The Age of Breakable Things

With Brexit around the corner, the potential for a Donald Trump presidency and a host of other global problems (big problems), it’s hard not to talk about all the chaos and what it might mean to investors even when there is lots of other things to go over. For now, this will be our last article on the subject of Brexit until next week following the vote. I will take a look at some other issues later in the week.

One thing that jumps out at me about “Brexit” is how fragile much of our world is. Progress is most often thought of as making things stronger or better, but that is only true to a point. Progress also has the unfortunate downside of making things much more fragile. The more progress allows us to do, the more fragile each step makes us.

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Beautiful tall buildings like this remain a testament to our progress and how profoundly fragile it all is.

Historically that fragility can frequently be seen during times of war. Britain, undoubtedly the world’s most powerful empire at the outset of the first and second world war, saw how quickly its strengths could be overcome by the weaknesses of a far flung empire. The supply lines, the distant resources and the broad reach of the war all exposed the underlying frailty of the British Empire. Two World Wars was all it took to end an empire that had been 500 years in the making.

What we hold in common with the British Empire is the causal assumption that things are the way they are naturally, that we cannot change the inherent status quo in our lives. Canada, the United States and Europe are rich nations because they are naturally rich nations, and not the result of a combination luck, science, philosophy and culture that have conspired to land us where we are today.

We live in a breakable society, one that doesn’t realize how fragile it is. In the past few years it has been tested in a multitude of ways, and this year is no exception. Brexit isn’t even the worst of how it can be. Syria has been reduced to rubble, Turkey has essentially lapsed into a dictatorship, with Russia having gone the same way. Venezuela, which I wrote about earlier, has moved from breadlines to mob violence.

Progress isn’t just uneven, it also isn’t guaranteed. Nations, empires and great civilizations have all come and gone, each of them burning brightly, however briefly, before being extinguished. The speed of a decline in Venezuela isn’t just a result of bad management, it is a reflection to just how much support our civilization needs. The rise of the new introverted nationalism doesn’t see this, and has sought an imagined self sufficiency as a way to relieve temporary difficulties. If people thought that the EU was difficult to deal with when you were a part fo it, wait until you aren’t.

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Brexit is a choice that is both scary and appealing because it is scary. For an entire generation there may never be a choice like this again, a chance to permanently alter the geopolitical landscape, even with little understanding of what those changes can mean or do. Whether Britain will be poorer or richer over the next decade may ultimately hinge on the vote this Friday. Far more frightening is whether our ability to build something lasting, powerful but fragile will be permanently undone in the European sphere.

Notes from the Edge

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The June 18th cover for The Spectator

 

With the BREXIT vote now only days away its worth taking a moment to consider the dramatic political shift that seems to be happening around the globe. Where once left/right politics dominated, or pro-capitalism vs. pro-socialist forces clashed, today the challenge is far more frightening. Today we sit on the brink of the end of the new internationalism and face the rise of old nationalism.

In Jon Ronson’s funny and insightful book THEM: Adventures with Extremists, the author describes his final meeting with a founding member of the Bilderberg Group (yes, that Bilderberg Group) Lord Healy, who explains that at the end of the Second World War a real effort was made to encourage trade and economic growth as a way of deferring future wars. The Bilderberg Group is but one of many, slightly shadowy and often undemocratic, organizations that exist to further those goals, encouraging powerful people to air out their issues and discuss ways to make that vision of the world more likely.

But for millions of people the new internationalism that has been fostered through trade agreements, globalization and corporatism has made the world more hostile to millions of “left behind” voters. It has seemingly given power to cigarette manufactures in Africa, or created unfair and uncompetitive “tax free zones” in South Pacific nations. It has fostered sweatshops in Sri Lanka, dangerous factories in Bangladesh, all at the expense of industrial workers in Western developed nations. In Europe this internationalism is blamed for feckless leadership on humanitarian, fiscal and bureaucratic issues. In America it is blamed for the rust belt through the mid-west.

The response to the growing frustration on all these issues has been a resurgence of nationalism and political “strong-men”. Putin’s Crimea grab was as much about returning pride to Russia as it was about diverting attention from his own domestic issues, reestablishing  Russia’s place as a significant regional power. Across Europe there are rumblings, both of renewed regional nationalism from within countries, as well as growing concern that a “leave vote” in Brexit could destabilize the entire EU experiment. In the United States these issues have given power to the Donald Trump populism, but have also fired the Bernie Sanders campaign.

Energy to these issues have undoubtedly been fueled as a result of 2008, a disaster so wide reaching and so disruptive to the Internationalist narrative about the skill set of the political and corporate classes that it shouldn’t be surprising that millions of people seem ready to do irreparable harm to the status quo. The subsequent inability to provide a strong and sustained economic recovery like some recessions of the past has only made matters worse. Every ill, every short coming, every poor decision and every injustice inherent within the structure that we inhabit is now expected to be resolved by setting the whole thing on fire and assuming that the problem is solved.

