Entries from May 2018 ↓

The gap

Sunday afternoon. The uppity part of town. Two provincial politicians, opposites, face a daunting crowd to debate a polarizing issue. To wit – should some people pay extra tax because they own more, regardless of what they paid, or earn?

In BC, and especially Vancouver’s Westside, this is burning issue of fairness. The people who own houses pushed absurdly higher by a delusional real estate market says it’s grossly unfair they should now pay more property tax, just ‘cause. Those who wish they had houses say it’s only fair ‘multi-millionaires’ cough up as much as possible, to bridge the wealth divide.

These days the Dipper government is 100% on the side of the have-nots, wannabes, envious and angry. After all, this is politics. There are way more votes on one side of the ledger than the other. Odds are overwhelming the extra property tax that people living in $3 and $4 million properties now face ($2,000 more a year) will stay. The protest that surrounded Sunday’s event is a lost cause. This is class warfare – the first inklings of a progressive wealth tax in Canada, based on real estate.

The new BC levy is an asset tax. It matters not what someone who owns it paid to acquire it, or what they earn (they could be retired and on a fixed income). For that reason the provincial Libs label it a dangerous precedent and some warn such a surtax will migrate down to include $1 million houses (over 90% of all detacheds in YVR would be captured). The radical moister organization ‘Generation Squeeze’ is calling for more – a new 1% surtax on all houses valued at more than seven figures, adding $10,000 a year to the average homeowner’s overhead and essentially doubling their property tax. Because, of course, real estate now = wealth. And the wealthy (mostly Boomers) should hand it over.

Witness some comments in the local media this weekend:

Awww is mean and nasty (NDP cab minister David) Eby going to take some of your precious money if you have a house worth more than $3,000,000. Good for Eby, he should be taxing the wealthy home owners to help fund affordable housing for average people. Working people can no longer afford to live in Vancouver any more, unless steps like this are taken, there will be no one to provide services. Go get them David. I love hearing the wealthy squeal. HaHaHaHa.

Of course, all the money collected in the tony hood wouldn’t build a single six-plex and won’t put anybody into an affordable house but, as you know, that ain’t the point. It’s revenge. This is what happens when wealth inequality builds, then amplified by a phemon like the Canadian real estate bubble. When the masses think of life’s economic unfairness, they have a most visible symbol. Houses.

There is no wealth tax in Canada, yet. Property tax – a levy based on the market value of land and buildings – is the closest cousin. The inherent unfairness of taxing an asset divorced from its acquisition cost of the financial means of its owner, has been recognized by government. That’s why seniors or folks of modest incomes in BC can defer their property tax bills until they sell – when the accumulated amount is deducted from the sale proceeds.

What the provincial NDP is doing is new. The property tax surtax, payable when a property rises to a certain valuation (determined by a government agency), is just a penalty for an event the owner had nothing to do with. Unlike regular property tax – which funds schools, garbage collection, cops and area first responders – the Westside Wallop will go into general government coffers. So it’s existence as a wealth tax is confirmed.

Now that we have a new uber tax bracket in Canada, thanks to T2, and the marginal rate on incomes has drifted up to the 53% mark, there’s not a lot of room left to Hoover up what higher-income people earn. Despite that, the Ontario NDP (if elected) are proposing to boost the top rate to a withering 55%. (We may be 11 days from a fateful night in Toronto.)

So, like the Gen Squeeze people insist, wealth taxes are coming as the Canadian political landscape leans left. As stated, that will target real estate.

And here’s the irony – that’s not where the wealthy actually keep their riches. Check out this chart from New York University’s Edward Wolff. While the data is American, the results would be even more skewed in Canada, where house lust is unbridled.

The conclusion? Real estate ownership is a middle-class obsession. The top 1% of society have just 10% of their net worth in property. The bottom 90%, in contrast, are obsessed with houses – with almost 60% of wealth tied up there. It’s no coincidence, either, that the amount of debt carried by the rabble (74%) is crushing, as people over-reach, over-leverage and over-pay for assets they could rent and use for a fraction of the cost.

Tax the wealth? Be careful what you wish for, kids.

