The New Class War: Can Our Society Be Made More Equal?

New Class War

Amidst all the various news during this ongoing pandemic, reports that American billionaires are getting richer, particularly those focused in tech, is unlikely to bring anyone much comfort. Though much is often made of income inequality, I tend to believe that inequality in of itself is not a pressing concern for most people. What does stick in the minds of your average citizen is that no matter what tragedy seems to befall the world, the richest keep getting richer, while their own situation continues to erode.

There are two interconnected factors at play here. One is how billionaires continue to do so well. The other is related to declining fortunes and mobility for a middle class that is less middle, but increasingly more class orientated.

The rise of a super-rich has a great deal more to do the dominance of the stock market in an age of globalization than any other single factor. You’ve probably heard some statistic like this before, that in the past a CEO would only have made 20x more than their lowest paid employee, only to find now that the ratio is 278x more than the average worker. Much of this shift has been a result of moving compensation for CEOs and C-level executives into stock options, a move aimed at improving governance, but has instead hyper charged the importance of stock returns in an increasingly globalized world.

Land of Promise

In his book Land of Promise by Michael Lind, he has this to say about globalization and global trade: “Between the end of the Cold War and the crash of 2008, globalization resulted in the organization of one global industry after another as an oligopoly, with most of the transnational enterprises headquartered in the United States, Europe, or Japan…Two companies, US-based Boeing and Europe’s Airbus, had 100 percent of the global market share in large jet airliners. Among their suppliers, the global market for jet engines was divided among three firms: GE, Pratt and Whitney, and Rolls-Royce. Microsoft enjoyed 90 percent of the global market share for PC operating systems. Four firms divided 55 percent of the PC market among themselves, while three companies shared 65 percent of the mobile handset phones. Three firms dominated the world market in agricultural equipment (69 percent) and ten companies dominated the global pharmaceutical market (69 percent). Ninety-five percent of microprocessors (chips) were made by four companies – Intel, Advanced Micro Devices, NEC, and Motorola. Four automobile companies – Gm, Ford, Toyota-Daihatsu, and DaimlerChrysler – manufactured 50% of all cars, while three firms – Bridgestone, Goodyear, and Michelin – made 60% of the tires. Owens-Illinois and Saint Gobin made two-thirds of all glass bottles in the world. Concentration in global finance was accelerated by US deregulation, which allowed the emergence of a small number of US megabanks, some of which grew even more during the Great Recession when, with the support of the US government, they absorbed failing banks, as Bank of America took over Merrill Lynch and JP Morgan Chase acquired Washington Mutual.”

However you may wish to slice it the system of globalization has been a huge boon to the wealthiest globally, consolidating wealth amongst an increasingly narrow group of companies and the people who own the bulk of the shares within those companies. And the more importance share holder returns have taken on, the more consolidated those companies have become.

The second problem I’ve mentioned is that of a middle class that is increasingly stratified. While the wealthiest keep getting wealthy, the middle class has followed suit, locking in wealth and reducing income mobility. While we may not consider life in the 1950s or 1960s particularly egalitarian, aspects about that more sexist and racist time in our past better facilitated economic mobility. For instance, a world where women did not hold many corporate positions of authority and didn’t work after marriage was also a world where women were more capable of “marrying up”. In contrast, today educated professionals marry other educated professionals. A surgeon is less likely to be married to a secretary and more likely to be married to another surgeon. The economist Tyler Cowen has called this “matching” in his book The Complacent Class, with people better able to “match” to those with similar interests and backgrounds. The effect of this “matching” has been to stratify wealth and decrease social mobility within the middle class.

the-class-sketchEducation represents another significant change that is stultifying the middle class. Education, particularly secondary education took on increasing importance in the 1980s, as those with university degrees started to out earn those with just high school, and those with professional designations (like lawyers and doctors) out paced those with just an undergraduate degree. Would more education fix this? Not really. As the cost of education continues to rise and new technologies filter into even white-collar jobs, young lawyers and accountants struggle to find work, while the management of major companies hangs in longer. The return on education continues to decline even as the costs go up, leaving those who come from wealthier educated families financially better off and better socially connected than those coming from lower income families trying leverage education into higher tax brackets.