I am constantly surprised by how little people actually want to see changed by referendums like these. During the Scottish Referendum, the expectation was that Scotland would continue on exactly as it does, but without any association to London. The Leave campaign in Britain is quite sure that while Britain will no longer be part of the common market, a deal can be worked out that will allow free trade to continue unabated and for British people who live in places like Spain and Italy to continue to do so without visas or travel restrictions. Donald Trump is quite convinced that he can have a trade war with China without upsetting American business interests there, and the host of smaller countries like Venezuela or Turkey can slide into despotism without adverse impacts to their international reputation.

We’re at the edge, with the mob pushing for change (any change) with little real understanding of the consequences. It is little surprise that the technocrats and political establishment are so unlikable and so uninspiring in the face of the radicals and revolutionaries that want to see a sizable change that can’t be brought about until everything is torn down. And while it is true that the status quo can’t remain, it is equally unlikely that the end of the EU, or a British exit will stem the tide of migrants from Eritrea, or that tearing up NAFTA will return factories to Michigan, or that Marine Le Pen can turn the clock back on France and bring back the beret.

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I expect market volatility over the next while as investors and deal makers try and figure out the correct response to either a leave or remain vote. If Britain does leave, the next 100 days will be telling as pronouncements will be made to try and smooth the troubled waters. But the real work will come in the next 2 years, as negotiations will begin to do all the hard work that the referendum creates. You can’t just burn it all down, you have to build something in its place. How successful the reformers are at the latter will be the real test of the new nationalism.

 

This House Kills the Middle Class

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This house sold for $1,000,000 in Vancouver. Is it houses that are in demand, or land?

In the mountains of articles written about Toronto’s exuberant housing market, one aspect of it continues to be overlooked, and surprisingly it may be the most important and devastating outcome of an unchecked housing bubble. Typically journalistic investigation into Toronto’s (or Vancouver’s) rampant real estate catalogues both the madness of the prices and the injustice of a generation that is increasingly finding itself excluded from home ownership, finally concluding with some villain that is likely driving the prices into the stratosphere. The most recent villain du-jour has been “foreign buyers”, prompting news articles for whether their should be a foreign buyer tax or not.

What frequently goes missing in these stories are the much more mundane reasons for a housing market to continue climbing. That is that in the 21st century cities, like Toronto, now command an enormous importance in a modern economy while the more rural or suburban locations have ceased to be manufacturing centres and are now commuter towns. Combined with a growing interest in the benefits of urban living and the appeal of cities like Toronto its no surprise that Toronto is the primary recipient of new immigrants and wayward Canadians looking for new opportunities.

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Toronto itself, however, has mixed feelings about it’s own growth. City planners have made their best efforts to blend both the traditional idea of Toronto; green spaces, family homes and quiet neighbourhoods, with the increasing need of a vertical city. Toronto has laid out its plans to increase density up major corridors while attempting to leave residential neighbourhoods intact. Despite that, lots of neighbourhood associations continue to fight any attempt at “density creep”. Many homeowners feel threatened by the increasing density and fear the loss of their local character and safety within their neighbourhoods, at times outlandishly so. Sometimes this comically backfires, but more often than not developers find themselves in front of the OMB (Ontario Municipal Board) fighting to get a ruling that will allow them to go ahead with some plan, much to the anger of local residents and partisan city councillors.

The result is that Toronto seems to be growing too fast and not fast enough simultaneously, and in the process it is  setting up the middle class to be the ultimate victims of its own schizophrenic behaviour.

High house prices go hand in hand with big mortgages. The bigger home prices get the more average Canadians must borrow for a house. Much of the frightening numbers about debt to income ratios for Canadians is exclusively the result of mortgage debt, while another large chunk is HELOCs (home equity lines of credit). Those two categories of debt easily dwarf credit cards or in store financing. This suits banks and the BoC not simply because houses are considered more stable, but because banks have very little at risk in the financial relationship.

To illustrate why banks have so little at risk, you only need to look at a typical mortgage arrangement. Say you buy a $1 million home with a 20% down payment, the bank would lend you $800,000 for the rest of the purchase. But assume for a second that housing prices then suddenly collapse, wiping out 20% of home values, how much have you lost? Well its a great deal more than 20%. Because the bank has the senior claim on the debt, the 20% of equity wiped out translates into a 100% loss for you, the buyer. The bank on the other hand still has an $800,000 investment in your home that must be paid back.

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By itself this isn’t a problem, but financial stability and comfort is built around having a set of diversified resources to fall back on. In 2008, in the United States, home owners in the poorest 20% of the population saw not just their home prices collapse, but also all of their financial resources. On average if you were part of the bottom 20% you only had $1 in other assets for every $4 in home equity. By comparison the richest 20% had $4 in other assets for every $1 in home equity. The richest Americans weren’t just better off because they had more money, but because they had a diversified pool of assets that could spread the risk around. Since the stock market bounced back so quickly while much of the housing market lagged the result was a widening of wealth inequality following 2008.

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The impact of 2008 on household net worth by quintile. From House of Debt by Atif Mian and Amir Sufi

In Toronto the situation is a little different. Exorbitant house prices means lots of people have the bulk of their assets tied up in home equity. Funding the enormous debt of a house may preclude investing outside the home or building up retirement reserves in RRSPs and TFSAs. A change in interest rates, or a general correction in the housing market would have the effect of both wiping out savings while simultaneously raising the burden that debt places on families.

The issue of debt is one that the  government and the BoC take seriously, yet despite the potential impact of high debt levels on Canadians and the looming threat it poses to the economy the mood has remained largely indifferent. The BoC, under the governorship of Stephen Poloz, has said that it isn’t worried too much about Canada’s housing market. This isn’t because there isn’t a huge risk that it could implode, but because even if it does it is unlikely to start a run on the banks. By comparison the view of Stephen Poloz on the debt levels of Canadians is that its your problem. A curious stance given that the BoC’s position has been to try and stimulate the economy with low borrowing rates.

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There will probably never be as full throated a reason for my job than the burden the Toronto housing market places on Canadians. From experience we know that concentrating wealth inside a home contributes to economic fragility, potentially robbing home owners of longer term goals and squeezing out smart financial options. But far more important now is that city councillors and home owners come to realize that the housing market is more prison than home, shackling the city to ever more tenuous tax sources and weakening the finances of the middle class. Until then, smart financial planning alongside home ownership is still in the best interests of Canadian families.

The Robot Revolution Will Cost $15/hour

The future is already here – It’s just not very evenly distributed

William Gibson

Back in August of 2015 McDonald’s started rolling out self serve kiosks into it’s “restaurants”. McDonald’s was quick to point out that the arrival of the touch screen ordering stations would not endanger jobs, and that McDonald’s as you know it will continue on; producing sub-par food that you will regret eating 20 minutes after you’ve finished.

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This is patently false (not the food bit, but the employment bit), but that doesn’t mean McDonald’s is lying. They too may think that speeding up ordering won’t impact jobs. But this is what the robot revolution looks like. Not a mass movement to unemployment, but a gradual reduction in the number of jobs available.

Typically when people think about job loss they tend to think of blue collar, formerly middle class factory work that has been outsourced to overseas production. That makes sense because it is one of the most visible forms of improved productivity. But people didn’t move factories to China because they had the most advanced robotics. They moved to China because they (initially) had the cheapest labour. The productivity increase was not one of improved output through advanced manufacturing, but a much older standard of fundamentally cheap human labour.

Factories that have stayed in North America and Europe have largely been the beneficiary of more robotic improvements. But these robots, despite improving consistency, wiped out thousands of jobs. In towns like Flint Michigan, where GM once employed 80,000 people in 1980, they employed fewer than 8000 by 2010. But the scars left by yanking thousands of jobs from a community are hard to shake and they may have sculpted our modern thoughts on what the robot revolution will look like. But it is wrong.

If you want to see what the revolution will actually look like, look no further than the airline industry. Around the same time that General Motors was starting to outsource suppliers or introduce new robotics to the factory floor a subtle shift in technology effectively began to eliminate 1/3 of the jobs from airlines. Because starting in the 1980s airplanes no longer needed a flight engineer.

People don’t often think of a flight engineer, but as once the third person in a cockpit on most commercial jets his job was made obsolete by better computers. Today, out of fleets and fleets of aircrafts there are no flight engineers, but nobody is launching into long winded speeches in congress about it, no protests have been scheduled and Michael Moore has yet to make a movie about their job loss. The reason for this it is obvious, flight engineers were phased out as new technology was brought in, not let go on mass. Over time there were simply fewer jobs until there were none. Students didn’t study to become them because they knew the job was unlikely to exist, and pilots, while the loss of the flight engineer might have been initially unnerving, became attuned to more computers handling stuff in the cockpit. While new pilots didn’t miss what had never been there.

How many flight engineers do we not have? That’s a hard number to come up with, but assuming that an FE was necessary person in all airplanes means that American Airlines employs roughly 7000 fewer people than it would have needed to otherwise. If you are looking at the number of flights per day globally, including all the cargo and travel flights, that’s 100,000 flights. Assuming that a crew only does one flight a day (shut-up, I know that’s not accurate) that’s 100,000 fewer people who don’t hold a job because it doesn’t exist.

