Category: Market Action

There is an interesting trend in the commodities market:

As Barclays Plc, JPMorgan Chase & Co. and Morgan Stanley leave parts of the business, prices of commodities are moving more independently of stocks. The correlation between U.S. equities and corn, cattle and wheat fell to less than 0.05 in January, compared with almost 0.3 in 2008, an analysis by David Bicchetti and Nicolas Maystre, economic affairs officers at the UN Conference on Trade and Development in Geneva, shows.

Banks, hedge funds and other financial institutions piled into physical commodities and derivatives over the past 12 years, amplifying a run-up in prices for everything from copper to oil, in short supply before the 2008 global recession, the UN found in a 2011 study. The exodus is nudging futures markets back toward their original function, as a way for farmers, miners and other companies in the commodities business to hedge against price swings.

I’m not sure, but I think the study Bloomberg refers to above is by David Bicchetti and Nicolas Maystre, titled The synchronized and long-lasting structural change on commodity markets: evidence from high frequency data:

This paper analyses the intraday co-movements between returns on several commodity markets and on the stock market in the United States over the 1997- 2011 period. By exploiting a new high frequency database, we compute various rolling correlations at (i) 1-hour, (ii) 5-minute, (iii) 10-second, and (iv) 1-second frequencies. Using this database, we document a synchronized structural break, characterized by a departure from zero, which starts in the course of 2008 and continues thereafter. This is consistent with the idea that recent financial innovations on commodity futures exchanges, in particular the high frequency trading activities and algorithm strategies have an impact on these correlations.
…
This paper documented striking similarities in the evolution of the rolling correlations between the returns on several commodity futures and the ones on the US stock market, computed at high frequencies. It also highlighted a structural change that took place recently in these markets. Prior to 2008, high-frequency co-movements between commodity and equity markets did not usually differ from zero over a long lasting period at such high frequencies. In the course of 2008, these correlations departed from zero and became strongly positive after the collapse of Lehman Brothers.

In our view, this finding adds to the growing empirical evidence supporting the idea that the financialization of commodity markets has an impact on the price determination process. Indeed, the recent price movements of commodities are hardly justified on the basis of changes of their own supply and demand. In fact, the strong correlations between different commodities and the S&P 500 at very high frequency are really unlikely to reflect economic fundamentals since these indicators do not vary at such speed. Moreover, given the large selection of commodities we analyse, we would expect to have different behaviours due to their seasonality, fundamentals and specific physical market dynamics. Yet, we do not observe these differences at any frequency. In addition, the fact that these correlations at high frequencies started during the financial shocks provides additional support for financial-based factors behind this structural change. Therefore, the very existence of cross-market correlations at high frequencies favours the presence of automated trading strategies operated by robots on multiple assets. Our analysis suggests that commodity markets are more and more prone to events in global financial markets and likely to deviate from their fundamentals.

It seems odd to me that the authors don’t spend much time discussing monetary policy. The links between commodity financialization and monetary policy were highlighted on PrefBlog on November 11, 2010 and in the post QE2 and Inflation.

Econbrowser is prominent in the above links, and the blog also hosts a recent piece titled Guest Contribution: Commodity-Price Comovement and Global Economic Activity:

Our approach to understanding the drivers of the comovement in commodity prices uses a theoretical model in which the prices of commodities are determined by two sets of forces. First, there are the forces that affect commodity prices directly, by which we mean forces which alter the supply or demand for commodities even for a fixed level of global economic activity. For example, we classify a technological improvement in the production of commodities as such a force, because it would increase the supply of commodities even in the absence of any subsequent effects on global economic activity. Of course, to the extent that these forces change commodity prices, they ultimately alter the level of global economic activity and feed back into commodity prices through general-equilibrium effects. But the key to identifying these forces is that they affect commodity prices even absent any endogenous response of global activity. By contrast, the second set of forces are those that affect commodity prices only through the changes that they induce in the level of global economic activity, i.e. “indirectly”. Changes in government spending, variation in the desired markups for the production of consumer goods, or improvements in the technology used to produce final goods are all examples of such forces. The composition of all such forces is summarized by the indirect factor. These two drivers are common to all commodity prices. The model also permits there to be idiosyncratic forces specific to individual commodities.

Looks like Abenomics is working on the data but not on embedded expectations:

Tokyo’s consumer prices rose 2.7 percent in April from a year earlier, the biggest jump since 1992, pumped up by a sales-tax increase and a year of unprecedented stimulus from the Bank of Japan.

Inflation excluding fresh food accelerated from 1 percent in the previous month, while nationally the same price gauge rose 1.3 percent in March from a year earlier, statistics bureau data showed today. The Tokyo price gains compared to a 2.8 percent median forecast in a Bloomberg News.

The Tokyo data provide a first look at the effects of the April 1 tax increase that’s damping consumer demand and is projected to tip the economy into a one-quarter contraction. Investors are assessing prospects for extra monetary easing, with Bank of Japan Governor Haruhiko Kuroda’s board set to meet on April 30 to review policy and release updated forecasts for inflation and growth.
…
BOJ officials are increasingly concerned the nation’s bond market is failing to reflect emerging inflation, raising the risk of a sudden surge in yields, according to people familiar with the matter. Officials hope yields will rise gradually, in line with developments in the economy and prices, the people said. Benchmark 10-year government bonds yesterday yielded 0.615 percent, little changed from March 2013.

There’s one good aspect to the federal Target Date pension plans I’ve been complaining about recently:

Meanwhile Denis Lemelin, president of the Canadian Union of Postal Workers, said he fears the government will eliminate defined benefit plans for employees at Canada Post and other Crown corporations. “We’re really worried about this announcement,” he said.

Hey, that’s a good justification right there! Bring it on!

Assiduous Reader MG writes in about Target Date Pension Plans and says:

Hi James, thanks for including my response yesterday. Not to prolong the discussion but I just wanted to make on additional point regarding the pooling. Your last paragraph yesterday stated:

Well, OK. But pooling of longevity risk can be accomplished with an annuity. The basic problem is familiar; I wrote an article about it some time ago in another context and now can’t remember the article: risk cannot be destroyed. It can only be passed on or changed in form. And while I seem some risk-pooling for the beneficiaries here, I see no indication that the company bears any; therefore, it’s a DC plan with bells and whistles.

The issue with defined contribution plans is that you need to make decisions at the point of retirement which would not be required under target benefit plans. If you annuitize at the point of retirement, you are making a call on the timing of accumulated savings, i.e. if your investment went down prior to retirement you may be annuitizing a lower capital. You are also captive of the level of long term interest rates at the point of annuitization. If they were 18% (like when I started in the business), it is not an issue. If they are at 3.5%, it is a problem. A target benefit plan would likely be invested in such a way that there is some continuity, i.e. no call on timing of markets and long term rates when benefits start. In a defined contribution plan, you do not need to annuitize but then you have a lot of uncertainty due to unknown longevity, so there is a temptation to get it over with and just get whatever you get through an annuity purchase.

All of this may be a moot point, as I have seen similar arrangements proposed by the federal or provincial governments. Typically these have not been a success for a variety of reasons. In this situation, TB plans would only apply to federally regulated companies, unless provinces do the same. Federally regulated companies would include banks and transportation including CN and CP. Historically many of these already have defined benefit plans, so the only potential would be among employees of much smaller companies.

OK, fair enough. A DC plan member can transfer the value to a Locked-In Retirement Income Fund which – presumably – will have all the continuity he wants, but does not address mortality risk. So a Target-Date will pool the mortality risk for the participants, which is a benefit – it will be able to pay out more aggressively than a self-managed investment portfolio. On the other hand, this pooling occurs in the context of an active pension plan, while leaving the investment risk with the employee (on a pooled basis, of course). This might not be a good thing, depending on the risk characteristics of the pool vs. the risk characteristics of the client.

