Wednesday Night #1284

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What will happen to the price of oil?
The recent predictable increase in the price of petroleum had been a matter of constant concern, especially considering the finite nature of petroleum reserves, the proliferation of automobiles, especially in China, North America’s love affair with the SUV and the ubiquitous use and disposal of plastics. The dream of a return to a thirty-dollar barrel seemed possible, but dreams tend to be unidimensional, ending abruptly on awakening to a totally different reality. In the short term, petroleum prices could attain fifty-five to sixty dollar levels, but the lack of investment in infrastructure over the period of low oil prices would appear to make future increases inevitable. Problems contributing to the inevitable increase include lack of dry docks to construct new tankers; the three-year lag for oil tankers to become operational; refineries are operating to capacity, the Chinese who today buy half as many cars per year as the U.S. and in three years will equal U.S, demand; and North Americans, whose demand for SUVs remains insatiable. In the UK 80% of cost of gas is tax so they do not see the wild fluctuations in price that has been experienced in North America.

Pension Plans
The nightmare of under-funded pension funds, airline and other bankruptcies, increasing longevity, lower birthrates and greater employee mobility continue to haunt those looking forward to aging in comfort. Although the trend from defined benefit to defined contribution schemes appears to be universally accepted as the only option in an aging population, different countries have sought and implemented various solutions to this common problem.
The UK trend is from defined benefit to defined contribution schemes. This means that employees, not the company, carry the investment risk including those of a shifting market or inaccurate actuarial calculations and how much pension the accumulated fund will buy on retirement; in defined contribution schemes there is no guarantee of income level at retirement.
Following broadly the recommendations of the Pensions Commission report, the UK government is proposing to restore the earnings link for the universal basic state pension, to revamp the contributory second state pension and to introduce personal savings accounts into which employees would be automatically enrolled (with an opt-out provision) and to which both employees and employers would have to make minimum contributions. One of the aims of the changes is to reduce the huge cost to the government of paying out additional means-tested benefits to low-income pensioners. A national pension savings scheme suggested at 8% of earnings would not build up sufficient funds to support an adequate pension for an employee entering the workforce.
It is planned that the state pension age would increase in stages from 65 to 68 by 2050 to reflect increases in life expectancy. Despite this, the cost of pensions will still increase from about 6% of GDP to around 7.5% by 2050. And the question remains whether those whose employment require mostly physical as opposed to intellectual skills, would be able to remain adequately physically active if their period of employment were to extend to the age of seventy or even to sixty-eight or sixty-nine.
The U.K. has established the position of Pension Fund Regulator and insurance fund, which, while not providing as great benefits as the pension plan, the basic state pension nonetheless provides some protection and ensures that pensioners are not left completely destitute. This fund is valid only in cases of employer bankruptcy, as in other scenarios, the benefits have not been defined.
Something similar to the British National Pensions Savings scheme is happening in the US The problem in the US is that the accounting laws were not changed soon enough to ensure that companies are recording their liabilities honestly. Although published reports indicate that the Pension Benefits Guarantee, operated by the Federal Government, is 23B$ under-funded, it is probably nearer to 100B$ and will rise to 400B$ when accounting rules change. This deficit cannot be covered The United States does provide more generous tax benefits to pensioners than does Canada, but encourages individual investment plans and costly insurance company retirement plans for its citizens.
Canada lies mid-way between the U.K. and the U.S., with fewer tax breaks on retirement. savings and without the ability to shelter savings to cover mortgage payments if one looses one’s job, as is the case in US. Canada has the Nanny –state mentality. There is some talk of reducing the tax burden on savings withdrawn from RRSP’s and RRIF’s to ease the burden on pensioners.
One of the peculiarities of Canada is the provincially-run investment entities such as the Caisse de Depôt in Québec. While there has been some concern that the possibility of conflicts of interest might lead them to be less efficient than private investment companies they do, in fact consult private companies and their historical track record has indicated that this concern is unwarranted. The very successful Ontario Teachers Pension Fund also manages its own risk rather than funding out to other institutions.

The Stock Market
In the stock market as in many areas, history tends to repeat itself, but Wednesday Nighters tend to have more faith in the historical record of our successful Analysts. Based on historical trends and the analysis thereof, the following picture emerges.
Although the end of the bull market may be near, it has not yet arrived. The market rose too fast at the beginning of the year but we have had minor corrections at the end of June in New York and in July in Toronto, followed by a big upturn, still within the bull market. Historically, September is the worst month of the year, but this year, an exception, saw the market rising in a strong recovery.
At the beginning of a bear market Toronto historically leads New York downwards, but not this year, thus the conclusion that the bull market continues.
Finally, historically, the end of the bull market is invariably marked by greed, as in the frantic buying of Nortel just prior to the bursting of the electronic bubble. This year, there was no similar frantic buying spree of energy stocks.
In short, the outlook for the market sees the New York market pausing and then once again rising until at least January and February as fund managers, flush with money accumulated since 1992 that must be invested, make their decisions.
Risks are the US deficit and the over-extended consumer in the US, however the outlook for next year is good – “make hay while the sun shines”.
Stocks to buy? Oil and gold are now attractive after the correction. Methanex, despite recent drastic corrections, is at an 11-year high and still interesting. Potash should go to $200.

International
Neither the North Korean nuclear explosion, a possible foreshadowing of a world crisis, nor ongoing concerns regarding the impact of climate change are expected to affect the market which maintains its own rhythm through world crises.

Political leaders
It is strange that the gods who have produced such bright, capable leaders in the areas of science and industry appear to have failed us in the realm of politics.
In the U.K., Tony Blair will be gone before next summer. It is anticipated that his successor will be fifty-five year old Dr. James Gordon Brown, Chancellor of the Exchequer.
In Canada, with Stephen Harper getting mixed reviews, Michael Ignatieff is leading the pack of Liberal leadership hopefuls. Although his brilliance is recognized and he appears to have succeeded in making inroads in Québec, his lack of familiarity with the inner workings of politics is a concern, especially for a party in such dire need of renewal. Those who are or may be supporting him as the number of candidates thins out, may or may not be thinking more of such personal issues as cabinet posts or other favors than of what is best for the country. As for Stephen Harper who has earned his laurels but must maintain his position or improve on it if he is to form a majority government, he is accused of lacking a real agenda to bring substantial change to the country.

The political outlook in Canada
Inexplicably, many in this province who supported Stephen Harper because they believed that his pre-election statements represented the direction that he would take the country, now appeared astonished that once in office, he has brought us closer to the U.S. in keeping with his pre-election agenda. This has lost him much support in Québec [Editor’s note: see his interview with Linda Frum in the National Post of Saturday September 16], critical for his possible re-election to head a majority government. [A further complication arises from the Dawson shootings: Jean Charest wants to focus the debate on the national gun registry, a program that Harper and the Conservatives have long resisted, and that Charest has now vowed to defend].

This makes the Liberal leadership race all the more interesting. Three credible candidates remain in the contest for leadership, namely Michael Ignatieff, Bob Rae and Stéphane Dion, each with strengths and weaknesses.

At first glance, Stéphane Dion should be the most viable candidate, brilliant, charismatic, fluent in both languages, and experienced in the politics of holding a cabinet post. However, he has become extremely unpopular in his own province, which currently holds the balance of power in any federal election.

Bob Rae has had the political experience, but in addition to being a recent reborn (or perhaps born for the first time) Liberal, he brings with him the additional baggage of a less-than-heroic record of fiscal management in Ontario.

By all measures Michael Ignatieff should logically be the front-runner. Extremely articulate, intelligent, frank, open and intelligent, his only real problem is his lack of experience in government. Government, especially at the provincial and federal level, is a business of humongous size and complexity. Without having served an apprenticeship, the unwritten rules and subtle human interdependencies risk transcending intelligent thinking or honest goodwill. Not having served that apprenticeship and learned from it, one is especially dependent on rivals, advisors and civil servants whose own ambitions are to be the major actors in running the government to the detriment of unsuspecting elected officials whom they feign to help. It is believed that it was this culture that led to the downfall of Paul Martin. If Mr. Ignatieff is to succeed he must learn to distinguish between what is true and what is politic.

Additional notes from Catherine Gillbert

Ian McFarlane: What will happen to the price of oil? It must rise again as the conditions that caused the last price-rise are still in place.  The lack of investment in infrastructure over the period of low oil prices.  Dry docks, oil tankers take 3 years to become operational. Demand in China will grow, at the present they are buying 50% of cars/ yr as US. In 3 years the demand will equal that of US.
80% of cost of gas in UK is tax so they do not see the wild fluctuations in price that has been experienced in North America,

Peter Ratzer on pensions
UK moving from defined benefit to defined contribution.  This means that employees carry the risk not the company.  Also there is no guarantees of income level at retirement.
The UK government has set up a National Pensions Savings Scheme to insure all workers have basic pension to avoid the huge cost to government of paying out additional benefits to low income pensionners. All employees are automatically registered although it is possible to opt out. Contributions, paid by both employer and employee, are set to meet liabilities. There is a suggestion is to raise retirement age to 68 by 2050.  It will take about 10 years to clean up the current deficits.

