Author: garth turner

A few things we should get on the record…

Bill vs Mark

This week the prime minister said he had full confidence in Bill Morneau as finance minister. Really?

This came on the heels of two big developments. Fist, Bill royally screwed up by accepting gifts (travel and accommodations) from the creepy WE brothers, then forgetting to pay until being forced to face a Parliamentary inquiry. Worse, he let WE employ his daughter. Even worse, his billionaire wife is a big WE contributor. Worse still, he personally approved giving millions to the charity in the form of a grant. And worst of all, he didn’t recuse himself when Cabinet approved a $900 million contract for student volunteerism that WE would oversee (and profit from).

Bad, Bill. Very bad.

Second, Mark Carney came back to town after serving as the Governor of the Bank of England – a job he took after heading up Canada’s central bank. In fact, he’s the only dude in the world to have been tapped to run two of the planet’s major CBs. Plus, he has experience as a senior guy at Goldman Sachs, along with bone fides as a climate change warrior and, apparently, has a social conscience. Finally, he looks chiseled, cool and unflappable. Never sweats. Makes the stud finders at Home Depot light up.

Prediction: Carney will win a seat as MP in the upcoming Toronto by-election and, by this time next year, be the finance minister. Canada will be better for it. Then he will go on to be prime minister, by the way. Morneau will go back to his $6 million house in Bennington Heights. (I used to own a shack down the street.)

Gold does it again

The bullion-lickers were out in force a few days ago when I dissed the yellow rocks, saying a gold position was wholly inappropriate for most people. The metal soon topped two thousand dollars an ounce before crashing more than a hundred dollars on Tuesday, then rebounding a bit in the next 24 hours. All this proves my point. PMs are intensely volatile, emotional, unpredictable and flaky. They pay no interest and no regular dividends. This makes bullion completely speculative, in the same category as junior resource stocks or the Covid vaccine company your BIL started in his basement. Normal people do not own gold. For good reason.

Gold bugs buy and never sell. They usually refuse to harvest gains, thinking more are coming. Greed is the enemy of investing, of course. It creates gamblers, most of whom fail. As for the metal’s future, it’s as murky as always. Fluctuations are certain but in the absence of runaway inflation, currency collapse or the pandemic wiping out a billion people, the old pattern will continue. Gold is bling. Not money.

How not to fight a bug

Did the countries locking down to fight the virus, thereby idling millions of people and cratering their economies, get it right? Was Covid backed off more than in places which took a different tack?

Nope, no evidence of that, says Prem Gururajan, the CEO of tech startup RideCo and a regular blog dog. “I have read in your recent posts that the social costs/damage caused by the lockdowns outweighs any benefits,” he says. “I agree with your assessment. I have been analyzing the outcomes in lockdown countries vs. countries that did not implement a lockdown – Japan, Sweden, S. Korea, and Taiwan.”

The conclusion: lockdowns don’t work. Masks and hand-washing (and common sense) do. Governments that turn off the economy end up feeding suicide, poverty, depression and economic despair. It’s a failed strategy. In fact, unemployment will kill more people than the virus. By a long shot.

Prem has penned an interesting article on this topic. Read it here. In it he points out how governments wildly, perhaps irresponsibly, inflated the potential mortality of Covid. That was referenced here days ago in reminding you our health minister said between 30% and 70% of Canadians would get sick. So far it is 0.3%.

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Housing’s dark underbelly

He’s at it again. CMHC boss Evan Siddall is a unique public servant. He says what he thinks, regardless of what his overlords want to hear. And he’s passionate. We need more.

Siddall has warned that the dream of homeownership has the potential for turning nightmarish for those who buy when they actually can’t afford it. His views of the economic future are dark, brooding and cautionary. He thinks we’re a nation of debt junkies, that real estate has turned into a casino and lenders are rapacious. What’s not to love?

So now Siddall has written to bankers and brokers imploring them to stop handing out big mortgages to households that are seriously leveraged as a result. High-risk borrowers should be denied, he maintains, because 5% down mortgages are just feeding potential negative equity. And the current mid-pandemic housing boom is doomed. Later this year prices will retreat when the CERB money evaporates, structural unemployment takes hold and the mortgage deferral cliff arrives.

“We would hope you would reconsider highly leveraged household lending. Please put our country’s long-term outlook ahead of short-term profitability,” he tells the lenders, adding, “there is a dark economic underbelly in this business that I want to expose.”

If Minister Mark doesn’t happen, let it be Evan.

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Let’s noodle this.

Beating the virus apparently means spending more money than anyone could imagine. Billions. Trillions. Cash nobody has. All debt.

It’s working. The economy was turned off to stop Covid but all this cash kept things functioning, Thumbs up, baby. But as every family knows, debt doesn’t disappear. There are consequences. Let’s think about that for the next 700 words.

Those CERB cheques, business bailouts and payroll subsidies are all being made with newly-printed money, since Ottawa has no reserves. Ditto in Washington. The more money that’s created, the less all the existing money is worth – which is exactly what the gold-lickers have been yammering about.

But for most people the legacy of the bug will come down to one thing. Inflation. Not out-of-control hyper-pricing. No Venezuela or Zimbabwe. Just steadily higher costs and, yes, rising interest rates. Especially when economic growth resumes with a vengeance later in 2021 (as the vaccine arrives) and thereafter. It’s a reasonable bet central banks will gradually tighten, starting in 2023. By 2025 these sub-2% mortgages we’re seeing will be like the bittersweet memories of your youth.