Similarly, costs of living continue to climb in essentials. In Toronto, where housing prices have climbed steadily for the last two decades, it has given birth to an intransient NIMBYism. Homeowners, having taken on large amounts of debt to get into the housing market are generally protective of their neighborhoods and tend to push back hard on attempts to increase density for fear it pulls down housing value. Poorer neighborhoods in cities like Toronto find themselves pushed out by gentrification, an ironic blend of resistance to development that increases the price of living while denying the development that could keep prices lower for a more diverse group of residents to live together. The effect is one where neighborhoods may indeed be racially diverse, but not income diverse. The effect to a middle class is to be both more precarious and less open.

The response from governments to both these changes hasn’t been encouraging. Playing around with the tax rates, trying to force people into expensive four-year degrees, potentially embracing a universal basic income (UBI) amounts to tinkering with the system, not fixing it. And while UBI has garnered a lot of interest, it smacks of an acceptance of the current situation. If you can’t get ahead, here is some money to make life more tolerable. A population of people dependent of a government stipend is not a population that is very free. But if politicians efforts are well meaning, distrust of them remains understandable, as the political class and billionaire class rub elbows at places like Davos, recommitting to strengthening the very system that seems to be the source of many of the present issues.

Over the past several years I have dedicated this blog to the issues I think that remain most pressing from a financial standpoint to our society, frequently touching on issues of housing prices, technology, anti-urbanization, populism and the middle class. All these issues seem to be accelerating, and if there is a thought that might bind these ideas together it is a sense of loss of imagination on how we deal with major issues. In addition to a consolidation of corporate power and wealth amongst a smaller group of people, we also see fewer companies with IPOs, and fewer companies listed on the stock market in general. There is also less imagination from our political class, which remain wedded to a narrow set of ideas about how to deal with new problems.

Essential Democracy

Successful societies like Canada can be handcuffed by their past achievements, limiting options to things already tried before. But problems that do not get fixed don’t go away. Instead they fester, presenting themselves in other more threatening ways. As I write this there are riots in Minneapolis, ostensibly about the death of a citizen in police custody (part of a long list of Black Americans killed at the hands of police for nonviolent offences) but that riot has swiftly turned towards an affordable housing project and local big box stores in addition to the police. In a 2016 poll, only 30% of Americans born in the 1980s believed that living in a democracy is essential, the lowest since such polling had begun. In Europe polling showed that the core countries of the EU; Spain, France and Italy, had largely negative views about their current economic situation a decade on from the Great Recession.

Postive Economic View Europe

Now, in the middle of this global pandemic, many of these fault lines are being exposed. There may be no better way to sum up our situation than to speak of Walmart, a store that exists and thrives because of the globalized order, importing products from China. According to Ian Bremmer, the largest employer among Fortune 500 companies is Walmart, employing 2.2 million people, easily out pacing any other single company. In 2003 the CEO of Walmart, H. Lee Scott, earned 1500 times as much as a full time Walmart employee.

This trend is not confined to Canada or the United States. It is global, and affects China and India as much as it does the West. But the effect on populations of an economic story that increasingly benefits the wealthiest, while making middle classes more precarious and defensive is to undermine the legitimacy of democracies. The backsliding of democratic countries, and the erosion of the international order is connected to these domestic economic challenges. The pandemic is speeding up this inequality effect, and how we rise to meet it will play a large roll in deciding who calls the shots in the 21st Century.

Miniature people standing on piles of different heights of coins. The concepts of person and wealth.

Author’s Note – In addition to the normally sourced articles I’ve relied on several books for this article, they include:

  • Plutocrats: The Rise of the New Global Super-Rich and the Fall of Everyone Else by Chrystia Freeland
  • The Retreat of Western Liberalism by Edward Luce
  • The Complacent Class by Tyler Cowen
  • Income Inequality, The Canadian Story (Volume 5), Edited by David A. Green, W. Craig Riddell and France St. Hilaire
  • Land of Promise by Michael Lind

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.

