To say that Canadians aren’t financially literate may seem a touch unfair, but everywhere you look we find testaments to this unavoidable fact. Credit cards, car loans, mortgage rates and even how returns are calculated are a confusing mess for most people. The math that governs these relationships is often opaque and can feel misleading, and its complexity assures that even if some do understand it, the details will only be retained by a tiny minority.
Even relatively straightforward investments can be terrifically misleading. Take for instance a well-known credit union offering a (limited) 90-day rate of 2.5% on a GIC. This advertised rate is not simply featured in the windows of its various locations but is promoted online and on the radio.
Banks and credit unions frequently offer improved GIC rates for a limited time to drive deposits. But how those rates are advertised can be misleading. The aforementioned “2.5% 90 Day GIC rate” has its own website where it contrasts its deposit rate against other major financial institutions, all of them paltry compared to the prominently displayed 2.5%.
At the very bottom of the website there does exist a footnote however. That 90-day GIC rate? It’s an annualized number, meaning that the interest you will earn at the end of that 90 days is 0.62% not 2.5%. The most egregious part perhaps is that it compares its misleading return to the far more understandable 90 day return of other GIC providers.
Other innovations in obfuscation abound. Exploring their website and we find a “linked GIC” which offers to protect your principle while giving you market returns linked to a custom index. The marketing material promises to “give you exposure to the Canadian stock market” and offers you a chance to see it performance results. But if you click to learn more of the details you find out that returns on the 3 year product are capped with cumulative returns of 15%. Not bad until you remember that traditionally returns are annualized in Canada. The maximum returns the product will offer is 4.77% regardless of what the market does in that time. Better than a 3 year GIC perhaps, but potentially far worse than what the market may deliver.
As always, the details are available for those interested. They’re just a scroll farther down, an additional click, or perhaps another page over. So, if there exists full disclosure, what am I complaining about?
The answer is best illustrated in every search you do on Google. At the top of the page are the websites that have sought to be promoted. 67% of clicks are on the top five results on a google search. 95% of clicks are exclusively for the first page only. Things on the next page barely warrant looking at. It’s just not of interest. Disclosure details may only be a click away, but from the point of view of an average person looking over the details, they may never get around to reading them.
GICs are considered the safest investments for Canadians looking for security, but their function is to provide banks with low cost loans to help finance their own business activities. Every investment made in a GIC may help bring someone comfort at night, but they’ve really entered a business relationship with a bank. Framed as such it seems that better and clearer disclosure should be the primary order, but because our thinking is that GICs are a form of product they are treated as such.
Importantly, I must stress that these banks, credit unions, and other financial institutions are not lying. They are doing what they are allowed to do under the various laws that govern financial institutions. That such rules fall short is precisely why its always smart to talk to an independent financial advisor like myself. Providing context, clarity and advice free from the conflict of corporate proprietary products is how we help people every day, and its what makes us unique.
If you have questions about this article, or wish to discuss an important financial matter please call or email us!
Since 2008 (that evergreen financial milestone) central banks have tried to stimulate economies by keeping borrowing rates extremely low. The idea was that people and corporations would be encouraged to borrow and spend money since the cost of that borrowing would be so cheap. This would eventually stimulate the economy through growth, help people get back to work and ultimately lead to inflation as shortages of workers began to demand more salary and there was less “slack” in the economy.
Such a policy only makes sense so long as you know when to turn it off, the sign of which has been an elusive 2% inflation target. Despite historically low borrowing rates inflation has remained subdued. Even with falling unemployment numbers and solid economic growth inflation has remained finicky. The reasons for this vary. In some instances statistics like low unemployment don’t capture people who have dropped out of the employment market, but decide to return after a prolonged absence. In other instances wage inflation has stayed low, with well-paying manufacturing jobs being replaced by full-time retail jobs. The economy grows, and people are employed, but earnings remain below their previous highs.
Recently this seems to have started to change. In 2017 the Federal Reserve in the United States (the Fed) and the Bank of Canada (BoC) both raised rates. And while at the beginning of this year the Fed didn’t raise rates, expectations are that a rate hike is still in the works. In fact the recent (and historic) market drops were prompted by fears that inflation numbers were rising faster than anticipated and that interest rates might have to rise much more quickly than previously thought. Raising rates is thought to slow the amount of money coursing through the economy and thus slow economic growth and subsequently inflation. But what is inflation? How is it measured?
One key metric for inflation is the CPI, or Consumer Price Index. That index tracks changes in the price or around 80,000 goods in a “basket”. The goods represent 180 categories and fall into 8 major groupings. CPI is complicated by Core CPI, which is like the CPI but excludes things like mortgage rates, food and gas prices. This is because those categories are subject to more short-term price fluctuation and can make the entire statistic seem more volatile than it really is.
