PrefBlog

There is increasing awareness that the economy is not all that great:

Bank of Nova Scotia economists are now raising the possibility of no move in the Bank of Canada’s benchmark interest rate until 2016.

Other observers have speculated on late next year or early in 2015 for the first rate hike by the central bank.

But Scotiabank’s Derek Holt, Mary Webb and Dov Zigler say the Bank of Canada is now signalling a hold of more than two years, citing signs in a recent speech by senior deputy governor Tiff Macklem, among other things.
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“The BoC probably now envisages spare capacity remaining into 2016,” the Scotiabank economists said, adding the central bank now projects hitting its 2-per-cent target for annual inflation in mid-2015.

They believe the Bank of Canada may change that forecast, to an even later date, when meets later this month and also issues its monetary policy report.

But that’s OK! We’ll all retire on the CPP:

A proposal to boost the retirement benefits for the middle class from the Canada Pension Plan through increases in contributions is rekindling momentum for pension reform ahead of a key December meeting with Finance Minister Jim Flaherty.

Prince Edward Island Finance Minister Wes Sheridan is trying to rally his colleagues around changes that would see the maximum CPP contribution rise to $4,681.20 a year from $2,356.20 starting in 2016, and the maximum annual benefit would increase to $23,400 from $12,150.

Qualifying for the maximum benefit would take an income of $102,000, up sharply from the current maximum insurable earnings cutoff of $51,000. The overall goal is to boost the savings rates of middle-income Canadians who earn less than six figures.

And – surprise! – middle-class jobs are scarce:

The top-10 list suggests there are really two sets of expanding job opportunities, at either end of the income spectrum – and not much in the middle.

If you’re entering the labour market – say you’re young, or you’re a newcomer to Canada – there are lots of points of entry at the low end of the scale. But they are not generally the types of jobs that lead you down a career path to something better, nor do these jobs fully employ many workers’ skill sets. If you are lucky enough to find full-time, full-year work in these types of jobs, paying $13 an hour or less, you would be making $26,000 a year before taxes, or less.

There is another cluster of job opportunities that pay median wages of $35 an hour or more, which translates to $70,000 a year before taxes, or more.

There are fewer opportunities in the middle, jobs that pay in the $20-something per hour range.

However, a bright note is that European distressed assets seem to have found a level:

Blackstone Group LP (BX) raised more than $4 billion in 2009 to buy European property assets anticipating that cash-strapped banks would be forced to sell as the region’s debt crisis worsened. Almost all of it sat idle for two years.

Today, the inaction has given way to a surge of deals, as lenders from Lloyds Banking Group Plc (LLOY) to Commerzbank AG (CBK) cut loose soured real estate, corporate and consumer loans. Sales of loan portfolios and other unwanted assets by European Union banks could reach 60 billion euros ($82 billion) in face value this year, according to PricewaterhouseCoopers LLP, the most since the firm began tracking data in 2010.
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Apollo is among the most active investors, amassing loans with a face value of about 12 billion euros, including 11,000 mortgages in the U.K. Blackstone, the world’s largest alternative-asset manager, last year put $3.5 billion into distressed European mortgages and properties, the most its real estate group has plowed into the region in one year.
Investors also are buying European properties from real estate developers and taking over troubled companies or lending directly to them where banks have scaled back.
EU banks unloaded 29 billion euros of portfolio loans and assets such as mortgage-servicing units and branches in the first half of 2013, according to Richard Thompson, a partner at PwC in London. That compares with sales of 46 billion euros for all of last year, 36 billion euros in 2011 and 11 billion euros in 2010. The majority of sales have been distressed loans, Thompson said.

The arbitrary nature of corporate bond pricing (and hence the opportunity for profit) is well illustrated by this tale of woe:

Goldman Sachs Group Inc. (GS) mistakenly added about $1.5 million of interest costs to a Ford Motor Co. (F) bond sale last week by using the wrong Treasury note as a benchmark for the security, according to two people with knowledge of the transaction.
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Typically, banks set the price of new corporate securities by using Treasury bonds with similar maturities. If the U.S. government issues notes in the middle of the week, underwriters don’t use that security as a benchmark until the following Monday.

