Wall Street suffered its worst day in eight months on Wednesday, and the TSX didn’t do much better, suggesting that the new North American trade agreement and the parade of upbeat U.S. economic reports have taken a back seat to what investors fear is coming next: Rising borrowing costs and squeezed profit margins.
Global stocks were pummeled just days after U.S. indexes celebrated fresh record highs, amid simmering concerns about rising bond yields, increased trade tensions between China and the United States and speculation that corporate financial results will soon disappoint. U.S. technology stocks and Canadian energy names were among equities hardest hit.
The S&P 500 fell 94.66 points, or 3.3 per cent, to 2785.68, touching a three-month low. The Dow Jones Industrial Average fell 831.83 points or 3.2 per cent, to 25,598.74.
The turbulence occurred well beyond U.S. markets though. U.K. stocks fell 1.3 per cent and German stocks fell 2.2 per cent.
In Canada, the S&P/TSX Composite Index fell 336.65 points or 2.1 per cent, to 15,517.40. The latest dip continued a losing streak for Canadian stocks that began last week soon after political leaders tentatively agreed to the United States-Mexico-Canada Agreement (USMCA), removing a key concern over North American trade.
Wes Gray had some interesting remarks in the Globe, by which I mean I agree with them:
Despite heightened awareness around fees and their power to destroy long-term returns, Canadians saving for retirement are still parking their money in traditional mutual funds, the vast majority of which carry management expense ratios of 2 per cent or more. “Down in the States, if you had a fund that charged 2 per cent plus, you’d get murdered,” Mr. Gray said.
…
In the U.S., everything’s getting more transparent. Canadians are pretty bright folks and yet their financial system is like North Korea. We know the reason – the banks control everything. Canada just seems so prime to move into the future but for some reason it’s slow on the uptake. A lot of it comes down to distribution channels where you never get to see the real fees. We would love to help people be more cognizant of fees and not just believing whatever the bankers are telling you.
The FDIC has released a paper by Haelim Anderson, Daniel Barth and Dong Beom Choi titled Reducing Moral Hazard at the Expense of Market Discipline: The Effectiveness of Double Liability Before and During the Great Depression:
Prior to the Great Depression, regulators imposed double liability on bank shareholders to ensure financial stability and protect depositors. Under double liability, shareholders of failing banks lost their initial investment and had to pay up to the par value of the stock in order to compensate depositors.We examine whether double liability was effective at mitigating bank risks and providing a safety net for depositors before and during the Great Depression. We first develop a model that demonstrates two competing effects of double liability: a direct effect that constrains bank risk-taking due to increased skin in the game, and an indirect effect that promotes risk-taking due to weaker monitoring by better-protected depositors. We then test the model’s predictions using a novel identification strategy that compares state Federal Reserve member banks and national banks in New York and New Jersey. We find no evidence that double liability reduced bank risk prior to the Great Depression, but do find evidence that deposits in double-liability banks were stickier and less susceptible to runs during the Great Depression. Our findings suggest that the banking system was inherently fragile under double liability because of the conflict between shareholder incentive alignment and depositor market discipline; the depositor protection feature of double liability reduced the threat of funding outflows but may have undermined its effectiveness as a regulatory tool for reducing bank risk.
…
In this paper, we study the effectiveness of double liability as a regulatory tool for reducing bank risk and as a safety net for protecting depositors. We begin by providing a simple model that characterizes two competing effects of double liability on bank risk-taking. The first is a reduction in moral hazard that results from shareholders’ increased skin in the game (Esty (1998), Grossman (2001), Mitchener and Richardson (2013), Koudijs, Salisbury, and Sran (2018)). However, double liability also reduces market discipline by depositors, who receive more protection from losses in the event of a bank failure. All else equal, this weakened market discipline may actually promote bank risk-taking.
