After a one-week rebound occurred in late October and early November when it jumped from $27 to $35 (almost +30%), the stock plunged back to unprecedented low levels. The long-term downtrend remains in place, built by the higher lows posted in last December, May and August (points A, B and C on the chart). There is also a medium-term downtrend since the high of August (point C) and goes through the highs of September (point D) and November (point E). This is the immediate resistance line for the price

Click To Enlarge

On the downside, several indicators argue that a further fall may be possible. Based on the 14-day Relative Strength Index (RSI), the stock is not oversold. The MACD has also curved downward and crossed below its signal line last week, on November 12. It’s a bearish signal.

In complement, we can also use the indicator VHF. The Vertical Horizontal Filter (VHF) determines whether prices are in a trending phase or a congestion phase. Typically, the VHF compares the sum of a one period rate-of-change to the range between high and low prices over the specified period.

The problem for many trading systems is their inability to determine if a trending or trading range market is at hand. Trend-following indicators such as MACD and moving averages, tend to be whipsawed as markets enter a non-trending congestion phase. On the other hand, the oscillators which perform well during trading range markets tend to overreact to price pull-backs during trending markets. The VHF indicator attempts to remedy this by measuring the “trendiness” of a market.

There are three ways to use the VHF indicator:

1) The VHF values above or below certain levels indicate the degree of trending. The higher the VHF, the higher the degree of trending.

2) The direction of the VHF can be used to determine whether a trending or congestion phase is developing. Rising VHF indicates a developing trend whereas falling VHF indicates that prices may be entering a congestion phase.

3) The VHF as a contrarian type indicator. Expect congestion to follow high VHF values. Low VHF values may indicate a trending phase will soon follow.

Here it is interesting to note that the VHF has started to rise the same day the MACD triggered its bearish signal. It means that it has confirmed the generation last week of a bearish trend which duration may depend on the level of overselling in the market. A VHF rise above 40 would indicate that the trend is near its end.

In this scenario we can expect a lower move before a potential congestion phase and eventually a rebound. A target of $19.7 is possible as it corresponds to 4% further decline, which is the objective for the broad S&P/ASX 200 before it reaches its main support level.

Question 1. What do you get when you own shares in BHP Billiton?

Question 2. What do you get when you own shares in Woolworths?

Question 3. What do you get when you own shares in Qantas?

Answers, in order are - a mining company, a supermarket company, and an airline.

Admittedly it is not quite as simple as that. BHP mines all sorts of different things such as iron ore and coal, and it even drills for oil.

Woolworths sells thousands of different products in its supermarkets from cleaning fluids to dog food to fresh vegetables.

And Qantas for the most part gets its passengers safely from one city to another in aeroplanes.

But all three have something in common. You don’t need to be an expert in mining, supermarkets or airlines to understand what the company does and how it makes its money.

We do have a bonus question that may be a bit harder to answer. But see how you go anyway.

Question 4. What do you get when you own shares in Macquarie Group?

Well, to be fair, you would have been pretty unlucky not to get this one right because it seems that Macquarie does everything. This morning Macquarie released its first half results. The highlights were a 43% drop in profits, and a huge increase in write-offs - sorry, write downs.

But that doesn’t answer the question about it does. So let’s go through a list of some - but not all - of the businesses that Macquarie Group is involved in and where it invests shareholders money:

Brisbane Airport, London City Airport, Belfast City Airport, Pennsylvania Turnpike, Thames Water, APRR toll road in France, Arqiva, European Directories, M6 Toll road, Wales & West Utility, 407 ETR toll road…

… but wait, there’s more - Copenhagen Airport, Sydney Airport, BrisConnections, Spirit Finance, Macquarie Goodman Asia, Macquarie Office Trust, Macquarie Leisure Trust, Mortgages in Australia, US, Canada and Italy…

… and not forgetting bonds, hybrids, CDOs and other derivatives.

In fact Macquarie owns a share in over 800 assets worldwide. That’s more than the mines owned by BHP, more than the supermarkets owned by Woolworths, and more than the aeroplanes owned by Qantas.

Plus it makes money with its broking and advisory division. In a nutshell, Macquarie Group is an active managed fund. One where it buys up a bunch of assets to either own directly, indirectly or to on-sell as a structured product. And naturally it isn’t doing all this for love, it charges a management fee to manage those assets.

