Tag: Interest Rates

Why is Inflation So Hard to Beat?

April was a turbulent month for markets. Having begun 2024 with an abundance of enthusiasm about the prospect of (very near) interest rate cuts from central banks, an improving economy both domestically and abroad, and resilient employment, 2024 promised the fulfillment of a long-held dream; for the central banks of Canada and the United States to tackle inflation without causing a recession.

Though recessions seem to not be lurking in the immediate vicinity, the best-case scenario for the year is now fully off the table. Several months of higher-than-expected inflation numbers have caused markets to reconsider their earlier optimism and contemplate some of the more pessimistic predictions for economies.

In turn, US markets shed several percentage points through the first two weeks of April, not wiping out the year’s gains but reducing them by about half. Bond markets, having placed bets on rate cuts and longer duration bonds have retreated as well, wiping out gains for the year and forcing bond traders to retrench into safer, shorter duration positions.

Markets have steadied since then, and have been encouraged by Jerome Powell’s statements that the Fed still intends to cut rates, but the earlier optimism about many cuts totalling more than 1% for the year seem unlikely, and even now we will need more data in the coming months to trigger the first cut that had been anticipated for the early year.

Why is this, and why have markets been so easily convinced that rates were bound to fall so quickly?

There’s no obvious single answer. Like many issues surrounding complicated problems a multitude of events, including human bias and the best of intentions have formed the foundations for a great deal of misunderstanding. For the Fed’s part, it has remained committed that data will drive all interest rate decisions, a sensible argument but one that has tied their hands. Investors and analysts have shown a natural bias of optimism, and have assumed that with the bulk of inflation easily defeated through 2022 and 2023 that the final pieces would fall easily into place. This optimism has not learned from the recent past, as 2023 began in much a similar way, with anticipation of rate cuts happening in the second and third quarter of the year only to have rates start increasing in May.

But after these more human problems, what remains are a series of headwinds that will likely be with us for the foreseeable future. While prices of many commodities have fallen from their peaks, and “supply chain constraints” are no longer choking the global trade network, the world is fundamentally different than its was before 2020. China’s relationship with the West is now more openly antagonistic, and a combination of “reshoring” or “friend shoring” is ensuring that costs will be higher than they were in the past. Food prices have continued to rise, with sometimes opaque reasons. In some instances there are clear justifications for higher costs, like bird flu affecting American egg prices or higher gas charges pushing up the cost of shipping. But other times it seems that prices have risen because grocery stores simply can. Finally, commodity prices, while lower than they were in 2021/2022, remain above pre-covid levels. This applies especially to the price of energy, which seems set to stay elevated for the near term.

Performance of the 1 year WTI contract – Source: Bloomberg

Underlying this remains some larger issues about inflation’s presence in our lives before 2020. As I’ve previously written, many parts of our society were experiencing inflation long before CPI began to worry economists and other experts. Prices of physical goods had been falling for decades, but price of homes, child care, education, and food had all been climbing over that same period. The price of housing might be better if governments took a more active role in getting the cost of development down, but permits and other government fees now account for anywhere between 20% (CMHC estimates) to 60% when all taxes, red tape, permit costs and development charges are accounted for, a lucrative source of funds for municipal budgets.

From blog Carpe Diem by Mark Perry:
Source: https://www.aei.org/carpe-diem/chart-of-the-day-or-century-8/

 Additionally, since 2008 interest rates had been at “emergency levels”, the lowest borrowing costs of any time in history. Those near zero rates, which were intended to help remove slack from the economy and encourage large capital expenditure instead stimulated enormous share buybacks among major corporations. Instead of new jobs and a hotter economy we got increasing share prices and more corporate debt.

Problems that take a long time to form do not get fixed quickly. Repeatedly markets have shown an impatience for corrections and are quick to assume that pauses in inflation must mean that the trend of higher prices has both been beaten and that interest rates can fall back to previous emergency levels. Even if interest rates are at sufficient levels to regain control over the direction of inflation, it still doesn’t mean that rates can fall quickly, and the longer rates stay elevated above the emergency levels of the past, the deeper and more costly current interest rates become to the economy.

