Friday, July 30, 2010

Fun Facts

  • The European bank stress test assumed a 1% economic contraction, the American bank stress test assumed a 4% contraction.  If the European stress test had used 2% contraction instead of 1%, the amount of additional equity required by European banks jumps from €4.5 billion to €24 billion.

  • European banks need to refinance senior unsecured debt to the tune of €3.3 trillion, about three times as much as US banks, which stand at USD1.3 trillion.

  • Greek trucker are entering their 4th day of strike, oil foodstuffs are becoming scarce.  Government has implemented War measures to no effect (yet).

  • China’s second largest steel producers increased capacity by 26% in 2010 to 45 million tons, number one producer’s capacity stands at 47 million tons.  The entire US steel production capacity is 16 million tons.

  • America has 140 million homes 19 million house for sale, about 8 million empty homes.  China has 65 million empty homes (on purpose) being held as a hedge against inflation.

  • America has 80 million baby boomers that are beginning to retire at a rate of 10,000 per day, Generation X includes 65 million who are much poorer then their parents.  The implications for house price are important, as it will require lower home prices going forward.  Housing, as an investment strategy is no longer a sound idea.

What do these things mean for Canada, its economic development and growth?  One certain fact is that problems in Southern Europe have not been solved; they’ve just been on holidays for a few weeks.  Greece is now entering a difficult stage where the early “victims” of the austerity measures will set the tone for what happens next (think Thatcher’s showdown with the miners in the early 80s).  A banking shock could easily occur in Europe – a failure of Greece would certainly impact the European banks’ balance sheet.  Moreover, any sign of weakness will have a huge impact on the banks ability to refinance their long term debts.  The implication for banks is that they will either have to borrow from the ECB, or reduce loans outstanding.  I would suggest that both avenues will be explored.  Banks will increase their lending standards, which will lead to a recession, which will cause further bank losses.

On this side of the pond, the economy is clearly having a hard time.  Despite quantitative easing, massive government surplus and very low interest rates, the economy is sickly, especially after the Q1/Q2 inventory boost is now over, virtually every economic indicator (except for corporate profits) is indicting a slowing economy.  The impact on China is certain to force the government there to undertake a second round of stimulus.  

Tuesday, July 27, 2010

Good news on Canada?

Over the past few days there has been a large amount of Canadian economic news:

(a)                Retails sales fell more than anticipated
(b)               Inflation was lower than anticipated (1.7%)
(c)                Q2 GDP growth is down (2.5%)
(d)               Wholesale trade was down, and inventories are rising

The data is a mix of good and bad news; the Canadian economy is clearly slowing, the Baltic Dry Index, which has dropped dramatically over the past month is an illustration of the change in trade of heavy things – for which Canada specializes.  Housing market seems to have reached an inflexion point, in all but two markets the losses of the 2007-08 housing slowdown have been fully made up (Calgary is still off by 10%). 

One key issue for Canada is inflation.  It would appear that deflation is not a problem in Canada, inflation appears to be well within the 1% to 3% range that the Bank of Canada favors at around 1.7% (once you strip out energy and food),  slightly down from the 1.8% level, and below the consensus forecast of 1.9%.

Worrying is the fall in wholesale trade and the commensurate rise in inventories, and the unknown as to capacity utilization.  Statistics Canada doesn’t provide a breakdown of the merchandise trade, so it is difficult to determine what percentage of imports are machinery – a reaction to the increase in the Canadian dollar that will force manufacturing firms to increase automation and reduce labor costs (via an increase in productivity).

The BoC has revised its growth forecast downward, and has also revised its estimate for the level of excess capacity available in the Canadian economy.  According to the Bank of Canada, 2010 GDP growth will be around 3.5% for the year, and full capacity utilization will not occur until the end of 2011.

Canada’s economist is dependent on exports; oil prices are hovering around $75 bbl and have for nearly a month.  Exchange rate between the CAD and USD is around 1.02 or 0.98 (depending on the scale used). 

Little economic news is expected this week, aside from the National Bank Terranet House price Index on Thursday, which everyone is anticipating to be flat.

Thursday, July 22, 2010

SOLVED: Chicken or Egg which came first

OK, we can cross this one off our list...
From Metro UK:
But now they believe they have cracked the conundrum of what came first: the chicken or the egg.
British researchers say the chicken must have come first as the formation of eggs is only possible thanks to a protein found in the chicken’s ovaries.
‘It had long been suspected that the egg came first but now we have the scientific proof that shows that in fact the chicken came first,’ said Dr Colin Freeman, from Sheffield University, who worked with counterparts at Warwick University.
Now if only the scientists can figure out why and how AIG was able to funnel $300 billion in taxpayer funds to themselves and their "circle of trust".

