Entries from May 2018 ↓

The latest

Will rates jump again in May?

Nope, says Mr. Market. Ain’t gonna happen. The latest economic stats (out on Friday) were more tepid than the rate bulls had expected. So, a weaker inflation number caused the dollar to slump and the odds of another set of mortgage increases to wither from 40% to 28%. Having said that, markets are still giving big odds to increases in July and October – adding a half point to the prime, lines of credit, VRMs and five-year loans. In fact increased yields in the bond market over the last few weeks probably foretell fatter mortgages to come.

The bottom line(s): Variable-rate mortgages will remain bargain-priced (as explained here last week) for a considerable period to come. Canada’s yield curve has inverted in the long end, which is just as uncomfortable as it sounds. The cost of borrowing will continue to increase, but this is likely to be a long and drawn-out process. Might as well have a cheap VRM in the meantime, and make more of every payment go to principal.

Anyone with a GIC, like blog dog Jean, should also take note. She and Gerard have over a million saved as they head into retirement, thanks to a Big Job in the oil patch. But a whack is in GICs, locked up for years at 2.5% in a non-registered account. “I am so-o-o nervous,” she says. “Just can’t stand the thought of losing anything.”

Fair enough. But the inflation rate is 2.2%, and rising. Worse, G makes good money and is in the near-50% tax bracket. So, yes, they are losing wealth – every single month. Worse, GICs generate phantom returns – interest on which you must pay annual tax even before you receive it (at maturity). And in retirement they provide no income stream, as does a balanced portfolio of ETFs from which a taxless flow in the form of return of capital can be enjoyed.

But I digress.

Two more hikes this year in Canada. Two or three more in the US. No recession on the horizon, and little threat of a pullback in US markets. Meanwhile Canadian equities are cheap and unloved (like me) and likely to remain so until after the Ontario election, NAFTA is decided, and a pipeline rammed up the Horgan.

$    $    $

So this house costs $500,000 in Orlando. It has 3,600 square feet of living space, and costs less than $140 a foot. Compare that to $1,000 a foot in Toronto for an upscale downtown condo, about $820 a foot for the average unit, and $1,210 for houses on Vancouver’s Westside.

US real estate costs a fraction of that in Canada, despite Americans having a similar median household income and comparable interest rates. US income taxes are less in most states (but not ones like NY or Cali), mortgage interest is somewhat deductible and the home ownership rate, at 64%, remains considerably below that of Canada. US citizens own about three times more equities in their retirement plans and we do, and the household debt ratio is steeply less than it was in 2005, while ours increases every quarter. In short, Canadians have chosen a one-asset, highly-leveraged financial strategy leading to a wild price inflation and enhanced risk. Plus you don’t get to live in a house like this.

Want to see what five hundred grand buys – from a tiny NY City apartment to a southern palace? Here is the link.

$   $   $

So if prices are falling and peak house is in the rear view mirror in the GTA and Vancouver, why aren’t listings flooding on to the market? In fact, in Toronto, why are they falling? The number of new ones dropped almost 25% last month, compared to April of last year – so this is roughly equal to the tumble in sales.

The result is price resistance. Fewer buyers chasing fewer listings means supply and demand are balanced with no precipitous valuation plunge. At least, not overall. In certain areas this blog has previously identified (the outer ring of particleboard McMansions) it’s a different story. Scant buyers, more sellers, desperation and 25% drops in sale prices.

In general, why are homeowners not going to market during what’s always been the strongest selling season of the year?

“They’re holding out because they think the market is going to turn around,” says a TD economist. That’s the conventional view, being shared by house-humping realtor web sites and the real estate cartel. But there’s more. Lots of people lives in houses they could not afford to buy – especially with the B20 mortgage stress test now in place. If they sold they’d have to purchase, exposing themselves to those onerous financial requirements. People moving down into lesser properties might not care, but those selling so they can climb the property ladder face two big obstacles – high asking prices (close to peak house) and qualifying for financing at 5.34% or better.

So there you go. Another unintended consequence of government diddling in the marketplace. Makes this $499,000 house in Baltimore look even sweeter.

Bad behaviour

DOUG By Guest Blogger Doug Rowat


“He did that to me twenty times. Then I got smart.”

