Entries from December 2014 ↓

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Just two more sleeps until 2015. Amazing. Twenty years ago I sat at my shiny new Macintosh and wrote a book called “2015” which sold so many copies my publisher genuflected every time I saw her. Seriously embarrassing.

Anyway, the book peered into a future when the Boomers would start turning into diseased wrinklies by the boatload, and made some predictions. Financial assets will do well by then, I said, and begin a long up-trend, while commodities and residential real estate will begin an equally powerful decline.

Of course, nobody understood two decades ago about what would come – the dot-com bubble, the collapse in interest rates, the financial crisis of 2008, the US housing crash or the eruption of house-horniness in Canada. But I did know that 32% of the population would end up approaching the age when you need thirsty underwear more than a four-bedroom particle board McMansion in Mississauga.

So here we are. And I’m sticking with the plan.

You might be interested in these overall returns for 2014 – major stock markets, a couple of commodities, and real estate in the country’s biggest and most vibrant housing market. These numbers come after a year in which we saw oil prices destroyed, mortgage rates hit historic lows, inflation morph into deflation, the Parliament Buildings shot up, stock markets tumble twice and the Pope said dogs go to heaven. I knew that.

Toronto stocks (TSX S&P)
+ 10.78%
Dow Jones Industrial Index
+ 11.37%
S&P 500 (broad measure US stocks)
+ 15.4%
Gold
(-2.5%)
Oil
(-40.9%)
Toronto real estate
+ 7.4%

My expectation is that this general trend will continue, with the exception of house prices. As I’ve told you too many times, demographics are negative for real estate, and the positives – cheapo rates, pent-up demand and easy debt – will diminish. Mortgages will not go any lower than they are now, and in fact will cost more in a year. A whack of house-rich, asset-poor and pension-starved Boomers will have little choice but to be trading in house equity for income over the next decade. Too bad they own all the wrong kinds of properties. Oh well.

Meanwhile the global recovery will accelerate, sparked by the US economic renaissance and greased with half-price energy. Corporate profits have been robust, and as Europe, then China, revive thanks to bargain oil and increased US import demand, markets should continue to do well. Besides, billions of new dollars will find their way into financial stuff as the big generation of half-dead hippies like me get wealth out of under-performing real assets and into things that pay them.

This coming year, seems to me, could be a watershed one. For the first time in six years, the cost of money will rise. For the first time ever, the Dow could pass the 20,000 mark (I think I suggested that in 1995). This year China will likely become the biggest economy ever. By mid-2015, house prices in all Canadian cities will be lower than a year before – for the first time. Ontario, for the first time in years, will again be subsidizing Alberta. And, of course, we’ll have a federal election, complete with a $10,000 TFSA limit next January.

So bonds yields will go up, as will equities. In advance of that, fixed-income assets like preferreds and some REITs will get cheaper. Yummy. The first mortgage rate increase will ignite a flurry of buying as the moist virgins panic – ensuring they buy at the top with the greatest possible amount of debt. Smart. Following that, a broad and lengthy pall will fall over the housing market. Oil, ever volatile, will probably stay cheap. Gold is finished. And, for a while, the dollar’s toast.

By the way, you should have known me in 1995. I was so cocky and sure of myself. Hard to imagine now.

Think rich

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Three days ago, before I became disgusted and quit writing until now, this blog compared investing in a house to putting your wealth in financial assets over the last seven years.

There was a reason I did so. To show that even with the worst stock market dump in 80 years, a balanced and diversified portfolio did just as well as a house. In almost all markets, it did better. Plus, it was liquid, flexible and provided income, while a house could be illiquid, immobile and costs a whack of money to own – interest, property tax, maintenance, insurance, closing fees, pressure-treated two-by-fours and a new kitchen with stone backsplash. The message was intended to be simple: don’t put all your eggs in one basket, especially when you need massive debt to do so.

So why was I too disgusted at carry on?

Because I was bombarded with messages like this: “You are a charlatan, Garth. Manipulating math, as always. Even you are not taking mortgage leverage into account (but everybody does when investing into housing.) Glad I didn’t listen to you.”

Sigh. I have concluded (it took me a while – I’m thick) that most people will never, ever understand what I yammer about. They don’t comprehend what risk is, so they jump in. The house culture that’s developed around us makes most middle-class couples think like those commenters over the last three days. There’s only one financial strategy for those people – real estate, and the borrowing required to get it.

In fact, have you noticed mortgages are now good debt? People speak of leverage like it’s a sure-fire tool for ratcheting up wealth. It’s the cult of the 5%-own condo buyer, who truly believes her ‘investment’ will only ever increase in value, despite overwhelming evidence to the contrary, and the fact home loans aren’t tax-deductible.

The real estate myth has also spawned a false belief house gains are tax-free while investment profits are taxed away by 50%. In truth, to buy a $500,000 house in Toronto, for example, costs $12,500 in tax just to sign the deed, and another $25,000 in property tax over five years, plus a further $25,000 in commission to sell, plus HST, and none of it is deductible from income. That means the house has to appreciate 12% to break even. Meanwhile most investors keep 85% of their gains from investment portfolios, after tax, and can deduct all costs incurred to own it.

But this is not my point today. Let’s go back to risk.

Because most Canadians live beyond their means, and yet feel entitled to a house with Moen taps and granite countertops, whatever the cost, they borrow from the future to finance today. This works so long as the future behaves. But you have no control over that. So the more you borrow, the greater the risk.

Americans did the same a few years back, bidding houses higher and swallowing big loans to get in on a sure thing – just like us. Then the market topped, slid lower over the course of a few years, and wiped out families who gambled on tomorrow. Because middle class Americans, just like us, had so much of their net worth in a single asset and too on so much leverage to get it, this was a killer.

A New York University prof, Edward Wolff, has done some interesting research for us. He found rich people (the top 1%) have just 9% of their net worth in their houses, while middle-class Americans have 63% there. Worse, rich people account for just 5% of outstanding consumer debt, while middle-class families hold 74% of it. So, it’s true. The rich own equity. The rest own debt.

In fact, rich people have 47% of their net worth in business assets and another 30% in financial stuff. They are as massively diversified as the average schmuck is not. Not surprisingly, the rich are getting a lot richer lately. The rest of us, not so much. Just more indebted.

So when this one asset that most people have hitched their star to falters, the consequences can be extreme. And that’s why we have such income disparity in American following the big housing blow-out of 2007-10.

Says Wolff (as summarized by The Wall Street Journal):

The research helps explain part of why the recent recession, which hinged on a housing bust, was so much more difficult for the middle class than a typical recession. It also helps explains why the recovery has been do disappointing to many. Housing has regained its ground only slowly while corporate profitability has boomed. In other words, we’ve seen slow growth in the major middle class asset, but substantial growth in the assets held by the wealthiest.

By the way, here’s how assets and debt shake out among Americans. I fully expect that if we had similar, current data for Canadians, you’d see the same pattern. Take a look at where the debt sits:

OWN THE DEBT

Well, there ya go. If our economy does great over the next decade, with sustained low rates, robust growth, lots of new jobs, revved-up commodity prices, real estate appreciation and steadily higher incomes, then all the house-lusty people have nothing to worry about.

But, in case not, ape the rich.