Thursday, October 28, 2010

High Frequency Trading runs wild

Yesterday between 14:25:27 and 14:27:20 (one minute and 53 seconds), 2.8 million orders were made for on particular ETF:  XLF which is the ETF for U.S. financial companies (Bank of America, Citibank, Wells Fargo etc etc).  That equates to 23 trades per millisecond -- the idea here was to generate a small profit, in this case one penny, but if you do this kind of trade at the right point of the cycle -- it can be very profitable.

No wonder retail investors are quiting the market, so far we are up to more than USD 80 billion withdrawal from the market over 26 weeks.   The game looks rigged, the market, despite its "optimism" still trades below 1220, and has not broken this level since September 2008, when it was heading down from its all time peak of 1550.  You cannot make money in that market, and it appears to be rigged!

Wednesday, October 27, 2010

Canadian House price continue to rise

Look at the dichotomy between Canada and the U.S.  Between 2007 and 2010, house price in the U.S. fell by, on average, 29%, in Canada they are up by 6%.  One massive difference is income, whereas average income has been stagnating (some would say even falling once you remove health care) it has been rising in Canada.



The impact of this on the economy is two fold:  First, Canadian banks – the primary lenders to the housing sector are seeing few problem mortgages, and even if there are problems sales prices are sufficiently high to minimize losses (moreover in Canada a loan is a personal liability, any shortfall from the disposal of the property remains as a liability of the mortgagee).  Secondly, is spurs the new home construction industry, since demand keep s on growing, a result of Canada’s different aging factors and the continued growth in household formation.  It is difficult to believe, but U.S. household formation has dropped, over the past 5 years, from 600,000 per annum to just slightly more than 200,000.  While in Canada (1/10 the size of the US) household formation has remained constant in the 175,000 to 210,000 range for the past 4 years.

One question is always, are house prices, on an income basis, higher in Canada than in the U.S., despite the recent 29% drop in the U.S. and the 6% rise in Canada, the reality is that if you look at house prices from 1987 to 2010, Canadian house price index is lower than in the U.S.  However, if you use average income, then Canadian house prices are  remaining reasonable.  Moreover the U.S. figure for household income doesn't take into consideration the annual increase in health care costs, which have been growing at a double digit rate.

Housing market is "fully priced" by all accounts.  There is no doubt that Canada could easily face a pricing correction, especially if the Canadian dollar continue on its current trend.  However, the level of over-valuation is hard to estimate, it could be in the range of 5% to 20% (the more gloomy forecasters)





Monday, October 25, 2010

A bit of S&P 500 Trivia: What lasts for 11 seconds?

70% of stock purchase of S&P 500 companies are held for 11 seconds 120 seconds or less.  The implication of this is that most market activity on S&P500 companies is driven by high frequency trading (HFT) activity; there is virtually no other reason for this figure to occur.  2/3 or all stock trading is done for no fundamental reasons, but because some algorithm has detected some minute arbitrage opportunity.

It also explains why long short equity strategies don’t function; in fact the stock market has become highly correlated, first the presence of ETF has ensured that investors are seeking investment strategies that are high beta (looking at riding the market – not picking the winners), and secondly the presence of HFT has insured the any slight anomaly will be corrected immediately.

Aside from aging baby boomers (in 2000 average age of baby boomers was 45 today its 55) that have decided that principal security is more important that riding the market (which has not generated any positive performance in a decade) hence an increased demand for fixed income securities, we find a rigged market where profit opportunities have been arbitraged away by algorithm. 

This will not end well!

Correction:  Please note that the figure of 11 seconds is an urban myth, but 2 minutes is an official figure -- not much of a difference.  As of Q1/2010, HFT accounted for 74% of all S&P500 trading...

Friday, October 22, 2010

Inflation & Taxes

So Canada’s currency, like the Australian and New Zealand dollars remains strong – my gut feeling is that this is a bad thing, especially since on a “fair market value” the Canadian dollar is probably 5-7¢ lower!  However, a small economy, such as Canada, has little control over its currency, especially when the rest of the world seems to be run by a bunch of people intent on debasing their currencies.

Earlier today, Statistics Canada released the inflation figures for September 2010, bottom line inflation is weak in Canada and falling.  Core inflation that was edging around 2.1% in January is now around 1.5%, while the headline inflation rate is higher up by 0.2% over the month to 1.9% entirely caused by higher fuel costs.


 




Going forward the one element that is worrying is the service inflation, which at 2.2% is higher than desired – service accounts for a large percentage of the economy (45%) so this is not a trivial figure.  However, pressures seem to be abating there, so that expectations are for service inflation to fall off until the end of the year.  Moreover, contraction in excess capacity is slower than anticipated so there is little pricing power.  Based on the anticipated forthcoming American quantitative easing program, odds are that the Canadian dollar will be stronger until the end of 2010.

These factors (and other such as a slowing economic growth) are probably the core reason for the Bank of Canada’s Tuesday decision to keep interest rate very accommodative, at 1.0%.  Canada’s economy cannot be viewed in a vacuum, GDP growth from exports has been weak, in fact Canada’s central bank has reduced projected growth for 2010 to 3.0%, the 4th reduction over the past 7 months, and now below my target of 3.2%... Who knew, I was too bullish!

BTW, what is interesting here is the fact that inflation in Canada (and the US) is still very low and falling --  not rising as many naysayer were predicting.

There are two major changes in Canada’s fiscal environment:  (1) Federal corporate taxes will fall by 1% beginning January 2011, and (2) Unit trusts loose their flow-through status, forcing them to revert to “ordinary” company structures.

The first change has been sold as a $6 billion tax cut – its nothing of the sort, because the way Canada’s treasury department compute the benefits of tax cut is in a vacuum, assuming all other things equal – which is clearly wrong.  The impact of this first (of three) cuts will be to make Canada’s federal tax structure equivalent to its American neighbors, restoring Canada’s fiscal competitive position.  The second is rather more important, most investors don’t seem to know this, but when a Unit Trust distribution are always considered dividend, and so are treated as income (not capital gains), the implication for investors is dramatic…

Monday, October 18, 2010

Will the Bank of Canada pause its interest rate increases?

Contrary to market sentiments of a few weeks ago, the general view now is that Mark Carney and his chums at the Bank of Canada will now pause in their objective to further normalize Canadian interest rates, to level that better reflect Canada’s economic “health”.  As a small open economy, with an 800 pound gorilla next door which appears to be heading back into the intensive care unit, we can ill afford interest rate differential in excess of 40-75 bps.

The Canadian dollar (the Loonie) is hovering near parity with the US dollar when most economists believe that it should trade 10% lower, around the 91/92 level.  Industrial product (the non-service part of the economy) is doing poorly, and there is still a substantial amount of slack in Canada’s economy.

Over the past 10 days the numbers for Canada have been strong but remain dismal, and had it not been for Canada’s housing market, commentators would be concerned about economic growth in the 4th quarter of 2010. 

  • Industrial product generated good numbers, up by 2%, but it remains that manufacturing in constant dollar is 12% below its 2007 peak, and 19% below its current dollar level.

  • Strong industrial performance was principally caused by the automobile sector, but at the same time vehicle sales in Canada are flat for August/September (down 4.8% in August and up 4% in September)

  • Factory sales rose in August, but remain very depressed from their 2007 level

  • TIC report shows that cash is again pouring into Canada (3rd highest month with $11 billion), aside from its location, is considered one of the few economies not considering debasing its currency (as are Australia and New Zealand). 

  • The Bank of Canada’s balance sheet is back to its pre-2007 size, with all quantitative easing “stimulus” fully drained out of the financial system (although it was relatively simple process since the banking system only required liquidity during the worse of the crisis).

So, today the consensus is that tomorrow the BoC will leave interest rates unchanged.  This should have “negative” implications for the CAD (which would be a good thing for Canadian exporters).

Friday, October 8, 2010

Employment, Interest Rates and Construction

Canadian economic data doesn’t make the headlines as it does in the U.S.  However, as the G-7 best performing economy (still not sure this is a compliment!) data out of the “Great White North” is interesting because as an open (ish) economy what happens here can be seen as an early warning system.

First, the data:

  • September employment numbers were -6,600 instead of +10,000.  Although the headline was a little worse than the underlying data; 43,000 temp jobs were lost and 37,000 permanent jobs were created. 
  • Losses were uneven across the country, Ontario did the worse losing 23,000 and Quebec did the best with 15,000 new jobs.  On that note, Quebec has created more than 122,000 jobs over the past 12 months.  Quebec’s economy is 1/50th that of the U.S., so Quebec’s job creation performance is the same as if the U.S. had created 6.4 million jobs.
  • New permits for construction are off by nearly 10% in August, a further indication that Canada’s economy is slowing down rather fast.
  • According to David Rossenberg, Canada’s performance in Q2/2010 and Q3/2010 now appears to be worse than that of the U.S.
What does this mean?

First, the Bank of Canada’s window to increase interest rate is quickly closing. In fact, since the beginning of the summer 2010, economic data for Canada has underperformed that of the U.S.  Although, I suspect that the large U.S. banks are about to hit a massive brick wall with the mortgage mess which is getting bigger every day, and more dangerous.  

Wednesday, October 6, 2010

Debt, Deflation, Inflation and Hyperinflation

This is where the rubber meets the road.  Kyle Bass at the Barefoot Economic Summit in Texas made some very interesting points discussing the risk of hyperinflation, cause by the Fed reserves QE2 program (which by the way is now “baked-in”).  The big word used by everyone is “Price Convexity” which is a big word for feedback loop, in effect the prices rise because the prices rise, which leads to the destruction of fiat currencies (dollar, Euro, Yen etc).  The example of the best performing stock market in the world in 2007 was Zimbabwe, yet despite extraordinary returns, fiat currency wealth was completely destroyed.

One of Kyle Bass’ first comments was that America doesn’t have the luxury of going to way of Japan – by the way that was not the objective of the interviewer.  In fact, he was angling to find out if things could get as bad as they did in Japan, and Bass’ point was that because ½ of America borrowings are from foreign investors, that every week “America” borrows $120 billion (rolling over and new money), where the current borrowings are growing between 6-9% per annum (by 2014) the implication is that America’s debt will have risen by 30%.  

Bass’ point is that America would face a convexity point – going from very low inflation to very high inflation in a very short period of time, because the bulk of America’s borrowing are short term the impact of an increase in inflation would quickly feed to higher interest rates (1% increase in interest would raise America’s borrowing cost by $120 billion).

His is the first analysis that posses the right question, that the problems of America with its foreign held debt are bound to come to a head sooner rather than later, and although America is considered a the safest bet as creditor, it remains that there exists a tipping point, so the question is not “if” but “when”. 

Which may explain the recent price movement in many natural resources – first is the epic drop in the value of the U.S. dollar over the past 12 months (13%) – although against the Canadian dollar price remain stable, but from agricultural products (32%), Metals (17%), gold (26%) price of raw materials have exploded.  This could be the first wave of early investors – the smart (or conservative) money, diversifying away from fiat currencies towards tangible assets.  BTW hyperinflation is very very bad for stock prices.  Projections for Gold, Platinum, Silver are all for substantial increases as investors look for ways to insulate their wealth from the vagaries of fiat currency.

Every indictor seems to point to 2012-14 for the “big crunch” – I guess far enough in the future that there is still time for things to change.  For Canada the impact is unclear.  There is a risk of contagion, and Canada’s debt to GDP is not but hyperinflation tend to be isolated, but an open economy highly dependent on trade with our American neighbors is bound to be affected – you can be careful, but a bad neighborhood is still a bad neighborhood!

