The End of Globalization?

Globalization End

I’m not one to indulge in predicting radical transformations to the world order. As a rule, change remains slow and while its end can’t always be guessed, its direction is often telegraphed. So, while I’m reluctant to make any grand pronouncements about the future after the lockdowns and life resumes a more normal trajectory (like people no longer working in offices!), I think there is enough evidence today to say that the globalized world is under heavy threat.

The COVID-19 global pandemic has highlighted some strategic weaknesses that must be addressed, and that governments will be unlikely to tolerate into the future. Chief among them is the large dependence on China as a source of medical supplies, including 80% of global face mask supplies and (at least in the US) 30% of personal protective equipment.

We might assume that this is a problem with China, but it isn’t. This is actually a problem with globalization and how dependent it is on a global leadership structure. As supply chains have become global their operation depends on a strong global framework that keeps trade open and coordinates needs across borders. That means that there must also be leadership that can fight (more metaphorically than literally) to keep those chains open in a crisis. That role has been traditionally occupied by the United States, but under Trump’s management the country has taken a big step back from such a global leadership role with other nations making a similar retreat.

As the coronavirus was starting to make inroads in Europe and North America it became impossible to get masks from China, regardless of which factories made them (Medicom, a Canadian manufacturer has three factories in China but none of those masks ever made it back to our borders) as the Chinese government simply requisitioned all masks for their population. Other countries have also taken similar steps, restricting the transportation of some drugs and medical supplies. Finally, in a moment of clarity for Canadians regarding their relationship with the US, Trump invoked a Korean War era law to halt the sale of N95 masks to Canada. That was eventually rescinded, but the message was received loud and clear. Nations have no friends, only interests.

This is true with large international organizations as well. The World Health Organization is facing a lot of scrutiny over its early handling of the pandemic and for its perceived subservience towards China. The WHO, which can only operate in China with the government’s permission, had limited access to people on the ground in Wuhan, accepted the Chinese explanation of no “human to human” transmission, and in respecting the Chinese position on Taiwan can not engage or work with the Taiwanese government to understand how they have very successfully curbed the outbreak. All this has raised eyebrows about how useful this group is. In the past this might prompt more engagement from its largest backers, the United States, and fought for reforms to improve its responses. That’s not the case today, as instead Trump has opted to cease funding to the WHO as both a retaliatory act and a way to shift focus from his own administration.

For sometime globalization has been coming under increasing pressure as a result of the erosion of industrial domestic manufacturing, inequality, and populism. But the pandemic seems to be hastening that process as opposed to repairing it. At a time when a global coordinated effort is desperately needed, no nation is inclined to fill that role. This effect has been described by political scientist Ian Bremmer in his book Every Nation For Itself as a “G-Zero World”, a world with no global leader.

That role has traditionally fallen to the United States, which has seen its own prosperity connected to considerable soft power. But as domestic issues and populism have risen voters of wealthy Western nations have become increasingly inward turning. Some might think that China would fill that role, but China is too nakedly self-interested in its own ambitions, making it difficult for nations to embrace the country’s “help”. Meanwhile, as other nations continue to develop economically they are growing less willing to accept the terms of IMF and World Bank help, and more committed to their own national wants.

Whenever the world begins its return to normal we should expect countries to decouple some of their supply chains from China purely for the public good when it comes to health and medical supplies. But other businesses are taking note that during this crisis they have also been held hostage by China. Apple intends to have its new budget phone assembled in Brazil, and the ongoing trade war with China (now rapidly turning into a cold war) is unlikely to be eased when this is put behind us. Instead we should expect it to accelerate.

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.

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.

All Eyes Are On China

People in China

China, the first hit by the coronavirus and the first to emerge from its enforced hibernation, is the global centre of attention as people watch to see how fast its economy can recover from the from the pandemic chaos unleashed in January. If China is able to bounce back quickly it will be good news for other countries and should raise spirits of investors, businesses, and governments that a global shut down may not lead to the worst of all worlds.

