Bank of Canada keeping rates steady

The Bank of Canada has kept the target overnight interest rate steady at 1%. This surprised nearly nobody. Their statement is relatively unchanged from the prior one.

The chart to keep looking at is not the BAX futures, but rather the 10-year benchmark government bond yield:

With the yield spread from short-term rates to the 10-year at about 205 basis points, the bank is unlikely to lift rates anytime soon.

BAX futures are as follows:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 JN 98.695 98.705 98.695 0.005 12727
+ 11 JL 0.000 0.000 98.630 0.000 0
+ 11 AU 0.000 0.000 98.615 0.000 0
+ 11 SE 98.630 98.640 98.630 0.000 31347
+ 11 DE 98.500 98.510 98.480 0.020 37387
+ 12 MR 98.350 98.360 98.310 0.040 24564
+ 12 JN 98.200 98.210 98.140 0.060 13081
+ 12 SE 98.040 98.050 97.970 0.070 3855
+ 12 DE 97.870 97.890 97.790 0.090 809

The market has priced in a rate hike by year’s end, but I do not think this projection will come to fruition – come December, the 98.5 price will be likely around 98.7 – a thin value bet could be placed here.

Playing the risk aversion card

I have deployed a good chunk of the idle cash balances (presently earning 2%) into slightly higher-yielding debentures which should mature within a 1-year time frame with little risk – the underlying companies have cash and/or liquidity to pay off the debt without too much difficulty and could withstand a 2008-style financial crisis. The transaction can also presumably be reversed without too much difficulty in case if I need to deploy the capital into a more efficient area.

Researching the public markets is like trying to find those proverbial needles in the haystack – each hour you pour into the haystack increases your chances of finding needles, but in no way are you ever guaranteed to finding them. Also, the way you sort through the hay might be more or less efficient than other haystack sorters, but your own output is proportional to the amount of time you put into the effort.

The markets also give you some hints on how many needles are in the haystack – right now everything appears to be “stable” and there are no world crises occurring of any significance, hence, the broader markets are likely to be closer to efficient pricing than when things were really rocking a couple years ago. I would suspect the number of needles (at least the ones made out of platinum) to be found are few. There are likely to be more silver needles and a lot of lead!

I have not had a lot of time over the past few weeks to efficiently sort through hay, hence, I have been a bit inactive and parking my portfolio into a very risk-averse position. The easiest way to lose capital is to force trades through without some sort of justification why you are getting sale prices on what you are buying. Companies like Hewlett Packard (NYSE: HPQ) appear to be on sale, but I typically shy away from companies with such huge capitalizations, but you never know what you might get.

Here we go again – Market volatility

The main US indicies are down under the reports that more European countries are facing debt downgrades – Italy today is the prevalent one.

However, since I think it is safe to say the whole world knew that other European countries other than Greece are going to face similar meltdowns in their finances, investors should be aware that there are other possibilities – such as a slowdown in demand.

Such a slowdown in demand will not be in favour of commodity markets, but will be in favour of anything defensive – consumer staples, utilities and bonds. The insurance sector should also look good, but these companies are difficult to research.

It is also very difficult to make money in these sorts of marketplaces (at least long-only) since indexers will be selling their equity and thus it becomes a game of timing when the supply stops – this could be months down the road. It is a good time to prime that research list and take advantage if we are going to be seeing a significant drop in equity prices.

Soft Drinks and Pseudovariety

Philip H. Howard, a professor at a university in the state of Michigan, wrote a paper dealing with the structure of the soft drink industry. He determined that when you link the variety of brands back to their parent companies, three companies controlled 89% of the scene given a retail sample in Lansing, Michigan (the state capital, metropolitan area population of approximately half a million people).

When reading the paper, strictly from an economics standpoint, leads me to ask two questions:

1. If you are invested in the industry (e.g. in Coke or Pepsi), how likely is it that the industry will continue to be entrenched as-is for the indefinite future? Warren Buffett made a large bet that it will be. How can a company such as Coca Cola destroy its own brand?

2. If you are a potential competitor to the industry, how do you break into the field and still make money? The industry is quite self-protective and will purchase or destroy competitors, as appropriate – they have plenty of tools to doing so, such as purchasing optimal shelf space at grocery chains, etc. Witness Jones Soda (Nasdaq: JSDA) for an example when you get on the radar of the majors.

Note that there are similar industries in nature – in particular, tobacco and liquor distribution come to mind. Tobacco is an industry that is almost impossible for a newcomer to break into the field because of government protection. Liquor is somewhat less restrictive, but the only real breakthroughs have been with beer and wine as opposed to hard liquor.

Reviewing track record of IPOs and other matters

Now that I have been thinking about some IPOs that I have covered in the past, we have the following:

Whistler Blackcomb (TSX: WB) – I stated in an earlier article that this is one to avoid and I might think about it at $5.30/share and so far nothing has changed this assessment.

Athabasca Oil Sands (TSX: ATH) I did not have a firm valuation opinion other than that the shares seemed to be overpriced at the offering price ($18/share) and stated the following (previous post):

Once this company does go public it would not surprise me that they would get a valuation bump, and other similar companies that already are trading should receive bumps as a result. I have seen this already occur, probably in anticipation of the IPO.

If you had to invest into Athabasca Oil Sands and not anywhere else, I would find it extremely likely there will be a better opportunity to pick up shares post-IPO between now and 2014.

While the valuation pop from the IPO did not materialize (unlike for LinkedIn investors!) the rest of the analysis was essentially correct – investors had the opportunity to pick up shares well below the IPO price (it bottomed out at nearly $10/share in the second half of 2010), although I don’t know whether the company represents a good value at that price or not. I didn’t particularly care because Athabasca Oil Sands has some other baggage that made it un-investable (in my not-so-humble opinion).

While I am reviewing my track record on this site, one of my other predictions dealt with BP, Transocean and Noble Drilling, that:

Over the course of the next 2 years, $10,000 invested in BP (NYSE: BP) at the closing price of June 16, 2010 will under-perform $10,000 evenly invested in Transocean (NYSE: RIG) and Noble (NYSE: NE). Assume dividends are not reinvested and remains as zero-yield cash.

At present, BP would have returned US$14,392.46 to investors, while RIG and NE would have returned US$14,198.52. If I had the ability to close this bet for a mild loss, I would – the political risk for the three companies in question have completely gravitated toward the “status quo” once again after the Gulf of Mexico drilling accident. Drilling capacity is likely to rise, depressing the value of the contractors and favouring BP in this particular bet.