I have written several articles on combination theory.A combination is a mini-merger.A small number of shares(from 5 to 25%) can be purchased which gives the acquiring company a chance to train or apprentice as the owner of the smaller company.I have ,in an earlier blog, on both Wordpress and Tumblr discussed the possibility of Temple Hotels starting a combination with Lanesboro REIT.Both are reits and both own properties in the Canadian north.In particular, properties in Fort Macmurray.
Needs and Resources
Lanesboro has only $5 million left in it's revolving loan credit facility.It has refinanced it's mortgage loans at better interest rates but there is no more financing capacity left on their mortgages.Lanesboro has stated that it intends to sell another property before the end of the year but does not state the location.It also had a small operating loss in the last quarter.However it still has about $125 million in shareholder equity and $475 million in assets.Temple Hotels (TPH) has hotels in Fort Macmurray and hotels throughout Canada but it only has hotels. Lanesboro (LRT) has extended stay properties and senior residences.Both have properties in Fort Macmurray and both are affected by the drop in occupancy rates.There is getting to be more competition especially for hotels.But the occupancy rate has stabilized.It was about 90% in 2013 and fell to 86% and then 80% in Q1 2014.Now it is back to 89%.However both TPH and LRT want an occupancy rate of 96 to 98%.
LRT needs some cash to renovate their big project called Parson's Landing.Quite a few suites have been renovated but it is still only 94 % complete.LRT will be strapped for cash as it has only $5 million left on it's credit facility. On the other hand, TPH made $15 million Operating Income for 9 months and has about $15 million cash on hand.This is a chance for a combination.TPH also has only 69% of it's assets in debt and could increase one of it's convertible debt issues;it has four series and lots of debt capacity left.
The Proposal
Right now Lanesboro shares are trading at about $.80 per share.TPH could buy 8 million shares for about $8 million.This would give it less than 35% as the price would go up for a large block but it would probably give it 50 to 65% and the start of a combination.TPH might sell off an older property that it has lots of equity in and has lower occupancy rates.This would give it higher occupancy rates overall and the cash necessary to help it's 30% owned partner to improve Parson's Landing.Some renovations to other Fort Macmurray properties might raise the occupancy rates on both TPH and LRT properties.Higher occupancy rates on the "Fort" properties would have great impact on profit margins for Temple Hotels and it's 65% owned partner.This combination stage would give both partners a chance to improve operations and margins and see if they want to go further.
Saturday 29 November 2014
Sunday 23 November 2014
Northland Power -very busy but still on track
On November13,2014 Nothland Power released it's third quarter results and their key financial indicators are still growing.Northland intends to take a 60% interest in a 2.8 billion Euro capital cost project called Gemini in the North Sea. $286 million was already raised in Q2 and more was raised in Q3.Now it announces that it is taking a 85% interest in another large project just offshore of Germany called Nordsee One,Two And Three.There is going to be construction starting in early 2015.These are two big projects and have already raised Northland's payout ratio from 63% in 2013 to 82% in the present quarter.
This aside their financial performance figures look good.There is a 13% increase in revenue from Q3 2013 and 11% increase in profits.There is also a 15% increase in adjusted EBITDA in Q3 2014 over Q3 2013.However there is a 10% decrease in quarterly cash flow as debt payments are kicking in for two solar projects-one is in North Battleford.Conversely the increase in revenues is largely due to these two new installations.In addition, free cash flow is reduced because of the newly started debt payments on the two new installations.
New projects
Adjusted EBITDA is up by 15% or by $11.1 million because of new projects that were started in the first nine months of 2013.There are four of them and all have been built on Canadian soil.Profit will likely even increase in Q4 from these new Canadian projects.In addition, more financing has been arranged for the large Gemini project and costs incurred here.More will be incurred in Q4 but they will be offset by revenues from the new projects..Gemini will not be completed until 2016 and revenues will not likely come in until 2017.This will likely raise the payout ratio again in 2015.Northland Power(NPI) does have the liquidity to keep the dividend as it is.The payout ratio has been higher in the past temoroarily and NPI does intend to keep the dividend as it is.
