Friday, September 13, 2013

Don’t Bet Against Boring Canada?

Frederic Tomesco and Theophilos Argitis of Bloomberg report, Don’t Bet Against Boring Canada, Caisse’s Lescure Says:
Investors betting against Canadian assets are poised to lose out because the country’s growth prospects mean the securities offer protection against potential crises, Caisse de Depot et Placement du Quebec’s chief investment officer said today.

“In a way, Canada is a bit boring,” Roland Lescure said at the Bloomberg Canadian fixed-income conference in New York.

“Shorting something that’s boring -- good luck. It can cost you a lot of money,” Lescure said, referring to the practice by investors of selling assets in hopes of buying it at a cheaper price in the future.

Canada’s dollar, stocks and bonds have lost some of their luster over the past couple of years, in part due to investor concern the nation’s housing market will correct and record household debt would slow the consumer spending that had been driving growth since the end of the recession.

Canada’s benchmark stock index is underperforming U.S. equities for a third year on expectations for better U.S. growth, while the Canadian dollar has fallen 5.5 percent over the past 12 months. The Bank of America Merrill Lynch Canada Broad Market Index underperformed the U.S. in 2012 for the first time in three years.

While Canadian bonds and stocks have fared better in recent months, futures traders are still betting on a decline in the Canadian dollar.
Dollar Shorts

Bets by hedge funds and other large speculators that the Canadian dollar will decline against its U.S. peer reached the most since June 14 last week, figures from the Washington-based Commodity Futures Trading Commission show. The difference in the number of wagers on a decline in the loonie compared with those on a gain -- net shorts -- was 34,639 on Sept. 3, compared with net shorts of 24,959 a week earlier, data Sept 6 showed.

“When you want to short something, you want those things to go up in flames,” Lescure said. “Canada is not going to explode in the air. In the next five to 10 years, it’s probably going to be growing steady as she goes.”

The Caisse oversees pensions for retirees in the French-speaking province of Quebec, with a dual mandate of maximizing returns and fostering economic growth in the province. It had net assets of C$185.9 billion ($180 billion) of assets as of June 30, ranking it second among Canadian pension managers after the Canada Pension Plan Investment Board.
Real Estate

Under Lescure and Chief Executive Officer Michael Sabia, the Caisse is increasing investments in assets such as real estate, infrastructure and private equity to reduce volatility in returns. The Caisse plans to add C$10 billion to C$12 billion in what it calls “less liquid” investments in the next two years, Sabia said in January.

Publicly traded equities were the Caisse’s biggest asset class as of the end of 2012, accounting for about 37 percent of assets. Fixed income, with just under 37 percent, ranked second. More than 57 percent of the Caisse’s total assets were held in Canada, compared with 20 percent in the U.S.

“The U.S. is more volatile, with a lot of opportunities,” Lescure said. “We like to invest in the U.S. and are doing it more and more. But there’s more risk.”

Even as it invests more abroad, the Caisse will continue to hold a significant portion of assets at home because its liabilities are denominated in Canadian dollars, Lescure said.

The Canadian dollar’s recent decline against its U.S. counterpart in the last year means that the currency is “now better aligned with fundamentals,” he said.
Global Leaders

To make up for an expected drop in fixed-income returns, Lescure said the Caisse has been buying shorter-duration bonds, provincial debt and “some corporates, well chosen.” In addition, he said, the fund manager has added “some equities that look a bit like fixed income.”

In January, the Caisse began building a fund to buy stakes in companies such as Nestle SA (NESN) and HJ Heinz Co. that it considers global leaders. Lescure said the fund, which had assets of about C$9.5 billion as of June 30, targets companies that are “very visible, safe, with strong visibility of cash flows.”

Apple Inc. (AAPL), while a “great company,” is probably too volatile for the Caisse, Lescure said.

“In a way, we are more Coke than Apple at the Caisse,” Lescure said, referring to Coca-Cola Co. (KO), which “sells about 25 billion bottles of Coke every year. In five years, they might be selling 26 or 24. It’s not going to be a roller coaster.”

The Caisse would consider investing in BlackBerry Ltd. (BB) if the smartphone maker were to go private, Lescure also said, echoing comments made last month by Sabia.

“We are open to any opportunity for sure,” Lescure said when asked about BlackBerry. “We are trying to avoid rumors, but most importantly I think we are doing our homework. We are doing research, we are trying to understand companies whether it’s BlackBerry or another one, and then when we decide to act you guys usually hear about it.”
I met Roland Lescure last year and came away very impressed. He's extremely sharp and well read on financial and political matters. He's also very nice and down to earth.

