What the 700B Bailout Delay Could Mean for Canada

Many are asking if or when the frozen credit system and slower growth in the U.S. will impact the Canadian economy. The answer is broken down to a number of points:

• The energy index fell greater than the TSX Index
  
• The materials index fell greater than the TSX Index
• 5-year first time mortgages reached almost 8% (signaling a flight to safety)*
• The auto industry remains in a decline
  
• Gold rose
  

* as reported by Diane Francis in Financial Post for Sep 30. Rate could not be verified

Impact on Toronto Real Estate

I have been assessing the Toronto real estate activities for 2008. The theme remains the same: listings are increasing (supply), days on the market is increasing (activity is slowing slightly), housing prices have increased. With mortgage rates rising significantly due to the events in the U.S., the purchasing power for consumers will weaken.

As we have already seen, provinces most exposed to the commodity market will see declining profit (and a need to hire more workers). Again, there will be pressure on the demand side of the housing market.

At some point, perhaps in a month's time, the prices for homes in Toronto will need to adjust to the pressures of the global economy. After all, other countries have been proven to be impacted by the weak U.S. economy. This includes China, London, India, and Europe. Canada will be no different.

Chart below: U.S. Energy Sector reflects economic health for Canada:


Source: http://stockcharts.com/charts/gallery.html?XLE

Excerpt from TSG Weekly Market Watch
September 26, 2008
Written by Matt Blackman

About the $700B Bailout plan

• They are highly inflationary and even if they do temporarily work, result in rapidly eroding buying power as government deficits soar and the value of the dollar plummets
• Recessions are a necessary part of maintaining healthy capital markets longer-term. They remove excesses that have been built up over years of easy money and rapidly appreciating asset prices as the inevitable bubbles build. To try to interrupt this cycle makes about as much sense as trying to suspend the law of gravity

Housing

• August new home sales fell 11.54% from July and are now down 34.4% year-over-year. All the bailouts and money pumped into markets have yet to have any impact on sales according to the latest Census Bureau data.
• July marked the first time since the bubble began to pop that the excess of homes being build (red area) exceeded sales and as we see from the chart, this situation continues to plague builders.

Stock Market:

• Every sector remains in a technical downtrend demonstrated by a series of lower highs and lower lows.

Conclusion:

We will have to wait to see if the bailout has a positive impact on this but as we have said in the past, this is not a liquidity problem, its is a solvency crisis that no amount of liquidity will cure.

Full Article here: http://tradesystemguru.com/content/blogcategory/34/68/

Seeing Beyond the $700B Smoke of Distraction

I found a great counter-argument to the market's assumption that the stock market is still healthy. I, personally, am having difficulty assuming the markets will rally between November and April (on seasonal strength). The current smoke screen investors are facing is the 700B bailout making its way through congress.

Let's look at the figures to see beyond today's headlines.

In the U.S. for August, 2008:

• Durable goods orders declined 4.5% .. Source: @ http://www.census.gov/indicator/www/m3/adv/pdf/durgd.pdf

• Fresh claims for unemployment benefits jumped sharply to 493,000 (it last reached the 500,000 mark in September 2001)
• Even after adjusting 50,000 jobless claims (hurricane Ike), the 4-week average of 443,000 claims was last reached November, 2001
• new home sales plunged by 11.5 percent in August, (1 percent dip that had been expected). Annual seasonally adjusted annual sales rate of 460,000 is the slowest pace since January 1991
• The average price of a new home fell in August by 11.8 percent to $263,900, the biggest one-month drop on record
• The median home price was down 5.5 percent to $221,900.

Sources:
http://seekingalpha.com/article/97377-the-perfect-storm-even-with-bailout-economy-is-hurting

http://news.yahoo.com/s/ap/20080925/ap_on_bi_ge/economy;_ylt=AkeTtzMaEZ4Qh04Yh.1sAi5u24cA

It remains clear that although I believe by sentiment that the markets will stabilize or even rally, the fundamentals are not there yet for a sustained rally.

