A big disconnect between the Stock Market and the Canadian Economy

Canada’s economy is expanding at its fastest annualized rate in six years according to Statistics Canada. That’s a quarterly expansion rate of 4.5% which is the highest figure since the third quarter of 2011. It was led by the biggest binge in household spending since before the 2008-2009 global recession.

Economists had predicted Canada to grow around 3.7% and the Bank of Canada latest forecast was for GDP to expand at 3% in their July press release. When combined with the 3.7% expansion of the first quarter, it’s the strongest six month start in 15 years.

Why isn’t money pouring into the Toronto Stock Market?

Often times the equity market is moving well before the economy does and of course the Canadian equity market had a robust year in 2016. Investors may already have priced in all the good news last year, when Canada’s stock index gained 18 percent, one of the world’s best performances.

Part of the problem is that Canada’s stock market isn’t totally reflective of the economy, since it’s heavily reliant on energy and financials. Those two sectors account for 54 percent of the S&P/TSX Composite Index.

The outlook for oil is very subdued, it is still trading below $50 a barrel even with the shutdown of refineries due to hurricane Harvey. Global inventories continue to stay high and OPEC’s has lost its influence in cutting production. Crude oil prices in the future’s market are still below $50 a barrel for all of 2018 and part of 2019. Foreign investors are taking money out of the Alberta’s oil patch.

Continued growth in residential investments which was up an annualized 16 percent in the first quarter is also likely to fade as the impact of government measures to cool housing markets kick in. Although, bank earnings have beat expectations by a wide margin, loan growth going forward is expected to decline and loan losses are expected to increase. U.S. hedge funds are still shorting Canadian financials expecting the housing bubble to burst.

Investors believe that this robust growth will force the Bank of Canada to continue raising interest rates this year. It could add extra pressure to lowering consumer spending due to high indebtedness of Canadian households. It will also add a cooling effect to the hot housing prices in both the Vancouver and Toronto real estate markets. The rapid rise in the value of the Canadian dollar is added proof that currency traders are betting that a hike in interest rates is coming soon.

Uncertainty over NATFA  renegotiation

Global political developments aren’t helping, with renegotiation of the North American Free Trade Agreement which started in August, created a new spat with the U.S. erupting over aerospace manufacturing.

Already, data suggest investment into the country is cooling. Foreign direct investment in Canada dropped 25 percent to C$8.68 billion in the first quarter, according to separate data released Tuesday. The country relies heavily on foreign funding to finance spending — totaling C$130 billion over the past two years, according to balance of payment data.

Canada has benefited from a convergence of developments that include a coordinated global recovery and rising trade volumes. The bottoming of the oil shock in western Canada, along with federal deficit spending, rising industrial production in developed economies. Canadian consumers have benefited from a buoyant jobs market and rising home values, resulting in a surge in consumer spending.

Is this Sustainable? I think not!

Economists had been predicting a slowdown in growth to about 2 percent in the second half of this year, but are revising numbers up after the GDP report. I believe this surge in economic growth is temporary. The higher value of the Canadian dollar and higher interest rates will dampen economic growth.

The Toronto stock market returns for all of 2017 are flat which could indicate that foreign investors also believe the future going forward isn’t so rosy!

 

 

 

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How has the Trump circus effective your investments?

As a Canadian, I think that the Washington circus is no longer funny. It has become “very scary”. We came very close to a nuclear war. Tensions regarding North Korea have lessen temporarily and the market sell off could have been a lot worse. So far, investors have ignored the noise coming out of Washington as U.S. corporate earnings have been better than expected.

Canadian and European investors with holdings in U.S. dollars have seen their investment returns reduced by the falling value of the U.S. dollar. For example, my investment club’s U.S. portfolio is up 10.2% as of the end of July. However, it is up only 2.3% when converted into Canadian dollars. The value of the Euro is also up 10% compared to the U.S. dollar.

The recent rally in gold is another sign of a weakening value of the U.S. dollar. A falling dollar not only increases the value of other currencies, it also increases the demand for commodities like gold. Investors buy gold as a hedge against a further weakening of the U.S. dollar.

American investors with holdings outside of the U.S. have benefited the most from a weaker dollar. Corporations that generate revenue outside the U.S. will get an earnings boost from foreign profits.   Keep in mind that the bond market doesn’t believe the Trump growth agenda will get passed any time soon. The yield on 10 year treasuries has fallen back to pre-election lows. Returns in U.S. bond portfolios have been positive for American investors.

