often is this done? It’s hard to say, but The Wall Street Journal reports that Allan Roth, a financial planner at Wealth Logic in Colorado Springs, estimates that at least 20 times a year he sees “account statements from financial advisors comparing a client’s returns, with dividends, against those of market benchmarks without dividends.”

There’s yet another way – an even simpler way – that money managers outperform their benchmark. They use the wrong one. Fixed-income managers will compare their performance to an equity index. Small-cap managers will compare their performance to a large-cap index. Global equity managers will compare their performance with a domestic index. And vice versa.

Major investment banks have one more trick up their sleeves. When a fund (or managed account) performs particularly poorly, they shut it down or merge it into another one. Poor returning funds? No problem. Just get rid of them.

Past Performance Doesn’t Predict Future Results

Let me state, for the record, that ethical money managers don’t do these things. However, not all firms are ethical. And not everyone at a first-rate firm is an ethical representative. I could tell you stories that would raise the hair on the back of your neck.

So what’s the takeaway here? First, if you’re paying for investment services, know whom you’re dealing with. Examine the printed literature and don’t rely on oral representations. Second, when a money manager states his average annual investment returns, recall the old boilerplate: Past performance really doesn’t predict future results.

And that past performance? You may want to look twice.

Good investing,

Alexander Green

Reprinted with permission of the publisher. The above story can be read on the website www.investmentU.com. The direct link is: http://www.investmentu.com/2011/June/why-money-mangers-fail-to-beat-the-market.html

Nothing published by Investment U should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Investment U should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Views expressed are not FNArena's (see our disclaimer).