Monthly Archives: January 2015

Bank of Canada Lowers Interest Rates by 0.25%

Sorry folks I saw this coming a mile away.

Want some proof? I will reblog a blog post I did on March 24, 2014 titled “What if?” quoting extensively from a speech from our recently appointed Bank of Canada Governor, Mr. Stephen S. Poloz.

Mr. Poloz was telling everyone and anyone, almost a year ago that Canada was not going to be the hotbed of growth – far from it – for the foreseeable future. And he made these comments well before the price of crude oil crashed in the last few months of 2014 that will negatively impact both Canadian government budgets and growth prospects (capital spending) for 2015. Mr. Poloz back on March 18th, 2014 took the opportunity to speak plainly to all of us who were willing to listen.

And to add insult to injury, according to Bloomberg, no Canadian economists polled forecasted a downward change in interest rate policy for the Bank of Canada for the first few months of 2015.

So have a read (or reread) of my reblog, especially in the light of today’s news, and I think you will come to the same conclusion as I did…that the next move on interest rates from the Bank of Canada was going to be DOWN (that happened today) and this was telegraphed almost a year ago.

And I will also reiterate, as I did in my “What if?” blog, that the Bank of Canada reduced its bank rate from 1% to 0.75% – obviously by 0.25 basis points – leaving another 0.75 basis points to zero matching all the other major central banks in the world today.

 

“What If?”

I’m still in mourning over Mark Carney, the former Governor of the Bank of Canada, leaving us for the Bank of England.

So I haven’t focused at all on our new Governor of the Bank of Canada – Mr. Stephen S. Poloz.  So on Tuesday, March 18th, 2014, I was heading to our office kitchen, for my one cup of Earl Grey tea I allow myself, through our trading and technology office space when Mr. Poloz was on our trading floor big screen television and said three words that made my head spin around.

“Blah, blah, blah, … lower interest rates, blah, blah”!

Nursing my whiplash, I know one thing about ‘Central Bankers’; they would never say these three words in any context without thinking through its communication value.

So I went to the Bank of Canada website to read his speech, “Redefining the Limits to Growth”, he delivered to the Halifax Chamber of Commerce, in obviously Halifax, Nova Scotia.

Let me say, every Canadian investor should read this speech!  For a central banker this speech is direct, forthcoming and has huge implications for your investments – not to mention the future for your kids and grandchildren.

Mr. Poloz is giving everybody a very direct assessment of the Canadian economy and its not very good.  Down right scary as a matter of fact.

The highlights include:

1)        Five years after the financial crisis the world economy is still stuck in a period of slow growth – say 2% annual growth, if we are lucky.

2)        For the first time in 50 years, and starting in 2011, the growth rate of the population of working-age Canadians crossed below that of the overall population.  As a way of comparison the US still has 0.2% – 0.3% growth in hours worked – a small but still growing population of working-age people.

Why is this important?  Mr. Poloz explains in his speech, “Long-term economic growth is driven by two factors: 1) growth in the supply of labour, which is connected to population growth and changes in its composition, or what we call “demographics;” and 2) productivity growth, which is economists’ shorthand for how efficiently we produce goods and services. For illustration, if we had 2 per cent trend growth in the supply of labour and 1 per cent trend growth in productivity, trend growth for the economy would be about 3 per cent.

So the growth rate of the population of working-age Canadians will be negative for the seeable future, say negative 0.1% – 0.2% annually.

Therefore our only growth influence in the Canadian economy will be the nebulous and hard to pin down productivity growth that economists calculate.  Mr. Poloz stated “Productivity growth fluctuates around a long-term trend, tending to be weak during recessions and the early stages of a recovery, and stronger in periods of economic expansion. It follows then that the weakness in productivity growth since the financial crisis may be a symptom of a post-crisis hangover. Indeed, in Canada, the latest data show a pickup in productivity in the second half of 2013, to around 2 per cent, which is very promising.”

Really!

