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My Car Runs on Geopolitics – Why “Fracking” is an Important Investment for Your Portfolio

frackingI’m an environmentalist. But as a Financial Advisor I consider that some of the best opportunities I can provide to my clients is exposure to the burgeoning US and Canadian energy markets. That’s right I’m a big proponent for one of the most ecologically damaging and publicly derided forms of energy extraction.

However, next time you put gas in your tank consider this: 7000 fighters are currently making a mockery of whatever pretense Iraq was making at being a legitimate country. ISIS, the Islamic faction currently pushing into northern Iraq from Syria with aims to establish an Islamic Caliphate in the region has been routing Iraqi government forces. An army a quarter of a million strong, equipped with the latest in weapons, tanks and aircraft are losing regularly to a rag tag group of extremists equipped only with machine guns.

Meanwhile in the Ukraine we have fresh assurances that Russia will abide by a new ceasefire between Ukrainian government forces and rebels loyal to the Russian government. While Russia may have undone its own objectives of building a rival economic group, they have successfully reminded everyone why Russia, no matter how weakened it may be, is a powerful force that controls a great deal of energy needed for global consumption.

Across many of the nations that produce some form of energy (oil, natural gas, coal, etc.) there are very few that can claim to be a democratic, civil society not embroiled in some kind of sectarian civil war. But as of this year the United States has become the world’s largest producer of energy, outpacing Russia and Saudi Arabia, and that promises to change the way we think about economies and economic opportunities going forward.

production

In many developed countries there is a great deal of hand-ringing about the sudden rise of hydraulic fracturing – a relatively recent method of energy extraction that is reducing the cost of production and breathing new life into American manufacturing. “Fracking” comes with a number of environmental downsides, some of which are both scary and quite dramatic.

But energy is the life blood of civilisations and a steady supply of affordable energy is what gives us the ability to grow our economies and invest in new technologies. Sometimes this means making hard choices about how we allocate resources, and what the long term impacts of certain industries to our environment might be. But affordable energy, in the form of both oil and natural gas, provided from countries like Canada and the United States doesn’t just help bring back domestic manufacturing. It also economically weakens dictators and states that ignore human rights and puts power back in the hands of liberal democracies to enforce sanctions.

In other words there are numerous political and economic benefits that come along with cheaper Western energy. While this doesn’t address our environmental problems it’s important to love your monsters. The tools that give us our wealth and prosperity shouldn’t be abandoned just because they pose challenges, rather it invites us to both reap profits and seek new ways to conquer those problems we face. That is at least until either Google or Tesla solve all our driving problems.

Ninjutsu Economics – Watch the Empty Hand

First, an apology that we have been on a break from our website. Over the last month we’ve had lots going on that has distracted us from doing our regular writing, but we’re back now for the rest of the summer!

Since 2008 there has been two great themes in investing. One, is the search for yield, or income, from safer investments. The second has been the imminent arrival of a rising interest rate environment which threatens to gobble up everyone’s money. If you aren’t too familiar with monetary policy or even how low interest rates work on the economy, don’t worry. What you need to know is this:

In really bad economic times Keynsian theory states that the government should help the economy by creating inflation through stimulus spending and keeping borrowing rates low. This is often done by printing large amounts of money. The availability of cheap money has an inflationary effect on the market, and the economy is believed to rebound more quickly than it would have if it had simply let businesses fail and people be laid off work.

The flip side is that many believe printing money can lead to serious and even extreme hyper-inflation (not entirely unfounded) that in the long term can be extremely detrimental to the financial health of people. This is the fundamental tension in modern economics that is nicely summed up in the below parody video of John Maynard Keynes vs F.A. Hayek. Should markets be steered or set free? Or put more bleakly, should economies be allowed to collapse or should they be saved in the midst of an enormous financial meltdown?

In the past few years there has been an enormous amount of money printing going on (Keynsian) but at the same time governments have been trying to reduce their debts and deficits (Hayek). But the money printing has many people worried. The printing of billions of dollars globally has many inflation hawks declaring that the end of America is nigh, that the currency will soon be worth nothing and that the older traditional economies are doomed to fail. This concern has seeped into the general consciousness to a great degree and it’s not uncommon for me to get questions about whether the United States is on the verge of some new financial collapse.

I tend towards the contrarian angle however, and encourage you to do the same. So much energy and time has been focused on the threat of inflation, few seem to be watching the encroaching danger from deflation.

