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The Failure Of Google Glass Is A Useful Warning To Investors

Google_Glass_with_frameLast week Google announced that it would not be proceeding with another round of Google Glass for 2015, meaning that the most ambitious experiment in wearable technology had come to an end. Google Glass has many failings, ranging from looking stupid to attracting angry mobs of people, but it did seem to be the vanguard of wearable technology. Wearable tech has attracted a great deal of attention, both from consumers and investors, but I have a feeling that it’s rise may be overstated.

For the most part wearable technology is a subset of the “internet of things“, the growth of cloud computing, mobile sensors and high speed communication between stuff. The most beneficial forms of this could be about smart city grids communicating with cars to smooth traffic flows and reduce congestion. In reality it is largely counting how many steps you take everyday.

Looking past the incredible number of terrifying elements about our privacy and data mining that go along with these devices, by and large most wearable technology hasn’t really taken off. Google Glass may be a high end flop, but the vast amount of wearable devices on the markets today have yet to win over big audiences. They remain largely niche devices with a high drop off rate. Where as people adopted smartphones on mass, many people have just shrugged their shoulders and moved on, while those that do buy into wearable tech often stop using it after a few months. This suggests that there is a disconnect between understanding what smartphones get right and wearables get wrong.

That gap is clearly frustrating tech companies, and it will be interesting to see whether Apple’s first wearable device, the Apple Watch, is able to change the pattern. But for investors the allure of the new as a reason to invest should be tempered, and excitement over the prospect of “the next big thing” and the importance of getting in on the ground floor may prove financially costly.

Take for instance TESLA Motors (TSLA: Nasdaq). Tesla may be a car company, but it is treated like a technology company on the stock market, meaning that it is currently trading with a ridiculous P/E ratio, close to 130x next years earnings. Put simply, if Tesla were to pay out all of its earnings to its shareholders it would take 130 years (given current earnings) for you to receive the equivalent value of what you paid for a share. That gives Tesla, a company that sells cars by the thousands a market cap similar to General Motors, a company that sells cars by the millions.

That’s crazy, but normal for the tech world. This has been exceptionally true social media sites like Twitter, Linkedin and Pinterest. All of them also trade well and above “normal” valuations, especially given that they don’t make anything.

The lesson for investors is to be cautious about technology companies. They come with a host of pitfalls and unique qualities that are frequently glossed over in the excitement of the new. Investors have been swept up before with the prospect of some great new device that can’t go wrong, but with some notable exceptions much technology often finds itself on the scrapheap of history. Or maybe we will all start carrying around smart glasses for every beverage

 

Russia’s Entire Stock Market is Worth Less Than Apple Computers

Let's just call this what it is. Awkward.
Let’s just call this what it is. Awkward.

A few days ago a bizarre inversion took place. A single company was suddenly worth more than the entire investable market size of a major economy. While I like Apple a lot and applaud the incredible profitability of the company, this is more a story about how badly the Russian economy is doing.

Back when Russia was first inciting dissent inside the Ukraine following the ouster of the quasi-dictator running the country, it had banked on the idea that it’s continued escalation inside the borders of a sovereign nation would go unchallenged as few countries would wish to risk a military skirmish over a single, marginal country in Europe.

Vladimir Putin miscalculated however when he didn’t realize how precarious the Russian economy was. Sanctions were implemented and what followed was a largely hollow trade war that did more to identify Russia’s weakness than strength. But the most recent blow to Russia has been the change in the price of oil.

Screen Shot 2014-11-21 at 12.31.04 PMNow that the price of oil is under $80, Russia is suffering severely. Like many oil rich nations, oil exports substitute for taxes. This frees autocratic rulers to both pursue generous social programs while not having to answer to citizen complaints about high taxes. It’s how countries like Saudi Arabia  and Iran get by with little democratic input and a relatively passive population with little to no public disobedience about democratic rights (mostly).

This relationship though means that there are actually two prices for oil. First the breakeven price for extracting oil from the ground, and second break breakeven social price of oil. Those prices are different in every country. In Alberta for instance, tar sand oil is usually quoted at $70 a barrel for breakeven. But to cover the costs of running the government the price is much higher. For Russia the slide in price from $109 a barrel to $80 has meant wiping out it’s current account surplus.