U.S. Protectionist Trends:

  • 60% of Tea Party members believe that trade has been bad for America
  • 65% of union members believe that trade has been bad for America
  • 95% of large U.S. corporates believe that trade has been good for the profits


This will not end well!

Monday, October 4, 2010

Food Price Inflation in 2011

Last week I noticed that certain economic sectors were seeing some rather dramatic price inflation over the past 12 months.  The numbers out of the U.S. are worrying:  Food price inflation of 17%, and Non-food agriculture (bio-Mass) 44.7% inflation.  That’s a lot, especially when you consider that the Nfa concerns ethanol (in plain English we are talking about Corn).  This morning, StatsCan revealed that the numbers for the 2010 harvest were looking bad, estimates for the wheat harvest (Alberta, Saskatchewan, Manitoba) at 22,200 tones is off the 2009 harvest by nearly 20% -- add to this the fact that Russia is experiencing dramatic drop in yields (because of excess heat and fire) and the impact good be serious. 

Canada’s wheat production has the following profile:

2010:  22,200
2009:  29,700
2008:  36,900
2006:  23,600
’00-05:  20,000 (avg)

This is equivalent to a 40% drop in lest than 36 months.  We know that China had a difficult year with its wheat production.  Now, this is not a disaster (forgetting what’s going on elsewhere in the world).  Average production for the first half of the decade was around 20,000 tones, so 22,200 is not the end of the world, bust still represents a poor harvest when we consider that worldwide wheat production is off

Canada only consumes 2,000 to 3,000 tones of wheat annually, the rest is exported.  Prince impact for 2010 is likely to be important, as the supply seems to be tight, and data supports that view.

Picture of the Day

Tiger Woods Shoots Golf Ball Directly At Photographer's Camera

Photographer decides to stop Tiger's ball with his lense.

Friday, October 1, 2010

Because I’m bored!

Ok, this is a bit of an inside joke.  There’s this guy (hereinafter know as the “Guy”) in Montreal who just joined a big investment bank.  He used to be a minister (equivalent to a secretary in the US) under the previous liberal federal administration.

A few weeks ago, the Guy was interviewed by a major national newspaper about his new job (as vice chairman of the investment banking group), and he referred to the head of the Montreal office (basically his boss) as a “good boy” (he actually said it French which is even more condescending), needless to say that in the IB community this was “the joke” for August and September – you get bet that the “boss” was less than happy about that one, since he was on the receiving end! 

Yesterday the Guy gave second interview to another national newspaper and suggested that it should be a constitutional obligation for the Province of Quebec to hold a referendum on independence every 15 years, so that for the other 14 years the real economic problems of the province could be addressed.  This is such a stupid idea, that to even suggest such a thing makes the Guy to be, at worse, a complete moron, or at best a political neophyte.  Neither outcome are very good when you are about to start your new job as vice chairman (and rain maker) at a major Canadian financial institution.

However, the Guy does have a point.  A well know economic commentator demonstrated that building roads in Quebec is about 30% more expensive than in the rest of Canada (I won’t even mention the difference with the adjacent U.S. states).  Because the province of Quebec is French speaking there are some barrier to trade with the rest of the provinces, labor is not as mobile, and the union representing the workers are – to stay polite – militant, and have some rather “interesting” contacts with individuals who seem to have role in Quebec’s organized crime scene.  Moreover, the top 3 contractors in the province account for 80% of all road work.  Last year the province allocated a number of new kindergarten licenses across the province, and guess what, 90% of the winners were know as strong supporter to the current administration (liberal).  Now the current bunch has been in power for a few years, and the other bunch (Parti Quebecois) don’t exactly have a clean reputation either.  Mention Oxygen 9 to any high level PQ operative, they turn pale, and walk away… fast.

So the Guy was not wrong, the political process in Quebec is all about Canada Vs. Quebec which means that issues as corruption, poor decision process and sheer incompetence can be swept under the rug.

Still that move was so stupid, it’s breathtaking. 

Next game is:  how long with the “Guy” last in his new job!