Author: Jonathan Ratner

Financial leverage has again emerged as a major concern for investors. This time, however, its not the world’s leading financial institutions causing the worry, its sovereign debt.

In the past, countries that faced the biggest fiscal challenges were emerging economies or those ravaged by war. That makes it somewhat strange to see the weakest government balance sheets in developed economies, during peacetime.

This is not to say that these sorts of issues are new to Greece. In fact, the first ever recorded default in history apparently occurred in Greece in the 4th century BC. The country has also spent more than half the last 200 years in default — more than any other country in Europe, according to a recent report by Citigroup.

The problematic balance sheets of countries like Greece, Portugal, Spain, Ireland make the fiscal positions of most emerging markets look strong by comparison. While there will likely be more contagion stemming for sovereign credit concerns, including a dampening of the recovery and a delay of the withdrawal of cheap money, the the global fallout should not be severe enough to drive a double-dip recession, according to Robert Buckland, global investment strategist with Citigroup.

“There are a number of resolutions for big fiscal deficits. Some are positive for equities, others are not,” he said, noting that cheap valuations should provide some protection against further disappointments for global stocks.

Nonetheless, Mr. Buckland recommends equity investors tilt away from areas where fiscal issues are most acute until the problems are seriously addressed.

Of the 45 countries in the MSCI All Country World Index, Citigroup economists forecast that four will have larger deficits than Greece in 2010 and that represent more than 10% of annual GDP. Japan, the United Kingdom and the United States have some of the most troubling positions. However, Japan and the United States are deemed less of a concern. While Japan has the highest gross debt to GDP, it is a creditor economy with a current account surplus. Greece is second. Meanwhile, the United Kingdom is an economy that looks to be experiencing rising inflation, which may put pressure on the cost of financing, Mr. Buckland noted.

He expects emerging markets – where governments have sound balance sheets and companies offer solid growth – will continue to benefit from cheap global liquidity.

From an equity investors’ perspective, the strategist feels the best way to resolve a sovereign debt problem is via rapid economic growth. That means higher tax revenues to relieve the government’s fiscal shortfall, but also requires strong company earnings supported by a solid macro backdrop.

“Equities benefit from rising corporate profitability and falling risk premiums,” he said. “The rapid economic expansion may generate inflation, which will be to the detriment of bond holders. A bailout is better for financial markets, but likely to help bond investors more than equity investors.”

Jonathan Ratner

Photo: Greece's Finance Minister George Papaconstantinou arrives for a press conference in the Finance Ministry in Athens on February 9, 2010. Papaconstantinou announced Greece's new tax policy, to help the country get out of its economic crisis. (LOUISA GOULIAMAKI/AFP/Getty Images)

U.S. equity index futures are slightly higher this morning. S&P 500 futures were up 1 point in pre-opening trade. Slight weakness in the U.S. Dollar contributed to strength. Commodities priced in U.S. Dollars including copper and crude oil moved higher.

Investors are waiting for Federal Reserve Chairman Ben Bernanke’s semi-annual testimony on monetary policy in front of Congressional Committees. He presents to the House of Representative’s Financial Services Committee this morning at 10:00 AM EST. The focus is on timing for an exit strategy for monetary stimulus.

Fourth quarter earnings reports released overnight were mixed. Thomson Reuters and Toll Brothers reported better than expected fourth quarter earnings. Finning International and First Service reported less than consensus fourth quarter earnings.

Finning International also reported a surge in orders for tractors used by the mining industry. The Metals and Mining Sector currently is in a period of seasonal strength with a sweet spot from early March to mid May. 

Goldman Sachs is taking a more positive stance on selected U.S. energy stocks. Goldman upgraded EOG Resources from Neutral to Buy with a target price of $119 and raised its rating on Exco Resources 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

Shares of Lululemon Athletica Inc. have risen more than 300% in the past year and investors continue to show confidence in the yoga apparel retailer’s future growth prospects. However, the stock has fallen back slightly in the past few days after a negative Wall Street Journal’s Heard on the Street column.

John Jannarone argues that future cannibalization and competitive threats are primary obstacles to Lululemon’s growth.

