# The Rule of 72

There are many lessons to be learned in this world. Some of them taught in classrooms, others in life. The best ones are those that carry substance yet are simple to understand. One of the most useful lessons I have learned is what is known as The Rule of 72. It is a simple and effective way to easily understand some of the financial jargon many salesman like to throw around these days. It is also a great way to break down what seems to be complex financial calculations into understandable math.

The Rule of 72 is a mechanism of measuring how many years or return per year [%] it would take to double an investment. I will illustrate with a few examples.

Using Number of Years:

Initial investment: KD 100

Investment Horizon: 10 Years

Annual rate of return [ROR]: Unknown

In this case you are presented with an investment whereby you have been told that the investment would require KD 100 and you would leave the investment for 10 years without touching it.

What would be the annual rate of return needed in order to double the initial investment to KD 200 by the end of 10 years?

Simply divide 72 by the number of years to get the answer: 72/10 years = 7.2% annual ROR. That means that if the investment returned greater than 7.2% on an annual basis you would expect to double your initial investment of KD 100 earlier than 10 years.

Using Rate of Return:

Initial Investment: KD 100

Investment Horizon: Unknown

Annual Rate of Return: 20%

In this example we assume that you are able to achieve an annualized return of 20% on your initial investment. The Rule of 72 will enable you to quickly calculate how many years it would take for the investment to double. Please note that the annual rate of return is also interchangeable with the IRR [Internal Rate of Return] that many salesmen in finance like to throw around.

How many years would it take to double the initial investment of KD 100 if the 20% IRR is maintained?

Again, we take 72 and divide it by 20% [do not use decimals] to get the answer. Therefore, it would be 72/20 = 3.6 Years. In other words it would take 3 years and approximately 7 months to end up with KD 200.

To my knowledge 72 is the only number that possesses this magical financial prowess. It is a rule that has served me well in my finance career. I urge you to embrace it and I guarantee your financial world will be that much simpler.

# Court order halts Kuwait Stock Exchange trading

I received a phone call last Thursday morning around 10:40 am informing me that all trading on the Kuwait Stock Exchange [KSE] has been suspended. Here is what the press reported:

Lawyer Adel al-Abdul Hadi says the Administrative Court in Kuwait City ruled on Thursday that all trading be halted. The order takes effect immediately and is to last until next court hearing on November 17 [1]

At first I was not sure of the story and I kept getting different answers so I decided to focus on the event itself and not the details of what happened. What is confirmed is the parties involved are a lawyer[s], Kuwaiti Courts, and the KSE. This is what I imagine happened:

Ø§Ù„Ù…Ø­Ø§Ù…ÙŠ: Ø§ÙÙÙÙ ! ÙƒÙ„ ÙŠÙˆÙ… Ø­Ø¯ Ø£Ø¯Ù†Ù‰! ÙƒÙ„ Ø§Ù„Ù„ÙŠ Ø£Ø´ÙˆÙÙ‡ Ø£Ø­Ù…Ø±! Ù„ÙŠØ´ Ø§Ù„Ø­ÙƒÙˆÙ…Ø© Ø§Ù„ÙƒÙˆÙŠØªÙŠØ© Ù…Ø§ ØªØ³ÙˆÙŠ Ø´ÙŠØŸ

ÙŠØ¯Ø®Ù„ Ø§Ù„ÙØ±Ø§Ø´ ÙƒØ¹Ø§Ø¯ØªÙ‡ Ø§Ù„Ø³Ø§Ø¹Ø© Ø§Ù„Ø­Ø§Ø¯ÙŠØ© Ø¹Ø´Ø±Ø© ØµØ¨Ø§Ø­Ø§ ÙˆØ¨ÙŠØ¯Ù‡ Ø§Ø³ØªÙƒØ§Ù†Ø© Ø§Ù„Ø´Ø§ÙŠ Ù…Ø¹ Ø§Ù„Ø¯Ø±Ø§Ø¨ÙŠÙ„

