Some good reads from around the Web.

I once asked readers to admit they were nostalgic for the turbulent days of 2008 and 2009, when banks were going bust and stock markets were a bargain.

The post was slightly tongue-in-cheek, with my idea being to remind readers that the bad days don’t last forever, even if the headlines take a while to change.

There is a reason to lament more stable times, though, and that’s that buying cheap is the best guide you’ll get to good future returns from equities.

And cheapness tends to come hand-in-hand with fear and turmoil.

Spain is still partying like it’s 2009

Given how I supposedly love cheap markets and can look through bad headlines and gyrating share prices, I have asked myself if I should be putting more money to work in Europe – and in particular Spain.

While the economic slowdown has dragged on everywhere in the Western world, Spain feels like the clock stopped three years ago.

It’s several years ago that the US and UK authorities forced a bailout of their banking systems. Spain is still doing it. Last week saw its fourth attempt to shore its banks, after the all-but nationalisation of one of the biggest domestic lenders, Bankia.

And while Obama may be tearing his hair out about stubbornly high unemployment in the US, compared to Spain’s 24% rate, the US rate of around 8% seems a boon. UK GDP is dipping, but it’s diving again in Spain.

The credit crisis that nearly froze international trade and finance is still spluttering in Spain, too, albeit more evident in the very high yields on Spanish government bonds. The government’s move on Bankia was partly a response to rising fears among Spanish savers over the safety of their money.

Costa notta lotta

Given all this – replicated to a greater or lesser extent across peripheral Europe – why would anyone consider investing in Spain?

Because it’s seemingly dirt cheap, of course.

The Spanish market is down roughly 25% on the year, with the index flirting around the level it touched in early 2009.

In contrast US markets were recently making new highs. Even after its recent falls, the UK’s FTSE 100 is up over 50%.

This weakness is reflected in a very low P/E rating for the Spanish market of around 7.5, according to FT data. That compares to over 10 in the UK (still not exactly expensive) and around 14 in the US.

You might think that a low P/E is warranted, given Spain smells about as healthy as a morgue during a mortician’s strike. As a fan of the country and a semi-regular visitor, I don’t disagree it’s tough there.

My Spanish friends confirm the country is in a right mess. The structural problems behind youth unemployment are almost worse than the headline figures. Much of what makes Spain so great – such as its hedonistic lifestyle and its family-focused culture – is partly to blame for its woes. Then you have issues like an entire generation raised on consumer credit, who make British 20-somethings look like a legion of proto-Warren Buffetts.

The root and consequence of Spain’s problems is a crazy property boom that took people out of real jobs, took money away from productive investment – and that incidentally acted as a cesspit for much of the easy money that flowed here in Britain 5-10 years ago, too.

It’s very difficult to gauge how much of this has been unwound, but again the hidden cost (graduates who eschewed careers to work on building sites, for instance) could be even worse.

But there’s a but as big as any you’ll see at any Greek wedding.

Spain is international, too

The leading companies in Spain are as multinational ours or Germany’s, and more so than America’s. Even the big banks like Santander make the bulk of their money overseas.

It’s therefore somewhat irrational for shares in Spain to be particularly hard hit by the problems at home. They will certainly suffer in a worst-case scenario for Europe, but arguably the more highly-rated US ones will do at least as badly if the global economy turns south as a result.

Some of the discount is warranted because the big financial companies have a life-threatening Spanish asset base, even if they theoretically have plenty of productive assets overseas.

We all know now that a bank can be wiped out if a minority of its assets flounder. The surviving Spanish banks (most of the little ones have gone) have been setting aside money to reflect their shaky property loans, but nobody knows how much is enough.

You might also argue that there’s a certain markdown that’s justified because of the chaos that ejection from the Eurozone could cause.

But perhaps the biggest fear in a country that was a dictatorship in living memory is a return to those truly bad days. If Spain turned into a basket case like Argentina, we could see one of those once-in-a-century blow-ups that makes looking at the historical returns from international markets so revealing.

I don’t think that’s likely, and I believe Europe can cope with its problems – at least to an extent that will eventually justify much higher share prices.

In fact, some of the solutions to Europe’s woes such as restructuring in the South and higher spending by Germany could be a positive boon for corporates.

However so far I can’t bring myself to go overweight on Europe, even though I’m not a pure passive investor and I think the markets look cheap. I have considered buying shares in the likes of Santander and Telefonica, but instead I’ve restricted myself to tilting some of my index fund allocations more in Europe’s direction.

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A few weeks ago, I mentioned I’d stopped putting new money into shares around Christmas, and that I’d become more defensive in the active part of my portfolio.

I was also wondering where to stash the cash I’d raised from CGT defusing and a (still) imminent windfall lump sum.

Was there a good alternative to another Pavlovian lunge for equities?

It proved a lucky time to get reflective, given the subsequent market falls. I don’t claim to be able to call the market, but I do keep an eye on it, and now two years in a row I’ve been fortunate to see shares slip just after I’ve gotten slightly less gung-ho about valuations.

