Archive for March, 2011
Thursday, March 31st, 2011
Here’s a Phil’s Stock World favorite for today. John Rubino is the co-author of the book “The Collapse of the Dollar” and writes frequent articles about the economy at his blog, “Dollar Collapse.” – Ilene
More on How Inflation Turns Us Into Con Artists
Courtesy of JOHN RUBINO of Dollar Collapse
John Maynard Keynes once said of inflation:
There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
Here’s one of the “hidden forces of economic law” to which Keynes referred, courtesy of yesterday’s New York Times:
Chips are disappearing from bags, candy from boxes and vegetables from cans.
As an expected increase in the cost of raw materials looms for late summer, consumers are beginning to encounter shrinking food packages.
With unemployment still high, companies in recent months have tried to camouflage price increases by selling their products in tiny and tinier packages. So far, the changes are most visible at the grocery store, where shoppers are paying the same amount, but getting less.
For Lisa Stauber, stretching her budget to feed her nine children in Houston often requires careful monitoring at the store. Recently, when she cooked her usual three boxes of pasta for a big family dinner, she was surprised by a smaller yield, and she began to suspect something was up.
“Whole wheat pasta had gone from 16 ounces to 13.25 ounces,” she said. “I bought three boxes and it wasn’t enough — that was a little embarrassing. I bought the same amount I always buy, I just didn’t realize it, because who reads the sizes all the time?”
Ms. Stauber, 33, said she began inspecting her other purchases, aisle by aisle. Many canned vegetables dropped to 13 or 14 ounces from 16; boxes of baby wipes went to 72 from 80; and sugar was stacked in 4-pound, not 5-pound, bags, she said.
Five or so years ago, Ms. Stauber bought 16-ounce cans of corn. Then they were 15.5 ounces, then 14.5 ounces, and the size is still dropping. “The first time I’ve ever seen an 11-ounce can of corn at the store was about three weeks ago, and I was just floored,” she said. “It’s sneaky, because they figure people won’t know.”
In every economic downturn in the last few decades, companies have reduced the size of some products, disguising price increases and avoiding comparisons on same-size packages, before and after an increase. Each time, the marketing campaigns are coy; this time, the smaller versions are “greener” (packages good for the environment) or more “portable” (little carry bags for the takeout lifestyle) or “healthier” (fewer calories).
Where companies cannot change sizes — as in clothing or appliances — they have warned that prices will be going up, as the costs of cotton, energy, grain and other raw materials are rising.
“Consumers are generally more sensitive to changes in prices than to changes in quantity,” John T. Gourville, a marketing professor at Harvard Business School, said. “And companies try to do it in such a way that you don’t notice, maybe keeping the height and width the same, but changing the depth so the silhouette of the package on the shelf looks the same. Or sometimes they add more air to the chips bag or a scoop in the bottom of the peanut butter jar so it looks the same size.”Thomas J. Alexander, a finance professor at Northwood University, said that businesses had little choice these days when faced with increases in the costs of their raw goods. “Companies only have pricing power when wages are also increasing, and we’re not seeing that right now because of the high unemployment,” he said.
Most companies reduce products quietly, hoping consumers are not reading labels too closely.
But the downsizing keeps occurring. A can of Chicken of the Sea albacore tuna is now packed at 5 ounces, instead of the 6-ounce version still on some shelves, and in some cases, the 5-ounce can costs more than the larger one. Bags of Doritos, Tostitos and Fritos now hold 20 percent fewer chips than in 2009, though a spokesman said those extra chips were just a “limited time” offer.
Trying to keep customers from feeling cheated, some companies are introducing new containers that, they say, have terrific advantages — and just happen to contain less product.
Kraft is introducing “Fresh Stacks” packages for its Nabisco Premium saltines and Honey Maid graham crackers. Each has about 15 percent fewer crackers than the standard boxes, but the price has not changed. Kraft says that because the Fresh Stacks include more sleeves of crackers, they are more portable and “the packaging format offers the benefit of added freshness,” said Basil T. Maglaris, a Kraft spokesman, in an e-mail.
And Procter & Gamble is expanding its “Future Friendly” products, which it promotes as using at least 15 percent less energy, water or packaging than the standard ones.“They are more environmentally friendly, that’s true — but they’re also smaller,” said Paula Rosenblum, managing partner for retail systems research at Focus.com, an online specialist network. “They announce it as great new packaging, and in fact what it is is smaller packaging, smaller amounts of the product,” she said.
Or marketers design a new shape and size altogether, complicating any effort to comparison shop. The unwrapped Reese’s Minis, which were introduced in February, are smaller than the foil-wrapped Miniatures. They are also more expensive — $0.57 an ounce at FreshDirect, versus $0.37 an ounce for the individually wrapped.
At H. J. Heinz, prices on ketchup, condiments, sauces and Ore-Ida products have already gone up, and the company is selling smaller-than-usual versions of condiments, like 5-ounce bottles of items like Heinz 57 Sauce sold at places like Dollar General.
- When Fed officials claim that inflation is “well contained” are they measuring per ounce or per package? It wouldn’t be a surprise, given how disconnected from reality they frequently sound, if they’re being fooled by manufacturers’ packaging scams. [The Fed officials may measure package to package without being "fooled." I remember reading that that was permissible and will look for the reference. See also Michael Panzner's "More than a little doubt." - Ilene]
- If manufacturers are playing games with package sizes you can bet they’re also using cheaper ingredients, so not only are we getting less of our favorite things, they’re probably not as good as they were when we first developed an attachment to them.
- It’s an article of faith among modern economists that a little inflation is a good thing because it lets companies raise prices and workers get raises, so everyone feels richer. But that ignores the other side of the equation, which is, as we’re now seeing, a decline in product quality and producer credibility. In the end we don’t feel richer because we got a raise; we feel ripped off by companies we used to respect.
