Book Giveaway Winner and Reader Predictions for the Next Bubble

Congratulations to Jordan who won the draw for the free book The Cost of Capitalism (and if you did not see my note to send me an email with your name and address, this is a reminder).

Robert Barbera, the book's author believes that bubbles are an inevitable recurring part of our capitalist system. So I asked for opinions on what would likely be the next bubble. Here is the tally from the comments:

• Green tech - 3 mentions
• Infrastructure - 3
• Water - 2
• Food/rice - 2
• Technology - 2 (again?!)
• Health care, China, India, energy, alternative energy, the US Federal Reserve - 1 each

My own vote would go to green tech related to energy (into which I lump alternative energy) for these reasons: it sounds good, has a real basis and there is a strong need for it (just like the tech bubble was based on the powerful reality of the Internet and computing) which means people can believe in it but be fooled in the assessment of the value of individual companies; big money players like venture capitalists (the same ones who were instrumental in the tech bubble), pension funds, governments, mega-corporations, investment banks all have a strong incentive to create another bubble and are pouring large sums into it already; it's new and people will be able to say "this time it's different".

Effects of Ageing Population on Economics and Investing: Report by Nomura

Invest Skeptically has dug up a fascinating report The Business of Ageing by John Llewellyn and Camille Chaix-Viros on the implications of ageing populations. There is a lot of thought-provoking original research in the almost book length 136 page pdf from Nomura International plc published Nov.28, 2008. Topics covered include: life expectancy and health-in-old-age trends, retirement age trends and incentives, effect of pension liabilities on companies and asset prices, effects on bond/equity asset prices, currencies and real interest rates, a series of impact assessments on eleven major sectors from autos, through banks, leisure, media, real estate, insurance, food and general retail, media, healthcare and pharmaceuticals. Below are highlights from the report.

Population, Health, Working, Pensions

• old no longer means age 65, it means 80 in terms of health and capability to work
• people in their 60s and 70s are generally healthy and do not live a miserable, vegetable-like existence in a wheelchair waiting to die i.e. we can expect to more or less be ok and enjoying life till shortly before we die
• the age of still being healthy has been rising faster than life expectancy - a greater proportion of our extended lives are healthy
  
• four things that will add up to 14 years extra life: eat lots of fruits and vegetables, don't smoke, consume alcohol in moderation, exercise regularly
• governments (for cost reasons) and companies (for cost and because older workers are good workers) will deploy incentives to retire later
• an older population doesn't mean a decaying economy - there is a lot of room for quite capable older folk to go back to work, or to keep working instead of retiring early
  
• life expectancy has been rising for many decades and probably will continue to do so
• women outlive men - a fact evident since 1840 and there is no sign of that changing
• life expectancy (average of the sexes) in 2050 will have risen to between 85 and 89 in all developed countries; even rampant obesity (the undisputed obesity champion being the USA with about 30% of the population being obese while Canada occupies 8th place at about 15% and the UK is 4th at 20% )
  
• spending on healthcare only rises dramatically in the last 3 months of a person's life (US data)
• people on defined benefit pensions retire earlier than those on defined contribution schemes
• the official retirement age is likely to be raised progressively in most countries
• "All the predicted problems in financing pension and health schemes that result from a rising old-age dependency ratio could be avoided. All that would be required would be to remove the public policy and private incentives that at present induce people to give up work sooner than they might freely choose to do." That last bit is interesting - people are induced in various ways to retire (like tax and income penalties for staying in work) when they otherwise might not. The problem all developed countries face could be fixed without nasty, punitive government action.
• older workers can actually be better workers for companies: less absenteeism, less stealing, better customer service, more experienced / knowledgeable, less staff turnover, more profit, as the B&Q case study shows
  

Investment

• "meltdown" is too strong a word to describe the idea that as boomers age and sell their investments (equities and bonds) for living expenses, asset prices will be driven down; there will be a muted effect on lowering asset prices
  