In Canada low interest rates helped stimulate an enormous increase in property values through the 2010s and into the pandemic. Higher interest rates threaten those gains and as we go through 2024, almost 60% of mortgages will have renewed into more expensive loans since rates began climbing. Even if interest rates begin to fall, homeowners can expect that the cost of borrowing will be much higher than they’ve been for many years. Between the desire of home owners to keep house values high, municipalities to keep their tax bases stable, and banks to ensure that the value of properties they’ve underwritten don’t move too much, the pressure to get inflation down runs squarely into our own self interest.

The urgency and desire for lower interest rates are real, but so are the headwinds that keeps inflation pressure high.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)* – if applicable ACPI is regulated by the Investment Industry Regulatory Organization of Canada (http://www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (http://www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and

bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Revisiting Inflationary Heat Waves

About 12 months ago I had reflected on a summer of global heat waves and how rising global temperatures would ultimately be inflationary as citizens and governments would be stressed in a multitude of ways to tackle heat waves, flooding, and health issues. But as it turns out there were other (not considered) ways that global warming might become an inflationary issue for countries.

If you’ve never stopped to look into global shipping, you’re missing out on one of the most impressive global logistical challenges that has been tackled by human civilization. The ubiquity of cargo containers and the ships that move 90% of everything we use across oceans, renders both the novelty of this achievement and its impressiveness invisible. It wasn’t that long ago that shipping things (anything) was a cumbersome and wasteful endeavor where the distance something could be shipped, its speed in getting there, and the amount that would arrive unspoiled was a pitiful fraction of what travels today. The creation of standardized shipping containers and the development of ever larger ships to carry them has been a cornerstone of globalization.

But the speed of shipping is also dependent on two enormous infrastructure projects of significant historical importance; the Suez Canal and the Panama Canal. The histories of these mega projects are impressive and they retain essential roles in cutting down transportation times for ships crossing from one side of the planet to the other, speeding raw materials and finished goods to markets faster and for less money.

As I like to point out, most stories involving global warming are really stories about water. The Panama Canal, though it connects two oceans, is in fact a freshwater canal and relies on tributaries and rainfall to maintain its depth. But 2023 has delivered a serious drought to Panama and left tributaries and rivers dry, leading to a shallower draft in the Panama Canal. The managers of the canal have taken several measures to deal with this, the most notable has been reducing the draft limit of ships by six feet.  

Six feet may not sound like a lot, but each foot reduced equates to a reduction of between 300 to 350 cargo containers per ship. Six feet is about 2000 fewer containers per boat, or around 25% of a typical cargo ship. This has meant that ships have to carry less cargo, or manufacturers are paying a premium to ensure their cargo is on an earlier scheduled ship. Other options include unloading and shipping some of the cargo by train and reloading it at another port, or travelling around the southern tip of South America, adding weeks to the voyage.

As if this wasn’t enough, lower water levels have also meant fewer ships allowed to transit the canal, with daily transits dropping from 40 to 36 to 32 trips a day, while fees for those crossings have risen to $400,000 per trip. For ships that have set travel times and book passage through the Panama Canal in advance, the impact of these changes has been less pronounced, but other types of shipping, like bulk and gas carriers that must wait for a slot in the canal are now waiting an average of 10 days (an increase of 280% since June) to make it through.

Inflation has many sources, but one we’ve been assumed would recede quite quickly was inflation due to infrastructure and shipping. Initially global supply chain stresses came from China, pandemic shutdowns, and backlogs. But time would ultimately fix these issues as China reopened and ports cleared the backlog of ships. The challenges of the Panama Canal show that climate change will likely remain a source of inflation, unanticipated and requiring considerable money to manage. Since water infrastructure is something that we typically underfund, there is almost no place, rich or poor, that isn’t looking at considerable future costs to improve and maintain existing infrastructure, let alone new infrastructure.

As we head into the winter, its very likely that the drought in Panama will ease, and shipping costs may come down while transportation times shorten. But this marks another change in the environment that may become a reoccurring pressure point on economies, and one that may become so regular as to recede into the background even while it impacts our daily lives. The lesson to investors should be that global warming remains inflationary and will demand ever more money for infrastructure.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Unravelling

In his book Fooled by Randomness, Nassim Taleb says of hindsight bias “A mistake is not something to be determined after the fact, but in the light of the information until that point.”  With this guidance we can forgive some of the covid precautions and restrictions governments imposed on populations in 2020, a period of great uncertainty. 

But in mid-2022 assessing the course of action by governments and central banks as they attempt to tackle a number of non-pandemic related crises (as well as still managing a pandemic that is increasingly endemic) I think its fair to say that mistakes are being made. From political unrest, to cost of living nightmares and finally inflation dangers, the path being plotted for us should be inviting closer scrutiny by citizens before we find ourselves with ever worsening problems. 

Let’s start with the twin risks of inflation and interest rates. Inflation is high, higher than its been in decades, and central banks the world over are attempting to stamp this out with aggressive rate hiking. It is easy to point to Turkey, a country whose inflation rate is 70%, and see that their recent cutting of interest rates is a mistake in the face of such crippling inflation. But what are we to make of North American efforts to slow inflation, even at the risk of a recession? Inflation for much of the West has been tied to economic stimulus (in the form of government action through the pandemic), supply chain disruptions and low oil and gas inventories. The economy is running “hot”, with lots of businesses struggling to find employees. But inflation, measured as the CPI is a rear-view mirror way of understanding the economy, also known as a lagging indicator. But here is one that is not. The price of container freight rates, which have fallen substantially from the 2021 highs.

We can count other numbers here too. The stock market, which is having a bad year, has fallen close to pre-pandemic highs. A $10,000 investment in the TSX Composite Index would have a return of 6.1% over the past 28 months, or an annualized rate of 2.6%. In February of this year that annualized rate was 8.85%, a 70% decline in returns. The numbers are worse for US markets. While US markets have performed better through the pandemic, the decline in the S&P500 is roughly 75% from its pandemic high in annualized returns (these numbers were calculated at the end of June, offering a recent low point in performance).

For many who felt that the stock market was too difficult to navigate but the crypto market offered just the right mix of “can’t fail” and “new thing”, 2022 has wiped out $2 trillion (yes, with a “T”) of value. 

In fact speculative bubbles are themselves inflationary and their elimination will also help reduce inflation. Writes Charles Mackay in his famous book Extraordinary Popular Delusions and the Madness of Crowds (1841) on the Mississippi Bubble in France, “[John] Law was now at the zenith of his prosperity, and the people were rapidly approaching the zenith of their infatuation. The highest and lowest classes were alike filled with a vision of boundless wealth…”

“It was remarkable at this time, that Paris had never before been so full of objects of elegance and luxury. Statues, pictures, and tapestries were imported in great quantities from foreign countries, and found a ready market. All those pretty trifles in the way of furniture and ornament which the French excel in manufacturing were no longer the exclusive play-things of the aristocracy, but were to be found in abundance in the houses of traders and the middle classes in general.”

Evidence today indicates that supply chains are beginning to correct, an important component of taming inflation, while trillions of dollars have been wiped out of a speculative bubble. Even oil, which seems to be facing structural issues that would normally be inflationary has had a significant retreat, along with other commodities like copper, lumber and wheat. Some of these declines may only be temporary as markets react to recession threats, but these declines do not happen in a vacuum. They are disinflationary and should be treated as such.  

But central banks seem ready to trigger a recession in the name of defeating the beast of inflation even as it seems to be bleeding out on the ground. In June the Federal Reserve raised its benchmark interest rate by 0.75%, and the current view is that the Bank of Canada is likely to do the same in July. All this is sparking deep recession fears that seem to be driving markets lower. 

In the background remain genuine issues that seem to be addressed at best haphazardly. Inflation is a real issue making food prices go up, but its been crushing people in housing for years. Even as interest rise and house prices moderate lower, average rents in the GTA were up 18% over the last year. The Canadian government’s response to the mounting costs of living has been to propose a one time payment of $500 to low income renters. That is just a little more than the average increase in rent over the previous 12 months. 

