Category: Market Action

I have long worried that the craze for alternative investments by pension funds and insurance companies was going to lead to trouble. Here’s an example from Dallas:

Dallas police and firefighters are withdrawing hundreds of millions from their retirement plan following a series of investment blunders, heightening the risk that a major U.S. pension fund could run out of money.

The revolt by members of the $2.27 billion Dallas Police and Fire Pension Fund offers an extreme case of what can happen when a pension wagers on lucrative returns to cover funding shortfalls.
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A series of aggressive real-estate bets from Hawaii to Paris and a conflict over the value of those properties triggered more than $500 million in losses, leaving the fund with enough to pay just 45% of future benefits. Officials are warning the pension could go broke by 2027.
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For 10 years, Dallas has had the highest percentage of assets in real estate of any of the about 150 plans tracked by the Public Plans Database. Pension officials traveled as far as Australia and Abu Dhabi to scope out prospective investments, according to a 2008 newsletter.

The strategy appeared to be working, with Dallas returns often beating national medians. But that success received scrutiny in 2013 when the Dallas Morning News reported that many properties hadn’t been appraised for years. Instead, certain holdings were valued based on their purchase price and in some cases by also adding development and operating expenses, said Chief Financial Officer Summer Loveland, who joined the fund in November 2013.

This revaluation loss leads one to wonder what will happen to this speculation:

While Chinese home buyers have sent prices soaring from Vancouver to Sydney, in this corner of Southeast Asia it’s China’s developers that are swamping the market, pushing prices lower with a glut of hundreds of thousands of new homes. They’re betting that the city of Johor Bahru, bordering Singapore, will eventually become the next Shenzhen.

“These Chinese players build by the thousands at one go, and they scare the hell out of everybody,” said Siva Shanker, head of investments at Axis-REIT Managers Bhd. and a former president of the Malaysian Institute of Estate Agents. “God only knows who is going to buy all these units, and when it’s completed, the bigger question is, who is going to stay in them?”
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Developers have a pipeline of more than 350,000 private homes planned or under construction in Johor state, according to data from Malaysia’s National Property Information Centre. That’s more than all the privately built homes in Singapore. Forest City could add another 160,000 over its 30-year construction period, according to Bloomberg estimates, based on the projected population.

“Land is plentiful and cheap,” said Alan Cheong, senior director of research & consultancy at Savills Singapore. “But buyers don’t understand how real estate values play out when there is no shortage of land.”

Meanwhile, the TMX – acquired by the banks to extend their hegemony over the Canadian financial system in a transaction blessed by the regulators in exchange for extra payments to the regulators – continued to demonstrate its permanent free pass from the competition board:

The Competition Bureau has closed its investigation into TMX Group, concluding that owner of the Toronto Stock Exchange likely did not violate the Competition Act in the operation of its market data business.

Last year, TMX rival Aequitas Innovations Inc. complained to the Bureau about what it maintained was “anti-competitive conduct” from TMX Group in relation to its market data product. At the time, Aequitas was attempting to build out its own competing data product. Aequitas alleged that agreements between TMX and investment dealers prevented the sharing of private data without the consent of TMX Group.

Even though the Competition Bureau found in its investigation that this was indeed the case, there were other factors that had little to do with TMX, that made it difficult for Aequitas to launch a competing product, including dealers themselves having reservations about working with Aequitas. One such reservation was over the confidentiality of private market data, according to the Bureau’s statement.

The statement from the Bureau essentially states that it is the Bureau’s job to pick winners and they have picked their friends:

Abuse of dominance occurs when a dominant firm or group of firms in a market engages in a practice of anti-competitive acts, with the result that competition has been or is likely to be prevented or lessened substantially. The Bureau’s investigation focused on the last part of the abuse of dominance test – namely, whether the contractual clauses imposed by TMX Group were likely to substantially prevent competition in a market. Specifically, the Bureau examined whether sufficient future competition from the CMV would be likely to materialize in the absence of TMX Group’s alleged anti-competitive conduct.

Evidence obtained by the Bureau indicated that in order for the CMV to effectively compete with the current sources of indicative market data in Canada, Aequitas required a substantial volume of private market data from investment dealers. Accordingly, the Bureau considered whether there was compelling evidence that Aequitas would likely be able to obtain such a volume of private market data from investment dealers absent TMX Group’s contractual clauses. The Bureau found that:

• •the level of interest among investment dealers in Aequitas’ proposed CMV product varied considerably;
• •investment dealers had a number of concerns with respect to the CMV, including with respect to the confidentiality of private market data, and it was unlikely that Aequitas would be able to address these concerns within a reasonable period of time; and
• •Aequitas had not obtained credible commitments from investment dealers to provide their private market data absent TMX Group’s contractual clauses. Moreover, it was unlikely that Aequitas would be able to obtain such commitments within a reasonable period of time given the preliminary status of negotiations between Aequitas and investment dealers.