• another way of saying this is that real interest are now at their lowest point and likely to rise - bond and equity yields will rise
• current account surpluses in developed countries (= net savings = acquisition of foreign assets) will decline or stop and the money will be repatriated by boomer retirees for living expenses, which will drive up currencies of developed countries; a big question mark is whether the US will be the repository of demographically-induced savings to determine whether the USD appreciates along with other developed currencies, or depreciates by a lot. In the latter scenario, CAD also depreciates relative to other developed world currencies, but by less than the USD. In both scenarios CAD appreciates vs the USD over the next three or four decades. If this comes to pass, hedging US investments and leaving the rest of the world investments exposed to currency shifts is the correct strategy for Canadians.
• the whole chapter on pharmaceuticals is a good primer on the industry
  
• older people are big drug users, er consumers, for conditions like angina/hypertension, diabetes and cancer, which favours pharmaceutical companies; Eil Lilly and Novartis are said to be well-positioned with the right product mix
• generic drugs will continue to gain importance and companies like Barr Laboratories and Mylan Inc to benefit, along with Novartis and Teva
  
• auto companies will have to sell fewer but fancier cars to older folk
• "We expect the beneficiaries of ageing populations to be mainly the large, well-
  diversified life insurers and specialist reinsurers with strong balance sheets" who will provide retirement products
• older people spend a lot more on eating out and gambling(!) in their leisure expenditures than younger people
• real estate - "we expect a shift from the suburbs and commutable locations to the countryside, and from colder to warmer climes, with a general selling down given that retirees tend to sell more homes than they buy"
  

Claymore's Emerging Markets ETF (TSX:CWO) - Good and Bad Points

About a month and a half ago, Claymore Canada announced the launch of a new ETF with broad emerging markets equity exposure sold on the TSX under symbol CWO. At the time, Canadian Capitalist posted a brief assessment and so did his readers with excellent comments. With due recognition to CC, here is my summary, along with some extra bits on the currency hedging method used by CWO (my analysis) and investor costs (input from Som Seif, President of Claymore, who was kind enough to respond to my email enquiry).

The Good:

• broad emerging markets exposure in a Canadian ETF - this is a new thing, though Canadians could have bought Vanguard's emerging markets fund in the US (NYSE: VWO), which is in fact the same thing since CWO's holdings consist 100% of VWO
• fund is Canadian domiciled, i.e. is a Canadian not a US security, for US tax purposes, which prevents this fund from being subject to US estate taxes for high net worth investors - those with estates of more than c.USD$3.5 million (I wish!) according to PriceWaterhouseCoopers' U.S. Estate Tax Exposure for Canadians (updated April 2009)
  
• MER of 0.65% is reasonable considering trading and currency transaction fees, especially those doing regular rebalancing and using a broker who won't allow wash trades or USD in a registered account. Som Seif sent this comparison of a Canadian buying VWO and holding it three years:

  When you buy and sell, you pay 1-1.5% exchange rate spread.
  
  So, cost to you for buying and then holding for 3 yrs is 1%+3x25bps+1%=2.75%. That's 90bps a year.
  
  If you do any trading in between the 3 yrs for rebalancing, the cost goes up even more.

The Bad

• currency hedging in CWO is CAD vs the USD not CAD vs the various currencies of the emerging markets countries starting with India (19% of the portfolio), Brazil (15%), Korea (12%) etc. What Claymore does is called proxy hedging - the USD is used as a proxy / replacement for the basket of CWO's currencies on the supposition that as goes the USD, so goes the basket. The reason for doing proxy hedging is that few world currencies are liquid enough to easily and cheaply hedge. Som Seif says it works, but being ever the skeptic, I took a closer look, using the top ten countries which comprise 90% of CWO as my sample. My simple analysis in the chart below suggests that over the last 1-year and 3-year periods, the USD and the CWO currencies have not gone up and down together against the CAD. In fact, the CWO currencies as a whole have hardly changed at all vs the CAD, suggesting that hedging isn't necessary at all! Individual currencies have had big shifts but they have almost completely cancelled each other out. Meanwhile the USD has had much larger swings. Granted, this is a short time period so CAD might gain against the emerging world for the next twenty years, and reduce the CAD value of those foreign holdings as a result, which would make hedging worthwhile. But hedging USD vs CAD seems to be a poor way to hedge VWO. CWO's tracking errors against the MSCI index it is supposed to mirror are likely to be very large.
  

I Invest Therefore I Tweet > panel discussion on May 25th

Received this press release from the folks at Questrade about an online webcast. Given the panelists it may well be worth listening in and maybe even firing some questions at them. Bloggers starting to get some respect from the mainstream, wow!

