The Mystery of Market Volatility

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This past week markets had a sudden and sustained sell off that lasted for two days, and though they bounced back a little on Friday, US markets had several negative sessions. The selloff in US markets, which began on Wednesday and extended into Thursday, roiled global markets as well, with extensive selling through Asia and Europe on Wednesday evening/Thursday morning. At the end of the week Asian, European and Emerging markets looked worse than they already were for the year, and US markets had been badly rattled. This week has seen an extension of that volatility.

Explanations for sudden downturns bloom like flowers in the sun. Investors and business journalists are quick to latch onto an explanation that grounds the unexpected and shocking in rational sensibility. In this instance blame was handed to the Federal Reserve, where members had been quoted recently talking about higher than expected inflation forcing up lending rates at an accelerated pace. This account was so widely accepted that Donald Trump was quoted as saying that “The Fed has gone crazy”, a less than surprising outburst.

TSX YTD

TSX year to date performance is currently just over -4.3%

I tend to discount such explanations about market volatility. For one, it seeks to neuter the truth of markets as large complex institutions that are subject to multiple forces of which many are simply invisible. Second, by pretending that the risk in markets is far more understandable than it really is, investors are encouraged to take up riskier positions and strategies than they rightly should and ignore advice that has proven effective in managing risk. Finally, I have a personal dislike for the façade of “all-knowingness” that comes along after the fact by people who have parlayed luck into “expertise”. Markets are risky and complex, and it would be better if we treated them like a vicious animal that’s only partially domesticated.

Dow YTD

The Dow Jones performance has been quite good this year, but in the past week lost just over 5%, bringing year to date returns to 2.94%

In fact, as markets continue to grow with technology and various new products, complexity continues to expand. At any given time markets are subject to small investors, professional brokers, pension funds, algorithm driven trading programs, mutual fund managers, exchange traded funds and even governments, all of whom are trying to derive profits.

So what does that tell us about markets, and what should we take from the recent spike in volatility? One way to think about markets is that they operate on two levels, a tangible level based on real data and expectations set by analysts, and another that trades on sentiment. On the first level we tend to find people who advocate for “bottom up investing”, or the idea that corporate fundamentals should be the sole governor of stock’s price. If you’ve ever heard someone discuss a stock that’s “under-performing,” “undervalued,” “out of favor,” or that they are investing on the “principles of value” this is what they are referring to. People who invest like this believe that the market will eventually come around to realizing that a company hasn’t been priced correctly and tend to set valuations that tell them when to buy and sell.

DAX YTD

Germany, the strongest economy in EUrope has already struggled this year under the burden of the EU fight with Italy’s populist government and ongoing BREXIT negotiations. YTD performance is -10.56%

The second level of investing is based on sentiment, informed by the daily influx of headlines, rumour and conspiracy that clogs our news, email inboxes and youtube videos. This is where most investors tend to hang their hat because its where the world they know meets their investments. Most people aren’t analyzing a specific bank, but they may be worried a housing bubble in Canada, or the state of car loans, or the benefits of a recent tax cut or trade war. The sentiment might be best thought of as the fight between good and bad news informing optimism and pessimism. If a bottom up investor cares about a company they may ignore general worry that might overwhelm a sector. So if there is a change in in the price of oil, a value investor may continue to own a stock while the universe of sentiment sees a widespread selling of oil futures, oil companies, refining firms and downstream products.

Shanghai Comp YTD

China is the world’s second largest economy and the biggest market among the emerging markets. Having struggled with Trump’s tariffs, YTD performance is a whopping -22.8%

As you are reading this you may believe you’ve heard it before. Indeed you have, as our advice has remained consistent over the years. Diversification protects investors and retirement nest eggs better than advice that seeks to “beat the market” or chases returns. However, it seems to me that the market sentiment is undoubtedly a stronger force now than its ever been before. As more investors come to participate in the market and passive investments have grown faster than other more value focused products, sentiment easily trumps valuations. Since we’re always sitting atop a mountain of conflicting information, some good and some bad, whichever news happens to dominate quickly sets the sentiment of the markets.

