Archive for February, 2009

It’s 3 o’clock, an hour before the close of the markets. I really don’t prescribe to technical analysis for stock trading, but like reading your horoscope, it makes you feel better to see a five star day.  We are currently equal to the old low from last November. Optimists (bulls) cling to the notion that this value represented a low level from which the markets would slowly and carefully resume an new upward trajectory. So to avoid a problem I am posting this before the close of market trading. Maybe the market (world) cares about the S&P 500 staying above 752 or maybe not. Intellectually I know it doesn’t make any difference. Emotionally I could use the boost.

U.S. President Barack Obama is visiting my cold and overcast city today. With this visit Canada becomes the first foreign destination for the new President. This has generally been the case for his predecessors as well. I understand that we won’t get to see him as he will be hidden from view for the 6 hours or so that he spends on Canadian soil. From a foreign policy perspective our hope is that this is the start of a friendly and mutually beneficial relationship between President Obama and Prime Minister Harper. Everyone needs someone they can confide in, especially when the challenges are many (to use Obamaspeak). This is just a meet and greet but if we could submit some questions…

For President Obama

1. Why stimulus? Are tax cuts simply a non starter?  The Regan-Thatcher years were a required response to big deficits and inflation problems of the 1970 and 80s.  Could we jump to a solution that actually worked?

2. How long do we hold the spigot open? Financials, Autos  … who is next?

3. Could we just give the auto workers the money and cut out the middleman? Would this cost less? Has anyone done the math?

4. What engineering superiority are we protecting by maintaining the auto industry as currently configured?

5. How does cutting salaries for Bank Presidents repair the economy?

For Prime Minister Harper

1.  What’s the plan for minimizing the environmental impact of the Alberta Tar Sands? How can we continue to supply this enormous quantity of oil at prices that we do not control without properly matching  all of the costs to the revenue stream?

2. Do you have a plan for Cap and Trade?

3. Do we believe in the gains from trade? What is the Canadian government doing to improve our position in emerging markets like India and China?

4. Now that the North American stock markets are down again this year, any more market timing suggestions you would like to share with us?

5. Who is going to win hockey’s  Stanley Cup this year?

The top rated banking system in the world – Canada, really?  I guess it had to happen sometime. It seems after the recent global carnage, banks that leveraged their assets the least have won. European Banks had borrowed more than fifty times their assets to increase the size of their operating business.  So a 2% loss in net operations pretty much wiped out their equity. The U.S. banks levered north of 25 times so it took a 4% net asset write off. Canada at 15 times has a 6 % cushion. It should be noted that much of the global bank liabilities are guaranteed through deposit insurance, reducing the risk. As we have recently found, relatively small, highly risky ventures can spin out of control. You and I can’t get a loan with 2% equity backing the note. If we did we might be too big to fail as well.

Last week Chancellor of Queen’s University and former Governor of Bank of Canada, David Dodge spoke at a lunch presented by the Canadian International Council (CIC). His topic -Rebuilding the Global economic and financial Order. He had a couple of insightful statements about leverage. In his view changes to accounting standards (FASB)  are adding volatility to stock markets in marking assets to market while leaving debt largely at cost. If debt isn’t repriced  as equity on the balance sheet then you get bigger reductions in earnings in recessions and larger growth in earnings in good times.  Higher highs and lower lows add risk without a corresponding increase in return since debt and equity will end up priced at liquidation value in any case. Transparency is always desired but only if  assets and liabilities ares  treated equally. Mark-to-market is really made up numbers since you only really know what something is worth when someone else pays to buy it.

Mr. Dodge is also a proponent of good regulation. He thinks that Canadian Banks may have ended up in a deeper problem without strong  federal guidelines. He concludes that upcoming G20 meetings present the best opportunity to co-ordinate meaningful global improvements in the economy.

In my opinion,  Canadian Banks would find themselves in the same position as  U.S. Banks had they been allowed to operate unfettered from regulation. For example, foreign ownership limits are federally imposed on the sector. Canadian banks lobbied to have them removed so that they might merge and invite larger interests to invest. It is lucky for them that they were unsuccessful in that effort.

All good and bad things come to an end. This financial crisis will as well. So to track the progress we have to first define the beginning. My metric is the last high of the market as defined by the S&P 500.  So the bear market began October 9, 2007 closing at 1565. A bear market is commonly defined as a 20 percent decline in the index. This is the 7th bear market of the past 40 years and by measure of decline the only S&P 500 drop to exceed 50%.  The lowest point was 741 on November 21, 2008, a 52% decline. Today we are down 47% from the 2007 high. Stock prices are immediate measures and are often referred to as leading indicators or predictors of where the economy might be going.