Let’s look south of the Canadian border to look at long-term trends of productivity growth in the US.  According to Jeremy Grantham, of the money management firm GMO, for forty years after WW II economists calculated productivity growth of around 1.8% per year.  Unfortunately the following thirty-year period saw US productivity growth slowing to 1.3%.  With some economists seeing a trend of lower productivity growth in the foreseeable future.  This is in the United States, the most productive and inventive society on earth.

Mr. Poloz points to a short-term spike in productivity in the Canadian economy over a certain period of time but no one – at least not me – really believes that Canada will out do the US in terms of productivity growth.  And remember productivity growth is really hard to measure, if at all.

So, do the math.  The CDN labour force is contracting say, 0.1%-0.2% per year.  Productivity growth, let’s just say, it’s the same as the US – big assumption, in that productivity is growing 1.3% per year.  So the maximum growth rate in Canada over the foreseeable period of time will be 1% per annum – if we are lucky!

Going one-step further inflation in Canada has been falling like all industrial countries all over the world.  Inflation last year in Canada according to Mr. Poloz was 1.2%.  The goal of the Bank of Canada is to have 2% annual inflation.  So there will be no real growth in Canada for the foreseeable future!

Mr. Poloz states “the global economy may not be just suffering through a hangover from the financial crisis. There are other, longer-term forces at work as well. Some analysts are suggesting we may be facing a long period of secular stagnation. On this alternative view, the economy could perform well below normal, leaving many out of work or underemployed for a long time to come.”

Candid hard-hitting stuff!

3.         Mr. Poloz cites the Club of Rome!  “Over 40 years ago, the Club of Rome published a book entitled, The Limits to Growth. To the global think tank, those limits were about finite natural resources and the environment. Although the timing remains uncertain, its arguments remain relevant today.”

 

This, my friends is jaw dropping.  For a central banker to cite the Club of Rome, in a public address is unheard of.  If Janet Yellen, the new Chairperson of the US Federal Reserve, had made this reference, and maybe she will in the future, the US would be in a full-scale panic with both public and private debates on how the US economy can exceed these “Limits to Growth” and reference the presidential years of one Jimmy Carter.

4.         There are other items in his speech that are interesting.  Including statistics on where Canadians are allocating an ever-increasing and significant portion of their wealth over the last 10 years.  Interested?  My lips are sealed in hopes that you will read the speech.

Conclusion

Shocking speech and a must read.  Mr. Poloz wasn’t on my radar screen but he is front and center now.  The investment implications of this speech are quite real and should be considered by all investors.

So “What if” Mr. Poloz is right?

My interpretations are:

1.         The Bank of Canada rate – similar to the Fed Funds rate – is still around 1%, leaving Canadian chartered bank prime at 3%.  The US Fed Funds rate is 0 – 0.25%.  The Bank of Canada still has room to drop interest rates, if need be.  When, not if according to this speech, the Bank of Canada starts to reduce short-term rates look for GIC’s and other short-term debt instruments to follow suit squeezing retirees and savers even further.

2.         We have already seen a decline in the value of the Canadian dollar under 90 cents to the US dollar.  The weakness is probably making Mr. Poloz happy, in that a weak CDN dollar is giving the Canadian economy, especially Ontario; a must needed boost (cheaper exports) and higher short-term import inflation.  The economic impact of the lower CDN dollar does take time.  I’m sure the Bank of Canada will be monitoring export growth, import inflation and interest rates very carefully in the future however this speech is confirmation to me we are probably in the early stages of a secular decline in the CDN dollar vis-a-vis the US dollar.  (Something I have been professing over a year and a half ago.)

3.         Interest sensitive Canadian equities will probably have another bull rally to valuations higher than their previous stated valuation highs – EBV Levels – as income investors scramble for higher dividend and income returns that are lacking elsewhere or when the Bank of Canada starts to reduce the Bank of Canada rate.