Biggest Market Risks

  1. More inflammatory tweets from Trump regarding North Korea
  2. The resignation of Trump’s key economic advisors, Gary Cohn and Steven Mnuchin
  3. The Fed increasing short term rates causing an inverted yield curve which historically causes a U.S. recession.
  4. In fighting within the Republican Party continues and they are unable to pass meaningful economic fiscal policy.
  5. Trump’s desperation for a win causes him to tear up the NAFTA agreement?

I find this very disturbing:

President Trump’s approval rating is at its lowest since he took office with only 35% of Americans giving him a positive rating, according to a Marist Poll released Wednesday.

Although he is still popular among Republicans, his key constituency, his job performance rating has dropped among strong Republicans from 91% in June to 79% now.

Hard to believe that 79% of Republicans still approve of President Trump!

Lets hope that American voters will come to their senses during the 2018 elections!!

Share buyback binge is going strong, investors beware!

Is there anything wrong with this? Yes, it means that companies are spending more money on “financial engineering” than on capital spending. It certainly does indicate that companies are at a loss on how to improve their top line, which is what will ultimately improve the bottom line. It leads to frequent complaints by analysts about the “quality” of earnings.

It’s a very important point. Apple is part of an elite group I call “buyback monsters,” companies that have been aggressively buying back stock for years. Apple’s shares outstanding topped out in 2013 at roughly 6.6 billion shares. Since then it has been down every year and now stands at 5.2 billion.

That is a reduction of 21 percent in shares outstanding since 2013. What’s that mean? It means all other things being equal, the company’s earnings per share are 21 percent higher than they would have been had it not done the buybacks.

But that’s only since 2013 … there are companies that have been doing this much longer. IBM shares outstanding topped out at 2.3 billion way back in 1995, it’s been going down almost every year since then, and now stands at 939 million shares. Think about that. That’s a 60 percent reduction in shares outstanding in a little more than 20 years.

Same with Exxon Mobil, after the Mobil acquisition in 1999, shares outstanding topped out at just shy of 7 billion in 2000 and have been going almost steadily downhill since. There’s now 4.2 billion shares outstanding, a reduction of 40 percent since 2000.

Here are just a few more buyback monsters:

  • Northrup Grumman: 50 percent since 2003
  • Gap: 55 percent since 2005
  • Bed Bath & Beyond: 50 percent since 2005
  • McDonald’s: 36 percent since 2000
  • Microsoft: 30 percent since 2004
  • Intel: 30 percent since 2001
  • Cisco: 32 percent since 2001

Why are there buybacks at all? They were originally used to support the issuance of stock options. The options increased the share count outstanding, so to keep the countdown the company bought back shares. But as the opportunity for significant top-line growth waned, buybacks to reduce share counts became a separate strategy to prop up earnings growth.

What is my beef with buybacks? Part of management’s compensation packages include stock options. Buying back company shares ensures that their stock options don’t expire worthless.  It not only fools investors that the earnings are growing but it rewards poor management.

Take IBM for example, despite being one of the most aggressive buyback monsters on the Street, you can’t say IBM’s stock price has soared in the last decade. In 2014, the company eased off a bit on its buybacks, and the stock headed south. It headed south because IBM was beset by fundamental growth issues: Its revenues from its old line businesses were shrinking and there was not revenue from emerging  businesses (like Watson and artificial intelligence) replacing it.

The lesson: No amount of financial engineering like buying back shares can replace management’s inability to grow the business.

 

 

Is Basic Income the answer to a new AI world?

I am so glad that I am a retired senior. I don’t have to worry about a robot taking my job. Since I have lots of time on my hands to think, I wonder what a new AI world would look like. For example; will my 2 year old granddaughter even need to get a driver’s licence? Will the Uber or cab that she orders even come with a driver?

Now I have always been a big fan of science fiction movies. There is a scene in the movie “Logan” where Wolverine has to dodge driver-less trucks to cross the highway to help some people. Installing AI in 16 wheeler trucks could replace the need for a lot of truckers.

Fast food restaurants have been the training ground for teenagers and young adults.  I used to tell my kids that they better get a good education or you will end up using the phrase “would you like fries with that” while working at MacDonald’s. However, even MacDonald’s are installing new self-serve kiosks. Now you can even order your Starbucks coffee using your phone. Where will young people get work experience?

Everywhere I look, jobs are slowing disappearing, the new AI technology seems to have very few limits.

“For example, Australian company Fastbrick Robotics has developed a robot, the Hadrian X, that can lay 1,000 standard bricks in one hour – a task that would take two human bricklayers the better part of a day or longer to complete.”