Ø§Ù„ÙØ±Ø§Ø´: Ø³Ù†Ùˆ ÙÙŠÙ‡ Ø¨Ø§Ø¨Ø§ØŒ Ù„ÙŠØ´ Ø²Ø¹Ù„Ø§Ù†ØŸ

Ø§Ù„Ù…Ø­Ø§Ù…ÙŠ: Ù‡Ø°Ø§ Ø§Ù„Ø³ÙˆÙ‚ØŒ ØªØ¯Ø±ÙŠ Ø§Ø´ÙƒØ«Ø± Ø®Ø³Ø±Ø§Ù†ØŸ

Ø§Ù„ÙØ±Ø§Ø´: Ø³Ù†Ùˆ ÙŠØ¹Ù†ÙŠØŸ ÙƒÙ… ÙÙ„ÙˆØ³ ÙŠØ¨ÙŠ Ø¨Ø§Ø¨Ø§ØŸ Ø£Ù†Ø§ ÙŠØ¹Ø·ÙŠÙƒ

!Ø§Ù„Ù…Ø­Ø§Ù…ÙŠ: Ù„Ùˆ ØªØ´ØªØºÙ„ 100 Ø³Ù†Ø© Ù…Ø¹Ø§Ø´Ùƒ Ù…Ø§ ÙŠØºØ·ÙŠ Ø±Ø¨Ø¹ Ø§Ù„Ø®Ø³Ø§ÙŠØ±

Ø§Ù„ÙØ±Ø§Ø´: Ø£Ù†Ø§ ÙŠÙ‚ÙˆÙ„ Ø­Ù‚ Ø§Ù†ØªØ§ Ø³Ù†Ùˆ ÙŠØ³ÙˆÙŠ.. Ù‡Ø§Ø¯Ø§ ÙÙŠ ÙƒØ±Ø§ØªØ´ÙŠ Ø³ÙˆÙ‚ ÙƒÙ„ ÙŠÙˆÙ… ÙŠÙ†Ø²Ù„. Ù†Ø§Ø³ Ù†ÙØ± Ø±ÙˆØ­ Ø³ÙˆÙŠ “Ø¨Ø±ÙˆØªØ³Øª”Â  Ø­Ù‚ Ø­ÙƒÙˆÙ…Ø© Ù…Ø§Ù„ Ø¨Ø§ÙƒØ³ØªØ§Ù†ØŒ Ø­ÙƒÙˆÙ…Ø© ÙˆÙ‚Ù Ø³ÙˆÙ‚

Ø§Ù„Ù…Ø­Ø§Ù…ÙŠ: Ù‡Ø§ØŸ ÙˆØ§Ù„Ù„Ù‡ ÙŠØ·Ù„Ø¹ Ù…Ù†Ùƒ! Ø§Ù†Ø²ÙŠÙ† Ø±ÙˆØ­ ÙŠÙŠØ¨Ù„ÙŠ Ø¨Ø¹Ø¯ Ø¯Ø±Ø§Ø¨ÙŠÙ„

Lawyer: Damn it! Its limit down every day! I see is red! Why isn’t the Kuwaiti government doing anything about this?

Tea Boy enters with red chai and darabeel [2] as he usual does at 11:00 every morning

Tea Boy: What’s wrong Baba. Why are you upset?

Lawyer: This market, you know how much I have lost?!

Tea Boy: What does that mean? How much money do you need, I’ll give you.

Lawyer: If you work for 100 years, your salary won’t cover a quarter of my losses!

Tea Boy: Let me tell you what to do. In Karachi, the market was down every day. People went to ‘protest’ and the government stopped the trading.

Lawyer: Huh? Well you do have some good ideas. Now go get me more darabeel.

The rest is history.

If anyone has a copy of the court ruling please email me a copy and I will post it

To be fair, stock markets do close when extraordinary situations prevail. An example would be 9/11 when the American stock markets were closed from September 11 – 14, 2001. However, it was a decision made by the government not for the government by a lawyer.

What actions should be taken

I believe that if there are people that are willing to spend the time and effort improving the public markets and investment community they should be addressing the following.

Issue: Liquidity

Objective: Liquidity is the lubricant the market needs in order for it’s internal gears to function smoothly. In addition, liquidity also provides forced sellers a means to exit their positions in order to fulfill their obligations.

Proposed Solution:

• Market makers: In a free market operation, a buyer will always seek a seller and vice-versa. At times, we find that there is a large gap between buyer and sellers in a market due to liquidity constraints. Market makers are in the business of ensuring liquidity is available to whomever needs in by always making a bid [buyer] and offer [seller]. Instead of the Kuwaiti government merely injecting cash into the market, I suggest they establish a KD 150-200 mm Market Maker fund. The government would appoint various investment companies, that meet the criteria, to become market makers using these funds. The company would benefit by being able to generate income on the spread and the government will address the issue of liquidity, a win-win situation.

Issue: Regulation

Objective: To ensure that a conflict of interest does not exist between the financial market regulator and an exchange operator.

Proposed Solution:

• FSA model: London’s Financial Services Authority is a good example to follow as an independentÂ  non-government body with a wide range of rule-making, investigatory and enforcement powers in order to meet their objective. The FSA has no relation to the exchanges which operate in England and are accountable to the Parliament. [3]
• Private Bourse: Kuwait should allow the establishment of private bourses or exchanges. Not only does this improve efficiency through competition, but it also enables greater access to market participants for companies that currently do not meet listing requirements. However, this is not limited to equity exchanges as we should also develop exchanges to trade credit [bonds & sukuks] , commodities, and other financial instruments.