I will leave it to an actuary to comment on how risks taken by the Target Benefit plan on behalf of the entire pool impact on the risk sustained by the individual retirees! But now I’m wondering if the big insurers could offer such a thing for DC beneficiaries when they cash out. Offer mortality pooling in a mutual fund-like vehicle (but with investments irrevocably locked in!) with an actuarially blessed monthly pay-out, charge a fat fee …

S&P downgraded Russia:

• •In our view, the large capital outflows from Russia in the first quarter of 2014 heighten the risk of a marked deterioration in external financing, either through a significant shift in foreign direct investments or portfolio equity investments. We see this as a risk to Russia’s economic growth prospects.
• •We are therefore lowering our foreign currency ratings on Russia to ‘BBB-/A-3’ from ‘BBB/A-2’, lowering our local-currency long-term rating to ‘BBB’ from ‘BBB+’, and affirming our local-currency short-term rating at ‘A-2’.
• •The outlook on both the foreign and local currency ratings remains negative. If we perceived increased risks to Russia’s creditworthiness stemming from much weaker medium-term economic growth or due to reduced monetary policy flexibility, we could lower our sovereign ratings on Russia further. We could also lower our ratings on Russia if tighter sanctions were to result in additional weakening of Russia’s net external position.

The CMHC is fiddling around with mortgage insurance eligibility rules again:

Canada Mortgage and Housing Corp. is voluntarily tightening up the types of mortgage insurance it will offer.

The Crown corporation said Friday that it is going to stop offering mortgage insurance on second homes. It will also stop offering mortgage insurance to self-employed people whose income cannot be validated through traditional means. The changes on second homes also mean that anyone who has an insured mortgage will not be eligible to act as a co-borrower on another insured mortgage.
…
CMHC says that its second home program and its self-employed-without-third-party-income-validation programs combined account for less than 3 per cent of its insurance business volumes in terms of the numbers of mortgages insured.

“Given the limited use of these products, their discontinuation is not expected to have a material impact on the housing market,” it stated in a press release.

More smoke and mirrors. Fiddling with the rules keeps the voters happy, but leaving the spigots open for plain vanilla insurance keeps the banks happy.

Pembina Pipelines, proud issuer of PPL.PR.A, PPL.PR.C and PPL.PR.E, was confirmed at Pfd-3 by DBRS:

DBRS has today confirmed the Issuer Rating and Senior Unsecured Notes of Pembina Pipeline Corporation (Pembina or the Company) at BBB, and the Preferred Shares at Pfd-3. The trends remain Stable. The confirmation largely reflects DBRS’s view that the Company’s exposure to fractionation spreads and seasonal pricing differentials has lowered considerably while its financial profile has improved over the past 24 months (since the April 2, 2012, closing of the Provident acquisition (the Acquisition)). The confirmation also reflects DBRS’s expectation that: (1) further improvement of the business risk profile will be achieved once the Company substantially completes all of its current expansion projects; and (2) Pembina will continue to finance its expansion with appropriate debt and equity to maintain its debt-to-capital structure in the range of below 40% and cash flow-to-debt ratio at least 25%.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts and FixedResets both gaining 8bp, while DeemedRetractibles were off 2bp. Volatility was totally nonexistent yet again. Volume was below average.

I renewed my mockery of Target Benefit Plans yesterday. Assiduous Reader MG writes in and says:

I used to be a pension actuary, however a long time ago. So I asked someone who retired more recently what he thought about target benefit plans. Here is the answer I received:

I am not sure of the details of the federal proposal. However, if it looks like the New Brunswick arrangements, then you get pooling of mortality risk, limited pooling of investment risk (across generations), and economies of scale with respect to plan expenses. In essence, you can think of it as a pooled RRSP. Employer contributions will be more or less fixed (limited ability to change contributions), employee contributions and benefits go up and down with plan experience

+++++++++++++++++++++++++++++
Essentially I believe you are correct that employees assume most of the risks but it appears that it is not one-sided, i.e. they can win or lose depending on results.

I don’t believe this a great deal. I think it will have a limited impact. Except for some pooling, the main advantage is that it allows members to have a better idea of what the ultimate benefits might be (assuming assumptions are realized) which is a weakness of defined contribution plans.

Fair enough. I’m not sure how the beneficiary reporting is handled, but it seems to me that this reporting could be realized inside the framework of a one-choice DC plan by (i) Estimating the accumulated value on the projected retirement date, and (ii) Estimating the monthly benefit of a no-guaranty life annuity purchased on that date.

But there were some more details today:

The Conservative government released extensive details on a proposed target benefit plan Thursday that would see federal legislation lay out the rules as to what these funds would look like and how they should be managed.
…
“Base benefits” could be reduced in cases where the pension fund is in deficit, but would have a high level of protection and could only be lowered “as a last resort,” according to the Finance Canada consultation paper released Thursday. Meanwhile “ancillary benefits” would have “a lower but reasonable level of protection” and would be reduced before base benefits were reduced and could also be increased when the plan is in a surplus situation.
…
[Minister of State for Finance Kevin] Sorenson argued it would be better than a defined contribution plan.

“Unlike defined contribution plans, target benefit plans would offer a more predictable stream of benefit payments and high benefit security, since the target benefits would be based on a per-determined formula,” he said. “Members and retirees would benefit from the pooling of longevity risk, which is not a feature of defined contribution plans.”

Well, OK. But pooling of longevity risk can be accomplished with an annuity. The basic problem is familiar; I wrote an article about it some time ago in another context and now can’t remember the article: risk cannot be destroyed. It can only be passed on or changed in form. And while I seem some risk-pooling for the beneficiaries here, I see no indication that the company bears any; therefore, it’s a DC plan with bells and whistles.

Tapering is old news. The new worry is credit quality:

Corporate dealmaking that helped propel the Standard & Poor’s 500 stocks index to a record is playing out differently for debt investors, who must contend with the biggest threat to credit grades since 2009.

With borrowings to fund mergers and acquisitions accelerating amid an improving economy, the number of credit-ratings cuts linked to such deals is exceeding increases by the most since the fourth quarter of 2009, according to data from Moody’s Analytics. The firm’s credit-assessment unit lowered 96 ratings during the year ended March, while raising the rankings on 78.

The damage to balance sheets is coming amid a growing chorus of concerns that a sixth year of record-low interest rates engineered by the Federal Reserve has left bond prices overvalued and allowed borrowers to get away with financings that they wouldn’t be able to do in normal times. Valeant Pharmaceuticals International Inc. is pursuing Allergan Inc. in a takeover that may drop the Botox maker to junk status.

The Valeant / Allergan deal became notable for taxation reasons as well:

GE can tap the $57 billion of cash it has amassed overseas to finance a purchase of most of France’s Alstom SA (ALO), a person with knowledge of the matter said. By doing so, GE would take advantage of its overseas profits instead of bringing them back to the U.S., where they would be taxed at a higher rate.

Valeant’s pursuit of rival Allergan Inc. underscores another twist. Many drugmakers are buying companies in low-tax countries and then setting up operations there to avoid U.S. taxes. If the Canadian company succeeds in buying Allergan, the combined entity would have a tax rate in the single digits, Valeant Chief Executive Officer Michael Pearson said. Allergan paid a tax rate of about 26 percent in 2013, data compiled by Bloomberg show.

“You have effectively created an incentive to move to a low-tax country,” said Gordon Caplan, a partner at law firm Willkie Farr & Gallagher in New York. “There is competition between high-tax countries and low-tax countries.”

U.S. companies are keeping cash offshore to avoid paying up to a 35 percent tax rate on profits they earn around the world. They only pay taxes when the cash is repatriated. By spending money overseas, the effective cost for a buyer can also be lowered, making acquisitions easier.