Japan has the highest percentage of people over the age of 60 and their population is shrinking. As a nation, there is a shortage of workers and they have embraced the use of robots in the work place. This trend could be coming to North America sooner than you think.

As a baby boomer, I worry about the future cost of health care. The world population is aging and health care costs are raising. I hope that science fiction turns into reality and my caregiver looks something like this.

   or this 

Why universal basic income may be necessary

A 2013 study by Oxford University’s Carl Frey and Michael Osborne estimates that 47 percent of U.S. jobs will potentially be replaced by robots and automated technology in the next 10 to 20 years. Those individuals working in transportation, logistics, office management and production are likely to be the first to lose their jobs to robots, according to the report.

For many, basic income sounds like a free ride or welfare. Economist believe that masses of people will not just sit at home but will make a contribution by continuing to work. The basic income would allow recipients to explore other options not available to them if they are struggling just to survive,  such as retraining or to find new job opportunities.

In theory, new opportunities would spring up to replace jobs done by machines. However, there are some practical problems, like where will government get the money if less people are working to pay for a basic income program? The North American education system would require a major overhaul to put more job training skills into the curriculum.

Some additional information to consider

The government of Ontario just announced a three year basic income pilot project to help low income earners in three cities. A single person can apply to receive $16,889 a year and couples will receive $24,027. Recipients who are employed will keep what they made from their jobs but their basic income would be reduced by half their earnings. For example, a single person earning $10,000 per year from a part-time job would receive $11,989 in basic income ($16,989 less 50 per cent of their earned income), for a total income of $21,989.

Is basic income just a pipe dream or a future reality?

 

 

 

 

 

Warning signs that oil prices are range bound for many years

The future price of crude oil is very important to the Canadian economy and to investors in the Toronto stock market (TSX). The Canadian oil patch represents a 25% weighting in the overall index. Over the past few months, we have seen a massive sell-off of oil sands assets by foreigners.

In March, Royal Dutch Shell and Marathon Oil sold stakes in the Alberta oil sands project to Canadian Natural Resources for $12.7 billion. Marathon sold its 20% stake in the project for $2.5 billion. Later in March, Conoco Phillips sold their partnership in the oil sands to Cenovus Energy for $17.7 billion.

Reuters reported last week that BP is considering the sale of its stakes in three Canadian oil sands projects.

“BP’s 50 per cent stake in the Sunrise project near Fort McMurray in Alberta, where Husky Energy Inc owns the rest and is the operator, is the most valuable of the three assets. It also owns a 50 percent stake in Pike, operated by Devon Energy Corp, which is still awaiting a final investment decision, and is majority-owner of the Terre de Grace oil sands pilot project.”

Also in the news is Chevron was exploring the sale of its 20% stake in Canada’s Athabasca oil sands project which could fetch $2.5 billion.

“Faced with a lower oil price environment and challenging economics, which include high cost operations and carbon taxes, global players are increasingly put off by the oil sands.”

Extracting oil from the vast majority of Canada’s oil sands is a very labor and capital intensive process. It requires much higher crude oil prices to justify the more expensive extraction method. Global players exiting their oil sands positions could be a warning sign that the price of oil getting above the $60 level is overly optimistic.

The upcoming IPO of Saudi Arabia’s state own oil company (Saudi Aramco) is another warning sign that the price of oil could be range bound. The company’s oil assets are valued around 2 trillion dollars. It begs the question; why would Saudi Arabia sell part of its state own oil assets to investors?

The simple answer is the Saudi’s need more revenue to pay for their government spending programs. I believe that this is another warning sign that the price of oil will stay lower for much longer. OPEC’s current production cuts are aimed at stabilizing the oil market so that the Saudi Aramco IPO will be successful in raising much need cash for Saudi Arabia.

The key question for the future of the oil market is for how long can a surge in U.S. shale supplies make up for the slow pace of growth elsewhere in the oil sector. The 5 year chart below illustrates the returns on owning two different oil ETFs. You would have lost money owning the Canadian oil ETF (XEG) and you would have broken even on the Spider ETF (XLE). 

In my humble opinion, long term buy and hold investors should avoid oil stocks. I have been bearish on Canadian oil companies for a long time because our oil and gas is land lock. Our only customer is the United States and they have already put a 20% tariff on softwood lumber. There are growing tensions around renegotiating NAFTA which could lead to a tariff on Canadian oil. Oil stocks are still trade-able but you need to be very nibble.

 

Do you agree or disagree? All comments are welcomed.

 

Disclaimer: This post is for discussion purposes only, do your own research before you invest.