Ian
In the UK the projection is that pensions will rise from 6% to 71/2% of GDP by 2050 as the life expectancy continues to rise. Is this affordable?
Something similar to the British National Pensions Savings Scheme is happening in the US The problem in the US is that the accounting laws were not changed soon enough to ensure that companies are recording their liabilities honestly. Despite the media stating that the Pension Insurance Fund, operated by the Federal Government, is 23B$ under-funded it is probably nearer to 100B$ and will rise to 400B$ when the accounting rules change.  This deficit cannot be covered.
Defined benefit schemes are the only option in an aging population.
The difference in Canada is that we get fewer tax breaks on retirement savings and cannot use sheltered savings to cover mortgage payments if one looses one’s job as is the case in US.  Canada has the Nanny -state mentality.
What about public sector pensions.?  These will probably remain defined benefit. The argument is that in the public sector one makes less while working but has better benefits.

Caisse de depôt manages its own risk rather than funding out to other institutions; the Ontario Teachers Pension Fund also operates this way. There was some discussion on the advisability of this approach. Ron Meisels considers the Caisse to be a well-managed fund.

Ron suggested that one way to increase savings is to allow people to take out RRSP contributions at a lower marginal tax rate.

What about the self-employed? It was considered by some that they had received sufficient tax breaks while operating their company to save for retirement.

What about the stock market?
Ian: Market rose too fast at the beginning of the year but we have had the correction. Risks are the US deficit and the over-extended consumer in the US. Things look good for next year- “make hay while the sun shines”.
Ron: There was a minor correction at the end of June in New York and in July in Toronto.  September is traditionally the worst month in the year and this year we did OK.
Why should we be optimistic? Each bull market ends in greed when the small investor rushes in as the big people sell out. We have not seen that yet in this bull market. Also NY always leads Toronto and with New York leading the way we are heading in for more increases.
Stocks to buy? Oil and gold are now attractive after the correction. Methenex is at an 11-year high but still interesting.  Potash will go to 200$

What is effect of Korean bomb on the markets? Not much.  Portfolio managers have too much cash on hand and will be forced to invest in the market or the bosses will suggest moving it too bonds.

We then had a short discussion on the political situation in the UK. It seems unlikely that anyone can beat Gordon Brown for the next leader of the Labour Party.

In Canada the Liberal Leadership is still an open race.

The Prologue

There was a time when October 12 was Columbus Day in the U.S. Now, Columbus Day – or at least the holiday – is a somewhat movable feast, generally coinciding with Canadian Thanksgiving. We, however, quite like the symbolism of October 12, celebration of the great Discoverer (even if he had no idea what he had found) as a symbol for Wednesday Night and thus are pleased that this Wednesday Night falls on the eve of Columbus Day. Like Columbus, we frequently undertake voyages with definite goals, only to turn up in uncharted lands, whence we emerge with new ideas, but no clear idea of how we arrived at them.

Last Wednesday was, of course, not that kind of intellectual voyage. With Stéphane Dion as a guest, we had a pretty good idea of where we were headed and what we might discover when we arrived. We were not disappointed. There were a few pleasant surprises, and, as anticipated, the crew was enthusiastic and competent, the land we visited fertile, rich in ideas, and our guide was reliable.

This week’s voyage is less predictable,- more in the Columbus mode. We will certainly anchor for a while in the not-so-tranquil waters of pension funds, with able helmsman Peter Ratzer. Although we cannot be present at the first of this year’s Massey Lecture tour with our beloved Margo Somerville, we will run up the requisite signals of congratulation and hope that a shore party may come alongside later in the evening to give us news of the event. In the meantime, the sounds of drums in the wilderness have aroused our interest – if not dread – and it is likely that we will navigate the rough waters of the Yellow Sea and the Atlantic Ocean to seek the truth about North Korea‘s nuclear capability and world reaction, not to mention possible impact on U.S. congressional elections. Will the public believe that this new development requires support for the Administration, or will the Christian Right persuade voters to stay focused on issues of bribery, corruption and worse.

We have barely dipped our oars in the waters and feel sure that many other discoveries await us. With luck, we may return to post-Raj India for further exploration. On our Wednesday Night chart we see shoals with names like Iran, Iraq, the United Nations … bring your sextant and join us.