Author: Jonathan Ratner

With more than half of the companies in the S&P 500 having reported first quarter results, corporate profits have again come in well above consensus estimates. The normalization of credit conditions, a steep yield curve, improving prospects for global business and cost cutting made up much of the profit surprises.

As the economic recovery process deepens, cost cutting efforts are realized and global credit conditions thaw, analysts have responded by steadily increasing their earnings estimates.

While earnings are expected to accelerate further, the scope for further upside earnings surprises is waning, UBS Wealth Management Research warns. In contrast to this past year when analysts were playing catch up with the business cycle, most have now reset expectations and the bar has now been raised.

“With earnings revisions a key driver behind directional moves in equities, an absense of upside surprises should temper gains in stocks until year-end,” Michael Ryan and Stephen Freedman of UBS said in a report.

Despite the profit surge, they are sticking with a neutral (benchmark) tactical allocation in equities, an overweight in commodities, and below benchmark allocations to both fixed income and cash.

While market bears frequently point to the vulnerability of earnings estimates as a potential catalyst for a sharp pullback in equities, George Vasic noted that analysts have become more prudent over the years.

Despite what his colleagues noted, UBS Securities Canada's chief economist and strategist looked at the pattern of earnings revisions and found that it now takes far more economic weakness to generate the same earnings cuts as in the past.

“Accordingly, bears looking for earnings disappointment as the catalyst are either living in the past or expecting a very severe double dip for the economy,” he told clients.

With the economy representing a significant source of uncertainty, the magnitude of earnings revisions natural tracks GDP growth. But what investors may not have noticed is that the relationship between the two has shifted in recent years.

Mr. Vasic pointed out that in the past, it took an absolute boom in the economy for earnings estimates made at the beginning of the year to actually come to pass. However, in the new relationship, Mr. Vasic cited the example of the 30% cut to 2009 estimates as being consistent with a 2.6% drop in real GDP. He said the implication for investors is that 3% GDP growth in 2010 should only lead to modestly negative revisions. In the past, the strategist said this would have been consistent with a cut of more than 20%.

“Stated otherwise, it will likely require a major double dip in the economy to generate the earnings cuts envisioned by equity bears.”

Jonathan Ratner

U.S. equity index futures are mixed this morning. S&P 500 futures are down 1 point in pre-opening trade. Index futures eased slightly following release of the advanced first quarter GDP report. Consensus was annualized real growth at a 3.3% rate. Actual was growth at a 3.2% rate.

Commodity prices including gold, crude oil, silver and copper are slightly higher following mild weakness in the U.S. Dollar Index.

Canada’s economy continues to grow at a satisfactory rate. Real GDP recorded a gain of 0.3% in February. Consensus was a gain of 0.3%. The Canadian Dollar was unchanged on the news.

First quarter earnings reports continue to surprise on the upside. Domtar and Chevron reported higher than consensus earnings.

Goldman Sachs fell 3% after Federal prosecutors confirmed that they were exploring the possibility of registering legal charges against the company.

Cenovus Energy slipped slightly after UBS downgraded the stock from Buy to Neutral. Target price is $31.

The U.S. oil services sector is trading lower after FBR Capital downgraded the sector. President Obama announced this morning that no new offshore drilling will be allowed until after the Gulf of Mexico oil spill disaster is investigated. 

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 

Those that follow the gold and currency markets know that the price of bullion and the U.S. dollar typically move in opposite directions. However, this negative correlation can turn positive from time to time and is happening now. 

The correlation between weekly changes in the U.S. dollar and bullion has turned from -0.7 at the start of 2010 to +0.41. This is the biggest positive since 2007.

During gold's biggest rally ever between 1978 and 1980, the U.S. dollar traded sideways. Back then, demand for bullion was being driven by fears of a collapsing global monetary system, and investors fled all paper currencies. These days, the situation isn't very different except that U.S. dollar reserves are being accumulated in large numbers.

Sovereign debt concerns in Greece, Portugal and elsewhere in Europe continue to put pressure on the Euro currency as investments in gold and the U.S. dollar are in high demand from investors seeking safe havens.

Historically, episodes of U.S. dollar appreciation coupled with rising gold prices tend to be fleeting, according to Stéfane Marion, chief economist and strategist at National Bank Financial.

In a note to clients he wrote, "…we still think that the historical negative correlation between gold and the greenback will resume once the uncertainty is lifted about the introduction of credible loan programmes between eurozone partners to help certain members reduce their fiscal deficits."

As Adam Kritzer of forexblog notes, at the moment the correct interpretation is that anything is preferable
to the Euro since its sovereign debt problems are the most pressing.