Taken together, this evidence suggested that, even absent TMX Group’s contractual clauses, it was unlikely that Aequitas would be able to obtain a sufficient volume of private market data from investment dealers to develop a sufficiently competitive product.

It’s all very simple, isn’t it? Abuse of dominance is restraint of trade. If there’s no trade to restrain because it’s been snuffed out in the planning stages, then there can be no abuse of dominance. QED.

The war on banks has not been without its hilarious moments; JPMorgan provides another example:

JPMorgan Chase & Co. intern had poor grades at the Wharton School. His supervisor in Asia told colleagues that “he’s not really built” for investment banking. He had “attitude issues,” had trouble “following basic rules” and was a prolific napper. Yet in 2010 he was offered a full-time job, over the reservations of some executives.

Those details emerged on Thursday as JPMorgan agreed to pay about $264 million to settle U.S. allegations that it hired children of Chinese decision-makers to win business in violation of anti-bribery laws. Investigators described a systematic effort to curry favor with government officials and business executives.

The Wharton student’s father was an executive of a Taiwanese company offering an $800 million transaction to the bank. In an e-mail, one banker wrote, “The quid pro quo is an analyst job for his son.

The government’s 21-page agreement with JPMorgan ended an almost three-year investigation that set off a debate on Wall Street over whether U.S. business standards should be applied in foreign countries and whether favors to influential officials amounted to criminal activity.

U.S. officials said JPMorgan employees at the bank’s Hong Kong subsidiary sought to maximize profits by providing jobs and internships to children of individuals it hoped to do business with. In spite of a company policy prohibiting such quid pro quo, employees kept a spreadsheet that tracked the recruits and the revenue attributable to each one — and then doctored or altered paperwork about the hiring activity “to conceal the corrupt arrangement.” In all, the bank generated at least $35 million in profits as a result of those hires, U.S. officials said.

The WSJ has further details.

This is exactly how business is done in the West, except that we’re more adept at nodding and winking. Just ask Trust Fund Johnnie, Mayor of Toronto, about his long and arduous ascent to the executive ranks at Rogers.

I can just imagine the scenes at the prosecuting attorney’s offices … all those well paid government lackeys who got their jobs – and their entry to law school, and their partnerships at spiffy law firms – strictly on merit, dammit, strictly on merit, with just a little help from Daddykins, having apoplectic rages about horrific corruption. Of course, a lot of that is covered up by a disingenuous pleading that it’s because the hoi polloi wear brown shoes.

There’s plenty of merit in the financial services industry – more, now, with the rise of high frequency trading – but trust me, there’s no shortage of nods and winks either.

Remember the thirty months following the dividend reset on TRP.PR.A that kicked off the bear market. Wasn’t that awful? It seems like every day the Government of Canada Five Year Yield would go down a little bit and the preferred share market would go down in sympathy.

Well, things are different now, thanks to President-elect Trump and his intended fiscal stimulus! Now the Government of Canada Five Year Yield goes up a little nearly every day and the preferred share market goes down in sympathy. Totally different environment.

PerpetualDiscounts now yield 5.39%, equivalent to 7.01% interest at the standard equivalency factor of 1.3x. Long corporates now yield just over 4.0%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 300bp, a dramatic widening from the 275bp reported November 9.

US fiscal stimulus bets first increased:

Routs in global bonds and emerging markets intensified, while the dollar climbed as investors positioned for the wave of U.S. fiscal stimulus that President-elect Donald Trump has pledged to unleash.

The yield on 30-year Treasuries rose to the highest since January, with last week’s record debt selloff bleeding into Monday trading and weighing on credit markets. The Bloomberg Dollar Spot Index advanced to a nine-month high as the U.S. currency strengthened against most major counterparts. American stocks were little changed and shares in developing nations sank to a four-month low. Copper climbed, while oil fell with gold.

… and then moderated:

The fallout from Donald Trump’s election to the U.S. presidency showed signs of moderating in financial markets with benchmark Treasuries and emerging-market stocks advancing for the first time in a week amid a retreat in the dollar.

The yield on U.S. government bonds due in a decade fell from its highest level of the year and sovereign notes in Australia fluctuated after a three-day slide. Bloomberg’s dollar index declined for the first time since Americans voted Trump in a week ago and an MSCI gauge of emerging-market stocks rebounded from a four-month low. Gold pulled out of its steepest slide in more than a year, while zinc led a rally in industrial metals. Crude oil rose from an eight-week low as OPEC members sought to agree output quotas.

