Over the top

It’s almost half-past 2021, so let’s review.

First, your portfolio. If it’s B&D©, carefully-weighted and globally-exposed you should be up so far this year by high single-digits. Completely ignore the cowboys, swaggering stock jockeys and anon Internet braggarts who come here to make you feel inadequate. Investing isn’t a race or a contest. It’s not about scoring a 15% return. Instead it’s a path of steady, predictable, low-vol returns which will get you to the goals that matter. Retirement. A house. Educating your kid. Starting a business. Or, in the case of many in the steerage section, a personality transplant.

Some people worry we’re in an Everything Bubble. Stock markets are at record highs, they say, so surely it cannot last. Were it not for central bank money-printing, profligate politicians and the distorting effects of the pandemic, there’d be a reckoning. And it’s coming, anyway, they yell. This is the bread-&-butter of doomer bears like Toronto’s David Rosenberg, the crusty Harry Dent or debunked prophets like Gerald Celeste. These guys are just, well, nuts. Consistent, but nuts…

The reality is this: after 16 months of pandemic, the economy is reopening with a vengeance. GDP growth of 6% is just the start. Romping bank profits are but an inkling of what’s to come. Unemployment levels will sink to 2019 levels or below. Oil could be on its way to a hundred bucks a barrel. The S&P 500 is seeing 90% of member companies advancing at the same time. Bay Street has jumped 15% this year. Estimates are for corporate bottom lines to swell between 40% and 50% over year-ago levels.

Last year delivered an historic, global, holy-crap recession of Biblical proportions as we battled the slimy little pathogen from Hell. Governments spent $20 trillion in response. Hundreds of millions of people lost their work. But we got over it. Vaccines were developed at record speed and now 70% of Canadians have been jabbed. Large parts of the economy went online and flourished. Technology has allowed us to break back into the sunlight.

There is now record demand for cars, houses, boats, RVs and anything you can nail, saw or glue. That demand is about to extend to travel, tourism, entertainment and personal services as new cases of Covid crash 80%. There is a mountain of personal savings in the US and Canada being unleashed. Plus the wealth effect from a real estate boom nobody expected a pandemic could produce. Consumer spending in the next year will be epic.

Meanwhile history tells us that periods of expansion following severe contractions are not short. They average about six years. If we’re just starting on this path that suggests it’ll be later in the decade before the next correction arrives. Yes. The Roaring Twenties. If you’ve been sitting in cash, holding David Rosenberg’s paw and trembling, prepare to see a lot of positivity pass you by.

What could go wrong?

Lots, of course. For sure we’ll have more inflation so prices of everything will stay elevated, even when the supply chain gets fixed.  And interest rates will not stay where they are, despite what everybody thinks. The average tightening cycle for the Fed is a little over 800 days and involves about 10 rate increases. This will begin in the next year or so, and our CB will follow. Higher rates have proven in the past not to affect stock markets much, but they can kick real estate where it hurts.

But wait. What if Covid comes back? The Delta version?

Could happen, but more quarantines, lockdowns and restrictions are unlikely to be the response. Besides, by the autumn 75% of North Americans will be fully dosed so even a Fourth Wave would have far less impact on the health care system. In short, it’s over.

How about debt?

Yup, tons of it around. Higher rates will make it more costly to service. But by far the greatest debt is in the hands of governments, which have tools to deal with it. Like printing money (more inflation, more rate hikes). Or tax increases – look at the Biden agenda, for example. And soon (after the election, if he wins) you’ll see what T2 has in store.

So more inflation, more interest, more tax, but this will be balanced by rampant growth, rising financial markets, more jobs and profits. Suddenly the bubble in equities looks not so frothy at all. “This is the greatest re-opening trade EVER,” says stock veteran Ed Pennock.

There’s more money available than ever before. Should we invest in Growth or Value? The answer is YES. The landscape has changed. Shortages have transferred power to the workers. Between stimulus payments and the savings from work from home, personal balance sheets look better than we can ever recall. Prices are up but so are wages. Housing costs are up. A negative, yes. However, there’s also the “Wealth Effect” of housing prices. We have changed the basic way we consume goods and services. Think Amazon, Etsy and Shopify. In its totality, we think this is a perfect setup for the “Roaring Twenties”.

Wow. But nothing’s perfect, of course. China could disrupt trade. Biden could keel over. Jag could become prime minister. The virus could trick us. The lesson of the pandemic is that bad things can happen really fast.

And, yes, that’s exactly why you should be B&D©. It’s like having four-season tires. Or marrying a plumber. You can never be too sure.