Could inflation return to, say, 4% or 5%? Of course. GICs might yield four points again. Home loans could rise to 6%. Easy. Not soon, but with the legacy of Covid, abysmal public finances and the insatiable need for debt financing by governments it seems completely logical this is in the cards. Moreover, central banks will be desperate to raise rates in the coming years – to prepare for the next economic plop. If the cost of money doesn’t increase in better times, it cannot be crushed to heal a problem. Those who believe rates will be at zero for a decade simply do not understand.

So, imagine if you could insulate yourself from the increases until, say, 2030. How smart would that be?

Seriously wise.

You now have a rational way to do this, which is the 10-year mortgage. The cost of this borrowing has collapsed in recent weeks to just over 2.5%. That is about 60 basis points more than locking up for a five-year mortgage and almost full point more than going for a one-year term with a low-cost lender who might also sell donairs.

Here’s why this kind of loan makes sense. First, rate protection. There is (in the mind of this pathetic blog) a 100% chance the cost of money will be reasonably higher in 60 months and heroically greater in 120. No way the CBs are staying at these levels for a day longer than necessary. As the economy reopens, repairs, climbs and grows (this is inevitable since pandemics are temporary) so will key lending rates.

Second, qualify for a mortgage once, then forget it. No stress test later. No bankers pocking through your credit history. No worries if you get laid off, retire or lose your mind and start a small business.  And, third, you know what your monthly payment will be for a long, long time. That allows for better planning, saving, investing and getting ready for what lies ahead. In a world of surprises, this is one less.

But there are downsides, too. The 10-year mortgage costs more (slightly) than a shorter one, so you have to play the long game. Over time the savings could be outsized. But if you happen to sell and move in the first five years, a significant penalty will enue – not only the higher interest rate, but a mortgage-break fee that won’t be pretty.

After that, clear sailing. The Canada Interest Act dictates all mortgages become open after five years, so the loan can be paid off in the second half of its life with a penalty equal to only three months of interest. Not so bad.

As you may have noticed lately, people are nuts. They’re treating real estate the way they did toilet paper in March. FOMO has returned, panic buying is everywhere and houses are selling as if there were no recession, no double-digit unemployment and, oh yeah, no global pandemic with our closest neighbour being the epicentre of infection and death. Go figure.

But if you’re buying, refinancing or coming up for a mortgage renewal, seriously consider the decade-long option. The cost has never been lower. The benefits never more obvious. The peace of mind alluring.

Come back in a decade and see. In case I’m daft enough to still be here.

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Arthur’s a typical teacher. Owns a house but not much more. “My wife has an investment portfolio but it isn’t a lot,” he says. “To be honest, my pay has been used to pay off bills and the mortgage over the decade we have been married while she was on maternity leave for our two kids. We both have TFSAs but I just recently started investing in it. I have so much room I don’t think I will ever be able to max it out.”

Well, teach wrote me because the big 5-0 looms, they want to retire within a decade and wonder how they can prepare.

“We are not willing to go into debt – read as dip into our home equity – to borrow for investments as the next 2 – 3 years will likely be volatile with people learning to live with the virus and its impacts on our health and the economy.

“I know your advice will be sound, and I trust that you will give me an answer that will most likely lead to a conversation that I don’t want to have.”

So why are they typical teachers? Simple. So many people with DB pensions (defined benefit) truly believe they can skate through life spending all their take-home pay, saving nothing in a retirement fund, and living happily ever after. Of the countless classroom people I’ve encountered over the years, few have financial reserves. All of their trust, plus the rest of their lives, has been placed in the hands of a faceless pension administrator.

But teachers have great holidays. The locals in Cancun and Varadero are so grateful.

So what can go wrong?

First, pension incomes are way less fulsome than most people understand. For example in Ontario a long 30-year teacher career landing you in the $85,000-per-year position would result in a pension of about $50,000. That’s pre-tax, of course, and it’s a lot better than many people enjoy. But this represents a 41% drop in income. So the question is simple: if you made $85,000 a year and saved nothing, how do you live on $35,000 less?

Some people think being retired means spending little, staying home knitting scarves and counting the cars driving by. But, since 65 is the new 45, people at this age are active and alive. Travel, hobbies, toys, entertainment, renos – it all costs big. In fact a lot of folks end up spending more in retirement than when sitting in the workplace all day. Fail to budget carefully for a fixed-income life and you might end up selling dope or parking buggies at Walmart (equally distasteful).

Second, leaving your entire financial future in the hands of others is, well, a leap of faith in this altered world.

Here’s an example.

Four days after the virus whacked financial markets, driving equities into the quickest bear market on record and crashing interest rates, regulators in Ottawa panicked. On March 27th, this letter was sent to the administrators of DB pension plans across Canada:

As a result of the COVID-19 crisis, OSFI has made adjustments to its policies to protect the interests of pension plan members and beneficiaries and to allow administrators of federally regulated private pension plans to focus their efforts on addressing the many challenges posed by this crisis, including its impact on financial markets.

Transfers and annuity purchases are being prohibited at this time to protect the benefits of plan members and beneficiaries, given that current financial market conditions have negatively affected the funded status of pension plans. The payment of pensions to retirees and other beneficiaries is not impacted by the freeze on portability transfers and annuity purchases. We will review this temporary measure in the coming months as we continue to monitor the impact of this crisis on defined benefit pension plans.