Early economic data is both more and less reassuring than one might expect. The impact of the lockdown in China took a sizeable bite out of the economy. The one year change in the value of exports is -15.9% (down already since the trade war began), industrial production was -13.5%, the fastest contraction in 30 years, while retail sales in China were down -20.5%.

China Data

But as things return to normal in the shadow of the pandemic, numbers may also be improving faster than we thought. Reported in the Financial Times on March 20, of the 80% of restaurants that had been closed in February, less than 40% are closed now. That’s good news for small businesses watching from across the Pacific. There is good news in manufacturing as well. The Purchasing Manager’s Index (PMI) has been officially reported at 52.0, which indicates that manufacturing is growing and not contracting. In February the PMI for China was 35.7, a record low for the country. That positive PMI result is helping extend gains today (March 31st) and giving hope to governments and markets that the worst of this pandemic may be shaken off faster than economists have predicted.

PMI China March

But economic activity is still well below 2019 levels and have a way to recover. In addition, China is one nation, the Western economy is made up of many, and the countries worst hit by the COVID-19 outbreaks have yet to peek and plateau. Italy, Spain and the United States are all fairing poorly, with Italy and Spain perhaps just finally reaching peak of cases now. The United States on the other hand now has more officially recorded cases than any other country, while New York, Catalonia, and Madrid are on track to pass Lombardia as the worst affected cities both in infections and mortalities.

Ft Capture Countries

The coronavirus remains the central unknown in this story. If tamed, can it be permanently subdued? If not, can new cases be dealt with on a case by case basis, or will we have to revert to aggressive forms of social distancing? Concerns remain about whether there will be a second wave of infections in Asia, while China has maintained that all new cases are being imported and can be dealt with proactive screening and testing.

FT Corona City Mortality

In Europe and North America the best news has been to see production of ventilators, masks and the deployment of field hospitals ramp up to deal with the threat. In the wider Asian region, wide testing and a willingness to follow government dictates and a focus on personal protection through the adoption of wide mask usage has had a direct impact on taming the virus in Taiwan, South Korea and Japan (the exception here might be Japan, which seems to have relaxed prematurely and now is considering shutting down Tokyo). But the best news may still be from China and a sudden and rapid improvement in their economy as restrictions are lifted. If prolonged the early rally than began last week, and has continued yesterday and through overnight trading may become the foundation for a more sustained recovery. If not markets may be thrown back into turmoil.*(Please note, markets seem to be in turmoil again.)

Covid-19 CHina Economy

Today, at the end of March, I think the potential for a slower recovery remains possible. Huge stimulus packages have been put in place by governments to help ease the worst of the economic fallout. Governments and their citizens seem to be facing the challenge head on, even if they have been late to the game. America’s enormous manufacturing capacity is being used usefully to deal with the pandemic (better late than never) and early economic news from China is encouraging, but should be treated with caution.

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.

When Only One Thing Matters

iStock-968895338.jpg

In my head is the vague memory of some political talking head who predicted economic ruin under Obama. He had once worked for the US Government in the 80s and had predicted a recession using only three economic indicators. His call that a recession was imminent led to much derision and he was ultimately let go from his job, left presumably to wander the earth seeking out a second life as political commentator making outlandish claims. I forget his name and, so far, Google hasn’t been much help.

I bring this half-formed memory up because we live in a world that seems focused on ONE BIG THING. The ONE BIG THING is so big that it clouds out the wider picture, limiting conversation and making it hard to plan for the future. That ONE BIG THING is Trump’s trade war.

I get all kinds of financial reports sent to me, some better than others, and lately they’ve all started to share a common thread. In short, while they highlight the relative strength of the US markets, the softening of some global markets, and changes in monetary policy from various central banks they all conclude with the same caveat. That the trade war seems to matter more and things could get better or worse based on what actions Trump and Xi Jinping take in the immediate future.

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Now, I have a history of criticizing economists for making predictions that are rosier than they should be, that predictions tend towards being little more than guesses and that smart investors should be mindful of risks that they can’t afford. I think this situation is no different, and it is concerning how much one issue has become the “x-factor” in reading the markets, at the expense of literally everything else.

