Category: Canada

(Link: BoC interest rate announcement)

The Bank of Canada surprised somewhat with a non-change in interest rates, but giving obvious forward guidance that rates next meeting are likely to head higher. Today’s BoC meeting is coincidentally aligned with the US Federal Reserve meeting, which also held pat, but announced they were going to stop the additional purchases of government and mortgage-backed debt starting in March.

The two key sentences are in the last part of the Bank of Canada statement:

The Governing Council therefore decided to end its extraordinary commitment to hold its policy rate at the effective lower bound. Looking ahead, the Governing Council expects interest rates will need to increase, with the timing and pace of those increases guided by the Bank’s commitment to achieving the 2% inflation target.

The Bank will keep its holdings of Government of Canada bonds on its balance sheet roughly constant at least until it begins to raise the policy interest rate. At that time, the Governing Council will consider exiting the reinvestment phase and reducing the size of its balance sheet by allowing roll-off of maturing Government of Canada bonds.

This suggests that the target rate will rise (from 0.25% to 0.5%?) on March 2nd, coupled with a slow rollback of their ~$450 billion balance sheet of government and provincial bonds.

The interest rate futures markets were somewhat surprised at the non-rate rise:

… the prices are implying a 1% increase in rates by the end of the year and another quarter-point in early 2023.

One other observation is that the 5-year government bond yield is down to about 160bps – it got up to about 170bps last week which is the highest it has been in some time (great for those rate-reset preferred shares if they’re due to be reset soon – about 50bps higher than they were 5 years ago).

Within the monetary policy report, some items of note:

The neutral nominal policy interest rate is defined as the real neutral rate plus 2% for inflation. The neutral real rate is defined as the rate consistent with both output remaining sustainably at its potential and inflation remaining at target, on an ongoing basis. It is a medium- to long-term equilibrium concept. For Canada, the economic projection is based on an assumption that the nominal neutral rate is at the midpoint of the estimated range of 1.75% to 2.75%. This range was last reassessed in the April 2021 Report.

Notably with the above, the market is predicting an interest rate at the lower range.

Consumer price index (CPI) inflation is expected to be higher than projected in October. The outlook for CPI inflation in 2022 is revised up by about three-quarters of a percentage point to 4.2% and remains unchanged in 2023 at 2.3%. This upward revision mainly reflects larger impacts from various supply issues, notably those affecting shelter costs and food prices.

The projected CPI will continue to make headlines as the monthly reports come in. Considering the huge price spikes on the inputs to consumer supply (energy, wood, metals, etc.) it is difficult to see how costs will not be rapidly increasing in the future – especially considering the other component – which is human know-how – will be rapidly rising in price as well, likely in excess of commodity prices themselves.

And in what I consider to be the award for the month for the “most unnecessarily complex data visualization”, we have the following gem:

Should anybody be shocked that the purple #1 (upper-left hand side) represents “Employment level index, public sector”?

Here is my take-away: The Bank of Canada is heavily anticipating that things will ‘correct themselves’ through two effects – supply chain resolution, coupled with restoration of global conditions (allowing for exports). They assume domestic spending and consumption will resume as the Covid effects abate, and this will drain the accumulation of savings that were distributed in the past couple years.

I don’t see it this way. The separation of employment characteristics, for example, by age/gender and “public sector”, and “mid-high wage”, does not tell the story at all. It is very much unexplained (at least in the eyes of the Bank of Canada) why there are persistent labour shortages. The most obvious explanation is that what is being offered vs. the headaches of employment compared to what such employment purchases is out of proportion. In other words, wages need to rise dramatically, or what the existing wages can purchase need to increase – the latter case is not going to happen due to continual monetary debasement. People are basically deciding to exit the game – and some perhaps are becoming full-time cryptocurrency traders.

The best thing the central banks can do is engage in a massive monetary draining. The bitter pill would last a couple years, similar to what former FOMC chair Paul Volcker did when he raised interest rates into the double digits in the late 70’s and early 80’s. This facilitated a monetary cleansing. The central banks will not do this, one reason being it would collapse the asset markets and given the amount of debt that is collateralized by such asset values, will cause a huge amount of financial disruption.

Posted below are 50 companies with a market cap over $50 million (i.e. weeding out those that actually went completely bust during the year) that have the worst year-to-date stock performances from 2021. I also include a short one-liner description of these companies and/or quick thoughts. This is as of closing prices on November 12, 2021.

Themes / Notes:
The “top 50” lost 72% to 36% of their market value during the year;
Gold mining or shiny metal companies (whether they actually are operating or theoretical) populate 20 of 50 of these;
Bio/pharma (or medical instrumentation) companies were 8 of 50;
Cannabis and related are 7 of 50;
Hydrogen or “clean energy” are 4 of 50.

When looking at these 50, there were none of them that passed my own personal screens for being worthy of a watchlist placement. Your mileage might vary. There is no “best of the worst” here, I really don’t like this year’s crop of tax loss candidates, at least the top 50.

Since the beginning of July, the Bank of Canada’s balance sheet hasn’t really gone anywhere. This is despite stating in the July 14th interest rate announcement that they would be continuing QE at a $2 billion/week rate.

Before COVID-19 began, the Bank of Canada historically has held about $75 billion in government bonds and $25 billion in (short term) treasury bills.

Today, the balance sheet consists of about $6 billion in treasury bills and $414 billion in government bonds.

The size of the Bank of Canada balance sheet is the same on August 11th as it was on September 1st. I would expect the balance sheet to increase slowly with QE but this hasn’t been happening.

For every asset there is either liability or equity, and in this case, the liability is the amount due to Members of Payments Canada (the big banks) – they collectively are owed about $276 billion as of the last September 1st snapshot.

We will see what happens on September the 8th when the next rate announcement is made. Given the ongoing federal election, there will be a lot of eyes on this report from non-traditional viewers.

On the US side, things still show no sign of stopping – it’s QE forever there.

This monetary froth, one way or another, ends up inflating the value of yield-bearing assets. The most obvious targets are government bonds themselves, but as money permeates up the risk spectrum, anything with a yield gets bidded up, making future returns on capital much lower, to the benefit of incumbent asset holders.

The last two weeks of summer, psychologically speaking, are the two weeks before labour day weekend. Families are still on holiday (whatever types of holidays are still available with the myriad of Covid-related disruption around us), children are not at school, and the weather is usually warm enough that one wants to stay outside before the big Canadian winter freeze commences.

In the markets, this also means institutional managers are in the same boat – major policy decisions on how to steer the computerized program trading will likely be made after labour day.

So I do not put much stock in market action that is occurring, other than to observe that the TSX and S&P 500 is at an all-time high:

The Nasdaq 100 is also the same way. Both US indexes are a functional proxy for Apple, Microsoft, Amazon, etc. The S&P 500’s top 10 is about 28% of the index, while the Nasdaq 100’s top 10 is just over 50% of the index.

The TSX’s top 10 are: SHOP, RY, TD, BAM.A, ENB, CNR, BNS, BMO, CN and CP. They are about 40% of the index.

You would think the markets reaching all-time highs would generate some news headlines. It has been exactly the opposite. What do we hear about today?

1. Disaster in Afghanistan
2. Disaster in Covid-19 (take your pick: vaccines not working, variants, travel curbs, ‘fourth wave’, etc.)
3. Disaster in supply chains
4. Disaster in climate (take your pick: hurricanes, wildfires, droughts, heat waves, etc.)
5. Disaster in the Liberal Party of Canada (OK, OK, this was a joke – I will write about the Canadian election later)

The one thing that has clearly NOT been a disaster are people that have their capital in return-bearing assets. Indeed, it has been a disaster if you were NOT in the markets. The TSX is up about 17% year-to-date, while the S&P is up 21%. If you’re lagging this number, you’re effectively ‘falling behind’.

This rise in the stock market continues to be fuelled by monetary policy, with the USA and Canadian central banks still vacuuming up treasury bonds like no tomorrow; and also fiscal policy, with both governments spending like crazy.

The cash will circulate in the economy until the point where it ends up locked in bank reserves, which currently earns a very low rate of interest and will continue to do so for the indefinite future. Individuals that have satisfied their material needs have no other choice but to put their capital into the asset markets, lest they lose purchasing power.

This is the market we have been seeing post-COVID-19, until at such point we do not.

We are well into seeing the price ramifications in this monetary/fiscal regime. The front-row-center for many is the elevated cost of residential housing in urban centers. Indeed, even second and third-tier cities/towns have had an influx of capital just simply because of the people escaping the urban centres. Because of the elevation of such asset pricing, correspondingly, the cost of everything else rises to bake in the extra capital required to use the land.

We also see the impact on the stock market.

The physical world is where things get interesting with regards to the impact of monetary/fiscal policy. Although most of what happens in finance is a transaction of electrons, the physical world is messy. Primary industries produce the raw materials necessary for the functioning of society, and this includes food, energy and minerals. Somebody needs to produce this. As the debasement of currency continues, it stands to reason that the elevated cost structure will result in these commodity prices elevating.

Almost everything (with the exception of gold and silver) has risen since the start of the Covid pandemic.

The result of the increase in commodity prices will be a price transmission on the physical side of the economy that we will have not seen since the 1970’s. This will likely continue until we see a market dislocation event. I do not know what or how this will take place, but when it occurs, it will be like a 9.0 Richter Scale earthquake right next to where you live. And just like earthquakes, it will be very difficult to predict.

Until then, and especially as the conventional media has completely tuned the masses away from the rising stock market, the major indexes are most likely to continue their existing trajectories.