BHP Billiton – Is it time to buy?

There are at least half a dozen broking firms that I’m aware of that are currently recommending that their clients buy BHP Billiton. None of these brokers can mention BHP without also mentioning the word “China” in the same sentence.

Firstly let’s note this: The revenue that BHP derives from Europe, North America and Japan is (in aggregate) far greater than what it derives from China. Secondly, the UK, Germany, the United States and Japan are all in recession. Thirdly, a significant proportion of Chinese exports end up in countries that are currently in recession.

I’m convinced that what most research amounts to is looking at what the share price of companies like BHP were at their peak and looking at what the price is now and saying “it must now be cheap”. Throw is some vague notion about demand from China and some promotion by brokers and suddenly BHP is “cheap”.

But BHP is a company that is actually extremely difficult to properly value. What do you really need to know to accurately value BHP?

You need to know what the prices of the following commodities are going to be over 2009 and beyond: Oil, LNG, copper, silver, zinc, lead, gold, coal, iron ore, manganese, chrome, aluminium, titanium, nickel and diamonds. Do you know of anyone who could accurately forecast the prices of those commodities?

When the price of a barrel of oil can fluctuate between $US147 and $US32 in the space of six months you can begin to see just how difficult it is to make forecasts for commodity prices.

There have also been truly enormous fluctuations in the prices of other commodities such as copper, lead, zinc and nickel. However, oil is the only commodity that most people take notice of because they use it on a daily basis.

What is the fair price for a barrel of oil? Do you know? How about the price for a tonne of zinc – any ideas? [If you want to have some fun, ask your broker what the primary uses of zinc, nickel and titanium are and see what they say – I’ll bet you they won’t know.]

To understand what caused BHP’s share price to reach $50 you have to understand what was actually happening in the global economy, and it’s as much about the United States as it is about China.

During the boom years (up to 2007) Americans were consuming far more than their maintainable incomes would have allowed (Americans were not alone in this; other developed countries had similar consumption levels). Additional consumption was being financed by borrowing against the appreciating value of assets (primarily the home or the investment property).

China was supplying much of the consumed goods and running large trade surpluses with the United States (and other countries). Logically, the prices of raw materials used to provide these goods increased because of this demand.

For commodity producers this was fantastic, they were able to make very large (abnormal) profits during this period. This in turn sent the share prices of companies like BHP and Rio Tinto to levels that could not have been imagined even 2-3 years earlier.

As you all know, the game of borrowing against the appreciating value of assets has come to an abrupt and very painful end. Globally, banks have significantly tightened lending criteria and house prices in many developed countries have collapsed.

Consumption will now be curtailed – there is no alternative. For BHP, this impacts not only on their customers in countries that are actually in recession, but also on China’s exports to those countries.

It should also be noted that China’s growth rate dropping 2-3% is no different to a country that was growing at 2% per annum dropping to 0% or -1%. For commodity producers exporting to China, this is a recessionary like environment in comparison to what they had previously experienced.

In my opinion the profits generated by the likes of BHP, Rio and others during the commodity boom were abnormal profits and it would be dangerous to base any valuations of these companies on the assumption that they will return to those levels of profitability any time soon.

The profits were abnormal because they were based on a demand for goods predicated on the availability of easy credit which in turn was predicated on rising asset prices. This allowed many consumers to temporarily live beyond their means. This cycle is now well and truly over and it’s not going to recur again any time soon.

I cannot forecast the prices of all of those commodities that I mentioned above. However, the very fact that this forecasting is extremely difficult to do (if not impossible) means that anyone who is purchasing shares in BHP or other mining companies is speculating that the price of commodities will return to levels something like that seen during 2007. That’s a gamble that I’m not personally prepared to take, especially when most of the largest economies in the world are in recession.

Now you may have a very different opinion to me.

The Art of Stock Valuation

When you purchase shares in a company, how do you know that the price you are paying is a good price? When you sell, how do you know if the sales price is a good price?

