Category: Finance

I note with amusement that Shopper’s Drug Mart is devaluing their “loyalty program” points by about 9-18%, effective July 1, 2010. I am sure there will be some sort of uproar about it.

Before, you needed the following points to redeem the following dollars:
7,000 – $10 (700 points/$)
15,000 – $25 (600 points/$)
30,000 – $55 (545 points/$)
40,000 – $75 (533 points/$)
75,000 – $150 (500 points/$)

Effective July 1, 2010 it will be:
8,000 – $10 (800 points/$) – 12.5% devaluation
22,000 – $30 (733 points/$) – 18.1% devaluation
38,000 – $60 (633 points/$) – 13.9% devaluation
50,000 – $85 (588 points/$) – 9.4% devaluation
95,000 – $170 (559 points/$) – 10.6% devaluation

Whenever dealing with any sort of currency, including “points” (of which the vendors have no legal requirement to redeem for any acceptable value whatsoever) you always have to be aware of its purchasing power and the chance that such purchasing power will decrease in the future.

I personally find it a pain to participate in any of these programs (who wants to keep extra cards in their wallet?), but there is a significant segment of the population that are actually influenced into making uneconomical decisions by offers of air miles or “save-on-more”. This is presumably why these marketing programs exist – to enhance lock-in of consumer dollars. For those that participate in it, it is best to cash out their holdings as early as they can since you will never see an increase in the purchasing power of your points – essentially, there is a negative interest rate on points earned through loyalty programs.

In the event of holding cash, Canadian dollars have inflated away over the past 96 years at the rate of 3.13% according to the Bank of Canada. If you wish to retain any sort of purchasing power, you are forced to invest your cash somewhere – at the very minimum, a short term high-yield savings account will help stem the decay of the purchasing power of cash.

There is no “investment” option with respect to loyalty programs, which is why points and perks for putting up with the hassle of these marketing programs should be cashed out immediately. If you do a lot of dollar volume business with a particular retailer offering such a program, it probably makes economic sense to sign up. However, it makes no sense whatsoever to not liquidate the proceeds when you can for something that you find useful.

As I write this, the major US indexes are down about 3-3.5%, while the TSX is down about 2%. The usual things in market downturns are happening today – US dollar is rising, Canadian dollar is down relative to the US dollar (nearly two pennies), and there is a rush into US treasuries. Apparently this might be due to another EU country that is on the verge of requiring a bailout, but this was to be expected.

Due to the fixed-income nature of my portfolio, it is relatively stable today – assisted somewhat by the exchange rate fluctuation, but even when you back it out the damage is less than half a percentage point. Although my cash balance is roughly 8%, some of the securities in the portfolio have very little volatility and thus the risk-reward is ratio is minimized. I receive a decent return while waiting and this is by design.

Patience, and stalking targets for purchase is all you can do when the marketplace starts to become volatile. For those that have taken out cheap money on margin and invested it into the marketplace, you can be sure that they are starting to feel a lot of pressure to liquidate and reduce their leverage ratios. Ideally, you want these people to liquidate at exactly the wrong time, and at the same time, and you want to be there to place a bid for those shares or securities that are trading well below your estimated fair value, and you have sufficient buying power (or a whole bunch of cash) to take advantage of the situation.

I am continuing to look at low volatility equities and am really not interested in increasing the risk in my portfolio at present. The reward just isn’t there and there still isn’t enough panic factored into the marketplace.

Also, 2010 has so far been the lowest volatility year to date. Right now the portfolio is less than 1% down from the end of March 2010 (where I stated that I don’t expect much more in the way of performance for the rest of the year).

Some people claim they can trade by just reading charts. I am not one of them.

However, marketplaces that are crowded with technical traders will have the ability to be successful in the short run. The technical end of the stock market are zero-sum gamers employing algorithms that take advantage of weaker algorithms.

Thus, I do believe in the validity of technical analysis. I just don’t think many people can do it – at a minimum if you are not cognizant of your “enemies” (i.e. other traders) are up to, then you are the proverbial fish around the poker table.

One branch of physics, called econophysics, heavily depends on technical data to drive conclusions. Back in my university days, I dabbled in an econophysical model which was an interesting study. Some professors have taken it to the next level, and have mined technical data to try to predict market crashes, with partial success.

In absence of fundamental data, the model might be successful in predicting algorithmic activity, rather than being a crash predictor.

I love nearly everything David Merkel writes, and this is a gem:

The lesson is this: in investing, ignore yield to the greatest extent possible. Focus instead on earning a good return, with safety, and ignoring the payout. It is a little known secret that REITs with the lowest payouts tend to be the best performers over the intermediate-to-long term. It is easier to earn money off of taking equity risk than credit risk.

So, aim for best advantage in investing. Don’t trust yields, but rather look at the underlying economics of the business that you are investing in or lending to. Yes, it is a lot more work, but it is work that you should be doing.

One issue I have with a lot of “Dividend stock investors” is that they do not look at the underlying fundamentals of the company to determine whether yield (and growth of that yield) is sustainable. During the Canadian Income Trust mania (roughly in 2003-2006 before the government shut the whole operation down) you had corporate entities converting into a trust that had absolutely no chance of being able to sustain such distributions. To list all of the offenders in this post would be burdensome, but one of my “favourites” (not that I had ever invested in it, but because they were a local business I paid attention to them) was Hot House Growers Income Trust.

HHG went public in late 2003 after they had a good year. They had distributions which were higher than their net income and they had a significant amount of debt. They began to suffer operationally (too many people were crowding into the business sector) and a couple years later they collapsed and had to be taken over by the surviving entity, Village Farms, which is a penny income trust that will not be giving any yield because their business still has too much debt. They are still publicly traded, although they will likely have to recapitalize again to pay for their debt.

People were buying income trusts in droves simply because they saw the yield and did not consider the return on investment, i.e. whether you would be able to retain the capital in the investment.

My own income trust investments are quite “yieldy”, but their underlying business fundamentals are solid, and generate significant net income (not just cash flows) to sustain the business, after required capital expenditures. Probably the easiest screen you can perform is making sure that net income and cash flows are above the yield (dividend/distribution) rate and ask yourself if the business that is underneath it all can be sustained for the indefinite future.

The other question you should be asking is whether the company has the ability to invest capital that is left over after distributions and debt payment into other capital projects that will continue to give yields that are above the current cost of capital. If so, such companies should not have excessively high payout ratios.

Most dividend stock investors have the right idea, but they don’t do the rigorous research to ensure that they will be paid out without taking a disproportionate risk of capital loss – instead, they just look at the yield/dividend number, and just care that it has gone up historically over a period of many years. This blind-style of investment is akin to driving while looking at the rear view mirror.

The BC government in the previous budget is now enabling people that own homes and financially supporting somebody that is 18 years old or younger to defer their property taxes, at the rate of interest of the bank prime rate. Previously only seniors (55 and older) were able to exercise this option.

Essentially homeowners are given the option of borrowing money (the amount of their yearly property taxes) at the prime rate, and will only have to repay this amount when your property is transferred (i.e. you sell the place).

Almost everybody that is financially sophisticated that is eligible to do this should be exercising this option. Getting money at the prime rate outside a mortgage is not that easy, and at the prime rate you can very likely make an investment that would give a higher rate of return.

The trick is making the interest amount tax-deductible, and if you use the deferred property tax amount for income-generation purposes then in theory you should be able to deduct the interest.