Annual Roundup 31/12/10

Early in the year I joked to a friend that the FTSE100 would reach 6000 by the year end. It closed on Christmas Eve at 6008, although it has taken a tumble today. Well, I can tell you now that it feels great to be such a market guru. This just confirms my belief that when it comes to economic forecasting no one knows anything. For the last few weeks, markets seem mainly to have noticed only positive news flow and given us a traditional, thinly-traded Santa rally (and, I assume, therefore, wholly coincidental fund manager bonuses). This is a situation which could quite easily go into reverse when the next Euro/China/US shock arrives and perhaps that is already happening.

On the month, Sterling ended at €1.1612 and $1.5522. UK 10 year gilts fell to give a gross redemption yield of 3.55%. Gold has risen a little to $1410 per ounce. Brent Crude future rose slightly to $92.53 per barrel and copper rose strongly to $9662.50 per tonne.

The FTSE100 rose from 5528.30 to 5899.94 and the FTSE250 rose from 10607.74 to 11558.80, increases of 6.7% and 8.9%, respectively. The annual figures are 9.0% for the FTSE100 and 24.1% for the FTSE250, showing a better performance this year for the more domestically orientated mid-cap businesses.

For commodities, both oil and non-ferrous metals have had substantial rises this year. The former rising about 25% and the latter varying from 8% (aluminium) to 50% (tin) with only zinc showing a fall. Gold has risen sedately by 25% while silver has jumped 70%. Most food staples, too, have risen appreciably and mostly in the second half of the year. All of which has given rise to inflationary pressures, but especially in the UK where the decline in Sterling and the rise in VAT have added to this trend.

Equity Portfolio (+3.7% on month, +23.6% on year)
Over the year there have a couple of investment disasters in my portfolio. ROK went bust and BP poured away its dividend all over the Gulf of Mexico. Also, there have been some poorly performing, zero-yield stocks like Colliers International (recently perked up owing to director buying), Premier Foods and Taylor Wimpey, all of which have struggled with debt. In addition, I made a bad call with BT, selling out at £1.30 but it has now risen to around £1.80 on largely positive pensions newsflow.

However, it is clear that, overall, my gains far exceed my losses and, at 23.6%, I have comfortably beaten the FTSE100, as I did last year (51% as against 22%), though not the FTSE250. Sadly, I don't have reliable figures for the year before, but I don't think I did nearly as badly as the 31% loss recorded by the main London market and, in any case, I was far less exposed to equities then. However, before I get too smug, I must remember that my figures include dividends of circa 2.8% since, without some tedious calculator tapping, I don't have a way of stripping these out. Moreover, my calculations are just based on annual cash in/cash out and do not allow for periodic capital flows via a true time-weighted rate of return and tend, therefore, to overstate the upside in this instance.

This year's good performance has been due in part to reliable dividend payers like Aviva, Balfour Beatty, Electrocomponents, National Grid, RSA and Vodafone. However, the heavy capital lifting was done by the energy, resources and specialist engineering sectors (the relatively low level of Sterling, except as against the Euro, was a help here). Oxford Instruments is an example of the latter, which I bought at £1.60 last autumn. I sold a third of my holding at £6.70 a couple of weeks ago, a fourfold gain, and they have since risen further to around £7.00. Their contract last year to supply silver wire to the interesting but probably doomed ITER Project kickstarted their recent success.

I've realised some of my profits over the year so that I can have some cash available for further buying, but at the same time I've necessarily reduced my exposure to some of my best performers. My cash holdings are still just above 50%, if Index Linked Certificates and Premium Bonds are included, so perhaps I have been too timid in my investing. There have certainly been some foregone opportunites as well.

For example, Telecity is a major Internet hoster and service provider that I briefly considered and then dismissed for no other reason than it reminded me too viscerally of the machine rooms and server racks that I see every day in my job. Truth to tell, I've been irrationally prejudiced against IT for a decade (we all have our demons). Weir, the pump and valve maker, which has risen from around £4 to £18 in two years and in my favoured energy services sector, was frequently on my buy list, but suffered from the "let's wait until it drops a bit" syndrome. GKN, which makes some of the bits that make cars and trucks move, was a no brainer (what is it, again, that petroleum is used for?) but, having not enough of the grey matter myself, I failed to move on that one. Likewise, Rio Tinto, I didn't buy, probably because of my instinctive dislike of high prices: buying 50 shares, for example, just seems so pathetic. 2000 shares in ROK, anyone?