Issue: Transparency

Objective: Stockholders should always have the right to access company information as they are owners in the businesses they invest in. Management should not try and deceive shareholders and are expected to provide accurate and non-misleading information.

Proposed Solution:

• Frequent investor communication:Â  A simple way o ensure that stockholders are aware of the company’s activities is by holding events where the management discusses such issues. In addition to the annual report and general assembly, companies should have more frequent communication with investors and analysts covering the stock. This ensures that decision makers are equipped with the necessary information in order to make decisions as the whether to buy, sell, or hold. I suggest that companies have quarterly analyst and investor calls/meetings that discuss the financial statements produced.

Issue: Competence

Objective: Te ensure professionals managing and advising client assets are qualified to do so.

Proposed Solution:

• Regulation of investment professionals: Kuwait must develop licenses for investment professional who are managing or advising client assets. The General Securities Representative license [Series 7] is one example of the requirements needed in the US for a professional to communicate with retail investors, among other things. It is essential that we establish such guidelines and licenses in order to ensure that qualified and competent people are managing our money.

Obviously these suggestions are not the be-all and end-all of what needs to be done. However, I believe they tackle the most important issues we are faced with today. I am confident that if we focused our time and effort in trying to address these issues and implement the proposed solutions rather than having silly protests, we will be one step closer in establishing a more sophisticated financial community.

[1] The Associated Press. November 13, 2008.

[2] Darabeel: Arabic sweets

# What the markets think of Donkeys & Elephants

It has been an interesting year so far and the punches keep coming. This is what it must feel like if you stepped in the ring with Mike Tyson. Soon enough you would find yourself with a broken jaw, black eye, chewed off left ear, half a nose, and possibly a missing pinky toe.

The most recent uppercut is the election of the first African-American President of the United Sates of America , Barack Obama, by the American people. November 4, 2008 will be etched into history books and millions of school children will be forced to memorize the date as the day America ‘Changed’. Enough on politics, lets take a closer look at what the markets think of all this.

For reasons that I don’t quite understand, and I am not sure I am interested enough to find out, Republicans are commonly referred to as Elephants and Democrats as Donkeys. What I am interested in however, is seeing how the markets reacted to these Donkeys and Elephants over time.

I used the following indexes to represent different segments of the market:

• S&P 500: Large corporates
• NASDAQ: Tech industry

[I wanted to include other indexes but it was getting too complicated. Plus, Office 2007 kept crashing on me]

The table below is a summary of each US President and the respective terms served. All data used is from Jan 20, 1977 – Nov 7, 2008.

Market reaction: S&P 500 Index [Bloomberg: SPX Index]

The chart below shows the S&P 500 shaded to represent the Donkey [blue] or Elephant [red] that was living in the White House at the time.

Source: Bloomberg. Daily closing price. 1977 - 2008. Al-Hamour

To be able to understand the market’s reaction to each President’s term I have included a ranking that takes the annualized return for each term served. So, because Bill Clinton served for two terms he will have two entries.

Source: Bloomberg. Al-Hamour

I then took the overall annualized return to measure the market return for the entire period served for each President. Here are the results:

Source: Bloomberg. Al-Hamour

Observations:

• During Bill Clinton’s single and overall terms the S&P 500 performed the best on an annualized basis @ 9.91%
• The Elephant [George W. Bush] has the worst record relative to his peers

Market reaction: NASDAQ COMPOSITE Index [Bloomberg: CCMP Index]

The chart below shows the NASDAQ daily price close, shaded to represent the Donkey [blue] or Elephant [red] that was living in the White House at the time.

Source: Bloomberg. Al-Hamour

To be able to understand the market’s reaction to each President’s term I have included a ranking that takes the annualized return for each term served. So, because Ronald Reagan served for two terms he will have two entries.

Source: Bloomberg. Al-Hamour

I then took the overall annualized return to measure the market return for the entire period served for each President. Here are the results:

Source: Bloomberg. Al-Hamour

Observations:

• During Jimmy Carter’s term the NASDAQ performed the best on an annualized basis
• The Elephant [George W. Bush] has the worst record relative to his peers

Lessons learned:

• Donkeys ranked number one for both the S&P 500 and NASDAQ
• George W. Bush is the worst Elephant and overall President

What to expect:

Despite the current banking and financial crisis we would expect that President-elect Barack Obama follow in the footsteps of the Donkeys before him. He has a tough road ahead of him and will have to address key issues such as rising unemployment, failing financial institutions, and the US dependency on oil exports. I suggest he attend Bill Clinton’s speech hosted by the National Bank of Kuwait [Bloomberg: NBK.KK Equity] next Sunday the 16th of November. Maybe he can pick up a few pointers. I know I will be there.