For Dearborn, Michigan-based Ford’s Sept. 26 offering, Goldman Sachs added a 1.45 percentage-point spread to the 1.375 percent Treasury note due September 2018 that was auctioned on Sept. 25, Bloomberg data show. Instead, the bonds should have been based off the 1.5 percent security that matures in August 2018.

Matthew Klein of Bloomberg offers an excellent perspective on endowment investing:

The modern style of institutional investing can be traced to Yale University’s David Swensen, who literally wrote the book on the subject. … Three core ideas inform his thinking.

1. Savers are paid to take risk. If you want to generate big returns you have to be willing to endure large losses at any point.

2. Universities and other institutional investors have long time horizons because they expect to exist forever. This makes them different from regular people who save for retirement.

3. Contrary to standard academic theory, which suggests that savers should invest in broad indexes and avoid fees, market imperfections create opportunities for talented money managers. They can improve a portfolio’s performance through a combination of high returns and diversification benefits.
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The potential for a mismatch between assets and liabilities is one big problem with the Yale model. Another is the focus on hunting for the best hedge funds, private-equity managers and stock pickers. This is where most of the money is made (and lost) in the endowment business. According to the Yale endowment’s most recent report, “nearly 80 percent of Yale’s outperformance relative to the average Cambridge Associates endowment was attributable to the value added by Yale’s active managers, while only 20 percent was the result of Yale’s asset allocation.” That’s great for Yale, but it’s impossible for every institution to have the best managers.

In general, I think Mr. Klein overstates the need for liquidity – it’s important, but my views are closer to precept 2 than that which he espouses.

I don’t think there’s anything wrong with the Yale model, but there are definitely problems with the implementation – as I told one guy recently, just because I believe the “Warren Buffet style” of investment CAN work, doesn’t mean I think YOU can do it.

The field is filled with ignoramuses and charlatans and institutional boards aren’t any better at picking winners than any other retail investor who handles his investments as a part-time job. Hiring a small group of specialists to farm out the work to third party firms just makes matters worse, because then allocations are made on the basis of two salesmen talking to each other.

For an institution to outperform, I believe that you have to have most, if not all, of the investment expertise in-house. ‘You don’t need to sell anything, guys, you just have to outperform on a rolling four year basis or you’re fired.’ This is the Teachers/OMERS model – and it works.

Canajans, eh? The Bank of Canada has published a working paper by Mikael Khan, Louis Morel and Patrick Sabourin titled The Common Component of CPI:An Alternative Measure of Underlying Inflation for Canada, in which the authors use factor analysis to find a common factor among 54 different components of the Consumer Price Index.

Click for Big

But, you ask, which of these 54 series was best correlated with this single underlying factor? Well, I’m glad you asked that question:

Table 2. Relationship between common component and individual components of the CPI

CPI components (y/y)	Correlation	% of explained variance
Alcoholic beverages served in licensed establishments	0.86	0.74

This suggests a new currency ….

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts getting whacked for 40bp, FixedResets off 3bp and DeemedRetractibles gaining 4bp. Predictably, the Performance Highlights table is heavily populated by losing PerpetualDiscounts. Volume was slightly above average.

SEC Chair Mary Jo White gave a speech titled Focusing on Fundamentals: The Path to Address Equity Market Structure. All the usual blather, but there was one point of interest:

So, today, I am pleased to announce a new initiative we are launching that is designed to promote a fuller empirical understanding of the equity markets. SEC staff has prepared and assembled resources and data on the SEC’s web site focusing exclusively on equity market structure. The new web site should be available as early as next week and will serve as a central location for us to publicly share evolving data, research, and analysis.

Part of this initiative will be to disseminate data and related observations drawn from MIDAS that address the nature and quality of displayed liquidity across the full range of U.S.-listed equities –from the life-time of quotes, to the speed of the market, to the nature of order cancellations.
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The new web site will also feature staff research papers based on a variety of data sources and staff reviews that identify and assemble information from the expanding economic literature on market structure topics. One paper, using order audit trail data on off-exchange trading, provides key metrics describing the underlying nature of off-exchange trading by the 44 alternative trading systems that trade equity securities. The staff’s primary observation is that ATS trading looks very similar in many respects to exchange trading.[20] Another paper summarizes current studies that address market fragmentation – both visible and dark. Additional research papers and reviews are already planned.

