A Repeat of Two Weeks Ago

A couple of weeks ago, I wrote a post “It’s Different This Time But it’s Also the Same”. The Canadian market is down 7% and the Dow is down 6% with under 10 minutes left in the trading day. The markets were jittery from the outset as some participants didnt believe the financial bailout would come to fruition.

We can panic and sell as account values shrink with each day. However, looking at individual securities, there are many companies that will carry on who have limited debt, excellent cash flow, but are down tremendously with this month’s losses. 

Canadian Natural Resources is down 16% today. Suncor is down 11%. CIBC is down 7% while some Real Estate Investment Trusts are down 10% in one day. Are these numbers justified? One could argue that it is as oil prices dropped $10 today. However, these oil companies had their estimates based on $90 oil, less than where it is right now.

When this will end, no one knows, but I do know that the valuations get more compelling by the minute. For more information on our company, you can visit us at http://www.rothenberg.ca

Your comments are greatly appreciated.


You Want It…You Got It

The earnings announcement of Research in Motion (RIM) last night triggered me to write about something that had been brewing in my mind for some time. RIM missed their earnings by one penny and the stock is trading 25% below yesterdays close.

The market punishes companies for missing guidance as companies like RIM are priced to perfection. This is where the problem lies and I believe has lead to alot of the problems for financial stocks in the US and the rest of the world.

I laughed when I heard that the FBI was going to do an investigation on the executives of the failed financial firms as the whole system is to blame for what has happened and these same executives would have been fired earlier on had they not done what they did.

As a publicly traded company, investors demand results and they compare your results with those in your sector. Revenue growth, earnings growth, and a key measure in the financial sector is something called Return On Equity (ROE).

In the past, financials that had an ROE of 15% were considered operating at exceptional levels. However, investors demanded more of the executives and wanted ever increasing Return on Equity as higher ROE leads to higher stock prices. How does this happen? Well, a good place to start is by increasing the leverage on ones balance sheet. If one company leveraged their balance sheet 10 times, the next would increase theirs to 11 and so on to increase their ROE to numbers that exceeded 25%.

If a firm or its board were so inclined to keep their balance sheet conservative, they could be shunned by investors as their earnings growth and ROE didnt match their competitors leading investors to bail on the stock for greener pastures. The same executives that are being investigated would have been fired along time ago for not matching the results of their peers.

This leads to my thoughts on what changes need to be made. Why should a company in the case of RIM have their stock drop 25% in one day after their year over year sales increase by more than 100% but earnings miss by one cent a share. Companies are forced to perform and make decisions in the short run that are not in the best interest of the company in the long run.

I don’t have a solution yet but would love to hear your thoughts on this topic.

Christmas Comes Early But Dont Celebrate…

The TSX  went up 7% today following the lead of global markets last night. No one was happier than me to see this and my commentary about naked short selling a couple of days ago helped spark this rally in conjunction with other initiatives to improve liquidity and the balance sheets of financial firms around the world.

While I am against naked short selling and feel that the strategy can kill some otherwise sound corporations, the strategy of short selling stock that is available to be borrowed is valid and helps keep excessive pricing at bay. Think back to the tech boom of 1999 – 2000. Excessive prices took hold and many people got burned. 

The policy of not allowing any short selling has swung the pendulum too far in the other direction and we can be sure that once the policy is reversed, the short sellers will come in and drive prices of financial stocks down but hopefully not to previous lows.

That date is slated for October 2nd. Lets all hold our breath.

What do you think will happen between now and then?

Markets Should Rally On Naked Short Selling Restrictions

With the markets continuously going down, one wonders when it will come to an end. Well, the end could be near with a powerful rally around the corner. The SEC is implementing restrictions on naked short selling of all stocks, not just Fannie Mae and Freddit Mac.

Previously, there was no disincentive for broker-dealers to reject naked short selling trades. With fines and penalties looming, naked short selling should come to a halt and allow for an orderly market to take place. The excessive selling should be reversed allowing stocks to trade on fundamentals. Hopefully this will curtail the daily watch on which companies are next to declare bankruptcy as liquidity dries up and taxpayers get left holding the bag.