Actually, the first question that occurs to me is: how seriously can we take the shareholders’ promise to pony up cash for a failed enterprise? Early in my career I was fascinated by the Husky Energy deposit receipt fiasco, in which deposit receipts were issued for $X at a time when the stock was trading at $2X (the remaining $X of the share purchase price was due about a year later; it was a forward contract, not an option!). The stock promptly fell below $X, resulting in a negative value for the deposit receipts and with much excitement trading began with negative prices … i.e., the purchaser of a receipt got the position AND a sum of money from the seller.
I’ve never been able to find anything on the internet about this, presumably because it happened before the internet existed. The regulators should be funding and publicizing a study on the matter, but you’re going to have to search a long time before you find a regulator with any interest in doing a decent job.
There were a LOT of defaults when the receipts came due; it proved to be difficult to find many of the purchasers whose only known address was a foreign post-office box. I wouldn’t put any credence in any promises to pay double liability unless there was a ferocious regulatory regime in which the depositaries required a matching cash deposit at all times, which kind of defeats the purpose of setting up the system as a ‘capital call’ in the first place.
PerpetualDiscounts now yield 5.65%, equivalent to 7.34% at the standard equivalency factor of 1.3x. Long corporates now yield a little more than 4.20%, so the pre-tax, interest-equivalent spread (in this context, the “Seniority Spread”) is now about 315bp, a slight (and perhaps spurious) widening from the 310bp reported October 3.
So, to answer Assiduous Reader MF, who asked:
I am surprised by the resilience of perpetual prices. I thought that with increased long bond rates that they would drop.
… PerpetualDiscounts are basically maintaining their spreads against long corporates, which is more or less what they should be doing. I expect some narrowing of spreads as overall yield conditions normalize, but we haven’t seen it yet!
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -1.6606 % | 3,154.8 |
| FixedFloater | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -1.6606 % | 5,788.9 |
| Floater | 3.44 % | 3.59 % | 39,543 | 18.33 | 4 | -1.6606 % | 3,336.2 |
| OpRet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.2859 % | 3,233.0 |
| SplitShare | 4.60 % | 4.59 % | 55,520 | 4.74 | 5 | 0.2859 % | 3,860.9 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | 0.2859 % | 3,012.4 |
| Perpetual-Premium | 5.60 % | -2.28 % | 59,026 | 0.14 | 12 | -0.0861 % | 2,921.7 |
| Perpetual-Discount | 5.52 % | 5.65 % | 64,850 | 14.44 | 21 | -0.3137 % | 2,968.4 |
| FixedReset Disc | 4.16 % | 5.11 % | 131,339 | 15.23 | 43 | 0.2039 % | 2,605.9 |
| Deemed-Retractible | 5.26 % | 6.18 % | 66,397 | 5.29 | 27 | -0.0351 % | 2,941.3 |
| FloatingReset | 3.55 % | 3.74 % | 40,542 | 5.58 | 4 | -0.3104 % | 2,869.4 |
| FixedReset Prem | 4.87 % | 4.23 % | 220,629 | 2.84 | 34 | -0.0092 % | 2,570.9 |
| FixedReset Bank Non | 3.20 % | 3.98 % | 67,521 | 0.37 | 9 | -0.0316 % | 2,579.1 |
| FixedReset Ins Non | 4.38 % | 5.38 % | 100,084 | 5.32 | 22 | 0.0745 % | 2,562.5 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| BAM.PR.K | Floater | -3.51 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 17.59 Evaluated at bid price : 17.59 Bid-YTW : 3.70 % |
| CU.PR.G | Perpetual-Discount | -1.68 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 20.50 Evaluated at bid price : 20.50 Bid-YTW : 5.57 % |