He also points out that many are betting that gold will eventually distance itself from the U.S. dollar if and when America's fiscal problems escalate to the level of a
Greek-style crisis. "At this point, gold will start to trade as an
alternative to the entire forex market!"

According to Deutsche Bank, gold has decoupled from the dollar since at least
the end of March. "If the correlation re-establishes itself before
July, either the dollar must continue to decline or investment into
bullion-backed funds must pick up in order to avoid erosion in gold
prices," analysts at the investment bank said recently.

Jonathan Ratner

 

American International Group Inc. (AIG) may be overvalued at US$40 per share based an updated sum-of-the-parts analysis that reflected recent developments by Andrew Kligerman at UBS. The analyst arrived at a fair value of US$31 based on changes in insurance sector multiples, pending sales of AIGs Asian unit (AIA) and its Alico foreign life insurance business, as well as other revisions.

However, Mr. Kligerman feels there are several potential catalysts that could provide upside to his valuation, including a restructuring of the government’s equity stake at favourable terms for AIG common shareholders. While the analyst does not think this is a highly probable outcome, multiple expansion in the life insurance or property and casualty space would boost the value of AIG’s insurance operations and the equity-linked securities received from selling Alico and AIA.

“Current management has been disciplined in its asset sales, optimizing returns on asset disposals (not seen in the prior leadership),” Mr. Kligerman said in a research note. “Abating credit losses and successful debt offerings by subs suggest less reliance on the Fed Credit Facility.”

In addition to the sum-of-the-parts analysis that signals potential downside risk, the analyst also warned that AIG shares could see significant earnings per share and return on equity erosion if the non-cumulative series E/F preferreds were replaced by common shares or cumulative public preferreds.

“AIG’s earnings power will be materially weaker (post the sales of key foreign life subsidiaries) and there are some concerns around the adequacy of its P&C loss reserves,” he added.

Jonathan Ratner

LG Mobile Communications has jumped aboard the Android train in hopes that running devices on Google’s mobile operating system will help stem falling sales and market share. Google CEO Eric Schmidt recently noted that 60,000 Android devices are shipped each day, a number that doubled compared to the previous quarter.

In the first quarter of 2010, LG’s sales fell 18.4% compared to the previous three months. Handset revenues declined 20% on a quarterly basis in the seasonally low first quarter, while operating margin rose 100 basis points to 0.7% but was down from 5.6% a year earlier.

The year-over-year decline in profitability resulted from change in product mix and ongoing investment in expansion of channel coverage in the emerging markets, according to RBC Capital Markets analyst Mark Sue.

While LG remains in third place among global handset vendors after shipping 27.1 million units in the first quarter, that figure represent a 20% quarterly decline, which is significantly higher than the 2% dip for global units as a whole.

“This market share loss is a result of decreased sales in North America due to the demand shift to smartphones,” Mr. Sue told clients.

While this was partially offset by growth in emerging markets such as China (+126% yoy) and Central and South America (+60% yoy), the company’s lack of a solid smartphone line-up continues to impact units.

Targeting double-digit sequential growth for the second quarter to 30 million units, LG is focusing on building out its smartphone lineup with the launch of two Android-based smartphones.

The LG Optimus is targeting first time smartphone users. It runs on the Android 1.6 operating system (OS), has a 3 mexapixel camera, 4 GB of expandable memory, a 3 inch touchscreen display, GPS, social networking integration and auto face-tagging. The device will initially be available in Europe around May 1st, with additional markets to follow.

The LG Aloha looks to capture consumers in the high-end market. It will run on Android 2.1 and include a 1 GHz processor, which Mr. Sue said supports initial claims that its performance will be on par with other high-end smartphone devices such as the Google Nexus One. Aloha also has a 5 MP camera, GPS and Wifi.

While Mr. Sue believes this shift to smartphones will likely support increased earnings and improved average sale prices, the analyst warned that continued investment in research and development and marketing will likely continue to pressure LG’s margins. 

Jonathan Ratner

With global banks facing pressure from regulators in terms of their capital levels, Barclays Capital analyst John Aiken believes there is a very real risk that target payout ratios at Canadian banks will reverse themselves, reverting back to between 35% and 45% of earnings.

He warned that industry earnings would have to increase by almost 25% from the strong levels in the first quarter of 2010 to reach the mid-point of this range.

“Should the banks begin to lower their payout ratios, investors could have to wait several more quarters before they see material dividend increases,” Mr. Aiken said in a note. “Additional growth would be required to generate dividend increases.”