Maneuvering over the US debt limit continues:

Lew and President Barack Obama have said they won’t negotiate on the limit, which is tied to obligations the U.S. has already incurred. Boehner, an Ohio Republican, has issued a list of demands before he’ll support raising the ceiling. His conditions include approval of TransCanada Corp. (TRP)’s Keystone XL pipeline, major revisions to the tax code and a one-year delay of the insurance mandate in the Obama health-care law.
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The U.S. government is already limited in action after Republicans and Democrats in Congress failed to agree on funding for the new fiscal year that began yesterday. That led to a partial shutdown of the government at midnight, forcing about 800,000 federal workers off the job. The shutdown could cost the economy as much as $10 billion a week, the White House said on its website.

DS is having a good year with US junk:

Royal Bank of Canada is on pace to join the ranks of the 10 largest underwriters of high-yield debt in the U.S. for the first time as the largest Canadian lender seeks profits abroad with issuance slowing at home.

Royal Bank’s RBC Capital Markets ranks 10th among arrangers of speculative-grade bonds at the end of the third quarter after luring bankers from firms including Deutsche Bank AG (DBK) and Credit Suisse Group AG. (CSGN) The Toronto-based firm has never been a top-10 underwriter for non-investment-grade debt in the U.S. on any given year, according to data compiled by Bloomberg.
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While RBC expects total sales of junk bonds in the U.S. market to surpass last year’s record $353 billion, on Sept. 4 it cut its annual forecast for Canadian issuance to as little as C$4 billion ($3.9 billion) from about C$6 billion. The firm boosted the headcount in its U.S. credit team by 15 percent in the past two years, hiring almost 20 people, including 10 sales staff and eight traders. Last month Neil Yaris, who has held jobs at Credit Suisse and Bank of America Corp., joined as co-head of high-yield debt trading.
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Royal Bank’s long-standing goal to be a Top 10 investment bank in the U.S. contrasts with retrenchment in other areas of banking. The company sold its unprofitable U.S. lender RBC Bank to PNC Financial Services Group Inc. in March 2012, ending an unsuccessful decade-long foray into U.S. retail banking.

In Canada, RBC slipped to the third spot among underwriters of high-yield debt, from No. 1 in 2012. Still, the firm has led arrangers of investment-grade company bonds in Canada for at least 14 years.

I’m in the wrong business:

Carnegie Hall employs five full-time stagehands and uses part-timers as needed, a spokeswoman, Synneve Carlino, said in an e-mail.

The full-timers earned an average of $420,000 in 2011, according to the tax return. They move equipment in and out of the building and prepare three stages for performances, while operating audiovisual and other equipment. They work on holidays and weekends.

Oh, they work on holidays and weekends. Well, I’m glad that’s cleared up.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts down 15bp, FixedResets gaining 7bp and DeemedRetractibles off 2bp. The Performance Highlights table is average sized – by standards of the last few months – with BAM issues notable on the downside. Volume was average.

PerpetualDiscounts yield 5.56%, equivalent to 7.23% interest at the standard equivalency factor of 1.3x. Long Corporates now yield about 4.8%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) is now about 245bp, a significant increase from the 235bp reported September 25, as long corporate yields have declined about 10bp on the week, while PerpetualDiscounts haven’t done much of anything.

Tiff Macklem gave a speech to the Economic Club of Canada titled Global Growth and the Prospects for Canada’s Exports – I found Chart 12 to be of great interest:

A second factor influencing our exports is competitiveness. Between 2000 and 2012, the labour cost of producing a unit of output in Canada compared with the United States, adjusted for the exchange rate, increased by 75 per cent (Chart 12). The majority of this loss of competitiveness reflects the appreciation of the Canadian dollar (shown in blue), but weak productivity growth in Canada relative to the United States also played a significant role (shown in green).

Click for Big

From the bureaucrats at the UBC Staff Pension Plan comes an excellent lesson in bafflement via bullshit:

“We have what is called a target benefit plan,” says Mr. Parker, who is executive director of the University of British Columbia’s staff pension plan.
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In a target plan, the employer and its employees make fixed contributions, similar to a defined contribution plan. The payouts that can be expected are set as a target, which depends on projections, made by actuarial experts, of what the plan will be able to afford.

So in other words, it’s a Defined Contribution plan but they don’t want to say the words, so instead of handing over the dollar value of the account on retirement, they hand over a package of benefits, that may or may not increase or decrease and which will disappear when the beneficiary dies. Well done!