# 2008: Year of the Dove

The Chinese zodiac is quite unique in its construction. Based on a cyclical perception of time, the twelve animal signs are structured around a 12 year cycle. Starting with the Rat, they each represent various characteristics of people that are born during the Chinese year. [1] In China it is currently the Year of the Rat, a year symbolizing hard work, shrewdness, and ruthlessness. 2008 is also considered a lucky year as the number 8 is very auspicious and in Chinese, sounds similar to the word for prosperity or wealth.

The white dove and olive branch is arguably the most recognized worldwide symbol for peace. References of the dove range from The Holy Qura’an to Pablo Picasso’s artwork. [2] You can even purchase a War & Peace watch with a rotating Dove from the United Nations online bookshop for US\$45.95. [3]

In the finance world however, references to doves are not exactly meant to illustrate peace. Instead, financial jargon defines these words as follows:

• Dovish: A Central Bank that is cutting (reducing) interest rates
• Hawkish: A Central Bank this is increasing interest rates

Simply put, a Central Bank that reduces the interest rate at which commercial banks can borrow at is said to be Dovish and vice versa. In general, interest rates lower debt cost. For example, in Kuwait, loans are usually quoted as a percentage over the CBK rate and most of the loan terms are actually pre-determined by the Central Bank of Kuwait. That means that if you took out an Al-Afdal loan from Gulf Bank today [4% + CBK rate] your interest would be 8.5%.

As we all have come to know, 2008 has been terrorized by the banking and financial crisis and according to the latest SMS circling Kuwait, a year where only two banks are expected to remain – the Blood Bank and the Sperm Bank. However, the Central Banks have many tools at their disposal to deter such an event from becoming a reality. Increasing or decreasing interest rates are one of the many gadgets used to promote financial and economic stability. During these moments of crisis the Central Bank policy makers have joined together in a coordinated effort to reduce interest rates hence making this year a Dovish one.

The graph below highlights the year to date interest rate for the US Federal Reserve, Bank of England, and the European Central Bank. The US has been more aggressive than its peers in reducing interest rates as it struggles to keep its economy afloat.

Interest Rates – YTD %

Source: Bloomberg

• ECB: 3.75%
• US FED: 1.00%
• BOE: 4.50%

Policy Effectiveness:

Merely noting the net change in the interest rates does not give a clear picture as to whether the policy was effective in achieving its objective. One measure of credit and liquidity risk in the banking system is the TED spread. It is calculated by taking the 3 month London Interbank Offer Rate [LIBOR] and subtracting the 3 month T-Bill yield.

• LIBOR: It is a measure of how much banks are willing to lend US dollars to each other. The reported rate is an average of participating banks.
• T-Bills: The interest rate at which you can borrow, essentially risk free, from the US government.

As a rule of thumb, when the TED spread is:

• High: Banks are less willing to lend to each other as they believe other banks are not safe
• Low: Banks are more willing to lend to each other as they expect to get their money back

In this particular case, policy makers reacted to a nosediveÂ  in global equities during September and scrambled to take action. From September until about mid October, the TED spread continued to rise as banks simply stopped lending to each other. However, after interest rates were reduced globally the TED spread started to come off its high.

• All time High: 4.57% [October 10, 2008]
• All time Low: -0.034% [September 12, 2001]

TED Spread

Source: US Federal Reserve. Bloomberg. Al-Hamour.

We can see that the coordinated rate cuts were effective in reducing the credit risk in the banking system as banks became more willing to lend to one another. As of November 1, 2008 these are where things stand:

• TED Spread: 2.41%
• LIBOR: 3.02%
• T-Bill: 0.61%

However, when comparing the TED spread to the May 1987 average of 1.7% and the October 1987 average of 2.26% we are still at higher levels. This is somewhat anticipated as the current crisis is far greater in depth and breadth than The Crash of 1987 which started on October 19, 1987 in Hong Kong. [4]

TED Spread

Source: US Federal Reserve. Bloomberg. Al-Hamour.

In summation, I would like to leave you with a recap of the main points discussed in this post and what you can anticipate going forward:

• Dovish Central Banks help reduce the overall cost of debt and aid in de-leveraging of the economy
• The TED Spread is a measure of credit and liquidity risk in the banking system
• Expect LIBOR rates to decrease as liquidity is injected into the system and inter-bank trust is restored
• Expect Central Banks to continue to reduce interest rates
• Consider making a deposit at your local Blood Bank and/or Sperm Bank

I will be posting a follow up to this topic later this week and will discuss the various Central Bank actions year to date.

Please do not hesitate to leave a comment or send me an email if you have any inquiries or would like to discuss the post.

[2] Dove of Peace. Pablo Picasso.

[4] Investopedia