In the face of such mounting housing pressure the city of Toronto has done the following things:

  1. Ban the feeding of birds.
  2. Consider the leashing of cats.
  3. Raised development fees 49%. 

For the record, Toronto is believed to have the second biggest property bubble globally. 

Globally Europe looks to be on the cusp of a serious recession. If North American central banks are looking too aggressive, Europe is struggling to chart a path for its shared currency. Rates have been at record lows but recently the ECB has said it will begin raising rates to tackle inflation. Across the continent the rate of inflation is over 8.1%, but it varies widely country to country, with Germany closer to the average, while Lithuania is at 22%. In the face of mounting inflation the ECB hasn’t raised rates once yet this year, though its expected to this month, even has the European economy and stock markets have been doing worse and worse. 

Coincidentally, Germany, who is now both the linchpin in NATO support for Ukraine while simultaneously its weakest link, has seen its economic health crumble due to decisions made years ago to pin Germany’s energy needs to Russian energy supplies. Will Germany today be able to make political decisions that support NATO and the EU even if it means further economic pain for a country that has grown accustomed to being the beneficiary of these arrangements?

It is not just Western or developed nations that are struggling. China is in the middle of some kind of debt bubble in its real estate market, whose impact is harder to know, but will likely be long lasting given its size. Numerous developing nations are on the cusp of debt defaults, the tip of the iceberg being Sri Lanka.

A small island nation off the southern tip of India, Sri Lanka has been reasonably prosperous over the past few decades with an improving standard of living. Yet government mismanagement, graft and a haphazard experiment in organic farming have left the country destitute. Literally destitute. Out of money, gas and food. In the past few days protests have moved beyond general unrest into a full blown revolution, with the Sri Lankan people storming the government and the political leaders fleeing for their lives.

Behind them is El Salvador which has decided to embark on an experiment in making Bitcoin an official currency, a move designed to liberate the country from the tyranny of the World Bank and the US Government. It has instead likely led to a default, financial instability, and a more regressive and authoritarian government. 

This year stands out for the complex problems that have grown out of the pandemic, but if we’re serious about the kinds of big problems politicians regularly say that must be tackled, then it raises a question as to whether we are handling them properly, or whether we are making mistakes given what we know right now.

For the last few years I have written or touched on many of these topics; on housing, inflation, crypto currencies and the fragile nature of many of our institutions. And while I am cautious about making grand predictions, it remains worth asking whether we are making smart choices given what we know, and if we are not we should be making greater demands of our elected leaders. And if our elected officials continue to make poor decisions, we as investors should plan accordingly.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

What’s Happening With Markets?

Markets have been falling through the year, and despite some encouraging rallies the trend so far has been decidedly negative. The NASDAQ Composite, one of the three big indexes heavily tilted towards technology companies had a -23.86% YTD return as of Monday, May 16th, a minor recovery after it had reached a low of -27% on Thursday of the previous week. The Dow Jones and the S&P 500 have YTD returns of -10.31% and -14.82% respectively. The question for investors is “what to do?” in such markets, especially after some of the best years despite the pandemic.

A closer inspection of the markets however shows that while there have been some steep sell offs reflected in the broad market, the real market declines have been far more concentrated. And while there are many different market headwinds to choose from when it comes to reasons for the recent selling action; inflation, interest rates, geopolitical strife, COVID-19, maybe even Elon Musk, the sector that has been sending markets lower has been the tech sector.

Over the past couple of years the companies posting the biggest gains in the markets have been tech companies. Apple stock (AAPL) was up 88.97% in 2019, 82.31% in 2020, 34.65% in 2021, and is down -11.6% so far in 2022. Amazon (AMZN) was up 76.26% in 2020, and has fallen -30.18% this year. Facebook, now META Platforms (FB) gained 56.57% in 2019, 33.09% in 2020, 23.13% in 2021 and has lost -38.08% in 2022. Netflix was up 67.11% in 2020, and a further 11.41% in 2021 but is down -68.74% this year. Tesla, which had an astounding 743.4% gain in 2020 and another 49.76% return in 2021 is so far down -17.36% in 2022, how long can it resist gravity? (All prices and YTD performance were collected from ycharts.com on May 6th, 2022).