I was surprised to hear a little while ago that many high-school students can’t do long division and was even more surprised to have that confirmed by a young relative. So I read an article in a men’s magazine titled 5 Math Lessons You Don’t Really Need in the Real World with great interest:

#5. Long Division

Long division is a calculation technique where one number can be divided by another using nothing more than note paper and a tremendous amount of time. And despite all the horrible things that have happened to my brain since grade five, I basically still remember how to do it. You start at the left and pick the largest nominator that can fit in the regulator, then take the leftovers and add them to the next downmost digit of the dividule, then repeat. Right?

Note that I’m talking about the usefulness of long division specifically here. Everyone obviously has to understand how basic division works, as that comes up all the time in the real world, when dividing up apples among friends or whatever. But the only division you ever really need to do in the real world is with integers under 100, and that takes rote memorization really, not long division. So what good is long division?

What They Say This Is Used For:

Long division is meant for those occasions when we need to divide large numbers and we don’t have a calculator at hand.

What a Normal Human Being Might Actually Use This For:

Nothing.

Basically the only people who use long division now are fifth-grade teachers teaching long division to fifth graders. Long division was added to our math curriculum in a primitive era when people smoked for their health and calculators were rare. But that’s obviously no longer the case; right now you probably have three or four devices within arm’s reach capable of doing division.

I’ve thought a bit about this – and even left a comment on another anti-long-division blog post, which I’m not sure will be published – arguing that right off the top of my head I can think of five crushing pro-long-division arguments:

• It’s a reasonably easy to understand algorithm for solving what looks incomprehensible in terms of procedures that are already known
• The thing that’s already known is multiplication – long division serves as good drill for multiplication without actually looking like drill
• It can serve as an introduction to the concept of limits
• It can help illustrate the difference between rational and irrational numbers
• It’s what I learned in school, therefore everybody should learn it in school

I like to think the first point is most important, although I confess that I’m not sure whether the last point is really what I’m trying to justify. Algorithms are important. The author of the other blog post I mentioned suggest the Euclidean algorithm as a competing example, but I think long division is better, since it builds on material already known.

And the introduction to algorithms is important and should be emphasized as such: a major complaint I have regarding my mathematical education is that nobody ever explained why we were being taught something. Not even once. Putting these abstract concepts – such as long division – into a framework would be much more satisfactory.

Just as another f’rinstance, the second item on Cracked writer’s list of complaints is Geometric Proofs. which is dismissed with:

All of this stuff is super useful if you’re an engineer. Actually, let’s say mandatory. Yeah. I’d kind of like the guys we have building bridges to really “get” triangles, thanks.

Also, the technique of taking simple axioms and combining those into more complicated theorems is great training for more complicated mathematical proofs. This is useful if you want to continue your career in mathematics, which boy, man, are you sure you want to continue your career in mathematics?

Two problems with that – first, yes, we want engineers to “get” triangles. But we also want people who “get” triangles to realize that they “get” them and realize that this makes them part of a skilled group. We don’t want to take a randomly chosen group of 18 year olds and send them off to engineering school. High school is not just about cramming irrelevant detail into your head, it’s also about becoming exposed to various simple things and learning what you like and what you’re good at.

Also – and this is a long-standing grievance of mine – the process of “taking simple axioms and combining those into more complicated theorems” isn’t a one way street into more mathematics. It’s the whole basis of argument! I have often thought that the first week of trigonometry – which I believe occurs in Grade 10 – should actually be taught in conjunction with English class, in which the English teacher discusses debating and argument. These aren’t just intimately related subjects, they’re the same damn thing; it’s just that axioms underlying mathematics are simpler and should therefore be easier to understand. Attacking a false argument about capital punishment is exactly the same process as attacking a false proof that two angles are equal, and this should be emphasized in mathematical education.

However, the proof of the pudding is in the eating. I suspect that none of the official pro- or anti-long-division contenders have actually tested education in the presence or absence of long-division to test their hypotheses. This is because they didn’t pay attention to the role of experimentation in confirming or negating hypotheses in their grade 11 physics class; or perhaps their physics teacher didn’t explain why you have to do experiments.

Three cheers for Rob Ford!

DBRS has today confirmed the ratings of the City of Toronto (the City or Toronto) at AA. All trends remain Stable, reflective of the City’s ability to levy taxes on a large, well-diversified economy, and its demonstrated fiscal prudence in recent years.
…
The City posted a $1.3 billion operating surplus in 2012, on better-than-expected revenue growth and lower spending.
…
DBRS notes that fiscal resolve has improved notably in recent years. The City estimates that the ongoing Service Review Program and other restraint measures have led to over $900 million in operating budget savings and generated an additional $30 million in user fee revenues between 2011 and 2014.

It was a strong day for the Canadian preferred share market, with PerpetualDiscounts winning 26bp, FixedResets gaining 13bp and DeemedRetractibles up 15bp. Volatility was surprisingly low, given the sharp move. Volume was average.

The Globe & Mail picked up a story in the New York Times titled The American Middle Class Is No Longer the World’s Richest:

While the wealthiest Americans are outpacing many of their global peers, a New York Times analysis shows that across the lower- and middle-income tiers, citizens of other advanced countries have received considerably larger raises over the last three decades.

After-tax middle-class incomes in Canada — substantially behind in 2000 — now appear to be higher than in the United States. The poor in much of Europe earn more than poor Americans.
…
The findings are striking because the most commonly cited economic statistics — such as per capita gross domestic product — continue to show that the United States has maintained its lead as the world’s richest large country. But those numbers are averages, which do not capture the distribution of income. With a big share of recent income gains in this country flowing to a relatively small slice of high-earning households, most Americans are not keeping pace with their counterparts around the world.
…
Three broad factors appear to be driving much of the weak income performance in the United States. First, educational attainment in the United States has risen far more slowly than in much of the industrialized world over the last three decades, making it harder for the American economy to maintain its share of highly skilled, well-paying jobs.
…
A second factor is that companies in the United States economy distribute a smaller share of their bounty to the middle class and poor than similar companies elsewhere. Top executives make substantially more money in the United States than in other wealthy countries. The minimum wage is lower. Labor unions are weaker.
…
Finally, governments in Canada and Western Europe take more aggressive steps to raise the take-home pay of low- and middle-income households by redistributing income.
…
“Things are pretty flat,” said Kathy Washburn, 59, of Mount Vernon, Iowa, who earns $33,000 at an Ace Hardware store, where she has worked for 23 years. “You have mostly lower level and high and not a lot in between. People need to start in between to work their way up.”

I’m not a social scientist and have made no detailed study of the problem. But I suggest that part of the reason is productivity, which is still impressive in the States, despite recent problems:

ObamaCare is slowing economic recovery in many ways, ranging from implicitly increasing tax rates on individuals to hindering business growth by creating incentives for small business to remain below 50 employees or to only hire part-time workers. In larger businesses and corporations, uncertainty about the future of health-care costs is holding back investment and hiring.

Statistics suggest that new banking regulation may be significantly hindering small business lending. In July 2013, the Office of Advocacy of the U.S. Small Business Administration reported that small business loans (those less than $1 million) declined about 10% between 2010 and 2012. Reforms that reverse this trend are needed.

Reform is also required to make it easier for immigrants to start businesses. About half of the most successful high-tech startups in the U.S. were either founded or cofounded by immigrants. But U.S. law restricts immigration for people with the skills to start the next Intel. The current H1-B visa program for skilled workers is capped at around 65,000 workers, and the most recent year’s application for this visa was oversubscribed within one week.

This problem is so acute that Silicon Valley-based startup incubator Blueseed plans to launch a cruise ship next year to be docked 12 miles off of San Francisco in international waters so immigrants can start businesses without needing residency. Immigration reform is the biggest free lunch facing policy makers, yet its fate remains uncertain in Washington.

and further:

What the most recent numbers regarding prices of IT equipment imply is that the efficiency gains brought by the digital revolution may be petering out, and that will have a direct effect on our ability to become more efficient workers. And if we want to get back to the worker-productivity gains we were experiencing a decade ago, we need to somehow figure out how to encourage the kind of technological innovation that has led to previous waves of sharp productivity growth.