''Toronto, ON (May 19, 2009) – On Monday, May 25^th, at 2 p.m. ET, a live webcast / panel discussion will explore the recent surge in usage of social networking tools for investment and trading advice.

The panel, I Invest Therefore I Tweet, is moderated by Michael Hainsworth, host of Market Call on Business News Network (BNN), and includes panelists FrugalTrader (MillionDollarJourney.com author and blogger), Jonathan Chevreau (blogger, author, and National Post personal finance columnist), and Sam Seiden (pro trader, author and trading instructor).

The panel investigates the ways traders are using social media to take charge of their investments, including the tools that are being used, how they are being used, personal privacy and security issues, and how to filter information for accuracy and reliability.

Edward Kholodenko, President and CEO of Questrade says: “Investors are exhausted by the market downturn. Their portfolios are diminished. They don’t know who to trust for advice any more. While the use of social networking like Facebook, blogs, forums, even Twitter isn’t new for online investors, what is new is how pervasive and influential these tools have become.”

The panel discussion will take place in Online Trading Academy (Canada)’s new high-tech facility in Toronto, and will be webcast live. Registration for the event is free and is available at www.Questrade.com/tweet. Viewers of the live webcast will be able to Twitter their questions to http://twitter.com/Questrade or post questions directly in the webcast window.

Kholodenko continues: “Since our inception 10 years ago, Questrade’s mission has been to give Canadians the information they need to achieve financial independence. I believe our mission is even more relevant now, particularly as we incorporate social media tools into our business model. Investors are leaving their full-service brokers and replacing them with social media to ‘crowd-source’ their financial advice, and we’re committed to supporting their needs.”

I Invest Therefore I Tweet is sponsored by Questrade Inc., Online Trading Academy (Canada) and Business News Network (BNN). The panel discussion is the kick-off event for Online Trading Academy (Canada)’s grand opening.''

Book Review and Giveaway: The Cost of Capitalism by Robert J. Barbera

The cost of capitalism is repeated market mayhem, bubbles and crashes caused by financial system excesses, according to Robert Barbera, an economist with one foot in the practical world as a long time economist with investment banking firms and the other foot in the theoretical world as an academic professor.

This slim volume of 200 pages expounds the central idea with a series of fascinating, even entertaining vignettes of the bubbles and crashes of the last 30 years - the 2008 crisis and its current aftermath (the book was completed in January 2009), the 2000 tech bubble, the Japanese real estate bubble and subsequent lost decade, the 1998 Asian currency crisis. It is a book of economics for the non-economist, with no jargon and simple, but precise explanations of events, illustrated by pertinent graphs. The writing and language is engaging and flows smoothly, perhaps the by-product of Barbera being obliged to communicate constantly with non-economists in his job.

The author exhorts us to heed the ideas of Hyman Minsky, who stated that people's attitude towards risk changes with stages in an economic cycle: with prolonged good times in the recovery and growth phases, individuals get complacent and believe that the good times will continue forever, leading them to take on ever-increasing risk and leverage, goaded on by the financial system, till a typically small negative event, which he calls a "Minsky Moment", pricks the bubble and the violent slide destroys wealth, at which point everyone gets very (too) risk-averse. The financial system itself, as the holder of all the "cannot be paid back" debt, then has to be bailed out by the government. As he puts it, "Thus, government rescue operations are an inescapable part of capitalism."

There is a brilliant example on page 31 contrasting a homeowner with a conservative mortgage and one with a very large mortgage predicated on rising house prices to sustain affordability, such as was common in the USA in the years leading up to the housing crash there. The easy-to-follow table shows how a small rise in interest rates or a small decline in house prices will cause catastrophe for the large mortgage holder. This example is then extended to explain to show how the risky mortgage default effect can cascade into the general economy through financial institutions and create havoc even for those home buyers who have been cautious, or for completely unrelated companies and sectors.

Barbera thinks that destructive capitalism of most businesses benefits society by cleansing bad businesses with better ones but he says that the financial system is an exception and must be prevented from failing to prevent destructive deflation such as happened in the 1930s - thus he severely criticises the decision to allow Lehman to fail in September 2008. Barbera has an ax to grind and that ax is what he believes is the mis-perception by governments, central bankers and the mainstream of economic thinking on how the financial system works to create recurring bubbles.

