PrefBlog

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.

Click for Big

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!

Jobs, jobs, jobs!

A surprisingly powerful surge in hiring pushed unemployment to a six-year low of 5.9 percent in September as the U.S. labor market showed renewed vigor.

The 248,000 gain in payrolls followed a 180,000 increase in August that was bigger than previously estimated, the Labor Department reported in Washington. Revisions boosted the job count by 69,000 over the previous two months. The jobless rate fell from 6.1 percent to the lowest level since July 2008.
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Another report today showed the U.S. trade deficit shrank in August to the lowest level in seven months as exports edged up to a record. The gap decreased 0.5 percent to $40.1 billion, the smallest since January, from $40.3 billion in July, the Commerce Department reported.

The narrowing deficit prompted economists at Barclays PLC in New York to boost their tracking estimate of third-quarter gross domestic product to a 3.3 percent gain at an annualized rate from 2.7 percent.

Also today, another report showed service industries grew in September to cap the strongest quarter of expansion in more than 10 years. While the Institute for Supply Management’s non-manufacturing index fell to 58.6 from the prior month’s 59.6, the third-quarter average was the highest since the first three months of 2004, the Tempe, Arizona-based group said.

The quarterly average for the group’s factory index was the highest since early 2011, a report showed earlier this week.

Meanwhile, in Canada:

Canada swung to an unexpected merchandise trade deficit in August as imports surged to a record and exports fell for the first time in four months.

The C$610 million ($543 million) deficit followed a July surplus that was pared to C$2.20 billion from the initial C$2.58 billion estimate. None of the 14 economists in a Bloomberg survey predicted that Ottawa-based Statistics Canada would report a trade deficit today, and the median estimate was for a C$1.6 billion surplus.

The report is another setback in a week that saw Statistics Canada report the world’s 11th-largest economy stalled in July after a second-quarter expansion that was led by a jump in exports. Bank of Canada Governor Stephen Poloz said last month he saw early signs of a needed rotation toward growth led by exports and business investment.

And problems in moving exportable goods don’t seem to be getting any better:

Even with a grain harvest falling below last year’s record, Western Canadian farmers can’t find enough rail cars in the right places to move their crops.

Wet, cool weather across parts of the Canadian prairies has reduced the amount of high quality grain available, helping to fuel another showdown between shippers and the nation’s largest railways. While the crop is 20 percent smaller than last year’s, it will be harder to find and move the right grades to match export sales.

Grain shippers said railways haven’t been supplying enough cars, and about 24,000 orders for transport on the prairies haven’t been filled. Canadian National Railway Co. (CNR), facing a fine for failing to meet its minimum weekly grain shipping target, said farmers haven’t been delivering enough grain to country elevators to comply with the government order.

People are borrowing for more than just houses:

If stock investors are any guide, the $1.3 trillion U.S. junk-bond market is being inflated by a growing amount of leverage being used by buyers.

Both stock and junk-bond managers tend to deploy more leverage when markets are booming, and more than ever is being used to purchase U.S. equities, based on levels of margin debt on the New York Stock Exchange, according to UBS AG (UBSN) analysts. That suggests junk-debt buyers are engaging in similar financing activities.

As investors use more borrowed cash, they increase the potential for bigger losses in a downturn. This trend adds to concern that six years of unprecedented Federal Reserve stimulus has produced a bubble in the junk-bond market — and one that will be all the more painful when it eventually pops.
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Margin debt has surged to more than 2.5 percent of U.S. gross domestic product, about the highest level in data going back to the early 1990s, the UBS analysts [Stephen Caprio and Matthew Mish] wrote. The measure of leverage tends to be a leading indicator of relative yields on speculative-grade bonds, with a rising level of margin debt increasing the odds of future spread widening.

Investors are demanding 4.42 percentage points more than benchmark rates to own dollar-denominated high-yield bonds, compared with 5.9 percentage points on average over the past decade, Bank of America Merrill Lynch index data show.

… and Rob Carrick writes about Corporate bond ETFs: More than meets the eye:

Determined to avoid future catastrophes, the world’s regulators, central banks, investment strategists and money managers are asking questions and raising concerns about all kinds of investment trends and products. One of the latest to be scrutinized is a useful and seemingly innocuous category of exchange-traded fund that holds corporate bonds.