To answer these questions you have to be able to estimate intrinsic value. Intrinsic value is the underlying real value of a share in a company. It doesn’t necessarily equate to the current stock price, although the current stock price is frequently (but not always) close to the intrinsic value.

The most widespread method used to determine intrinsic value is the discounted cash flow (DCF) method as put forth by John Burr Williams in the 1930s in his book, The Theory of Investment Value. Williams defined intrinsic value as follows:

“The value of any stock, bond or business today is determined by the cash inflows and outflows discounted at an appropriate interest rate that can be expected to occur during the remaining life of the asset.”

A bond can be valued with precision using the above method because most bonds are contractually required to pay a certain percentage of the face value of the bond each year for a specified period of years.

Seth Klarman (a highly successful investor who founded the Boston based Baupost Group) states in his book, Margin of Safety:

“Stocks, for example, have no maturity date or price. Moreover, while the value of a stock is ultimately tied to the performance of the underlying business, the potential profit from owning a stock is much more ambiguous. Specifically, the owner of a stock does not receive the cash flows from a business; he or she profits from appreciation in the share price, presumably as the market incorporates fundamental business developments into that price.

Although some businesses are more stable than others and therefore more predictable, estimating future cash flow for a business is usually a guessing game.

The financial markets are far too complex to be incorporated into a formula. Moreover, if any successful investment formula could be devised, it would be exploited by those who possessed it until competition eliminated the excess profits. The quest for a formula that worked would then begin anew.”

And that in a nutshell is the problem with the DCF method: It requires the forecasting of cash flows for years into the future and this simply cannot be done with a high level of accuracy. Because of this, most DCF valuations are very limited in their usefulness.

Another funds manager, David Dreman, has shown that forecasting by analysts is generally poor and certainly not precise enough to use in a DCF model. In his book, Contrarian Investment Strategies: The Next Generation, Dreman states:

“Most current security analysis requires a precision in analysts’ estimates that is impossible to provide. Avoid methods that demand this level of accuracy.

There are no highly predictable industries in which you can count on analysts’ forecasts. Relying on these estimates will lead to trouble.

Many pros believe that their own analysis is different. They themselves will hit the mark time and again with pinpoint accuracy. If they happen to miss, why it was a simple slip, or else the company misled them. More thorough research would have prevented the error. Next time it won’t happen.”

What most of the “pros” actually do is make a naïve extrapolation of recent earnings into the distant future (usually 10 years) and come up with a share value. It should be noted that even relatively small differences in the forecast results can result in significant differences in the valuation that is arrived at.

In my opinion, rather than messing around with highly imprecise DCF models, you would be much better off taking the advice of billionaire Kerr Neilson:

“When all the numbers and discernable facts point to a company being abnormally cheap using 20 to 30 year relationships of price to book, enterprise value to sales and understanding of the company’s inherent cash generating capacity, the shares have a high probability of making you a handsome return.”

I’ll give you two real life example of Kerr Neilson’s above advice.

During the period 2005-2007, Caltex traded at average prices of around twice book value. Looking at Caltex’s historical price to book value would have informed any potential investor that Caltex was very much over-priced at around twice book value. History showed that a fair price was approximately book value (or may be slightly more).

Analysts and brokers attempting to value Caltex using the DCF model were quite prepared to pay twice book value because they had incorrectly forecast the cash flows and therefore their models justified prices of $20 per share or more.

Caltex was included in The Stock Scribe portfolio at $6.18 because:

1. That price represents a very significant discount to its book value;

2. The company has low debt levels in relation to its tangible equity;

3. It pays an attractive fully franked dividend;

4. It produces a product which is absolutely vital to all of us;

5. It’s a large company with a long history (having listed on the ASX in 1980).

The second example is the banks. During 2006 to early 2008, the big four banks were all trading at material premiums to their long-term price to book values. Any potential investor who studied this one statistic would have known that the prices that these banks sold for during this period were too high.

As a shareholder in a few banks, I was happy to sell at the then prevailing prices (my best sale was NAB at $41.98). Analysts using DCF models and naïve extrapolations of the very recent past found justification for paying $50 or more for CBA or $40 or more for NAB, but I couldn’t.

Selecting stocks based on historically low price-earnings ratios, price to book values, high dividend yields, low debt etc, does not mean that you are going to automatically make a fortune.

Once you have selected stocks using these sorts of screens, it then requires very good judgement as to whether you make an investment or not - and that is where many investors will fall down. The screening process is relatively straight forward, but the next decision (to buy or hold off) is much harder and there is simply no substitute for experience and plain good judgement.

Is Mohnish Pabrai the Real Deal?

He has been billed as the “new Warren Buffett” but is this justified?

Mohnish Pabrai first came to my attention in 2007 when he was the successful bidder in an online charity auction the prize for which was lunch with Warren Buffett.

Pabrai is a smart guy and he knew that his lunch with Buffett would achieve at least three things.

Firstly, he got to spend some time with his hero. Secondly, the media attention he attracted would have resulted in increased sales of his second book, The Dhandho Investor (which had been conveniently released shortly before the successful online auction bid). Thirdly, the media attention would also have resulted in an increase in funds inflows to Pabrai Investment Funds. Talk about hitting multiple birds with a single stone!

Before founding Pabrai Investment Funds in 1999, Mohnish Pabrai had founded a company called TransTech. His $30,000 investment in this company was turned into $4.5m in approximately 10 years. That’s impressive, but TransTech was an IT firm and had nothing to do with investing in the stock market.

From 1999 to 2007 Pabrai Investment Funds returned 28% per annum (after fees). This was a great start. I don’t know what the return for 2008 will be, but it’s safe to say that it will be far lower than 28%.

Pabrai Investment Funds was modelled on Warren Buffett’s original 1956-1969 “Buffett Partnership”.

In his book, The Dhandho Investor, Pabrai enunciates nine core principles of his investment framework. (I recommend that you read the book if you haven’t already, you will enjoy it). I have no issue with seven of these principles, but I will take issue with two of them.

Buy Distressed Businesses in Distressed Industries

Pabrai’s idea here is to pick up shares in companies at far below their true worth due to temporary distress in the business and the sector in which the business operates.

This piece of advice from Pabrai is, (in my opinion), terrible advice. Why? Because the vast majority of distressed businesses in distressed industries are going to eventually collapse. The average investor would simply be unable to determine which distressed businesses are going to survive and as such, they would be taking an enormous gamble if they were to try this for themselves.

As an example, lots of people (including those who should have known better) thought that companies like Babcock & Brown, Allco and Centro were very cheap after their initial share price collapses – none of them were, they were all doomed to fail. Unless you have inside information (and it would be illegal to trade on that anyway), Pabrai’s advice is for speculators not investors.

Pabrai also contradicts himself in that he states that investors should buy distressed businesses in distressed industries and also advocates that investors invest in businesses with “durable moats”. The two principles are not compatible. Businesses with genuinely durable moats (i.e. dominant businesses with significant barriers to entry) will not find themselves in a “distressed” situation, that is to say facing bankruptcy and the like.

Bet heavily when the odds are overwhelmingly in your favour

Once again, for the average investor who doesn’t have the superb analytical abilities of a Warren Buffett, this is very bad advice.

In stock market investing, diversification is the only easy thing that an investor can do to gain an advantage (through the protection that adequate diversification offers). All the other things that a successful investor needs to do are much more difficult and require very sound judgement forged from years of experience.

I don’t advocate extreme diversification (as practised by many fund managers) but no diversification or inadequate diversification is a recipe for disaster unless you think that your analytical abilities are on a par with the likes of Warren Buffett!

Unless you have inside information, you will never know for sure that the “odds are overwhelmingly in your favour”. You can know that your chances of success are better than your chances of failure, but it’s very difficult to accurately quantify your likely chances of success – is it 90%, or 75% or 60%?

If you take Pabrai’s advice and place a significant amount of your portfolio in an investment that you assessed as having a 90% chance of success and in reality that investment only had a 55% chance of success, you could wipe out a significant part of your portfolio very easily. It’s just bad advice.