So if we look at an investment in Macquarie the same way as we would look at an investment in a managed fund it turns out investors may not be getting quite as good a deal as they think.

The market capitalization of Macquarie is $5.7 billion. This represents the total value of shareholders’ funds. The total expenses incurred by Macquarie during the half year was $2.2 billion, which if we annualize that equates to around $4.4 billion.

Even if we are kind and value the Macquarie fund on its net asset position it still only totals $10 billion.

So if we put it this way, if you had a lazy $10 billion to spare, would you spend it all on Macquarie Group knowing that the expenses (or MER as they call it in funds management) worked out to about 44% per annum?

Inexplicably, the market has loved the first half result this morning with the shares trading up by 13%. From what we can see, an investment in Macquarie requires a helluva lot of running just to stand still.

As a result, this disequilibrium generates several consequences, where the most important one is of course the severe decline in prices since last July.

At the beginning of the year, the stock was of 929,000 tonnes of aluminium on the London Metal Exchange (LME). As the offer increased but the demand slowed, the current stock is now above 1,600,000 tonnes. It’s a surge of 72% in 11 months.

The production margins are very tight now. Between 30 to 50% of the costs are energetic as producing aluminium is highly-consuming in electricity. Currently, the average cost to produce one tonne of aluminium is around US $2,000. As the price on the LME is now below $1,900, it means that the industry experiences large difficulties as 40% of the aluminium producers are not profitable anymore.

Consequently the production decreases now, and factories close regularly. For instance, Alcoa, one of the biggest players in the world, has reduced by 15% its production. The Chinese Chalco has also reduced its capacity significantly. China is the biggest producer in the world, and is a huge exporter too. The slowing economic growth over there could impact even more the aluminium market.

The experts expect that around $50 billion of investments will be delayed in 2009. With the growing inventories, the bear market is likely not over yet.

Click To Enlarge

Technically, aluminium prices haven declining continuously for 4 months now. The original bullish trend started in July 2005 (point A on the chart) posted a high in May 2006 (point B) and more recently in July 2008 (point C), just below $3,300 a tonne. Points B and C built a long-term “double-top” pattern which is a trend reversal signal. The key support around $2,300, which is the 61.8% Fibonacci ratio of the bull market occurred between points A and B, was cleared in early October. It was a signal for a further decline. The current price is now around $1,870 and the next potential support is set $100 lower, at $1,770 (dash line).

Since the high of July at $3,291, prices fell by 43%. The immediate resistance is the 20-day moving average (in red) where the price action failed in late October when it started to bounce back. A complete retracement towards $1,675 (level of point A) is expected and build a “double-bottom” pattern therefore a basis for a rebound.

Good Investing,

Gabriel

The LME has only been quoting prices for steel since the middle of this year so the historical data is limited. However, if we can use the Steel price as a proxy for the price of iron ore we can see that it is enough to make Marius Kloppers choke on his biltong.

The Weekend Australian reported that BHP Billiton expects $920m in iron ore losses. Oops! This puts it in the same boat as Rio Tinto [ASX: RIO] and Brazil’s CVRD.

The Dow Jones Newswire service gained confirmation from BHP that it has been in talks with Chinese steel mills “over the possible deferral of some contracted iron ore shipments.” Despite this troubling news the company was at pains to point out that this would have no impact on production levels.

Back to the Weekend Australian report, the paper spoke to BHP’s chief commercial officer Alberto Calderon. We are glad it wasn’t us speaking to Mr. Calderon, because based on his comments in the article he sounds a sensitive on the issue.

He told the paper, “I am adamant you don’t cut production - there’s no reason for a low-cost producer to cut, and this has nothing to do with the EU.” Alright, alright, we believe you.

He went on, “If you make money and you are investing a lot of capital, you don’t subsidise high marginal-cost producers, who you see in China dramatically reducing (output) right now.”

This development in the iron ore market comes only two weeks after Mount Gibson Iron [ASX: MGX] had to sign new offtake agreements with two Chinese firms after three of its customers had defaulted on agreements. Shares in Mt Gibson Iron have slumped from about $1.50 in early October to 32 cents at the close on Friday.

And as for the company which until a few months ago had a larger market capitalization than ANZ Bank [ASX: ANZ], Fortescue Metals [ASX: FMG] has had to deny rumours the China Investment Corp (CIC) is interested in a minority stake in the company.

