Investment Vacation Mode

I have still been somewhat on investment vacation mode – I have not been making any portfolio alterations, and have been letting time pass by.

It is a very, very, very important concept in investing that decision be made with the fullest of convictions, after research. It is usually a good way to lose money to “force” trades, or to try to reduce the cash balance to zero. When you see cash earn a short-term return of 2% sitting in an account, it is frustrating to know that you could invest it, minimally, in some preferred shares that yield 6.5%, but what inevitably happens is that when you want to utilize this cash, you will take a capital loss selling your preferred shares.

I think a lot of retail investors out there are chasing yield and are shying away from non-income bearing equity. You will continue to see inflows in bond and income funds, while equity will be shunned. This is something I will be eyeing a little more closely in terms of taking advantage of the matter.

The one huge advantage of cash is that it retains its principal value and is completely liquid to do whatever you want with it when the opportunity arises. Right now I am just not finding much in the way of opportunity, and hence, I wait patiently and enjoy the Canadian summer, as short as it is. This makes for boring writing, but boring is better than the alternative – permanent loss of capital.

Choosing the right credit card will save some money

For personal expenditures, some shopping around for a credit card that is aligned with ones’ spending profile will result in some savings. It will not be a life-changing amount, but it will be a perk. Some people like to collect airline miles and some like to collect points in their favourite retailers. As long as you cash in the rewards in a timely fashion, it will typically result in a 1-2% payback compared to the amount of money you spent on the card. In other words if you spend $10,000 a year on a credit card, typically you should be receiving something worth $100-200 had you paid for it in cash.

In light of the fact that credit card processors generally charge merchants over 2% for the privilege of having people use credit cards, they are still profiting, but the price you pay at retail inevitably reflects this premium. Merchants and people are essentially locked into using credit cards given that there is currently no differential payment (i.e. reduced prices for cash purchasers). You have to choose carefully in order to claim back the implied increase costs at retail. If you are not using a credit card that has some sort of “rewards” feature, then you are typically missing on a slight reduction in expenses.

Currently MBNA is offering a credit card that gives you 3% cash back in groceries and gasoline (5% for the first 6 months), and 1% on everything else. They pay it in $50 increments when you have accumulated the necessary credit. I have found this card quite beneficial to my own spending profile, which tends to be concentrated with the gas and grocery types of expenditures. The couple hundred dollars a year savings is certainly better than choosing a method of payment that does not give you a small kickback.

What will be interesting to see is if merchants start offering 2% discounts for cash purchases. The Government of Canada recently enabled this ability for merchants in their Code of Conduct that was adopted earlier this year. Item 5 is the most relevant.

Canadian Tire is the only major retailer that I know of that has some form of this – they give 1% Canadian Tire money for cash purchases. One wonders if other retailers will give point-of-sale discounts for cash purchases.

Bank of Canada raises rates a quarter point

The Bank of Canada, to nobody’s surprise, raised interest rates by 0.25% today. Key parts of their statement:

Economic activity in Canada is unfolding largely as expected, led by government and consumer spending. Housing activity is declining markedly from high levels, consistent with the Bank’s view that policy stimulus resulted in household expenditures being brought forward into late 2009 and early 2010. While employment growth has resumed, business investment appears to be held back by global uncertainties and has yet to recover from its sharp contraction during the recession.

The Bank expects the economic recovery in Canada to be more gradual than it had projected in its April MPR, with growth of 3.5 per cent in 2010, 2.9 per cent in 2011, and 2.2 per cent in 2012. This revision reflects a slightly weaker profile for global economic growth and more modest consumption growth in Canada. The Bank anticipates that business investment and net exports will make a relatively larger contribution to growth.

…

Given the considerable uncertainty surrounding the outlook, any further reduction of monetary stimulus would have to be weighed carefully against domestic and global economic developments.

The take-home message is that growth projections have moderated to a “business as usual” type of economy after the 2008 calamity and the Bank of Canada is reserving all rights to not committing themselves to future rate increases. It is likely the global situation, rather than the domestic situation, will have significant influence over the decision to continue to raising rates.

As of today, the target rate is 0.75%, and I expect a rate of 1.00% by years’ end.

The only implication of this decision is that short-term corporate paper and inter-bank lending rates will correspondingly increase. People with variable rate mortgages will see interest increases, but this will not be affecting the longer-term fixed rate mortgage rates. The other subtle implication for most people is that financial institutions such as ING Direct might be willing to offer better rates on short-term savings and/or short-term GICs.

Bank of Canada Interest Rate Projections

On July 20, the Bank of Canada is very likely to increase the overnight target interest rate from 0.50% to 0.75%; this has already been baked into the marketplace. The Prime Rate is likely to correspondingly increase from 2.5% to 2.75%.

In terms of what lies ahead in the future, we look at the only financial product in Canada that one can use to predict such rate changes, the 3-month Bankers’ Acceptance Futures:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 JL 0.000 0.000 99.045 0.030 0
+ 10 AU 0.000 0.000 98.960 0.030 0
+ 10 SE 98.875 98.880 98.880 -0.005 10612
+ 10 DE 98.700 98.710 98.710 -0.010 20474
+ 11 MR 98.540 98.550 98.540 0.000 17714
+ 11 JN 98.350 98.360 98.360 0.000 10038
+ 11 SE 98.140 98.150 98.140 0.080 2281
+ 11 DE 97.890 98.110 97.890 0.080 209
+ 12 MR 97.580 97.700 97.680 0.000 341
+ 12 JN 97.370 97.490 97.430 0.090 0

What we see is a 3-month future rate of 1.12% in September; and by years’ end we have a 1.29% rate.

There are four more meetings left in 2010; July 20, September 8, October 19 and December 7.  Right now, the market is speculating that there will be 0.25% increases in two of these meetings, leading to a year-end target rate of 1.00%.  It is possible that after September 8, that the Bank of Canada will leave short term rates unchanged for the duration of the year.

In 2011, the market believes that the short term rate will increase by about 0.75% above this; to 1.75%, still a very low rate by historical standards.

Presumably after its July20 statement it will change the language which will sufficiently guide the marketplace to adjust its prices.

Of note is the impact on mortgage rates; only variable-rate mortgages will be going up as a result of these short-term rate increases.  The reason is because longer-term rates are set by the marketplace, and these have gone down over the past quarter.  A 5-year government bond yields 2.49% currently; this was as high as 3.2% back in April.

BP – When to exit?

Earlier, specifically on June 16, I stated the following about BP:

For people that insist on getting into BP, the next couple weeks should be a good time. The exact timing in terms of price is an unknown variable, but I would estimate layering in 25-30 dollars a share (e.g. if it goes down to 28, you will get a 40% allocation).

Indeed, the common shares fell to a low of 26.75, which means that using the “25-30 dollars a share” algorithm would have resulted in a 62.5% position (e.g. if your typical position is 5% of your portfolio then you would have ended up with 62.5% of 5%, which would be 3.125%). The average price would have been $28.375/share, not factoring in commissions.

Now that BP has risen and the big headline (“they’ve solved the oil leak”) has come out in the news, it brings up questions of what the ideal price to liquidate will be.

I see a two-phased trading approach should work well. The first phase should involve an immediate bump up due to the “news” coming out. This has mostly occurred, as you can see by this one-day chart:

After attracting the initial wave of profit-takers, I anticipate a second wave of demand coming for BP shares which should bring the stock to the $45-50 range. This is the target I would set for my sell order. The simple justification is that I estimate this whole debacle should cost BP about $40 billion dollars, or about $13/share. Before this all began, BP was valued at around $60/share, so simple math would assume an approximate $45-50 valuation, hence the sell point at this price. Assuming the exit is achieved, you would be looking at around a 67% gain on the transaction, which I would estimate between now and the end of the year.

This is a very elementary valuation exercise; naturally to properly model the situation you have to take into assumption the strategic effects of the oil spill (i.e. reduced offshore drilling in the Gulf of Mexico) but also have to strongly factor political considerations.

I have not and will likely not trade common equity in BP, but I have sold puts on Transocean and they have moved out of the money at present from my initial transactions. They will likely expire in August.

This was probably one of the better trading opportunities I have seen in 2010.