4.         Canadian companies that have any growth, say high single-digit or low double-digit growth, in any Canadian or international economic market sector will have a high valuation (EBV Level) as investors will pay any price – valuation – for growth in a no-growth country (maybe world).

5.         Assuming all the above happens, this will increase the valuation of the S&P/TSX Composite from currents levels to EBV+3.  See chart below.  This will imply an upside of approximately 35% from current levels.

S&P/TSX Composite Index with monthly price bars and EBV Lines (colored lines).

S&P/TSX Composite Index with monthly price bars and EBV Lines (colored lines).

If the S&P/TSX Composite did achieve this valuation level, EBV+3, in any future time period this would represent full value for this Canadian Index and much needed caution for Canadian equity investors.

Just a normal weekend my friends, alone with my investment thoughts!

“What if?” indeed!

Central Bank Maneuvers

Is 2015 going to be the year of central bank fireworks?

On Thursday morning the Swiss National Bank (SNB), Switzerland’s central bank, shocked everyone by eliminating the floor on the Swiss franc and will start charging a negative interest rate (0.75%) to anyone holding their national currency.

In response the Swiss franc exploded upward, up almost 30% against the euro and other global currencies. This move was one of the biggest currency shocks since the collapse of the Bretton Woods system in 1971, as many financial columnists have pointed out.

So let me be clear…. if I had $1 million Swiss francs on deposit at a Swiss bank, the bank is now charging me $7,500 francs per annum for the pleasure of holding these Swiss francs. The result? Individual and global institutions lining up Thursday to purchase Swiss francs!

Huh?

Global finance has gotten a little crazy these days, don’t you think?

The other little thing – tongue in cheek – that is going on is nominal interest rates on any and all government debt has been falling like a stone over the past year. Except for Greek government debt, and who knows whether a bondholder will eventually get paid back in Greek euros or drachmas, all sovereign bonds yields have had a big move in price (upward) and yield (downward). Shouldn’t interest rates be going up by now?

I have to say these bond moves (big moves by historical standards) have become the 800-pound gorilla in the room of all portfolio managers and investment strategists. Nobody, it seems can explain it (lower yields) but better still nobody can say where the yields are going and certainly nobody wants to extrapolate what this means for the global economy.

So what is the end game here, I continually ask myself… in terms of global bond yields?

And let me go further to posit the question: Will nominal yields on all sovereigns go to zero? (Germany, Japan and a few other European countries have negative interest rates on their government bonds – up to 5 year and less – why not Canada?)

Here is screen shot of one of my favorite screens from the Bloomberg website showing 10-year yields of the major countries in the world and how much the yields have fallen during the year.

Screen Shot of Bloomberg Website Page

Screen Shot of Bloomberg Website Page

 

As Paul Krugman writes in his column, “Francs, Fear and Folly,” in the New York Times, “What you need to understand is that all the usual rules of economic policy changed when financial crisis struck in 2008; we entered a looking-glass world, and we still haven’t emerged.”

Can Model Price Theory explain what is going on here?

Partially.

First I want to show you two charts. The first graph I tweeted out back in November 2014 showing the global total debt (excluding the financial sector) for advanced economies plus major emerging market economies. As you can see debt has been growing at healthy rate over the last 12 years. Of course most of this increased debt is national and territorial governments issuing large amounts of debt to supplement increased economic activity.

Global debt to GDP

Global debt to GDP

The second chart is our Solvency Curve that I introduced to you back at the start of this blog and one of our ‘Key Concepts’.

Solvency Curve from Model Price Theory - See Key Concepts

Solvency Curve from Model Price Theory – See Key Concepts

 

It’s the dynamic of what the economic actors are doing along our ‘Solvency Curve’ in each national country over a period of time is what I’m pointing out here. First, each national government, since the financial crisis of 2008, has substantially increased their national debt – some larger than others. This Keynesian national debt increase helped individual and together globally national economies sustain and increase economic growth to correct substantial drops in global demand that occurred around the world because of the financial crisis of 2008.

