Monday, August 31, 2009

Today’s heroes – Yesterday’s villains.

Last week Royal Bank reported record high earnings. In the twilight of Canada’s recession, Canada’s biggest, bluest bank surprised us all. Other banks experienced healthy profits too. Bank analysts and the financial press reported that the Canadian economy and the real estate/mortgage sector had not been as bad as they had been predicting – and this was why the banks reported such strong quarterly earnings. This, plus one other factor: trading revenues from investment banking and capital markets divisions.

Apparently 21% of Royal Bank’s record high earnings came from traders. And we all know that traders are paid salary + bonus. And, because those trading profits were so high, we can guess that those employees’ bonuses will be really high too.

Wasn’t it just seven short months ago that new president Barrack Obama expressed outrage at the bonuses being paid by the US banks he was bailing out? Even though the traders and managers had made money for the failing banks and had done their jobs, they didn’t deserve their bonuses. For those American banks late last year, the economy was weak and the real estate/mortgage sector was collapsing. Times were so bad that US banks were failing despite the traders’ having done their jobs. The traders’ bonuses were reduced because the mortgage department lost so much money.

We wonder how that problem was eventually resolved. Did the American banks’ traders get paid less? Or did they simply have those bonuses postponed until the banks became profitable again? Or did they quit their jobs in New York and join the Canadian banks in Toronto?

How the rules change in the investment business. What works one year may not work the next. It appears that rule-changing can also apply to people’s paycheques. Traders who had earned their bonuses in US banks in 2008 were financial villains who did not deserve to get paid. But Canadian traders in 2009 are financial heroes, helping propel Canadian banks back to blue chip status. Either way, their fate seems to have been determined by the mortgage department, not the trading department. Because Canadian banks’ mortgage departments were profitable, Canadian traders will have no trouble collecting their 2009 bonuses. Because American banks’ mortgage departments were a disaster in 2008, their traders were criticised for their ‘undeserved’ bonuses. This time around, American investment bankers and capital markets traders were somehow dependent on the bank’s mortgage portfolio for their bonuses.

How about your personal investment bank – or your personal capital market: do your advisors deserve a bonus? Most mutual funds investors pay management expenses of over 2% of the value of their investments. When your investments go down in value, you pay them 2% of that lower value. If your investments are down 30%, your mutual funds manager receives 30% less management fee. In a strange way, it almost seems fair; but it doesn’t feel fair. In fact, it feels outright unfair.

In the world of finance, feelings count. When the banks were being bailed out by the government, it didn’t feel right that bank employees would receive big bonuses, no matter how good a job they did. Now that the Royal Bank has proven to the world that Canadian banks are high quality blue chip banks, there is no problem paying those big bonuses.

In my book, Beyond the Bull: Taking Stock Market Wisdom to the Next Level, I discuss how our feelings affect our investments. In seven short months, banks have gone from presidential rebuff to examples of blue chip stability. And in those same seven months, Royal Bank stock went from under $30 per share to over $55. Your feelings count.

Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc.

Links to Beyond the Bull:




Monday, August 17, 2009

Casino Bus Riders

The Blue Chip Bus

I was driving to work today with Sheldon Liberman, portfolio manager for the investment firm CastleMoore Inc. We were on the highway being passed by a bus heading for Casino Niagara. Chinese letters and two-foot poker chips were painted on the side of the bus. We were quipping about the phenomenon of gambling in our culture and wondering about the minds and hearts of the enthusiastic passengers on that bus. And this was all happening before nine a.m!

Based on the fact that there were so many blue poker chips painted on the bus, I joked that the passengers were probably all financial planners and mutual funds salesmen.

Shel shot back with the following conundrum: has the expression “blue chip” lost its meaning? Blue chip used to refer to higher quality safer investments. But in 2008 the biggest insurance company in the world [AIG], the biggest bank [Citibank], the biggest stock broker [Merrill Lynch] and the biggest mortgage company [“Fanny Mae”] all needed to be bailed out. And in 2009 General Motors, formerly the world’s biggest auto company went into bankruptcy. It seems that blue chip stocks have become the area of highest risk in the stock market.

Maybe my guess that the casino bus was full of financial planners was closer to the mark than I first thought. Mutual funds salesmen are trained to sell the products of the biggest mutual funds in the industry. Somehow they have been trained to believe that huge mutual funds companies are safer than the smaller companies. Somehow big blue chip is touted as being better for their clients than small, efficient, entrepreneurial. Maybe that’s the problem with Canadian investors’ RRSPs: we are too heavily exposed to the blue chip sectors of the stock market and the mutual funds industry. Canada’s financial planners just keep betting on the favourites and losing.

