PrefBlog

I briefly mentioned subsidized gasoline in Saudi Arabia on November 11. Here’s a report on subsidized electricity in India:

The villagers of Dharnai in northern India had been living without electricity for more than 30 years when Greenpeace installed a microgrid to supply reliable, low-cost solar power.

Then, within weeks of the lights flickering on in Dharnai’s mud huts, the government utility hooked up the grid — flooding the community with cheap power that undercut the fledgling solar network. While Greenpeace had come to Dharnai at Bihar’s invitation, the unannounced arrival of the state’s utility threatened to put it out of business.
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It’s a scenario playing out at dozens of ventures across India’s hinterlands. Competition from state utilities, with their erratic yet unbeatably cheap subsidized power, is scuppering efforts to supply clean, modern energy in a country where more people die from inhaling soot produced by indoor fires than from smoking.

I mentioned a new round of bank-bashing yesterday, in connection with their commodities businesses. Could it be that this is related?:

Congressional scrutiny of Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS)’s commodities businesses is another strain for units that already saw revenue drop by two-thirds from peak years.

Goldman Sachs produced $1 billion of revenue from its commodities unit and investments in commodity businesses in 2012, down from $3.4 billion in 2009, according to a Senate Permanent Subcommittee on Investigations report released today on banks’ involvement in those markets. Morgan Stanley’s commodity revenue fell for four straight years, from $3 billion in 2008 to $912 million in 2012, according to the report.

It’s an ill wind that blows nobody any good:

Six years after Bernard Madoff’s fraud collapsed, the cost of liquidating his defunct investment advisory firm to repay thousands of victims has topped $1 billion, though the con man’s former customers aren’t footing the bill.

The fees, paid by the industry-backed Securities Investor Protection Corp., which is managing the case, have financed a team of lawyers who this week surpassed $10 billion in recoveries for victims, or almost 60 percent of the principal that vanished after Madoff’s arrest in December 2008.

Irving Picard, the bankruptcy lawyer who’s leading the effort as trustee for Madoff’s company, included the new fee total in an interim report posted today on his website. A bankruptcy judge in Manhattan regularly approves the fees, sometimes over the objections of victims’ groups.
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“It’s obscene,” Helen Davis Chaitman, a lawyer representing some victims in the case, said in an e-mail about the fees. Chaitman, who has frequently challenged Picard in courts, said federal prosecutors recovered most of the cash for victims and Picard should pay out more than just principal.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 29bp, FixedResets up 16bp and DeemedRetractibles gaining 15bp. Volatility was low. Volume was average.

Recent musings on an Ontario tax hike should focus attention on Japan’s woes:

Japanese Prime Minister Shinzo Abe is discovering that haste makes waste.

Trying to double his nation’s sales tax to 10 percent over an 18-month period has resulted in the fourth recession since 2008 and the need to postpone the increase’s second part planned for next October. With an election now pending, the levy may be on hold at 8 percent until 2017.

The lesson is that the increases proved too much, too soon, and baby steps may have been more prudent, with the initial 3 percentage-point boost equivalent to 60 percent of the original level. In contrast, the U.K.’s 2011 increase of 2.5 percentage points amounted to a much smaller 14 percent boost and didn’t generate a recession.

Coming up next …Greenspan’s Conundrum Redux!

When then-Federal Reserve Chairman Greenspan raised the benchmark overnight rate from 2004 to 2006, long-term borrowing costs failed to increase, thwarting his attempts to tighten credit and curb excesses that contributed to the worst financial crisis in 80 years.

“We wanted to control the federal funds rate, but ran into trouble because long-term rates did not, as they always had previously, respond to the rise in short-term rates,” Greenspan said in an interview last week. He called this a “conundrum” during congressional testimony in 2005.

The bond market is signaling that past may be prologue as Yellen’s Fed prepares to raise rates next year. The yield on the 10-year U.S. Treasury note has fallen 0.71 percentage point in 2014 even as the Fed wound down its bond-buying program and mapped out a strategy to raise the benchmark federal funds rate from near zero, where it has been since 2008.
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The Fed does have one tool that Greenspan didn’t: a $4.49 trillion portfolio accumulated in three rounds of asset purchases. Selling some of those assets might provide a way to lift long-term rates if necessary, said Michael Gapen, senior U.S. economist at Barclays Plc in New York.

