Wednesday, June 29, 2011

LSE TSE merger/sale is off

The Toronto Star said it best;  This was not a merger it was a sale.  

Investors wondered what was the deal logic, eventually the TSE shareholder meeting yielded a rather massive: NO.  Only 54% of proxy votes supported the transaction, well short of the 70% requirement.  The consequence is that the only deal now is a :Pan-Canadian deal via the Maple group, basically Canada's banks will be buying the stock exchange.  

Canadian banks own Alpha and CDS -- the first is a "dark" exchange for institutional investors -- similar to what is available in other jurisdiction.  CDS is Canada's trade clearing and settlement system for eligible securities.  Of course for two banks the cost has been high; BMO and RBC both invested heavily time, energy and reputation to get the LSE/TSE merger off, and they failed -- my guess is that they will soon join the Maple bid...

Another big loser is the CEO of the TSE, his role in the group become "more difficult" to remain polite.  We shall see.   

Teranet - National Bank House Price Index

This morning from TBNHPI:

Canadian home prices in April were up 1.1% from the previous month, according to the Teranet–National Bank National Composite House Price Index™. That rise took the index to a record 140.47 (June 2005 = 100). The April increase was the largest of five consecutive monthly rises following three straight monthly declines. For the first time in 10 months, prices rose in all six of the metropolitan markets surveyed. The gain was 1.8% in Vancouver, 1.4% in Ottawa, 1.0% in Montreal, 0.8% in Halifax, 0.7% in Toronto and 0.6% in Calgary. For Calgary it was only the second monthly rise in nine months. Vancouver extended its string of monthly increases to seven, the longest run among the six markets.
As if further proof was required, April saw the single largest increase in Canadian house prices.  Bottom line Canadian housing is "on fire".  On a year of year basis house price rose faster than inflation.  Any clearer signal needed, that inflation is a problem?  

BTW this occured at the same time as Canada CMHC (equivalent to US government agencies) reduced the term of loan and increased the minimum deposit required on their insured housing loans.

Actually, April was the last month of CMHC's higher borrowing amount and longer term, which may partially explain the "rush to beat the deadline.."  May will see what happens and if the April rise was driven by CMHC changed borrowing requirements.

Inflation is becoming a real problem in Canada

This morning from Statistics Canada:
Consumer prices rose 3.7% in the 12 months to May, the largest increase since March 2003. This follows a 3.3% increase posted in April. The increase in May was primarily a result of higher gasoline prices.
Granted that most of this increase was food and energy (respectively 5% and 16%), yet it remains that the 3.3% registered in April was suppose to be (according the Bank of Canada) a peak, and now it appears that the peak is even higher.  Virtually all sectors saw price rise (excluding clothing), with transportation the worse affected (since fuel costs are a very large component of this sector...).  

(Source: StatsCan)

The Canadian authorities are taking a very aggressive stance vis-a-vis the risk of exogenous shocks, the BoC's recent risk assessment tot he global financial system shows greater stress than 12 months ago, and yet the internal numbers are worrying.  Will the BoC eventually be forced to "overreact" on interest rate if it waits much longer. The Canadian market has largely discounted a rate rise  before May 2012 (Q2/2012), but of course this is only the futures market, that opinion can "change on a dime".  It remains that inflation pressures are strong in Canada due to "local" risks (a booming economy).  

I am no longer ready to put money on the table for a rate rise, but there is no doubt that as an investor, my fixed income duration exposure will remain relatively short (the 5y range), simply because the BoC eventual rate rise will probably not shift the yield curve, rather they will affect the slope of the curve (which works well for intermediary duration exposure).  I'm not that bright, but the steepness of the Canadian yield curve is near "historical" highs.

The current and inexplicable position adopted by the BoC brings to mind my reaction to the U.S. and U.K's initial decision to invade Iraq "they must have data that shows WMD that they are not releasing, they are just not revealing everything!"  I was naive, in fact, they had nothing and were actually goosing the data to create a false positive on WMD.  Again here I assume that Mark Carney (Governor BoC) has non-public information on the state of the global economy that worries him to such a point that he is concerned with an exogenous shock!  Maybe I am being naive here too?

Monday, June 27, 2011

Shale Gas & Dot Com bubble – similarities?

The new Eldorado according to some, to others it’s just “this side” of poison. One thing for sure that this weekend’s long article on Shale Gas in the New York Times does put the sector in perspective here and here. My usual source of “all things energy related" here has more to say on the whole issue

First, a few months ago a study was published that showed the incidence of water table poisoning for test samples within 1km of the drilling/fracking site (doesn’t that sound a little too much like Battlestar Galactica!) however it refers to the practice of fracturing the rocks so that the gas/oil can be extracted. Part of the problem with regards to the “poisoning” aspect of the gas extraction is that certain of these chemicals have not been deemed to be poison, because they are almost never found in the drinking water. Especially with regards to Methane that has been found (and has been documented recently in a feature length movie).