So while the banks are suggesting that higher interest rates will have a positive impact on margins and earnings, if dividends remain static, valuations may come under pressure.

With the industry’s payout ratio now back down below 50%, concerns regarding dividend cuts have subsided. However, increases could ne another issue entirely.

Jonathan Ratner

U.S. equity index futures are higher this morning. S&P 500 Index futures gained 6 points in pre-opening trade. Index futures are responding to a recovery in the Euro on guarded hopes that a resolution on Greek sovereign debt could be near.

Traders are awaiting news from the Federal Reserve. Results of the Federal Reserve’s Open Market Committee meeting on interest rates are expected to be released at 2:15 PM EDT. Traders are expecting the Federal Reserve to maintain the Fed Fund rate at current levels. Traders also are watching the Federal Reserve’s statement for clues when the Fed Fund rate will be raised.

The parade of better than expected first quarter earnings reports continues. Reports from Canadian companies were a focus this morning. Canadian companies that reported higher than consensus earnings overnight included Barrick Gold, Jean Coutu, TMX Group and Rogers Communications.

U.S. companies that reported higher than expected first quarter earnings include Comcast and Dow Chemical.

Cisco added 1% after RBC Capital upgraded the stock from Outperform to Top Pick. Target was raised from $30 to $33.

Ford slipped 1% after Credit Suisse downgraded the stock from Neutral to Underperform.

Tellabs gained 5% after an upgrade from Neutral to Outperform by JP Morgan.

Norfolk Southern added 2% after Wells Fargo upgraded the stock from Market Perform to Outperform.

Technical analysis: The gold winner is…

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   

With dividend yields on Canadian banks stocks in the 3.2% to 4.3% range, they are roughly three times greater than selected U.S. peers. That puts Canada in a very favourable position given that long-term historical levels have dividends on both sides of the border at similar levels.

All other things being equal, the situation dramatically favours Canadian bank valuations, according to Brad Smith, analyst at Stonecap Securities. Of course, all other things are not equal.

He explains that the bulk of the yield differential that has developed in the past few years is a direct result of a collapse in earnings among U.S. banks. This has forced them to recapitalize and dramatically cut dividend payout rates. In fact, from a long-run average of almost 45%, payout ratios at U.S. banks has plunged to just over 20%. During the same period, payout ratios for Canadian bank stocks have risen from the 30% range to approximately 50% these days.

“While the maintenance of payout ratios by domestic banks reflects the well documented capital and credit profile strength from which they entered the recent period of global credit stress, it also dictates that future dividend growth will to a large extent be tied to earnings growth,” Mr. Smith told clients.

Assuming that U.S. banks can grow their earnings at comparable rates to their Canadian counterparts, which is somewhat conservative given the potential for the U.S. economy to recovery from a much deeper recession, and assuming that banks on both sides of the border see a return to historically normalized payout ratios, the analyst expects Canadian bank dividends will grow at a compound rate of just under 3%. Meanwhile, U.S. bank dividends could grow at a compound rate of just over 20%.

So while current yields favour Canadian bank valuation, the potential for rapid dividend growth amid a North American economic recovery strongly favours forward returns for U.S. banks.

“This view intensifies if the one believes that a recovery will be accompanied by a general increase in interest rates,” Mr. Smith said.

Jonathan Ratner

Standard and Poor’s decision to cut its credit ratings on Greece and Portugal demonstrates that there will surely be plenty more turbulence in global financial markets as Greece’s situation and that of the other PIIGs plays out.

Amid the uncertainty, there are two significant dates we can be sure of and one unknown date – all of which will cause volatility and uncertainty surrounding the Euro.

All three will likely occur in the next three weeks, according to Andrew Busch, global currency and public policy strategist at BMO Capital Markets.

On May 9, elections will be held in Rhine-Westphalia, Germany’s most populous state. This mandates that German Prime Minister Angela Merkel drag her feet on a bailout of Greece, Mr. Busch said in a note. “A bailout is very unpopular and Merkel will lose important seats in the Bundestag if she strongly supports the bailout.”

May 16 is the date when €8.5 billion of Greek debt needs to be rolled over. With Greek 2-year notes yielding 14.5% on Tuesday, Greece can’t afford to refinance at these yields.

“They will need to get access to cheaper funding supplied by either the European Union or by the IMF,” Mr. Busch said. “While the situation looks dire at this point, it is likely they will get the funding and it’s likely the IMF will supply it. This is the simplest and cleanest solution.”

As experts from the IMF, the European Central Bank and the European Commission comb through budgets at the Finance Ministry in Athens, balancing receivables against outstanding obligations and appraising the effects of the austerity program on the Greek government, some feel the tip of the mountain of debt has yet to be discovered. German magazine Der Spiegel says it is considered highly likely that they will encounter the occasional surprise.