The sanctions on Russia are having some effect, even if some of the effects were unforeseen:

A recession is imminent, inflation is getting out of hand and the ruble and oil are in freefall, Economy Minister Alexei Ulyukayev told Putin, according to people who attended the meeting at the presidential mansion near Moscow in mid-October. Clearly, Ulyukayev concluded, sanctions need to be lifted.

At that, Putin recoiled. Do you, Alexei Valentinovich, he asked, using a patronymic, know how to do that? No, Vladimir Vladimirovich, Ulyukayev was said to reply, we were hoping you did. Putin said he didn’t know either and demanded options for surviving a decade of even more onerous sanctions, leaving the group deflated, the people said.

Days later, they presented Putin with two variants. To their surprise, he chose an initiative dubbed “economic liberalization,” aimed at easing the financial burden of corruption on all enterprises in the country, the people said. It was something they had championed for several years without gaining traction.

The policy, which Putin plans to announce during his annual address to parliament next month, calls for a crackdown on inspections and other forms of bureaucratic bullying that cost businesses tens of billions of dollars a year in bribes and kickbacks, the people said. It entails an order from the president to end predatory behavior, with prosecution being the incentive for compliance, they said.

There will be another round of bank bashing:

The biggest Wall Street banks have used their ownership of metal warehouses, oil tankers and other commodities businesses to gain unfair trading advantages and dominate markets, according to a U.S. Senate investigation.

In a 400-page report focused on Goldman Sachs Group Inc., Morgan Stanley (MS) and JPMorgan Chase & Co., a Senate panel said the firms have eroded what was once a strict line separating banking from commodities to the detriment of consumers and the financial system. The activity gives banks access to non-public information that could move markets and increases the likelihood that industrial accidents will spur taxpayer bailouts, the Permanent Subcommittee on Investigations found.

“We simply cannot allow a large powerful Wall Street bank the power to influence the price of a commodity essential to our economy,” Senator Carl Levin, who chairs the panel, told reporters in Washington today. He added that his staff “found substantial evidence that these activities expose major banks to catastrophic risks that are poorly understood.”

The controversy over banks’ involvement with commodities has spurred the Federal Reserve to review regulations and prompted some Wall Street firms to try to shed assets. Levin’s new findings include details on clients who entered into controversial aluminum transactions with Goldman Sachs and reveal that an employee questioned whether market-moving information could be passed on to traders.
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In August [2013], a district judge dismissed a suit against the firm and others brought by aluminum consumers, saying that an increase in a price component of aluminum was “an unintended consequence of rational profit maximizing behavior rather than the product of conspiratorial design.”

It was a good day for the Canadian preferred share market, with PerpetualDiscounts gaining 3bp, FixedResets winning 14bp and DeemedRetractibles up 13bp. Volatility was nil. Volume was very low.

PerpetualDiscounts now yield 5.03%, equivalent to 6.54% interest at the standard equivalency factor of 1.3x. Long corporates yield about 4.2%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 235bp, unchanged from the November 5 report.

There are some interesting trends in bond markets:

The influence of high-frequency traders in the Treasury market is growing. About 60 percent of Treasury securities trades are expected to be transacted on electronic platforms by the end of next year, an increase from 40 percent in 2013, according to Tabb Group LLC, a New York-based research firm. Of those trades, 10 percent were executed by robots in 2010, a share that will probably grow to 20 percent next year, according to Tabb.
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New rules adopted after the 2008 credit crunch are also part of the new normal. Global guidelines called Basel III, instituted by the Bank for International Settlements in Basel, Switzerland, require banks to hold more cash in reserve for assets such as bonds they keep on their balance sheets.

Partly in compliance with the regulations, the 22 primary dealers authorized to trade directly with the Fed reduced their U.S. government debt holdings to $46.3 billion at the end of October from a record high $146 billion in October 2013, Fed data show. While they still hold inventory, they’re allocating less to opportunistically buying big clumps of bonds and then slowly selling them, a process known as market-making.
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Hedge funds have filled the vacuum created by the retreat of the big banks. On the morning of Oct. 15, the turmoil in Treasuries echoed in the trading of junk bonds. As $8 billion was being wiped out in that global market, Toronto hedge-fund manager Philip Mesman fielded e-mails from U.S. bankers clamoring for him to buy their customers’ holdings.