Now, today natural gas is sold for about $4 (per million BTU) and shale gas extraction costs about $7, so there’s a tiny little hole in the profitability of the endeavor. However, natural gas is ‘clean energy” therefore favored by many jurisdictions – the Germans just announced their intention to shut down all their nuclear power plans (currently producing 25% of all of Germany’s electricity) and replacing this energy with gas power solution (to note here that most natural gas come from Russia – who’s had few compulsion to use its ability to shut down supply to meet certain geo-political objectives).

Anyway the articles in the NYT discuss the hype in the shale gas business, and how reserves seem to be overestimated – to make the investment pill more palatable. Part of the dilemma of a new industry is the extraction rate. When the oil sand business was started in the mid 1980 (yes that long) extraction rate for above ground supplies (literally the oils ands were sitting out in the open (BTW leaching into water supply) was low – probably no more than 1% (it stands at about 10% today). This is the problem, 1980 technology would show that recoverable oil would be 1/10 of what it is today (it may be even higher as new technologies are introduced). Still, the data from the NYT seems to indicate that shale gas companies are playing loose with recoverable levels and production costs – as the “new energy” of Pennsylvania is seen as an Eldorado.

The basic rule of investment remains: If it sounds too good to be true, it probably is!


Saturday was a miserable day in Montreal, the weather was just awful with heavy rain most of the day, so I was reading the papers (on my Ipad...Please) and listening to CBC Radio One (French) generally their opinions are just a little strange; a few weeks ago a commentator was bitching that the process of building one of Montreal's two teaching hospital was very slow because the Quebec government has used Public Private Partnerships (P3 for short). This was not challenged by anyone on the show, despite the fact that contracts have not yet been awarded! It's like blaming the taxi driver for being late when you have not yet called him!

Back to our story, many will remember that there was an electoral tsunami in Quebec during the May 2, 2011 federal election, where the Block Quebecois (a nationalist movement) was wiped out by the left wing NPD (trust me they are left wing...). This was a vote of protest for many Quebecois tired of hearing the word "independence" and wanting to change the conversation after more than 30 years. In fact, most Quebecois would be hard pressed to understand the electoral platform of the NDP, some candidates won with out running or even setting foot in their electoral district!

Back to our radio station, that said that one major reason why the celebration of June 24th was so poorly attended (considering the weather Friday evening, my gut instinct that the only people out would be ducks!) because Quebecois didn't want to hear about sovereignty anymore. Yep, this too went unchallenged, despite ample evidence that the primary sites in Quebec city and Montreal were covered in mud, and that the rain was relentless. OK, maybe in years past Quebecois would have overlooked such bad weather, and maybe this can be associated with the lack of interest in the independence movement, but a free concert is a free concert (BTW with some of the biggest names in show business). It is an indication of how far the discourse has moved that any "shortfall" in participation is deemed to be proof that the movement for independence is dying.

Maybe it is (actually probably) the youth of the province has different concerns (and different social makeup) that their parents or grandparents. It was easier to plead for "Quebec injustice" when the rest of the world was remote, and not part of the daily conversation. It is difficult to complain about our lot when we see the events in the Middle East in general and in Syria in particular; our "oppression" looks like the complaints of a 7 year old (in this context).

Wednesday, June 22, 2011

1978 & Babby-Boomers

This amazing graphic from another blogger, Worthwhile Canadian Initiative shows the amount of equity in U.S. and Canadian housing since 1990. Two things to note: First, as far as Canadians are concerned all the increase in house price is accounted for by more debt – recently there has been negative equity build-up in the Canadian housing stock, because house price are increasingly financed with debt (instead of equity). The second item is the level of “equity” in the U.S. housing stock, it is today equivalent to the level last reached in 1978, or as Stephen Gordon says: “Nineteen seventy-freaking-eight”32 years ago

Interestingly the peak in U.S. home equity occurred in 2006, with deceleration in 2005, an interesting match with the housing crisis. Here in Canada the situation was slightly different (as was the hiccup in housing prices) that was about 9/12 months later than in the U.S. (See the Teranet National Bank house price index).

The most interesting analysis of U.S. housing dynamic relates to the “changing of the guards” occurring in the U.S. as the baby-boomer begin to retire (apparently at the rate of 1,500 per day…) their housing needs are changing. Imagine your parents, the kids have moved out and mom and dad decide to get a down-town two bedroom apartment. Basically, their housing needs goes from 2,500 sqf house to a 1,000 sqf apartment. Problem is that Gen-X doesn’t have the income to buy mom and dad’s but more importantly as a demographic they are far less numerous. On the basis of the generational shift, it would seem that U.S. housing demand will decrease by 4.3 billion sqf, or 1.7 million homes that’s out of a 140 million homes (that’s 4%).