Fitch is unimpressed with the games in Washington:

The US government shutdown is not in itself a downgrade trigger for the sovereign’s ‘AAA’/Negative rating. However, it undermines confidence in both the budgetary process and critically in the prospect of the debt ceiling being raised in a timely manner to avert the risk of default on US sovereign debt obligations, says Fitch Ratings in a reiteration of its June 28 rating commentary.

A formal review of the rating with potentially negative implications would be triggered if the US government has not raised the federal debt ceiling in a timely manner prior to when the Treasury will have exhausted extraordinary measures and cash reserves. According to official comments by the US Treasury secretary, extraordinary measures could be exhausted by 17 October.

In such a scenario, the Treasury would be forced to dramatically cut back on current spending with adverse implications for the economic recovery. Even if it were to prioritise debt service – something the Treasury has repeatedly stated it has neither the legal authority nor logistical capability to do – it would likely incur arrears on a range of payment obligations and thus continue to incur debt, but in a disorderly and disruptive manner.

Even if the debt limit is not raised in a timely manner we believe there is sufficient political will and capacity to ensure that Treasury securities will continue to be honoured in full and on time. Nevertheless, investor confidence in the full faith and credit of the US would be undermined in such a scenario. This “faith” is a key underpinning of the US dollar’s global reserve currency status and reason why the US ‘AAA’ rating can tolerate a substantially higher level of public debt than other ‘AAA’ sovereigns.

Non-essential operations of the federal government will cease from today – the government shutdown – after the US House of Representatives and Senate failed to agree a continuing resolution to grant it the necessary spending authority.

Further to my rant of September 25, I was infuriated by the “Moment in Time” feature in today’s Globe (not available on-line), which claimed that “[Henry Ford] raised wages so his workers could become customers”, I looked around more carefully and found this:

It should be obvious that this story doesn’t work: Boeing would most certainly be in trouble if they had to pay their workers sufficient to afford a new jetliner. It’s also obviously true that you want every other employer to be paying their workers sufficient that they can afford your products: but that’s very much not the same as claiming that Ford should pay his workers so that they can afford Fords.
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Ford’s turnover rate was very high. In 1913, Ford hired more than 52,000 men to keep a workforce of only 14,000.
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Car production in the year before the pay rise was 170,000, in the year of it 202,000. As we can see above the total labour establishment was only 14,000 anyway. Even if all of his workers bought a car every year it wasn’t going to make any but a marginal difference to the sales of the firm.

We can go further too. As we’ve seen the rise in the daily wage was from $2.25 to $5 (including the bonuses etc). Say 240 working days in the year and 14,000 workers and we get a rise in the pay bill of $9 1/4 million over the year. A Model T cost between $550 and $450 (depends on which year we’re talking about). 14,000 cars sold at that price gives us $7 3/4 million to $6 1/4 million in income to the company.

It should be obvious that paying the workforce an extra $9 million so that they can then buy $7 million’s worth of company production just isn’t a way to increase your profits. It’s a great way to increase your losses though.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts up 30bp, FixedResets off 3bp and DeemedRetractibles gaining 3bp. Not surprisingly, there’s a bit of a skew in the Performance Highlights table towards winning PerpetualDiscounts. Volume was average.

The US government is heading towards shut-down:

The U.S. government stands poised for its first partial shutdown in 17 years at midnight tonight, after a weekend with no signs of negotiations or compromise from the Congress or the White House.

House Republicans, led by Speaker John Boehner, want to delay President Barack Obama’s Affordable Care Act for a year and make other changes to the law. Democrats, led by Obama, say that won’t happen. Republicans and Democrats say they don’t want to close the government, though neither side is budging from their positions.
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A brief government closure won’t lead to any significant change of the Treasury Department’s forecast for when the U.S. will breach the debt limit, a Treasury spokeswoman said yesterday in an e-mail. The Treasury has said measures to avoid breaching the debt ceiling will be exhausted on Oct. 17.

It was a very, very slightly negative day for the Canadian preferred share market, with PerpetualDiscounts and DeemedRetractibles off 1bp and FixedResets off 2bp. Considering the modesty of the overall moves the Performance Highlights table is surprisingly lengthy, with BAM issues notable on the winning side. Volume was above average.

And that’s it for another month!