The market cap of Fortescue now sits at just $5.3 billion, well below the $30 billion it reached during the middle of this year, when CEO Andrew Forrest briefly became Australia’s richest man.

Now a minority stake of say 10% in Fortescue is only likely to set CIC back around $500-600 million. A drop in the ocean for the sovereign wealth fund that holds over $200 billion worth of investments.

The Last of a Dying Breed
Tomorrow Macquarie Group [ASX: MQG] releases its interim profit results. But it doesn’t look as though it will be the usual love-in for Macquarie, its staff, and the analysts that cover it.

Gone are the days when the bank was lovingly (not quite) referred to as the Millionaires Factory. Now the only millions that the market is interested in are the millions that have gone down the toilet in its funds. And more importantly for many, what impact this will have on Macquarie Group itself.

Last week Macquarie shares closed at a 5-year low of $22.73. That is around a 77% fall since the middle of last year. But at least it has fared much, much better than the upstart Macquarie wannabes.

The only one left worth mentioning is Babcock & Brown [ASX: BNB] which has sunk to its own woefully low levels. Last week it closed at its lowest ever level of 48 cents.

Macquarie still has quite some way to go before it gets as low as that. But it is very close to a key support level at $20 per share. After that, from a technical perspective, you’re looking at potential drop below $15. We’ve asked the Swarm Trading Gabriel Andre if he can take a proper technical look at Macquarie Group in tomorrow’s Money Morning.

We can only sympathise with the executives at Macquarie who face a tough uphill battle to get their executive options back in the money. Those issued in 2006 and 2007 have exercise prices at $61.79 and $71.41 respectively. And they only have a five year time frame to exercise them before they expire worthless.

Even options issued to executives this year will most likely not turn into the bonanza they once were, when the share price traded between $40-$50.

Which brings us to another final point on Macquarie. It’s probably about time they updated the chart on the shareholder section of the website. The last chart they have is for December 2007 showing a mightily impressive return compared to the All Ordinaries.

However, it may not be quite so impressive if they were to do the comparison now.

Maybe they will leave the old chart there for a while longer.

Cheers.

Kris.

The only sector of the market we have been cautious on is financials. The banks especially. But now we are tempted to start whistling a different tune.

It’s risky because the Australian banks are not out of the woods yet. In fact some of them are only just starting to admit they have been hiding in the woods. Commonwealth Bank [ASX: CBA] springs to mind.

And we also shouldn’t forget that ‘being too big to fail’ is of no comfort to shareholders. You only have to look at Northern Rock in the UK. The bank was nationalised to protect depositor’s funds, yet shareholders saw the share price fall to zero.

And there could be worse to come for the banks. In his address to its annual general meeting, CBA chairman John Schubert told shareholders “it will be some time before the critical element of confidence is restored and recovery in the broad economy commences. We therefore remain cautious about the general outlook for the economy for at least the next 18 months.”

That is hardly a ringing endorsement for a more bullish view on the stock market. As we write the Dow Jones Industrial Average has gained by 6% this morning and the Australian market looks certain to open higher.

That doesn’t necessarily mean that it will only go up from here. But it does add some weight to the argument that the market is settling into a trading range. And it is starting to look like this is as low as it’s going to go.

We only hope we don’t get our fingers burnt.

When a Rating is Not a Recommendation

Yesterday the Treasury and ASIC released a joint report. It wasn’t on short selling, it was on a “Review of credit rating agencies and research houses.”

To be honest, we were quite staggered to find out that the three credit rating agencies that operate in Australia - Standard & Poor’s, Moody’s and Fitch are not required to have an Australian Financial Services License (AFSL).

As a bit of background, any organization that is offering any sort of financial service, especially if it is offering advice, is required to have an AFSL. Port Phillip Publishing has an AFSL as we offer general advice through our newsletters - Australian Small Cap Investigator and Diggers & Drillers.

However, for some reason the ratings agencies have been exempt from this provision. The report states that because ratings agencies do “not typically include a recommendation to ‘buy’, ’sell’ or ‘hold’ a financial obligation” and that a credit rating “is not an opinion about an obligation’s value”. So the agencies don’t need licenses.

To us that appears to be an extraordinary standpoint. It is correct that a credit rating does not give an explicit recommendation. Butit does give implicit advice on how secure a company is.

You only have to look at recent history with AIG in the United States. When the ratings agencies downgraded AIG the immediate reaction by stock holders was to sell. The credit downgrade cast doubt on the ability of AIG to meet its obligations.