So is Roland right about not shorting boring Canada? The Canadian stock market is underperforming its U.S. counterpart for a third straight year on better U.S. growth expectations. But it's also worth noting the resource heavy TSX is now a lot more correlated to China than the U.S. market. If the recovery in China's economy gains momentum, it will be favorable for Canadian equities.

But while resource stocks are weighing on the overall index, Canadian banks are hitting new highs. Earlier this week, had a chat with Jim Keohane, President and CEO of the Healthcare of Ontario Pension Plan, and we talked about Canadian banks and the interest rate environment. Jim told me short covering by hedge funds likely contributed to the recent upswing in Canadian banks but in general, they are "flush with cash and in great shape."

Jim also told me that HOOPP's returns in 2013 will not be as impressive as last year but the rise in rates has bolstered their funded status even more (they are already fully funded). He told me he thought the recent backup in yields was "a bit overdone" but as long as rates rise, their liabilities will decline. "The duration of our liabilities is higher than that of our assets so as rates rise, our liabilities fall more than our assets."

As far as Canada's real estate market, we talked about how risk from any downturn in real estate is being passed off from the banks to the CMHC. This is why I never thought shorting Canadian banks was the way to play the downturn in real estate. Instead, I always recommended shorting the loonie and think it has room to fall further.

I've been bearish on Canadian real estate for the longest time -- and been dead wrong! Canadian home prices are at record highs as the real estate market rebounds, climbing 2.3 per cent in August from a year earlier, but economists see no bubble:
National Bank economist Marc Pinsonneault sought to put this in perspective, suggesting there’s no bubble here despite that view held among some observers.

“Even if it exceeds CPI inflation … home price inflation in Canada remains subdued in August, especially if it is compared to the 12-per-cent rate registered by the U.S. Case-Shiller index,” he said.

“Note that the latest monthly rise is lower than the average change in the month of August in the last 12 years,” he said, adding in his research note that the August readings are not “indicative of an overheating market.”

Separately, Statistics Canada reported today that prices for new homes rose 0.2 per cent in July from June, and by 1.9 per cent from a year earlier.

Calgary led that charge, with an annual gain of 5.8 per cent, the fastest pace since December, 2007.

While August’s annual pace may seem fast, Derek Holt and Dov Zigler of Bank of Nova Scotia note that it has been easing since the 12-per-cent rates of mid-2010.

“No wonder Statistics Canada reported yesterday that a quarter of all mortgage borrowers are paying more than 30 per cent of income in housing affordability costs as housing affordability measured by actual – not artificially constructed – payments remains under elevated pressure,” they said.

"For that reason, we believe that the Canadian housing market will do better than what many observers, including The Economist, expect."
But while most economists don't see a bubble in Canadian real estate, I agree with Brian Romanchuk who recently explained why the Canadian economy has not blown up yet:
In my previous article, I argued that the Canadian economy is doomed as a result of its housing bubble. My argument is not based on house prices and only indirectly on excessive household debt levels; the mechanism for the slowdown will be the restructuring of the labour market. Too many people are working in Construction, and there is no mechanism in sight for them to transition to another other work, absent a long, painful recession (as seen in the United States, where the exact same process is still underway). But the question arises – why has this not happened already?

My argument is that there are two equilibria for the Canadian economy – one where there is self-reinforcing effects that cause stronger growth, and the other where the negative effects will cause a downward spiral, at least until the automatic stabilisers kick in*. (Many heterodox economists dislike the use of the term “equilibrium”; I am using it here as it is used in mathematics: a steady state condition.) Canadian economic growth is currently mediocre, but the growth-reinforcing equilibrium is still in evidence.

One way of seeing why the housing bubble poses more risk than might be supposed is the fact that housing represents a very different type of economic good than other goods and services. The problems associated with reallocating production between different types of output do not appear in single consumer good models that are the backbone of mainstream economic modelling.
I will leave it up to you to carefully read the entire comment. Until recently, Brian was a senior quantitative analyst at the Caisse's fixed income group. He is one of the sharpest and nicest guys I've ever worked with. Institutional investors are very lucky he's now writing a blog, Bond Economics, sharing his insights for free (Note: Brian is available for consulting mandates and can be reached through his blog).

Below, Roland Lescure, chief investment officer at Caisse de dépôt et placement du Québec, talks about global financial markets, Canadian bonds and investment strategy. He speaks with Theophilos Argitis at the Bloomberg Link Canadian Fixed Income Conference in New York. Great interview, well worth watching.