I also feel that Pabrai held quite a bit back in The Dhandho Investor. He just gave us a very brief overview of what he does – the book lacks sufficient detail.

The discounted cash flow valuation (DCF) that Pabrai and many others advocate is flawed unless of course you know with a high degree of accuracy how much a company will earn in the coming years. (Anyone who thinks they can do that can drop me a line – I’ve never known or seen anyone that can do it with accuracy). This will be the subject of a separate post.

So what do we make of Pabrai?

He is a smart guy – there is no doubt about that. But he isn’t Warren Buffett, (Buffett is well beyond smart).

Pabrai only has nine years under his belt as a funds manager and it’s simply not long enough to draw any firm conclusions. I think that those who would write him up as the next Warren Buffett are somewhat premature in their analysis.

I’m sure his actual methods of investment run much deeper than what he told us in The Dhandho Investor. I also feel that if Pabrai keeps loading up on distressed businesses in distressed industries, it’s only a matter of time before he makes some very serious mistakes (if he hasn’t made them already).

Anyway, read the book and judge for yourself.

A Portfolio selected using Graham’s techniques

In his book The Intelligent Investor (first published in 1949 and updated in three further editions the last of which was published in 1973), Benjamin Graham detailed his criteria for selecting common stocks.

While I don’t intend reproducing those criteria here, (anyone who is interested can buy or borrow the book), I did use Graham’s filters to screen every company and trust listed on the ASX and selected a portfolio (using 5 December 2008 data).

Graham never tried to deeply analyse the business in which a particular company was in or attempt to forecast its earnings/growth rate etc. As he states in The Intelligent Investor:

“… stock valuations are only dependable in exceptional cases. For most investors it would probably be best to assure themselves that they are getting good value for the prices they pay, and let it go at that.”

Later in that same book, he states:

“… those who emphasise protection are always especially concerned with the price of the issue at the time of the study. Their main effort is to assure themselves of a substantial margin of indicated present value above the market price – which margin could absorb unfavourable developments in the future. Generally speaking, therefore, it is not so necessary for them to be enthusiastic over the company’s long-run prospects as it is to be reasonable confident that the enterprise will get along.”

What Graham was concerned about was having a “margin of safety” between the price he paid and the intrinsic value of the company. He used measures like the price-earnings ratio, the price-to-book ratio, a sound track record, the payment of dividends over a long period of time, sufficient size of the company and long-term debt being less than current assets minus current liabilities as his filters.

Graham’s criteria are very stringent. For example, the requirement that long-term debt be less than current assets minus current liabilities excluded the vast majority of companies listed on the ASX at 5 December 2008. Of the remaining companies, many were eliminated based on Graham’s other filters.

What I was left with were only 10 companies. Three of those 10 companies were more or less illiquid. Those companies also had wafer-thin profit margins (even though they all had sales of more then $500m in the last annual reporting period – a measure that I used to filter out companies that were not of an adequate size). For these reasons those three companies were eliminated.

Seven companies are too few for adequate diversification so I added four more that didn’t meet Graham’s criteria but are sound businesses available at (what I think) are reasonable prices: ASX, Austereo, WA Newspapers and Milton Corporation:

Company	Price	No. of shares	Sector
Caltex	$6.18	14,710	Oil & gas
Harvey Norman	$2.35	38,685	Retailing
Soul Pattinson	$8.33	10,913	Diversified financial
Sims Metal	$11.74	7,744	Metals & mining
Flight Centre	$8.30	10,953	Consumer services
Hills Industries	$2.90	31,348	Capital goods
Beach Petroleum	$0.75	122,026	Oil & gas
ASX	$31.60	2,877	Diversified financial
Austereo	$1.11	82,271	Media
WA Newspapers	$4.70	19,342	Media
Milton Corporation	$14.02	6,484	Diversified financial

The portfolio value is $1m with $90,909 invested in each company.