What’s deflation? It’s like inflation only much worse, since no one knows how to fix it. Deflation is a self fulfilling prophecy where a decreasing supply of circulating money leads to a drop in general prices for everything (this includes labour and products). On the surface that doesn’t sound too bad, but since people tend to earn less in a deflationary environment your existing debt tends to become ever more burdensome. In the same way that the collapse of the American housing market made many homes less valuable than the mortgages on them, deflation just does it to the whole economy. Japan has been in a deflationary situation for nearly 20 years, with little sign of relief. Even last year’s introduction of the unprecedented Abenomics has yet to produce the kind of inflationary turnaround that Japan is in such desperate need of.

When I look to Canada (and more specifically Toronto) I tend to see many of the signs that deflation looms in the shadows. Borrowing rates are incredibly low, largely to encourage spending. Many small retail spaces sit empty, squeezed out by  rising lease costs. Manufacturing sectors in Ontario continue to suffer, while wages remain stagnant. Canadians are currently sitting with record amount of debt and most growth in Canadian net worth have come through housing appreciation, not through greater wealth preservation. In other words, the things that contribute to a healthy economy like rising incomes and a growing industry base are largely absent from our economy. The lesson here is that when it comes to markets, we should worry more about the issues we ignore than the ones we constantly fret over. It’s the hand you don’t watch that deals the surprising blow!

By the Numbers, What Canadian Investors Should Know About Canada

I thought I had more saved!I am regularly quite vocal about my concern over the Canadian economy. But like anyone who may be too early in their predictions, the universe continues to thwart my best efforts to make my point. If you’ve been paying attention to the market at all this year it is Canada that has been pulling ahead. The United States, and many global indices have been underwater or simply lagging compared to the apparent strength of our market.

But fundamentals matter. For instance, the current driver in the Canadian market is materials and energy (translation, oil). But it’s unclear why this is, or more specifically, why the price of oil is so high. With the growing supply of oil from the US, costly Canadian oil seems to be the last thing anyone needs, but a high oil price and a weak Canadian dollar have conspired to give life to Canadian energy company stocks.

YTD Performance of Global Indices as of April 25th, 2014
YTD Performance of Global Indices as of April 25th, 2014

Similarly the Canadian job market has been quite weak. Many Canadian corporations have failed to hire, instead sitting on mountains of cash resulting in inaction in the jobs market. Meanwhile the weak dollar, typically a jump start to our industrial sector, has failed to do any such thing. But at the core of our woes is the disturbing trend of burdensome debt and the high cost of homeownership.

I know what you want to say. “Adrian, you are always complaining about burdensome debt and high costs of homeownership! Tell me something I don’t know!” Well, I imagine you don’t know just how burdensome that debt is. According to Maclean’s Magazine the total Canadian consumer and mortgage debt is now close to $1.7 Trillion, 1 trillion more than it was in 2003. That’s right, in a decade we have added a trillion dollars of new debt. And while there is some evidence that the net worth of Canadian families has gone up, once adjusted for inflation that increase is really the result of growing house prices and recovering pensions.

Today Canadians carry more personal credit card debt than ever before. We spend more money on luxury goods, travel and on home renovations than ever before. Our consumer spending is now 56% of GDP, and it is almost all being driven by debt.

Canadians have made a big deal about how well we faired through the economic meltdown of 2008, and were quick to wag our fingers at the free spending ways of our neighbours to the South, but the reality is we are every bit as cavalier about our financial well being as they were at the height of the economic malfeasance. While it is unlikely we will see a crash like that in the US, the Canadian market is highly interconnected, and drops in the price of oil will have a ripple effect on borrowing rates, defaults, bank profits and unemployment, all of which is be exasperated by our high debt levels.

Canada’s Economy Still Ticking Along, But Don’t be Fooled

Money CanThis year the Canadian markets have been doing exceptionally well. Where as last year the S&P/TSX had been struggling to get above 2% at this time, this year the markets have soared ahead of most of their global counterparts. In fact the Canadian market triumph is only half of this story, matched equally by the disappointing performance of almost every significant global market. Concerns over China have hurt Emerging Markets. The Ukrainian crisis has hindered Europe, and a difficult winter combined with weaker economic data has put the brakes on the US as well.

