Author: Jonathan Ratner

Where do analysts say is the best place to invest overseas?

You guessed it… Ukraine.

On a bottom up basis, analysts predict the
PFTS index will rise by 41% to 810.08, after closing out 2009 at
572.91, making it the best likely performer in 2010.

Meanwhile, the Indian NIFTY is forecasted to decrease by 1.25% to 5,135.93, after closing 2009 at 5,201.05.

Last year, the variance for analyst forecasts for Ukraine was -10% and +47% for India.

They were near-perfect on Spain with a variance of just +64 basis points, while missing the most on Taiwan at -57%.

Jonathan Ratner

Despite Monday's 0.5% rebound, the S&P 500 is still down 4.6% from
its January 19 cyclical high of 1,150.

Investors need to remember that
equity pullbacks are part of every economic recovery. In fact, the
average pullback 12 months after the end of a recession is 13%, or 8.8%
if 2001 is excluded, according to National Bank Financial.

The 33.8% decline in 2001 is an unlikely scenario this time around
because the S&P 500 was trading at 21 times forward earnings,
according to economist Stéfane Marion. He noted that this is well above current valuations around 14 times.

"As such, we would not expect to see a
larger-than-average recovery pullback in the coming months," the economist told clients. "The
improving economic backdrop remains supportive of equities."

Jonathan Ratner

Upcoming earnings reports will mark the end of the earnings recession in Canada, according to a new report from CIBC World Markets. After four down quarters, operating profits for S&P/TSX composite companies are expected to be up 43% when earnings for the final three months of 2009 are tallied.

“The gain for the TSX looks like a tough wall to climb, but will in fact benefit hugely from an easy comparison with a year earlier, when both the Canadian and global economies sank into recession, dragging commodity prices and profits down,” CIBC senior economist Peter Buchanan said Monday.

He noted that TSX earning will only need to rise by five to six per cent from the previous quarter to meet expectations. The economist expects the bulk of the gains will be driven by the insurance and mining sectors, which should account for about three quarters of the total year-on-year rise in earnings.

Insurers lost more than $1-billion in the fourth quarter of 2008 as a result of adjustments on segregated funds and other assets and liabilities. He noted that the sector should see a positive swing in profitability of well over $3-billion.

The diversified mining group, meanwhile, is forecast to see a $1.5-billion year-over-year improvement as a result of the strong metals-led rally in commodity prices.

Mr. Buchanan feels that the greater challenge may not be this quarter, but rather the targets for the coming year. Analysts on both sides of the border have been raising their near-term expectations for earnings in response to improvements in the economy and commodity prices. In Canada, positive revisions have accounted for 53% of all revisions for the quarter ahead, while that number is 73% in the United States.

“That suggests more of the positive news may already be priced into stock valuations than a few quarters ago, limiting the potential for stocks to rally strongly on the upcoming reports,” he said. “Although such increases have occurred after past recessions, that has generally been in the context of stronger economic recoveries than we expect this time, given the drag from a scaling back of fiscal stimulus programs in both Canada and the U.S.”

Jonathan Ratner

Real estate investment trusts are unlikely to increase their net operating income this year through internal growth, but Raymond James analyst Mandy Samols says the sector still should have an average total return of 10% to 15% in 2010.

“Historically REITs have performed well heading out of a recession,” said Ms. Samols, forecasting average yields of 7% with the rest of the return coming from capital appreciation.

The analyst expects REITs to rise as capitalization rates continue to fall and external acqusitions drive growth. She also expects demand for yield products will help the sector.

“REITs should trade at premium to net asset value in 2010,” said Ms. Samols, adding the sector is now trading at an 8% premium to NAV.

Historically REITs have traded as much 30% above or 40% below NAV. Other positives for the sector include the fact spreads between REIT yield and Bank of Canada rates remain “above the historical average and at levels last seen at the beginning of the last REIT fundamental cycle.”

The REIT sector will also get a boost from new federal laws taxing income trusts but exempting REITS. It comes into effect at the end of this year. She does say that an “extraordinary” increase in interest rates or a “double-dip  recession” would negate some of what she has predicted.

Garry Marr

Macquarie Research analyst Sumit Malhotra upgraded Bank of Nova Scotia to Neutral from Underperform, noting that the stock has declined a sector-worst 9% in 2010.