However, this year's gain, when added to last year's, has come at a good time for me, but I am under no illusion that this will continue. I've been investing, on and off, for twenty years, but I don't feel like an experienced investor and for much of that time I haven't been nearly reflective enough on my failures and successes. I've lacked discipline and have not remained focussed. What's saved me is saving itself. Obviously, my thoughts now are turning towards what will be the good sectors for next year. I'm not necessarily expecting the same ones to do well, but equally, I won't be surprised if they actually do, and so I am not going to sell any more in the near future. In fact, I may well try to accumulate more in the energy services field, perhaps even the likes of Amec or Rotork, two seemingly well run companies, whose prices, sadly, are now well up with events.

The economic backdrop for next year is not that good. In addition to the risks identified here, there are others less immediately likely but more difficult to evaluate, like a collapse of the Chinese property bubble or an escalation of tensions in the Middle East. As a general rule of thumb, sectors that have gone through a rough patch will have their day again, but next year is, I fear, still too early to cheer on the likes of, say, construction or retail. At the present time, a sector I like is property because I flatter myself that I understand it. There is something comforting about bricks and mortar (just ask any Irish or Spanish bank manager). More seriously, though, --and concentrating on commercial property-- you can get a feel for the business by simply walking the streets, while technical information on rents, void rates and so forth is easy to come by. In the UK, commercial property companies are often configured as REITs (Real Estate Investment Trusts) which gives them certain tax advantages, providing they distribute, under certain conditions, 90% of profits to shareholders.

The REITs break down roughly into the office, industrial and retail categories, cross-classified by whether they are in prime (mainly London at the moment) or non-prime (mostly everywhere else) locations. The two biggies are British Land and Land Securities. They are very similar and operate in prime UK office (mainly City of London) and retail locations. Investing in these two is largely a play on financial services and shopping, so don't fool yourself into thinking that they are low risk. They've been in the game a long time, however, and have a good track record.

I have held British Land and Great Portland Estates (mainly London West End office and retail exposure) for a long time and participated in the 2009 rights issues. To these, I have added Hansteen (industrial, mainly Germany and Netherlands), Local Shopping REIT (UK provincial retail), SEGRO  (UK and European industrial) and Workspace  (Greater London industrial and small office) over the past 18 months. Although I am in profit on all of these, the gains are still far from secure and I may have jumped the gun on at least one of them (LSR). Ones I like the look of for the future are Hammerson (European retail and office), perhaps Derwent London (Greater London office) or Land Securities itself. With its recent development (the tedious New Change, which looks like Milton Keynes has landed in Cheapside --hurrah for the roof terrace, though), Land Securities has astutely developed the market for retail in the City. A company that amuses me, but which I am not going to touch any time soon, is the troubled Minerva (Greater London office). Its fortune is mostly tied up with the large but elegant, yet seemingly unlettable, Walbrook Building. Nice pile, shame about the company.

REITs tend to be cyclical and the better run companies are now well off their lows. Don't expect them to be great growth stories as they are mainly yield plays, although, property being property, there is always a likelihood of a bubble over the next decade. For example, I am still down 25% in capital terms on my British Land purchase in 2005, but I am fairly confident this will turn to profit over the next five years. Indeed, had I bought five years earlier, I would have doubled my investment, as I have done with Great Portland Estates, which never fell below my original buying price during the 2009 nadir.

There are always risks, of course. In the prime London areas, what seems to be a frightening amount of floor space is coming on stream in the next two to five years as the major players have all mostly resumed building or refurbishing, although in percentage terms it's probably only around 5% of the total, so far. As far as the industrial and retail specialists are concerned, their fortunes are largely geared to the wider economy in Europe or the UK as appropriate. The companies I have mentioned give a diverse spread of sizes, subsectors and risk profiles. For convenience, I summarise them here:

The figures are taken in each case from the last full year accounts and those for NAV and debt in particular may be well out of date. Prices are current as at 24/12/10. More recent interims and trading statements should be scrutinised carefully before buying, of course.