Mr. Busch said that with the Euro continuing to trade around US$1.33 since the end of March, this situation must be resolved by either an IMF led bailout or by Greece defaulting/restructuring within three weeks time. He suggested that this means a large move of 5% to 10% is also likely up or down as the two outcomes mandate a large move. “Given the large dichotomy of outcomes, the Euro can not remain at these levels.”

Jonathan Ratner

By Norman Levine

Equity markets in North America (and many other parts of the developed world) continued their march upward during the first quarter. Around the world, though, results were very much mixed. Emerging Asian markets such as China, Taiwan, Korea, and Singapore were negative. Main European markets were positive, some substantially. However, their gains were overshadowed by those European markets whose government finances are highly questionable.

Portugal, Ireland, Italy, Greece, and Spain all have runaway budget deficits and massive amounts of debts. Of the group, only Ireland’s stock market was able to show positive returns for the quarter. Greece and Spain declined substantially. They are all members of the European Union.

Unfortunately, the European Union works better in principal than in reality. It is more of a currency union than an economic union as, while it operates under a common currency, each country is responsible for their own economies as long as they operate under Union guidelines. The great advantage of the Union is that there are no tariffs on goods or services between members. This was a great inducement for countries to join. The great disadvantage is the lack of wiggle room for a country in economic trouble.

It doesn’t matter whether you are economically strong like Germany and France or weak like Greece and Spain. Your currency is the euro. In pre-Euro Europe, if a country got overextended it simply devalued its currency. This had the effect of helping the country inflate and export its way out of trouble. With the advent of the Euro, however, all countries use the same currency regardless of its economic strength. This is a huge problem for the economically weak.

Greece had no business joining the European Union. It has a long history of fiscal promiscuity. According to economists Carmen Reinhart and Kenneth Rogoff, Greece has spent 92 of the past 184 years in default on its sovereign debt. When it joined the Union, its debt was 12 times as much as it disclosed in its statements and its citizens and companies have a very poor history when it comes to paying taxes.

The recent recession has caused all of Greece’s warts to be put on full display and now it is crying out for help from its fellow Eurozone partners. Unfortunately, as Dennis Gartman is quick to point out, Germany, the strongest country in the Union, is loathe to help as its citizens have just emerged from the painful and very expensive experience of merging East and West Germany together. They were family. Greece is not.

Germans pay their taxes, work harder, get fewer vacations and retire later than the Greeks. They are in no mood to help their slothful neighbours. Besides, if Greece is rescued by the Union, then Portugal, Ireland, Spain, and possibly Italy will demand equal treatment. Even the United Kingdom could be in line for help.

Things are likely to get uglier in Europe before getting better. We are not in a position to guess as to how things will work out or how long it will take. However, we are being constantly vigilant as to how events will affect us as Canadian investors.

Currency changes are one thing that are working favourably for Canadian investors. People still ask our opinion about the weak US dollar but we have to ask, “Weak against whom?” Despite its many problems, the US dollar is showing great strength against European currencies (be it the Euro, Pound, Kroner or Franc) as well as the Japanese Yen. Its turnaround has gone largely unnoticed in Canada as our dollar has been even stronger, being a beneficiary of the problems in Europe and the US as well as being viewed by the world as a commodity currency. This led to the Canadian dollar being the second strongest major currency in the world during the past quarter, behind only the Mexican Peso (who knew?!).

While headline writers fret about the many perceived negatives of a strong Canadian dollar, we look upon a strong currency as a gift. Not only does it help mute inflation, keep interest rates lower, and make imports and foreign travel cheaper, it also forces our manufacturers to become more productive. Most important to us, though, is it makes foreign investment very attractive. Currencies move up and down constantly and the best time to invest outside your home country is when your currency is strong as you are able to buy more assets for the same amount of money.

We have no idea how high the Canadian dollar will rise or for how long it will remain strong. We do know though that it will not stay strong forever.  We are a commodity currency. Live by the sword and die by the sword. Commodities do not just go up. Commodity prices peaked in January and yet our dollar continues to strengthen. Either commodities resume their upward trend (much more difficult now with a strengthening US dollar) or our dollar becomes vulnerable.

A Greek tragedy is unfolding. For a Canadian investor, it is causing European assets to go on sale. The financial crisis in the United States has caused their assets to go on sale relative to ours. Japan’s coming demographic catastrophe will have the same effect on its assets. Companies are not countries. Strong companies (especially international ones) can reside in weak countries. We have always been big believers in international investing. We will be emphasizing it even more in coming months.