Combined with the falling rouble (now 30% lower than the beginning of the year) and the growth of corporate debt sector, Russia is now in a very precarious situation. I’m of the opinion that energy, and energy companies have been oversold and a rise in price would not be unexpected. But whether the price of energy will bounce back up to its earlier highs from this year seems remote.

This is a stock photo of a guy thinking. Could he be thinking about where to invest his money? He could be. It's hard to tell because he was actually paid to stand there and look like this and we can't ask him.
This is a stock photo of a guy thinking. Could he be thinking about where to invest his money? He could be. It’s hard to tell because he was actually paid to stand there and look like this and we can’t ask him.

Over the last few months I’ve been moving away from the Emerging Markets, and while the reasons are not specifically for those listed above, Russia’s problems are a good example of the choices investors face as other markets continue to improve their health. If you had a dollar today that could be invested in the either the United States or Russia, who would you choose? The adventurous might say Russia, believing they could outlast the risk. But with more Canadians approaching retirement the more sensible option is in markets like the US, where corporate health is improved, debt levels are lower and markets are not subject to the same kind of political, economic and social instability that plagues many emerging economies.

 

How To Invest In Energy When You Hate Volatility

***This post will refer to both a mutual fund company and a particular fund. This post should not be construed as endorsing that fund. We always make sure that we cite our sources and in this instance our source is a fund company, and we are not suggesting in any way that you should invest in or purchase this fund. If you are interested in any fund, please consult with your financial advisor first for suitability, especially if that financial advisor is us!*** 

frackingSince the price of oil dropped there have been lots of reasons to be excited. First the price of gas at the pumps is so low that I don’t hate going there anymore. Second, investments in energy have suffered since oil lost close to $30 in value.

WTI price over the last 6 months. From NASDAQ.com
WTI price over the last 6 months. From NASDAQ.com

And while energy stocks have recovered somewhat from their low points, they are still way off where they were earlier in the year. I’m not going to get into the finer points about the nuances of energy producers and the various types of oil and  costs of production. It’s a worthwhile article, but will take up too much time here. Instead I wanted to focus on a different way that Canadians can participate in the energy sector.

Commodities can be volatile but also a valuable element of a portfolio. So how can Canadians play the energy sector while being mindful of the risks associated with it?

The answer may be by investing in what is called “Midstream MLPs”. Midstream MLPs (Master Limited Partnerships) are American operators that transport energy from the producers to the consumers. It’s a capital intensive business that is federally regulated but traded on the stock market. It therefore provides consistent cash flow while offering liquidity to investors. But Canadians already have opportunities for energy infrastructure, so why should they care about this in the United States?Midstream2The answer has everything to do with the rising levels of oil production in the United States combined with what federal regulators are willing to do to encourage new growth.

That brings us to the growth of the shale revolution in the United States. Newly discovered reserves (of significant size), improved technology and a dropping costs of production have set the US on a course to be the largest global energy provider in the coming years. This combination of efficiencies means that the United States is going to continue to increase its oil production over the next decade, while dropping the cost of extraction for each additional barrel. But each barrel produced has to go somewhere.

Projected Oil Growth in the United States
Projected Oil Growth in the United States

In the United States, Midstream MLPs are responsible for moving that oil. But it’s a sector that also must grow. Infrastructure to move oil efficiently from shale producers doesn’t exist yet, and regulators are eager to get MPLs in place with new development. New infrastructure is costly, and while the business model for an MLP doesn’t require a high price for energy to be profitable, it does need assurances about the consistency of the volume of oil to be moved. To encourage that growth regulators are allowing the price that MLPs charge to rise at a rate faster than inflation. Why are they doing that? Much of the shale oil is having to be shipped via rail to get to its right home. This causes price disparities that reduces producer margins and rankles federal governments.

 Pipelines in the US. Most of the pipelines direct energy to Texas, which isn't set up to handle the ultra light crude from shale projects. that energy, coming out of North Dakota, needs to get to New Jersey. The lack of pipelines means it is being shipped by rail to Chicago and then via pipeline.