In the retail space then, we won’t see people laid-off, so much as we will simply see fewer people hired. As minimum wages continue to creep up in a vain effort to try and improve living standards (and yes it is in vain and I don’t have time to explain why in this article) the value in adding a robot that can fold t-shirts becomes far more appealing. It won’t mean firing every person who works in the GAP, but it will likely mean that each GAP store employs fewer people over the long term.

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This is the abandoned Packard factory in Detroit, at its peak employed 6 times as many people as the future Tesla factory 

 

That’s what the robot revolution looks like. A gradual, but persistent reduction in the needed number of people to fulfill a set job. It’s why when Bernie Sanders or Donald Trump talk about unfair trade practices they really can’t undo what has already been done. Even as “good paying factory jobs” return to the United States, fewer and fewer of them reach the shore. Tesla’s Gigafactory 1, the largest building by area on the planet, will only employ 6500 people. By comparison, the Packard Factory in Detroit (the world’s largest abandoned factory) employed 40,000 people at it’s peak. The robot revolution promises to do this to every job, over time as more and more menial aspects of work can be reliably handed over to more complex bots.

So when McDonald’s says that it’s new self-serving terminals won’t threaten jobs, they may mean it but we should know that they are wrong. McDonald’s pioneered standardization in the food industry. They made people into robots long before robots were common. They should know above all, that new cheaper and versatile robotics will in the long term reduce their number of employees, a reality that will speed up as minimum wages continue to rise.

What a Real Economic Collapse Looks Like – The Slow Death of Venezuela

Hey, millennials, which socialist nation is about to implode? Did you guess Venezuela? Because its Venezuela.

Food Line

This is what a bread line looks like in the 21st Century.

For those less in the know about what is happening to Venezuela, the country is nearing a total economic collapse, brought about by a decade and a half of total mismanagement by an old-school socialist dictator entirely in keeping with the historical context of South America.

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The author of this book is completely serious. I mean it.

Once hailed as a hero by such famous radicals as author Tariq Ali and professional curmudgeon Naom Chomsky, Hugo Chavez was the ideal socialist leader for a number of people who would never have to live under his dictatorial reign. Chavez nationalized oil companies and provided extensive programs for Venezuela’s extensive poor. But more than a decade on, and three years following his death Venezuela’s luck has seemingly run out.

Chavez’s hand picked replacement, President Nicolás Maduro, has kept on with Chavez’s well established tradition of blaming all of his nation’s problems on the United States since he took office in 2013. But the reality is that Venezuela has been a victim of it’s own poor planning and it’s outcome entirely predictable.

Having made the cornerstone of it’s economy the export of oil, the nation has suffered greatly for three reasons. First, Dutch Disease, or the result of a rising value of a domestic currency as a result of selling an extensive natural resource. Put simply, nations that sell a lot of oil tend to have a petro-currency, which makes domestic manufacturing less competitive on the global stage.

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On Hugo Chavez, Chomsky said that “for the first time, the country is using…energy resources for its development…in construction and health.”

Second, cronyism; Chavez was old school in his commitment to creating a personality cult around him. Positioning himself as the savior of the poor he did many things to try and improve the lives (and earn the love) of Venezuela’s many impoverished people. But in the course of that he also removed anyone who might be his opposition. From the standpoint of the management of Venezuela’s oil reserves it has meant poor production and no new investment. Oil production fell 25% in the time Chavez ran the country.

Bloomber Venezuela

The last reason is of course the price of oil. As oil prices fell the fragility of the economic system made itself obvious. Today Venezuela is broke and the look of total economic collapse is depressing and scary. Inflation is out of control. Some estimates say inflation will hit 189% this year, while the IMF thinks it will be 720%. To fight the growing poverty, which is now 76% and up from 55% in 1998, the government has hiked the minimum wage by 30%; the twelfth such hike since President Nicolás Maduro took office. Real wages fell last year by 35% and their currency has lost over 90% of its value in two years.

Bolivar vs Dollar

The people of Venezuela now face a frightening prospect that any economic recovery will be decades away, and that the policies followed by their socialist government have made them an outlier from the largely positive trends that have been improving life across many developing nations. But this is not about hypothetical future problems, but current issues. There is no food in Venezuela, no toilet paper, no basic necessities and no prospect for reversing course. In January this year the government told people they would have to begin producing their own food, a follow-up from governments telling farmers that they would have to sell their food to the government at pre-determined prices.