While there are only 11 companies in the above list, they represent seven different sectors of the market (which is very important in terms of not being over-exposed to one or two sectors). And of course, someone with $1m to invest would not put all of it in the share market, it would be prudent to put 50% of it in the bank.

I know that practically none of those companies listed above have robust outlooks for 2009 (tell me which companies do), but that’s the whole point – you can only buy at sensible prices when pessimism pervades the market. At other times you are normally buying at too high a price.

You don’t need to be a genius to know that some of these companies are going to experience reasonably significant earnings declines in 2008-09 – but for the most part that would already appear to be reflected in the depressed share prices.

The portfolio has an average price-earnings ratio of 9.6 (sure to go up as earnings decline), an average dividend yield of 7.8% (sure to go down as earnings decline) and an average price-to-book-ratio of 1.92 (which is distorted upwards by WAN, a company with a grossly under-stated book value, without WAN this would be 1.07).

The portfolio earnings yield (100 divided by the price-earnings ratio) is 10.4% versus a rate of 4.28% (as I write this) for the 10 year Government bond – that would appear to be a very significant margin of safety.

Let’s see what happens over the next few years.

Note: None of the above constitutes financial advice. You need to do your own research and consult appropriately qualified people for advice (where necessary).

Investors lose faith in Macquarie Satellites

Macquarie Group controls the management of eight ASX listed entities that have performed abysmally in recent times as the following table shows:

Name	2007 Price High	2008 Price Low*	Percentage Decline
Macquarie DDR	$1.395	$0.053	-96.2
Macquarie Countrywide	$2.300	$0.200	-91.3
Macquarie Communications Group	$6.910	$0.740	-89.3
Macquarie Office	$1.750	$0.225	-87.1
Macquarie Media	$5.200	$0.675	-87.0
Macquarie Leisure	$3.890	$0.875	-77.5
Macquarie Infrastructure Group	$3.990	$1.310	-67.2
Macquarie Airports	$4.390	$1.785	-59.3
Average decline (high to low)			-81.9
Decline in S&P 200 (high to low)*			-53.0

* Low to 28 November 2008.

Macquarie Group itself may have been run prudently (it’s what they keep telling us), but even in the current environment, no prudently managed company or trust has experienced losses of the magnitude shown in the above table. As can be seen, average declines were well in excess of the S&P 200 index.

Then of course there was also BrisConnections. This toll road is being constructed between the Brisbane CBD and the airport and was floated by Deutsche Bank and Macquarie Group during 2008 at $1 (with two more installments of $1 to be paid during 2009 and 2010). It’s currently trading at one tenth of a cent. It would be trading at zero if the ASX did not have a rule prohibiting listed securities from trading at less than one tenth of a cent. It’s a disaster of monumental proportions.

What’s worse is that Macquarie strongly encouraged broking clients to buy units in BrisConnections. Disgruntled investors are now contemplating legal action. Stay tuned.

Macquarie Group reportedly received a fee of $100m for the float of BrisConnections and I predict that it will eventually cost Macquarie in excess of $100m – i.e. they will have done the work for free. (Macquarie and Deutsche Bank will have to provide the unpaid installments for every unit holder who cannot pay – and that’s a good percentage of them).

Macquarie Countrywide and Macquarie Office are typical of the manner in which many of these Macquarie entities were run. Both started out as 100 percent Australian based REITs with good assets and low debt. However, over the years, they were taken on a wild international expansion phase using ever increasing levels of debt. That debt is now being partially paid down by selling US properties (purchased in boom times) into one of the worst real estate markets in memory. The end result of all of this for investors is evident in the above table.

Total remuneration of executive key management personnel at Macquarie Group during the 2008 year was $124.8m – shared between 13 people. That’s an average of $9.6m per person or the equivalent of $184,600 per week. Think about that for a minute. That amount of money would have paid the annual salaries of approximately 2,200 Australians earning an average wage.

When a company decides to remunerate its executives at those sorts of levels they must perform all the time – there is absolutely no excuse for the non-performance we have seen from the entities that I’ve listed above and from Macquarie Group itself.