I am really torn as an investor and as an analyst: the market is more ripe for short-term trading than for value investors who like to buy and hold. It is for this reason that one might find my notes contradictory from one entry to the next.

The market simply needs to hope that the government bailout action will at the very least restore liquidity in the debt markets in the face of declining employment, lower home prices, and higher commodity prices.

Notes on Matt Blackman's Trade System Guru Newsletter:

http://tradesystemguru.com/content/blogcategory/34/68/

Week of September 22 2008

• “As a group, 17 or the 19 stocks for which naked shorting was banned jumped nearly 20% in the three-day period (July 15-18)!” Unfortunately, this rally was short-lived.
  
  In other words, the last SEC action generated nothing more than a short squeeze where prices were temporarily driven higher by short covering. Prices then continued to fall putting in lower lows.
• There was a net loss of more than $70 billion (net sale of Treasuries) during the July low in stock markets. More concerning, the orange linear regression trend line remains strongly negative and the sales remain below the yellow dashed line that shows the approximate amount that the US Treasury must raise each month just to pay off last year's budget deficit – a deficit that has skyrocketed with all the bailouts announced so far this year! Falling purchases of Treasuries has the potential to put strong upward pressure on interest rates if it continues.

Furthermore, Matt's summary view on the market is the same as mine:

• Until there is a significant turnaround in earnings, the housing market firms and economies start growing again, any recovery will be short-lived.

Comments and Analysis:
The trading on Monday was disappointing: there was no upward follow-through, which means the market is not confident the $700B bailout will succeed. The US Government has a monumental yet simple task it needs to accomplish: convince the world that it can restore credit liquidity and be able to back it.

The huge (historic) drop in the US Dollar led to a rise in gold and oil prices. The latter will undermine consumer confidence and therefore my call to take a long on the consumer goods sector.

Thoughts on the Rescue Plan...Outside View

Sunday Links: The Splurge
http://abnormalreturns.com/2008/09/21/sunday-links-the-splurge/

Capitalism will survive, but not for lack of trying to commit suicide.
http://www.becker-posner-blog.com/archives/2008/09/the_financial_c.html

Links shared by Daniel Carroll, FSX Team on FSX Fantasy Stock Exchange.

What Credit Crisis?

Business reports around the world are reporting last week's trading activity was net neutral. For example, the Toronto Stock Exchange was up 1% for the week. The Bush Administration is creating another bailout package that will cost US $700 Billion. This is a massive amount. Worse is that this is on top of the cost of saving AIG ($80B) and Fannie And Freddie Mac ($200B combined). The total deficit excluding these items will be $482 Billion.

It has taken me months to really comprehend why the credit market is seizing. Mortgages were given out to many homeowners who should not have qualified in the first place. Why? There were "workarounds" against the checks and balances associated with calculating the risk these homeowners would default. The repackaged debts, CDOs, and other instruments that were created still actually have value, but there is no market for them. What do you assign investments that have no buyers? Zero. Yet these debt obligations have property backing them, so its book value should not be zero.

The government is effectively buying all of the above illiquid debt obligations and creating a market for them. This should solve the problem of the credit market seizing up. In fact, this was so severe that several money market funds had a redemption value of $0.99 for every $1.00 deposited. Investors were even buying US 30 day T-bills were paying almost 0% interest.

The action taken by the Government was necessary. Now, as stock investors, we must review the consequences of this drastic bailout, and make a few assumptions.
Let's start with the logical assumptions:

1. Credit markets open up again, making it easy for consumers to borrow again
2. Consumers re-gain confidence and boost spending
3. Companies boost revenue because consumers are happy again and buying their things
4. Companies do not lay off employees because their sales are steady
   
5. Companies import raw materials, developed products thus aiding in economic growth for China, India and Europe
   
6. US Consumers take out mortgages and buy homes, and assume that housing prices will not fall the next month
7. US Consumers take on more credit card debt, and don't mind paying the high credit borrowing rates

Assumption #2, Consumer Confidence, will be a key factor in ensuring the latest banking sector bailout succeeds.

