Benjamin Graham: Lecture 1

I have decided to make a detailed study of the lectures that Graham gave while he was a professor at Columbia Business School.

You can access the transcripts of the lectures here.

In the first lecture, Graham states that the purpose of these series of lectures is to identify the current problems in security analysis. It is also to provide an update on the textbook, "Security Analysis".

The most pressing problem identified was that security analysts read too much into the stock market. They should only strive to provide an analysis of the securities at question and not try to become a market analyst by trying to predict the direction of the market.

However, Graham goes on to preach that one can observe the following principles when studying the behavior of stocks. The principle of continuity and the principle of deceptive selectivity.

The principle of continuity relates to the observation that stock prices do not stray far away from their fundamentals and they will approach the norms after some time. There is no such thing as a fundamental shift that occurs forever.

The principle of deceptive selectivity is the analysts' perception that they are able to yield better returns by buying stocks that have better earnings prospects which can be seen prominently. Such perception only leads to lower returns for the analysts. The method of selectivity that Graham preaches is the identification of value differentials through the application of security analysis techniques.

Graham recommends that investors avoid IPOs as these offerings are made by a well-trained sales team that ensures that you will most likely not get a good bargain.

The security analysis methodology that Graham recommends is the balance sheet method. By using this method, analysts will be able to calculate the true earnings of the company being analyzed as this method removes the impact of reserves.

Dilemmas for Central Banks

Central banks need to balance between excess inflation and high unemployment. Three years has passed since the global credit crisis. In place of the credit bubble, there is currently a surge in global food and commodity prices.

In 2008, there was an inflation shock that ultimately was cured by the financial and economic crisis in advanced economies. With inflation coming back now, central banks might have to raise interest rates. However, central banks in advanced economies believe that the "output gap" resulting from high unemployment in these economies would ultimately put downward pressure on inflation.

History also tells us that since the second World War, big falls in US inflation have all occurred during or just after recessions.

Summary: 5 Jan 2010

• Eurozone inflation at 2.2%; price pressures are expected to remain subdued with fiscal austerity measures; ECB would not raise rates with banking systems in debt crisis
  
• Oil price nears $100; oil prices at such high levels threaten economies' recovery; OPEC is faced with pressure to increase their oil output; ratio of oil import bills to GDP is close to the levels seen during the financial crisis
  

Dai-ichi Life Acquires Tower Australia

This acquisition will help Australia boost Dai-ichi's net income attributable to overseas businesses from 3% to 9%. As Japan's market has mostly stagnated, Dai-ichi has chosen to expand in Australia where the market in Australia is growing by about 10% per annum. The company aims to use the Australian group's management experience in developing its own overseas businesses. The return on equity from Tower Australia is 11.4%, which is higher than Dai-ichi Life's return on equity of 7.8%.

Dai-ichi has been targeting overseas life assurance businesses and individual savings product businesses as the most promising growth areas.

Liquidity vs Solvency

Current market conditions have shown that the euphoria following formation of the Eurozone led some lenders to believe that there was no greater sovereign risk in Greece than in Germany. This led to a significant rise in exposure to weaker economies. The credit bubble has now led to where we us today.

History holds some lessons for the present.

The conditions of Latin America in the 1980s were pretty similar to what the peripheral economies in the Eurozone are now currently facing. Mexico was the first country to default on its debt. During that time, IMF and the US Treasury came in to defuse the situation by imposing austerity measures and adding to the countries debt. This only served to prolong the solvency issues of the country.

It was not until a plan was devised in 1989 for creditors to accept "haircuts" either through a principal reduction or a lowering of the interest rates that the situation began to improve.

Backwardation to commodity futures

Backwardation describes a market in which the price of a near term contract is higher than the price for later deliveries. It is usually an indication of tight physical supplies. The opposite is referred to as contango, which produces a negative roll yield. Over the long run, the low inventory commodities tend to outperform high inventory commodities. Although this is usually the case, retail investors show a knack for buying into futures indices at times of steep contango. This is in contrary to what they should be doing.

Economists raise forecasts for 2011 growth

The proposed fiscal deal between Republicans and Democrats will provide a big boost to growth in 2011. The result is an extra fiscal stimulus of $1,000bn during the next two years. The extension of the Bush-era tax cuts will help to boost consumption:

• Extension of unemployment insurance throughout 2011 (highly effective to stimulate spending as the jobless tend to spend almost everything)
  
• Tax cuts for all income groups
  

The Fed is forecasting a more optimistic growth than many market forecasters due to this announcement.