Category: Finance

Finance and Economics related articles

Still not buying anything

Despite having over a 70% cash position at present, I still remain highly skeptical of the marketplace. Although I am happy to see things dive down another 4% on the major indicies (2% on the TSX), the root causes of this mayhem have not been addressed at all yet. I still highly suspect there is more to come. There will continue to be gut-wrenching rallies up and crashes down and today is an example of a crash down. The next two hours of trading can change everything, but the mid-term trend is clearly down. Although mathematically volatility is “up and down”, it strongly correlates with a down market when buying volatility futures!

However, when looking at the numbers, today’s dump feels less liquidity-inspired than the previous dump (where everything was getting thrown out the window if there was a bid). I do notice that certain fixed income products have been able to outperform (by falling less) and also Canada has fallen less unless if you are invested in the natural resource sector (commodities have been hammered). Typical defensive issues (e.g. consumer staples) have also fallen less than commodity-linked products.

My entire premise for this market drop is a combination of a grave concern on a macroeconomic scale (i.e. a pending devaluation of the US dollar) with a deleveraging of portfolios – you can only borrow at 1-2% and purchase income-oriented securities for so long before the capital value of such income-oriented securities suddenly take a plunge and then you have to deal with the margin call of the decade to truly pay for it.

While we are on the topic of interest rates, Canadian short term implied rates have also projected a chance of a rate cut by years’ end:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 SE 98.780 98.785 98.755 0.025 5322
+ 11 OC 0.000 0.000 98.725 0.000 0
+ 11 NO 0.000 0.000 98.805 0.000 0
+ 11 DE 99.020 99.030 98.910 0.110 16290
+ 12 MR 99.120 99.130 99.000 0.120 21771
+ 12 JN 99.150 99.160 99.010 0.140 11273
+ 12 SE 99.140 99.150 98.980 0.170 4853
+ 12 DE 99.130 99.140 98.950 0.190 2782

A December BAX rate of 99.02 corresponds to a rate of 0.98%, which should be compared to a 1.18% rate for 3-month Bankers’ Acceptances – the markets are predicting a higher chance of a rate cut than not.

The week ahead

In what promises to be a less exciting week coming up in the market as it continues its summer doldrums, market participants should be aware that most of the brains behind the heavy money funds will be on vacation in August.

It would not surprise me in the least to see some sort of bounceback in the S&P 500 to levels about 5% higher than here, but there are larger undercurrents going on that may continue having the computer traders pound anything that is offering liquidity – mainly the well-known European sovereign debt crisis.

Back in 2008 when Bear Stearns, Merrill Lynch and Lehman Brothers were collapsing, everybody knew what was causing the financial crisis, but nobody had a clue when the damage would stop – in this case, it was in March 2009 when the ultimate lows were reached. I suspect that something like this will be happening again, but it is difficult to tell whether it will be a few months after a main triggering event, or even a few years.

Either way, the root cause of most financial problems stem from debt and leverage. Right now, the problem is that certain banks assumed that their assets (debt in less than reputable soverign nations) were worth as much as they are on their balance sheets, but ultimately they are not.

Looking a little less globally, when less knowledgeable people listen to their “financial advisors” and borrow money at prime (3%) to invest in some bond or index fund which will make them a “long term stable return” of 6%, they will also discover the urge for liqudiation when their leverage factor imparts huge losses on their net worths.

I do not believe it is time to start buying things yet, but the valuations look compelling. Rather, now is the time to research things that will be worth buying when the market decides to take another deleveraging-induced dive.

Something I have consistently found puzzling is that there are a variety of companies that are selling under projected P/Es of 10, which makes them seem infinitely more attractive than the 10-year government bonds that are giving out a yield of 2.24%. Just to use an arbitrary example of Dell (Nasdaq: DELL), we have a company that has a market cap of $28 billion, about $7 billion net cash on the balance sheet, and for the past two years has generated about $3.5 billion in free cash flow (about $1.87/share) and trading at a stock price of $14.87, or roughly 8 times free cash flow generation.

What the bond market is effectively betting is that companies like Dell aren’t going to make as much money as they have been, or that the risk premium afforded to common shares of Dell is quite high. It is not like the company is in the pharmaceutical industry where you have to worry about patent expirations and other time-sensitive risk. It is quite difficult to conceive of scenarios where you would see the diminution of the business – perhaps Amazon will compete? An investor would have to answer this question in order to consider owning the stock, otherwise they are playing poker without looking at their own cards.

In the eye of the financial storm

Unfortunately this week has been a rather busy one for myself and I have little mental time to properly do some market research even though I am getting bombarded with email alerts for low prices that have been triggered.

“V” type bottoms rarely happen in the marketplace. The only exception I can think of was the March 2009 low and that was after a protracted agony of a financial crisis.

I notice that in today’s (Wednesday’s) 5% plunge in the markets that crude oil managed to hold its ground while the indicies fell. Also, certain issues of stocks that could be considered “higher quality” were not hammered – indeed, some of them rose despite the indexes falling a significant amount.

I am expecting Thursday to be a positive market day, although I say this with the safety and comfort of seeing the S&P 500 futures up 1.7% well before the market is going to open. During financial storms, you always see sharp action in both directions as the market continues to suck in all of those that continue to try to play their risk-on and risk-off charades in a very short time frame. As long as people are still talking about which bargains to pick up in the markets, it is still not time to buy unless if you are worried about covering your short sales.

I remain mostly sheltered with a very large cash position at present.

Bank of Canada to cut interest rates?

I notice that December BAX futures are pricing in a rate decrease by the Bank of Canada to 0.5 to 0.75%:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 11 AU 0.000 0.000 98.880 0.000 0
+ 11 SE 98.890 98.895 98.895 0.000 23059
+ 11 OC 0.000 0.000 98.865 0.000 0
+ 11 DE 99.140 99.150 99.150 0.000 50455
+ 12 MR 99.140 99.160 99.170 -0.020 32592
+ 12 JN 99.140 99.150 99.170 -0.030 17723
+ 12 SE 99.110 99.120 99.140 -0.040 6277
+ 12 DE 99.050 99.070 99.090 -0.020 1582

Indeed, the only people making any money out of the marketplace right now are those that have been holding onto long-term government bonds, an instrument that almost everybody stated couldn’t go lower in yield.