Author: David Pett

U.S. equity index futures are higher this morning. S&P 500 futures were up 6 points in pre-opening markets.

Index futures moved slightly higher following release of economic news at 8:30 AM EST. Consensus for December Personal Income was a gain of 0.3% versus an increase of 0.4% in November. Actual was a gain of 0.4%. Consensus for December Personal Spending was an increase of 0.2% versus an increase of 0.5% in November. Actual was an increase of 0.2%.

Slight weakness in the U.S. Dollar also helped equity index futures. Commodities priced in U.S. Dollars including gold, silver and crude oil are trading higher.

President Obama is scheduled to release his 186 page $3.8 trillion 2011 budget at 10:00 AM EST. Investors are bracing for the likelihood of a rising federal government budget deficit.

Exxon Mobil added 2% after reporting higher than expected fourth quarter earnings. Consensus was $1.19 per share versus $1.54 last year. Actual was $1.27. Almost all earnings came from upstream oil and gas production. The company lost $189 million from marketing and refining operations, but recorded significant gains from its petrochemical operations.

Research in Motion was upgraded by Standpoint Research from Hold to Buy. Target price is $80 U.S.

Don Vialoux, chartered market technician, is the author of a free
daily report on equity markets, sectors, commodities, equities and
Exchange-Traded Funds. For more visit Don Vialoux's Web site

Jeremy Grantham of GMO, the Boston money manager, has been one of the most accurate market prognosticators of the past decade. Unlike many managers, he’s succeeded with both bearish calls and bullish ones.

For instance, Grantham warned of the dotcom bubble in 1999; a few years later, he cautioned that home prices had gone insane. A decade ago, he argued that emerging market stocks and debt would be top investments. More recently, he predicted that the S&P 500 would shoot higher in late 2009.

So what does the oracle of Boston see now? A bit of good news, but mostly a darkening outlook.

In his most recent quarterly letter, Grantham suggests there is a strong chance that the S&P 500 will go to 1200, if not higher, during the next six months. The problem is that the market is only worth about 850 or so, he figures. “The real trap here, and a very old one at that, is to be seduced into buying equities because cash is so painful,” he writes.

Grantham believes the best values are to be found in high-quality U.S. stocks, such as Microsoft Corp., Johnson & Johnson and Wal-Mart Stores Inc.. He predicts these cash-producing, low-debt firms will produce real returns of 6.8% a year over the next seven years. In contrast, he believes the broader group of large-cap U.S. stocks will eke out only 1.3% real annual returns.

One notable change to Grantham’s outlook is that he no longer sees an overwhelming case for emerging-market stocks. He thinks they will produce 3.9% annual real returns over the next seven years, but will lag slightly behind international stocks in the MSCI EAFE index of Europe, Australasia and the Far East. As he sums up: “EAFE equities seem a little overpriced, emerging markets more so, and fixed income seems badly overpriced.”

Freelance business journalist Ian McGugan blogs for the Financial Post. 

Goldman Sachs Group Inc. has already taken a beating in the press and more blows are on the way.

Some of the punishment follows the less than impressive testimony on Wednesday by U.S. Treasury Secretary Tim Geithner about his role in rescuing AIG Inc., the failing insurer. The rescue resulted in a multi-billion-dollar payout to Goldman, which held credit default swaps with AIG.

Simon Johnson, an MIT economics professor and former chief economist at the International Monetary Fund, has five questions about the bailout. Among other things, Johnson would like to know is why Goldman was paid in full for its AIG swaps although it was presumably carrying them on its books for considerably less.

While that issue will probably be probed in detail over the months ahead, other aspects of Goldman’s operations are also receiving attention. Jeff Matthews, a hedge fund manager, has posted an interesting story about Goldman’s role in advising and covering Bare Escentuals Inc., a cosmetics company. It’s a story that illustrates perfectly how seriously an investor should take Wall Street’s buy and sell recommendations.

Matthews relates how Goldman brought Bare Escentuals public at US$22 a share in 2006. Following a couple of secondary offerings at even higher prices, Goldman slapped a “buy” rating on Bare Escentuals stock and predicted it would go to US$44 a share.

The stock instead proceeded to lose ground. Goldman changed its rating of Bare Escentuals to “neutral” and watched as the stock sank to US$2.45 a share, then gradually recover to US$13 late last year. At that point, in December 2009, Goldman labeled it a “sell.”

