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.

How To Invest In Energy When You Hate Volatility

***This post will refer to both a mutual fund company and a particular fund. This post should not be construed as endorsing that fund. We always make sure that we cite our sources and in this instance our source is a fund company, and we are not suggesting in any way that you should invest in or purchase this fund. If you are interested in any fund, please consult with your financial advisor first for suitability, especially if that financial advisor is us!*** 

frackingSince the price of oil dropped there have been lots of reasons to be excited. First the price of gas at the pumps is so low that I don’t hate going there anymore. Second, investments in energy have suffered since oil lost close to $30 in value.

WTI price over the last 6 months. From NASDAQ.com
WTI price over the last 6 months. From NASDAQ.com

And while energy stocks have recovered somewhat from their low points, they are still way off where they were earlier in the year. I’m not going to get into the finer points about the nuances of energy producers and the various types of oil and  costs of production. It’s a worthwhile article, but will take up too much time here. Instead I wanted to focus on a different way that Canadians can participate in the energy sector.

Commodities can be volatile but also a valuable element of a portfolio. So how can Canadians play the energy sector while being mindful of the risks associated with it?

The answer may be by investing in what is called “Midstream MLPs”. Midstream MLPs (Master Limited Partnerships) are American operators that transport energy from the producers to the consumers. It’s a capital intensive business that is federally regulated but traded on the stock market. It therefore provides consistent cash flow while offering liquidity to investors. But Canadians already have opportunities for energy infrastructure, so why should they care about this in the United States?Midstream2The answer has everything to do with the rising levels of oil production in the United States combined with what federal regulators are willing to do to encourage new growth.

That brings us to the growth of the shale revolution in the United States. Newly discovered reserves (of significant size), improved technology and a dropping costs of production have set the US on a course to be the largest global energy provider in the coming years. This combination of efficiencies means that the United States is going to continue to increase its oil production over the next decade, while dropping the cost of extraction for each additional barrel. But each barrel produced has to go somewhere.

Projected Oil Growth in the United States
Projected Oil Growth in the United States

In the United States, Midstream MLPs are responsible for moving that oil. But it’s a sector that also must grow. Infrastructure to move oil efficiently from shale producers doesn’t exist yet, and regulators are eager to get MPLs in place with new development. New infrastructure is costly, and while the business model for an MLP doesn’t require a high price for energy to be profitable, it does need assurances about the consistency of the volume of oil to be moved. To encourage that growth regulators are allowing the price that MLPs charge to rise at a rate faster than inflation. Why are they doing that? Much of the shale oil is having to be shipped via rail to get to its right home. This causes price disparities that reduces producer margins and rankles federal governments.

 Pipelines in the US. Most of the pipelines direct energy to Texas, which isn't set up to handle the ultra light crude from shale projects. that energy, coming out of North Dakota, needs to get to New Jersey. The lack of pipelines means it is being shipped by rail to Chicago and then via pipeline.

Pipelines in the US. Most of the pipelines direct energy to Texas, which isn’t set up to handle the ultra light crude from shale projects. that energy, coming out of North Dakota, needs to get to New Jersey. The lack of pipelines means it is being shipped by rail to Chicago and then via pipeline.
The various prices of oil. Oil from Canada is sold at a discount while Brent crude is sold at a premium to WTI. Improving infrastructure would rectify this problem and equalize prices. (The WTI price is listed from the summer). Click on the image to see it larger.

 

Currently there is only one fund option in Canada that we are aware of for investing in MLPs. We had an opportunity earlier this week to meet the managers of this fund and were greatly impressed by what they had to show us. I am already a big believer in the growing Shale Revolution, and am particularly pleased by the arrival of new opportunities for investment. Growth in the Canadian and American energy sectors is good news for not just investors, but also citizens. Russia, Saudi Arabia, Venezuela and a host of other despotic and semi-despotic regimes have been able to get by on the high price of oil. Now they are feeling the pinch of a decreasing price that has the benefit of bringing jobs back to North America while weakening their influence. In all, this is a good story for everyone.

Want to talk oil? Send us a message!

 

 

California could be at a tipping point…

I’ve been quite vocal about how one day we will have to accept that things we get for free may not be free forever. Water is of particular concern for everyone not simply because it’s a necessity, but because almost none of us live with water scarcity anymore its often hard to connect the dots when it comes to facing real water shortages.

Take for instance California, whose three year drought has reached new and frightening proportions. There are some excellent articles about what impact the drought is having here and here, but take a look at these images of water reserves from 2011 and then the same locations from 2014. Running out of water is a frightening prospect, but 30 million people don’t just pack up and move because water has gotten a little scarce. What happens instead is you begin paying more for water while getting less back in economic benefits.

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I highly recommend Elizabeth Renzetti’s excellent piece in the Globe and Mail today, and I suggest everyone have a read of it. Its an excellent reminder that the biggest issue we face in managing serious economic and environmental problems is not a lack of skill, knowledge, or imagination, but a simple willingness to face the problem. The outcome of which is usually higher costs for everybody immediately, and possibly disastrous results in the future.