The Keystone Veto Was Meaningless

OILPossibly the most significant news in the last 24 hours was that Barack Obama had used his veto for the first time in five years to end the Keystone XL Pipeline. The pipeline, delayed by 6 years carried with it the hopes of the Canada’s Conservative party and oil executives in Alberta. The pipeline had been opposed, studied and debated, being bounced back and forth through the US government. It had been primarily opposed by environmentalists who object to the environmental impact of Alberta Tar Sand oil and hoped that by killing the pipeline less of it would be extracted, alternative fuels would fill some of the gaps and the world would be a healthier place as a result. It’s subsequent (and rather final) cancelation is being heralded as a victory by many environmental activists.

As we’ve already written, this was not case. While the pipeline hadn’t been built it hadn’t slowed the development of the oil sands, or impeded its movement to refineries. Instead it had simply been supplanted by rail cars. Although more expensive, the roughly $9 a barrel premium was well worth it when oil was above $100 a barrel.

The current price of oil helps explain why there was little real political risk to anybody in the veto of the pipeline. While oil was expensive there was real incentive to get Canadian oil to US markets. It helps offset oil from more troubling parts of the world and makes the economy run a little smoother. But the rise of US shale, the falling price of oil, the use of train cars, an improving economy and rising dollar has wrecked the economics of building the pipeline. By the time the Obama had vetoed the bill there was very little at stake politically except to satisfy his environmental base of voters. The pipeline may yet be still resurrected, but six years on and a new economic reality will likely mean little will get done soon.

The death of the pipeline is troubling most of all for Canada. Shipping oil by train is more expensive, and considerably more dangerous. It also reflects the new found reality that the government cannot rely on oil prices to bolster the economy.  But most of all it reflects the continuing declining fortunes of Alberta and returns focus to Ontario, the once and future king of the broad economy.

Canada’s Problems Are More Severe Than You Realize

house-of-cardsOn December 10th, the Bank of Canada released it’s Financial System Review for 2014. It outlined numerous problems that continue to grow and potentially undermine the Canadian economy. Globally this report attracted a great deal of attention, not something the BoC is used too, but with a rising concern that the Canadian housing market is overvalued, an official document like the FSR gets noticed.

Screen Shot 2014-12-14 at 10.56.42 AMTo understand why Canada is growing in focus among financial analysts around the world you need to turn the clock back to 2008. While major banks and some countries went bankrupt, Canada and its banking system was relatively unscathed. And while the economy has suffered due to the general economic slowdown across the planet, the relative health of our financial system made us the envy of many.

Screen Shot 2014-12-16 at 10.39.42 AMBut the problems we’d sidestepped now seem to be hounding us. Low interest rates have helped spur our housing market to new highs, while Canadians in general have continued to amass debt at record levels. Attempts to slow the growth of both house prices and improve the standard of debt for borrowers by the government have only moved loan growth into subprime territory.

If all this sounds familiar, it’s because we’ve been talking about it for sometime, and sadly the BoC hasn’t been able to add much in the way of clarity to this story. While we all agree that house prices are overvalued, no one is sure quite how much. According to the report the range is between 10% to 30%. Just keep in mind that if you own a million dollar home and the market corrects, it would move the price from $900,000 to as low as $700,000. That can make a considerable dent to your home equity and its too big a swing to plan around.

Screen Shot 2014-12-16 at 10.39.06 AMOn top of this is the growth of the subprime sector in the market. Stiff competition between financial institutions and an already tapped out market has encouraged “certain federally regulated financial institutions” to increase “their activities in riskier segments of household lending.” This is true not just in houses but also in auto loans, where growth as been equally strong.

The Financial System Review also goes on to talk about problems growing in both cybersecurity and in ETFs (both subjects we have written about). It also talks about some of the positive outlooks for the economy, from improving economic conditions globally and support for continued economic activity. But its quite obvious that the problem Canadians are facing now is significant underlying risk in our housing and debt markets. These problems could manifest for any number of reasons (like a sudden drop in the price of oil, a significant slowdown in China, or a fresh set of problems from Europe), or they may lay dormant for months and years to come.