In my book, Beyond the Bull, I observe that stock market rules change from time to time. And if we plan to accumulate a lot of capital for our retirement, we’d better take these rule changes into account. Right now it is clear that Sheldon is right: the meaning of the phrase blue chip has changed. Somehow “blue chip” has come to mean “dysfunctional” and “high risk.” Yet somehow the financial planning/ mutual funds community has not yet picked up on it.

Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc

The Amazon links for Beyond the Bull are:


Thursday, August 13, 2009

Mutual funds - is the honeymoon over?

Too much of a good thing: The AIC buy-out.

Consider the recent marriage of Manulife Financial and AIC.

AIC’s founder, Mike Lee-Chin, is an inspiration to ambitious young finance students everywhere. The rags-to-riches story of the Jamaican immigrant who became a billionaire inspired me too. I knew Mr. Lee-Chin when he was merely a millionaire; he was the manager of Regal Capital Planners Hamilton office and I was the manager of Merrill Lynch Canada’s Hamilton office. He had a passing interest in my specialty which was technical analysis of the stock market. I had more than a passing interest in Canada’s top mutual funds salesman, rumoured to be earning a million dollars a year in commission!

In 1983 I moved to Toronto to search for opportunity in the financial capital of Canada. Mike stayed in Hamilton and proved that there was plenty of opportunity there too.

Apart from the human interest angle, will the Manulife-AIC wedding have any impact on the Canadian investment scene?

In my recently released investment book, Beyond the Bull, I talk about the three great drivers of the stock market: investor brains, investor heart and investor position. Brains is the easiest to understand: investors are motivated to buy and sell because of rational logical facts and figures about stocks and companies. Heart is easy to understand too: when investors are fearful or worried, they often sell stocks at too low prices – when they are full of confidence they sometimes pay too much for stocks. It’s the last one, investor position, that poses a potential problem to the Manulife-AIC newly weds.

AIC mutual funds’ core holdings include TD Canada Trust, AGF Management, CI Financial and IGM Financial. A quick check of Manulife’s website showed me that they too love the financial sector: about one third of their largest mutual funds are invested in this one sector alone. But, can a mutual fund own too much of a good thing? At one time it was rumoured that AIC had 10% of their total assets in one stock: TD Canada Trust. Portfolio managers refer to this as ‘concentration.’ Critics would say ‘over concentration.’ That’s an investor position problem.

If this mutual funds company wedding results in Manulife having too many of their collective eggs in one basket, they will be selling some of AIC’s TD, AGF, CI Financial and IGM stock. And the reason for the selling has nothing to do with the growth and value of these four companies. Nor does it have anything to do with Manulife’s portfolio manager’s emotional liking or disliking these four companies. The problem is their position: they own too much of a good thing.

Part 1 of the problem
Manulife may have to sell significant amounts of financial stocks because of this merger. This selling could dampen the performance of that sector over the next few months.

Part 2 of the problem
Use your imagination: if you were managing a big mutual fund or pension fund and you saw this AIC-Manulife wedding, what would you do? What if you had been planning to sell of some of your financial stocks over the next few months? Would you wait until the Manulife selling starts, or would you sell now? Of course, you would sell now. This selling could also dampen the performance of the financial stocks for a while.

Using position analysis, we might expect the financial sector, specifically TD Canada Trust, AGF Financial, CI Financial and IGM Financial to under perform the market until Manulife’s possibly over weigh position is liquidated.

Part Three.
What about the brains and the heart? Are there logical or emotional reasons why bank stocks and mutual funds management stocks might under perform? Wasn’t it only last year that the biggest banks in the USA and Europe were being bailed out? And isn’t the mutual funds industry in consolidation? AIC shrunk from $14 billion to $3.8 billion: it seems unlikely that AGF, CI or IGM would be thriving in times like these.

Part Four: it gets worse
Speculation has it that Mr. Lee-Chin received a dowry of around $150 million in Manulife Financial stock in exchange for his beloved AIC. Talk about an over concentration! Is it reasonable to assume that he might like to sell some shares of Manulife? Could his selling contribute to the under performance of Manulife stock?

Manulife management knows all about their position problems and will act prudently, so as to protect their shareholders and unit holders. They will have made plans for this wedding months ago. My company, CastleMoore Inc, manages investors’ portfolios too. We have no plans to buy financial stocks until the honeymoon ends.

Ken Norquay, CMT
Chief Market Strategist,
CastleMoore Inc

Links to Beyond the Bull: