A simple risk-free money procedure

This post is not to be taken seriously, but if you actually tried it, it would work.

Steps:

1. Have marginable assets (i.e. shares of widely held and liquid companies) in Interactive Brokers.
2. Withdraw cash from Interactive Brokers. For every $100 in shares you have, you will be able to borrow $70 in cash (using Canadian shares of widely held companies as an example, which allow for 30% margin). This obviously leaves zero room for a decline in equity price, so you would have to judge accordingly.
3. Observe margin rate. Currently 1.753% for the first $120,000 and 1.253% for the next $980,000.
4. Deposit cash proceeds into Ally, with a current interest rate of 2%. (Note: The risk here is that Ally would go belly-up, and CDIC only covers $100,000).
5. Whenever the margin spread goes to zero, close the transaction.
6. When it comes to tax time, remember to deduct the interest expense (margin) against the interest earned.

Assuming you had $142,857 in stocks in your account, you could conceivably pull out $100,000 cash and be able to earn an extra pre-tax $247/year, at current rates risk-free!

Obviously there is a limit to how this scales up, but you can easily see how the same procedure can apply to anything else with a higher yield. The risk you have to manage is the risk of losing principal on the investment (in this case you are investing in cash earning 2%, but in real-life scenarios people would typically invest in preferred shares or corporate debt or any other yield-bearing investment), liquidity risk (if another 9/11 happened and you were not able to sell your shares, you would be in trouble) and margin risk (making sure that you are not forced to liquidate the holdings).

Borrowing money at low rates and investing it in higher rate products is what banks and insurance companies typically do, but there is no reason why retail investors, assuming they know what they are doing, can’t get in the action as well.

Feeling brave? Invest in Greece

The National Bank of Greece has an issue of preferred shares which trades on the NYSE that gives out $2.25/year in quarterly payments. Right now they are trading at an implied yield of 12.8%, assuming they actually pay. They are non-cumulative, and callable @ $25 in 2013, but this seems to be unlikely at the moment.

Yield chasers might note that if the crisis continues to worsen, 12.8% might go significantly higher, so market timing is a critical element in picking it off.

I won’t be touching these securities, I have a strict rule against investing outside my depth, and certainly the internal political situation and the dynamics of the Greek banking sector are far from my field of expertise.

Never use market orders

A trading example (of which I did not participate at all) of the day – the company in question is Pacific & Western Credit Corporation:

We see the stream of trades:

Time Price Shares Change
14:11 3.000 200 -0.250
14:11 3.010 400 -0.240
14:11 3.000 3,000 -0.250
14:11 2.760 900 -0.490
14:11 2.900 500 -0.350
14:10 3.160 5,000 -0.090

What happened?

Some guy put in an order to sell 5000 shares, and got filled in at 3.16. This might have triggered a stop order, which was sent to the market at the nearest available bids, in this case 2.90 and 2.76. The market maker likely stepped in at this point and picked up shares at 3 and above. Right now the bid-ask is 3.12-3.17.

The advice I have for absolutely everybody is you should never, EVER use market orders. If you must hit the market, enter in a limit order buy at the ask or above, or a limit order sell at the bid or below, but never use market – it is just giving a blank cheque to people that most certainly rip you off.

Whoever was on the selling end of those 900 shares at 2.76 paid about $360 for the privilege of getting rid of their shares at a low price.

Greek credit crunch analysis

The impact of the European Union’s credit crunch in their less than financially solvent countries is playing out before our eyes. Since the market has had the ability to see this event happening far in advance, I do not believe the impact will be nearly as severe as the US credit crunch. In addition, the US/Canadian direct exposure to Greek debt is limited, but indirect exposure (via the European banks, who have the real exposure) may be significant.

The obvious impact, now that this has clearly hit the media, is the following:

1. Whenever there is a financial crisis, the rush to safety always goes into US dollars and US treasury bonds. 30-year yields are down from 4.8% to 4.4% in April. Canadian bonds have seen some inflow, but not nearly as much as the USA.

2. US currency, relative to the Euro is signifciantly higher, but this has been being priced into the market over the past few months. The Canadian dollar has been relatively unchanged against the US currency.

3. Stocks will take their tumbles as people rush for liquidity and reduce risk.

4. Commodities will be lower due to less implied demand.

The EU bailout will, at most, be a band-aid for the Greek government, but does not address the underlying problem in any way, mainly that the list of entitlements that the Greek government has promised its people it cannot pay for. This should be a word of caution for those that think the government can continue to have most of its people on the dole without consequence – if there is no political will to reform entitlement programs, then the financial market will make the decision for you. In the case of Greece, it has clearly come to this point.

Greece, by joining the Euro, has removed one important tool that could have otherwise allowed it to recover – currency devaluation. Without a devaluation option, they have to make politically much more difficult choices.

In the grand scheme, Canada is relatively placed better than most European countries, as long as we don’t keep giving out entitlements thinking they are free.

In terms of future decisions, it would imply that interest rates would be kept lower with an expanded European crisis than without, so this could be a boost to fixed income securities.

I don’t think this will transform into a market meltdown like what happened in 2008, although again, I could be wrong. If the markets do continue to plunge, this is exactly what you have cash reserves for – to snap up underpriced bargains that have gotten to that price level because of other people forced to liquidate.

Financial Psychology – Real Estate

When seeing a post like this, which describes somebody posting a piece of paper saying “Don’t become a mortgage slave!” on a telephone poll or plastering a “Certified Bubble Pricing!” sticker on a realtor’s sign, it makes me wonder – why do they do it?

In fact, why is real estate and gasoline prices the only real conscious items where we lament the high price, as opposed to inflated equity pricing, or inflated bond pricing (i.e. low interest rates)?

It’s likely because such commodities are heavily transparent in daily life – everybody needs a roof over their head, and many people own a car and consume gasoline.

In the case of real estate, it can also be divided into two general categories for the common person – people that do not own a place, and people that do. The people that do own are very unlikely to engage in such dialog, so it can only be assumed that people that do not own real estate take the time to do such activity.

Finally, such activity highly suggests that these people would eventually want to own, if the price is acceptable (whatever it may be). It is unlikely that somebody that has zero interest in purchasing real estate would go through such an effort.

My pondering is the following – is the goal of this person to “save” other people? Or is their goal to lessen demand in the market, causing lower prices in the marketplace?

In either case, you have to question the motives since it just seems like that if real estate in Vancouver did correct by some magnitude that the people putting up the message would be buying themselves, serving as a buffer against price decreases.

I am always fascinated by this concept of “needing to own”, when ownership is better conceptualized as “renting title from the government”. The government still has control over the land usage (through zoning), and if you want to do any significant improvements to your lot, you need approval from regulatory authorities in terms of obtaining a building permit with requisite approvals. Ownership used to mean control, but control in the modern era has been whittled down by regulations. The intangible benefits to ownership appear to be selecting which colour of paint to put on the walls and the right to own a pet, and people have to pay a very heavy premium for those rights. I can see, however, how the cultural concept of ownership has inflated the value of it.

One other constraint that most people face is the inability to invest surplus capital in products other than low-interest bearing GICs – most people have been burned by other financial products, and thus view their mortgage/home equity as an optimal investment vehicle. This is part of my argument why real estate valuation is so high in Vancouver, because of historical performance, including that relative to other financial products.