PrefBlog

The equity jocks are off their meds:

After plunging 1.5 percent on Oct. 7 and rallying almost 1.8 percent yesterday, the Standard & Poor’s 500 Index dropped 2.1 percent at 4 p.m. in New York today, the biggest turnaround in almost three years. As investors weigh the prospect of slower economic growth overseas against the benefit of U.S. interest rates staying near zero, a measure of 10-day volatility has risen to the highest level since April, data compiled by Bloomberg show.

The only phrase that generates more comments on this site than “real estate” is “trailer fees”. So it is with some glee that I report that the trailer fee wars are heating up:

“Trailer fees – the meteor is closer than you think” was the title of a recent note put out by Mr. Sedran and Mr. Holden [of CIBC]. The meteor in question is a ban on trailer fees.

“Regulators are studying the impact of these fees, with the results of those studies and a recommendation expected early 2015. A ban on trailer fees would follow a global trend and would address the regulators’ conflict of interest concerns. We think such a ban is coming, and sooner than many think.”

The story is marred by an inaccuracy:

The big knock against trailer fees is that despite the advisor having a fiduciary duty to put the client in the product that best serves their needs, there is a financial incentive for the advisor to sell the client the fund with the highest trailer fee – a glaring conflict of interest.

… but we may see a lot of “portfolio managers” without track records:

Mr. Sedran and Mr. Holden say the industry will likely transition to a model where advisors would be paid for managing a client’s entire portfolio, similar to how financial planners are paid today. Furthermore, under such a model, the advisor’s compensation would be tied to whether their client’s portfolio appreciates in value. The implication is that it will also be in the advisor’s interest to put clients into the funds they believe will perform the best over time.

The so-called implication is laughable – it will continue to be a lot easier for salesmen to get a fresh $1,000 into the account from the client than it is to outperform by 1% on a $100,000 portfolio. But people like to dream.

There’s a laugh line:

The bigger players, such as the Canadian banks who already have vast mutual fund sales forces in branches, should be able to manage the transition just fine, according to Mr. Sedran and Mr. Holden.

Well, of course. If it hurt the banks, their future employees at the regulatory agencies wouldn’t dream of the idea. I remain interested in the regulatory agencies views on new issue commissions and proxy solicitation fees – which are functionally equivalent to trailer fees – but the silence continues.

I have often remarked at the superiority of US institutions over their Canadian counterparts with respect to transparency. It is very useful to gain insight into the policy-setting process by reviewing the countervailing arguments within the various committees – but, of course, there are always some who would prefer a two-line press release:

Joseph LaVorgna, chief U.S. economist at Deutsche Bank AG in New York, said officials risk sowing confusion.

“It’s hard to have a unifying message when you have this many people who feel it’s incumbent on them to tell you what the Fed is thinking,” he said.

“I wish the Fed would answer generalities with generalities,” he said. “When they try to quantify, that’s when the problems come up.”

There’s some more information from Pew Research regarding stagnant wages:

Following the better-than-expected September jobs report, several economic analyses have pointed out the continuing lack of meaningful wage growth, even as tens of thousands of people head back to work. Economic theory, after all, predicts that as labor markets tighten, employers will offer higher wages to entice workers their way.

But a look at five decades’ worth of government wage data suggests that the better question might be, why should now be any different? For most U.S. workers, real wages — that is, after inflation is taken into account — have been flat or even falling for decades, regardless of whether the economy has been adding or subtracting jobs.

Cash money isn’t the only way workers are compensated, of course — health insurance, retirement-account contributions, education and transit subsidies and other benefits all can be part of the package. But wages and salaries are the biggest (about 70%, according to the Bureau of Labor Statistics) and most visible component of employee compensation.
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But after adjusting for inflation, today’s average hourly wage has just about the same purchasing power as it did in 1979, following a long slide in the 1980s and early 1990s and bumpy, inconsistent growth since then. In fact, in real terms the average wage peaked more than 40 years ago: The $4.03-an-hour rate recorded in January 1973 has the same purchasing power as $22.41 would today.

A similar measure, “usual weekly earnings” of employed, full-time, wage and salary workers, tells much the same story, albeit over a shorter time period. In seasonally adjusted current dollars, median usual weekly earnings rose from $232 in the first quarter 0f 1979 (when the series began) to $782 in the second quarter of this year (the most recent data available). But in real terms, the median has barely budged over that period.