Norman Levine is managing director of Portfolio Management Corp.

Photo: US Treasury Secretary Timothy Geithner (L) meets with Greek Finance Minister Giorgos Papakonstantinou on April 24, 2010 at the International Monetary Fund in Washington, DC. (TIM SLOAN/AFP/Getty Images)

Will a ruling in Ontario that would eliminate payments to pharmacies from generic companies spill over into legislation in Quebec?

Analyst Irene Nattel of RBC Dominion Securities believes it is premature to change her take on Quebec-based pharmacy chain Jean Coutu Group Inc. at this point based on the possibility of future changes in the market.

“Improved sales and productivity from the generic drug operations should drive higher gross margins again [in the fourth] quarter,” said Ms. Nattel, who rates the shares Sector Perform with a target price of $11.

She is anticipating earnings per share of 18¢, compared with 15¢ in the same period last year.

As for Shoppers Drug Mart, which opposes the Ontario government’s plans and has warned it might have to cut staff and close stores (the chain memorably cut pharmacy operating hours recently in London, Ont., the riding belonging to provincial health minister Deb Matthews), Ms. Nattel has maintained her Outperform rating on the shares but shaved her target price to $47 from $48. She is predicting earnings per share of 56¢, a penny above consensus.

Hollie Shaw

U.S. equity index futures are lower this morning. S&P 500 futures are down 5 points in pre-opening trade despite encouraging first quarter reports released overnight. Companies reporting higher than consensus first quarter earnings included UPS, Canadian National Railway, Dupont, Texas Instruments, Nexen, Ford and MMM.

Equity index futures were concerned about several issues including the testimony by Goldman Sach's executives, the ongoing saga of the Greek financial crisis and early warning signs that economic growth in China is about to slow due to tightening monetary policy.

Seven Goldman Sach's executives are scheduled to testify in front of a Congressional panel this morning. The session is slated to be more of an inquisition than a fact finding mission based on accusations made by members of the panel prior to testimony.

The Greek financial crisis remains unresolved. Members of the European finance ministers, particularly Germany are demanding greater concessions by Greece before completing a loan agreement. The Euro remains under pressure this morning and is testing support at 132.69.

Efforts by the Chinese government to curtail speculation in the housing industry are starting to impact the Chinese economy. The Shanghai Composite Index closed last night at 2,908. The Index has dropped 8.6% during the past 10 days.

Base metal prices are responding to a possible economic slowdown in China. Copper fell another $0.07 U.S. per lb. overnight to $3.47 per lb. Copper and base metal stock prices generally peaked with the peak in the Shanghai Composite Index.

Canadian National Railway is notably weaker this morning despite reporting higher than consensus first quarter earnings. The stock is down 2% after UBS downgraded the stock from Buy to Neutral.

Oracle was initiated as a Buy at Citigroup. Target is $32.

The February Case/Shiller Index for home prices showed a year-over-year gain of 0.6%. Consensus was a decline of 0.1%. Response by equity index futures to the news was not significant. 

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  

After its third mortgage rate hike in less than a month, Royal Bank of Canada’s total increase is up to an even 100 basis points. In what is becoming an almost weekly occurrence, Royal boosted its five-year closed fixed-rate mortgage rate by 15 basis points to 6.25%.

“With similar, but not as stark, increases in its other offers, this will obviously benefit profitability, but since it takes time for pricing changes to roll through the portfolio, this will not likely benefit second quarter earnings,” Barclays Capital analyst John Aiken said in a note.

While the Bank of Canada has not increased interest rates yet, the market expects this will happen sooner rather than later. As a result, he said Royal appears to be trying to get ahead of the curve, so to speak, and believes that raising rates ahead of the central bank will not have too much of an impact on volume growth.

“There is always an element of strategic gamesmanship in announcing mortgage rate changes outside of changes in the underlying interest rates,” Mr. Aiken said. “And while the remaining banks appear to be willing to let Royal sweat it out a little in front, we question why the others would pass up on the additional profitability, particularly if asset growth could slow.”

Consequenty, the analyst does not believe that Royal will be lonely for long since profits will likely outweight any market share aspirations.

TD Canada Trust wasn’t far behind Royal, raising rates on some mortgages between 15 and 25 basis points.

Jonathan Ratner

Royal Bank of Canada was upgraded to Outperform from Market Perform at BMO Capital Markets. Analyst John Reucassel also hiked his price target on shares of Canada’s largest bank to $67 from $63 after strong results from U.S. banks suggest credit conditions and the business environment are improving faster than expected.