The issue for home buyers then becomes more complex as the issue of home appreciation (forgetting for a second the current overhang due to economic dislocation, since even if people are not renting, they will live somewhere), this is a pure demographic analysis, that will worsen as the babby-boombers move from 1,000 sqf to assisted living facilities that even smaller. The long term impact is to make your house less a store of value, and more a place to live. Implications for the preference of ownership vs. rental become more uncertain.

Note: I think there is a problem with the Canadian data, because the BoC stats shows that as of 5 months ago the amount of equity in new home purchase has actually increased, which would make the above graph incorrect -- because house prices are still rising. The wrong series may have been used...


StatsCan today revealed that Canada’s population was 34,349,200 at the end of March 2011. So almost exactly 11% of the United State’s population and around 9% of America’s GDP. Without making a comment about the validity of these numbers, they are what they are.

Last night while picking up cheeses for a dinner party (it was excellent) I heard the cheese shop owner discussing with a bunch of French tourists (surprised that the quantity of cheeses in the shop – something like 200 different cheeses), he mentioned that Quebec’s population was about 7.5 million. Well he short changed the province by nearly 500,000 residents. In fact, hence the title, Quebec’s population according to StatsCan is 7,957,600, just 42,400 shy from 8 million… a nice round (but meaningless) number.

Of course Quebec is not the fastest growing province that goes to Alberta – Canada’s energy capital which has seen the fastest growth rate (2.3% per annum over 40 years). In 1970, Alberta’s population was 1.5 million, today it is 3.7 million.

Tuesday, June 21, 2011

Think of the Greek parliamentarian’s dilemma

At 9 PM (GMT) the Greek parliament will vote on confidence vote with regards to the government’s proposed austerity economic strategy. The question is how will the opposition vote?

Greece’s problem is that the current administration discovered that public finance were a mess, far worse than anticipated. In fact, they discovered that total debt was three times higher than had been previously revealed. The prime minister tried to form a national unity collation, the opposition would have none of this (why share the blame). Now the opposition has three choices: Support, reject or abstain. My guess is that they will be blamed even if they abstain – since the government would win the confidence vote. So they will have to choose between elections -- maybe taking power and having to solve the mess themselves or support the current administration, and let them suffer the eventual electoral backlash. Difficult calculations if you “believe” that more debt is the solution (in my opinion it is not), but easier if you believe that the ECB/IMF have only kicked the can down the road with the hope that an eventual pain free solution emerge.

Once you believe that the solution lays in negotiating with the ECB/IMF a new deal (including hair cuts for foreign private creditors) then Greece has a chance to make it! Clearly remaining in the Euro area is out of the question. Transition out of the Euro is complex but not impossible.

The solution will not please the ECB, but then, everyone knew that Greece was faking the stats when it joined the Euro – and yet no one said anything!

My gut feeling is that the opposition will support the government, because the next 8 to 12 months are going to be horrible for anyone in power. Might as well be the other guy! I was wrong, eventually the vote was down to party lines.  The opposition decided that they had nothing to gain in supporting the government.

Retail Sales:

Headlines are good, dig deeper and it’s not so great. First the headline, retails sales grew by 0.3% (3.6% p.a. annualized), but strip out cars and car parts and there is no growth. Again this sounds worse than it is, in fact slightly more than half of retail sector saw growth (with the sale of new automobiles at 8.6% the top), and the growth segment represent ¾ of the retail sector.

Still, compare to previous retail sales report this is by far the weakest, with an unbalanced economy that is causing some headaches. Needless to say that the market sees no hikes in interest rate this year, and even Q1/12 is looking mightily dodgy in terms of increase. Economic weakness is certain to affect policy, and may even cause the Federal government to slow down its “exit” from stimulus expenditure contraction.

Overall, this is a transitory number; there is no reason for Canada’s retail sector to slow down, except fear of a “collapse” south of the border. In reality, Canada’s economy looks solid, this weakness may be transitory… watch this space

Canada Vs. the United States

According to the press, Michael Bachmann candidate for the Republican Party’s presidential nomination said that Canada was doing better than the U.S. and that the Conservative government had not provided any stimulus to the economy.

Now, we know here that in early 2008, the Prime Minister Harper (and his finance minister) where rather keen to provide only minimal stimulus to the economy, but as a minority government they were “forced” to implement a more aggressive package (strike one for Bachmann – but then she’s about as uninformed as can be, a true blowhard!). In retrospect, I suspect that Harper and Flaherty were happy to bend to the demand of the opposition parties.

Canada did in fact implement a $40 billion economic recovery package of governmental spending. In Quebec, where I live, there is no doubt that the participation of the Federal Government in several programs helped greatly (the bulk of Canada’s Federal government spending are indirect). Quebec had long announced (and planned) a huge infrastructure program (literally our bridges were falling down, and killing people!), the impact of all the Federal money was to mute the recession impact in Quebec, to a point where it went almost unnoticed!

