Friday, April 30, 2010

I was Pepper Sprayed Yesterday!

OK, yesterday instead of going to the gym (I’m good at finding excuses) a buddy and I went to lunch at Ruben’s a “fake” deli in Montreal’s downtown.  So, we sit down to eat, and I my nose is itching, and throat is raw, I start sneezing, and keep on sneezing throughout the meal.  My buddy notices that many people in the restaurant (including staff) are also sneezing. After leaving, I was walking along the street and suddenly felt an intense pain in my right eye!  I though maybe I should go and see my doctor, it was remarkably uncomfortable.

This morning I discover this, building was evacuated, 30 people found ill!  It seems that on Wednesday night Montrealers got a little exited when their hockey team (Montreal Canadian) won their series again Washington.  The cops used pepper spray to calm things down (why anyone would think that pepper spray would calm things down is beyond me…).  Some how the pepper spray lingered until Thursday… strange but true.

Wednesday, April 28, 2010

Are you kidding me!

Yesterday was supposed to be flurries in the morning and rain in the afternoon.  We got heavy snow all day...this picture was taken by Ms. FitN at 9 pm, the snow as still being driven hard, total accumulation was about 10cm .. 4 inches.

Of course that was at home, down town (on google map, 1.3km walk) there was only a sprinkling.

Tuesday, April 27, 2010

PIIGS’ Impact on Canada

This blog is unashamedly Canadian in content; if it doesn’t relate to Canada I’m not interested, there are so many blogs that have a U.S. or European slant this one is about Canada.  First and foremost, very little of Canada’s trade takes place with Europe, China and the U.K. are more important partners (I know UK is part of Europe…).  What would be the impact of a EMU failure on Canada?

Some of my colleagues tell me I’m a pessimist; I think I’m a realist.  What are the odds that Greece (the "G" in the PIIGS) will be able to reduce government spending in a meaningful way without creating a domestic depression and a change in government?  History shows that when outside forces coerce a government to reduce expenditure -- think of Germany in the 1920 bad things can happen.  According to some analyst it would take 30 years of austerity to reduce government debt to 60% of GDP. 

Two possible outcomes: 

(1) Germany relents and the EU agrees to provide Greece with Euro 45 billion (with IMF).  Rates collapse (currently 2 year Greek debt sells at 13%), and things go back to normal until the next crisis

(2)    Germany because of the regional election on May 9th cannot reach an agreement to participate in the rescue, and Greece leaves the EMU.  Immediate impact Greek banks face near collapse, bond face value drops from their current 65% -- 75% to 30%.  The Drachma is revived.

What is the impact of this on Canada?  In 2009, merchandise trade with the Eurozone was nearly flat (small deficit for Canada), and services are also near flat, but a dramatic reduction on the value of certain European currencies would have a small impact on the balance of payment for Canada

If the PIIGS are forced to leave the EMU the consequences are important for trading nations in general – the impact on China (which exports large amounts to Europe would be important, this would lead to knock on effect on China’s suppliers).  In fact the risk is that the “collapse” of the EMU would be drop which makes the vase overflow.  The Chinese stock market (down 15% this year) is already taking notice of the European crisis.  

The impact on Canada would therefore be a “first derivative” event, we would be affected by changes to other trading nations reduction in merchandise trade with the Eurozone.  It follows that the natural resource ride of the past 2 years would end, prices for oil, gas, copper, aluminum, steel etc would drop.  Canada, as a major exporter of these goods (in total 40% of Canada’s GDP) would feel the impact, the Canadian dollar would drop and imported inflation would rise – the risk therefore for Canada is STAGFLATION!  Where both price rise and economic activity declines -- the worse outcome for Canadian and the Bank of Canada.  Is this the only outcome?  Not really it is possible that emerging market continue to grow but were the "First world" takes a smaller and smaller portion of the cake. OPEC nations may decide to reduce production quotas to maintain their $85 per barrel price target... then the Canadian economy is spared the worse because  Canada is now a Petrol nation.

Monday, April 19, 2010

Foreigners continue to buy Canada

According to StatsCan, foreign investors continue to buy Canadian securities. Non-residents added another $6.7-billion ($7.8 billion in bonds, -$1.1 billion in equities & others) to their holdings of Canadian securities in the month, all of which were bonds as they sold stocks and money-market paper.  Foreign investors have added Canadian bonds to their portfolios for 14 straight months, with acquisitions totaling $100.7-billion since January 2009.

Why are foreigners suddenly so enamored with Canada?   Several reason stick out, first the Canadian dollar is increasingly behaving like a petro-currency (see Mike Moffatt’s analysis), which shows the CAD’s correlation with the WTI (Oil) near 90%, what other “acceptable” currency has this kind of profile (ok the Ausi and Kiwi dollars)?  Secondly, (and I wont post it here again) Canada has a very enviable sovereign debt profile with all (Federal and provincial) governments looking to control deficits.    Finally, Canada’s central bank can worry about other things than the health of the country’s financial institutions, economic growth (which appears more secure every day), and employment (still a problem but going in what seems to be the right direction).  

