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> Lovell's Landscape

Tom Lovell is independent strategist, trader and advisor with boutique advisory firm Pulse Markets and is the author of Lovell's Landscape. Register here for a free 21-day trial to Lovell's Landscape. Tom has worked in the money and stock markets for the last 19 years. This has included stints in Hong Kong, Singapore, Tokyo and Sydney.

Although I have a passion for the stock market, it is my experience in the OTC markets that has provided me with a deep understanding of the related nature of all markets. This has given me the ability to analyse the key indicators and price action of money, bond, FX and equity markets to bring you a fresh approach.

Until recently I was Director of Treasury at ICAP Australia. ICAP is a broker and provider of post trade risk services, the largest in the world carrying out transactions for financial institutions rather than private individuals. Apart from managing money market desks, I have also traded and invested for myself over the last ten years. Nothing teaches you more about money management and yourself like putting your own hard earned cash on the line.

There are a lot of so-called experts out there; I don't profess to be one of them. However I do profess to being addicted to the markets and constantly trying to pick the relevant trends. As Dennis Gartman once said "in trading/investing an understanding of mass psychology is often more important than understanding of economics." Over the past nineteen years I have had many successes and failures in the markets, which is why I believe in accountability and telling it how it is.

Ignorance, greed, fear and hope are the four most important words when dealing with the markets. Don't be ignorant, don't be greedy, don't be fearful and when you find yourself hoping that something will happen, know that there is a very good chance it won't.

  
 
  
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Lovell's Landscape
Lovell's Lan...
post Posted: May 3 2012, 11:18 AM
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The Power Of Compounding

Richard Russell of Dow Theory letters has always been a proponent of compounding, and has written a piece on it which you can find on his website. If only I had taken his advice 12 years ago when I first started reading his letters, I would be much wealthier than I am today.

Trading and investing are very hard. The sad truth is most people don’t make much money out of it. With a lot of hard work and dedication you can do it, but after nearly 20 years of battling with the markets, I would have to agree with the R man that, “Compounding is the royal road to riches.”

If you’re comfortable with a company’s ability to keep pumping out dividends and you can compound your dividends, i.e. reinvest them back into shares, you can ride out a lot of the volatility with a clearer mind.

Here is an example. If five years ago you had $100,000 dollars to invest and you decided to put it in a bank account that compounded interest at a daily rate, using the RBA cash rate less 25 basis points, you would have $119,834.67 by now.

If you bought $100,000 dollars worth of Telstra five years ago at a price of 4.14 (currently at 3.37) you would have collected $37,197.16 worth of dividend cheques. However if you spent that money on flat screen TV’s, paying the mortgage and holidays to Bali, you would have had a good time but your investment would now be worth $81,398.98.

If on the other hand you put $100,000 into Telstra at 4.14 five years ago and invested the dividends back into Telstra shares, your total holding would be worth $126,624.38. And that’s despite Telstra being 18% lower than when you bought it.

If you assume that Telstra maintains the same dividend and the share price goes nowhere, by 2016 your holding would be worth $174,988.80.

Pretty powerful stuff, which should make you think long and hard about your approach to investing/trading. If you have a good job that pays your mortgage and expenses, make sure you compound your dividends. Did I just hear all those baby boomers (like my mum) say, “I need to live off my dividends!”

You see there’s the rub. Most of the western world has terrible demographics. Europe’s are horrific and China’s aren’t great either. With aging populations, you have swathes of the population deleveraging, selling second properties, selling shares, needing income and becoming more risk adverse.

On top of that, we have western governments (think UK, US and Europe) either deleveraging (austerity) or on the verge of doing so. Also we have a world financial sector, particularly in Europe that is also deleveraging, which means less credit flowing around the system. These will be major headwinds for growth.

On the flip side you have countries like India and Indonesia with fantastic demographics, with the majority of the population under the age of 30 years old. You also have central banks willing to print money and lend a hand at a moment’s notice. It is deflation vs inflation.

Chart of the day is the M2 Money Supply index.

Velocity of money measures the rate at which money changes hands. This Bloomberg generated index is calculated by dividing the Current GDP index by the M2 Money Supply index. It would appear that less and less money is changing hands.

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Back to compounding again. There is a downside: it works in reverse. If you have ever juggled several credit cards at 18% or had a massive mortgage over your head, you know what I am talking about; it is very hard to get out from underneath a blanket of debt.

I have known some very wealthy people who have lost 30 years of work in the space of 12 months, due to too much leverage and debt.

This is the exact problem that Europe, the US, Japan and the UK have. They have been living beyond their means for so long and piling up mountains of debt that it is compounding at a rate of knots. Which is why, when interest rates start rising past a certain point, as they did in Greece and Portugal, and as they are doing in Italy and Spain, the market loses faith in your ability to fund your obligations.

The problem with governments is that they like to be elected and they don’t like making the tough decisions until it’s too late. I read the other day that governments unlike traders, don’t like to take the first cut and tend to let a bad position run until it’s too late. I couldn’t agree more.

So if you have a good job or business that pays your expenses, do some compounding. Do it for your kids - they will thank you in 20 years. Stay out of debt because your local government sure as hell won’t.



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Disclaimers may be tedious, but please read this one.

The ideas and information contained in these reports come from me and me alone. I am a sophisticated investor. I am armed with a Bloomberg terminal and nearly 20 years experience of making and losing money in the markets. My risk tolerance and financial objectives will be very different from yours. The information on this site was obtained from various sources; however I cannot guarantee accuracy or completeness. This information is general only. It does not have regard to a reader's specific investment objectives, financial situation and/or his/her particular needs regarding the appropriateness of investing in any securities or investment strategies discussed or recommended herein. Readers should understand that statements regarding future returns may not be realised. So please do not act on any recommendations in this report without seeking advice from your financial planner, stockbroker, accountant and most importantly your partner. In 99% of cases your partner is far smarter than you.

One last thing. I trade and invest for a living so more often than not, I will have a position or an interest in a recommendation that I make. I reserve the right to change my view at a moment's notice; that is the nature of trading. Subscribers should verify all claims and do their own homework before investing in or trading on any recommendations in this publication. Investing in securities, particularly options, futures, commodities, bonds and CFD's is extremely speculative and comes with a huge degree of risk. Subscribers may lose untold sums of money investing or trading in such securities or investments.

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