Entries from November 2018 ↓

The capitulation

Is it over? Well, almost?

That’s what Mr. Market is asking about that long string of future rate hikes everybody expected a month or two ago. The return on US ten-year bonds has dropped like Tony Clement’s shorts and now sits closer to 3%. The yield on Government of Canada five-year bonds (which influences fixed-rate mortgages) has retreated decidedly from the 2.5% neighbourhood.

On Wednesday US stocks surged 600 points (and 200 on Bay Street) after dovish Fed comments. Speculators on futures markets have been betting four more hikes next year are turning into just two. And Donald Trump’s amped up the vitriol when it comes to bank boss Jay Powell. “I am,” he said this week, “not even a little bit happy with him. They’re making a mistake because I have a gut and my gut tells me more sometimes than anybody else’s brain can ever tell me.” Hours later Powell threw in the towel. We’re almost there, he said.

Higher rates would prick Trump’s bubble at the worst moment. His big tax cuts and fiscal stimulus wallop of last year are wearing off.  The one-man global trade war has ended up making investors nervous and goosing input costs for big US corps like General Motors (look what just happened). The decade-long economic expansion grows longer in the tooth. And nine Fed hikes are taking a toll (house prices in bellweather places like Seattle and Dallas are fading). Trump wants greatness at all costs – record stocks, inflating wages, full employment.

Bond yields slip. Mortgage pressure off?

Meanwhile in Canada, yuck. The oil patch is a mess thanks to crappy crude prices, clogged pipes and political constipation. The GM announcement on Monday was taken as a sign the new USMCA may have Trumped us. And the feds just abandoned even trying to balance the books, assuring deficits of close to $20 billion a year will be the Trudeau legacy. Last week Morneau brought in billions worth of corporate tax breaks – something that would be unneeded if the economy needed higher rates to chill.

But, back to bonds. They tell us a lot.

When stock markets were roiling last month, rivers of money flowed into the safe stuff. Now a bunch is flowing back, since equity values are more attractive, sentiment has improved and corporate profits continue to please (RBC just hit it out of the park). If Trump and Xi come to an agreement this weekend at the G20 summit – any deal, even a tepid one – markets could roar into a year-end romp.

What does it mean?

If rates moderate and the trade tantrum fades anyone who bailed out of their portfolio in panic last month will regret it. Unloved equities and oversold preferreds are assets to be bought, not punted. The best strategy of all is to get a balanced and diversified portfolio, then fuggedaboutit.

As for real estate, well, the big banks are having a year from hell in terms of new mortgage originations. The golden goose croaked was sautéed by the new stress test which wiped away about 20% of the market. So while higher interest rates help bank spreads, more costly mortgages erode one of their most important long-term sources of revenue. Rest assured if bond yields continue to back off, a home loan rate cut is coming.

Second, if we’re looking at one, two or maybe three more central bank increases before this cycle ends (instead of five or six), it makes sense to borrow with a variable rate. This now feels less like gambling, and means borrowers can enjoy lower payments for a long time. Those VRMs are still out there for about 2.5%.

In short, interest rate risk is falling. But before you pull your party pants on, be aware market risk is rising. House sales are slowing, prices are under pressure, credit is restricted and family finances are tight. If GM means anything, that’s not cool. And our oil situation won’t turn around fast, which is a threat to the whole economy – just like the feds adding $100 billion to the national debt, guaranteeing (even) higher taxes. At the same time, a quarter of all mortgages come up for renewal in the next few months, and most borrowers will see their payments rise.

So, curb your enthusiasm.

Finally, this pathetic blog yaks about Vancouver and Toronto too much, as you know. This is not all of Canada, as yesterday’s post tried to make clear.

“Just thought I’d send you a note on house prices in our little city,” writes Dan from Saskatoon. “These are CREA stats, I’m surprised they still publish them with their push for the lipsticked pig of HPI.  I saw a lot of articles recently about how Canada has achieved a soft landing (they even called it “Magical”) which seems premature. Tell someone who lost $50,000 in two years (15% so far), that it was soft and even magical!”

Things are not so 'magical' here


The escape

Over the course of eight years as a hired financial gun I spoke an average of 100 times every twelve months, before deciding running a blog was a helluva lot simpler (and so much more glamorous). From crystal hotel ballrooms to grimy church basements with a borrowed bedsheet as my projection screen, I saw the nation.