In a note to clients, Mr. Reucassel pointed out that when bank stocks are upgraded in between quarters this often suggests some particular insight into the next set of earnings. But that isn’t the case this time around. In fact, Royal Bank came up shy of the Street’s expectations in the past two quarters, which might explain why the stock has
underperformed the Canadian bank index in 2010.

Instead, the analyst’s conviction comes from a belief that Royal Bank has a number of franchises that should benefit from an improving business environment beyond the cyclical recovery in provisions for credit losses. He said its wealth management, insurance and domestic retail banking businesses will provide good earnings leverage beyond this year.

“In 2010, a better environment should lower losses in U.S. retail banking,” Mr. Reucassel said, adding that strong trading results from the large U.S. banks could increase expectations for Royal Bank’s second quarter 2010 trading revenue. However, the analyst left his trading estimate for the quarter unchanged at $1-billion.

“Looking past the recovery in loan losses, we believe that Royal has amongst the most attractive potential earnings growth rates in the group due to large asset management and insurance operations as well as consistent results from domestic banking,” Mr. Reucassel said. “Regulatory and government actions (in response to the recent crisis) should be the biggest risk to Royal investors, particularly vis-a-vis wholesale banking.”

While the timing of acquisitions is unknown given the uncertainty surrounding new capital rules, regulatory rules should become more clear by fall 2010. Given that economic conditions continue to improve, the analyst expects the regulator to provide banks with more flexibility in decisions on how to fund acquisitions. “This could be a major catalyst for Royal Bank.”

Jonathan Ratner

Brazil is the most likely winner of the 2010 World Cup in South Africa, according to UBS Wealth Management Research. The forecast is based on in-depth quantitative analysis that places great emphasis on a country’s previous performance at World Cup soccer tournaments. The model’s creator, UBS Chief Economist Andreas Höfert, not only correctly picked Italy as world champions four years ago, he also predicted six of the eight quarter-finalists.

Almost all of the historical favourites such as Brazil, Italy, Germany, the Netherlands and England are traveling to South Africa with very strong teams. UBS says this makes it very unlikely that, with the noticeable exception of Spain, we will see “a new, fancy” World Cup winner in 2010.

It will be the first World Cup held in Africa. While South Africa continues to be the continent’s economic powerhouse, generating nearly a quarter of Africa’s total GDP, the country is losing ground relative to its global emerging market peers.

Predictions and football addictions aside, the UBS team felt the event warranted an investor’s guide to Africa since the continent is too often forgotten when it comes to searching for opportunities. The report highlighted many issues, including the fact that Africa accounts for 15% of the global population. However, strong demographic trends are likely to push that figure up to 20% in just a couple of years.

Africa also boasts the world’s highest mobile phone subscription growth with some 40% of the population owning a device. A recent study showed that adding 10 extra phones for every 100 people in a typical developing country boosts GDP per person by 0.8 percentage points.

“This makes the mobile phone one of the most important drivers of living standards in Africa,” UBS said.

Agriculture plays a huge role in Africa, with the sector making up 25% of African economies’ overall economic production on average. That compares with 1% in Switzerland, for example.

Despite the fact that the majority of the sub-Saharan labor force is employed in the agricultural sector, most African countries cannot provide the food they need. As a result, trade between African countries makes up only 10% of their total trade. The other 90% consists of trade with the rest of the world.

China’s role as a trade partner is becoming increasingly important. Africa’s exports to China increased by a yearly average of 31% between 2000 and 2008, compared to 13.5% for exports to the United States. China is also boosting its foreign direct investments in Africa, due in large part to the Asian giant’s hunger for commodities.

“With its energy hunger, China will continue to support African commodity exporters and, in the longer term, will likely help the continent grow richer,” UBS said.

Africa holds an estimated 13% of the world’s proven crude oil reserves and new discoveries mean that number is likely even higher. The continent currently produces 12% of the world’s crude oil supply and consumes less than 4%, leaving Africa with a large surplus.

While it is expect it to remain a growing source of commodity supply in the years to come, Africa has 14.7% of the world’s population so it will not enjoy excessive energy reserves in the long run.

“As African economies develop and grow, they too will have a bigger appetite for energy,” UBS said, noting historical numbers that suggest Africa might become a net importer of oil by 2040. “Thus, supplying the world with non-renewable resources today comes at the cost of scarcity for future African generations.”

The demographics of these future generations are such that the age-groups going into the workforce now and in the coming decades will be larger than the population of children and aged dependants that they support. That means income per capita can rise faster.

