Category: Market Action

I thought this was an excellent article on index funds and corporate governance:

No passive investor cares much about governance of a particular company. The impact on an index when a single company underperforms is usually either slight or offset by gains from its competitors. It may be rational for index funds to ignore governance, since the money they spend on improving it benefits not just them but also rival funds that invest in the same stocks.

So it’s a problem when these investors control voting outcomes for the companies that they invest in. This is often the case, since 88% of public companies count one of three large institutional investors— State Street Global Advisors, Vanguard, and BlackRock—as their largest investor. All investors have a stake in companies being well-run, but they aren’t always willing to pay higher fees for monitoring or governance. And because there is no such thing as universally good governance, the blind application of one-size-fits-all governance solutions across vastly different companies often has negative effects.

Blackrock touts its Investment Stewardship team:

The BlackRock Investment Stewardship team is a centralized resource for portfolio managers. In our stewardship work we aim to:
1 Protect and enhance the value of clients’ assets through engagement with companies
2 Encourage business and management practices that support sustainable financial performance over the long-term
3 Provide specialist insight on environmental, social and governance (ESG) considerations to all investment strategies, whether indexed or actively managed.

… but the opinion piece points out:

But there is reason to believe that these teams are not up to the task. As of October 2016, Vanguard’s governance team employed 15 people to cover some 13,000 companies; BlackRock employed about 20 for its 14,000 companies; and State Street employed fewer than 10 for about 9,000 companies.

The Globe had an excellent article on productivity in Ontario which well illustrates my view on the minimum wage controversy:

Don’t lecture Jocelyn Bamford about lack of ambition. She helps run Automatic Coating Ltd., a company founded by her husband’s family in the 1950s.
…
“We are absolutely losing our competitiveness,” Ms. Bamford said.

The culprit, she said, is a provincial government that has rained blows on small and mid-sized businesses over the past two years. The unwelcome changes include unpredictable energy costs, a complicated cap-and-trade system for greenhouse-gas emitters, the planned hike in the minimum wage and new rules that will make it far easier for organizers to unionize workplaces.
…
Right now, she says, the only factor that allows many of the province’s manufacturers to compete against U.S. rivals is the low Canadian dollar. But she worries about the impact of the new workplace legislation, especially the radical hike to the minimum wage.

The problem, she says, is that a higher minimum wage forces up wages across the entire pay scale. Experienced workers who are already making $15 an hour will demand a few dollars more, and the ripple effect will result in dramatically higher labour costs over all.

What are her alternatives? She and her husband have debated whether it makes sense to cut jobs and automate more of their factory operations. Even simpler, though, would be a move to Mississippi, where the state is dangling a tempting package of relocation benefits.

Well, I’m not impressed by business owners who seek success through cheap labour and government handouts. Fortunately, the Globe also interviewed a man after my own heart:

“But all that being said, I don’t think the $15 minimum is likely to be a game changer in the long run,” says Craig Alexander, chief economist of the Conference Board of Canada, a not-for-profit research organization.

He notes that several U.S. states have announced their own plans to move to similar wage levels over the next few years. Rather than relocating operations, many employers in Ontario are likely to respond to higher wages by reducing jobs and installing more automation.

“You already see the trend at some fast-food restaurants, where you order at a screen instead of talking to a human,” Mr. Alexander says.

His analysis demonstrates the complexity of any policy change: By encouraging automation, higher minimum wages could boost productivity over the long run, which the province badly needs.

… and at least one of the interviewed business owners gets it:

Mr. Josephs, the freezie maker, acknowledges the many conflicting factors. It’s difficult to find anyone who will work for minimum wage these days, he says. His big worry is not so much the hike itself but the knock-on effect it will have on workers who may be making slightly more than the $15-an-hour level and will want raises of their own.

If he decides to stay in Ontario, he’s looking at automating his plant to drastically reduce his use of seasonal workers, slashing the number of hires from 100 to about 40. “And we’ll be looking to reduce even further,” he says.

