Are "Safe Haven" Investments As Secure As We Think?

For any risk-adverse investor, bonds have always been the way to go. In comparing risk among various investments, bonds have long sat at the far end of the spectrum as safe haven investments. Bonds are easy to understand and are best defined as a promise, a promise that the issuer will pay you back with market-determined interest come the bond's maturity date. The idea that a bond is at its essence, just a promise, is what makes bonds so easily mistaken as the securest of investments, especially during weak economic times.

Unlike being a securitized investor, bonds typically have no securitization if a company goes under. Because bonds are just a promise, the investor will have no access to all of the liquidated assets held by the bond issuer during bankruptcy. This is why bonds can disappear just as easily as a company's stock when an economy goes through a crisis like that of 2008.

As of June 30th 2009, there was approximately $13.5 trillion in outstanding U.S. corporate and treasury bond debt, with the outstanding debt split evenly between the two. This combined total amounts to nearly the entire United States annual GDP. The main concern I have with so much money being owed in the bond market is that most of these promises were made during the boom phase prior to 2008. This was a time when companies were more likely to make over-extending promises to pay back bond-holders years down the line. Considering that there were virtually no forecasts predicting the recent global downturn, I believe some companies may have put themselves into a tough financial position by loading on too much bond debt, not knowing what was to come. It is also important to note that between 2004 and mid-2007, bond prices had steadily decreased causing bond yields to rise. This occurred because of the gradually increasing federal funds rate following the artificially low interest rates during Alan Greenspan's tenure as chairman of the Federal Reserve. Ultimately, this now means higher interest to be paid on each dollar of bond debt come maturity.

With the future only looking increasingly bleak for the U.S. considering the massive government debt, I fear that some companies will be under much pressure to honour bond commitments in the medium-to-long term. This is especially true when you consider the current deflationary environment that has helped contribute to the stand-still in U.S. growth. Until banks can afford to lend as much as they once did prior to 2008, money supply growth will continue to be sluggish. As an investor, I would be weary of any corporate bonds for undiversified companies that have yet to expand to emerging markets and are still exposed to a potential double-dip recession in the United States.

As companies will aim to cut costs and free up capital, I predict that pensions will be the first to come under attack. With so much money tied up in pension funds, struggling corporations may look to the attractive amounts of capital tied up in pensions as a way to greatly reduce costs. This is especially true if the U.S. continues its plan to slowly adopt and incorporate International Financial Reporting Standards (IFRS) which set out more strict accounting principles for pensions and benefits.

Finally, when the government does make the ultimate decision to get their financial house in order and attack the deficit, I believe this will further weaken the private sector and put increasing pressure on organizations to honour their bonds. If the future is even remotely close to what I predict for the United States, the tough times ahead will begin to test how much a promise is really worth.

- The Watchdog

June 23, 2010 (1:45 EST): Earthquake Shakes Toronto, GTA and Ottawa Region

I'm sitting at my desk at work and our office just experienced a small earthquake/tremor. Just in case you were looking for confirmation, it wasn't just your imagination... My chair was moving back and forth, my screen began rocking, and my head became a little woozy. Apparently the tremor was felt as far as Ottawa. The details are just becoming known now. Stay tuned for more information as it becomes available. Leave a comment of your experience if you felt it too!

Update: the USGS has reported the quake came in at a magnitude of 5.5

Made in China: Why China Will Come Out on Top

Your iPod, your cell phone, your favourite cologne or perfume, your laptop, your coffee mug, your picture frame, most of your clothing... the list is virtually endless. This is just a small sample of the long list of items we purchase on a regular basis that are produced abroad. The most shocking aspect about this trend, however, is just how many goods we purchase that have been "Made in China".

The United States and Canada have long been regarded as consumer nations who rely heavily on the strength of consumerism to grow the economy. With the immense wealth that has been created here in North America through continued improvements in productivity and a capitalist system for corporations to thrive, it is no surprise that consumerism has flourished to this degree. All of this wealth came as a result of a once balanced economy that succeeded on both consumption and production. Today, however, we are not quite the industrial giants we once were. Consumerism has only continued to grow while manufacturing has been outsourced around the world with the onset of globalization.

One clear example of the retraction from manufacturing can be found in Detroit, Michigan. Detroit once thrived on domestic production and was the epitome of a great American city. Ever since production had been shipped out of Detroit, the local economy has greatly suffered. From my own recent visit, I can attest to the overwhelming poverty and the major transformation that has taken place over the past 40 or so years. While the degradation of the city is not solely the cause of globalization, it is surely a contributing factor that has helped cause Detroit's cyclical downturn.