Tuesday, July 20, 2010

Foreign capital inflows growing

Canada has always been an inconsequential portion of the world economy – the “boring American cousins”. Early in 2009 the American TIC data started showing a trend: Americans investing in Canadian securities was growing.  This American trend is expanding with global investors investing “heavily” in Canada.  

Statistics Canada released data showing the growing inflow of money into Canada, equivalent to 7.6% of our GDP.  Net foreign purchases of long-term securities (bonds and equities) rose to $23.7 billion in May 2010. Over the past 12 months total foreign direct investment into Canada totaled $121 billion. 

(Statcan data via global Insight)

Continuing a global trend ¾ of all these inflows have been into bonds:  first and foremost, Federal government followed by corporate bonds and then provincial bonds.
(Statcan data via global Insight)

What makes Canada such an attractive investment destination?

Canada got the deficit religion early; in the mid 90s, the Federal government undertook massive cost control programs, slashing budgets and expenditures.  At the time global economic growth was around 6% per annum.  Now that “Deficits matter”, Canada’s early action is admired and as the only G8 country that will see a reduction of sovereign debt from 86% in 2008 to 76% in 2014 is looking like a heaven of fortitude.

The Bank of Canada recognized that a stronger economy can sustain higher interest rates – and today (20th July) increased (for the second time this year) base interest rates by another 0.25%.  Inflation pressures appear to be under control, the Canadian dollar appears to be trading around its far value of 0.92 to the U.S. dollar.  Some economists see Canadian interest rate rising by another 1.25% by the end of 2011, and near 2.5% by the end of 2015.  Although, the Bank of Canada’s GDP growth forecast of 2.9% and 2.1% in 2011 and 2012 may temper that trend.

Canadian labor productivity and Oil Prices: An Observation

(This is a long blog – sorry about that because initially I was only going to talk about oil, but then it dawned on me that the issue is what will be the impact of higher oil prices on the Canadian economy because of international competition issues)

In 2007, oil prices peaked at over $140 per barrel.  Most blamed speculators for this meteoric rise in prices, but one inescapable fact is that in the short term oil demand is inelastic, and oil supply is not growing nearly as fast as demand.  Overtime consumers can modify their behavior to accommodate rising oil prices, but in the short term they cannot.


The International Energy Agency (“IEA”) predicted that be 2011 global oil demand will reach 87.8 billion barrel per day – the previous peak in 2007 was around 86.5 billion.  Since the OECD demand has dropped from a high of nearly 50 billion barrel to 45 billion, a 10% drop, but non-OECD countries saw demand rise from 35 billion to 43 billion barrels over the same period (23%).  On the bright side supply is also expanding, but if non-OECD demand continues its current trend oil prices only have one to do, and its up.  Global production is rising by slightly less than 2% per annum, but on its current trend demand is rising by more than 3% per annum, excluding OECD countries demand which flat.  All of Asia is in growth phase, recession in China is considered at sub 10% annual GDP growth.  Finally, as of July 2010, the world’s largest energy user is China, America has been supplanted by a nation 5x larger (in population terms).

According to the IEA, Canada’s oil proven oil reserves are second only to those of Saudi Arabia.  Canada is one of the world’s largest oil exporters (#14 in 2006, #6 in 2008, # 5 in 2009), and after the disaster in the gulf of Mexico, demand for oil sands is certain to grow.

Most Canadian economist see the Canadian dollar (the “loonie”) at parity and beyond against the US dollar.  In fact, the two main drivers of a strong dollar (positive correlation) are the S&P 500 and oil prices.  The rest of Canada’s economy may not be so keen on a further strong appreciation of the Canadian dollar, Scotia Capital had the loonie at 1.10 in 2012, about 13% higher than it is today.  It is often forgotten that the Canadian dollar traded at a low of 0.62 in 2002, so that over a decade the Canadian dollar has nearly doubled in value (177%) against the US dollar.

My point is that whatever happens in the G7 or G8 is now irrelevant as far as Canada is concerned, the Canadian dollar will continue to rise as oil prices continue to rise.  The implication for labor costs in Canada is dire, unless Canada can address its long standing difficulties with raising productivity.  As of June 2010, Canadian productivity still lags that of America, although the differential is not as bad as it used to be, as in March 2010, Canadian productivity rose by 9%, bringing Canadian productivity to a level identical to America in 2003.