There is no doubt that the action of the Canadian Federal government and of the Bank of Canada (which provided liquidity to the Canadian banks) was key in keeping the economy from excessive contraction. However, other factors were more important: (1) Canada’s housing recovered from a short term price dip to reach even higher (bubble) levels, (2) construction and investment reached unprecedented peaks (all segments: commercial, retail and housing). (3) Canadian banks had few bad loans as the economy continued to grow, and (4) “Emerging Economies” continue to demand raw material – a core activity to Canada’s economy.

The reality is that $40 billion in a $1.5 trillion economy is only 3%, and that this money was spent over several years, contributing no more than 0.75% to GDP – helpful, but not the core element to Canada’s success (sofar).

Canada now finds itself in the same position that the U.S. did 4 years ago; excessive mortgage debt, excessive personal borrowing (and income has been rising in Canada). Eventually, like all roller coaster the market would have to return to long term normal. But to say that Canada’s conservative government did not help during the crisis would be wrong.

Today unemployment in Canada stands at 7.4% (May), whereas it stands at 9.1% in the U.S. -- if we compare unemployment the same way as the U.S. it is actually a full 1% lower. Capacity utilization is nearer to the historical average, and strikes are growing in number (Air Canada & Canada Post) as tightness in the labor market is rising. Canada’s economy is very different to that of the U.S. – Just 15 years ago the S&P 500 was a good proxy for the Canadian (TSX60) this is no longer the case. Finally, the Canadian government is looking to achieve a balance budget by 2014! The Bank of Canada withdrew its liquidity support 14 months after the beginning of the crisis (a fact largely unnoticed by bank observers across the world). Canada is far from perfect, we make jokes at the expense of our American neighbors – especially with regards to their inefficient health care system, but we often forget that here in Canada health care costs are rising substantially faster than inflation – and Governments accounts for nearly 100% of all health care expenses. Our housing market is beginning to exhibit all the signs of overheating (frankly in some areas bubbles), and our successes are exogenous – it is the energy buyers, the raw material buyers that have propelled Canada’s economy, the massive advantage of a small open economy, but should China slow down, or the rest of the world see a falling demand for raw materials, and Canada’s fortune would be greatly affected.

That’s our reality

Friday, June 17, 2011

Troubling data on the Canadian manufacturing segment

The problem with data is lag, let’s say that Canadian manufacturing companies believe that the CAD is going to stay at the 1.05/95 level, it changes their pricing perspective both in Canada and abroad, but this expectation as to interest rate takes time to be absorbed. The same also applies to exogenous events – such as the Japanese Tsunami of a few months ago.

(source: StatsCan)
April 2011 saw a 1.3% reduction in manufacturing sales, by no means “end of the world” and to a certain extent represents a walk back of the previous month’s increase, so conclusions are hard to draw, especially when one sector is responsible for the bulk of the pull back: namely transport. In the case of April the shortfall is not only Aerospace (11.6%) but also automobiles (8.6%) and parts (5.4%) that are to blame for the drop off. Energy manufacturing was also to blame but marginally (2.3%), while food 1.8%, machinery 3.2% and chemical 1.7% added to the positive side of the equation.

Far more serious is the rise of inventories and the inventory to sales ratio (never a good thing) while surprisingly order books we also rising (especially if aerospace is removed). So while the strong CAD (which by the way is now back to near parity – thanks to weaker oil prices – WTI near $94 this AM). It remains that the segment is going through a difficult phase – and this despite a very accommodative monetary policy.

Adding to this situation wholesale trade was also lower this month.

(source: StatsCan)

This may explain why the BoC is hesitating in moving more aggressively towards higher interest rates, they see some weakness in the manufacturing sector (although it accounts for less than 30% of GDP today Vs around 40% a decade ago). Overall the market is now discounting any BoC interest rate increase for 2011 – and Q1/12 is looking tight. Of course this could all change quickly, but market suspicions are that the BoC is very concerned with the international situation, and takes the view that raising rates now to reduced them in two months would send a worse signal than being “overly cautions”.

One reality that has been of concern of the BoC has been the weakness – and over leverage of the European banks especially with regards to the Greek and Portuguese bond exposure.

(Source: Early Warning)

Thursday, June 16, 2011

Mark Carney: I cannot call it a bubble, but...

Yesterday, Mark Carney (Governor of the Bank of Canada)gave a speech on the direction of the Canadian housing. Bottom line, he concerned that some part of the country have seen prices reaching unsustainable level (e.g. Vancouver). Canadians will only have themselves to blame if they rise to the bait and believe that these prices will continue to grow at their current rate.

Central bankers can say certain things, but to say that the Canadian housing market is in a bubble is not one of the things they can say -- imagine that Canadian suddenly see this as a reason to be wary of leaving money in their bank accounts (it could happen). However, in his speech here

he said two things:

"One cannot totally discount the possibility that some pockets of the Canadian housing market are taking on characteristics of financial asset markets, where expectations can dominate underlying forces of supply and demand,"

“The risk is that expectations become extrapolative, prompting the classic market emotions of greed and fear — greed among speculators and investors — and fear among households that getting a foot on the property ladder is a now-or-never proposition.”

