The Monday Edition- 1) Corporate Profits & Economic Cycles And 2) Opportunities In Brazil & Canada

By Yaser Anwar, CSC of Equity Investment Ideas

Corporate profits & Economic Cycles-

  • Given the weak forecast for real economic growth and developments in labor costs, I believe that corporate profit growth is set to slow. Why?
  • Unit labor costs in the nonfarm business sector are now growing faster than the prices nonfarm businesses receive for their goods and services. A deceleration in economic activity automatically causes productivity growth to weaken on a cyclical basis. ULC then climb because payrolls are not immediately pruned in the face of reduced output growth.
  • And since labor costs account for the majority of production costs, rising growth in labor costs vs. the growth in total revenues would be expected to have a negative impact on corporate profits. However, Fed rate easing cycles take hold when productivity is slowing and ULC are rising (at least in theory), and forward-looking inflation gauges so far are pointing down.
  • As a student of Economics, I’ve come to learn that in the old days (70s & 80s) it was possible to have a degree of confidence as to where we were within the context of a stable business cycle. Recently, it has been difficult to have a sense of confidence in one’s feel for the cyclical dynamics of the economy because technology driven globalization has changed so much in so many ways.
  • From the cyclical dynamics that dominate most markets (peak, contraction, trough & back) to a re-engineered global economy that has many more reciprocating parts. Until now the G.E. has shown a tendency to run more smoothly, in the context that- cyclical expansion phases have been longer and less asperous.
  • Before I end this section- Historically a move below 50% (in ISM, almost there) has been a good indication that the Fed would soon start to cut rates. The good news for manufacturers is that pricing pressures have receded, prices paid measure plunged in Oct., suggesting that the margin squeeze from high energy prices is easing.

Global Macro- Opportunities in Brazil & Canada

  • B: Torpid economic growth & receding inflation will enable Brazil’s CB to cut interest rates in the coming months. The combo of falling interest rates & inexpensive valuations should lead the market higher on a 6-12 month horizon, with financials (CIB, BBD) the main beneficiaries. Lower policy rates and declining inflation will keep the domestic bonds in bull mode (my favorite being the 3-yr yields for 13%).
  • C: By now you would have heard of the falling axe on Canadian income trusts. I believe there is a good opportunity here thanks to the Canadian FM Jim Flaherty. In a matter of hours there was billions of dollars in market cap. wiped out. So where is my opportunity?
  • Some income trusts now trade with extremely attractive dividends (PGH 17%, PVX 13.4%, PMT 19%). What you need to keep in mind is that the aforementioned stocks (and some more) have a 4-year exemption from paying corporate tax. So you’ll receive the same income streams until 2011.
  • Choose the best energy and resource income trusts you can find, buy ’em cheap. Enjoy the huge income streams for the next 4 years & who knows maybe the Canadian government decides to make an exception for the energy and NR sector? Four years is a long time in politics.

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