While this stunning directive did not reduce payments being made to former teachers (and civil servants), it immediately froze the commuting of pension assets to those planning on taking a lump-sum amount for retirement. As we’ve yammered about in the past on this blog, liberating pension money so you can control it, manage the tax exposure and pass it on to your family is generally an excellent idea. So imagine the impact of this outta-the-blue stunner to those who’d planned on such a move.

(The directive was reviewed again in May, recognizing the over-reaction. Now  those within 10 years of retirement age may partially commute their pensions – if allowed by a specific plan. Big relief for many people.)

Here’s the key point: when you don’t control your own financial future, be prepared for surprises. Public sector DB pensions have been the envy of society for decades, but when a temporary bout of stock market willies cases this reaction, anything can happen:

The effect of the COVID-19 pandemic on the financial and economic environment has resulted in market volatility. This has made the impact on the solvency ratios of defined benefit pension plans difficult to gauge, and the Superintendent came to the view that transfers or annuity purchases from defined benefit pension plans could impair their solvency.

So, Arthur, here’s what you don’t want to hear: having almost all of your personal financial wealth in one asset (your house), with no Plan B for income and no mechanism in place to supplement cash flow during two or three decades of retirement is a gamble. You should spend every day fixing that. Do a monthly budget to chop spending and funnel enough into savings to at least max out both TFSAs. In retirement, cash flow from these plans will not count as income and further erode CPP and OAS payments – unlike RRSP money.

Invest the TFSA funds into equity-based growth assets. Ignore market volatility, the virus or your own tepid emotions. The world will come out of it pandemic phase in a blaze of growth, and you should take advantage of it. Tapping into some of the home equity is far from a bad idea. Loans are ridiculously cheap, interest is 100% deductible from taxable income (for non-registered investment accounts) and you need only service that debt. Repay it when you cash in the assets you financed.

Now do a realistic plan for after work. If you save nothing now, you’ll probably want to replace your full income. A $40,000 annual shortfall, for example, means you need about $600,000 working for you in a balanced portfolio. You have ten years to get there. Stop reading. Start doing.

About the picture: “Bonjour de Montréal Garth!” says Martin “My girlfriend and I have been happy readers of your blog for many years (thanks for everything) and we thought we could share this picture taken this afternoon on Papineau street in Montreal. Merci pour tout et au plaisir de vous lire encore pour de très nombreuses années!”

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So how do you like 2020 so far?

The fastest descent into a bear stock market ever as the virus hit. Then the quickest recovery. From full employment in the US to over 30 million jobless. Our federal deficit swelled a dozen times larger than planned. Mortgages plunged below 2%. And while eight million people went on government support with almost a million unable to pay their loans, real estate took off again. Airlines cratered. Retail was crushed. And two-thirds of people are too scared to go back to work. But the S&P is up 17% from last August and grew 50% since March. Now we’re thirteen weeks from a US election the results of which could be transformative.

  And Covid? Almost 20 million cases across the world, big troubles for America and Canadians have been told to mask up for a second wave. Maybe. So far 0.03% of us have tested positive for the virus and it was only five months ago that federal health minister Patty Hajdu (remember her?) had this terrifying statement:

“I would say that it is safe to assume that it could be between 30 per cent of the population that acquire COVID-19 and 70 per cent of the population.”

Was that totally irresponsible? Or just uninformed? In fact no country on earth has experienced that rate of infection. In Canada alone it would have meant 15 million to 26 million people with Covid. As it turned out, 120,000 souls got it. Of those 111,000 have recovered.

However, we turned off the economy, made public finances circle the drained, destroyed a number of industries, ensured higher future taxes, created structural unemployment, turned downtowns into ghost towns and scared the stuffing out of a majority of the population.

Seems Mr. Market has decided a few things.

• The pandemic can be contained, controlled and conquered. It’s temporary. It will end.
• 2021 will likely be a catch-up year of rampant growth, recovery and the restoration of profits.
• Politicians screwed things up so monumentally that excessive spending will continue in order to paper over consequences.
• Interest rates will be in the ditch until 2023 with bonds and savings paying nothing, pushing more dollars into equities.
• There will be a vaccine. Or at least a good treatment. It will change everything overnight.
• Trump is done. Biden is a centrist. Trade wars will fade.
• And the virus episode brought new opportunity (the stay-at-home sector) while pumping up tech (the FAANG boys) and creating value (airlines – people will fly again).

There are many lessons for you, me and those who want a secure life.

Don’t be afraid of volatility, because we’re now into years of it. Markets will move more violently up and down. Ignore it. If 2020 has taught us anything it’s that those who react to short-term fluctuations end up as road kill.

Society will take time to heal from the damage done by the fearmongering and missteps of politicians. The virus may not be done, but so far the government and financial response has been overkill. The economy cannot function with social distancing in place, masks, no large gatherings and two-thirds of employees afraid of their workplaces. It’s not different this time.

The year so far has been a complete validation of investing in a balanced and diversified fashion. When the market crashed in March, equity losses were tempered by bond gains. When CBs crushed rates, fixed income assets jumped. When stock markets recovered, so did the growth portion of portfolios. As in 2008-9, a balanced portfolio fell less, reduced volatility and regained ground quickly. Sixty per cent growth, forty per cent fixed wins again. Set it, and forget it.