Pipelines in the US. Most of the pipelines direct energy to Texas, which isn’t set up to handle the ultra light crude from shale projects. that energy, coming out of North Dakota, needs to get to New Jersey. The lack of pipelines means it is being shipped by rail to Chicago and then via pipeline.
The various prices of oil. Oil from Canada is sold at a discount while Brent crude is sold at a premium to WTI. Improving infrastructure would rectify this problem and equalize prices. (The WTI price is listed from the summer). Click on the image to see it larger.

 

Currently there is only one fund option in Canada that we are aware of for investing in MLPs. We had an opportunity earlier this week to meet the managers of this fund and were greatly impressed by what they had to show us. I am already a big believer in the growing Shale Revolution, and am particularly pleased by the arrival of new opportunities for investment. Growth in the Canadian and American energy sectors is good news for not just investors, but also citizens. Russia, Saudi Arabia, Venezuela and a host of other despotic and semi-despotic regimes have been able to get by on the high price of oil. Now they are feeling the pinch of a decreasing price that has the benefit of bringing jobs back to North America while weakening their influence. In all, this is a good story for everyone.

Want to talk oil? Send us a message!

 

 

What Your RRSP Should Have In Common With The CPP

rrsp-eggTo many Canadians the CPP is something that you simply receive when you turn 65, (or 70, or 60, depending on when you want or need it) with little consideration for how the program works or is run. That’s too bad because the CPP is successful, enlightening and puts its American counterpart, Social Security, to shame.

You’ve probably heard American politicians decrying the state of Social Security, claiming that it is broken and will one day run out of money. That’s a frightening prospect for those who will depend on it in the future. Social Security is a trust that buys US debt, and its use of US Treasuries (low risk debt issued by the US government) is crippling that program and even puts it at odds with attempts to improve government financial health (it’s more complicated than this, but it’s a useful guide). In comparison the CPP isn’t bound by the same restrictions, and operates as a sovereign wealth fund.

A sovereign wealth fund is simply a fancy way to describe a program that can buy assets, which is exactly what the CPP does. The Canada Pension Plan may be larger and more elaborate than your RRSP, but it can look very similar. The CPP has exposure to Canadian, American, European and Emerging Market equity. It invests in fixed income both domestically and abroad, and while it may also participate in private equity deals (like when the CPP bought Neiman Marcus) in essence the investments in the CPP are aiming to do exactly what your RRSP does.

CPP Breakdown

The big lesson here is really about risk though. The CPP is one of the 10 largest pension plans in the world. It’s wildly successful and is run in such a way as to be sustainable for the next 75 years. The same cannot be said for Social Security. But by taking the “safest” option Social Security is failing in its job and will run out of money by 2033. But by buying real assets and investing sensibly the CPP is far more likely to survive and continue to thrive through all of our lifetimes.

What’s also notable is what the CPP isn’t trying to do. It isn’t concentrated in Canada. It doesn’t need to get a substantial rate of return, and it doesn’t need every sector to outperform. It needs consistent returns to realize its goals, and that’s how it’s positioned. By being diversified and not trying to time the market, the CPP finds success for all Canadian investors.

I’ve said in conversation that if there was an opportunity to invest directly in the CPP I would take it. However until then the best thing investors can do is take the CPPs lessons to heart!

Canada Has Always Been a Weak Economy

real-estate-investingIt may come as a real surprise to many Canadians but we have never been a strong economy. From the standpoint of most of the world we barely even register as an economic force. Yet a combination of global events have conspired to make Canadians far more comfortable with a greater sense of complacency about the tenuous position of Canada’s economic might.

Don’t get me wrong. It’s not that Canada and Canadians aren’t wealthy. We are. But having a high standard of living is largely a result of forces that have been as much beyond our control as any particular economic decisions we’ve made.

Consider for a second the size of Canada’s economy in relation to the rest of the world. While we may be one of the G8 nations, the Canadian economy only accounts for about 2-3% of the global GDP, and has (according to the IMF) never been higher than the world’s 8th largest economy. Even with the growth in the oil fields Canada hasn’t contributed more than 2.8% to global growth between 2000 and 2010.

nortel-21
The Rise and Fall of Nortel Stock.

