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.

TFSA teaser rate dropped at ING Direct

ING Direct offered a 3% interest rate on TFSA accounts in early January; this was presumably done to capture people’s money in the account. They dropped the rate to 2% at the beginning of the month of May, which is more reflective of the market rate.

Ally continues to be the best option for short term savings accounts, offering 2%. They also offer 4% on a 5-year GIC, which is currently the best rate available.

As Garth Turner points out, GIC products have problems concerning liquidity (in the case of the 5-year GIC you will relinquish 1.5% interest), and also taxability (as ordinary income is fully taxable). He is suggesting the world of preferred shares or corporate debt, two fixed-income products which have different characteristics than GICs.

James Hymas has an excellent document which explains the differences between preferred shares and GICs.

If your goal is to preserve income (note: not capital) then preferred shares generally are a better option than GICs for a multitude of reasons. The only problem for most people, however, is that you’ve got to be doing your homework. If this is done correctly, you will be able to obtain a tax-preferred advantage of likely 200 basis points, if not more, than the prevailing rates offered by GICs. Judging from most of the comments seen in an average post on Turner’s site, it seems that most want to be spoon-fed ticker symbols to purchase.

Canadian Fiscal Monitor, February 2010

The government of Canada released its fiscal report for the 11 months ended February 2010, and we continue to see considerable improvement compared to last year’s results:

In the February 2009 vs. 2010 (one month) comparison:
1. Corporate income tax collections are up 31%;
2. GST collections are up 52%;
3. Other excise taxes and duties are up 22%;

Employment continues to be weak; EI payments are up 35% from the previous year. As EI benefits will only last one year, it is likely that during the same period in 2011 that this number will be lower as employment picks up.

The next month will have tentative results that I will make year-to-year comparisons with, in addition to seeing where the government was significantly off with its fiscal projections compared to the Budget 2009 document that was tabled in late January 2009.

Fixed income and rising interest rates

The public perception is that the value of fixed income securities goes down when interest rates rise.

In a sense, this is true, but how it get reflected in the marketplace is different than what the common “retail” perception is. A better way of phrasing this is that the value of fixed income securities go lower when the there is a perception of interest rates rising.

Even though the whole planet knows that the Bank of Canada overnight rate target is 0.25%, the whole world also knows that this will increase by an amount coming June. This expectation has already been baked into the marketplace, and thus in most circumstances it should be baked into the prices of fixed income securities.

Reading the comments on some Garth Turner articles, where Turner is generally pushing preferred shares over GICs, readers are giving “blowback” stating that the price of those securities will drop when rates rise.

In the eyes of the marketplace, rates are going to rise. You can see this in the 5-year Canadian bond rate.

The question is whether the market prices for preferred securities is going to reflect this or not. In any market, you have to ask yourself about the participants, and a lot of preferred issues are dominated by retail traders. In this event, and assuming retail traders think prices are going to go down because of a flawed notion of a price impact with a rate increase, it would suggest there is a dislocation of information that can be exploited.

Preferred shares require a bit extra research than standard equities or bonds simply because they contain varying provisions which gives the holders and company certain rights that have dramatic effects on their risk profile.

Also, the intent of owning preferred shares is to provide income, rather than capital appreciation and this should always be taken into consideration – it is an alternative to putting money in a savings account, rather than a replacement for an equity (growth) component of a portfolio.