UBS says this is the reverse of the rapidly aging populations of Europe, the United States and Japan. The so-called “demographic dividend” is also believed to have played an important role in the economic miracles of the “Asian Tiger” nations over the last decades.

“However, it is no done deal that Africa will be able to benefit from its shifting demography,” UBS said, noting the threat HIV/AIDS poses for the working-age population, particularly in sub-Saharan Africa. Poor education, corruption and a lack of well-regulated markets also put at risk the positive effects of Africa’s demographic trends. “Nonetheless, demography probably remains Africa’s biggest opportunity of the next 50 years.”

Jonathan Ratner

Photo: South African children play football in the mountains of Eastern
Cape, 20km from Port St Johns, on November 19, 2009. South Africa is
hosting the 2010 football World Cup from June 11, 2010 to July 11. (ALEXANDER JOE/AFP/Getty
Images)

Despite Beijing’s concerted effort to cool China’s residential property market, house price inflation continued its rapid acceleration in March. Property prices in 70 of China’s large and medium-sized cities rose 11.7% on a yearly basis in March, data from the National Bureau of Statistics (NBS) shows. It was the biggest year-on-year increase for a single month after the NBS expanded its coverage to 70 cities in July 2005.

After taking steps to restrict lending and curb speculation as soon as house prices started to recover in the middle of 2009, Chinese officials have since responded with another round of measures. The latest measure had the central government raise the required down payment for a family purchasing a second house from the existing 40% to 50%. Their promise of tough action has also been backed by directives to banks to cut lending and increase reserve requirements. The Shanghai stock exchange’s property index continues to trend lower as a result.

However, these efforts will not be enough to prevent overheating, according to the emerging markets research team at RBC Capital Markets. It forecasts a stronger yuan in 2010 and initial rate hikes in the next few months, with the benchmark lending rate climbing by 108 basis points to 6.39% by year-end. RBC also anticipates higher property taxes.

“Although bank lending was weaker than expected in March, suggesting that efforts to tighten liquidity are starting to work, it remains to be seen whether the strategy Beijing has adopted to date will be enough to slow down residential property, let alone curb overheating risks and contain price pressures in other parts of the economy.rebalancing of the Chinese economy,” RBC said in a report.

The general public seems to be getting the message with the local press reporting that some homebuyers are concerned about Beijing’s resolve to rein in the property market. RBC expects the impact of these measure will be most severe in cities that have seen the biggest gains – Shenzhen and Guangzhou looking most vulnerable.

Higher policy rates and a stronger currency may be the most effective way of removing policy stimulus and rebalancing the economy, Beijing is clearly being cautious about using these instruments. If the government’s fine-turing efforts work, China will face less pressure to move as quickly on rates and the yuan.

However, RBC feels that the strong momentum in China’s residential property market in recent months suggest that any easing in house price inflation will be limited. The analysts said other areas of the exonomy also face a serious risk of overheating as long as financing costs remain at current levels.

“The steps Beijing has already taken should have some impact, but we think policymakers still have more work to do.”

Despite skittishness that China’s surging GDP could cause an economic overheat, McLean & Partners Wealth Management portfolio manager Paul Ma believes the negative chatter signals an opportunity to add to positions in China.

“We believe that the Chinese government is fully capable of managing sustainable economic growth,” he said in a recent report that followed at visit to China.

Mr. Ma said the growth is a testament to the ability of China’s leadership in economic management. He cited the move to raise mortgage rates and down-payment requirements in a single day, and the $7.5-trillion yuan quota on total bank loans as efforts that should further shrink the bubble.

When China does announce an interest rate increase, the portfolio manager thinks there will be little effect since the corresponding market correction has already happened for the most part.

“As we expect no more bad news on the interest rate and the real estate fronts, the market slide is probably nearing its bottom and looking to move back up,” he said.

Jonathan Ratner

With the red-hot Brazilian economy set to grow at 6% this year and its central bank already behind the curve on inflation that is expected to climb above 5%, RBC Capital Markets is warning that Brazil is overheating.

This will likely lead to growing imbalances, asset bubbles and inflation with “deep momentum that could be difficult and risky to correct,” Nick Chamie’s emerging markets research team said in a report.

RBC forecasts inflation in Brazil will rise to 5.4% and 5.6% in 2010 and 2011, respectively. This red-hot performance will be driven by the government’s efforts to expand public-sector bank credit growth, a dramatic expansion government-led investment initiatives, activities related to the 2014 World Cut and 2016 Olympics, more public-sector social progams, and the “Bolsa Familia” family allowance.