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But amidst all the gloom and doom, there’s some good news:

Prince Edward Island has joined Ottawa’s move to create a national securities regulator, bringing the total to five provinces who have signed onto the plan.

The federal Finance Department said Thursday the province has signed a memorandum of agreement to join the Co-operative Capital Markets Regulatory System.

The addition of P.E.I. follows a decision in July by Saskatchewan and New Brunswick to join B.C., Ontario and the federal government in establishing a national regulator.

I have said for a long, long time that piecemeal cooperation is better than none and much more attainable than the single-regulator pipedream. Mind you, I think the commentary we occasionally see regarding the wonderfulness of a national-mostly regulator is highly overwrought. All that will happen is that some unnecessarily duplicated paperwork will be eliminated. But that’s good reason enough.

It was a poor day for the Canadian preferred share market, with PerpetualDiscounts down 12bp, FixedResets losing 13bp and DeemedRetractibles off 8bp. Volatility was average and balanced, but comprised entirely of FixedResets. Volume was on the low side of average.

Russia is intervening in the currency markets:

Russia’s central bank sold $420 million of foreign currency in its third day of interventions this month to slow the ruble’s world-beating decline.

The monetary authority spent the funds on Oct. 6 to shore up the ruble, the latest data on its website showed today. The bank also said it shifted the upper boundary of the currency’s trading band by 5 kopeks yesterday. The exchange rate was little changed at 44.6979 versus the dollar-euro basket as of 10:12 a.m. in Moscow today.

Bank of Russia will probably need to spend as much as $30 billion by year-end to slow the decline in the ruble, which lost 14 percent against the dollar last quarter, according to UralSib Capital.
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Demand for dollars and euros is growing among Russian companies as they contend with $54.7 billion of debt repayments in the next three months, according to central bank data.

A little bird asked me to comment on a paper by Pablo Fernandez of University of Navarra – IESE Business School titled CAPM: An Absurd Model:

The CAPM is an absurd (having no rational or orderly relationship to human life; contrary to all reason or common sense) model because its assumptions and its predictions/conclusions have no basis in the real world. The use of CAPM is also a source of litigation: many professors, lawyers… get nice fees because many professionals use CAPM instead of common sense to calculate the required return to equity. Users of the CAPM make many illogical errors valuing companies, accepting/rejecting investment projects, evaluating fund performance, pricing goods and services in regulated markets, calculating value creation…

According to the dictionary, a theory is “an idea or set of ideas that is intended to explain facts or events”; and a model is “a set of ideas and numbers that describe the past, present, or future state of something”. With the vast amount of information and research that we have, it is quite clear that the CAPM is neither a theory nor a model because it does not “explain facts or events”, nor does it “describe the past, present, or future state of something”.

It is important to differentiate between a fact (something that truly exists or happens: something that has actual existence; a true piece of information) and an opinion (what someone thinks about a particular thing). The CAPM could be described as an uninformed opinion, and not as a sensible opinion.

We all should try to explain a portion of “the world as it is”, not of “the world according to a wrong theory” nor of “the world if men were not men”. Ricardo Yepes, professor of philosophy of my university, wrote: “Learning means being able to keep perceiving reality as it truly is: complex – and not trying to fit every new experience into a closed and pre-conceived notion or overall scheme”. We may find out an investor’s expected IBM beta and expected market risk premium (MRP) by asking him. However, it is impossible to determine the expected IBM beta and the expected MRP of the market (for the market as a whole), because these two parameters do not exist. Different investors have different cash flow expectations and use different expected (and required) returns to equity (different expected market risk premium and different expected beta). One could only talk of the beta and the market risk premium if all investors had the same expectations. But investors do not have homogeneous expectations.

Sections 11 and 12 show how to calculate required returns in a sensible way and how to use betas being a reasonable person.
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Just an example: calculation of the beta of electrical companies done by a European Electricity Regulatory Commission. “We calculate the betas of all traded European companies. Leveraged betas were calculated using 2 years of weekly data. The Market Index chosen was the Dow Jones STOXX Total Market Index. There is a great dispersion (from -0.24 to 1.16) and some odd betas (negative and higher than one). We decided to maintain all betas… To unlever the betas, we assumed that the beta of the debt is zero for all companies. Then, the Commission calculates the average of the unlevered betas and relever it using an objective debt to equity ratio based on the average debt to equity ratio of comparable companies. The levered beta proposed by the Commission for the transport activity is 0.471870073”

The Commission acknowledges that calculated betas have a “great dispersion (from -0.24 to 1.16)” but calculates the average of all of them and finally provides betas with a precision of 9 figures after the decimal point!
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According with the CAPM “the market” assigns a beta to every company and that beta may be calculated with a regression of historical data. Of course, every investor should use this “market beta”. As we have already mentioned, the first problem is that this “market beta” does not exist.