The concern starts with a lack of liquidity in the corporate bond market today. A liquid asset can be easily traded, without concern that you’ll have to pay a premium to acquire it or accept a discount when selling. Corporate bond liquidity has been negatively affected by a combination of a changing regulatory environment for the banks that dominate trading of these securities, and strong demand for these bonds from investors.

Today, the lack of liquidity means investors have to pay up to buy corporate bonds. When interest rates rise, it could mean they’ll take a hit if they sell. ETFs, which hold baskets of corporate bonds, complicate things. If investors dumped corporate bonds en masse, would these ETFs be able to efficiently sell their holdings as needed?

He then spoils this excellent question by allowing disingenuous salesmen to slip off the hook really easily:

If you did submit a sell order for your corporate bond ETF, it would be matched with a buy order from another investor. Even if corporate bonds turn toxic, there are investment dealers designated to maintain an orderly market in ETF trading. They’re supposed to put in a bid for the ETF units you’re selling, even if the price would reflect prevailing market conditions.

These dealers would have the option of exchanging the ETF units they’ve accumulated for the underlying securities. At BlackRock Canada, they say that’s not a problem. “You can’t make an ETF if you don’t have liquid underlying [investments],” said Noel Archard, the company’s head and managing director.

Alfred Lee, vice-president and portfolio manager at BMO Mutual Funds, said corporate bond ETFs give investors more liquidity than if they tried to sell an individual bond. “Given a liquidity event, liquidity is not going to be as good as in a normal environment. But we’re going to be owning the most liquid bonds out there.”

To sum up, problems in the corporate bond market will be reflected in the price of bond ETFs. However, ETF industry people say their funds will not exacerbate things.

(The article is also spoilt by the inclusion of the old nonsense about how risk and return are magically changed by putting the raw materials into a box.[ETF] Disadvantages: No maturity date, which means prices subject to interest rate trends. See Bond ETFs demystified for an explanation of what is really going on.)

Anyway, I hope that Noel Archard was misquoted, or quoted out of context, or severely shortened, or something, because his statement is nonsense. Synthetic ETFs can be a threat to financial stability; I’ll agree that there aren’t many of these in Canada, but we do have some, we could have more, and the underlying investments can be illiquid.

Alfred Lee also evades the question, by claiming that his firm (? Does this mean BMO ETFs? BMO Mutual Funds? BMO as principal?) will ‘be owning the most liquid bonds out there’. Who cares, in a crisis (and, I might ask, does he have a mandate to focus on liquidity?)? The issue is the price sensitivity of these bonds.

There are three main problems that I see:

• Firstly, in a crisis, people are going to want to get out faster than they got in; i.e., we could see one month’s redemptions equal to X month’s current purchases. This will pressure dealer inventories and hence prices.
• Secondly, we can expect risk aversion to increase in a crisis, which will increase the price sensitivity to this picked up selling, and
• Thirdly, there is the structural issue … ETFs are meant to increase the liquidity of an investment in their underlying. That’s their whole point! The implication is that you have investors in a particular asset class (e.g., the corporate bonds currently being discussed) whose holdings would be reduced, or non-existent, if they had to invest directly in the underlying (i.e., the liquidity provided by the ETF is a critical contributor to their decision to invest in the asset class). Therefore, on top of the increase in risk aversion due to the crisis, you’ve also got a structural increase in risk aversion.

It could be ugly, by which I mean a beautiful time to be trading.

There’s a strange story on US employment law:

On Oct. 8 the Supreme Court will hear arguments about whether that time counts as work. In 2010 two former employees of Integrity Staffing Solutions, a temp agency that supplies workers at many of Amazon’s U.S. warehouses, sued the company demanding back pay for the time they spent in security lines after clocking out at Amazon warehouses in Nevada. The security checks, the plaintiffs argued, were required by Integrity and therefore part of the job. (Amazon-employed workers go through the same checks.)

At issue is the scope of a 1947 amendment to the Fair Labor Standards Act that says employers don’t have to pay for time spent on work-related activities like getting to or from the office. Nine years later, the Supreme Court established in a pair of rulings that the key is whether the activity in question is “integral and indispensable” to the principal activities workers are paid to do. Butchers at a meatpacking plant, the court found, had to be paid for time spent sharpening their knives, and workers at a battery plant deserved compensation for time spent showering after work to wash off traces of sulfuric acid and lead.