Consequences to stabilizing the Financial Sector:

1. The US will buy debt and increase Money supply, fueling inflation
2. Higher consumption = Higher supply of products = Greater demand for oil, metals, and other commodities
3. Interest rates will need to increase, creating higher borrowing costs
   
4. The US dollar will weaken
5. The US is spending $400B a year just to pay for the interest on the debt. This will severely limit the ability for the next President to fulfill spending promises.

It's clear that the cost of this massive government action will be severe inflation. Therefore investors need to do the following:

• Buy gold (trades inversely to the price of the US Dollar)
  
• Buy commodities, especially oil
• Sell US Government Bonds (I can no longer recommend TLT)
• Begin to take a position on the consumer discretionary sector and semiconductor sector

The VIX (Volatility Index) peaked on Thursday @ 42.16 and is headed down. Stock markets will probably trade in a range but may risk re-testing lows reached early last week.

...and On Toronto Real Estate?

The renewed bank sector stability in the US will have a positive impact on Ontario's economy. Home buyers will be less fearful that the weakness in housing in the U.S. will spread here. As always, I would recommend home buyers monitor the health of the commodities market and the job market. These two factors are good indicators for the health of home buyers.

I recommended TLT on September 4th. It is now a SELL.

Eyes on the US Dollar. Buy Gold

AIG is the most recent bailout that will cost the U.S. 85 Billion. It's a big number, but in the grand scheme of things, the cost is not unreasonable. In fact, the government might even be able to make a profit from this "investment" a few years down the road. The reward of bailing out AIG is far higher than the risk of global-wide credit market liquidity.

In the short-term, the global reaction to the costs incurred by the U.S. Government need to be monitored. How? Monitor the U.S. dollar. As I had remarked in a previous entry, the USD rallied gallantly, but a sell-signal was recently triggered. My initial short-term price support target for the USD is 77.07.

To profit from this short-term trend, buy gold. It rallied 9% yesterday.

Yielding to Fear

As mentioned yesterday, the Volatility Index peaked at 33.70 before settling to 30.30. It last reached such levels in March 2008. It indicates that the market is reaching a capitulation stage, the emotional point where investors are surrendering to the markets.

I found a practical description for capitulation on this blogger's site.


Fibonacci lines indicate the VIX will settle at around 20. Markets are going to establish a trend line before potentially moving upwards again. Investors should compile a list of well-valued stocks in the appropriate sectors and should even placing positions in them.

Notes on the Lehman Brothers Fallout

Excerpt from The Economist:

Even if markets can be stabilized this week, the pain is far from over—and could yet spread. Worldwide credit-related losses by financial institutions now top $500 billion, of which only $350 billion of equity has been replenished. This $150 billion gap, leveraged 14.5 times (the average gearing for the industry), translates to a $2 trillion reduction in liquidity. Hence the severe shortage of credit and predictions of worse to come.

Indeed, most analysts think that the deleveraging still has far to go. Some question how much has taken place. Bianco Research notes that while the credit positions of the 20 largest banks have fallen by $300 billion, to $1.3 trillion, since the Fed started its special lending facilities, the same amount has been financed by the Fed itself through these windows. In other words, instead of deleveraging, the banks have just shifted a chunk of their risk to the central bank. As spectacular as this weekend was, more drama is on the way.

Full Article: http://www.economist.com/finance/displayStory.cfm?story_id=12231236&source=features_box1

Analysis:

• WaMu and AIG might be next to file for bankruptcy
  
• Look for the U.S. Federal reserve to lower interest rates
• Monitor for weakness in the US dollar rally: a weaker US dollar is bullish for commodities and most especially, gold.

Note that the VIX (Volatility Index) closed at 31.7. This indicates the market is reaching a capitulation phase.

