Author: David Pett

U.S. equity index futures are higher this morning. S&P 500 futures added 1 point in pre-opening trade. Index futures moved higher following news that the European Union has reached an agreement to bail out Greece. Details have yet to be released.

Index futures briefly moved slightly higher following release at 8:30 AM of the weekly jobless claims report, but slipped lower prior to the opening. Jobless claims fell a surprising 43,000 to 440,000.

Crude oil added another $0.21 per barrel after the International Energy Agency raised its estimate for world crude oil demand in 2010 by 1.6 million barrels per day.

First Energy has offered to acquire Allegheny Energy in an all stock deal valued at $4.7 billion.

Several Canadian companies reported lower than expected fourth quarter earnings including Canadian Tire, Encana and SunLife.

Pepsico is slightly higher after reporting fourth quarter earnings in line with expectations. Revenues exceeded expectations.

Bernstein upgraded 3M from Market Perform to Outperform. Target price was raised from $90 to $99.

Analysts are taking a more positive stance on the U.S. Oil Service sector. ‘Tis the season for the sector to move higher! This morning HSBC raised its rating on Cameron International from Neutral to Outperform. Target price is $49.

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

Canada’s largest real estate investment trust is once again being questioned about paying out more income than it is pulling in.

RioCan REIT might end up with a distribution above adjusted funds from operations, says Heather Kirk, an analyst with National Bank Financial. She had expected RioCan to have funds from operations of 33¢ per unit in the fourth quarter but the REIT finished with 28¢ per unit of FFO. That was down from FFO 39¢ per unit a year ago.

“The miss is largely as a result of an absence of gain revenues once again in the quarter and an increase in interest expense. Last quarter management had indicated that the $9-million to $10-million of expected gain revenues would decline to $7-million and be pushed into Q4 and Q1 2010. This has not materialized,” said Ms. Kirk.  “If gain income does not recover, distributions are expected to remain above AFFO.”

The big question then becomes will RioCan be forced to cut its distribution, something chief executive Ed Sonshine said he wouldn’t do at the company’s annual general meeting last year.

“Will the distribution be cut?,” said Ms. Kirk. “We do not expect so given that the shortfall is small when taken in the context of the overall value of the REIT’s portfolio and in particularly if you back out the reinvestment of distributions.  Adding additional leverage to make up the shortfall would barely turn the dial in terms of RioCan’s debt to gross book value.”

Garry Marr

As financial regulators around the world get set to boost capital requirements, banks everywhere are being forced to reassess the benefits of acquisitions.

A case in point is the potential purchase of Siam City Bank by Bank of Nova Scotia affiliate Thanachart Bank of Thailand.

According to CI Capital Market analyst Brad Smith, overnight reports out of the Southeast Asian country suggest the Thai central bank is on the brink of deciding whether to sell its 47.6% stake in Thanachart Bank, and the likely winner is the BNS affiliate, rumoured to be offering $984-million.

"The real issue here is not the impact of the SCIB acquisition but rather the relatively low level of BNS’s existing Tier 1 capital ratio," Mr. Smith said in a note to clients today.

If Thanachart Bank goes ahead with a previously announced $1.2-billion rights offering to fund the deal with Scotia subscribing to its share, the Canadian bank would end up with a lower Tier 1 capital ratio. BNS's Tier 1 ratio is currently 1.2% below the median level of its domestic peers of 12%, Mr. Smith said.

"Even when looked at from the proposed Basel III perspective the Common Tier 1 ratio after the SCIB funding would be around 6% compared to a median of 6.8% for the other Big Five banks.

Perhaps the simplest way to fix the problem would be an equity offering. Mr. Smith estimates Scotia would have to issue at least $2-billion of equity to bring its Tier 1 up to the same level as its peers, resulting in about dilution of about 5%.

John Greenwood

Put together Greek bureaucrats and U.S investment bankers and what do you get? A state-of-the-art way to quietly run up even more public debt.

Der Spiegel, the German news magazine, says that Greece’s accounting fiddles are even more elaborate than people thought. Beginning in 2002, the country allegedly used various derivative transactions to legally circumvent the European Union’s rules on government debt and deficits.

Der Spiegel says the latest revelation continues Greece’s long tradition of cooking the books: “The Greeks have never managed to stick to the 60% debt limit and they only adhered to the 3% deficit ceiling with the help of blatant balance sheet cosmetics. One time, gigantic military expenditures were left out, and another time billions in hospital debt.”