Of course, this raises the age-old question that economists have been arguing over for generations: What causes innovation? Conservative economists tend to believe that innovation is spawned mainly by the ingenuity of entrepreneurs. They rely on what is known as Say’s law, named after the classical economist Jean-Baptiste Say, which states that “supply creates its own demand.” … In this worldview, the entrepreneur is the instigator of growth, and therefore we must do what we can to avoid dampening his incentive to create.

But the entrepreneur isn’t the only source of productivity growth. Firms can simply invest more in existing technology, intellectual property, and research and development. And it turns out that growth of this sort of spending has slowed from an average of 4.7% per year in 1980 to 2000, to 2.8% per year over the past 10 years, according to the report.

Compare this angst to Canadian angst:

For three decades, growth in Canadian labour productivity (at its simplest, output in dollars per hour worked) has lagged behind productivity growth in the United States and other major countries. A recent update of the productivity data by Statistics Canada, to the end of 2011, has revealed that the problem has gotten even worse.

If we continue to discount or dismiss the productivity issue, Canadians’ future incomes will be threatened – particularly if there is a sustained downward adjustment in the price of key natural resources. If there ever was a time to take poor productivity growth seriously, that time has arrived.

So I will hypothesize that this median-income thing is not something to celebrate: I suggest it may be a direct result of our lousy productivity. The middle class did very well in the 20th century, when productivity improvements meant spending $250,000 to buy the machinery that turned a labourer into a skilled tradesman. I suggest that in this century, productivity improvements mean spending $1,000,000 to replace that skilled tradesman with some software.

And it is productivity that makes us rich, not equality.

I read a fascinating paper recently by Marc Oliver Rieger, Mei Wang and Thorsten Hens titled International Evidence on the Equity Premium Puzzle and Time Discounting:

We examine time discounting factors in an international survey. Our analysis reveals a significant relationship between time discount factors and historical equity premiums across 27 countries. This result implies that higher historical equity risk premiums are observed in countries where survey participants tend to be more short-term oriented. This finding is consistent with the explanation of the equity premium puzzle provided by myopic loss aversion.
…
Our results suggest that differences in time discounting can indeed explain some of the differences in equity premiums. Admittedly, the causality can go into both directions; namely, a high equity premium can also lead to more time discounting because of the higher expected return. However, we find that the subjective discount rates measured in our survey are far higher than the equity premiums, suggesting that equity premiums may not be the main drivers of time discounting.

The excellent updated Equity Risk Premiums (ERP): Determinants, Estimation and Implications – The 2014 Edition has a very good section on equity liquidity:

The notion that market for publicly traded stocks is wide and deep has led to the argument that the net effect of illiquidity on aggregate equity risk premiums should be small. However, there are two reasons to be skeptical about this argument. The first is that not all stocks are widely traded and illiquidity can vary widely across stocks; the cost of trading a widely held, large market cap stock is very small but the cost of trading an over-the-counter stock will be much higher. The second is that the cost of illiquidity in the aggregate can vary over time, and even small variations can have significant effects on equity risk premiums. In particular, the cost of illiquidity seems to increase when economies slow down and during periods of crisis, thus exaggerating the effects of both phenomena on the equity risk premium.

While much of the empirical work on liquidity has been done on cross sectional variation across stocks (and the implications for expected returns), there have been attempts to extend the research to look at overall market risk premiums. Gibson and Mougeot (2004) look at U.S. stock returns from 1973 to 1997 and conclude that liquidity accounts for a significant component of the overall equity risk premium, and that its effect varies over time.12 Baekart, Harvey and Lundblad (2006) present evidence that the differences in equity returns (and risk premiums) across emerging markets can be partially explained by differences in liquidity across the markets.13

Canadian hedge funds aren’t winning any prizes:

Still, the poor performance relative to the TSX raises more questions about their long-term returns. Since Scotiabank created its index in 2004, hedge funds only beat the S&P/TSX composite and the S&P 500 when their returns are asset-weighted. When they are evenly-weighted, meaning they are calculated as a simple average, the returns are simply on par with the indexes.

Asset-weighted returns are a better reflection of the sector; but it’s a little surpising that equal-weighted returns aren’t better than asset weighted. There must be a fair number of clowns running small, lousy funds.

Remember the idiotic Target Benefit Plans that I mocked on October 1, 2013? Now they’re federal government policy!

The Conservative government is throwing a new idea into the heated debate over Canadian pensions, launching a national discussion over proposed new pension plans that share the investment risk between employers and employees.
…
Under a target benefit plan, employers and employees jointly oversee the management of a plan that aims to collect defined contributions in order to achieve a targeted benefit in retirement.

However if returns come in lower than expected, employers are not obligated to top up the fund. Instead, the fund could reduce the size of the benefits, increase the size of contributions or both.

Similarly, if investments overperform, decisions could be made to increase benefits or lower contributions.

The goal is to encourage more employers to offer pensions and to entice those offering a defined contribution plan to offer something better.

Sadly, the Globe article does not explain how a Target Benefit Plan is supposed to be better than Defined Contribution. Maybe because If the beneficiaries, who are taking all the risk, get lucky, the company benefits via lower contributions?

Thomson Reuters, proud issuer of TRI.PR.B, was confirmed at Pfd-3(high) by DBRS:

DBRS expects the earnings profile of Thomson Reuters to remain well positioned within the current rating category as the Company continues to execute its restructuring indicatives and acquire higher growth businesses. That said, DBRS expects revenues from ongoing businesses in 2014 to remain relatively flat at approximately $12.5 billion as growth across most business lines is expected to mitigate continued declines in the Financial & Risk segment. DBRS expects the trajectory of declines in Financial & Risk to continue to moderate as the economy rebounds and the Company continues to improve its product offerings. DBRS forecasts adjusted operating margins to rise from 24.5% (including severance charges) in 2013 to between 26% and 27% in 2014, due a decline in restructuring expenses year over year, further cost-cutting and a continued shift towards higher margin growth businesses. As such, DBRS expects EBITDA from ongoing businesses should rise to approximately $3.3 billion in 2014 (including $120 million of remaining severance charges). DBRS expects the Company to generate $400 million in annual cost savings by 2017 through product simplification, restructuring initiatives, and the achievement of scalable benefits.

Going forward, DBRS believes Thomson Reuters’ financial profile will remain consistent with the current rating category. DBRS expects the Company to use free cash flow and issue incremental debt for acquisitions and share repurchases such that leverage remains within its newly set financial policy guidelines (i.e., a net debt-to-EBITDA ratio of up to 2.5x).

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts off 1bp, FixedResets up 6bp and DeemedRetractibles gaining 5bp. Volatility was minimal. Volume – with the exception of the new issue – was extremely low.

A tiny bit of sanity accidentally crept into the Basel III derivatives rules:

The Basel Committee on Banking Supervision, which set out a year ago to block banks from relying too heavily on each other, changed course last week, opting to let firms preserve most derivatives and repurchase agreements among themselves. The panel revised formulas for evaluating exposure and used a broader definition of capital. Those tweaks spare about $1 trillion in deals at seven of the biggest U.S. banks that would have exceeded proposed limits, according to a November study by the Clearing House, an industry group.
…
In March 2013, the Basel committee proposed a new way of calculating how much money banks stood to lose on their derivatives deals. While the panel set a ceiling for total exposure to any one party, including nonfinancial firms, at 25 percent of a bank’s capital, 29 institutions deemed systemically important faced a tighter threshold of 10 percent to 15 percent for dealings with each other.