   (Source: National Bank of Canada)

In fact, the trade results seem to confirm this because although the Canadian trade deficit grew in June, both imports and exports rose dramatically.  Canadian industry now fully realizes that the strong Canadian dollar is here to stay, and that productivity increase is the only way they will remain competitive.

There are four factors which drive productivity; Canada has structural weakness in two of the four:

(1)               Innovation and Technology:  Canada is a small open economy.  Its small size, labor market inflexibility and stronger union make this force weaker in Canada.
(2)               Specialist knowledge workers;  Canada is a country of generalist, specialists are often attracted away from Canada to other markets
(3)               Reallocation of resources:  Canada has suffered far fewer, and less severe recessions – creative destruction has had less impact here.
(4)               Globalization as a tool of market expansion:  Canada, is one of the world’s most open economies, and should be able to improve productivity because of its growing markets.

Canada’s disadvantage because of a stronger currency can only be alleviated by better productivity.  A constant headache for Canadian policy makers, who have noted that for years Canadian labor productivity has lagged that of the US.  The number of studies on Canadian productivity’s shortfall is too numerous to count. 

Policy has tried to accommodate the needs of industry, remove impediments to increased productivity.  Maybe the treat of a stronger dollar is the only real incentive to Canadian entrepreneurs to increase productivity.

Wednesday, July 14, 2010

Baltic Dry Index – Reasoning for its 34 day collapse:

The record slaughter of shippers continues as the BDIY posts the largest overnight drop of 4.5% in the most recent 34-consecutive day trounce in dry bulk shipping rates. At this point it is not a question of if but when the bulk of shipping companies especially levered ones, start going bankrupt and flood the seas with yet more anchored rusting dry bulk hulls.

First over the past month the Baltic Dry index has been droping through the floor, problem is that the container business has not seem the same kind of drop of, my guess, and it can only be a guess is that there are a number of factor affecting the Baltic Dry Index, first is the massive new vessel build that has begun delivery over the past 2/6 months.  Again, actual numbers are not available, but from the new vessel order (size and type) it is clear that 2010 was the beginning of a massive delivery cycle for new ships from an average of 10-20 a year to around 80.  Rising to 100 vessels in 2011/12.

The report estimates that the dry bulk carrier fleet, currently standing at 7,839 ships with a total capacity of 432 million deadweight tonnes, will grow by an average of 9.5 percent through the end of 2013, up from 6.5 percent annual average growth the previous five years.

Clearly some off this new capacity is replacement capacity.  Bulk carriers have a relatively short life, because of the nature of their cargo transport – the average is around 10-14 years.

More important is that China has stopped buying for stockpiling purpose. The trade surplus earlier in the year was low, at least in part because of a surge in commodity stockpiling which, should be treated as capital investments rather than as imports, but that’s over for now, for several reasons, primarily because storage areas are now full.  For bulk carriers the trend line is returning to its 2009 level.  

For Canada the news is not very good, in fact both Canada and Australia seem to be operating on the basis that the high commodity prices are behind us (at least for this segment of the cycle). Last week alone iron ore spot prices fell 9.4 per cent and Brazil-China freight prices fell 20 per cent. China's trade figures showed iron ore imports fell 14 per cent last month, measured year-on-year, after rising an average 8.4 per cent each month until May.

What is true for steel extends to other metals an natural resources, although China recently purchased large amounts of Uranium to fuel its growing number of nuclear power stations.

Fun fact:64 million empty apartments in China

According to Yi Xianrong, an economist at the Chinese Academy of Social Sciences, a government think tank in Beijing, noted estimates from electricity meter readings that there are about 64.5 million empty apartments and houses in urban areas of the country, many of them bought up by people wagering on a constantly rising property market.

At first I tried to make a comparison with the U.S., but that’s simply impossible, there is simply no equivalent for this anywhere in the world.  This figure only counts “urban” areas, Chinese stats count a small 2 million people city as “rural” which would mean that most American (never mind Canadians) live in rural settings.

Monday, July 12, 2010

This has nothing to do with Canada’s Economy

Videotron is a Montreal based internet/TV/telephone provider – after the 2002 deregulation in Canada, internet providers were allowed to provide voice over internet protocol, services, basically, they were allowed to compete with Bell Canada – until then the sole provider of telephone services.

Since then there’s been an explosion in demand, seriously eroding Bell Canada’s profits and market share.  One reason was the price that Bell Canada was charging had become ridiculous – for what I was paying Bell Canada for phone service I could get the internet cable TV and phone service, so me and many others jumped ship (everyone was surprised starting with Videotron). 