A value play

RYAN  By Guest Blogger Ryan Lewenza

In my last blog post I laid out my investment approach, which combines macro, fundamentals and technical analysis. Apparently this was a bit of a snooze fest for readers as it only garnered a paltry 59 blog comments. Garth’s blogs often generate over 200 comments and Doug and I are resigned to the fact that we cannot match Garth in his wit, biting prose and chiseled abs. Having come to grips with this harsh reality, I must persevere and stick with what I know best – providing boring (yet insightful??) financial analysis, in the hopes that a handful of readers will find the analysis and commentary helpful. Having got that off my chest, today I further flesh out my investment approach by examining the macro, fundamental and technical factors for value stocks, which we believe are starting to look tasty.

Growth stocks, which include the likes of Amazon, Netflix, Facebook, etc. have been the place to be over the last decade. Since 2009, the S&P 500 Growth Index has returned 344% on a price basis versus the S&P 500 Value Index up 259%. Value stocks pay higher dividends so when including dividends the outperformance narrows but still growth stocks have been the clear winner over this period. Looking at the last 10 years, growth stocks outperformed value stocks in 8 of those 10 years, which is very rare.

Over the long-run this should not be happening. In a seminal research report from economic professors Eugene Fama and Kenneth French, it was determined that large-cap value stocks returned 11.8% annually going back to 1927 versus large-cap growth stocks at 9.2% annually, an outperformance of 2.6% annually. They concluded that value stocks are the place to be over the long-run. It seems like someone forgot to tell the Elon Musks, Jeff Bezos, and Mark Zuckerbergs of the world.

So given this massive underperformance and our contrarian nature, we’re starting to kick the tires on value stocks to see if this trend may reverse, providing a good buying opportunity. Let’s see what the factors say.

Growth Has Crushed It

Source: Bloomberg, Turner Investments

First, from a macro perspective now should be time for value stocks to be outperforming. Value stocks tend to be concentrated in the more cyclical sectors of the economy including financials, energy, and industrials. With the global economy growing at the fastest rate since 2011 this should bode well for these sectors. Also, we believe we’re late cycle which historically is when these sectors shine.

Another macro support for value stocks are interest rates. Value stocks tend to outperform in a rising rate environment. This is captured in the chart below which shows the relationship between interest rates and the relative performance of value to growth stocks. Note the 2003 to 2007 period when interest rates were steadily climbing and how value outperformed growth over this period (rising green line captures value outperforming growth). Well, with the US 10-year bond yield now above 3%, the highest level since 2011, this should be supportive of value stocks. In fact there has been a notable divergence (second dotted box) between interest rates and value stock performance, which we believe could be creating a buying opportunity in the form of a “catch up” trade.

Value Tends to Outperform When Rates Rise

Source: Bloomberg, Turner Investments

Next we move on to the fundamentals. With growth stocks knocking the lights out over the last decade they are now quite expensive based on a number of fundamental metrics. Currently, the S&P 500 Growth Index trades at a P/E ratio of 25.5x, a 7x P/E premium to the Value Index at 18.5x. Typically, values stocks trade at a discount to growth stocks given their lower earnings growth, but the current discount looks extreme.

When you consider their earnings growth, value stocks look even more attractive. For 2018 both the value and growth indices are projected to grow their earnings by roughly 30%, so you would be getting cheaper valuations through value stocks with similar earnings growth potential.
Finally, with the current bull market now in its 9th year, we believe playing the equity markets a bit more defensively makes sense so higher dividend yields is one way to do this. Currently value stocks are yielding 2.6% versus the growth index at 1.3%.

Things look like they are starting to stock up in favour of value.

Value is Trading at a Sizable Discount

Source: Bloomberg, Turner Investments

The final piece of the puzzle is technical analysis, and currently they continue to favour growth stocks as seen below, with growth stocks still in a long-term uptrend versus value stocks. As I like to say “fundamentals tell us what to buy and technicals tell us when to buy.”

So we patiently wait for now for the technicals to turn in our favour, thus providing the final trigger for us to implement this in client portfolios and increase the odds in our favour for a successful trade.

Value Still In a Downtrend – Waiting for the Breakout!

Source: Stockcharts, Turner Investments

Of course we can’t just give away this advice for free, so if you want to know when and which ETF to purchase for this investment theme, you’ll have to give us a call. And it will only cost you 1%. Speaking of a value play!

Ryan Lewenza, CFA,CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.