Gravity

Well, remind me to never again write about climate change. Or Trump. Cannabis. The stock market. The UN. Bonds. The Fed. Gold or guns.

Dogs seem okay, though. Plus hormones and real estate (sometimes). If I stray into other subjects and I’m sure to be ripped a new one by all the macroeconomists, political scientists and Nobel Laureates who have pilgrimaged to the steerage section of this pathetic blog. We are blessed to have you all in one place. Just like a Texas juvenile detention centre. Fun!

In a moment, some insight from a realtor, of all people. First, this piteous letter just arrived:

The last time I e-mailed you, you posted my e-mail on your website and basically made fun of me for not being financially responsible. I am e-mailing again because my situation has changed and I want some advice.

I’m looking for a plan for a young couple to cruise into retirement. Can you help?

We are currently living in Calgary. I am a teacher (28) making roughly $85,000 a year; take home cheque is roughly $4450/mt. She (27) is a nurse making $65,000 a year; take home cheque is roughly $1600/bi weekly.  We have about $16,500 total in TFSAs and $7,000 in an emergency fund in a savings account.

We own a 1000 square foot bungalow purchased last year for 375,000 ($350k mortgage). Houses around selling for that still. We also own a condo purchased in 2015 for $300,000 ($210k left on mortgage); similar units now listed for $260,000. We currently rent it out for $1400 a month. We are losing $220/mt (Condo fees, cash call, insurance, tax, etc.).

We both have a car payment student loans. I want to sell both places, take the loss and start renting. I am very worried about our future. I do not know what to do about the condo. I cannot see our renter renewing her lease when she could find another place cheaper. We also want to have kids soon.

Help me with my life Garth! Be the good man you know you can be.

Seriously. This dude came here once for advice (‘should I sell my Calgary condo?’), was warned and scorned, slunk off and ignored it. Now he’s back, looking for a path from age 28 to retirement. And he throws his miserable financial carcass upon my goodness. Sheesh.

Obviously this is a nice little example of how the nesting instinct can destroy your finances. Calgary is a rotten real estate market and has been so for most of a decade. These unfortunates not only bought a house with 5% down, which will deliver a loss when sold, but they also hung on to a loser condo. Now they gutted their savings, the unit’s worth way less, plus they’ve been shedding about $750 every month ($220 in cash flow loss and $90,000 in equity making zip). After a sales struggle and commission, the losses will deepen.

All in, real estate will deliver at least $120,000 in net losses, little of it deductible. Once all is sold they’ll clear maybe $5,000 in equity from the two properties after commissions and mortgage break fees. Given their level of savings, this escapade will set them back at least five years. Now they want children and retirement. Thank their lucky stars they’ve snared government DB pensions. But they’re still pooched.

And, finally, I have no idea what he’s asking of me. A blessing for stupidity? If he’d listened to the advice of a year ago, sold the condo, took a small loss, rented and saved, life would be more promising. Calgary ain’t coming back for a long time. More importantly, these kids don’t have the resources or cash flow to be buying properties.

The Big Mistake? Being human. People cannot admit to ever having made an investment mistake, so they hang on. Stocks, condos, MICs. Even when the red ink flows thicker monthly. By refusing to sell, take a loss and get out, they gamble further. It rarely ends well. Especially now. The housing bulls are facing their greatest challenge in a generation. It’s debt.

Instead of using ten years of cheap rates to tackle, eradicate, reduce and crush their indebtedness, Canadians did the opposite. They’ve borrowed their snouts off. Household debt at $2+ trillion is bigger than the entire economy and most of it (67%) is in long-term mortgages – destined to reset at higher costs. Now the era of emergency rates is over. Maybe for good. Meanwhile the asset most of that debt was used for (real estate) is under pressure. It’s a vise. Relentless. Will tighten again in nine days.

Toronto realtor John Pasalis posted a nice chart-based summary of this mess:

Click the chart to enlarge.

Real estate’s historic 3% appreciation rate soared to 7% as the Bank of Canada dropped its key rate to 1%. Then as oil collapsed in 2015 the bankers shocked everyone by crashing the rate 50%, to just half a point. Housing became a speculative mania as debt soared off the charts. After all, if you could borrow at 2% and grab a house that was appreciating at 30%, why not?

“It didn’t matter that any rent that could be gained wasn’t high enough to cover the carrying costs of the home (mortgage, taxes, etc.) because the value of the home was increasing by more than the money they were out of pocket each month.,” Pasalis points out.

The period of loose credit and very low interest rates led to a surge not only in house prices but a surge in debt as many of these investment properties were financed entirely with debt. In many cases, home owners were borrowing $150-$200K against their existing home to use as a down payment on the investment properties they purchased.

But every housing bubble is almost always followed by a tightening of credit. Policy makers typically increase interest rates and/or tighten the qualifying requirements for any new credit in order to cool down the growth in household debt. This is precisely the trend we have seen since the summer of 2017.

The Bank of Canada began to increase their overnight in the summer of 2017, eventually increasing it by a full percentage point in one year. Then, on January 1, 2018 the Office of the Superintendent of Financial Institutions introduced a stress test on mortgages that required all uninsured mortgages to be approved under a new “stress test” interest rate which is roughly 2% higher than the contract rate of the mortgage.

So here we are. Mortgage costs rising in the last few days. The central bank moving next Wednesday. More hikes coming in the first half of 2019. As the Toronto broker points out, a couple earning $125,000 three years ago could afford an $800,000 house. Today they can spend $625,000. In a year that could be $580,000.

There is nothing. Not economic growth. Not Trumpenomics. Not immigration. Not buyer incentives. Nothing that can compete with the lethal combination of debt and rising rates. The letter at the top of this column is the future. Don’t make it yours. Gravity’s back.

