The Big Picture...  November 27, 2009... In a shortened week, it was expected to be relatively quiet.  Much of the focus will be on the retail activity going on in the US as Black Friday is shopping paradise apparently.  Initial reports from Best Buy are encouraging, but that is one of many yet to report.  Dubai World waited until the markets were closed for US Thanksgiving to announce their woes (more on that below) but the fear appears to have passed.  I know I frustrate a few people by saying this, but do not take your advice from the media! 

The Rest of the Story...

Dubai World (DW) was, I am sure, unheard of to most prior to this week and garnered a great deal of publicity with its comments that it may need a six month delay in some payments on its debt.  DW is a holding company for the government of Dubai, it is the holdco not the government that is approaching technical default.  Basically, DW's mandate is to build a growth engine for Dubai in variety of industries including tourism, shipbuilding, property development and financial services.  A quick look at their projects will show an ambitious and grandiose intentions.  Keep in mind that many people (the media) tend to approach debt in the wrong way.  If you do an improvement to an office for instance, typically you can amortize the cost over five years.  If you are building a country and its infrastructure, amortizing it over a longer period is appropriate and the debt is not meant to be repaid quickly.  More importantly, this is not likely going to create a large disruption in global credit markets, but it is the fear (again!) that is going to be the determining factor.  Most of the exposure appears to be in Middle East and European banks, and the only Canadian bank that can reveal its exposure right now is BMO (as it has already released results, other banks are in a quiet period) and BMO has said that they do not have any DW exposure.  We have said for some time that defaults will rise through the greatest credit crisis in 65 years, so seeing more defaults should not be surprising. This does not appear to be the beginning of another credit avalanche.

The National Association of Realtors (in the US)said Monday that home resales increased by 10.1% to a 6.10 million annual rate from 5.54 million in September.  Expectations were for a 2.3% increase in sales during October.  The numbers were better than expected and there are calls now that the US housing market has turned the corner.  A surge in new home sales for October were also surprising as new home sales rose 6.2% to an annual rate of 430,000 versus the 410,000 expected by economists.  New home sales are crucial to an economic recovery ( I am repeating myself, I know) as obviously construction workers and materials are needed to build new homes, adding to jobs and production demand.  It is not all roses, however, housing starts for October were down 10.6% at 529,000 in October from 592,000 in September and mortgage data showed weakness with the highest rate of delinquencies, loans in foreclosure and foreclosures started, since the dataset was initiated in 1972.  In the third quarter delinquencies as a percentage of all mortgage loans outstanding climbed to 9.64% (seasonally adjusted), up 2.65% from a year ago.  Loans in foreclosure climbed to 4.47%.  According to the Mortgage Bankers Association, "33 percent of foreclosures started in the third quarter were on prime fixed-rate and loans and those loans were 44 percent of the quarterly increase in foreclosures.  The foreclosure numbers for prime fixed-rate loans will get worse because those loans represented 54 percent of the quarterly increase in loans 90 days or more past due but not yet in foreclosure." It appears that the bond market is saying that the Federal Reserve will likely keep rates extraordinarily low for the foreseeable future.  The combination of increasingly attractive housing prices and low interest rates, and let's not forget the Obama's housing incentives, is helping lift housings' spirits. 

Negative Yields?
The two year US Treasury note is an interesting item as it yielded about 0.669% at one point last week, only a hair away from the low of 0.657% set in the depths of last December.  As investors flock to safe havens with the year coming to a close, yields on U.S. Treasury bills have crossed into negative territory. The situation suggests fear still rules the market. "One of the primary catalysts keeping yields at the front end low is the amount of liquidity in the system that needs to find a spot over the calendar flip," said William O'Donnell, a strategist at RBS Securities.

There was a bit of a surprise for many as the industrial production numbers in Canada lagged even that of the US. The global industrial output is increasing, although keep in mind the US is coming off of some very low comparables, but the combination of higher C$ and lower energy prices is hampering a Canadian surge in output.  The US is likely now experiencing the benefit of the weaker greenback much in the same way that Canada did in the mid 80's and early 2000's and exports will likely be the key to the US recovery.  The consumer will likely continue to lag until we get back into the cycle where profits again rise to allow more job growth, job growth then leads to more spending, and increased spending to more profits... and the cycle can then continue.  There is still much of the stimulus package, both in the US and Canada, to come.  I did see an interesting piece that mentioned that if the government were to build a giant monument to its greatness then the expenditure of labour and materials would add to the GDP numbers, but would not provide any sustainable economic growth.   While the doomsday view is perhaps that this is happening, I think it is far more constructive than that.  Infrastructure is an investment in the ability of an economy to function more reliably and more efficiently.  I have not seen evidence of wastefulness such as 'bullet trains to nowhere' or 'monuments to greatness', but if I had I would certainly be singing a different tune. 

