Author: David Pett

Will 2010 be good for the banks?

The first quarter at least will have its share of challenges as players contend with slowing economic growth and other headwinds, according to James Bantis, an analyst with Credit Suisse.

After a remarkable run in the second half of 2009 where the banks benefited from substantial trading profits, they now face a tougher environment characterized by slower revenue growth, low interest rates, and the uncertainty over new financial regulation.

"We expect the deleveraging theme to continue well into 2010, with a greater focus on reducing market related risk assets," Mr. Bantis said in a recent note to clients.

Though the financial crisis is mostly behind us, many players continue to back away from risky investments and pay down debt.

He asks the question: "What is new money in the sector really paying for?"

He argues that much of the good news including a return to normalized earnings and declining credit losses has already been incorporated in bank share prices.

The big banks kick off their Q1 season this week with CIBC and National Bank of Canada reporting on Feb 25 and Scotia wrapping up on March 9.

John Greenwood
 

Canfor Pulp Fund's current yield of 14.8% looks safe after pulp producers raised prices on northern bleach software kraft (NBSK) pulp. Even better, the company's distributable cash is only going to get bigger, says Daryl Swetlishoff, Raymond James analyst.

"Given current pulp markets we not only view [the current] distribution level as sustainable but see upside," he said in a note to clients.

Canfor Pulp's current yield of 12¢ per month or $1.44 per year represents a 66% payout ratio based on a NBSK price of US$850 per metric tonne and a loonie at US95¢.

Mr. Swetlishoff said Canfor has historically paid out at a 90% ratio, implying a 20% yield or $2.17 per year dividend. But he estimated that the distribution could go even higher.

"Canfor maintains high leverage to NBSK pricing and we highlight that at current spot pulp [of US$880 – US$910/mt] and FX rates our model forecasts Canfor generating $2.75 – $3.29 in annual distributable cash implying 28% – 34% annualized yields," he said.

The analyst raised his rating on Canfor Pulp to Strong Buy from Outperform and increased his price target to $12.50 from $11.50 per share.

David Pett
 

If you’ve ever wondered about the veracity of officially reported figures on national deficits, you have every reason to be skeptical. Satyajit Das explains in the Financial Times that at least two nations have used derivatives to hide the true extent of their borrowing.

The most notorious user of these devices is Greece. But Italy has also used currency swaps and the like to meet its obligations under the European Union’s Maastricht treaty.

While the details get complicated, the core notion behind these swaps is that a government exchanges one stream of future payments for another. By fiddling with the rates and assumptions, it’s possible to arrive at a situation where the country gets a big pot of money up front in exchange for making higher-than-market payments down the road.

What’s the advantage of doing all this? A swap is not considered a loan, so it doesn’t count again a country’s official deficit. The disadvantage, of course, is that it creates an artificial appearance of prosperity. But, as Greece has demonstrated, the game can go on for a long time before anyone gets caught.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

2010 is supposed to be a tough year for bonds, but it's so far, so good when it comes to the corporate variety. 

Indeed, during the recent market slump, corporate bonds have nicely outperformed other 'risk assets' like stocks. Backed by strong fundamentals, the rest of this year is also shaping up well, says UBS analyst Larry Hatheway.

"Earnings and revenues are recovering strongly, debt levels
are under control and debt service ability is good," the economist said. "Credit default
rates have peaked, and healthy fundamentals suggests further improvement to come."

If there is any concern, Mr. Hatheway said it is the fact that valuations have somewhat discounted the fundamentals, particularly in investment grade corporate bonds.

However, with the prospect of lower default rates, yields and spreads in high-yield credit remain relatively attractive, he said.

"We retain our overweight of high-yield credit and market-weight of investment grade corporate bonds. Inflation-linked and government bonds remain underweight in our model portfolio."

David Pett

Down on U.S. treasuries, China is the likely candidate to scoop up some or all of the 191 tonnes of gold that the International Monetary Fund put on the block last week,  says Alan Heap, analyst, Citigroup Capital Markets.

The IMF said that sales would be phased over time, but left open the possibility of direct transfers to central banks. The proceeds will be used to fund new loans to developing countries.

"The [People's Bank of China] is deeply dissatisfied with the performance of its US treasury holdings and has made clear its intention to diversify including into gold," said Alan Heap, analyst Citigroup Capital Markets.

"In November and December the PBC sold US$46-billion of treasures; they must be buying something."