Watching the Crisis Unfold in Real Time

Housing Crisis 2

The economic fallout of the pandemic has garnered many shocking headlines, from concerns over how many restaurants may fail to the sheer number of people seeking unemployment insurance. Some of this is economic rubber necking, basking in the shocking and outlandish statistics generated by the lockdown and pandemic. The real test is still in front of us, determining what is temporary and what is permanent.

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From the New York Times

Concern that a number of restaurants may not reopen seems a reasonable fear, since lots of restaurants don’t survive normally. The impact to the airline industry will take years to work out, since you can’t just put all those planes back in the sky. It will take time to determine which routes should be brought back first, how many people want to fly and the planes themselves will need considerable maintenance before any of them roll down a runway.

But hope springs eternal. Eight weeks into the lockdown and efforts remain underway to gradually reopen the economy, and in time we will see which parts of our society (not economy, but society) need real help to get back on its feet.

I remain largely optimistic about the speed of the recovery once it’s safe to reopen, but remain cautious regarding existing problems within the Canadian economy that the pandemic will likely accelerate. Problems that were hidden just under the surface will find themselves in the cold light of day, and those problems will have repercussions, many of which will not be easy to predict.

As I wrote back in March (Will Covid-19 Make Real Estate Sick?)

“Problems rarely exist in isolation, and a problem’s ability to fester, grow and become malignant to the health of the wider body requires an interconnected set of resources to allow its most pernicious aspects to be deferred. In Canada the problem has been long known about, a high level of personal debt that has grown unabated since we missed the worst of 2008. What has allowed this problem to become wide ranging is a banking system more than happy to continue to finance home ownership, a real estate industry convinced that real estate can not fail, and a political class that has been prepared to look the other way on multiple issues including short term rental accommodation, in favour of rising property values to offset stagnant wages”

The issue of debt, real estate and short-term accommodations may be one issue undergoing a seismic shift in real time. The website MLS paints a surprisingly changed picture of the rental situation in downtown Toronto. Condominiums like the Ice Condos, located at the bottom of York Street were written about last year because so many of the units were being used for Airbnb. Today they offer hundreds of long-term rentals. The story is not limited to a few buildings either, much of the downtown condo scene, once reserved for Airbnb customers, has suddenly opened to long term accommodation.

Condo Rentals
A snapshot of available rental in May 2020 in downtown Toronto

For a city that only a few months ago was running perpetually short of rentals this change has been rapid, but its fair to assume that many of these landlords are hoping that the crisis will pass and that things will return to normal, with lucrative business in short term rentals resuming. The effect of all these new rentals is not happening in a vacuum. According to Rentals.ca in their May 2020 report, the price of condo rentals in locations like the Ice Condos have dropped by 10%.

Rental Change in TO
From Rentals.ca

The flip side of the real time change has been the sudden collapse in real estate sales. Reportedly year over year housing sales have dropped in Toronto by 67%, and new listing are down 64%. The selling and buying of houses has simply come to a grinding halt, and with it much of the city’s revenue from the land transfer tax, creating a secondary crisis within cities that have depended on the land transfer tax for revenue growth. In a cruel twist on a well-intentioned effort to get government finances under control, Toronto isn’t allowed to run a deficit, a constraint that has turned into a fatal weakness under the pandemic.

It is here that we should stop and consider a reality. In a few short weeks two major sectors of the Canadian economy within the city of Toronto (and Vancouver for that matter) have been radically altered. But this is also a period where we have seen the most government support and extensive economic intervention. Long term expectations have yet to shift. Airbnb hosts wish to remain Airbnb hosts. Homeowners hope to continue to use their houses to expand their financial footprint. But we should take a page from the city of Toronto reviewing its financial books, the real crisis has yet to truly unfold.