The new twist is the use of cross-currency swaps in which the Greek government issued debt in dollars and yen then swapped it for euros, while agreeing to exchange that money back into the original currencies at a later date.

Der Spiegel says that the swaps were constructed with the help of—you guess it—Goldman Sachs. It says the U.S. bank “devised a special kind of swap with fictional exchange rates. That enabled Greece to receive a far higher sum than the actual euro market value of 10 billion dollars or yen. In that way Goldman Sachs secretly arranged additional credit of up to $1 billon for the Greeks.”

While contravening the spirit of the EU rules, this kind of transaction is perfectly legal. Nobody, though, appears to be rushing forward to claim credit for the deal. Der Spiegel says Goldman declined comment on the matter, as did the Greek Finance Ministry.

If the German publication is right, Greece’s financial situation is even worse than thought. When its bond issue matures in 10 to 15 years, Greece will have to pay up for the swap transactions.

Don’t worry about Goldman, though. Der Spiegel says it sold the swaps it held as part of the deal to a Greek bank in 2005.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

What a difference a couple of months make.

At the end of the last year, a weakening U.S. dollar was giving a charge to commodities, with gold hitting record highs, oil back above US$80 and copper and other base metals boasting triple-digit gains from earlier in the year. 

But these days, it's like markets have been turned upside down: The greenback is surging and commodity prices are in retreat. 

Larry Jeddeloh, the founder and chief investment officer of Minnesota-based TIS Group, doesn't see much hope for another about-face in favour of commodities anytime soon.

With a weak euro expected to get even weaker as the European Union struggles to deal with the sovereign debt crisis in Greece and potentially other PIGS nations like Portugal and Spain, he predicts the U.S. dollar will continue to strengthen, in turn driving commodity prices even lower.

"I do not think this decline in commodities is done," he said in a note to clients.

He recommended being short copper and "pretty much all base metals" for the next little while, noting price action in copper suggests investors are being forced to sell.

"Forced liquidations are the most difficult to handle because until prices collapse and the last seller is out of the way, it is hard to know when the selling will end," he wrote.

Gold, meanwhile, is trading under similar pressure and could trade down to US$1,030 per ounce before dropping further to US$900 to US$950.  

"At those levels, gold becomes interesting as oil does in the $60-$65 range," he said.

David Pett

How should the European Union help out Greece? By letting inflation rip, says Thomas Straubhaar, president of the HWWI economic institute in Hamburg, Germany.
 
Allowing inflation to soar would reduce the real burden of the huge nominal debts that have been run up by Greece and other European countries. Of course, diluting the euro might be seen as a desperate remedy to these countries’ problems, but, as Straubhaar points out, there are no good options in this predicament.

If the EU helps Greece, it will be forced to bail out other indebted nations, such as Portugal and Spain. A series of such bailouts would be hugely expensive and would punish European countries that have lived within their means. German taxpayers in particular would be enraged at the prospect of paying higher taxes to subsidize pensions for Greek civil servants.

On the other hand, if the EU does nothing, the disparities in living standards among European nations will grow larger. Hopes for closer integration will be smashed. And that may result in more discord in the future.

Straubhaar adds that the extra benefit of allowing higher inflation is that it would cause the euro to depreciate further. That would provide an extra boost to European exporters.

But Straubhaar’s proposal also raises the question of what happens if other countries decide to follow a similar policy. U.S. homeowners, for instance, might welcome an outburst of inflation that would wipe away part of the real cost of their mortgages.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

Recent worries that red-hot economic growth in China, India and the rest of the developing world is unsustainable may be overblown, says a new report from Win Thin, senior currency strategist, Brown Brothers Harriman & Co.

While that's likely good news for recently struggling markets, without a rebound in U.S. stocks, it may not be enough to restart the global rally.

"Given what we view as strong EM fundamentals and improving growth numbers, we can see the basis for a strong EM performance during the rest of 2010," said Mr. Thin in a note to clients.  "However, much will depend on what’s going on in the US markets, as the correlation remains strong." 

The strategist noted a recent Bloomberg report discussing the
parallels between the current emerging market correction and a
two-month drop in the MSCI EM index of 11% in 2004, that was followed
by a 26% rally through the end of 2004.