When we calculate betas using historical data we encounter several well-known problems:
1. They change considerably from one day to the next.
2. They depend very much on which stock index is used as the market reference.
3. They depend very much on the historical period (5 years, 3 years…) used.
4. They depend on what returns (monthly, yearly…) are used to calculate them.
5. Very often we do not know if the beta of one company is lower or higher than the beta of another.
6. Calculated betas have little correlation with stock returns.
7. β = 1 has a higher correlation with stock returns than calculated betas for many companies
8. The correlation coefficients of the regressions used to calculate the betas are very small.
9. The relative magnitude of betas often makes very little sense: companies with high risk often have lower calculated betas than companies with lower risk.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 1bp, FixedResets off 7bp and DeemedRetractibles down 8bp. Volatility was low (Floaters don’t count!). Volume was low.

PerpetualDiscounts now yield 5.16%, equivalent to 6.71% interest at the standard equivalency factor of 1.3x. Long corporates are now at about 4.2%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 250bp, a widening from the 240bp reported September 10.

Europe isn’t looking very good:

U.K. 10-year government bonds rose with their German counterparts as a report showed factory orders in Europe’s largest economy plunged the most since 2009 in August, underlining risks to the euro area’s recovery.

Five-year gilts advanced for the fifth time in six days. The yield fell last week to the lowest level since February as reports signaled the U.K. economy was losing momentum, fueling speculation the Bank of England will delay interest-rate increases. The pound declined versus the euro as Business Secretary Vince Cable said Britain’s currency was still too strong and stifling exports.
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U.K. house prices fell for the first time in almost a year and a half in September, Nationwide Building Society said on Sept. 30, while a Markit Economics report on Oct. 3 showed services growth cooled more than economists forecast, further signs that the recovery may be losing enough momentum for the Bank of England to refrain from increasing borrowing costs. That has fueled gains in government bonds and slowed the rally in the pound.

… and there are renewed deflation fears:

Inflation in the euro area has fallen yet again and now stands at 0.3 percent. Prices are already falling in several of the European Union’s weaker economies. Even so-called core inflation, which excludes temporary factors and reveals the underlying trend, stands at less than 1 percent, a full percentage point below the ECB’s target.

… which is causing some to criticize Draghi and the ECB:

European Central Bank President Mario Draghi has disappointed investors and economists by failing to detail the size of the expansion he’s seeking in the central bank’s balance sheet. This much is clear from today’s investment bank research reports. Parsing Draghi’s comments from yesterday, as his favorite inflation measure fell to a record today, raises the chilling prospect that it may already be too late to avert deflation in the euro region — and that he knows it.

For the first time, Draghi has abandoned the incantation he’s used for months against the perceived evils of falling prices: “Inflation expectations for the euro area over the medium to long term continue to be firmly anchored.” That’s how he put it in his opening remarks at the August monetary policy press conference, and then followed it up, at the question-and-answer session, with, “Long-term expectations remain anchored at 2 percent.”
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Yesterday, in addition to dropping the mantra from his speech, Draghi also demurred when he was directly asked if he thought inflationary expectations were anchored:

Well, first of all, the inflation expectations — first of all, we don’t use — let me get this clear, because there has been a certain amount of misunderstanding in the last few weeks — we don’t use one single measure of inflation expectations. We use a broad range of indicators. And our inflation expectations measures have gone down especially on the short horizons and are now around 8 points below 2 percent on the five-year on five-year, and so we look at that with — definitely with great attention. I would say that the measures we’ve taken have been determined exactly because our medium-term outlook on inflation expectation has worsened and we see that the risks have increased.

Lena Komileva, the chief economist at G Plus Economics in London, a research company, interpreted the absence as a sign the ECB is aware that the euro region risks what she calls “Japanification.” Annual inflation was just 0.3 percent last month; it hasn’t touched 2 percent since January 2013.

All this gloom had an effect:

Stocks tumbled and bonds rallied, sending yields to the lowest since May 2013, as the International Monetary Fund cut its global outlook and German industrial production plunged. Oil slid to a 17-month low.