Our future contains, but has yet to have pass, the retreat of government financial support. It has yet to put people back to work, yet to reopen universities, yet to ramp up our manufacturing base, yet to know much of anything about moving past Covid-19. Clarity about what governments should or should not do are hindered by China’s resistance to openness and transparency, while other nations that have already faced the pandemic and seemed to recover are running into second waves. There is no clarity about the future.

iStock-518182156 (1) (1)Real estate remains at the heart of the Canadian economic story for the last 20 years. Appreciating housing prices are the chief source for growth in Canadian families’ net worth. Borrowing to buy houses and borrowing against home equity remain our chief sources of debt. Our politics revolves around the tension of needing more housing in certain highly desirable areas while preserving those areas from over development. That dynamic has revolved around a status quo that seemed to have no conceivable end. The pandemic may have radically altered the Canadian real estate landscape regardless of how people feel about it or what they want. Whether we can walk back changes of this magnitude remains very much unknowable. For now we can only watch the changes our society and economy are undergoing and hope that what we are witnessing will be for the best, those changes that have happened, and those yet to come.

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.

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

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

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

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

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

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

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From Bloomberg

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

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

A Financial Advisor’s Thoughts on the Election

2015 election

Politics is personal and we are not in the game of telling you who to vote for, nor are we endorsing one party over another. These are our thoughts about three issues we find relevant to what we do on your behalf and how we look at the market.

Despite however sophisticated we may think we are, elections are still a confusing mess of promises, accusations and distractions. And making sense of what has been promised is quite difficult. Take for example the Liberals promise for an additional $20 billion in transit infrastructure spending over the next decade. That sounds great and will no doubt be welcome, but that works out to $2 billion a year nation wide (it is not being proposed to be allocated that way, but for simplicity purposes this will do). The cost of the controversial Toronto subway expansion is likely to exceed the $3.56 billion currently budgeted. Given the huge cost of transit infrastructure I’m at a loss to know how much difference $2 billion a year make across the country. Its a big sum, but I don’t know what it’s worth and I’d wager neither do you.

For this reason elections regularly fall victim to the desire of political parties and the media for an easier story to tell. And disappointingly this election spent far too much time talking about the niqab, an issue that, despite how you may feel, has only affected two people since the 2011 ban was first introduced.

There are a lot of issues in this election, but some that could have a meaningful impact on your investments and retirement savings, and I thought I’d share some thoughts on them.

TFSAs

Tax Free Savings Accounts have been a popular new tool for investing since they were introduced in 2009. Originally allowing for a $5000 per year contribution, then raised to $5500 and finally to $10,000 per year in 2015, the Liberals and the NDP have both vowed to roll back the increased contribution room to the more modest $5500 arguing that the room only benefits the wealthy. I have previously written that I think this is a bad argument and that TFSAs are a valuable tool for saving regardless of income. Obviously the Conservatives have promised to keep the contribution levels where they currently are, and notably there has been no discussion yet as to how a roll back would affect existing contributions and future contribution room, nor how the CRA would track this year.

Pension & Income Splitting

Pension splitting has been reaffirmed as a necessary and vital tool for retirees by all the parties. Conservatives, Liberals and the NDP have sought to reassure Canada’s most reliable voting block seniors that pension splitting will remain a part of their income options. In a telling move that illustrates how cynical perhaps our politics are and who will reliably turn up to vote, pension splitting will stay, but the NDP and Liberals would like to see income splitting go.

Income splitting, if I’m being honest, makes a lot of sense to me. Designed to help families with a large income earner and where one parent stays at home to raise children, it balances taxes paid where a two income family would pay less even though their combined incomes are equal to one large earner. The tax benefit is only open to families with children under 18 and capped at $2000, so it isn’t a necessarily huge tax write-off.

Interestingly, the argument against income splitting isn’t a great one. According to the Liberals (and backed up by independent think tanks) the tax credit is really only available to about 15% of Canadian households, and so by that logic alone has been described as a $2 billion tax break for the rich. My math suggests otherwise.

According to the 2011 census, there are just over 13 million private households in Canada. Couples with children account for more than 3 million of those households (3,524,915) or around 28%. That means (and I’ll admit I may have this wrong) eligible families for income splitting account for more than half of all households with children. So the idea that it isn’t a useful or widely available tax credit may not be as accurate as portrayed given who it is targeting.

