Canada: The First Nation of Hockey and Capitalism?


Position:  We currently have no position in Canada, though have a bullish bias


We have been consistently bullish of Canada for the last six months.  A primary reason actually jumped out at me while watching "X-Men Beginnings: Wolverine" in a theatre earlier this week.  (I think I appreciated the movie more than my girlfriend did.)  The protagonist, Wolverine, is serving in the U.S. Army in a special platoon and while on a mission in Africa decides to desert.  He is confronted by the leader of the platoon who insists that he is serving his country and has taken an oath to do so. Wolverine responds simply, "It doesn't matter, I'm Canadian anyway." In the context of the global investment marketplace, the reason to invest in Canada may be as simple as that, Canada is not the United States (no offense to our American friends!).


While the United States is Canada's largest trading partner, ie Canada will always be dependent on the U.S. economy, Canada is also one of the most resource rich nations in the world.  Specifically, based on conventional and non-conventional oil reserves Canada ranks 2nd in the world only to Saudi Arabia.  In effect, Canada has what China, "The Client", needs.  Further, Canada has a solvent and functioning banking system.  The Canadians did not let their underwriting standards slide like the Americans did throughout the 2000s, so the credit system is fully functioning north of the border.


More importantly, Canada plays into our theme of socialism versus capitalism, which is the idea that you want to be long of those countries that are moving towards capitalism and short of those countries that are moving towards socialism.  With Conservative Stephen Harper at the helm, the Canada government, despite their socialist roots and tendencies, has been shifting more and more to the economic right.  This is, of course, in stark contrast to the United States and its first few months under the tenure of President Obama (and to be fair the last few years under President Bush).


A few points to consider in regards to Canada becoming an appealing nation from an investment perspective are outline below.  We've borrowed some of these from a report put together by the Cato Institute and while these facts compare Canada to the United States, the point more broadly is the direction in which Canada is moving from a fiscal policy perspective.  These points are as follows:


  • Government spending - Canadian government spending as a percentage of GDP peaked at 51% in 1990 and has been steadily declining every since. In 2008, Canadian government spending as a percentage of GDP was 40% versus the United States at 39%. For the first time in modern economic history, the United States government is poised to spend more money as a percentage of GDP in 2009 due to the massive stimulus plan that the American Congress has passed.


  • Federal public debt - The Canadians have been steadily bringing down their federal public debt as a percentage of GDP since 1995 when it was at 71%. By the end of 2008, this number was at 32%. In 2008, the U.S.'s ratio of federal public debt as a percentage of GDP was 40% and expected to rise to 61%.


  • Balanced budget - Canada has balanced it's budget every year since 1998, and in fact generated a surplus. The American government has run a deficit for that entire period and a time when the Americans will be able to balance their budget again is far, far into the future.


  • Social security - Both the Americans and Canadians spend roughly the same on social security, approximately 4.4% of GDP. The Canadians, though, have a plan that is solvent and full funded, while the Americans have massive unfunded obligations.


  • Taxes - On the tax front, Canada is and has been lowering taxes, primarily because they have the ability to do so. In 2010, it is expected that the U.S.'s highest personal income taxes rate will be increased to 46%, which is on par with Canada, while Canada has a lower capital gains tax rate. On the corporate front, Canada's tax rate is 15% on the federal level and has been trimmed on the provincial level, which, in aggregate, make Canadian corporate rates lower than the United State's standard 40% rate (a rate that is predicted to go up next year).


Canada has rightfully and always been known as the world's superpower of hockey, but the time seems near when Canada will also be held on a podium for their fiscal prudence and free market policies, especially in contrast to the trend that its southern neighbor is on.


Daryl G. Jones
Managing Director


Canada: The First Nation of Hockey and Capitalism? - canada

A Whole Lot of Nothing

I'm not sure if it's because WMT is no longer reporting monthly same store sales are there are fewer companies reporting across the board, but May results feel like a very small part of the bigger picture at this moment (because they actually are!).  Yes, the majority of companies missed estimates but at the same time the actual results were also generally in line with company guidance. Expectations were a little higher as the trend last month got baked in and the trajectory of recovery appeared to be gaining momentum.  At the very least, May results remind us that volatility can and still exists with consumer on a weekly and monthly basis. 


Check out the two charts below showing sales trends in mall-based vs. specialty apparel and in department stores. The 1 and 2-year comps have been all over the place, but the 3-year (which mitigates issues like weather, stimulus checks, tax rebate timing, etc...) has hardly budged at (-3%) to (-5%).