Canadian Real Estate Not Immune to U.S. Housing Weakness

According to CREA:

• Sales of previously owned Canadian homes fell 3.4 percent in August from July
  
• Year-over-year, resales were down 19.3 percent
• Average house prices fell 5.1 percent from the year before to C$316,052 ($296,160)
• number of new listings in the country's major markets fell 5.3 percent on a seasonally adjusted basis, to 47,657 units

Price weakness was greatest in Vancouver. In Toronto, prices actually rose very slightly in August.
Full Article.

Analysis:
Home buyers need to continue to monitor the health of the Canadian job market. With the commodities/resources sector now declining very rapidly over the past month, the risks are higher that job losses will increase for Canada. Therefore, the Western part of Canada (Alberta, Calgary, Vancouver) will be hit harder than the other provinces first.

The housing market weakness in the U.S. is due predominantly to tight credit market conditions, and the banking failure fallout of FRE, FMN, LEH, and soon AIG and WaMu.

Today's Lesson: Fibonacci Lines

The text below was taken from a newsletter published at Stock Charts.

Chip Anderson | ChartWatchers

FIBONACCI LINES - HOW MUCH IS "TOO MUCH"?

How high is "too high?" How low is "too low?" Think back to any time that you've owned a stock and think about when you started to get worried about it's performance. At what point did "your gut" start to tell you that you needed to sell? Chances are your gut started talking to you after the stock had moved up (or down) by 38.2%.

Wow, that's a really specific number - "38.2." It seems kind of arbitrary also. There's no way that could be correct, right? I mean, without knowing anything about the stock you were trading, or the amount of money involved, or the overall market conditions, or anything else - how can we stand here and tell you that you got nervous right at 38.2%?

The reason is because 38.2 appears to be programmed into the human psyche (as well as many other parts of nature). 38.2 is one of a set of numbers called "Fibonacci Percentages." They are derived from the "Fibonacci Sequence" which is a list of numbers where each number equals the sum of the previous two. i.e.,

1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610 etc.

The branching in trees, arrangement of leaves on a stem, the flowering of artichoke, an uncurling fern and the arrangement of a pine cone - all these things exhibit Fibonacci characteristics . In addition, if you take any large Fibonacci number and divide it by the previous number, you'll get something very close to 1.6180339887 (the larger the number, the closer you'll get). Now, 1.6180... has been known for centuries as "The Golden Ratio" - mostly because we humans tend to prefer things - art, sculptor, architecture, etc. - that have proportions that equal the Golden Ratio.

[...]

...R.N. Elliott made the first well-known connection between price movements and the Golden Ratio. He noted that many reversals occurred around 61.8% or its compliment 38.2% (i.e., 100 - 61.8). Combined with 50% and 100%, they make up the standard set of Fibonacci Percentages.

[...]

Unfortunately many people have gone on to claim that Fibonacci lines (and their variants) have almost "magical powers" to predict price movements. Like most Technicial Analysis tools, we think Fibonacci Lines are useful forecasting tools - but not magical.

You can add Fibonacci Lines to your charts using our ChartNotes annotation tool. To get started, simply click on the "Annotation" link below any SharpCharts.

Chip

Application of the above:

Canadian Housing - No Bust Just Yet

After declining 5.3% in June, the value of building permits increased 1.8% to $6.4 billion in July, mainly as a result of multi-family dwelling permits in Central Canada and industrial construction intentions in Saskatchewan.

In the residential sector, the value of building permits rose 2.7% to $3.7 billion, mainly as a result of an increase in the value of multi-family dwelling permits in Ontario, Quebec and Manitoba.

In the non-residential sector, the value of building permits edged up 0.6% to $2.7 billion. An increase in industrial construction intentions more than offset declines in both commercial and institutional permits.

Residential: Increase in multi-family dwelling permits

After two consecutive monthly declines, municipalities issued $1.5 billion worth of permits for multi-family housing in July, up 9.6% from June.

At the same time, single-family permits declined 1.4% to $2.2 billion. Ontario accounted for more than half of the decline, while Quebec posted a second consecutive monthly increase in single-family housing.