- Those same economists see deflation as a bad thing because it makes debt harder to carry. But this also overlooks the impact of incentives on behavior and character. Consider: if you make, say, candy bars and the prices of sugar and chocolate are going down, you want to avoid having to cut your selling price because holding the line on price produces a wider profit margin. So you start using higher-grade chocolate or increasing your candy bars’ size — and you let your customers know that you’re improving your products. Your credibility goes up because you’re offering a better deal, and doing so very publicly. As this practice spreads through the larger economy, the result is a culture of quality and integrity and customer service. Where inflation turns merchants into secretive con artists, deflation produces transparent purveyors of ever-better deals. In a deflationary world, our paychecks don’t rise as much, but everyone seems to be working for us rather than trying to rip us off.
- Viewed this way, only an idiot (or a Keynesian economist) would choose inflation over deflation.
Picture credit: Jesse’s Cafe Americain
Tags: Canned Vegetables, Co Author, Collapse, Con Artists, Currency, Economic Law, energy, Family Dinner, Food Packages, Frequent Articles, Grocery Store, John Maynard Keynes, John Rubino, Man In A Million, New York Times, oil, Price Increases, Stauber, Stock World, Surer, Three Boxes, Time Ms, Whole Wheat Pasta
Posted in Credit Markets, Energy & Natural Resources, Markets, Oil and Gas | Comments Off
Thursday, March 31st, 2011
“Big CPP” Dragged Into Canadian Politics?
Another federal election campaign in Canada (sigh!) and this time pension politics are front and center. Les Whittington of the Toronto Star reports, Liberals propose supplementary public pension plan:
A Liberal government would earmark an extra $700 million a year for low-income seniors and create a supplementary public pension plan to help Canadians save for retirement, Liberal Leader Michael Ignatieff says.
The party’s proposed expansion of the Guaranteed Income Supplement would provide the poorest of seniors with an extra $650 a year, Liberal officials said.
If elected, the Liberals would also quickly open discussions with the provinces to gradually increase premiums and benefits of the Canada Pension Plan, the party announced.
“Canadians who work their whole lives to provide for their families deserve a secure retirement,” Ignatieff commented during a campaign stop in Vancouver.
He said the situation is urgent because 75 per cent of Canadians working in the private sector do not have a registered pension plan.
Strengthening the CPP can only be done in concert with the provinces, Ignatieff noted. “This is a case where the federal government of Canada has to step up and provide leadership on pensions. We’ve had no leadership from Mr. Harper on pensions in five years.
“So what we want to do is sit down with the provinces . . . and work out with them how we get there. And it’s going to require something that Mr. Harper doesn’t seem to know how to do, which is sit down with the premiers and say, ‘We’ve got a common Canadian challenge, which is how to provide retirement security for all Canadians.’ ”
The main innovation promised by the Liberals is a Secure Retirement Option, or SRO, which would allow employees to top up their retirement savings through a supplementary plan administered by the CPP board.
It would allow employees and employers to voluntarily contribute to a tax-deductible retirement fund. An individual’s annual contribution ceiling would be determined by his or her RRSP contribution limit. Contributions to an RRSP and the SRO could not, when combined, exceed the individual’s annual RRSP contribution ceiling.
The Liberals said the plan would offer a low-cost, secure savings option. Ignatieff also proposed a Stranded Pension Agency to help manage the private pensions of employees left stranded when a company goes bankrupt.
In government, the Conservatives expressed interest last year in gradually strengthening the CPP but instead opted to begin work on a Pooled Registered Pension Plan, which would be administered by banks and insurance companies.
The Conservatives said they were offering this plan because negotiations with the provinces over enhancing the CPP were dragging on without agreement. Opposition parties and union leaders said the new private plan proposed by the Conservatives would do little to address the problem of low retirement savings for average Canadians.
In the recent federal budget, the Conservatives proposed an increase in the Guaranteed Income Supplement of $300 million annually to provide more assistance to low-income seniors. The NDP, which had asked for a $700-million increase, said the Conservatives’ measure was inadequate, citing it as one of the reasons the NDP would not support the Tory budget.
Tags: Canada Pension Plan, Canadian, Canadian Challenge, Canadian Market, Canadian Politics, ETF, ETFs, Federal Election Campaign, Federal Government Of Canada, Government Of Canada, Guaranteed Income Supplement, Income Seniors, Liberal Government, Liberal Leader, Michael Ignatieff, Open Discussions, Public Pension, Registered Pension Plan, Retirement Option, Retirement Savings, Retirement Security, Star Reports, Toronto Star, Whittington
Posted in Canadian Market, Credit Markets, ETFs, Markets | 5 Comments »
Wednesday, March 30th, 2011
Revolution Or Evolution In The World Oil Market?
By Bob van der Valk
Time has not made much of a difference since 2008…at least in the price of crude. The price for the U.S. West Texas Intermediate (WTI) crude oil was $107 a barrel on September 28, 2008, vs. around $105 per barrel today.
On the other hand, the average price at the pump was $2.57 a gallon then, compared with the average is $3.58 per gallon today. The chart below shows the average price for the period from March 24, 2009 through March 24, 2011):
The reasons for the difference in the pricing of gasoline is exactly the opposite of why they were back on September 28, 2008. Back then, the US economy went into a tailspin with fuel prices decreasing faster than crude oil prices. They eventually caught up with each other in early 2009 and have been increasing in-sync ever since.
Today’s fuel prices are keyed more to the Brent crude oil price posting on the Intercontinental Exchange (ICE) in London instead of the WTI crude oil posting on the New York Mercantile Exchange (NYMEX), which has become somewhat inconsequential since it is landlocked in Cushing, Oklahoma.
Cushing, OK is the delivery point of NYMEX from where WTI is shipped by pipeline to various U.S. Midwest and Gulf Coast refineries. In contrast, the Brent crude oil inventories are held at a harbor in Belgium easily reached by any ship able to carry large amounts of crude oil into and out of that location.
The volatility in the price of crude is caused by any world events threatening crude oil supplies as they are the world’s main source of energy. Wall Street bankers and their clients are a big influence in the commodity market and tend to exaggerate prices by making bets for or against the price of crude oil causing speculation in the
Prior to the 1980’s, the price of crude oil was set by the parties involved in actually producing and refining it. That changed when the NYMEX started trading first in crude oil and gasoline, and added natural gas and heating oil later on.