For Canadians the big issues should be getting over our sense of economic specialness. As I heard one economist put  it “Canadians feel that they will be sparred an economic calamity because they are Canadian.” This isn’t useful thinking for investors and as Canadians we are going to have separate our feelings about our home from the realities of the market, something that few of us are naturally good at. But long term investor success will depend on remaining diversified (I know, I link to that article a lot), and showing patience in the face of market panic.

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Canada Has Always Been a Weak Economy

real-estate-investingIt may come as a real surprise to many Canadians but we have never been a strong economy. From the standpoint of most of the world we barely even register as an economic force. Yet a combination of global events have conspired to make Canadians far more comfortable with a greater sense of complacency about the tenuous position of Canada’s economic might.

Don’t get me wrong. It’s not that Canada and Canadians aren’t wealthy. We are. But having a high standard of living is largely a result of forces that have been as much beyond our control as any particular economic decisions we’ve made.

Consider for a second the size of Canada’s economy in relation to the rest of the world. While we may be one of the G8 nations, the Canadian economy only accounts for about 2-3% of the global GDP, and has (according to the IMF) never been higher than the world’s 8th largest economy. Even with the growth in the oil fields Canada hasn’t contributed more than 2.8% to global growth between 2000 and 2010.

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The Rise and Fall of Nortel Stock.

It’s not just that Canada isn’t a big economy, we’re also a narrow one. In the past we’ve looked at how the TSX is dominated by only a few sectors, but the investable market can play even crueler tricks than that. If you can remember the tech boom and the once great titan Nortel, you might only remember their fall from grace, wiping out 60,000 Canadian jobs and huge gains in the stock market. What you should know is that as companies get bigger in the TSX they end up accounting for an ever greater proportion of the index. At its peak Nortel accounted for 33% of the S&P/TSX, creating a dangerous weighting in the index that adversely affected everyone else and skewed performance.

Similarly much of Canada’s success through the 90s and early 2000s had as much to do with a declining dollar. While it may be the scourge of every Canadian tourist, it is an enormous benefit to Canadian industry and exports. Starting in 2007 the Canadian dollar began to gain significantly against the US dollar. This sudden gain in the dollar contributed to Canada’s relative outperformance against every global market. The dollar’s rise was also closely connected to the rise in the value of oil and the strong growth in the Alberta oil sands.

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This mix of currency fluctuations, oil revenue and narrow investable market has created an illusion for Canadian investors. It has created the appearance of a place to invest with greater strength and security than is actually provided.

Some studies have shown that the average Canadian investor will have up to 65% of their portfolio housed in Canadian equities. This is insane for all kinds of obvious reasons. Obvious except for the average Canadian. This preference for investing heavily into your local economy has been coined “home bias” and there is lots of work out there for you to read if you are interested. But while Canadians may be blind to the dangers of over contributing to their own markets, it becomes obvious if you recommend that you place 65% of your money in the Belgium or the Swedish stock market. However long Canada’s relative market strength lasts investors should remember that all things revert to the mean. That’s a danger that investors should account for.

Don’t Be Surprised That No One Knows Why The Market Is Down

Money CanLast Friday I watched the TSX start to take a precipitous fall. The one stock market that seemed immune to any bad news and had easily outperformed almost every other index this year had suddenly shed 200 points in a day.

Big sell-offs are common in investing. They happen periodically and can be triggered by anything, or nothing. A large company can release some disappointing news and it makes investors nervous about similar companies that they hold, and suddenly we have a cascade effect as “tourist” investors begin fleeing their investments in droves.

This past week has seen a broad sell-off across all sectors of the market in Canada, with Financials (Read: Banks), Materials (Read: Mining) and Energy (Read: Oil) all down several percentage points. In the course of 5 days the TSX lost 5% of its YTD growth. That’s considerable movement, but if you were looking to find out why the TSX had dropped so much so quickly you would be hard pressed to find any useful information. What had changed about the Canadian banks that RBC (RY) was down 2% in September? Or that TD Bank (TD) was down nearly 5% in a month? Oil and gas were similarly effected, many energy stocks and pipeline providers found themselves looking at steep drops over the last month. Enbridge (ENB) saw significant losses in their stock value, as did other energy companies, big and small, like Crew Energy (CR).

