April 23, 2014

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

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

After-tax middle-class incomes in Canada — substantially behind in 2000 — now appear to be higher than in the United States. The poor in much of Europe earn more than poor Americans.

The findings are striking because the most commonly cited economic statistics — such as per capita gross domestic product — continue to show that the United States has maintained its lead as the world’s richest large country. But those numbers are averages, which do not capture the distribution of income. With a big share of recent income gains in this country flowing to a relatively small slice of high-earning households, most Americans are not keeping pace with their counterparts around the world.

Three broad factors appear to be driving much of the weak income performance in the United States. First, educational attainment in the United States has risen far more slowly than in much of the industrialized world over the last three decades, making it harder for the American economy to maintain its share of highly skilled, well-paying jobs.

A second factor is that companies in the United States economy distribute a smaller share of their bounty to the middle class and poor than similar companies elsewhere. Top executives make substantially more money in the United States than in other wealthy countries. The minimum wage is lower. Labor unions are weaker.

Finally, governments in Canada and Western Europe take more aggressive steps to raise the take-home pay of low- and middle-income households by redistributing income.

“Things are pretty flat,” said Kathy Washburn, 59, of Mount Vernon, Iowa, who earns $33,000 at an Ace Hardware store, where she has worked for 23 years. “You have mostly lower level and high and not a lot in between. People need to start in between to work their way up.”

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

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

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

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

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

and further:

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

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

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

Compare this angst to Canadian angst:

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

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

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

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

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

We examine time discounting factors in an international survey. Our analysis reveals a significant relationship between time discount factors and historical equity premiums across 27 countries. This result implies that higher historical equity risk premiums are observed in countries where survey participants tend to be more short-term oriented. This finding is consistent with the explanation of the equity premium puzzle provided by myopic loss aversion.

Our results suggest that differences in time discounting can indeed explain some of the differences in equity premiums. Admittedly, the causality can go into both directions; namely, a high equity premium can also lead to more time discounting because of the higher expected return. However, we find that the subjective discount rates measured in our survey are far higher than the equity premiums, suggesting that equity premiums may not be the main drivers of time discounting.

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

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

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

Canadian hedge funds aren’t winning any prizes:

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

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

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

The Conservative government is throwing a new idea into the heated debate over Canadian pensions, launching a national discussion over proposed new pension plans that share the investment risk between employers and employees.

Under a target benefit plan, employers and employees jointly oversee the management of a plan that aims to collect defined contributions in order to achieve a targeted benefit in retirement.

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

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

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

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

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

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

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

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

HIMIPref™ Preferred Indices
These values reflect the December 2008 revision of the HIMIPref™ Indices

Values are provisional and are finalized monthly
Index Mean
(at bid)
Mod Dur
Issues Day’s Perf. Index Value
Ratchet 0.00 % 0.00 % 0 0.00 0 0.4761 % 2,418.5
FixedFloater 4.67 % 3.90 % 31,789 17.71 1 0.0491 % 3,679.9
Floater 3.02 % 3.15 % 49,640 19.35 4 0.4761 % 2,611.3
OpRet 4.35 % -4.70 % 36,126 0.11 2 0.1550 % 2,698.4
SplitShare 4.80 % 4.27 % 63,745 4.22 5 -0.0238 % 3,089.3
Interest-Bearing 0.00 % 0.00 % 0 0.00 0 0.1550 % 2,467.4
Perpetual-Premium 5.54 % -7.68 % 106,515 0.09 13 0.0000 % 2,390.5
Perpetual-Discount 5.40 % 5.38 % 110,416 14.63 23 -0.0093 % 2,495.6
FixedReset 4.67 % 3.61 % 190,473 4.32 80 0.0550 % 2,536.6
Deemed-Retractible 5.03 % -3.50 % 144,580 0.14 42 0.0517 % 2,497.3
FloatingReset 2.66 % 2.43 % 171,747 4.08 5 0.0000 % 2,481.2
Performance Highlights
Issue Index Change Notes
TRP.PR.C FixedReset 1.03 % YTW SCENARIO
Maturity Type : Limit Maturity
Maturity Date : 2044-04-23
Maturity Price : 22.25
Evaluated at bid price : 22.58
Bid-YTW : 3.69 %
Volume Highlights
Issue Index Shares
BMO.PR.S FixedReset 1,557,213 New issue settled today.
Maturity Type : Call
Maturity Date : 2019-05-25
Maturity Price : 25.00
Evaluated at bid price : 25.42
Bid-YTW : 3.65 %
RY.PR.Z FixedReset 60,425 Nesbitt crossed 24,000 at 25.50.
Maturity Type : Call
Maturity Date : 2019-05-24
Maturity Price : 25.00
Evaluated at bid price : 25.61
Bid-YTW : 3.41 %
MFC.PR.L FixedReset 42,269 RBC crossed 24,800 at 24.87.
Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.91
Bid-YTW : 4.02 %
BNS.PR.Z FixedReset 37,596 TD crossed 10,000 at 24.38.
Maturity Type : Hard Maturity
Maturity Date : 2022-01-31
Maturity Price : 25.00
Evaluated at bid price : 24.40
Bid-YTW : 3.57 %
ENB.PR.D FixedReset 28,424 Nesbitt crossed 21,500 at 24.40.
Maturity Type : Limit Maturity
Maturity Date : 2044-04-23
Maturity Price : 23.02
Evaluated at bid price : 24.35
Bid-YTW : 4.14 %
BAM.PR.X FixedReset 27,570 RBC crossed 21,500 at 21.66.
Maturity Type : Limit Maturity
Maturity Date : 2044-04-23
Maturity Price : 21.34
Evaluated at bid price : 21.65
Bid-YTW : 4.28 %
There were 16 other index-included issues trading in excess of 10,000 shares.
Wide Spread Highlights
Issue Index Quote Data and Yield Notes
CU.PR.G Perpetual-Discount Quote: 21.81 – 22.34
Spot Rate : 0.5300
Average : 0.3500

Maturity Type : Limit Maturity
Maturity Date : 2044-04-23
Maturity Price : 21.51
Evaluated at bid price : 21.81
Bid-YTW : 5.22 %

ENB.PR.Y FixedReset Quote: 24.01 – 24.42
Spot Rate : 0.4100
Average : 0.2662

Maturity Type : Limit Maturity
Maturity Date : 2044-04-23
Maturity Price : 22.76
Evaluated at bid price : 24.01
Bid-YTW : 4.20 %

TD.PR.P Deemed-Retractible Quote: 26.23 – 26.58
Spot Rate : 0.3500
Average : 0.2352

Maturity Type : Call
Maturity Date : 2014-05-23
Maturity Price : 25.75
Evaluated at bid price : 26.23
Bid-YTW : -17.75 %

GWO.PR.H Deemed-Retractible Quote: 23.13 – 23.47
Spot Rate : 0.3400
Average : 0.2252

Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.13
Bid-YTW : 5.87 %

MFC.PR.F FixedReset Quote: 23.17 – 23.47
Spot Rate : 0.3000
Average : 0.1989

Maturity Type : Hard Maturity
Maturity Date : 2025-01-31
Maturity Price : 25.00
Evaluated at bid price : 23.17
Bid-YTW : 4.28 %

NA.PR.L Deemed-Retractible Quote: 25.26 – 25.53
Spot Rate : 0.2700
Average : 0.1721

Maturity Type : Call
Maturity Date : 2014-06-14
Maturity Price : 25.00
Evaluated at bid price : 25.26
Bid-YTW : -4.43 %

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