The Threads of 2020

The end of the year always brings on reviews of the biggest stories, but its probably more accurate to say that the biggest stories of any year are really the consolidation of events and ideas from many years prior. So as we look ahead, what events from the past might come to their rightful end in 2020?

Fragile Worlds and Global Challenges

Corona 1
Figure 1 People wearing protective masks arrive at a Beijing railway station on Tuesday to head home for the Lunar New Year. NICOLAS ASFOURI/AFP via Getty Images

News of the rapid spread of the “novel coronavirus”, the dramatic quarantining of multiple Chinese cities and the wall to wall media coverage have made the new disease an inescapable part of life. But while the ultimate severity of the virus remains unknown, the larger impact on the global economy is slowly coming into focus. An interconnected planet that is dependent on economies functioning half a world away can find itself in serious trouble when 40 – 50 million people are suddenly quarantined. Consumer spending in China has dropped off significantly, and expectations are that the government may have to take dramatic action to ultimately support the economy. However, the impact of such a large public effort will not only hurt the Chinese economy, but may hamper the already minor commitments that they have made to the US in the new “Phase 1 Treaty”, which will also hurt the US economy, one that has already showing signs of weakness over the last year. The long-term threat of the corona virus may not be its impact to our bodily health, but to financial health.

The Missing Inflation

For years economists and central bankers have been puzzled by the lack of inflation from the economy. No amount of economic growth or declining unemployment seemed to move the needle on inflation, and it remained stubbornly and frustratingly at or below the 2% target most banks wanted.

Labor Participation RateOne explanation for this is that the labor participation rate has been very low and that the unemployment rate, which only captures workers still looking for work and not those that have dropped out of the workforce altogether, didn’t tell the whole story about people returning to the workforce. The result has been that there has been an abundance of potential workers and as a result there really hasn’t been the labor shortage traditionally needed to begin pushing up inflation.

But there are some signs that inflation is coming back to bite. First, and interesting article from the CBC highlighted just how many vacancies there are in trucker  . There is currently a shortage of 22,000 drivers, and that’s expected to climb to 34,000 in the next few years. Trucking pays well, but maybe it doesn’t pay well  enough. In a universe where many Canadian university educated citizens can’t get work outside of Starbucks, how is it that people haven’t jumped at the chance to get into this lucrative practice?

Trucking isn’t the only trade lacking employees. Nursing and pilots are another two trades that are facing severe shortages. How long can some major industries resist raising wages as shortages start to pile up?

Canada’s Economic Problems

Insolvency RatesThe short version of this story is that Canadians are heavily in debt and much of that debt is sensitive to interest rates. Following a few rate hikes, insolvencies started to creep up in Canada and 2020 may be a year in which the historically high personal debt rates of Canadians start to have an impact on the Canadian economy. According to the Toronto Star and CTV News Canadian insolvency rates are   highest they’ve been since the financial crisis, only this time there isn’t a crisis.

As I wrote before Christmas, economic situations create populist movements, and if Canadians are facing a growing economic problem, widespread and with many Canadians vulnerable we should be mindful that an economic problem may become a political one.

A Crisis in Education and Generations

Student Debt w SourceWalking hand in hand is the increasing cost of education, and the declining returns it provides. In the United States the fastest growth in debt, and the highest rate of default is now found in student debt. According to Reuters the amount of unpaid student debt has doubled in the last   to about $1.5 trillion. The financial burden can be seen in the age of first-time home buyers which has been creeping up over the previous decade and is now pushing 35. The primary step in building a life and the pushing of that life off explains some of the current disaffection with politics and economy that has led a growing number of younger people to hold a favorable view of Communism.

Debt and DelinquencySource for consumer loan growth

The Recession Everyone is Waiting For

Following three years of growing trade wars, a decade of uninterrupted economic growth, and market valuations at all time highs, the expectation of a recession has reached a fever pitch. With 2020 being an election year it seems likely that Trump will try and sooth potential economic rough patches, the first of which will be with China, where his trade war is as much about getting a better deal as it is about winning political points with his followers. The first phase of the trade deal is to be signed very soon but details about that deal remain scant. It’s likely that the deal will do more for markets than the wider economy as there is little benefit for China to go for a quick deal when a protracted fight will better work to their advantage.