Physical and futures markets were meant to run responding to actual supply and demand, but instead have added a layer of uncertainty for anyone producing fuel in order to keep prices within an affordable range to their consumers.
The Commodity Futures Trading Commission (CFTC) is now proposing limits for energy speculators. Ten big US banks will be affected the most and will have the option to trade on the Intercontinental Exchange (ICE) based in London, which does not have any trading limits.
Now, the Middle East and North African (MENA) revolutions have also been added to the equation making crude oil a commodity speculators dream to come true. Trouble brewing in MENA and Saudi Arabia will keep both crude oil and fuel prices on an ever increasing path until the unrest settles down.
Iranian Oil Minister Massoud Mirkazemi, who currently holds the OPEC rotating presidency, was quoted as saying:
“There is no need for an OPEC emergency meeting in the current situation as the oil market is well balanced. OPEC is only able to pump about 30 million barrels of oil to the world markets per day, which is nearly a third of the global oil production.”
This was reported by the local English language satellite Press TV in Tehran, Iran report on Sunday, March 28, 2010.
OPEC will cut oil shipments to its lowest level since October as civil war halted exports of crude oil from Libya. OPEC oil exports are due to fall to 23 million barrels a day in the four weeks to 9th April, down 1.8 percent from 23.5 million in the period to 12th March.
Oil producers typically respond to strong price signals and are able afford to wait until OPEC’s regular meeting in the middle of June before deciding whether to raise crude oil output. It will be too little too late to prevent higher oil prices.
Crude oil prices are determined on a “futures” market at the NYMEX or ICE. The prices of crude oil traded today determine the future prices at the pump. Thus, if the speculators see current inventories are sufficient to cover demand until futures contracts are delivered, the downward price happens almost immediately.
A war and revolution in Libya has caused higher prices for gasoline and diesel all the way in the U.S. The lyrics in John Lennon’s song Revolution are as applicable today as they were back in 1968,
“You say you want a revolution? Well you know, we’d all want to change the world. But if you want money for people with minds that hate, all I can tell you is brother you’ll have to wait”
About The Author - Bob van der Valk is an Independent Consultant with over 50 years of experience in the petroleum gasoline and lubricants industry.
The views and opinions expressed herein are the author’s own and do not necessarily reflect those of EconMatters.
Tags: Brent Crude Oil, Brent Crude Oil Price, BRIC, BRICs, Commodity Market, Crude Oil Inventories, Crude Oil Price, Crude Oil Prices, Crude Oil Supplies, Cushing Oklahoma, Delivery Point, energy, Gulf Coast Refineries, Intercontinental Exchange, Market Revolution, Mercantile Exchange Nymex, New York Mercantile Exchange, oil, Price Of Crude Oil, Van Der Valk, West Texas Intermediate, World Oil Market, Wti Crude Oil, York Mercantile Exchange
Posted in Emerging Markets, Energy & Natural Resources, Markets, Oil and Gas | Comments Off
Wednesday, March 30th, 2011
John Smolinski, Portfolio Manager, TD Canadian Equity Fund, discusses the impact of the Japanese crisis and the political turmoil in the Middle East and North Africa on the Canadian banking and energy sectors and shares names of some stocks that he likes.
In the interview, TD Mutual Fund’s John Smolinski addresses the following concerns:
- How are you managing the constantly evolving global risks?
- What has been the impact on the markets?
- Will natural gas benefit from increased demand?
- How are you positioning the portfolio?
- Are there any sectors or companies that you like?
Click on the image below, or here, to watch the interview:
John Smolinski, CFA
Title: Managing Director
Education: BA Economics, York University, Chartered Financial Analyst
Industry Experience: Since 1990
Funds: TD Canadian Equity Fund, TD Balanced Growth Fund
Tags: Ba Economics, Canadian, Canadian Equity Fund, Canadian Market, Cfa, Chartered Financial Analyst, Director Education, energy, Energy Sectors, Global Concerns, Global Risks, Industry Experience, Interview John, Managing Director, Middle East, Mutual Fund, Natural Gas, North Africa, oil, Political Turmoil, Portfolio Manager, Smolinski, Tsx, York University
Posted in Canadian Market, Energy & Natural Resources, Markets, Oil and Gas | Comments Off
Wednesday, March 30th, 2011
by William H. Gross, April 2011
- Medicare, Medicaid and Social Security now account for 44% of total federal spending and are steadily rising.
- Previous Congresses (and Administrations) have relied on the assumption that we can grow our way out of this onerous debt burden.
- Unless entitlements are substantially reformed, the U.S. will likely default on its debt; not in conventional ways, but via inflation, currency devaluation and low to negative real interest rates.
That adorable skunk, Pepé Le Pew, is one of my wife Sue’s favorite cartoon characters. There’s something affable, even romantic about him as he seeks to woo his female companions with a French accent and promises of a skunk bungalow and bedrooms full of little Pepés in future years. It’s easy to love a skunk – but only on the silver screen, and if in real life – at a considerable distance. I think of Congress that way. Every two or six years, they dress up in full makeup, pretending to be the change, vowing to correct what hasn’t been corrected, promising discipline as opposed to profligate overspending and undertaxation, and striving to balance the budget when all others have failed. Oooh Pepé – Mon Chéri! But don’t believe them – hold your nose instead! Oh, I kid the Congress. Perhaps they don’t have black and white stripes with bushy tails. Perhaps there’s just a stink bomb that the Congressional sergeant-at-arms sets off every time they convene and the gavel falls to signify the beginning of the “people’s business.” Perhaps. But, in all cases, citizens of America – hold your noses. You ain’t smelled nothin’ yet.