Housing

Economist Canadian DebtAs you know, I hate Canadian housing, (but love talking about it). It’s a known disaster waiting to happen that consistently defies odds and makes everybody nervous. But while it’s where Canadians have accumulated the greatest amount of debt it hasn’t really been an election issue. The importance of reducing the cost of housing hasn’t really been recognized either. There are efforts from all parties to create more affordable housing, but that isn’t the same thing.

https://twitter.com/Walker_Report/status/655065283007225856

To this end both the Conservatives and the Liberals have brought some terrible ideas to the forefront. Conservatives have made their once temporary home renovation tax credit permanent, although they’ve cut it’s value in half to $5000 from the original $10,000 and have pledged to increase the maximum you can borrow from the Home Buyers Plan. The Liberals are offering to allow you to dip into the First Time Home Buyers plan more than once. Neither of these plans are great. The housing market is too hot and encouraging the use of RRSPs (you know, your private retirement savings) to encourage more homeownership highlights the complicity of Canada’s government in the soaring debt levels of Canadian families.

Home Ownership

In the end we may long for a political party that advised caution against further home ownership in a country where it is already at record highs, and one of the highest in the developed world. Just a reminder, the view of the government is that while high debt is a natural byproduct of low rates, too much debt will still be your fault.

https://twitter.com/Walker_Report/status/654734014243205124

We aren’t trying to influence your vote, but we think it is important to understand that underneath the bluster and mudslinging are policies which can directly impact the financial well-being of Canada, and Canadians like you. So please remember, on October 19th, vote!

Danger Creeps: Housing Bubbles and Crying Wolf

I can not find a better metaphor for Canada's housing market than this image from the movie UP! (Which is a film I highly recommend)
I can not find a better metaphor for Canada’s housing market than this image from the movie UP! (Which is a film I highly recommend)

If you’re looking for some good reading Google “Canadian Housing Bubble” and you could fill a library with the amount of material available. There isn’t a week that goes by without some new article somewhere screaming with alarm about Canada’s precarious and overvalued housing market. I’ve written many myself, but in conversation almost everyone admits that regardless of the danger nothing seems to abate the growth in home values.

From the Globe and Mail, published May 13, 2015
The history of the average five year mortgage in Canada going back to the mid 1960s. It’s hard to believe that Canadians once paid interest rates in excess of 20% to buy a home. Today rates are at an all time low and unlikely to rise anytime soon. From the Globe and Mail, published May 13, 2015

This defying of financial gravity gives ammunition to those that doubt there is any real risk at all. The combination of low interest rates, willing banks, rising prices and an aggressive housing market has given a veneer of stability to an otherwise risky situation. Combined with the “sky is falling” talk about the house prices and it is easy to understand why many simply accept, or outright dismiss, the growing chorus of concerns about house prices.

26621859Nissam Taleb’s book “The Black Swan” highlighted that negative Black Swan events tended to be fast, like 2008, while positive Black Swan events tended to be slow moving, like the progressive improvement in standards of living since the end of the Second World War. But it would be fair to say that creating a negative event requires a prolonged period of danger creep, a period where a known danger continues to grow but remains benign, fooling many to believe that there isn’t any real danger at all.

I would argue we are living in such a period now. The housing market is continuing to grow more precarious and many Canadians are finding that their own financial well being is connected to their home’s appreciating value. Between large mortgages and HELOCs, Canadians are deeply indebted and need their home prices to continue to inflate to offset the absurd level of borrowing that is going on.

As an example of how the “danger creeps” have a look at this article from last week’s Globe and Mail which highlights a young couple living in Mississauga with a burdensome debt and an unexpected pregnancy. They are classified as some of the “most indebted” of Canadians; house rich and cash poor. By their own estimates they are over budget every month and 100% of one of their incomes goes exclusively to pay the mortgage, stressful as that is they aren’t worried. It may seem irresponsible on their part to buy such a home, but they couldn’t do it if there weren’t many others complicit in making such a bad financial arrangement. Between lax rules from the government, a willing lending officer and well intentioned families that help out, it turns out that creating a financially fragile family takes a village.