Armed with that info you might feel like the whole project makes sense. In reality, there are lots of questions about inflation that should concern every Canadian. Consider the associated chart from the American Enterprise Institute. Between 1996 – 2016 prices on things like TVs, Cellphones and household furniture all dropped in price. By comparison education, childcare, food, and housing all rose in price. In the case of education, the price was dramatic.
Canada’s much discussed but seemingly impervious housing bubble shows a similar story. The price of housing vs income and compared to rent has ballooned in Canada dramatically between 1990 to 2015, while the 2008 crash radically readjusted the US market in that space.
The chart below, from Scotiabank Economics, shows the rising cost of childcare and housekeeping services in just the past few years, with Ontario outpacing the rest of the country in terms of year over year change when it comes to such costs.
My desktop is littered with charts such as these, charts that tell more precise stories about the nature of the broader statistics that we hear about. Overall one story repeatedly stands out, and that is that inflation rate may be low, but in all the ways you would count it, it continues to rise.
In Ontario the price of food is more expensive, gas is more expensive and houses (and now rents) are also fantastically more expensive. To say that inflation has been low is to miss a larger point about the direction of prices that matter in our daily lives. The essentials have gotten a lot more expensive. TVs, refrigerators and vacuum cleaners are all cheaper. This represents a misalignment between how the economy functions and how we live.
Economic data should be meaningful if it is to be counted as useful. A survey done by BMO Global Asset Management found that more and more Canadians were dipping into their RRSPs. The number one reason was for home buying at 27%, but 64% of respondents had used their RRSPs to pay for emergencies, for living expenses or to pay off debt. These numbers dovetail nicely with the growth in household debt, primarily revolving around mortgages and HELOCs, that make Canadians some of the most indebted people on the planet.
In the past few years, we have repeatedly looked at several stories whose glacial pace can sometimes obscure the reality of the situation. But people seem to know that costs are rising precisely in ways that make life harder in ways that we define as meaningful. When we look at healthcare, education, retirement, and housing it’s perhaps time that central banks and governments adopt a different lens when it comes understanding the economy.
Trends are a big deal in the investing world. Even if you aren’t going to pour over mounds of financial data sometimes trends are all you need to know about to successfully invest. Lots of people have beaten “experts” because they followed a trend rather than become intimate with the financial fundamentals.
It should be no surprise then that trends also dovetail nicely with investing hype and stock market bubbles. The trend is your friend only so long as it still makes sense. In fact being able to understand why the trend is occurring maybe the only thing that saves you from being an apocryphal lemming running over an apocryphal cliff.
In the movie The Big Short, Christian Bale’s character is shown to be a maverick who correctly bet against the housing market. But his bet, notably, was based on reviewing all the underlying mortgages that made up the mortgage backed securities and how the presence of sub-prime mortgages and rising borrowing rates tied to grace periods in the investments would lead to a housing collapse. There were a lot of people on the housing boom trend, but not many on the big short side. What separated them was knowledge about fundamentals.
Trends represent an essential aspect of investing that we typically discourage; betting on outcomes when the fundamentals are opaque or in dispute. Here are a few that we think investors should be wary of.
Self Driving Cars: In reality you aren’t likely to come across too many investments in this space. I’ve seen some through venture capitalists, but as a growing field and surrounded with lots of hype there is every reason to believe that firms will increasingly be looking for investors outside the venture capital space.
In principle self driving cars sound awesome and could radically change how we live and get around. Lots of companies are excited by the prospect of a self driving vehicles, including insurers and freight firms. However the entire enterprise depends on being able to eliminate the human component completely. That seems less likely and anything short of that (like having a driver always ready to take back control at a moment’s notice) will make the biggest benefits disappear. Beyond that there are also numerous other aspects that haven’t been considered. The cars will have to stop for all pedestrians, so what’s to stop pedestrians from just walking into traffic knowing that the cars will always stop? Or more terrifyingly, the potential for hacking cars and creating accidents with malware?
Those kinds of hurdles don’t get much attention in the fawning media coverage of self driving cars, but they represent the challenges that need to be comprehensively addressed before investors come to believe that this trend is safe and reliable.
Marijuana Stocks: I’ve written about the concerning hype regarding marijuana stocks before and haven’t had a reason to change my opinion since. One of the biggest reasons that investors should be excessively cautious regarding marijuana is because its still illegal. One of the lesser reasons is that as it transitions into a regulated drug, it will be more likely to be treated like cigarettes and alcohol.
In Ontario it has raised ire of prospective sellers that the LCBO would like have control over the sale of pot. In the United States, where marijuana is a Class A drug and regulated by the federal government, it was still unclear whether the federal government would get involved with states that had voted to legalize the drug. Yesterday the Attorney General, Jeff Sessions, announced that federal prosecutors will be allowed to decide how much energy to put into federal enforcement, rescinding the Obama era policy of staying out of the way of states the vote to legalize its sale.
This kind of regulatory uncertainty should give investors real pause when they consider which companies to invest in. Most marijuana growers have no profits and only debt and are betting on big returns once markets open up. They would not be the first companies to badly misread what the future holds.