Canada you have been warned. BTW the current "craziness" in Toronto and Vancouver (and to some extent in Montreal) for $1,000 sqf condo offering tells you something about market sentiments.

Thinks are getting interesting

Although a rather arcane art, the funding market is the canary in the coalmine of the financial markets, and the canary appears to have succumbed overnight. Ultra short term liquidity has died – BTW (and this is an analogy) just like it did the days before Lehman collapsed…

This is hugely serious, also relayed by a friend was last night DB note on his visit with 70 money managers in Finland, where all those who he asked (virtually everyone) if they has supported the “True Fin party” reply was unanimous, no one in the room did (all were emphatic about this). The question then becomes are financial types (including officials) misreading the distrust and disgust of the general population vis-à-vis all the game that are being played in their name?

Only time will tell, but the next 48 hours will be fascinating.

Wednesday, June 15, 2011

No much going on in Canada, So…

Let’s talk Greece!

You just have to go on the web here to see that things there are deteriorating. Riots, members of parliament resigning, German minister stating that commercial lenders must take a hair cut, Belgian Minister saying no hair cut, and president of ECB saying: What’s a hair cut!

The market has already decided that the inevitable will happens very soon. Kudos to the German banks for selling off all the Greek, Portuguese debt to the ECB, they probably got top dollars…and are now asking for a Greek debt restructuring. French banks not so amused, Trichet told them, no restructuring of Greek debt, so they kept it all, Result: French banks are looking at the hard end of an S&P downgrading.

Some say that Greece has hundred of billions in assets to sell (after all it could sell the Elgin marble to the British for a few bucks!) The reality is that most buyers know that when the seller is sovereign, has a gun to his head and feels that all its treasure is worth a fortune, is no probably the best time to buy assets. The Greek “sale” breaches the primary principle of a willing buyer and willing seller, since Greece is being “forced” to sell its assets…

Following all the comings and going at the ECB, European minister 1 day 2 day conference on the “crisis” interest rates on 2 year Greek debt has risen to 28%. The problem was always that there was no real solution being contemplated by the ECB/IMF for solving Greece’s excessive debt burden – just more debt. Selling state owned assets is certainly a solution (see above), but it will take years, in many instances the asset sales are complex and would require new laws. The Greek government could sell the water works, rail system and other utilities – that would raise cash, but it assumes that ratepayers will agree too much higher utility rates. You could sell motorways and a few Geek islands (they are a large number), but overall very complicated issues would need to be addressed.

I live in Quebec, try mentioning here that selling Hydro Quebec would be a good idea to reduce the province’s debt burden… in fact I double dare you to try that , it is what is called politely political suicide, or a lynch mob.

The Greek train wreck will continue on its path as do all tragedies (how fitting that the father of the tragic play was Aeschylus -- a Greek), the end is inevitable the interest is in seeing what progression, or road the actors take, some actors are heroic others less so, but the outcome has been settled at the outset, it is all too sad!

Monday, June 13, 2011


That is the difference between Brent crude ($118bbl) and WTI Crude ($97) this morning. Now one problem is that Cushing is where the WTI price is established, whereas Brent is based on deliverable oil anywhere in the world. So generally WTI crude must take into account glut conditions at Cushing (you got to store oil...).

Anyway, no one seems to know why the differential is as large as it is today -- a month ago (when the storage issue at Cushing was even worse than today) the difference was $14.

Are U.S. banks suffering because of their level 3 assets

Over the past 6 months, and unnoticed by most is the weakness of the U.S. banks share price. One issue, often forgotten is the level 3 assets held (either willingly or unwillingly) by America's largest banks. A good portion of these level 3 assets related to Mortgage Back Securities of one form or another. During the pre-2007 days banks would often keep some of the juicier tranches (higher rating with good coupons).

Over the 2007/10 period many of those securities saw a rehabilitation in their price for a variety of reasons; (1) oversold, or (2) Armageddon, in the form of massive write-offs, didn't occur! Now a new reality is emerging. First, that loan recoveries (that were in the past around 60/70% are now in the 10/20% range -- in some areas the recovery is below zero -- trust me its possible), secondly in many cases the title chain has been broken. Most famously by Countrywide which as of 2002 decided that transferring title was too much trouble (actually admitted this in court).

There's a double impact there: first without clean title transfer, ownership of the loan is difficult to establish (hence the robo-signing). More serious (for the note holders) is the tax implications. The impact of not transferring the mortgage title has a very serious consequence on the MBS notes tax position. MBS benefit from a favorable tax treatment, that other debt instrument do not have. For the IRS, it becomes a binary situation, and since they care little for who owes what, but rather the tax position, the IRS will take the view that "forged" documents are illegal (I know it should be obvious but many courts "admitted" in evidence and acted upon documents that were clearly forged - most amusingly signed transfer documents by parties that no longer legally existed).