Do you think that this measure will help spark a rally? Your thoughts are more than welcome.

It’s Different This Time…But It’s Also The Same.

The markets are correcting around the world trading somewhere between 20% – 45% from their highs of last year or in the case of Canada, three months ago. As some of the largest financial institutions unravel and close their doors due to excess leverage, lack of capital, and naked short selling, one starts to reflect on what is happening, when will it all end, and will everything go to zero?

It is somewhat different this time. The amount of leverage that institutions took on exceeded that of a commodity futures trader or an investor who was fully margined during the Great Crash of 1929. The complexity of the transactions, the volume and size is unparallelled. Companies like Lehman Brothers that have withstood market upheaval for 158 years are coming crashing down to earth.

Financial experts, Alan Greenspan, Ben Bernanke, portfolio managers, and others have not experienced the financial restructuring that is going on today. The crash of 1987 came quickly. There were some casualties but most survived and prospered. Interestingly enough, it was the brokerage firms in Canada that needed rescuing from the major banks after a bought deal with British Petroleum didn’t sell and the firms required injections of capital to survive.

So why is it the same? We will come out of this market having learned some more lessons. Sound lending principles will come back. Naked short selling will be curtailed. The structured products that came to market will no longer have a market of buyers. It is the same because the same companies that built their  businesses in the past on strong principles with limited debt will survive again as they did in the past and their investors will be rewarded with ever increasing dividends and share prices.

The companies that Sir JohnTempleton and Warrent Buffett made their fortunes on will continue to exist and flourish regardless of the markets over the long term. Nothing has changed in this regard. Fortunes in the market are made by buying low and selling high. We are nearing a low point and the ability to buy great companies at cheap prices is surely worth celebrating as opportunities like this don’t come along very often.

What are your thoughts? Do you think that the market represents good value today?

The Smith Maneuver….What You Need to Know?

“Pay down your mortgage in 8 years instead of 25”. “Make the interest on your mortgage tax-deductible.” You have seen the ads in publications around town with free seminars. You’ve heard the ads on radio.

What’s the catch to this seemingly impossible scenario? In theory, if the sun, moon, and stars align properly and all assumptions go according to plan, you may be able to pay down your mortgage in a shorter time frame and get a tax deduction on your mortgage interest.

This is how the plan works. The easiest scenario is to set up your mortgage as a line of credit rather than your typical mortgage amortized over a specified length of time such as 25 years. You would keep your payments the same paying down your mortgage every month just as you always have.

However, every month when the principal on your mortgage is paid down, you reborrow an equivalent amount of principal on the line of credit. The amount reborrowed is invested in a balanced portfolio of stocks, bonds, etc…which is easily done in a mutual fund. Because the funds are used for investment purposes and to generate an income that would ultimately be higher than the interest paid on the line of credit, you are able to write off the interest paid on the line of credit.

The tax refund you receive would then be put on the principal of the home which in turn increases the line of credit. After a few years, the rate that this happens would accelerate allowing you to pay down your mortgage at an ever increasing rate and a lot sooner than just having a regular amortized mortgage.

On the surface, this sounds great and in theory it is. So what are the downfalls? Firstly, you are paying your regular mortgage payment and will then have to make interest payments on the line of credit as well. In the beginning, the interest required is rather small. After just a couple of years, however, the interest required to service the line of credit will run into the thousands of dollars each year.

How do you get this money? Well, you can sell off a part of the investment portfolio that you have adding to each month through what is called a systematic withdrawal plan to cover the interest cost. This is where the problem potentially begins. Assume you have a line of credit for $100,000. The interest cost will run about $5000 per year at current interest rates. If you sold off $5000 worth of funds and the market drops as it has done the last couple of years, your $100,000 investment portfolio may only be worth $70,000 -$80,000 while the line of credit continues to grow from its current $100,000. If the markets stay down for just two years, the possibility of the fund recovering to the level of your line of credit is extremely remote.

The strategy uses something called leverage. The same strategy that created the mess for financial institutions around the world. Before considering the Smith Maneuver as a way to become mortgage free sooner, please speak to an independent financial planner or advisor to learn more about the risks?

What do you think of this plan? Would you consider it for your current financial situation?