MSCI vs PriceEfforts to hold off an actual recession though may have moved beyond the realm of political expediency. Globally there has been a slowdown, especially among economies that export and manufacture. But perhaps the most worrying trend is in the sector that’s done the best, which is the stock market. Compared to all the other metrics we might wish to be mindful of, there is something visceral about a chart that shows the difference in price compared to forward earnings expectations. If your forward EPS (Earnings Per Share) is  expectated to moderate, or not grow very quickly, you would expect that the price of the stock should reflect that, and yet over the past few years the price of stocks has become detached from the likely earnings of the companies they reflect. Metrics can be misleading and its dangerous to read too much into a single analytical chart. However, fundamentally risk exists as the prices that people are willing to pay for a stock begin to significantly deviate from the profitability of the company.

Real Price vs Earnings
Figure 2 http://www.econ.yale.edu/~shiller/data/ie_data.xls

Market watchers have been hedging their bets, highlighting the low unemployment rate and solid consumer spending to hold up the markets and economy. But the inevitability of a recession clearly weighs on analysts’ minds, and with good reason. In addition to the growing gap between forward earnings expectations and the price people are willing to pay, we now see the largest spread between the S&P 500 Stock price Index and the S&P 500 Composite Earnings (basically more of the above) ever recorded for the S&P 500. While this tells us very little about an imminent recession, it tells us a great deal about the potential for market volatility, which is high in a market that looks expensive and overbought.

Climate Change

Picture1
Photo by: Matthew Abbott/The New York Times via Redux

Climate change has garnered much attention, and while I believe that more should be done to deal with the earth’s changing biosphere, I fear that the we are having a hard time finding the most meaningful ways of doing that. In the wake of our inaction we will witness the continued economic costs of a changing environment.

Australian TemperatureAustralia, which has had years of heat waves, has recently faced some of the worst forest and brush fires imaginable (and currently bracing for more). At its peak in early January, an area of land roughly the twice the size of Belgium was burning, and an estimated billion animals had died. Some towns have been wiped out and the costs of all this will likely come somewhere into the billions once everything has been totaled. What’s important, and the bit hard to get your mind around, is that this is not A FIRE, but is a season of fires and there were more than 100 of them. And it is happening every year. It’s now a reoccurring problem in California, as well as Western Canada, and in the rainforests of Brazil. As I’ve said before, the story of climate change is about water, and the cost of that will be high.

Australia Burning
Figure 3 Image copyright EU COPERNICUS SENTINEL DATA/REUTERS

More of the Same

There is a lot of focus on the growing disparity between the very wealthiest and poorest in our society. This renewed interest in the level of inequality is a conversation worth having but is frequently presented in a way that isn’t helpful. For instance it’s been pointed out that the concentration of wealth at the very top of society has only continued to intensify, and a recent report from the Canadian Centre for Policy Alternatives (Published January 2nd, 2020)  points out that a “top 100 CEO” saw their pay increase 61% over the last decade. However, to muddle matters, the “top 100 CEOs” remains a fairly non representative group and within Canada wealth concentration for the top 1% has been falling since  2007 (which also represented the highest concentration since 1920).

Trillions of Wealth

Canadian 1% Wealth

This isn’t really about wealth inequality, so much as how unhelpful it is to sling statistics back and forth at one another every day endlessly. A better way to understand what’s happening is to see where is winning rather than who is winning. In the United States, which has seen a long period of job growth, 40% of new jobs were created in just a handful of cities (20 to be precise).

City Jobs
Figure 4 Source: Reuters analysis of Bureau of Labor Statistics data

Those cities, like Seattle, Portland, LA, Atlanta, Austin, Dallas, and, Miami, have all been rewarded in the 21st century, while many of the remaining 350 metropolitan areas had to share the other jobs, and many of those areas saw their share of jobs decline in the same period. An even smaller group of five cities have picked up the bulk of new innovation businesses, a key issue as traditional industries like retail and manufacturing falter, but Computer System Designers are thriving in the new economy. The issue of wealth inequality is not going to be easily dealt with by simply taxing billionaires. Inequality is a geographic story and one likely to persist into the future.