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The S&P TSX over the last five days

All this begs the question, what changed? The answer is nothing. Markets can be distorted by momentum investors looking to pile on to the next hot stock or industry, and we can quibble about whether or not we think the TSX is over valued by some measure. But if you were looking for some specific reason that would suggest that there was something fundamentally flawed about these companies you aren’t going to have any luck finding it. Sometimes markets are down because investors are nervous, and that’s all there is to it.

Market panic can be good for investors if you stick to a strong investment discipline, namely keeping your wits about you. Down markets means buying opportunities and only temporary losses. It help separates the real investors from the tourists, and can be a useful reminder about market risk.

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So was last Friday the start of a big correction for Canada? My gut says no. The global recovery, while slow and subject to international turmoil, is real. Markets are going to continue to recover, and we’ve yet to see a big expansion in the economy as companies deploy the enormous cash reserves they have been hoarding since 2009. In addition, the general trend in financial news in the United States is still very positive, and much of that news has yet to be reflected in the market. There have even been tentative signs of easing tensions between Russia and the Ukraine, which bodes well for Europe. In fact, as I write this the TSX is up just over 100 points, and while that may not mean a return to its previous highs for the year I wouldn’t be surprised if we see substantial recoveries from the high quality companies whose growth is dependent on global markets.

Forget Scotland, Canada is Playing Its Own Dangerous Economic Game

house-of-cardsIn a few hours we will begin finding out the future of Scotland and the United Kingdom, and we may be witness to one of the most incredible social and economic experiments  in the history of the Western World.

But while many suspect that a yes vote for Scottish independence may cast an uncertain economic future, it shouldn’t be forgotten that as Canadians we are also going through our own uncertain economic experiment. According to a survey conducted by Canadian Payroll Association and released this month, 25% of Canadians are living paycheque to paycheque, with nothing left in their accounts once their bills have been paid for.

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In addition, the majority of Canadians have less than $10,000 set aside for emergencies and these numbers get (unsurprisingly) worse as you look at various age groups. Young Canadians are the worst off, with 63% saying they are living paycheque to paycheque between the ages 18 to 29.

But when it comes to planning for retirement, the numbers are significantly more dire. More and more Canadians are expecting to delay their retirement, citing insufficient funds for their retirement nest egg. Even as people (correctly) assume that they will need more money to last them through retirement, 75% of those surveyed said they had put away less than a quarter of what they will need, and for those Canadians getting closer to retirement (north of 50), 47% had yet to get to even a quarter of their needed savings.

None of this is good news, and it undercuts much of the success of any economic growth that is being reported. While the survey found that people were trying to save more than they had last year it also highlights that many people felt that their debt was overwhelming, that their debt was greater than last year and that mortgages and credit cards by far accounted for the debt that was eating into potential savings.

The report has a few other important points to make and you can read the who thing HERE. But what stands out to me is how economies and markets can look superficially healthy even when the financial health of the population is being eroded. This is a subject we routinely come back to, partly because its so important, and partly because no one seems to be talking about it past the periodic news piece. Our elections focus on jobs, taxes and transit, but often fail to begin addressing the long term financial health of those voting.

From The Desk of Brian Walker: The Hardest Part of Retirement

rrsp-eggThe moment you retire you are expected never work again.

Think about that for a minute. Every dollar you’ve ever EARNED has been EARNT. Your bank accounts will never be replenished again from your toil. All of your income from here on will be the result of your Canada Pension and OAS, any private pensions you are a part of and your savings. This is your life and your future boiled down to a number.

And as most companies stopped defined benefit pensions, many Canadians have had to turn (usually out of necessity) to investing in the market to grow and fund their retirement.

I have yet to retire, although I admit to being closer to it now than I was 20 years ago when I started this business, and I have to acknowledge that I find the prospect of retiring frightening. Work has occupied most of my life, and while I enjoy travelling and have a number of hobbies I have developed over the years I wonder if they can fill my days. But the thing that always sits at the back of my mind is about the money.

Because regardless of how well you have done in life there is always the potential to lose money in the markets, but so long as you are working you can replenish some of those losses. Once you have retired however, that’s all there is. A financial loss can be permanent in retirement and its impact will last the rest of you life, defining all your future decisions.

photoFor my currently retired and retiring clients the thing that has surprised me the most is that while these concerns are very present, they sit alongside a concern that should really be receding: market growth. For all the worry about protecting their retirement nest egg from severe downturns and unforeseen financial disasters, many investors are still thinking like they are accumulating wealth and have twenty years until they retire.