Hence since February 2011 (whey many US banks began writing back loan loss provisions) the value of investment grade MBS has been dropping dramatically. The AAA tranches 45 to 35, AAA rated CMBS from 97 to 91 and the AA rated tranch from 80 to 55. No only are the banks' top lines not doing great, but now they will have to take on additional provisions for these loans.

[Added June 14] Today the IRS announced that they will not pursue for tax those RMBS and CMBS structures where the lien was not perfected (or the mortgage note was not transferred), they will treat such failures as benign neglect issue, and will therefore not pursue investors for "tax due" on unsecured transaction that were booked as mortgage backed. Little consolation for investors (although rumors are that BoA is taking on huge additional provisions for its mortgage portfolio.

Friday, June 10, 2011

22,000 Vs 54,000

Earlier this week, the US released its job creation for the month of April May, the number was a disappointing 54,000. Canada over the same period created 22,000 jobs, in an economy 1/10 of that of the U.S. Canada's unemployment fell from 7.6% to 7.4% (if we counted jobs the same way the Americans do, we would be a 6.4%). Clearly, the employment situation is positive, but also labor unrest for higher wages is also starting: Canada Post has staged one day strikes across the country (did anyone notice?) and Air Canada's ground crew is looking at strike action later this month.

Obviously, Canada's economy is now firmly detached from its southern neighbor (although exports account for 1/3 of our GDP and 3/4 of that goes to the U.S.). The market is still of the firm belief that interest rates will remain at their current accommodative level of 1.0% (although long dated Canadian interest rates 10Y and 30Y are 50bps and 87bps lower than for similar duration U.S. sovereign debt), it remains that there exists tremendous scope for the yield curve to flatten out in Canada with a rise in the short term interest rate; Carney (the Governor of the BoC) has often indicated that he dislikes surprising the market, but he could pull a Korea (which just raised short term interest rates last night -- to the market's surprise), and raise interest rates.

All the elements are there for a concerted action by the BoC:

(1) Bubbly housing market
(2) Out of control indebtedness (now higher than in America)
(3) Strong labor market
(4) Capacity utilization close to historical average
(5) A currency that has calmed down (at 1.02/98 to the USD)
(6) Inflation at 3.3% and core inflation at 1.6% -- at the upper edge of BoC comfort level

These are all good reasons for interest rates to rise. On the negative side

(1) The U.S. economy seems to be slipping back into recession (at the very least slow growth)
(2) PIIGS in general and Greece in particular look like nearing the endgame for bailout
(3) China seems to be slowing down
(4) Austerity in U.S. government spending seems to be the new mantra -- accounting for 14% of US GDP that will impact GDP growth
(5) China appears to be slowing (although how much reliance can you put in Chinese data?)

In a sense all the excuses to do nothing are externalities over which Canada's central bank has zero control (or even input). Canada has the choice to take action now before things get completely out of control (a friend moving to Toronto from New York decided to rent -- house prices in Toronto are higher than in NY for similar properties).

The question is: What Will Carney Do?

Thursday, June 9, 2011

Canadian exports down 1.9% in April

Obviously, the 4.8% growth in March 2011 exports was not sustainable (especially since Canada’s #1 trade partner seems to be slowing down), and exports were of by nearly 2% (equality divided between volume and price). The worse sector down (36%) was the forever volatile aerospace sector. Aerospace sales rise and drop with little regards to the economic cycle. Overall (and because of aerospace) exports of machinery and equipment was down 8.9%. Exports of food were up, but exports of metal and minerals were down. Finally, energy exports were up, entirely because of higher volume (prices have been relatively constant).

On the import side there has also been a slide, although volumes are up 1.5%, price decline lead to an overall drop in value of 1%. The biggest loser was the automotive segment, down 9% (which is massive) and completed automobiles and chassis were down 22%. It seems that Japan’s damaged automotive sector is largely to blame here following the terrible earthquake and tsunami.

In a nutshell, Canada went from a marginal trade surplus, to a small ($4.8 bn) trade deficit, mostly with countries other than the US. Overall this is an inconsequential report, it seems that the strength of the CAD (now weaker) has had a very limited impact on Canada’s overall trade situation.

Wednesday, June 8, 2011

Canada's Federal Government -- A balance budget in three years or less!

While our southern neighbors seems to find new ways to increase the Federal deficit, Canada's new majority conservative government plows ahead with plan to turn its current deficit into a surplus by 2014/15.

As I have often mentioned Canadian are well versed in the risk of ever rising deficit, and most Canadian remember how painful the correct was to Canada's economy (1996/00). We also know that we correct our budget deficit while the world economy was growing at a fast clip (no longer the case).

Jim Flaherty "re-introduced" his March budget (the one that caused the 2011 Federal elections) almost unchanged. Canada's economic position remains more or less unchanged -- although the Canadian dollar, unlike other resource based currencies has remained subdue in the face of rising commodity prices because of the fear that America's economy is heading back into a recession.