So … we’ll see! But Eric Reguly reminds us:

Mr. Trump has awakened the bond vigilantes. They can be nasty. In 1994, they battled president Bill Clinton and won. In his first term, Mr. Clinton wanted to boost spending and implement a middle-class tax cut. Investor worries about high spending sent U.S. 10-year yields above 8 per cent and Mr. Clinton was forced to dilute his domestic economic agenda.

… while Scott Barlow reports:

The five-year government of Canada yield – yes, the one that drives mortgage rates – popped above one per cent this morning after starting last week with a yield of 70 basis points.

The close for GOC-5 was 0.95%, according to Perimeter Markets Inc..

There is continued excitement over potential US fiscal stimulus:

A bond-market gauge on Thursday hit its highest level since the summer of 2015. The 10-year break-even inflation rate indicated expected annual inflation of 1.89% over the next 10 years. That measure, reflecting the gap in yields between Treasurys and their inflation-protected counterparts, known as TIPS, was 1.73% two days ago, according to Tradeweb.

The yield on the 10-year Treasury note, which rises when bond prices fall, climbed another 0.05 percentage point on Thursday to 2.118%. It has jumped a quarter of a percentage point since before the U.S. election result, the biggest two-day rise since 2011. Nominal bond rates have been rising faster than those protected against inflation, meaning that inflation protection is increasingly viewed as the more attractive investment.
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One spark for the latest inflation trade came when Mr. Trump mentioned infrastructure spending prominently Wednesday morning in his victory speech, investors say. Others believe efforts to repeal financial regulations enacted by President Barack Obama’s administration could expand bank lending activity, and that restrictions on trade could boost wages in an already strong labor market.

The New York Times has a bit more colour:

For the last few years, the world has suffered from a chronic shortage of demand, depressing inflation and interest rates worldwide.

If those conditions persist, a Trump administration may have some room to expand deficits without triggering a spike in interest rates that would undo any economic boost those deficits create.

But many economists don’t see it working out that way. Mark Zandi, chief economist at Moody’s Analytics, was skeptical in a much-discussed paper released earlier in the year estimating the economic impact of a Trump administration. He assumed that if Mr. Trump’s policies were taken at face value, it would increase the deficit from 3.5 percent of G.D.P. this year to more than 10 percent by the end of Mr. Trump’s term. He said this would cause the Federal Reserve to raise interest rates above 6 percent in 2018 to prevent inflation.

Who’s up for a 6% Fed policy rate? Who wants to know what will happen to the loony and Canadian house prices then?

Those hoping for higher global interest rates via expansionary fiscal policy may soon get their wish:

Donald Trump’s gracious victory speech did two things. It defused much of the negative impact of the shock; and it reminded everyone that the US would have a more expansionary fiscal policy under a Trump presidency than it would have done under a Clinton one. This latter point may take time to be reflected in the markets, and the negative tone on international trade will put pressure on emerging markets. But it is quite plausible that US shares will rise rather than fall over the next few weeks. The dollar should recover swiftly too.

The reason for this is the easing of fiscal policy. With a supportive Congress it should be possible for the new President to get his proposed cuts in both corporation tax and income tax into law next year. Big business did not support a Trump victory but it will benefit from it. Of course, recession fears remain, for this has been a long expansion and the economy is pushing towards full capacity, but US growth next year may surprise on the up side, not the down. Additional spending on infrastructure will take time to feed through – there is no such thing as a shovel-ready project – but such investment will inevitably add to growth in the medium-term.

It is hard, however, to see growth being fast enough to close the budget deficit. A looser fiscal policy will be countered by a tighter monetary one. There was great hostility in the Trump campaign towards the Federal Reserve and to its chair Janet Yellen. But the Fed is independent and it would be unwise of any new administration to pick a fight with it. Right now the markets estimate that the chances of another rise in interest rates in December have shrunk from a near-certainty to an even bet. But this election increases the intellectual case for higher rates. Once they have settled down the markets may come to accept that such rises are inevitable and welcome.

There’s good support for this view:

The Committee for a Responsible Budget said this has made it difficult to evaluate Mr. Trump’s proposals, but estimated they could add $5.3-trillion (U.S.) to the federal debt over 10 years.
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The initial impact of Mr. Trump’s protectionist policies may not be all bad. Economist Barry Eichengreen argued earlier this year that while tariffs threaten to fan trade wars and geopolitical tensions, the initial impact would be to boost U.S. wages and inflation, something the Federal Reserve’s easy money policies have so far struggled to accomplish.

Mr. Zandi’s team at Moody’s Analytics estimates that fully implementing Mr. Trump’s trade and immigration proposals could drive up inflation, eventually triggering aggressive Fed rate hikes and a recession, a concern shared by some investors.

PerpetualDiscounts now yield 5.13%, equivalent to 6.67% interest at the standard equivalency factor of 1.3x. Long corporates now yield about 3.9%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 275bp, a sharp narrowing from the 290bp reported on November 2.