Just last week, Bare Escentuals was acquired by Shiseido Co. for US$18.20 a share. The adviser on the deal? Goldman, of course.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

President Obama's plans to reform U.S. banks will put the brakes on the rally in equities, but not enough to halt the momentum entirely, as overall growth in corporate profits continues to impress, says Carmine Grigoli, chief investment strategist, Mizuho Securities USA Inc.   

Although erratic stock market performance is likely to continue as a result of this political uncertainty, we maintain our positive perspective, he said in a note to clients.  

Mr. Grigoli noted that fourth quarter profits are exceeding expectations as they roll in this month, while guidance for future quarters is on the rise for the second straight quarter.  

He forecasted another 20% increase in S&P 500 earnings in the next four quarters and said surplus cash that is generated from higher profits will be used to repurchase shares and make acquisitions.

The strategist's forecast may have been even higher, were it not for President Obama, whose proposal this month to impose a special tax on banks and to overhaul financial regulations has roiled markets south of the border and elsewhere around the world.

"It appears to us that the President’s proposals would intensify the financial sector’s problems and derail the banking recovery," Mr. Grigoli said.  

"These planned changes would lead to lower profits and increased uncertainty and would lessen credit availability without benefiting economic growth."

David Pett 

Improving equity markets and easing credit risk is expected to help Canada's struggling life insurance sector return to more normal earnings over the next few quarters,

Add in attractive relative valuations to the banks, and the upside potential for lifeco stocks is compelling, says Michael Goldberg, analyst, Desjardins Securities.  

"Though we believe that the return to historical valuations is likely to take time, the trend should begin as lifecos prove that their recurring earnings are moving back to at least steady normalized levels with much less volatility and noise," he said in a note to clients. 

Mr. Goldberg said Canadian lifecos have historically traded at similar multiples to country's banks  on both a price/earnings and price-to-book value basis. However, over the past year, life insurance companies have largely underperformed and in the fourth quarter of 2009, fell 8.3% as a group on the Toronto Stock Exchange, compared to a drop of just 0.6% for the banks.

"…Unlike the banks, lifecos as public companies have not gone through a severe economic downturn before. Therefore, investors are less confident in the ability of the lifecos vs the banks to return to normalized earnings, which has in effect held back their valuations," he said.

Noting a preference for lifecos over banks, Mr. Goldberg said the earnings success of country's top four life insurance companies largely depends on their individual exposures to equity and credit risk.

"We believe Manulife Financial Corp. will benefit the most from the direction of these drivers, given it is the most sensitive to equity risk and relatively low credit concerns," he said. maintaining his top pick rating and $25 price target.

"Great-West Lifeco., which has reported relatively stable earnings year to date, should benefit the least as it has the lowest equity market sensitivity but relatively high credit risk."

Mr. Goldberg has a Hold rating on Great-West with a $28.50 price target. Meanwhile, Sun Life Financial is also rated Hold with a $34 target and Industrial Alliance is a Buy at a target of $37. 

David Pett

An analyst day hosted by home improvement giant Rona Inc. has paved the way for a slew of consolidations in the market, setting its market share target to 20% by 2011 from a current level of 17.5%.

“We interpret management’s tone as cautiously optimistic,” analyst Vishal Shreedhar UBS Investment Research wrote in a note to clients, maintaining his neutral rating on the shares and raising his price target to $18 from $17.

“Rona’s valuation is adequate. It currently trades at 12.9 times forward per share earnings, in line with its historical average,” and trades at a 21.6% forward price to earnings discount to rival Home Depot, he added.

Keith Howlett of Desjardins Securities maintained his buy rating and $17.50 price target on the shares, but reduced his 2010 estimate to $1.23 from $1.34.

“Based on management’s projections of sales and margin growth excluding acquisitions, operating leverage to sales growth will be more muted in 2010 than we had previously projected,” he said.

With an aggressive phase of market consolidation projected to begin, “we would stay on board as the story unfolds.” 

Hollie Shaw

As the equity market rally tires, large cap stocks are starting to outpace their small cap cousins in the U.S. and global, but here in Canada, the trend is slow in taking hold.

"In the U.S., small caps have been trailing large caps by 279 bp in the last three months," said Vincent Delisle, equity strategist, Scotia Capital Markets.

"Globally, large caps have been assuming leadership since Q3/09, and we expect this trend to continue in 2010 as yield curves flatten and P/E multiple expansion is contained."

The Scotia strategist said the situation in Canada has been the reverse, in large part because the country's small cap space continues to receive big benefit from it's high percentage of commodity-based names as metals demand from China is unabated.

