Entries from December 2017 ↓

The revolution

Love him or loathe him, Donald Trump now matters. This is getting serious. The tax cut bill, to take effect in 2018, is revolutionary and may touch your life. Most Canadians have absolutely no idea what this is, or why it’s happening.

Some key points to know: the overall corporate tax rate will be dropped by 40%. That’s extreme. Corporations will be able to deduct the cost of new equipment for the next five years immediately, instead of over decades. Also extreme. Small business owners will get a 20% tax cut on incomes below about $300,000. Compare that to what Bill Morneau’s doing. Personal deductions double and the average federal tax bill will fall, says Trump, “by half.” The top personal tax bracket clicks in at $600,000 (it’s $220,000 here), and is reduced by 7%. Mortgage interest remains deductible. Death taxes drop by 50% until 2026. Trump heirs, say mainstream media, will save about $1 billion.

Of course there’s a lot more to it, and comparisons with our system are facile. Families here get public health care and fat cheques for having kids. We have no mortgage break, but keep all house profits. Canadian taxes are higher, but we have a government that can’t keep its fingers off anything or stop apologizing and writing cheques. Beavers seem to like bloated governments, and are willing to pay for them.

So, what’s it mean? Probably this…

Extra sauce for investors

Dropping corporate taxes by two-fifths is massive. And while Trump proclaims this will goose employment, raise wages and spur the economy, that’s unlikely. Unemployment has already turned into full employment, stock markets are at record levels and the US is on a roll – adding an average of 19,000 new manufacturing positions monthly.

Corps are sitting on $2.3 trillion in cash reserves, which is double the level of 15 years ago. They don’t need lower axes, and are unlikely to shovel the savings into creating more jobs. Remember that there are now more jobs available in the US than there are applicants to fill them. So, the hundreds of billions in reduced overhead this tax reform will yield will likely go into profits, then dividends, and flow to investors. If you think the Dow is high at 24,000, just wait.

New reasons to look south

If your company spends $50 million building a plant in Windsor you get to write that massive investment off your corporate taxes gradually over the life of the factory. If you build it across the river then, thanks to Trump, you can now deduct it entirely the day you move in – and use that to wipe out corporate taxes for years, or decades. It’s a huge incentive to move to the States for any company that’s been thinking about it, taking jobs along with it. Ouch.

Higher mortgage rates & a lower dollar

Lower taxes for corporations and individuals, along with spending incentives will likely pour more gas on the American economy, resulting in inflation and higher interest rates. Already the Fed has raised then four times in 12 months and is on tap for at least three more hikes in 2018. With tax reform that could turn into eight more increases over the next two years, catapulting American rates above ours. The immediate impact is a lower dollar here and a rising cost of living as imports become pricier. But augmenting bond market yields caused by the Fed will also hike Canadian five-year mortgage rates. Yes, just as the universal stress test is taking hold.

If the Bank of Canada acts to shore up the currency and address mounting inflation with rate increases of its own, the economy here may be pinched, and residential real estate squished. With epic family debt, you know what that means.

And in the long run, crypto?

When I was 18 and went off to military boot camp for a few months my mother handed me a box of condoms and said, ‘short term pleasure, long term pain.’ It worked. Now the Trumpian tax cuts have us in a similar spot – making economic whoopee, to be followed by dismal decades. The legislation being passed will add between $1 trillion and $1.5 trillion to the American deficit by irresponsibly lowering federal revenues without cutting expenses. To stave off crisis or sustain the value of its currency, Washington will be forced into even harsher decisions down the road than would have been the case pre-Trump.

The next administration will have to gut spending, which could mean social unrest, or add a big new tax burden to staunch the red ink – which will shrink the economy and throw millions out of work. And guess what the chances of that happening are?

I’m starting to suspect Donald Trump is the Bitcoin guy.

A healthy balance

DOUG By Guest Blogger Doug Rowat

In October 2003, a tractor-trailer shipping Biovail’s (now Valeant Pharmaceuticals) anti-depressant Wellbutrin XL overturned spilling tens of thousands of pills along an Illinois highway. In less than a week, Biovail stock plunged more than 33% and the S&P/TSX Health Care Index dropped almost 15%. The decline highlighted one of the deficiencies of investing in Canada: lack of sector diversification. For millions of Canadian investors, gaining health care exposure essentially meant buying one or two companies, which placed an incredible burden on their operational success.

Almost 15 years later, nothing has changed. In fact, the Canadian health care sector has only become more problematic as Valeant—one of only six stocks in the S&P/TSX Health Care Index—has seen its market cap move from a high of roughly $118 billion in 2015 to less than $10 billion currently, emphasizing the volatility within the Canadian health care sector. The US S&P 500 Health Care Index, by comparison, has 62 members with 59 having market caps greater than Valeant. Needless to say, US health care investors are not concerned by overturned delivery trucks.

So, the importance of looking outside Canada for broad exposure to this important and recession-resistant sector is obvious. According to Deloitte, global health care expenditures are projected to reach US$8.7 trillion by 2020 from US$7.1 trillion in 2015 and IQVIA estimates that global spending on medicine alone will rise to US$1.4 trillion by 2020 from US$1.1 trillion in 2015. Naturally, emerging markets will be a big driver of this additional spend. IQVIA notes that China, India, Brazil and Indonesia, for example, with a combined population of 3.23 billion in 2020, will account for nearly half of the increased medicine usage globally.

And, of course, the growth will never stop. ‘Favourable demographics’ is perhaps an overly cited and difficult-to-time catalyst, but it’s still worth noting that the world is aging rapidly. The United Nations notes that

Virtually every country in the world is experiencing growth in the number and proportion of older persons in their population…. the number of older persons—those aged 60 years or over—is expected to more than double by 2050…rising from 962 million globally in 2017 to 2.1 billion in 2050….

Further, according to research and consulting firm Frost & Sullivan, people over 60 years use 4–5 times more health care services than younger people.

So, in short, every long-term portfolio needs global health care equity exposure and the Canadian market alone just won’t provide it.

Healthcare Spending: 2015-2020

Source: Deloitte; US$ billions

There is also a reasonable probability that there will be another US recession at some point in the not too distant future (one or two recessions per decade is a consistent, if unpleasant, average). Another advantage of health care exposure is its non-cyclical defensiveness. Understandably, US health care stocks outperform during periods of economic weakness; however, this outperformance has been remarkably consistent over all periods. The chart below illustrates the long-term outperformance of the S&P 500 Health Care Index vs the broader US market. Note that Health Care has strongly outperformed in each of the past three recessions. A relatively straightforward example of health care defensiveness was illustrated during 2008 when the S&P 500 fell 38.5% while the S&P 500 Health Care Index dropped only 24.5%.

Health Care Outperforms During Economic Weakness – And Just Outperforms Generally

Source: Bloomberg; chart measures cumulative price return (%)

So, for all the reasons above, a globally balanced portfolio needs health care. Currently, our weighting within the equity component of our model portfolio is modest (~10%), but this will steadily increase over time and we will certainly more rapidly add to health care if we sense increased risk of a bear market.

Stay well. And hopefully a few Tylenol will be your only contribution to the global medicine-spend this holiday season.

Cheers to your (portfolio) health.

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