Are there any other sectors I'm interested in for next year? You bet, but that is enough for now. As for 2011 itself, I'm expecting more volatility with probably little overall gain except dividend income. A prosperous New Year to you all.

Victorian Values

In Oscar Wilde's play Lady Windermere's Fan, Lord Darlington remarks that a cynic is a man who knows the price of everything and the value of nothing. Perhaps we are all to a greater or lesser extent cynical, in that we have difficulty assigning real values to things even though we may be well aware of their prices. We know, in economic terms, that there is a loose correlation between value and price and that the correlation varies in its validity and is hardly ever exact. Our judgements on this help to drive the market. Few of us, I hope, value friends and family in terms of price, but equally, in our day to day lives of getting and spending, we need to measure the value of all sorts of goods and services. Price is generally the way we do it. The sources of economic value, its storage and its relationship to price has long interested me, as it has generations of economists. Since there are different schools of thought on the matter, I assume it's not just a technical question, but one deeply rooted in society and its wider values.

Let's start with something tangible. For older British readers the picture below may well prove evocative.

For those in the dark, I should explain that it is a set of the old UK coinage as it existed prior to "D-Day", 15th February 1971. I am not a coin collector and nor was my father who just had a fancy to purchase this set in the dying days of Lsd. The face-value of the set which comprises (ignoring the medallion at the top) one half-crown, one florin, two shillings, one sixpence, one thru'penny bit, one penny and one ha'penny, was seven shillings and fourpence ha'penny, or 7/4½, as it was usually written. In modern terms, that is 36.875 pence or "new pence", as we used to say back then. The modern face-value is, of course, zero, since all the coins have now been phased out. You could not use any of these coins in a shop. Well, not normal shops anyway, but you could use them in a coin emporium. In this case, you would not be using the coins as money, a medium of exchange, but as goods that you wish to exchange for money.

A cursory surf on the Web tells me that my proof set of 1970 coins now has a value of about £18. That's an increase of 4715% in nominal terms since, in 1970, the nominal value was equal to the face-value. If we adjust for inflation (RPI), we find that the increase in real terms is 314% over 40 years. Not a bad investment, in fact. It compares well with UK house prices over the period which, according to the Nationwide house price index, achieved a value increase of 3715% in nominal terms and 247% in real terms over the same period. By comparison, the values for gold (valued in Sterling) are 4052% and 270% respectively, according to the World Gold Council. So, my set of coins has beaten both gold and property over the period. A pity, then, that Dad didn't buy a thousand sets.

How does this compare with other asset classes? Well, in the same period, crude oil has risen 372% in real terms (a terrific investment), but copper, which is actually the main constituent of all the coins, has only managed a real terms increase of around 20% (had we carried out this exercise 18 months ago there would would have been 10% decrease). So, the transformation of this set of items from useful money to a useless collectible, despite the fact it is actually made out of a material that has been a poor investment, has resulted in a huge increase in value. I find that very, very strange. What is the cause?

The answer in practical economic terms would appear to be our old friend supply and demand. There were 350,000 sets issued, so the supply is limited if not particularly small. Set against this, there is the demand from coin collectors. It's not something I understand, psychologically, but I accept it exists. I surmise that the attraction is largely the self-reinforcing one of anticipated capital gains or, as we might say, increases in "value". Here we touch upon an old conundrum which is probably as old as civilisation but neatly exemplified by Adam Smith.

Smith chose water and diamonds to make his point. Why is it, he asked, that water, which is so necessary to human life, has such a low value; whereas, diamond, a material almost wholly useless (especially in Smith's time), has such high value? The proximate answer contrasts the abundance of water and the scarcity of diamonds. Both substances are in demand but, strangely, the utility value of water cannot compete with the fetish value of diamonds, at least not usually. A modern parallel might be copper and gold. The latter has been continuously in demand for 5,000+ years with little utility value, whereas copper was hugely useful until about 1000 BC and then again from about 1830 AD, with only modest interest in between. Smith just missed out on its unexpected resurgence.