Tough gig. But instructive. A lesson quickly learned was how local most of us are. In a world where mobility’s never been easier, people are like trout. They just want to swim home, live in their puddle and raise fingerlings. Sometimes that works out great. Other times, and places, it’s a disaster.

When asked why they stay in unlivably expensive Vancouver, for example, most people say ‘family’ keeps them. Because bonds of proximity have never been broken, they’re afraid to try. So they end up struggling in a city which pretty much guarantees financial insecurity.

While not being much fun, spending years on the road (with your spouse as a roadie) sure widens the view. Tired of being chained to the Big Smoke, a few years ago we contemplated where to set down other roots. The decision was a seaside town of two thousand souls. It was perfect. Now we spend lots of time in a place where nice houses cost four bills, nobody really needs a car, doors don’t lock and I’ve never smelled weed. It should’ve happened decades earlier. If I were a young man again, living in a time when technology made location irrelevant, the best road in the city would be the one in the rearview.

I thought of this as I read Joe’s letter.

My partner and I are 38 with kids: 5 and 3. We live in a Toronto house that we purchased back in 2008 when the world was burning. We were younger, dumber, and less aware of sound personal finance principles or what sort of sheer financial and personal chaos and upheaval becoming parents would be. As the story turns out, we were also very lucky. In the last 10 years, the value of the property has appreciated to more than double what we paid and our real estate agent thinks we can get about 850-900k based on houses just sold on our street.

Our mortgage has 130k left on it. Over the decade we’ve put in 130k from the combined property taxes, insurance, utilities, repairs, and renos – roughly 13k/year. If we were to find a fool to pay the theoretical going price and factor in the 3% commissions/fees, pay off the balance of the mortgage, subtract the decade of property-related costs above, we’d make out with about 6.2% annualized returns since 2008. Not terrible that our living arrangement also nearly matched what a long-term market average may provide, however, since 2008 the S&P500 returned about 13.9% annualized.

We are no longer enamored with the idea of owning a house and with the real estate bubble in the process of bursting, it is an opportunity to cash in. Living in this City with a couple of young kids and both of us spending way too much time working, commuting, and rushing around in a constant state of exhaustion has significantly eaten into our wellbeing and health. Let’s not mention the $24k a year in before/after/daycare fees – and I’ll keep mentioning it because it hurts – multiply that by 4 to get an idea of the total spent over the last 5 years with 2 youngs and no free-extended-family daycare situation to speak of.

We net about 130k after all deductions and have worked our savings rate back up to 30% with being frugal and have amassed 400k.  We have a few places in mind that we may consider relocating to where housing and/or cost of living are lower and our job prospects remain reasonable and we have social connections. Some options include Lunenburg, Halifax, Charlottetown, Niagara Region, or similar rural towns in Southern Ontario. Schools and family Doctors are an important factor. Renting a house will be our strategy. No more buying property, considering our net worth, unless we can nab something for a pittance the next time the world is set on fire.

Cutting out 1 or both of our commutes is the goal as well as removing the $24k Toronto childcare cost by one of us having flexible or reduced hours. We can afford to chop out 24-30k of our net income if we don’t need to use childcare. These are possibilities given the various trades and skills that we have and can leverage working from home or doing a variety of consulting/manual/contract work in a smaller community. The whole point is that we have some flexibility in adjusting our situation to optimize our finances and wellbeing at the same time.

At this point, I should probably be paying you by the hour to read this.

—- The Question —-

So, here’s the question: Is checking out of Toronto and heading out to the seaside financially and mentally sane? I’ve run some numbers and it’s possible to also keep the Toronto home and rent it out for $3k /month, pay some property management company, and have it cover the rest of the mortgage and produce some income over the years while it weathers the real estate ups and downs.

The first question, Joe, you’ve already answered. Not only sane, but inspired.

The second question has an equally simple reply: of course not. You’d have to collect more than $5,000 in monthly rent just to break even on the equity invested in the house plus its carrying costs. Most of that would be fully taxable and the house itself could become an illiquid, aging, expensive anchor in a place you don’t want to live in, occupied by tenants you don’t control and probably hate you. Why not collect your windfall, taxless gain and move on? Invest the cash in a balanced and diversified portfolio instead of sticking it all in one asset you must insure, maintain and babysit? If retiring early is a goal, you need liquid assets, not a pile of city bricks.

Cut the cord, Joe. It’s a giant, glorious, affordable and welcoming country. Be cool and you might even get to ride on my tugboat.