Investors were unloading the debt of the riskiest companies, forcing exchange-traded funds and mutual funds to sell. Before Basel III and the Volcker Rule, which limits the ability of U.S. banks to trade on their own accounts, dealers would’ve bought the bonds themselves and held them until finding someone to take them. Instead they were forwarding the “sell” messages to firms they knew had quick access to cash.
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The size of German bund futures that can go through the market at one time without moving the price has fallen 46 percent to 784 contracts as of Oct. 17, from this year’s peak of 1,450 contracts in April, according to JPMorgan. The average over the past four years was 920 contracts.

Yay! More regulation! The 2014 Ontario Economic Outlook and Fiscal Review states:

The government is also undertaking a review of the regulation of financial planning. An expert committee will be appointed to look at more tailored regulation of financial advisers and financial planners.

Only through increased regulation will Granny be able to get financial advice from a reliable and knowledgeable source: her friendly neighborhood bank teller, who will be pleased to sell her an index linked GIC.

There will be no fast-track for Keystone:

The U.S. Senate refused to approve TransCanada Corp. (TRP)’s $8 billion Keystone XL pipeline after years of a political fight over jobs, climate change and energy security.

The vote was 59-41 with 60 required for passage in the Democratic-led Senate. Republicans have said they will try again next year after their party takes control of the chamber. House Speaker John Boehner and Senate Republican leader Mitch McConnell say passage of a Keystone measure is a top priority.

President Barack Obama has opposed legislation approving the Keystone project, saying it would bypass a review being conducted by the State Department. He didn’t say whether he would sign or veto the bill if it reached his desk.

It was a good day for the Canadian preferred share market, with PerpetualDiscounts winning 27bp, FixedResets up 14bp and DeemedRetractibles gaining 8bp. Volatility was minimal. Volume was low.

To my astonishment, it looks like there is an adult on the buy-side:

Oeyvind Schanke, head of asset strategies at Norway’s $860 billion sovereign wealth fund, has worked out how to dodge traders in the U.S. trying to profit on his orders by leaving no pattern for them to track.

Investors who want to pre-empt trades by the world’s biggest sovereign-wealth fund and act on that information to make a profit — a practice known as front running — won’t have much success, he said.

“We’ve done a lot to try and avoid leaving those patterns,” Schanke said in a Nov. 14 interview at the Oslo headquarters of the fund. “We’re trading less using algorithmic trading now than we did some years ago and are doing much more trading in large block sizes to avoid pattern-reading.”

Incredible. He had a problem (though why the media insists on calling it “front-running” is beyond me); he sat and thought about it; he tried something new; it’s working. This is probably the most amazing advancement in institutional money management since the invention of the client lunch. CFA Level 27. This guy should get the next three Nobel Prizes in Economics, at least. He’s awesome.

BIS has published a paper by Michael Brei and Leonardo Gambacorta titled The leverage ratio over the cycle:

This paper analyses how the Basel III leverage ratio (Tier 1 capital/exposure) behaves over the cycle. The analysis proposes a setup to test for the cyclical properties of bank capital ratios, taking into account structural shifts in banks’ behaviour during the global financial crisis and its aftermath. Using a large data set covering international banks headquartered in 14 advanced economies for the period 1995-2012, we find that the Basel III leverage ratio is significantly more countercyclical than the risk weighted regulatory capital ratio: it is a tighter constraint for banks in booms and a looser constraint in recessions.

To universal surprise, the G-20 decided to encourage growth:

Group of 20 leaders agreed to take measures that would boost their economies by a collective $2 trillion by 2018 as they battle patchy growth and the threat of a European recession.

Citing risks from financial markets and geopolitical tensions, the leaders said the global economy is being held back by lackluster demand, according to their communique following a two-day summit that ended yesterday in Brisbane. The group submitted almost 1,000 individual policy changes designed to lift growth and said they would hold each other to account to ensure they are implemented.

But what else could they do, given the recession in Japan?

Less than 24 hours after heads of state gathering in Brisbane, Australia, agreed to take measures that would boost their economies by a collective $2 trillion by 2018, the Cabinet Office delivered news in Tokyo that Japan’s gross domestic product unexpectedly shrank an annualized 1.6 percent in the three months through September, the second straight contraction.

Disappointment is becoming routine for the global economy, with the International Monetary Fund last month cutting its 2014 world-growth outlook for the sixth time since January 2013. Weaker expansion stands to add pressure on policy makers including European Central Bank President Mario Draghi who are already pushing the limits of monetary stimulus and governments that are reluctant to increase spending.

