A Case For the Best Case

A Case for the Best Case

*In an act of hubris I have written this before companies have begun releasing their earnings reports. I can only assume I will be punished by the animal spirits for such reckless predictions!

The news has been grim. The number of people seeking EI has spiked so much, so quickly that it reduces the previous unemployment numbers to a flat line (this is true in both Canada and the United States, US EI graph below). Countries remain in lockdown and some of the worst hit countries like Italy and Spain are starting to plateau, adding ONLY between 500 to 1000 deaths a day. In Canada the numbers continue to climb and the economy has been largely shut down, with governments rolling out unprecedented quantities of money to stem the worst of this. Talk of a deep economic depression has been making rounds, while the Prime Minister has reluctantly suggested that we may be in a restricted environment until July.

Us Jobless Claims - Q3 2017 - Feb Q1 2020
These two charts show the unemployment rate in the US just before the coronavirus, and after. From Refinitiv
US Jobless Claims Including April 2020
These two charts show the unemployment rate in the US just before the coronavirus, and after. From Refinitiv

And yet.

And yet.

And yet, I suspect we may be too negative in our outlook.

First, just how restricted is the economy? Despite the wide-ranging efforts to restrict the social interaction that daily economic activity produces, much of the economy continues to function. Office and white-collar jobs have quickly adapted to remote working. Few have been laid off in that respect. Industrial production is down, unless they are deemed essential, but the essential label has applied to a lot of businesses. Until the recent additional restrictions applied on Sunday April 5, 2020 in Ontario, Best Buy, Canadian Tire, Home Depot and a number of other stores remained open to the public. Those businesses have had to restrict access to their stores, but remain functioning through curb pick and online delivery.

Even the service economy is still largely functioning. Most restaurants remain open providing take out and delivery. Coffee shops, gas stations, grocery stores, convenience stores are all open, as are local grocery providers like butchers and bakers (and candle stick makers). Its’ true that large retail spaces like Yorkdale or the Eaton Centre are closed but this too tells us something.

The government has helped make it easier to get money since people have been laid off, and many of the people who have been let go will only be out of work for a short time. They are the waiters, union employees and airline pilots who will be rehired when the society begins to reopen. Even in the period I began writing this, Air Canada rehired 16,500 employees, West Jet will be rehiring 6,500 employees, and Canadians applying for the new CERB (Covid-19 Emergency Response Benefit) have reportedly already begun receiving it.

You might be reading this and thinking that I’m being callous or simply ignoring the scope of the problem that we are facing, but I want to stress that I am not. I recognize just how many people have found themselves out of work, how disruptive this has been, how scared people are and how this pandemic and its response has hit the lower income earners disproportionately more. But just as few people correctly saw the scale of the impact of the coronavirus, we should remain cautious about being too certain that we can now anticipate how long the economic malaise may last, or how permanent it will likely be, and what its lasting impacts will look like.

Labour work

The sectors of the economy worst hit will likely be those already suffering a negative trend line. The auto sector, for instance, is one that has been hemorrhaging money for a while, with global car sales in a serious slump. Some retail businesses, already on the ropes from Amazon’s “retail apocalypse” may find they no longer can hold on, though government aid may give them a limited second life. Hotels and travel will likely also suffer for a period as they carry a high overhead and have been entirely shut down through this process (sort of).

Longer term economic problems may come about from mortgage holders who have struggled to fulfill their financial obligations to banks, and it may take several months to see the full economic fallout from the efforts to fight the pandemic, so some of the effects may be staggered over the year.

Economist image

But even if that’s the case, the current thinking is that the market must retest lows for a considerable period, with few people calling for a rapid recovery and many more calling for a “W” shape (initial recovery then a second testing of previous market lows) and in the Economist this week “one pessimistic Wall Street banker talks of a future neither v-shaped, u-shaped or even w-shaped, but ‘more like a bathtub’”.