The Clearing House, representing 21 of the largest commercial banks in North America and Europe, released estimates after Basel’s proposal, showing how much seven of the largest banks would collectively exceed exposure limits. The study included scenarios showing the rule’s impact if changes were made to satisfy different objections.
…
The Basel committee’s most significant changes to the proposed methodology last week affected how derivatives and repo exposures are calculated. It picked 15 percent as the limit for systemic banks instead of 10 percent. The panel also chose Tier 1 capital, which includes preferred securities, instead of only common equity as the base for calculating the exposure ratio.

On the derivatives side, the proposed methodology would have forced banks to report a sixfold increase in the risks they calculate under their internal models, the Clearing House estimated. The final rule only doubles those figures.

The committee also modified a proposal that would have forced banks to add in their exposure to the issuer of a bond used as collateral in a derivatives trade. If a bank buys a credit-default swap from a hedge fund that posts Italian sovereign bonds as collateral, the bank would be exposed both to the Italian government and the fund. That requirement was eliminated in the final rule unless the collateral is issued by another bank or financial institution.

Well, that last bit is just wrong; if a hedge fund posts Italian sovereigns as collateral, the sovereign exposure only kicks in if the hedge fund defaults. Now, there is certainly an amount of correlation between the two – the hedge fund could be taken down by its Italian exposure – that that correlation is certainly less than 100%.

There’s more news about NY Attorney-General Schneiderman’s crusade against the 21st century – he’s upset with AirBnB:

In an effort to jam the wheels of Airbnb’s juggernaut, Mr. Schneiderman subpoenaed the company in October to hand over data concerning some 15,000 New Yorkers who have advertised rooms on the website’s booking service. The attorney-general isn’t, apparently, chasing legitimate householders offering up a spare room, but those who are violating state laws by renting out multiple rooms in the manner of a hotel or even a brothel.

Or even a Satanic slaughterhouse run by pedophiles, eh, Schneiderman? It’s all for the public good, all for consumer protection … right? Wrong. It’s all box-ticking:

Nearly two-thirds of New York city apartments recently listed on Airbnb were illegal sublets, according to an affidavit from the state Attorney General’s office, the newspaper said.

The affidavit, which is expected to be filed in court on Monday by the AG’s office, shows 64 percent of Airbnb’s 19,500-plus offerings for January 31 cover an “entire apartment,” the NY Post said. (r.reuters.com/sun68v)

More than 200 of the offerings came from just five “hosts,” suggesting third parties were renting out pads on behalf of their owners, the newspaper said.

Schneiderman opened an investigation last year into whether hosts on Airbnb, a Silicon Valley venture capital-backed website that lets people put up spare rooms or couches for rent, are breaking a 2010 law that prohibits renters from subletting their room for less than 30 days.

I often point out that the whole HFT kerfuffle is due to the old-boys having their lunch eaten by the geeky outsiders; I should point out that it is not just the old-boys who prefer to compete by regulation. Very often, it is the new kids on the block who prefer to compete on grounds other than price and performance:

But let me tell you, trailing commissions make previous battles look like minor skirmishes. The industry has drawn a line in the sand and brought out the heavy artillery. With few exceptions, the fund companies, dealers and banks have formed a united front and nobody is stepping out of line. The message is clear – banning embedded commissions will destroy the industry and make it difficult for small investors to get advice. The status quo should be maintained. In other words, “Just let us charge most of our clients too much (unknowingly) so we can subsidize the small clients (thank you, thank you, thank you).”

Yeah, yeah. Your business practices are the only moral ones – in fact, they define morality – and competition should be illegal. Next!

I recently became aware of a piece by Larry Swedroe titled Why you should avoid preferred stocks. It’s not very interesting – the usual qualitative bad points are compared to the usual qualitative good points, and a quantitative decision appears by magic – but it did have one interesting feature:

Of even greater concern is that a five-factor regression shows that not only do preferred shares have significant exposure to equity risk (0.42 loading on the market factor) and significant exposure to value stocks (0.43 loading), but much greater exposure to default risk than high-yield bonds. The loading on default for preferred stocks was 1.5, as compared to the default loading for 1-10 year high-yield bonds of 0.54 and for 10-30 year high-yield bonds of 0.77. (All the figures are statistically significant.) In other words, preferred stocks had about three times the exposure to default risk as 1-10 year high-yield bonds and about twice that of 10-30 year high-yield bonds.

A five-factor regression? Interesting. Mr. Google finds a reference to a paper by Eugene F. Fama and Kenneth R. French titled Common risk factors in the returns on stocks and bonds:

For corporate bonds. shifts in economic conditions that change the likelihood
of default give rise to another common factor in returns. Our proxy for this default factor, DEF, is the difference between the return on a market portfolio of long-term corporate bonds (the Composite portfolio on the corporate bond module of Ibbotson Associates) and the long-term government bond return.

So right away, I’m suspicious. Although comparing returns on long-term corporates vs. long-term governments is reasonable enough in terms of return analysis, it is not particularly focussed on default risk; spreads between the two in terms of yield – and hence on returns, when looking backward – are more of a liquidity indicator than a default-risk indicator.

The factors were used in a piece by James L. Davis of Dimensional Fund Advisors titled Investment Characteristics of Preferred Stock to decompose returns in the American market as:

Click for Big

So – assuming this was Mr. Swedroe’s source – one declared result is that preferred stock returns are relatively uncorrelated with the five magic factors. A lack of correlation is supposed to be good in Modern Portfolio Theory, isn’t it?

It’s an interesting approach and I’ll think about it, but the problem with this kind of ‘Look-Mummy-I-Gotta-Spreadsheet’ investment analysis is that correlations are extremely dependent upon the time period chosen and the sampling frequency. Not only is any given sample period not necessarily representative of any future sample period – which is a standard criticism of virtually any quantitative work – but there is not a jot of evidence presented that these factors are stable even when subjected to small changes in period. I’ll think about this … it might be worth an article.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 19bp, FixedResets up 9bp and DeemedRetractibles gaining 6bp. Volatility was non-existent, even technically, for the second day running, which might even be a record. Volume was extremely low.

Felix Salmon writes a good piece on Michael Lewis’s flawed new book (Flash Boys) [emphasis added]:

And he also mentions that while you used to be able to drive a truck through the bid-offer prices on stocks, pre-decimalization, nowadays prices are much, much tighter — with the result that trading is much, much less expensive than it used to be. Given all that, it stands to reason that even if the HFT shops are making good money, they’re still making less than the big broker-dealers used to make back in the day. But that’s not a calculation Lewis seems to have any interest in.

In his introduction to the book, Lewis writes this:

The average investor has no hope of knowing, of course, even the little he needs to know. He logs onto his TD Ameritrade or E*Trade or Schwab account, enters a ticker symbol of some stock, and clicks an icon that says “Buy”: Then what? He may think he knows what happens after he presses the key on his computer keyboard, but, trust me, he does not. If he did, he’d think twice before he pressed it.

This is silly. I’ll tell you what happens when the little guy presses that key: his order doesn’t go anywhere near any stock exchange, and no HFT shop is going to front-run it. Instead, he will receive exactly the number of shares he ordered, at exactly the best price in the market at the second he pressed the button, and he will do so in less time than it takes his web browser to refresh. Buying a small number of shares through an online brokerage account is the best guarantee of not getting front-run by HFT types. And there’s no reason whatsoever for the little guy to think twice before pressing the button.

And that emphasis, boys and girls, is the reason why there’s such a big fuss about High Frequency Trading. But don’t forget the lawsuits!