As usual the normal caveat must be assumed, should the U.S. really fall into a new recession (instead of a slow down) then all bets are off, since Canada is extremely dependent on the U.S. for its export market -- down from a peak of 85%, to around 75% -- a solid percentage of that are natural resources... still. On another note the market is 100% discounting (today at least) of any rise in interest rate by the Bank of Canada for the rest of 2011 (Q1/12 is starting to look iffy too).

Tuesday, June 7, 2011

Europe's 33 largest banks apparently need $347 billion in additional capital

In part blame the PIIGS (at least for $180 billion) for the banks' capital problems. One reason given by those who are optimistic that the European single currency will survive -- the problem for the banks is such that Europe's government cannot contemplate a collapse of Greece under any consideration.

Earlier today some analyst indicated that European bank's capital ration was in excess of 50, in other words for every 100 Euro of lending, the banks have $2 in capital, compare that to about $8 for U.S. banks and about $10 for Canadian banks!

In a nutshell a loss of 2% of their assets would wipe them out! Look at this analysis

OK nothing to do with Canada, but tomorrow data is coming out about the European banks' capital strength...

Canada Post on strike yesterday -- did anyone notice?

There was a time when I would receive all my bills by the mail, electricity, taxes, credit cards etc. Today, even contractors send you bills via email. what I get in the post is mostly flyers and magazine (mostly addressed to the previous owner!).

So apparently yesterday the Quebec branch of Canada Post was on strike (OK it may have been Montreal only!) but I don't think anyone noticed (I certainly didn't). The problem for Post Canada is that its a 20th century service that 21st century customers don't need (like a fixed phone line).

I have not received a personal letter in many years -- 99% of birthday, Christmas and other greetings have become eCards. I ended all newspaper subscription about 18 months ago (thank you Ipad), The FT, The Economist, WSJ, and local newspaper are all delivered electronically.

Bills are all electronic...

the one service I would appreciate from the post office is a package delivery system that actually works well. There is a post office less than 500 yards from my place, and yet all package deliveries are more than 2km away... My guess is that the postal system will die its natural death over the next 5-10 years (as soon as the outlying regions have access to the internet).

Access to the internet is the key here to the death of the internet.

As an aside, last quarter, Amazon sold more ebooks than physical books (a first). Music stores are almost all dead (thanks to iTune), book stores will end up the same way soon.

Monday, June 6, 2011

Canadian Building Permits (Frustrating entry)

There are statistics that are worth following, and then there are statistics that tell you absolutely nothing… building permits (like aerospace orders) are so lumpy that an average analysis over several months is required to “say anything” about the state of the Canadian building industry.

Bottom line new building permits in May were down 21% from the previous month… now in March they were up 18% and in April they were up 9%. In the non-residential segment building permits fell 33%!

This kind of volatility is troublesome, and year on year analysis (2010 Vs. 2011) is also not very informative. However, one thing can be said, that the overall average (excluding 2008 recession) remains “in-line” with expectations. Non-residential levels are actually very low, and are testing levels last seen during the recession of 2008 (and yet GDP growth in Q1/11 was 3.9%).

Maybe smarter people than me can draw some interesting conclusion as to why so few non-residential permits were issued, I cannot, but observe that reality and wonder…

Friday, June 3, 2011

Something strange

Yesterday, Muddy Waters Research continued its trend in exposing Chinese fraud, with its exposure of Sin-Forest Corporation (TSE:TRE) a Canadian listed company with a Canadian CFO (Guess who’s maybe going to jail…). I don’t want to discuss the Sino-Forest data, but rather a quirkiness of markets; last night the TSX suspended trading of Sino-Forest shares pending clarification.

Now considering that Muddy Waters did a rather in-depth analysis (and provided all their data in a massive data dump), I don’t see how the TSX will re-authorize trading until all the information has been digested (especially if a ponzi scheme is suspected), and yet today it is possible to buy and sell Sino-Forest on the Pink sheet in the U.S. Strangely the stock has not been suspended in the U.S.

For those who are curious the stock is currently trading around $6.15 (effectively down 75% from Wednesday’s close.

Will QE3 be a concerted attack against the 10 year bond?

A few weeks ago several of us were discussing what shape could QE3 take, clearly (even at the Feds) QE2 has been a dismal failure; after all it only created bubbles in energy and stock prices. Expectation for economic growth have been substantially below target once the Fed (State and Local too) started contracting spending. Virtually all the GDP growth over the past 2 years has been driven by government spending, companies have improved profits by cutting costs – especially labor cost (there is clearly no labor inflation). Top line growth has been minimal – that’s important. The fact, that investors are finally waking up to Q1/11 GDP growth of 1.8% and not 4% is sinking in – BTW pay attention to bank stocks, look at GS, its not $175 anymore…

So Bernake has to find a new target, and that target has to be the longer end of the interest rate curve. The Feds will begin an aggressive program of buying America’s real benchmark bond – the 10 year. You don’t believe me; look at the 10Y T-Bill yield (it’s below 3%, a first in nearly 18 months). His objective to make the cost of borrowing for American companies lower (since companies don’t borrow overnight), it will also reduce mortgages (again the 10Y TBILL is a benchmark).