Time to get serious about tax avoidance. Governments can’t drop the hammer just yet because of a fragile economic recovery, but they will. In Canada we may see a new tax bracket created for higher income-earners, an increase in the capital gains inclusion rate, maybe even a financial transaction tax, another assault on professional corps or a real estate speculation levy. Whatever. Taxes are going up, not down. Act accordingly.

Fill your TFSA to the top. Use RRSPs and registered education plans for your kids, harvesting tax deductions and free grant money. Take advantage of the cheap prescribed interest rate (1%) to make a spousal loan and income-split. Open a retirement plan for your lower-income partner. Invest to earn cap gains and dividends rather than rent or income.

As for real estate, don’t fall for the run-to-the-burbs meme. It’s temporary. Downtowns will repopulate in time. People will commute again and want urban locations. Condos will take longer to recover in proportion to height, so buy low-rise. Lock in your mortgage – five years at under 2%. It’s a once-in-a-lifetime gift. And wait to purchase (if you can truly afford it) until the mortgage deferral cliff arrives.

Remember this year. Especially what’s to come.

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  By Guest Blogger Doug Rowat

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Ah, recency bias. Perhaps the most dangerous and pernicious of all behavioural investing biases.

As Covid-19 runs rampant across the US, volatility rises throughout global equity markets and the catastrophic 33% plunge in US Q2 GDP sits fresh in our minds, it’s tempting to simply wrap the entirety of one’s investment portfolio in the security blanket of US bonds.

And why not? The US is the wealthiest and most powerful nation in the world and its bonds are amongst the very safest. And in the face of all of this year’s horrible news, the Barclays Aggregate US Bond Index is up an impressive (and comforting) 13.7% y-t-d, obliterating the y-t-d total return of the S&P 500. But this is what recency bias does—it fixates investors only on the present and coerces them into thinking that what is happening now will persist long into the future.

But, naturally, such conclusions are incorrect. With recency bias undue importance is given to performance and events that have occurred, well, recently, resulting in the more predictive long-term market trends getting overlooked. And I don’t need 22 years in the investment industry to understand the powerful and misleading effects of recency bias. I live in Toronto—a hockey-mad city that succumbs constantly to it. Every brief Maple Leaf winning streak or nifty Auston Matthews goal will, in the collective mind of this city, translate to Stanley Cup glory and a parade down Bay Street.

But back to US bonds. A much more meaningful performance timeframe wouldn’t be the few pandemic-dominated months of 2020, but rather the entire previous decade. Examining this 10-year timeframe, everything reverses. From end-2009 to end-2019, on a total return basis, the S&P 500 returned 13.5% annually while US bonds returned only 3.7%.

This long-term track record is why we tilt the vast majority of our client portfolios towards equities. High-quality bonds are essential for stabilizing portfolios and controlling emotion during periods of turmoil, but this doesn’t make them worthy of being the dominant component of one’s asset allocation.

First, the obvious. US bond yields have been declining for decades and therefore overall US bond returns have been declining right along with them:

US bond returns have declined decade after decade

Source: Bloomberg, Turner Investments

We, of course, don’t know if overall US bond returns will decline this decade as well, but it’s rarely a good idea to bet against a well-defined multi-decade downtrend. Btw, US 10-year Treasury yields have declined 95% over the past four decades and if you think they won’t eventually go negative, which longer term would mean even more anemic overall bond returns, take a closer look at France, Germany, Switzerland, the UK and Japan.

Second, US bonds no longer yield meaningfully more than inflation. There was a time when their advantage over inflation was double-digit. Ancient history. Granted, the present US inflation rate is low, but the long-term inflation rate has averaged about 3%. With the US 10-year Treasury yield, for example, currently at only about half a percent, it’s unlikely that bond yields will be eclipsing long-term inflation rates any time soon. Remember: the Fed raised interest rates NINE times from 2015 to 2019 and even that streak only took the 10-year Treasury yield above 3% very briefly. Is anyone predicting nine interest-rate increases from the Fed now? A US 10-year Treasury bought now and held to maturity would almost certainly lose money after inflation.

US 10-year Treasury yield minus inflation rate: it’s becoming more and more unlikely that Treasury yields will beat inflation

Source: Bloomberg

Finally, US equity dividend yields currently provide much better value. Yes, you have to take more risk, but if a main consideration is simply income, you’re better off with equities. Again, the yield advantage for Treasuries, which was once double-digit, has evaporated. Also, historically speaking, US corporations raise their dividends 5-6% annually, so your equity dividend, unlike a bond coupon, will almost certainly grow at a faster rate than inflation. I also haven’t even touched on the preferential tax treatment of dividend versus interest income.

US 10-year Treasury yield minus S&P 500 dividend yield: equities now generate substantially better income

Source: Bloomberg

So, before you succumb to the fear created by the recent dire headlines and flee to the safety of US bonds consider the tricks that recency bias may be playing on you. The bigger picture is actually suggesting that most US bonds offer poor value at the moment.

And combating recency bias always demands looking at the bigger picture. What holds more importance? A pattern that presents itself over just a few months or a pattern that presents itself over more than four decades?

Or in the case of the Maple Leafs, more than five decades.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.