He told clients that its valuation no longer warrants an Underperform rating, particularly given the positive outlook on the progress of BNS building out its underrepresented business lines, and the smaller exposure it has to both capital markets and the United States as a whole – the areas that face the greatest regulatory risk.

Both non-performing loan formations and provisions for capital losses declined in the fourth quarter for Scotiabank’s international segment, which Mr. Malhotra calls a signficant development given that its differentiated operations are important to investor sentiment. Similarly, the analyst noted that Citigroup Inc. cited “improving economic conditions” as a factor that aided the quarter-over-quarter decline in Latin America credit losses.

In terms of the Basel proposals and the impact on the bank’s Tier 1 ratio, he said it should decline from 10.67% currently to 7.17% – one of the lowest in the sector. So while capital uncertainty will likely limit deployment in the interim, Mr. Malhotra noted that Scotiabank should be able to recover more than 200 basis points of Tier 1 in 2010-2012.

The lower Tier 1 ratio also reflects in large part management’s decision not to issue common equity at depressed levels in 2008. In fact, the bank’s share could is up just 4% since the end of 2007, compared to 11% to 20% gains for its peers.

“Though BNS faces its share of challenges (managing with lower capital, slowing loan growth, uncertain credit outlook), we believe the bank has the revenue and expense levers to generate a more-than-respectable level of profitability in 2010,” the analyst said. “We have always believed that BNS should trade at a premium to the sector, it was just question of how much.”

His target price on the stock is $45.50.

Jonathan Ratner

U.S. equity index futures are higher this morning. S&P 500 futures are up 6 points in pre-opening trade. Futures are responding to comments over the weekend by members of Congress and the White House assuring bi-partisan support for the renomination of Ben Bernanke as chairman of the Federal Reserve. The Senate must approve the renomination by January 31st.

The U.S. Dollar weakened on the news. The weaker U.S. Dollar triggered strength in commodities priced in U.S. Dollars. Gold, silver, copper, platinum and crude oil are trading higher. The U.S. Dollar has found short term resistance at its 200 day moving average.

Halliburton gained 6% after reporting higher than consensus fourth quarter earnings.

AK Steel added 5% after reporting higher than consensus fourth quarter earnings. The company continues to benefit from rising steel prices.

Apple added 2%. Traders are anticipating launch of Apple’s tablet on Wednesday.

Goldcorp added 1% following an upgrade from Hold to Buy by TD Newcrest. Target price is $50.

Thomson Reuters improved 1% following an upgraded by Citigroup from Hold to Buy.

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

The one-notch downgrade of Bank of Montreal’s long-term deposit and financial strength ratings by Moody’s Investor Service was said to be a result of the bank’s wholesale investment banking business exposing BMO to greater earnings volatility than assumed in the past. Moody’s expects the bank’s risk-adjusted profitability will remain constrained due to weak earnings from its U.S. retail and wholesale banking businesses.

While the downgrade is unwelcome news for any leveraged financial institution with acquisition aspirations and is likely to add to margin pressure, CI Capital Markets analyst Brad Smith notes that it concludes a review process that was initiated in June 2009. After Friday’s downgrade, BMO’s ratings outlook was upgraded to stable from under review, which had been the status since late in October.

Mr. Smith’s earnings per share forecasts of $4.10 and $4.50 for 2010 and 2011, respectively, remain unchanged as they are already 4% and 15% below consensus. He maintained an Underperform rating at $45 price target on BMO shares.

Jonathan Ratner

The case is growing for the Fed to hike rates sooner and more aggressively than the market is expecting. As a result, investors should brace for what strategists at Scotia Capital feel is a needed change in tone from the Fed in the coming months, including dropping or softening its important “extended period” reference.

“That will ultimately result in increases to each of the interest on excess reserves, the Fed funds target rate, and naturally the effective Fed funds rate,” Derek Holt and Karen Cordes said in a research note. “The case for emergency rates has waned and we’ve transitioned toward the need for a different, low-but-not-emergency rate environment.”

They argue that this is ever truer in Canada.

One of many things to watch is excess capacity, which is still in massive supply, but is being closed off. This still requires low rates, just not emergency rates. After bottoming at 68.3% in June, it climbed to 72% in December.

The Scotia strategists, who note that the unemployment rate may be peaking now or soon, believe job growth will resume in the U.S. economy this year.