In the past month the TSX completion index has outperformed the TSX by 5.3%. Over a six-month period, the small cap advantage jumps to 30%.

"If the USD continues to edge higher in 2010, the large cap trend should finally play out in Canada in coming months," said Mr. Delisle. 

David Pett

Now that investors have digested another record quarter from Apple Inc., the focus shifts to the iPhone maker's scheduled event this Wednesday, when cross your fingers, a new tablet version of the Mac is introduced.

"Given high expectations, near term valuation volatility around Apple's Jan 27 event may offer accumulation opportunities," said Mike Abramsky, analyst, RBC Capital Markets. 

Aside from the expected "wow" factor should the new tablet be introduced, Mr. Abramsky thinks investor sentiment will be driven by the new gadget's price point. A range between US$500 to US$700 represents the "sweet spot."

He thinks the perceived scope of the tablet will also be an important driver, with success dependent on broad cooperation from disrupted content providers, including news, books, music. 

If the tablet is considered a niche product, it implies sales of roughly $1-million units, A "hit" product, however, would see more than $10-million units sold per year.    

"A "hit" would could provide a possible new growth engine for Apple," said Mr. Abramsky.  

David Pett

While President Barack Obama took aim at U.S. banks and their proprietary trading practices last week, the folks creating regulations about how much capital banks need to put aside to
guard against the types of financial and operational risks banks face, seem more willing to support it.

Michael Goldberg, Desjardins Securities analyst, said the latest Basel 2.1 proposals are soft on proprietary trading, which involves banks using their own money as opposed to its customers' money in order to make a profit.  

"The inherent belief seems to be that there is nothing wrong with proprietary trading; the models just have to better capture the risks," said Mr. Goldberg in a note to clients.

He noted that proprietary trading has been wrongly characterized as being similar to putting a casino at the top of a bank. Indeed, he thinks it is too harsh a condemnation of casinos.

In a casino, he reasoned, the odds truly favour the house. He said the casino also knows what the odds are for all of the games and it can charge enough to mitigate its tail risk.

Additionally, Mr. Goldberg noted that casinos are generally regulated so that they cannot engage in pricing competition that undercuts their ability to earn underwriting profit. Short of that, casinos can simply change the rules going forward, stopping successful gamblers from making new bets.

"Perhaps a better analogy is that proprietary trading involves gamblers employed by a bank, who have convinced management to bankroll them at a casino because they believe that they have developed a 'system' that can beat the house," he wrote.

"And, it may be that most of the time the system does beat the house. But, when it does not, the losses can be spectacular. The public policy question, still being debated, is whether depositors should fund this activity."
 
Based on his 2010 forecasts, Mr. Goldberg said the ratio of net capital markets revenue to banks' operating profit in Canada would average 20% for the major banks.

Individually, National Bank' ratio would be 35%, Royal Bank of Canada would be 29%, Bank of Montreal, 23%, Bank of Nova Scotia and TD Bank, 17%, and CIBC, 15%. 

"While this captures far more than proprietary trading, we believe that National Bank's high ratio is indicative of its greater sensitivity," he said.

David Pett

Add luxury retailer Coach Inc. to the list of U.S. multinationals expected to benefit from China's rapid economic growth.

Last week, Coach reported better-than-expected second quarter results, with sales up 11% to over US$1-billion and net earnings up 12% from this time last year to US75¢ per diluted share.

While most of the attention fell on North American comparable store sales, which returned to growth by rising to 3.2% in the quarter, the double-digit revenue growth from China was also a highlight and may ultimately prove more important to the future bottom line for the company

"China continues to exceed expectations, causing management to accelerate the growth strategies for the region and revise the long-range plans significantly higher," said Murray Leith, analyst at Odlum Brown Ltd in Vancouver

He said unaided awareness of the Coach brand is approximately 8% in China, compared to 72% in the U.S. and 63% in Japan, offering great growth potential inside the borders of the world's most populace country.

Coach stock fell 9% last week depite the favourable results, but Mr. Leith said investors simply got ahead of the company's fundamentals, having bid up the shares earlier in the week.

Now that Coach is selling at less than 15x fiscal 2011 earnings, he considers it a good buying opportunity and maintained his Buy recommendation and $40 target price. 

David Pett

Rising bond mutual fund flows could be a bad omen for stocks, says Tobias Levkovich, chief U.S. equity strategist, Citigroup Capital Markets.