I predict that we may never fully understand how the pandemic changed thinking and why stock prices climbed so much, but the reality was that many tech companies benefited from people staying home, going online and the changing priorities that coincided with not having to be in offices and commuting. Tech companies that became huge like Shopify (SHOP), which allowed traditional retailers to become online retailers, benefitted immeasurably from the lockdowns. But it too has seen its stock decline this year by -69.59%, pushing the price back to where it was in December 2019.  

Because the tech sector has become so large, particularly in the NASDAQ, the retreat of these companies carries big implications for indexes and by extension the wider market as well. As markets fall, it encourages investors to panic sell, aided and abetted by the army of computers that help multiply the effects of momentum selling. This is especially true as investors have migrated to low-cost passive index ETFs, a trend so noticeable that experts worry it might be warping the market as investors worry less about the value of individual companies and instead pile money into broad indexes with no quality filters.

Markets are facing other risks too. Inflation, which seems to be running at about 8%, can threaten economies as people buy fewer items due to cost increases. Interest rate hikes, which are meant to ultimately curb inflation by restricting monetary supply and reduce lending/economic activity have hit bond markets particularly hard. Higher interest rates mean higher borrowing costs, and its here we might hypothesize about some of the unintended consequences of the incredibly accommodative monetary policy that the pandemic introduced. That might be that investors were able to borrow to invest, and the threat of both rising interest rates and stumbling returns will only hasten the exit of money from the market by some investors. Higher borrowing costs will also have another impact on markets, as a sizeable amount of stock market returns over the past decade have come from share buy backs, funded in part by low-cost borrowing.

Having said all that, economies are still looking very strong in the present. Earnings have remained high, jobless claims continue to fall, and while we’ve seen a spike in costs the ability to address those inflationary pressures may not be something that can be easily done through monetary restricting.

There are many different sources of inflation, but two significant issues are not connected to “cheap money”. Instead we have issues that are primarily structural and represent the failure of political foresight. The first among these has to do with oil. Since the price of oil fell in 2014, infrastructure development has stalled, heavily indebted producers have retreated, and now Russia has been closed off from much of the global market. This confluence of events has unfortunately arrived as economies are reopening, global use nears pre-pandemic levels, and global refined supply is at historic lows. There is no simple solution for this, as the only remedy is time (and development). In theory, Canadian and US oil could make up much of the global need, but for a multitude of reasons neither country is in a position to rapidly increase production.

Similarly, supply chain disruption and the heavy reliance on offshore manufacturing have meant that there is no simple solution to production problems occurring in other nations. China is the key issue here, with an enormous grip on much of global supply on many items and their current insistence on a “Covid Zero Policy” China is effectively shut to global business. This means ships can’t get into port, and with-it products cannot make it to market.

Higher borrowing costs seem unlikely to handle this problem. High gas prices and lack of supply may be inflationary, but high borrowing costs can’t target those issues. Instead, higher interest rates and the threat of more in the future are hitting the parts of the market that have been pushed higher by cheap credit. The stock market and the housing market.

If markets seem to be moving independently of economies, its possible that won’t stay that way for long. As previously mentioned, higher energy prices are not controllable by higher lending rates. But higher energy prices can introduce demand destruction, a fancy way of saying that economies shrink because prices get out of control. Oil is still in high use and its needs go far beyond powering cars. In fact internal combustion engines only account for 26% of global oil need, meaning those higher prices for crude, if they get too high, can have wide inflationary impacts to the entire economy.

Higher lending rates may also lead to a substantial economic reset, especially for Canadians who have much of their net worth tied up in their homes. With almost 50% of new mortgages in Canada variable rate mortgages, home prices having skyrocketed in the past few years and with most Canadian debt connected to homes, the risk to home owners is very real. Can the Bank of Canada tame inflation, orchestrate a soft landing for the housing market and keep the economy chugging along? Such a question invites highwire act comparisons.

So what’s happening with markets? Perhaps we are simply correcting a narrow subset of the market that got too hot through 2020-2021. Perhaps we are seeing the dangers of printing too much money. Perhaps we are seeing the realities of people buying too many index ETFs. Perhaps we are witnessing people being too fearful about the future. Perhaps we are too fearful of inflation or interest rates. Perhaps we are on the brink of a recession.

Perhaps, perhaps, perhaps.

But let me offer a slightly different take. Investing is frequently about connecting your needs as an investor with the realities of the world. As Warren Buffet famously said, in the short term the stock market is a voting machine, in the long term a weighing machine. If you can afford risk, you can be risky, and with that comes the potential for significant market swings. If you can not afford risk, then your portfolio should reflect that need. If you cannot stomach bad days, potentially weeks or even months of bad news, then you need to find a way to keep your investment goals aligned with your risk tolerance.

When I started this essay we had just completed one of the worst weeks of the year, which bled into the second week of May. As I finish this piece markets are in the process of rallying for a third day, posting modest gains against the backdrop of significant losses. It would be nice if I could end this with some confidence that we’ve turned a corner, that markets had bottomed and that the pessimism that has led to so much selling is evaporating as people come to recognize that stocks have been oversold. Yet such prognosticating is the exact wrong tack to take in these markets. Instead, this is a good time to review portfolios, ensuring that you are comfortable with your risk, that your financial goals remain in sight and that the portfolio remains positioned both for bad markets, and for good ones too.

If you have any concerns about how your portfolio is positioned and need to review, please don’t hesitate to contact us today.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

A Canadian Story of Woe

 

drowning
A Canadian homeowner going for a relaxing swim in his mortgage…

 

One of the challenges of being a financial advisor is finding ways to convey complex financial issues in simple ways to my clients and readers. I believe I do this to varying degrees of success, and I am informed of my failures by my wife who doesn’t hesitate to point out when I’ve written something boring or too convoluted.

One such subject where I feel I’ve yet to properly distill the essential material is around the housing market. While I’ve written a fair amount about the Canadian housing market, I feel I’ve been less successful in explaining why the current housing situation is eating the middle class.

In case you’re wondering, my thesis rests on three ideas:

1. The middle class as we know it has come about as a result of not simply rising wages but on sustained drops in the price of necessities.
2. The rise of the middle class was greatly accelerated by the unique historical situation at the end of the Second World War, which split the world into competing ideological factions but left the most productive countries with the highest output and technological innovation to flourish.
3. A global trend towards urbanization and a plateauing of middle-class growth has started reversing some of those economic gains, raising the cost of basic living expenses while reducing the average income.

The combination of these three trends has helped morph housing from an essential matter of accommodation into a major pillar of people’s investment portfolios and part of their retirement plan. The result is that homeowners are both far more willing to pay higher prices for a home in the belief that it will continue to appreciate into the future, while also attempting to undercut increases in density within neighborhoods over fears that such a change will negatively impact the value of the homes. In short, stabilizing the housing market is getting harder, while Canadians are paying too much of their income to pay for existing homes. All of this serves to make the Canadian middle class extremely vulnerable.

 

Household Debt
You may be tempted to think “Wow, debt levels really jumped through 2016” you should remind yourself that this chart STARTS at 166%!!!

 

Proving some of this is can be challenging, but there are some things we know. For instance, we know that Canadians are far more in debt than they’ve ever been before and the bulk of that debt is in mortgages and home equity lines of credit (HELOC), which means much of that debt is long-term and sensitive to hikes in interest rates. We also have abundant evidence that zoning restrictions and neighborhood associations have diligently fought against “density creep”. But to tie it all together we need the help of HSBC’s Global Research division and a recent article from the Financial Times.

FT Global Leverage

Last week, HSBC issued a research paper on global leverage. Providing more proof that since 2008 the world has not deleveraged one bit. In fact, global debt has settled just over 300% of global GDP, something that I wrote about in 2016. An interesting bit of information though came in terms of the country’s sensitivity to increasing interest rates. Charting a number of countries, including Canada, the report highlights that Canadians (on average) pay 12.5% of their income to service debt. A 1% increase in the lending rate would push that up over 13%. For a country already heavily in debt, a future of rising rates looks very expensive indeed.

