What to worry about

LAWYER modified

Well, that was fun. Days ago markets were crashing and fools were selling. By Friday bargain-hunters were plumping stocks and draining bonds. It was enough to make a boy dizzy.

What happened, and what comes next?

In a word, markets (which were a tad frothy and fat) were attacked by fear. It may have been largely irrational, but fear’s like that. You don’t think it, you feel it. This time it came from worry everything was starting to come unraveled – Europe’s a mess, ISIS goons are winning, deflation’s coming, the US is sputtering, and Ebola.

Picture4  In fact, here’s an interesting chart for you (from Myles Zyblock, at Dynamic) which tracks the main American stock market, the S&P 500, and the number of news stories about the spread of the West African virus. Coincidence? Hardly. People are like that. They overreact to risk. Markets hate surprises. And selling begets more selling.

After a few days of this, driving share prices down almost 9% in New York and over 10% in Toronto, the panic petered out. The news got better. US corporate profits rose, consumer confidence shot up as mortgage rates and gas prices fell, central bankers stepped in and jobless claims dropped. Brave investors moved in to Hoover everything in sight. And up she went.

“Needless to say, we do not see the typical hallmarks associated with a deep and prolonged downturn,” says Zyblock in a research note. “In fact, leading data argues that the economy and earnings should continue to march higher over coming months – a development which is usually associated with positive longer-term returns for equity investors.”

In fact, when you think about it, not a lot changed last week to cause all the freaking. The American economy is doing just fine by every measure that matters – job creation, corporate profits and government finances, for example. The unemployment rate is at an eight-year low and the federal deficit has virtually plunged, thanks to less spending and more taxes.

Europe sucks, but we knew that. The central bank there is about to start a stimulus program, and has just slashed interest rates so much that some banks are charging to hold your money. ISIS is evil and scary, but will probably end up being bombed back to the 13th Century. And Ebola is pure terror – until you realize it’ll be heart disease or cancer that kills you.

The week showed how destructive emotions can be. Imagine rushing to your laptop to dump the equity ETFs in your TFSA on Wednesday, only to see them rocket higher on Friday. And being in a registered account, you couldn’t even save any losses to write them off against taxable gains. Bummer.

Human nature often betrays us. It’s amazing how much time some people spend trying to identify and avoid risk – driving, cooking, walking the dog, dressing the kids and, of course, investing. Meanwhile we pick careers haphazardly, and fall into love and marriage randomly. In short, we worry about the wrong stuff, fretting over global markets while we snorfle a maple glazed at Tim’s.

This is why having a balanced and diversified portfolio makes sense. When the TSX was nailed for a 10% loss this past week, that portfolio was down less than 1.5%. By design. ‘Balance’ means you own both growth assets (like exchange-traded funds holding the S&P) plus fixed-income stuff, like bonds – which soared in value as stocks fell. Meanwhile the diversification element gives you a steady income stream from more stable assets, like preferred shares, and ownership of stuff that’s not correlated to stocks, such as real estate investment trusts.

The goal is to grow money without swilling Imodium. The best way to do that in a world where you can’t control disease or stupidity, is to hedge your bets by owning a lot of assets, in a rational mix (40% safe stuff, 60% growth, works well) that ends up being an antidote for fear. In the past seven days there was all the proof ever needed that this approach works.

Now, what next?

Hard to imagine the volatility is over. The Fed still has to end its stimulus spending this month, or not. Either way, that will get people excited. So will more Ebola in the US, which looks predictable. Earnings season continues, and that’s going well. Lower gas and rates should goose consumer spending going into the key holiday retail season. Overall, the American recovery continues and Europe has only one direction in which to travel. No wonder some people were buying. They don’t believe the wheels are coming off. Me neither.

So, you can flop around with emotional wrecks flipping stocks in their Qtrade accounts. Or, you can build that portfolio and concentrate on your love life. Tough choice.

The end

TAILS modified

Remember the Fort Mac dude who told us some weeks ago he was going to unload his house in a squalid city populated with horny engineers? (Like there’s any other kind.)

Well, the guy has horseshoes up his rear, apparently, listing and selling just days before the price of a barrel of oil plunged enough to put oil patch execs into cardiac arrest. “First of all, thanks for reading and posting my story! I feel somewhat famous now,” he says, pathetically. “My house just sold for $10k less than what I bought it for back in June of 2008.

