Author: garth turner

Two days ago we detailed the housing boom now gripping North America. It’s everywhere. It’s real. It both defies the pandemic and feeds from it. It’s potentially dangerous. And buyers need to be incredibly careful. For this has the potential to turn on a dime.

As stated, there are valid economic reasons for the surge (cheap mortgages and pent-up demand), but mostly the phenom is emotional. Nesting. Cocooning. Dog bonding. The flight to security in an insecure world. Fear of the virus. Most of this has been fueled by remote working. Time will surely show this is a temporary thing that most people believe is permanent. Big mistake.

Did you see the latest clickbait survey?

A new poll (ADP) found almost two-thirds of Millennials hate the office. Instead they prefer flexibility, a Zoom existence with only the occasional visit to the cubicle farm. But they expect to be paid as usual. Naturally. Seventy per cent say flexibility should come with full compensation. A quarter of the remoters are afraid of catching Covid at the office, which is interesting since the national infection rate is currently one third of one per cent. Thanks, media.

Okay, so trend No. 1 fueling the housing market is an altered perception of ‘home’. Now it means a Leave-it-to-Beaver, leafy street with detached houses and minivans, rather than sleek condos in a hip urban tower with a bicycle elevator. Remote employment makes people want more space, privacy and physical comfort, since home is work and work is home. It’s led a lot of folks to borrow excessively and spend immodestly.

Look at central Toronto, for example. In August average prices increased 26%, sales were ahead 38% and four in ten properties sold for more than the asking price. This is ridiculous during the month of the year traditionally peppered with vacations and sloth.

Trend No.2 is also emotional at its core. The flight to the burbs. It’s a meme now, and outer-urban areas – like Toronto’s 905 belt, or the sprawling suburban areas around Montreal – are seeing strong sales and popping prices. The biggest stumbling block to moving to Mississauga, for example – commuting and spending four hours a day on the clogged QEW – is gone. At least for now. And as the survey above shows, a ton of Mills think it’s gone forever.

Data doesn’t actually support this.

For example, Zillow found in the States (same conditions as here at the moment) sales of both urban and suburban homes are brisk. And about equal. DOM comparable. Above-asking sales the same. Average price increases similar. Detached prices are growing faster than those of condos (as here), and this is the summary for real estate searches:

Suburban home listings are not seeing any more attention on Zillow than they were last year, relative to urban or rural listings. Suburban homes made up 62.2% of all Zillow pageviews of for-sale listings in June 2020, down just slightly from 62.6% in June 2019. Urban and rural pageviews each climbed 0.2 percentage points from last year

In Canada condo inventories are up, thanks to a whack of new units hitting the market, the collapse of Airbnb and the shutdown of Landlord-Tenant boards which led to non-payment of rent and panic for many amateur landlords. Of course, the virus has impacted too, since masks are now mandatory items even when heading for the garbage chute. Ugh.

Having said that, condo prices are not falling. Detached inventories are running higher. And the prices of SFHs are, frankly, outrageous. The amount of additional debt required is scary. When all those buyers today with sub-2% mortgages are renewing in 2025, well, it might be a shock.

Can the work-from-home, I-loathe-the-office, suburban-no-commute thing carry on indefinitely? Even post-Covid? In a neo-Zoom world?

We’ll see. But it’s doubtful. As stated here before, cities developed for a reason. People come together to work for a reason. People want to live in proximity to each other and services for a reason. Productivity and efficiency are higher in group settings, for a reason.

Meanwhile, pandemic job loss, restructuring of industries, curtailing of immigration, no-school child-care woes and the ending of epic government cash and mortgage deferrals have yet to be felt by the housing market. Emotions, like FOMO and cocooning, can start a real estate fire. But to keep burning, it takes employment security and confidence about the future.

Moisters hiding from the boss in the guest bedroom? It means we’re not even close at the moment. Govern your urges accordingly.

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Donald Trump went to Kenosha, that small city in Wisconsin where a police officer shot a black man in the back seven times, igniting protests, violence and, ultimately, death. The visit was not designed to invoke calm. It was a symbol. As such, perhaps a turning point in an election like no other, in a year without equal.

Markets have been digesting the worst recession since the 1930s, Depression-era unemployment numbers, crushed interest rates, unprecedented government spending and the first global pandemic in a century which by November 3rd may have taken 200,000 American lives – they are all real.

Despite that, equities have surged 50% since March and sit near all-time highs. Some companies – Apple, Tesla, Zoom to name three – have exploded in value. Day-trading is the rage of Robin Hood-loving novice investors. There’s a real estate boom all over everywhere (except Alberta). Despite a big, smoky hole in the GDP and millions on government benefits plus an historic public health emergency, Trump could win. That event would cap 2020 as the year of infinite irony.

This was the news out of financial giant JP Morgan yesterday. Strategist Marko Kolanovic wrote a report reflecting a growing sentiment on Wall Street that Joe Biden could be smoked, not for economic reasons, but emotional ones. Lots of people are afraid of violence and disorder. Talk of defunding police scares them. It’s a threat, and the master of social media, Trump, knows it. Hence the Kenosha trip. Turmoil serves him.

The strategist muses that a seismic shift of five to 10 points in polls, from Democrats to Republicans, could occur if the public perception of protests morphs from peaceful to violent. That’s a big change from three months ago when Black Lives Matter won widespread support and the president’s approval rating slumped. Kolanovic also argues polls showing a Biden lead could be inaccurate as people lie. Apparently that happens. Imagine.

