The Carry Trade

The carry trade involves borrowing at a low interest rate and investing (or lending) at a higher return. Lately, big money investors have been engaged in the carry trade by borrowing US$ at very low rates and investing in Australian bonds, emerging markets, and commodities, as well as plain old stocks and bonds. Traders are essentially betting on a falling US dollar, and they've been right so far.

The problem with this type of carry trade is that it is creating a bubble. A bubble occurs when investors borrow against an overpriced asset to buy more of that asset. (See Galbraith's A Short History of Financial Euphoria in the amazon panel on the right for an interesting treatise on bubbles). When interest rates or the US dollar go up, or the market price of the asset starts to fall, investors have to sell what they can to avoid defaulting on their loans. This leads to panic selling and falling asset prices.

So you can expect a fall in emerging markets, Oz bonds, and commodities, and probably everything else. This could happen as soon as mid to late 2010 if the Fed raises rates then. It could happen earlier if the US dollar rises.

Interestingly a big doom and gloomer based on the carry trade is Roubini, who predicted the securitized debt meltdown (see here).

Citron Research

Anther great resource is Citron Research. Citron exposes the seamy side of companies. For example, I was all set to buy LPHI until I read Citron's post on it.

Bought Canadian Utilities @ $38.55

It you believe that slow and steady wins the race, then you'll like Canadian Utilities (CU.TO, CDUAF.PK). Most of its operations in Alberta. About a year ago, I calculated that about 70% of its revenues were either regulated or under long-term power generation contracts. Its current dividend is $1.41 CDN, and its TTM earnings are $3.18 CDN, for a coverage ratio of 2.25. So, the dividend is safe. Also, its revenues don't depend much on consumer discretionary spending, of which I expect there to be less and less.

• Unlike Fortis, or Brookfield Asset Management, CU doesn't have any commercial real estate holdings.
• the expected yield based on this price is 3.65%
• the present value of a $100 investment is $149.38, with a discount rate of 3.5%. (Still, you have to take this with a grain of salt. I think general economic growth will be a lot lower in the future.)
• Its valuation is pretty good, as shown below in this graph from TD Waterhouse.

Over the last 10 years...

• CU's ROE has hovered around 15%, despite being a utility
  
• Its balance sheet has been conservative
• Leverage around 3 (good for a utility) (and currently 2.4)
  
• a current ratio between 2 and 3 (and currently 3.4!)
  
• It has not had a negative cash flow year
• It's a Canadian dividend aristocrat
• A real widows and orphans stock
  

Wait a few days before buying because the ex-dividend date is November 5.