I speak, of course, to the budget deficit and Washington’s inability to recognize the intractable: 75% of the budget is non-discretionary and entitlement based. Without attacking entitlements – Medicare, Medicaid and Social Security – we are smelling $1 trillion deficits as far as the nose can sniff. Once dominated by defense spending, these three categories now account for 44% of total Federal spending and are steadily rising. As Chart 1 points out, after defense and interest payments on the national debt are excluded, remaining discretionary expenses for education, infrastructure, agriculture and housing constitute at most 25% of the 2011 fiscal year federal spending budget of $4 trillion. You could eliminate it all and still wind up with a deficit of nearly $700 billion! So come on you stinkers; enough of the Pepé Le Pew romance and promises. Entitlement spending is where the money is and you need to reform it.
Even then, the situation is almost beyond repair. Check out the Treasury’s and Health and Human Services’ own data for the net present value of entitlement liabilities shown in Chart 2.
Tags: Bill Gross, Budget Deficit, Bushy Tails, Cartoon Characters, Currency, Currency Devaluation, Debt Burden, Federal Spending, Female Companions, French Accent, Future Years, Gross Investment, Infrastructure, Investment Outlook, Medicare Medicaid, Overspending, Promising Discipline, Sergeant At Arms, Silver, Stink Bomb, Trillion Deficits, White Stripes, William H Gross
Posted in Infrastructure, Markets, Outlook, Silver | Comments Off
Wednesday, March 30th, 2011
by Robert Arnott, Research Affiliates
Stocks ought to produce higher returns than bonds in order for the capital markets to “work.” Otherwise, stockholders would not be paid for the additional risk they take for being lower down the capital structure. It comes as no surprise, therefore, that stockholders have enjoyed outsized returns for their efforts for most—but not all—long time periods.
Ibbotson Associates, whose annual data compendium1 covers U.S. stocks and U.S. bonds since January 1926, shows the S&P 500 Index compounding through December 2010 at an annual rate of 9.9% vs. 5.5% for long-term government bonds, an excess return of 4.4%. This return compounds exponentially with time. A $1,000 U.S. stock investment in 1926 would have ballooned to $3 million by December 2010 vs. $92,000 for an investment in long-term bonds, a 32-fold difference.
Emboldened by the 1980s and 1990s (when stocks compounded at 17.6% and 18.2% per annum, respectively), “Stocks for the Long Run” became the mantra for long-term investing, as well as a best-selling book. This view is now embedded into the psyche of an entire generation of professional and casual investors who ignore the fact that much of those outsized returns were a consequence of soaring valuation multiples and tumbling yields. In this issue we examine historical U.S. equity performance from a larger perspective and find that today’s overwhelming equity bias is built on a shaky foundation, reliant on a short and unrepresentative time period.
Let’s Talk Really Long-Term
For those willing to do the homework, longer-term stock and bond data exist for the United States. But that picture isn’t quite as rosy as from 1926–2010; therefore, it doesn’t receive as much attention from Wall Street optimists. From 1802–2010, U.S. stocks generated a 7.9% annual return vs. 5.1% for long-term government bonds.2 Our realized excess return was cut to 2.8%—a one-third reduction—by adding 125 years of capital markets history!
Of course, many observers will declare 19th century data irrelevant. A lot has changed! The survival of the United States was in doubt during the early part of the century (War of 1812) and during the debilitating Civil War of the 1860s. The United States was an “emerging market”! The economy was notably short on global trade and long subsistence agriculture. Furthermore, there were three major wars and four depressions—two were deeper than the Great Depression—between 1800 and 1870, a span when data on market returns were notably thin.
By the following century, the United States and its equity markets enjoyed good fortune. It was not invaded and occupied by a foreign power. It did not suffer a government overthrow… just ask Russian investors their return on capital after the Bolshevik Revolution! As Ben Graham might caution, beware the difference between the loss on capital (a drop in price, from which we can recover) and a loss of capital (100% loss, from which we cannot). Russia’s stock market wasn’t alone in the 20th century as three additional top 15 markets in 1900—Egypt, Argentina, and China—suffered a 100% loss of capital while Germany (twice) and Japan (once) came very close.3
Whether we use 200+ years or 80+ years, how many people are pursuing an investment program of that duration? No one, of course. Even “perpetual” institutions such as university endowments aren’t exempt. As the late economic historian Peter Bernstein commented, “…this kind of long run will exceed the life expectancies of most people mature enough to be invited to join such boards of trustees.”4 Relevant horizons for all “long term” investment programs are significantly shorter—10 years or 20 years, maybe 30.
Shouldn’t a span of one, two, or three decades be sufficient for investors to be rewarded for bearing the risk of holding stocks? As displayed in Table 1, trailing returns for stocks haven’t come close to earning the excess returns that we’ve all come to expect, even after stocks worldwide doubled from the early March 2009 lows during the Global Financial Crisis! We’ll save an exploration for how the Fundamental Index® concept radically reshapes this picture for another time.
Where is the wealth creation implied by the Ibbotson data? Stock market investors took the risk—riding out every bubble, every crash, every spectacular bankruptcy and bear market, over a 30-year stretch. How much were they compensated for the blood, sweat, and tears spilled with all this volatility? A measly 53 basis points per annum! Indeed, investors who have incurred the ups and downs over the past decade have lost money compared to what they could have earned from long-term government bonds. They’ve paid for the privilege of incurring stomach-churning risk. Not only did Treasury bond investors sleep better, they ate better too!
A 30-year stock market excess return of approximately zero is a huge disappointment to the legions of “stocks at any price” long-term investors. But it’s not the first extended drought. From 1803 to 1857,5 U.S. equities struggled; the stock investor would have received a third of the ending wealth of the bond investor. Stocks managed to break even only in 1871. Most observers would be shocked to learn there was ever a 68-year stretch of stock market underperformance. After a 72-year bull market from 1857 through 1929, another dry spell ensued. From 1929 through 1949, stocks failed to match bonds, the only long-term shortfall in the Ibbotson time sample. Perhaps it was the extraordinary period of history—The Great Depression and World War II—and the spectacular aftermath from 1950–1999, that lulled recent investors into a false sense of security regarding long-term equity performance.6
Fortunately for the capital markets and equity investors, an examination of history shows that, yes, stocks have a high tendency to outperform government bonds over 10-year and 20-year periods. Figure 1 illustrates rolling 10- and 20-year “win rates” for equities versus government bonds. We break the data into Ibbotson (1926–2010) and Total (1802–2010). The Ibbotson timeframe confirms investor behavior in the 30 years since Ibbotson and Sinquefield published their groundbreaking study.7 For the vast majority of periods—86% for 10 years and 96% for 20 years—equities outperform bonds. But the longer term data are less convincing. For 10-year periods, equities outperform in 71% of the observations, rising to 83% for 20 years.
