October 12, 2011 Market Update
Attached
you will find Empire’s report on their fund performance to the end of
September. Once again we see very clearly that only the bond and
money market and income funds are showing positive numbers in the year to
date, six month and three month columns and in fact the income fund has turned
negative for the past 30 days. Remember that the income fund is holding
dividend paying stocks so the income generated by the dividends is no longer
enough to off-set the decline in the stock prices.
The larger
question In most minds is where is the market heading going forward. The
past few days we could read that the Europeans are working desperately to
address the potential Greek default. The Europeans really have a big problem
because they have a single currency but they do not have a single
government. So the European Central Bank, (ECB) does what it can but is
severely limited because it does not have real legislative power. Then we
also have the new European Financial Stability Fund (EFSF) which will be
replaced in 2013 by the European Stability Mechanism (ESM). Both of these will
function as a liquidity manager. As near as I can determine, these funds are
set up so that they can issue Euro Bonds and exchange these bonds for debt that
banks have on their balance sheets as assets but they may have less value than
required. That’s even reads convoluted. . So let’s try to explain.
Bank “A” in France buys a bond from Greece. They pay 95 dollars for a 100
dollar bond times millions of course. But the Greek government likely
cannot pay the bond back. Or at least they can only afford to pay a percentage
of the bond back. So the bond is worth maybe 80 cents on the dollar or
maybe only 50 cents on the dollar. So the bank will need to show this
bond on its balance sheet as an asset that’s 50% less than it paid for it.
That sure sounds like a capital loss to me and that type of write down would
quickly show that the bank was bankrupt. So, the EFSF will but the Greek
bond from the bank and in its place will issue a Euro bond. The Euro Bond will
show up on the bank balance sheet at full value and this way the bank can
continue. But, Now this worthless bond is in the EFSF. And the EFSF is
backed by the European Common Market. And Greece is a member there.
So , it would appear that Greece is buying back its own bad debt with new paper
that it issues under the EFSF. Looks like a Ponzi scheme to me. We
send people to jail for that in the real world. But, who am I and what do
I really know about big world stage finance. All I know for sure is that
in Canada, our Prime Minister is a highly respected economist and his
government is so concerned about the fragility of the economy in Canada and the
world that he is prepared to legislate Air Canada flight attendants back to
work because of that fragility.
I also
included the TSX chart for the previous 12 months. If you draw a line from the
low in April to the low in October and then draw a parallel line from the high
in July through the high in September, then you will see that the TSX is
trading in a range that is sloping down at quite a steep rate of decline.
This channel is similar to the channel we saw initially in 2008.
And you all know what happened after that.
So, this
little bounce up in the markets is very temporary in my opinion. We might
see a further bounce up in the S&P to 1230 and in the TSX to 12,200 or
12,250, but that should bring us to the next downdraft. So if you did not
get out of equities in April or July, then you have an opportunity now again.
But this will likely only last for a few more days. Of course we could
see the markets move sideways for a longer period of time then that, but I
believe that the next major drop is just around the corner.
If you
believe that inflation is also around the corner, then you want to move to a
money market fund. I personally believe that we are in for a few years of
deflation so a Canadian Bond Fund is my recommendation.
Also, keep
in mind that what happens in the world and in the stock market is still
separate from what happens here locally in our economy. We leave in a
part of the country that has two very great advantages. We are surrounded
by agriculture and we are very near the oil sands. Both food and energy will
remain a necessity. As long as people have the money to pay…