What this should mean for investors is two-fold. That analysts are increasingly making more useless predictions since “the x-factor” leaves analysts shrugging their shoulders, admitting that they can’t properly predict what’s coming because a tweet from the president could derail their models. The second is that as ONE BIG THING dominates the discussion investors increasingly feel threatened by it and myopic about it.

This may seem obvious, but being a smart investor is about distance and strategy. The more focused we become about a problem the more we can’t see anything but that problem. In the case of the trade war the conversation is increasingly one that dominates all conversation. And while the trade war represents a serious issue on the global stage, so too does Brexit, as does India’s occupation of Kashmir (more on that another day) , the imminent crackdown by the Chinese on Hong Kong (more on that another day), the declining number of liberal democracies and the fraying of the Liberal International order.

This may not feel like I’m painting a better picture here, but my point is that things are always going wrong. They are never not going wrong and that had we waited until there were only proverbial sunny days for our investing picnic, we’d never get out the door. What this means is not that you should ignore or be blasé about the various crises afflicting the world, but that they should be put into a better historical context: things are going wrong because things are always going wrong. If investing is a picnic, you shouldn’t ignore the rain, but bring an umbrella.

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The trade war represents an issue that people can easily grasp and is close to home. Trump’s own brand of semi-authoritarian populism controls news cycles and demands attention. Its hard to “look away”. It demands our attention, and demands we respond in a dynamic way. But its dominance makes people feel that we are on the cusp of another great crash. The potential for things to be wiped out, for savings to be obliterated, for Trump to be the worst possible version of what he is. And so I caution readers and investors that as much as we find Trump’s antics unsettling and worrying, we should not let his brash twitter feuds panic us nor guide us. He is but one of many issues swirling around and its incumbent on us to look at the big picture and act accordingly. That we live in a complex world, that things are frequently going wrong and the most successful strategy is one that resists letting ONE BIG THING decide our actions. Don’t be like my half-remembered man, myopic and predicting gloom.

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.

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?

Screen Shot 2016-03-03 at 10.33.51 AM

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.

 

 

Hyperbole and a Half: Terrible Financial Advice

bear market

Walking into my office this morning I was bracing for yet another day of significant losses on global markets. It’s a tricky business being a financial advisor in good or bad markets. But seeking growth, balancing risk, and managing people towards a sustainable retirement (a deadline that looms nearer now with every passing year) only grows more challenging in terrible markets like the ones we are in.

In some ways it can seem like divining, working out which thread of thought is the most crucial in understanding the problems afflicting markets and panicking investors. Is the rising US dollar enough to throw off the (somewhat) resurgent American manufacturing sector? Has China actually successfully converted its economy, and is no longer requiring infrastructure projects to drive growth? Is oil oversold, and if so should we be buying it?

Aiding me in this endeavor is the seemingly boundless supply of news media. There is never a moment in my day where I do not have some new information coming my way providing “insight” into the markets. The Economist, the world’s only monthly magazine that comes weekly, begins my day with their “Economist Espresso” email I get every morning. No wake-up period is complete for me without glancing at the Financial Times quickly. My subscription to the Globe and Mail and the National Post never go unattended. Even facebook and Reddit can sometimes provide useful information from around the planet. After that is the independent data supplied by various financial institutions, including banks, mutual fund companies and analysts.

So what should you do when the Royal Bank of Scotland (RBS) screams across the internet “Sell Everything Before Market Crash”.

Panic%20button

The answer is probably nothing, or at least pause before you hit the big red button. It’s not that they can’t be right, just that they haven’t exactly earned our trust. RBS, if you may recall, was virtually nationalized following losses in 2008, having 83% of the bank sold to the government. In 2010 despite a £1.1 billion loss, paid out nearly £1 billion in bonuses, of which nearly 100 went to senior executives worth over a £1 million each. In 2011 it was fined £28 million for anti-competitive practices. In short, RBS is a hot mess and I suppose it is in keeping with it’s erratic behavior that it should try and insight panic selling the world over with a media grabbing headline like this.