If a similar rally is to take place this time around, it will likely go hand in hand with a rebound in U.S. stocks, he said, noting a daily
correlation between MSCI EM and MSCI US at .9379,

"[That's] very high but down
from a peak of around .9800 at the beginning of 2009 and again in late
2009," he wrote. "That correlation has broken down from time
to time during the financial crisis, but always seems to rise again
back towards 1. 

Recent monetary tightening in China and India has helped hinder world stock markets, with the MSCI Emerging Market Index is down 13% from its peak Jan 11, compared to a drop of 7% in U.S. stocks and a 9% fall for developed markets as a whole. However, it does not appear to be slowing overall economic growth in emerging markets the way many investors have anticipated.

Following a 75 basis point rate hike in January, India still estimates that GDP growth for fiscal 2009/10 ending Mar. 31, will hit 7.2%, up from 6.7% the year earlier. China, meanwhile, is still predicting growth of 10% this year despite recent tightening moves, including a planned increase in bank reserves.

With the exception of Russia, whose economy is expected to grow a relatively weak 3.6% in 2010, most other emerging market countries, including Brazil are also expected to book strong growth.

Ongoing concerns about inflation should result in further tightening in the developing region, but not enough to slam the brakes on projected growth, said Mr. Thin.

David Pett

A couple of new options to buy gold bullion hit the Canadian market this week, feeding a growing appetite for precious metals in their physical form.

BMG Management Group Inc. launched the BMG Gold BullionFund on Monday, an open-ended mutual fund that invests exclusively in physical gold bullion. The new fund requires a $1,000 minimum investment ($2,500 inside an RRSP) and carries a maximum management fee of 2.25%.

“Core holdings of a portfolio should start with fully allocated and
insured physical bullion." said Nick Barisheff, president and CEO of BMG, in a statement.

"There should be no derivatives or hedges of
any kind, nor should there be any third-party claim on the bullion,
counterparty risks or dependency on portfolio managers for trading
strategies.”

Later this week – likely Wednesday – the previously announced conversion of closed–end Claymore Gold Bullion Trust into an open-end exchange traded
fund will also take place. 

The new Claymore ETF will carry a management fee of 0.50%, including all operating expenses and custody fees. 

David Pett 

Last week's mixed jobs data left many investors still deeply concerned about North America's employment situation, but be patient, says George Vasic, UBS strategist, the recovery in corporate profits squarely points to a rebound in jobs very soon.

"In our view, the best guide to the secular trend in employment has been profits, since real jobs can only be created once firms have the money to spend. Indeed, profits have led job growth by two quarters, and the good news is that profits turned positive in Q309," said Mr. Vasic.

Despite the severity of the recent recession, Mr. Vasic said profits troughed at higher levels than is normal historically. 

"In Canada, he noted that profits are currently 9% of GDP, which compares to about 5% in 1991 and 7% in 1982. In the US, the profit share dipped to 8% before its recent rebound, which was also above the 2001, 1991 and 1982 troughs.

"The relatively high profit level means that the lag to jobs should not be longer than usual – and points to a lasting job recovery starting in the months ahead," he said.

David Pett  

One of the interesting effects of the global downturn has been to reshuffle the hierarchy of which nations are considered economic geniuses and which are considered dunces.

India, for instance, is now deemed to be a member of the honor society. Its economy expanded 6.7% in 2009 and is expected to grow 7.5% this year. The country’s government has won top marks for its strong, confident management of the recent crisis.

So what are the keys to India’s success? Oddly enough, the country’s biggest successes seem to be what people used to perceive as its largest failures.

Consider its heavily regulated economy, for instance. No doubt all those layers of red tape have slowed down innovation, but they have also prevented Indian banks from playing with the fancy financial instruments that blew a hole in so many North American and European banks.

In another strange twist, India has benefited during the recent crisis because its exports have never been hugely successful. The country’s reliance on domestic demand has proven to be a plus when international demand is shrinking.

Finally, the country’s regulators have been shown to be right in pursuing policies that once drew the scorn of North American economists.

For instance, the Indian government was willing in recent years to increase lending standards for banks to combat runaway stock prices and property values. That was considered silly at the time. Now it looks rather smart.

Freelance business journalist Ian McGugan blogs for the Financial Post.