So that’s going to be the strategy (assuming that Congress can get its act together by August 2nd and raise the debt ceiling).

An alternative strategy is that the GOP is serious and its only goal is to defeat Obama in 2012 at ANY cost, if its 15% unemployment, recession and mass poverty, that’s a cost it is ready to assume. Since the GOP is now the party of very rich people and corporations – don’t confuse supporters with overlords! The GOP (and the Democrats to a certain extent) will answer to their paymaster [yes I know I am a cynic], but a strategy to defeat Obama needs to include a recession and high unemployment. The hatred (polarization) between the two parties has grown to such an extent that to defeat the other side Armageddon is not only contemplated but seems to be actively promoted.

I have a theory on Europe!

This may sound crazy, but I am starting to believe that the “extend and pretend” on Greece will continue until mid August. In fact, Europe’s ECB will be looking to a restructuring date a week or two after America’s August 2nd debt ceiling. Europe maybe taking the view that if everyone is concerned with America then maybe no one will pay attention to Europe. My take is that they are betting that the world can only have one major crisis, so if its America in August, Europe can do its thing and no one will notice.

Call me crazy, but for the life of me, I cannot understand the ability of Europe’s leadership to disregards the reality that Greece’s contraction in governmental spending has lead to a contraction of the GDP, now they are looking to maybe continue lending to Greece with the hope that they will achieve a different outcome. Greece was give 12 parameters that were to be met so that further lending could occur, Greece failed to meet all 12!

Insanity is pursuing the same action over and over and hoping for a different outcome!

America’s broken job creation machine

On Monday GS and friends predicted that the NFP number (job creation) would be in the 300k range for May, well this morning the number came out at 54k (BTW the kind of number that is seen as very positive, not impossible, in Canada). The granularity is even more worrying, the Birth/death adjustment added 200k jobs to the total – and this a the time when America’s small business organization just released data from their members indicating that may was one of their worse month for job creation.

This is a terrible number and may force a QE3 program (although it is not clear how Benake will do this)

Wednesday, June 1, 2011

Canadians' personal debt -- worse than America

The number is terrible, $25,597 per Canadian (and this excluding mortgage debt), so how is it made up? First, and probably the single largest item is car loan: Cars are expensive, especially if like most Canadian you've discovered 4 wheel drive (trust me with winter here, 4x4 is not a luxury, its a necessity!), but its not cheap.

Second is credit cards, massive debt that is carried around for years (with an interest rate in excess of 20% for more cards). There have been many warnings about Canadians' indebtedness, and here in Quebec its growing even faster than the rest of Canada (up 7.8% whereas the Canadian average is 4.5% -- still bad, but not "as bad"). Bottom line lots of consumption demand in Canada is fueled by borrowing, when interest rates start rising (anybody's guess) the pain could be substantial. Then again, if Canadians are borrowing on their credit card at 20%, I don't suppose they will freak out when it goes to 25%...

Canadian interest rates are on their way up

Until last week, most Canadian economist (institutional) took the view that, in their opinion, Canada should raise interest rates, but that the BoC appear to look for any excuse not to raise them. It had become a joke; last month it was America forthcoming recession, and this month it would be "Club Med's possible default", well, how a BoC rate setting meeting can change things.

Canada's impressive Q1/11 growth (granted a good chunk of that was inventory growth) at 3.9% (annualized) far exceeds the BoC's anticipated growth rate of 2%, the "transitory" inflation story is proving to be not so transitory, as headline CPI remains at 3.3% while core is around 1.6% -- both figures are considered high!

Yesterday's BoC statement (keeping overnight rates steady) signaled that this policy is about to change, giving Canadian interest rates analysts a "good feeling" that by the end of 2011, the BoC overnight rate could be as high as 2%... Ideally this would lead to a whole shift upward of the Canadian interest rate curve (maybe). In its statement the BoC indicated that current interest rates were excessively stimulative for an economy that appears to be operating at capacity (hence the signs of inflation), and that it was time for the BoC to "normalize" interest rates!

The market is now pricing the probability of a rate rise on Q3, at around 25% (probability of a 25bps increase), but since the market is slow to react to such "ideas" it may take a while until this trend is reaffirmed by the futures market. BTW, and this is important, the BoC doesn't like to to surprise the market, expectation for inflation (CPI) is for 2.3% for the whole year -- right in the middle of the target range for the BoC -- Economists have a tendency to be more aggressive than the market for interest rate increases -- C.D. Howe Institute has been calling for rate rise for nearly a year now...

Addendum: This comment now seems out of date, the street is now only thinking of a Q1/12 25 bps rate rise... the action south of the border and in Europe make any tightening suicidal