“Profitability will likely suffer more as Lululemon ventures beyond its concentration in major cities to the heartland, where incomes are lower,” he wrote.

Mr. Jannarone also noted that industry veterans such as Victoria’s Secret and Adidas have entered Lululemon’s market, offering similar products at lower prices. “That could threaten sales even in top-selling stores in high-income metropolitan areas,” he said.

Given Lululemon’s low penetration in the United States, those issues are still far off, according to Howard Tubin, analyst at RBC Capital Markets. He also highlighted the company’s continued strength in far less populous Canadian markets, such as the Greater Toronto Area.

In terms of competition, Mr. Tubin said Lululemon has defended well against lucy activewear inc., which was considered the company’s primary competition in 2007. Nike also pushed harder into women’s yoga, but pulled back on its efforts subsequently, and Limited Brands’ La Senza Spirit test banner has not been expanded in Canada.

The Wall Street Journal article also cited estimates that Lululemon’s U.S. stores are less productive that Canadian ones. Mr. Tubin noted that this should be expected as U.S. stores mature. However, with chain-wide productivity well north of $1,000 per square foot, the analyst feels this is a “high quality” problem that most retailers would envy these days.

“With the stock’s sharp recovery and a moderating market environment, the emergence of these valuation-questioning stories is unsurprising given the large short interest in the stock,” the RBC analyst told clients. “While a little weakness is not unexpected with these types of articles in a moderating market, we would be very hesitant to bet against Lululemon right now given the opportunities for positive developments ahead.”

Jonathan Ratner

Barack Obama’s healthcare reform proposal that will serve as the basis for discussion at the bipartisan summit later this week still faces major challenges. In fact, many expect Thursday’s meeting will likely be mostly political theatre.

Some even believe the Democrat plan, which calls for insurance regulation at the federal level instead of by states, is intended to go down in defeat. That’s because it is highly unlikely that the Republicans will approve a bill that layers Federal premium regulation on top of already existing state regulations and puts additional taxes on capital gains, interest, rents and royalties of high earners. The plan calls for those new taxes to fund Medicare, in addition to increasing the Medicare payroll tax hike.

The proposal also includes the creation of a subsidy to buy insurance through an exchange and expands funding for state Medicaid programs. The Federal Government would pay 100% of costs for newly eligible individuals from 2014 to 2017, 95% in 2018 to 2019, and 90% in 2020 and beyond.

The suggestion is that the Republicans will take the blame if nothing is accomplished. But passing no bill is better than comprimising on a bad one that does little to control costs, sets new taxes in motion and hurts capital formation, which affects job growth, says Larry Jeddeloh, chief investment officer of Minnesota-based TIS Group.

Instead, the Republicans will try to push the reset button on reform and propose market-based solutions. At the same time, they will likely raise the fear among voters over a “government takeover” and mandates for both individuals and employers.

As far as asking the pharma companies to foot $1-billion in fees in order to control costs, that’s a drop in the bucket in the context of overall Medicare spending, Mr. Jeddeloh writes in Thursday’s edition of the Market Intelligence Report.

He also  wonders if capital gains taxes will eventually rise above personal tax rates.

“New taxes have a way of never going away, just growing larger. The scope for expanding taxes on unearned income is massive, given future costs of Medicare, if Medicare is not reformed.”

Nonetheless, the bill would be less bad for Managed Care stocks than what was feared after the January 19 elections in Massachusetts, according to Citigroup’s Charles Boorady. The sector, which consists of health insurers and related businesses such as pharmacy benefit managers, peaked after the Republican victory and has fallen 12% since.

The analyst expects money will rotate into healthcare stocks after federal healthcare reform efforts conclude, possibly by mid-April. He maintains a positive rating on the Managed Care sector and anticipate they will continue to rebound in 2010 from historically low valuations in 2009.

Obama’s proposal combines the Senate and House bills, but the American people seem pretty clear that they don’t want either to pass in their current form. In the end, expect something labeled “reform” to pass. But it will surely be scaled back from the 2,000-plus page bills passed in the House and Senate.