Another example of unexpected non-utility value would be this,

the famous penny black stamp, the world's first adhesive postage stamp issued in 1840. They are not particularly rare and there are an estimated 1 to 2 million extant. These stamps in poor condition can be had for £10 and good ones for £100, while unused mint condition stamps fetch over £1,000, apparently (I know nothing about stamps). Not bad, considering that in face-value terms it would be worth today about 30p.

Many years ago, I considered buying cask whisky as an investment (not that I actually like the stuff hugely), but rejected the idea as not being sufficiently liquid and contented myself with the odd bottle. Ditto wine, which I drink but not with any expertise. Maybe in retrospect I should have taken the plunge, since the supply of the specific underlying assets steadily diminishes worldwide, but I feel there are too many pitfalls for the unwary.

It's hard for me to understand the long term stable or rising values of items like coins and stamps or, for that matter, diamonds and gold. They seem to exist in a microeconomy that sustains itself through the activities of just a tiny proportion of the race, many of whom are just interested in driving up the price. It's a fact, however, that despite various fluctuations their value seems enduring, especially for gold and gems. In times of disaster, however, what use are they? Would I trade my last diamond for your last remaining bottle of water? I don't know. It might depend on how optimistic or pessimistic I was feeling or whether there was a whisky to hand. However, why would you sell it to me? Only because, perhaps, you were sufficiently optimistic to look forward to an imminent resumption of normal times and, thus, values. Sometimes, markets can turn strange and so can values.

Ricardo and Marx considered that labour was virtually the only source of value. Today, I think, we would want to add energy and resources into the mix and I am sure that there must be many more theories of value out there, including a modern academic tendency to regard discussions of value as too subjective anyway. Perhaps also, we should accord some value to the types of societies we have built (I seem to recall Galbraith was keen on this). Certainly, Eloise probably thinks so. I don't really begrudge the woman her benefits and if it's true that her parenting is good, then it's a price worth paying, but many of us might feel that the presented sentiments, if they are truly hers, have gone wrong somewhere.

Although I am hardly a communist, Marxist analysis of value has always appealed to me. In particular, the idea of commodity fetishism which, in conjunction with the complexities of the production and distribution chain, obscures the true value of goods. In some ways, of course, money remains the ultimate, state ordained, fetishised item. The talismanic power of the positive bank balance or net worth appeals to most of us, as does the folding stuff itself. It's a kind of faith we have that sometimes goes wrong. Whenever I go to Scotland I am amused to receive Scottish bank notes. They are not legal tender anywhere in the UK, but people trust them just the same (in Scotland that is  --just try using one out of the King's Cross taxi rank).

In sum, I don't think it's cynicism that prevents us understanding the nature of value, it's the complicated nature of the idea. The quote from Wilde panders to the glib notion that economic values and what, it is implied, are some other kinds of values, ("real/human/deep etc") don't correlate. We can, I think, all "buy" into that one, prima facie. You can't buy friendship, a happy family life or beautiful countryside. That's literally true, but you can buy, directly or through taxes, a good education, a decent home and a sustainable land use policy, all of which help to create the right conditions. Values are interconnected, economic or otherwise. I think Marx and some other Victorians saw that. The base really matters, whatever our feelings. The economic perversions of the C20th, left and right, have masked something here.

Sorry, a bit random, I know, but that's the effect of liquid investments.

Modelling Inflationary Outlooks

I'm not much of a budgeter in the sense of keeping meticulous records of spending and trying to keep to targets. Fortunately, in the past few years I haven't needed to be. Nevertheless, with my farewell to paid employment next year, I need to plan ahead and to be careful. One of my key tools is, unsurprisingly, the spreadsheet of income and expenditure. I do have reasonably good records for the past few years in the form of bank statements and credit card bills, so I can estimate our expenditure profile reasonably well (we use the CC only as a spending tracker and whenever we can -- it's a free service, after all).