The National Association for Business Economists ramped up its economic forecast for next year, predicting that businesses will stop eliminating jobs and start creating ones in a matter of months. The association said GDP in the U.S. will increase 2.9% in 2010, compared with a 2.6% expansion predicted last month. "While the recovery has been jobless so far, that should soon change," said Lynn Reaser, the group's president. "Within a few months, companies should be adding instead of cutting jobs."  We saw U.S. weekly new-jobless-claims figures come in at 466,000, down from a revised 501,000 last week.  This was a larger drop than was expected by economists, and is the first time in over a year that claims have fallen below 500,000.

On Tuesday, the Federal Reserve Board released the minutes of its Nov. 3-4 monetary policy that showed that the Fed has lifted its forecast for this year and next.  They did comment that there is nervousness about the potential impact of the weaker US dollar and that the extended low interest rate environment could encourage speculation and excessive risk-taking.  The Fed also trimmed its forecast for joblessness in 2010 and 2011, predicting a jobless rate in the 9.3% to 9.7% range (down from 9.5%-9.8%).  I believe I have mentioned the difficulty that Main Street has had in borrowing money, and it is interesting to see the record issuance of $1.171 trillion in bonds this year, according to Bloomberg. LIBOR, that has quickly dropped from the media's attention, has fallen to 0.261 percent, according to the British Bankers Association, down from 1.41 percent at the start of the year.  While large companies are taking advantage of the Fed’s low interest-rate policy in capital markets, consumers face tighter terms and less available credit. Consumer loans held by commercial banks in the U.S. fell to $846.7 billion in October, down 0.7 percent from the same month a year earlier.

There continues to be debate over the path of the best cure for the credit flu that has stricken economies globally.  One side considers the continual application of government support and stimulus to be recklessly delaying the inevitable payday that the US must face.  And keep in mind, they will not face that crisis alone.  Another camp considers the application of higher interest rates and the withdrawal of the stimulus to be the worst of all evils.  The good mood that Bernanke has been is very comforting as he apparently is facing a calmer dragon than that of the past two years.  Armageddon appears to have past.  Are there troubles ahead?  You'd better believe it... but there are always troubles ahead.  Isn't it a Chinese proverb that says everybody always has exactly 83 problems?  (  When a man asked Buddha to help him with his problems, he said that he couldn't... the man was shocked that this great master couldn't help him with any of his 83 problems, asked, "then what do you do, exactly?" Buddha replied, "I help with the 84th problem. Wanting the other 83 not to exist." )

Bank of Montreal was the first bank to report this week and here are a few comments from our Portfolio Advisory Group...
The strength from financials could come as a result of what can be described as a good quarterly report from Bank of Montreal this morning.  My colleague, Geoff Ho, provides more details on the results below, but overall the cash operating EPS of $1.13 beat expectations.  A lot of the results were essentially in line, including the specific loan loss provisions of $386 million which were higher than last quarter's $357 million; however, this is not terribly surprising as we tend to call Q4 the kitchen sink quarter which allows banks to "clean the slate" for fiscal 2010.  A few things of note though that I would highlight include:
We can actually say that retail results were better than expected than wholesale results.  For some time we had been seeing wholesale divisions easily beating retail divisions based on expectations, but we've seen a bit of a reversal with Q4.  The weakness in non-retail on a sequential basis appears to be coming from trading revenue at $262 million compared to $391 million last quarter.  Pundits had noted that trading revenue of quarter's past was unsustainable and it would appear with these results that this is the case in Q4. On the flip side, retail earnings posted year over year growth and we saw both sequential and year over year improvements in Canadian and U.S. retail net interest margins.  Tier 1 Capital increased to 12.2%, so Bank of Montreal is starting to get into the "too much capital" category like Royal Bank.  Although Bank of Montreal decided to keep its dividend unchanged, capital levels such as these will put further pressure on BMO to do something with that capital or return it to shareholders.  Normally we see bank's tell us what their targets are for the next fiscal year, but I must admit that I was disappointed to see Bank of Montreal provide "medium-term" targets.  Of course medium term is subject to interpretation and it allowed BMO to provide very general goals instead of concrete numbers and time lines.  In terms of their medium term targets the bank wishes to grow EPS by 10% per year and see operating ROE between 17% to 20%.

The tea leaves...  The technicals for the S&P500 showed that the S&P500 completed a minor top on the slide below 1082, and support is emerging at 1065/62 with 1054 right behind it.  Below here opens up 1026 from which a good recovery attempt would be expected. Above 1088 would suggest a reversal and above 1112  is needed to have the trend turn higher again towards 1126 initially.