Demand is finally growing, although  from a low base. 

Inflation is still perceived to be on track (although these are perceptions) to be within the 2.0% to 2.5% target band.

On April 12th, the Bank of Canada released its quarterly survey of Canadian businesses.  The result above shows that capacity utilization is still below potential, but getting closer (than in '90) to full capacity utilization, which illustrates that the 2008-09 recession saw some level of absolute capacity destruction (considering the unemployment is still around 8%) 

On Thursday the Bank of Canada will issue its latest “view and opinions” about the strength of the Canadian economy, several will be looking for a definite signal of tightening with rising interest rates – although it may be premature since a quarter of strong performance is not exactly that large en endorsement of The Recovery!  

So foreigners are attracted to Canada, in 2009 our banks were deemed the safest in the world (despite a number of naysayers) and weather the crisis with only liquidity requirements (when Lehman failed banks were unable to fund their activity at any price), this quantitative easing is largely terminated in Canada, and the BoC has returned its balance sheet to its pre-crisis size.

The final analysis as to why foreigners are investing so heavily in Canada seems to be that although things in Canada are OK (not great), they are far worse elsewhere!  maybe not the best reason to invest here, still not too bad...

Tuesday, April 13, 2010

Funny joke this afternoon

How is sex in a canoe like American beer? 

They’re both fucking close to water!

OK not very nice, but heck

Monday, April 12, 2010

Wall Mart as an inflation indicator

Last week Wall Mart announced that they were cutting price on 10,000 items!  To give you a sense of what this means, the CPI is calculated on less then 6,000 items!  Also last week the FOMC released its March 16, 2010 minutes.  Not much has changed from the previous meeting, but one thing has, inflation expectations were revised downward.  Those who have been looking for inflation were disappointed AGAIN! 

But then on the face of a contraction of the M2 by $11.7 billion and the MZM by $5.2 billion the M2 is contracting at a rate of 2% per annum, while the MXM is contacting by 7.2%.  The Feds have allowed the monetary base to shrink (a first), so while rates are low, the abundance of money supply is beginning to recede.  Finally bank credit continues to shrink by $13.2 billion, or 8% per annum – another record, banks instead are playing the yield curve, borrowing short term money from the government and lending it back at a much more attractive rate.   

          Teranet - National Bank of Canada 
          National House Price Index

Ok so that’s the US, up here in Canada inflation seems to be stronger – housing for one is up rather dramatically, in fact Canada is one of two OECD countries that has not yet had a housing recession (the other being Australia).  Some are pushing the inflation diffusion index, where producers are looking to increase the price of their goods – good luck with that, with dollar parity, it will be easy for Canadian to compare prices in the U.S. 

Producers will soon discover that there is a big difference between wanting to increase prices and being able to increase prices!  Most Canadian live within 160 km of the U.S. border and the penetration of the internet is very high.  Already vehicle dealers are getting nervous (cars in Canada are 20-30% more expensive than south of the border). 

Finally this morning from David Rosenberg of Gluskin Sheff: 


Total U.S. corporate profits rose 30.6% YoY in Q4, a huge swing from the -25.1% trend a year ago. Almost the entire story is in the financial sector where profits have soared 240%, which is unprecedented. With the banks shrinking their asset base, the surge in earnings has been due to the ability to ‘extend and pretend’ post the FASB 157 changes a year ago and the ability to play a super steep yield curve. Financial sector profits have accounted for 85% of the overall increase in corporate earnings. Total non-financial earnings are up the grand total of 5.2% on a YoY basis, though this is still much better than the -17.9% pace a year ago.


I really enjoyed the $60 billion "bailout" for the EU & IMF for Greece, once again it's less than meets the eye!  Any drawing under the new facilities will require unanimous approval of all members (Angela still has wiggle room after all).   As was discussed this morning on several blogs that money helps Greece's liquidity but does nothing to solve the problem of solvency!

The Canadian dollar’s fair value

Aside from Greece, the Canadian financial press is all about the strength of the Canadian dollar, which hovers around parity with the American greenback.  One of the most interesting aspects has been the increase in the estimates of fair value for the Canadian dollar, from around .87¢ in 2006 to the U.S. dollar to near .93¢ today.  
                     CAD Vs. USD 2002-2010

It has been nearly 25 years since I really though about economic theory, and currency was discussed in one class only – Money and Banking taught by Bill Watson (at McGill U.) so I had to hit the books again to look beyond the Big Mac Index (made famous by the Economist) and look at the BoC and FEER models [FEER dates back to 1994 – Williamson et all].  The question with the CAD dollar approaching parity with the US dollar what’s the fair market value for the CAD?