On track
N orthland intends that there will be a continued increase of profit and EBITDA coming in from their pipeline of new projects for the rest of the year.This will create an increase in EBITDA for the fourth quarter as well.Also some more capital will likely be raised for Gemini although construction will not start yet.Nevertheless NPI is on track to produce EBITDA in Q4 of about $100 million;this will bring annual EBITDA to $365 to $375 million.NPI will only say that it will meet it's guidance of $350 to $360 million for 2014 and $380 to $400 million for 2015.It will certainly meet guidance for 2014 fairly easily and that will create earnings per share of about $2.50 per share and a price/earnings ratio of less than 7. This should bring Northland Power's share price close to the $19 level by the end of Q4.
This aside their financial performance figures look good.There is a 13% increase in revenue from Q3 2013 and 11% increase in profits.There is also a 15% increase in adjusted EBITDA in Q3 2014 over Q3 2013.However there is a 10% decrease in quarterly cash flow as debt payments are kicking in for two solar projects-one is in North Battleford.Conversely the increase in revenues is largely due to these two new installations.In addition, free cash flow is reduced because of the newly started debt payments on the two new installations.
New projects
Adjusted EBITDA is up by 15% or by $11.1 million because of new projects that were started in the first nine months of 2013.There are four of them and all have been built on Canadian soil.Profit will likely even increase in Q4 from these new Canadian projects.In addition, more financing has been arranged for the large Gemini project and costs incurred here.More will be incurred in Q4 but they will be offset by revenues from the new projects..Gemini will not be completed until 2016 and revenues will not likely come in until 2017.This will likely raise the payout ratio again in 2015.Northland Power(NPI) does have the liquidity to keep the dividend as it is.The payout ratio has been higher in the past temoroarily and NPI does intend to keep the dividend as it is.
On track
N orthland intends that there will be a continued increase of profit and EBITDA coming in from their pipeline of new projects for the rest of the year.This will create an increase in EBITDA for the fourth quarter as well.Also some more capital will likely be raised for Gemini although construction will not start yet.Nevertheless NPI is on track to produce EBITDA in Q4 of about $100 million;this will bring annual EBITDA to $365 to $375 million.NPI will only say that it will meet it's guidance of $350 to $360 million for 2014 and $380 to $400 million for 2015.It will certainly meet guidance for 2014 fairly easily and that will create earnings per share of about $2.50 per share and a price/earnings ratio of less than 7. This should bring Northland Power's share price close to the $19 level by the end of Q4.
Wednesday 19 November 2014
Southern Pacific has an operational update
On October 27 Southern Pacific had an operational update for Q3.It was a report on the operations of their Mackay plant and the Senelac plant.Their workover was completed on 5 well pairs and are back onstream.4 well pairs had workovers successfully completed and a fifth was deferred until later.Production at two well pairs was only 200 to 250 barrels per day.Total production at the Mckay installation was 2000 barrels per day and at Senelac it was 1300 to 1400 barrels per day.Overall production then was 3400 barrels per day.There has been no production at the Phase L installation at Senelac ; it is scheduled for December.
Comparison to other juniors
An earlier blog on Tumblr compared Southern Pacific(STP) to two other juniors-BNK Petroleum and Argent Energy.Production at that time was about 4500 barrels per day.STP had predicted that once well bore conformance was obtained production might reach 7000 barrels.It was on track to match these other two juniors.And Phase L (at Senelac) was going to be producing probably in December.
Then STP carried out a Strategic Review Process and investors reacted by sending the price down from the $.20 to $.25 area to the present $.025 to $.03 area.This is an overreaction.If you compare STP to other heavy oil producers it can be seen as oversold.For example, Palliser Oil is another heavy oil producer and it has production of only 1200 to 1700 barrels per day.It's assets are only $104 million and shareholder equity of $35 million.Yet it trades at $.065 per share.Another example is Rock Energy,another heavy oil producer. It has production of about 4800 barrels per day and assets of only $170 million with shareholder equity of $116 million.This heavy oil producer trades at about $4.00 per share.This indicates that STP should at least be trading at $.10 to $1.5 per share.
More Strategic Reviews It is true that Southern Pacific's production fell in this quarter from about 4200 barrels per day to 3400 barrels partly because of conformance problems in the newer wells.But this has now been almost remedied and approvals are in place to increase production up to 7000 barrels per day.In conclusion, if Southern Pacific's management had comforted it's shareholders more then it's shareholders would have given it a more reasonable share price now.This blog predicts that the price will stay in this price range until production is back up around 5000 barrels per day.Any further strategic reviews should be kept in the boardroom.