Now to my story:  Saturday morning I realized that the internet was no longer functioning – nor was the phone.  After resetting the modem and the router the phone came back, but the internet was gone.  So I called Vidoetron service number.

I call these guys at 8:30 AM Saturday morning, expecting voicemail.  My wife expecting a bunch of well placed expletives from me decides she had better things to do and went to make some coffee. 

Imagine my surprised after entering my account number and date of birth; I was connected to a real live technician. A really nice guy, with who determined that my cable modem was dead.  The technician informed me that he was scheduling a call for a technician to come to our home THAT SAME DAY, between 9:00 and 17:00.

Imagine my surprise when at 10:30 the door rang, and there was a technician standing in my doorway with a modem in his hand!  10 minutes after installing the modem it was determined that the current surge had blown my Ethernet ports on my wifi routers and my desktop machine (since it’s a MAC it also has a wifi port that was unaffected).

 By noon everything was repaired and a new Apple router was purchased.  I just could not believe it, hearing from my American friends suffering at the hands of AT&T or other service providers when no human can be reached or service calls are suddenly cancelled with no notification.  

I interacted with two technicians and in the space of two hours everything was fixed..incredible!.

Friday, July 9, 2010

High probability that the Bank of Canada will raise interest rates in July

Canada’s economy is about 1/10 of that its neighbor at the south ($1.5 trillion Vs $15 trillion), so today’s blowout announcement that June employment rose by 93,200 is as if the U.S. had announced the creation of 930,000 jobs (instead they lost another 125,000).  Since Jan 1, 2010 the Canadian economy has created more than 300,000 jobs, which is truly astonishing.  

As a major exporter Canada is excessively exposed to the world at large, probably the last country one would expect to “decouple” from the G8 crisis.  In fact, Canada finds itself in the interesting position to have reached a level of employment almost equal (still 14,000 jobs missing) to the pre crisis level.

Wages are still decelerating (despite the strong employment growth), and this new gives the Bank of Canada an opportunity to increase interest rates – allowing Canada’s central bank to create a buffer for future recession.  According to David Rosenberg, this is not the very first time that Canada economy has diverged from the US in the past 90 years; it’s the third time (including the great depression).

Looking closely at the labor numbers two sector did poorly:  manufacturing and transport, these are the two most “American” sectors of the Canadian economy – for those who don’t know the Automobile manufacturing sector in North America is completely integrated, and as demand for vehicles drop so does production (annualized sales of 11 million vehicles in North America is on par with the number of cars sold in 1990 – bad).  On the transport side, the vast majority of Canada’s trade is North South, not East West, Quebec trade towards to US dwarfs the trade between Quebec and Ontario or Quebec and the Eastern provinces.  Both manufacturing and transport saw labor shrinkage.  In fact, it appears that Canada is looking East for hits trade business (China, Japan, Korea) instead of the god old US of A.  

Again the issue is what will the BoC do to short term interest rates. 

  1. Employment picture is pointing to a general economic recovery
  2. Wages and salaries are stable (if not falling in the face of positive inflation)
  3. Number of hours worked fell marginally (equal to 43,000 jobs lost)
  4. Expectations (95%) are for a July rise in the s/t interest rate by 25bps to 50 bps
  5. Global economic situation seems to have stabilized (for now?)
  6. Housing prices are still rising, although sales seems to have rolled over.
The jury is still out on a increase in interest rates, but assuming that things remain "even" and that there are no major external shocks, its probably safe to say that the Bank of Canada will be sorely tempted to increase interest rates, the decision is probably more in the size of the increase, as opposed to the decision to raise rates at all.

Maybe this time my prediction will be better, than it was at the end of May

Monday, July 5, 2010

Proof that the U.S. banking system is a big head fake

Saturday evening I had dinner with a number of American friend, Europe and its problem was at the core of their discussion, I kept my mouth shut until one guys said that they were happy to live in the U.S. were things were much better.  It shows how little people understand about the American's financial system's difficulties.  In fact, the U.S. banking system is probably insolvent (as a whole).  Last night, I did a bit of digging and this morning David Rosenberg provided the bulk of the pieces.  First, here are some numbers:

  1. Two-thirds of American homeowners have a mortgage — 56 million in total. Around 50% are guaranteed by the GSEs (e.g. Fanny May & Freddy Mac), 35% are held directly on the balance sheets of the banks, and 15% are private label. .
    1. Estimates suggest that 14% of these 56 million mortgages are already in arrears or in the foreclosure process
    2. This means that about eight million Americans have stopped paying their mortgage. Staggering.  
    3. Other estimates suggest that over 90% of these late-paying/non-paying debtors will never get back to being current. So what we are looking at is something like 7.2 million mortgages that will inevitably go into foreclosure in the near future
  1. Meanwhile, the pace of foreclosures has been slowed via loan modifications brought on by government pressure and the simple fact that banks do not want to take deflated property onto their books.
  2. What does not get reported often enough is that the rate of non-foreclosure on delinquent borrowers is surging — 24% of the people who have not made a single mortgage payment in the last two years have still not been foreclosed on.
  3. The banks don’t want to take the hit and in the meantime the foreclosure pipeline is completely clogged up. (It has to be said that the banks are content in kicking the can down the road since homeowners are making good on their second lien — $842 billion outstanding, most held at the big four banks, and they are holding these at par even as the first lien has already gone bad!) 
Second liens worth USD 842 billion, which are probably worth nothing (since they rank junior to the first lien on the houses).  As a matter of curiosity how much of the US financial system doesn’t 842 billion presents?  How about 112%

In effect, the US banking system is bankrupt when one takes into consideration ONLY their exposure to second mortgages on residential building – forget the losses when one considers commercial real estate.

That’s how bad it is!

Friday, July 2, 2010

GDP Growth in April at Zero

After two strong quarters Canada's GDP growth has taken a break.  Some will say that the road to 4-5% GDP growth for 2010 will generate some reduction in the growth rate.  However, others (me), who take the view that after two strong quarter (Q4/2009 and Q1/2010) Canada was growing too quickly, in view of what is happening in the rest of the world.

If my target growth rate for Canada of 3.2% is to be achieved, Canada's economy will slow down dramatically in the second half of the year.  The Baltic Dry Index, a "fair" indicator of demand for bulk good is way off its year high of 4,500 -- as it hovers around the 2,900 mark, a 35% drop since mid December 2009.  The death cross has been reached on this index (when the 50 day average falls below the 200 day average), which speaks of wide spread weakness in the bulk good delivery system.

Oil prices are off the high, Copper is also way off its 12 month high, a further indication that demand is faltering.  For Canada, where mineral and energy exports accounts for 40 of GDP, and nearly half our exports that is bad news.  It also means that the Canadian dollar is going to trend down against the US dollar going forward.  

The Bank of Canada had been presumed to increase interest rates by another 25-50 bps in July, to eventually increase the differential in interest rates to nearly 1% between Canada and the U.S.  Now that theory is finding fewer takers! Especially since inflation seems to be largely contained (they key factor for the BoC is the stability of money, and not exchange rates).

Interesting factoids: (1) the number of 18-25 year old in China will drop by nearly 30% over the next three years; the Chinese government's "One Child" policy is finally beginning to affect the labor supply in China -- making China far less interesting as a cheap labor pool -- this will have implications for Chinese wage inflation. (2) Ben Venue Laboratories a US company interviewed 3,600 people for jobs in its labs, they required 9th grade level math skills -- they still have 53 opening -- they only found 47 who had the math skills (by the way these jobs pay $31,000 per annum).  This is rather appalling, although I remember interviewing a young woman for the job of administrative assistant, one question on the "math test" we had was:  What is 10% of 100?  She had no idea, despite the answer being in the question!  But then some people are baffled by the question:  What was the color of Napoleon's white horse? 


  1. Focus on safe yield: High-quality corporates (non- cyclical, high cash reserves, minimal refinancing needs). Corporate balance sheets are in very good shape.
  2. Equities: focus on reliable dividend growth/yield; preferred shares (“income” orientation). Starbucks just caught on to the importance of paying out a dividend.
  3. Whether it be credit or equities, focus on companies with low debt/equity ratios and high liquid asset ratios — balance sheet quality is even more important than usual. Avoid highly leveraged companies.
  4. Even hard assets that provide an income stream work well in a deflationary environment (ie, oil and gas royalties, REITs, etc…).
  5. Focus on sectors or companies with these micro characteristics: low fixed costs, high variable cost, high barriers to entry/some sort of oligopolistic features, a relatively high level of demand inelasticity (utilities, staples, health care — these sectors are also unloved and under owned by institutional portfolio managers).
  6. Alternative assets: allocate significant portion of asset mix to strategies that are not reliant on rising equity markets and where volatility can be used to advantage.
(Source:  David Rossenberg, Dinner with Dave, June 30th, 2010, Gluskin Sheff)