Ending badly

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Ontario’s about to bring in climate change legislation. Alberta unveiled its plan Sunday. And, soon, the feds. That’s altruistic, responsible and forward-thinking. Evidence abounds the world is hooped without human action. We’ve already managed to harvest 70% of the fish and eliminate half the animals in the time I’ve been married to Dorothy. Since I was born the global population has doubled. This will end badly.

But the economic costs are huge, and you’re probably not being told what to expect. In Ontario, for example, a carbon-pricing regime will add about 4 cents to a litre of gasoline, increase home heating costs, electricity and the cost of almost everything you buy. In Alberta, the bill will be $500 per family per year, including a 7-cent gas hit. This is all intended to reduce consumption and inhibit economic expansion through higher charges. You either consume less or pay more. The toads and butterflies love you, but your finances don’t.

As a former director of the Sierra Legal Defence Fund (now Ecojustice), which gives money to lawyers to litigate for environmental protection, I don’t consider myself to be a dino when it comes to such issues. We’re wanton wasters of the world. But I also think folks should stay focused on what’s coming when we elect a bunch of progressives who (as our federal government self-avows) say climate change trumps the economy.

For Canadians, this zeal could hardly come at a worse moment. Oil has careened to the $40 range and shows no sign of recovery. Household debt has bloated higher again, with $75 billion in new mortgage borrowing in the last year. Wage growth is anemic, unemployment’s stuck and layoffs seem everywhere. The economy spent half the year in recession and our dollar sank to 75 cents after the central bank was forced to cut rates to stave off deflation. On Friday we found the last federal government not only left the cupboard bare, but burned it to keep the lights on. The new guys propose to increase spending and debt, tax those who the most taxed, increase family levies and pension premiums plus reduce the ability of everyone else to save. And rescue the planet.

If this sounds vaguely scary, you get it.

The economy needs greater investing activity, leading to jobs. Not bigger government, more debt and higher overhead. But it’s too late to moan now. People wanted a hot anti-Harper with nice hair, tats and groupies. So that’s what we have. No judgment there. But preserving and building wealth is about to become more challenging.

Unless the oil sands are exempted, a carbon tax, cap-and-trade or any other climate-guarding regime will kill them. It will also reduce cash flow for most households, since they carry an historic debt load, and add to inflation – exacerbated now by a low dollar. As the US moves to raise rates for the first time in a decade (next month), the dollar will fall more. So, as Ontario, Alberta and Ottawa shift onto a climate-change agenda over the next few years, it’s reasonable to expect slower economic growth, higher costs and reduced job creation.

How should you invest in this kind of world?

First, reduce your Canadian exposure. Big time. If your financial guy is old-school and has stuck you in a bunch of ‘high-quality, blue-chip’ Canada stocks, then run. The TSX in the last year has underperformed the S&P 500 by almost 10%, and European markets by about 25%. The Canadian market is overweighted in energy and resource issues, plus the financials that support them – and there’s no light at the end of the tunnel.

Second, that means at least two-thirds of the growth assets you own should be US or international. They should be broadly diversified, which suggests using index exchange-traded funds, spread between large-cap and smaller companies. It’s also wise to hedge against the loonie, so having about 20% of your portfolio in US$ is smart – in fact, this saved the butt of many investors over the past year.

In a recent report on the connection between investing and climate change, Mercer had this to say:

“UK, Australian, and Canadian equities to be more sensitive given the higher exposure of these regional equity markets to carbon-intensive sectors. UK and European equities to be less vulnerable to climate change policy shocks given existing policy and commitments in place. We expect these markets to be better prepared for additional climate-related policy given the relative transparency regarding the direction of future policy. We expect the US to continue to drive global equity markets in the near term. Therefore, we would expect any significant policy developments in the US to impact global equities to a greater extent than developments in other regions.”

Third, do not discount the value of balance, having 40% or so of your portfolio in safe stuff – like government, corporate, high-yield and real return bonds, plus preferred shares which will benefit as rates rise. This is called ‘fixed income’ and it gives a modest yield regardless of where stock markets head. Remember to keep bond durations short, as they will be minimally impacted when the cost of money increases. Also consider a small weighting in commercial real estate, through REITs, since they are not correlated with equities. Rents continue to be paid, collected and passed through to investors.