Bitcoin: Whatever is attracting people to Bitcoin at this stage, most serious investors are keeping back. The common chatter is that no one is sure what is driving the price up except demand. Bitcoin is meant to be an alternate currency, one protected by the blockchain and whose algorithm should limit the physical number of total bitcoins in the world. While that may all be true, investors aren’t treating bitcoin that way. Instead prices have fluctuated violently, reaching peaks of $20,000 USD and falling sharply to $13,000 USD. Currently its trading at just over $14,717 USD.
Currencies that are subject to incredible volatility are not normally appealing to investors. In fact stability is the key for most currencies, and the Bitcoin phenomena should not be an exception to this. Bitcoin’s intellectual champions point out that it is a versatile currency and a store of value, but if you were a retailer how would you feel accepting payment from a currency that can drop 30% in one day? As a consumer it also would trouble you to pay $5 worth of bitcoins one day only to find out it was worth 1000% more a month later. Currencies work because people will readily part with it for other goods confident that the value is roughly consistent over time.
Bitcoin, and by extension other crypto-currencies lack this basic property, and instead operate in an expensive, unregulated market with little oversight. Investors should give extensive thought as to whether Bitcoin represents good value for money.
As 2018 unfolds, no doubt there will be more ideas that will seem credible but may have little to offer investors except brief excitement. Scepticism remains an investors best accomplice when assessing excitement and investment hype.
Getting old is something that comes to us all and is rightly considered a blessing of our modern world. Free from most wars, crime and disease the average age of Canadians continues to rise, with current life expectancy just over 82 years.
But being old is no fun. From your late 70s onward quality of life begins to decline in a multitude of ways. From a media perspective we tend to focus on outliers, like the oldest marathon runner, or the oldest male model, men and women who seem to exemplify youth well past their physical. In truth though the aging process is simply a battle that we have gotten good at slowing down.
In his excellent book Being Mortal, author and practicing surgeon Atul Gawande goes through the effects of aging, the limits of science to combat it and how we could be using medicine better to improve quality of life for the elderly. It’s a great and sometimes upsetting read that I recommend for everyone.
One of the great challenges that looms on the horizon is the cost of an aging population. The dependency ratio for the elderly (the metric of people over 65 against those between the working ages of 20-64) is rising, putting higher living costs on a smaller working base. In Canada the dependency ratio is expected to climb to 25% by 2050, and is currently at 23.77% as of 2015. That may not seem like much, but in 1980 (the year I was born) the ratio was 13.84%.
Since old age is also the point where you consume the most in terms of health care costs we should be aware that Canada’s population isn’t just aging, but that our retiring seniors are poised to become the biggest and most expensive demographic; financially dependent on a shrinking workforce and more economically fragile than they realize. That’s a problem that nations like Japan have been struggling with, where old age benefits are extensive, but the workforce has dwindled.
In other articles we’ve touched on the various aspects of the rising costs of old age. I’ve written about: the importance of wills, the impact of an aging population on our public health care, how demographics shift both investing patterns and warp our economic senses, why seniors may be getting too much of a break economically, how poor land management has made cities too expensive and that’s hurting retirement, and how certain trends are making retirement more expensive. Often these are written as issues in a distant (or not too distant) future. But increasingly they won’t be.
This past week eight long term care facilities have said they will be leaving Toronto. As part of a bigger project, long term care spaces are being rebuilt to meet new guidelines. A new facility is larger, more spacious and designed to maximize medical care. However land costs within Toronto are proving to be too high to be considered for the updated facilities. Why is that? The government pays $150 a day per bed in a facility like the ones leaving. From that subsidy costs for maintenance, nurses, janitors, medicine and food as well as the profit of the business must all be extracted. Margins are thin and building costs in the city are huge. Six more facilities are also considering leaving the GTA for cheaper land.
Eric Hoskins, health minister for the province, is arguing that the subsidy the government provides is enough, but he is already embroiled in other fights with the medical community. In 2015 the ministry cut doctors fees and began clawing back previously earned money as well. Currently lots of people in Ontario struggle to see their family doctor, and there are 28,000 elderly waiting to get access to long term care facilities, and only 79,000 beds. Coincidentally this is also the year that the Ontario Liberals balanced the books. Something about that should give us pause.
This is the reality of getting old in 2017. Costs are rising and are expected to continue growing. Some of this you can’t avoid, and many of us will end up in private retirement homes, assisted living situations, dependent on the government or even family. But there are steps that can be taken to protect assets and insulate against protracted medical or legal disputes.
Here’s a list of eight things that can help you with retirement and your estate:
- Keep an updated will and a named executor young enough to handle your affairs. I know it goes without saying, but its extremely important and many of us don’t do it.
- Ensure that you’ve got a Power of Attorney (POA) established and that it is current.
- Make sure you have a living will and discuss with your family your expectations about how you want your life to end.