City Job Share

Conclusion

The stories of 2020 are likely going to hit many of the themes we’ve been touting over the last 8 years. Cities, affordability, resiliency, aging populations, environmental change and reckless speculation will remain central to news reporting. But the biggest story will likely be how well we responded to these issues…

Did I miss anything? Let me know! And as always if you have any questions, wish to review your investments or want to know how you can address these issues in your portfolios, please don’t hesitate to email me! adrian@walkerwealthmgmt.com

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 Zombie Apocalypse and Investing

If 2008 was the financial apocalypse it is often written about, it is a zombie apocalypse for sure. It’s victims don’t die, they are merely resurrected as an infected horde threatening to infect the other survivors. And no matter how many times you think the enemy has been slain, it turns out there is always one more in a dark corner ready to jump out and bite you.

This past month has seen the return of the zombie of deflation, a menacing creature that has spread from the worst ravaged economies in Europe into the healthier economies of the Eurozone. Deflation is like the unspoken evil twin that lives in the attic. I’ve yet to meet an analyst, portfolio manager or other financial professional that wants to take the threat seriously and doesn’t insist that inflation, and with it higher interest rates are just around a corner.

The eagerness to shrug-off concerns about deflation may have more to do with the reality that few know what to do when deflation strikes. Keeping deflation away is challenging, but not impossible, and it has been the chief job of the central banks around the world for the last few years. But like any good zombie movie, eventually the defences are overrun and suddenly we are scrambling again against the zombie horde.

This. Except it’s an entire economy and it won’t go away.

In the late 1990s, Japan was hit with deflation, and it stayed in a deflationary funk until recently. That’s nearly 20 years in which the Japanese economy didn’t grow and little could be done to change its fate. The next victim could be Europe, whose official inflation numbers showed a five year low in September of 0.3%. That’s across the Eurozone as a whole. In reality countries like Greece, Spain and Portugal all have negative inflation rates and there is little that can be done about it. Pressure is mounting on Germany to “do more”, but while the German economy has slowed over the past few months it is still a long way from a recession and there is little appetite to boost government spending in Germany to help weaker economies in the EU.

Japanese GDP from 1994-2014
Japanese GDP from 1994-2014

Across the world we see the spectre of zombie deflation. Much has been made of China’s slowing growth numbers, but perhaps more attention should be paid to its official inflation numbers, which now sit below 2% and well below their target of 4%. The United States, the UK, the Eurozone and even Canada are all below their desired rates of inflation and things have gotten worse in this field over the summer.

What makes the parallel between this and a zombie apocalypse so much more convincing is that we have squandered some of our best options and now are left with fewer worse ones. Since 2008 the world hasn’t deleveraged. In fact governments have leveraged up to help indebted private sectors and fight off the effects of the global recession. Much of this come in the form of lower (from already low) interest rates to spur lending. But when the world last faced global deflation the cure ended up being broad based government spending that cumulated in a massive war effort. By comparison the debts of the government haven’t been transformed into lots of major public works initiatives, instead that money has sat in bank accounts and been used for share buybacks and increases in dividends.

For investors this is all very frustrating. The desire to return to normalcy (and fondly remembering the past) is both the hallmark of most zombie films and the wish of almost every person with money in the market. But as The Walking Dead has taught us, this is the new normal, and investing must take that into account. Deflation, which many have assumed just won’t happen, must be treated as a very likely possibility, and that will change the dynamics of opportunities for investment. It leads to lower costs for oil and different pressures for different economies. It will also mean different things for how people use their savings for retirement and how they will seek income in retirement. In short, the next zombie apocalypse can likely be defeated by paying attention and not keeping our fingers in our ears.

tumblr_m690z9rmAy1qhnl93
If it were only this simple….

4 Reason Why Planning for Retirement is Getting Harder

How expensive is this Big Mac? More expensive than you might think...
How expensive is this Big Mac? More expensive than you might think…

For the enormous wave of Canadians that are on course to retire over the coming few decades, retiring and planning for retirement is getting harder.