Meanwhile CRM2 is having its intended effect:

Financial advisors who work at three of the Big Six banks had much to complain about concerning their pay as a result of recent changes to their compensation packages.

Notably, advisors who work at Toronto-based Bank of Nova Scotia, Montreal-based National Bank of Canada and Toronto-based Canadian Imperial Bank of Commerce (CIBC) either gave their firms the lowest or much lower ratings in the “firm’s total compensation” category in this year’s Report Card on Banks because of changes that led to drastic reductions in their take-home pay.

Scotiabank received the lowest rating in the category (6.9) – a tie with National Bank – because advisors are dissatisfied that Scotiabank eliminated the investment bonus from advisors’ pay packages.

“[The bank] took away about $16,000 to $18,000 – or 20% of my salary,” says a Scotiabank advisor in British Columbia.
…
Similarly, advisors with National Bank took issue with several recent tweaks to the firm’s compensation regime. For starters, the bank announced a new compensation structure this past January, through which advisors will take an 8% cut in their salary as of July 1; this did not sit well with many advisors surveyed.
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The new payout structure for National Bank advisors is 70% base salary and 30% variable compensation, says Nancy Paquet, vice president, partnerships, with National Bank. The changes include an 8% reduction to advisors’ salary, as well as changes to how the variable portion is calculated; specifically, the latter now is paid quarterly instead of annually.

Isn’t it great? Trailer fee disclosure will drive a lot of business away from independents to the banks, where the nice man at the bank will put investors into the bank’s funds and GICs (because GICs are safe!) – with no fee! Well, sure, there’s a MER, but all funds have MERs … advice will be free, free, free!

I am sure we all look forward to the day when trailer fees are banned completely; then all those expensive bank advisors can be replaced with high school students working part time. The banks were successful in implementing such a change (as far as I was ever able to tell) with respect to institutional salesmen in the first decade of this century and we can all look forward to universality.

The trouble is that nobody ever asks, considers or resolves the question: ‘what are the capital markets for? How can the capital markets accomplish their purpose more efficiently?’. Nobody’s paid to do it. In an ideal world the regulators would have these questions front and centre of every proposal, but in this world regulators are mandated to make sure there are no scandals that might embarrass their political masters. And so public markets get more inefficient, investment outcomes become more of a one-size-fits-all plain-vanilla whitewash and – most importantly – big banks get bigger and find they need more ex-regulators on staff.

A rate hike in Canada won’t come as soon as some people think, according to recent inflation numbers:

The Bank of Canada’s efforts to set the stage for a rate increase were set back Friday after data showed inflation pressures continuing to ease.

Canada’s consumer price index rose 1.3 percent in May from a year ago, the slowest pace this year, down from an annual pace of 1.6 percent in April, Statistics Canada said Friday from Ottawa. Another key gauge of price pressures that excludes gasoline and some other more volatile items fell to the lowest since 1999.

The inflation report undermines the case for a quick rate hike by the Bank of Canada even as the nation’s economy has been growing at a pace that is among the fastest in the developed world.

I remain convinced that it will come eventually – but trying to time it is a mug’s game. But there are doubts about US inflation:

Barely a week after raising short-term interest rates for the second time this year, Federal Reserve officials are increasingly divided on the timing of their next move, with some saying they won’t support another increase until they see a pickup in inflation.

Inflation, as measured by the Fed’s preferred gauge, breached its annual 2% goal in February for the first time in nearly five years but has since retreated, sinking to 1.7% in April.

Fed officials in their public remarks since their policy meeting last week have disagreed on whether the recent weakening of price pressures is likely transitory or perhaps more persistent.

Fed Chairwoman Janet Yellen, New York Fed President William Dudley and Cleveland Fed chief Loretta Mester view the recent sluggishness as probably temporary, driven by some one-time factors such as new, more generous cellphone plans and slower growth in prescription drug prices.

Others such as regional Fed bank presidents Charles Evans of Chicago, Neel Kashkari of Minneapolis, Robert Kaplan of Dallas and James Bullard of St. Louis have expressed more concern about slower inflation.

