Cracked

Well, it’s happening. The first bank – and the biggest – has dipped its key mortgage rate, which is a shot across Ottawa’s bow. On the weekend RBC trimmed the posted number for its five-year home loan by about a fifth of a point.

Big deal? You bet. The cut is small, but it’s the first time since the stress test came into effect that one of the big boys has done this. By dropping its posted rate the Royal is challenging other banks to follow, which will reduce the hurdle borrowers have to jump.

The move comes literally days after OSFI (the bank cop) and CMHC’s feisty boss argued for the stress test to remain intact, keeping those pesky and house-horny moisters at bay. It also comes just days before the US Fed – which more or less sets interest rates for the entire planet – is due to announce its direction. Given Tariff Man’s unpredictability, Iran, Brexit, the grid in South America, Putin, Kim and a long-in-the-tooth recovery, the odds are fair that cuts will be in the air. Maybe on Wednesday. Maybe not. But soon.

Here’s why. The yield on five-year Canadian government bonds has cratered to the 1.3% level from close to 2% last winter. Despite that plunge (in the bond world, this is epic) posted mortgage rates – and the stress test qualifying rate of 5.34% as a result – have not budged. This is despite the fact on-the-street mortgage costs have dropped to 3% or lower for fivers and down to 1.99% for shorter terms at some crazed credit unions.

The trip down: 5-year gov't bond yield

So the RBC move signals a break, a sign, a harbinger that the entire rate environment is moving south as economic conditions soften and uncertainty rises. Besides, the lenders have been suffering as much as borrowers. The high stress test straddle has sucked the oxygen out of the mortgage business over the past year as consumers qualify to borrow lese or not at all.

If a couple more banks join the Royal (no doubt) then the stress test rate will automatically be reduced – at least by a little. Borrowers will qualify for more debt and in Canada (of course) the bigger the loan, the more you can buy and the richer you are!

A lower posted rate also means a reduced break penalty if you discharge your mortgage early. And, naturally, it will be welcomed by realtors who have been living in the back seats of their Audis, under bridges, for months now. Ironically, real estate in markets like the GTA may be stabilizing a bit, just as economy softens. At least the Raptors can take your mind off that. If not, there’s always that clown called Drake.

Stay tuned Wednesday for the main event from Washington. After nine interest rate increases, we’ve hit the ceiling. As analyst Ed Pennock wrote to clients today:

“Do they cut or Not? Should it be an Insurance Cut, then OK. They should let the Market know that it’s coming in July. If they don’t it’s a huge “Risk Off”. If the economy is weaker than most think then it’s a Big “Whoops”. It can’t even have the Aroma of a FOLD to the Tweets from 45. Going forward, is the Economy really weak or Not? If it isn’t really then We can’t believe that (Fed boss) Powell will Ruin his Credibility by Folding.”

Yes, this Fed meeting will be a critical one. Like the RBC move, it’s a deep indication of what’s coming. Plus it will be a response to Trump, who has been pushing hard for rate cuts in order to compensate for the damage his tariffs are causing. The central bankers don’t want to be pushed around by a politician. But they have to act properly to keep the economy out of the ditch. A rate cut will signal weakness. No cut might look like they don’t get it. Much depends on the words to come, two sleeps from now.

Meanwhile the stress test just cracked. Draw your own conclusions.

Trump’s crash


 .

As he headed off to launch his 2020 campaign, Donald Trump modestly tweeted the stock market will crash if he’s not re-elected.

Is that even possible?

Sure. But unlikely. Stocks go up because companies make money. When they’re on the ropes – or investors fear that will happen – equities retreat. So far this year the S&P 500 has gained 15.1%. Over the past twelve months it’s ahead 6% – eliminating the Q4 crash of 20% that had this blog’s steerage section changing its Depends hourly. The index is within a hundred points of its all-time high, so barring Iran getting nuked or the trade war getting worse, a new high may be coming before long.

By the way, Bay Street is also on a roll. The TSX is ahead in 2019 about 14%. Higher oil prices and this week’s federal pipeline decision should goose that further. In fact, the economic fundamentals in Canada – jobs, growth, inflation – are running ahead of those in Trumpland.

Having said all that, and as mentioned here last week, everybody should expect a recession in the next year or two. Central banks are. And this is why a balanced and diversified portfolio is so crucial. The financial crisis proved that. While stocks lost 55% of their value and took seven years to recover, a B&D portfolio shed 20%, took one year to recover, and returned an average of 5% over three years (2008-10). Last year, when Canadian equities were nailed for a 12% hit, this portfolio was down just 3%, and made that up in the first five weeks of the new year.

In short, if you have a portfolio with the correct weightings – a balance between fixed income and growth assets plus a range of securities with global exposure – you can pretty much set it and forget it. Rebalance once or twice a year. Spend your free time learning Mandarin.

The point (Doug made the same one on the weekend) is that trying to time markets, or rushing into silly things like gold or crypto because you fear recession or believe Trump’s threat, is foolish. Worse that foolish, actually. It’s gambling. Don’t.

On Wednesday the Fed reviews rate, and they might go down. Up ain’t an option anymore. In fact markets are expecting (and pricing in) three cuts by the end of 2019. The only guess is whether that starts now or a little later. The dramatic reversal from a few months ago (when central bankers were still talking about hikes) is on the expectation of an economic slowdown. The Fed will cut to soften the fall and make the recession like me, memorable but short.

Ironically, it’s all on Trump. The trade wars – especially with China – have slowed the US economy by curtailing exports and increasing input costs. Consumer prices have been rising and with 70% of the economy dependent on it, the impact’s real. Now job growth has gone flaccid, with last month’s weak print shocking analysts. Meanwhile Trump’s antics have helped strengthen the dollar, making exports less competitive.

Markets are laying 50% odds that our central bank will follow with a cut or two this year, but later. Maybe not even before the October election. It’s worth remembering that lower rates aren’t good news. They encourage debt, take years to normalize, and only appear in times of economic distress.

The best plan now is to ignore Trump. He’s capable of anything as 2020 approaches. Instead accept that the business cycle is doing its thing and a period of growth will be followed by one of torpor. This is why you should own multiple asset classes. When equities peter out, bonds do well. Real estate investment trusts are decoupled from stocks. As rates touch bottom and grow again, preferreds will benefit. There is no compelling reason to leave the 60/40 model (60% in Canada, US and international equity ETFs with 40% in fixed income), to bail out of American assets, rush into cash or believe a bunch of rocks will finance your retirement.

Stocks crash if Tariff Man goes? You’ve gotta be kidding.

$    $    $

Alphonse is a 1%er with a question about my Rule of 90.

“How does it apply in my situation? The house is worth 1M and we have been mortgage free for over a decade now. I am 57 years old…. so I fail the rule? Non RE assets are over 2.8M. I am recently retired. If I should abide by the rule, then I need to sell and down size. Not sure I will be doing myself and family a service by moving into a house worth $330 000 here in Montreal. Overhead house costs would not be dramatically reduced by downsizing. What should my strategy be here.”

Relax, A. The rule’s intended as a guideline to ensure residential real estate does not end up dominating your financial picture. It states that the percentage of net worth in your house should not exceed 90 less your age. Your net worth is $3.8 million, of which real estate equity is $1 million, or 26%. You’re 57 years old, so the factor (90-57) is 33. You pass.