THE CANADIAN DOLLAR IS OVERVALUED

The TD Economics department put out an interesting research piece on the value of the Canadian dollar arguing that the loonie is slightly overvalued.

The research piece argues that, although there are strong macroeconomic reasons for the rise in the Canadian dollar, three forecasting models tested argue that the level hit by the loonie in the fourth quarter of 07 – when it reached $1.10 to the US dollar – is not sustainable. Their three models give the loonie a value of $0.93 - $0.95 US.

Below are graphs displaying the actual value of the loonie and the value implied by their three models (a Purchasing Power Parity approach, a Behavioural Equilibrum Exchange Rate model, and the Bank of Canada model). Note that all these models show the dollar to be above the forecasted (i.e. explainable) level. They also have a great graph showing the correlation between commodity prices and the Canadian dollar.

GREENSPAN ON INFLATION

I'm currently reading Alan Greespan's memoir, The Age of Turbulence. Here is a quote on the effects of inflation:

"[I]nflation had everybody spooked. People cut back on spending because they worried about making ends meet. In businesses, inflation creates uncertainty and risk, which makes planning more difficult and discourages managers from hiring, or building factories, or indeed doing any kind of investing for growth. That's what happened in 1974 -- capital spending essentially froze, making the recession far more severe."

I'm posting this excerpt because I always felt economics textbooks did a crappy job of explaining why inflation is so detrimental. I found this to be a rather clear explanation.

FALLING INTEREST RATES AND THE STOCK MARKET

The Federal Reserve cut its funds rate by 50 basis points (bps) this week, on top of last week's unannounced 75 bps reduction. A good article on The Economist last week pointed out that on the 15 occasions since 1970 when the US Federal Reserve has cut interest rates by 75 bps or more, European stock markets have risen by an average of 10.3% over the next 6 months.

The same article has a great graph displaying the performance of some major world indices since January of 2007 (see below). Note that Japan's main index, the Nikkei 225 average, is down about 25%. This explains why my EAFE fund is down a devastating 15% at the moment (about 1/4 of EAFE is allocated to Japanese stocks).