A Whole Lot of Nothing - Apparel Mall Specialty May Chart


A Whole Lot of Nothing - Department Stores May 2009 


Perhaps the term "stabilization" was used a few too many times over 1Q earnings season.  The trend does remain stable but shorter term upticks and downticks will continue.  The facts is, May is the smallest month of the quarter, inventories remain clean across the sector, and everyone knows comparisons are getting increasingly difficult as we lap stimulus checks. 


In looking at the standouts, of which there are few, there is nothing overly surprising.  Those companies with momentum still have it.  TJX, ROST (the only company to cite weather as a positive), ARO, and KSS are the outliers to the upside.  Not so surprising again in that all of these companies are price-driven, value retailers.


In trying to discern product or regional trends, anecdotes were mixed across the board.  Consumable categories appeared to outperform while home related goods were mixed.  On the apparel side, dresses are still the hot category and footwear remains a positive call out.  The Southwest region was most often cited as being an outperformer while the Southwest was the weakest.  Overall, it sounds like the pricing environment remains unchanged (i.e. no uptick in promotional activity or heavy discounting) and traffic was a just a bit weaker than anticipated.


So the question is, what has changed now that May sales have been released?  Nothing.


Eric Levine


Understanding Why

"Because things are the way they are, things will not stay the way they are."
  -Bertolt Brecht
Arbitrarily we titled two posts yesterday "In search of...."  I know I'm in search of why the S&P is levitating at 931.  Don't get me wrong I'm happy the S&P is at 931, I just want to understand why.
Yesterday, there was some bearish manufacturing numbers and a warning from Federal Reserve Chairman Ben Bernanke that U.S. deficit spending is contributing to higher long-term interest rates.
On top of that the there are also similar indications from senior officials in Germany and Australia that interest rates are going higher!  Guess what, interest rates can only go one way - UP!  
And the reality is they are! Interest rates on 30-year fixed-rate mortgages averaged 5.25% this week, up from 4.81% last week.  The biggest sequential jump since October!  As mortgage rates rise, this leads to a decline in mortgage applications, which suggests the good news on housing has peaked too.
On top of that you can only conclude that there are a number of factors that are likely to continue to weigh on consumer spending; a weak labor market, a decline in consumer assets, increased savings rates and tight credit.  All of this should cast a bearish cloud over stocks, yet it has not.  
On this news, the S&P 500 was ONLY down 1.3% yesterday.   Amazing resilience to unsettling trends!
I can't find a company that is going to tell me that they are going to provide guidance to the investment community that will include positive trends for the balance of 2009; and when I ask them about 2010 they just laugh.  How many times have you heard there is no visibility into our current trends!   
As I sit here this morning the futures are looking higher, despite the fact that most retailers will communicate a mixed bag of May sales trends.  As we look at the numbers today we will be "in search of" signs of a second-half economic recovery.  Clearly things are less volatile and bottoming, but it's still not "good."  I guess I'm jaded because I spend every waking moment talking to consumer centric companies that continue to express to me the reality that things are not really getting better for the consumer.    
Coming into Friday's jobs report, we have zero exposure to US equities.  As we said yesterday, Friday's employment report should be less constructive than the last two - which were bullish catalysts for us as we looked for signals that the rate of job losses was compressing.  Now our thesis has become consensus- as is optimism.
Anything less than a relatively strong payroll number can give the bulls something to think about, but who is bullish?  

The Early Look is brief today, because I'm in "search of" good news and I can't find it. If I do find any you'll be the first to know!
Function in disaster; finish in style
Howard Penney
Managing Director

CAF - Morgan Stanley China Fund- A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package.  To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.

TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

GLD - SPDR GOLD -We bought more gold on 5/5. The inflation protection is what we're long here looking ahead 6-9 months. In the intermediate term, we like the safety trade too.

XLU - SPDR Utilities - As long term bond yields breakout to the upside, Utility investments are the relative yield loser. Utilities underperformed the market yesterday, closing down 1.7%.

EWW - iShares Mexico- We're short Mexico due in part to the repercussions of the media's manic Swine flu fear.  The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.

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If you have read our work for a while you probably know that we have a pronounced bullish bias towards Australia. With significant geographical hurdles and commodity export dependence to deal with, the land down under has consistently shown resilience through the level headed policy of central bankers there through the good times and swift government stimulus actions during the bad.


