18 Nobel-Worthy Insights from My Conversation with Dr. Joseph Stiglitz: Asian Financial Forum 2012, Part 3

ASIAN FINANCIAL FORUM 2012 SPECIAL

Dr. Stiglitz and veteran news personality Lorraine Hahn. Photo taken with my crappy cellphone camera which doesn't give Ms. Hahn's extraordinary beauty justice

A quick run through for insights 1 to 9:

1. Everyone's spooked because China's growth in 2011 was just 8% to 9%.

2. All eyes on Asia.

3. What a 0% savings rate really means.

4. What is saved in Asia should stay in Asia.

5. What "savings glut"?

6. Breaking something that ain't broke.

7. A case of diversification making things worse.

8. The problem with too-big-to-fail banks is that they are too big to fail, and everyone knows it.

9. The reason why we still haven't achieved transparency for complex financial products like credit default swaps and other financial derivatives is that that is how these people make money from these things.

And now for the much awaited continuation of this special series...

10. Restoring confidence in the US economy is a matter of green shoots turning brown. Economic recovery cannot be achieved with just a speech--especially if the facts disagree with what you're saying. For example, one oft-cited statistic is how unemployment has gone down from 9-point-something to 8-point-something percent the last time someone counted. Experts have interpreted this "dent in unemployment" as a sure sign of US economic recovery. But if you take a closer look at the numbers, the main reason for the decrease in the metric is that some people gave up looking for a job, so technically they don't count as unemployed anymore. The sad reality is that one out of every six Americans who want a job cannot find one...

11. One way to bring about economic recovery in the US is to restructure the economy and focus on increasing real productivity. That is to use less resources for the same output, particularly in agriculture and manufacturing.

12. Debt should be the least of the US's worries, if only because interest on US debt is very low at almost zero for short term debt and 3% for long term debt.

13. Austerity is to the economy as "blood letting" is to a sick person in the middle ages (or in Westeros, just ask the Boltons - IJ); as blood is drawn from the sick person, he or she gets worse, and medieval doctors respond with, wait for it--more blood letting! In other words, "austerity" or slashing spending will only make things worse for the American economy. At least until the poor soul finally dies. What the US should do instead is take advantage of low interest rates and invest in more value-creating projects, which are often just right under everyone's noses. Also, raising taxes and increasing spending actually increases GDP more than any austerity plan--if only it weren't for some genius politicians...

14. The end of the euro? Maybe we should not be so surprised. When the Eurozone was formed, economists were skeptical of whether or not it will prosper. Why? There's actually some sort of checklist for when it's appropriate for a group of countries to adopt a single currency. Guess what? These Eurozone countries did not satisfy these criteria.

15. Ratings agencies only contribute to the woes of Europe and the rest of the world. It is their moral responsibility to ensure that complex financial products are as transparent as possible. Unfortunately for all of us, in this case the "less moral" has outbid the "more moral", as is almost always the case.

16. Asia is in a good position to play an important role in the drive for global economic recovery. We cannot insulate ourselves forever; fortunately, when there's a need, we are capable of responding with policy in a timely manner. Also, since there's still a vast, undertapped domestic market in many parts of the region, growth is still possible. It definitely won't be easy, and it would only work with constant vigilance.

17. Where's China in all of this? Domestic spending should increase, and savings go down. Not for households, though. With higher wages, they should be able to maintain an ample savings rate and spend more at the same time. The Chinese should not go overboard with consumption, though. If China follows the US's patter of consumption (recall: a whopping 110% of income spent), then we are all doomed.

18. The issue of income inequality is not the politics of envy, as what many right-wing politicians declare in their speeches. More and more Americans are getting worse off year after year. One would find income inequality on other parts of the world, yes, but different. China may have more inequality if one uses a measure like the GINI coefficient, but for many Chinese poverty has been greatly reduced--and that's a good thing. And this difference suggests that the "degree of inequality" may not be as important as the "equality of opportunity", which is very lacking in the US where there are now very few opportunities for a great majority of the population to move up in the world. 

If only all economists were like Dr. Stiglitz... or, at least, if only world leaders listened to economists who think and reason as he does... We would be living in a very different world, where green shoots grow and bloom and don't turn brown very quickly--I think.

