Canada hits the polls

Canadians will be subject to relentless federal election advertising over the next 5 weeks as the major parties try to win seats in the House of Commons.

The big financial question will be: Can the Conservative government achieve a majority government? The House of Commons has 308 seats and thus 155 seats are required for a majority. The Conservatives were able to win 143 seats in the prior election.

If the Conservatives do not win a majority, it is more likely than not that the Liberals, NDP and Bloc Quebecois will try to form a coalition government. One of the first items on their legislative agenda will be to raise corporate income taxes, which will have a negative effect on valuations of profitable Canadian companies, in addition to causing capital outflows.

This uncertainty will have some indirect impact on the Canadian markets, and the Canadian currency. In essence, some proxy bets can be made on the outcome of this election. Now that the UBC Election Stock Market is unfortunately not open to allow people to take direct bets on the election, there will only be a limited way for investors to speculate on the outcome.

Just as a word of warning for readers – I do have heavy political involvement and because of this my writing will slow down considerably until the beginning of May (when I presumably will have recovered). There is zero chance of me finding suitable investment candidates in the meantime!

He has power to move markets

John Hempton of Bronte Capital writes very entertaining articles. Most of his extensive postings are about companies that have “issues”, such as his strong suspicions of financial wrongdoing at the Chinese company Universal Travel Group (NYSE: UTA).

His latest spread is regarding Northern Oil and Gas (NYSE: NOG), which I found thoroughly fascinating, for a few reasons.

The first reason is that my earlier article on Petrobakken (TSX: PBN) and its steep decay rate of oil flowing from newly drilled Bakken-shale wells assisted his thinking with respect to NOG’s depletion rates. He is very gracious to link to my article.

The second reason is that apparently the rest of the market has “picked up” on Northern Oil and Gas’ low rate of expending of depletion and has decided to price this in (note the article hit the wires on Tuesday, although it seemingly was digested on Wednesday):

Interestingly enough, before this all hit the wires, NOG had about 20,000 shares available for borrowing at Interactive Brokers. Today there are none.

Thirdly, he writes good analysis. There is good reason to be skeptical of NOG’s management and their intentions. Even disregarding that, it does appear the valuation of the company is well above fair value. That said, the company’s balance sheet does show a net cash position (assuming those balances are truly there!), so the shares are most certainly worth something, unlike most of the other likely frauds that Hempton has been writing about.

Disclosure: No positions in any stocks mentioned in this article, nor do I intend on opening any. I’m watching this purely for entertainment value, although others likely have money on the line.

Back to normal volatility

Curiously, the VIX, after spiking in the aftermath of the Japanese earthquake, and the onset of the military action in Libya, went to a peak of about 30, has slid back down to about 20:

Most people make the mistake of thinking that the VIX is predictive – it is not. It does anti-correlate with the S&P 500, however.

The real question that investors should be asking themselves is that was this just a single ripple in the market pond, or is this a good time to be loading up on index put options while the volatility is still cheap?

Notably, the April VIX futures closed at 21.50 today; going further out, July closed at 23.10. These products are not easy to trade profitably unless if you have a sharp computer model working in your favour.

Group Contrarianism and Japan

My very quick judgment is that “buy Japan” has been contrarian mantra issued to so many people that it now is conventional wisdom.

There is always opportunity to invest in companies that are in the middle of massive public scandals (e.g. BP), but whether such opportunities become a good value is whether people massively misjudge expectations.

In the case of BP, it was a political execution that translated into a disproportionate hit on the share price. In the case of “Japan”, it is very difficult to make the same judgment.

Hence, I’m keeping my eyeballs elsewhere.

Canadian Interest Rate Futures

Examining the short-term interest rate expectations of the futures market:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AL 0.000 0.000 98.710 0.000 0
+ 11 MA 0.000 0.000 98.640 0.000 0
+ 11 JN 98.660 98.665 98.670 -0.005 17877
+ 11 SE 98.490 98.500 98.500 0.000 25173
+ 11 DE 98.310 98.320 98.310 0.000 32785
+ 12 MR 98.130 98.140 98.140 0.000 15601
+ 12 JN 97.950 97.970 97.960 -0.010 4616
+ 12 SE 97.770 97.790 97.790 0.000 945
+ 12 DE 0.000 97.640 97.610 -0.030 648

The Japanese earthquake and general instability in the marketplace has driven the June futures up from 98.545 on March 1st to 98.66 today – which is pricing in a small chance that the Bank of Canada will increase interest rates on their May 31 interest rate announcement. It is far more likely that the short term rate will be 1%.

The futures still anticipate that the year-end short-term rate will be 1.5%, so it will be interesting to see if this comes to fruition. With reports of food inflation rising (primarily due to commodity price increases), the Bank may have to make an undesirable decision to raise interest rates to stem inflation, which would have an adverse effect on the economy and stock markets.

I stated earlier I do not expect the Bank of Canada to raise interest rates until 10-year government bonds go above 3.5%, and they are presently at 3.19%:

Notably, the Canadian 10-year bond is trading at a yield of 10bps less than the US 10-year note.