Top of the Morning

A recent report from the Geneva 16 notes the continued build-up of debt on a global scale and concludes that “developed economies at least must expect prolonged low growth or another crisis along the way.” On her blog, economist Frances Coppola delves into what this report overlooked and identifies the real problem associated with growth of total debt outstripping the pace of the global economy’s expansion:

Global debt, it seems, is a terrible problem.

None of this will come as a surprise to anyone, except perhaps the news that the world as a whole is actually accumulating debt rather than deleveraging. The deleveraging efforts by developed countries are being more than offset by the increasing debt of emerging markets, particularly China.

But as I read the report, I found myself wondering why there was no discussion of the other side of all this. Who are the owners of all this debt?

There is a simple answer to this. Households and corporations own this debt. It is the savings of households and the uninvested profits of corporations…

Reports such as this, that look on debt as a problem and ignore the associated savings, fail to address the real issue. The fact is that households, corporations and governments like to have savings and are terrified of loss. Writing down the debt in which people invest their savings means that people must lose their savings. THIS is the real “shock, horror”. This is what people fear when they worry about a catastrophic debt default. This is what the world went to great lengths to prevent in 2008. The problem is not the debt, it is the savings.

If we really wish to reduce the global debt pile, we must either accept that the households, corporations and governments that currently own that debt must take losses, or find alternative investment vehicles. The problem, of course, is that potential replacements are either illiquid (property), risky (equities) or volatile (commodities).

On the Homefront

TSX 60 futures are moving lower ahead of the open after the composite index took a hit on Tuesday.

 

The Canadian dollar continues to linger near its lowest level of the year, trading around 0.892 against the greenback.

 

The yield on the five-year Government of Canada bond has sunk below 1.62 percent overnight.

 

Oil crushed. The bottom fell out of crude oil on Tuesday following a report from Reuters that claimed OPEC’s oil production jumped by 3 percent month-over-month in September to levels not seen since November 2012. As one would expect, supply growth that exceeds the pick-up in demand has put immense downward pressure on prices. This drop-off in oil weighed on the TSX on Tuesday, with the Energy sector serving as a key drag on the index. The run-up in prices early in the year helped Canada’s benchmark index outperform its American counterpart by a substantial margin; continued declines will likely see the gap between the TSX’s year-to-date gains and the S&P 500’s vanish completely.

 

A spot check on the state of the manufacturing sector. At 9:30am (EDT), the RBC Canadian Manufacturing Purchasing Managers’ Index (PMI) for September is scheduled to be released. This long-soft sector has been picking up steam recently, buoyed by a firming U.S. economy and, to a lesser extent, a lower Canadian dollar. In July, manufacturing sales rose to a record high (though in volume terms, there’s still much progress to be made!), while August’s PMI hit its highest level since November 2013, suggesting that the sector’s momentum was increasing.

 

Ebola drug maker in the spotlight. Shares of Tekmira Pharmaceuticals (TKM) spiked in the after-hours session on Tuesday and are up about 30 percent in the pre-market trade this morning. After the close, the U.S. Centers for Disease Control and Prevention confirmed that the first case of ebola on U.S. soil had been diagnosed. Tekmira, which has an experimental treatment for the deadly virus currently being used in Africa, saw investors instantly bid up the stock on this news.

 

The agenda for Canadian Pacific Railway’s investor day. Under the leadership of Hunter Harrison, Canadian Pacific Railway (CP) has managed to boost efficiency to bring its operating ratio more in line with (but still below) its rival, Canadian National Railway (CNR). However, at today’s meeting with shareholders, Harrison will strike a different note, outlining how he plans to grow the top line, and how that translates into better results on the bottom line, writes The Globe and Mail’s Eric Atkins. On Monday, the iron horse said that it was more than doubling the maximum number of shares it may repurchase under the buyback program that began in mid-March.

 

Canadian pharma giant on a tear. Valeant Pharmaceuticals (VRX) has strung together five consecutive sessions in the green on Bay Street, with Tuesday’s gain coming despite a written notice from the U.S. Food and Drug Administration indicating that the production, storage, or installation of one of its anti-wrinkle treatments failed to adhere to the agency’s regulations. During this streak, the stock has risen more than 14 percent to hit a level that puts its offer for Allergan above $180/share – a price that many of the Botox maker’s shareholders are said to be happy with. By comparison, Canada’s benchmark is down 1 percent over the same stretch.

 

Canadians fleece foreign investors. Though Canadians are often wary about foreign ownership of our natural resources, perhaps these fears are largely misguided. Foreigners end up paying a premium for these assets, and often experience buyer’s remorse. Two cases in point: Japanese Marubeni Corp. is selling its stake in a Canadian coal mine for $1 after the firm paid $1 billion to acquire it in 2011, and a Wall Street Journal article that details the experience of a Chinese company whose Canadian Bakken oil play isn’t going nearly as well as expected. “Mr. Ni in 2007 targeted production of 20,000 barrels of oil a day within Canada Capital Energy Corp.’s first five years of business,” Chester Dawson writes. “Yet the company pumped 567 barrels of oil a day last year, according to the Saskatchewan government, and has forecast production in the mid-thousands of barrels of oil and natural-gas liquids by early next year.”

 

Provincial governments need to get their act together. On Tuesday, the Parliamentary Budget Officer published a report examining the sustainability of debt at the federal and subnational (primarily provincial) levels. In short, the former is on a solid path, but thanks in large part to rising health care costs, the latter is not. The authors urged provincial governments to take action to reduce excess health care spending (that which cannot be explained by the growth in incomes or attributable to the aging population) to help get their collective fiscal house in order. If current policy is not altered, subnational debt is projected to rise to 338 percent of GDP by 2088.

Daily Dispatches

The Japanese manufacturing sector isn’t doing too badly, according to a pair of surveys released on Tuesday night. The TANKAN survey showed that large firms plan to boost capital spending by 8.6 percent this year, while the nation’s Markit PMI suggested that the sector is expanding at a modest clip. “This survey [the TANKAN] will do little to change the view that the JPY is simply a horrible currency to own,” writes IG chief market strategist Chris Weston. “USD/JPY has been heavily traded today and, after a brief dip following the TANKAN release, saw strong bids coming back into the market, with ¥110 acting as a magnet.” Prior to Tuesday evening, this pair hadn’t breached the 110-mark since August 2008.

 

Manufacturing in the euro area was mixed in September. On one hand, France’s PMI rose to a four-month high of 48.8 (which suggests the sector is contracting, but at a slower rate), while Italy’s PMI bounced back from a sub-50 reading in August to jump back into expansionary territory. But in another sign that the euro zone’s economic engine is stalling, Germany saw its PMI dip into contractionary territory and sink to a 15-month low. “September’s eurozone PMI makes for gloomy reading,” writes Chris Willliamson, chief economist at Markit. “The euro area’s manufacturing economy has lost the growth momentum seen earlier in the year, lurching closer to stagnation.”

 

The time is right for countries to invest in infrastructure, according to research from the International Monetary Fund. “In a sample of advanced economies, an increase of 1 percentage point of GDP in investment spending raises the level of output by about 0.4 percent in the same year and by 1.5 percent four years after the increase,” the article reads. Arguments in favour of these public works projects are often associated with classic Keynesian stimulus, and this one is no exception. The authors note that increase to output in the short-term is “substantially larger” when infrastructure spending occurs when an economy still has room to grow following a negative economic shock. The kicker: this debt-financed spending can, in theory, not lead to an increase in a country’s indebtedness. The authors stress that if performed correctly, the increase in growth attributable to infrastructure spending is as large as or larger than the cost of the project.