“Certainly a lot can happen in the next ~60 days to change the odds, but we currently believe that momentum in favor of Trump will continue, while most investors are still positioned for a Biden win.”

Okay, so what does this mean to your portfolio? (This is not a social justice blog, remember. We care only about filthy lucre. And dogs.)

First, what if Biden’s numbers are solid and he wins the prize? Does this open the door to American socialism and a tax fiesta?

Nah. Mr. Market thinks not.

Since the polls have telegraphed a Biden win for several months, and markets have steadily marched higher, the Democratic threat seems muted, if it even exists. Remember that equities are forward-looking and they have not bought the Trump warning that stocks would “disintegrate…drop down to nothing” is Joe is President.

What about taxes? Biden has proposed to roll back a big chunk of Trump’s corporate tax cut, raising the rate to 28% from the current 21%. That would hurt profits and slow economic recovery coming out of the Covid crisis, but this also has been brushed aside by investors as a negative outcome. It’s too unreasonable that anyone would jack taxes and damage a recovery that cost trillions of public dollars to create. JP Morgan says this, actually: ““We see Biden winning as neutral to slight positive.”

And what if Trump succeeds?

Well, what you see is what you get. He is no longer an unknown, dark, looming question mark. The market knows him now as a pro-growth, nationalist, inflationary business protagonist. Often flaky, unpredictable, impetuous, divisive and disappointing, nonetheless he extended the Obama recovery to achieve full employment, record markets and corporate bliss.

In short, for Wall Street, Bay Street and your balanced portfolio, this is no black-&-white contest. Either guy, about the same outcome. As my buddy Ryan has detailed here in recent weeks, the US economy has actually done a little better historically under the Dems. And Biden is no wild-eyed young reformer.

So what’s the threat?

Uncertainty. Like twenty years ago when the Bush-Gore slugfest took ages to settle, during which time the market tumbled 12%. Given Trump’s statements about mail-in ballots being ripe for fraud (no evidence of that exists) plus his reluctance to say he’ll accept the electoral outcome have raised this specter. If he doesn’t win, will he not leave anyway while an army of lawyers swarm losing states? That would suck.

Strategy?

Don’t gamble. Putting too much net worth into a few stocks – especially the inflated ones – would be foolhardy. So would rolling the dice on forex, or jumping onto precious metals. Stay invested in a balanced way, with 40% safe stuff and the rest spread out globally – between Canada the US and international. Buy low-cost, liquid major market index ETFs. Don’t hunker in cash, silly HISAs or comatose GICs. 2021 will be a year of virus recovery, reopening, growth and catch-up. Rising global growth will likely kick up commodities, and fuel Bay Street. And once a proven vaccine emerges and spreads, stand back. Eruption.

  BTW, be glad you live in serene Canada. Don’t lose your head.

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Ottawa. Victoria. Niagara. Kelowna. Montreal, Toronto and Vancouver. Mississauga, Burnaby, Etobicoke, Abby and PoCo. It’s the same story everywhere. House sales exploded in July and August. Prices have risen to meet demand, since inventory levels in most markets were at a Covid low.

Logically, this is nuts. Unemployment in Canada is north of 10%. In centres like the GTA, a lot worse. Millions remain on government pogey and hundreds of thousands have been unable to pay existing mortgages. Small shops, restaurants and factories have been whacked and many will never reopen. Tourism is dead. So are conventions, sports and travel. The country’s in the midst of the worst recession since the 1930s. Nine thousand people have died of a contagious virus for which we have no cure. Social distancing and masks have crucified retail and are destroying eateries. Downtown cores are dusty wastelands. Schools have been shut for six months. Airport passenger levels are down 90%.

And yet, a real estate feeding frenzy. Debt levels are surging. Bidding wars, blind auctions, bully offers and people grabbing houses they’ve only Zoomed or FaceTimed. It’s all happening. It’s real. It defies reason.

And it’s not just isolated, a unique Canadian affliction. Check out these headlines from my daily feed:

Why the Indiana housing market remains so hot during the pandemic
The Indianapolis Star

New Yorkers are Fleeing to the Suburbs. ‘The demand is insane’
The New York Times

Hot Property newsletter: Hot times in the real estate market
Los Angeles Times

Why residential real estate is becoming more attractive in the suburbs
Montgomery County Paper

Real estate market soars despite pandemic
Roanoke Times

Real estate sales reaching lofty heights
The Anna Maria Island Sun

Why residential real estate in South Bay is red hot despite the pandemic’
San Jose Spotlight

Act fast to land a home in today’s market
Orange County Register

Expert: Panic buying hits Denver housing market
Westword

Housing market continues to soar in southwest Michigan
ABC 57 News

Portland broker see rebound in housing market during pandemic
KGW.com

Millennials help power this year’s housing-market rebound
Wall Street Journal

Record sales, record prices in Colorado’s real estate market’
9news.com KUSA

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If we can understand why this is happening, perhaps we can determine if it’ll last. Knowing that could answer this question: are today’s virus buyers savvy or senseless?

The obvious first reason houses are going up is that interest rates have come down. Cheap mortgages allow folks to borrow more, spend more, and squeeze prices higher. Second, we had no spring market. It was lockdown time, so pent-up demand exploded like a sailor on shore leave. Third, demographics have been pushing real estate. The largest cohort in society are the Millennials, all 9.8 million of them. That’s 27% of the population, and they’re all horny. For houses.