RBC’s forecasts suggest that Brazil’s output gap will close by the third quarter of 2010. So within six months, the lead of actual GDP is expected to widen over potential GDP thereafter. Other measures of spare capacity, such as unemployment and industrial capacity utilization, also warn of disappearing slack.

The threat of overheating means the Banco Central do Brasil (BCB) needs to tighten aggressively, RBC said. However, anchoring inflation expectations will be an enormous challenge given how high inflation has risen and the speed at which it has done so.

“Given we are 6-9 months away from the output gap closing (according to our estimates) and monetary policy tends to work with a 12 to 18 month time lag, it is fair to say the BCB is already behind the curve, as reflected in the rapid rise in inflation expectations and the sizeable steepening of the yield curve observed recently,” the analysts said.

The degree of uncertainty has risen in recent weeks following the departure of two key members of the central bank’s COPOM rate-setting panel. Both monetary policy director Mario Toros and economic policy director Mario Mesquita were considered very strong technically and generally hawkish, which served to bolster the BCB’s credibility.

“However, their departure and subsequent replacement has left policy deliberations somewhat uncertain with anecdotal evidence, in out view, pointing to an increase in the dovish voices on the COPOM,” RBC said.

This apparent preference for lower interest rates may serve to limit the chance of a 75 basis point increase to beging the rate hiking cycle.

“This would raise the odds of a larger and lengthier rate hiking cycle needed to contain inflationary pressures,” the analysts said. They currently forecast a 400 points of rate hikes in the next 12 months.

Jonathan Ratner

Research In Motion Ltd.’s valuation reflects a “sentiment war” over its prospects, but its annual product showcase kicking off on Monday in Orlando should alleviate some concerns.

The BlackBerry maker has historically used its Wireless Enterprise Symposium (WES) to showcase its plans for growth, developments in carrier partnerships, and its latest products and solutions.

The event should draw plenty of attention as management its expected to address how it intends to regain top-line growth relative to Apple Inc. and other emerging handset and smartphone vendors. RIM is also expected to launch a new lower-priced BlackBerry aimed at consumers in emerging markets, a new faster browser that may include things like Flash support, and a new operating system (OS).

“As is clearly evident to BlackBerry users, the current web-browsing experience has significant shortcomings in terms of quality of experience, compared to the Apple iPhone or even new Smartphones introduced by HTC, Nokia, Motorola and Samsung,” Northern Securities said in a report. “This has been cited as one of the key reasons for limited penetration of the BlackBerry within the consumer segment, in addition to lack of a iTunes-type distribution platform.”

While some on the Street are concerned about competitive threats from Apple and Google Inc., momentum in North America and RIM’s enterprise business, RBC Capital Markets analyst Mike Abramsky thinks WES should produce improved sentiment.

He told clients that the event represents the “kick-off” to rising visibility for a number of new software, services, strategies and next-generation handsets RIM will launch in the second half of 2010. The analyst also thinks WES may help skeptical investors concede that RIM has a better chance than generally thought to narrow perceived competitive gaps and invigorate consumer uptake.

It may also further solidify RIM’s differentiated advantages versus Apple and Google. This, coupled with a “satisfying” browsing, user interface and application experience, may sustain market share, profitability and smartphone leadership.

Mr. Abramsky highlighted a variety of possible announcements RIM could make at WES. He assigned a 90% probability to a Webkit-based browser with iPhone-like speed, tabbed browsing and Flash support. A CDMA Bold 9650 handset announcement and launch timing was given a 75% chance, as was a 3G Pearl 9100, media/content partnership announcements and details on its China strategy.

Investors will be hungry for any commentary on the company’s success in China and other emerging markets as it may serve to offset the threat posed by a CDMA-based iPhone at Verizon Wireless. Northern Securities noted that Verizon Wireless and AT&T generate an estimated 40% of RIM’s total revenue and the launch of a CDMA-version of the iPhone is expected to erode RIM’s market share in the United States, which generated 58% of total revenue or US$8.6-billion in fiscal 2010.

The consumer market accounted for more than 50% of RIM’s current net subscriber additions each quarter during the past 12 months. Northern Securities believes this success is partly due to the company’s increased carrier partnerships in emerging markets and the European Union, as well as the introduction of lower-priced smartphones.

“With potential improvement in the web-browser to compete with consumer demand, we believe RIM can at least maintain its market share in the consumer market,” it said.

It also expects the enterprise refresh cycle during the second half of 2010 will bode well for RIM during 2010 and 2011 given its dominance in North America. “With Smartphone market share in key emerging markets like China and India up
for grabs, we believe it is too early to write off the potential success of the BlackBerry relative to the iPhone.”

Jonathan Ratner