The stuff the complaint complains about, by the way, is mostly just what’s in “Flash Boys.” Basically it’s that high-speed traders trade faster than low-speed traders, via latency arbitrage or moving in reaction to orders in the market or co-location or direct data feeds or … there’s some weird stuff here, like an accusation that high-frequency traders trade in advance of index-fund rebalancing, which is just intelligently making use of public information but which these lawyers find objectionable.[Footnote]

[Footnote reads]:Like:

Most retirement savings, such as public and private pension funds or 401(k) and individual retirement accounts in the United States, are invested in mutual funds, the most popular of which are index funds which periodically “rebalance” or adjust their portfolio to account for current prices and market capitalization of the underlying securities in the stock or other index that they track. This allows trading algorithms to anticipate and trade ahead of stock price movements caused by mutual fund rebalancing, making a profit on advance knowledge of the large institutional block orders. This results in profits being transferred from investors to algorithmic traders, estimated to be at least 21 to 28 basis points annually for S&P 500 index funds, and at least 38 to 77 basis points per year for Russell 2000 funds.

I do not get it. Index rebalancing is public information. If you have a computer that does the math and calculates that people will be buying a lot of stock on an index add, and you buy some of that stock to profit from that calculation — what is illegal or fraudulent or whatever about that? This is not in the book, by the way; they came up with this on their own.

The old guard’s next line of attack might be best execution in a rebate environment:

Brokers entrusted with orders in the U.S. stock market can choose from dozens of exchanges and private venues. Some money managers such as T. Rowe Price Group Inc. (TROW) have told regulators that incentives offered by exchanges for attracting orders can put a broker’s financial interest at odds with the customer’s.
…
Brokers can face a conflict of interest as they select where to send customer orders. Brokers can either capture a rebate or pay a fee to an exchange depending on the type of order used, while private venues known as dark pools charge lower fees but don’t have to disclose how they treat customers.
…
While improved disclosure is helpful, the SEC should experiment with altering the economic incentives that affect how orders are handled, [T. Rowe Price head of equity trading Andy] Brooks said. T. Rowe has joined the New York Stock Exchange, Royal Bank of Canada and IEX Group Inc. in lobbying regulators to ban the “maker-taker” system, which pays rebates to large brokers to attract trades.

Brokerages often put their own self-interest in front of their clients’ under maker-taker, according to a study by Robert Battalio and Shane Corwin of the University of Notre Dame and Robert Jennings of Indiana University.

The linked study is titled Can Brokers Have It All? On the Relation between Make Take Fees & Limit Order Execution Quality:

We identify retail brokers that seemingly route orders to maximize order flow payments: selling market orders and routing limit orders to venues paying large liquidity rebates. Because venues offering high rebates also charge liquidity demanding investors high fees, fee structure may affect the arrival rate of marketable orders. If limit orders on low-fee venues fill when similarly priced orders on high-fee venues do not, routing orders to maximize rebates might not always be in customers’ best interests. Using proprietary limit order data, we document a negative relation between several measures of limit order execution quality and the relative fee level. Specifically, we show that when ‘identical’ limit orders are concurrently displayed on two venues, orders routed to the low-fee venue execute more frequently and suffer lower adverse selection. Using the NYSE’s TAQ data, we show that the negative relation between take fees and execution quality extends beyond our proprietary dataset.

The big problem in Europe is deflation:

Inflation in Europe has been in decline since late 2011, thanks to gruesome unemployment, excess manufacturing capacity, the weak recovery, falling energy prices and the rising euro. At last count, it was running at 0.5 per cent, well below the ECB’s [European Central Bank’s] target rate of slightly under 2 per cent. The question is whether 0.5 per cent is the bottom or close to it. The International Monetary Fund says that Greece alone will post a slightly negative inflation rate in 2014 and most economists forecast inflation at 0.9 per cent to 1.5 per cent for the euro zone his year, rising marginally next year.

The figures don’t suggest deflation is coming. Yet the ECB in its last governing council meeting signalled it was ready to haul out the heavy artillery. Besides another interest rate cut, the options include quantitative easing, in which the ECB would make large-scale purchase of government and private debt (more likely the former) to boost money supply, or charge banks a fee to park their funds at the ECB.

As soon as [ECB honcho] Mr. Draghi said the ECB was ready to launch son of “whatever it takes,” bond yields fell in the expectation that the ECB is about to buy every bond in sight. In the past month, the yields of Portugal’s 10-year dropped 0.7 of a percentage point, to 3.7 per cent, which is only one point higher than U.S. Treasury yields. Remember, this was a country on the verge of bankruptcy not long ago. Italy’s yields have slumped to 3.1 per cent. They were double that level, or higher, two or three years ago. Greece’s yields fell so far so fast – they’re now below 6 per cent – that the country considered the prime candidate to bolt from the euro zone in 2012 is back in the debt markets. Last week, it couldn’t keep up with demand for its new five-year bonds.

It’s always interesting to read how the competition is doing:

Merrill Lynch & Co. Inc. is dangling a new incentive in front of its brokers by creating a “recognition club” for those who bring in $8-million (U.S.) or more a year from clients, more than doubling the top goals set by its securities industry rivals.
…
The new “Pinnacle Club” will pay its members $10,000 in cash and additional benefits if they produce $8-million of revenue or build up five million of production credits.

Club membership also gives members bragging rights as elite brokers, the ability to advertise their status on their websites, and priority when accounts of departing brokers are redistributed or when customers are referred to the broker-dealer from other parts of Bank of America, according to a description of the recognition clubs in Merrill’s 2014 compensation booklet.

Brokers who qualify for Pinnacle as well as for Merrill’s seven lower-tier recognition clubs also can participate with their significant others in “Top Advisor Summits” that are usually held over several days in resort areas.

In reporting first-quarter earnings last week, Merrill said its 13,725 brokers were on target to produce an average of $1.06-million each this year, one of the highest averages in the brokerage industry. The average is skewed, however, by heavy hitters who could qualify for the new club. Fewer than 5,200 of its advisers had $1-million or more of production in 2013.

Treasuries are, on the whole, doing better than the Street expected:

One reason yields have fallen is the U.S. labor market, which has yet to show consistent improvement.

The world’s largest economy added fewer jobs on average in the first three months of the year than in the same period in the prior two years, data compiled by Bloomberg show. At the same time, a slowdown in China and tensions between Russia and Ukraine boosted demand for the safest assets.

Wall Street firms known as primary dealers are getting caught short betting against Treasuries.

They collectively amassed $5.2 billion of wagers in March that would profit if Treasuries fell, the first time they had net short positions on government debt since September 2011, data compiled by the Fed show.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts and FixedResets both gaining 9bp, while DeemedRetractibles were off 2bp. Volatility was not even technically existent. Volume was very low.

The Globe ran a piece on an upcoming insurance pow-wow in Toronto:

“The irony of the way insurance works, as opposed to the way banking works, is that it’s not always clear that capital is the relevant solution,” he said. “It’s often not, because insurance companies get into trouble in different ways.”

For example, insurance companies wouldn’t experience a ‘run’ on deposits, Mr. McGavick said, when reserves may not be able to cover mass customer withdrawals in the same way a bank would.

This seems like an odd remark to me, because while bank runs may be rooted in capital problems, they are made possible by liquidity problems – this is the old illiquid vs. insolvent distinction that I frequently mentioned during the Credit Crunch and which is well illustrated by the Panic of 1907.

Anyway, the Geneva Association produced an analysis titled Variable Annuities — An Analysis of Financial Stability, which references (among other things):

Key Financial Stability Issues in Insurance, released in July 2010, comprises analytical work carried out on specific issues that had been raised by regulatory and supervisory counterparts in areas such as investment management, liquidity management, limits of insurability, crisis resolution mechanisms in insurance and the confused concept of an “insurance run” (supposedly akin to a bank run).

and Key Financial Stability Issues in Insurance, which is quite interesting, but which the dorks have copy-protected so I can’t copy-paste the good parts.

Capital is virtually irrelevant during a bank run (although loss of capital might trigger the run); capital is actually more important in the insurance game. While it is quite true that Segregated Fund owners can’t take their money and run – eliminating much of the need for liquidity – a lack of capital will have severe effects on the viability of the operation – as Manulife very nearly found out during the crisis.