Change and confusion all ’round! Last Friday, Quebec was upgraded. Today Saskatchewan is downgraded:

• •Weaker commodity prices and elevated capital spending are negatively affecting the Province of Saskatchewan’s budgetary performance and debt burden.
• •As a result, we are lowering our long-term issuer credit and senior unsecured debt ratings on Saskatchewan to ‘AA’ from ‘AA+’ and affirming our ‘A-1+’ global scale and ‘A-1(High)’ Canada scale short-term ratings.
• •The stable outlook reflects our expectation that, in the next two years, as Saskatchewan realizes positive results from its revenue measures and cost efficiencies, its budgetary performance will continue to stabilize, leading to near-balanced operating balances and declining after-capital deficits of less than 10% of total revenues

…
The downgrade reflects the province’s weakened budget performance and growing debt burden, which are symptoms of low commodity prices in two of
Saskatchewan’s key economic sectors: oil and gas, and potash. Low commodity prices have prompted the province to implement tax reforms and cost control targets, which are expected to support an improvement in budget outcomes. However, despite these efforts, Saskatchewan’s budget trajectory is now weaker than it was last year, due to slower economic growth and higher near-term capital spending intentions under its Saskatchewan Builds Capital Program. We now expect Saskatchewan’s after-capital balances to remain negative over the next two years. We also expect new borrowing requirements tied to SaskBuilds and government-related entities (GREs) to cause its tax-supported debt burden to approach 150% of consolidated operating revenues, which is high compared with similarly rated international peers’.

We expect Saskatchewan will record, on average, a modest operating deficit of about 2% of operating revenues and an after-capital deficit of 10% of total revenues for fiscal years 2016-2020. We expect that new revenue measures, such as eliminating certain exemptions and increasing the provincial sales tax, will help to mitigate the negative influence of weak commodity prices, leading to a steady improvement in budget outcomes over the next two years. Saskatchewan is forecasting operating revenue growth of 3.7% per year, on average, between fiscal years 2018 and 2020. On the expense side, considering continued spending control and a projected return to more moderate levels of capital spending in the outer years of our forecast, we expect that the province’s after-capital budgetary performance will moderately improve. Saskatchewan is projecting an operating expenditure decline of 1.2% in fiscal 2018, followed by expenditure growth of 1.2% per year, on average, between fiscal years 2019 and 2020.

PerpetualDiscounts now yield 5.08%, equivalent to 6.60% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.60% (maybe a little over) and so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 300bp, a widening from the 290bp reported June 14.

It was quite a day today … I saw a flying pig, a cat with horns, and S&P upgrading Quebec:

• •We expect the Province of Quebec to extend its record of prudent fiscal policies, with strict cost controls and growing tax revenues keeping its budget in surplus and causing its debt ratios to further shrink over the next couple of years.
• •As a result, we are raising our long-term issuer credit and senior unsecured debt ratings on Quebec to ‘AA-‘ from ‘A+’, and affirming our short-term issuer credit rating at ‘A-1+’.
• •The stable outlook reflects our expectation that, in the next two years, Quebec will generate modest after-capital surpluses and reduce its tax-supported debt ratio.

…
We expect Quebec to continue benefiting from moderate economic momentum and strict cost controls, enabling it to achieve operating and after-capital surpluses of 8.7% and 1.2%, respectively, from fiscal years 2016-2020. This outlook is better than we foresaw last year, despite the government’s recent decision to hasten the elimination of the health premium tax and boost its program and infrastructure spending before the October 2018 election. While the government’s fiscal framework could change post-election, regardless of the party elected, our base-case assumption is for general continuity in fiscal policies, given the high visibility in undoing some of the fiscal checks, such as the requirement for balanced budgets and the Generations Fund that are enshrined in legislation. The province also has contingencies available within its 2017 budget, should its economic picture moderate or other spending priorities arise.