The question in the Integrity case is whether security checks are more like those showers or more like commuting. With screenings increasingly common, the case could have implications for a wide range of workplaces….

Integrity says it doesn’t owe the workers money because the screenings weren’t directly related to their jobs. “No court has ever held that ‘not breaking the law’ is a principal job activity for which compensation must be paid,” the company’s lawyers wrote in a brief last May.

To me, this is open and shut. Of course time spent going through a security check should be compensated, if the employer insists you do it. I can reduce my commute by living in a tent at the warehouse’s front door, but reducing the time spent proving I’m not a crook is beyond my power (unless I quit my job, which I would). But not only has this case made it to the Supreme Court, but the Comrade Peace Prize administration is supporting the employers!

The Departments of Justice and Labor also submitted on Integrity’s behalf. There is, Solicitor General Donald Verrilli Jr. wrote, “no clear-cut distinction—either in terms of purpose or effect—between petitioner’s screenings and those that are routine at countless government and private-sector buildings.”

Crazy world. The forces of fear have won.

As an aside, I went to hotair.com to see what this week’s official Republican talking points on the issue are, but couldn’t find a mention of the SCOTUS Integrity case. I did find this complaint about a subtraction algorithm in the Common Core, though; as I often am when reading HotAir, I was perplexed by the level of annoyance shown. I use this algorithm all the time when doing mental subtraction. What’s the big deal?

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts gaining 5bp, FixedResets off 1bp and DeemedRetractibles down 4bp. Volatility was minimal. Volume was low.

Treasury trading is going electronic:

While investors traditionally negotiated prices for U.S. Treasuries by telephone, they’re increasingly turning to computer-based marketplaces for a range of price quotes from different dealers. A record 48 percent of trades in U.S. government debt have occurred on electronic platforms this year, up from 31 percent in 2012, according to a Greenwich Associates study released yesterday.

There’s a new pseudo-scandal:

A high-frequency trader was indicted for “spoofing,” the placing and immediate canceling of orders to manipulate commodities markets, in what the U.S. Justice Department says is the first criminal case of its kind.

Michael Coscia, 52, of Rumson, New Jersey, the principal of Panther Energy Trading LLC, was indicted by a federal grand jury in Chicago and charged with six counts of commodities fraud and six of spoofing. He’s accused of illegally reaping nearly $1.6 million as a result of orders placed through CME Group Inc. (CME) and European futures markets in 2011.

Matt Levine of Bloomberg is a superb journalist. He not only explains the allegations better than the news story did, he also adds some wise words of his own:

Basically, spoofing doesn’t hurt fundamental investors directly.11 Fundamental investors trade based on fundamental views of value, not order-book information, so they shouldn’t be thrown off by fake bids and offers. Also they probably trade too slowly to even notice this sort of spoofing. Spoofing only directly hurts market-makers, whose job is to buy and sell in reaction to changes in supply and demand. In most modern markets, that means primarily high-frequency traders. If the FBI is going after spoofing, that’s good for other high-frequency traders. The reason to crack down on spoofing is that high-frequency traders are socially valuable and need to be protected.

I wouldn’t object to exchange-initiated rules about order cancellation – say, a black-out period of one second, so an order can’t be cancelled until it has been live for a second. But anti-spoofing laws – with criminal penalties, yet! – aren’t just silly, they’re extremely difficult to enforce.

Canadian Utilities, proud issuer of , has been confirmed at Pfd-2(high) by DBRS:

DBRS has today confirmed the ratings of the Unsecured Debentures and Issuer Rating of Canadian Utilities Limited (CU or the Company) at “A,” along with confirming the Commercial Paper and Cum. Preferred Shares at R-1 (low) and Pfd-2 (high), respectively, all with Stable trends. The confirmation reflects (a) the low-risk regulated electric and gas business of its wholly owned subsidiary, CU Inc. (CUI; rated A (high) by DBRS), which accounts for approximately 65% of consolidated earnings, (b) the self-sustaining and minimal funding requirements for its non-regulated operations, and (c) the low level of debt at the holding company level ($200 million). The one-notch differential in the ratings of CU and CUI primarily reflects structural subordination at CU.