Today's GDP release for Q1, 0.4%, looks positively robust in the current global environment as order flow from "the client" and government spending have kept unemployment relatively stable, combined with stimulus checks, which have encouraged consumer spending to stabilize.


The numbers also reveals some real pain however, with private investment declining by 1.6% and imports off by over 10% the expectation that the positive overall trend can continue hinges in large part on recovery in the sectors not directly linked to energy, agricultural and industrial commodities to provide confirmation.  While plenty of worrying factors remain (the financial sector continues to be a concern for us with the recent increase in bad loan provisions by major financials, and commercial real estate remains a minefield) the improving housing market and a comparatively robust equity syndicate calendar seem to bode well for the broad equity market.


We continue to like Australia and will be looking to go long the equity market there via the EWA ETF if presented with a favorable entry point. As always our trading will be informed by price action as well as fundamentals.


All props to Mr. Seamus Quick, our man in Sydney.


Andrew Barber






Lately everyone has been sharing their thoughts on the yield curve with me.  Unsolicited.  PMs, academics, floor traders  -even some of my nefarious journalist contacts.


The general breakdown of these opinions seems to suggest that the more sophisticated your understanding of finance or impressive your credentials, the more likely you are to arrive at a thesis (with complex academic underpinnings naturally) that could support a sustained period at a range close to present levels. Mere mortals tend to expect the curve to moderate sooner and faster, and tend to expect absolute yield to rise more significantly. 


As Keith noted in his morning note today, the Treasury Department sponsored limbo contest on the short end of the curve has literally left depositors bending over backwards to help  fatten margins for lending institutions with the spread between the 2 year and the 10 year above 270 basis points the curve is at its steepest point in living memory.  I drew the chart below to illustrate the current spread in context. The outlying points since 1976 focused on are the spikes in 1992 and 2003 as the flow of cheap money that Chairman Greenspan let loose to combat recession drove spreads north of 250 basis points; while the monster backwardation in early 1980 marks the height of Paul Volcker's assault on double digit inflation.


The obvious initial conclusion that anyone would draw from this picture visually is that mean reversion should have a moderating impact on the slope of the curve. Additionally, any casual observer could reasonably surmise that with nowhere for short term yields to go but up and with the debt to GDP ratio of the US balance sheet continuing to balloon, the fundamental catalyst for this reversion is both clear and present.  The spread between short term treasuries and the target rate has diverged for sustained periods in the past (as well as jumping wildly in the volatile 1982-83 market) so indications from the Fed that rate policy will not change in the near term do not negate these presumptions.


As always, the moment of confirmation for the peak will arrive well after it has passed.  Until then you can continue to feel free to share your view with me.


Andrew Barber



IN SEARCH OF A TOP - spreads


Is the hotel fee business the greatest thing since sliced bread?  It may appear to be in the middle of a strong cycle.  However, when times are tough (now) or even in a recovery period, the fee business doesn't look as invincible. 


Let's take a look at Starwood since Marriott generates significantly more franchise fees as a percent of total.  As shown in the following chart, 51% of Starwood's fee revenue came from base management and some franchisee fees, 20% from incentive fees, 18% from Bliss & "Miscellaneous", and 11% came from amortization of deferred gains on asset sales and termination fees in 2008.  The base management and franchisee fee are high quality revenues that deserve a high multiple, but what about the rest?  Incentive fees will be lower in 2009 and again in 2010 and will take a very long time to recover.  The Spa business is highly cyclical could be permanently impaired in the economic reality.  We're not sure how to value "miscellaneous" but "amortization of gains" deserves close to a zero multiple since it is non-cash and proceeds have already been received.




In the next chart we attempt to break down fee revenue between same store (organic) and non-organic growth.  Same store growth includes contribution from new management contracts except those obtained through asset sales encumbered with management contracts.  We estimate it took 6 years for HOT to regain the prior peak level of core fee revenue generated in 2000.  Obviously, new management contracts this time around could expedite the recovery but beyond 2010 there are some serious hurdles to growth.




While limited new supply is good for hotel owners, the challenging financing environment will make it difficult to grow the hotel fee business.  Non-recourse financing, which the vast majority of hotel owners have used, is a thing of the past.  Most investors will think twice about constructing a hotel if their personal assets are on the hook.  For existing assets, banks are simply looking to reduce exposure. When loans come due or if any technical breach occurs, banks are using it as an opportunity to call part of the loan, regardless of the rate opportunity.  We have seen this on the institutional side, with almost every amendment coming with a mandatory reduction in credit facility size.

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