Hot Off the Web- October 2, 2009

Personal Finance and Investments

In the Financial Post’s “Strange bedfellows: Moore, Boogle” Jonathan Chevreau refers to Bogle’s new book “Enough”.  Chevreau writes that “Enough begins and ends with a short anecdote Kurt Vonnegut Jr. described in New Yorker magazine, about a chat with Catch-22 author Joseph Heller at a party thrown by a hedge-fund billionaire. Told the hedgie made more money in a day than his novel made over its entire history, Heller replied, “Yes, but I have something he will never have –enough.”

WSJ’s Lisa Scherzer reports in the WSJ that “Social Security’s January Surprise” will be the absence of a cost of living increase for the first time in 30 years. The past year’s drop in CPI of urban wage earners may not necessarily be representative of “senior inflation” but it does govern annual adjustments. (CPP/OAS payments are calculated differently than Social Security, and in differently from each other. CPP was increased for 2009 by 2.9%, while the OAS will stay unchanged for the three months starting October 1, 2009; there were no OAS changes since last quarter of 2008.)

The Globe and Mail’s John Heinzl lists “The seven deadly sins of managing your money”; among them are: too much risk, outrageous fees, too many overlapping funds (so still undiversified), chasing ‘hot’ investments, etc

The WSJ’s Jeff Opdyke in “Small investors make big bets on currencies” tells readers about “one of the riskiest corners of Wall Street”- currency trading. With leverage of as much as 500:1, it’s one of the fastest ways to lose your money; you don’t want to go there.

Jamie Golombek in the Financial Post’s “A tempting opportunity from the CRA”reminds readers of income splitting opportunity among spouses/partners given the 1% prescribed interest rate on loans to spouse for investment purposes. Rate stays effective for the duration of the loan. “it’s probably a good idea to get a lawyer to draft a promissory note or loan agreement between spouses to evidence both the terms of the loan and the fact that the loan was properly extended and dated during a 1% prescribed rate calendar quarter.”

Pensions

Julien Russell Brunet in Maclean’s “Hung out to dry” (thanks to SI for bringing to my attention) discusses the urgent need for changes to the BIA (Bankruptcy and Insolvency Act) to protect Canada’s pensioners by moving pension plan underfunding into a priority claim position to correct the current “fundamentally unfair” situation. (The alternative would be to introduce pension guarantee funds like in the US, UK, and elsewhere.)

Matthew McClearn of the Canadian Business has a great overview of the coming retirement crisis in Canada in his “Inside the looming retirement crisis”, except for a few details on DB plans. McClearn forgot to mention: the potential conflicts of interest of the professionals servicing the pension industry (hired by the company creates implicit pressure to do what’s good for the company rather than the pensioners), aggressive actuarial assumptions (minimizing estimated liabilities) and aggressive investment strategies (taking too much risk by gambling with pensioners’ assets for the benefit of the company, instead of using Liability Driven Investment approach) to minimize employer contributions, weak/inadequate regulations which constrain pension plan members from accumulating assets in a tax efficient manner yet providing ineffective regulation of the pension plan itself (valuation only every three years, relief from keeping the plan funded even if sponsor has low credit rating: as in “too big to fail” and extending shortfall make-up interval from 5 to 10 years, making plans even more underfunded.), unlike most OECD countries which have a proper pension insurance fund or provide some level of priority to underfunding of pension plans in bankruptcy, Canada does neither. It is also strange  to argue against government “bailout” of DB pension plans due to “moral hazard”, after government/regulators failed to prevent drastic underfunding  by ineffective regulations, ineffective enforcement and when in trouble, relaxation of already ineffective rules, making government directly complicit for disastrous state of affairs!

Real Estate

“Teranet-National bank House Price Index”  “Canadian home prices in July were down 5.1% from a year earlier, according to the Teranet-National Bank National Composite House Price Index™. Though it was the eighth consecutive 12-month decline, it was also the first time in 13 months that prices in every region covered by the index were up from the month before. For the composite index it was a third consecutive monthly rise. The trend reversal is consistent with improving market conditions for the country as a whole in recent months – more homes have been selling and fewer have been coming on the market.”

The July Case-Shiller Home Price Index of U.S. home prices was also released this week and the 10 and 20 city indexes are (up) m/m by about +1.6%, (down) y/y about -13% and (down) from 2006 high by about -30%. Only Las Vegas and Seattle were down on m/m.

For those of you who are interested in a worldwide ranking of cities based on a real estate affordability index, read the 5^th Annual Demographia Housing Affordability Survey . The data was actually collected in Q3 of 2008. The affordability metric is the “ratio of median house price to median household income” and the rating categories are defined as follows: affordable <3.0, moderately unaffordable 3.1-4.0, seriously unaffordable 4.1-5.0, and severely unaffordable >5.1. Australia is 6.0, Canada is 3.5, and US is 3.2. Some of the cities are: Vancouver 8.4, New York 7.0, London (UK) 6.9, Winnipeg 3.0, Ottawa 3.4, Montreal 4.6 and Toronto 4.8.

Things to Ponder

John Authers writes in the Financial Times that “Crisis creates new sophistication in risk”. Correlation based approaches to risk failed to protect the downside in the recent crash, when suddenly everything became correlated. Some other approaches being tabled now are: (1) “risk factor” rather than asset class based (risk factors such as-not just the classical equity, default, interest rates, inflation, liquidity, but also public policy), (2) “risk of outright loss, rather than the volatility of returns” (look at 9 types of risk: concentration (‘fad’ investing), leverage, liquidity, transparency, sensitivity to overall equity and bond markets, event, volatility, and operational risk.) The move to passive approach will continue. Style-based approached will be replaced by search for manager with ‘skill’ and relative performance will be of lesser concern than absolute returns. Also less leverage will be used. (You might be also interested in many other stories in an “in-depth” section of the Financial Times on The Future of Investing)

In the Financial Times’ “Wanted: New models for markets” John Authers discusses the challenges faced by the building blocks of current finance theory: efficient markets, bell curve, efficient frontier, static nature of correlations, traditional asset class correlations (e.g. stock market and energy usually negatively correlated, but not recently), etc. People are now suggesting that perhaps the assumptions upon which current finance theory is based are valid most of the time, except of course, when there are discontinuities (i.e. at times of high stress). “This is a godsend to academic study…The challenge is really positive. But I don’t think that what we see means we can throw away existing theory”. For those interested in the subject might also want to read my in-depth blog this week on Mandelbrot’s book “The (Mis)behaviour of Markets” .

Brian Milner writes in the Globe and Mail’s “Deflation taking root in global economies”that “Fuelled by continuing overcapacity, shrinking credit, reduced corporate spending and falling consumer demand, deflation is on the rise in its old stomping ground of Japan and taking root in the battered U.S. and European economies.” So the threat is not inflation but deflation accompanied by “years of dismal economic performance, staggering unemployment, and deeply pessimistic consumers and businesses that cease spending and focus on surviving”.

Marko Dimitrijevic in the Financial Times’ writes that “Emerging market label is obsolete”. “Emerging markets represent half of the world’s economy; their financial markets are large and liquid with volatility, corporate governance and government policies very similar to developed markets. These traditional distinctions between emerging and developed markets, once pronounced, have disappeared.” Developed markets have recently demonstrated that that they can suffer from “poor corporate governance and less market-friendly government policies” just like emerging markets. Emerging market growth rates have significantly exceeded those of developed countries and “differential in growth will continue for three key reasons: the differentials in GDP and population growth will be maintained for the foreseeable future; many emerging markets’ basic needs have not yet been met, so starting from a lower base, consumption and investments will continue to grow faster; and from a risk standpoint, their companies were and continue to be less leveraged, with higher interest coverage ratios than those in developed markets.” Most importantly emerging markets “represent only 12 per cent of the MSCI All Country World Index, while representing 30 per cent of the world’s market capitalization, 50 per cent of the world’s economy, and the world’s best growth prospects. Investors focusing on benchmarks will miss this opportunity.”

And finally, in the Financial Post’s “$1T cash hoard” Jonathan Chevreau reports that Canadians are sitting on $1T while Americans on $10T cash. (And remember that Toronto Stock Exchange capitalization is only about $1.6T.)