"Since earnings are discounted off of long-term government cost of
money, higher bond yields in the future are likely to have meaningful
repercussions for stock prices and thus equity investors need to be
aware and somewhat concerned about the extent of the rush into bond
funds," Mr. Levkovich wrote in a note to clients.

"Indeed, it is the likely upward trend in long bond yields that drive our concern about 2010 S&P 500 performance."

In the United States, mutual funds took in US$377-billion in 2009, with US$357-billion flowing into bond funds. U.S. stock funds, meanwhile, experienced net outflows to the tune of $25.7-billion. Here in Canada, long term mutual fund sales also favour bonds over equities.

Mr. Levkovich said the record flows into bond funds reminds him of the surge in the aggressive growth equity mutual funds during the late 1990s.

That particular buying frenzy ended abruptly when the tech bubble burst, and Mr. Levkovich is worried that a repeat of history maybe close at hand.

"With the government needing to borrow to fund the [US$1.4-trillion] deficit, there's not that much wiggle room for bond investors to look elsewhere for returns," the strategist said.

"Should investors sense that losses will grow as existing portfolios' yields rise, flows could reverse and further exacerbate a rising yield dynamic." 

David Pett

You may like or dislike Barack Obama’s hazy proposals for reforming the U.S. banking sector. Few people, though, would disagree that reform of some sort is needed. What should be included in that reform? John Hussman, the very smart guy who heads up Hussman Funds in Maryland, offers an eight-point plan and it makes for interesting reading.

For starters, there’s the obvious: the Federal Deposit Insurance Corporation needs expanded powers, so it can take over troubled insurance companies or bank holding companies or non-deposit-taking investment banks. The lack of these powers was a glaring omission during the recent crisis.

There are many less obvious ideas as well. Hussman is a fan of requiring banks to hold a substantial chunk of their capital in the form of convertible debt. Under Hussman’s proposal, this layer of convertible debt would automatically become equity if a bank runs into trouble. The additional level of equity would provide an extra buffer to protect depositors and counterparties from crisis.

Also worth considering is a rule that would prohibit the use of credit default swaps except for purposes of genuine hedging—in other words, banning the use of credit default swaps for purely speculative purposes.

Hussman’s final point, though, may be his most heart-felt: he wants both Federal Reserve chief Ben Bernanke and U.S. Treasury Secretary Tim Geithner to be fired. Both, he says, have done end runs of questionable legality around Congress to protect the bondholders of banks and both deserve to be kicked to the curb as quickly as possible. That sounds like an increasingly common sentiment in Washington.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

Who wins the wireless battle unfolding in Canada, will largely determine the winners and losers within the telecom and cable sector over the next few years, says a new report from Desjardins Securities.

"We believe that growth in cable and telecom operations is rapidly converging and companies with a significant wireless presence and capacity for cost-cutting should outperform over the short to medium term," said analyst Maher Yaghi, who initiated coverage on eight of the country's telecom and cable companies last week. 

He said valuations in the sector support higher stock prices in the next twelve months, with companies that have a strong wireless presence the most likely to benefit from strong growth.

While cable companies have the technological advantage over wireline companies with regard to TV and Internet services, Mr. Yaghi said all companies in the sector who can demonstrate cost cutting abilities should be rewarded by the market. 

His Buy recommendations include wireless giant Rogers Communications Inc., undervalued Telus Corp. and Quebecor Inc., which should gain share in a very competitive wireless market in Quebec.

As the for the other names in the space, Mr. Yaghi has a Hold rating on BCE Inc., Bell Aliant Regional Communications Income Fund, Cogeco Cable Inc., Manitoba Telecom Services Inc., and Shaw Communiciations Inc.  

"While we believe that BCE has the capacity to further trim costs, our view is that the company's broad exposure to wireline could prove to be a disadvantage in an environment where wireless substitution could become more prevalent," he wrote.

Cogeco Cable, may have some upside left, he added, but the expected turnaround of its business in Portugal may take longer than anticipated.

Meanwhile, valuations of Shaw, Bell Aliant and Manitoba Tel are "fair and that upside could be limited over the short to medium term."

David Pett

The abrupt resignation of Bob Quatermain, as president and CEO of Silver Standard Resources Inc. could be just the thing for the company's limping stock price.

At least, that's how Trevor Turnbull, analyst at Scotia Capital Markets, sees it and last week, he offered up some suggestions for the next CEO.

"It can be debated whether or not Silver Standard needs a different approach, but the recent share price performance would indicate it does," he said in a note to clients.