DGS.PR.A was confirmed at Pfd-3 by DBRS:

The net asset value (NAV) of the Company has increased steadily since the last rating confirmation in April 2013. As of April 3, 2014, the downside protection available to the Preferred Shares is approximately 46.9% and the dividend coverage ratio is approximately 1.1 times. The Pfd-3 rating of the Preferred Shares is based primarily on the downside protection available and the additional protection provided by an asset coverage test, which does not permit any distributions to holders of the Class A Shares if the NAV of the Company falls below $15.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 16bp, FixedResets gaining 3bp and DeemedRetractibles up 13bp. Volatility was minimal. Volume … was peculiar. Very little breadth, but quite a lot of depth! A very high proportion of the volume leaders have been called for redemption.

The BoC kept the overnight rate low, with a fairly gloomy outlook:

Inflation in Canada remains low. Core inflation is expected to stay well below 2 per cent this year due to the effects of economic slack and heightened retail competition, and these effects will persist until early 2016. However, higher consumer energy prices and the lower Canadian dollar will exert temporary upward pressure on total CPI inflation, pushing it closer to the 2 per cent target in the coming quarters. We expect total CPI inflation will remain close to target throughout the projection, even as upward pressure from energy prices dissipates, because the impact of retail competition will gradually fade and excess capacity will be absorbed.
…
The Bank continues to expect Canada’s real GDP growth to average about 2 1/2 per cent in 2014 and 2015 before easing to around the 2 per cent growth rate of the economy’s potential in 2016. Competitiveness challenges continue to weigh on Canadian exporters’ ability to benefit from stronger growth abroad. However, a range of export subsectors have been growing in line with fundamentals, which suggests that as the U.S. recovery gathers momentum and becomes more broadly-based, many of our exports will benefit. The lower Canadian dollar should provide additional support. We continue to believe that rising global demand for Canadian goods and services, combined with the assumed high level of oil prices, will stimulate business investment in Canada and shift the economy to a more sustainable growth track.
…
In sum, the Bank continues to see a gradual strengthening in the fundamental drivers of growth and inflation in Canada. This view hinges critically on the projected upturn in exports and investment. With underlying inflation expected to remain below target for some time, the downside risks to inflation remain important. At the same time, the risks associated with household imbalances remain elevated. The Bank judges that the balance of these risks remains within the zone for which the current stance of monetary policy is appropriate and therefore has decided to maintain the target for the overnight rate at 1 per cent. The timing and direction of the next change to the policy rate will depend on how new information influences the balance of risks.

… so the loony got knocked:

The Canadian dollar touched the lowest level in more than a week after the Bank of Canada said its next move on interest rates could be up or down as a forecast pickup in business investment has been slow to materialize.

I saw some husked corn for sale at my favourite greengrocer today; but was told that it was from the US so it will be all dried out. Geez, we can get Chilean apples; why can’t we get Brazilian corn?

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 11bp, FixedResets gaining 1bp and DeemedRetractibles up 8bp. Brookfield’s floaters got whacked – probably on the BoC announcement – but otherwise volatility was minimal. Volume was low; all the highlights are FixedResets.

Nothing happened today.

It was an off day for the Canadian preferred share market, with PerpetualDiscounts down 7bp, FixedResets losing 11bp and DeemedRetractibles off 5bp. Volatility was minor. Volume was average.

It is possible that the US will lose its IMF veto:

At issue is the global community’s efforts to align the IMF’s power structure to match changes in the distribution of strength in the global economy. Each country is assigned shares, or quota, to match its contribution to the world’s gross domestic product. The 2010 changes — which, ironically, were prompted by President Barack Obama — would give more clout to countries such as China and India and reduce the influence of some European nations whose relative share of global GDP has shrunk over time.

The U.S. would remain the IMF’s dominant member. It would retain more than 17 per cent of total shares — which gives the U.S. veto power because approval of members representing 85 per cent of shares is required to approve major decisions. The next closest would be Japan and China, each of which would hold about 6.4 per cent of total quota.

Yet the governance overhaul also requires increased contributions to the fund’s permanent resources. The contributions are akin to insurance, as countries would only lose money if the IMF’s loans to troubled countries went unpaid.

Most legislatures approved the increased financial commitments to the IMF long ago. Mr. Obama, however, has failed repeatedly to muster enough votes in the U.S. Congress to pass the measure. Republican leaders in the House of Representatives and the Senate characterize the Obama administration’s request as akin to asking American taxpayers to bail out troubled countries such as Greece and Portugal.

Seems to me that the IMF should simply let the US drop below 17% if that’s what it wants – and perhaps assign caps to member contributions, instead of quota. If the Chinese want influence, let them buy it. I’ll sell them my share!

Canadian grain farmers aren’t the only ones complaining about railroads:

They can’t move because increasing oil production from North Dakota’s Bakken field, a record grain crop and unprecedented cold weather overwhelmed the U.S. railroad system. In part because of transport delays, coal inventories were down 26 percent in January from a year ago. A quarter of all U.S. freight rail traffic passes through Chicago, or 37,500 rail cars each day. The trip through the city can take more than 30 hours.
…
Coal producers including the Western Coal Traffic League, whose members are shippers of coal mined west of the Mississippi River, point at inconsistent rail service as the primary culprit and railroads put the blame on Chicago. The group asked on March 24 that the U.S. Surface Transportation Board institute a proceeding to address BNSF’s coal service in the region.

BNSF said in a response to the agency that it plans to spend $5 billion this year on service. “As these resources come on line, service will gradually improve,” it said in a March 25 letter.
…
Dwell times, a measure of how long loaded railroad cars sit in a railyard, averaged about 26 hours during the first quarter, up from 21 hours during the same period in 2013, AAR data show.

Trains are getting mired in Chicago’s tangle of bottlenecks, said Charles Clowdis, an IHS Global Insight analyst in Lexington, Massachusetts.

Sheryl King reminds us that long rates are different from short rates:

When it comes to any possible bearish sentiment, bond market investors are currently preoccupied with estimating the neutral policy rate for central banks, and how far long-term bond yields may or may not rise. At this point, however, there has very little focus on where the slope of the yield curve will be headed. History suggests it will get a lot flatter as we head toward the first Federal Reserve rate increase at some point in 2015; and Canada’s bond curve will follow suit.
…
So when will the yield curve start to discount policy tightening? It may already be happening in the U.S., with the curve almost 20 basis points flatter now than it was a few weeks ago. But the Canada curve remains at a cycle high.

The yield curve remains steep because doubt persists about the strength of the economy, which is keeping yields low at the front end of the curve.

Brace yourself for disaster – the regulators are getting interested in the bond market:

Bill Gross and Larry Fink manage a $3 trillion pile of bonds — an amount almost as big as Germany’s economy. Their firms, Pacific Investment Management Co. and BlackRock Inc. (BLK), doubled holdings since 2008, outpacing the market’s growth of 50 percent.
…
The lopsided bond market has caught the attention of the U.S. Securities and Exchange Commission. Not only is the SEC examining whether the biggest players get preferential prices and access because of their influence, it’s also worried about what happens when the five-year bond rally ends as U.S. policy makers prepare to raise interest rates.
…
The biggest funds’ dominance may make it harder for everyone to sell when the Fed boosts borrowing costs from record lows and sends bond prices tumbling. In essence, their selling may crowd narrowed exits, making it more painful as all investors race to get out of a falling market.
…
More than five years of near-zero interest rates from the Fed has propelled corporate bonds to record performance and the biggest debt managers have ballooned in size. Pimco, Vanguard Group Inc. and Fidelity Investments manage 39 percent of all mutual fund-owned taxable bonds today, up from 18 percent in 1997, according to Morningstar Inc. data. The smallest 205 fund providers manage 0.1 percent of the market.
…
At the same time, regulators are examining the way larger firms benefit in markets where transactions are often executed the same way they were a decade ago — through telephone conversations and e-mails.