- Look into your funeral arrangements while you can. It seems macabre, but funerals can be wildly expensive and burdensome to thrust onto grieving family.
- Create a space where all important documents can be found by your next of kin and with a detailed contact sheet so people can help settle your estate.
- Look into assisted living options early and consider what you might be able to afford. Have your financial plan reflect some of these income needs.
- Consider passing along family heirlooms early. Is there a broach, or a clock that you would like to see in someone’s hands? These conversations are easier to handle when you are well than when you aren’t, and downsizing frequently involves saying goodbye to long loved possessions.
- Big assets like houses and cottages should be discussed with family, especially if there is a large family and the assets might need to be shared. A lot of family strife comes from poor communication between generations and among siblings.
There will be much more to say about getting old, about protecting quality of life and managing the rising costs of living on fixed incomes. We gain little from sticking our heads in the sand and hoping that we will be healthy and strong to the day we die. In reality our retirement plans should better reflect not our most hopeful ideas of retirement but instead our greatest concerns and seek ways to preserve our quality of life.
Years ago I walked the Camino De Santiago, a holy pilgrimage across Spain that dates back to the 9th century. Not being Catholic I’m sure that a number of religious aspects of my month-long trek were lost on me, but what I did take away was a cursory understanding of Spain’s curious political instability. Everywhere I went there was graffiti calling for the independence of Catalonia, a movement that I had been completely ignorant of. In fact, other than the Basque region, it had never occurred to me to even question the essential makeup of the nation of Spain.
Last week Catalonia held a highly contentious referendum on its independence. Like Scotland and Wales, Catalonia has a devolved parliament and is a region with its own language and history distinct from (and forever tied to) Spain. Leading up to the referendum was a fair amount of heavy handedness from the government in Madrid that only made things worse. Strictly speaking the referendum is likely illegal, and the Spanish constitution does not recognize Catalonia’s decision to simply walk itself out the door on a whim. More puzzling has been the outcome of the vote, with the Catolinian government refusing to categorically claim independence. A deadline set for this Monday was meant to clarify Catalonia’s declaration of independence, but it seems to have lapsed without clarification.
In the universe of investing events like this seem poised to throw everything into chaos, and yet markets have shown themselves to be surprisingly resilient in the face of big political upheavals. Last year included a surprise win for the Brexit vote, which initially began with a market panic, but morphed into a prolonged rally for the British markets. The US too has had a surprising run in the Dow and S&P500 despite numerous concerns about the stability of the US government and its inability to pass any of it objectives.
So how should investors react when political chaos erupts? Is it a sign that we should hunt for safer shores, or should we simply brave the chaos?
One thing to consider is that we probably over estimate the importance of events as they unfold and assume that things that are bad in the real world are equally bad in the markets. War is bad objectively, but it isn’t necessarily bad for business. Protracted wars in Afghanistan and Iraq have been damaging to those involved but they haven’t slowed market rallies much, a depressing but necessary distinction.
On the other hand chronic instability has a way of building in systems. One of the reasons that serious conflicts, political instability and angry populism haven’t done much to negate market optimism is because the nature of Western Liberal democracies is to be able to absorb a surprising amount of negative events. Our institutions and financial systems have been built (and re-built) precisely to be resilient and not fragile. Where as in the past bad news might have shut down lending practices or hamstrung the economy, we have endeavored to make our systems flexible and allow for our economies to continue even under difficult circumstances.
However there are limits. In isolation its easy to deal with large negative events, but over time institutions can be pushed to their breaking point. There are compelling arguments that the wave of reactionary populism that has captured elections over the past three years is a sign of how far stretched our institutions are. Central banks, democratic governments and the welfare state have been so badly stretched by a combination of forces; from a war on terror, a global financial crisis and extended economic malaise, that we shouldn’t find it surprising that 1 in 4 Austrians, 1 in 3 French and 1 in 8 Germans have all voted for a far right candidate in recent elections.
Equally we can see the presumed effects of Climate Change as large parts of the US have suffered under multiple hurricanes, torrential downpours, or raging forest fires. For how many years can a community or nation deal with the repeated destruction of a city before the economy or government can’t cope?
In this reading, markets have simply not caught up yet with the scope of the problems that we face and are too focused on corporate minutia to see the proverbial iceberg in our path.
While I believe there is some truth in such a view, I think we have to concede that it is us as citizens that are too focused on the minutia. The market tends to focus on things like earning reports, sales predictions and analyst takes on various companies before it considers major events in the valuation of stocks.
Consider, for instance, the election of Donald Trump. Trump rode a wave of dissatisfaction with free trade and promised to shake up the trade deals the US had with other nations. Superficially this threatens the future earnings of multinational firms that depend on trade deals like NAFTA. But how many people didn’t go and buy a car they had been intending to buy over the last year? As is often the case the immediacy of political craziness obscures the time it will take for those issues to become reality. Trump may end up canceling NAFTA, but that could be years away and has little impact on the price of companies now. That applies to events like Brexit and even the Catalonian vote. Yes, they create problems, but those problems are unlikely to be very immediate.
