Bank of Canada in the spotlight

The Bank of Canada will announce its interest rate decision tomorrow. Most economists believe that Bank of Canada governor Mark Carney will increase the benchmark overnight rate by 0.25%, which brings the rate to 0.5%.


Ever since economists started to debate about when Canada and the US will increase their interest rates, my forecast has been September for Canada and Dec 2010/Jan 2011 for the US. However, rosy economic data have emerged from Canada one after another, with the most recent being today's news that the Canadian economy grew at an annualized rate of 6.1% in the first quarter. In fact, by April, the rosy economic numbers basically guaranteed a rate hike on June 1.

However, the debt crisis in Europe then occurred, which devastated stock markets, and threatened to plunge countries back into recession. This threw into doubt a rate hike on June 1, which was previously all but certain.

Today, there are two camps on what the Bank of Canada should do. One camp is for a rate hike on June 1, and their biggest argument is the rosy economic data. For example, fourth quarter GDP rose by 4.9%, while first quarter GDP grew by 6.1%. The second camp is for a rate hike in July. Their main argument is that the debt crisis in Europe and the high unemployment in the US will slow Canada's economic growth. This would occur through lower Canadian exports and less foreign investments in Canada.

Regardless, if Mark Carney raises the interest rate by 0.25% tomorrow, I do not expect an impact on the TSX. This is because consensus is expecting a June 1st rate increase, and the rate hike has already been priced in. The main factor determining the direction of the stock market is going to be Europe (and particularly Spain) for the next few weeks.

Spain will decide where stock markets go

At this point in the European debt crisis, world attention has shifted from Greece to focus entirely on Spain. This is because the outcome in Spain's banking sector will determine the direction of stock markets around the world for the next few weeks.

At the centre of attention are Spain's 45 regional savings banks, which have 50% of the country's bank assets. These regional banks are called cajas. The collapse of one such bank, CajaSur, caused panic in the markets on Monday, as investors feared other Spanish banks would follow.


The cajas provided cheap loans in the 1990's, which helped to cause a property boom in Spain. However, the subsequent collapse in the housing market has resulted in a non-performing loan ratio of about 10 per cent in bank loans to property companies. Combine the questionable health of the cajas with the country's 20% unemployment rate, and Spain becomes potentially the next shoe to fall.

If very few cajas in Spain go bankrupt, a significant rally in risk-assets can be expected. However, if the Spanish banking sector is devastated, banking industries in the rest of Europe will be impacted. Thus, stock markets in North America would enter into a much deeper correction. In fact, a correction of 20% to 30% can be expected.

Potash and Agrium could be the stocks of this decade

Today, UBS Securities Canada cut its target price on fertilizer companies Potash Corp (POT) and Agrium (AGU) from $116 to $113 and from $83 to $80, respectively. It cited price increases “have been slow to materialize.” Both Potash Corp and Agrium produce and market potash, phosphate and nitrogen fertilizers.

With the emergence of the BRIC countries (Brazil, Russia, India and China) the demand for food is skyrocketing, as millions of formerly impoverished people move into the middle class. Investors are constantly looking for the next big play. Oil was the play of the decade from 2001 to 2010. While some believe renewable energy to be the next big thing, I believe it is still too early to earn big profits from investing in companies involved with renewable energy, since solar panels and windmills are not widely used. Instead, agriculture/fertilizer companies are facing an imminent boom in the demand and price of their products, simply because of demand from the BRIC nations.

With Potash's closing price today of C$102.46, and Agrium's closing price of C$57.38, they represent tremendous upside considering UBS's target price of C$113 and C$80, respectively. In fact, UBS's target price represents a return of 28.3% for Agrium. Furthermore, UBS is not the most bullish on the two stocks. For Potash, the consensus target price of 23 analysts is US$125.36 (return of 23.8%); meanwhile, my target price is C$130, which is a level most recently reached in December.


Basically, the debt crisis in Europe has caused these two stocks to be as low as they are today, which is similar to many other stocks on the TSX. Once the worries about Europe fade, demand for fertilizers will take these two stocks significantly higher in the next 12 months.

The worst of the correction is likely over

On Friday, the Dow rose 125 points to close at 10,193 points, on news that Germany has approved its part of the commitment for a new European stability fund. Financial and commodities stocks were particularly strong, with JP Morgan Chase and Bank of America rising 5.9% and 4.5% respectively on Friday. In addition, the volatility index VIX dropped to 40.1, the euro rose 1.7% to post its largest weekly rise in 8 months, and the price of copper rose 4%. It was simply a reversal of what had been happening the whole week.


Given the current market condition, I stand by my prediction of a 10% correction for the TSX (which takes the TSX to 11,089.58). With Friday's developments, I believe the pace of decline in the stock market will slow in the coming weeks. 100-point falls on the TSX will replace 200-point drops, and the TSX will have days in which it ends in positive territory, in addition to days where it ends in negative territory. However, with the VIX at 40.1, which is higher than the norm of 20, expect significant volatility in the week ahead. Also, keep in mind that in order for the TSX to experience a 10% correction, it has to further fall 431 points.


For individuals with cash on the sidelines, now would be a great time to buy. In terms of the TSX, the only shares that I see are currently overpriced are shares of banks and gold and silver companies. Meanwhile, commodities and energy are sectors that offer many stocks that are undervalued, such as Canadian Oil Sands Trust (COS.UN), PetroBakken Energy (PBN) and Teck Resources (TCK.B). These stocks, along with many others in their sectors, offer tremendous upside potential in the coming months.

How big will this correction be?

The S&P 500 entered into correction territory today by dropping 43.46 points or 3.9% to close at 1,071.59 points. The definition of a correction is a 10 percent drop from the market highs, and the S&P 500 has declined 11.12% from its 2010 high of 1,205.03, reached on April 26.

The TSX, on the other hand, has been slightly stronger over the same period. With today's fall of 259.82 points to close at 11,405.95, the TSX has declined 7.43% from its 2010 high of 12,321.76 on April 27. Thus, the TSX has not reached correction territory.

The TSX has outperformed the S&P 500 during this period probably because of the relatively better debt situation in Canada compared to the US. With the implosion of the government debt problem in Greece and its affect on the rest of the EU, some have begun to warn that the US could eventually be in the same situation if its national debt continues to increase at the present rate.

The story is simply that the debt crisis that began in Greece has triggered significant losses in stock markets around the world. The question now becomes: How big is this correction going to be? David Rosenberg stated today that he expects the correction to be 31%. His views are consistently bearish, and his predictions have not been the most accurate since the market bottom in March 2009. I believe that, with the current market condition, the TSX will experience a correction just slightly greater than 10%, which puts the index slightly lower than 11,089.58. However, if the situation worsens (e.g. the EU and IMF bails out another country/countries) then the decline in the TSX could be greater.


A silver lining is that, according to Bespoke, currently only 7% of S&P 500 stocks are above their 50-day moving average (50 DMA), while 93% are below their 50 DMA. This is the lowest level since March 2009, when the reading was 5%. What followed, of course, is one of the greatest rallies since the Great Depression.

Another silver lining is that the debt crisis in the EU now makes a June 1st interest rate hike by the Bank of Canada much less likely. This is positive, since high interest rates are always bad for the stock market.

RIMM cracks list of top five handset makers for the first time ever

A new report today from Gartner shows that Research in Motion (RIMM) cracked the top five list in mobile phone market share for the first time ever by placing 4th on the list. RIMM shipped 10.6 million phones to increase its market share to 3.4% in Q1 2010, from 2.7% in Q1 2009. Number 1 on the list is Nokia, with 35%, second place went to Samsung 20.6%, while LG finished third with 8.6%.


Mobile phones are widely used today. What is more important is the smartphone market, since sales of smartphones are increasing rapidly, while the sale of feature phones (cell phones that lack the features of smartphones) are in decline. In fact, a report shows that smart phone sales could equal feature phone sales in 2011. With today's report, the big question in this lucrative industry becomes: Which handset company's shares are the best to buy?

First of all, we can cross Nokia, Samsung and LG off the list. This is because all three companies lack popular smartphones. In addition, both Nokia and LG are seeing their market share decrease because of this (from 36.2% to 35% and 9.9% to 8.6% respectively).

In terms of RIMM, its shares closed today at $64.79, with a P/E ratio of 15.00. Now, Apple's (AAPL.Q) market share has been increasing at a faster rate than RIMM, from 1.5% in Q1 2009 to 2.7% Q1 2010. However, Apple is starting from a lower market share. More importantly, while Apple represents a faster growth rate, the shares are significantly more expensive, closing at a P/E of 24.42 today (versus 15.00 for RIMM). As for Google (GOOG), the market share of its mobile phones did not make Gartner's list. However, the market share of its operating system, Android, increased rapidly from 1.6% in Q1 2009 to 9.6% in Q1 2010. While this is an impressive feat, it is important to note that Google does not make any money from its Android operating system, since it does not charge phone makers such as HTC to use the Android.

All in all, Apple's mobile phone market and Google's Android operating system are both increasing market share faster than RIMM. However, with RIMM's earnings continue to increase at a rate of 20% per year, and with a P/E of 15.00, it is a much better buy than Apple. As for Google, while the growth in market share of the Android appears to outpace both RIMM and Apple, it is irrelevant since Google does not receive any revenue from selling/giving Android to handset-makers such as HTC.

Germany bans naked short-selling, but it's better to solve the problem than look for scapegoats

Germany today banned the naked short-selling on shares of its top 10 financial institutions. This ban also applies to credit default swaps (CDS) on Euro government bonds and Euro government bonds themselves.

Banning short-selling is a common tool that is used when there is turmoil in the markets. For example, during the financial crisis in late 2008, the US government banned short-selling in an attempt to prevent market declines. However, it was ineffective in preventing 300 and 400-point declines, since those still occurred after the ban was put in place. In fact, research has not shown that bans against short-selling actually decreases decline in markets. For example, the graph below shows that the Euro has been falling relative to the US dollar since November. This is due to debt issues in Greece and the PIIGS, and should not be blamed on short-sellers.


What European governments should realize is that rather than looking for scapegoats when stocks are falling, they should solve the underlying problem that is causing the decline. If the fundamentals of the Euro are strong, then few people would short the Euro and risk losing money. In this case, if the health of the German banks were strong, no one would short the shares of these banks and risk losing money.

I expect this ban to have no effect in slowing the decline in shares of German banks, the rise of the prices of CDS and the rise in yields of Euro government bonds. However, with this decision by the German government, it is very likely that other European governments such as France and PIIGS countries would follow with similar measures.

With an onslaught of fear from Europe and panic in the markets, it may be a good time to buy

Contagion fears from Europe continued today. In fact, the euro hit a 4-year low. This fear has caused the overall bearishness level in the markets to reach a high relative to recent months. The TSX closed today at 11,813, down 201.97 points or 1.68%. Commodities were particularly hard hit, with Teck Resources down $2.23 or 6.31% to close at $33.11, and South Gobi Resources down $1.30 or 11.30% to close at $10.20.

Contagion fears from Europe have caused the slide in commodities stocks, but China has also contributed. Measures by the Chinese government to cool the housing market has caused the Shanghai Index to be down 20% this year. Commodities stocks are heavily dependent on China, so stocks like Teck Resources have also seen a slide of about 20% this year.

However, despite bad news from Europe and China, it is a good time to buy. If you are currently underweight equities, it is a good opportunity to start adding commodities stocks such as Teck Resources and South Gobi Resources, especially with the former at a 6-month low while the latter is at a 10-month low . While contagion fears from Europe can have a negative impact in the markets for days or week(s) to come, with the TSX at 11,813, there is more upside potential than downside. In fact, I see strong support at the 11,600 point level on the TSX.