Global Poverty

Global rates of poverty have collapsed and now sit at under 10%. Sadly this isn’t the case for Venezuela. (Read the article here)

Unsurprisingly, none of this bodes well for Venezuela’s population. Violence is a real potential and people are wondering when (or if) Maduro will step down, and whether a government change can occur without violence. So far he has resisted and despite the recent loss of congressional elections he still holds sway over the judiciary and economic appointments. In fact his current economic czar doesn’t believe in inflation. No really.

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All this leads to some disquieting truths, most important of which is that economic realities catch up to everyone. Since the fall of the Soviet Union and the so called “End of History” there has been a growing warmness to socialism by a generation who has never experienced it. Venezuela is a good reminder that bad economic policies are always bad, and the economic challenges we all face, be it poverty, damaging wealth inequliaty, globalised manufacturing or predatory banking do not resolve themselves magically with a flip of the switch and friendly socialist rhetoric. Instead those problems must be solved within the system, not by destroying it.

Burning It All Down – The Rise of Trump’s Conservatism

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Last August I wrote that Donald Trump was my pick for the Republican nominee, despite his incessant self-aggrandizing style and boorish behavior. I wrote that article because I saw something in Trump that reminded me of Rob Ford, a call back to an angry populism that favours the loud and obnoxious precisely because they are loud and obnoxious. Trump’s style of bombast is a snub to a political elite that adopt a façade of manners that suggest cordial rivalry, even while private donations and Super PACs flood the airways with crude, misleading and sometimes plain false advertising.

Despite a continued and coordinated assault on Trump by the core Republican establishment, Trump went from an outside contender to the leader of the pack. In fact the more that it seemed like the establishment was aligned against him the more support coalesced around him. And last night it seemed that enough of that support had come together to make him the presumptive nominee.

With Ted Cruz and John Kaisch now mathematically eliminated from any chance of a first round win, and the likelihood of a contested convention becoming more dubious as Trump narrows in on his needed delegates, it might be time for people to move past the look of Trump’s rhetoric and into what he’s actually saying. Because this election doesn’t bode well for anyone, but it is very much in keeping with the times.

The times, in case you’ve been hiding under a rock, are not being kind to the neoliberal world that has defined much of the 1990s and early 2000s. America’s foreign influence is waning, the middle class is shrinking, economies are floundering and the European Union is struggling to hold it all together. From a resurgent Russia to a migrant crises and angry middle class voters, this year is testing the resolve of political organizations and global partnerships to continue to do what they do; knock down borders, free up trade and move people across the planet. Citizens across much of the West now doubt many of the promises that have been made to them, notably that more free trade would make us all rich and that people from far flung lands are just like us with similar values.

That doubt about the modern world has been fueling the campaigns of both Bernie Sanders and Donald Trump, and a close look at their platforms shows some important overlap. But with Bernie Sanders also likely eliminated from any chance of the nomination the general election may come down to an establishment candidate in Hillary Clinton and the now (kind of) anti-establishment Donald Trump.

Donald Trump’s rhetoric is decidedly conservative in an old-school kind of way. His commitment to building a wall across the border with Mexico, to ignoring much of the Middle East and backing away from trade deals with China is reminiscent of a 1940s style conservativism and is a direct challenge to the current establishment view on all of these issues. I’m not convinced that Hillary Clinton, dragging her own varied and damning baggage with her, will be up to the challenge of convincing the voting public to continue to support the neoliberalism that she is so closely tied with. It seems even more unlikely that she could become the credible liberal standard bearer for an anti neoliberal platform at all.

I had initially said that Trump was my pick for nominee because the Republicans had become a tired shell of their former selves, squandering elections by ostracizing women, minorities and urban voters in favour of curmudgeonly racists, the science skeptics and the frighteningly devout. The election cycle, spent pandering to this shrinking group of largely social conservatives, was handing the democrats election after election. As I said in the summer, one party shouldn’t be electable and the other crazy. This election may indeed offer some real alternatives about the kind of world that Americans may want to live in.

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You don’t understand Picard! Trump became president in my timeline! Mars is overrun with casinos, and not the nice ones from Vegas, the kind from Atlantic City.

 

So rather than wring our hands at a Trump election has the end of all things, let’s cast this election to something akin to Brexit, another insurgency by an increasingly unhappy and dissatisfied middle class that has come to suspect that their leaders no longer work for them, but for larger more self-interested groups that tend to congregate in Swiss towns and busy themselves with networking and back patting. If Trump is successful in his Whitehouse bid we may be surprised at the kind of world that is ushered in to being; one that is increasingly isolated, protectionist and introverted. If that isn’t a wakeup call to TED Talk speaker’s circuit, I don’t know what will be.