A 70% or 80% win rate still offers pretty good odds. In professional basketball, those are average to above-average free throw percentages. But the relatively small probability of failure masks the magnitude of a miss. Just as a single missed free throw can cost a basketball championship, so too can an equity “miss” lead to drastic consequences, as the past 10 years have shown. There is no guarantee of superior equity returns, which begs the question: Why does our industry act like there’s one? More important, why take all that risk for a skinny equity premium?
We aren’t saying that we should expect bonds to beat stocks over the next 10 or 20 years. Rather, this brief history lesson illuminates that the much-vaunted 4–5% risk premium for stocks is unreliable and a dangerous assumption on which to make our future plans. In our view, a more normal economic environment would suggest 2–3%, which is the historic risk premium absent the rise in valuation multiples in the past 30 years. But these are not normal times. Today’s low starting yields, combined with the prospective challenges from our addiction to debt-financed consumption and aging population, would put us closer to 1%.
It would be foolish to act as if the past 200 years is fully representative of the future. For one thing, the United States was an emerging market for much of that period, with only a handful of industries and an unstable currency. In the past century, we dodged challenges and difficulties that laid waste to the plans of investors in many countries. Nassim Taleb points out that “Black Swans”—unwelcome outliers that exceed the bounds of normalcy—are a recurring phenomenon; the abnormal is, indeed, normal. Our own stock market history is but a single sample of a large and unknowable population of potential outcomes.
Peter Bernstein relentlessly reminded us there are things we can never know, that prosperity and investing success are inherently “risky”; they can disappear in a flash. Uncertainty is always with us. The old adage puts it succinctly: “If you want God to laugh, tell him your plans.” Concentrating the majority of one’s investment portfolio in one investment category, based on an unknowable and fickle long-term equity premium, is a dangerous game of “probability chicken.”
1. Ibbotson® SBBI® 2011 Classic Yearbook: Market Results for Stocks, Bonds, Bills, and Inflation 1926–2010, Morningstar.
2. For much of this section, we rely on the data that Peter Bernstein and I assembled for “What Risk Premium is ‘Normal’?” Financial Analysts Journal, March/April 2002. We are indebted to many sources for this data, ranging
from Ibbotson Associates, the Cowles Commission, Bill Schwert of Rochester University, and Bob Shiller of Yale. For the full roster of sources, see the FAJ paper.
3. See Arnott and Bernstein (2002).
4. See Peter Bernstein, “What Rate of Return Can You Reasonably Expect… or What Can the Long Run Tell Us about the Short Run?” Financial Analysts Journal, March/April 1997.
5. 20-year bonds were used whenever possible but the longest maturities tended to be 10 years for much of the nineteenth century. Also, in the 1840s, there was a brief span with no government debt (we should be so lucky!),
hence no government bonds. Under these circumstances, the equivalent to today’s Government Sponsored Enterprises, railway and canal bonds, were used as these projects typically had the tacit support of the government.
6. For more on this, see Robert Arnott, “Bonds: Why Bother?” Journal of Indexes, May/June 2009.
7. Roger G. Ibbotson and Rex A. Sinquefield, “Stocks, Bonds, Bills and Inflation: Year-by-Year Historical Returns (1926–1974),” Journal of Business, January 1976.
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Tags: Annum, Best Selling Book, Bond Data, Capital Markets, Capital Structure, China, Currency, Emerging Markets, Excess Return, Government Bonds, Ibbotson Associates, Investment Bonds, Optimists, Research Affiliates, Robert Arnott, Russia, Shaky Foundation, Stock Investment, Stockholders, Term Bonds, Term Investing, Term Stock, Time Periods, Urban Legend
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Wednesday, March 30th, 2011
Over the next 15 years, the number of children in middle-class households in emerging market cities around the world may grow 10 times faster than those in developed countries. This future generation living in places such as China, Latin America and South Asia should drive the demand for goods and services, housing and transportation that extend beyond the basic necessities of life.
In McKinsey Global Institute’s recently published report, “Urban world: Mapping the Economic Power of Cities,” the researchers focus on demographic and economic trends to determine which cities will provide the most economic growth in the future.
The pie charts show how dramatically the world’s economic weight is expected to shift over the next 15 years. Today, developed economies such as the U.S., Western Europe and emerging market megacities—cities with more than ten million people—contribute 73 percent of world GDP growth. By 2025, their contribution diminishes to a mere one-third of global GDP.
The largest drivers of this growth comes from small cities, rural areas and “middleweight” cities—those with populations between 150,000 and 10 million people—in emerging markets.
To establish which cities will be the next powerhouses, McKinsey developed a comprehensive list of urban centers they named the City 600, ranked by their GDP contribution. Currently, 23 megacities and 577 middleweights make up one-fifth of the world’s population and two-thirds are located in emerging market countries, including China, India and Latin America.
The population of these 600 cities is estimated to grow 1.6 times faster than global population, and 250 million new households are expected. China and Sub-Saharan Africa are two areas with the fastest pace of household growth, and both are expected to double by 2025. The growth in these emerging market cities could be so tremendous that by 2025, one out of every three developed market cities will likely be replaced by emerging world middleweights. China hosts the majority of these growth hotspots, but others include the cities of Fortaleza and Manaus in Brazil, Sharjah in the Middle East, and Nagpur and Vadodara in India.
Twelve of these emerging market middleweight cities are projected to grow to be megacities, each housing more than 10 million people by 2025.
Ranking the top 25 cities of today’s City 600 by GDP, the majority are in developed countries. However, three North American cities and four in Western Europe will be replaced by new megacities in Asia (see map).