“Zero liquidity and frozen credit markets amplified the just-in-time inventory management cycle’s response to the deleveraging shock such that production and employment over-corrected in dropping over 7 million jobs in 2008 and 2009,” they said. “Automatic stabilizers require re-hiring some of them, and so does fiscal stimulus.”

They also feel that continued challenges in the housing market alone will not keep the Fed from hiking in the second half of 2010.

Finally, if the market corrects on anticipated hikes, the strategists suggested that the Fed might be in a better position to actually deliver hikes by clearing such concerns out of the way.

Jonathan Ratner

We knew re-regulation was going to be something investors would have to monitor, but the magnitude of proposed changes to the U.S. financial sector are nonetheless startling.

Barack Obama’s plan to curtail risk-taking by financials increases the stakes higher than many could have imagined a few months ago. In addition to keeping valuations for U.S. financial stocks depressed until more clarity arrives, the impact could also spill over into other regions as other countries may decide to break up their banks or institute similar reforms.

With the health care reform bill before Congress likey dead in its current form, the President’s new “whipping boy” – the banking industry – may help bring his constituents out to vote in the upcoming mid-term elections. After all, everyone hates the banks, right? It appears that Obama is trying to force the Republicans to take a stand on financial regulation and grasped onto this banking issue in an effort to win in November.

Attempting to avert future crises in the financial system, President Obama has proposed banning propriety trading and investment in hedge funds or private equity firms by traditional banks and their holding companies. If implemented, this proposal would entail the broadest transformation of the financial sector since the 1929 Glass-Steagall Act.

The move comes just a week after imposing a Financial Crisis Responsibility Fee on institutions that were generally the recipients of government aid in an effort to recoup as much as US$120-billion.

Many see the new rules for financial institutions as a back-door attempt to bring back the Depression-era Glass-Steagall law, which separated commercial banking and investment banking, but was repealed in 1999. But with former Federal Reserve Chairman Paul Volker on board, the plan could gain some credibility, according to analysts at RBC Capital Markets. Volker has been pushing for months to divide certain high risk capital markets activities from traditional commercial banking activities.

Those affected may have to wind down their targeted operations, which would mean reduced volumes, liquidity, international investment flows and a smaller industry in general. Citigroup’s Michael Hart suggested that while banks may simply divest from proprietary operations and hedge funds, but keep them intact at arm’s length, this will splinter the industry. It probably shrink it too since the then-autonomous entities will have less access to capital and leverage.

While Canadian banks may look like a superior investment opportunity as a result, and changes in the United States may attract some net foreign buying interest to Canada, CI Capital Markets analyst Brad Smith expects declining U.S. bank valuations will likely transcent borders in the near term.

At the same time, he noted that domestic banks with U.S. capital markets businesses may be able to turn the uncertainty at their Wall Street competitors to their advantage by making strategic hires while the political battle continues.

There are options for escape. For example, financial institutions that became banks at the height of the crisis in order to be able to access the Fed’s Discount Window and other facilities, may decide to hand their licenses back. This may be particularly appropriate for institutions that never had traditional deposit businesses in the first place.

There is also the possibility that the issue will be fudged, since it is difficult to distinguish between trading operations that are related to serving customers from those that are not. Banks may try to circumvent the rules by setting up ownership structures that respect the letter of the law, but not the spirit.

“It appears that in most scenarios, the outcome would be a massive reduction in financial investment around the world and consequent capital repatriation,” Mr. Hart said.

He estimated the amount could be much greater than the US$200-billion repatriated during the safe haven flight at the end of 2008, which reversed part of the US$1-trillion outflow from the previous five years. So while the initial market reaction may have been negative, this suggests that the outcome could eventually be dollar-positive. Of course, there may also be some off-setting capital outflows leaving the United States given the anti-business nature of the plans.

And while the plan will likely be phased in over several years, expect the banking industry to fight back aggressively. In the meantime, investors should focus on the fundamentals, not the headlines.

Jonathan Ratner

Beginning investors are always told that it’s vital to assess the quality of a company’s management, especially the ethics of senior executives, before buying a stock. But what does that mean in practice?

John Hempton of Bronte Capital has written a hilarious account of his experience with Rent-A-Center Inc., a Texas-based chain of rent-to-buy stores. Rent-A-Center is in the business of selling low-income customers a variety of furniture and electronics at fiendish mark-ups.