I know, for example, that we spend about £2000 per month as a family of four living in a medium sized, Victorian terraced house. That includes just about everything (except holidays), namely: mortgage, council tax, energy, water, comms, insurance, necessary travel, food and drink, charities, entertainment, gifts, miscellaneous services and the obligatory £100 or so of unidentifiable "stuff" that I suppose leaks away from most households. There's scope for cutting back and, certainly, I was pleased to be able to reduce my buildings insurance this year by 70% and my nominal energy costs by 18%, but in the interests of domestic harmony other cuts are not imminently on the agenda. Ruling out unforeseeable family catastrophes, the question for me is, how are my income and expenditure profiles going to change over the next few years?

The biggest determinant will be inflation, so it's worthwhile modelling this and playing with the numbers. Obviously, assumptions will have to be made and these are mine. There are, of course, multiple inflations, but officially in the UK there are only two that really matter, CPI and RPI. The government has made its intention clear insofar as it is going to exploit the difference between them. Even if, at some point in the future, these measures are consolidated or further differentiated, I think the principle of the semi-official inflation wangle will still hold good in some form or other, so I am going with them for now.

CPI is a geometric mean that tends to minimise disparate sectoral inflation rates and excludes housing costs. It's well above target at the moment and for political reasons will probably remain so for a year or two, but I think it will be nailed to the target figure of 2% over the longer term. The reason for my confidence here is that it is the peg to which benefits and pensions will be fixed. Anyone with a defined benefit pension, public or private and regardless of what it says in the scheme rules, will find by legal strategem that it gets linked to CPI, not RPI. With the possible exception of the state basic pension (currently to be defined by an odd "triple lock", but that may change), all other state benefits will be linked to CPI by some kind of formula. Therefore, the pressure to keep CPI low will be immense. Accordingly, I have set any official family incomes to grow by CPI at 2%. Of course, the target may get lowered, but there's a limit to my pessimism.

Now for RPI. As an arithmetical mean, this reflects much more what we all experience and, despite the whingeing that goes on about the ONS tricks of the trade, such as discounting for increased functionality and so forth, I am prepared to accept it at face value. Obviously, I peg my expenditure to RPI, since even if I pay off the mortgage, I can't avoid council tax. What rate should I choose? Arbitrarily, I have chosen 5% as the long term average. Is this a good choice? Frankly, I haven't a clue. Direct energy costs, I think, will grow above trend and this will obviously drive up other stuff as well, but I assume that commodities and food will always cyclically attract production efficiencies at the right price (I am with Julian Simon and against Paul Ehrlich on that one, as is history).

Finally, and having roped off some capital for family educational developments, I have to assume what my investment returns will be. This will be a mixture of dividends, interest and capital gain/loss (I do not draw a hard distinction between capital and income). Based on a survey of my (admittedly rather poor) records, I've reckoned this, for now, at CPI+2%, which is about half my estimated returns over the past 15 years. Although this is a bit fuzzy, I think it is conservative and reasonable, since it is what I assume GDP growth will be over the long term. I see no point in imagining endless bear markets.

Having thus got my model, I am in a position to play with it. I've extended it out for 30 years, by which time I will either be dead or past caring. When you take that long term view, small changes to the parameters can have big effects. To give one example, altering RPI can be pretty scary. At 5%, I'm comfortable. At 6%, I'm feeling miserable (declining capital). At 7%, I'm spending my twilight years in soup kitchens (all money gone). On the other hand, at 3%, I could be funding soup kitchens, unless we are gripped by deflation, in which case, other parameters will have changed also. This is the beauty/ugliness of compounding. The other choices I have are to move to Mid-Glamorgan or, perish the thought, find a job.

I think this is an interesting exercise to do and, I hope, realistically based. I wonder what others are doing in this area? Are you modelling or relying on strategy for your future? If, on the other hand, you've decided to muddle through, is it because you've taken the (perhaps sensible) view that playing with numbers like this is all a bit silly? Merry Xmas everyone.

Mistakes You can Afford to Make

A bit of a ramble this time but not, I hope, too much of rant. As widely remarked in the media, yesterday was not only the winter solstice but the occasion of a lunar eclipse (sadly not visible from the London area owing to cloud). The timing was fairly coincidental, since the eclipse midpoint was at 0817, whereas the solstice occurred at 23.38 and was thus nearly into today, the 22nd (as it sometimes is). Many of our distant ancestors were wont to read a great deal into lunar phenomena and the fact that the apparent motions of the Sun and Moon do not mesh in any simple arithmetical way caused widespread frustration and, for a few, useful employment in the ancient world devising calendars, horoscopes and so forth.

