Not normal

Markets don’t give a fig about collusion. Or Lavalin. So let’s jump to what matters.

Last week we talked about an American inverted yield curve. That’s when short-term interest rates (like the central bank benchmark) are greater than what most bonds pay. Especially l-o-n-g bonds – a decade or more. So investors can reap the same returns by investing money for a few months as for an entire decade. That’s not normal.

Why is it happening?

Because Mr.Market believes future interest rates will be lower as inflation and economic growth erode. So long bonds currently available become more valuable (the price rises) since they carry a higher coupon rate than ones to be issued later. As bond prices increase, the yield decreases. And now 10-year ones pay less than 90-day deposits. (If your head hurts a little, you’re normal. Bonds are weird.)

So this has just happened in Canada, too. First time in 12 years – since before the credit crisis hit.

Canadian interest rates have crashed more than almost any other western country over the past six months. There is a 50-60% decline in five-year and 10-year Government of Canada yields. In other words, the sunny ways projection contained in last week’s federal budget was, well, er, ah, more faerie poop. At least, the market ain’t buying it. Neither should you.

Retail sales have dropped. Household debt is at epic levels, and continues to rise. The mortgage business is in tatters because of the stress test, tapped-out households, wobbly housing markets and ill-conceived taxes on buyers from out of the country, secondary homes and high-end houses. (Now Toronto is close to slapping a new uber-transfer tax on $3 million+ properties. It never ends.) The sum of all fears is that families have gorged on too much debt, spent their brains out and will retrench to try and save or pay of borrowings. Since two-thirds of the economy depends on you buying stuff, it’s bad news.

Next: reduced credit as lenders pull up the drawbridge to reduce risk and the ultimate house-killer – rising unemployment. All this has generated a massive turnaround in expectations. The market’s giving 32% odds of a Bank of Canada rate cut in September and even a 24% chance the bank will fold in July. Wow. Just 90 days ago we were being told to expect two more hikes in 2019.

Meanwhile global trade has dropped almost 2% in the last three months (the biggest in a decade). Brexit is a total, bleeding mess. And now 45’s all cocky and puffed-up again, which bodes badly for the China trade talks.

So, yeah, no more rate hikes in Canada. If the yield curve inversion continues (it may not) then we could be about a year and a half from a recession. In advance of that you can expect monetary or fiscal stimulus – rate cuts or increased government spending. The trouble with Canada is that rates are still very low (the bank rate’s just 1.75%, even after five hikes compared to the Fed’s 9 increases) and Ottawa’s already spending tens of billions more than it collects annually. Our economy has shrunk in three of the last four months. This could explain why beaver bond yields have crapped out more than elsewhere.

Anyway, here’s what it means to everyday life.

First, GIC and high-interest savings rates will be falling. Second, so will fixed-term mortgage costs. Thus, third, you might want to go with a variable-rate home loan or lock into one of those cheapo spring specials now being unveiled. Fourth, none of this is long-term good news for real estate. Sure, loans will cost less, but wounded consumer confidence is a bigger determinant of property sales. People worried about jobs don’t buy houses.

Now, lest all the pantywaists who read this pathetic blog over-react, go to cash and head for their bunkers packed with Cottonelle, Milkbones and Star-Kist, be aware. The yield curve thing might once again banana. A mortgage war and motivated sellers could deliver a far better rutting season than we saw last year. And financial markets have soared so far in 2019, with no reason to expect an abrupt reversal. In other words, if you require a house and can afford one, buy it with cheap financing. And if you’re not yet a multi-millionaire and need to grow your money for retirement, well, don’t stop. Ever.

Bad to the bone

About the picture: “I was out running errands today,” says Scott, “and when I looked over and saw this guy with his set up I immediately thought of what a great picture for one of your blog posts. I didn’t have much time to snap a pic, but here it is from the lovely Cowichan Valley in the highly over regulated, over governed and anti-business province of BC.”
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Mueller, blah, blah. Brexit, blah, blah. Inverted yield curve, blah, blah. Lavalin, blah, blah.

Let’s take a few minutes and kick off the new week with insignificance. Macroeconomic navel-gazing. First up is Franco, renting and vexing in a dodgy west end Tranna hood.

“Hey Garth: (Insert standard blog suck up). I have an interesting opportunity I was hoping to get your feedback on. I currently rent a 3 bedroom detached home in Roncesvalles from a friend’s father, who is giving me a stellar deal ($2000 + utilities, and I get to sublet the basement for $1050). It’s a solid house in a great neighbourhood, doesn’t need much reno work but I would probably open the back wall to let some more light in.

“The owner wants to sell me the house. I could never qualify to get into this housing market, as I am a high school English teacher making 50k a year, 37 years old and single (recently divorced). I have about 50k (30k of which is in an RRIF) in investments, and am starting to build a small portfolio of ETFs, etc. The owner of the home is willing to lend a second mortgage to me at a good rate (probably 5%). So I would just have to qualify with the big banks for a downpayment of 20% to him, and then I would pay him additionally on top of the bank.

“I am thinking of offering him 1M or 900k for the property based on the comparables I have researched and the current market conditions. My plan would be to renovate the basement slightly (put in a proper kitchen) and up my tenant’s rent from $1,050 to $1300 most likely.