Will Canadian interest rates rise in the short term (which is to say, five years)? I think so; they’re ridiculously low right now, have been for five years and are distorting the housing market. But not by much. The strength isn’t there.

Deutsche Bank AG is getting out of the kitchen:

Deutsche Bank AG will stop trading most credit-default swaps tied to individual companies, exiting a business that new banking regulations have made costlier, according to a spokeswoman.

The lender will instead focus on transactions in corporate bonds, while maintaining trading in the more active market for credit swaps tied to benchmark indexes, Michele Allison, a spokeswoman for the Frankfurt-based bank, said today. The firm also will continue trading swaps tied to emerging-market borrowers and distressed companies, she said.
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Deutsche Bank is exiting a part of the market that shrank to less than $11 trillion from $32 trillion before the financial crisis, data from the Bank for International Settlements show. Dealing in credit swaps, which have been blamed for exacerbating the 2008 financial crisis, has become more expensive for lenders like Deutsche Bank as regulators across the U.S. and Europe require banks to hold more capital to back trades, reducing the returns for shareholders.
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Among measures that regulators have enacted since the crisis is requiring large swaths of credit swaps to be backed by clearinghouses, which are capitalized by banks and require traders to set aside collateral, or margin, to cover losses if they can’t make good on the transactions. Much of the market, where the privately negotiated trades have typically been done over phone calls and e-mails, is also being shifted to electronic systems.

The regulatory crackdown pushed some of Wall Street’s most profitable credit derivatives and corporate-bond traders to less-regulated hedge funds. One trio of Deutsche Bank credit traders departed the bank’s New York office for hedge funds in 2011 and 2012 after making a combined $1 billion for the firm during the two preceding years, people with direct knowledge of the situation said in a 2012 Bloomberg News story.

Brookfield Investments, proud issuer of BRN.PR.A (which trades by appointment only and is not tracked by HIMIPref™) has been confirmed at Pfd-2(low) by DBRS:

The rating continues to be based on the strength of Brookfield Investments’ owner (Brookfield Asset Management Inc. or BAM: rated A (low), Stable trend by DBRS), as well as the Company’s relatively stable portfolio of real estate and asset management investments, with strong asset and dividend coverage. The rating remains limited by Brookfield Investments’ exposure to the volatility of overall capital markets, concentration of investments in the real estate sector, lack of investment restrictions and the relative illiquidity of unlisted investments.

Overall asset coverage (based on market values) for the Senior Preferred Shares increased to 17.49 times (x), for the six-month period ending June 30, 2014 (H1 2014), from 14.60x a year earlier. This was mainly due to an increase in investment values, particularly the Company’s investment in Brookfield Property Partners (BPY). That said, Brookfield Investments’ portfolio continues to have a high degree of exposure to the real estate sector. The Company also reduced its investment in Western Forest Products Inc. (Western) by disposing of 26 million shares in January 2014. As at Q2 2014, the Company had a 12.0% ownership interest in Western. As a result of the aforementioned portfolio changes, the Company’s exposure to real estate investments was 67.3% (on a market value basis as at Q2 2014). Specifically, BPY represents 55.7% of the Company’s investment portfolio on a market value basis. This should continue to support overall market values and provide stable dividends going forward. DBRS believes that asset coverage of 17.49x for the Senior Preferred Shares (based on market values in H1 2014) and dividend coverage of 12.45x are strong for the current rating category and provide a good level of downside protection. In terms of future investments, DBRS expects the Company will focus on stable, income-producing assets, such as preferred or common shares in real estate and power sectors.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 18bp, FixedResets off 1bp and DeemedRetractibles gaining 4bp. Volatility was average. Volume was low.

There are some thoughts that Keystone has missed the boat:

Delays of the Keystone XL pipeline are providing little obstacle to Western Canadian oil producers getting their crude to the U.S. Gulf Coast, with shipments set to more than double next year.

The volume of Canadian crude processed at Gulf Coast refineries could climb to more than 400,000 barrels a day in 2015 from 208,000 in August, according to Jackie Forrest, vice president of Calgary-based ARC Financial Corp. The increase comes as Enbridge Inc.’s Flanagan South and an expanded Seaway pipeline raise their capacity to ship oil by as much as 450,000 barrels a day. Canadian exports to the Gulf rose 83 percent in the past four years.