Were it not for the fact that the Moon is our nearest cosmic neighbour, it would hold little interest for us. Given the huge complexity of Earth (active geology, atmosphere, life, etc.) it's probably fair to say that we know more about the Moon than our home planet. Yet, intriguingly, there are some things still not understood. As far as we are concerned, the connection (if any, other than cultural) between the lunar and human menstrual cycles, for example, is still mysterious. Since the menstrual cycle of our closest living evolutionary relatives, the chimpanzees is 37 days (I believe), it may just be coincidence, and I think it still is the case that there is no firm evidence one way or the other.

As well as length of the lunar cycle, the reddening effect that occurs during a lunar eclipse prompted some ancient peoples to connect it with menstruation and fertility. By not connecting the reddening with terrestial sunrises and sunsets (a true linkage), they got it totally wrong. However, as long as they understood the connection between the movements of the Sun and the agricultural cycle, it would not have mattered much. Some mistakes you can afford to make and some you can't.

All of which preamble is a rather pathetic attempt to inject some seasonal mood into the traditional end of year thoughts about the future. Barring nuclear wars in, e.g., Iran or Korea, I don't see Armageddon around the corner, but clearly 2011 (and probably 2012) isn't going to be a lot of fun in many parts of the world. In the UK, we can look forward to higher inflation, higher unemployment, low growth, unpredictable fallout from the Eurozone shambles and, of course, our own gloomy forebodings. Quite what is sustaining the FTSE100 at nearly 6000 at the moment, I don't really know, but I suspect it is just thin volumes combined with beliefs in emerging market bubbles. I'm somewhat more than half expecting a crash to around the 5000 level in the next 12 months and if that happens I shall be buying in. But if that doesn't happen, it's a mistake I can afford to make.

Longer term, I am not a pessimist. I do not, for example, share the more downbeat prognostications of Simple Living in Suffolk, but I think he is right in the sense that he, I think, has concluded, that it is a mistake he can afford to make. There are disasters and there are disasters. In the historical record (and as far as Europe is concerned), there only three major apocalyptic economic events: the Bronze Age Collapse of 1150-1000 BCE, the European Dark Age of 550-650 CE and the Black Death consequences of 1350-1400 CE. In each case, major depopulation (caused in at least the last two cases principally by disease) was a necessary concomitant of the collapse. These things don't happen very often and the trials and tribulations of the 1920s and 1930s were pretty minor by comparison; and then, scarcely a generation after the bloodiest war in history, all the major participants were thriving as never before.

If human beings have adequate food and shelter then they can withstand a lot, especially if they can remain tolerably free from disease and violence. That's why I believe that many of the PF bloggers, like the aforementioned, have got it so right when they concentrate on the basics. If they get it wrong, it's not going to matter too much, but if most of your livelihood and time is tied up with trying to call markets and commodities, rather than minimising living costs and vulnerabilities, the downsides could be pretty big. However, whilst it has its attractions for some, going completely off-grid is only viable for a few households and for most it would involve too many sacrifices. Humanity hasn't seriously lived like this for 5,000 years because markets in food and energy (and the communities they tend to generate and support) have too many advantages.

The more sensible approach is to diversify your dependencies as well as your income and wealth. Mrs. G and I don't have any land on which to grow food. We just have our small garden, so for us it's simply a place to enjoy without direct utility (apart from the apple tree), whereas for foxes (with or without a tail) it's partly a hunting ground, but mostly a toilet. This one was snapped in October.

Maybe I'm just an urban softie, but I like our little community of foxes, even if I'm forever scooping up their leavings. They thrive because our neighbour feeds them. Not everyone likes this, but since he's a nice, helpful guy and repairs washing machines for a living (and caters for all the locals at more or less cost price), no one is going to be stupid enough to complain. Getting on well with your neighbours is part of the dependency diversification. Even if, to take a cynical view, you get no material benefits from neighbourliness, it's a mistake you can afford to make. Good manners (and a little consideration) cost nothing.

We can't all dig our gardens as Voltaire enjoined, at least not literally, but a good many can attend to financial home improvements. To take three geographically spread examples in the UK, Frugal Queen, No More Spending and Highland Life are all, in different circumstances, trying to turn their households around economically. Like all of us, they operate within constraints of family, locality and age, but they have different goals and make their decisions accordingly. (As an aside, why are these sorts of bloggers mostly female? Is that assessment even right?) Youth gives us options which gradually close down with the years but, as so many have realised, personal debt racked up for consumption is a mistake you definitely can't afford to make at any age. Perhaps my youth was boringly too well spent, but it's not a situation I've ever been in, even if at times I had next to nothing. However, I do have the wit to realise that, although there are times when being highly geared can be highly profitable and that there are also times, like the present, when it may seem that the world is even rewarding you for being so, nevertheless, staying in the black is a mistake you can always afford to make.

It always seems to be assumed that, just as personal debt is bad, so corporate and national debt is also always bad. Again, it depends on why the debts have been incurred. If you've bribed your electorate and lied your way into a currency union, that's bad. If you've patted your banks on the back and implicitly offered them unlimited credit every time they've thought up a new way to expand the property market, that's bad. If you've banged on unendingly about balancing the books when the good times arrive and then completely forgotten about it when they do, that's bad. However, when you are struggling to get to a better place, it's not much use complaining about where you are, you just need to get moving. Many of the PF bloggers who've got mired in debt have realised this and worked out, not only a strategy for getting out of it, but also tactics for making that strategy feasible, by giving themselves rewards or leaving certain aspects of their lives untouched.

So it is, I think, with central banks and governments. Ultimately, they have to stay in power or they can do nothing (. . . the art of the possible). Yes, some of the decisions that have been taken in the UK and elsewhere over the past year will have regrettable consequences, but debts have to be cleared or, at the very least, consolidated in the short term. The complex solution of further borrowing, cuts, inflation and muddling through is probably the right and inevitable way forward. Monetary policy is arguably too loose, but it is a mistake we can afford to make --for a while. As for the Euro, well, let's not go too deeply into that one. We might get hit anew by some sort of break up, of course, but if that happens, I think a little bit of quiet Schadenfreude might not be too reprehensible.

As for myself, I have a negotiated redundancy to undergo in 2011, with a consequent drop in net income of 55%. I have spent the past few months looking at my financial options and doing my spreadsheets with a substantial dose of RPI factored in. I am not assuming that I can make any expenditure cuts, but if I can trim costs on energy, food or services I shall, if only to reduce the effects of future inflation on these items. I realised the benefits of financial planning a long time ago. It was not always done well or with sufficient commitment and certainly not with a disciplined strategy like that of Retirement Investing Today or the market savvy of Monevator, but with a historical savings ratio of typically 15-20% I am now in the very fortunate position of having some variable investment income and a CPI-indexed pension. I have to confess, dear reader, that it is a public sector pension, but you won't (as taxpayers) be directly paying for it, since it is market funded. Fortunately for me, it has been conservatively run since, had it not been, that would have been a mistake I could not have afforded to make. Ah, I do love complex conditions . . .

Peer to Peer Update

I blogged earlier about my foray into P2P lending. This is largely based around Zopa, the "market leader" in the UK. More recent entrants include Quakle, RateSetter and Yes Secure. All these operate a market between individual lenders and borrowers, although with variations in fees, risks, rewards and, for want of a better word, styles. Different again is Funding Circle, in which I also have a (tiny) interest. This site deals exclusively with lending to small businesses, whereas the others concentrate on individuals, although Zopa does facilitate the occasional commercial loan.

Recently, rates on Zopa have fallen markedly. Over the summer it was possible to disburse money on the premium A* 36 month market for 8%, whereas now 7% is scarely possible. My last loan was for 7.2% towards the end of November. I am not prepared to chase down rates below 7% since, after fees, this becomes 6% before tax and defaults. Such returns no longer justify the risks and so I have not put any money into the markets for the last few weeks. For the moment, I am content to watch my 350 x £10 loans mature (or go bad). Over all the markets in which I lend I am currently making about 7.5% after fees and real and imminently likely defaults.

I actually can't be bothered to watch Zopa that closely (to judge from its message boards some people clearly devote a lot of time to its intricacies) so it's not obvious to me why rates have drifted down, but I suspect it's just a combination of more lenders pouring in and a small decline in borrowing. There is a theory that after Xmas, there will be a rise in people needing to consolidate their credit cards and hence a rise in demand. Well, we'll see.

Of more interest, perhaps, is the default rate. So far, I have one loan written off (and in the A market, too). Zopa reckon I might get 15% of this back, so I have lost, probably, £8.50 on that one. I have one loan that has gone into voluntary arrangement (A* market!) with reduced payments owing to job loss. As for the rest of the problem loans, there are just four late payers: two in the highest risk C market, one in B and one in Y (young). Having tracked the latter down on the Internet (it took but a few seconds), this one is the most likely, I feel, to default.

Assuming (not unreasonably) that all my late payers will default, my returns, so far, are still better than expected, but this will almost certainly change in 2011 as the reality of public sector cuts kicks in. Surprisingly, I have had not a single problem with the individual listings. This is the part of the system where people, often having been refused access to Zopa markets, make an appeal directly to lenders. Invariably, the essence of their pitch boils down to "I am very good with money. That's why I need to borrow some." Oddly, like a piece of dark chocolate, I occasionally succumb to these.

For me, Zopa is a bit of a toy. If rates rise I might put a bit more in, but I am chiefly interested in it as a microcosm of UK economic life. Unlike some Zopa lenders, I do try to obtain good rates and so I suppose I am not as altruistic as some. On the other hand, I suspect that many recent lenders simply see P2P as an easy high reward alternative to banks. These people are fools and they will discover a harsher reality over the next couple of years. Meanwhile, I'll continue to play quietly.

Weekly Roundup 03/12/10

Economic Snapshot
According to the ONS, mean household spending in the UK dropped from £471 per week in 2008 to £455 per week in 2009, a drop of 3.4% in monetary terms and 6.5% in real terms. Most of the decrease was due to lower mortgage and transport costs. On the one hand it's good news that people may be saving more, but on the other . . .

Cheers
In the UK, the Markit purchasing managers' index (PMI) for November rose from 55.4 to 58, compared with the previous month, the highest figure for 16 years. In China, there was also a rise in factory output from 54.7 to 55.2. The index for UK construction also rose from 51.6 to 51.8 but, looking out on the snow, I doubt that will continue.

Jeers
Portugal continues to deny, officially, that it requires financial assistance, although its 10 year bonds were yielding nearly 7% earlier in the week. The UK PMI for the services sector fell from 53.2 to 53.0 in November, indicating that jobs growth in this are will be subdued. In the US, unemployment rose to 9.8% with only 39,000 jobs created in November.

On the week, Sterling was flat at €1.1774 and rose slightly to $1.5755. UK Treasury 2020 fell slightly to give a gross redemption yield of 3.41%. The FTSE100 rose from 5668.70 to 5745.32 and the FTSE250 rose from 10809.43 to 11082.17. Gold rose from $1355.00 to $1403.50 per ounce. Brent Crude rose from $85.67 to $91.14 per barrel and copper rose from $8227.50 to $8737.50 per tonne. After a volatile start to the week, the markets seem to have shrugged off Eurozone worries and have had a positive week.

Equity Portfolio (+2.1% on week, +19.01% ytd)
The brewer and pub owner Marston's delivered some good results this week with underlying profits up by 4.6% on the year. However, the recession has taken its toll and the dividend, prudently, has been cut from 8.5p to 5.8 p, but this still yields an attractive 5.5%. The company continued to invest through the downturn after raising cash via a rights issue. Net debt has been reduced, but not by much, and now stands at £1.08 billion, still horribly large when set beside the market cap of £600 million.

I first bought them in August last year at 96p and they have advanced to £1.08 since then. They are liable to fall as the economic woes of 2011 roll in but, given the recent track record, I may buy more if they do.