Hedge Funds emerged in the early nineties as an investment for wealthy investors.  By 1998, Long Term Capital Management (LTCM) was one of the largest.  It attracted the wealthy in New York and Washington, because the fund was a sure bet.  Afterall, the two people running it, both of whom won a Nobel Prize for economics, had figured out how to beat the stock markets.  Unfortunately, their theory failed in 1998 and the fund became insolvent.  The pursuing market crash nearly took down all stock markets around the world.  As a result, investors in Hedge Funds quickly liquidated their holdings, and much of the industry went into hibernation after a good two-thirds of funds went broke. 

After a few short years, investors returned to Hedge Fund investing because the funds only hired the best brains in the investment business.  By 2007, there were 15,000 hedge funds across the globe.

Hedge Fund managers became rich overnight because of their “Two and Twenty” fee, which entitled the fund to an annual 2% for management fee, plus 20% of all profits earned.  A small hedge fund, employing roughly 20 people, would easily generate a hundred million in fees per year.  It needs to be pointed out that during the 2008 implosion, the average fund lost 23%, and, not surprising, not one fund gave investors back their management fees.  After 2008, investors began withdrawing their money.  Within months, there were only 4,500 hedge funds remaining. 

The stock markets have done well the past couple of years.  This has created a surge in new Hedge Funds.  Today, there are 11,000 funds world-wide controlling $2.9t.  Because of the amounts these funds manage, stock markets can only offer so many opportunities for them to invest in.  As a result, they are now investing in private companies that cannot be openly traded.  We do not recommend these investments for conservative investors because this increases the risk level for the simple reason; how does one value a private company on a daily basis? 

CalPERS, California’s main public pension fund, is the sixth largest in the world.  Over the past 20 years, the fund has averaged an 8.4% annual return.  CalPERS farmed out some of their money to hedge funds over the past few years.  Recently, they fired every hedge fund as most never came close to equalling what the pension fund did on their own.   All investments will now be done ‘in house’. 

While a handful of Hedge Funds make investor’s money, the majority rarely do.  If this was not the case, the number of Hedge Funds would remain stable, rather than watching half of them close within a year in any down market.  We expect many of the funds to disappear in the months ahead.   

All Hedge Funds are high risk.  We recommend one avoid these investments.  Buying blue-chip securities that pay a regular dividend will outperform most hedge funds over ones lifetime.  This will remain the simplest, and most profitable, method of investing.  

The Federal Reserve, along with the central banks of the European Union, Japan and Britain have flooded their respective economies with surplus cash.  The result has been expanding national debt, which is at historical highs. 

America’s debt is near $18t.  This was made possible by decades of irrespsonsbile budgeting as well as the U.S. Federal Reserve keeping the printing presses (Quantitative Easing) working overtime.  The bulk in the growth of their money supply in the last few years has been created for no other reason than to purchase their own short-term debt in order to keep U.S. interest rates at historical lows.  The Federal Reserve has announced that Quantitative Easing is over and they will now begin withdrawing money from the system.  Do not believe it - it is next to impossible for this to occur without interest rates jumping.

Insead, the printing presses will be working overtime for months to come, or, until Washington is forced to correct the financial mess it is in.  Washington, for years to come, will have to pay close to a trillion dollars annually in interest.  This is cash they do not have, other than via the printing press.

Governments cannot dictate interest rates; the market does it for them.  If this was not the case, lending rates would be uniform across the globe no matter the economy.  The stock markets, which are leading indicators, are telling us that things are not rosy in the immediate future.  If you choose to jump into the market tomorrow, make sure it is in companies that will continue to supply society’s needs, as well as one that offers a dividend yield around 4%.  Or, you can continue to be patient and wait for this market to unfold.  Sacola continues to favor cash for the time being.  Sit tight and check back on November 15^th.

One word you rarely hear from politicians is ‘deflation’.  Yet, we feel it is gaining ground around the world and rising house prices are masking it. 

Zero interest rates are deflationary for the simple reason that savers are experiencing falling returns on their bank deposits and dividend yields.  This translates to falling income.  Interest rates around the world continue to slide. This is contrary to economic theory which states that interest rates must rise during inflationary cycles.  For example, the European Central Bank has lowered its rate to .05 of 1%.  Similarly, German 10 year government bonds have fallen, for the first time, to under 1%.  After taxes and inflation all investors are losing money.  This is 100% deflationary. 

Japanese 10 year bonds yield .5%.  They have been this low for 11 years now.  Japan has had 24 years of negative interest rates, and the country has slid into deflation three times over the same period.  Today, a new threat is taking place; Japan has a falling population and one of the world’s highest numbers of people aged over 65.  This has resulted in a shortage of skilled workers.  Oddly enough, wages are falling for the first time in 24 years.  Japan is showing to anyone who is paying attention that prices and wages can fall.  Too many in the West believe prices, especially those for all forms of real estate and wages can only go increase year after year.

We have been told for many months now that the American economy is on the rebound.  Yet, interest rates continue to fall as 10 year government bonds are bouncing at all-time lows.  With real unemployment at 12% (U.S. Debt Clock), the American economy is going nowhere.  New housing starts are up, however,  there remains thousands of new homes built between 2005-2008 that have yet to be sold.

It appears all of Europe is about to take a slide into deflation.  There is very little governments and Central Bankers can do to stop it from happening.  The only thing they can is to put more money into the consumer’s pocket.  Instead, the Bankers only want to reward people who are deep in debt via low interest rates.

History tells us deflation is a real threat.  In the recent issue of the Sacola Financial newsletter we wrote, “on the last Friday of August in both 1929 and 1987, the Dow Jones Industrial Average traded at the then all time high.  Two months later, the stock markets around the world collapsed”.  As a note of interest, the last Friday of August 1987 was the 29^th, the same as this year. 

       On the 29^th  of August, both  the S&P 500 index and the Toronto Stock Exchange  traded at their all time highs.  The Dow Jones Industrial average closed at .02of 1% from its all time high set July 16^th.  Are we about to repeat the fall months of 1929 and 1987?  We do not know, but only a fool ignores history.  To protect oneself, you should have no debts and some cash in the bank.  Cash becomes King during any deflationary period.

Zero Interest Rates

Not one politician understands what destruction the zero interest rate policy is doing to the economy.  All they see is that people, businesses and governments can borrow cheaply.  Not one sees the opposite effect; low interest rates discourage savings.  Savings is the foundation of the economy.  Without it banks would not lend to consumers to buy houses and businesses to build plants.  An economy that lacks savings eventually creates poverty.

Low interest rates act like a tax increase on savers and pensioners by reducing their income. Today’s monetary policy has transferred income from older savers, to younger borrowers and banks.  For example, since 2008, borrowers with a $100,000 mortgage are over $2,400 better off every year. However, savers with $100,000 in cash or fixed-rate bonds are over $2,750 a year worse off.   How can our politicians expect these people to rush out and buy new homes and cars?  The reality is, savers cannot afford to spend without depleting their savings.

Many corporations and governments have taken advantage of the low rates to borrow and stick the cash ‘in the bank’, whereas the consumer has chosen to borrow more to spend.  As a result, the average Canadian consumer debt is at historical highs which will be a threat to the economic recovery when interest rates do rise.

Corporations are sitting on trillions of cash doing nothing.  If these businesses did see savers spending their money they would be building new plants, expanding markets and hiring skilled people.  Instead, they are hoarding cash for future opportunities rather than investing it today. 

The longer interest rates stay at zero the longer the economy will stay flat.  Even if interest rates were to rise next month it will not help much because too much of the saver's cash is tied up in 1 to 5 year GICs.  If rates do start to increase it will benefit savers in no less than a years’ time.

Today, corporate profits are healthy.  However, a year from now profits will be in a slow decline due to savers being squeezed by low investment returns.  This will be compounded by the over-leveraged consumer.  Stock markets, over the long term, follow the direction of corporate profits.  As a result, a year from now they will begin a slow decline as long as interest rates stay where they are.  The current interest rate policy, which is well into its 6^th year, has proven to offer zero benefit to the economy.  As long as our politicians continue to protect the borrower rather than the saver our economy will go nowhere.

Remain on the sidelines until the CEO’s of the world stop building cash reserves to historic highs and put their money to work. 

All Canadian pipelines will be working at full capacity until the end of 2015.  The producers and the pipeline companies are now in negotiations for space until 2020.  Some producers are asking for contracts to last into 2022. 

                With Gateway not going to be built until at least 2018, and maybe never, plus the Keystone decision being delayed until year end at the earliest, the demand for pipeline capacity will increase substantially.  The earliest Keystone could be in operation is mid-2016.  The southern portion has already been built and is in operation. 

                Especially throughout Alberta, lots of small pipelines are being built today.  These pipelines will be full for the next 6 years at least.  This should result in higher earnings for the pipelines.  And hopefully more dividend increases. 

                We do not see oil rail tanker cars fulfilling the demand.  Plus, railroads are more expensive than pipelines.  If there is another accident like that a year ago in Quebec the demand to use the rails will collapse. 

                The only negative for the pipelines, and it is a small one, is that America is discovering oil via shale rock.  As a result, sometime over the next year Americas demand for Canadian oil will temporarily decline.  However, over the long term America will need as much of our oil we can pump.  Hopefully Ottawa and Victoria will realize this and expedite the approval of the pipelines.  

                We have been holding pipeline shares for 6 to 9 years.  We can see holding for another five due to potential for rising dividends.  We see foreign demand growing with each passing year.