Let's Talk Turkey

The US was talking turkey and football last week but shopping is the real tell tale sign as to whether the turkey will get across the road as we head to year end.

Looking at XSP (iShares S&P 500 hedged into Canadian dollars) the technicals have been positive since early March. The price of XSP has risen from a low of $8.03 to $12.69 (58% increase). The current price crossed the 50-day moving average back in March, the 100-day in April and the 200-day in July and has kept its position with relative strength rising of late.

Let’s look at a few perspectives from different groups to see how they view the market in the US.

Credit Suisse reported “historically December is the best performing month for the S&P 500 as measured by the stock market. Additionally, stock market performance in December tends to be in the same direction as the market moved from January to November. When the Jan-Nov return is positive, the market performance in December tends to follow through with positive returns 80% of the time.”

Mostafa El Messiri writes in CIBC World Markets “The Week Ahead” news release on November 30, 2009. “While stock markets haven’t gone anywhere in the last decade, profits on a national accounts basis are 80% higher, raising doubts that markets are overvalued.”

Last week the markets reacted negatively to the news that Dubai wanted some relief on the $80-90 billion owed to its lenders. John Mauldin put things in perspective in his article “Why I am an Optimist” on Nov 28, 2009. He wrote, “Dubai is one of the Arab Emirates; but unlike its neighbour Abu Dhabi, oil is only about 6% of the economy. While the foundations of the country were built with oil, the country has diversified into finance, real estate, tourism, trading and manufacturing. It is a small country, with a little under 1.5 million residents, but less that 20% being natural citizens – the rest are expatriates. The gross domestic product is around US $50 billion…Dubai has become a byword for thinking large. The world’s tallest building, underwater hotels, manmade islands, indoor skiing in the desert, etc… Now here’s the deal. Abu Dhabi has the world’s largest sovereign wealth fund, at over $650 billion. Abu Dhabi could write a small check and make all the problems disappear. It just seems they are not ready to do that, at least not yet…. Given the massive losses that world banks have already taken, this is rather small potatoes. So why the reaction by the markets? Because I think many participants know that the potential for there to be serious correction is quite real. When anything as relatively small as Dubai spooks the market, it should serve as a warning sign.”

Scotia Capital wrote, “The turkey has been eaten and the Black Friday weekend is over. Investors weren't too happy with the Dubai World situation on Friday sending U.S. indices lower, but not by a large margin and volumes were understandably light. Today the focus moves from Dubai to the U.S. consumer as we get initial sales numbers from the shopping weekend. According to the National Retail Federation (which is sticking to its forecast 1% drop in spending this holiday season), more consumers went shopping over the Thanksgiving holiday weekend, yet spent less than last year. While Black Friday has significant importance as holidays sales make up about a third or more of retailers' annual profit, we must emphasize that today's Cyber Monday is gaining in importance every year as shoppers are more than happy to avoid the hassle of visiting bricks and mortar operations and shop online. So while we can claim that the shopping activity over the weekend was relatively neutral, there is more to come today, as we should see one the busiest online shopping days of the year. It's inevitable that consumption will pick up, but the past weekend suggests that the time when it picks up is not now. The one piece of good news we can take away from the weekend is that the U.S. consumer is not dead…. he or she may not be thriving, but they're not staying home on a permanent basis.”

The consensus is that the turkey will cross the road in dangerous traffic conditions.

The Flying Cow

Lately things have been flying high for Cow. It is currently trading at a 52 week high and appears to be continuing on a highflying trajectory as we approach year-end. Over the last six months COW has basically flat lined and fluctuated around its 50 day moving average. It has fluctuated above and below the 50 day moving average for both briefly and in small amounts until recently.

COW is the Claymore Global Agriculture ETF (exchange traded fund). It is composed of 35 stocks from the U.S., Canada, Japan, Switzerland, Chile, Brazil, Mexico, Netherlands, China and Caymen Islands. The companies operate in crop production, livestock, farming, agriculture products, fertilizers & agriculture chemicals, construction, farm machinery, packaged foods and meats. The results seek to mimic the performance of the MFC Global Agriculture Index. The current average P/E is 10.7X and the dividend yield is 1.47%.

Technically, the current price crossed the 50-day moving average on November 5th at about $17.51. It has continued it’s sharp ascent for the last 2 weeks of trading days with relative strength rising and a positive signal from MACD (moving average convergence divergence). From a longer term perspective the next point of resistance is at about $20 and support is at about $17. Cow looks bullish from a technical perspective.