For years, policymakers have been warning that things will be different when boomers start retiring in large numbers. You’ve probably heard the phrase so often that it’s lost all impact. But guess what? It’s no longer a matter of “when.” It’s a matter of now that the boomers are retiring in large numbers.

Stephen Gordon, a professor of economics at Laval, has the numbers (as well as a scary chart) on Worthwhile Canadian Initiative, the excellent blog on Canadian economics which he co-authors. His post shows that the working-age population as a percentage of the total population is beginning a sharp decline. Since 2005, the data have been at the extreme bad end of the 13 scenarios imagined by Statistics Canada.

Gordon figures the decline in the size of the labor force is going to cut per-capita GDP growth rates by about 0.4% a year. While Gordon doesn’t go into all the ramifications, it seems safe to assume that an aging population and slower economic growth will put pressure on the government’s deficit projections—not to mention Canada’s booming real estate market.

Freelance business journalist Ian McGugan blogs for the Financial Post. 

Investors will have to wait until May to get more clarity on Bell Aliant Regional Communciations Income Fund's plans to convert to a corporation.

However, based on estimates from the Street, one thing is already for sure. The wireline company's current distribution will need to be cut.

Yesterday, Bell Aliant released inline fourth quarter results and guidance for 2010, including a distributable cash estimate of between $750 – $790-million, which equates to a $2.90 per share payout this year. Management said it will announce its post-conversion dividend policy in May, after one more quarter of economic and competitive visibilty.

"While we view the current 10.9% yield as attractive, investors should
be aware that while we expect the distribution to be cut to $2.60/share in 2011 from $2.90 in 2010, the new distribution rate is
not sustainable in the long term," said Maher Yaghi, analyst, Desjardins Securities. 

"While Bell Aliant is not expected to pay much in cash taxes until 2013, a tax run rate of 27% beyond that time will require a further distribution cut."

Mr. Yaghi estimated the distribution will need to be cut to a range of roughly $2.10 to $2.20, resulting in a yield over the long term of about 8% based on the current unit price. 

Overall, Mr. Yaghi said his thesis remains unchanged for Bell Aliant. He maintained his Hold rating and trimmed his price target to $26 from $27, saying the unit price currently represents fair value. 

Based on a similar assumed effective tax rate, Phillip Huang, UBS analyst said Bell Aliant has the capacity to support dividend payments of $2.25-2.50 per share.

"This would imply a yield of 8.6%-9.5%, which would be more attractive than MBT's 7.9% yield," he wrote, reiterating his Neutral recommendation and $25.50 price target. 

Meanwhile, Michael Mills, Beacon Securities analyst, told clients he expects an annual dividend in the range of $1.80-$2.00 per share starting in 2011, "despite the ability to shelter tax for the first couple of years."

He maintained his Hold rating, and 12-month price target of $26.

David Pett

The B shares of Berkshire Hathaway Inc. have had a nice run since a 50-for-1 stock split reduced their price from the US$3,500-a-share neighborhood to the far more affordable level of around US$70 a share. While there are many good reasons for the stock’s increase, don’t discount the impact of dollar illusion.

Quite simply, a stock that’s going for the price of a couple of nice bottles of wine sounds like a much better deal than one that costs as much as a vacation. The value on a dollar-for-dollar basis is exactly the same, of course—but bringing the stock price under $100 makes it seem like nearly an impulse buy.

The question now is whether other companies might take a page from Warren Buffett’s book and do their own stock splits. One candidate would be Fairfax Financial Holdings Ltd. of Toronto. Its shares are trading around $370 apiece. Splitting them, say, five for one would bring them down to around $75 each.

Apple Inc. would be another candidate. It’s selling for US$200 a share. Jeffrey Miller, a money manager with NewArc Investments Inc., believes Apple deserves a much higher share price. He thinks that investors are balking at paying more because of the number of dollars involved. He suggests splitting the stock, perhaps 10 for 1. “If this were a $20 stock, it would soon be a $30 stock,” he declares.
 
Freelance business journalist Ian McGugan blogs for the Financial Post.

You may want to take a new look at the initials that come after your fund manager’s name. They can affect the level of risk in your portfolio.