But those are just the reasonable reasons. There are a slew of unreasonable ones, too. They have to go with a certain global pandemic. Maybe you heard.

Covid has infected millions of brains, inserting fear and a sense of victimization. In a scary, out-of-control world which is beyond the experience of anyone alive, people are seeking shelter, refuge, safety and all the predictability they can get. Nesting. Cocooning. Owning a home seems like gaining control over your own surroundings and destiny. In the fog of emotion it seems if you lost your job, or society continued to unravel, you’d be better off as an owner than a renter who could be turfed. Of course that ignores the far higher costs of owning than leasing, but this is no time for logic.

Then there’s the direct virus impact. Millions are working remotely, so the dwelling becomes their world, 24/7 & 365/yr. They want more space from kids and spouse. The office downtown is shut now and may be for a year. So they can move to the burbs or a small hinterland city and finance more house. Meanwhile fear of germs, strangers in the hallway, sticky elevator buttons and scary garbage rooms have fueled a flight from high-rise condos into low-rise semis, towns and detacheds.

Layer on this a thick coating of financial illiteracy. Most people have no liquid investments, have never invested, think the stock market is a casino and only know their parents made a fortune on a house they bought in 1978. So what if they need a $1 million mortgage now? Nobody actually expects it off since you’re renting money as you move up the property ladder with equity the market hands you. every year.

Lastly, all of the above has created FOMO. Fear of missing out. It’s a huge driver of the emotions which lead people to take irrational actions. Toronto agent Steven Fudge has written about this convincingly:

Fear evokes a visceral reaction, which focuses entirely on the moment (fight or flight). FOMO has incredible strength and ability to separate people from their logical assessment of a property. Things like budget, property inspection and even the concept of debt are pushed directly to the side as the homebuyer focuses on the task at hand and is willing to do what it takes to secure a purchase.

As a result, in the midst of a pandemic and the worst downtown in our lives, house prices have peaked and household debt is soaring when rates are at an historic low and can only increase. What could possibly go wrong?

Well, the mortgage deferrals are done. No more. Now we get to understand the consequences.

Earlier today the federal regulator dropped the hammer, telling banks any new deferrals they grant will be treated as non-performing loans, requiring them to raise more capital. In effect, it signals the end of a six-month period in which almost 800,000 families stopped paying their obligations.

The program will be phased out over the next 90 days with the bulk of deferrals ending next month. “Banks are now in a better position to employ their business-as-usual alternatives to support troubled borrowers,” the regulator said. In general that means moaning and weeping.

It’s begun.

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Chrystia. Justin. Taxes. A trillion in debt. Biden-Trump mashup. Second wave, maybe? Mortgage deferral cliff. Millions on the dole. BLM in the streets. Cops defunded. Statues falling. Vigilantes. Masks protests. Historic deficits. 847,659 deaths. Closed borders. And a real estate boom. Oy, whadda world this is.

The afflicted believe governments should support them. The paleos think commies are taking over. The left-right divide is gaping just like the wealth disparity. The pandemic came along and crushed the indebted, the unprepared and the uninvested. The same crisis propelled markets as stimulus flowed and portfolios plumped. Now it’s all political. The rest of 2020 will be even more arresting than the first eight months.

Determined not to waste this crisis, the prime minister punted his Bay Street finance minister, installed a lefty journalist, shut down Parliament and is preparing a ‘go big’ plan for a green new deal. Details in four weeks. Then a badass budget. Meanwhile the USA is in the grip of a presidential contest that resembles a brawl. And the virus continues.

Last week this pathetic blog naively asked, how to prepare? How to ready for a world that promises more government, more tax and greater wealth distribution? As you know, most citizens are pooched and expect politicians to bail them out. They continue to save nothing while over-spending on real estate. Theirs is a world of hopium. And they all vote. Yikes.

Some suggestions…

Emergency fund – a perennial tenet of financial advisors, but does it really make sense to have enough money for six months of living expenses sitting in a HISA paying one-half of one per cent (taxable)? Ah, no. A better option is to ensure you have a personal line of credit established with your bank or CU, and invest that emergency money in your TFSA in some nice, cheap, diversified ETFs.

The LOC costs zero to set up and zero to maintain. The only interest payable is on the money actually drawn from the line, and odds are an emergency will never occur. If one does, just look needy and the feds will send you money!

Refinance debt. This is the time. Rates are in the ditch and will stay there for months. Maybe a year or two, until inflation starts being a threat. Lock in the mortgage at less than 2%. Don’t be a cowboy and go variable to save a few thin basis points. If an existing mortgage is 3% or more, talk to your lender about blending and extending the loan. This will reduce the overall rate, push out the renewal date and avoid a mortgage break fee.

Capital gains. Take them soon. Most observers (this blog included) think the odds are high T2/Chrystia will up the inclusion rate from 50% to maybe 75%. That’s a mother of an increase. Today half of gains are tax-free with the other half added to your income and taxed at your own marginal rate. So upping this to three-quarters is punitive.

The amount of revenue the tax raises is inconsequential in the face of a $350 billion annual deficit, but it’s a political move designed to message those with no investments (but a house) that the 1%ers are being shellacked. While it’s possible the change could be retroactive to the beginning of the year, it’s doubtful, given a budget won’t come until October at the earliest. We’ll see.

Or you can wait until Erin O’Toole is prime minister. Ha.

Other portfolio moves: keep at least 20% in US$-denominated assets. Once the American election is done and the virus starts to fade, the greenback is likely to appreciate while our balance sheet is weighted down by public spending. The loonie could weaken – but it’s always a good idea to hedge against our currency.

Also keep your registered accounts – TFSA, RRSP, RESP – topped up. Growth within them is tax-free with no worries about a rising capital gains inclusion rate. The tax-free account especially is a valuable tool for now and forever since income can flow without affecting your marginal rate. Never put a brain-dead GC in there, but focus the TFSA instead on equity-based ETFs. Lend your spouse money for his/her account. And your adult children (so long as they give it back).

Income-splitting: the advice oft-stated here is repeated. Establish and fund a spousal RRSP if one of you makes substantially less. Set up a spousal loan to give him/her/them/its (we are a pronoun-sensitive, modern blog) money to invest since the rate is ridiculous (1%) and no attribution is involved. Make the less-taxed spouse the investor while the higher-earner pays family expenses.

Take the cash: open an RESP for your kids and get a 20% grant from the feds each year (some provinces also give money). Apply for and enjoy CPP payments starting at age 60. It’s not worth waiting until later since  years of monthly payments can be stuffed into growth assets in your TFSA.

Have a mortgage at less than 2%? Then stop aggressively paying it off. Investment portfolios have been returning three times this amount for decades, so direct the cash there, building net worth faster (and establishing valuable liquidity). Always invest via a diversified and balanced portfolio. No individual stocks (too much volatility). No mutual funds (rapacious fees). If you fear a second wave of Covid,  quietly stock up now. Each week double the staples you buy at the supermarket. The drug store. The pet food place.

Finally, if you can’t easily pay your mortgage or the deferral is ending and your job is iffy, list the place. There’s an insane, FOMO-fuelled real estate bash going on, a better price may never arrive. Besides, you’ll trash debt, free up liquidity and shed ownership costs. By the way, rents are going down and tenants are now driving the bus.

Gold and guns? Sorry, wrong blog. Try this.

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   By Guest Blogger Ryan Lewenza

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Some of you may be wondering how the heck have the markets recovered so strongly and the S&P 500 recently making a new all-time high, when the US/global economy is still mired in the worst economic downturn in decades. Well the answer is actually quite simple – the unprecedented government stimulus that has been injected into the system and that the US/global economy looks to have bottomed and is slowly turning around.

I’ve been very fortunate over my career to have worked with and been mentored by a number of brilliant and experienced investment professionals. One of those was our old Chief US Investment Strategist out of St Petersburg, FL, Jeff Sault, who not only is an interesting and entertaining guy (I did a road show with him across Canada and boy do I have some good stories from that trip!), but is also a market genius and someone I learned a lot from.

One particular piece of market wisdom was, “Ryan, markets don’t care whether the economy is good or bad, they care whether things are getting better or worse”. Meaning it’s not about the actual number (i.e., the US unemployment rate is at 10%), it’s whether the unemployment rate is moving from 10% to 9%. In the business we call this “second derivative” change and as I’ll cover today, the US economy is rebounding, which in part explains why the markets have recovered so strongly in recent months.

As Covid-19 worsened and morphed into a global pandemic, the global economy was brought to its knees as governments around the world enforced unprecedented lockdown measures to help contain the breakout. As a consequence millions of people lost their jobs, whole industries have been rocked and we’re stuck in the deepest economic downturn in many decades. But, the worst looks to be behind us.

In recent months we’ve seen a sharp rebound in major components of the US economy. For example, the US housing market is roaring back with housing starts rising by 22% M/M in July, housing sentiment among builders is at the highest level in years, and new home sales up 14% M/M in the latest report.

Manufacturing is also on the mend with the ISM manufacturing index jumping to 54.2 in July, now indicating expansion in the US manufacturing sector. Some of this is being driven by the US auto sector, which saw monthly production surge from just 1,800 units in April to over 140,000 in June.

While important areas like the travel and leisure industry continue to feel a lot of pain, other key areas like housing, manufacturing and retail sales are showing real strength, suggesting to us, the worst may be behind us.

US Housing and Manufacturing Are Surging Back

Source: Bloomberg, Turner Investments

All of this is then being reflected in the GDP data. In the second quarter we saw the US economy contract by an unprecedented 33% Q/Q annualized. To put this print into context, my data goes back to 1950 and the next worse quarterly GDP figure was -10% in Q1 of 1958. This number is borderline apocalyptic and illustrates just how much the US economy has been impacted by this pandemic.

But I believe that Q2 may represent the low in this downturn, and see the US economy returning to growth in the third quarter. Currently consensus estimates point to a 20% rebound in Q3 and 6% growth for Q4.

The recovery is not going to be perfect and there will be setbacks along the way, but based on what I’m seeing in the current economic data, and my expectations going forward, I believe we’ve hit the low in this economic downturn.

US Economy Is Expected to Return to Growth in Q3

Source: Bloomberg, Turner Investments

While I’m optimistic for a return to growth in the coming quarters there remain a number challenges to the global economy that could imperil the recovery. As I’ve been telling clients in our market updates I see three key risks to our outlook:

First, and stating the obvious is the next phase of this virus. As the global economy reopens and we begin interacting more closely and freguently with eachother, it’s only logical that we could see a ramp up of infection rates. The virus is no less contagious today and with us heading into the flu season, this fall/winter could prove to be a difficult time. If we were to see a massive increase in Covid infection rates and deaths, this could cause government officials to slowdown reopening measures, hampering the recovery and our call for a return to growth. Our base case view is we just work through the increases in rates, as the economic toll is just too grave.

Second are all the bankrupties that are likey to occur. J Crew, Chesapeake Energy, and Hertz to name just a few that have filed for Chapter 7 and many more are expected to do the same in the months ahead. Edward Altman, an expert on corporate bankruptcy, sees bankrucptices from this downturn eclipsing that seen durign the financial crsis. And it is estimated that 30-50% of all restuarants and bars could go under as a result of this pandemic. That will mean a lot of lost jobs and income for millions of people.

Lastly, I believe more government assistance is likely needed in the US as the employment insurance $600 top-up has expired and many Americans have already blow through their one-time $1,200 government payment.

Below is a chart of US personal income, which includes all the wages and salaries, investment income and government benefits that Americans receive in total. Note the dip, then surge in income as the US government dolled out billions of financial assistance for millions who were let go from their jobs. Without this, consumer spending would have collapsed and the US economy would have been even harder hit than the -33% contraction. Now much of this assistance has rolled off as the two parties were unable to reach an agreement on a second stimulus plan. Without another round of support this could signficantly weigh on consumer spending and the recovery in the coming quarters.

While there are clear risks to the economy and markets, as there always is, I see more pluses than minuses and see the US economy slowly recovering in the coming quarters.

US Income Has Been Supported by Government Assistance

Source: Bloomberg, Turner Investments

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.

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The biggest impact central banks have for most people is setting the cost of money. That’s called interest. It’s what you pay to get money or the amount you receive when you lend it.

The CBs in Canada and the US for decades have worried about inflation, as it jacks prices and wages making money worth less. So they used higher rates to empower money, thereby corralling the rising cost of living. Maybe you’re old enough to remember about ugly inflation in the early 1980s. If so, you might recall 15% GICs and 22% mortgages. The Bank of Canada pulled out all the stops to crash prices.

It worked. Real estate went from boom to bust lickety-split.

Lately the central bankers crushed rates in order to save the economy from virus-induced deflation. Look at today’s Canadian GDP stats. Fugly. The economic crash in the second quarter equaled 38.7% on an annualized basis. Worst ever. And while things have been creeping back in July and August, it will be months (or years) before the jobless numbers restore to early-2020 levels.

What have those cheap rates done? Exactly. Fuel real estate. In fact, the pandemic itself is throwing gas on the housing market, especially the detached, suburban, minivan-infused former cow pastures where children sprout and adventure dies. People want safe. Boring. Fences. Sales in Barrie jumped 84% in July, where the top adrenalin-pumper is bowling and there’s a Polaris in every garage.

Now, more changes coming.

Yesterday, while the Corona president was giving a speech to a thousand people without masks or social distancing the American CB, the Fed, made a big move. Inflation won’t be the main focus anymore, it suggested. Rates won’t automatically start to rise when the core inflation rate hits the long-standing threshold of 2%. Instead, the cost of living will be allowed to grow ‘moderately’ above that, even if full employment is achieved again, leading to wage demands.

A biggie, this is. The policy shift suggests the Fed’s worried about virus backsliding taking place and is signalling it’s prepared to keep rates supressed for a long time. “Yesterday’s action by the Fed likely provides risk-assets with the assurance they need — easy money is here to stay,” Bloomberg reported a Wall Street strategist as reacting. As a result, bond yields went down and bond prices went up. Stocks continued to advance toward record highs (where else is money going to go?). The US dollar declined, which meant commodities like gold advanced. And people kept on buying houses in Barrie even as StatsCan was reporting the economy croaked.

Now, all this means we are getting closer and closer to free money. The implications are legion. As reported days ago, it’s possible to nab a five-year, fixed-rate insured mortgage for 1.5% in some places. (Even the big banks are handing out 1.9% money to everyone with a mask and a pulse.) Now, for the first time, comes a 1.4% one-year home loan – which is less than half the cost of 18 months ago. In fact, this rate for a fixed-term mortgage is cheaper than the cheapest variable-rate loan – another first.

Of course 1.4% is still 1.3% more than the going inflation rate in Canada, which should give everybody pause. Despite higher gas prices, food costs, insurance premiums, communications charges and surging house prices, we’re just a hair above deflation. That’s what keeps our CB boss, Tiff Macklem, up at night. It’s why the Fed’s abandoning its carved-in-stone, anti-inflation mandate, why mortgage money and bond yields have dug a hole and why this is a potential disaster for indebted homeowners and hapless savers.

The inverse relationship between real estate and rates is driving property prices up, taking debt along with it. The amount of money Canadians owe has been swelling relentlessly throughout the pandemic. First from job loss and the inability to service credit card debt. Second, from 800,000 households not making mortgage payments, adding unpaid interest to their principal. And now with an avalanche of new borrowing as people scramble to get cheap home loans and pay record prices for detached houses and space in the boonies.

Money may stay cheap for a few years. But not forever. Big debt could be a big problem. For the nation. For your family. If a second wave hits, lockdowns happen or job numbers reverse… well… you know.

For savers, there’s no place to hide. High-interest savings accounts pay nothing. GICs are a disaster. Bond yields are in the ditch. Unless you already have a big enough pile to finance the rest of your life, there’s no alternative but to swallow some risk and invest in assets with the potential for growth (like equity-based ETFs) or a tax-efficient income stream five times higher than a guaranteed investment certificate (like preferred shares). The best bet for a world gone nuts, where up is down and rules change weekly, is a balanced portfolio (with both safe and growth elements) and one that’s diversified (index holdings and global exposure).