“I’m just glad it’s over, especially the way the world markets have been acting this past week! I’m pretty sure back when I bought it the exact same thing was happening globally, but I was completely oblivious to it, just like these new greater fools probably are. I bought at a bad time, but looks like I probably just sold at a great time.”

Now, remember the Financial Post dude who dissed me recently, arguing there’s no real estate bubble – only a gasbag full of twits like me writing about it. “Booming real estate markets are producing another kind of bubble: An expansion of authors writing about a looming crash,” he wrote. Then Marr quoted such unbiased and credible people as Joe Owe and Brad Lamb to help calm the afeared masses.

Well, times change. Sometimes ya gotta flip. Sometimes, flop. Mr. Marr, praise be, has seen the light. “No matter what statistics show, Canada’s housing boom is about to end, experts say,” is his latest piece. Just in time, too. CREA reports sales fell last month – a significant event. Even Royal LePage is warning consumers not to expect real estate to perform. And Capital Economics’ David Madani earns some ink with this observation:

“What concerns me is some buyers seems to have this view that prices can only go up. People feel it’s a one-way bet. A lot of younger people seem to think that if they don’t get in now on the home ownership ladder, they’ll miss out. Some of these people will come to regret this decision. In the more expensive markets, it’s almost like a capitulation where they say ‘If I don’t buy now, I’ll never own a home’. This is what happens in a housing bubble.”

Meanwhile, even The Motley Fool is lining up to take a whizz on the housing market. “If you buy Toronto real estate now, you’ll hate yourself later,” says this week’s headline. In arguing for an investment in nice REITs that pay you actual cash to own them, the Fool reminds is why GTA housing is a potential sinkhole.

“The city’s real estate boom has produced some jaw dropping figures. For instance…

  • $951,000: Toronto is about to become the second Canadian city where a single-family home costs more than $1 million. Last month, the average detached house sold for $951,000, up 8% year-over-year.
  • 130 skyscrapers: Toronto has more skyscrapers under construction than any other city in North America. Today, there are 130 high-rise projects underway.
  • 39,000 realtors: The number of realtors in Toronto has doubled over the past 10 years. Today, there’s one realtor for every 140 people in the city.
  • 37x rental income: Toronto housing prices are valued at 37x annual rental income. Typically, the market has traded between 15x and 20x rental income.
  • 3.7% cap rate: Toronto capitalization rates — the rate of return based on what a property is expected to earn in rental income — have hit new lows. This was highlighted last year when the Bayview Village shopping mall sold for a record low cap rate around 3.7%.

The conclusion: “You should buy assets that make sense based on cautious assumptions. Nobody should be speculating that people will pay growing premiums for a house.”

That sure is good advice these days in a bunch of cities, like poor Regina. The latest realtor survey shows the average two-story house is 7% cheaper than it was a year ago, even as sales hold steady, while bungs have dipped 8%. Inventory has been flooding on to the market as more sellers sense this is a now-or-never moment. There are more houses for sale than at any time in the past twenty years. Says local broker Mike Duggleby: “The inventory levels available on the market right now are approximately 40 per cent higher than usual, which has created a supply-demand imbalance and pushed home prices down. Strong unit sales this quarter have not been enough to support previous price levels.”

In all of Nova Scotia, including Halifax, prices are dropping. They were off about 3.5% last month compared to the same time a year ago, with more than full year’s worth of houses sitting on the market. In Montreal, prices are running less than the rate of inflation, after an absolute decline through the summer.

Of course, this is at a time when the cost of money has never been lower and a five-year mortgage can be stapled down for a lowly 2.8%. As mentioned earlier this week, already 60% of Canadian markets are seeing falling sales, with most experiencing rising inventories. So the hot housing conditions most realtors and reporters keep telling us exist is really a three-city phenom. And, as I wrote here a few days ago as oil collapsed, you really have to wonder about Calgary.

Well, a crappy, raw semi with a Wild Kingdom basement on a hipster street in Toronto sold this week with twelve offers – all from virgins. The asking was under $830,000, and the sale was over $950,000. When I spoke to the agent for one of the losing bidders (who reads this blog), all he would say is, “I am so done with this town.”

Smart people know where this is going. Tails up.