A new study by Oguzhan Dincer of Illinois State University, Russell Gregory-Allen of Massey University and Hany Shawky of SUNY Albany looks at whether money managers who have achieved the prestigious Chartered Financial Analyst designation or earned an MBA do better than managers without those
credentials.

The study finds that neither designation does much to boost performance. Managers with the credentials perform no better or worse than managers
without them.

But there does seem to be an effect on risk. Managers who hold the CFA charter consistently build lower risk portfolios than managers with MBAs. This result is surprising and may have something to do with the ethics instruction that is part of the CFA course but not most MBA programs.

“It suggests that business schools are teaching MBAs to enhance risk,” the authors conclude. “Although MBAs and CFAs learn the same material, from the
same books (and often the same teachers), with the high ethical standards that are embodied in the CFA designation, perhaps they are less likely to
take the path of maximizing bonus without respect for the portfolio investors.”

Freelance business journalist Ian McGugan blogs for the Financial Post.

Nickel prices will rise to US$9 per pound in this year and US$10 per pound in 2011, say analysts at Desjardins Securities.

Demand will continue to outstrip supply over the next two years, due to "ongoing strikes at Vale Inco's operations, unacceptable nickel laterite and a 'pick-up' in stainless steel prodution," said John Redstone and John Hughes in a note to clients.

The analyst said the Voisey's Bay and Sudbury operations of Vale Inco, which combined produces 6% of the world's nickel, are firmly on strike and won't resume before the second quarter of 2010.

Supply is also hindered by poor quality nickel laterite ore that is imported to China for use in nickel pig iron, a crude nickel-bearing product used primarily by stainless-steel mills.

"According to the CRU, much of the material imported in 2009 had an unsuitable nickel/iron composition," the analysts said. "CRU estimates that of the 9.3 thousand tonnes of ore currently stockpiled at Chinese ports, roughly 80% (7.7 thousand tonnes) is unacceptable."

Meanwhile, sentiment has improved in the stainless steel sector and Mr. Redstone and Mr. Hughes expect prices to increase 8% in 2010 and 10% in 2011.

They like Sherritt International Corp., FNX Mining Co. Inc., Asian Mineral Resources Ltd. as their preferred nickel plays.

David Pett

Down 7% in just two days, it may be time to scoop up some stock in Canada's second biggest railway.

Canadian Pacific Railway Ltd. shares have fallen 7% since last Thursday, when management announced fourth-quarter earnings that beat the Street, but also let known their less-than-rosy thoughts about the coming year.  

"Management spent considerable time on
2010 headwinds and a relatively cautious view on volumes," said Walter Spracklin, RBC Capital Markets analyst.

"Even pricing
renewals of 4% are expected to be negatively impacted in 2010.

While the near-term sentiment puts some pressure on
the share price in the near-term, Mr. Spracklin continues to like the operating leverage opportunity at CP and recommends buying on weakness to clients.

He maintained his Outperform rating and $65 price target.

David Pett

An increase in Toronto Dominion Bank's capital base in the fourth quarter of 2009 strongly indicates that Canada's second largest bank by market capitalization is planning an acquisition or more, says Brad Smith, CI Capital Markets analyst.

TD's equity capital account grew by US$1.7-billion during the past quarter, according to the latest call report data from the Federal Deposit Insurance Corporation. The bank's full year surplus is now just over US$3-billion.

"Why TD management saw fit to bolster the subsidiary's capital base so aggressively when the return on invested capital remains well below management's own assessment of its cost remains an open question," said Mr. Smith in a note to clients.

"The likelihood of repatriating the capital anytime soon is in our view low leaving us to conclude that further acquisitions may be on the horizon sooner rather than later."

David Pett

Canadian Tire Corp. credit card write-offs are falling and should return to normal next year, says Keith Howlett, Desjardins Securities analyst.

For December, the well-known retailer said its net credit write-off rate fell to 7.67%, down from 8.1% in November and 8.28% in October.

"Subject to the state of consumers' finances after the holiday-spending period, write-offs appear to have peaked in 3Q09," said Mr. Howlett.

"It appears not unlikely that Canadian Tire may return to its target write-off rate (securitized and on-balance sheet) of 5-6% sometime during 2011." 

Mr. Howlett said expect all of Canadian Tire's divisions, except petroleum, to have had lower year-over-year EPS in the fourth quarter of 2009. He maintained his Hold rating and $57 price target on the stock.

David Pett