A nation of debtors is a vulnerable one indeed. I’ve often said that financial strength comes through being able to withstand financial shocks, and this is exactly where Canadians are falling short. It’s the high debt load and minimal savings (and that these two issues are self-reinforcing) that make Canadians vulnerable. A change in the economic fortunes would force many Canadians to deleverage and in the process would inflict further damage to the economy and likely many homes onto the market.

Such an event is strictly in the “uncharted seas” sector of the economy. No one has a clear idea what it would take to shift the housing sector loose, or what would happen once it did. And that’s just the unknown stuff. With interest rates at an all time low it would also only take a small increase in the interest rate (say 2%) to bump up many people out of their once affordable mortgage and into unaffordable territory.

That’s the problem with slow growing danger, it has a glacial pace but when it arrives it is already too large to be dealt with easily. In one of my favorite movies, the Usual Suspects, Kevin Spacey utters the line “The greatest trick the devil ever pulled was convincing the world he didn’t exist”. That’s something we should all be wary of, the longer the housing market stays aloft the more convinced we become that not only is it not dangerous, but that there was never any danger at all.

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.

How Imminent is the Next Market Crash?

image001This past week I received an article from a client regarding ideas about “wealth preservation” that made some good sense, and offered advice about calculating how much money you need for retirement. But while the premise was sound; that it makes sense to pursue investment strategies that protect your nest egg when your financial needs are already met, a one off comment about the future of the stock market caught my attention.

You can read the article HERE, but the issue I wanted to look at was the not so subtle implication that the US markets were now due for a correction. A serious one. Quoting the Wall Street Journal contributing writer William J. Berstein,

“In March, the current bull market will be six years old. It might run an additional six years—or end in April.”

This isn’t the first time I’ve heard this point before. It isn’t unique and sits on top of many other market predictioner’s tools, but its use of averages gives a veneer of knowledge the writer simply doesn’t possess.

Obviously we would all like to know when a market correction is due, and it would be great to know how to sidestep the kind of volatility that sets our retirement savings back. But despite mountains of data, some of the most sophisticated computers, university professors, mathematicians and portfolio managers have yet to crack any pattern or code that would reveal when a market correction or crash should be expected.

Which is why we still rely on rules of thumb like the one mentioned above. Is the age of a bull market a good indication of when we will have a correction? Probably not as good of one as the writer intends. Counting since 1871, the average duration of a bull market is around 4.5 years, making the current bull run old. But averages are misleading. For instance the bull markets that started in 1975, and 1988 (ending in 1987 and 2000 respectively) lasted for 153 months each, or just shy of 13 years. Those markets are outliers in the history of bull markets, but their inclusion in factoring the average duration of the bull markets extends the average by an additional year. Interestingly if you only count bull markets since the end of the second world war the average length is just over 8 years, but that would only matter if you think our modern economy has significant differences from an economy that relied on sailing vessels and horses.

table_us_bull_markets_since_1871

The fact is that the average age of bull markets is only that, an average. It has little bearing on WHY a bull market comes to an end. There was nothing about the age of the bull market in the 2000s, when people had become convinced of some shaky ideas about internet companies that make no money, that had any bearing on its end. The bull market that ended in 2008 had more to do with some weird ideas people had about lending money to people who couldn’t pay it back than it did with a built in expiration date. Even more importantly, the market correction of 1987 (Black Monday) was an interruption in what was an otherwise quarter century of solid market gains.

Taking stabs at when a market correction will occur by using averages like duration sounds like mathematical and scientific rigour, but actually reveals very little about what drives and stops markets. And a quick survey of the world tells us a great deal more about global financial health and where potential opportunities for investment are than how long we’ve been the beneficiaries of positive market gains.

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

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

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

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

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The S&P TSX over the last five days

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

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

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

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.