In effect a credit downgrade to such a degree can be viewed the same way as a research house changing their view from ‘buy’ to ’sell.’

We are sure the agencies won’t kick up too much fuss, they are probably just grateful they got away with it for so long.

$2.8 Billion in Revenue and Nothing to Show For It

While the share market was plummeting to earth over the last couple of days, at least one stock was bucking the trend. Asciano [ASX: AIO]. Earlier this week it fell from $1.75 to 50 cents. In the following two sessions it has recovered most of that ground to close at $1.50 yesterday.

On Tuesday, broking firm Citi cuts its price target on Asciano. It previously had a buy recommendation and a target price of $6.08. As of Tuesday this changed to a sell and a target of 82 cents.

The gist of the research from Citi is that Asciano has too much debt . Not only that , but its earnings are likely to be impacted in a slowing economy.

The sucker punch though was the comment in the first paragraph of the report which said “the stock is worthless.”

Ouch! No wonder the price fell out of bed.

So, is it all doom and gloom for Asciano? Or does the quick price rebound qualify it as one of our ‘Bounceback Belters’? Our first cautionary note is not to forget what happened to Babcock & Brown [ASX: BNB].

If you recall, back in September the B&B share price slumped from $2 to about 70 cents in a matter of days. In the following couple of weeks it clawed its way back to $3. Part of that was thanks to the introduction of the short selling ban. Surely it would be plain sailing now without the evil short sellers around. Now everyone could focus on the fundamentals of B&B, which everyone had told us were sound.

Not that we believed them.

Well, it turns out that the market did focus on the fundamentals. And it turns out those fundamentals were just plain mental. Since then the share price has re-slumped back down to yesterday’s closing price of 55 cents.

As we take a look through the Asciano annual report - all 152 pages - we see that for the last financial year it had a financing expense of $401 million. That’s thanks to loans exceeding $4.6 billion.

A further look at the balance sheet doesn’t paint a pretty picture at all. Total assets of $7.4 billion, which includes goodwill of $4.3 billion. How much will that be worth if the company is put through a fire-sale? Not $4.3 billion is our guess.

The income statement (or profit and loss for us old timers) isn’t much to shout about either. The profit before financing costs was only $422 million, so if you take out the financing costs and a bunch of other things the company had nothing to show for $2.8 billion of revenue.

Asciano may have been a bargain at 50 cents for a short term trade. But anyone thinking it is still a bargain at $1.50 shouldn’t be surprised if it pays a visit back to 50 cents in the near future.

“$2 company has new meaning” reads the front page story. It tells us that 48 of the S&P/ASX200 companies are trading for less than $2. We did a similar check on the S&P/ASX100 index yesterday. Fifty-three of those companies are trading for less than $5.

Of course the actual dollar value of the share price is not always significant. The market capitalisation of the company is more relevant. But it’s certainly a far cry from the euphoria of last year. Remember when pundits were jumping up and down with excitement trying to pick which Australian share would be the first to break through the $100 barrier?

Leading the charge was Macquarie Group, CSL, Rio Tinto and Perpetual. Where are they now?

The chart below tells us the story.

From December 2006 all four of them led a charge towards the $100 level. Then October 2007 came along and spoilt the party. Since then, as you’re no doubt aware, the share prices have plummeted.

As of yesterday Rio Tinto was $75.20, Macquarie was $26.95, CSL was $36.95 and Perpetual was $35.26.

Templeton’s $1 Stocks MkII

But back to our original premise.

Company share prices are getting smaller and smaller by the day. Market caps are falling. In fact, some of the companies that used to be blue chip are now targets for inclusion in our Australian Small Cap Investigator report. More on that later.

You may have heard this story. In 1939 US investor John Templeton bought $100 worth of stock in every New York Stock Exchange listed share that was trading for less than $1. So the story goes, there were 104 companies that he invested in with 37 of them in bankruptcy.

Three years later he was in profit on 100 out of 104.

Unfortunately we don’t have the time or space to do the analysis on every share currently listed on the NYSE. So here’s what we have come up with. After taking into account inflation, 1939’s $1 is now the equivalent of $14.78.

The NYSE now has 3,619 US companies listed, which is double the amount listed on the Australian Stock Exchange (ASX). But it doesn’t include listings of overseas companies - or the thousands more that are traded on the NASDAQ.

