It’s All About Oil Prices
Governments Insist on Lowering Oil Prices
The bogeyman known as inflation kept raising its head this quarter even though oil prices started to fall from the $120 peak in June to less than $80. Now it appears OPEC wants to throw their hat in the ring by putting a squeeze on supply which may force oil prices back up again. This has added to inflationary pressures, and with most Governments wanting inflation to be in a relatively narrow range – say 2% per year – they are showing their willingness to raise short term interest rates to kill economic demand and slay the inflation bogeyman once and for all. For example, the US prime rate, which is the rate charged by banks to their best customers, has risen from 3.25% in mid-March this year (a 10 year low) to 6.25% currently (a 10 year high). A little draconian perhaps?
Oil Price Chart is from Macrotrends.net
What About Bonds?
According to the Government of Canada, the yield on a 2-year Government Bond is currently above 4% while a long-term bond (over 10 years) yields roughly 3.25%. This inversion of having shorter term bonds yield more than longer term does not happen often. Generally, when this happens interest rate head down soon afterwards or normalize such as happened in 1981 and 1990 which turned out to be excellent times to buy and hold long term bonds. I am sensing something similar may happen today. For investors holding a 60/40 split on their investments between stocks and bonds, now would be a good time to go longer term on their bonds or “extend their maturity”. Using 1981 as an example, rates started dropping in September of that year with the equity market bottoming out some 9 months later as the economy slowed dramatically in 1982.
Some Value Examples?
What I find interesting is the number of bargain securities that can be purchased today. Pessimism has a way of holding stock prices down and some obvious bargains have presented themselves which might mean this pessimism is a bit exaggerated. For example, AGF the stock currently trades at what Peter Cundill would refer to as the magic 6s. It has a price/earnings ratio under 6, a yield of over 6% on its dividend and trades at a price/book of less than 6 with virtually no debt. The news for AGF has improved recently as the regulators have disallowed the use of deferred sales charges on fund sales. This means AGF does not have to upfront any commissions to salespeople as it did previously and administrate cost will also be reduced. For example, it is downsizing staff in its head office and also reducing its cost structure. Earnings for the latest quarter were 32 cents per share which, if you annualize, would be $1.28 on a $6 stock or an earnings yield of over 20% per year. While I am only using this as an example, I should disclose I recently purchased some shares myself.
Another example is Canadian Western Bank shares which traded at over $41 per share just last November and today closed at $21.63 which means a price/book of under 60 cents on the dollar. Laurentian Bank of Canada trades at less than 50 cents on the dollar. What this means is that if you and I got together and wanted to form a bank like Canadian Western it would cost us roughly $4 billion today in equity. Then time and effort to set everything up like offices and staff hiring and attracting clients. Or, we could simply put in an order from our smartphone without getting out of bed to buy some shares at $21 when we know they are worth just under $40. If we could get the whole Company at today’s price it would cost us just $2 billion.
With the markets willing to prove the majority wrong as they always do, I would think interest rates will begin to fall, making bonds a good investment choice. Until they do, stocks will likely muddle around at this level unless signs of a recession win out.
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