You don’t have to take my word for it either. There is some very interesting data to back this up. Value investing, arguably the earliest form of standardized profit seeking from the market, has remained out of favor for more than a decade. Meanwhile the growth of ETFs has continued to pump money into the fastest growing parts of the market, boosting their returns and attracting more ETF dollars. When the market suddenly changed direction on Wednesday, the largest ETF very quickly went from taking in new dollars to a mass exodus of money, pushing down its value and the value of the underlying assets. At the same time some of the worst performing companies went to being some of the best performing in a day.

MW-FZ971_CSetff_20171211161201_NS

This chart shows that actively managed mutual funds have hemorrhaged money oer the past few years, while passive ETFs have been the chief beneficiaries, radically altering the investment landscape.

So what’s been going on? The markets have turned negative and become much more volatile because there is a lot of negative news at play, not because interest rates are set to go up too quickly. Sentiment, that had been positive on tech stocks like Amazon and Google gave way to concern about valuations, and with it opened the flood gates to all the other negative news that was being suppressed. Brexit, the Italian election, the rise of populism, currency problems in Turkey, a trade war with China and rising costs everywhere came to define that sentiment. As investors begin to feel that no where was safe, markets reflected that view.

Our advice remains steadfast. Smart investing is less about picking the best winner than it is about having the smartest diversification. A range of solutions across different sectors and styles will weather a storm better, and investors should be wary of simplistic answers to market volatility. Markets always have the potential to be volatile, and investors should always be prepared.

The Paradox of Donald Trump

10-donald-trump-debate-w750-h560-2xDonald Trump’s presidency is most generously described as a mixed bag. To his supporters he is the most accomplished president since Regan, maybe ever. To his detractors he is a dangerous demagogue whose flouting of democratic norms and curiously close connections to Russia (which predate his run for the presidency) threaten multiple constitutional crises. Undeniable is that his pursuit of electoral victory has meant that he’s been more than willing to entertain the support of racists and neo-nazis, and even his champions admit he seems oblivious to the importance of the traditional alliances that support the world order. Economists bemoan his understanding of economics, which seems especially dubious when it comes to international trade and tariffs. We’ve yet to discuss his own personal vulgarities.

Having said all of this, we must address the paradox of Donald Trump, and that is his ability to pursue change, and find success on issues that are seemingly set in stone. His NAFTA talks, which have ended in a deal, have brought only minor concessions from Canada and Mexico. However it should be noted they are concessions slightly greater than previously negotiated under the TPP which the US declined to be part of. His chaotic approach to governing seems to endanger many of his own goals, and when he is stymied in his objectives he is typically the source of his own sorrows. But that doesn’t mean that he doesn’t have some method to his madness.

The world order that has existed since the end of the WW II, and which went into overdrive following the collapse of the Soviet Union, has succeeded in enriching the world in ways that might be considered unimaginable by previous generations. In 2018 more free nations exist, fewer people live in poverty while crime and war are at all time lows. This is all part of a trend known as the great convergence, the catching up of developing economies to developed ones and the benefits a post scarcity society brings. This change, which is helping wipe out extreme poverty and improve the lives of billions brings with it a global shift in power. Europe and the United States, though still the largest economies, are no longer alone on the world stage and the idea of a unipolar world is no longer viable. Regional powers are reasserting themselves and that includes China whose rise has been considered inevitable by most Western nations.

But China’s ascendance is coming with a high cost. China refuses to respect international rules around intellectual property; as an economic power it’s trade practices can destabilize markets; as an international power it is busy buying access to foreign countries with large scale infrastructure projects; as a military power it is in a belligerent fight to take control of the major trade routes through the South China Sea; and in the fields of espionage it is engaged (like Russia) in extensive cyber activities. Left unchecked China represents an opposite pole in the globe that (like Russia) promotes a global order that isn’t interested in law, international agreements and global norms, but aims instead towards regional autonomy free from such restrictions.

