Ready or not

Preferred shares scored in the last twelve months. As forecast. For example, the exchange-traded fund called CPD gained 21% since the lows of January past, beating every real estate market. Plus it came with a 5% dividend yielding cash flow. (Did your house do that?) And a dividend tax credit. The only things missing were a pony and a tummy rub.

Preferreds have rebounded because bonds have declined and yields swollen. Looks like there’s more to come, three days before the Inflation President ascends his golden throne. Protectionist, expansionary and pro-business, Trump’s expected to slice corporate regs, slash business tax rates, skew trade deals and measure his success not in social justice but GDP. Prices, profits and wages go up. Markets, too. And rates. Get ready.

On Wednesday the Bank of Canada reacts to this. No, the cost of money won’t change here (that comes later) but we should get a read on how our central bank will respond in Trumpian times. Recall that our bank rate is now an in-the-ditch 0.5%. It can’t stay there. It will not be cut. This is it, kids. Ze bottom.

The Canadian economy has been doing better lately, as the following chart of our trade shows – the first weensy little surplus since way back in 2014. Plus the latest labour stats were great. And Justin Bieber has just traded his man bun for bangs. So it’s all good. We’re on the path.

The question for bank governor Steve Poloz is how much risk Trump poses. Obviously whacking Canadian cars with a 35% border tax would be a disaster, or imposing the Border Adjustment Tax that we referenced here the other day. Or telling US oil producers to frack their little hearts out in the name of jobs and US energy independence. Or cutting American corporate taxes to a level well below ours, sucking off investment capital. Or ripping up NAFTA. Time will tell. Let’s see what the guy says in the morning.

So why are swaps trading showing a 33% chance that Canadian interest rates will actually rise this year?

Part of the answer comes from what consumers have been up to – driving residential real estate prices higher and swallowing unheard-of amounts of debt in doing so. Higher rates would target that activity, especially combined with things like Ottawa’s tough new mortgage regs of last October, and CMHC’s third insurance premium hike in four years, announced this week.

Meanwhile one of the world’s biggest money managers, Vanguard, says categorically that our central bank will pull the trigger later this year, upping its key rate by a quarter point – which would be a 50% increase from the present level.

Says Vanguard’s chief economist: “Our contention has been and remains that the U.S. economy and the Canadian economy would remain resilient, even in the face of the ferocious commodity sell-off and even with the froth in the housing market. I think the recent data toward the end of 2016 only bore that out. I think it’s appropriate to have modestly higher interest rates.”

At the same time, US rates are set to increase (Vanguard adds) in both March and June, with Poloz popping some time later. Moody’s Economics agrees – a quarter point increase in Canada in the autumn – while Deutche Bank says the cost of money in Canada will be higher in the last 90 days of 2017.

It’s a big deal. Our bank’s last two moves (in 2015) were down. Rates have been crushed for the past eight years – long enough that a whole crop of Millennial housebuyers can’t even remember when a mortgage cost 4%. Just look at the comments on this site every time anyone warns that interest can go up. They’re not buying it – understandably, given nobody wants to reflect on their own financial vivisection.

There it is. Friday. Wave normal goodbye.

Bad choices

David’s a prairie moister. He’s 24, makes $46,000 a year (“I have great job security”) has three grand in his chequing account and $32,000 in a TFSA. Dave lives with his parents in Winnipeg, because “we both want me to save as much money as possible”

Not bad for a kid. But all that liquid wealth is burning a hole.

“I was saving for a house until a co-worker mentioned your blog about 5 months ago and now I am torn apart between renting and buying a house for $250,000. I have excel sheets of scenarios going on with different interest rates for a $250,000 home and have concluded that the money lost in the home (interest, property tax, home insurance, utilities) is equivalent to renting for $1000/month. I get it that prices will go down in Vancouver and Toronto but what about Winnipeg and other similar cities. Should I buy the $250,000 home when I have saved enough money or should I move out and rent after I saved roughly $50,000 and wait for housing prices to fall? Will they decrease significantly? If I buy, the house might go up or down in value and if I rent I would make approximately 3.5% in my TFSA on that $40,000-$50,000.”

Is this the only nation on the planet where hormonal kids dream of real estate? And run Excel spreadsheets on mortgage rate scenarios? What happened to buying a Fat Boy and chasing the horizon?

“Why,” I responded, “is a 24-year-old single guy obsessed with buying a house?”

And he replied thusly: “I think I am obsessed with not throwing money away. I would live in an apartment in a heartbeat knowing that houses in Winnipeg will not increase by 2-4% in value per year (as my relatives believe they will increase in value). I am just playing with numbers and seeing where I lose / gain money over 5-20 years.”

First, Davey boy, buying a $250,000 house in the Peg without CMHC’s premium will take a down of $50,000, plus $5,000 in closing costs. The mortgage monthly will be $920, which turns into $1,350 with property tax and insurance. Add in the lost investment gains on the downpayment (at 6%) and the cost of the house is about $1,600 – without utilities, improvements or repairs. Meanwhile a one-bedder in Winnipeg (a nice one) goes for just $899 – and it’s cat-friendly! (I just know you have a cat.)

In other words, the premium for owning over renting is $700 a month – which is 25% of your entire net income of $33,600 a year, and enough to brim the TFSA annually. So for anyone obsessed with not throwing money away, it’s a no-brainer. Hate to break it to you kid, but your parents are wrong. (There may not be an Easter bunny, either, dude. Just a heads up.)

Why would a moister want to buy a house in Winnipeg, take on a big mortgage and Hoover his investment account in the process? To get a capital gain, of course, using leverage to create wealth you could never achieve through saving and investing. But, wait. Prices in prime hoods like Fort Garry, East Fort Garry, West Fort Garry, Fort Richmond, Waverley Heights, Wildwood and University Heights were actually lower in 2016 than the year before – off an average 3.1%. That’s not huge, Dave. But when you’ve bought a property with 80% leverage, it wipes out more than a quarter of your equity. Ouch. Plus you’re paying double what that swishy, cat-coddling apartment costs.

However, this post isn’t really about Winnipeg. Thank God. It’s about the social delusion that keeps people making bad decisions. Unless you’re in specific markets at certain times, residential real estate isn’t all it’s cracked up to be. Especially now.

For example, last month a stunning 1,500 newly-built condos were sitting empty across Calgary, 800 of which are high-rise units. It’s the worst vacancy rate in 15 years, getting badder by the month. Back in 2014 the market was hot, buyers were plentiful and builders revved up. Now those units are coming on stream when the economy’s turned, rates are rising, mortgage rules tightening, and buyers gone.

As an agent said to local media: “I’ve had people that have bought not one, but two or three of these, hoping to flip them or to rent them out, and where they really got caught is the rental market. They were planning on having rentals cover their investment in these and it’s not working out at all.”

Finally, anyone who thinks southern Ontario is immune from shocks should get used to a new world that begins this Friday at noon. On Monday the Trumpinator warned German car companies (like BMW) they will face a withering border tax on vehicles entering the US for sale.

“If you want to build cars in the world, then I wish you all the best,” he said. “You can build cars for the United States, but for every car that comes to the USA, you will pay 35% tax.”

First Mexico. Now Germany Is Canada immune? Are you kidding? Last week a Trump spokesguy made that one clear. No way. But over 75% of our exports go to America, accounting for 30% of our GDP. Half of that is cars.

The world’s largest economy is now led by a 19th Century protectionist with a Twitter account. You want advice, Davey? Go for the Harley.