Are Investors Asking the Right Questions?
“Money Ball: The Art of Winning an Unfair Game” is a book by Michael Lewis that was made into a movie starring Brad Pitt. Pitt plays Billy Beane, the General Manager of the Oakland A’s, a major league baseball team, with a very small budget to compete against the likes of the New York Yankees and the Boston Red Sox. One day, Beane has an epiphany that the conventional wisdom of baseball was wrong. Using a system developed by Yale educated Peter Brand, the Oakland A’s went on to change the way players were evaluated and teams were built.
The system was based on a simple but profound thought – maybe the General Managers of professional baseball teams were asking the wrong questions. The art of the question, asking the right question, allows you to get to the root cause of the problem. This is a very important step in the investment process. Today, we can apply this rule to the current negotiations between the Eurogroup, the International Monetary Fund (“IMF”), the European Central Bank (“ECB”) and Greece.
Is Greece’s debt sustainable? We believe the answer is yes, if we use international accounting standards. No, if we use check book accounting.
We believe the question not being asked by many investors is “What is the net present value of Greece’s Net Debt to GDP, using International Public Sector Accounting Standards (“IPSAS”) or accrual accounting?” In a May 9, 2016 Bloomberg article, “The IMF Is Right About Greece”, Vincent Truglia, retired head of Moody’s Sovereign Risk Unit, states “I would argue strongly that Greece adopt IPSAS-based accounting, the gold-plate of recognized accounting standards to measure not only the Greek government’s debt, but should be used to determine budget decisions going forward”. If Greece did adopt IPSAS-based accounting standards, the reported net present value of net debt to GDP would be substantially below the 94% net debt to GDP that Canada has. Suffice to say, many investors have taken up the task.
The media and many in the official sector quote the future face value of debt as defined in the Maastricht Treaty which focuses on the contract value of debt due at maturity (cash accounting). The IPSAS is the public version of International Financial Reporting Standards (“IFRS”) that companies are required to follow. IPSAS is a full set of 32 accrual standards which countries such as Canada, the United States, New Zealand, France, and Sweden, to name a few, follow. The standards add transparency as well as introduce the concept of the time value of money, a key consideration when one is making major policy changes or monitoring the sustainability of debt levels. Greece still follows the rules of cash accounting. If any of its debt has been restructured, the reduction of interest rates and the extension of maturity would not be taken into account. It’s the Greek government’s responsibility to report their finances in a manner that captures the true economic value. There are significant market consequences for this lack of strong financial management. As the Greek government looks towards the IMF, the Eurogroup, and the ECB to provide a vote of confidence, all that is really needed is the implementation of sound financial accounting standards and procedures. Then the Greek government could show the global financial markets the true state of the country’s finances.
For some reason we are again witnessing the fight to maintain the status quo. Vested interests refuse to acknowledge that they have all agreed to support international accounting standards to measure debt. This required a country to report their debt in a manner that represents a true and fair value view of economic reality. This has been missed by the World Bank, IMF, ECB, EU and the Rating Agencies. Why don’t they follow the standards that they set and agreed upon? I personally have no clue…However, these are the same institutions that missed the risk in the run up to the global financial crisis. This time it’s not different and cycles do repeat. The numbers presented in IPSAS would lower the cost of capital, attract foreign capital, and stimulate economic growth.
Speaking of economic growth, China has been investing in Greece and see it as part of its foundation is implementing its belt road initative. From investing in ports, to promoting Chinese tourists to vacation in Greece, the economic integration between these two economies has yet to make the front pages of main stream media. To be sure, the smart money has noticed. We have positioned Pendragon to benefit from these two significant forces that will make Greece a very attractive destination for foreign capital.
Accredited Investors Only
The Fund is available on a private placement basis only to residents of Canada who are qualified “Accredited Investors” as defined under National Instrument 45-106 Prospectus Exemptions and who are resident in Canada. This material is for information purposes only and does not constitute an offering memorandum or an offer or solicitation in any jurisdiction in which an offer or solicitation is not authorized. Please read the Fund’s Offering Memorandum before investing. Prospective investors should rely solely on the Offering Memorandum which outlines the risk factors in making a decision to invest. The indicated rates of return are historical annual compounded total returns net of fees and expenses paid by the Fund, including changes in unit value and reinvestment of all distributions, but do not take into account sales charges or income taxes payable by any security holder that would have reduced returns. Investments in the Fund are not guaranteed, their values change frequently and past performance may not be repeated. Investment losses do and may occur, and investors could lose some or all of their investment in the Fund. The information herein does not consider the specific investment objectives, financial situation or particular needs of any prospective investor. No assurance can be given that the Fund’s investment objective will be achieved or that investors will meet their investment goals. Prospective investors should consult their appropriate advisors prior to investing. Information presented herein is obtained from sources we believe reliable, but we assume no responsibility for information provided to us from third parties. Caldwell Securities Ltd. and Caldwell Investment Management Ltd. are wholly-owned subsidiaries of Caldwell Financial Ltd. Officers, directors and employees of Caldwell Financial Ltd. and its subsidiaries may have positions in the securities mentioned herein and may make purchases and/or sales from time to time. This information may not be reproduced for any purpose or provided to others in whole or in part without the prior written permission of Caldwell Investment Management Ltd. All information and opinions indicated herein are subject to change without notice. Inception date: September 15, 2016.