The main issue with an economy overly reliant on consumerism is that it is absolutely unsustainable. In the past, our consumption patterns were naturally more domestic as the drivers of globalization had yet to exist. Today, though, we can buy products from all over the world. With today's highly integrated global economy, where we choose to buy from is also who we choose to support. By purchasing products from abroad, we allow other nations to compete for our business and ultimately profit from our consumption. The extent to which this happens depends greatly on the locality of the supply chain and the final retailer's country of origin.

For example, by buying clothing from The Gap we are largely supporting the U.S because the Gap (as the final retailer) profits the most from this transaction. But, if the producer of this clothing is located in India, we are also supporting the Indian economy but at a much lesser extent because they do no profit nearly as much as the retailer does. On the other hand, if we were to buy a car from Toyota, we are largely supporting the Japanese economy because both the retailer and the producer reside in Japan (most of the time) and this results in wealth being transferred from one country to another. As you can see, when these transactions happen billions of times, over and over, the wealth that has been created here in North America slowly disperses to the rest of the world. I am not opposed to this process, but I just aim to point out that this is all part of the global and free market cycle.

This natural cycle occurs because the lesser developed nations (who typically have a weaker currency) have the most competitive environment to manufacture and produce goods for the wealthier nations. As these countries continue to make gains from consumption by the wealthier nations, they experience a slow but steady growth. Through this process, economic conditions begin to improve for these countries and they eventually reach a point where their currencies increase in value. This then leads to the emergence of other foreign markets who use a relatively weaker dollar as a competitive advantage for increased manufacturing. As you can see, this is a cycle that makes complete sense. For North Americans, however, we do not want to give up the prosperity and privileged lifestyles we have become accustomed to. Ultimately, the only way to reverse the current trend is to have a relatively weaker dollar and introduce more pro-manufacturing policies. This is the only way to help balance out the current trade deficit in the U.S and slow down the dispersing of wealth that is currently taking place.

Why China?

So where does China play into this? Well, China is due to be the next major superpower if this cycle continues on. Of all the developing nations, China has been most successful in establishing an export-driven economy. They currently rank atop the list of most exports per country and this does not even incorporate Hong Kong or Taiwan who rank 11 and 17 respectively. The most recent numbers out of China show a near 50 percent increase in exports year-over-year for the month of May. Along with these impressive gains in exports, imports were also shown to have increased in May because of flourishing domestic demand.

With exports being one of the largest drivers of growth for China, its been in their best interest to keep the yuan pegged at a low valuation to keep international demand rampant. By keeping the currency pegged, China has come under much fire as the general consensus is that the yuan is very much undervalued. Under pressure from finance ministers worldwide, China's central bank has now decided it will unpeg the yuan and let the currency appreciate in value. With this new move, it is likely to have a modest effect on their robust export industry. At the same time though, this will increase the purchasing power for Chinese consumers to help guide China towards an economy less dependent on exports and more so driven by consumption.

Savings, Savings, Savings

China is also known to have one of the best savings rates in the world. With an economy that has been primarily driven by savings compared with credit, it amazes me to think about the potential for China when the use of credit becomes more commonplace. From my own research, I was shocked to find out that a majority of Chinese consumers have been making their first car purchases using cash! Comparatively, I cannot think of any more than a handful of my friends or family that actually use their savings for any major purchases, let alone a brand new car. Savings has always been known to be a key driver of future growth and prosperity which leads me to believe that China has a sound foundation from which to build a healthy economy that isn't as reliant on credit as their Western counterparts.

Communism Done Right (Please note, I am not a supporter of Communism)

What will truly be a difference maker going forward is the current neo-communist regime in China. The Chinese government has shown it has impressive foresight combined with a willingness to act in the best interest of the economy. One recent example is the move by the Chinese government to enforce banks to curb lending in what looked to be overheating in the housing market. By being able to learn from the mistakes made in the U.S., China has been swift to make radical adjustments to ensure their economy can avoid the treacherous burdens that bubbles can bring. By taking the role of watchdog versus the typical laissez-faire style practiced in the U.S., Chinese lawmakers are in great position to make decisive moves to help sustain a healthy economy that can better avoid the perils of boom/bust cycles. My belief is that China will slowly come to adopt a more Taiwanese-like capitalist system which will only further propel this nation into more prosperity, much like that experienced in the United States for the past 60 to 70 years. If the Chinese can successfully make this transition, I have no doubt that they will become the world's largest economy within the next decade.

Why China Still Has a Long Way to Come

In order to ever take the reigns as the top global superpower, there is still much work ahead for China. Currently as the world's largest economy, the United States has many unrivaled aspects that make it a difficult country to ever emulate. Even a nation like China has a long way to come before it can ever match up with the U.S. What makes the United States so great is the fact that it is a world leader in so many industries. While I do believe their industries have been able to grow with such resilience because of the U.S. system that feeds on debt, they nonetheless still stand far ahead of the competition. For example, when you look at the entertainment and sports industries, two of the most irreplicable, its easy to see that there are no worthy competitors anywhere else in the world. These industries have helped to drive global demand for American products because the world is constantly tuned into the latest trends and fads coming out of the U.S.

For China to ever be able to equate the U.S. on this front, it will take much time and continued lackluster growth in the United States. If the current situation of major unemployment, unprecedented debt, and weak economic growth continue on in the U.S., China may have a real opportunity to not only lead the world out of this recession but also find itself as the new world leader.

- The Watchdog

A Flock From Stocks: How to Gain in a Losing Streak

With the equity markets more volatile than ever, most investors are worried, cautious, and uncertain about what lies ahead. The DJIA moved down nearly 500 points over the month of May among unfavourable investor sentiment regarding the global economy. While there is much unpredictability about the future for equities, its simple to see that this extreme volatility is very much influenced by human psychology, strategy and utter emotion. No longer are these markets subject to industry fundamentals but rather, the pessimistic news coverage that is driving investors to flock from stocks and move to more stable investments like government bonds and gold. If you're looking to win in this market, it is crucial to play the strategy card above all else. At this point in time, traditional investment strategies leave you at risk of getting eaten alive.

To understand what is going on in the stock market, you need to understand that just like you and I, people want to make money and make up for their losses as quickly as possible. Keeping this in mind, dissecting and simplifying the market can help to make patterns more predictable. By reading into the implications of major news stories, a major driver of this market, it is possible to make smarter investment decisions ahead of the herd. By using common sense (oh how far typical investment strategies have come from this), it is much more simple to see where things are headed. With so much negative news around the world and very little light at the end of the tunnel (at least in the near term), it is crucial to make the best of opportunities as they arise. In this type of environment, you need to be an active trader and protect yourself from what potentially lies ahead. I have a few recommendations to help get your portfolio back in the black.

My first recommendation is don't buy long term! I truly believe this market has yet to bottom out because investors are standing along the sidelines and moving their money out of equities until things clear up. The stubborn long term investors have still yet to make their way out of this mess but when they do, prices will only fall further. If you see a good opportunity to buy based on favourable news or sell-short on a hunch, it is always best to clear all of your trades by the end of the day to hedge against the risk that tomorrow brings. Be humble and admit you don't know what's ahead because in reality, nobody really knows what will happen tomorrow (oil spill anyone?). The events we can't and don't predict are the ones that affect us most! In a precarious environment like this, it doesn't hurt to close your trades before 4:00.

My second recommendation is to be a strategist. Think like you aren't an investor and be unconventional. To be a successful strategist, you need to be aware of common trends and take advantage of them. For example, right now investors have been acting in a rather predictable way. As soon as the market seems to be gaining momentum, traders pare their losses by selling while the market is up. This is the primary reason why the last few hours of each trading day have been especially downward trending. By using good shorting strategies, you can come out on top after the indexes have peaked. Keep your eye on how people have been treating certain news and if you see a trend, play it to your advantage.

My last recommendation holds for both bull and bear markets... Don't be greedy! Considering most indexes are averaging losses each and every day, take whatever gains you make and run with them! If you're greedy and try to suck more gains out of your current trades, you can easily reverse any gains you may have made in only a matter of hours. Set a realistic percentage gain goal for your investments and as soon as you achieve your goal, sell sell sell. While you may only make a half a percentage here and there, this can quickly add up if you are an active trader. To be successful, you can't look back in hindsight and regret making trades too early. Be happy that you came out in the black and be thankful you didn't end up like the investors who were greedy and paid the price.

Investing Tips:

Avoid Stocks and Corporate Bonds: Going forward, I am bearish on investments in equities and corporate bonds. With the likelihood of a double-dip recession only rising, the stock market is a dangerous place for your investments. During this time, the best way to play equities is to short-sell. I am also skeptical that U.S firms will be able to continue to issue debt via bonds as I feel the principle and interest payments will become a major burden for these companies. With decreases in global demand and hindered productivity growth, meeting their bond obligations will be a growing issue among institutions. If you are still interested in corporate bonds though, look to multinationals who have growing stakes in China and other developing countries where consumption is likely to increase in the coming years.

Go Gold: Even with gold hitting new highs today, I think this is just the beginning of the gold rush. In the months ahead, the debt problem for major governments (particularly the U.S) will cause investors to seek refuge in what has always been the safest investment and best hedge against catastrophe. I predict that the United States debt concerns will begin to unravel in the coming months which will drive gold to new highs. As the U.S economic recovery continues on its rather stagnant growth path, the truth about the difficulties for budget reform will weigh heavily on investors minds. This will scare U.S bondholders (bonds being the current safe-haven) and this will ultimately cause investors to turn more and more to gold and/or other precious metals. Since the gold mining stocks and ETFs are still highly influenced by the overall stock market and its downward momentum, I would avoid such investments. Instead I would look into gold futures and bullion.

In the next 2 years, I can see gold reaching new highs of approximately $1,500 or more an ounce. If you are overweight enough in gold, I would look to achieve at least a 20-30% gain before selling. I believe the eventual rush to gold will very much depend on when the U.S debt crisis is fully realized and/or the U.S has to put in place major spending cuts or increased taxes. In the worst case scenario, if you have no issues with the potential for only 5-10% annual growth in your gold investments, I would highly recommend making this investment in the very near future. Note: waiting for a bad day in gold is a good strategy, its nerve-wrenching to buy after a plunge but considering the usual trends it will likely pay off.

Where do you think the market is headed? Are you a bull or a bear? Leave a comment and let me know what you think...

- The Watchdog

Horrifying Images From the Gulf

I just came across this post showing a few of the horrific images from the Gulf of Mexico. As I said in my earlier post, the full extent of the damage to the ecosystem and the environment will slowly emerge.

Note: These images are somewhat graphic.

What BP Doesn't Want You To See From Their Oil Spill

First Out of the Gate: Is the Adjustment by the Bank of Canada Justified?

In a bold move Tuesday, the Bank of Canada raised its overnight lending rate by a quarter percent to 0.5%. Canada becomes the first of the G7 nations to raise interest rates after the fallout of 2008. Even among the uncertainty of the European debt crisis, the BP oil spill, and the potential outbreak of war in the East, the BoC's Mark Carney firmly decided to raise the lending rate to banks across Canada. The recent move doesn't seem to make much sense considering the current economic scene but this is a time when it doesn't hurt to be safe rather than sorry.

The Canadian economy has done comparatively well amongst other developed nations worldwide and the first quarter results have Canada on track to grow GDP by 6.1% in 2010. Canada has greatly benefited from the gains made in the commodity markets and the boom in construction and infrastructure. Not to mention, the financial crisis was well contained in Canada as the Canadian banks showed strength with more conservative positions in consumer lending and derivatives trading. Considering all that has gone well for Canada so far, I find it not too surprising that the BoC has decided to (even modestly) raise rates.

While the rate hike is still very conservative, it is a good stepping stone for future increases if needed. With the current state of the economy, there is reasonable concern for the possibility of bubbles arising or the risk of inflation. As of right now, two issues should be of critical concern to the BoC: the housing market and the growing consumer debt load. As a resident of Ontario, I have seen both of these growing trends first hand.

Firstly, the housing market, especially in Toronto, has seen quite the boom. While there is no way to be certain, I question whether property value appreciation is legitimate or rather, based on speculation that there will continue to be an insatiable demand for homes and condos in Toronto. Aside from my nature to be critical, there does seem to be at least a few reasons why Toronto could be experiencing a partial real estate bubble. As it stands currently, real estate in Toronto is deemed to be overvalued by approximately 10-14% and the average value of a home in Toronto is now above $425,000. Note: this situation is even more intensified in Vancouver, BC. What's important about this figure is that while homes have been increasing in price, real income has been rather stagnant. If income cannot keep up with increased housing prices, affordability will drop off and this could ultimately stagnate the Toronto real estate market.

Along with the current rise in home prices, there is intense competition among condo developers to build condominiums on the corner of nearly every major block. Driving through Toronto, you can see the wide array of new condominiums currently being constructed, all looking to be complete within the same 2-year time span. With this ever increasing supply of housing space, I can't help but to think that supply will eventually outweigh demand, especially now that demand is likely to fall with the HST in effect starting July 1st and mortgage rates only coasting higher from here. Considering the above, I see two viable outcomes. 1) The condominium market will be high in demand and people will flock from their homes to downtown condominiums. This will cause housing prices to take much needed correction and go down to more realistic prices. 2) There may eventually be an oversupply of condos which could lead to a price correction in the condo market. Of the two scenarios, I am leaning more towards the second.

The other issue of great importance for the BoC is the growing consumer debt load. While right now it is not near the astronomical levels reached in the United States, it has still increased modestly for the past year. The problem with an overload of consumer debt is that it can quickly grow out of control and give a false sense of "growth" in the economy. This is why it is important that the BoC keep a close eye on the relevant statistics going forward to make sure interest rates are hiked if household debt continues to climb.

With the recent upward tick in the interest rate, the BoC stands in good position to deal with any overheating within the Canadian economy. I hope that going forward, the BoC makes the tough decisions to continue raising rates, even in lieu of the slowly recovering global economy. The time has never been better for Canada to become more economically independent and less exposed to the potential of another global recession. As a Canadian, I am proud of our results coming out of this recession. Even with our success though, it is critical to keep focused; for the most important economic decisions have yet to come.

- The Watchdog