Municipalities approved 19,518 new residential dwellings in July, up 12.0%. This was due to a 24.4% increase in multi-family units. The number of single-family units approved declined 1.4% to 8,257.

Source: www.statscan.ca

Analysis:

The figures are skewed by building starts for condominiums in July. Real estate activity continued to increased but so did supply. Investors must continue to monitor the health of the commodities market (currently declining), unemployment levels, and the health of U.S. banks and U.S. real estate market.

How Real Estate Stocks Are Performing

Some of the Canadian real-estates stocks that have stabilized include Brookfield Properties, Riocan, and Rona. Although technical signals for these stocks are positive, there are risks in their fundamentals.

Brookfield properties has the potential to rally to $28. Careful, as it has heavy exposure to New York's commercial property market:

Riocan:

Rona's Rally quite a surprise:

Fannie Mae and Freddie Mac to be Worth Zero for Shareholders

I wrote on August 18th that these companies would not be worth anything for shareholders. As reported by Marketwatch: "The Treasury Department is expected to announce as early as this weekend a plan to bail out and recapitalize collapsing home mortgage giants Fannie Mae and Freddie Mac in one of the biggest government rescues in U.S. history."

Full Story here: http://www.marketwatch.com/news/story/treasury-set-bail-out-fannie/story.aspx?guid={46D1439E-A2C4-418C-9BE0-09BE0B9EE60D}&dist=msr_4

Fannie Mae and Freddie Mac own/guarantee ~ 50% of the $12 trillion in outstanding US home mortgage debt. This again will put even more pressure on US government debt levels. I wonder, then how it is possible for the US dollar to continue to rally. In essence this entry is a contrarian view to my call for a stronger dollar.

So, both stocks will have a stock value of zero, and preferred dividends will be slashed.

Read full blog analysis from Peter Cohen at http://www.bloggingstocks.com/2008/09/05/will-fannie-and-freddie-shareholders-be-wiped-out-this-weekend/

Have you ever heard of the expression, 'dead cat bounce?'

How to Profit from a Stronger US Dollar

The US Dollar's strength over the past two months has held strong. This is due to the market realizing that the US is not the only country facing slower growth. Worse is that Europe, India, and China are also facing even slower growth than that of the U.S. (from a growth deceleration perspective).


To profit from the inflow of foreign investors into the U.S., investors should be long on the US 20-year treasury bill. Boring yes, but profitable as well.
Chart Source: http://stockcharts.com/charts/gallery.html?$TLT

While the most recent rally might be at risk of pulling back, investors should consider entering TLT on a close above $96.

Note: Credit should be given to Iain Fraser for recommending TLT several months ago on DV tech talk.

Have Oil Prices Finally Popped?

The business section of newspapers will be littered with speculation that the oil bubble has popped, along with the commodities market in general. North of the border, the S&P/TSX Composite index fell 470 points, or 3%. Is that a whopping number?

The commodities market will be in a tug of war between speculation of a widespread slowdown in global growth, and a recovery in the U.S. markets. Since commodity prices will be affected largely by demand from China and India, one cannot exclude the U.S. accounts for a large level of demand from these very countries.

In short, economic figures for China and India are limited, and investors only have their stock market indices as an unreliable guide (both are down substantially for 2008).

Going back to energy prices, let's take a look at OIH:


Negative technical divergence occurred moving into March 2008. Upon sell-off, the stock rebounded from support levels at around $165 (marked L on the chart). The rally to new highs ended with another sell-off on stronger volume, a bearish sign.

Between July and August, support held strong. The stock is currently below the support price and has broken its upward support line. This does not provide conclusive evidence that the oil bubble has popped. Expect volatility as oil struggles to fight to the support line @ $185.

Think of fundamentals as well: world growth might be slowing but not so much that demand is being impacted. Solar energy is today's market darling, but there is not enough of it as an energy source to dent demand for oil. Finally, the auto market is just starting to develop more small, energy-efficient vehicles.

The downside for OIH (and oil) is 8.5% at best.