FT China Cinema

That pessimism is well warranted, and I count myself among those expecting markets to have a second dip. But I admit to having my doubts about the full scale of the impact to the real economy. There will no doubt be some fairly scary charts, like thre were from China, showing the drop off in cinema goers and people eating out. But the more certain, the more gloomy, the more despairing the outlooks get, the more I wonder if this is an over compensation for having overlooked the severity of the virus, or if it is the prevailing mood biasing these predictions? Only time will tell, but I am taking some comfort in knowing that there is still a case for the best possible case.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

Making Economics Meaningful – How Official Inflation Figures Obscure Reality

Since 2008 (that evergreen financial milestone) central banks have tried to stimulate economies by keeping borrowing rates extremely low. The idea was that people and corporations would be encouraged to borrow and spend money since the cost of that borrowing would be so cheap. This would eventually stimulate the economy through growth, help people get back to work and ultimately lead to inflation as shortages of workers began to demand more salary and there was less “slack” in the economy.

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

Such a policy only makes sense so long as you know when to turn it off, the sign of which has been an elusive 2% inflation target. Despite historically low borrowing rates inflation has remained subdued. Even with falling unemployment numbers and solid economic growth inflation has remained finicky. The reasons for this vary. In some instances statistics like low unemployment don’t capture people who have dropped out of the employment market, but decide to return after a prolonged absence. In other instances wage inflation has stayed low, with well-paying manufacturing jobs being replaced by full-time retail jobs. The economy grows, and people are employed, but earnings remain below their previous highs.

Recently this seems to have started to change. In 2017 the Federal Reserve in the United States (the Fed) and the Bank of Canada (BoC) both raised rates. And while at the beginning of this year the Fed didn’t raise rates, expectations are that a rate hike is still in the works. In fact the recent (and historic) market drops were prompted by fears that inflation numbers were rising faster than anticipated and that interest rates might have to rise much more quickly than previously thought. Raising rates is thought to slow the amount of money coursing through the economy and thus slow economic growth and subsequently inflation. But what is inflation? How is it measured?

One key metric for inflation is the CPI, or Consumer Price Index. That index tracks changes in the price or around 80,000 goods in a “basket”. The goods represent 180 categories and fall into 8 major groupings. CPI is complicated by Core CPI, which is like the CPI but excludes things like mortgage rates, food and gas prices. This is because those categories are subject to more short-term price fluctuation and can make the entire statistic seem more volatile than it really is.

CollegeInflationArmed with that info you might feel like the whole project makes sense. In reality, there are lots of questions about inflation that should concern every Canadian. Consider the associated chart from the American Enterprise Institute. Between 1996 – 2016 prices on things like TVs, Cellphones and household furniture all dropped in price. By comparison education, childcare, food, and housing all rose in price. In the case of education, the price was dramatic.

Canada’s much discussed but seemingly impervious housing bubble shows a similar story. The price of housing vs income and compared to rent has ballooned in Canada dramatically between 1990 to 2015, while the 2008 crash radically readjusted the US market in that space.

The chart below, from Scotiabank Economics, shows the rising cost of childcare and housekeeping services in just the past few years, with Ontario outpacing the rest of the country in terms of year over year change when it comes to such costs.

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My desktop is littered with charts such as these, charts that tell more precise stories about the nature of the broader statistics that we hear about. Overall one story repeatedly stands out, and that is that inflation rate may be low, but in all the ways you would count it, it continues to rise.

DIe6Fh2UMAEDmaIIn Ontario the price of food is more expensive, gas is more expensive and houses (and now rents) are also fantastically more expensive. To say that inflation has been low is to miss a larger point about the direction of prices that matter in our daily lives. The essentials have gotten a lot more expensive. TVs, refrigerators and vacuum cleaners are all cheaper. This represents a misalignment between how the economy functions and how we live. 

DJs5AdwXoAANcDTEconomic data should be meaningful if it is to be counted as useful. A survey done by BMO Global Asset Management found that more and more Canadians were dipping into their RRSPs. The number one reason was for home buying at 27%, but 64% of respondents had used their RRSPs to pay for emergencies, for living expenses or to pay off debt. These numbers dovetail nicely with the growth in household debt, primarily revolving around mortgages and HELOCs, that make Canadians some of the most indebted people on the planet.