The Standard & Poor’s 500 Index (SPX) fell 1.5 percent to 1,935.10 at 4 p.m. in New York, the lowest level since Aug. 12. The Dow Jones Industrial Average lost 1.6 percent, the most since July. The yield on 30-year Treasuries retreated 8 basis points to 3.05 percent as investors sought safety. Oil tumbled 1.7 percent to the lowest since April 2013, while gold futures climbed 0.4 percent. Volatility rose, with the VIX jumping to the highest since March.

The IMF cut its outlook for global growth in 2015 and warned about the risks of rising geopolitical tensions and a financial-market correction as stocks reach “frothy” levels. German industrial production dropped 4 percent in August in the biggest decline since 2009.

With Hallowe’en fast approaching, I would be remiss if I didn’t alert Assiduous Readers to the BEST PRANK EVER:

A lewd statue of the devil that seemingly popped up overnight in East Vancouver has been taken down by city officials after raising eyebrows — among other things.

The statue stood about eight to nine feet tall on a pedestal near the intersection of 4th Avenue and Clark Drive for several hours Tuesday.

It was removed by city crews at around 3:15 p.m.

The statue also appeared to sport a full erection, a detail that likely raised hell with some of the commuters who use the station.

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It was a positive day for the Canadian preferred share market, with PerpetualDiscounts winning 18bp, FixedResets gaining 1bp and DeemedRetractibles up 2bp. Volatility was minimal. Volume was low.

Nothing happened today, but there was a nice column from Megan McArdle of Bloomberg regarding the Intregity case before SCOTUS that I mentioned on October 3:

But the law is never simple and intuitive, in large part because case law is made by the difficulty of hard corner cases. The briefs run through some of this history. For example: Does your employer have to pay you for your commuting time? That doesn’t seem reasonable; employees could relocate to the far exurbs and get themselves time and a half for hours spent driving and singing along to “Free Fallin’.” Okay, but what if you work in an airport, and at the end of your commute is a lengthy trip through the Transportation Security Administration lines? Should you get paid for what is essentially a mandatory 15 minutes added to your commute? A court said no; the TSA line is not part of your primary duties. Okay, how about if you work in a nuclear power plant, where, for the sake of the neighbors, everyone is rigorously searched and subject to radiation screenings? I can see the workers’ argument there, but a court ruled against them.

The workers’ brief tries to distinguish those cases from the Amazon case. The TSA case seems pretty easy: The security screening is not there for the benefit of the employer; it’s there because it’s required by law. You can’t demand that your employer pay you for commuting just because they’re located in the middle of an extended 15-mph zone. The security checks at the Amazon warehouse, on the other hand, are exclusively for the benefit of the employer, who is trying to prevent theft.

It was a positive day for the Canadian preferred share market, with PerpetualDiscounts winning 11bp, FixedResets gaining 3bp and DeemedRetractibles up 5bp. Volatility was minimal. Volume was very low.

Interestingly, due to microscopic pricing changes, the median YTW-Duration (the YTW-Duration is the duration of the Yield-to-Worst scenario) of the FixedReset subindex is now in the ‘perpetual’ range, for the first time since April, 2009. After recovering from the pricing slump that gave rise to that scenario, there followed a long period during which the bulk of the issues in the index were the huge-spread bank FixedResets, which reduced their expected term by one day every day. In May, 2012, new issuance started making things more interesting with a series in the range of four (median expectation was a call of a relatively new issue at the first opportunity), a series starting at eight and declining to about 6.5 (median expectation is the Deemed Maturity of a bank issue 2022-1-31) and a third, relatively recent series at about 8.5 (median expectation is the Deemed Maturity of an insurance issue, 2025-1-31). And today … continued low yields for the Government of Canada 5-year bond, massive issuance of relatively low-spread FixedResets and calls of the higher-spread issues have tipped the balance to perpetuity. Fun times! This median YTW-Duration figure will almost certainly be volatile for the next year or so.

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For those who are obsessive about such things, the median issue is BAM.PF.F, which at its bid of 25.25, HIMIPref™ calculates as having a 4.32% yield to Call 2019-9-30 and (given a GOC-5 yield of 1.58%), has a yield to perpetuity of 4.31%. At its closing bid of 25.26 on Friday, its YTW scenario was the call 2019-9-30 to yield 4.30%; I was using 1.61% as the GOC-5 yield on Friday. I told you the changes were microscopic!