I may be unfair to RBS. I didn’t speak to the analyst personally. The analyst was reported in the Guardian, a newspaper in the UK whose views on capitalism might be best described as ‘Marxist’, and inclined to hyperbole. It’s not as though I am not equally pessimistic about the markets this year, nor am I alone in such an assessment. But it should seem strange to me that an organization whose credibility should still be highly in question, who undid the financial stability of a major bank should also be trusted when calling for mass panic and reckless selling.

The analyst responsible for this startling statement is named Andrew Roberts, and he has since followed up his argument with an article over at the Spectator (I also read that), outlining in his own words the thoughts behind his “sell everything” call, essentially spelling out much of we have said over the past few months in this blog. I find myself agreeing with much of what he has written, and yet can’t bring myself to begin large scale negation of sound financial planning in favour of apoplectic pronouncements that are designed as much to generate headlines and attention as they are to impart financial wisdom.

Panic Selling

The point is not to be dismissive of calls for safety or warnings about dire circumstances. Instead we should be mindful in how we make sense of markets, and how investors should approach shocking headlines like “sell everything”. I am not a fan of passive investing, the somewhat in-vogue idea that you can simply choose your portfolio mix, lean back and check back in once every decade for a negligible cost. I advocate, and continue to advocate for ongoing maintenance in a portfolio. That investors must be vigilante and while they should not have to know all the details of global markets, they should understand how their portfolios seek downside protection. My advice, somewhat less shrill and brimstone-esque , is call your financial advisor, discuss your concerns and be clear on what worst case scenarios might mean to your portfolios and what options are available to you. If you don’t have a financial advisor, feel free to reach out to us too.

Concerned about the markets and need a second opinion? Please drop us a line and we will be in touch…

 

Swiming With Rocks in Your Pockets

drowningSince 2008 governments the world over have tried to fight the biggest banking collapse since the great depression with modest success. Eight years on and you would be loath to say that the world has turned a corner, ushering in a return of unrestrained economic growth.

Why this is the case is a question not just unanswered by the average layman, but by experts as well. Huge amounts of money have been printed, financial institutions have been patched and repaired, interest rates are at all time lows, what more can be done to fix the underlying problems?

It turns out that nobody is really sure, but as we begin 2016 global markets are reeling on the news that the Chinese economy has even greater problems than previously thought. Only a few days into the week and most markets are down in excess of 2-3%, giving rise to concerns that a Chinese led global recession could be on it’s way.

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The S&P/TSX over the past week.

The difference between now and 2008 is that much of the resources used to try and stem the problems from nearly a decade ago have already been deployed, and there is little left in the tank for another round. Central bakers have been trying to get enough inflation into the system to raise interest rates up from “emergency” levels to something more “normal” but outside of the US this seems to have largely failed.

One of the saving graces after 2008 was that the Emerging Markets were seemingly unaffected. In fact, since 2008 the developing world has become more than 50% of global GDP but in that time the rot that often accompanies success has also set in. EM debt is now considerable, putting many countries that had once extremely healthy balance sheets heavily into the red. Borrowing by these nations has increasingly moved away from constructive economic development and more into topping up civil servants and passing on treats to voters.

World GDP

For some, myself included, it has been encouraging that the Chinese have not proven to be the economic übermensch that some had feared. The rise of the state directed economy with boundless growth had many people concerned that China might represent an economic nadir for the planet. To see it every bit as bloated, foolish and corrupt may not be good for markets, but at least takes the bloom off the rose about Chinese economic supremacy.

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Still, this all of this leads to a couple of frightening conclusions. One is that we have yet to come across any rapid comprehensive solution to a global financial crisis like 2008 that can undo the damage and return us to an expected economic prosperity. The second is that we may have been going down the wrong path to resolve the economic problems we face.

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If debt was the driving force behind 2008, you couldn’t argue we’ve done much to alleviate the problem. At best we have merely shifted who holds it. In the United States, the US government took on billions of dollars of debt to stabilize the system. In Europe, despite attempts to reduce balance sheets across the continent, every country has taken on more debt as a result, regardless of whether they are having a strong market recovery, or a weak one. In Canada, arguably one of the worst offenders, private debt and public debt have ballooned at a frightening pace with little to show for it. Rate cuts and government spending are no match it seems for a plummeting oil price and a lack lustre manufacturing sector.