DWS3VJkX4AAXXaT

In the past few years, we have repeatedly looked at several stories whose glacial pace can sometimes obscure the reality of the situation. But people seem to know that costs are rising precisely in ways that make life harder in ways that we define as meaningful. When we look at healthcare, education, retirement, and housing it’s perhaps time that central banks and governments adopt a different lens when it comes understanding the economy.

2017 – The Year Ahead

dad-jump-2

Many of you won’t know this, but my father used to sky dive. He’d stopped by the time I was born (reportedly because my mom had a natural aversion to life threatening hobbies) but in many ways his hobby would be a reoccurring source of guidance for life lessons.

For instance, whenever I was nervous about doing some BIG THING, my dad would let me know that once you were doing THE BIG THING, your anxiety would drop considerably. Sky divers know this, as they are only nervous until they jump out of the plane, and then get very calm. The fear is in the anticipation, not the actual doing.

2016 had a lot of anticipation, but not an actual lot of doing. Brexit happened, but hasn’t really happened. Donald Trump has been elected, but hasn’t been sworn in. The Canadian housing market continued its horrific upward trend and news stories began to abound about the looming robot job-pocalypse. 2016 was full of anticipation, but little action.

donald-twitterbot2017 will begin to rectify some of these issues. Next week we will see the arrival of President Donald Twitterbot™, finally ending speculation about what kind of president Donald Trump will be and seeing what he actually does. So far markets have been reasonably calm in the face of the enormous uncertainty that Trump represents, but his pro-business posture seems to have got traders eager for a more unregulated market with greater earnings for the future. Right now bets are that Trump might really jump start the economy, but there are real questions as to what that might mean. Unemployment is already very low and inflation looks like it is actually beginning to creep up. Housing prices (amazingly) are back to 2007 levels and the economy seems to be moving into the later stages of a growth cycle.

2017 will likely not be the year that the Canadian housing bubble/debt situation comes crashing down, but its also unlikely to be the year that the situation improves. Economically the short term outlook for Canada is already kind of bad. The oil patch is already running second to a more robust energy story from the United States. Canadian financials had a very healthy year last year, but as we’ve previously written while the TSX was the best returning developed market over 2016, in a longer view it has only recently caught up with its previous high from 2014.

2017 may be the year that automation starts being a real issue in the economy. Already much of Donald Trump’s anger towards globalisation is being challenged by analysis that shows its not Mexico that steals jobs, but robots. But as robots continue to be more adept at handling more complicated tasks there is simply less need for humans to do much of that work. Case in point is Amazon’s new store Amazon Go, currently being opened in Seattle.

While many point to this as Amazon’s foray into the world of groceries (and a better shopping experience) Amazon’s real business is in supply management. The algorithms they use and the new technology they’ve developed are not designed to be one offs, but ways to handle high volumes of business traffic with as few people, and as low a cost as possible. Combined with driverless cars (currently being tested in multiple cities & countries)and our growing app economy, we will be pushing more people out of steady work across multiple sectors of the economy in coming years.

brexit

2017 will also be the year that Brexit will begin, though it will be two years before it is complete. Many people will be watching on how Teresa May’s government handles the Brexit negotiations, how confident England looks on its position, and how hostile or open Europe seems to be to conceding to Britain’s views. Either way it should provide lots of turbulence as it unfolds over the coming years.

But despite all this, there is a kind of calm in the markets. We’ve crossed the line on these issues and there’s nothing to do but continue ahead. Trump will be President Donald Twitterbot™, Brexit will happen, regardless of how many people remain opposed and markets will either go up or down as a response. Perhaps the new normal is a great deal more similar to the old normal than we all thought.

Then again…

 

Cities Are Hurting Your Retirement

The Economist endorses the Walker Report!

Well not really, but they have joined my cause on the problems we face with regards to urbanism and increasing urban density. It’s not everyday that you can say that the economist endorses your position (even if they don’t know it) but in early April my constant nagging about the insane price of housing became a feature for the weekly.

Most Expensive Cities In The World To Live In

How it felt when I saw The Economist article on wasted space in cities.
How it felt when I saw The Economist article on wasted space in cities.