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As goes 416, so goes Van. The latest housing stats from YVR echo those in Toronto, where sales have jumped more than 20% from last July, despite the fact last summer there was (a) no pandemic, (b) no CERB, (c) no mortgage deferrals, (d) eight million people still had jobs, (e) your office was still open, (f) nobody wore a mask, (g) only a crazy person would believe the federal deficit would be $450 billion and (h) you didn’t know what what a “WE’ was.

Wow. So many changes. So much to go wrong. Nine thousand Covid deaths in Canada, Lockdowns. Airlines grounded. No tourism. Depression-era unemployment stats. A recession. And, yup, FOMO – driving house sales nuts form Halifax to Victoria.

Once again we’re reminded of a truism on this blog from years ago: there’s an inverse relationship between interest rates and real estate. When one goes down, the other one goes crazy. This year, especially, when the contrast between an orgy of buying and the economic destruction the pandemic has caused is acute.

Well, there’s more coming. A significant national lender has now broken the 2% barrier for an advertised five-year fixed mortgage rate. Quietly the major banks have been handing out such loans at around 1.98% (or a little less), while their official posted rates remain higher. But Tangerine has dipped to 1.99% (although it’s a collateral mortgage). As mentioned here the other day, 10-year money has also been eroding in cost, with a decade-long mortgage now available at a little over 2.5%.

So does this make variable-rate mortgages unwanted?

Mostly, yeah, it does. VRMs might be had for a couple of basis points less, but why bother? A fiver at these prices means your loan rate will almost certainly be lower than inflation in the years ahead. That’s akin to free money. So this generational, virus-induced collapse in the cost of home loans is exactly why we have a real estate boom in the middle of a health crisis. That, plus the fact the spring market was pushed into July.

Not only are fixed-term rates equal or less than the cost of a variable-rate loan but (a) they are likely to drop further (a little) as central banks pump out stimulus and drive bond yields lower, and (b) this won’t last. When Covid fades as vaccines arrive, those CBs will be raising rates again to offset the ridiculous accumulation of debt they’re causing. Borrow today at 1.9% and look like a Nobel economics laureate in 2024. Easy to get dates then.

So will this boomlet last?

   In a blog post this week, then in a Toronto magazine article, my answer was ‘no.’ Of course not. Cheap mortgages combined with pent-up demand and low inventory is realtor catnip, but we continue to face strong economic headwinds. Unemployment will still be double-digits by Christmas. Mortgage deferrals will come to an end. CERB is turning into EI – which has a negative footprint on credit/employment histories. The airlines, tourism, entertainment, hotels, sports, live entertainment, bars, conventions and trade shows – all these sectors have been hobbled and will remain so as long as social distancing is in place and pandemic fears rage. It was interesting some industry rockstars attacked me for saying such things. Moral hazard, I guess.

So what about a second wave?

No idea if it’s out there, or just media fiction. But we do know most Canadians are freaked out about Covid, unwilling to see the border open, suspicious of eating out and terrified of flying. The masks everyone now sports are visible symbols of a surrender to fear.

In this environment, the sales and price stats bursting out of the major centres (except those in Alberta, Saskatchewan, Manitoba, NB and the Rock) look like aberrations. Buyers are certainly embracing risk. And it’s not over yet. As infections spread in the US and the gong-show presidential election approaches, bond yields could fall further taking mortgage costs with them. Not a lot. But enough to hook more buyers and jack up values.

Amazing. A 13% unemployment rate and record property prices. Something has to give.

By the way, a recent Edward Jones survey found the pandemic is sinking retirement plans for a lot of folks in their 50s and 60s. They’re diverting income to supporting their Millennial offspring, and lack enough savings – since most net worth is in real estate. The median nestegg among members of this cohort without a corporate pension plan is… wait for it… just $3,000.

That’s what real estate does. The illusion of security.

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The head fake continues.

This week – perhaps tomorrow – real estate boards will start reporting July stats. They will be, at least in Toronto (and perhaps Montreal, Van and Victoria) wholly detached from reality. Buyer activity will not reflect millions of people on the dole, a 13.6% local unemployment rate, close to a million mortgage deferrals, empty downtown office towers or planes grounded at the island airport (Porter Airlines now says no flights until October… or maybe never).

Against this backdrop of economic slaughter, get this: Toronto realtors this week will report last month was the best July ever. Sales were up 23% from the same period last year, when we weren’t wearing masks or leaping off the sidewalks. The number of deals was a third higher than the 5-year average and 32% beyond the ten-year norm. “Seemingly unbelievable,” says Re/Max dude Robert Ebe, who has fashioned this chart:

July madness: record sales in a dangerous time

Click image to enlarge.

So why did the better part of 11,000 buyers take the plunge in the last four weeks, pushing prices ahead by double-digit amounts in a flurry of blind auctions and bully bids? Don’t they watch the news on the Corona Broadcasting Corp, or look south and see the bug ripping through more than three dozen states, keeping the border closed for months and months more to come? How can real estate in the GTA hit new record pricing in the midst of a global pandemic with Depression-era joblessness and government benefits running out? Huh?

Ebe asks three things. Is the market in a dead cat bounce? (You throw a deceased feline out the window… it bounces… but it’s still dead.) Is this just normal coming-back? Or are we into a new era of currency devaluation and big inflation now that the government has blown everything on Covid and printed more money than God has?