So, how many companies are trading on the NYSE for less than USD$14.78? It would be a lot, so we won’t bother counting. But if we look at a narrower range of stocks, say the S&P500 it tells us the following story.

Of the 499 companies in the S&P500, a total of 142 are trading at the inflation adjusted equivalent of less than a Templeton dollar. And they aren’t all Mickey Mouse companies either. There are some big names in the mix: Western Union, Sara Lee, New York Times, Morgan Stanley, Motorola, Mattel and Intel.

To make the equivalent investment to Templeton, an investor today would need to stump up around USD$210,000.

As for the Australian market. We’ll be writing about that in the next Australian Small Cap Investigator which is due to be released next week.

Cheers.

Kris.

Obviously having a domestic manufacturing industry is important. And it is preferable that it is an Australian business so that investment and profits remain on shore. If that isn’t possible then the next best thing is for foreign businesses to invest in Australia. At least that way it creates jobs for the economy which means employees will spend their wages domestically.

The third option is that the manufacturing is done offshore and delivered to Australian distributors who then mark up the price for a profit so then again at least some of the profits remain on shore.

Finally - and this has increased thanks to the internet - products are manufactured and sold from offshore direct to the end consumer in Australia. All money flows out of the Australian economy into a foreign economy.

But, that is what happens with free markets. And that is why you see in developed economies the shift towards service based industries which are much harder to move offshore.

The government throwing $6 billion at the three local car manufacturers is going to have next to no impact on the viability of the companies. Especially Ford and General Motors.

GM and Ford on Life Support

We wondered yesterday why anyone would bother investing in the likes of GM and Ford. As we noted, GM has revenues of about USD$180 billion. Yet it cannot turn a profit.

Investors usually look at either capital growth or income when choosing an investment. Or sometimes a combination of the two. What growth opportunities does General Motors have? It has been losing market share gradually for the last twenty years to the Asian auto manufacturers.

What income potential does it have? At the moment it looks pretty good. It is paying a USD$1 annual dividend which at the current share price gives it a 23% yield. We don’t need to tell you that means there is a lot of risk built into that yield.

Will the dividend be saved? Of course not. Not if we look at what has happened to other companies caught up in the current financial problems. The dividend is the first thing to go. For GM it will probably involve shareholders losing everything as it goes into chapter 11 bankruptcy protection.

One of its biggest problems is the underfunded pension liability, which if GM does go bust will probably leave the fund even further in the red and require an even bigger bail out by the US government. How so? Well, typically company sponsored pension funds will invest a big stack of the fund in the company’s own shares. Nothing like not spreading the risk around!

We do remember a few years back during our previous incarnation as a stockbroker when a client decided he would like to invest $10,000 in each of Ford and General Motors. The rationale being that the government wouldn’t allow them to fold and go out of business and that in twenty years they would come good.

Fortunately we managed to talk him out of it on the basis that GM and Ford may continue to produce cars but it doesn’t mean that the shareholders would still be in the game. You only have to look at the US airline industry to see that.

Short Selling Debate to Go On, And On, And On…

The short selling debate continues to drag on. Now the federal opposition wants to have a full scale review according to the Australian Financial Review. We won’t rehash completely our views on this, but thanks to the government, ASIC, ASX, investor groups and now the opposition, a simple and logical solution is being caught up by indecision and red tape.

The restriction on short selling is supposed to be lifted next week with the exception of financial stocks. Those will remain restricted until January.

We seriously wonder whether the restrictions will ever be lifted or whether it will just go on indefinitely with everyone hoping that it gets forgotten about. Short selling is predominantly the realm of sophisticated and institutional traders and so there will be zero political fallout for any of the protagonists if the restriction is not lifted.

In fact it creates a great opportunity for them to argue they are looking after the ‘battlers’ by preventing the ‘big end of town’ from driving the market down.

Of course they will forget to mention that the market has fallen significantly since the restriction came into force anyway.

Cheers.

Kris Sayce

US bails out economy - Bad.

Europe bails out economy - Bad.

China bails out economy - Good.

Well, not quite. For a start, the AU$849 billion ’stimulus package’ proposed by the Chinese sounds like a lot of money. And it is. It is more than the US government is spending on its TARP initiative to bail out the credit market.

But at least the Chinese money might be spent on something useful. The US government is spending nearly the same amount just to buy dodgy debt.

The one thing we don’t know about this package is how much of the USD$586 billion is additional money to what had already been promised.