In this two-tiered market, brokers choose which rivals and clients may see their bond prices on electronic trading systems by turning quotes on and off. Dealers often give bigger investors better prices in return for all of the business they do with Wall Street.

The SEC is examining to what extent smaller buyers are disadvantaged, and whether the behavior constitutes market manipulation, according to two people with direct knowledge of the matter who asked not to be identified because the probe hasn’t been made public.
…
Finra is examining whether Wall Street firms overcharge investors and whether they unfairly allocate new corporate debt issues to reward certain clients, Nancy Condon, a spokeswoman, confirmed in an e-mail last week.

It’s getting tougher to trade bonds as the business gets less profitable for Wall Street. Corporate-debt trading volumes in the U.S. have failed to keep pace with issuance, increasing 14 percent since 2010 as outstanding notes grew by 33 percent, according to Finra and Bank of America Merrill Lynch index data.

Requirements that banks hold more cash in the event their investments tank have prompted dealers to reduce their inventories, giving the biggest managers even more sway in the market. The largest dealers had slashed their holdings of corporate bonds to $56 billion as of a year ago from $235 billion in 2007, according to Fed Bank of New York data. The inventories worked to cushion against price swings and made it easier to trade in larger sizes.

There’s a little pushback on the evil-HFT narrative:

Michael Lewis’s argument that the $23 trillion U.S. stock market is rigged in favor of speed traders is careless, according to Nasdaq OMX Group Inc. Chief Executive Officer Robert Greifeld.

The controversy over high-frequency trading intensified with the publication of Lewis’s book “Flash Boys” on March 31. Lewis argues that the fastest trading firms prey on slower investors by getting early access to nonpublic information.

“I think that was irresponsible on his part,” Greifeld said in an interview on PBS’s “Charlie Rose” show. “I feel poorly for the academics. Our markets are researched more than any other market that’s out there.”

Greifeld said about 100 academic papers have been written about how the U.S. markets operate and a similar number have been produced on overseas markets. Academics who have spent their careers studying markets are divided on high-speed trading, he said, with some in favor of it and some opposed.

“It’s not a story-telling type of issue,” he said. “It’s really dense academic papers to get through what happens in the marketplace.”

Mind you, the Europeans are seizing the opportunity to have more regulators writing more rules:

European Union lawmakers are poised to approve some of the toughest restrictions in the world on high-frequency trading, the first crackdown in the aftermath of Michael Lewis’s latest book, “Flash Boys.”

The curbs are part of revamped EU markets legislation ranging from commodity derivatives speculation to investor protection. The high-frequency trading limits include standards meant to keep the price increment for securities from being too small, mandatory tests of trading algorithms and requirements that market makers provide liquidity for a set number of hours each day.
…
Members of the European Parliament will vote tomorrow on EU rules that also include a requirement for traders to have their algorithms tested on venues and authorized by regulators. The assembly in Strasbourg, France, is set to endorse a tentative deal reached with governments on the measures earlier this year.

So … when do you figure the first scandal about a regulatory clerk selling code after approving it is going to happen? Another point of interest is … if an HFT firm discusses with the regulators what they have to do to get approval, does this mean that the regulators are in the business of writing code? That line of reasoning has been advanced in connection with Credit Rating Agencies and structured products!

Here’s a good joke!

Click for Big

Howard Gold comments on MarketWatch:

Its 20th annual Quantitative Analysis of Investor Behavior paints such a grim picture that if it were a painting, it would look like Edvard Munch’s “The Scream.”

After citing familiar figures on how individual investors substantially underperform the market averages because of terrible market timing, the firm, which has reported these statistics for 20 years, calls out investors’ obtuseness and the miserable failure of the financial-services industry to change their dysfunctional behavior.

“After decades of analyzing investor behavior in good times and in bad times, and after enormous efforts by thousands of industry experts to educate millions of investors, imprudent action continues to be widespread,” the report asserted.

“Attempts to correct irrational investor behavior through education have proved to be futile. The belief that investors will make prudent decisions after education and disclosure has been totally discredited.”

I know I’ve discussed DALBAR somewhere. In PrefLetter, I think. Dan Hallet has discussed DALBAR:

I suspect that DALBAR calculates what it calls investor returns by applying dollar-weighted fund redemption rates to benchmark returns – rather than applying a DWRR [Dollar Weighted Rate of Return] calculation directly to the funds. And if they’re doing that, they’re not calculating investor returns.
…
If I’m right, it’s not clear exactly what they’re calculating. But this explains why their figures show such staggering gaps of several percentage points. My research on this topic over the past 13 years is more in line with figures I’ve seen from Morningstar.com. In the U.S., Morningstar calculates what they call “investor returns” using the same method I have for more than a dozen years – i.e. calculating actual fund DWRR. … But even that is an estimate because it’s based on monthly data; and daily fund flows are required for a precise DWRR. But DALBAR’s reported figures aren’t even an estimate because they appear to blend fund flows with index returns.

Accordingly, DALBAR is probably correct in direction – i.e. whether TWRR [Time Weighted Rate of Return] is higher or lower than DWRR – but not even close in quantifying the gap between the two measures.

You can buy the DALBAR report for USD 775. That’s right, only USD 775! Damn well better be right.

There’s always a lot of political argument about contracting-out … for instance, only Rob Ford was brave enough to defy the unions and contract out garbage collection in Toronto. Many people will claim that government services are cheaper because there is no built-in profit … many people should price a visit to the International Space Station:

Later this month, a company called SpaceX is scheduled to launch its Falcon 9 rocket on a routine supply mission to the International Space Station (ISS). But if all goes as planned, this mission could herald the beginning of something decidedly not routine: the use of private, reusable rockets to service America’s space program.

SpaceX and another private launch company, Orbital Sciences, are the beneficiaries of a recent shift in the American space program toward privatizing more routine missions – such as the transport of supplies and eventually people to and from the ISS. While this upcoming mission is only a preliminary test, SpaceX eventually hopes to dramatically reduce the cost of launching cargo and people into space by eventually making both the first and second stages of its rockets reusable. Last year, the company estimated that once its rockets are able to land back on earth and, after re-fueling, quickly be re-launched, the cost for a trip to the ISS could drop to as low as from $5 million to $7 million.
…
Factoring in NASA’s financial assistance in developing the Falcon 9 rocket and the cost of the 12-launch contract, the space agency is paying SpaceX about $166 million per launch to the ISS. By contrast, estimates for the cost of sending the recently retired space shuttle to the ISS range as high as $1.5 billion, including the money spent developing and building the shuttles.

It was a modestly positive day for the Canadian preferred share market, with PerpetualDiscounts gaining 1bp and both FixedResets and DeemedRetractibles up 5bp. Volatility was higher than usual, with a number of FixedReset winners. Volume was below average.

5Banc Split Inc., proud issuer of FBS.PR.C, was confirmed at Pfd-2 by DBRS:

The Preferred Shares pay a quarterly fixed, cumulative, preferential distribution of $0.11875 per Preferred Share yielding 4.75% per annum on their initial issue price. Based on the current dividend yields on the underlying banks, the Preferred Share dividend coverage ratio is approximately 2.2 times. Holders of the Capital Shares are expected to receive all excess dividend income after the Preferred Share distributions and other expenses of the Company have been paid.

Since the rating was upgraded in April 2013, the Company’s performance has been positive, with net asset values increasing steadily. Downside protection available to holders of the Preferred Shares was 68.6% as of April 3, 2014.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 3bp, while FixedResets and DeemedRetractibles were both off 5bp. Volatility was minimal. Volume was low, but the highlights are comprised entirely of FixedResets.