McKinsey’s report expands on a theme we discuss often about how urbanization in many other developing countries drives global economic growth. As an example, in a previous blog, I discussed how China’s urbanization is driving housing growth and car sales (read the blog).
I encourage you to read the full McKinsey’s report and explore their interactive charts. McKinsey’s report offers a great visual representation of emerging market trends and validates our expectation that rising urban, middle class populations in developing world will continue to drive demand for commodities, natural resources and infrastructure projects. As McKinsey states, “urbanization will be one of this century’s biggest drivers of global economic growth.”
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Tags: Cities Around The World, Developed Countries, Economic Power, Economic Trends, Emerging Market Countries, Future Generation, Global Gdp, Global Population, Household Growth, India, Infrastructure, Latin America, Market Cities, Mckinsey Global Institute, Pie Charts, Powerhouses, Rsquo, South Asia, Sub Saharan Africa, Urban Centers, Urban World, World Gdp Growth
Posted in Brazil, Commodities, Emerging Markets, India, Infrastructure | Comments Off
Tuesday, March 29th, 2011
by Mark Mobius, Vice-chairman, Franklin Templeton Investments
Chinese officials are concerned about future developments in their country. As a result of some labor shortages and rising wages in the low-end labor intensive manufacturing sector, some managers are moving parts of their production out of China to lower-cost countries such as Vietnam. This of course raises the question of unemployment in the export-oriented area which, combined with inflation, could result in social turmoil and labor unrest, if it’s not well-managed. One positive aspect is that the Chinese government recognizes the issues and addresses many of them in their new Five-Year Plan.
China’s 12th Five-Year Plan adopted in March of 2011 includes a program to shift away from its reliance on cheap exports towards greater domestic consumption. This will hopefully help to correct the trade imbalances that have developed, which are a concern to the global community, although China now dominates in so many consumer goods areas and increasingly in technical products that a stronger renminbi could result in even greater trade imbalances, at least in the short-term, since buyers have no other source of supply. The Plan calls for improvement in 12 areas: (1) growing its services such as insurance, banking, retail trade, etc.; (2) improving its industries with emphasis on added value; (3) encouraging local innovation; (4) relying less on global demand and policies; (5) reducing trade friction by increasing imports; (6) reducing the portion of investment devoted to government fixed asset investment; (7) addressing the environment to prevent further environmental degradation; (8) improving energy efficiency and thereby limiting energy demand; (9) ensuring better distribution of wealth from future economic growth; (10) preventing labor unrest by addressing workers’ rights and better union representation; (11) ensuring that citizen complaints about housing, health care, education and other areas are addressed; and (12) reducing regional disparities.
Rather than focusing purely on growth, it seems that this new plan will stress better development with an emphasis on a “harmonious society”. In order for China to make this transition, many economists realize that the government will need to rely more on private capital and market forces. This eventually amounts to a relaxation of government controls over the massive state enterprises so that they can expand internationally. In other words, the government needs to rely less on resource allocation and instead allow consumers to determine those allocations. This means that the government must focus on infrastructure, development of human capital with better educational facilities, social services and health care.
The Chinese government has been moving in that direction since Deng Xiaoping re-opened China to the world and introduced a series of economic reforms. The state-owned sector has fallen from 78% of the overall industrial output in 1978 to an estimated 30% in 2009. Nevertheless, the government still exerts a high degree of control over things such as grain and energy prices, as well as wage-setting in state and many listed government-controlled companies. The new Plan calls for more market-oriented pricing, a liberalization of interest rates and a further reduction of state-owned enterprises.
Signs of an increasingly consumerist society are readily evident. China has become the world’s largest automotive market with annual sales of 18 million compared to 13 million for the U.S. 
We have seen an increasing use of credit cards, the rise of local minimum wages in most provinces and increasing dividend payouts to shareholders of state-owned companies. The government wants to put more money in the hands of consumers by raising bank interest rates so that they get better returns from their savings, cutting income taxes and expanding consumer credit. In addition, the government is also building more affordable housing and raising social spending so that consumers need not save as much for education, healthcare and retirement. When we consider that the current number of Chinese in the middle income class is 157 million, about half the size of the U.S. population, there is substantial room for expansion within the consumer-related sector.
I have heard queries from baffled investors about past underperformance of the Chinese stock market despite the long-term positive outlook for China. One key factor that I would like to stress is that, as equity investors, we look at individual stocks rather than the market as a whole. There is quite a difference between what’s happening in the domestic Chinese A share market and the H share market in Hong Kong, which is where we are buying and hold stocks. The A share market is generally closed to foreign investors, the renminbi is not convertible in this market and the capital cost structure and a systematic shortage of equity supplies; all contribute to higher volatility. In addition, the underperformance of the broader Chinese A share market last year was a result of the influx of initial public offerings, which made a strong comeback on the mainland, soaking up a significant amount of liquidity from listed stocks to higher-valued new companies. We continue to focus on the H shares and the so-called “red-chips” listed in Hong Kong, which is where we finding the most interesting opportunities. Most importantly, markets go through cycles, and investments, and the Chinese market are no exception. This underscores the importance of patience and our view that any serious investor should have at least a five year investment horizon.
 Source: ©2009 OECD, State Owned Enterprises in China: Reviewing The Evidence. As of January 2009.
 Source: China Association of Automobile Manufacturers (CAAM), as of January 21, 2011.
 Source: ©2010 OECD, The Emerging Middle Class in Developing Countries. As of January 2010.
Copyright © Franklin Templeton Investments
Tags: Asset Investment, China, Chinese Government, chinese officials, Citizen Complaints, Distribution Of Wealth, Domestic Consumption, Emerging Markets, energy, Energy Demand, Environmental Degradation, Five Year Plan, Fixed Asset, Franklin Templeton Investments, Global Demand, Improving Energy Efficiency, Infrastructure, Labor Shortages, Labor Unrest, Manufacturing Sector, Mark Mobius, Moving Parts, oil, Social Turmoil, Union Representation
Posted in Credit Markets, Energy & Natural Resources, Infrastructure, Markets, Oil and Gas, Outlook | Comments Off
Tuesday, March 29th, 2011
Commodities in Portfolio Construction
by Alfred Lee, CFA, DMS
Vice President & Investment Strategist
BMO ETFs & Global Structured Investments
BMO Asset Management Inc.