The lesson for investors is to remain calm and conduct regular reviews of your portfolio with your financial advisor (if you don’t have a financial advisor you should give me a call), to ensure that the logic behind the investment decisions still makes sense. Nothing will be more likely to keep you on track with your investment goals and sidestepping bad decisions than making sure you and your investment advisor remain on the same page.
Obviously I’m no economist and having recently finished Tom Nichols book “The Death of Expertise” I approach this subject with some trepidation. But while I may not be an expert, public policy deserves to be reviewed, debated, and questioned by the public.
The nature of the debate follows predictable patterns. On one side, enthusiasts for the hike in the minimum wage believe that this will be an important financial boon to lower income families. Sadly far more people today subsist off of minimum wage than we might guess, and raising families on such an income is really little more than wage slavery and a sentence of poverty, problems that have serious consequences for the society at large. They also cite the benefits of boosting aggregate demand for spurring economic growth that can result from a wage hike.
Opponents argue that this will put off hiring, increase prices on goods and usher in more automation. These are also valid and well founded criticisms that deserve to be seriously addressed since they represent problems that are hard to unwind one you’ve got them.
The first issue that those of on the sidelines might ask is “what is the right minimum wage?” Surprisingly that question seems to lack any definitive answer. A quick review of the history of minimum wage tells us that neither do governments. This is partly because the minimum wage was initially established to fight substandard wages but has grown into an attempt to build “living wages”, stamp out sweat shops, provide a minimum cost for labour while still protecting businesses and growing the economy.
To accomplish those various tasks, minimum wages are really the response to lots of different inputs and therefore don’t yield correct or exact solutions. The perfect example of this has been the minimum wage experiments in cities like Seattle. Last year Seattle raised its minimum wage to $13 an hour, a substantial jump over its previous rate of $7.25. Analysis of this move has showed that people earned more per hour, but fewer hours were worked resulting in an average decline of $125.
This mixed blessing is at the heart of big jumps in the minimum wage. Attempts to make things better frequently have unexpected and unpredictable consequences, and this is largely because trying to tackle poverty through the exclusive use of adjusting the minimum wage only addresses one factor in many that contribute to debilitating wealth inequality.
I had previously written that “The Robot Revolution Will Cost $15 an Hour” and highlighted the arrival of McDonald’s new “digital kiosks” were part of that robot revolution. Across other low income work we see similar moves into greater automation, from airport ckeck-ins to Walmart E-Commerce towers and even Amazon’s recent purchase of Whole Foods. Raising the minimum wage provides the kind of creeping costs in personnel that improve the cost benefit analysis of big capital expenditures into new technology that will, in the long term reduce payrolls.
The flip side of the coin is that smaller companies that don’t have big financial resources tend to be stuck with higher costs for staff on-top of other overhead costs that may not be under their control. If that seems like an unfair hypothetical simply stop by a neighbourhood store and ask them how they find the cost of street front rental over the last few years. I promise your local grocer or bookstore seller hasn’t been able to raise prices faster than the growth in their rent.
For me the crux of this issue comes down to an old rule of thumb for budgeting: 50-20-30. If you don’t know it, it goes like this. 50% of your income should go towards essentials, including housing, food and transportation. 20% should go to savings, and 30% is discretionary. That sounds like great advice. Now check out this 2015 report from TD bank about how average renters in Toronto are paying 50% of their income just for the rent.
The story for Toronto is all about housing. Toronto is a successful growing city, but one that continues to play catch-up for its infrastructure and housing needs. The lowest incomes can be raised but the likelihood is that it won’t address the problems that continue to make many citizens struggle under the weight of burdensome costs just for living in the city. From the middle class to the working class high debt rates and expensive homes are gobbling up the economic prosperity of Canadians, and that deserves consideration before we charge blindly into making matters worse by hitting the minimum wage with steroids.
But what do I know. I’m not 40 economists.
This past week a number of articles spilled forth regarding the VIX index being at record lows. If you aren’t familiar with the VIX, that’s quite okay; the VIX is an index that tracks the nervousness of investors. The lower the VIX is the more confident investors are. The higher the VIX, the greater the concern.
At first glance the VIX seems to clearly tell us…something. At least it seems like it should. The index is really a measure of volatility using an aggregate of prices of options traded on the S&P 500, estimating how volatile those options will be between the current date and when they mature. The mechanics aren’t so important for our purposes, just that this index has become the benchmark for the assumed fear or comfort investors have with the market.
So what does it mean when the VIX is supposedly at its lowest point in nearly a quarter of a century?
Because we live in the 21st century, and not some other more primitive time, we have the best technology and research to look to when it comes to discerning the meaning of such emotionally driven statistics. Its here that the the area of study of behavioural economics and investing supposedly cross paths and that we might be able to yield some useful insight from the VIX.
The holy grail of investing would presumably be something that allowed you to accurately predict changes in the market based on investor sentiment. Though over time stock markets are meant to be an accurate reflection of the health and wealth of an economy, in the short term the market more closely tracks a series of more micro events. Investor sentiment, political news, potential scandals as well as outside influences like high frequency trading and professional traders pushing stocks up and down all make up daily activity.
The VIX seems like an ideally suited index to then tell us something about the market, and yet it probably isn’t. The problem with research into behavioural economics (and its other partner, big data) is that it is great at telling us about things that have already happened. The goal, that we could use this information to change or alter human behaviour, is still a long way off (if it exists at all). Similarly the VIX is basically great at telling us stuff that we already know. When markets are bad the VIX is high. When markets are good its generally low.
Thus, the VIX represents a terrible forecasting device but an excellent reminder about investor complacency. When markets are “good” (read: going up) there is a tendency for investors to ask for more exposure to those markets to maximize returns. If you feel uncertain about the future, investors and financial advisors are less likely to “drift” in terms of their investing style, but if people feel very good about the future their far more likely to take their foot off the breaks.
Real market panics and crashes tend to be triggered by actual structural problems. 2008 wasn’t the result of too much confidence about the future from investors, but because the market itself was sitting on a bubble. That the VIX was low only tells us what we already knew, that we weren’t expecting a financial crisis.
With markets down sharply yesterday its tempting to see that this level of investor complacency/confidence harbingered the most recent sell off. But that’s not the case. Trump is, and remains, a kind of nuclear bomb of unpredictability that must be factored into anyone’s expectations about the markets. But what we should do is consider the VIX a mirror to judge our willingness and preparedness to deal with unexpected events and market downturns. If you’ve started to assume that you can afford growing concentration in your portfolio of high performing equity or that you don’t need as many conservative positions, you should take a long hard look at why you feel that way. Maybe its just because you feel a little too confident.
Like everyone else.
Some time ago I wrote that it really didn’t matter whether or not there was a housing bubble, because what we actually have is a debt bubble. Houses just happen to be where the debt is. At that time many people were sceptical about the likelihood of an actual bubble. It wasn’t that prices weren’t high, it was just that people had been calling for a housing crunch for so long that most “serious” people simply didn’t think it was immediate or likely. That was several years ago now and the mood has shifted considerably. The housing bubble now occupies more mental space than any other economic challenge facing the country.
If one thing has gotten under the skin of economists and government officials, its how ineffective their attempts to lance this boil have been. Despite more stringent banking rules little has slowed the volume of cheap capital flooding the market that’s kept purchases up. We’ve even teetered into the murky xenophobic reasons for high house prices; absentee Chinese owners. Despite these initial efforts several realities have been hard to deny.
- Banks are lending too much: With interest rates at all time lows banks have lent more for less to keep profits up. Undoubtedly some of the mortgages (possibly many of these mortgages) should not have been offered by the banks at all.
- Secondary mortgage markets have grown substantially: If you couldn’t clear the low (low) bar that the banks had set to qualify for a mortgage you could always turn to the secondary banking market (we talked about them here) which would offer you a mortgage at a more punitive rate.
- There is a housing crisis: I’ve done my best to connect the high price of houses to a dwindling middle class, but it deserves to be mentioned again that there simply isn’t enough land development fast enough at high enough densities to offset the sheer number of people trying to work in and around the city of Toronto.
- Canadians have too much debt: How much debt is too much debt? I can’t say for sure but I promise we’ve already passed the tipping point on that. The numbers, mentioned so often that people can quote in their sleep, is an astonishing 167.3% of debt to disposable income at the end of 2016. Those numbers are worse when you realize that a large chunk of the Canadian population doesn’t carry any debt and so the level is actually much higher for those that do.
The response so far has been timid, as businesses and politicians are keen not upset the apple cart. But in the last two weeks several things have happened that, while not likely to lead to the downfall of the Canadian economy, put into stark relief how quickly these problems can arise and what they look like.
First, the housing crisis. This April we got headlines showing rents doubling for several people living in Toronto. While not normal it turns out that under the law, in certain circumstances, this is permitted. But as rental becomes more expensive and home ownership more unobtainable the province has felt the need to step in.
You can read Ontario’s Fair Housing Plan here if you like, but the response has been lukewarm from economists. The plan makes allowances for more development of land and attempts to give further powers to cities for things like a vacancy tax, but its unlikely that anything could be implemented quickly to change the market. The bulk of the plan is to extend rent control on all buildings in the province, capping the inflation rate on rent at 2.5%. This plan has been denounced by CIBC chief economist Benjamin Tal as “the exact opposite” of what is needed. Encouraging.
The next issue came out of Canada’s second largest mortgage provider, Home Trust Group. Dinged by the OSC for essentially misrepresenting the credit quality of borrowers on applications, they’ve had a sudden run on their high interest savings accounts (used to fund the mortgages). Investors were terrified that the company was about to collapse under the weight of risky mortgages. That may have been premature, but the fallout has forced them to seek a line of credit from a major pension and speaks to how nervous people are about the market.
But for every article worried about the imminent doom of the housing market, there is another one that is quite sure that things are still okay and somewhat stable, citing any number of structural differences between Canada and the situation in 2008. While that may be true, its important to remember that what hurts economies and makes nations week isn’t a single crisis, but a series of interlocking problems that are all connected. The Canadian housing bubble is about homes, but its also about debt, consumer spending, middle class anxiety, low yielding investments and aging populations, retirement financing and urban and suburban growth.
What Canada now has is a mortgage monster, debt so large and so important to the economy that no one is sure how to slay it without hurting the wider market at the same time. Against this shoggoth creature our politicians hurtle small stones, stern words and the promise of ever more study. These solutions will have the impact you might expect; very little. Whatever solution that exists to both increase affordability without undermining the debt situation or crashing the housing market currently exists beyond the reach of our politicians.
Facing a problem as great as this it’s a wonder more people don’t go mad.
For the past week I’ve been tinkering with a piece around the allegations that TD’s high pressure sales tactics had driven some staff to disregard the needs of their clients and encourage financial advisers in their employ to push for unsuitable products, and in some instances drove employees to break the law.
My general point was that the financial advising industry depends on trust to function, and runs into problems when those that we employ for those jobs serve more than one master. The sales goals of the big banks are only in line with the individual investor needs so long as investor needs serve the banks. In other words, clients of the banks frequently find that their interests run second to the profit and management goals of Canada’s big five.
Yet I was having a hard time getting the article together. Something about the message was too easy; too obvious. No one who read the reports from the CBC was in any doubt about the ethical dubiousness of TD’s position, and forgetting the accusations of illegality, I doubt most people were surprised to find out that banks put their corporate needs ahead of their average Canadian clients.
But then yesterday something truly shocking happened. One of Canada’s larger independent mutual fund companies had to pay a $1.5 million settlement to the OSC for “non-compliant sales practices” (you can read the actual ruling by the OSC HERE). Effectively the OSC was reprimanding a company for giving excessively large non-monetary gifts to financial advisers, rewarding them for being “top producers”.
For the uninitiated, Canada’s mutual fund industry can seem a little confusing, so let me see if I can both explain why a mutual fund company would do what it did, and how you can avoid it.
First, there are several different kinds of mutual fund companies:
- There are companies like those of the banks, that provide both the service of financial advice and the mutual funds to invest in. This includes the five big banks and advice received within a branch.
- There are also independent mutual fund companies that also own a separate investing arm that operate independently. Companies like CI Investments own the financial firm Assante, IA Clarington owns FundEx, and the banks all have an independent brokerage (for example TD has Waterhouse, RBC owns Dominion Securities and BMO owns Nesbitt Burns).
- Lastly, there are a series of completely independent mutual fund companies with no investment wing. Companies like Franklin Templeton, Fidelity Investments, AGF Investments and Sentry Investments all fall into that category.
The real landscape is more complicated than this. There are lots of companies, and many are owned by yet other companies, so it can get muddy quickly. But for practical purposes, this is a fair picture for the Canadian market.
In theory, any independent financial adviser (either with a bank-owned brokerage, or an independent brokerage, like Aligned Capital) can buy any and all of these investments for our clients. And so, the pressure is on for mutual fund companies to get financial advisers to pay attention to them. If you are CI Investments, in addition to trying to win over other advisers, you also have your own financial adviser team that you can develop. But if you are a company like Sentry, you have no guarantee that anyone will pay attention to you. So how do you get business?
Sentry is a relatively new company. Firms like Fidelity and Franklin Templeton have been around for more than half a century. Banks have deep reserves to tap into if they want to create (out of nothing) a new mutual fund company. By comparison, Sentry has been around for just 20 years, and has had to survive through two serious financial downturns, first in 2000 and then 2008, as an independent firm. By all accounts, they’ve actually been quite successful, especially post 2009. You may have even seen some of their advertisements around.
But while Sentry has had some fairly good performance in some important sectors (from a business standpoint, it is more important to have a strong core of conservative equity products than high flying emerging market or commodity investments) it has also had some practices that have made me uncomfortable.
For a long time, Sentry Investments paid financial advisers more than most other mutual fund companies. For every dollar paid to an adviser normally, Sentry would pay an additional $0.25. That may not sound like much, but across enough assets thats a noticeable chunk of money. And while there is nothing illegal about this, it is precisely the kind of activity that makes regulators suspicious about the motives of financial advisers and the relationships they have with investment providers. Its no surprise that about a year ago Sentry scaled back their trailer to advisers to be more like the rest of the industry.
The fact is, though, that Sentry is in trouble because of their success. No matter how much Sentry was willing to pay advisers, no-one has a business without solid performance, and Sentry had that. The company grew quickly following 2008 and has been one of the few Canadian mutual fund companies that attracted new assets consistently following the financial meltdown. When times are good, it’s easy for companies to look past their own bottom line and share their wealth. That Sentry chose to have a Due Diligence conference in Beverly Hills and shower gifts on their attending advisers was a reflection of their success more than anything else.
And yet, from an ethical standpoint, it is deeply troubling. I have always been wary of companies that offer to pay more than the going market rate for fear that the motives of my decision could be questioned or maligned. Being seen to be ethical is frequently about not simply following the law, but doing everything in your power to avoid conflicts of interest (Donald Trump: take notice). The financial advisers attending the due diligence (who would have paid for their own air travel and hotel accommodation) probably had no reason to believe that the gifts they were receiving exceeded the annual contribution limit. But now those gifts cast them too in the shadow of dubious behaviour.
So how can you protect yourself from worries that your adviser is acting unethically, or being swayed to make decisions not in your interest? First, insist that your adviser at least offers the option of a fee for service arrangement. While the difference between an embedded trail and a transparent fee may be nominal, a fee-for-service agreement means that you have complete transparency in costs and full disclosure about where your advisers interests lie.
Second, if an embedded trail is still the best option, ask your adviser what the rationale was behind the selection of each of the funds in your portfolio, and what the trail commission was for each of those investments. This is information that you are entitled to, and you shouldn’t be shy about asking for.
Lastly, ask what mutual funds have given your adviser, but be open to the answer. Gifts to advisers are meant to fall into the category of “trinkets and trash”, mostly disposable items that are visibly branded by the company providing them, though gifts can be moderately more expensive. The difference between receiving cufflinks from Tiffany’s and cufflinks that bare the logo of a mutual fund firm is the difference between ethically dubious and openly transparent.
Regulators in Canada are pushing the industry towards a Fiduciary Responsibility for financial advisers. While that may clarify some of the grey areas, it will certainly create its own series of problems. Until then though, investors should not hesitate to question the investments they have, and why they have them. It may be unfair to expect the average Canadian to remember all the details about the types of investments that they have, but you should absolutely expect your financial adviser to be able to transparently and comprehensively explain the rationale and selection method behind the investments that you own.
If you would like an independent review of your current portfolio, please don’t hesitate to give us a call. 416-960-5995.
Over the weekend investors got a chance to read the fine print on the faustian bargain they had with President Donald Trump. Since Trump’s election night win, markets had jumped significantly. The promise of stimulus spending, tax cuts and a renewed focus on deregulation had given investors a “sugar rush”, and eclipsed the more basic concerns about Trump’s general lack of suitability to be president.
But with the stroke of a pen investors were being reminded about how quickly Trump’s essential character and the presidency he promised could bring chaos and confusion. On Friday Trump signed an executive order to temporarily restrict accepting refugees from seven predominantly muslim countries. The order was vague, poorly thought out, badly executed and quite possibly illegal. Confusion reigned and initially the order was applied to people with legal immigrant status in the United States, including those with green cards.
The weekend was filled with protests at airports, backtracking by members of the administration, and out and out insurrection by members of the government who believed that the order was unconstitutional. Very quickly the official story has descended into the kind of decontextualized factual minutia that has come to characterize attempts to grapple with the truth in the age of the internet. Did Obama do something similar? Is this a Muslim ban or something more restrained? Is it more or less reasonable than it was presented? Accusations or partisan hackery and racism powered the internet and every conversation everyone had over the weekend and well into today.
The answers to these questions are largely immaterial. Trump is a populist and is likely going to do exactly what he said he would do on the campaign trail. That his cabinet is a group of people with little understanding of the nuances of government and that he may in fact be heading up an administration that is kleptocratic on par with a South American government is part of his current appeal. This weekend won’t be the last time controversial and vague (or illegal) orders are issued by this president and it won’t be the last time that they are met with organized resistance.
2016 was a year in which great changes to the status quo were made without many of those changes having an impact. Investors may have come to believe that the rising tide of angry populism won’t have any negative repercussions, or may even be positive. But this weekend brought investors face to face with the reality of unpredictable populist outsiders calling the shots. Volatility is in the cards, and even if (as many believe) that Trump will be good for the economy, his style is not slow and deliberate, but fast and reckless. Investing in the US, which has a strong economy, is unlikely to be smooth even if the trajectory is up.
That’s the problem with Faustian bargains. You get what you want but what you sacrifice has typically been undervalued. The future for the American markets still looks good; but NAFTA talks loom, there are threats of trade wars, and a stable and predictable government seems unlikely. Investors should take note; its day 11 and there are another 4 years ahead. Even if we can’t predict tomorrow, we should acknowledge that tomorrow’s unpredictability may be the thing that investors have to make peace with.