Well, the reasons for July were stated here a few months ago (we told you it was coming). Pent-up demand from house-horny people who couldn’t buy in the spring (lockdown), combined with scant inventory (sellers too scared to sell) in an era of 2% mortgages (because of the virus). Boom. Up she goes.

The real question is what comes next. Was July possibly the worst month ever to spend $1.8 million on a slanty semi in a hip hood, or are all the scary times over?

Realistically, the odds are growing (sadly) that politicians may drop the hammer again with little provocation if the polling persists. Have you noticed how they kinda like states of emergency, with no legislatures sitting, no opposition leaders squawking, no question periods and lots of shiny new powers? This benevolent dictatorship is now wholly supported by a majority of Canadians. Over 80% want the key US-Canada border shut for a long, long time. A survey out Tuesday found 73% support for another wholesale economic shutdown in the event of a second wave of Covid. “Even with the economic uncertainty, Canadians are quite receptive to a shutdown of the economy again if there was a resurgence,” says pollster Nik Nanos.

Meanwhile, guess what? A second wave emerging. In Australia, Britain, Germany, California, Japan. With luck, common sense and soap we’ll avoid that here. But if clusters of cases emerge in the GTA, there’s little doubt the mayor and the premier will drop the hammer. Business and restaurants shut. Stores closed. And way more people losing their jobs – just as the CERB ends and four million are shunted onto EI benefits.

Meanwhile, the lenders – after months and months of reduced mortgage revenues – are struggling to maintain profitability, control risk and deal with bum business and consumer loans (more than $11 billion was set aside for this). Do you think they’ll be more selective about lending in a renewed pandemic? Duh.

As for employers, the last few months have sent many businesses into survival mode. If the pandemic shows signs of lasting, oh, two years, then it’s a safe bet they’ll be shedding overhead, and workers. Many economists fear structural unemployment coming out of this mess. They’re right.

And the government cannot continue to shield us all from virus reality. To date, pollster Nanos says, “there hasn’t really been a connection between businesses closing and major disruptions to the economy and Canadians’ day-to-day ability to pay bills because their government has been there to support them through the CERB. The economic stimulus for Canadian individuals has been generous, so many working-class Canadians haven’t really felt a major economic pinch as a result of the pandemic.”

It’s clear this program – which costs well over $20 billion per month – is unsustainable. Public finances are being shredded. The only long-term solution is less spending and increased taxes. That will include increased tax on land transfers, home ownership and possibly sale proceeds.

Now, let’s be clear. Pandemics are temporary. They all pass. This is not the end of normal. If you do reasonable things, the outcome will be fine. Is buying a house at a historically high price in a bidding war during a public health crisis in the middle of the worst recession since the 1930s with millions out of work and just prior to another potential economic lockdown one of those things?

You must ask?

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Over the last decade we’ve endured much.

Credit crisis recovery, US debt ceiling panic, oil price collapse, Trump, trade wars, protectionism, Brexit, Bitcoin, Hong Kong, record debt and now the first global pandemic in a century. Stock markets swooned in a serious way four times. Interest rates collapsed. GICs pay 1%. Houses are inflated. Wages got stuck. Lots of people did stupid things. Eight million on the dole and a million unable to pay their house loans when the Covid storm rolled in gave evidence of that.

Through it, this blog has told you the best path was to stay balanced, ignore what you cannot afford, eschew debt, avoid putting everything in one asset, try not to be a cowboy flipping stocks, chasing bullion or crypto, be diversified, reduce tax, stay invested and understand that real risk means running out of money, not losing it. Alas, few listened. Human nature almost always leads us astray. We chase houses. Think short-term. Borrow too much. Get investment advice from moms and brothers-in-law. And we’re complete slaves to emotion. Fear. Greed. Envy. Nesting. FOMO.

But if dogs were in charge of finances, they’d just do what works, and stay at it. Simple. Results are all that matter when you don’t have email and have to pee outside.

Why have I yammered at you for the past ten years about a balanced and diversified portfolio? Because despite all the turmoil and scary stuff we’ve been through, this has proven itself with an average annual return of just a little over 7%. That doesn’t mean seven points a year, every year since there have been times of decline (it lost 3% in 2018, for example). But net worth is built over time and, like dogs know, by doing proven things repeatedly.

Time for a refresher and an update on asset allocation.

First a B&D portfolio generally means 60% in growth stuff and 40% in safer things. The logic is that when stocks sell off in a sweat (like when the virus hit) that other assets will rise in value as money seeks refuge (like bonds). This is exactly what occurred in 2020.

But wait, you cry, interest rates have tanked and bonds pay nothing. Why on earth would you own any?

Because they go up in capital value when stocks fall, thereby slicing volatility. Nobody owns bonds any more to collect interest. That’s so 80s. They’re shock absorbers – with the added bonus that (as stated) when rates shrink the value of bonds plumps. And remember, a good portfolio doesn’t just contain pay-nothing government debt. It also has exposure to provincial and corporate bonds, adding some yield.

But the real payers in the fixed-income part of the portfolio are preferred shares, with a dividend now in the 5-6% range, plus reduced tax. Rate reset prefs are interest-sensitive, too, so when the cost of money falls, their value drops. These days they’re cheap to buy and still churn out that nice return. As central banks inevitably increase rates in future years, these will surely hand over a capital gain.