Here are the four big reasons why!

1. Inflation

Inflation is the scary monster under the bed when it comes to one’s retirement. People living off of fixed pensions can be crippled by runaway costs of living, and naturally retirees dread the thought that their savings won’t keep pace with the cost of their groceries. But while historic inflation rates have been around 3.2% over the last hundred years, and have been around 2% (and less) over the past few years, inflation has been much higher in all the things that matter. Since the inflation rate is an aggregate number made up of a basket of goods that include big things like computers, fridges and televisions that have been dropping in price over time, those drops offset the rising price of gas, food and home costs. Since you buy food all the time and fridges almost never, the rate of inflation is skewed lower than your pocket book reflects.

You can show this in a simple way by comparing the price of a McDonald’s Big Mac over time. When the Big Mac was first introduced to Canada the price was .45¢, today that price is $5.25. Inflation has fluctuated a great deal since then, but let’s assume the historic rate of 3.2% was an accurate benchmark. If you apply that rate the price of a  Big Mac today would be $1.91, in reality the inflation rate on a Big Mac has been  much closer to 5.5%.

Canadian Inflation Rate from 2008 - 2014
Canadian Inflation Rate from 2008 – 2014

2. Interest Rates

The business of central bankers has gained greater attention since 2008, but for many making the connection between interest rates, the broader economy and their retirement is tenuous at best. The short story is that weak economies means low interest rates to spur borrowing. Borrowing, or fixed income products, have been the typical go-to engine for creating sustainable income in retirement, and low borrowing costs means low fixed income rates. The drying up of low risk investments that pay livable, regular income streams have left many retirees scratching their heads and wondering how they can keep market volatility at bay while still drawing an income. But as rates have stayed low, and will likely do into the future, bonds, GICs and annuities won’t be enough to cover most living costs, forcing retirees into higher risk sectors of the market.

Source: Bloomberg and FTSE TMX Global Debt Capital Markets, monthly data from July 31, 1989 to September 30, 2014, Courtesy of NEI Investments
Source: Bloomberg and FTSE TMX Global Debt Capital Markets, monthly data from July 31, 1989 to September 30, 2014, Courtesy of NEI Investments

3. Living Cost Creep

Guess what, the cost of living is going up, not just in real dollars, but because what we consider to be a “normal” number of things in our life keep expanding. Don’t believe me? When your parents retired they probably had a tv and an antenna for it. The cost of their tv was whatever they paid for it, and whatever it might be to replace it if it broke. By comparison most people today have moved into the realm of digital television, PVRs, and digital cable subscriptions. It’s almost unheard of today to not have a smartphone with a data plan and our homes are now filled with a wide assortment of goods and products that would have been inconceivable to a previous generation. The same is true for cars. While cars themselves cost less, prices are kept high by the growing feature creep that have slowly moved into the realm of necessity.

4. You Aren’t Dying Fast Enough

This appointment is wayyyy out in the future...
This appointment is wayyyy out in the future…

Don’t get me wrong, I’m not in a rush or anything; but the reality is that you are going to live a long time, and in good health. Where as retirement was once a brief respite before the angel of death swooped in to grab you maybe a year or two later, living into your 90s is going to be increasingly common, putting a beneficial, but very real strain on retirement plans.

In short, retirement is getting harder and harder to plan. You’re living longer, with higher costs and fewer low risk options to generate a steady income.

What Should You Do?

Currently the market itself has been responding to the low interest rate environment. A host of useful  products have been launched in the past few years that are addressing things like consistent and predictable income for those currently transitioning into retirement. Some of these products are able to reduce risk, while others explore non-traditional investments to generate income. But before you get hung up on what product you should have you should ensure that your retirement plan is meeting your needs and addressing the future. There is no product that can substitute for a comprehensive retirement and savings plan, so call your financial advisor today if you have questions (and yes, that includes us!)

Want to discuss your retirement? Send us an email and we’ll be in touch right away!

Ninjutsu Economics – Watch the Empty Hand

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

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

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

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

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

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

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

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

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!