| PWF.PR.A | Floater | -1.65 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 21.50 Evaluated at bid price : 21.50 Bid-YTW : 3.04 % |
| PWF.PR.Q | FloatingReset | -1.61 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 21.35 Evaluated at bid price : 21.35 Bid-YTW : 3.74 % |
| MFC.PR.N | FixedReset Ins Non | -1.11 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.24 Bid-YTW : 5.97 % |
| PWF.PR.L | Perpetual-Discount | -1.10 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 22.18 Evaluated at bid price : 22.46 Bid-YTW : 5.68 % |
| MFC.PR.Q | FixedReset Ins Non | -1.08 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.75 Bid-YTW : 5.82 % |
| SLF.PR.E | Deemed-Retractible | -1.05 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 20.78 Bid-YTW : 8.03 % |
| PWF.PR.P | FixedReset Disc | -1.01 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 19.60 Evaluated at bid price : 19.60 Bid-YTW : 4.91 % |
| RY.PR.H | FixedReset Disc | 1.02 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 23.24 Evaluated at bid price : 23.84 Bid-YTW : 4.94 % |
| MFC.PR.B | Deemed-Retractible | 1.02 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 20.71 Bid-YTW : 8.30 % |
| PVS.PR.F | SplitShare | 1.03 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2024-09-30 Maturity Price : 25.00 Evaluated at bid price : 25.41 Bid-YTW : 4.59 % |
| GWO.PR.N | FixedReset Ins Non | 1.08 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 18.80 Bid-YTW : 8.26 % |
| GWO.PR.P | Deemed-Retractible | 1.20 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.41 Bid-YTW : 5.92 % |
| RY.PR.J | FixedReset Disc | 1.35 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2020-05-24 Maturity Price : 25.00 Evaluated at bid price : 24.79 Bid-YTW : 4.45 % |
| BAM.PR.X | FixedReset Disc | 1.48 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 19.15 Evaluated at bid price : 19.15 Bid-YTW : 5.18 % |
| MFC.PR.H | FixedReset Ins Non | 1.53 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 24.60 Bid-YTW : 5.99 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| CM.PR.S | FixedReset Disc | 99,690 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 22.81 Evaluated at bid price : 23.97 Bid-YTW : 4.96 % |
| MFC.PR.G | FixedReset Ins Non | 75,497 | YTW SCENARIO Maturity Type : Call Maturity Date : 2021-12-19 Maturity Price : 25.00 Evaluated at bid price : 24.15 Bid-YTW : 5.16 % |
| MFC.PR.O | FixedReset Ins Non | 72,540 | YTW SCENARIO Maturity Type : Call Maturity Date : 2021-06-19 Maturity Price : 25.00 Evaluated at bid price : 25.80 Bid-YTW : 4.49 % |
| TRP.PR.A | FixedReset Disc | 65,050 | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2048-10-10 Maturity Price : 20.60 Evaluated at bid price : 20.60 Bid-YTW : 5.25 % |
| BMO.PR.D | FixedReset Prem | 62,849 | YTW SCENARIO Maturity Type : Call Maturity Date : 2022-08-25 Maturity Price : 25.00 Evaluated at bid price : 25.20 Bid-YTW : 4.36 % |
| BMO.PR.E | FixedReset Prem | 61,309 | YTW SCENARIO Maturity Type : Call Maturity Date : 2023-11-25 Maturity Price : 25.00 Evaluated at bid price : 25.40 Bid-YTW : 4.59 % |
| There were 45 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| MFC.PR.C | Deemed-Retractible | Quote: 20.00 – 21.19 Spot Rate : 1.1900 Average : 0.7515 YTW SCENARIO |
| MFC.PR.R | FixedReset Ins Non | Quote: 25.23 – 25.90 Spot Rate : 0.6700 Average : 0.3672 YTW SCENARIO |
| BAM.PR.K | Floater | Quote: 17.59 – 18.20 Spot Rate : 0.6100 Average : 0.3759 YTW SCENARIO |
| TD.PF.D | FixedReset Disc | Quote: 24.57 – 25.00 Spot Rate : 0.4300 Average : 0.2651 YTW SCENARIO |
| PWF.PR.A | Floater | Quote: 21.50 – 21.90 Spot Rate : 0.4000 Average : 0.2894 YTW SCENARIO |
| CM.PR.Q | FixedReset Disc | Quote: 24.61 – 24.97 Spot Rate : 0.3600 Average : 0.2572 YTW SCENARIO |