Positive operating results are allowing Quebec to deposit more than C$2 billion yearly into its Generations Fund, which we treat analytically as a sinking fund. We expect the balance in this fund to reach C$15.9 billion by fiscal 2019, up significantly from C$8.5 billion in fiscal 2016. This, alongside increasing revenues, will lower Quebec’s tax-supported debt to 211% of consolidated operating revenues by fiscal 2019. This is a major reduction from its peak of 235% in fiscal 2015. Nevertheless, even at the lower level, Quebec’s debt burden would remain high by domestic and international standards and, if it doesn’t materially decline below this projected level, would likely remain a barrier to further upgrades. We also anticipate the province’s interest expense to decrease slowly, averaging 9.3% of adjusted operating revenues from fiscal years 2017-2019.

Andrew Willis of the Globe had some very good commentary on the Home Capital settlement:

Part of the solution, announced Wednesday, is a regulatory settlement that sees Home Capital absolve the OSC of any blame for the whole mess. In a news release, Home Capital chair Brenda Eprile said the company “acknowledges that the Commission is not to blame for the events of recent months involving its liquidity position.”

I’m guessing Ms. Eprile grit her teeth while signing off on that line. But her goal is to get Home Capital moving forward, and that meant resolving regulatory issues and potential class-action lawsuits. As part of a settlement that’s going to set back Home Capital – or its insurance company – approximately $30-million, it doesn’t cost Ms. Eprile anything to give the OSC a little political coverage.

I’m also guessing that Ontario’s Premier was thrilled to see that statement, as the provincial Liberals wouldn’t want to be fighting an election next year as the party that nearly vaporized the largest lender to homeowners who can’t borrow from the big banks.
…
From the OSC’s point of view, sources say there is an equally strongly-held view that Home Capital and its legal advisers dug in their heels on the terms of the settlement and that led to the public showdown.

This view is bolstered by the fact that many lawyers believe Home Capital and its executives would have been cleared if the OSC allegations had ever been taken to a hearing. Disclosure decisions that Home Capital made back in 2015 were approved by one former OSC chair – lawyer Jim Baillie from law firm Torys, and are now being defended by another former head of OSC, Stikeman Elliott’s Ed Waitzer.

I expect that the next company announcement of a big, well-publicized negotiated settlement will include a phrase along the lines of ‘I am a running-dog lackey of the anti-investor deviationist line! I have been an unwitting dupe of the pro-inadequate disclosure camp!’ Give bureaucrats power that can be countered only by the superior political connections of the Big Banks and Big Insurers and what else do you expect?

What a difference a week makes!

Investors and economists are recalibrating rate forecasts after the central bank’s surprise talk of tightening this week signaled a policy move could come sooner rather than later.

A Bloomberg survey of 17 economists found the majority now project a rate increase this year. Six predict higher rates in October and two suggest a September hike. That’s an about face from a week ago, when only two forecasters were projecting rates would rise in 2017.

Traders are also pricing in a full 25 basis point increase to the central bank’s 0.5 percent benchmark interest rate by the December meeting, according to Bloomberg calculations on overnight index swaps.
…
Swaps trading on Thursday showed a 46 percent chance of an increase in July, and a 75 percent chance of one by December. A week ago the odds were 5 percent and 27 percent.

The Canada five-year bounced upwards today, closing at 1.14%.

As expected, the FOMC hiked the US policy rate:

Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined. Household spending has picked up in recent months, and business fixed investment has continued to expand. On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.
…
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

The US market took it all in stride:

Treasuries rose, the dollar trimmed losses and U.S. stocks turned lower after Yellen suggested weak readings on inflation won’t persist amid a tightening labor market.

And, in fact, the Canada five-year reversed itself today, closing with a yield of 1.10%, down 5bp on the day.

PerpetualDiscounts now yield 5.10%, equivalent to 6.63% interest at the standard equivalency factor of 1.3x. Long corporates now yield a little over 3.7%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 290bp, a narrowing from the 300bp reported June 7.