Mr. Heap maintained his second half 2010 gold forecast of US$1,162 per ounce, noting two of the main risks to his estimate, fiscal deficit concerns and inflation, are both pointed to the upside.

David Pett

When it comes to predicting to future direction of stock prices, not all earnings surprises are made equal, says a new report from Chad McAlpine, quantitative analyst, RBC Capital Markets.

Citing a 2006 study from scholars Narasimhan Jegadeesh and Joshua Livnat, Mr. McAlpine said earnings beats primarily driven by better-than-expected revenues lead to better stock performance than profit surprises due to lower-than-expected expenses.  

"Several studies have found that when earnings surprises are accompanied by revenue surprises, the change in earnings is more likely to persist in future periods, and a greater drift in [stock] price can be expected," he said

"However, when earnings surprises are caused by expense surprises, the amount of post-earnings-announcement drift is generally less."

Mr. McAlpine identified 16 stocks that have announced both an earnings and a revenue surprise this quarter.  They include Corus Entertainment Inc., Cogeco Cable Inc., AGF Management Ltd., Astral Media Inc., Industrial Alliance Insurance, Jean Coutu Group Inc., BCE Inc., EnCana Corp., Loblaw Companies Ltd., Open Text Corp., Celestica Inc., Gildan Activewear Inc., Inmet Mining Corp., Canadian REIT, TMS Group Inc., Shaw Communications Inc.

As of this past Wednesday, 39 of 68 companies have announced positive earnings surprises, with 24 associated with revenue surprises, and 14 resulting from expense surprises.

Mr. McAlpine noted that revenue surprises were responsible for the majority of earnings surprises in every sector except industrials where expense surprises have outpaced revenue beats by a margin of two-to-one so far. 

David Pett

Olivier Blanchard, the chief economist at the International Monetary Fund, and a couple of colleagues have been touting the case for boosting the targeted rate of inflation to 4% rather than the 2% that most central bankers prefer.

Their argument is that higher inflation gives central banks more ammunition to stimulate the economy should problems occur. How’s that? Higher inflation means higher nominal interest rates, which in turn means more opportunities for the central bank to cut interest rates. You can chop rates more times if you start from a high number than a low one.

To anyone who witnessed John Crow’s painful battle to wring every drop of inflation out of the Canadian economy in the early 1990s, the idea of suddenly doubling the Bank of Canada’s inflation target sounds unholy and perverse. But if nothing else, Blanchard’s proposal appears to signal the beginning of an intellectual shift. Maybe inflation is no longer the enemy. Maybe it’s an ally.

Stephen Gordon, a professor of economics at Laval, believes Canadian monetary policy is just fine as it stands. As he points out, Canada has never experienced the dreaded zero-bound problem in which interest rates hit rock bottom and the economy doesn’t respond.

But is that really the case? One counter-argument is that Canada has benefited over the past couple of years from the enormous amount of U.S. fiscal and monetary stimulus. Absent that, and the zero bound might have been more of a problem than it was.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

How brave are you? Greece’s financial woes are front-page news, but some stalwart investors are taking the opportunity to bargain shop for Greek stocks. Their theory is that several of these stocks are paying an unfair penalty for their nation’s woes.

Consider Coca-Cola Hellenic Bottling Co. (NYSE: CCH). Only about 10% of its volume comes from Greece, according to financial writer James Altucher. But merely because of its name, it’s taken a hit. It is trading for around US$23 down from US$28 before the crisis began.

Another casualty is Hellenic Telecommunications Organization SA (NYSE:OTE). It pays an 8% dividend, trades for eight times earnings, and fetches US$6, down from just under US$10 before the turmoil struck. In addition, Deutsche Telecom owns 30% of the company’s common stock, which suggests that if things get tough, this phone company will have places to turn.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

Backed by Bank of Nova Scotia, Thanachart Bank is reportedly nearing a deal to acquire the Thai cental bank's 47.6% stake in Siam City Bank for about $983-million. A person familiar with the negotiations also told Bloomberg that Thanachart plans to make an offer for the rest of Siam City. 

If Thanachart does put an offer out for the remaining stake, the deal looks to be valued at above US$2-billion, according to Barclays Capital.

Although Bank of Nova Scotia should have no problem with the increased equity injection needed to keep its roughly 49% ownership in Thanachart, pending capital rules changes could make this a little more difficult to balance than in the past, Barclays warned.