Monthly Strategy Report March 2011
Over the last decade, commodity and commodity-related investments have gained significant popularity with both institutional and retail investors. Given their sizable returns over the last ten years, historical low correlation to traditional asset classes and emerging markets soaking up much of the supply, it should not come as much of a surprise. Coming out of the credit crisis, major central banks around the globe, most notably the U.S. Federal Reserve (Fed), were focused on reflating the global economy.
The co-ordinated easy monetary policies, government stimulus measures along with quantitative easing were largely a positive for broad commodities which tend to be used as a hedge against declining currency values and particularly a falling U.S. dollar. Essentially, investors benefited from merely having exposure to a broad basket of commodity and commodity related investments.
With global stimulus and the second instalment of quantitative easing1 (QE2) moving further into the rear-view, the reflation trade should be less of a driver in global commodity prices going forward, especially considering the Fed is anticipated by some to remove QE2 stimulus this summer. Independent supply and demand fundamentals as a result should play a more important role in driving commodity prices going forward. In addition, with political turmoil in the Middle East and now the unfortunate tsunami in Japan, these issues will have different macro factors on the varying commodity sub-groups.
With that in mind, investors may want to consider commodity differentiation at this point in their portfolio construction process. As global economic fundamentals slowly improve, correlation between assets and within assets such as commodities should naturally decrease (as detailed in the correlation matrices on the following page) in an economic thawing process. Moreover, as previously mentioned, the negative headlines will have varying impacts and ramifications on each of the commodity groups. Investors should therefore focus on commodities that have the best risk-adjusted returns and those which will further optimize their overall portfolio.
As many investors are aware, the proliferation of exchange traded funds (ETFs) and exchange traded products (ETPs)2 have allowed investors to efficiently implement commodity exposure to their portfolios in a number of different ways. Through ETFs and ETPs, investors can access commodity futures, commodity related companies and in some cases, spot prices. Investors should however first be cognisant that different commodity sub-groups react differently to macro-economic events and each also has its own fundamental and technical trading patterns. Secondly, how each ETF or ETP structure reacts to these same macro-events can also be different based on how it is accessing the specific underlying commodity (ie through spot, futures or equities).
For further information on the advantages and disadvantages of each commodity ETF/ETP structure, please see the “Gaining Commodity Exposure Through ETFs” on our website. In the following pages, we will outline our fundamental and technical outlook on four major commodity subgroups: agriculture, base metals, energy and precious metals.
- Agriculture. As we mentioned at the beginning of the year in our BMO ETF 2011 Outlook Report, food price inflation will be a topic du jour this year, with global population anticipated to hit seven billion and the rising wealth in the emerging nations continuing to place upward pressure on soft commodity prices. Furthermore, extreme weather patterns over the last year in Australia and Latin America will lead to tighter supplies. Already this year, we have seen the
future contracts of a number of soft commodities such as wheat hit its limit up3 in trading.
Now with a number of agriculture commodity contracts such as wheat, corn and soybeans currently trading in backwardation4 or in mild contango5, we prefer attaining soft-commodity exposure through futures based ETFs/ETPs. Some agriculture related companies may experience expansion at the middle portion of their income statements should they not be able to pass full grain cost appreciation to consumers. As a result, futures may provide a more pure exposure to higher agriculture prices considering the current characteristics of the commodity curve. We would caution however, that with the strong run up in many of the agriculture contracts, we would look at technical indicators such as RSI6 and MACD7 for entry points.
Potential Investment Opportunities:
- BMO Agriculture Commodity Index ETF (ZCA)
– on pullbacks.
- Base metals. Base metals as a group saw very sizable returns in 2009 with the S&P/GSCI Industrial Metals Spot Index gaining 91.2%. As copper, zinc and nickel are largely tied to industrial production, prices in these metals are rather sensitive to economic expansion. In addition base metal prices are highly correlated to stock market sentiment, given equity values on a whole are also a leading macro-economic indicator. In 2010, volatility in equity market sentiment with
investors switching frequently between the “risk-on” and “risk-off” trade, led base metals as a group to lag other commodity groups. We are the least favourable on base metals when looking for assets to best optimize a portfolio’s risk/return characteristics because of the high correlation between copper, zinc and other industrial metals to equity prices.
Moreover, as we see equity market volatility shocks to be a common theme this year, base metal future trades should be utilized more for higher-beta momentum trades based on timing than portfolio construction building blocks. For investors looking for base metal exposure, we do however currently favour futures based ETPs over equity-based ETFs as base-metal related companies have run significantly against the S&P/GSCI Industrial Metals Spot Index. The futures curve characteristics for base metals are mixed with a number of contracts recently moving to a steeper backwardation. Nevertheless, products incorporating a “smart-roll” feature that look to reduce roll effects should be considered by those desiring exposure in this area.
Potential Investment Opportunities:
- BMO Base-Metals Commodity Index ETF (ZCA)
– for momentum based trades.
- Energy. Energy prices remain one of the wildcards in the revival of the global economy. Should Brent crude prices and, to a lesser extent, West Texas Intermediate (WTI) defy gravity for a sustained period of time, it could potentially put the brakes on the global recovery as higher oil prices would increase everything from costs of production inputs to transportation. However, much of the recent rise in crude prices is also a result of the markets pricing in a risk premium and an emotional element, seen through a widening gap between implied and realized volatility on crude.
Investors with an extremely short-term horizon may want to consider futures-based energy ETPs. Though we wouldn’t be surprised to see the price of Brent crude and WTI rise further, it comes at a higher risk/reward trade-off given the sizable amount of emotion that is currently priced into oil. Last month, when rumours that Libyan leader Muammar Gaddafi was shot broke out, the emotional premium in oil prices quickly dissipated before rapidly recovering after the news was declared
false. This demonstrated the excessive level of political premium currently built into crude prices. An investment in crude through futures is therefore an indirect bet that turmoil in the Middle East will continue. Additionally as we had forecasted back in January, higher crude prices would come at higher volatility levels this year. As such, we believe oil related companies have a better risk/reward trade-off at this point, even if they have lagged crude prices as they show a more stable trend and have exhibited lower volatility levels.
Potential Investment Opportunities:
- BMO Energy Commodity Index ETF (ZCE)
– Shorter-term investors
- BMO Junior Oil Index ETF (ZJO)
– Longer-term investors
- Precious Metals. Of the four commodity groups mentioned, precious metals have shown to be the least correlated to broad based equities. The non-correlation to both the S&P 500 Composite Index and the S&P/TSX Composite Index is largely the affect of the market’s utilization of precious metals, such as gold, as a multi-purpose hedge. Last year, the sovereign debt crisis and concerns of a global currency war led to the use of precious metals as a hedge against fiat currencies. This year, with food and commodity prices rising, money is slowly transitioning out of the former trade as an alternative currency and into a hedge against inflation concerns.
On a technical level, gold prices have recently shown strength particularly against the equity market and base metals. Within the precious metals sector, small-cap gold companies, which we were extremely bullish on throughout 2010, have recently been gaining relative strength against large-cap gold companies. Investors looking for portfolio diversification may want to consider bullion or ETPs that track gold through bullion or futures, whereas investors looking for ways to generate portfolio alpha should consider junior gold companies.
Potential Investment Opportunities:
- BMO Precious Metals Commodity Index ETF (ZCP)
– Investors looking for portfolio diversification
- BMO Junior Gold Index ETF (ZJO) – Investors looking
to generate portfolio alpha
In conclusion, we believe commodity exposure will remain an instrumental building block for both institutional and retail portfolios. However, with correlations between commodity sub-groups on the decline, investors should first consider the sub-group of commodities that will best optimize their investment strategy and then determine the investment structure that is best suited to execute their objectives. With the possibility of the removal of QE2 stimulus by the Fed quickly approaching, investors will also need to consider individual supply and demand fundamentals of each commodity since the reflation trade will be less prevalent in keeping all commodities afloat.
1 Quantitative easing: An unconventional monetary policy used by some central banks when traditional measures have not produced the desired effect. Money supply is typically increased in an effort to promote increased lending and liquidity.
2 Exchange-traded products (ETPs): A broader categorization of exchange-traded funds that also include products that hold commodities, futures and other asset types.
3 Limit up: The maximum amount by which the price of a commodity futures contract may advance in one trading day. Some markets close trading of these contracts when the limit up is reached; whereas others allow trading to resume if the price moves away from the day’s limit. If there is a major event affecting the market’s sentiment toward a particular commodity, it may take several trading days before the contract price fully reflects this change. On each trading day, the trading limit will be reached before the market’s equilibrium contract price is met.
4 Backwardation: When the futures price is below the expected future spot price. Consequently, the price will rise to the spot price before the delivery date.
5 Contango: When the futures price is above the expected future spot price. Consequently, the price will decline to the spot price before the delivery date.
6 RSI: Relative Strength Index is a technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset. A reading of 30 or less is generally considered oversold, whereas a reading of 70 or more will be considered overbought.
7 MACD: Moving Average Convergence Divergence: A trend-following momentum indicator that shows the relationship between two moving averages of prices. The MACD is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA. A nine-day EMA of the MACD, called the “signal line”, is then plotted on top of the MACD, functioning as a trigger for buy and sell signals.
For more information on BMO ETFs, please visit our website bmo.com/etfs or contact your financial advisor.
To be added to the distribution list for our Monthly Strategy Report and Trade Opportunities Report, please visit our homepage at bmo.com/etfs to subscribe or email firstname.lastname@example.org with title: “Add to distribution list.”
Standard & Poor’s®, S&P® and S&P GSCI® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and have been licensed for use by BMO Asset Management Inc. BMO Agriculture Commodity Index ETF, BMO Base Metals Commodity Index ETF, BMO Energy Commodity Index ETF, BMO Precious Metals Commodity Index ETF are not sponsored, endorsed, sold or promoted by S&P or its Affiliates and S&P and its Affiliates make no representation, warranty or condition regarding the advisability of buying, selling or holding units of the ETFs.
Commissions, management fees and expenses all may be associated with investments in exchange traded funds. Please read the prospectus before investing. The funds are not guaranteed, their values change frequently and past performance may not be repeated.
This communication is intended for informational purposes only and is not, and should not be construed as, investment and/or tax advice to any individual. Particular investments and/or trading strategies should be evaluated relative to each individual’s circumstances. Individuals should seek the advice of professionals, as appropriate, regarding any particular investment.
BMO ETFs are administered and managed by BMO Asset Management Inc., a portfolio manager and a separate legal entity from the Bank of Montreal.
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Tags: Alfred Lee, Asset Classes, Asset Management Inc, BMO, BMO ETFs, Central Banks, Commodities, Commodity Prices, Correlation Matrices, Credit Crisis, Currency, Currency Values, Economic Fundamentals, Emerging Markets, energy, ETF, ETFs, Global Commodity, Global Economy, Gold, Instalment, Investment Strategist, Last Decade, Last Ten Years, Macro Factors, Monetary Policies, oil, Political Turmoil, Portfolio Construction, Rear View, Retail Investors, Strategy Report, Structured Investments, Tsunami In Japan
Posted in Commodities, Credit Markets, Energy & Natural Resources, ETFs, Gold, Markets, Oil and Gas, Outlook | Comments Off
Tuesday, March 29th, 2011
Not All Emerging Markets Are Equal
Tuesday, March 29, 2011 at 05:18PM
While emerging markets actually provided a safe haven during the equity market’s most recent sell off, not all emerging markets have been performing equally. While the BRIC countries have become synonymous with emerging markets, most of the BRICs have been lagging. In US Dollar adjusted returns, the only BRIC that has outperformed the United States over the last year is Russia, which has rallied more than 28%.
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