 

*** I’ve taken some time off of writing our articles to focus on work and family, but I’m feeling rejuvenated now and will be back with our weekly outlook on the world. Sorry if you’ve missed us!***

The Blind Men & The Elephant

1280px-Blind_monks_examining_an_elephantMarkets have reached six or seven week highs, (HIGHS I say!) and questions are arising as to whether this represents a sustained recovery.

The crystal ball is decidedly opaque on that question, not simply because there is an abundance of conflicting data, but because more of it is produced everyday. Add to that the fact that the “mood” often dictates much of the day’s trading, plus the often counter-intuitive reality that sometimes sufficiently bad news is considered good news in its own right.

Take for example China’s financial woes. China’s economy is definitely slowing, and the tools used in the past to spur Chinese growth are no longer useful in the same way. To summarize, the Chinese economy got big by building big things; cities, ports, factories, and other big infrastructure to facilitate its role as a manufacturer to the world. In turn the world sold China many of the resources needed to do that. Now the Chinese are up their eyeballs in highways and empty cities they must “transition” to a service economy, essentially an economy that now serves its people rather than the rest of the planet.

Such a transition is no easy thing, and to the best of my knowledge there is no law that says the Chinese government is somehow more adept at managing such a transition. But every bit of bad news may either make investors nervous, or give them hope that the Chinese government may be encouraged to do more economic stimulus. Moody’s, the ratings agency, recently downgraded their outlook on Chinese debt from stable to negative, and downgraded their credit rating. The market’s response?

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That big jump is after they received the downgrade! We see similar patterns out of Europe and the United States. Raising US interest rates has been widely decried by various financial types and talking heads, urging the Federal reserve chairman Janet Yellen to either reverse, stop or even consider negative rates to help the economy. Why such panicked response? Because it has become a common thought that raising rates is now more damaging that the requirement of lowering them!

This has less to do though with distortions in the market and more to do with people trying to accurately read and project from various data points, even when many of those reports conflict. In the short term the abundance of conflicting news creates a blind men and the elephant relationship between investors and economies. Everybody is feeling their way around but all coming back with wildly different descriptions of what is happening.

Janet Yellen

Janet Yellen has raised interest rates and has said she expects to raise rates four more times this year. She has met serious opposition on this matter from many within the financial sector.

What we do know is that there are some big problems in the markets and economies, and the threat of a global recession is very real. What day traders and analysts are looking for is confirmation on whether this threat is easing or not. So, if we suddenly read that managers see a contraction in oil production we might see a sudden rise in the value of crude oil. That news has to be weighed against that fact that global oil supply is still growing, and whether it still makes sense to price oil by its available supply, or against its expected future reduced production.

And that is the challenge. Big problems take time to sort out, and in the intervening period as they are addressed the blind men of the markets make lots of little moves trying to bet on early outcomes, attempting to assess the correct value of a thing often before a clear picture is actually there. For investors the message is to be cautious, both in making large bets or by trying to avoid risk all together. It is a mantra here in our office on the benefits of diversification and risk management, precisely because it reminds us to hold positions even when the mood has soured greatly, and shy away from investments that have become too popular. The goal of investors should to not be one of the blind men, guessing about what they touch, but to make irrelevant that shape of the markets altogether.

 

 

Sunlight Is Still The Best Disinfectant

Yesterday a disturbing article came across my desk. From Bloomberg, it was titled “It Just Got Even Harder to Trust Financial Advisors” and is a brief summary of a new report out of the United States that suggests that there is wide spread misconduct within financial services. Far from being an isolated number of financial advisors, the scale of the disciplinary actions is extensive and has encompassed some of the largest banking institutions in the United States (for those mistrustful of the Wall Street crowd that may not be a big shock) including some well known names like Wells Fargo and UBS.

Being disciplined within the world of financial services is controversial and being reprimanded does not necessarily denote contrition from advisors. The two chief complaints from investors, both in Canada and the United States, revolves around suitability of investments and subsequent fees. Those might seem like straight forward complaints to have, but many investors have a difficult time wrapping their heads around “risk”, showing great comfort in investments that can rapidly rise, while expressing dismay when they fall just as rapidly back to earth. Thus investors and advisors can mistakenly assume that they are on the same page with each other, only to find that at a later point that they have badly misunderstood one another.

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This will be so awesome if I don’t fall!

Regulators have correctly understood that the problem is a misalignment of education and comfort. If investors knew more about investing they would be better at understanding risk. If that were the case though investors would be unlikely to need the services of financial advisors. Thus financial advisors are expected to treat their clients as though they know little, and should be expected to challenge investors, even reject investor requests if the investment is deemed too risky by the advisor.

What regulators want is for advisors to understand their role now as “risk managers” rather than product floggers and order takers. In an industry where the average age is north of 55, most advisors got their start and built their business around exactly that, selling interesting and exciting ideas. The transition from that to telling investors that they can’t do what they want with their money (it’s their money after-all) has not been simple.