Macquarie’s logo is often described as the “silver doughnut” but it seems that their executives have consumed the doughnut and left their investors with the hole.

The above facts raise some very serious questions:

1. How on earth does an executive team that has presided over the annihilation of value in these satellite entities justify such wantonly excessive remuneration?

2. Will any of the investors who experienced severe losses in the above entities ever trust Macquarie with their money again?

3. How does a provider of funds management services who has lost the confidence of retail investors (and some institutional ones as well) not avoid a material shrinkage in the size of its business? Is it true that 3000-4000 staff will be retrenched during 2009?

4. When does Macquarie intend writing down the asset valuations in the above entities to realistic levels? The market is much more accurately reflecting what these entities are really worth than the book values reported by Macquarie. In particular, the capitalization rates used to value US properties in the REITs appear to be pure fantasy in the current environment.

An added question for the Macquarie Capital division of Macquarie Group: How many more deals can you continue to do between yourself and other Macquarie controlled entities?

I’ve always thought that buying something and then selling it to another entity controlled by that same buyer and booking a profit on the sale (as well as taking a fee) was pure chicanery. Surely this level of wheeling and dealing within the Group is not sustainable and is a key vulnerability for Macquarie Group because Macquarie Capital generates most of its (so called) profit.

Macquarie has now switched its focus to unlisted investment vehicles, but the problem remains – there has been a loss of confidence and significant damage to reputation from the terrible results experienced by investors in Macquarie branded entities. That loss of reputation is not immediately quantifiable but it is nevertheless very real.

Old lessons to be learned from the Panic of 2008

There is a lot of panic out there at the moment.

People who invested large portions of their portfolio in the stock market have taken a real beating.

It is times like these that provide an expensive education for those who have forgotten or never knew some of the golden rules of investment:

1. Never keep a significant majority of your investments in the stock market (I don’t care what your age is either, no young person who has lost half their portfolio is getting it back any time soon);
2. Always adequately diversify your portfolio;
3. Don’t invest in things that you don’t understand;
4. Don’t invest in companies that have high debt levels;
5. Don’t invest in companies that have only been listed for a short period of time (anything less than 10-12 years);
6. The great Ben Graham advised not to pay more than 15 times the last three year’s average earnings – this is very sensible advice and those who stuck to it are now experiencing far less pain than most;
7. Don’t borrow money to invest in stocks;
8. There is nothing new under the Sun. The laws of finance were laid down a very long time ago and there is no one who has ever managed to change those laws (even if it looked like they had temporarily);
9. No one cares more about your money than you do. Many are now seeing the folly of entrusting their savings to people who had less expertise (and far less care) in investing their money than they would have had;
10. The media will be most enthusiastic about the stock market when it’s the worst time to buy and most pessimistic when stock markets have fully priced in the worst possible scenario.

Now, I just want to pick up on those last three points.

There is nothing new under the Sun

Nearly all large corporate collapses follow a similar path:

1. Those running the company have some initial success;

2. Their initial success attracts followers;

3. This following allows the company to raise debt and equity during good economic times;

4. The company expands aggressively using debt to overpay for assets at the height of the cycle;

5. The economy turns down, conditions change;

6. Debt cannot be repaid or refinanced;

7. The company collapses.

In the 1990-91 downturn we saw companies like Adsteam, Qintex, Bond Corp, Rothwells and many others collapse. Fast forward to 2008 and we can substitute: Allco, MFS, Babcock & Brown, ABC learning, Centro and a number of listed property trusts. These companies and trusts may have had different businesses, but there was practically no difference in the modus operandi of any of them.

The above steps to corporate collapse could be circumvented by either the lenders to these companies or their auditors (in cases where the financial statements provided by the companies clearly misrepresented the true financial position of the company). However, there was no resistance on these fronts.

At the height of any boom the banks are more than willing to indulge in all sorts of imprudent lending practices. They just never learn. And rest assured, they will repeat this folly in the decades to come once the memories of 2008 fade.