 

Whether Trump believes in the “global liberal order” isn’t clear, but he seems to see that America is involved in a fight with China, one that it may not have an opportunity to fight again under terms this favorable. This is part of the paradox of Donald Trump. As political theorist Ian Bremmer has pointed out, much of Trump’s insights are not bad but the way he puts them into practice undermines his own ambitions, and hurts the alliances that are needed to sustain his goals and the liberal order. Thus, he’s as likely to upset his allies as he is to rattle America’s foes. In this respect Trump is more similar to Vladimir Putin or Xi Jingpin, who see that national interests should supersede international ones (and where national interests never conflict with the leader’s interests).

Last week I wrote an article about how Canada could lose NAFTA, only to have a new deal come into place on Sunday. I scrapped that piece, but my view remains that Trump’s only sacred cow is his own instincts and that investors shouldn’t assume that that things will work out simply because there might be some political or popular resistance. The success of the status quo is not a guarantee that things will fall back into place and history reminds us that the assumption of inevitability is folly. Things can change, sometimes irrevocably so.

Donald Trump remains a paradox, a leader who touches on good ideas but is unsure how to implement them. The head of the free world who seems far more comfortable in the company of strong men and dictators. An anti-war candidate that may be in a Thucydidean trap with China. An elitist billionaire who seems to have better understood the frustrations of the common citizen. A self-described “great negotiator” whose skill nets only small gains. Investors, take note.

I recognize that writing about politics runs the risk of upsetting or offending readers. Some may regard criticism of a political person or view as an indirect criticism of themselves. This could not be farther from the truth, and we recognize that Trump would not be elected if he didn’t understand something true about the world. We write to help explain our world view and how we believe we should approach investing opportunities and risks. If you are curious about what has informed this view we recommend the following books:

  1. Enlightenment Now, Steve Pinker
  2. The Road to Unfreedom – Timothy Snyder
  3. The Clash of Civilizations – Samuel Huntington
  4. The Return of Marco Polo’s World – Robert Kaplan
  5. Every Nation for Itself – Ian Bremmer
  6. Homo Deus – Yuval Noah Harari
  7. China’s Great Wall of Debt – Dinny McMahon
  8. The Retreat of Western Liberalism – Edward Luce
  9. The Return of History – Jennifer Welsh

The Deceptive Nature of Indices

Index

An essential part of the business of investing involves figuring out how well you are doing. In some respects, the best benchmark for how well you are doing should be personalized to you. How conservative are you? What kind of income needs do you have? How old are you? While the case remains strong for everyone to have a personal benchmark to compare against their investment portfolios, in practice many people simply default to market indexes.

I’ve talked a little about market indexes before. They are poorly understood products, designed to give an impression about the overall health and direction of the economy and can serve as a guide to investment decisions. Large benchmarks, like the S&P 500, the TSX, or the FTSE 100, can tell us a great deal about the sentiment of investors (large and small) and what the expected direction of an economy may be.

But because these tools are usually poorly understood, they can contribute to as much confusion as they do clarity. For instance, the Dow Jones uses a highly confusing set of maths to determine performance. Last year General Electric lost about 50% of its market capitalization, while at the same time Boeing increased its market capitalization by 50%, but their impact on the Dow Jones was dramatically different. Boeing had an outsized positive contribution while General Electric had a much smaller negative impact.

The S&P 500 currently is one of the best preforming markets in 2018. Compared to most global indexes, the S&P 500 is ahead of Germany’s DAX, Britain’s FTSE 100 and FTSE 250, Japan’s Nikkei and Canada’s TSX. Yet if you are looking at your US focused investments, you might be surprised to see your own mutual funds lagging the index this year. If you were to ask an ETF provider or discount financial advisor why that is they would likely default to the answer “fees”, but they’d be wrong.