About the picture: “Long time reader since the 90’s and appreciate all the guidance over the years,” writes Marlene. “Here is a photograph of our sweet girl Daisy.   15 year old Yorkshire Terrier.  We love her more each day.”

The ‘N’ word

Expect change in the real estate market over the coming months. More sellers. Fewer buyers. Sales volumes declining. Less obsession with housing as the economy opens and people travel, recreate, shop and do all that stuff which was forbidden for more than a year.

At the same time offices and workplaces will reopening. Not a gush, but a steady stream. Not everybody will be called back, but enough to raise serious questions about the viability of living in Tillsonburg, Hope or Tatamagouche. Suburban and hick-city valuations will flatline, if not decline. Urban prices, especially for condos, will stay robust.

Bidding wars will calm. Buyers will accept any offer. Blind auctions will disappear in many markets. Any doubt about the sifting sentiment should be quashed by an article just published by Re/Max, probably the pumpiest of the house-humping real estate outfits in the land. “There are signs that the spike in prices has peaked,” it says, which means FOMO is a risk. In fact Re/Max has just used the ‘N’ word. Yes (shudder), “negative.”

If people are diving into the real estate market now and pay way over the asking price, it is more than likely that they will not experience the same level of growth. As a result, many new homeowners will be stuck with negative equity on their properties for many years to come.

To punctuate that thought the company actually quotes BMO econoguy Robert Kavic, saying, “It’s not hard to see a scenario where froth comes out and the last buyers in (especially in a blind-bid scenario) are faced with years of negative equity.”

Note to Kids: Negative equity occurs when the value of your house falls below the principal amount you owe on a mortgage. In a world where 20x leverage is common and people buy with just 5% down, even a modest market reversal (of, say, 10%) can make this happen. So long as that persists, the property is unsaleable without a cash infusion from the owner on the day of closing.

For example, a $685,000 condo purchased with 5% down would have financing of $651,000 (after paying closing costs with cash). Adding in the CMHC insurance would boost the debt to $670,000. If the market fell 10% the unit would be worth $616,500. After selling it and paying commission of $31,000 the owner would be left with about $585,500, yet owe up to $670,000. Therefore the poor seller would have to write a cheque for up to $84,500 to close a sale. Or just live there and carry a debt for more than the place is worth (paying a premium to someone who leases an identical unit) and hope for the best.

Now imagine a 15% decline. Or the 32% plop that happened at the end of the last crazy spike in Canada (when the market took 17 years to recover).

Seriously. This is where history matters. And negative equity could easily return. (Reread yesterday’s post.)

Oh, wait. Here’s some extra news about urban real estate ownership.

Turns out the pandemic’s been especially gnarly for condos – which may become apparent soon to unsuspecting owners. Condo (or strata) fees are a big deal. They cover common spaces, utilities, insurance, maintenance and usually water, plus security, cleaning and more. The normal charge is 60 to 75 cents a foot, but can range up to a dollar (and often rise as a building ages). So a modest 600-foot box would cost about $400 a month in fees (plus financing, property taxes and other utilities).

The fees are set by the condo board, comprised of elected owners and perhaps the management company. Each condo corp is audited and required to maintain a sizeable reserve fund to cover preventative maintenance and special items. Monthly fees can be increased by the board pretty much at will, and condos can’t engage in deficit financing (unlike our leaders). So when costs rise, they must be covered.

Enter Covid.

The slimy little pathogen has been expensive. PPE for staff members. Pandemic supplies and sanitizer. Enhanced cleaning of common spaces. More security services. And, above all, water. With so many people WFH, the consumption of H2O has turned epic. Imagine a condo complex with several hundred units in it, full of people working in their jammies all day, using the loo and bathing the pandemic puppy.

As chartered accountant and condo consultant Stephen Chesney has pointed out, water consumption has shot up by as much as 40%. “In a typical high-rise building, the water expenses can be between $100,000 and $200,000 per year,” he says. And there’s nobody to pay, other than unit owners.

Unfortunately, many boards will now have to increase monthly condo fees by a significant amount or even pass a special assessment onto the owners to cover the deficits. At a time like the one we find ourselves in now, this will not be an easy task, nor will it be well received by the owners.

So, prepare for the hike. Or, you can rent. Let the poor schmuck who bought the unit worry about the monthly. Pee hourly. Revenge.

About the picture: “It’s been 10 yrs since I sold my house and got on the plan with you,” writes Scott,  from BC’s Lower Mainland. “Here’s one for the blog. This is Seger, our 6 yr old Rotti x Malamute. He’s looking forward to us retiring and more lake days (soon).”