Toronto Dominion Bank published a report: Has the Canadian Dollar gone too far too fast? [2008/Q1] Which makes a valiant attempt at generating a reasonable answer.  Between June 2002 and September 2007 the Canadian dollar has risen from 0.65¢ all the way to 1.10¢ to the USD a 70% rise in 5 years… returning the Canadian dollar to the level it averaged in the 60s and 70s (yes Dorothy the CAD trades “above” the USD for many years).  A subset of the FEER model, the Behavioral Equilibrium Exchange Rate: 

Et (qt)-qt = rt - rt* + λt 

Basically:  Value of the real exchange rate [Et(qt)-qt] should be equal to the difference in interest rates [rt - rt*] Plus a risk premium for the country risk (this is largely how futures are priced by the way).  This translates into the BEER function which says that the correct exchange rate is a function of the real interests rate spread (between two countries), the terms of trade (tot), the relative price of traded good (tnt), net foreign asset position (nfa), and the ratio of fiscal deficit to GDP(def):

BEER = f(r-r*,tot,tnt,nfa,def) 

This gives us a reason for the increase in the fair market value of the dollar, whereas today the differential between Canada and America’s interest rates is negligible, the terms of trade over the past 4 or five years are important:

This shows that Canada has been operating with a trade surplus for several years (despite the reversal of  2009), the trend is well established, so that there is an imbalance between Canada and the U.S., the last two factors are the more important, where the relative price of goods have been in Canada’s advantage, although completely exogenous to Canadian cost of extraction (Metals, energy etc…).  Finally, over the past two years the important factor has been the ratio of fiscal deficit to GDP, where Canada’s ration is going from 78% to 69% (by 2014) the U.S, situation is the reverse – from 85% to nearly 100% today and estimated to be 108% by 2014.

These are the factors that explain the rise in the fair value of the Canadian dollar from .83¢ to .87¢ to .93¢ today.  If Copper, Aluminum, Oil & Gas, and other export material continue their price rise, it is fair to estimate that Canada’s fair value exchange rate will continue to rise.  Apparently, the Bank of Canada uses a different model which puts more emphasis on trade; in fact, the BoC maintains that terms of trade account for 90% of the Canadian dollar’s fair value…

There you have it, the reason the fair value of the Canadian dollar has been rising is due to prudent fiscal policy (ok don't want to over do that one), and Canada trade balance, due to the increase in price of the natural resources produced in Canada!

Tuesday, April 6, 2010

Its hard to be a bear!

And getting harder everyday especially a Canadian bear, because the hard data just doesn’t support my position.  Certain days it gets very depressing, like many investors I missed the stock market rally of 2009, could have caught it on the way up, but I never believed in it!  I was always waiting for the other shoe do drop, so far I’m still waiting.

Up here (in Canada) the economy is humming, there is no doubt about it, growth appears solid, and although the Federal and Provincial governments “open the spigot” they’ve now firmly closed them.  The Liberal administration which runs the Quebec government was courageous in the face of impossible circumstances; namely that health care costs are out of control, and now absorb 40% of government spending (Vs. 31% in 1980), furthermore the trend is worrying, health care costs are growing by 5.8% per annum vs. 2.8% for the rest of government expenses.  It doesn’t take a PhD in mathematics to figure out that is an unsustainable trend line.

So up here in Canada the various levels of governments are taking the bull by the horns, and if Canadians are able to live with the short term pain, the long term gain is obvious – a healthy liberal (in the greater sense of the term) economy.

This healthy attitude, is obviously the result of very aggressive debt growth control at the federal level in the mid 90s (why is it always “leftwing” governments which tackle the debt burden, and rarely the “conservative” ones).  But it is also driven by Canada’s export orientated economic activity, first and foremost because being next door to the American giant forces competitive pricing on Canadian manufacturers.  It helps that we have more energy available than we can consume (Nuclear, Oil & Gas, and electricity), we have raw materials in quantities – although we are not the largest producers in many commodity, we are a serious player in many.

Our biggest failing is our productivity, which lags our American counterparts (several reasons have been postulated for this lag) first and foremost is that the investment environment is not as attractive in Canada than in the U.S.  Others blame the higher rate of unionized labor (probably a bit of everything).  I also suspect that some of this has something to do with our economic make-up which is less service orientated than in the U.S.  

However, what we are seeing in the funds flow is a big Thumbs Up sign from the international investment community.  Until recently, investing in Canada meant buying Canadian Treasury bonds.  Provinces raised some money in NY and London but this was largely limited to Quebec and Ontario (the largest two).  Foreigners are discovering Canada as an investment destination, the strength of the Canadian dollar is a testament to this trend. 

Back to our title: It’s hard being a bear!

The S&P/TSX is priced to perfection; strong economic growth here and with our trading partners is essential, a continued strong dollar will not impact this, as long as it stays in the 0.95 ~1.05 range.  The strength of the Canadian dollar seems to be directly linked to oil prices, but it probably has to do with the weakness of the U.S. dollar. 

The problem is when a market is priced to perfection, any slight imperfection can have a drastic impact on multiples and yields…  

I could still be right...then again