Meanwhile, Royal Bank of Scotland is said to be in talks with a potential buyer for its Colombian operations. RBS is trying to refocus on its core businesses by disposing of assets inherited from ABN AMRO and is in talks with Scotiabank, according to Sky News.

Analysts at Barclays are not surprised that BNS may be interested as the asset would boost its presence in the region. And while the purchase would probably not be material for either bank, Barclays warned that "Scotia could be spreading itself a little thin in this environment of capital preservation, should it truly be pursuing acquisitions in Columbia and, as previously reported, in Thailand and Vietnam."

Jonathan Ratner

It worked during the crash of 1987 and through the market collapse of 2007-2009, but most of the time, panic selling ends up being a losing proposition for investors, says David Bianco, chief U.S. equity strategist, Bank of America Merrill Lynch.

"Timing re-entry into the market is extremely difficult, if not impossible," he said in a note to clients.

"Rule based strategies of exiting the market after any major sell-off generally underperform on both short-term and long-term basis as best gains in the market tend to be very close to major sell-offs."

As defined by Mr. Bianco, investors using the "panic selling" strategy exit the market following a one-day drop of 2.5% or more. Investors then stay out of the market for at least 20 trading days until the market is flat or up over the 20 days after the last 2.5% or more down days. 

Compared to a strategy of just staying invested, the "panic selling" approach does a good job identifying all major corrections and selling after such days helps to avoid some of the market's worst performance periods, said Mr. Bianco.

At the same time, he said such selling and waiting for the calm to repurchase, results in overall underperformance because some of the market's best days are also missed. The only time in 50 years that staying invested hasn't outperformed "panic selling" was following the October crash of 1987 and the most recent bear market.

"All but 4 of the market's best 50 days since 1960 have come within 20 trading days of a 2.5% down day," the strategist said. 

"Sharp down days are useful warnings to carefully reassess the economic and EPS outlook. But if conditions and valuations appear supportive, we think it best to stay invested after sharp down days to benefit from strong rebound days likely ahead."

David Pett  

As bad as the global economic downturn has been over the past year, one thing has turned out to be even worse: government statistics.

By now everybody knows that Athens’s official numbers are the greatest work of Greek fiction since the Odyssey. It’s also becoming clear that Japan’s data is seriously wonky.

The Asian nation announced Monday that its economy expanded at a much faster-than-expected 4.6% annual rate in the fourth quarter. Investors, though, aren’t getting themselves too worked up. Japanese GDP numbers have a habit of being extensively revised.

Take, for instance, the third-quarter figures. They originally showed that Japan’s economy had grown 1.2% quarter-on-quarter, then were revised in December to show just 0.3% growth, then were further revised on Monday to show no growth at all.

The one good thing you can say about the quality of Japan’s data is that it’s better than Greece’s. The New York Times reports that the former head of the Greek government statistical agency is still sticking by his story that the enormous Greek budget gap is a work of fiction.
 
Manolis Kontopirakis says the new socialist government is trying to make itself look good by exaggerating the scale of the problems. The new government said last year that, sorry, folks, the deficit was going to be just under 13% of GDP, not the 4% that the previous government had promised.

No matter who turns out to be right in this battle, it’s clear that better data are needed. If governments around the world truly do want to throw money into job creation, one excellent place to start would be by hiring more and better statisticians.

Freelance business journalist Ian McGugan blogs for the Financial Post.

Investors have shied away from Canadian banks in recent months resulting in a 0.4% dip in share prices during the fiscal first quarter from November through January. By comparison, U.S. banks are up 9%.

One of the reasons for the underperformance to global peers might be valuation. But according to UBS analyst Peter A. Rozenberg, Canadian banks aren't that overpriced on closer inspection.

"Canadian banks trade at 9.2x “normalized” F12e EPS compared to global
banks at 7.5x 2012e EPS," he said in a note to clients. 

"However, valuations are largely in  line given
higher returns, and are cheaper than similar Australian banks. Also,
Canadian banks are lower risk and have much higher  capital than their
peers."

Based on fiscal 2010 estimates, PEs for the banks are 12.1x, representing the high end of their average range of 10 to 12x.

Mr. Rozenberg said that is not unreasonable assuming a 16% increase in EPS growth in fiscal 2011 from 2% this fiscal year. 