If you haven’t been keeping up, I essentially have three big issues with homes in Canada:

  1. House prices are too high, especially in cities, which is driving a debt problem for many Canadians.
  2. Inflation in the housing market is likely creating a bubble, and considerable risk is building into the Canadian housing market as people over extend themselves.
  3. This problem is compounded by the need for city living. Increasingly people’s jobs depend on living in one of Canada’s big cities, where restrictions on development are aggrivating the situation.

Canada’s housing market is therefore a confusing and expensive mess. The risk is high but the need for housing is great and this fuels a great deal of arguments over how great the problem in Canadian housing really is.

The Economist’s take on this matter is an interesting one. It’s not just Canada that has an urban housing problem. Name a major urban centre and you are likely to see the same problem repeated. From Tokyo to London to New York and back to Vancouver urbanites everywhere are dealing with escalating home prices.Rising Property Prices

But the problem goes beyond merely being frustrated by increasing realty costs. Housing is a significant aspect to any economy. Building homes makes a lot of jobs, but affordable housing encourages a growing economy. As home prices eat up income there is simply less money to go around. It hurts domestic growth, slows trade and reduces standards of living.

The culprit is not a big bogeyman like the banks (though they are benefiting from this situation) but ourselves. In an effort to improve aesthetic standards of living by restricting changes to our surroundings we have unwittingly hurt our economic standard of living. Almost every city today is burdened with development guidelines and urban bylaws that restrict density and height. These rules run into the hundreds of pages and fill volumes in most city halls around the globe. It’s made cities like Bombay one of the most expensive in the world in a country that is one of the poorest. It restricts taxes and hinders economic and city improvements.

And cities need taxes. We tend to be critical of enormous budgetary outlays for cities, but whether it’s a new subway line in Toronto or a super-sewage pipe in Mexico City, cities depend on the taxes that are generated primarily through dense urbanization. This week the free newspaper Metro published an article showing which wards in the city of Toronto contribute the greatest amount in taxes. Unsurprisingly the “downtown” wards contributed the bulk of city revenue. Wards out in Scarborough had some of the lowest, a difference in the hundreds of millions of dollars for city revenue. Some are quick to point out that the “lie” about spoiled downtowners, but the reality is that density improves economic performance and reduces the burden of taxes while improving its efficiency.

https://twitter.com/Walker_Report/status/590534234059706368

The Economist argues that we waste space in cities, and that comes with a high cost. According to their article the US economy is 13.4% smaller than it could have been in 2009, a total of $2 trillion. Because cities that offer high incomes (like San Francisco) become too expensive people endup working in lower productivity sectors, while making it difficult to live for those that choose to reside in those cities. In the case of Canada this potentially fueling an enormous and dangerous housing bubble while undermining our economic growth. But this is a problem of our own doing. Through our own efforts we have masterminded a situation that threatens our own economic well being. The question that remains is whether we can be clever enough to undo it before it hurts us all.

As for The Economist I will assume they should be calling me anytime to start writing for them regularly….

That phone call should be coming any minute now...
That phone call should be coming any minute now…

It Doesn’t Matter if There Isn’t A Real Estate Bubble

Last week I published a piece on the dangers of the housing bubble in Canada. It caused a stir with a number of clients and followed many articles over the past two years about our concerns with the Canadian economy.

Debt-Shackle-Charlotte-Bankruptcy-Lawyer-North-Carolina-Debt-Attorney

But on Wednesday I was at an industry lunch with another group of advisors talking about the Canadian housing market and was met with a curious objection over whether there was any real danger at all. Another advisor happily pointed out to me that while the indebtedness of Canadians may be high, it is still affordable, and we should be mindful of the famous investors you have been hoisted by their own doom saying petards.

While it’s true that many doom saying predictions don’t come to pass and we should be careful before signing on to one particular points of view, arguing that lots of debt is affordable and therefore no threat is similar to a drug addict arguing everything is under control because they still hold down a job. The job is irrelevant to the problem, although it’s absence is likely to make matters worse.

calgary1

This is why it is somewhat irrelevant to worry about the Canadian housing market. Whether you believe there will be a soft landing, a hard landing or no landing at all, what Canadians have is a debt problem. Only it’s not a problem because it’s affordable. Also it’s a problem.