Screen Shot 2016-03-02 at 1.53.16 PMOne move, cited in the article, is to move to a fiduciary model to rectify outstanding issues around fees in particular. There is a persistent fear that advisors might choose high fee-low returning investments when cheaper and better performing options exist. Curiously, in Canada at least, there is not much evidence to suggest that this happens. But even if this avenue resolves such a problem many within the industry fear that “high fee/low return” will not be apparent until well after the fact, opening up practitioners to hindsight litigation.

The simple fact is though that regardless of the nuances and difficulties that surround properly managing and regulating the financial services industry, no good can come from a growing sense of mistrust in an industry that has become so essential to the retirement plans of so many. So what should investors know that will protect them from bad decisions or unfair fees?

First, be familiar with the nature of fees:

  • There is a tendency to assume that the best fee is the lowest, but costs frequently correspond to the complexity of the investments, the size of the assets under management and the support around the product. Be sure to find out what the MER (management expense ratio) is and find out whether it is comparable to other similar products. It’s fair to have questions about what products cost and whether those costs make sense.

Second, be more than a number:

  • The article contains one of those slights of hand when people try and diffuse blame, pointing out that it isn’t “just small dealers” that have been guilty of misconduct. This suggestion that small is typically the problem seems challenged by evidence. Big problems require scale, and it isn’t uncommon for some brokers in the banks to have thousands of clients. Brokers aren’t happy with that arrangement and neither are investors, but it is very common. It shouldn’t be surprising that misconduct can come from large banks seeking easy solutions with proprietary product.

Third, independent options are better than proprietary ones:

Fourth, be Canadian:

  • The concerns of America and Canadian regulators are very similar, but the good news is that Canadians have a better system. Despite complaining Canadians have some clear advantages. First, performance disclosure rules favour investors here. Rather than show returns with costs yet to be deducted, returns in Canada are shown net of all costs, meaning you see accurate performance. Second, the use of commissions and deferred sales charges, the source of ire for regulators and critics, have been dropping for years. Many financial advisors now rely on exclusively trailers or disclosed fees. Third, even trailers aren’t that bad. Where as there has been an outstanding concern is that embedded trail fees could unduly influence advisors to make poor choices. But while there is some truth to this statement, the vast bulk of investments within Canada have standardized their fees, with companies paying bigger payouts to entice sales having become the outlier.

Fifth, be with us:

  • As part of a small and independent firm one of the things we pride ourselves most on is to be in the right place to help Canadians. An open shop, we have both the luxury of picking the best investments from across the industry while offering investors competitive fees. But most importantly, we value transparency and clarity in managing your retirement savings.

As a family business that has been around for nearly a quarter of a century, the essential difference between being a number and receiving personal care is whether you have someone to work with that doesn’t just know your name, but comes to know you as well.

Also they should have a blog.

Give us a call if you are looking for some personal guidance in dealing with difficult markets or have questions about protecting your accounts.

 

The Market is Rallying – Why Again?

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Markets have begun to rally around the globe, perhaps signalling an end to the volatile beginning of the year. The mood has definitely lightened and there seems to be some broad support for a return of some positive numbers across the board.

But if we stop to ask ourselves why, we may be left scratching our heads at the answer. The current list of issues affecting the global economy is pretty long. China’s slowdown, the demand destruction for oil, problems across multiple oil and commodity producing nations, financial instability and an almost unbelievable amount of debt. In fact the the market turmoil has a lot of justification, far more than some of the previous sudden corrections over the last two years.

So what’s changed? Three things. First, central bankers have recommitted themselves to doing whatever it takes to put the economy back on a path to growth. Second, a deal has been announced with Russia and Saudi Arabia to cap oil production. Third, a growing concern about the financial assets of Deutsche Bank have been “put to rest” as it were by the German government.

As a list of reasons to be excited, I’m left somewhat underwhelmed. Take the deal between Russia and Saudi Arabia. The larger promise of this deal is that is spells out potential future moves to get oil prices back to a level of sustainability. For right now it simply outlines capping oil production at January levels, but will be largely meaningless if Iraq and Iran can’t be brought into the deal. Iraq and Iran for their part aren’t really interested. Iran, who isn’t exactly friendly with Saudi Arabia, has just got back into the global oil market and is looking to ramp up production. Iraq is also increasing it’s oil production, helping bring much needed funds to a country that is still looking to stabiles and legitimize itself. Neither are particularly interested in following Saudi Arabia’s lead.

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It would at least mean more however if the January production numbers reflected some kind of wide ranging reduction in oil output, but among OPEC nations, as well as the United States and even Canada, oil production has continued to increase despite the price drop.