Fundamentally I like the argument for agriculture as we see rising food demand because of changing appetites and rising incomes in emerging markets. The November 19th edition of The Economist had an interesting article “If words were food, nobody would go hungry” from the Economist print edition. It argues that we could see another price spike like 2007-2008 due to structural imbalances like food demand rising because of changing appetites and rising incomes in emerging markets. In addition biofuels are still competing with food crops for available land and yield growth in cereals is declining. The number of undernourished in the world has gone up dramatically in the last year. Compounding this problem is growing distrust of world trade where countries are shifting their focus to self-sufficiency due to scepticism about future trade in agriculture between countries. The sub headline is “This little piggy didn’t go to market”. Maybe this is the reason the COW is able to fly.

Default to High Yield

This morning I was explaining high yield bonds to my daughter. To get my point across, I had to use a practical application. A high yield bond is like lending her money and expecting to get paid back. How much extra would I have to charge her to compensate me for the risk that I might not get my money back vs. lending money to my Dad? Companies who are viewed as having more risk of non-payment (default) will have to pay a higher interest rate than those who are top rated by Moody’s Bond rating or any other independent bond-rating agency. Typically, BB rated or lower denotes high yield depending on the agency.

If we look at HYG-N which is an exchange traded fund traded on the New York Stock Exchange, we can see a steady rise from the low in March. It closed at $62 on March 6, 2009 and is now trading at about $86, which is about a 40% return. The current yield is 9.66%. Not a bad return considering it is arguably less risky than the equity market. The only other consideration is currency risk, which has been a drag on performance by about 20%. With the exception of few brief periods, the current price has maintained it’s position above the 50 day moving average and should be a good proxy for support at this level or just below it. If the current price breaks below the 100-day moving average, that might be viewed as the trend breaker. Relative strength has fallen back to the mid 40’s from it’s high of 84. MACD looks to be positive at this point. The technicals still look positive.

Looking forward, it is good to analyse how these corporations are fairing in the financial crisis. An article in the Wall Street Journal (WSJ.com) dated November 16, 2009 by Mike Spector and Kate Haywood; “Bankruptcy Rise Slows With Thaw in Lending” explains how default rates are falling. “These companies are now refinancing their balance sheets with new debt, pushing out maturities on existing loans or using distressed-debt exchanges to avoid bankruptcy filing…. Many analysts worry the refinancing wave is just ‘kicking the can’ down the road without fundamentally fixing companies’ deeper problems.” Some high yield bond fund prices reflected over 20% default rates earlier this year. “Now, Moody’s expects the U.S. default rate to peak at 13.6% this month and fall to 4.4% a year from now.” Although one could perceive that as being rosy, the challenge is moving from debt for refinancing to debt for growth. With high unemployment and an unpredictable consumer, it’s hard to see where the growth in revenues will come from. After all you can only cut expenses so far to increase profits. If we have another setback like what we experienced, you will see the price of high bonds fall also but not likely as much as stocks. Therefore, high yield bonds are an alternative to stocks and government bonds that will give you a higher cash flow. If the markets go south, you have some downside protection with the cash flow from the yield.

About to get Bucked

The most common question I get asked these days is where the Canadian dollar is going vis-à-vis the US dollar. Coincidently, since the bottom of the markets in March the trend in the Canadian dollar has been on the rise, notwithstanding some fluctuations over that period. This year the Canadian dollar has traded from just below 80 cents to just above 97 cents and is currently trading at about 92 cents.
If we look at the charts the current price crossed the 50-day moving average in March and has maintained its status with the exception of a short period in the summer. The current price has also remained above the 100 day moving average. When the Canadian dollar either rallies or reverses it usually does so for an extended period and establishes a strong trend. Although we have a strong indication when we look at the moving averages, MACD and relative strength tell a different story. Both have started to wane recently.
The October 24-31st edition of The Economist reported that statements by The Bank of Canada have had a strong impact on the recent movement of the Canadian dollar. In the article, Dollar depreciation, Denial or acceptance, the Economist reported, “ In a statement released after its monetary-policy meeting on October 20th, Canada’s central bank said the strength of the Canadian dollar would more than offset all the good news on the economy in the past three months. The currency’s strength would weigh on exports, said the bank’s rate-setters, and mean that inflation would return to its 2% target a bit later than previously forecast. Foreign-exchange markets took the hint: the Canadian dollar fell by 2% against the American one after the bank’s statement.”
Aside from what The Bank of Canada says, the Canadian dollar has a number of variables that impact its value. Most notably demand and supply issues, the US dollar, energy, materials, interest rates, the markets, international currencies and economic growth. It is difficult to predict which of these variables are going to impact the Canadian dollar directly or indirectly next, however, my bet would be whichever way the markets go these days so does the Canadian dollar. Conversely, the US dollar has been negatively correlated to the markets. If this is the selloff we have been waiting for look for the Canadian dollar to fall in the short term.
We are hosting a Friday Morning Coffee at 9am this Friday November 6 in Kelowna and again Friday Nov 20 in Vernon. Please call or e-mail to reserve your seat.