YTD FTSE S&P500 TSX

While the S&P 500 isn’t exactly “running away” it is doing considerably better than the TSX and the UK’s FTSE 100

This year is an excellent example of the old joke about Bill Gates walking into a bar and making each patron, on average, a millionaire. While the overall index has been performing quite well, the deeper story is about how a handful of companies are actually driving those returns, while the broader market has begun to languish. Of the 11 sectors in the S&P 500, only two are up, technology and consumer discretionary, while a further 6 were down for the year. In fact the companies driving most of the gains are: Facebook, Amazon, Apple, Alphabet (Google), Netflix and Microsoft. The 80 stocks in the consumer discretionary space not in that list have done almost nothing at all.

What does this portend for the future? There is a lot to be concerned about. The narrowing of market returns is not a good sign (although there have been some good results in terms of earnings), and it tends to warp investment goals. Investors demand that mutual fund returns keep up with their index, often forcing portfolio managers to buy more of a stock that they may not wish to have. In the world of Exchange Traded Funds (or ETFs), they participate in a positive feedback loop, pulling in money and buying more of the same stocks that are already driving the performance.

In all, indexes remain a useful tool to gage relative performance, but like with all things a little knowledge can be deceptive. The S&P 500 remains a strong performing index this year, but its health isn’t good. Healthy markets need broad based growth, and investors would be wise to know the details behind the stories of market growth before they excitedly commit money to superficially good performance.  

Did that make you worried? Don’t be scared, call us to set up a review of your portfolio to better understand the risks!

Do Banks Misrepresent GIC Rates?

I thought I had more saved!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%.

90 Day

This seems shockingly dishonest. Also the importance of that footnote seems understated.

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.

 

Linked GIC

Sounds good right? Don’t forget to click on the “More Details” button.

 

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?

 

Important disclaimer

This sentence feels like it should be in the yellow, and not a different webpage towards the bottom.

 

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!

 

 

Making Economics Meaningful – How Official Inflation Figures Obscure Reality

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.

Capture

Following the financial crisis lending rates dropped from historic norms of around 5% to historic lows and remained there for most of the next decade.

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.

CollegeInflationArmed 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.

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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.

DIe6Fh2UMAEDmaIIn 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. 

DJs5AdwXoAANcDTEconomic 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.

DWS3VJkX4AAXXaT

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 Investors Should be Sceptical About in 2018

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.

20160903_LDD001_0Self 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.

2860534_1280x720This 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.

CaptureCurrencies 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.

The Ballooning Cost of Growing Old

Senior Couple Enjoying Beach Holiday Running Down Dune

The reality about retirement is that this bit can be fleetingly short compared with the scope of being elderly. 

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.

20696006In 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%.

ch1_graph3.0-eng

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.

 

Toronto's City Hall, Nathan Phillips Square. (Shutterstock)

Toronto is a wonderful city, but we’ve done a bad job of making sure that we can still afford to live here. 

 

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:

  1. 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.
  2. Ensure that you’ve got a Power of Attorney (POA) established and that it is current.
  3. Make sure you have a living will and discuss with your family your expectations about how you want your life to end.
  4. Look into your funeral arrangements while you can. It seems macabre, but funerals can be wildly expensive and burdensome to thrust onto grieving family.
  5. 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.
  6. 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.
  7. 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.
  8. 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.

The Catalonia Effect

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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.

Antifragile-bookOn 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.

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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.

Watch Me Fight 40 Economists

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The Liberal government of Ontario is intending to raise the minimum wage to $15 an hour by 2019, and 40 economists have penned an open letter to back this plan, and I couldn’t disagree more.

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.

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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.

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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.

Vexed by the VIX

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?

Historic VIX

This is the historic performance of the VIX. Data provided by CBOE.

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.

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What is this, 2007? Might as well be the stone age!

Or not.

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.

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Bad forecasting can lead to terrible outcomes.

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.

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Yesterday’s selloff followed news that Trump’s Russia problem wasn’t going to go away, but remain a permanent feature of his administration.

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.

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We can hope.

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.