If that last sentence is confusing, don’t worry. It sounds worse coming from the Bank of Canada, who in their December Financial Systems Review pointed out that debt levels continue to climb but the relative affordability of the debt remains consistent. And while an economic shock to the system could make much of that debt unserviceable, for now that seems unlikely. They concluded this section of the report identifying the risk to Canadians as “elevated”.

This is non-committal nonsense. In economic terms there is a bomb in the room that needs to be diffused, has no timer but will go off at some indeterminate future point. The problem is that Canadians can’t seem to help by adding more debt to the pile. In January Canadians added another $80 billion of debt through mortgages, lines of credit and credit cards, a jump of 4.6%. Our private debt is now over $1.8 Trillion, larger than our GDP. Household saving’s rates are at a five year low, 3.6%. But in 1982 the savings rate was 19.9%. In other words we’ve had a dramatic shift away from savings and towards debt.

Savings rate

While 30% of Canadian households have no debt, almost every demographic is susceptible to the growing debt burden. Even seniors have a growing debt issue. Canada is now unique in the world for having debt levels in excess of the peak of the American debt bubble in 2008, and is currently only surpassed by Greece. Traditionally I am highly cautious about grand pronouncements about market doom and gloom, but in this instance I am of the opinion that ignoring Canada’s debt problem is willful blindness.

How to best handle this problem will have to be left to others. There is no simple solution that will not trigger the bomb, and the goal of any government is to slowly reduce the average debt burden without hurting the economy or deflating the bubble. For my part I tend to advise people to pay their debts down, shy away from things they cannot afford and encourage saving rather than debt spending to limit risk. When it comes to saving for the future there is no reason to make many people’s problems your problems.

Canada’s Housing Bubble Will Burst & We’re Not Ready

On Saturday a small book was released nation wide that made a big claim, Canadian housing prices are poised to drop between 40% to 50%. Written by a financial advisor in Edmonton, Hilliard MacBeth, When the Bubble Bursts is a grim and insightful polemic about both our obsession with housing and the danger such high valuations pose to our economy. I’ve been negative about Canada for a long time, particularly about Canada’s improbable and endless real estate boom, but what the author has done in his book is attach some actual numbers around how serious our housing problem is.

81lYobbkTmLI picked the book up on Saturday and it is terrifying. His insights are troubling and his points are all backed with reputable sources. Like all serious financial problems it is the interconnectedness of the our financial lives that magnifies the impact of any bubble. Hilliard’s chief accomplishment is to show just how interconnected these issues are. The real estate bubble eats into the middle class need of disposable income, encourages people to view their home as the primary source of savings while banks profit off the increasingly indebted backs of hard working Canadians. Government insurance on mortgages (which protects banks, not you) also ties the public coffers to the inevitable need of bank bailouts, while governments themselves worsen the situation by helping boost the homeowners’ market.

In Hilliard’s view we have sold ourselves on a dream, that our homes can increase in value forever (above the non-existent rate of inflation), that we can use our home equity lines of credit to fuel our lifestyles and that as Canadians we are somehow immune from the normal problems that affect other economies. We aren’t and we aren’t ready for the financial collapse that is coming. I’m sympathetic to this view.

HMcB
Click on the picture to see the article and interview

But since I live in Toronto, and our author lives in Edmonton I think it is important to note some financial nuances that should be considered. For instance, not every market is built equally. Bubbles are as much a product of oversupply as they are speculation (which fuels the supply). But in the last 30 years we have become an increasingly urban society. When it comes to value in homes it is frequently the land that we find valuable, not the building (the building is a depreciating asset, like your car). Desirable land is in short supply, and that explains why our urban world is more often than not a suburban world. Look at this expected growth in population around the GTA from now until 2031.

First printed in the Toronto Star, Friday Feb 27, 2015 http://www.thestar.com/news/insight/2015/02/27/ontario-farmland-under-threat-as-demand-for-housing-grows.html
First printed in the Toronto Star, Friday Feb 27, 2015 http://www.thestar.com/news/insight/2015/02/27/ontario-farmland-under-threat-as-demand-for-housing-grows.html

Notice that there isn’t expected to be substantial growth within the core city of Toronto. But as we look to the suburbs, where land is cheaper and desirability for homes will be lower but more affordable we find our source for significant speculation. In short the insurance against significant losses on your home has everything to do with desirability of the land.