The expansion shows Canadians are finding alternative entry points into the U.S. while the Keystone saga drags on. In the latest chapter, a Democratic senator and a Republican representative are seeking votes in their chambers to set the project in motion. The two are squaring off in a runoff election for a Senate seat from Louisiana, a state where support for the project is strong.

“Keystone is kind of old news,” Sandy Fielden, director of energy analytics at Austin, Texas-based consulting company RBN Energy, said Nov. 12 in an e-mail. “Producers have moved on and are looking for new capacity from other pipelines.”

TransCanada Corp. (TRP)’s Keystone XL, which would transport Alberta’s heavy oil sands crude to refineries on the Gulf, has been held up for six years, awaiting Obama administration approval.

… so, naturally, it’s a big issue:

Republicans, emboldened by big gains in last week’s midterm elections, have chosen to make Keystone XL into the first battle of wills with a lame-duck president.

And Mr. Obama, so far, isn’t backing down.

… because we’ve got other means of transport:

It’s not uncommon to see mile-long trains of tanker cars cutting through the centre of Lac La Biche, carrying tens of thousands of barrels of crude to market, snarling traffic as they go. And it’s not about to stop. Former mayor Aurel Langevin, who ran the town from 2012 to this past spring, estimates that, a year ago, Lac La Biche averaged three oil trains a day. That figure is expected to hit about eight per day, carrying upward of 100 tankers each, in the year ahead.

This new reality for Lac La Biche, and thousands of other towns across North America, is symptomatic of the critical–and costly–transportation bottleneck that now hangs over the oil sands. The lack of options for transporting Alberta’s heavy crude south, to oil refineries on the U.S. Gulf Coast, means it is sold at a significant discount to the benchmark West Texas Intermediate.

TransCanada Corp.’s $5.5-billion Keystone XL pipeline was supposed to be a key part of the solution–until it became a symbol for the debate over whether new pipes should be built anywhere in North America.

Actively managed US equity funds have done particularly badly vs. their benchmarks this year – various reasons have been put forward:

Here are some of the most-common excuses cited for what Arthur Miller might call “Death of a Stock Picker”: the Federal Reserve’s spigot of liquidity led to tighter correlations and less dispersion among industry groups that made it difficult to identify potential outperformers. And the boom in exchange-traded funds is also credited with having a similar effect.

Tom Lee of FundStrat Global Advisors today contributed another handy excuse: blame Apple Inc. Or rather, blame yourself if you didn’t load up on Apple shares. Apple, the largest company in the world, has rallied 41 percent this year, about four times as much as the Standard & Poor’s 500 Index. Last year, the shares were only good for about a fifth of the S&P 500’s 30 percent gain.

Not owning Apple in 2014 was one of the biggest reasons managers trailed benchmarks this year, according to Lee, accounting for 81.3 basis points of an average 340 basis-point underperformance. Skipping Microsoft Corp., up 33 percent in 2014, was good for another 36.2 basis points in underperformance, according to Lee.

And while many fund managers are cursing this year’s 18 percent rally in utilities, Lee points out that the group only accounts for 3 percent of the S&P 500 so the absence of the entire industry in a fund would only be good for 25 basis points of underperformance.

The ‘higher correlation’ argument needs to be taken with a grain of salt: if we assume every stock in the universe has exactly the same return at all times, then every actively managed fund will underperform by its MER; but by no more than the MER.

AltaGas Ltd., proud issuer of ALA.PR.A, ALA.PR.E and ALA.PR.G, was confirmed at Pfd-3 by DBRS:

DBRS expects the recent improving trend in the Company’s credit metrics to continue as the full-year benefits from assets placed in service are realized. Cash flow-to-adjusted debt has improved to 11.8% in Q3 2014 (9.6% in 2012) and adjusted debt in capital structure has improved to 51.9% (60.2% in 2012). DBRS expects the Company to finance its capital expenditure program with a prudent mix of equity and debt and maintain credit metrics consistent with its current rating.

Wow, DBRS has specified some very precise expectations there!

It was another mixed day for the Canadian preferred share market, with PerpetualDiscounts up 19bp, FixedResets off 6bp and DeemedRetractibles gaining 13bp. Volatility was average. Volume was very low.

And now it’s time for my monthly PrefLetter weekend!