It all helps, but I don’t think I’ve developed an unflappable sense of market timing – amusing though it would be to claim as much in 100-pixel high letters on Seeking Alpha.

(Here’s my market call: Sooner or later the FTSE All-Share is going to be a lot higher, and likely on a loftier P/E rating. I don’t know when, and nor does anyone else. I invest in anticipation).

Besides, I was really just tinkering at the edges.

I have been extremely long the stock market since 20091 because to me equities seemed cheap compared to the alternatives, which mostly look about as appealing as drowning your sorrows with a Slush Puppy on the Titanic.

I didn’t set out to become quite so overweight in equities, nor for my lob-sided bet to last so long. I had hitherto always retained a big cash cushion, at least.

Then again, I never imagined interest rates would be held at 300-year lows for three years, even as inflation topped 5%. These are unusual times, and my actions have been adaptive (and not particularly astute – I’d have made money with a lot less volatility if I’d held a sensible amount of government bonds throughout, instead of dumping them too early on fears of a bubble).

I don’t recommend this lack of diversification, although equally I don’t think it’s a terrible idea in your 20s and 30s if you can take the gyrations (and assuming you’ve an emergency fund, and that equity markets look cheapish).

In my circumstances and with my unusual temperament it suits, but even I don’t want to be like this forever.

What I currently like apart from shares

When shares seem to be leaving the bargain basement, it’s commonsense for even an ultra-aggressive investor to consider shoring up on diversification.

But how? A few readers asked me as much via email.

I couldn’t tell them and I can’t tell you what you should do to follow me for two good reasons:

1) This is an educational website, not the diary of a guru. Read and ponder but don’t copy. Most readers will be best off with at least 90% of their money invested passively, rebalancing mechanically, not speculating.

2) The stock market fell, and so I’ve reinvested most of the free cash back into equities anyway!

With the FTSE now around 5,500 and the UK market on a P/E of 10 or so, I’m not quite so concerned about lightening up any further. I never thought UK shares looked dear, and now they’re cheaper again. Europe looks a steal.

Long may it last! The last thing I want is for the stock market to go up while I’m earning money and buying shares, especially when cash and bonds are paying a pittance. I owe a Greek politician a few Euros (or some drachma, soon enough).

Nevertheless, here are some of the choices I made or considered on the road to staying close to where I started, just in case you find them interesting.

Gilts

Dismissed as too expensive. I’ve been wrong about this before. The Accumulator has made a good case for holding your nose and government bonds regardless.

Index-linked NS&I certificates

I’d love more of these tax-free beauties, but as I warned when they last showed their face, they’ve proven more fleeting than an English summer. In current conditions I would buy these whenever they’re offered.

Cash savings account

The worst of times. You can get 3.5% in an ISA, but my annual allowance always goes immediately into the stocks and shares flavour.

Outside of an ISA, you can get over 4% if you lock your money away. But it’s taxed (and harder than on dividends or capital gains) so the net rate is unattractive. For emergencies only.

Peer-to-peer revisited

I’ve been a tad more active with Zopa recently: I got money away in the prime three-year market at on average close to 7% earlier this year.

Long-time readers may remember when I was spooked by a rash of bad debts. Apparently the Zopa risk machine was on the blink for a week in 2008; that clustering didn’t escalate, after all.

Furthermore, Zopa has made itself more attractive with the introduction of a Rapid Return facility enabling lenders to potentially close out most or all their loans – an option originally only given to borrowers. It’s not perfect or free, but it’s better than nothing.

I’ve also realised that as an early adopter I’m paying a lower fee of 0.5%, versus 1% for new members. I do like a perk!

On the other hand, Zopa long ago removed the one-year terms I used to prefer (and it is fiddling again with the length of terms).

Zopa has been running for about seven years now, and I feel that (as best we can tell from the outside) it’s proven it’s not going to blow up overnight. I’ll probably put more cash into Zopa in the months ahead, and may investigate other peer-to-peer platforms.

Remember though that being a Zopa lender is not the same thing as opening a cash savings account –the loans you make to individuals are more akin to a corporate bond, and you get no compensation from the FSA if a loan goes bad.

I may be over-cautious, but for this reason I don’t think I’ll ever go crazy here (so no more than around 5% of my net worth).

Corporate bonds

I feel investment grade corporates only look at all good value currently because gilts are so expensive. As for higher-yielders, junk bonds in the US just hit an all-time low.

If junk bond buyers are right about the prospects of the companies issuing their junk bonds, then I’d rather be in the shares.

Quixotically enough, I did put an order in for a slug of the latest Tesco Personal Finance corporate bond, which is paying 5% and runs for 8.5 years. This looks attractive to me, but for a specialist view check out the write-up on the excellent Fixed Income Investor.

It’s free2 to buy into these at launch, which helps. With no dealing costs or spreads I wouldn’t mind investing in a few such offerings from various top-tier companies at 5% or more and holding to maturity, to create a slightly risky mini-portfolio.

Lloyds preference shares

I sold my 2010 tranche of these non-payers; I own some beaten-up Lloyds shares, too, unfortunately, and wanted to cut exposure. I got out at just over breakeven (no thanks to the huge spread).