Applying a 12x PE to fiscal 2011 EPS estimates, he projected a 14% return for Canada' bank group, plus a  4% yield. 

He prefers Royal Bank of Canada, Bank of Nova Scotia and CIBC due to above average returns.

David Pett

It’s beyond dispute: U.S. companies are announcing big plans to buy back their own shares. What is not so certain is whether this constitutes good news.

Mark Hulbert, founder of Hulbert Financial Digest, thinks that the recent spate of buyback announcements by companies such as Philip Morris, Colgate-Palmolive, United Health and Amazon is cause for rejoicing. He points out that if buyback activity continues at its current pace, the total for 2010 could easily double the 2009 level.

Share buybacks suggest that managers think their shares are undervalued. Buybacks also signal that companies are finally deciding to spend their cash hoards. And that, in turn, suggests that the economy may get a boost in the months ahead as corporate coffers pop open and money pours out.

The problem is that buybacks don’t always signal good news. While they can be a sign that companies think their shares are undervalued, buybacks can also be a way for management to offset the dilution caused by stock-option plans.

Megan Barnett of the Minyanville blog points out that buybacks have a knack for being badly timed. The volume of stock buybacks in the United States peaked in 2007, when the Dow reached a record high. In that case, buybacks proved to be a sign of a market top, not a market bottom.

Freelance business journalist Ian McGugan blogs for the Financial Post.
 

Retail will be the key driver to first quarter bank results due later this month, giving an advantage to Toronto Dominion Bank, says RBC Capital Markets analyst Andre-Philippe Hardy.

"In domestic retail divisions, on a year-over-year basis, we expect stronger wealth management revenues and robust growth in mortgages and consumer-related loans to more than offset higher loan losses," he said in a note to clients.

Mr. Hardy said TD Bank should continue to outperform its domestic peers with solid asset and revenue growth in Canada and the United States.

The bank's retail margins will expand in the first quarter, while sequential chargeoffs and loan loss provisions will stabilize, the analyst said.

He reiterated his Outperform rating and $80 price target, saying TD is a good name going into the quarter.

David Pett

Sure, winning the Nobel prize in economics is nice, but the hottest competition may be for the Dynamite prize in economics. This new award is going to be handed out to the three economists who contributed most to blowing up the global economy.
 
Among the contenders are Alan Greenspan, Milton Freedman and Larry Summers. The Real-World Economics Review blog, which is running the competition, sums up Summers’ contribution this way: “As US Secretary of the Treasury (formerly an economist at Harvard and the Word Bank), he worked successfully for the repeal of the Glass-Steagall Act, which since the Great Crash of 1929 had kept deposit banking separate from casino banking. He also worked with Greenspan and Wall Street interests to torpedo efforts to regulate derivatives.”

Vote for your favorite (or least favorite, as the case might be) at Real-World Economics Review blog. No money will be awarded, but think of the fame.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

The recent underperformance of emerging markets to developed markets is temporary, says Capital Economics.

"Emerging market equities have often underperformed developed market equities during previous periods when markets have moved down, said James Lord and John Higgins, economists at the U.K. research firm.  

"Nonetheless, we would point out that the underperformance this time around has been very small, and the time frame short. We also think that it will not last for long."

The MSCI Emerging Markets Index has dropped as much as 15% so far this year, versus 8% for the S&P 500 and 13% for the MSCI EAFE index, as global equities pull back from last year's rally on a slew of concerns, including policy tightening in China and Greece's sovereign debt crisis.

Although history shows there is risk that further weakness in developed markets will result in further underperformance of emerging markets, Mr. Lord and Mr. Higgins said it is far from automatic. 

They argued that prospects for economic growth in much of the emerging world remain more favourable than in the developed world. 

"Admittedly, this is not proving to be such good news in the short term – the strength of the recovery has led several central banks in the developing world to start tightening monetary policy, which has probably contributed to recent stock market weakness," the economists said.

"Market fears over what damage policy tightening might do should not last for much longer."

Secondly, Mr. Lord and Mr. Higgins said that public finances in emerging markets are relatively sound compared to developed markets, which puts less pressure on bond yields to rise in the developing world.

David Pett

Shares in Biovail Corp. barely budged following news that it has acquired the U.S. and Canadian rights to commercialize a new drug for rapid treatment of agitation in patients with schizophrenia or
bipolar disorder.