The future

James, brilliantly, sold his house last year and invested the money – about a million. Since then the value of the old digs has gone down and his portfolio’s gone up. “I’m okay,” he says. “Even learned to live with that up-down stock market volatility thing. Selling was the right move.”

In fact he and his partner now lease a better place than they owned. The portfolio pays the rent. Live for free. But James is starting to worry about larger and darker things than the real estate market or the VIX. I received this letter over the weekend:

Climate change and its effect on markets in the next twenty years (my own personal drop-dead date) and how to protect one’s income from looming disaster have me up at night. It is pretty clear from the latest IPCC offering that unless we do something big soon humanity is doomed and with Trump types driving the bus we are going over some form of cliff very shortly.

In my view:

  • Tropical zones will be uninhabitable perhaps within 15 years.
  • Mass migrations will occur (This is excluded from the IPCC report but its obviously going to happen as the tropics heat further and the sea rises. Bangladesh will disappear for instance.)
  • Manufacturing and trade will be massively disrupted.
  • Financial markets will suffer. (Note I didn’t say “crash”.)

Even if we do all the right things and limit emissions that will still on its own have a massively detrimental effect on markets. We can’t achieve a limit on warming emissions while continuing business as usual without curtailing fossil fuel use. Manufacturing will decline, shipping will decline, all forms of business that currently depend on fossil fuels will decline. Global tourism will decline as jet air travel is curtailed.

You tell me what the effect of all that will be on financial markets but I think values will decline and we will enter a planetary depression that will dwarf 1929. I am not sure we can fix this with more solar panels especially with people like Ford throwing sand in the gears.

So what does the small investor like me do to survive? I have one and a quarter million dollars invested, much as you suggest, we own no property, its all paper. I have never been a doom and gloomer nor a nuclear-apocalypse homesteader type but I am now worried that the proverbial will hit the fan long before I expire.

Staying invested is clearly sensible for the next decade but beyond that good planning would suggest thinking up a parallel plan B. Buying a small farm in Northern Quebec isn’t my gig and I would be too old to work it by the time I needed to but maybe my grandson could survive there?

Cheerful aren’t I? What are your thoughts? What can I do?

Well, first, if you’re a rednecky reader, think Trump’s a deity, believe carbon taxes are theft, the Paris Accord was a trap, the UN scientists are bogus and climate change is a hoax, just ignore this post. Go hunting. Or bowling. Under-oil your truck before winter. Teach your dog to fetch beer. Rest your knuckles. Generally stand down and let the lefties worry that hurricanes, drought, temp changes, wild fires, mud slides, typhoons and rising seas are, like last week’s international report claims, actually related and portend the future. After all, if you think climate change is bogus, you’ve nothing to fret over.

But if, like Jim, you see scary decades ahead and a retirement running smack into an environmental crisis, how might you prepare?

He’s not alone. A Global Investor Survey discovered almost 70% of professional money managers think climate change is “a material risk or opportunity across their entire investment portfolio.” The IPCC report last week figured this could cost the world $54 trillion (yeah, with a T) in lost economic activity and damage globally. It’s estimated retail investors (like us) will be dinged $4.2 trillion over the next five or six decades as the world heats, melts, floods and changes. A Stanford U report says world income could fall 23% during this century, and storm damage be epic (as with Michael, a few days ago).

Here’s an interesting quote from Henry Paulson, the guy who was Bush’s Treasury Secretary during the Lehman Brothers collapse and former CEO of Goldman Sachs: “As someone who has spent a good deal of time assessing risk and dealing with crises, I’m struck by the similarities between the climate crisis and the financial crisis of 2008. The greenhouse-gas crisis, however, won’t suddenly manifest itself with a burst, like that of a financial bubble. Climate change is more subtle and cruel. It’s cumulative.”

What to do?

The best strategy at this moment is to maintain a globally-diversified portfolio. You have no real idea where changing weather will have the greatest impact, so why try to guess? Every serious investor should have exposure to Canada, the US, Europe, Asia and emerging markets.

Second, understand why balance will help mitigate risk. Maintain a small pile of the right kind of bonds to dampen stock volatility plus own preferred shares for tax-efficient income and to offset rising rates (they are inevitable). Invest in REITs because they’re not correlated to stock markets and can provide return-of-capital distributions. And keep a little cash at all times, since it’s a defensive asset and can almost pace inflation now that HISA yields are rising. Use ETFs – don’t try to pick individual stocks. Elon Musk may be a visionary, for example, but he’s just a toke or two from blowing up Tesla. Of course, stuff your TFSA and mainline RRSPs as well if you don’t have a DB pension.

It’s probably a safe bet this portfolio will protect you and (hopefully) double your money over the next decade, six-tenths of which could be Trump years. If that’s the political reality, you can be sure zip will be done about climate change on a global basis.

After that, harder choices.

A decent idea will be to start dumping investments in companies and industries that feed climate change and will inevitably be punished for it. Coal’s a good example. Conversely, you can invest in industries that will be pushed to the forefront by government regulation, like wind and solar. Meanwhile don’t get too excited about so-called ‘ethical’ or ‘green’ strategies or funds – most of them give a dismal rate of return and do nothing to save the world.

Green bonds are an option. The market is small in Canada, but promising. So far Ontario and Quebec have issued them, along with one federal government agency, TD Bank, CoPower and Manulife. Returns aren’t bad – in the 3%-4% range – and the capital raised is used to fund environmentally-sustainable enterprises. Jut relax for now, and expect many more of these climate change assets to materialize.

As for have a stash of cash, Winchester Defender, months’ worth of food, a kick-ass vehicle, self-sufficient homestead, safe perimeter, survival skills and tasty beasts in the barn, well, you’d better befriend a redneck. Just don’t tell her why.