Growth assets mean equities (plus some real estate investment trusts). But not individual stocks, since most people can’t pick well nor stomach the volatility owning a handful of companies brings. Hubris, vanity and too much testosterone leads many people into thinking they’re smarter than Mr. Market and can pick a few ‘winners’. They can’t. It’s a guess. And guessing is gambling, which is not the same as investing. Don’t.

Better to own whole markets through broad-based equity ETFs – exchange-traded funds. They are cheap and liquid. Far superior to mutual funds. And don’t fall for home-country bias, keeping too much of your growth assets in Canada. Year/year the US market has delivered a 14% return while Bay Street is up just 3%. A good portfolio is a global one – North America, Europe, Asia, emerging markets.

There are other complexities, depending on how much you have to invest. Large and small corporate exposure, for example (small caps will likely lead the economic rebound, as usual). Sector exposure (like health care). US and Canadian-hedged funds (try to stay at least 20% US$-denominated). And don’t have too many positions. Fewer than 20, for sure, even if you have a couple of million in the can.

The current preferred weightings in a 60/40 portfolio are 26% in a variety of bond funds, 13% in preferreds, 20% in Canadian growth assets (including 5% in REITs), 22% in US equities and 18% in international stocks. Of course, try to move things around for tax-efficiency between a non-registered account (dividends and capital gains), an RRSP (sheltering bonds) and your TFSA (the hot stuff).

Finally, ignore the noise. Experts telling you to go gold or more equity exposure, for example. The US election. The virus. Government deficits, central bank policies or prime ministers with ethical blind spots. I mean, does your dog care about what was in the news on Thursday or how last year compared to the average period? Can she even spell MAGA or BLM?

Nope. Results. That’s all that matters. Woof.

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– Ksuksa Raykova photo

“We’re doing a story about the potential for a residential real estate crash,” the email from glitzy mag Toronto Life read. “The premise is basically that prices have held steady for the past few months, despite crippling economic conditions, so does that mean the bottom will inevitably fall out?”

A follow-up phone call materialized from the editor (I explained no crash was near). Then another note arrived. Housing is a hot thing these days. Apparently, even bigger than the virus and glory holes. ‘Okay,” I relented. ‘Send me the questions.’

“Has anything surprised you about how the market reacted during the pandemic? Pls explain.”

The current market sucks. Bidding wars. Blind auctions. Bully bids. Multiple offers. Prices rising double-digits. Many are incredulous how this could take place in the midst of a global pandemic with the downtown core a ghost city and a withering 13% unemployment rate in the GTA. Eight million Canadians have been on government pogey for four months, and the GDP has crashed the most on record. Yet when it comes to real estate, we’re partying like it’s 2017 again.

The reasons are profound, and temporary. There was no spring market in 2020, since we were all going to die of Covid, and stayed home in our underwear. Hence a big pent-up demand once it appeared life was going to carry on. What normally happens in April this year took place in June.

Second, lots of demand was unleashed on scant inventory. Available listings shrank faster than a dude in the Humber when the virus arrived. Live showings halted. Owners were totally unwilling to have anyone view their homes. The choices for buyers once public fears started to dissipate were thin. Good properties were immediate objects of desire and competition. Prices popped.

Third, money’s cheap. Ridiculously cheap. The major lenders are quietly giving mortgages for less than 2% on a five-year term. Even decade-long loans are 2.5%. As central banks rushed to rescue the economy from the pandemic, rates were slashed and billions thrown at buying up mortgage securities. Liquidity is sloshing over the gunnels. As mortgage costs decline, of course, people can borrow more money on the same income. So they are. The fact we no longer have any fear of excessive debt is driving real estate higher, unwisely.

But these things are temporary. The demand surge will temper. More properties will hit the MLS. Unemployment will stay elevated. Any economic or public health reversal now could make those who overpaid in June regret things in November.

“You mentioned the likelihood of a potential residential real estate crash is “basically zero.” Can you flesh out how you came to that conclusion?”

Sure. If this were Calgary or Kelowna or Windsor, a protracted period of decline would be no surprise. Lots of places in Canada will have many problems for the next couple of years. But the GTA will fare better, because of a highly diversified local economy, the financial core, migration and the synergy of a six-million-strong market.

No, no crash – which we’d define as a 20% price correction. But this does not mean a rosy market, either. There are several worrisome trends.

“You mentioned there might be a flatlining in the 416. What factors do you think would contribute to that? How long would you expect that to last before prices recover?”

After this little boomlet, it reasonable to expect a far different market to emerge. As mentioned, swollen unemployment is not going to shrink anytime soon. It will be well in 2021 before we get back to the levels of February. Second, a serious number of people deferred mortgage payments,  ending in the next few months. An unknown number will still be without work and forced to sell, so more listings. Also many coming up for renewal may be unpleasantly surprised at the reception they get from lenders who were just denied six months of payments.

And big troubles with condos. Airbnb has collapsed. Pre-virus, the GTA had over 21,000 short-term rental properties. Hundreds of those have been hitting the market lately, with thousands more to come. Add to this the 15,000 units coming available as new construction is completed over the next two years. Supply will overwhelm demand. This is why condo prices and rents will decline, pulling the entire market back.

Finally, the virus. It freaked out millions. No surprise that detached sales in 416 have actually declined while those in the boring, soulless expanse of 905 have jumped. People want backyards. Front doors to the street. No elevators or garbage rooms, corridors or parking garages. Besides, Covid showed that a lot of companies can function perfectly well with employees working remotely. So no need to spend three hours a day on the QEW and Gardiner Expressway. The burbs are suddenly sexy. The clogged Kingdom of 416 is tarnished.