It's not that the deal doesn't look good, says Marc Goodman, UBS strategist. Its just too early to know just how good.

"This deal helps deepen Biovail’s [central nervous system] pipeline. Biovail needs more shots on goal before investors start to give it credit for its pipeline. This is a good way to start the new year," the analyst said in a note to clients. 

He maintained his Buy rating and $16 price target, saying he needed to become more comfortable with the commercial potential of the drug.

"This drug is an interesting wild card. It works faster than orals and is less invasive than injections. At this point, we still need to determine how agitated most of these
patients are and whether inhalation is a viable option for most of them," he wrote.

David Pett

The bad news, says Vincent Delisle, Scotia Capital Markets strategist, is that U.S. equity markets may fall another 5% before the current correction ends. The good news is that he expects the S&P 500 to still hit 1,200 by year's end, representing upside of 15%.

"It is important to keep in mind that fundamentals are still supportive," Mr. Delisle said in a note to clients.

"Earnings are picking up with top-line growth now contributing, the latest ISM/global PMI readings were strong, CISCO provided some highly supportive comments last week indicating that business spending was back, and the U.S. economy is poised to print positive payrolls data late Q1/early Q2. In addition, forward P/E's have backed down to 13.5x."

While equities continue to look more attractive than bonds, Mr. Delisle reiterated his plan to take risk off the table in 2010.

For the time being, he is focused on mid-to-late cycle sectors, including Industrials, Cable/Media, Technology, Large Cap Oil, Fertilizers, and Insurance.

David Pett

The rally in the U.S. dollar has taken a bite out of gold, but recent history suggests a reversal of fortune for yellow metal prices and shares in miners that explore and produce it, says a new report from Raymond James analyst Brad Humphrey. 

Over the past few weeks, the greenback has strengthened dramatically, particularly against the euro that has been hit hard by sovereign debt woes in Greece. Up roughly 8%, it has become a safe haven for investors at the expense of gold, which has fallen 11%, and gold stocks, down 22%.

Mr. Humphrey said there have been three other similar "safe haven " rallies since the 2007 credit collapse. On average during these periods, the U.S. dollar rose 13%, versus a 9% drop in gold and 28% drop in gold stocks. 

Following these rallies, he added, the greenback fell 9% on average, while gold rebounded 11% and gold stocks climbed 37%.

"Although historic performance cannot be applied as a forward guide, we would highlight that these three recent periods of USD strength have provided an excellent entry point into gold equities, noting also that during the ensuing rally the equities have offered more than triple the upside than investing in the metal itself," the analyst said in a note to clients.

In the recent sell-off, Mr. Humphrey said Yamana Gold Inc., Lake Shore Gold Corp., Golden Star Resources Ltd., Aurizon Mines Ltd., and Aura Minerals Inc., have suffered the most.

Hard hit companies will often attract buying interest given their underperformance,  he wrote.

David Pett 

Every hipster knows that Apple Inc. is the nimble little perfectionist, while Microsoft Corp. is the evil empire and IBM Corp. is the lumbering dinosaur. That’s the way things have always been. Well, until recently.

Bespoke Investment Group points out that Apple’s market cap was only about a tenth of the size of Microsoft’s or IBM’s back in 2000. Since then, though, Apple’s share price has bulged to elephantine proportions. Apple’s market cap is now about 71% as large as Microsoft’s and US$17 billion bigger than IBM’s. (Maybe we should start calling IBM “Little Blue”.)

Apple’s increasing size raises questions about how long it can continue to grow its revenue and profit at the rapid clip it’s enjoyed over the past few years. One big danger is that it will start thinking more like a big company and become obsessed by its internal needs rather than by consumer desires.

Holman Jenkins Jr. of the Wall Street Journal argues that Apple is showing every sign of becoming more and more like Microsoft.

One piece of evidence is the iPad, a disappointing device that seems designed mostly to boost sales at Apple’s iTunes store. Another piece of evidence is Apple’s decision to exclude Flash, a piece of software that would allow iPhone and iPad users to consume video without going through iTunes.

Jenkins warns that Apple may soon become a company “that rolls out increasingly junky devices merely to lock more and more customers into the iTunes-App Store mall.” His warning sounds a mite premature, but it would be reassuring to see Apple respond to the criticism with stronger new products—especially ones that don’t involve peddling iTunes merchandise.

Freelance business journalist Ian McGugan blogs for the Financial Post.