Economics – Page 15

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.

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.

The US will not default

I was very curious why the markets tanked when S&P put out a notice that their credit outlook on the USA is negative. It is not like the world knew that they were incurring massive deficits and will find it mathematically impossible to bridge the gap without a political stimulus of the world turning off the capital spigot.

The USA also has the advantage of being able to print its own money, and borrow in its own money. This advantage is compared to the Eurozone countries, which cannot print Euros willy-nilly.

Instead of defaulting, it is quite apparent that the USA is choosing to inflate and dilute the value of its currency. This is not a permanent solution – they still must address the fundamental issue, mainly pouring more money out the window than taking in.

Although there will not be a default, holding US cash is a very difficult decision because its purchasing power will continue to whittle away. People have found diversification avenues in commodities, but you have to weigh in a whole bunch of other dynamics that you wouldn’t have to with plain cash – just ask investors in Uranium. Diversification is also available in real estate, but that has not been very good for US investors for the past few years – and indeed, real estate implicitly bets on the ability of the various states to enforce and respect land titles and property rights. This generally leaves the stock markets – where you can take a risk that companies will be able to maintain their cash flows, assuming the US government doesn’t tax it away to pay off their debts.

An interesting starting point is to look at your own personal consumption habits and invest to simply hedge your lifestyle consumption – for example, if you consume gasoline, purchase an oil company that has sufficient reserves. If you use a mobile phone, purchase shares in that telecom company. Assuming you are paying fair value, you will be able to offset cost increases in your consumption with equity valuation rises.

Onset of food price inflation

The best measure for food price inflation is usually through Loblaws’ quarterly releases.

In their year-end release, they have the following comment on food prices:

– the Company’s average quarterly internal retail food price index
was flat. This compared to average quarterly internal retail food
price deflation in the fourth quarter of 2009.

Anecdotal evidence by my food shopping trips to Superstore would suggest that food prices are increasing somewhat. For example, a 4 litre jug of milk is about CAD$4.40 presently, while a couple years ago it used to be around $3.90. The BC Dairy Board might have to do with this price increase. I also notice prices for bread products creeping up to around CAD$3 for a 1.5 pound loaf of good quality bread, although they do have a freshly baked 99 cent French Bread which is a very good value if you can use a knife to slice it. It has been this price for the past five years.

Staple commodities such as grains and sugar have been rising significantly over the past couple years since the economic crisis, and combining this with energy price increases, there doesn’t seem to be a way that costs can be kept down other than with removing labour costs from products. This does not bode well for employment.