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The price of changes on Bay Street and Wall Street

The policies being pursued on Wall Street are headed for trouble, says this analyst, but they could have some benefits for Canadian stocks.

Some people are convinced that only massive spending and new regulations will get us out of this economic mess.

Others are equally convinced that these solutions will be a disaster.

Count Mr. Ian McAvity among the latter. Living in Toronto and writing for investors on both sides of the border, he is not happy with much that is going on in government or in finance.

And he’s really steamed about the new residential sales tax that is going to descend on Toronto homeowners.

But we turn to an McAvity’s Deliberations on World Markets for a view that extends beyond Canada’s largest city (if you believe that Torontonians can actually look beyond Toronto).

We begin with a survey of the Canadian market. Some of the editor’s comments go against the grain of other analysts, especially when it comes to the banks.

We continue with an inside look at an attempt to fix Wall Street that this analyst believes is largely misguided. But he believes the problems it causes could rebound to the benefit of Canada’s resource industry.

The debauching of the US dollar

The Canadian equity market has outpaced New York’s S&P 500 index “dramatically” since 1999, Mr. McAvity tells his readers.

He informs U.S. investors that the exchange-traded fund (ETF) that reflects this performance best is the iShares MSCI Canada Index Fund (NYSE-EWC). It doesn’t replicate the TSX, but it’s a good proxy, he says.

And here’s the key to the future. “The resource based economies are liable to be the strong beneficiaries of the longer term debauching of the U.S. dollar implicit in the Obama administration spending plans, and the Bernanke/Geithner ‘bailout’ mania.”

That means Australia as well as Canada, he explains. The two markets naturally took a big hit on the “commodity price unwind,” but there are signs of potential leadership, this technical analyst indicates.

Relative strength

In Canada, metals and mining, materials and gold (as well as the so-called consumer staples) “bear watching for continued relative strength.”

The analyst brings up one telling sidelight on gold — for the first time in three years Newmont Mining (TSX-NMC; NYSE-NEM) is outperforming Canadian giant Barrick Gold (TSX/NYSE-ABX). (It is worth reporting that in the past few months we have noticed several U.S. advisories cool on their previous enthusiasm for Barrick.)

Energy has not “acted as well,” indicates Mr. McAvity. It may be rescued by merger and acquisition activity, he adds. The marriage between Suncor Energy (TSX-SU) and Petro-Canada (TSX-PCA) is obviously a big first step in that direction, but the analyst wants more constructive evidence before getting enthusiastic about energy.

As for Canada’s banks, his enthusiasm is practically non-existent.

No Mother Theresas

Canada’s banks are getting great reviews because they didn’t get caught in as many toxic deals as others did, Mr. McAvity points out. “Today they cluck about how clever they are.”

But their reasons for staying out of trouble aren’t entirely flattering to the big five. “In fact, they didn’t because they were fighting with the government to allow mergers to bulk up so they could play those games.”

In short, they were practically begging to get into trouble, as far as this analyst is concerned. But of course they weren’t allowed to merge.

With so many U.S. banks melted down, Canada’s banks are now among the senior market caps in North America. “But don’t award them any Mother Theresa medals just yet …” is this analyst’s caustic conclusion.

A change of labels

Meanwhile the solutions being applied to the financial system are liable to compound the problem, says the editor. Some of them involve a mere change of labels instead of real change.

The poisoned paper that brought down the system now has a dignified name — “legacy assets.” It sounds fairly appealing when you say, “Want to buy some Legacy Assets on 5% margin and zero cost financing?”

But less so when you say, “Will you buy some of this toxic waste if we guarantee 95% of your risk?”

Similarly, the Financial Accounting Standards Board changed its rules this month so that the first quarter reports for financial institutions wouldn’t look so bad. Are fudged earnings reports any way to restore confidence in the midst of a crisis, Mr. McAvity asks?

He’s also hearing from many investors worried that all that bailout money will do more to destroy the U.S. dollar than restore the system.

One change that could be very real, he speculates, are structural reforms that threaten to gum up the system. A super-regulator for hedge funds, for instance, or a new tax on trading transactions, or prescribed executive pay standards.

“A rush of regulations to protect U.S. investors from themselves looms and the age old concept of Caveat Emptor (buyer beware) is headed for a Congressionally-mandated grave yard,” concludes Mr. McAvity. “The people can’t be trusted to make their own decisions is what it really means.”

Change has been forced on us whether we like it or not. Even more than usual, individual investors have to very careful about where they put their trust.