Let’s say you’re one of those customers and you want to buy a sofa. As Hempton explains it, Rent-A-Center will “rent” it to you for 48 monthly payments that total 400% of the wholesale price. If you make all the payments, title to the sofa passes to you. But miss one payment and the sofa gets repossessed.

Remember: this is a rental contract, not a purchase, so if you make all your payments for three years, then miss one, you have no equity built up. The store takes back your sofa and you’re left with nothing even though you’ve already paid multiple times what the sofa cost wholesale.

As you might have gathered by now, this is not a business for the soft-hearted. It seems to take advantage of people without much money.  For all those reasons (and others) Hempton started out thinking it would be a good candidate for shorting.
 
Then he visited the company. Here’s how he describes his experience:

“This was a business where if Jesus was alive he would pull down the Temple over them..it offended my decency.  But the people were lovely.  I met management and a store owner – and – frankly they seemed exactly the sort of people you would like to have Friday drinks with.  I liked them.”

Hempton wonders how you are supposed to assess a situation like this. He winds up concluding that the best policy may not be to judge management by its likability, but by its unlikability—in particular, by its tendency to be cheap, smart and opinionated. As he notes, that’s how Warren Buffett assesses managers and his method appears to have worked pretty well for him.

Freelance business journalist Ian McGugan blogs for the Financial Post

Desjardins Securities analyst Jeff Roberts isn’t ruling out Cominar Real Estate Investment Trust acquiring BTB REIT, despite the latter’s current rejection of any deal. Cominar said it had approached BTB, a Quebce-based REIT with a market capitalization of $30-million, but was rebuffed by management. Cominar is not interested in a hostile takeover attempt.

Mr. Roberts said he believed the capitalization rate on the deal would have been about 8.8%, about the same price Cominar paid to buy Overland Realty Ltd. this week — part of move into Atlantic Canada for the Quebec City-based REIT.

“Because BTB’s management does not wish to negotiate a sale to Cominar, AM Total Investments, a company owned by the Dallaire family who are the founders and largest unitholders of Cominar, announced that it intends to sell its entire 19.7% stake in BTB, which should pressure BTB’s unit price.,” said Mr. Roberts.

The analyst said most of BTB’s 43 properties, which consist of 2.3 million square feet of diversified properties mostly in Quebec, would have fit in well with Cominar’s portfolio. Mr. Roberts predicts Cominar will still be able to acquire about $150-million to $200-million of accretive properties in 2010, despite missing out on BTB.

Plus, he added, the chase of BTB may be just on hold.

“Cominar’s management is patient and conservative, and may eventually acquire BTB. In the meantime, between other acquisitions and sizeable internal development projects, Cominar should continue its brisk expansion while growing its cash flow per unit,” said Mr. Roberts.

Garry Marr 

Google Inc. reports forth quarter earnings after the close on Thursday, with the results usually released between 4:00pm and 4:15pm ET, followed by volatile after-hours trading.

The current consensus earnings estimate is US$6.44 per share, although Google’s results often require significant adjustments.

Cleve Ruceckert of Birinyi Associates Inc. notes that the compnay has beaten analyst estimates 78% of the time and trades up following these beats. He also pointed out that Google shares are near the bottom of their trading range, which is currently US$573.52.

How rational is the market? Not very, based on the first day of trading for the so-called baby B shares of Warren Buffett’s Berkshire Hathaway Inc. The shares got off to a steaming start on Thursday, up nearly 4% in the early going.

This is not the way the market is supposed to work. Finance professors and finance textbooks have taught for years that the market is an efficient calculator of value. The market, according to every Finance 100 course, is far too smart to be swayed by a mere repackaging.

Yet that is what has happened here. All that Buffett has done is to split each of his company’s B shares into 50 smaller B shares. (The split was required as part of his deal to acquire Burlington Northern Santa Fe Corp.) The move makes the shares more affordable to small investors, because the B shares used to trade for more than US$3,000 each. But it doesn’t affect the fundamental value of what you get for each dollar you invest.

The surge in the baby B shares isn’t the only evidence that Mr. Market can get giddy for no good reason. Consider the shares of the old bankrupt General Motors, which now trade over the counter under the label of Motors Liquidation Co.

The restructured General Motors Co., which is now a private company largely owned by the U.S. and Canadian governments, has warned several times that the shares of Motors Liquidation are worthless. The shares continue to trade, though, and have actually had a nice run up in recent weeks.