As government debt increased, all national governments moved down our ‘Solvency Curve’ – left side – to a more insolvent state. All the other economic actors in each society see this, individuals and corporations, etc., and increase their own solvency to brace for future of tax increases (to repay the national debt accumulated) and reduced capital investment plans or projects to conserve cash as future growth looks uncertain.

For example, in Japan where the government has tried to lift the country out of its economic malaise and deflation, after its own financial crisis, for over the last 25 years has spent enormous amounts annually (budget deficits) to increase nominal demand and has increased the national debt to a staggering 229% of GDP – the largest of any country in the world today. Unbelievably, as the national government debt has risen, total cash held by individuals and corporations have also grown to a staggering 44% of GDP. Hope you see the dynamic going on here. The national governments going one-way (down our ‘Solvency Curve’ and everybody else is shifting (becoming Super-Solvent) to the right of our curve in response.

I know and would like to emphasize our concept – Solvency Curve – and movement along our ‘Curve’ is not the cause (not fully) of our current interest conundrum. It’s just until world governments and their respective central banks slow down this cycle or movement along the curve – each side of the curve moving away from each other – that lack of global growth and dis-inflation bordering on deflation is going to continue to occur.

Resulting in ever lower interest rates.

When and if these ‘Solvency Curve’ trends start to slow down or better still reverse (having national governments become more solvent allowing individuals and corporations to spend their cash and move up the right-hand side of the ‘curve’) do interest rates have the slightest chance of moving upwards.

Or is something going on here that is more prophetic with regards to interest rates.

Sometimes when I view this Bloomberg 10-year government webpage I feel it’s more like a countdown. I’m I witnessing a secular fall in interest rates that will last for a generation? Will global long-term interest rates in the western world and Europe go to Japanese levels and perhaps stay there, again, for a generation? What happens to western society, business investment and retirement plans if and when we have low interest rates for a prolonged period of time? Do these questions make any sense? Am I scarring you?

How are we in the west, the developed nations, supposed to retire if interest rates go to zero? Want to earn $100,000 in interest income? Well, at the current interest rate of 1.53%, a Canadian resident currently needs $6.5 million invested in a 10-year Government of Canada bond. Who has this amount of loose change lying around to retire on? But, I guess, the good news is that interest rates are 1.5%! What happens if they go to zero?

Just asking.

 

 

 

 

January 2015, S&P/TSX Composite Market Strategy Update

 

Is the tide coming in or out?

Don’t get this reference? Please refer to my previous blog “January 2015, S&P 500 Market Strategy Update” for a refresher.

The tide is certainly going out in Canada. World money flows have reversed not only in the commodity countries (Australia and Canada) but also in the BRIC countries, as well.

Commodity prices are slumping, with a huge drop in oil prices leading the way. Actually it’s kind of fun watching people in the financial press spin themselves into circles trying to come up with a reasonable explanation as to what is depressing crude and other prices.

I have no clue as to what is going on here – I can guess like others – but it seems to me both on the supply and demand side of the equation market dynamics and complexities are being sorted out by a daily market price that we all can see. So leave the predictions to others, here at Model Price, we have no need to entertain worthless prognostications when dealing with real facts.

See here at Model Price we have two pieces of independent data coming together and giving you real information – investible and tradable information. What are these two pieces of information? Stock prices (index values) and our calculated EBV Lines! Each source and piece of information is both independent and verifiable. I don’t know of any other financial concept or tool in use today that even comes close to this very valuable tool. And to me, even though it looks like technical analysis, this information gives me clues and a heads up on future fundamentals of a company and the market. Sure, we will never know in real time what the public future news will be, but as we all know markets always seem to move before the fact.

What is the Canadian market saying through Model Price?

First, let’s have a look at the model price chart of the S&P/TSX Composite Index as of January 12th, 2015

S&P/TSX Composite Index with weekly price bars and EBV Lines.

S&P/TSX Composite Index with weekly price bars and EBV Lines.

 

As a reminder we aggregate all companies in the S&P/TSX Composite Index into one chart on a market capitalized basis (like the S&P/TSX Composite Index itself), so we can see where the market – S&P/TSX Composite – is trading relative to its EBV lines.

As you can observe the Canadian market, as defined by the S&P/TSX Composite, is in the zone bookmarked by EBV+1 and EBV+2. If the market rallied to EBV+2 (14,764) this would represent a gain of some 3.5% (Upside). If the market corrected back to EBV+1 (12,405) investors would be suffering Index losses of almost 14% (Downside).

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

As I have annotated on the above model price chart we have experienced three negative transits starting back in mid-September. What does this mean? Simply the fundamentals are deteriorating in Canada and the market will probably feel more comfortable trading in the valuation zone between EBV+1 and EBV+2. Yes, this means EBV+2 now becomes resistance and EBV+1 becomes support. And, support for this market is a long way down…some 13%!

As I have said in last month’s blog on the Canadian market;

Where are we going, in terms of the Canadian equity market? Not sure! But until we see positive transits both in individual stocks and the S&P/TSX Composite Index I would be cautious with a healthy cash balance and wait and see where this market wants to go. I’m reminded of the great quote by Yogi Berra, “It’s tough to make predictions, especially about the future.” A negative transit is a negative transit and an investor can act accordingly, the future can take care of itself with or without my and your capital.

Conclusion

Three times the market has spoken. This is rare that a market through an index or a stock gives anyone this much of a warning. But in this situation the Canadian index is certainly giving all Canadian investors a warning that negative fundamentals maybe on the horizon. Certainly investors in the Canadian oil patch have already experienced negative (maybe severely negative) rates of return.

Any stock in the Canadian equity markets that resides in your portfolio and has a negative transit would be a sell candidate in my mind. Bear markets are about survivability on one hand and opportunity for excessive trading profits when to dust and the falling stock prices have stopped. This spells great opportunities ahead in the Canadian equity markets for those with capital and superior leading information about changing market fundamentals – future positive transits.

I can’t wait!

January 2015, S&P 500 Market Strategy Update

Sometimes simple is best.

Over the Christmas holidays I overloaded on financial business news. How do I know I was overloaded? I got confused. Like a pilot flying by the horizon on a cloudy day and not by his/her instruments, I was off course and started to stall.

Do you get like this sometimes especially about the financial markets? You want to take everything in. You want to hear from all the so-called experts and go through their PowerPoint decks. But at the end of the day…. what are you left with? What information should you weigh more than others? Speaking for myself I simply get confused and locked in a world where doing nothing, or worse, thinking I should go to cash is the result even though I know it’s not the optimal course of action.

Then I return to my world of MPT [Model Price Theory] and everything starts to make sense to me. All stock prices and index values look logical and rational. And a simple aphorism usually leaps out of nowhere from my subconscious that guides me on the right course. And in this instance it came to me in the form of a question.

“Is the tide coming in or out?”

Yes, I know I’m from the east coast – where tides rise and fall 35 to 38 feet, 40 minutes from where I grew up – but I think this simple question will help you distill all the financial analysis that is currently out there.

Huh?

If you have seen me on television you know I’m a big fan of the US dollar. (If not see my blog here on ‘King US Dollar Returning’.) So what does a strong US dollar have to do with anything? Well if the world is purchasing US dollars they need to purchase something with these dollars…yes? A lot of these dollars usually end up in the bond market, US Treasuries as a matter of fact. However some of these dollars do end up in the equity markets. And like the US Treasuries the instrument of choice for most foreigners is the S&P 500 Index ETF or what is known as ‘Spiders’.

Also big moves in currencies usually take a while to occur, that I like to call ‘secular’. How long is ‘secular’? Probably five (5) years a least. So as the US dollar floats upward this usually begets more buying further increasing the value of the dollar.