It was a poor day for the Canadian preferred share market, with PerpetualDiscounts losing 10bp, FixedResets down 8bp and DeemedRetractibles off 1bp. Volatility, while modest, was comprised entirely of losing FixedResets. Volume was low.

PIMCo doesn’t love us any more:

Pacific Investment Management Co.’s Total Return ETF slashed its holdings of Canadian debt to 2.1 percent from 9.2 percent in the five days ending yesterday, according to data compiled by Bloomberg.

The $3 billion exchange-traded fund, which follows a similar investment strategy as Newport Beach, California-based Pimco’s flagship $222 billion mutual fund, was run by co-founder Bill Gross before his sudden departure on Sept. 26.

Pimco has less invested in Canada than benchmarks recommend, said Ed Devlin, who oversees $17 billion, including the Canadian portfolios, for Pimco. He said he prefers markets such as Mexico.

“We still think Canada is a relatively unattractive market when we look at rates around the world,” Devlin said at the Bloomberg Canadian Fixed-Income Conference in New York yesterday. “Other markets are much more attractive.”

Devlin noted the yield on the Canadian 10-year bond, at about 2.1 percent, is in line with inflation. “What’s fun about that? Not much,” he said.

Equities started the quarter on the wrong foot:

The Standard & Poor’s/TSX Composite Index (SPTSX) fell 155.07 points, or 1 percent, to 14,805.44 at 4 p.m. in Toronto, retreating for a third straight day. The index lost 4.3 percent in September, the most since May 2012, and fell 1.2 percent in the third quarter.

U.S. stocks tumbled today amid concern over economic growth in Europe and geopolitical turmoil as the Federal Reserve prepares to end its bond-buying program. The Russell 2000 Index (RTY) dropped more than 10 percent from a record reached in March, meeting the common definition of a correction.

Equities fell as Italy cut its growth forecast, German manufacturing shrank and euro-area factories lowered prices in September by the most in more than a year. The weakness underlined the mounting challenge facing policy makers before the European Central Bank meets tomorrow.

… but bonds were on fire!

Treasuries gained the most in more than eight months as yields higher relative to most Group of Seven nations increased demand from investors worldwide concerned global growth is stalling.

Benchmark 10-year notes yielded almost the most versus their German counterparts since 1999 after the dollar touched a two-year high versus the euro yesterday. The European Central Bank may detail its plan to buy asset-backed securities tomorrow amid slowdowns in Germany in France. Stocks tumbled, pushing the Russell 2000 Index into a correction, and bolstering the haven appeal of U.S. government securities.
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The U.S. 10-year yield fell 10 basis points, or 0.10 percentage point, to 2.39 percent as of 5 p.m. in New York, according to Bloomberg Bond Trader data. It’s the biggest drop since Jan. 23. The 2.375 percent security rose 29/32, or $9.06 per $1,000 face amount, to 99 28/32.

U.S. 10-year notes yielded 1.48 percentage points more than their German counterparts after reaching 1.57 on Sept. 17, the most since June 1999. They were 1.85 percentage points higher than those of Japanese peers, up from 0.63 percentage point in May 2012.

Meanwhile, for you brokers out there worrying about clients leaving you after a not very exciting quarter … PIMCo feels your pain:

Pimco CEO Douglas Hodge said this week during a conference call that the firm is expecting and is ready for client redemptions. Pimco could see withdrawals of 10 percent to 30 percent, Sanford Bernstein said in a report. Pimco has not disclosed how much money has left the firm since Gross’s departure.

Investors yanked a record $446.5 million from Pimco’s $2.9 billion Total Return ETF after Gross’ departure from the firm on Sept. 26., before slowing redemptions to $98 million on Sept. 29 and $87 million yesterday. The exchange-traded fund follows a similar investment strategy as the Pimco Total Return mutual fund.

Pimco’s largest competitors had already been benefiting this year as investors have moved away from the firm’s Total Return into top-performing rivals as well as flexible funds that can protect from rising interest rates. Pimco’s Total Return Fund has lagged behind competitors this year, trailing 62 percent of its peers, according to data compiled by Bloomberg.

It was a mixed day for the Canadian preferred share market, with PerpetualDiscounts down 16bp, FixedResets gaining 1bp and DeemedRetractibles up 6bp. Volatility was minimal. Volume was low.