Interest Rates Globally

Having faced the problem of restrictive debt, putting much of the world’s financial markets in grave danger, our response has been to simply acquire more. Greece owes more, Canada owes more, and now the Emerging markets owe more. It was as though while trying to right the economic ship we forgot that we should keep bailing out the water.

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These charts come from an excellent report by McKinsey & Company called Debt and (not much) Deleveraging. You can download it HERE.

 

None of this is to say that every decision since 2008 has been wrong. Following Keynesian policy saved countless jobs and businesses. But at some point we should have also expected to tighten our belts and dispose of some of the debt weighing us down. Instead central banks attempted to stimulate inflation by juicing the consumer economy with incredibly low interest rates. But as we have seen there is only so much that can be done. A combination of persistent deflation, an aging population and extensive debt have largely upended the best efforts to restart the economy on all cylinders.

Economist cover

This shouldn’t be a surprise. Debt makes us financially fragile. It is an obligation and burden on our future selves. But if we found ourselves drowning in debt eight years ago, it is curious we thought the solution would be to add rocks to our pockets and expect to make the swimming easier.

 

Russia’s Entire Stock Market is Worth Less Than Apple Computers

Let's just call this what it is. Awkward.
Let’s just call this what it is. Awkward.

A few days ago a bizarre inversion took place. A single company was suddenly worth more than the entire investable market size of a major economy. While I like Apple a lot and applaud the incredible profitability of the company, this is more a story about how badly the Russian economy is doing.

Back when Russia was first inciting dissent inside the Ukraine following the ouster of the quasi-dictator running the country, it had banked on the idea that it’s continued escalation inside the borders of a sovereign nation would go unchallenged as few countries would wish to risk a military skirmish over a single, marginal country in Europe.

Vladimir Putin miscalculated however when he didn’t realize how precarious the Russian economy was. Sanctions were implemented and what followed was a largely hollow trade war that did more to identify Russia’s weakness than strength. But the most recent blow to Russia has been the change in the price of oil.

Screen Shot 2014-11-21 at 12.31.04 PMNow that the price of oil is under $80, Russia is suffering severely. Like many oil rich nations, oil exports substitute for taxes. This frees autocratic rulers to both pursue generous social programs while not having to answer to citizen complaints about high taxes. It’s how countries like Saudi Arabia  and Iran get by with little democratic input and a relatively passive population with little to no public disobedience about democratic rights (mostly).

This relationship though means that there are actually two prices for oil. First the breakeven price for extracting oil from the ground, and second break breakeven social price of oil. Those prices are different in every country. In Alberta for instance, tar sand oil is usually quoted at $70 a barrel for breakeven. But to cover the costs of running the government the price is much higher. For Russia the slide in price from $109 a barrel to $80 has meant wiping out it’s current account surplus.

Combined with the falling rouble (now 30% lower than the beginning of the year) and the growth of corporate debt sector, Russia is now in a very precarious situation. I’m of the opinion that energy, and energy companies have been oversold and a rise in price would not be unexpected. But whether the price of energy will bounce back up to its earlier highs from this year seems remote.

This is a stock photo of a guy thinking. Could he be thinking about where to invest his money? He could be. It's hard to tell because he was actually paid to stand there and look like this and we can't ask him.
This is a stock photo of a guy thinking. Could he be thinking about where to invest his money? He could be. It’s hard to tell because he was actually paid to stand there and look like this and we can’t ask him.

Over the last few months I’ve been moving away from the Emerging Markets, and while the reasons are not specifically for those listed above, Russia’s problems are a good example of the choices investors face as other markets continue to improve their health. If you had a dollar today that could be invested in the either the United States or Russia, who would you choose? The adventurous might say Russia, believing they could outlast the risk. But with more Canadians approaching retirement the more sensible option is in markets like the US, where corporate health is improved, debt levels are lower and markets are not subject to the same kind of political, economic and social instability that plagues many emerging economies.

 

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!