– WKRP in Cincinnati’s Herb Tarlek

I write frequently on this blog about behavioural investing, which basically means making erroneous investment decisions based on feelings instead of facts. However, I’ve never illustrated how behavioural investing mistakes play out in the real-life everyday thinking of our clients. And, unfortunately, these behavioural biases are often so deeply entrenched that the same mistakes are made repeatedly. So, in order that we learn faster than Herb Tarlek, allow me to introduce our new (hypothetical) Turner Investments client:

Our new client brings on-board a variety of legacy stock positions. He’s very particular about which ones he wants to sell. Mainly, however, he wants to hang on to all of his losing positions and won’t sell them until they’ve recovered and he’s earned a profit. Anchoring occurs when investors allow a specific piece of information to control all of their investment decisions. In this case, the client has become anchored to his purchase price. Purchase price is irrelevant if the company or sector outlook is poor. Why hold an energy stock, for example, if the oil market looks unfavourable? Hanging on to a position just because you can’t bear the feeling of realizing a loss is irrational (anchoring, in fact, is often closely related to loss aversion—another behavioural investing error).

The client has also been working for a large, publicly traded company for more than 10 years. He’s accumulated a great deal of stock, which now makes up more than 30% of his overall portfolio. He absolutely refuses to sell this position: “it’s a good, well-run company”. Well, unless he works on the board of directors or is the CEO, this is simply a false assumption. Countless employees no doubt thought Enron, Bear Stearns, Nortel or Research In Motion were well run also.

Generally speaking, participating in employee stock-purchase plans are a good idea because of the employer matching and/or strike-price discounts, but concentration risk is the problem. And risk has also been doubled: if the share price declines, not only is the client’s investment diminishing but probably his job security is as well. Familiar or “local” investments are not safer. This is one reason why we maintain broad-based global exposure in all our client portfolios.

Recency bias
We’re now ready to build our new client’s portfolio to our recommended model, but he has some hesitation regarding investing in the US market because it’s performed poorly over the past couple of days. Investors tend to believe that what’s happened recently will continue to happen. But recent events or trends shouldn’t be given disproportionate weight in investment decision making. The long-term trends and fundamentals are far more important. We can’t time markets over the short term and, historically, the odds of the S&P 500, as an example, recording an annualized positive gain over 10 years are impressively about 90%. Our objective is to get the portfolio built and then focus on the long term. Recency bias also often occurs after sensational news days (the Brexit vote or a terrorist attack, for example). While such singular events FEEL like they have enormous consequence, typically they don’t.


Now, once the portfolio has been built and the client has been with us for a time we often see these two behavioural investing mistakes emerge:

Self-attribution bias
Unfortunately, we weren’t able to convince the client to reduce his exposure to that company stock and, as it happens, the stock has done well. Naturally, we’re pleased for the client; however, the danger comes when investors attribute the successful outcome solely to their own actions or insight and don’t consider the possibility that it could have been a complete stroke of luck. Perhaps the positive performance was due to a strategic takeover. Here investors have to be honest with themselves—did they actually predict that particular takeover? And, unfortunately, the positive performance has probably only further obscured the concentration risk. Also, is the client being honest regarding his OVERALL track record with stock picks? If that record has been so outstanding then why is he paying us a portfolio management fee?

Hindsight bias
At the end of the first year, the client notices that his TFSA has performed much better than his other accounts. Generally, we position TFSAs more aggressively and towards equities because the capital gains aren’t taxed. I explain that equity markets have performed well and that his TFSA has benefitted. The client then questions why all of his accounts weren’t built this way. Hindsight bias, summed up nicely by Investopedia, “leads an investor to believe after the fact that the onset of a past event was predictable and completely obvious whereas, in fact, the event could not have been reasonably predicted.” It’s the equivalent of Monday-morning quarterbacking a portfolio. Naturally, we don’t know for certain that equities will outperform in any given year hence why we also maintain safer assets such as bonds. Inclusion of these defensive assets controls risk and allows us to limit downside when our outlook is incorrect.

I don’t highlight all of the above behavioural investing mistakes to suggest that our client is being unreasonable; after all, we’re only aware of these mistakes because we’ve made them ourselves. Remember WKRP in Cincinnati? We’ve made the error of throwing turkeys to their death from a helicopter so you don’t have to.

But, as God as our witness, we thought they could fly.

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