This bear market began as a financial problem and is now a full blown world wide recession. A recession is 2 consecutive quarters of negative real GDP. Recessions are backward looking measures as it takes time to collect the data.  This predictive ability comes with a degree of error as many more recessions have been predicted by the market than have come to pass.

The U.S. recession officially began in December 2007. The  National Bureau of Economic Research publishes some good data on past recessions. Peak to trough since the Second World War, the average recession has lasted 10 months. The range is large however: the longest peak to trough was experienced through the U.S. Civil War at 65 months. In the 1930s the duration was 43 months.  Unfortunately, there isn’t enough computing power in the world to confidently predict the end of a recession. The economy is simply too complex.

I think the stock markets will rebound. Optimism has always won in the end. The S&P 500 first hit 100 in 1968. Today, we worry as the Index has fallen below 900. This isn’t gravity, it’s a measure of growth in the economy. The economy is larger, the population has grown, companies make  more money, and these fundamentals are eventually reflected in the value of the index.

In future posts I will continue to review the evidence to try to determine when the uphill swing begins. Stay tuned…

I recently finished reading Outliers by Malcolm Gladwell. This current best seller is written by author of The Tipping Point and Blink. It’s a short read that is, in my opinion, worth the effort.  The central theme is success . Outliers, for the purposes of this book, are people who have achieved exceptional results in their professional pursuits compared to those who have perhaps underperformed.   There were a couple of notions that I found especially useful.  Gladwell claims that there is plenty of evidence suggesting that it takes 10,000 hours to master a profession. Based on a 2000 work year that adds up to about 5 years. He looks to the life works of masters like Mozart and Gates to demonstrate this time line. He concludes that intelligence, to a degree, plays a roll in the success, in that a minimum standard is required.  More importantly, demographics, timing and perhaps luck are the key contributors.

There is a Darwinian notion here for me. Outcomes are, to an extent, predetermined. Outliers appear continually and their impassioned exploits are rejected or rewarded based on things that are largely out of their control.  Demographics,  perhaps like natural selection, decide the timing for these mutations.  Gladwell concludes that the individual player has less to do with the outcome than we might give credit for… so I think I’ll wait for the unifying theory.

These notions can be considered when looking at our new generation of leaders.  The Jones Generation refers to that portion of the  population born between 1955 and 1964. They are the lost generation, sandwiched between Boomers and Gen Xs. President Obama and Prime Minister Harper are part of Gen Jones.  This generation had the shared experience of starting their careers in the recession of the early eighties. There  is a certain shared frustration as a result of  high expectations for success meeting 20% interest rates.  The view is that their older boomer brothers and sisters had an easier road.  Apparently, once they did manage to get a toehold on careers and families, the Joneses turned into perhaps  the greatest consumer generation of all time. It seems that as leaders the Joneses should remember some of the lessons of the early eighties. Tough times require a willingness to compete. Perhaps 10,000 hours working through a previous recession will serve as great training for this current group of leaders to succeed in the task at hand.

The financial press appears to be drawing parallels between our current financial challenges and the depression of the 1930s. To some it may seem reasonable. Yesterday, British Prime Minister Gordon Brown, in the House of commons, referred to the economic environment as a depression, though he later explained that he simply got the words wrong meaning to say recession. This is how rumours start.

While drawing parallels may make it easier to explain complex subject matter, there are many differences between now and then.

1. In the 1930s there was no social security. Today these cheques, delivered monthly, provide a basic level of subsistence.

2.  Peoples’ savings are protected from bank failures through federal deposit insurance. In the 30s investors lost their savings when banks defaulted.

3. Governments around the globe have lowered interest rates in response to a weak economy. In the 30s the U.S. actually raised rates simply getting the monetary policy wrong. These rate cuts are significant. The Bank of England is currently at 1% for fed funds, the lowest level since the Bank was established in the the 1700s . Japan has lowered the rate to zero. Canada and the U.S. are at 1%.

4. There has been a global increase in money supply unlike the contraction experienced in the 30s.

5. International trade agreements now promote trade between economies. The escalating trade barriers introduced in the thirties had the opposite effect.

6. As a global trend, corporate and individual taxes are low when compared to the rising tax environment which typified the 1930s.

7. We now have single digit unemployment. In the thirties unemployment exceeded 20% in North America.

8. Governments have acted quickly, introducing a fiscal stimulus package in a globally co-ordinated effort. In the 30s Roosevelt’s “New Deal”  took several years to launch.

9. We have the experience of the depression as our guide.

For a great read and perspective of economic cycles I recommend The Ascent of Money by British Historian  Niall Ferguson. It it densely written, and therefore a moderately difficult read but gives an excellent review of how governments have dealt with crises beginning with the advent of money.