Jonathan Ratner

Photo: U.S. President Barack Obama speaks from the Rose Garden during an event with medical doctors at the White House on October 5, 2009 in Washington, DC. Obama met wtih doctors from all over the country who are joining him in pushing for health insurance reform.  (Win McNamee/Getty Images)

Cameco Corp. has several interesting investment characteristics:
 
It recently entered into a period of seasonal strength from January 21st to June 5th. The trade has been profitable in 10 of the past 10 periods. Average gain per period was 21.7%. It’s not too late to enter the seasonal trade this year. The stock currently is trading slightly below its January 21st 2010 price.
 
Cameco’s technical profile is improving. Intermediate trend is up. The stock recently moved above its 200 day moving average and is testing its 50 day moving average. Short term momentum indicators are recovering from oversold levels. A MACD buy signal was recorded last Thursday. Stochastics already are short term overbought. Support is indicated at $25.31 U.S. ($27.11 Cdn). Resistance is at $33.74 U.S. ($35.00 Cdn.)

Encouraging news is likely to be announced when the company releases fourth quarter results on Wednesday February 24th. Fourth quarter earnings are expected to improve to $0.53 Cdn. from $0.46 Cdn. Of greater importance, the company is expected to update estimates on costs and production for 2010. Cameco announced on February 11th that the flooded Cigar Lake uranium mine has been pumped out and should be fully secured by October. The Cigar Lake uranium mine potentially is the largest uranium in the world when fully operational. 
 
Sector news on the uranium industry also has turned positive recently. Last week, President Obama committed $8.3 billion in loan guarantees for the production of two nuclear power units at an existing nuclear power facility. Political uncertainties in uranium producing areas raising the possibility of a restriction in supply (most notably Niger with 7% of the world’s production where a political coup occurred late last week).
 
Merv Burak, a technical analyst who follows the uranium sector closely recently upgraded his short term opinion on the sector to Bullish. Merv currently has a positive short term stance on Cameco.  

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

U.S. equity index futures are lower this morning. S&P 500 futures are down 4 points in pre-opening comments.

Index futures were unchanged following release of the December Case/Shiller home price index. Consensus was a year-over-year decline of 3.1% versus a decline of 5.3% in November for the 20 largest U.S. cities. Actual was a decline of 3.1%.

Several U.S. retail merchandisers reported higher than expected fourth quarter earnings overnight including Home Depot, Target and Macy’s. Home Depot also raised its dividend.

Stifel Nicolaus initiated coverage on the Smart Phone sector. Buy recommendations were given to Research in Motion and Nokia.

U.S. analysts continue to upgrade U.S. energy stocks. Argus upgraded Occidental Petroleum from Hold to Buy with a target price of $95.

Brookfield Asset Management is rumored to be preparing a “white knight” bid for General Growth Properties. Simon Properties bid on the company last week. General Growth Properties technically is in bankruptcy protection.

TransCanada reported lower than consensus fourth quarter earnings. 

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

There has been no shortage of hype surrounding Apple Inc.’s new iPad. While the reviews have been mixed and there is plenty of room for improvement in future generations of the device, demand and sales is what investors are focused on in the near term.

They should be happy to hear that pent-up demand for the device is strong. In fact, interest is at a higher level than it was before the iPhone was launched.

A RBC/ChangeWave survey of 3,200 people conducted from February 1-10 showed 13% of respondents are interested in buying an iPad. That compares to the 9% who indicated they might buy an iPhone in an April 2007 pre-launch survey.

This data suggest initial iPad uptake will be healthy, RBC Capital Markets analyst Mike Abramsky said in a research note.

Only 8% appear unwilling to pay Apple’s indicated iPad prices, which is below the 28% who balked at initial iPhone pricing.

Mr. Abramsky also noted that interest appears strongest for both the entry-level and tech-savvy iPad buyers, with 19% of those declaring themselves as buyers planning to buy the $499 16GB WiFi only version and 19% indicating they will purchase the $829 64GB 3G version.

“Preliminary, it appears that the iPad’s lack of Flash support, camera, multi-tasking does not appear to deter initial buyer interest,” the analyst said. “This data… suggests iPad may have greater potential than expected, to expand Apple’s addressable PC, iPod markets and to capture a segment of the home PC market.”

Of course, better than expected early iPad momentum could serve as  a catalyst for Apple’s valuation.

Jonathan Ratner

Worried that slowing growth in U.S. money supply (M2) is a sign of economic trouble? Don’t be. Most of the weakness can be traced to retail money market funds.

Money market funds generally make up 13% of M2, according to Stéfane Marion of National Bank Financial.

The economist notes that investors have grown more confident in recent months, opting to reduce their holdings of money market mutual funds by a near record amount.

Excluding that component, M2 is actually growing at a 6% annual clip. “This is actually pretty robust growth when compared to previous recoveries,” he said.

Recent sales trends suggest Toyota Motor Corp.’s problems may not lead to permanent market share gains by competitors like Ford Motor Co.

Toyota’s share price has fallen 21% since January 21, compared to an average decline of 5% for Honda Motor Co. Ltd. and Nissan Motor Ltd. If Honda and Nissan are assumed to be the natural beneficiaries in terms of market share gain from Toyota’s troubles, Toyota’s share price implies a permanent market share loss of roughly 3.8% in the United States, according to J.P.Morgan analyst Himanshu Patel.

However, there appears to be a disconnect in terms of what the market is implying for Toyota’s share loss and what its competitors are saying.

Some of Toyota’s rivals in the U.S. market are suggesting that there has yet to be a substantial amount of direct conquesting of Toyota consumers. Mr. Patel noted that these competitors sense that many Toyota customers concerned by the recall are simply choosing to not buy a vehicle all together during this period, instead of immediately defecting to another automaker.

Headline market share shifts were evident in January. However, Mr. Patel said this was probably due to the overall seasonally adjusted annualized rate softening as a result of the Toyota recall, rather than a substantial amount of Toyota customers immediately buying from another competitor.

“While it seems the Toyota troubles intensify almost daily, the recalls will eventually fade, the media will eventually focus elsewhere, and government scrutiny on the company will also likely become lower profile eventually,” the analyst said in a research note. “At that stage (which may be months away), we expect Toyota to fight hard to regain lost market share.”

Mr. Patel expects much of the company’s lost market share will come back naturally given Toyota’s patient and loyal customer base.

While an ideal outcome for the industry would see Toyota only increase marketing spending, outright price cuts are also likely, he said. The industry, particularly U.S. automakers, would have to respond, which raises their investment risk going into the summer.

Jonathan Ratner

Photo: Customers check a Toyota Rav 4 car on display at a Toyota car dealership in Tianjin municipality January 29, 2010. (REUTERS/Vincent Du)

U.S. equity index futures are higher this morning. S&P 500 futures added 4 points in pre-opening trade.

Federal Reserve Chairman Ben Bernanke is scheduled to present to the House Financial Services Committee this morning.

Schlumberger offered to purchase Smith International in a friendly share exchange valued at $11.3 billion. Schlumberger slipped 5% and Smith International gained 7% on the news.

Lowe’s Companies added 3% after reporting higher than expected fourth quarter earnings.

Campbell Soup is unchanged after reporting fiscal second quarter earnings in line with expectations.

Credit Suisse changed opinions on two Canadian energy stocks. Cenovus was downgraded from Outperform to Neutral. Canadian Natural Resources was upgraded from Neutral to Outperform.

GlaxoSmithKline eased 2% following a congressional report that raised concerns about Avandia, GlaxoSmithKline’s diabetes drug. 

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 most popular merchandising format of the last two decades in Canada has been value retailing, notes a new report from Desjardins Securities analyst Keith Howlett, who is recommending consumers buy shares of Dollarama Inc.

“With the exception of Dollarama, the value-oriented success stories are beginning to run out of market space for their existing formats,” he wrote in a report to clients. “Whether they will continue to dominate the next 20 years or not, it is clear that they have accelerated their market share gains during the recession.”