For instance, back in July US investment firm Merrill Lynch estimated Chinese infrastructure spending to be USD725 billion per year over the next three years. Sure, things have changed a bit since July, but there is no evidence yet that this is entirely new money.

Even so, it is still significant. So if we suppose the USD586 billion is added funds then it will likely take Chinese infrastructure spending to north of USD$1 trillion per year.

The upside is twofold. First it is being spent on things that country needs. Second, if it wants to, China can pay for it in cash, unlike in the US, Europe and now Australia where ’stimulus’ packages will have to come from debt.

And then we have the Australian government version of a stimulus. Give the money to a basket case industry and hope for the best.

The one positive about the hand-out to the three Australian based car manufacturers is that it involves them spending $3 to get $1 of government funding. To be honest, we’re not sure that is likely so the taxpayer’s $6 billion should be safe.

The automotive industry in Australia employs about 60,000 people directly and up to another 200,000 in related industries. It is a big employer. But does it warrant special treatment by the government on this basis alone? We don’t think so.

Our guess is that government’s view vehicle manufacturing the same way as they view national airlines: a ‘badge of honour.’

General Motors to be Worth Zero

We aren’t the only ones who think the $6 billion investment in car manufacturers is a waste of money. Deutsche Bank has downgraded shares in General Motors to… $0. That’s ZERO.

Barclays Capital doesn’t think much of the future of GM either. It has put a $1 price target on the company. That’s a long way from the stock’s price of $3.36 this morning. It’s an even longer way from GM’s all-time high of over $90 in early 1999. It doesn’t matter whether these analysts are right or wrong. But they sure think car manufacturers make a lousy investment.

You only have to look at the last financial statements for GM to see what a hole it is in. For the last financial year GM generated revenues of USD$181 billion. It made a net loss of USD$38 billion. In other words, it made nearly four times as much revenue as BHP Billiton. The difference is that BHP made a profit of USD$15 billion.

Surely if governments were interested in investing taxpayer money they should do it in a business that can make a profit.

B&B - Will it Survive?

We haven’t mentioned it in a while, but things don’t seem to be getting any better at Babcock & Brown [ASX: BNB]. It has turfed out some - not all - of its old management, and is desperately trying to offload some of its satellite funds.

Or maybe the funds are trying to get rid of B&B. We aren’t completely sure which party is the most desperate.

Now B&B can hear the sound of the death rattle from the ratings agencies. Standard & Poor’s has downgraded the company’s credit rating to ‘BB’ due to the “impact of the financial market dislocation on the pace of asset sales required for BBIPL’s debt reduction plans.”

This morning the B&B share price is down by 26% to just 55 cents. There must now be a serious question about whether it can survive…or whether it will go the same way as Allco Finance and ABC Learning.

Cheers.

Kris.

For the year it had total expenses of $1,057,400,000. Those expenses helped the company to generate revenue of $1,106,900,000. After tax ABC Learning achieved a profit of $37 million. In other words a 3% profit margin.

So based on these numbers the company could eat through the government support money within about 10 days. In reality it won’t as we are sure it will still achieve some revenues of its own.

But is there any guarantee that taxpayers will get any of that $22 million back? If so then it will be at the expense of other creditors to the company.
Federal Department of ABC Learning
Which is more important in the current economic conditions? The government being seen to ‘do something’, or allowing private enterprise to take advantage of market conditions.

Based on the evidence of last Friday it is the former. As you may have read, the federal government is tipping $22 million of taxpayers’ money into a failed private business. To be fair, it isn’t much. It is only a few dollars for each taxpayer.

But there is a bigger problem with it. First, does it represent the beginning of the beginning for government sanctioned bail outs? We’ve seen in the US how once the flood gates are opened, there is no stopping it. Remember the USD$700 billion Troubled Asset Relief Program (TARP) which was supposed to provide liquidity to credit markets? Now it seems as though it will be providing relief to Ford, General Motors and Chrysler as well.

Just as important is the message it sends to other businesses. What about all those successful child care centres out there? Many of them are run on a for-profit basis, and many are run on a not-for-profit basis. Most of them have not gone through with a stock market listing, and they have not put themselves into hock in order to go on a frenetic domestic and international expansion programme.

Instead they have grown their businesses responsibly and have provided a reliable service to the community. Their reward for running a good business? They now face competition from the new government backed ABC Learning Centres. Of course, they had competition from ABC before, but now they are being denied the opportunity to take on new business from ABC centres that would have closed, plus they are being denied the opportunity to potentially buy these centres at bargain basement prices.

The argument from government is that they are helping working families. The reality is that they are helping to save the bacon of a failed business.

NABs $4 Billion Cash Grab
We are still yet to be convinced by anything coming out of the banking sector. Last week we were treated to the admission by the major banks of their exposures to ABC and Allco.

At the start of this week we have the National Australia Bank raising $2 billion to “strengthen further its capital position.” This amount is approximately the same as the amount raised during the previous six months from the dividend reinvestment plan (DRP).

Importantly, it shows a big change in the bank’s capital position between 2007 and 2008. During 2007 the NAB did not issue new shares for its DRP. Instead it effectively used the dividend cash to buy shares from the market to give to the shareholders. Evidently the bank did not need to ’strengthen” its capital position at that stage.

In 2008 it has been a different story with the bank already issuing about $2 billion of new shares for the DRP. The effect of issuing new shares is that it retains the cash that it would have paid out in dividends while diluting the value of existing shares in issue.

Now it is raising at least another $2 billion from institutions. With the NAB market capitalization now at $38 billion that represents 10% of the bank’s value that it has needed in cash from the market this year.

Do we still think Australian banks have come through this market unscathed?

Cheers,

Kris

But what we do know is the Australian Securities & Investment Commission (ASIC) has taken him to court for short selling. To be more precise, for naked short selling. You see, what Mr Spagnolo did was sell shares that he did not own. Furthermore, he didn’t borrow the stock from anyone in order to deliver it on settlement. That is what makes it a naked short sell.

We don’t know the full details of the case other than what is on the ASIC website:

“ASIC alleges that between 28 May and 24 October 2007, Mr Spagnolo sold shares and options that he did not own, contrary to Section 1020B(2) of the Corporations Act, in a practice known as ’short selling’… Mr Spagnolo applied for shares and options in capital raisings by the companies. Before they were issued, he agreed to sell them on the stock exchange. Mr Spagnolo failed to deliver the shares and options on the due date for settlement.”

The problem as we see it is that Mr Spagnolo appears to have done exactly what large institutions do as a matter of course. The main difference is that the institutions are permitted to do so while the private investor is not.

The underwriter of a share issue can short sell stock in advance in order to reduce their exposure if they are left holding stock from a public offering or a placement. Yet it appears that private investors cannot do the same thing.

We wonder if this is the best way to tighten up the rules on short selling. We don’t think it is. There is a much simpler solution that could be easily implemented.

ASIC and the ASX should just follow the same system that operates in Hong Kong.

In Hong Kong investors must deliver stock to the exchange on the settlement day otherwise it triggers a ‘buy-in.’ That means if you want to short sell you must borrow the stock and deliver it to the exchange. If you don’t then the exchange automatically buys the stock back for you, thus closing out the trade.

It is a simple and effective way to almost eradicate naked short selling. It would not be difficult for the ASX to do the same here. It is just a case of whether they have the will to do so.

Are You Scared Yet?

Do you have kids? If yes, you would know all about the perils of any car journey longer than 20 minutes. Before long the question “Are we there yet?” begins and is repeated ad nauseum at regular intervals.

We could ask the same question to the stock market on whether it has bottomed out yet. And we could also ask a variant of the question to investors - “Are you scared yet?”

In what has become a bit of a cliche, Warren Buffett tells us to be “greedy when others are fearful.” In other words, start buying up stocks when the prices have slumped and most investors are running for the exits. As we write, the S&P/ASX200 is down nearly 140 points.

But how fearful do you want others to be? At the moment they are looking pretty fearful to us. Perhaps they can get even more so. Or maybe things will start to get better from here.

The main thing to remember is that markets tend to over-react on the upside and the downside. There is a lot of negativity in the media about recessions and job losses and companies going bankrupt. So surely all of this is already priced into the market, plus a bit extra for good measure.

Even so, it takes a big set of courage to run against the crowd. We have been bearish on the market for the last couple of years. Until a few weeks ago that is. Now, even though everything around us is looking bleak we can’t help but think that the market is offering up some pretty good bargains at the moment.

We are so confident of it, that we are planning to launch a new investment newsletter that will search for the best bargains across the whole market, not just the small caps. Look out for more details in the next few weeks.

Cheers,

Kris