Comparison to other juniors
An earlier blog on Tumblr compared Southern Pacific(STP) to two other juniors-BNK Petroleum and Argent Energy.Production at that time was about 4500 barrels per day.STP had predicted that once well bore conformance was obtained production might reach 7000 barrels.It was on track to match these other two juniors.And Phase L (at Senelac) was going to be producing probably in December.
Then STP carried out a Strategic Review Process and investors reacted by sending the price down from the $.20 to $.25 area to the present $.025 to $.03 area.This is an overreaction.If you compare STP to other heavy oil producers it can be seen as oversold.For example, Palliser Oil is another heavy oil producer and it has production of only 1200 to 1700 barrels per day.It's assets are only $104 million and shareholder equity of $35 million.Yet it trades at $.065 per share.Another example is Rock Energy,another heavy oil producer. It has production of about 4800 barrels per day and assets of only $170 million with shareholder equity of $116 million.This heavy oil producer trades at about $4.00 per share.This indicates that STP should at least be trading at $.10 to $1.5 per share.
More Strategic Reviews It is true that Southern Pacific's production fell in this quarter from about 4200 barrels per day to 3400 barrels partly because of conformance problems in the newer wells.But this has now been almost remedied and approvals are in place to increase production up to 7000 barrels per day.In conclusion, if Southern Pacific's management had comforted it's shareholders more then it's shareholders would have given it a more reasonable share price now.This blog predicts that the price will stay in this price range until production is back up around 5000 barrels per day.Any further strategic reviews should be kept in the boardroom.
Sunday 16 November 2014
Perpetual Energy grows by twists and turns
Perpetual Energy has for a couple of years grown very slowly .It's production has stayed around 19,000 to 21,000 boe/day.It's production hasn't exceeded 22,000 barrels per day for the last four years.One of the reasons that it has not grown past 21,000 barrels per day of production is that it has sold off non-core producing assets.On October 27 it announced that it had signed a purchase and sale agreement to divest of several non-core properties in eastern Alberta for $21.6 million.This deal will close on November 7.
This property has 870 Mboe of heavy oil reserves and 4026 net acres of undeveloped Mannville heavy oil rights.It was expected to produce 400 to 415 boe/day of heavy oil for Q4 2014.The money received will be used to establish a bank and working capital surplus and the ability to redeem convertible debentures that mature in December31,2015.It is Perpetual Energy's main strategic priority to reduce it's debt.However Perpetual will soon need capital for the waterflooding of several large pools in the Mannville area and the Edson area.So in order to keep increases in debt down they thought it prudent to sell these properties.
East Edson update
This is the most interesting discovery that Perpetual Energy has come across.It made a joint venture with an unknown partner that gave it $70 million to develop the property although money had to be put into an escrow account.9 wells have been developed so far ;7 in the northeast area and 2 in the southwest area.4 of these 9 wells have been completed and tied-in to their existing gas compression station and 2 through the new Rosevear gas plant.Both are producing above 10MMcf/day plus the accompanying liquids.2 more wells are starting initial flow back but it is too early to estimate final production.It is not clear from reading the Joint Venture Agreement if production from the South west area is covered by the joint venture agreement.Most,if not all of the production in this area might be considered as Perpetual production.Whereas it looks like the North east area has a royalty payment of 5.6MMcf/day.Any production beyond this amount goes totally to Perpetual Energy.Here( the N.E and S.W. area) is where Perpetual Energy has a chance to boost production to the 25,000 boe/day by the end of 2015.
Operations are on track for 6 new wells to be drilled before year-end.2 wells are to be drilled in the North east area and 4 in the South west area.Including production from the first 2 wells, total production from East Edson is about 25,000 MMcf/day or about 6,250 boe/day.With the 4 other wells coming onstream in Q4 Perpetual will likely have total production close to 23,000 boe/day.If not in Q4 then in Q1 2015.Also Perpetual has all regulatory approvals for the new East Edson gas plant and it will be built before September,2015.Pipeline has already been ordered to connect to the Alliance gas Pipeline.
West Edson properties
Since the end of Q2, 9 wells have been drilled and production here has exceded expectation;7 were completed and tied-in and 2 are in progress.Production at full capacity is expected to be 64mmcf/day or almost 11,000 boe/day.
Conclusion
For the last two or three years Perpetual Energy has been troubled by having too much debt;over this period it has pared down it's debt.But Perpetual is one of the busiest and most active drillers ,especially for junior producers.Now it has three drilling rigs that are active on it's properties.It has gotten some cash from it's joint venture and is using it for neighbouring ,contiguous properties.However Perpetual continues to lose production by selling off properties,especially around it's heavy oil property in the Mannville area.That aside,Q4 2014 or Q1 2015 are seen as the quarter that Perpetual will break out of this range and start to move towards 25,000 boe/day and $25 million in earnings for the quarter.
for consulting advice on energy stocks ;email daleandmac@gmail.com
This property has 870 Mboe of heavy oil reserves and 4026 net acres of undeveloped Mannville heavy oil rights.It was expected to produce 400 to 415 boe/day of heavy oil for Q4 2014.The money received will be used to establish a bank and working capital surplus and the ability to redeem convertible debentures that mature in December31,2015.It is Perpetual Energy's main strategic priority to reduce it's debt.However Perpetual will soon need capital for the waterflooding of several large pools in the Mannville area and the Edson area.So in order to keep increases in debt down they thought it prudent to sell these properties.
East Edson update
This is the most interesting discovery that Perpetual Energy has come across.It made a joint venture with an unknown partner that gave it $70 million to develop the property although money had to be put into an escrow account.9 wells have been developed so far ;7 in the northeast area and 2 in the southwest area.4 of these 9 wells have been completed and tied-in to their existing gas compression station and 2 through the new Rosevear gas plant.Both are producing above 10MMcf/day plus the accompanying liquids.2 more wells are starting initial flow back but it is too early to estimate final production.It is not clear from reading the Joint Venture Agreement if production from the South west area is covered by the joint venture agreement.Most,if not all of the production in this area might be considered as Perpetual production.Whereas it looks like the North east area has a royalty payment of 5.6MMcf/day.Any production beyond this amount goes totally to Perpetual Energy.Here( the N.E and S.W. area) is where Perpetual Energy has a chance to boost production to the 25,000 boe/day by the end of 2015.
Operations are on track for 6 new wells to be drilled before year-end.2 wells are to be drilled in the North east area and 4 in the South west area.Including production from the first 2 wells, total production from East Edson is about 25,000 MMcf/day or about 6,250 boe/day.With the 4 other wells coming onstream in Q4 Perpetual will likely have total production close to 23,000 boe/day.If not in Q4 then in Q1 2015.Also Perpetual has all regulatory approvals for the new East Edson gas plant and it will be built before September,2015.Pipeline has already been ordered to connect to the Alliance gas Pipeline.
West Edson properties
Since the end of Q2, 9 wells have been drilled and production here has exceded expectation;7 were completed and tied-in and 2 are in progress.Production at full capacity is expected to be 64mmcf/day or almost 11,000 boe/day.
Conclusion
For the last two or three years Perpetual Energy has been troubled by having too much debt;over this period it has pared down it's debt.But Perpetual is one of the busiest and most active drillers ,especially for junior producers.Now it has three drilling rigs that are active on it's properties.It has gotten some cash from it's joint venture and is using it for neighbouring ,contiguous properties.However Perpetual continues to lose production by selling off properties,especially around it's heavy oil property in the Mannville area.That aside,Q4 2014 or Q1 2015 are seen as the quarter that Perpetual will break out of this range and start to move towards 25,000 boe/day and $25 million in earnings for the quarter.
for consulting advice on energy stocks ;email daleandmac@gmail.com
Thursday 13 November 2014
I'd like to add you to my professional network on LinkedIn
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Friday 7 November 2014
Huronia Consulting (part4) or Georgian Consulting
When I was in Midland I started a series of blogs that I called Huronia Consulting.It was intended to offer some ideas on how to improve the economy in the Midland area.It could be used by local politicians.This blog is entitled Huronia Consulting(part4) but it refers to Wasaga Beach and should really be called Georgian Consulting although Midland believes that Wasaga Beach is a part of Huronia.
Wasaga Beach is midway between Midland and Barrie;it is about 40 kilometres from each.It is on the east side of Notawasaga Bay and on the Nottawasaga River.It is on the northern border of Flos,Sunnidale and Nottawasaga townships.It's full time population is about17,000 with about 16,000 others that are considered seasonal.
Wasaga Beach should be considered as a close neighbour of Collingwood.There is considerable interaction between the two towns. It is only about 13 kilometres from the east end of Collingwood to the west end of Wasaga.The province just paved the highway between them so it is an easy drive in to Collingwood.
Comparison to other Resort towns
Bobcaygeon
Wasaga can be easily compared to other resort or tourist towns.A pretty town that comes to mind as a comparable is Bobcaygeon which is north-east of Peterboro.It's full time population is about 10,000.Bobcaygeon does get some tourists and some business from Peterboro but Bobcaygeon does get more business from it's closest neighbour-Lindsay.However more business does tend to go from Bobcaygeon to Lindsay rather than the other way.Bobcaygeon ,like Wasaga, has a healthy motel and hotel business.But Bobcaygeon ,being near two lakes,gets a lot of fishermen and hikers and hunters.There are one or two top of the line resort locations but a few low rent motels that hunters and hikers can use.Two or three are in the middle of town.Wasaga is getting some new high-priced motels but needs to keep some lower priced motels for the lower-income crowd.The question is-should all the motels along it's main street be high-priced or should there be a variety of types here.I think Wasaga like Bobcaygeon has to cater to all would-be tourists.Also a good business to encourage further would be rafting and touring down the river, such as Spirit Tours.Wasaga needs more of this;maybe even a fishing or hunting camp at the edge of town along the river.
Bobcaygeon also has some smaller business.It has one or maybe two bakeries evn though they only employ one or two people each.It like Wasaga has a few lawyers and a surveyor and real estate companies.But the big employer in Bobcaygeon is the Kawartha Dairy.It started selling milk only to Peterboro and Lindsay;now it sells a variety of products,including yogurt and ice cream to a much bigger market area (including Barrie).This is where Wasaga falls behind Bobcaygeon;it does not have the small businesses although it has excellent locations to do this.For example,the WasagaDairy which is a retail outlet could be converted to a milk processing plant if the property next door is bought as well.Just like in Bobcaygeon!
Niagara Falls
Another town to compare Wasaga to is Niagara Falls.The epitome of tourist towns.But there are two Niagara Falls.One has the casinos and the top hotels;the other(at the far end of Lundy Lane) has the cheap motels,the cheap restaurants and the strip joints.This end of Niagara Falls is very competitive.It caters to low-income tourists.I ,myself, have stayed here for several months.You used to be able to get a small breakfast for $1.00 (not counting coffee).Prices were listed out front on all motels so you knew the price by just walking by.This encouraged many tourists to come in that would have kept on going.There is a library for this end of town and one downtown.Both are fairly new and have all facilities and lots of room.This is something that Wasaga does not do.It does not compete on price and show it's prices right up front.This does bring in extra tourists who might not stay otherwise.Also as everybody knows Wasaga Beach needs a new and bigger library.This does encourage local business that need to do research and find things out.Libraries can,for example,show free films and documentaries and exhibit local artist's work.
2015
Small towns such as Wasaga Beach and Bocaygeon and West Lundy Lane (Niagara Falls) will move slowly.This way residents are less disturbed.But Wasaga Beach would be well advised to make at least a small move towards zoning that would allow a dairy and helping Spirit Tours get some new equipment.Two small steps that might make for a better 2015.
Wasaga Beach is midway between Midland and Barrie;it is about 40 kilometres from each.It is on the east side of Notawasaga Bay and on the Nottawasaga River.It is on the northern border of Flos,Sunnidale and Nottawasaga townships.It's full time population is about17,000 with about 16,000 others that are considered seasonal.
Wasaga Beach should be considered as a close neighbour of Collingwood.There is considerable interaction between the two towns. It is only about 13 kilometres from the east end of Collingwood to the west end of Wasaga.The province just paved the highway between them so it is an easy drive in to Collingwood.
Comparison to other Resort towns
Bobcaygeon
Wasaga can be easily compared to other resort or tourist towns.A pretty town that comes to mind as a comparable is Bobcaygeon which is north-east of Peterboro.It's full time population is about 10,000.Bobcaygeon does get some tourists and some business from Peterboro but Bobcaygeon does get more business from it's closest neighbour-Lindsay.However more business does tend to go from Bobcaygeon to Lindsay rather than the other way.Bobcaygeon ,like Wasaga, has a healthy motel and hotel business.But Bobcaygeon ,being near two lakes,gets a lot of fishermen and hikers and hunters.There are one or two top of the line resort locations but a few low rent motels that hunters and hikers can use.Two or three are in the middle of town.Wasaga is getting some new high-priced motels but needs to keep some lower priced motels for the lower-income crowd.The question is-should all the motels along it's main street be high-priced or should there be a variety of types here.I think Wasaga like Bobcaygeon has to cater to all would-be tourists.Also a good business to encourage further would be rafting and touring down the river, such as Spirit Tours.Wasaga needs more of this;maybe even a fishing or hunting camp at the edge of town along the river.
Bobcaygeon also has some smaller business.It has one or maybe two bakeries evn though they only employ one or two people each.It like Wasaga has a few lawyers and a surveyor and real estate companies.But the big employer in Bobcaygeon is the Kawartha Dairy.It started selling milk only to Peterboro and Lindsay;now it sells a variety of products,including yogurt and ice cream to a much bigger market area (including Barrie).This is where Wasaga falls behind Bobcaygeon;it does not have the small businesses although it has excellent locations to do this.For example,the WasagaDairy which is a retail outlet could be converted to a milk processing plant if the property next door is bought as well.Just like in Bobcaygeon!
Niagara Falls
Another town to compare Wasaga to is Niagara Falls.The epitome of tourist towns.But there are two Niagara Falls.One has the casinos and the top hotels;the other(at the far end of Lundy Lane) has the cheap motels,the cheap restaurants and the strip joints.This end of Niagara Falls is very competitive.It caters to low-income tourists.I ,myself, have stayed here for several months.You used to be able to get a small breakfast for $1.00 (not counting coffee).Prices were listed out front on all motels so you knew the price by just walking by.This encouraged many tourists to come in that would have kept on going.There is a library for this end of town and one downtown.Both are fairly new and have all facilities and lots of room.This is something that Wasaga does not do.It does not compete on price and show it's prices right up front.This does bring in extra tourists who might not stay otherwise.Also as everybody knows Wasaga Beach needs a new and bigger library.This does encourage local business that need to do research and find things out.Libraries can,for example,show free films and documentaries and exhibit local artist's work.
2015
Small towns such as Wasaga Beach and Bocaygeon and West Lundy Lane (Niagara Falls) will move slowly.This way residents are less disturbed.But Wasaga Beach would be well advised to make at least a small move towards zoning that would allow a dairy and helping Spirit Tours get some new equipment.Two small steps that might make for a better 2015.
Wednesday 5 November 2014
Where is the turning point?
Before an investor determines the exact nature of the stockmarket,that is,whether it is a diminished bull market or the beginning of a bear market he needs to know it's overall direction.Are we in a bull market or a bear market?Furthermore if we are in a bull market when will this bull market turn down?There are a number of key indicators that can tell whether we are turning down or upwards.
I,myself, have a Master's degree in economics and my major was in business cycles. I have studied business cycles since before the second world war and have seen them change. I found that there is a strong correlation between business cycles and the stock markets. It is very difficult for there to be a bear market and have an economic upswing.However there are shades of grey in between that are very hard to tell and they do presage further swings upwards or downwards.This is where work must be done in order to tell how close we are to the turning point.
The new Business cycle
Since the second world war the average business cycle has lasted four to six years. And it had a"V" shape;production and incomes went down substantially in the first two to three years and back up even more in the following two to three years.This was a fairly violent change in incomes although overall total production and income increased over the five year period.One of the main problems with this dramatic change in incomes was the affect on unemployment. Unemployment in the first two years or the downswing(and even in the third year) went up dramatically. People demanded that governments do something about this dreadful situation.And they did. This was the beginning of Keynesian Economics.
John Maynard Keynes ,a British economist, realized that the dramatic drop in income and production was caused by a drop in aggregate demand.And this could be remedied by an increase in government spending.The government bought more bonds from the commercial banks and deposited them so the bank reserves went up and the banks were able to lend out more money.This was government created demand.This increased bank loans and hence total production.The effect of the increased demand was an increase in jobs and a reduction in unemployment.This was the beginning of using increase in government spending to reduce unemployment.
The "U" Shaped Business Cycle
History proved that increased government spending did remedy the high level of unemployment.It did not eliminate it but it did dampen it.In fact,the dampened demand modified the shape of the "V" cycle.It reduced the depth of the cycle and it lengthened it's duration. The four year cycle turned into a seven or eight year cycle and the "V" cycle turned into a "U" cycle.However the "V" cycle showed increases in production and incomes of 5 and 6% in the upper part of the cycle.Now there were three to five years of 2 to 3% increases in growth;economic growth had been dampened.Reductions in income and employment had been reduced but so had the increases in the upper part of the cycle.This produced the shape of the "U" cycle.
Stockmarket Indicators
The question is,does the downturn in the economy coincide with the turndown in the stockmarket?Do the stockmarket indicators correlate with those for the economy?The key indicators for whether the stockmarket will go up or down are the price/earnings ratio and the dividend yield.Not these ratios for an individual stock but for the entire TSX index.It is generally considered that a healthy P/E ratio is 15.Below 15 is a time to buy and above 15 is a time to sell.The yield is the dividend amount(in dollars)divided by the price of the stock.If the dividend yield for the index is above the 10 year government bond yield but rising then dividend yields will still climb and this is an indicator to continue buying stocks .If the index dividend yield is below the 10 year bond yield and falling then it is time to sell stocks and buy bonds.The price of bond yields will rise soon and earnings will drop.
Generally speaking when the economy is in a downturn the P/E ratio will be below the average of 15 times earnings.And the P/E ratio moves up when the economy moves into the upper part of the cycle.When dividend yields are low and below the 10 year bond rate, the cycle is near the bottom.This indicates earnings will soon start to increase and so will dividend yields.Conversely when the P/E ratio is 15 or higher and the dividend yield is above 3.5% the market has peaked.Price will be heading down soon and this is time to sell stocks.
Shades of Grey
So when the bond yield is still above 2% but falling the investor should be in the stock market.Bond prices are falling and the investor can earn more on dividends. The TSX index dividend yield is typically between 3 and 3.5% in a bull market.But when the 10 year government yield is above 3.5% it is time to think about moving back into the bond market to get forthcoming gains.It is likely that the stockmarket has peaked.Now we are at the top of the "U" curve and the P/E ratio is at a maximum or near to it.There is no hurry as the P/E ratio is close to 15 but will rise for awhile only temporarily.
The tie-in here to the economy is through earnings.As the economy slows down the growth in earnings starts to slow down.And as the growth in earnings slows the P/E ratio will automatically rise.That is because earnings will remain constant and the price will continue to rise slightly.Stocks will become more expensive. At a certain point the P/E ratio will remain close to or above 15 and the dividend yield will approach 3.5%.The 10 year bond yield will start to move up reflecting higher risk in the economy .However the price of bonds will now move downwards and some investors will pull their money out.While other investors will move into alternative investments such as cash or gold.
Conclusion
This study does not look at the amount of capital appreciation in the price of their stock nor in the price of bonds specifically.This paper looks at the direction of markets not the magnitude of the gains.This depends to a large degree on the astuteness of the individual investor.
The main theme that is explored here is that there is a strong correlation between the movement of the economic cycle and the movement of the stockmarket.There are indicators that can be used to tell when the business cycle is moving downwards;these indicators also tell that the stockmarket is moving downwards.There are specific numbers that can be used to tell just how close the stockmarket is to the turning point.Principally the economic growth rate and the length of the "U"curve.
We have concluded that we are presently in a "U" shaped business or economic cycle.And the bottom was in March, 2009.Since then the market has been moving up on the upwards part of the "U"curve.There has been positive economic growth from 2010 to 2013.The economic growth has gradually slowed down so that it now is expected to be only 2.5% in 2015.The"U" curve will almost be completed.
In summary,it seems as if 2014 is going to be a good year for investors in the stockmarket.But investors should probably cautiously in 2015 start to put their money into high quality stocks and high grade bonds.Growth and small 'cap" stocks may start to wither as interest rates move up.
I,myself, have a Master's degree in economics and my major was in business cycles. I have studied business cycles since before the second world war and have seen them change. I found that there is a strong correlation between business cycles and the stock markets. It is very difficult for there to be a bear market and have an economic upswing.However there are shades of grey in between that are very hard to tell and they do presage further swings upwards or downwards.This is where work must be done in order to tell how close we are to the turning point.
The new Business cycle
Since the second world war the average business cycle has lasted four to six years. And it had a"V" shape;production and incomes went down substantially in the first two to three years and back up even more in the following two to three years.This was a fairly violent change in incomes although overall total production and income increased over the five year period.One of the main problems with this dramatic change in incomes was the affect on unemployment. Unemployment in the first two years or the downswing(and even in the third year) went up dramatically. People demanded that governments do something about this dreadful situation.And they did. This was the beginning of Keynesian Economics.
John Maynard Keynes ,a British economist, realized that the dramatic drop in income and production was caused by a drop in aggregate demand.And this could be remedied by an increase in government spending.The government bought more bonds from the commercial banks and deposited them so the bank reserves went up and the banks were able to lend out more money.This was government created demand.This increased bank loans and hence total production.The effect of the increased demand was an increase in jobs and a reduction in unemployment.This was the beginning of using increase in government spending to reduce unemployment.
The "U" Shaped Business Cycle
History proved that increased government spending did remedy the high level of unemployment.It did not eliminate it but it did dampen it.In fact,the dampened demand modified the shape of the "V" cycle.It reduced the depth of the cycle and it lengthened it's duration. The four year cycle turned into a seven or eight year cycle and the "V" cycle turned into a "U" cycle.However the "V" cycle showed increases in production and incomes of 5 and 6% in the upper part of the cycle.Now there were three to five years of 2 to 3% increases in growth;economic growth had been dampened.Reductions in income and employment had been reduced but so had the increases in the upper part of the cycle.This produced the shape of the "U" cycle.
Stockmarket Indicators
The question is,does the downturn in the economy coincide with the turndown in the stockmarket?Do the stockmarket indicators correlate with those for the economy?The key indicators for whether the stockmarket will go up or down are the price/earnings ratio and the dividend yield.Not these ratios for an individual stock but for the entire TSX index.It is generally considered that a healthy P/E ratio is 15.Below 15 is a time to buy and above 15 is a time to sell.The yield is the dividend amount(in dollars)divided by the price of the stock.If the dividend yield for the index is above the 10 year government bond yield but rising then dividend yields will still climb and this is an indicator to continue buying stocks .If the index dividend yield is below the 10 year bond yield and falling then it is time to sell stocks and buy bonds.The price of bond yields will rise soon and earnings will drop.
Generally speaking when the economy is in a downturn the P/E ratio will be below the average of 15 times earnings.And the P/E ratio moves up when the economy moves into the upper part of the cycle.When dividend yields are low and below the 10 year bond rate, the cycle is near the bottom.This indicates earnings will soon start to increase and so will dividend yields.Conversely when the P/E ratio is 15 or higher and the dividend yield is above 3.5% the market has peaked.Price will be heading down soon and this is time to sell stocks.
Shades of Grey
So when the bond yield is still above 2% but falling the investor should be in the stock market.Bond prices are falling and the investor can earn more on dividends. The TSX index dividend yield is typically between 3 and 3.5% in a bull market.But when the 10 year government yield is above 3.5% it is time to think about moving back into the bond market to get forthcoming gains.It is likely that the stockmarket has peaked.Now we are at the top of the "U" curve and the P/E ratio is at a maximum or near to it.There is no hurry as the P/E ratio is close to 15 but will rise for awhile only temporarily.
The tie-in here to the economy is through earnings.As the economy slows down the growth in earnings starts to slow down.And as the growth in earnings slows the P/E ratio will automatically rise.That is because earnings will remain constant and the price will continue to rise slightly.Stocks will become more expensive. At a certain point the P/E ratio will remain close to or above 15 and the dividend yield will approach 3.5%.The 10 year bond yield will start to move up reflecting higher risk in the economy .However the price of bonds will now move downwards and some investors will pull their money out.While other investors will move into alternative investments such as cash or gold.
Conclusion
This study does not look at the amount of capital appreciation in the price of their stock nor in the price of bonds specifically.This paper looks at the direction of markets not the magnitude of the gains.This depends to a large degree on the astuteness of the individual investor.
The main theme that is explored here is that there is a strong correlation between the movement of the economic cycle and the movement of the stockmarket.There are indicators that can be used to tell when the business cycle is moving downwards;these indicators also tell that the stockmarket is moving downwards.There are specific numbers that can be used to tell just how close the stockmarket is to the turning point.Principally the economic growth rate and the length of the "U"curve.
We have concluded that we are presently in a "U" shaped business or economic cycle.And the bottom was in March, 2009.Since then the market has been moving up on the upwards part of the "U"curve.There has been positive economic growth from 2010 to 2013.The economic growth has gradually slowed down so that it now is expected to be only 2.5% in 2015.The"U" curve will almost be completed.
In summary,it seems as if 2014 is going to be a good year for investors in the stockmarket.But investors should probably cautiously in 2015 start to put their money into high quality stocks and high grade bonds.Growth and small 'cap" stocks may start to wither as interest rates move up.
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