It would be wrong to say that fixing our housing market will put things right. There is no silver bullet and to suggest otherwise is to reduce a complex issue to little more than a TED Talk. But the reality is that our housing market forms a major foundation of our current woes. A sustained campaign to grow our cities and reduce regulatory hurdles will do more to temper large debts that eat at middle-class security than anything I could name.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Making Economics Meaningful – How Official Inflation Figures Obscure Reality

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

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

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

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

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

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

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

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

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

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

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

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

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Interest Rate Awakens

Janet Yellen
Janet Yellen, of California, President Barack Obama’s nominee to become Federal Reserve Board chair, testifies on Capitol Hill in Washington, Thursday Nov. 14, 2013, before the Senate Banking Committee hearing on her nomination to succeed Ben Bernanke. (AP Photo/Jacquelyn Martin)

Today could be a big day. Today the Federal Reserve might finally raise interest rates.

If it does it will be the first time it has done so since 2006. Interest rates, which are precisely nobody’s preferred choice of water cooler conversation, are now the subject of such intense focus it’s hard to know whether we are making too big a deal of them, or not enough of a big deal.

To review, interest rates are used to either stimulate spending or increase savings. If rates are low, we argue that borrowing is cheap and it makes sense to spend money. If rates are high and it costs more to borrow, then people and businesses are likely to save. By this process we can increase or decrease the “cost” of money. Interest rates are therefore considered important in moderating an economy. If the economy is overheating and inflation is rising, raising interest rates should put a damper on it. If the economy is worsening or in recession, lowering rates could inspire companies to spend rather than save and encourage large purchases.

During 2008, in addition to bailouts and massive stimulus packages to the economy, the Federal Reserve in the United States heavily relied on the key interest rates to help stem the problems of the housing and banking crisis. Interest rates went from 5.25% in 2006 to 0.25% in 2008. And they’ve stayed there ever since.

US Fed Fund Rate
A short history of the Fed Fund Rate – since late 2008 the rate has been close to 0%

 

Officially the rate hasn’t moved up, although the Fed has “tightened” credit to the market. Slowing down its bond buying program and ending QE has helped nudge up long term borrowing costs. But eight years on the official interest rate is still near zero, effectively emergency levels, and the economy is (supposedly) vastly improved. So why hasn’t it moved before?

US unemployment
The US unemployment rate has dropped significantly. However there are lingering concerns that while there are fewer people now unemployed, many people are no longer looking for work and have dropped out of the labour force.

 

There is no simple answer to that question. Markets have been nervous, inflation expectations haven’t been met, the USD has risen too fast, unemployment has been too high, the global economy too weak; all of these reasons and more.

US GDP Growth
While it has fluctuated, US GDP growth has been reasonably strong, easily outpacing other global economies of the developed world.

 

But in the background has been a looming fear. That interest rates can’t stay at zero forever. That borrowing can’t be cheap forever. That if the market tumbles again we will have little room to maneuver. That eventually we will have to face significant inflation (and therefore significant interest rates). Those fears seem to have finally won over the largely dove-ish Federal Reserve.

But I want to posit a different thought with our readers. That maybe rates don’t matter as much as we like. Economies are large and complicated things. We only measure what we think is important and traditionally we’ve had to go back and reassess what makes economies work, especially in the face of serious recessions. Where once the Gold Standard was thought to underpin a strong economy, not a single country today relies on it. Where economies were thought to need to correct and businesses fail to right a recession, today we encourage large government spending. Where as we once thought that interest rates shouldn’t be factored into recessions, they are now our first line of defence.

Across the world interest rates are at historic lows to stimulate spending. The BoC recently suggested that interest rates could go negative, a startling and worrying sign for the Canadian economy, especially after two rate cuts this year. But behind this there must be some recognition that the use of interest rates to spur on an economy is at best logarithmic. Like slamming your foot on the gas pedal of a car the most power is delivered early on, not as the pedal reaches the floor.

Logs
Unlike exponential growth, logarithmic growth has a limit that it can not surpass.

 

And so it can be said that perhaps interest rates, currently at all time lows maybe don’t matter that much at all. Maybe you can’t trick people into spending money. Maybe there are limits to what we can do to help an economy. Maybe we have yet to truly identify what ails our economies.

I am of the opinion (in case you haven’t noticed) that the rise of big data may not foretell a future where we can know everything. Far from it, the abundance of data is at best showing that there is still much we don’t know. If the Fed hikes rates today, moving the rates up by 1/4 of a percent, I doubt that there will be any significant change to the economy. It will take years before we approach anything close to “normal” rates at around 2% or higher. In short, a rising rate today will likely mean more symbolically than it does tangibly to the economy.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

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.

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If it were only this simple….

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Throwing Cold Water On Investor Optimism (Not That We Needed Too)

Screen Shot 2014-09-30 at 2.41.51 PM
From The Geneva Report

Yesterday the 16th Geneva Report was released bearing bad news for everybody that was hoping for good news. The report, which highlighted that debt across the planet had continued to increase  and speed up despite the market crash of 2008, is sobering and seemed to cast in stone that which we already knew; that the global recovery is slow going and still looks very anemic.

The report is detailed and well over a hundred pages and only came out yesterday, so don’t be surprised if all the news reports you read about it really only cover the first two chapters and the executive summary. What is interesting about the report is how little of it we didn’t know. Much of what the report covers (and in great detail at that) is that the Eurozone is still weak, that the Federal Reserve has lots of debt on its balance sheets, but that it has helped turn the US

A look at the Fed's Balance Sheet from the Geneva Report
A look at the Fed’s Balance Sheet from the Geneva Report

economy around, that governments have been borrowing more while companies and individuals borrow less, and that economic growth in the Emerging Markets has been accompanied by considerable borrowing. All of this we knew.

What stands out to me in this report are two things that I believe should matter to Canadian investors. First is the trouble with low interest rates. Governments are being forced to keep interest rates low, and they are doing that because raising rates usually means less economic growth. But as growth rates have been weak, nobody wants to raise rates. This leads to a Catch-22 where governments are having to take direct measures to curb borrowing because rates are low, because they can’t raise rates to curb borrowing.

This has already happened in Canada, where the Bank of Canada’s low lending rate has helped keep housing prices high, mortgage rates down and debt levels soaring. To combat this the government has attempted to change the minimal borrowing requirements for homes, but it hasn’t done much to curb the growing concern that there is a housing bubble.

The second is the idea of “Economic Miracles” which tend to be wildly overblown and inevitably lead to the same economic mess of overly enthusiastic investors dumping increasingly dangerous amounts of money into economies that don’t deserve it just to watch the whole thing come crashing down. Economic miracles include everything from Tulip Bulbs and South Sea Bubbles to the “Spanish Miracle” and “Asian Tigers”, all of which ended badly.

The rise of the BRIC nations and the recent focus on the Frontier Markets should invite some of the same scrutiny, as overly-eager investors begin trying to fuel growth in Emerging Markets through lending and direct investment, even in the face of some concerning realities. It’s telling that the Financial Times reported both the Geneva Report on the same day that the London Stock Exchange was looking to pursue more African company listings, even as corruption and corporate governance come into serious question.

All of this should not dissuade investors from the markets, but it should be seen as a reminder about the benefits of diversification and it’s importance in a portfolio. It is often tempting to let bad news ruin an investment plan, but as is so often the case emotional investing is bad investing.

I’ve added an investment piece from CI Investments which has been floating around for years. It pairs the level of the Dow Jones Industrial Average  with whatever bad news was dominating the market that year. It’s a good way to look at how doom and gloom rarely had much to do with how the market ultimately performed. Have a look by kicking the link! I don’t want to Invest Flyer

 

***I’ve just seen that the Globe and Mail has reported on the Geneva Report with the tweet “Are we on the verge of another financial crisis” which is not really what the report outlines. 

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Economists Worry About Canadian Housing Bubble, Canada Politely Disagrees

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

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

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

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

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

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

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

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc