Pay No Attention to the Bubble Behind the Curtain

Housing Bubble
From The Financial Post Magazine, Sept 15, 2015: “Canada’s Ever Growing Housing Bubble”

In the Wizard of Oz we were told that to enter the Emerald City, everyone had to wear green tinted glasses to “protect their eyes” from the “brightness and glory” when in fact it was the method by which the city itself was made to appear green. The first great illusion of the Wizard in the book. Canadian housing feels much like this. The worse the situation gets the more we are assured that the “brightness and glory” of the housing market is unassailable or simply not an issue, and we are invited to don our own emerald glasses.

Toronto LifeThe latest installment challenging that gilded view of housing and mortgages come from the November Toronto Life. Titled “Mortgage Slaves” it is a depressing look into the world of shadow banking and sub-prime mortgages here in Toronto, which far from popular belief is a lively and growing business. Private lenders and shadow lending can turn the reasonable prospect of paying a mortgage into a spiralling mess of debt. The family they interview took a moderate second mortgage for renovations, and promptly found themselves in financial trouble. Seeking help they refinanced several times with private lenders, moving their borrowing rate up from a reasonable rate of interest to 12%. Ten years on and they owed more money than they had paid for their house and were poised to have their home sold from under them.

FSR MFC LendingPossibly the most frightening thing is that Canadians borrow $10 billion a year for their down payments, meaning that the whole point of down payments is undone. And it is here that we see how problems arise. Housing has gone from being one of the most conservative practices to one of the most aggressive. Down payments are small, you still only need 5% to get a mortgage. The secondary banking business is growing, precisely in the area we don’t want with less credit worthy families. Housing prices are ballooning at rates far in excess of what would be deemed sustainable. The CMHC, the people insuring many of the mortgages and who will be on the hook for significant defaults, also believes that the housing market is vulnerable to a correction.

Home prices adjusted for inflationThe response from political parties during the last election isn’t just underwhelming to these problems, it was counter productive. Harper had promised to raise the maximum you could borrow from your RRSP for the First Time Home Buyers Plan. Trudeau’s plan was arguably worse, allowing you to dip more than once into your RRSP. The best plan was from the NDP to cut taxes to build more rental units.

The IMF, the Bank of Canada, the CMHC and The Economist all believe that our housing market is over valued. The response from banks, private lenders and politicians is to shrug and tell us not to worry. There is complicity from home owners and realtors, who are enjoying seeing the rising home valuations and the flurry of activity that it brings. Economists don’t worry because despite the high level of debt, Canadians don’t owe all that debt at once but over decades. So what’s the concern?

Economist HousingBut it should not take a MENSA level intellect to determine that nothing good can come from growth in the continued drop in quality of the banking system or in the quality of debt on issue. Politicians and citizens have to face a reality that high house prices are only good too a point, and that taming the housing market will pay greater dividends than the eventual fall disinterested parties are predicting. But most importantly, young Canadians should know that buying a house at any cost does not define financial success. But it could spell financial failure.

A Financial Advisor’s Thoughts on the Election

2015 election

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

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

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

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

TFSAs

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

Pension & Income Splitting

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

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

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

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

Housing

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

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

Home Ownership

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

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

What The *$#! Is Going On? (And What To Do About It)

Money Worries

Over the past month it would seem that all hell has broken loose on global markets. A generous explanation might use the phrase “increased volatility” while a more pessimistic reading would say that we are heading for another global recession. Either way, people are nervous and money is being pulled out of the market by investors in droves. Year to date returns off of major indices are all negative. The TSX and the Dow are both -8% for the year while the S&P 500 is -5.5%. So what is happening?

Dow Jones Capture TSX Capture

The earliest threads for the most recent round of economic confusion date back to last year, when the price of oil began to fall. Normally falling oil is a welcome sign but in the economic climate we are in, one desperate to see some inflation, falling oil just meant more deflationary pressure. The plummeting oil price also hit a number of economies quite hard. Resource rich economies like Canada, Russia and Venezuela all took it on the chin. The falling price has been exasperated by the Saudi price war against the burgeoning US shale production.

For many investors a falling oil price also seemed to shine a light on a declining need for oil, not one born of environmental concern, but of a falling global demand. That leads us to the current problem with China. China’s problems are likely vast and not well understood yet. There is secrecy around the Middle Kingdom when it comes to economic matters, but it is likely that the Chinese are not immune to the same kind of avarice, greed and hubris that usually underlies most market bubbles. The Chinese have had a stock market collapse that has been followed by increasingly grim statistics and a revisit of the overbuilding narrative that has followed on the heels of China’s economic success.

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)
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)

The final piece of this puzzle was the looming interest rate hike from the United States. Interest rates are closely tied to rates of inflation and are important tools for governments in trying to mitigate recessions. Since the United States has had a near 0% interest rate there is some eagerness to push the rate up and give the Fed some options if the market sours. But critics have spent most of the year worried about a rate hike, citing the strengthening dollar and weak inflation rate as reasons not to do it. When the Federal Reserve took that advice though and opted to postpone the rate hike last week, the response of immediate joy was overwhelmed by the sudden realization that perhaps the US economy was not strong enough to withstand a rate hike and the global economic picture was far worse than previously thought.

Whether this means we are actually heading for a recession, it’s too early to say. No one knows what is really going on, but the sentiment, what people believe is going on, is resoundingly negative. Combined with an aging bull market and the highly liquid nature of investing has meant that there is simply more volatility in the markets than before.

Looking over the business news is little more than a guessing game informed by various analysts about what is (or is not) happening. But the best question that investors should be asking themselves is what do they need to have happen to their investments? While no one is looking to lose money, retirees and pre-retirees need to give real thought as to whether their investments suit their financial needs over the coming few years, and what kind of financial storm they could weather.  So the smartest thing you can do regarding your investments is call up your advisor and discuss your investment strategy going forward.

Need Some Help? Give Us A Call To Review Your Investment Strategy!

Beware False Prophets

Screen Shot 2015-08-27 at 4.38.40 PM
I have shamelessly grabbed this image from The Economist and their article “The Great Fall of China” which I recommend you read.

Investors endured an indignity Monday as global markets reeled from further bad news from China. Overnight (for us, not China) the Shanghai market saw it’s single biggest day decline, now dubbed “Black Monday” which set off sellers worldwide. The TSX dropped 420 points, the Dow Jones was down over 500 points, a drop in excess of 3.5%. The FTSE had its biggest drop in two years and brought it to its lowest since February 2014. In short, it was a bad way to begin a week.

Since then China has cut interest rates, which has encouraged global investors that doom may not be close at hand and markets have bounced up from Monday’s lows, most notably in the United States. But the news from China isn’t good. A toxic mix of investor debt, a bursting market bubble, falling exports, rumored slowdowns and a depreciating Reminbi have scared global investors. China is the world’s second largest economy, and though it isn’t integrated into the global economy like the United States, it’s impossible to conceive of a Chinese slowdown that won’t be felt the world over.

Investors should be cautious. There is a lot of speculation and it is still too early to truly know the full extent of both the problems in China and the fallout for global markets. But the threat of a global recession is real and when China’s problems are added to the abundant weaknesses found in many economies there are solid reasons to be concerned.

Big events like China’s shifting economy typically bring professional talking heads out of the woodwork to speculate about what the future might be like for investors as a result of the changing economic fortunes for the Middle Kingdom. These predictions usually over reach, though the seers behind them are intelligent, well meaning, knowledgeable and very sincere. It should be remembered too that there is great demand for experts who will take the hodgepodge of various financial data and attempt to turn it into a roadmap to understanding the future. Historically these predictions, and their adherents often don’t do well over the long term.

A name many will be familiar with illustrates my point. Canada’s own Eric Sprott, the founder of Sprott Asset Management, saw his success over the years brought to heel through his conviction in gold. Convinced that the vast printing of capital to combat the 2008 financial crisis would undermine currencies and the only safe investment was gold, Sprott ended up losing vast amounts of money by not just betting on gold’s future but by choosing the riskiest way to invest in it. Why did he do that? Backed by considerable data, a lot of analysis and his own success he was sure that he was making the right call. At the last event I attended for Sprott I sat bewildered as conspiracy theories were tossed around to explain the continued decline in gold’s price rather than face facts that they were simply wrong.

The shock of this event was largely not predicted. Afterwards predictions about American's economic future also proved incorrect.
The shock of this event was largely not predicted. Afterwards predictions about American’s economic future also proved incorrect.

There is enormous comfort in predictions. They give a sense of control and suggest an ordered universe that one can make sense of. But successful investors long ago realized that winning meant dealing with risk rather than predicting the future. Any event or scenario that seems to place countries, economies or people on a set destiny that cannot be broken is only ever superficial. Regardless of the seriousness of the situation invariably people will take action to change their fate, often with unexpected consequences. Whether it is a financial catastrophe like 2008, a price war over oil, or the sudden reversal of fortunes for the next anointed economic power, these situations are all temporary and the correct response from investors should be guarded opportunism and not confident certainty about future events.

Cities Are Hurting Your Retirement

The Economist endorses the Walker Report!

Well not really, but they have joined my cause on the problems we face with regards to urbanism and increasing urban density. It’s not everyday that you can say that the economist endorses your position (even if they don’t know it) but in early April my constant nagging about the insane price of housing became a feature for the weekly.

Most Expensive Cities In The World To Live In

How it felt when I saw The Economist article on wasted space in cities.
How it felt when I saw The Economist article on wasted space in cities.

If you haven’t been keeping up, I essentially have three big issues with homes in Canada:

  1. House prices are too high, especially in cities, which is driving a debt problem for many Canadians.
  2. Inflation in the housing market is likely creating a bubble, and considerable risk is building into the Canadian housing market as people over extend themselves.
  3. This problem is compounded by the need for city living. Increasingly people’s jobs depend on living in one of Canada’s big cities, where restrictions on development are aggrivating the situation.

Canada’s housing market is therefore a confusing and expensive mess. The risk is high but the need for housing is great and this fuels a great deal of arguments over how great the problem in Canadian housing really is.

The Economist’s take on this matter is an interesting one. It’s not just Canada that has an urban housing problem. Name a major urban centre and you are likely to see the same problem repeated. From Tokyo to London to New York and back to Vancouver urbanites everywhere are dealing with escalating home prices.Rising Property Prices

But the problem goes beyond merely being frustrated by increasing realty costs. Housing is a significant aspect to any economy. Building homes makes a lot of jobs, but affordable housing encourages a growing economy. As home prices eat up income there is simply less money to go around. It hurts domestic growth, slows trade and reduces standards of living.

The culprit is not a big bogeyman like the banks (though they are benefiting from this situation) but ourselves. In an effort to improve aesthetic standards of living by restricting changes to our surroundings we have unwittingly hurt our economic standard of living. Almost every city today is burdened with development guidelines and urban bylaws that restrict density and height. These rules run into the hundreds of pages and fill volumes in most city halls around the globe. It’s made cities like Bombay one of the most expensive in the world in a country that is one of the poorest. It restricts taxes and hinders economic and city improvements.

And cities need taxes. We tend to be critical of enormous budgetary outlays for cities, but whether it’s a new subway line in Toronto or a super-sewage pipe in Mexico City, cities depend on the taxes that are generated primarily through dense urbanization. This week the free newspaper Metro published an article showing which wards in the city of Toronto contribute the greatest amount in taxes. Unsurprisingly the “downtown” wards contributed the bulk of city revenue. Wards out in Scarborough had some of the lowest, a difference in the hundreds of millions of dollars for city revenue. Some are quick to point out that the “lie” about spoiled downtowners, but the reality is that density improves economic performance and reduces the burden of taxes while improving its efficiency.

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The Economist argues that we waste space in cities, and that comes with a high cost. According to their article the US economy is 13.4% smaller than it could have been in 2009, a total of $2 trillion. Because cities that offer high incomes (like San Francisco) become too expensive people endup working in lower productivity sectors, while making it difficult to live for those that choose to reside in those cities. In the case of Canada this potentially fueling an enormous and dangerous housing bubble while undermining our economic growth. But this is a problem of our own doing. Through our own efforts we have masterminded a situation that threatens our own economic well being. The question that remains is whether we can be clever enough to undo it before it hurts us all.

As for The Economist I will assume they should be calling me anytime to start writing for them regularly….

That phone call should be coming any minute now...
That phone call should be coming any minute now…

The Next Debt Bubble or The Last War?

car-bubbles
Illustration by Mike Faille/National Post

I recall hearing from my mother once that my grandparents had been deeply scarred by the great depression. In a multitude of ways it had affected the financial decisions they made for years after it was all over. It would probably be fair to say that investors have been similarly scarred by the 2008 financial collapse, and that no matter how far into the past it recedes, for a generation there will likely always be a nagging doubt about investing as they recall the days when the very future of currencies, countries and their savings seemed in very real danger.

This guy right here would like to give you a car loan even if you can't afford one! Isn't that nice?  Don't read the fine print.
This guy right here would like to give you a car loan even if you can’t afford one! Isn’t that nice?
Don’t read the fine print.

That concern has made us all highly suspect of debt and the cavalier attitudes of Wall Street financiers who remain unfazed by the dramatic peril they engineered through the early 2000s. So it should not go unnoticed when sentences with the words “subprime”, “growth” and “asset backed loans” seem to be on the rise, and recently that has been exactly the case.

Back in the early summer of 2014, Yahoo Finance ran a story about the growth of subprime auto loans and high interest leveraged loans. The short story was that banks had begun to take on more risk to counteract the weak economy and lack of decent yielding products in the market (themselves a product of trying to stimulate the economy).

In September The Economist also published a story called “Bad Carma” detailing some frightening statistics about borrowing rates, riskier assets and ample credit, all dog whistle terms to any investor who took the time to read anything following 2008.

That was followed by a report from CNBC in October regarding concerns of a new subprime lending bubble on the backs of auto loans. Again citing the same looming threat of a growth in the loan market of riskier quality, primarily driven by the desire to boost short term profits.

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Finally, in the beginning of this year we have begun to see some of the expected fallout of these subprime loans going bad. While default rates are still low, delinquency rates have started to creep up. Again, the culprits were car buyers with weak credit scores that had been offered subprime rates (like 22% or more) to buy cars. In fact according to the Wall Street Journal 8.4% of borrowers with weak credit scores who took out loans in the first quarter of 2014 had missed payments by November.

It’s easy to be suckered into an early freak-out with these reports, but details matter and in this instance the details, while troubling, are not the cause for concern it would be easy to let ourselves get into. According to The Economist, while the blueprint may look similar to the lead up to 2008, the fundamentals don’t match. First the total car borrowing market is $905 billion, or less than a tenth of total mortgage debt. Secondly subprime lending in the auto sector is a more established practice and accounts for about 20% of auto loans since 2000. But most importantly no one is under an illusion about the value of a car after it is driven off the lot. In the housing crisis borrowers and lenders convinced themselves that they would never lose value on a home, but in the auto sector cars are always a depreciating asset.

So should we be worried? I believe this is more a case of fighting the last war. We are so hyper aware now of what created the last bubble that we are watching for it with super vigilance. That’s not to say there isn’t risk. Wells Fargo recently announced that they would be capping the total percentage of subprime auto loans they make, and in Canada subprime auto loans are part of our dangerous growth of consumer debt. So it pays to e vigilant, but imagine if we were equally wary of tulip bulb prices and technology stocks? Wouldn’t that be ridiculous? It is good to be wary of known dangers, but it’s what we don’t know, or worse, what we choose to ignore that invariably wounds us most deeply.

Apple’s Watch and The End of Innovation

20130112_ldp001In early 2013 the Economist lamented that we may never produce something as innovative as the toilet. Certainly they were right in some ways, as some early innovations provided massive improvements in the standard of living with very little effort, where as new innovations did not add the same kind return for effort. It’s an interesting article and goes on to show that our understanding of innovation and whether we face a plateau in our technological progress is more nuanced and convoluted than we may be given to believe.

But industries do face innovation challenges. At some point all the easy refinements have been made and then starts the window dressing, attempts to “tart up” existing things that are little more than distractions from the initial great idea. The Apple Watch fits that criteria perfectly.

Apple Watch

To be clear, the Apple Watch does look to be all the things that Apple excels at; high quality, simple interface and good looks. But the point of the watch is somewhat unclear. You can answer phone calls, follow your heart rate, respond to messages and see your calendar. But these were all things that you can do now through your phone with a level of ease so surprising that you wonder what kind of person imagines that accessing this information is still too laborious.

The answer is likely marketers, who both see the trend towards wearable computers, and declining sales from other high priced items. Apple is a technology behemoth with a dedicated fan base of willing consumers. But even willing consumers have limits on their credit cards. High priced items like the iPad have cornered the tablet market, but they have also seen declining sales. Priced similarly like a phone, but lacking the phone contract subsidisation means that every iPad ends up costing between $500 – $1000. That’s pricey if every three years you are expected to buy a new one.

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The Apple Watch then is likely trying to do several things. Boost the profitability of secondary devices beyond it’s iPhone division. Create a product with a lower entry point that people will be more willing to replace, while at the same time take a stab at a much smaller high end market with a Veblen good.

Ya, that's right. It says $22,000. Less useful than a phone, less gold than a Rolex and it needs to be charged every night.
Ya, that’s right. It says $22,000. Less useful than a phone, less gold than a Rolex and it needs to be charged every night.

But why own one? The first serious app for the apple watch is from Salesforce, the online CRM tool. Salesforce is already accessible from pretty much anywhere. You can log in from any computer and it has a very comprehensive app for all major smart phone platforms. So why would a wrist watch be the ideal place to offer notes, charts or contact information? Already people are wondering what the first “killer app” will be for the watch. I’m curious too.

What made the first iPhone great was that it made using the internet on a small device practical and easy. It was an innovative way to engage with a host of useful things that were previously outside of your reach when not in front of a computer. Apple opened a new market and ushered in a revolution. But eight years on and I am struggling to understand why you would sink any money into wearable tech, with its bad battery life, planned obsolescence and largely pointless existence.

Apple Stock

This should give investors pause. Apple and many of its competitors have done well by striving towards continuing improvements in the look and use of their products. But with each new iteration, we see less innovation and more refinement. The Apple Watch is an attempt to create something new that is actually made up of already existing technology. It doesn’t do anything better, and that should serve as a red flag to investors. As of yet there has been no truly successful wearable technology, neither in the form of glasses or watches. Apple hopes to change that with a more stylish and aspirational device. In the end however, it is a product likely to be crippled in three years by its own obsolescence. Whether that is an appealing device is up to consumers, but as an investor I wouldn’t want to make it a big bet in my portfolio.