The total amount invested in the worthless shell is staggering. Motors Liquidation, which holds properties abandoned by GM during the restructuring process, continues to have a market capitalization of more than US$300 million, despite the certainty that its liabilities far exceed its assets.

Maybe it’s time to rewrite the finance textbooks.

Freelance business journalist Ian McGugan blogs for the Financial Post

U.S. equity index futures are slightly lower this morning despite a series of encouraging fourth quarter earnings reports. S&P 500 futures slipped 1 point in pre-opening trade. Futures moved lower after the weekly jobless claims report came in worse than expected. Jobless claims rose 36,000. Consensus was a small decline.

A parade of stronger than expected fourth quarter earnings reports was released overnight. Companies reporting higher than consensus earnings included Xerox, United Healthcare, Fifth Third, Fairchild Semiconductor, Southwest Airlines, eBay and Starbucks.

Goldman Sachs was notable on the list of companies reporting higher than expected fourth quarter earnings. Consensus estimate was $5.20 per share. Actual was $8.20. Goldman also announced plans to make a charitable donation valued at $500 million.

U.S. equity markets were jittery prior to an announcement this morning by President Obama about greater regulation of the banking industry.

China’s growth in the fourth quarter accelerated. China’s economy grew at a 10.7% annual rate.

Not all fourth quarter earnings report exceeded expectations. Vitera reported a larger than expected loss in the quarter.

Citigroup downgraded selected coal stocks. Arch Coal and Massey Energy were downgraded from Hold to Sell.

RBC Capital Markets downgraded Telus from Outperform to Sector Perform. Target is $42.

Raymond James downgraded Taseko Mines from Outperform to Market Perform.

Goldman Sachs upgraded Colgate from Buy to Conviction Buy. 

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 many calling for central banks around the world to start raising interest rates sometime in 2010, there is a general perception that this will pose a challenge for equity returns. While stocks typically post solid gains in the period leading up to rate hikes in the United States, markets tend to register only modest performance in the year following the first Fed tightening.

UBS looked at eight examples and found that leading up to the interest rate increase, stocks rose an average of roughly 16%. In every case, equity returns in the 12 months following a rate hike were lower than in the previous year. In two of the eight cycles, markets declined.

UBS economists forecast the Fed will begin to raise rates in late-June and the European Central Bank will lift rates in the third quarter. Meanwhile, the rate hike cycle has already begun in some places, with China just recently starting to tighten and Australia raising rates in 2009.

While cyclical sectors typically outperform in advance of interest rate increases, in the 12 months following a rate hike leadership is more mixed.

“A continued recovery in the global economy should keep equity markets around the world underpinned,” UBS strategists said in a report. “With Fed tightening still unlikely before late-Q2, our analysis supports forecasts from our regional strategy teams calling for additional market upside.”

UBS recommends investors trade up in quality, favouring companies with better fundamentals. The strategists also suggested a more balanced tilt between cyclicals and defensives than in 2009 for global strategies.

Jonathan Ratner

Every investor is taught to build a diversified portfolio of stocks and bonds. Problem is, that’s nonsense, says Andrew Smithers, head of Smithers and Co., an economics consulting firm in London. He thinks that bonds are highly overrated as an asset class and should generally be bypassed in favor of keeping cash in short-term deposits.

To make his point, Smithers looks at the long-term results that a U.S. investor would have achieved with a portfolio of half stocks and half cash versus what the same investor would have achieved over the same period with a portfolio of half stocks and half bonds.

Between 1899 and 2009, the stock-and-cash portfolio would have produced a real average annual return of 4.07%. By comparison, the stock-and-bond portfolio would have generated a real average annual return of 4.62%–just slightly more than the cash portfolio and at the cost of considerably more volatility.

The very slight advantage in return that is gained by adding bonds is mostly the result of the unusual period since 1979, when bond investors made out like bandits as yields fell from the inflationary highs of the stagflation years and bond prices soared. Remove that period and the mix of stocks and cash actually does better than the mix of stocks and bonds. No matter which period you choose, the stock-and-cash mix generally a better risk-adjusted return.

Smithers thinks that many investors are being lured into bonds these days as they search for an alternative to cash that is paying them nothing. He thinks these investors will be disappointed. As governments try to finance their expanding deficits with huge bond issues, and as inflationary expectations rise, bonds are set for a tumble.

Freelance business journalist Ian McGugan blogs for the Financial Post