YTD TSX Performance

But this sudden return to form should not fool Canadians. It is a common trope of investing that people over estimate the value of their local economies, and a home bias can prove to be dangerous to a portfolio. Taking a peak under the hood of Canada’s market performance and we see it is largely from the volatile sectors of the economy. In the current year the costs of Oil, Natural Gas and Gold are all up. Utilities have also driven some of the returns, but with the Materials and Energy sector being a full third of the TSX its easy to see what’s really driving market performance. Combined with a declining dollar and improving global economy and Canada looks like an ideal place to invest.

TSX Market Sectors

But the underlying truth of the Canadian market is that it remains unhealthy. Manufacturing is down, although recovering slowly. Jobs growth exists, but its highly anemic. The core dangers to the vast number of Canadians continue to be high debt, expensive real-estate and cheap credit. In short, Canada is beginning to look more like pre-2008 United States rather than the picture of financial health we continue to project. Cheap borrowing rates are keeping the economy afloat, and it isn’t at all clear what the government can do to slow it down without upsetting the apple cart.

For Canadian investors the pull will be to increase exposure to the Canadian market, but they should be wary that even when news reports seem favourable about how well the Canadian economy might do, they are not making a comment about how healthy the economy really is. Instead they are making a prediction about what might happen if trends continue in a certain direction. There are many threats to Canada, both global and domestic, and it should weigh heavily on the minds of investors when they choose where to invest.

 

Canadians Losing the Battle to Save For Retirement

Money WorriesPeople sometimes ask why I seem to be so focused on housing and its costs as a financial advisor, and I think the answer is best summed up declining rates of RRSP contributions. Currently many Canadians seem to be opting out of making a RRSP contribution this year, with both Scotiabank and BMO conducting separate and disheartening surveys about likely RRSP contribution rates. Unsurprisingly the answer most Canadians gave to why they would not be contributing this year was because they “did not have enough money.” These surveys also found that 53% of Canadians did not yet have a TFSA either for similar reasons. The expectation is that by 2018 Canadians will have over a trillion dollars of unused contribution room.

These kinds of surveys invariably lead to a kind of financial “tut-tutting” by investment gurus.

As one member of BMO’s executes put it, an “annual contribution of $2,000 to an RRSP… costs less than $6 per day.” which is true but does not really spell out a viable path to a retirement, merely the ability to make a contribution to a RRSP. While there is nothing wrong with the Gail Vaz-Oxlade’s of the world handing out financial advice and directing people to live debt free, Canadians simply do not live in some kind of financial vacuum where all choices boil down to the simple mantra of “can I afford this?” Frequently debts are incurred either because they must be (educational reasons, car troubles, etc.) or because it is not feasible to partake in an economic activity without taking on debt (like buying a house). Similarly it is not practical to assume that every decision be governed exclusively by a simple weighing of financial realities. It’s true it would cost less to live in Guelph, but many people do not wish to live in Guelph and would rather live in Toronto (Nothing personal Guelph!)

What we do have though is a precarious situation where the economy is weak (but maybe improving), which sets government policy through low interest rates. Low interest rates means borrowing for big ticket items like homes in places where supply is limited, like the GTA, or Vancouver or Calgary. This in turn keeps both house prices and debt levels high. It’s telling as well that a growing number of Canadians are beginning to look at their homes as a source of potential income in retirement. All of this seems to be happening while different financial “experts” argue whether the Canadian housing market is actually over valued, or not

This is where I get a chance to make a personal plug for the benefits of my role. While I don’t have much say in government policy, or even directing housing development in big cities, it is rewarding to know that financial advisors like me have a significant impact on the savings rates of those Canadians that work with us. A study called Value of Advice Report 2012 reported that Canadians that had a personal wealth advisor (that’s me) were twice as likely to save for retirement, and that the average net worth of households was significantly higher when they had regular financial advice from an advisor (again, me). The RRSP deadline this year is March 3, so please give me a call if you haven’t yet made your RRSP contribution. 

Be the Most Interesting Person at Christmas Dinner

Merry Christmas and Happy Holidays! We’ve been busy over here for the last couple of weeks and unfortunately I haven’t been able to update our blog as often as I would like. However lots of interesting and important things have been happening over the past two weeks and they are worth mentioning. Check them out below!

Bitcoin is maybe not going to survive. Maybe: There is an ongoing fight about whether Bitcoin, the digital currency, is in fact a real currency. Bitcoin has been criticized for being a tool of the criminal underworld, and praised for its inventiveness. But like all fiat currencies there is a lot of speculation about whether it is worth anything. After all, who is backing Bitcoin? There is no government that will guarantee it and not every government is happy with it, and its value fluctuates wildly. And yet Bitcoin persists, at least until today. China has just banned Bitcoin and its largest exchange will not accept any more deposits, sending the value of Bitcoin tumbling.

What’s good for the investor maybe bad for the economy: There is a demographic shift going on in the Western Developed nations. People are getting older. Not just older, but retirement older, and as a result the economy is feeling pressured to respond to needs arising out of this aging baby boomer trend. One of those shifts is towards dividends. Dividends are traditionally issued by companies to their shareholders when the companies have extra money lying around and can’t use it productively. However many companies, especially large ones that generate more cash flow than they can reasonably use issue regular dividends, such as banks and many utilities. This is useful to investors that are looking to retire or are retired already. Regular dividends help provide retirees with regular and predictable income. However dividends may be bad for the economy. CEOs are often rewarded for market performance, and markets tend to like companies that increase their dividends (Microsoft increased its dividend in September). But companies can be far more useful to the economy generally when they invest in growth rather than give money back to shareholders. That would mean hiring new people, building new factories and generally moving money through the economy. But as much of the population ages and looks for dividends this might undermine the both growth in economic terms and affect choices that CEOs make about the future of their companies.

Canadians are at record debt levels, again: This may not come as much of a surprise, but Canadians have record debt levels and nothing seems to be correcting it! This story began regularly occurring in 20102011, 2012, and of course 2013. What is more important about how high the debt of Canadians continues to rise, but what’s driving it. Not surprisingly it’s mortgages. The high cost of Canadian housing has worried the federal government, and many global organizations. But far worse would be a deflationary cycle on Canadian homes, driving down the price while saddling home owners with debts far in excess the value of their houses. Despite a number of efforts to limit the amounts that Canadians are borrowing, the very low interest rate set by the Bank of Canada is keeping Canadian’s interested in buying ever more expensive homes. The reality is that no one is really sure what is to be done, or what the potential fallout might be. What is clear is that this can’t continue forever.

We’re going to be taking next week off, but will be back in January!

It’s Official, Young Canadians Need Financial Help

I thought I had more saved!It must be terribly frustrating to be a twenty-something today. It’s hard to find work; you probably still live with your parents and a whole culture has developed around criticizing your generation. But beyond the superficial criticisms directed at twenty somethings, there are structural shifts going on within the economy that are making paupers of the next generation.

Some of these shifts do extend from things like a lack of good paying jobs in manufacturing and an increasingly reliance on service sector jobs. There are many university graduates that now find themselves in work that they are overqualified for and underpaid in. But some of the changes also come from an increasingly high cost of living that is making it financially untenable to move out of a parents’ home. This phenomenon has been dubbed “boomerang kids”, or “boomerang generation.”

The challenge that the Millennial generation is facing is that costs are rising as a proportion of their income. Consider the cost of a house in Toronto. In November of this year the average cost of a home sold in Toronto was $538,881, up 11.3% from November of last year. Assume you make the minimum downpayment to get a home, 5%, your downpayment would then be $26,944 (roughly).  Your monthly payment on a 25 year fixed rate mortgage would be $3,077 per month, or close to $36,924 per year. If we factor in real-estate tax and an average heating cost, that would bring annual costs to roughly $43,000 a year. That would mean that to qualify for the mortgage with a bank you would need to be earning at least $134,375 before taxes. The average income in Canada is $47,000.

We can quibble about how accurate these numbers are, but it would still amount to the same end. It costs a lot today to be like your parents. Buying a house for the first time is incredibly expensive and forces young people to make different choices about how to spend their money. For many millennials this has meant “postponing” growing up, financially as well as spiritually. But what today’s young generation actually need is a working budget that lets them get a big picture of their spending and allows them to set and reach financial goals. There are free services, like Mint.com (which I am very much in favour of), but even better is that young people should be encouraged to seek out professional financial help. People with a small amount of savings often feel discouraged about seeing a professional, but getting this guidance early on can lead to significantly better financial outcomes, comfort with the markets and wiser tax efficient planning!

Want to discuss your future planning?