The analyst, who has a Buy rating on the dollar chain’s shares with a target price of $26, notes that while brands are still important to consumers, they have “broken down a bias that paying a high retail price assures quality, of confers higher social status,” and will happily patronize Winners, Joe Fresh, H&M, Costco and Dollarama.

The analyst also observed that integrated retail models — in which retailers control brand building, production, distribution and retailing — are amongst the most financially successful, citing Lululemon, Joe Fresh and H&M.

Hollie Shaw

Photo: Shoppers at the Dollarama in Promenades Cathédrale in Montreal (THE GAZETTE/Dave Sidaway)

The Fed may not want the market to interpret its increase in the discount rate as any kind of tightening move, but that won't stop participants from speculating that it is.

In a note titled: Beginning of a Tightening Cycle?, Kevin Pleines at Birinyi Associates noted that prior to 1984, the discount rate was the primary tool for rate policy. Since 1984, they have used the Fed funds rate.

The current survey of economists by Bloomberg forecasts a Fed Funds rate hike in the third quarter of 2010.

In the six months after a tightening cycle began, oil has has the largest gains at an average of 17%, Mr. Pleines noted. The S&P 500 gains 3% on average.

Technology, health care and materials lead the sectors, while utilities, telecom and industrials lag.

Both the U.S. dollar and the 10-year treasury declined after the first hike. The dollar index falls 2.9% in the following six months, while 10-year treasuries fall 7.6%.

Based on Wednesday’s release of the Jan. 27 FOMC minutes, IHS Global Insight had expected a move to raise the discount rate as early as the March 16 meeting. As a result, the timing of Thursday’s announcement came as a surprise to Chief U.S. Financial Economist Brian Bethune.

He said the surprise factor could have unintended consequences of not only pushing up market rates in the near term, but also fueling speculation that the Fed is already moving on a path to tighten monetary policy earlier than previously expected.

“Hopefully, Chairman Ben Bernanke’s testimony to Congress next week will shed some important new light on the Fed’s policy intentions,” Mr. Bethune said in a note.

“Like the moves by the People’s Bank of China to raise bank reserve requirements, the Fed’s move can be seen as a prelude to future interest rate increases and a sign that the easy money party may be close to an end,” said Colin Cieszynski, market analyst at CMC Markets Canada. “Still, actual interest rate increases may be some time away yet, particularly considering that today’s lower than expected U.S. consumer price index, suggests that inflation remains benign pressures.”

Andrew Busch, global currency and public policy strategist at BMO Capital Markets in Chicago noted that the rumor was that the Fed had acted due to a CPI number that was going to be high.

He believes it will take a month or two of actual job creation to get the markets to believethat the Fed Funds rate will move.

What’s interesting to him, is that the yield curve moved up Thursday before the hike and isn’t giving much back.

“It appears the market is assessing the risk remains to the upside for rates regardless if the Fed holds the very shortest of rates at 0.25%.”

U.S. equity index futures are lower this morning. S&P 500 futures eased 4 points in pre-opening trade. Index futures are responding to news that the Federal Reserve increased its Discount Rate from 0.50% to 0.75%.

Index futures recovered part of their loss following release of the January Consumer Price Index at 8:30 AM EST. Consensus was an increase of 0.3% versus 0.1% in December. Actual was an increase of 0.2%. Consensus for core CPI (excluding energy and food) was a gain of 0.2% versus a gain of 0.1% in December. Actual was a decline of 0.1%. On a year-over-year basis, CPI rose to 2.6% and core CPI increased 1.8%.

Volume in North American equity markets could increase to above average levels today.  Volume is related to the expiration of February equity options, index options and index futures options. Today is the last trade date for most February listed options.

Dell eased 5% after releasing higher than expected fourth quarter earnings. However, the company lowered guidance for 2010.

Disney was initiated at a Buy recommendation by Jefferies. Target is $36.

Penn West Energy Trust was upgraded from Hold to Buy at Canaccord. Penn West has an improving technical profile. Units recently broke to a 14 month high. ‘Tis the season for Canadian energy equities and trusts to move higher!

Canaccord also upgraded Golden Star Resources from Hold to Buy with a target price of $4.00. 

More encouraging news for Oil Services HOLDRs (NYSE:OIH) – $122.81

Oil Services HOLDRs (OIH) are in the news again this morning:
Schlumberger is reported to be in advanced talks to purchase Smith International, another major company in the international oil service industry. Value of the deal is expected to exceed $8 billion. Schlumberger is down 3% and Smith International is up 17% in pre-opening trade. Takeover rumors likely will add value to other stocks in the sector.
Morgan Stanley upgraded several oil services stocks this morning. TransOcean was upgraded from Under Perform to Over Perform. Target price was raised from $130 to $140. Ensco also was upgraded from Under Perform to Out Perform. Target price was raised from $65 to $72.
The oil services sector currently is in a period of seasonal strength lasting until mid May.
Oil Services HOLDRS has an improving technical profile. Intermediate trend remains up. Units recently moved above their 50 day moving average. A MACD buy signal was recorded on Wednesday.

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

Kinross Gold Corp.’s deal to sell half of its stake in the Cerro Casale deposit to Barrick Gold Corp. for US$475-million provides a valuation boost for Kinross shares. The agreement will give Barrick 75% of the Chilean copper-gold project, while Kinross’ stake will be reduced to 25%.

“This is a great result for Kinross as it attains a very reasonable price on 25% and the residual stake of 25% is right-sized for Kinross,” said Canaccord Adams analyst Steven Butler.

He noted that the consideration paid by Barrick is considerably higher than the $773-million it paid for Arizona Star’s 50% share of the project in 2007. This is considered a reflection of today’s higher gold and copper price environment.

The sale has raised the valuation Canaccord Adams has on the asset from US$400-million to US$795-million. It also had Mr. Butler hiking his price target on Kinross shares from US$27 to US$27.75.

Wellington West Capital Markets analyst Paolo Lostritto previously valued 50% of the project at US$899-million.

Accompanying the transaction were details of an updated feasibility study. It showed that capital costs for the project have escalated from Wellington’s estimate of US$3.6-billion to US$4.2-billion. However, Mr. Lostritto said the Barrick transaction dampens the negative higher capital costs associated with this project.

“The announced partial divestiture of Cerro Casale has monetized some value and helped diversify future development risk,” he told clients, reiterating a target price of $22 on Kinross shares.

Meanwhile, RBC Capital Markets analyst Stephen D. Walker downgraded Kinross from Outperform to Sector Perform and trimmed his price target from US$25 to US$21.

This reflects the analyst’s projected decline in cash flow per share for both 2010 and 2011 compared to 2009, along with a net asset value decline from US$15.50 per share to US$11.75.

“While Kinross has a number of high quality development projects that should ultimately create shareholder value, the near-term share price catalysts are limited,” Mr. Walker said in a note.

He expects Kinross shares to trade in the US$17 to US$21 range for the next 12 months and would be a buyer at the low end.

Jonathan Ratner

The Federal Reserve Board’s decision to increase the discount rate – what it charges banks for emergency loans – from 0.50% to 0.75%, should not be interpreted as a change in its monetary policy. If it was, this would impact the borrowing costs for households and businesses.

The Fed wants the market to know that this is not a tightening move of any kind. Instead, the it should be seen as a logical step along the path of further
normalization of the Fed’s lending facilities. It is part of the first phase of withdrawing liquidity and winding down emergency programs, and follows the closure of a number of credit facilities.

“This step should not be viewed as a measure of monetary tightening,” according to UBS Wealth Management.

It noted that prior to the financial crisis, the Fed maintained a 1% spread between the target Federal Funds rate and the discount rate and only offered overnight loans. The latest move brings the spread back up to 0.5%.

UBS also pointed out that discount window borrowing has been a trickle compared to other liquidity provisions by the Fed.

Despite the fact that this change is cosmetic only, the psychological impact of the rate increase is real and is material nonetheless, according to Dennis Gartman. In Friday’s edition of The Gartman Letter, he used the nautical metaphor of a “warning shot across the bow” of the capital market.