I would have done better to hold given that I bought back in earlier this year, and again more recently.

Lloyds’ recent results confirmed its intention to resume payment on these securities, and sure enough the LLPC shares I own just went ex-dividend.

I’m hopeful I’ve locked in a long-term yield of over 10% on purchase here, with the potential of capital gains to come, and all in an ISA. I’ve bought a meaningful amount, but I suspect I’ll wish I’d bought more.

They’re much riskier than traditional fixed interest and shouldn’t be considered an equivalent, but the potential rewards are far higher, too.

Tilt towards more defensive shares

Over the past couple of years, I’ve churned a particular portion of my active portfolio like a hedge fund manager rolling in a bathtub of his client’s money.

In this account, I’ve gradually favoured more defensive shares as the market rises – generally ones that pay a decent dividend – then switched back later into either an ETF or else risky shares on big dips.

In the turmoil of late 2011 I switched out of the likes of Unilever into riskier fair, for instance, then earlier this year I switched back.

That sounds more elegant than the reality.

I only do all this trading because I’m so overweight the stock market overall: I am prepared to pay for (the illusion of) more control. It’s not ideal on either a cost or returns basis, but because markets have gone sideways, I feel it’s paid off – not least because I’ve slept better at night.

Note though that the majority of my individual share portfolio wasn’t touched in the past year, except to defuse capital gains.

Gold / other commodities

Considered and rejected. I do retain a little physical gold with Bullion Vault, partly as an experiment, but it’s not a very meaningful amount.

I’ve actually softened my views on gold over the past few years. I do still think it’s a barbarous relic, as Keynes wrote, but I’ve decided at heart we’re all barbarians so gold will have its moments. I’ve no idea how to value it though.

This leaves me to look at charts, cross my fingers, and hope. I may start to trickle money in if it gets below $1,500. I’d only be looking to build a 1-3% position.

I’ve occasionally looked at various ways to buy into timber, which is a great long-term asset in a funk due to the US construction slump. Some trusts look very cheap in terms of the discount to their net assets, but the managers extract a pretty pound of flesh in fees.

Currently on the back burner, but timber may get some windfall cash.

‘Special situations’

These are a couple of shares that I’ve bought because I think something unusual is on offer that’s not closely correlated with the wider stock market.

US residential property

I would love to buy into the US housing market directly. I think it looks cheap, especially off the beaten track.

I’m too scared to fly to Florida to buy a couple of ‘condos’ with ‘no money down’, mainly because I’m afraid I’d get arrested for asking for that in the wrong place…

US listed REITs or housebuilders are an option, but we’re back to equity risk.

I’ve an American friend who I trust and respect, and who I’d consider buying with. But he’s a cautious fellow, and isn’t biting!

To be honest, this is flight-of-fancy stuff. I’m no natural landlord, and I still don’t own a UK home, with all the tax advantages, as I fear they’re still too expensive.

However if I were writing this blog as a native of most of America, I’d be out shopping for a house tomorrow.

1. At one point in early 2009 I was selling physical possessions to buy shares! [↩]
2. My broker gets a half percent kickback from Tesco. [↩]

Good reads from around the Web.

Lee and Rob, two up-and-coming personal finance bloggers in the UK, are calling for better financial education in schools.

Over on Five Pence Piece, Lee writes:

Right now students leave the family unit to enter further or university education – or the even more daunting world of work – with only the vaguest hint of how to manage their money, wages, taxes and bills.

The little that is taught is about the math and not about the personal responsibility, the benefits of being financially astute and the dangers of not. It does not present the knowledge in a fun and ‘wow’ style; it’s just all about the numbers in the maths lesson.

Rob continues the theme on his own blog:

I was never taught anything about personal finance and to be honest with you I wish someone had at least taught me how to fill in a tax form or taught me my responsibilities with capital gains tax.  These are all things I had to teach myself when I didn’t see why they weren’t taught at school.

The two would like other personal finance bloggers to share their own views on educating youngsters in the ways of debt, APRs, and interest only mortgages.

I’m happy to highlight their campaign. But I’m not sure they’d want me on their team!

I’m skeptical of school-taught education, to be honest, especially pseudo-practical knowledge that is theoretical until you’re faced with buying your first house, say, or taking out car insurance.

I’ve seen plenty of people’s eyes glaze over as I’ve tried to explain how mortgage repayments work over the years. I don’t think little Johnny gives a monkey’s.

But to not be totally negative (who could argue with the aims?) I would certainly teach kids about compound interest, perhaps by alluding to the still-magical £1 million figure. That could capture the imagination.

Beyond that, I’d probably try to find something that appealed to the here and now, rather than to their future selves.

Lessons in the second series of The Wire gripped the young proto-gangsters with the economics of a corner drug dealing spot, but I’d hope things are not so bleak yet in the UK.

Perhaps using the personal finances of a top-flight footballer or a reality TV winner might do the trick?

The bottom line is our education system is teaching kids to start working life mired in debt by going to university without evaluating the return, so I don’t think Rob and Lee should hold their breath.

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