Monthly Archives: February 2011

Large caps appear cheaper than small caps

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Just from my cursory examinations of the markets, it appears that large cap stocks are representing a better value than smaller capitalization issues. I am guessing the market is discounting some form of zero-growth projection in the future for a lot of these firms. One factor to remove from the analysis is government revenues – the theory would be that companies with higher exposure to government business will face pressure as deficits will force spending cutbacks.

Because of the currency differential, US stocks appear to be a better value at the moment – dividend-bearing companies can also be put in the RRSP to avoid withholding tax.

Just as the most basic example, Walmart (NYSE: WMT) is projected to earn about 8.5% of its capitalization this year – much better than sticking it in a 10-year government bond yielding 3.41%. You would think that the company would be able to scale its business appropriately if there was a recession – indeed, by looking at the stock chart you would be hard-pressed to see even a hint of an economic crisis in 2008-2009. You don’t even have to do any research – there is virtually no chance of Walmart not being able to produce profitable retail business in the medium-term future. This is contrasted with Amazon, which has to justify its valuation with huge amounts of growth over the next decade.

You will never see your investment in WMT rise by 30% in a year, but then again, you will not see it sink 30% either. It almost trades like a bond. It is a typical good “grandmother” stock.

There are many better (and smaller) examples of large cap companies that are trading at very attractive valuations, have a “moat”, and unlike Walmart, you could envision scenarios where they will warrant higher valuations.

Onset of food price inflation

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The best measure for food price inflation is usually through Loblaws’ quarterly releases.

In their year-end release, they have the following comment on food prices:

– the Company’s average quarterly internal retail food price index
was flat. This compared to average quarterly internal retail food
price deflation in the fourth quarter of 2009.

Anecdotal evidence by my food shopping trips to Superstore would suggest that food prices are increasing somewhat. For example, a 4 litre jug of milk is about CAD$4.40 presently, while a couple years ago it used to be around $3.90. The BC Dairy Board might have to do with this price increase. I also notice prices for bread products creeping up to around CAD$3 for a 1.5 pound loaf of good quality bread, although they do have a freshly baked 99 cent French Bread which is a very good value if you can use a knife to slice it. It has been this price for the past five years.

Staple commodities such as grains and sugar have been rising significantly over the past couple years since the economic crisis, and combining this with energy price increases, there doesn’t seem to be a way that costs can be kept down other than with removing labour costs from products. This does not bode well for employment.

Bank of Canada Interest Rate Projection

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I am projecting that the Bank of Canada will leave the short term interest rate target at 1%. Their next policy rate announcement is on Tuesday.

BAX Futures for March are at 98.67, which suggest a low probability of a rate hike, but I stated before that I very much doubt the Bank of Canada will move until the 10-year benchmark yield is over 3.5% – with the geopolitical instability in North Africa, rates ended last Friday at 3.29%.

Especially with the Canadian currency at relative highs against the US dollar (which has a dampening effect on the export-driven Canadian economy) a rate hike seems unlikely at the moment, but the wording of the text may suggest that the next meeting may consider a hike if conditions warrant, beyond the already existing language.

Difference between West Texas Intermediate and Brent Sea Crude

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This article from the US Department of Energy is educational with respect to the price differential between Brent Sea crude oil and West Texas Intermediate.

It is clear that logistical issues with exporting Canadian oil sands crude will continue, especially if the Enbridge pipeline from Alberta to the Pacific Coast does not proceed. Oil sands production is steadily increasing so the supply pressure will continue to be apparent.

Although crude oil is being mined out, it is subject to cyclical patterns of supply-demand cycles. It should be noted that the last crude spike (in the middle of 2008) was so excessive that in conjunction with the economic crisis, pushed crude down 75% at its trough – producers still must produce supply but if demand lessens they must receive a lower price for the product.

In terms of cost accounting, there are situations where mining product is profitable from a marginal cost perspective, but when you fully burden in capital and other fixed costs, the project as a net becomes unprofitable – we are seeing this somewhat in the natural gas industry presently. Eventually the money-losing producers quit producing and/or demand will increase and you will see a price spike since bringing capacity online is not a speedy process.

Geopolitical concerns – Oil prices

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The headlines making the news right now are focused around political unrest in the North Africa region – first Egypt, now Libya.

This has strategic implications with respect to crude oil pricing – Brent Sea crude has traded significantly higher than West Texas Intermediate, which would suggest that North American markets are somewhat more insulated from what is going on across the Atlantic Ocean.