This held true particularly in the United States in their own housing bubble. Cities like Phoenix and their accompanying suburbs proved to be the most susceptible to the market downturn. New York on the other hand was far less severely impacted, and I would imagine even less so if we had numbers for Manhattan.

CaseShillerCitiesJuly2013
The above chart shows three numbers regarding several American cities using the year 2000 as a baseline; from the peak of the housing market, the lowest point in that market, and where they stood five years later (2013). In Phoenix, house prices had jumped 127% from where they had been in 2000. They then dropped back to their 2000 values in the correction, and had recovered by 37% by 2013. In New York however, prices had risen 116% from their values in 2000, but only lost 40% of those gains in 2008 and were valued at 67% above their 2000 price five years after the correction. Dallas and Denver were both above their bubble highs by 2013, while Los Vegas was still off 110% of their previous market high.

This should seem obvious. The old line on real estate is “location, location, location”, and it is location that locks in value. There is no hidden land to be developed in Leaside, no undiscovered country in Rosedale or Lawrence Park. On the other hand Vaughan, Pickering, Ajax and Mississauga are all areas to be concerned about, both because they attract younger buyers with lower savings and it is where we see the most growth in new homes. It’s logical to assume that the worst impacts of a correction will be felt there.

https://twitter.com/Walker_Report/status/580048068688678912

But the truth is, when the Canadian housing market corrects it will cause us all a problem. It will magnify the effects of a recession, put pressure on the federal budget and worsen our prospects internationally for investment. That some neighborhoods will be less affected than others is of small consequence. It will affect those with no savings far worse, disproportionately affect the younger (and more financially vulnerable) while hitting those baby boomers depending on their home sale for retirement very hard.

https://twitter.com/Walker_Report/status/580036170056269824

Since no one knows when this will happen the best thing for prospective home owners to do is have a conversation about the choices they are making now, to save more, reduce debt and rethink whether big home purchases or significant renovations are the best use of our money. Corrections are inevitable. Bubbles burst. Whether we are prepared or not can determine your financial future.

Nervous? Don’t be! Set up a meeting to talk about your financial future instead:

Further Readings About the Housing Market:

Canada’s Problems Are More Severe Than You Realize (December 16, 2014)

Forget Scotland, Canada is Playing It’s Own Dangerous Economic Game (September 18, 2014)

Ninjutsu Economics – Watch The Empty Hand (June 20, 2014)

By The Numbers, What Canadian Investors Should Know About Canada (May 1, 2014)

Canada’s Economy Still Ticking Along, But Don’t Be Fooled (April 24, 2014)

Toronto Has A Real Estate Problem (April 11, 2014)

Canadians Losing Battle to Save For Retirement (February 19, 2014)

It’s Official, Young Canadians Need Financial Help (December 4, 2013)

Economists Worry About Canadian Housing Bubble, Canada Politely Disagrees (November 12, 2013)

Why it’s so hard to see a financial correction when its staring you in the face

If you’ve been following this blog, you’ll have noticed how I am regularly concerned about the state of the Canadian economy. And while I maintain that I have good reason for this; including fears about high personal debt, an expensive housing market and weakening manufacturing numbers, the sentiment of the market isn’t with me. As of writing this article the TSX is up just over 14% YTD, spurred on by strong numbers in the small cap, energy and banking sectors.

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All this illustrates is the incredible difficulty of understanding and seeing the truth in an economy. Is an economy healthy or unhealthy? How do we know, and which data is most important? Economies produce all kinds of information and it’s frequently hard to see the forest for the trees. But even with all the secrecy around the bank’s and regulators financial misdeeds prior to 2008, the writing was on the wall that the US housing market was over inflated and that savings rates were too low and debt rates too high. And while you could be forgiven for not really understanding the fine points of bundled derivates and just how far “toxic debt” had spread, it wasn’t as though the banks had hidden the size of their balance sheets or the number of outstanding loans. It was all there for anyone to see. And people did see it and then shrugged.