“How do you think it would impact the market if there was a much-dreaded second wave of coronavirus?”

Like an asteroid. Combine that with joblessness, more shutdowns, the condo plop, mortgage deferral cliff, CMHC rule tightening (no more HELOCs to finance rental props) and more risk-averse lenders and the market would be a smoky hole in the ground for at least a year. Until the vaccine.

But why would this happen? We’re all wearing masks now. Leaping off the sidewalks from each other. Lining up like ducks at the grocery store. Washing hands all day and bathing in sanitizer. This is not March. The authorities are not going to lock down society or turn off the economy again. If infections rise and hotspots develop, so be it. The virus risk ain’t going to zero. It never will. And it will be a long, long time before the herd is dosed and social distancing ends.

The best time is to buy a house is when you need it and can truly afford it. And the worst time to do that would probably be now.

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   By Guest Blogger Ryan Lewenza

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I was recently trashed in the comments section, something I’ve had to get used to on this merciless blog. The angry commenter derided me for focusing my research and commentary on the US economy and S&P 500. So today I provide a deep dive on the S&P/TSX Index (TSX) and hopefully atone for my sins and gain sweet mercy from said commenter.

Here it goes…

The TSX has kind of sucked in recent years, especially relative to the US equity markets. For example, the TSX has returned 4.4% annually over the last five years, less than half of the S&P 500 at 10.7%. Longer term (e.g., 20 and 30 years) the TSX has also lagged behind the S&P 500. So what gives?

Long-term Equity Returns

Source: Bloomberg, Turner Investments; as of June 28, 2020

A big reason for the underperformance has been due to our devastated energy sector. I’ve spoken ad nauseam about this and how I believe we need a more supportive Federal government and the darn Trans Mountain pipeline expansion so we can have more than just one buyer for our oil (the US buys 99% of our oil exports, which given the US shale revolution means less demand for our oil).

Below I show the connection between the TSX and oil prices by charting the year-over-year percent change in TSX earnings and WTI oil prices. Note the correlation and how declining oil prices generally weighs on TSX earnings. Given this relationship, we need oil prices to rebound strongly for the TSX to really start moving again. On a positive note I see oil prices possibly getting into the US$60s next year as demand recovers but I don’t see US$80-$100/bbl any time soon.

Oil Prices and TSX Earnings

Source: Bloomberg, Turner Investments

Another reason the TSX has lagged behind the US is more about what we don’t have in the TSX – information technology, consumer discretionary, and healthcare stocks. These have been some of the best performing sectors in recent years, which given the combined weight of 14.8% of these sectors in the TSX versus 53% in the S&P 500, this also helps explain the TSX underperformance.

Let’s face it, the TSX remains a financials and resources driven index with those sectors representing 56% of the TSX. The good news is I see Canadian banks doing a lot better next year as the economy rebounds and credit losses peak this year. Combined with my expectation for a slow recovery in oil prices, 2021 is looking a bit better for our equity Canadian markets.

TSX Sector Breakdown

Source: BMO ETFs, Using ZCN as proxy for the TSX

Another big positive for Canadian equities are their cheap valuations. Below I chart the TSX price-to-book ratio (P/B) and currently it’s trading near a 27-year low of 1.5x, well below the long-term average of 2.2x. In contrast, the S&P 500 trades at a high P/B ratio of 3.5x. While we’re still bullish on the US equity markets and have a good weighting to the region, we are keeping a mindful eye on those elevated valuations.

S&P/TSX Price-to-Book Ratio (P/B)

Source: Bloomberg, Turner Investments

Even better, at the March lows the TSX fell below the magic 1.4x P/B level. I say “magic” since every time the TSX traded down to these dirt-cheap levels (09, 04, 98 and 95) we saw the TSX deliver great subsequent returns.

From the table below you can see that the TSX returned on average 27% over the next 12 months and 68% over the next 24 months, when it traded down to this 1.4x P/B level. If history repeats, we could be looking at some good returns over the next few years.

Basically, the TSX underperformance has compressed valuations to the lowest level in years, which could be setting the stage for much better returns in the years ahead.

TSX Returns After it Drops Below 1.4x P/B

Source: Bloomberg, Turner Investments

One final consideration for Canadian equities and the TSX is the attractive dividend yield it offers. Currently the TSX yields 3.5%, in large part due to the sweet 4% dividend yields offered by the big banks. Compare that to the S&P 500 yielding 1.7% and government bonds below 1%. Add in the tax advantage of Canadian dividends versus US and international equity dividends, Canadian stocks look more and more attractive each day.

S&P/TSX Composite Dividend Yield

Source: Bloomberg, Turner Investments

Ok that was a lot of numbers and boring information about sectors, valuations and dividend yields, so the key takeaway of today’s blog is that the TSX has underperformed in recent years, but I believe this underperformance could be setting the stage for a much better decade ahead. For our clients we continue to invest 2/3rds of their equity exposure in the US and international markets, but there could be a day when we decide to trim this back and beef up our TSX weight given some of the factors I highlighted today.

Now let’s see if that blog dog commenter throws me a bone and appreciates today’s topic on the TSX. I’m not holding my breath!

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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