"In our opinion, the company is striving to regain the confidence of the market in terms of being able to provide targets for the Pirquitas mine that are attainable. We believe a new CEO should have an easier time of this, but it is imperative that the mine delivers as promised this time."

Mr. Turnbull said the pace of Silver Standard's production development needs to improve. While Silver Standard declared commercial production at Pirquitas this past December, the mine is not expected to generate positive cash flow until the second quarter of 2010.

In addition, the analyst believes the Pitarrilla and San Luis projects should be moved ahead quicker than is now estimated so that lucrative cash flow can be realized sooner than later.

As for Silver Standard's dozen non-core silver and gold deposits, Mr. Turnbull said they should be monetized as soon as possible.

"These assets may not have hurt anything, but the majority of them have not helped either."

Since hitting a high of $27.19 on June 2 last year, shares in Silver Standard have fallen 24% to Friday's close of $20.58. The S&P/TSX Composite Index is up 7% over the same period.   

David Pett

The market for exchange traded funds continues to grow in Canada, but ETFs still have a long way to go to unseat mutual funds as the number one investment vehicle in Canada.

Canadian ETFs raised $8.5 billion in net new assets in 2009, up from $7.1-billion in 2008, said a new report on the global ETF market from BlackRock Inc.  a New York-based investment management firm and proprietor of iShares.

Canadian ETF assets have grown by 29.6% over the past five years to roughly $31-billion or 4.6% of all mutual fund assets in Canada.

“ETFs have grown consistently by 30% per year over the past five years demonstrating their appeal to investors in market conditions of all kinds – from the bull to bear to recovery,” said Heather Pelant, managing director, head of iShares Canada at BlackRock Asset Management Canada Limited.

“Without question, ETFs have become a popular and widely accepted tool that has fundamentally changed how institutional and retail investment advisors view the markets.”

With $25.4-billion in assets under management, iShares represents 80.7% of the total ETF market in Canada. Making up the remaining pie is Claymore Investments Inc. with roughly 11% market share. AlphaPro Management Inc. and their suite of Horizons Beta Pro ETFs account for 8% of assets and Bank of Montreal, the most recent entrant to the ETF game, makes up less than 1% of the total market.

Globally, ETF assets increased 45% to hit a record high of US$1-trillion at the end of last year, with assets for the ETF industry in the United States likewise climbed more than 40%, reaching an all-time high of US$705.5-billion.

The rumoured sale of a 47% stake in Thailand-based Siam City Bank, is an opportunity that Bank of Nova Scotia should not pass up, says Blackmont Capital analyst Brad Smith. 

"While not material from a consolidated bank perspective, the opportunity to have a front row seat in the formation of what could be Thailand's fifth largest bank sets BNS apart from its North American focused peers," said Mr. Smith in a note to clients.

The analyst said the favoured bidder for Siam City is Thanachart Bank, which is 49% owned by Scotiabank, however other players are expected at the table, including Korea Development Bank. It is speculated that a winning bid will cost the purchaser roughly US$1-billion.

Mr. Smith said a succesful bid would provide Bank of Nova Scotia earnings growth and regional diversification plus attractive risk adjusted returns on capital.

"Based on Thanchart Bank's nine month published results, BNS has earned an 11% annualized return on its invested capital which compares very favourably to negative to low single digit return levels achieved by its domestic peers on their US retail banking initiatives," he said. 

David Pett 

New and improved forecasts for gold, silver and copper will bolster upside in Yamana Gold Inc. shares over the next twelve months, says Dundee Securities analyst Ron Stewart. 

Mr. Stewart upgraded Yamana to Buy from Neutral this week, raising his price target on the miner 50¢ to $14.50.

"We recommend investors consider YRI as a relatively stable and liquid
precious metal equity based on the current outlook," the analyst said.

The update comes in the wake of Dundee's revised metals forecast that now anticipates gold bullion to average US$1,200 per ounce in 2010 versus its previous estimate of US$1,065 and US$1,325/oz in 2011, up from US$1,000.

Silver prices are expected to hit US$20 this year and US$22 in 2011, up from prior forecasts of US$17.50 and US$16.50, while copper price expectations increased to US$3.25 per pound from US$3 in 2010 and to US$3 from US$2.75 in 2011.  

Mr. Stewart also raised his recommendation on Goldcorp Inc. to Buy from Neutral, and increased his price target to $50 from $49.

"Given the increase in our valuation and the recent dip in the share price, we now consider [Goldcorp] to be undervalued," he said.  

David Pett