One of the big fallouts of the financial meltdown was extensive criticism directed at the professional class of economist and business reporters who give regular market commentary and missed the total implosion of the financial and housing sectors. After all, how good could these “professionals” be if they can’t see the financial freight train like the one that just came through? . But I would chalk that up to overly positive market sentiment. It’s not that they didn’t see the bad news, they just assumed that other better news was more important.

Look at these two articles from yesterday’s (August 20th, 2014) Globe and Mail:

Canada losing steam in its push for an export boom

&

Bump in shipping a boon to Canada

While these two articles aren’t exactly equal, (one is talking about Canada right now, the other is talking about prolonged growth of Canadian shipping over the coming decades) it’s interesting to note that they sit side by side on the same day in the same newspaper. For investors (professional and individual alike) it is an ongoing challenge to make sense of the abundant information about the markets without resorting to our “gut feelings”. Do we tend to feel good about the market or bad? Which headline should be more important? Here is a third article from the same day: (Click the image to see the full size article).

photoIts plain to see how I feel about the state of the Canadian market (and which news I place value on), but its also possible that I’m the crazy one. Lots of Canadians disagree with me quite strongly and it is shown everyday the TSX reaches some new high. Which brings us back to investor, or market sentiment. Described as the “tone” of the market, it might be better thought as human irrationality in assessing odds and errors in estimating value. Investor sentiment plays a significant role in valuing the market over the short-term, far in excess of hard financial data. And it isn’t until that sentiment turns sour that we begin to see corrections. Coincidentally, holding an opinion contrary to the popular sentiment is quite lonely, and many portfolio managers have been criticized for their steadfast market view only to be proven right after they had acquiesced to investor complaints about poor performance.

Following a correction, once the positive market sentiment has been washed away, it seems obvious to us which information we should have been paying attention to. But that doesn’t mean being a contrarian is automatically a recipe for investment success. I may be wrong about the Canadian market space altogether (it wouldn’t be that shocking), and in time I will regret not placing more value on different financial news. What is far more valuable to investors is to have a market discipline that tempers positive (and negative) sentiment. An investing discipline will reign in enthusiasm over certain hot stocks, and keep you invested when markets are bad and the temptation is to run away. Sometimes that means being the loser in hot markets, but that may also mean better protection in down markets.

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.

 

Economists Worry About Canadian Housing Bubble, Canada Politely Disagrees

real-estate-investingThis week the Financial Times reported that “Canada’s housing market exhibits many of the symptoms that preceded disruptive housing downturns in other developed economies, namely overbuilding, overvaluation and excessive household debt.”

These comments made by economist David Madani have been repeated and echoed by a number of other groups, all of whom cite Canada’s low interest rates and large household debt (now 163% of disposable income according to Statistics Canada) as a source of significant danger to the Canadian economy.

This is not a view shared by Robert Kavic of BMO Nesbitt Burns who believes that the Canadian housing market has long legs, saying “Cue the bubble mongers!”

Since 2008 predicting the fall of housing markets has become a popular spectator sport. Canada seems to have sidestepped most of the downturn, which has only made calls for the failing of Canada’s housing markets greater. But the reality is that our housing markets are very hot, and we do have lots of debt.

So is Canada’s housing market heading for a crash? Maybe. And even if it was its hard to know what to do. Fundamentals in Canada’s housing sector remain strong (and have improved). People also want to live in Canadian cities, with 100,000 people moving annually to Toronto alone. In other words, there is lots of demand. In addition regulations in the Canadian financial sector prevent similar scenarios that were seen in the United States, Spain and Ireland from occurring.

But housing prices can’t go up forever, and the more burdensome Canadian debt becomes the more sensitive the Canadian economy will become to interest rate changes. Meanwhile I have grown far more weary of over confident economists assuring the general public that “nothing can go wrong.” 

The big lesson here is probably that your house is a bad financial investment, but a great place to live. Unless you own your home, a house tends to be the bank’s asset and not yours. In addition your home, like your car, needs constant maintenance to retain its value. So if you wanted to buy a house to live in, good for you. If you want to buy a house as an investment my question to you is, “Is this really expensive investment the best investment in a world of financial opportunities?”