So, is the tide (in the value of the US dollar) coming in (up) or out (down)?

The tide is certainly coming in! And will do so for a ‘secular’ period of time. What will that do to US assets as a whole? US assets will go up, again over time.

How simple is that? “Pretty, pretty simple!” as Larry David would say.

And I like simple.

You?

As usual in these monthly blogs, let’s have a look at our Model Price chart on the S&P 500 Index to see what is going on.

S&P 500 Index with weekly price bars andEBV Lines (colored lines).

S&P 500 Index with weekly price bars andEBV Lines (colored lines).

 

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2217) this would represent a gain of some 8.2%. If the market corrected back to EBV+3 (1773) investors would be suffering losses of almost 14%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

Having another look at our long-term model price chart of the S&P 500 Index.

I haven’t published our long-term model price chart for a while, so let’s have a look.

S&P 500 Index with monthly price bars and EBV Lines (colored lines).

S&P 500 Index with monthly price bars and EBV Lines (colored lines).

 

As you can appreciate this long-term chart highlighting monthly price bars doesn’t change very often however I find this chart interesting to look at every once and a while.

What I like to draw your attention to are points ‘A’ and ‘B’ that I have annotated on the above chart. Roughly between 2002 and 2007, 5 years, the S&P 500 Index travelled along EBV+4, finding price support and resistance, along our calculated EBV Line.

Could this happen again?

Absolutely! Investors should consider all possibilities and probable market outcomes including the possibly of the slow upward gird. Less thrilling and won’t sell financial news impressions (‘clicks’) or link-bait but very profitable for investors who are long equities.

Is EBV+4 exceedingly expensive in terms of valuation?

Not really! Certainly the S&P 500 Index travelled this path before with higher interest rates and the US in the middle of raging two very unpopular wars – viewed in hindsight.

Were there scary moments over those 5 years – between 2002 and 2007 – that investors worried about holding equities? Again, I’m sure there were but the market still barreled forward in terms of gains, matching the compounding of book value of companies, included in the S&P 500, but not increasing the valuation of the overall market.

During this time period 2002 and 2007 the US dollar was in general moribund. The ‘action’ or money flows was directed to commodity countries (Canada and Australia) and of course the BRICs. Currently, with positive US dollar fundamentals this ‘tide’ will lift all boats, if you will. Economic fundamentals will count, of course, but money flows will help companies not only maintain valuations but also help during periods of economic and industrial rotations and/or dislocations. In other words, market corrections should be shallower and brief.

Conclusion

I don’t know if it’s me but the financial stuff I’m reading on the Internet is unusually bearish. And as I preface this blog even I get bogged down in the negativism that seems to be everywhere. But don’t be fooled, money flows into the US dollar are now positive – the tide is coming in! This very important and infrequent occurrence will help support the market’s valuation and may help increase valuations, maybe to EBV+5, as our global economic issues dissipate as national governments and central bankers adjust to new economic realities.

There are now millions of financial websites and I’m guessing here but most seem to be negative in orientation. Everyone viewing these sites on a regular basis can get caught up in their own ‘echo chamber’ of regular and recurring negative news even in good equity markets!

For me, this endless series of bad news and market factoids not only clutters up my thought process and at worst a major time waster. But sometimes, like over Christmas vacation, one does, and I did, take a peek to see what’s out there – guilty, your honor! Thank goodness for MPT [Model Price Theory]. At least I (and you) can run back to a world we have created that valuation of equities make rational and economic sense.

I’m on Market Call!

On Thursday, January 8th, 2015 I will be on Market Call on BNN (Canadian Business Show) 1:00 pm – 2:00 pm (eastern standard) with Mark Bunting.

Take this opportunity, open our Model Price Facebook application and follow along while I’m on the show answering viewer’s questions about individual stocks.

Would you say anything different based on your interpretation of Model Price Theory and chart? You can make your comments via Facebook.

Should be fun!