“Rather than waiting to change the rhetoric in the language of the next communiqué following the next FOMC meeting, the Fed has issued its warning shot in the form of this discount rate change,” Mr. Gartman wrote. “Cosmetic changes can be formidable in people and in economics, and this one such formidable costmetic change.”

National Bank Financial chief economist and strategist Stéfane Marion noted that despite the action, the gap between the Fed Funds target rate and the discount remains below its pre-crisis level of 100 basis points. Mr. Marion continues to expect a change in the Fed’s monetary policy stance will begin in August 2010.

The economist noted that Ben Bernanke’s prepared remarks, back when he was snowed in on Feb. 1, showed that an increase in the discount rate was coming.

“We have reduced the maximum maturity of discount window loans to 28 days… Also, before long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate. These changes, like the closure of a number of lending facilities earlier this month, should be viewed as further normalization of the Federal Reserve’s lending facilities, in light of the improving conditions in financial markets; they are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signalling any change in the outlook for monetary policy, which remains about as it was at the time of the January meeting of the FOMC.”

Beating the stock market seems like easy work. Any public library has a shelf of books on the topic and many of these books rest on a solid foundation of academic research. Finance professors have identified literally scores of market inefficiencies that appear to generate big profits—at least on paper.

So why do most mutual funds and most individual investors still lag behind the market? Aswath Damodoran, a professor of finance at the Stern School of Business at New York University, says the problem is transaction costs.

Your costs include trading fees and brokerage expenses. In addition, you may find that the stock price on paper is actually a “bid” price that is far below the “ask” price that current owners are demanding. There’s also the matter of liquidity: if a stock doesn’t trade much, your attempt to buy it may nudge the price upward. All of these factors can turn a strategy that works on paper into a money loser in reality.

Damodoran cites the case of the “loser stock” strategy. Academics noticed in the mid-1980s that stocks that have lost the most in any year seem to generate much better returns over the next five years than stocks that have done the best. This finding suggested that contrarian investing could produce big profits.

But there’s a hitch. It turns out that almost all the profits from this strategy come from buying stocks that have dropped below a dollar. The bid-ask spread on these penny stocks is enormous—20% to 25% of the stock price is typical. To make matters worse, these stocks are not very liquid. The moment you try to buy one of them, the price floats up. As Damodaran concludes: “Talking about money is easy…actually making money is far more difficult.”

Freelance business journalist Ian McGugan blogs for the Financial Post

With HSBC Canada’s fourth quarter results coming a few weeks ahead of earnings from the Big Six, analysts are again trying to gauge what it might mean for Canadian banks. They’ve had mixed responses.

It is important to note that HSBC’s quarter ended on Dec. 31, 2009, while the first quarter for the Canadian banks ends January 31, 2010. As a result, there are only two months of overlap so comparisons cannot be direct. The Big Six start reporting in a few weeks.

CI Capital Markets analyst Brad Smith thinks HSBC Canada’s margins bode well for the Bix Six (TD, Scotia, Royal, CIBC, BMO and National).

Overall, HSBC reported a 16 basis point (bps) net interest margin expansion, compared to a 3 bps increase during the previous quarter. A similar expansion for the Big Six in Q1 would equate to roughly $600-million in incremental quarterly earnings, Mr. Smith noted.

Over at Barclays Capital, John Aiken focused on trading revenues. He pointed out that while trading revenues were up on a sequential basis at HSBC, this was the result of write-downs in the third quarter related to its ABCP exposures. Normalizing for this, the analyst said trading revenues would have been down over 20% sequentially and were down 80% from a year ago.

“Weaker trading revenues are a material risk for the Canadian banks, which we do not believe is adequately reflected in current consensus estimates or valuations,” Mr. Aiken told clients. “That said, contributions from other sources of capital markets revenues were strong, consistent with our outlook.”

He admitted that with HSBC’s 16 bps margin gain, his forecasts for only modest margin expansion by the Canadian banks could prove to be conservative.

However, Mr. Aiken said the growth in provisions for credit losses HSBC experienced is a negative. The analyst believes that the market is anticipating lower provisions for the Canadian banks, but if HSBC’s experience is shared by the Big Six, this could generate material surprises to the downside.