Or, you can blow your savings and take on epic debt to get a fortress in the sticks. Save enough for camo undies.

About the picture: Covid nixed your group yoga class? Well, there’s always dog yoga with Sunny, adopted from an indigenous community and now romping through Red Deer. “He held that dog in the palm of his hand when he adopted it,” says the proud dog-blog parent who sent this to me. “I’ve never known him to love something that much or be committed to something so fully. Imagine if he felt that way about me?!”

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In 1993 I completely lost it and ran for the leadership of the federal Progressive Conservative party. That’s back when being a Con meant you worried more about finances than diddling. Socially liberal. Fiscally conservative. Worked for me.

Well, there was a big convention in Ottawa. Ten thousand people. And while my chances of winning were zero (Kim had it nailed) it was an opportunity to make a statement. So I did. After sweet-talking the Vancouver Board of Trade, they gave me their debt clock. I hauled that sucker to the nation’s capital and installed it in the lobby of the convention center, where it ticked ominously over the heads of delegates.

You know the rest. The PCs were annihilated in the next election. I lost my seat. The Chretien Libs kept the GST and finance minister Paul Martin attacked the deficit. In 1998 the debt clock was retired when the federal budget was balanced. And while I was not directly part of that effort, it felt close. Paul called me one day to say so. Classy.

My, oh, my. How things have changed. The national debt in 1993 was about $600 billion. By the time the credit crisis hit in 2008, it was down to $500 billion. Then the wheels came off. Since then nobody talks about the debt. Nobody cares. Now it’s $1 trillion. The Trudeau team is adding about $340 billion this year alone, and we’re apparently about to embark on a spending spree of Biblical proportions.

Capital Economics is calling it “Freeconomics” and the new architect is Chrystia. Now untethered to the pedantic pinstriped gray-hued Bay Streeter Bill Morneau, our prime minister is about to go nuts. Covid has morphed from a disaster into an “opportunity”, he says. The country’s about to get the kind of green new deal that Freeland was promoting just before being elected in 2013.

Say the economists:

New Finance Minister Chrystia Freeland has already shown her colours by ramping up fiscal spending after just one day on the job, and her previous calls for a “new New Deal” to address inequality suggest she may soon push for even greater spending. The opinion polls imply most Canadians would support this more activist approach and, despite record debt issuance already this year, the government can still essentially borrow for free in real terms. All this means the stage is set for sustained deficit spending in the years ahead, which could cause GDP growth to be higher than we currently assume.

Does any of this matter, except to paleo guys like me?

Nah. And T2 knows it. With interest rates in the ditch thanks to the virus, the Bank of Canada can push a few buttons, create billions more and fuel unfettered government spending. Of course all this money has to be backed by something, which will be a new mess of government bonds and (naturally) more tax revenues to service the debt.

Most recently Freeconomics has delivered another $37 billion in spending as CERB morphs into an expanded EI campaign. But unemployment is still over 10% nationally and expected to remain at elevated levels for months to come. So expect more income support payments. Then there are the hundreds of thousands of mortgage deferrals which will cease this autumn. The banks are reporting that between 12% and 18% of all home loans are not being serviced. So what happens when the clock runs out? Meanwhile businesses are hurting, and corporate tax revenues are falling along with revenues, which are down almost 12%.

Not that you care (I bet), but our debt is now equal to 50% of the economy. If we have another three or four years like 2020 in terms of federal deficits, that ratio will be 100%. (By the way, when provincial government debt is added we’re already at about 90%. And did you see the latest Alberta number? Ugh. Brutal.)

Is this sustainable?

If interest rates stay where they are, people get back to work, the economy reopens fully, businesses regain profits and the GDP swells, then we’re okay. But that won’t last. More economic growth brings expansion, wage pressures, rising prices and inflation. That means higher rates. Always. So the more debt that’s racked up now – even if it can be serviced handily  for a few years – locks in future generations to epic payments. When I hauled that debt clock across the country the feds were hobbled by handing over a third of all taxes collected in interest payments alone. Could happen again. Tell your kids.

Will the cost of money stay lower forever? Lots of people come here to say it will. They desperately need it to be so, for their own pooched finances. But it’s a gamble. The odds of losing the bet are high.

Soon the Freeconomics new deal will be here. Sources say Trudeau wants ‘to go big’.  He now has a willing, supportive sidekick in control of the purse strings. Will the majority of people even care? Or have we become a nation of people comfortable with endless debt and free cash flow?

Don’t bother. I know the answer.

Next week we’ll discuss how to prepare.

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Covid Diaries date 28.8.20. Hey, if Melania can be upbeat about her captivity, so can we.

Go Prefs!

When the virus came to town central banks crashed interest rates, crushing bond yields and preferred share values. Bond prices jumped, but prefs tanked. And what did this pathetic blog suggest? You bet – buy some preferreds. They’re cheap, we enthused, they chuck a handsome dividend, are tax-efficient and pretty much guaranteed to jump in value once the economy reopens.

Well, as it turns out, you didn’t need to wait that long.

Yes, interest rates are still in the ditch and will likely stay there for two or three years. But pref ETFs have now jumped more than 40% in value since March 23rd, they pay a juicy 5% (compare that to a 1% GIC) and you can collect the dividend tax credit. What’s not to love?

And look what the dudes running the Royal Bank just did!

RBC on Wednesday announced it’s redeeming about $1.5 billion worth of outstanding preferred shares – buying back six different issues at the price of twenty-five bucks. This comes on the heels of the bank issuing new debt last month, so a truckload of dollars will be looking for a new home – plus the outstanding supply of prefs has just been reduced. “This is huge!!” says my suspending-snapping portfolio manager buddy Ryan, who has far too little stimulus in his life. “If other banks follow suit this would add to the reduction of supply and be very positive for the pref market!”

In case you missed it, prefs swelled on Wednesday like a lovesick guppy.

So, you took the advice five months ago, right? By the way, our balanced portfolio model currently holds about 13% in prefs. The remainder of the 40% in fixed-income assets is government, corporate and provincial bonds and a smidgeon of cash. The overall yield of the bonds and prefs is about 3.75% – money you make while sleeping. The capital appreciation in preferred values is on top of this. Thanks, RBC. Love ya.

The kiss of death

BC, there were more than 22,000 Airbnb listings in Toronto alone. Today there are 90% fewer. And things are about to go from awful to terminal for those who have hung on to their vacation-rental condos, waiting for Covid to go away and the tourists to return.

Come two weeks, there’ll be new rules which will (a) destroy commercial Airbnb hosts, (b) free up more rental units, (c) help push lease rates lower and (d) suck more air out of the condo market. On September 10th all short-term rental operators will have to register with the city and collect tax (as in Vancouver), plus it’ll be illegal to have an Airbnb space not inside your principal residence.

Pow. This means some massive condo complexes (like the infamous ICE, downtown) which used to house hundreds of short term rental units bought by amateur landlords and specuvestors are now financially sinkholes for them. It’s the end of ghost hotels. Hallelujah.

This is welcome news for people who actually live in those buildings and are tired of the partying transients with their lousy garbage-room habits and suitcases – probably laced with Covid-carrying bedbugs – stuffing up the lifts. For renters it translates into hundreds, maybe thousands of new apartments coming onto the market as owners scramble for revenue and compete with rent cuts. And there’s already evidence of the impact on real estate, as condo listings explode, inventory builds and prices start to erode.

Local pols did the right thing. It only took an economic disaster, which they’re making a little worse, to get there. Good job.

Pressing your luck

As noted here days ago, five-year insured mortgages are now available for the ridiculously low price of 1.5%, or about half the going rate of 18 months ago – thanks to the bug. Cheap money lets people be even more irresponsible, hedonistic and house-horny than in the past, increasing their borrowing limit, allowing them to spend an additional amount on an inflated house in a bidding war conducted by a rockstar realtor who makes more than a cardiac surgeon.

Well, we’re apparently not done yet. The one-five barrier may be broken before long. Mortgage broker celebrity (only in Canada) Rob McLister is calling for a 1.49% home loan before long as US long bond yields flutter lower. But he’s also a responsible cookie, adding this: “Canadians already enjoy tremendously low (record low) rates. Insured rates are now just 10 bps away from 1.49%. If your mortgage closes in the next 120 days and you plan to lock in, be careful about pressing your luck too much.”

BTW, he brings some news on mortgage deferrals. Seems homeowners who stopped paying in March and April are still not making payments – at least to the major banks. In fact at Scotia, for example, the number of deadbeats has actually increased over the summer. So will the market plunge over a deferral cliff, come October?

We shall know soon enough. Curb your FOMO.

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This week the cowboy running our federal housing outfit raged on Twitter against a twit realtor. Well, to be fair, Owen Bigland actually has an outsized opinion of himself. The Vancouver agent has a blog, a book, a degree and boasts he’s been a successful life-long real estate investor. But that don’t impress Evan Siddall much.

So when Bigland tweeted this…

Many people miss the leverage factor in RE. Buy a condo for $500k with 10% down. 3 yrs later that condo has appreciated to $550k many look at it as a 10% return when it’s actually a 100% return. Leverage is how true wealth is built. You need to get your money working.

…Siddall fired back with this…

Sigh…Because in your made-up world, house prices only go up. This kind of investment advice is like selling penny stocks because they’re cheap/. You DO realize leverage works just as powerfully when prices go down… or were you not alive on 2008-9?

Ouch.

Well, the dude has a point. Realtors who pump real estate as a 100% speculative investment, and are careless about promoting 10x leverage deserve a reaming from time to time. Yes, property prices fluctuate (just like stocks), so when you buy using big piles of borrowed money, risk is seriously enhanced. A sane or prudent person would only do that when conditions were ideal.

And what are the current conditions? Let’s recap.

• A global pandemic. 820,000 dead
• No proven therapies or approved vaccine
• Authorities bracing for a second wave
• The worst  economic downturn since the 1930s
• Structural unemployment
• A crash in immigration
• Closed borders
• Millions surviving on government handouts
• Hundreds of thousands deferring mortgage payments
• Civil unrest and political instability for our major trading partner
• Historic debt. Epic deficits. Austerity and taxes likely.

But you know what’s happening. So does Evan. Canadian real estate – especially in markets like Toronto, the 905, Ottawa, Montreal and the Lower Mainland – is hot stuff. Because there was no spring market (we were all going to die, remember?), demand was uncorked in the summer even as the economy tanked. Low mortgage rates and emotion have combined to create a property boom in the middle of a recession, even as the government scrambled to keep the lights on. Amazing.

Says a new report from LowestRates.ca: “The coming reality check could be a painful one. It’s very hard to say right now if the blistering house price gains we’ve seen in the past few months will continue into the autumn and winter season. That’s when the market will really be tested. The overall economy is continuing to struggle with elevated unemployment and businesses hesitant to spend. So far, hot housing markets like Toronto’s have shrugged this off, but there’s higher risk than normal now of that reversing.”

The immediate threats: the end of mortgage deferrals leading to a surge in listings. A 65% plop in immigration, sapping demand. The collapse in Airbnb combined with jobless renters causing the condo market to swamp. Double-digit unemployment stretching well into 2021. CERB ending and government support winding down since Ottawa’s out of cash. The virus. Still here. Maybe that next wave or lockdown.

Wow. Serious stuff. Why would people take on this level of risk or, as Owen Bigland suggests, leverage themselves up the wazoo to speculate?

As with most decisions, there are good reasons and stupid excuses.

Here are the rational, logical, practical factors behind the current housing melt-up:

• Money’s cheap. More than that, it’s almost free. So why not borrow as much as possible to buy what I previously could not afford? I’ll never pay it off anyway, because I’m actually just renting a pile of dough. Life is short, brutish and they make you use Zoom. How is this a bad thing?
• Where else am I going to invest? It’s all too scary. Besides I get to live there
•  It worked for my parents.

But even more powerful are the emotional divers which have created a real estate boom in the midst of economic detritus. And, of all the emotions, fear rules.

• The world is terrifying. I need to cocoon. The newscasts are full of sickness, infections, deaths, protests and people who are angry, succumbing or talking through masks. My family and I need to bubble. In our house.
• The virus is terrifying. I want a safe environment. Why would I ride an elevator, walk a condo corridor, take the subway or even walk into the office again? My house is my world now, and it should be perfect.
• The city is terrifying. I want space and safety. A front door on the street. Fresh air through the windows. A back yard and a front walkway. Distance from others. Maybe the burbs aren’t so bad.
• FOMO. Sheesh, have you seen prices lately? If I don’t buy now I fear I’ll never be able to. Where do I sign, bro?

And up she goes. Of course when you buy something at an inflated price with money you have, risk is contained. When you borrow, it isn’t. For some, this may not end well.

Source

Never doubt the inverse relationship between house prices and interest rates. As the cost of a five-year insured mortgage spiraled down to 1.5% last week, real estate went nuts. Bidding wars, blind auctions, bully bids, manipulative realtors and greedy sellers. What a combo.

A mortgage of $1 million (more common than you might think) at 1.59% carries for just over four grand a month. That’s the cost of a two-bedroom condo rental in the downtown core of Toronto. (Of course you also have to pay $60,000 in land transfer tax when you buy, plus property tax to own and commission to sell.) A year ago a good mortgage was 3.2%, and that seven-figure loan cost $800 more a month to shoulder.

A small example. Let’s take Toronto where a million isn’t what it used to be. In theory a couple with a household income of $300,000 and a hundred grand for a down payment would qualify for a mortgage of $1.23 million at 1.59%, buying them a house worth $1.32 million. Compare that with last year when a five-year home loan cost 3.2%. Then the max loan would be just over $1 million, securing a property selling for $1.119 million. (In reality CMHC insurance ends for properties over $1 million. Plus there is the stress test to pass.)

See what Covid did? The same people could borrow and spend $200,000 more. And many are. Low rates are pushing houses higher, increasing the capacity of buyers to carry debt. Evidence of this is everywhere, and spreading. The low rates central banks are using to rescue the economy are having the same effect as in 2009, when this device was equally triggered. That’s when Canada’s real estate roulette started.

By the way, when is the typical million-dollar mortgage paid off?

Never, of course. Most Canadians move every four years or less, so they’re basically renting the money. Mortgages this cheap and plentiful are allowing people to buy homes they don’t actually own with cash they’ll never repay, while financing real estate inflation. Every time the For Sale sign is spiked into the front lawn, a greater fool rolls up.

But wait. The virus has done a lot more than just depress the cost of borrowing. It’s actually created cash flow.

Stores were closed for months. Clubs, concerts, conventions, arenas, theaters shuttered. Nobody’s travelling to Cuba or taking planes across the country. WFH means no commuting. No gas, car repairs or a new ride. No new dress slacks, high heels, lunches out or hair appointments. A survey by MNP last month found people had an average $150 more a month in disposable income than in March. The proportion of households within $200 of financial insolvency each month dropped from about half to just 43%.

Yes, in Canada when only four in ten folks are one muffler repair away from ruin, it’s considered success. Kinda like how Chrystia will manage federal finances. So, mortgages at 1.5% will, of course, seriously augment debt and set families up for an interesting future when the virus is no longer around to distort reality.

In fact, MNP warns that as economic normality slowly returns, creditors will be pushing households even further into debt as loans are refinanced or extended. “It’s difficult to predict how many Canadians will require some form of debt-relief as a result of COVID, but it’s not too much of a leap to say it will likely be as unprecedented as the scope of the pandemic itself,” it says.

After all, we know what’s coming. CERB payments will transition into EI. Unemployment will stay elevated well into 2021. Mortgage deferrals will end. Credit card and LOC payment holidays will be over. Workplaces will start to reopen, and commuting resume. And there could be mayhem and economic disruption as the US election unfolds in early November.

CMHC appears to be sticking with its prediction that house prices could drop from these levels by 20% before the year is out. If it were to happen, every buyer today with less than a fifth down would be under water – owing more debt than they own in house.

One thing’s for sure. If you get a honking big loan for 1.5%, you won’t be renewing it for the same price five years hence. No matter what President Harris or PM Freeland do.

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