18 Nobel-Worthy Insights from My Conversation with Dr. Joseph Stiglitz: Asian Financial Forum 2012, Part 2

ASIAN FINANCIAL FORUM 2012 SPECIAL

Photo courtesy of Val Roque

Well, if you want to be strict about it, it wasn't really a conversation, although I'd like to think of it as one.

Dr. Joseph E. Stiglitz is a Professor of Economics at Columbia University and former Chief Economist of the World Bank. In 2001, he received the Nobel Prize for Economics for his pioneering work on the consequences of information asymmetries (the basis of a popular capital structure theory, if my finance students would recall). He was the keynote speaker for the second day of the 2012 Asian Financial Forum, where he talked about a diverse range of topics--from how the "slower" growth of China in 2011 is not really so bad if you think about it to the Occupy Wall Street movement and inequality in the US. After his address, there was a one hour "open dialogue," which was basically just a Q&A, where I got to have "a conversation" with him (I fielded the first question from my front row seat :)). In this post, I will share some Nobel-worthy insights from Dr. Stiglitz, ideas that are definitely worth hearing and will hopefully make us think deeper about things that are going on around us.

1. Everyone's spooked because China's growth in 2011 was just 8% to 9%. Thirty years ago, people didn't even think that that kind of growth was possible. Get a grip, people, there's no need to worry. First of all, a big part of that "decrease" in growth was just caused by a change in the way things are measured, so it's not really a decrease. And even if China's growth has indeed slowed, it's all well and good because at least now this growth is more sustainable.

2. All eyes on Asia. In the 1820's, Asia's share of global GDP was 45%. Since then, with the onset of colonialism and unfair trade agreements, that share plummeted to under 10%. So we can just interpret the recent rise of Asian economies as a "rectification" of a 200-year anomaly.

3. What a 0% savings rate really means. Yeah, so that's the current average savings rate in the US. But take note that that's an average figure, and that rich Americans--the so-called "1%"--actually do get to save a bit, somewhere around 5% of their income. So how do we get to zero? The gap is accounted for by how the "bottom" 60% of Americans spend 110% of their income, which is basically a savings rate of negative 10%. That means around 190 million Americans spend more than they earn and live off debt, which may make sense if you take into account that debt in the US is actually very cheap (at least up to 2014, if the Fed is to be believed). Sadly, that "cheap" debt is actually financed by the savings of hardworking Chinese and other Asians...

4. What is saved in Asia should stay in Asia. The average savings rate in China is 50%. China is the world's largest saver and second biggest economy. Doesn't it make sense then that we manage these funds in Asia instead of anywhere else? Before 2008, Asian savings were "transferred" to the US and Europe and placed in the care of big multinational financial institutions for professional risk management, and just transferred back to Asia whenever there's a need for the funds (at a hefty commission, of course). 2008 happened, and everyone now knows how good these US and European institutions are at managing risk. Not.

5. What "savings glut"? That's what the Fed says, that's its explanation for what's been happening since 2008. But how could there be a savings glut when we see a lot of savings needs around the world, particularly in Asia. If you want to point fingers, point to how these these funds were mismanaged, particularly at how Asian savings were basically just used to finance a housing crisis and two expensive wars in the past decade.

6. Breaking something that ain't broke. For four decades after the Great Depression, financial regulation worked in the US. Then these geniuses who were supposed to overlook financial institutions for the general public came up with the idea of deregulating financial markets. So all the finance talent focused on developing "innovative" financial products that made a lot of money, yes, but led to no real productivity whatsoever.

7. A case of diversification making things worse. Diversification is supposed to make things safer by spreading risk among many "baskets": when one basket falls, at least there will still be some eggs left. Maybe this was the rationale behind letting financial institutions spread their reach to various continents around the world. Unfortunately, instead of spreading risk among a bunch of baskets and making things safer, everything just became connected to everything else, forming one global electric grid where if one part fails, everything goes out.

8. The problem with too-big-to-fail banks is that they are too big to fail, and everyone knows it. And this distorts financial markets since everyone now would bend over backwards to accommodate these banks, even if their demands are unreasonable or at least not supported by market forces.

9. The reason why we still haven't achieved transparency for complex financial products like credit default swaps and other financial derivatives is that that is how these people make money from these things: by making everyone, sometimes even themselves, completely ignorant and unaware of what's really going on.


I still have pages and pages of notes to make sense of, so I guess insights 10 to 18 will have to wait till Part 3 on Tuesday.

Do Mutual Funds Have a Tax Advantage Over UITFs?

DEAR INVESTOR JUAN

Dear Investor Juan

You didn't mention the tax on mutual fund vs uitf

In my case, Im comparing metrobank equity uitf and metrobank equity mutual fund.
Both of them have the same annual management fee, the difference would be:

1) mutual funds have entry sales load fee of 2%

2) uitf have 20% tax on profit.

My Conclusion: Assuming that the fund manager invest in the same portfolio, it is better to invest in mutual funds in the long run. Because the longer you invest (3-50 years) the more TAX you will have, while sales load fee is fixed.

Please clarify.

Anonymous


Dear Anonymous,

Thanks for your question.

It is true that any gains from the redemption of mutual fund shares are not subject to further taxes as stated in the National Internal Revenue Code of 1997. And since UITFs, which were only created through a BSP circular in 2004, are not explicitly covered by this provision, some speculate that gains from redeeming UITF units are subject to withholding tax on top of taxes paid on income earned by the fund's underlying assets.

First, even if UITF unit holders have to pay withholding tax upon redemption, what you suggest, that "the longer you invest (3-50 years) the more TAX you will have," is completely inaccurate since a unit holder would only have to pay withholding tax only when he or she chooses to redeem units and the tax amount is therefore independent of how long the unit holder's chooses to hold on to his or her units.

Second, according to this press release by Punongbayan and Araullo--one of the country's biggest public accounting firms--gains on UITF redemption are NOT subject to withholding tax. And I quote:

Our understanding of the nature of UITFs is that they are considered as revocable trusts since the beneficial ownership in a UITF is maintained with the trustor-beneficiary, and considering that in case of death of the trustor, the UITF participation forms part of the trustor’s estate subject to estate tax.

As revocable trusts, UITFs should be treated as one and the same taxable entity as that of the trustor.  Following the rules promulgated under BIR Ruling No. 003-05, if the applicable taxes have already been paid on the UITF investments, there should no longer be a need for the trustees of UITFs to withhold a 20% final withholding tax on the gains upon redemption of UITF participation.  Thus, proceeding from the above discussion, it is maintained that there should be no need for separate tax to be imposed upon redemption of UITF participation since the proper taxes have already been collected through the final withholding tax system. (Emphasis is mine.)

So to answer your question--NO, mutual funds do not have a tax advantage over UITFs, and given the same management fees, typical UITFs are more inexpensive than front- or back-loaded mutual funds.

I hope you find this helpful. Good luck!

6 Insights About Global Investment Opportunities and Sources of Sustainable Growth: Asian Financial Forum 2012, Part 1

ASIAN FINANCIAL FORUM 2012 SPECIAL

Let me start by wishing everyone a very prosperous Year of the Dragon. With Chinese New Year just around the corner, perhaps now is the best time to talk about what experts say about the prospects of the Asian region in the months ahead, as was discussed in the recently concluded Asian Financial Forum in Hong Kong. Before we continue, I would like to thank the Philippine Consulate to Hong Kong, particularly my good friend, Consul Val Roque, for giving me an opportunity to participate in the forum.

The theme of this year's Asian Financial Forum is: "Asia, Driving Sustainable Growth." It was held on January 16 and 17 at the Hong Kong Convention and Exhibition Center. The first day and the morning session of the second day focused on two related topics: global investment opportunities and sustainable growth. Panel speakers included important policymakers, top managers, and successful entrepreneurs from Asia and around the world. In this post I will share insights that I have gathered from these discussions that would help us better understand the economic prospects of the Asian region in the year ahead.

1. China is still seen as the most important investment destination in the world, with Southeast Asia coming in at second

This despite the slower growth of the Chinese economy in 2011. According to panel speakers, the predictability of policy and the ease by which a government can make things happen are two important indicators that investors use in evaluating global business opportunities, attributes that are made possible in China by its highly centralized system of government

Forum participants also view the developing countries of Southeast Asia as important sources of growth. Some of the panelists affirm this view by pointing out the still-vast infrastructure needs in many parts of the region. The emergence of Burma as the possible "next frontier" of Southeast Asian investment in the light of the recent opening up of its economy was also brought up in the discussions.

2. The emergence of the RMB as an important global currency

Last year we've seen the introduction of various RMB-denominated financial products like "dimsum" bonds (i.e., RMB-denominated bonds) and RMB REITs. This year, we should expect more such products to be introduced in the market. Also, the increase in importance of the currency is highlighted by how some governments have started to convert a greater portion of their currency reserves from euros and US dollars to RMB.

3. Greater interconnection among Asian economies is needed to make Asian economies more resilient to threats from the West

This point has been emphasized by several speakers, including Hong Kong's Chief Executive Donald Tsang. One way for Asia to minimize the impact of crises and shocks that emanate from the European and US economies is to limit its dependence on Western markets and improve economic relationships and cooperation in the region. Hong Kong is seen to play a vital role in making this happen since it is seen by the world-at-large as the de facto gateway to the Chinese goods, services, and financial markets.

4. Asian savings should not be used to pay for extravagant lifestyles in the West

This is another point that has been reiterated by several panelists as a way to protect Asian interests from financial crises. Instead of buying low-interest US debt, for example, experts suggest that China use its savings to invest in Asian infrastructure and real assets instead. Of course, for this to work, Asian governments also need to promote domestic demand but without encouraging unsustainable consumption levels such as those seen in many parts of Europe and the US.

5. The biggest opportunities for sustainable growth are in "green" technologies

Panelists acknowledged the very real and pressing problems brought about by climate change, and how sustainable growth can only be possible with the reduction of the environmental impact of doing business. As developing economies, a big part of Asia contributes more to the problem than developed economies in the West, so Asian governments and businesses need to do their part by enacting environment-friendly policies and by investing in research and development for renewable energy sources.

6. Increased urbanization is emerging as a serious threat to sustainable growth

One panelist pointed out the emergence of several "mega-slum" cities around the world, and how more and more of the world's population are projected to live in slum conditions in the foreseeable future. To address this problem, experts suggest increased investments in transportation and the development of rural regions to control urban migration and better manage increasing urban populations.

Reasons To Be Optimistic About the Foreseeable Future

IN THE NEWS from Asia Times

The Philippines' sound economic fundamentals, financial conservatism, and the Aquino government's efforts to shake up the bureaucracy seem to have finally caught the attention of the global investing community.

Recent upgrades from credit ratings agencies (and further upgrades expected in the near future) and positive outcomes of studies by respected multinational financial institutions have stoked investor interest and confidence  in an economy that has been a consistent underperformer in the region. One study now places the Philippines as one of the most important investment destinations in the world, trailing only China and Indonesia.

The points made in the article seem to validate some observations that were made in the ADB seminar about Emerging East Asia in December of last year about the resilience of the Philippine economy amid threats of another global financial crisis. All in all, these findings suggest that economic advances in the previous year will continue well into this year and that further investments in the Philippine stock market now might be a good idea. In 2011, the PSEi had been up 3.7% for the year even as other markets around the world floundered in the midst of economic uncertainties in the US and Europe.

The Price-Earnings Ratio Revisited

DEAR INVESTOR JUAN
PERSONAL FINANCE 101

10-year P/E ratios as predictors of 20-year annualized returns, as compiled by Prof. Robert Shiller

Dear Investor Juan,

Happy New Year! Kamusta na kayo sa HK?

Sir, it might appear like a silly question but I'm just confused: why is it good if the P/E Ratio is >10? Isn't it that if the earnings per share is higher, the company has good prospects since its generating more revenues (per share)? However, with a higher EPS, the denominator would also be big which will decrease the ratio.

Hoping for your response sir.

Thanks!

Nikko


Dear Nikko,

I'm doing fine here, thank you for asking. Just busy with my research and other things, but of course I always have time for Investor Juan. :)

I have already introduced the price-earnings or P/E ratio in previous posts like this one about stock picking, but I'll use your question as an opportunity to discuss it in greater detail.

First, let me briefly discuss what it is. As the name suggests, the P/E ratio is what you get when you divide a firm's stock price by its earnings per share or EPS (and we get EPS by dividing annual net income by the total number of outstanding shares--the number of shares currently owned by investors). So it's a measure of how much investors value a stock relative to the firm's earnings, and it is used in making personal investment decisions and and valuing stocks or businesses. Since the stock price should reflect a firm's future profitability, strictly the forecast earnings for next year should be used in computing for the P/E ratio. However, for practical purposes people just use current earnings to compute for something called the trailing P/E ratio since that information is what's more readily available.

On its own, the P/E ratio of a stock does not mean anything--it only means something when we compare it to a benchmark, like the P/E ratio of competitors or of the stock market index in the same period, or past P/E ratios of the same company in a time series. So if all we know is that a firm's P/E ratio is 11x (read: eleven times), we can't really say if that is "good" or "bad". What I'm saying is that no finance professor or practitioner worth his or her salt will tell you that "P/E ratio > 10 = GOOD"; even as a rule of thumb, it lacks basis and is therefore useless. So you have to check or question where you got that "rule" from (and write your thoughts in the comments section, if it's all right with you).

But if you know that the P/E of a stock is 11x and that the P/E of the stock index is, say, 13x, then now you have enough information to make some sort of evaluation: at least now you can say that it seems that investors are pricing the stock less than the market as a whole, or that the stock maybe cheap so it may be a good idea for you to buy some shares. But again, it is usually not as simple as that since you would have to consider other things like the state of the industry the company operates in and the firm's other financial and operating characteristics. And even if you are pretty sure that the P/E ratio of a stock is "low," that's not necessarily a good thing.

When would a "high" P/E ratio be "good"?

Investors place a premium on stocks that show promise of high growth in the foreseeable future; in more developed markets like the US, it is not uncommon for "tech stocks" like Google and Apple to fetch P/E's in the neighborhood of 25x and still be considered cheap even if the benchmark index is just at 15x. In general, high-P/E stocks may be considered good (to buy, that is) if:

• Past earnings have shown considerable growth in the past five years or so
• The firm pays little or no dividends and invests heavily in research and development instead (although a few firms like Apple would rather keep a sizable portion of its earnings as cash)
• The firm is in an industry with potential for expansion or reinvention (e.g., the tech industry, in general)

When would a "high" P/E ratio be considered "bad"?

In itself, a high P/E ratio would mean that a stock is relatively expensive for whatever reason, so unless this high price could be justified, it may be best to not buy such stocks for the moment. But sometimes a P/E ratio is high only because earnings are dismally low and investors speculate that the stock will bounce back eventually--and this combination of a failing business and excessive speculation is something investors would want to avoid. In my experience, it happens frequently with "penny stocks" (those that trade for only a few cents a share) as speculators bid the price up often undeservedly and almost always blindly and with mining stocks for which speculation has been rampant and where the possibility of successful operations is often insignificant.

When would a "low" P/E ratio be "good"?

Yes, you're right, if we think about it a low P/E stock with substantial and stable earnings should be a good thing for investors since it would mean that the stock is cheap enough to buy. Good, low-P/E stocks are usually characterized by the following:

• The business has reached the maturity stage of its life cycle and has exhausted all avenues for growth, but remains highly profitable 
• The firm is one of the top players in the market in terms of market share (this and the characteristic above make the firm a "cash cow" in the Boston Consulting Group sense)
• The stock pays regular, stable, and predictable cash dividends

When would a "low" P/E ratio be "bad"?

Sometimes even if the last reported earnings are still quite good, the stock price falls significantly and brings the P/E ratio down with it. This happens when investors come across information that the firm is about to fail; unfortunately for those who are left holding the soon-to-be worthless stock, reported earnings don't reflect material changes in information in real time. So even if you see a P/E that's temptingly low, first make sure that the firm still has a viable business or at least enough assets to justify a purchase.

That's it. I hope I was able to answer your questions satisfactorily, Nikko. Good luck to all your future endeavors. :)

The Not-So-Obvious Link Between Personal Finance and Obesity

FINANCIAL TUMBLR-ISMS

via Reddit