In terms of market implications, it remains to be seen whether this geopolitical unrest is going to flare up into something bigger (and thus interfering with trade more than it has) or whether it will be a blip that will pass by – and the major indexes continue their seven-month uptrend without any significant correction.

Note that I will be taking a little break and will not be posting for the rest of the week.

Watch out for Questrade – Check those statements

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(Update, February 18, 2011: David Del Grande from Questrade contacted me via e-mail regarding the issue I mentioned in this post. I will keep this post updated and see if they can resolve this issue.)

(Update, February 28, 2011: So far, Questrade has not responded to my reply.)

(Update, March 30, 2011: Much to my shock, I received a voice mail from Questrade and they have credited the amount in question, plus five commissions, to my account. I checked my account status and indeed they have made the appropriate corrections.)

Questrade recently went through an upgrade, and this has caused some disruption to their service.

I noticed that they have incorrectly processed a transaction on my account concerning a debenture trade – I sold some debentures about a week ago, and normally when you sell debt you receive a cash credit for accrued interest. On the trade history, it shows that there were three trades – two “sell” orders and a “cancel sell” which offset one of the sells. I noticed the interest was given on a sale, and taken back on the canceled sale, but the remaining sale did not have the interest income. This is wrong!

It is not a huge amount of money we are considering (about $80) but this sort of process should be correctly automated – I should not be having to waste my time and their time to contact customer support to get this corrected. Other people likely have issues with Questrade, since when I try accessing their live help (which generally has been a good way to correct issues with them), I get the following message:

You have reached Questrade’s Client Services. You are in priority sequence for the next available Client Services Specialist. Thank you for your patience, the average wait time is ’55′ minutes. Thank you for your patience.

There is no way that I am going to keep the window open for 55 minutes.

I am starting to seriously question why I have my money with this firm – they offer the cheapest trades, by far, for debentures and fixed income products. However, other hassles such as this one, offset any cost savings. Since fixed income opportunities are in very short supply these days, it is unlikely I will be needing to trade those products to the degree that I did back in 2009. The other reason why I stick around is because my other broker is Interactive Brokers, where I do the bulk of my transactions, does not do RRSP or TFSA accounts.

Finally, Questrade forced clients away from their dated “Webtrader” platform and onto their “QuestradeWEB” platform. I personally preferred the Webtrader platform as it was very simple, quick and just seemed to “work”. The QuestraderWEB platform is more heavy and takes more time to navigate. I understand their need to migrate people off of a platform that was coded 7 years ago, but why can’t they design a simple user interface to a stock trading service? A poor user interface costs them money – people will trade less.

When does the gravy train end?

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A couple charts: One of the S&P 500 and one of the TSX Composite over the past year:

Over the past half year has been a straight trendline up. Naturally anybody that has invested in anything has seen the winds of the marketplace at their backs. The only question is – when does it end?

The economic recovery is being priced in – in addition to cash being deployed in assets that will yield any sort of return. The only question now is whether this is a rational valuation, or whether these prices have not priced in future unknowns – or perhaps the existing prices have not priced in enough of a recovery and we will continue to see a monster run continue in the indexes.

Encana deal a signal of future natural gas prices

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Encana’s deal with PetroChina, where it sold a 50% interest for $5.4 billion dollars in their Cutbank Ridge property is likely a signal that management believes natural gas prices will remain depressed relative to the run-up experienced in the middle of 2008. The management of PetroChina likely disagrees or is trying to rapidly deploy capital even if they have to pay an expensive price in doing so.

Although the exact terms of the deal are not known, an injection of $5.4 billion in cash leaves Encana in a fairly unleveraged financial position – their total debt at the end of December 2010, net of cash is about US$6.5 billion. Encana will also be spending most of its operating cash flows on capital projects in 2011.

Financial Literacy

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The government of Canada commissioned a task force to study the issue of financial literacy in Canada. The report they released can be found here.

I will restrain my comments to say that just as how (in Western Europe) illiteracy was reduced from about 2/3rds in the 18th century to less than 10% today, I would estimate the financial literacy of Canada as being quite low.

By improving financial literacy, people will have a toolbox to make more efficient decisions. Just like literacy today, where you can be bombarded with outright false information, a financially literate population can be bombarded with financial garbage (such as scams that promote a risk-free 30% annual return), but will be better prepared to discard such trash. This is similar as to how people do not take the items printed on the supermarket tabloids seriously.

Financial literacy is a good idea in concept, but it requires a completely different skillset than written literacy – quantitative know-how. Having the mathematical know-how to properly process financial parameters is not an easy skill to teach. Genetic aptitude towards mathematics greatly helps the process.