What about the central bankers promising to use all their muscle (and some that we didn’t know they had) to save the economies of the planet and return economic growth? Having spent the last eight years with emergency level key interest rates and very little to show for it the only solution is to go to a negative interest rate. Earlier in 2015, Stephen Poloz suggested that negative interest rates were a possibility for Canada. Much of Europe already has negative interest rates. Japan surprised markets a few weeks ago by making their key interest rate negative. Last week Janet Yellen, head of the Federal Reserve, also said that negative rates were not “off the table.” Disturbingly, having interest rates as close to zero as possible hasn’t encouraged wide ranging inflation across developed economies. Obviously the only solution is more of the same but SAID LOUDER AND MORE CLEARLY.

Here is Christian Bale yelling at you to spend some of your money!

But possibly the least exciting of the exciting news is surrounding Deutsche Bank. Last week Deutsche Bank seemed to be cruising towards the unenviable title of “the next Lehman Brothers”, before the German government “encouraged” the the market with some supportive words around the stability of the bank; a coded signal that Deutsche Bank is both “too big to fail” and that the German taxpayer would be on the hook.

Deutsche Bank’s problems have been extensively catalogued. Between massive fines, massive losses, massive layoffs, and a massive derivative position currently in excess of $50 Trillion (yes, with a “t”) the potential for the world’s fourth biggest bank to implode and set of some kind of financial (and given it’s position within Europe, political) cascade effect is very real, even if they do get a bailout.

On top of all that is the regular bad news that we haven’t addressed. China’s liability is still unknown, and as it hemorrhages foreign currency reserves threatens yet another line of attack against markets. Venezuela may, or may not, default on it’s debt. Here at home provinces like Ontario would have at least been hoped that a combined falling dollar and oil price would start bringing new manufacturing within our borders, instead they must brace for the disappointing news that of three new auto plants for North America, we will get none.

Some people may be excited about the most recent rally, but I’m afraid I’m not one of them.

What “The Big Short” Can Tell Us About Market Risk

I81wBzBcSclL‘ve just had a chance to watch the movie The Big Short, based on the book of the same name by Michael Lewis. Michael Lewis has made a name for himself as a writer for being able to explain complex issues, often involving sophisticated math that befuddles the general population but is responsible for much of the financial chaos that has defined the last decade.

The principle of our story is Dr. Michael Burry, a shrewd investor whose unique personal qualities gives him the patience to tear apart one of the most complicated financial structures in modern finance. Having done that he creates a new market for a few people who had the foresight to see the US housing bubble and how far the crash might reach. The story is captivating and the tension builds to what we know is the inevitable conclusion of the worlds biggest crash, but there is a problem with the story.

No matter what they do in the movie, we know how it all ends. That hindsight undercuts the real tension in the film, the risk that these few traders and hedge fund managers took with other people’s money to bet against what were largely considered to be safe investments. In some ways, the US housing crash is unique because of how much institutionalized corruption had seeped into the system. The ratings agencies who sold their AAA ratings for the business, the mortgage brokers who pushed through unfit candidates into subprime adjustable rate mortgages, the analysts and financial specialists that repackaged low grade mortgages into AAA rated bonds; it took all of them and more to create the biggest market bubble since the South Sea.

Their smart move seems like lock, but if you look past the drama the heroic brokers of our story were taking a huge gamble with other people’s money. From Dr. Michael Burry down through the rest of the characters, hundreds of millions, billions even, were tied up in investments that few understood but carried incredible potential for losses. The confidence that our heroes show in demanding “half a billion more” as they come to understand the scope of the problem seem smart in hindsight, but they were making big bets. Bets that could have easily ruined people’s lives and finances.

This is the true nature of risk. Things are only certain in hindsight. At the moment we need to make decisions rarely do we possess the kind of clarity that we believe we should have when dealing with markets. If we look to current markets what can we honestly say we know about tomorrow? Markets are chaotic, oil prices are in the tank, central bankers are talking about negative interest rates (while some have gone and done it), and then we will have 2 or 3 days of market rallies. What picture should we draw from this? What certainty do we have about tomorrow’s performance?

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From Bloomberg

Our problem is that when we are inclined towards certainty we are also inclined towards fantastic risk. In fact we won’t even believe there is risk if we are certain of an outcome. And we are prone to lionizing people who risk it all and are proved to be right, while forgetting all those people who made similar gambles and lost everything, leading us to repeat a mistake that has undone many.

The story we need isn’t the one about the people who bet big and won. We need the story about the people who bet smart and navigated confusing and risky markets and came out fine. That story sadly won’t have the kind of impact or drama that we long for in a movie, but it’s the story that each and every investor should want to be part of.