Jonathan Ratner

Toyota Motor Corp. is having a rough go of it these days, but there were two positives taken from the company president’s third briefing on Wednesday.

Concerns have been raised that Toyota may have intentionally or unintentionally delayed taking action in response to the acceleration problem while knowing about it early on. Akio Toyoda responded to this suggestion by noting that management is not all-knowing and will honestly report what it did and did not know at the public hearing. He also said the company will outline what it can and cannot do technologically.

Given that the company has been asked to provide all internal documents relating to recalls since 2000, UBS analyst Tatsuo Yoshida thinks Toyota’s response suggests it did not intentionally delay taking corrective action.

Toyota has also learned the importance of eliminating customer concerns and disclosing information even when initial actions meet standards or laws, the analyst said in a report.

“In addition to improving the frequency and speed of collecting and analysing information on problems globally, it is also taking the initiative in showing progress of response measures on its website,” Mr. Yoshida said.

He expects these steps to raise the level of problem response demanded in the industry, which could mean that companies with inadequate resources will falter.

The UBS analyst expects Toyota’s share price to remain weak for the next two to three months on concerns about recall-related information and the sales impact. However, he noted that declines could be an opportunity for further long-term investment. The stock remains his top pick, with forecasted upside of nearly 50%.

Jonathan Ratner

Photo: Toyota Motor president Akio Toyoda (R) answers questions as vice president Shinichi Sasaki (L) looks on during a news conference in Tokyo on February 17, 2010 to provide an update on the progress of massive recalls. Toyota said it would fit all new models with a system that cuts engine power when the accelerator and brake pedals are applied at the same time, to prevent runaway car accidents. (KAZUHIRO NOGI/AFP/Getty Images)

Amid the noise, the global recovery should remain the overriding investment theme of 2010

By Andreas Höfert

The strong correction in bonds and equities in the last two weeks has put a dampener on the spectacular rally the market had experienced since March last year. This raises the question of whether the sell-off is simply a breather from the prolonged liquidity-driven momentum, or the start of something deeper given the rise of new market concerns.

We do not deny that 2010 will be bumpy for investors, but all indicators point to the correction being driven by fears, not fundamentals. There is no evidence of major headwinds impeding the ongoing recovery as business-cycle figures point up, central banks are still providing ample liquidity, credit markets are continuing to thaw, and corporate earnings are still surprising positively.

In our view, the three major fears casting gloom on the market – tighter financial regulation, central banks’ “exit” strategies and tightening, and doubts about the fiscal sustainability of some sovereigns – are overblown. We do not view the recent sell-off as the return of the bear market that triggered the rout in 2008 and early 2009.

While we can expect some new banking regulations in the United States, the proposals under the so-called “Volcker Rule” are politically unrealistic and unlikely to pass in their present form. While China’s monetary tightening came sooner than expected, it was the right move to stabilize its long-term economic growth. Similar stimulus-exit measures by other central banks should be viewed not as outright tightening but as signs of normalcy in the economy.

To be sure, the most recent source of investor anxiety – the dismal fiscal situation in Greece and other European countries – is unsettling. But it also has to be taken in context. The small size of Greece does not justify the market’s overreaction, especially considering that Japan, the UK and the US are also confronted with massive debts and questions on their fiscal sustainability.

Amid the noise, investors need to distinguish between fundamentals and special factors as drivers of their decisions. With fundamentals still in line with market expectations, the global recovery led by the emerging markets should remain the overriding investment theme, and special factors such as what have triggered the recent correction can be viewed as a buying window for the risk-tolerant investor.

When the dust settles, the investment horizon should remain the same: floating-rate notes should be preferable to long-term government bonds, investment-grade and high-yield corporate bonds should remain attractive, the energy sector should still outperform, and European and emerging market equities should deliver solid returns. Along the way, investors can take advantage of the dollar’s strength versus the euro, but only briefly – the dollar should remain weak in the long run.

Dr. Andreas Höfert is Chief Economist at UBS Wealth Management Research