Overall the book is a highly engaging and well-argued essay on what ails capitalism and the financial system. Barbera advocates that central banks should be mandated with controlling not just inflation but also asset bubbles to nip them in the bud before they grow too large and wreak havoc. He does not want to see overshoot on the regulatory side in reaction to the 2008 crisis, saying that the huge engine of wealth that is capitalism should not be hobbled too much - one might characterize it as "as much new regulation as necessary but only as much as necessary".

What is the value of this book for an individual investor?

• a cautious attitude - understanding that bubbles are inherent and inevitable in our system makes one cautious and on the lookout for the next one; that is a powerful message of this book
  
• awareness of bubble signs - it helps to know some signs to monitor since bubbles originate from the financial system, like high and climbing levels of debt and leverage; once a bubble exists it is impossible to predict when it will collapse as a slight seemingly innocuous event starts the fall
  
• awareness of calamity indicators - if financial institutions do start failing whether due to government neglect or powerlessness, then it really is time to look for escape and safety, certainly financially and perhaps even physically
  

My rating: four out of five stars

Giveaway! The publisher McGraw Hill has kindly provided me with a copy to give away. So leave a comment on this post with some kind of unique name, i.e. not "anonymous", by closing date of midnight EDT Thursday May 28, 2009. If the fancy strikes you, in your comment say what you think will be the next bubble - green tech, gold, oil ... I will do a random draw to pick a winner and then I'll need to get a postal address from him/her to mail it. Good luck everyone!!

Inflation Ain't What It Used To Be If You Are Retired

Did you know that inflation is usually higher for retired people? At least it is to the extent that Canada is the same as the USA. Moshe Milevsky in a January 2009 presentation along with the heavy duty paper version on Lifetime Ruin Minimization at the IFID website reveals that the mainstream average inflation calculation understated that experienced by older people (age 62+) by about 0.5% a year since 1983. The reason is that retirees spend a much greater proportion of their income on housing and health care as this breakdown chart from the presentation shows.

Are things the same or different in Canada? Unfortunately, there is no such alternate inflation measure put together by Stats Canada. I phoned them just to be sure and they said they don't have one. It would be very helpful e.g. for the government to use to adjust CPP, OAS, GIS and other payments to retirees. Of course, different parts of the country have different inflation rates, not to mention large differences because of lifestyles. Another neat idea on the BBC website is a personal inflation calculator - just plug in your own spending habits and it takes the UK individual CPI components (called Retail Price Index in the UK) and adds them up with your spending proportions.

A negative consequence is that one financial product's effectiveness is undermined for retirees. Real Return Bonds are meant to counteract the effects of inflation by indexing the principal and interest using CPI. If an understated CPI is used, RRBs won't go up fast enough. The Milevsky presentation has another chart on page 10 that shows very poor correlation between the CPI-E (E = Elderly) and actual returns from US RRB funds, in other words the returns from the RRBs didn't match up with inflation from year to year at all. In fact, as a result of such poor performance, Milevsky concludes that RRBs should treated as just another asset class within a portfolio by retirees.

Canadian Capitalist had an interesting post Investing in a Period of High Inflation with good comments about RRBs. One commentor's statement that the Canadian RRBs use only Core Inflation, which strips out the more volatile, but essential to most people, components of mortgage interest, energy and food instead of the overall Total CPI is incorrect. The RRB fact sheet on the Bank of Canada website says the CPI measure used is the "All-items" CPI, which a Bank of Canada spokesperson confirmed is Stats Can's Total CPI.

Honda Civic Still Most Popular Car ... to be Stolen

The Insurance Bureau of Canada publishes an annual list of the Top Ten Most Stolen Cars. The latest tally for 2008 shows that models of Honda Civics retain the two top spots, a place they have held every year since 2005. Not only that it is the same two model years 1999 and 2000. They are followed by another repeat offender, the 2004 Subaru Impreza. Huh? Don't thieves update their cars too? Don't want to have your car stolen? Apparently the least stolen cars are 2003 Cadillacs,, 2002 Lincoln Continentals and 2001 Lincoln Town Cars.