July 2017 | The Past is Prologue
The Past is Prologue
William Shakespeare, in his play The Tempest, uses the statement “The Past is Prologue” to suggest that all the events that have happened before have presented us with the opportunity we now face. Simply put, history sets the context for the present. Yet, in this world of instant gratification, few investors anchor their expectations using history as a guide.
What is the fair value of the Canadian dollar? Why would policy makers of an export led economy desire a stronger currency? With private debt to Gross Domestic Product (“GDP”) close to 180%, won’t higher interest rates hurt economic growth? Will policy makers be able to generate a soft landing in the real estate market? Meaning, the real estate bubble will pop without generating a significant decline in housing prices. We are entering a new phase in the commodity super cycle. All of the above questions communicated by many pundits over the past few weeks implicitly assume that the basic laws of economics don’t apply to the Canadian economy. We beg to differ.
Remember last year, the global economy was dealing with the crash of prices in the commodity complex. In Canada, wild fires in Alberta added to the problem by forcing a shut down of oil production. The fires in Fort McMurray were a major international story. Yet today, few anchor their expectations about the future on this fact.
The Canadian dollar has rallied over the past few months. The Bank of Canada is claiming victory from the appreciation of the Canadian dollar, caused by the recent interest rate hike. The Canadian dollar has now reached a point where one of the world’s most efficient railroads, the Canadian National Railway (“CN”), stated in its quarterly report that the strength of the Canadian dollar is now a headwind for economic growth. As the economy enters into a period where data gets normalized, those bullish expectations will subside. Looking at the Citigroup Economic Surprise Index, we can see that investors have extremely bullish expectations about the Canadian economy, while having extremely bearish views about the U.S. economy. Mathematics suggests that those expectations should reverse as we get into the fall.
The Bank of Canada has a single mandate: to target inflation. Data released in July 2017 revealed that inflation was at a 20-month low. Fundamentals suggest that the Canadian economy is lapping very easy comparisons, meaning growth looks better than it actually is in Canada, an additional point that CN makes in its quarterly report. Furthermore, basic economic theory suggests that an appreciating dollar is deflationary. So while all the cheerleaders are happy about the strong Canadian dollar, international investors most likely see Canada in a more objective light. The Canadian economy has had the benefit of two super cycles, one in commodities and other in real estate. To many observers, it looks like the Bank of Canada is targeting the real estate bubble. Popping the real estate bubble will not come without consequences, a decline in real estate prices will have a negative effect on economic growth. Some may suggest that the housing bubble can be popped without a decline in housing prices, however we do not see any evidence to support this. In theory, it could happen, but practically speaking, assuming an economy with private debt to GDP of 180% will not see a significant decline in economic growth in light of a decline in housing prices is a very dangerous position to hold.
The Bank of Canada raised interest rates. Was it justified? Were they targeting the real estate market? Is an appreciating currency good for an export led economy? Why are the rest of the world’s central bankers concerned about being below their inflation targets? The Bank of Canada is sure that the long shadow of the global financial crisis and secular stagnation has been defeated. Retail sales (not including the automotive sector) that were reported in July 2017 were negative. Job growth in Ontario was negative. Yet, the Governor of the Bank of Canada, Stephen Poloz, and his team are claiming victory. The Bank of Canada may just be taking back the two emergency cuts they did when oil crashed. Governor Poloz acted as Governor John Crow did to pop the housing bubble in the early 1990’s. Real estate prices declined by 50% at that time and Canada went into a recession. Instead of acting as cheerleaders, many pundits should be sounding the alarm bells. A major policy mistake is at hand. Canada is no longer competitive in manufacturing on a cost basis with the southern United States and Mexico. Canada has just experienced the benefits of two super cycles, commodity and real estate. A strong Canadian dollar is the last thing the Canadian economy needs at this juncture.
It seems that many in Canada don't think that cycles repeat, fundamentals do matter and policy mistakes can happen. Shakespeare was right, The Past is Prologue, but only for those that take a moment and reflect.
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Accredited Investors Only
The Fund is available on a private placement basis only to residents of Canada who are qualified “Accredited Investors” as defined under National Instrument 45-106 Prospectus Exemptions and who are resident in Canada. This material is for information purposes only and does not constitute an offering memorandum or an offer or solicitation in any jurisdiction in which an offer or solicitation is not authorized. Please read the Fund’s Offering Memorandum before investing. Prospective investors should rely solely on the Offering Memorandum which outlines the risk factors in making a decision to invest. The indicated rates of return are historical annual compounded total returns net of fees and expenses paid by the Fund, including changes in unit value and reinvestment of all distributions, but do not take into account sales charges or income taxes payable by any security holder that would have reduced returns. Investments in the Fund are not guaranteed, their values change frequently and past performance may not be repeated. Investment losses do and may occur, and investors could lose some or all of their investment in the Fund. The information herein does not consider the specific investment objectives, financial situation or particular needs of any prospective investor. No assurance can be given that the Fund’s investment objective will be achieved or that investors will meet their investment goals. Prospective investors should consult their appropriate advisors prior to investing. Information presented herein is obtained from sources we believe reliable, but we assume no responsibility for information provided to us from third parties. Caldwell Securities Ltd. and Caldwell Investment Management Ltd. are wholly-owned subsidiaries of Caldwell Financial Ltd. Officers, directors and employees of Caldwell Financial Ltd. and its subsidiaries may have positions in the securities mentioned herein and may make purchases and/or sales from time to time. This information may not be reproduced for any purpose or provided to others in whole or in part without the prior written permission of Caldwell Investment Management Ltd. All information and opinions indicated herein are subject to change without notice. Inception date: September 15, 2016.