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Events surrounding the GFC (Global Financial Crisis) and the actions of market participants and government officials in attempting to deal with the fallout have lead to some creative use of terms we once took for granted and even to some new terminology. It has also highlighted some of the fallacies associated with previously accepted industry terms and doctrine. This week we take a look at some of these terms and what they really mean.
Negative return – a term invented by the Fund Industry for incurred losses. Whilst you may be experiencing a loss of your capital at the hands of a fund manager, to them it is only a negative return.
Negative growth – a recession
QE1 and QEII (Quantitative Easing) – not majestic ocean liners but successive attempts at economic stimulus by the US Federal Reserve bank. The ‘normal’ way to stimulate an economy is to vary the price of money by lowering interest rates thereby encouraging borrowing to stimulate growth and spending. With interest rates at zero %, the only way to do this is to increase the supply of money so banks have more money to lend to businesses and individuals to invest and spend. But, in tough economic times, people are less inclined to borrow, so the money is sitting idle in US banks, and the economy remains sluggish and unresponsive to these stimulus attempts.
Structured product – a meaningless high risk investment disguised as a low risk investment and given a fancy name to give it marketing appeal and lull investors into complacency. A prime example are Collateralised debt obligations or CDO’s. The CDOs offered to investors before the GFC bundled together thousands of mortgages in an attempt to spread the risk of any one mortgage-holder defaulting. The mortgage pool was divided into several ”tranches”, or slices, with varying degrees of risk so they could be sold to investors with different risk tolerances. Many of these CDOs weren’t even mortgage backed investments, but derivative products that mirrored the underlying mortgage vehicles!
A haircut – can refer to the interest differentials charged and paid on Over The Counter (OTC) products like CFDs and Forex, and to reduce debt repayments when there is risk of a total loan default, an example is the huge ‘haircut’ European banks have taken on their loans to the Greek government. Either way, the client ends up with less money.
Buying dips, averaging in or dollar cost averaging – an attempt to defend bad decisions and/or bad advice. The GFC has proved that stocks do not always go up, and whilst a $15 stock may appear cheap at $9 and cheaper at $5, it is still worthless when it ends up at zero. There are many examples of “good stocks” that no longer exist – Babcock and Brown, Centro etc
Buy and hold – the strategy based on a theory that if you hold a stock long enough it will go up in price – refer to the above. It may be years before stock prices regain their pre-GFC highs, if ever for some. It took 25 years for stock prices to regain the losses of the 1929 crash, and Japanese stock prices have still not regained their 1989 highs.
Leverage and hedging – viable and effective tools in the hands of educated and professional traders and investors, financial dynamite in the hands of those who don’t have a full understanding of the use and implementation of these concepts.
Decoupling – relates to economies that have broadened to the point where they no longer depend solely on the US for their own economic growth. This is particularly so for Australia as we appear to be more in tune with China and other parts of Asia than the United States. It hopefully means that a full blown recession in the US will not have as greater impact on the Australian economy as it once would have.
Austerity measures – actions taken by governments of ‘strong’ economies and the International Monetary Fund (IMF) to act as lender of last resort to countries that cannot honour their debt obligations causing investors to lose faith in the country, it’s government, and it’s financial stability. In return for this “bail out” the lender of last resort will demand some measures of constraint and frugality on the part of the government and citizens of the economy being rescued.
From our perspective as active investors and managers of our own funds, we need to treat all of this with a grain of salt. As long as we have our plan and are consistent with the execution of this plan, then the actions of the “wizards” and the hype of the media does not need to impact on us. Our job is to execute our trading and investment plan according to the rules. If we stick to the rules we will remain clear about our goals and objectives over the long term whilst those around us continue to make knee-jerk reactions to every bit of news an opinion that inundates the financial and general media.