Fourth, reduce your Canadian residential real estate exposure. A slower economy, higher consumer costs, augmenting taxes and swelling mortgage rates are not supportive of housing. Already most markets are in neutral or decline with falling sales and stalled prices. If the bulk of your net worth is in this one asset, you’re seriously at risk.

We may not have much of a choice in dealing with climate change. Inaction means trouble. But this will be neither cheap nor painless. Unless you’re Al Gore.

The path ahead

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Ross Pavl sells luxury digs to cowboys with Big Oil money in Cowtown. “The appetite for homes over $2 million,” he says, “has almost completely evaporated.” Overall, the ‘luxury’ house category (over $1 million, which everyone in YVR thinks is a starter home) has fallen by 40% since this time last year.

Prices are still sticky, though. The average, says Pavel, is about 7.5% below last year. But I’d suspect that may soon change. A lot.

On the day when our new finance minister, Suicide Bill, delivered his first economic update, the Canadian dollar slid below the 75-cent US mark, and oil lost more ground as it careens toward forty bucks. We also heard on Friday it’ll cost a billion or two to fast track all those Syrian refugees – which is a big humanitarian operation, but one which was  uncosted during the election campaign.

Anyway, here’s the situation this weekend: the Cons lied. Thus, we do not have a balanced budget, as Joe O insisted for months and as the Harper government announced long before the election was called. That was a fabrication. It was marketing. Fraud.

In fact that $2.7 billion surplus has turned into a $3.9 shortfall. Oops. Thus, seven of the eight years of Harper rule in Canada were ones in which the government spent more than it took in – including two where we had the largest annual deficits in history. That added over $170 billion to the national debt. It is hardly Conservative.

What now?

Government revenues from income taxes are falling. Ditto for corporate taxes. Same story for energy royalties. Meanwhile expenditures are rising, particularly for unemployment insurance, with the hulk of new claims coming from Alberta – where the greatest decline in revenues is also emanating. This is why your pathetic blog has been talking about oil creep. Nobody escapes it.

The Liberals are planning on adding at least $10 billion a year in new spending to fulfill election promises, half of it for temporary, make-work infrastructure projects. The need for something is obvious. The economy was in recession for the first half of the year and will grow for 2015 by only about 1%. Concurrently the US is doing fine, and on track for the first interest rate increase in a decade next month. That will inevitably impact the bond market, and gradually increase the cost of financing the national debt, now at $612.9 billion.

Today the world’s awash in oil, and prices could certainly retreat further than the 40% hit taken in the last year. Commodities remain at 16-year lows, and while they will recover at some point, such an event is not yet on the horizon. It seems prudent to expect next year will bring more of the same, as well as a lower loonie when US rates actually do lift off. That will raise our inflation and eat into consumer spending.

All this – the Harper lies, the Trudeau excess, the oil hit and the bad choices most people have made in their daily lives – leads me to believe you need to be careful. Most voters think they just elected a government which will cut their taxes and goose their take – more cash for kids and better pensions, for example – because the Libs will Robin-Hood the overlords. In truth, collecting $3 billion more from rich people (it will actually be far less) just equals the mess the Harper gang left behind. The numbers no longer add up. It won’t be a big surprise if we end up with $20 billion deficits once again.

So with more spending come more taxes. It’s why this blog will spend time on tax avoidance strategies over the coming weeks, as we head towards the Trudeau government’s omnibus tax bill, to be tabled before Christmas and fast-tracked through Parliament, then the budget in late winter. The Libs may be rolling back the TFSA contribution limit by almost half, but there are ways you can maximize this and shelter significant amounts. Trudeau may be erasing family income-splitting, yet couples can still manage to reduce their overall household tax bill through legal means. One percenters are in the cross-hairs for earned income, which means they should take money in other forms, set up a new business structure or create a fat, tax-deductible mortgage.

We’re on a new path now. It’s no surprise Harper lost government. This week reinforces that. But a future with more tax and more spending, more deficits, more assaults on wealth and more majority government arrogance calls for more attention.

Remember, this blog’s agnostic. No political affiliation. No agenda. Just a lust for freedom.