“Any thoughts? Would I be insane to get into this market now, or should I take the hand that is being extended? I would never have an opportunity like this on my own, and they are basically treating me like family since we’ve been friends for about 20 years. Grateful for any counsel, and would appreciate if you didn’t post this situation on your blog! (My friend might be reading!)”

Okay, we’ll call you Jim. And you must be on drugs. Or just a dreamy, detached, financially illiterate English teacher.

I mean, get a grip, Jimbo. You have a grand total of $50,000, most of which is (for some reason) in a RRIF and doesn’t even qualify for the Home Buyers Plan loan. That means closing costs alone (double land transfer tax – after the first-timers rebate – plus legals) would eat up all your after-tax cash. On top, it sounds like you plan on borrowing the downpayment (20%) plus taking a second mortgage – plus looking for primary financing.

The bottom line will be 100% debt. So, a $1,000,000 mortgage. First, you don’t qualify to carry that amount of financing. Second, you’d fail the stress test in spectacular fashion. Third, the landlord/owner has obviously discovered you’re a total rube and is happy to unload this place on you without conscience. Fourth, you have zero money for renos. Fifth, if you make structural changes and put in a kitchen for the tenant, the property’s appreciation (if any materializes) will be subject to capital gains tax. Sixth, did she divorce you over money? Would make sense.

About the picture: “I am not a pet person but I just had to take this photo and email it to you for the blog,” says Jason. “I was in Bangkok a few days ago in Chinatown and saw this. I titled it ‘Dog in a hog’.”

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“Here is my situation’” writes Michael.

“I turn 52 this year.  I paid off my home this year….but I have contributed nothing to my RRSP in the last 10 years.  However, I have a LOC outstanding with 100k on it.  Question….do I now max out my RRSP and then use the tax rebate, apply it to the LOC….making small payments  to the LOC or Max out payments to LOC, paying it down, contributing small amount to RRSP.

“I have about 150k in RRSP contributions unused. I feel totally screwed about what to do here.  My slanty semi is in need of major renos and is showing it’s age now.  Every week something needs repair….that can’t be put off.”

Lots we don’t know about you, but assuming you want to retire in about a decade and (like most people) don’t have a DB pension, you’re way behind the curve in terms of liquid assets. If you have the cash to max your RRSP room, do it. That $150,000 will net a big refund (depending on income) – maybe thirty grand. Maybe more. Plunk that against the LOC.

If that line is unsecured, it likely has a rate of prime plus 2% or more – putting it in the 6% range. Change into a secured line against the house and the rate should decline to prime plus a half, or less than 4.5%. Of course, you could convert it into a new mortgage at sub-3%. If the principal amount were increased by a hundred grand or so, you’d have (a) reduced the cost of debt servicing, (c) found another $100,000 to grow for your retirement and (c) created a tax-deductible mortgage.

Worst choice: feeding the house.

About the picture: Here is some evidence he is still alive. “This could only happen,” says Smoking Man, “in southern California…”

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“Long time fan of your blog which I must say has been an interesting read over the last 5+ years,” writes Howard, who has a spouse problem. Maybe.

“I’m thinking of buying a home in Oakville.  Wife says rent as prices are crazy expensive. Need I say Help!!! We sold our home in Milton in Feb 2018 and been on rent so far. Our budget $800,000 max will get us a new 1800sqft+ freehold townhouse in a decent area within a 10 minute drive to GO station as me and wife both work downtown Toronto. Both have decent jobs. We can qualify for more but don’t want more.

“So here are some numbers – if we Rent, for a family of 4 (yes we’ve 2 teenagers) it’ll cost at least $2600-2800/ month to get a similar home in same area. Utilities are same for buy and rent. If we buy our monthly mortgage payment will be around the same amount with a 20%down for a $800k townhouse.  Plus $400/month for taxes and insurance.

“We intend living here for at least 5 years. So the rent outlay will be (2600*60= $156,000). So total monthly outlay In both situations will be about $3000 per month. If we buy we will have reduced our mortgage over 5 years and have some equity and worst case scenario 2-3% annual appreciation which is very typical for Oakville. If we rent – what do I have to show after 5 years?

“Really appreciate your insight as we have to take a decision very soon as our lease is coming up and wife and kids are 100% decided on moving to Oakville- better schools and less daily commute from Toronto for both of us. It takes 25 minutes in express train. Helppppppp…….”

Listen to her, H. And run the numbers again.

You’ll need at least $180,000 to close the deal, then a mortgage of $640,000. The payments on that are $3,100. Add in property tax (Oakville is expensive) plus insurance, and it’s at least $3,600. Remember you have given up the growth on $180,000 – which needs to be factored in. So add $900/month. Thus the cost of ownership is $4,500 a month. With no renos, no maintenance and no surprises.

That’s a good 60% premium over renting with no guarantee whatsoever townhouses selling for $800,000 in 2019 will command $950,000 in five years. You’d need that amount to break even after paying commission and to make up for the monetary advantage of renting.

The bottom line: there’s no financial case for buying. Invest the down payment instead – starting with fully-funded, fat RESPs for your teens. Your first obligation is to the family you created. She knows.