Auditors are the accomplices of banks. Auditors were willing to state that the relevant company’s reported financial position was “true and fair” (when it was anything but that). As long as they can extract exorbitant fees from the client, they are happy. If they end up being sued (as they always do), they have professional indemnity insurance to take care of most of the costs.

No one cares more about your money than you do

A cursory glance at the balance sheets of most failed companies (in cases where the audit had actually been done properly) would have revealed high levels of interest bearing debt in relation to tangible equity - danger sign number one.

Further, most failed companies have very short histories as listed companies - danger sign number two. This is always a danger sign because these companies had never been through a bear market (and all that it brings).

The point I would like to make here is that private companies cannot come under attack from short sellers, they do not have hundreds (or thousands) of people scrutinizing their accounts looking for vulnerabilities and they are not subject to having their “values” gyrate widely as those trading the shares are gripped by fear or greed. These are the reasons why a listed company is different to a private company.

All of these companies had business models that were predicated on boom times continuing indefinitely - danger sign number three.

Did those buying shares (or those recommending others buy shares) in companies like Allco, MFS and Babcock & Brown actually understand how those companies made money? Danger sign number four.

These danger signs didn’t worry many financial advisors and stockbrokers – they thought these companies were great investments and bought them aggressively for their clients.

Clients now realize that they were paying for “expert” advice, but there was no expertise evident in the advice that they received, in fact the opposite could be said. Does the client get his money back? You know the answer (and it can’t be described as anything other than criminal).

I cannot emphasize it enough, you just have to do your own research - no one cares more about your money than you do.

The Media

Following are some excerpts from an article written by one of Australia’s most respected business commentators in December 2007:

“My prediction for 2008 is that the global economy will muddle through America’s problems with sub-prime mortgage defaults, and that the share market will likely produce another year of double-digit returns.”

VERDICT: WRONG. MARKETS HAVE “RETURNED” NEGATIVE 50% OR SO.

“The housing collapse has been going for two years and has not sent the US economy into recession – indeed the data is suggesting that the fourth quarter of 2007 may be the low point in the economic cycle.”

VERDICT: WRONG. THERE WAS STILL A LONG WAY TO GO.

“There is no real evidence at this stage that the losses from the sub-prime crisis will be any greater than those from the savings & loan crisis of the late 1980s – that is, 2.5% of US GDP ($US350 billion or so).”

VERDICT: WRONG. LOSSES ARE NOW FAR IN EXCESS OF $US350 BILLION.

“In fact, the reaction to the sub-prime crisis in lending to corporations at this stage is nowhere near the degree of tightening that occurred in 2000-01 and led to a recession in the second half of 2001.”

VERDICT: WRONG. THE DEGREE OF TIGHTENING IN 2008 IS GREATER THAN THAT OF 2000-01.

“My own portfolio has about 10% cash at present and I am comfortable with that.”

VERDICT: HE MUST HAVE LOST AN ENORMOUS AMOUNT OF MONEY!

ADDITIONAL COMMENT: WE WERE ALREADY 5 MONTHS INTO THE CREDIT CRISIS WHEN HE MADE THESE COMMENTS!

I reproduced the above excerpts to show than even revered commentators have no predictive ability whatsoever. (Incidentally, the same individual was scaring the living daylights out of people by mid 2008 with all sorts of doomsday scenarios – what a pity he didn’t do that in December 2007.)

Our friend above was not alone with regard to his forecasts and I could have picked any number of ridiculously optimistic predictions for 2008 that appeared on respected web sites and also in newspapers. It’s the old story of looking at the recent past and extrapolating it into the future – a technique certain to lose you money over time.

Moral of the story: Don’t believe media commentators - they don’t get it right. Journalists are just that – journalists.

Take your cues from highly successful investors with long track records. They know far more than media commentators, economists or newsletter writers. And yes, they don’t tell you what they are doing each week, but they do occasionally grant interviews or write articles or comment in publicly available reports and some have even written the odd book – listen to what they say.