It’s not just that Canada isn’t a big economy, we’re also a narrow one. In the past we’ve looked at how the TSX is dominated by only a few sectors, but the investable market can play even crueler tricks than that. If you can remember the tech boom and the once great titan Nortel, you might only remember their fall from grace, wiping out 60,000 Canadian jobs and huge gains in the stock market. What you should know is that as companies get bigger in the TSX they end up accounting for an ever greater proportion of the index. At its peak Nortel accounted for 33% of the S&P/TSX, creating a dangerous weighting in the index that adversely affected everyone else and skewed performance.

Similarly much of Canada’s success through the 90s and early 2000s had as much to do with a declining dollar. While it may be the scourge of every Canadian tourist, it is an enormous benefit to Canadian industry and exports. Starting in 2007 the Canadian dollar began to gain significantly against the US dollar. This sudden gain in the dollar contributed to Canada’s relative outperformance against every global market. The dollar’s rise was also closely connected to the rise in the value of oil and the strong growth in the Alberta oil sands.

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This mix of currency fluctuations, oil revenue and narrow investable market has created an illusion for Canadian investors. It has created the appearance of a place to invest with greater strength and security than is actually provided.

Some studies have shown that the average Canadian investor will have up to 65% of their portfolio housed in Canadian equities. This is insane for all kinds of obvious reasons. Obvious except for the average Canadian. This preference for investing heavily into your local economy has been coined “home bias” and there is lots of work out there for you to read if you are interested. But while Canadians may be blind to the dangers of over contributing to their own markets, it becomes obvious if you recommend that you place 65% of your money in the Belgium or the Swedish stock market. However long Canada’s relative market strength lasts investors should remember that all things revert to the mean. That’s a danger that investors should account for.

What Investors Should Know After Europe’s Terrible, Horrible, No-Good Month

cartoon spin bull vs bearFalling inflation, terrible economic news and a general sense of dread for the future seems to have once again become the primary descriptive terms for Europe. Earlier this year things seemed to have improved dramatically for the continent. On the back of the German economic engine much of the concern about the EU had been receding. 2013 had been a good year for investors and confidence was returning to the markets. Lending rates were dropping for the “periphery nations” like Portugal, Greece and Ireland, giving them a fighting chance at borrowing at affordable rates. But first came the Ukrainian/Russia problem which caused a great deal of geo-political instability in the markets. Then came October.

I don’t know if Mario Draghi cries himself to sleep some nights, but I wouldn’t blame him. Despite the best efforts of the ECB, Europe looks closer to being in a liquidity trap then ever. Borrowing rates are not just low, they’re negative, with the ECB charging banks to now to deposit money with them. October also ushered in a string of bad news. For Germany, easily the biggest part of the Eurozone’s hopes for an economic recovery, sanctions against Russia have hurt the manufacturing sector. Germany began the month announcing a steep and unexpected decline in manufacturing of 5.7% in August, the biggest since 2009. This news was followed by criticisms of Germany’s government for not doing more infrastructure investment and being too obsessed with their strict budget discipline. Yesterday 25 banks in the Eurozone failed a stress test, a test that was meant to allay fears about the health of the financial sector.

For Europe then things look bad and even if the situation corrects itself over the next few months (sudden shifts in the economy may not always be permanent and can bounce back quickly) the concerns over Europe’s future will likely undermine any efforts by the ECB to properly stimulate the broad economy and encourage investment on a mass scale. By comparison it looks like the United States is having a party.

The US economy seems to be on track to grow, and as the world’s biggest economy (though there is some dispute) the country is fighting fit and especially lean. Cheap oil from shale drilling is helping the manufacturing sector, making the United States more competitive than South Korea, the UK, Germany and Canada, and the sudden drop in the price of oil is a boon to the US consumer to the tune of nearly 50 billion dollars. Consumer confidence is up, as is spending. Debt levels are down, both for companies and households. Most importantly the economy seems to be tipping over into an expansionary phase, with corporations finally starting to put some of their money to work.

Screen Shot 2014-10-28 at 12.22.48 PM

The coming months could be interesting for investors as we return to a time where once again focus is on the US as the world’s primary economy.Screen Shot 2014-10-28 at 12.32.45 PM The concerns of 2008, that the American consumer was done, the country had seen its best days and its corporations would never recover seem far fetched now. Worries over hyper-inflation are as distant as a the never arriving (but inevitable) rate hike from the Federal reserve. Worries about Great Depression levels of unemployment are problems of other nations, not the US with its now enviable 5.9%, now encroaching on full employment. Old villains seem vanquished and even Emerging Markets, long thought to be entering their own golden era, are now taking a back seat to the growing opportunities coming out of the US.

Investors should sit up and take note. It’s possible that the best is still yet to come for the US markets, and if market conditions continue to improve this bull market could prove to be a long one.

The Zombie Apocalypse and Investing

If 2008 was the financial apocalypse it is often written about, it is a zombie apocalypse for sure. It’s victims don’t die, they are merely resurrected as an infected horde threatening to infect the other survivors. And no matter how many times you think the enemy has been slain, it turns out there is always one more in a dark corner ready to jump out and bite you.

This past month has seen the return of the zombie of deflation, a menacing creature that has spread from the worst ravaged economies in Europe into the healthier economies of the Eurozone. Deflation is like the unspoken evil twin that lives in the attic. I’ve yet to meet an analyst, portfolio manager or other financial professional that wants to take the threat seriously and doesn’t insist that inflation, and with it higher interest rates are just around a corner.

The eagerness to shrug-off concerns about deflation may have more to do with the reality that few know what to do when deflation strikes. Keeping deflation away is challenging, but not impossible, and it has been the chief job of the central banks around the world for the last few years. But like any good zombie movie, eventually the defences are overrun and suddenly we are scrambling again against the zombie horde.

This. Except it’s an entire economy and it won’t go away.

In the late 1990s, Japan was hit with deflation, and it stayed in a deflationary funk until recently. That’s nearly 20 years in which the Japanese economy didn’t grow and little could be done to change its fate. The next victim could be Europe, whose official inflation numbers showed a five year low in September of 0.3%. That’s across the Eurozone as a whole. In reality countries like Greece, Spain and Portugal all have negative inflation rates and there is little that can be done about it. Pressure is mounting on Germany to “do more”, but while the German economy has slowed over the past few months it is still a long way from a recession and there is little appetite to boost government spending in Germany to help weaker economies in the EU.

Japanese GDP from 1994-2014
Japanese GDP from 1994-2014

Across the world we see the spectre of zombie deflation. Much has been made of China’s slowing growth numbers, but perhaps more attention should be paid to its official inflation numbers, which now sit below 2% and well below their target of 4%. The United States, the UK, the Eurozone and even Canada are all below their desired rates of inflation and things have gotten worse in this field over the summer.

What makes the parallel between this and a zombie apocalypse so much more convincing is that we have squandered some of our best options and now are left with fewer worse ones. Since 2008 the world hasn’t deleveraged. In fact governments have leveraged up to help indebted private sectors and fight off the effects of the global recession. Much of this come in the form of lower (from already low) interest rates to spur lending. But when the world last faced global deflation the cure ended up being broad based government spending that cumulated in a massive war effort. By comparison the debts of the government haven’t been transformed into lots of major public works initiatives, instead that money has sat in bank accounts and been used for share buybacks and increases in dividends.

For investors this is all very frustrating. The desire to return to normalcy (and fondly remembering the past) is both the hallmark of most zombie films and the wish of almost every person with money in the market. But as The Walking Dead has taught us, this is the new normal, and investing must take that into account. Deflation, which many have assumed just won’t happen, must be treated as a very likely possibility, and that will change the dynamics of opportunities for investment. It leads to lower costs for oil and different pressures for different economies. It will also mean different things for how people use their savings for retirement and how they will seek income in retirement. In short, the next zombie apocalypse can likely be defeated by paying attention and not keeping our fingers in our ears.

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If it were only this simple….