When it comes to investing, retirees need to be looking at investments that fit the bill of dependability and repeatability. Dividend paying stocks, balanced income funds and certain guaranteed products offer exactly that type of solution, kicking out regular, consistent income that you can rely on regardless of the market conditions. And as more and more Canadians head towards retirement we are seeing a growing base of useful products that fit these needs beyond the limited yield of GICs and Annuities.

The downside of these products is that they are all but certain to be constrained when it comes to growth. They simply will never grow at the rates of some companies, certain investments or aggressive markets by design. That’s a good thing, but nearly a quarter of a century of investing have instilled in many Canadians a Pavlovian response to the idea that investing must equal growth. But investors will be much better served by looking past desire for an ever expanding portfolio and towards investments that secure their long term income.

I’m not suggesting that once you retire you stop participating in the market, or that having any growth in your portfolio is wrong, or that it represents some kind of fault in your retirement planning. What is at stake though is controlling and protecting your savings and lifestyle by making your investment portfolio subservient to those needs over growth focused market participation. Your retirement could last almost as long as your entire working life, and easily as long as the amount of time you saved for your retirement. There will be plenty of things to worry about in retirement, and lots of other financial needs that must be addressed; from comprehensive estate planning to out-of-pocket health care costs. Why complicate your retirement needs by worrying about whether your are participating fully in bull markets, or worse, bear markets?

 

If you would like to discuss how we can help your retirement needs, or how we can re-tune an account for retirement please send us a note!

The Real Reason Why Tim Hortons and Burger King are Merging

While I rarely get the chance to watch late night TV anymore, I’m sure there will be a few segments on The Daily Show and Colbert Report about “inversion” – the process by which American companies buy another foreign firm and relocate their head-office there to avoid paying taxes, over the next couple of days.

 

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Click on this picture to see John Stewart make fun of “tax inversion”

The arrival yesterday of the Burger King/Tim Horton’s deal has a number of lawmakers and journalists screaming about lack of loyalty, tax dodging and  America’s uncompetitive corporate tax rate. But being quick to anger isn’t the smartest way to understand why one company might wish to purchase another and pull up stakes.

For instance, despite claims that Burger King intends to avoid substantial taxes in the United States in favour of Canada’s more moderate tax rate isn’t actually that true. As reported this morning by the Financial Times, the two companies both pay a very similar effective tax rate, literally only points apart from each other. So relocating a company like Burger King may indeed yield some benefits in taxation, but likely so small as to not make the deal worth while.

So why do it? It may have more to do with the Burger King itself and how it was acquired in 2010. According to the Financial Times, Burger King was purchased in a leveraged buyout, meaning that those doing the buying borrowed a great deal of money to do so. But interest expense is tax deductible. Since 2010, Burger King has been restructured and deleveraged, and since it went public in 2012 has had an 85% return in stock value. In other words, the people who own Burger King have done well. But buying Tim Hortons means that the consortium will once again have to borrow substantially to do the buying, creating further tax right-offs for the newly merged company.

Burger King's share price since it went public in 2012
Burger King’s share price since it went public in 2012

There are other reasons for this merger that actually make sense. Burger King is struggling to gain market share and is under pressure from the growing business of “fast-casual” restaurants like Chipotle. But despite that it has a strong operating margin, 52%, which shows that the restructuring has been effective at making the business profitable. Meanwhile Tim Hortons has an operating margin of only 20%, an opportunity for improvement in the eyes of Burger King. Together they will form the third largest fast food business in the world and open a new front into the coveted and notoriously difficult breakfast market.

Operating Margin and Effective Tax Rate for Burger King and Tim Hortons. Courtesy of the Financial Times
Operating Margin and Effective Tax Rate for Burger King and Tim Hortons. Courtesy of the Financial Times

There may be other synergies and reasons for this merger and subsequent inversion, and the tax benefits that come from borrowing could do with some scrutiny, but it would seem from the outset that avoiding taxes is hardly the exclusive driving force behind this deal.