Debt & Frugality

As Didi says in the novel (Findependence Day), “There’s no point climbing the Tower of Wealth when you’re still mired in the basement of debt.” If you owe credit-card debt still charging an usurous 20% per annum, forget about building wealth: focus on eliminating that debt. And once done, focus on paying off your mortgage. As Theo says in the novel, “The foundation of financial independence is a paid-for house.”

Positive if muted returns for most major asset classes in 2019, Franklin Templeton forecasts

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Despite Tuesday’s 3% plunge in US stock markets, Franklin Templeton money managers are optimistic most major asset classes will deliver positive if muted returns in 2019.

At the 2019 Global Market Outlook event in Toronto, William Yun, New York-based executive vice president for Franklin Templeton Multi-Asset Solutions, projected 7-year annualized returns for Canadian equities of 5.7%, compared to a 7.5% average the last 20 years [as shown in above chart]; 5.7% for U.S. equities (versus 7.4% historically), 6% for international equities (versus 5.5%), and 7.2 versus 9.4% for Emerging Markets. On the fixed income side, he is projecting 2.3% annualized 7-year returns for Government of Canada bonds (versus 4.7% historically the last 20 years), and 3.2% for investment grade corporate bonds (versus 5.2%).

All this is in an environment of continued desyncronized global growth (of 3%) and moderate inflation expectations. Long term, Yun is particularly optimistic about the long term growth of Emerging Markets equities, which at 5% is two-and-a-half times the 2% growth expectation for developed market equities. This optimism is based on positive population growth and labor productivity in Emerging Markets. Globally, inflation “remains muted” and “we don’t see many excesses in the global economy generally.” There are however, some excesses in the U.S. labor market.

More normalized interest rate environment

William Yun, Franklin Templeton Multi-Asset Solutions

Capital spending growth patterns are supportive and trending upwards since the 2016 US election, with the transition from very low interest rates post the financial crisis to a “more normalized interest rate environment.” The opportunity is to reinvest capital to more productive assets, as opposed to allocating to corporate share buybacks.

With respect to central bank balance sheets, markets are normalizing around the world, transitioning from excessive Quantitative Easing to Quantitative Tightening and shrinking balance sheets. Assets quadrupled at the Fed between US$1 trillion in 2008 to $4 trillion today as the Fed committed to buying bonds, with liquidity tapering off. He has similar expectations for the ECB, which has announced the ending of its QE programs, and it’s the same with Japan and China. “Central bankers are pulling back on Quantitative Easing.” There is a “restart of normalization in interest rate policy.”

Rising volatility 

Even as the Dow Jones Industrial Average was in the process of tanking almost 800 points Tuesday, Yun predicted rising volatility after a period of relative calm. In that environment, “investing passively [in index products] has been the way to go but we anticipate volatility returning.” With higher interest rates and more volatility, it may be a time for active management, Yun said, acknowledging his own firm’s expertise in active security management.

Emerging Markets gross domestic product (GDP) continues to rise relative to the rest of the world, from 40% in 1990 to 60% in 2017, and Yun expects that percentage to move higher still. The trend is driven by rising consumption growth for the middle class, which benefits industries like consumer staples and consumer discretionary stocks, technology and even investment management.

Emerging Markets are showing reduced reliance on developed markets, which are slowing. Whereas in 2007 eight of the top trade markets were with the United States, in 2017-2018 China has supplanted the US, with 8 of the top 14 destinations.

In short, Yun sees  a supportive global market for risk assets but lower returns: positive growth and moderate inflation, with increased volatility.

Ian Riach, Fiduciary Trust Canada

Ian Riach, Chief Investment Officer for Fiduciary Trust Canada and a senior vice president of Franklin Templeton Multi-Asset Solutions,  says it makes sense in this environment to make some “dynamic” (i.e. tactical) shifts to long-term Strategic Asset Allocation. Currently, the firm is underweight Canadian equities and Canadian bonds, because the loonie has been getting weaker and Canada is facing a number of challenges ranging from trade to energy to a shrinking manufacturing base, all of which “affects growth going forward.” In the short term, Riach expects short-term interest rates in the United States will be higher than in Canada, “given that they are growing more quickly than us.”

Flat yield curve

Even after the recent rate back-up, “we think Government of Canada bonds are expensive, Continue Reading…

Is Renting throwing away money?

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Most people tackle the rent vs. buy problem incorrectly by framing it as the cost of monthly rent versus the cost of a monthly mortgage payment. The argument goes something like, “if your monthly rent costs as much as a mortgage payment on the same or similar property, then it’s a no-brainer to buy the home and build equity rather than flushing your rent money down the drain.”

Others argue that a better comparison looks at the true cost of home ownership, which not only includes the mortgage payment but also things like property taxes, insurance, and maintenance.

However, as PWL Capital’s Ben Felix pointed out in the latest Rational Reminder podcast, neither argument paints a truly fair comparison of rent vs. buy. What you need to look at, he explains, is the total unrecoverable costsin each scenario.

For example, a monthly rent payment is a total unrecoverable cost: an expense that does nothing to improve the renter’s net worth. A mortgage payment, on the other hand, only has partial unrecoverable costs: the interest paid on the mortgage. The other portion reduces your mortgage amount and therefore increases your net worth.

A winning point for home ownership, right? Not so fast.

We need to add up all of those additional costs that a home owner bears (property taxes, insurance, maintenance), plus any upfront money spent on a down payment, land transfer tax, title insurance, home inspection, etc. to close on the home.

There’s also an opportunity cost on the down payment and other closing costs. That money could have been invested instead of put towards buying a home.

Rent vs. Buy: Let’s Do The Math

Let’s look at an example of a renter in Toronto who’s paying $2,000 a month to rent a 575-square foot condo. The same condo is listed for $449,000.

To purchase the condo our renter would need to put down 5 per cent, or $23,450, plus add another $17,062 to the mortgage due to CMHC insurance (required on all mortgages with down payments of less than 20 percent), for a total mortgage amount of $443,612.

Our upfront costs are not done, however, as we need to add in land transfer taxes of $10,910, lawyers fees of $1,000, title insurance of $449, plus a home inspection for $500.

Total upfront costs = $36,309. The opportunity cost of this amount in 25 years at 6 per cent a year = $155,834.

Now let’s look at the unrecoverable monthly costs. The mortgage is amortized over 25 years and has an interest rate of 3.50 per cent. The monthly mortgage payment is $2,215. Of that payment, $1,200 goes towards interest and $1,015 goes towards paying down the mortgage principal.

Then we have property taxes coming in at $375 per month, and we’ll also add the difference between home insurance and tenant insurance, which is $40 per month. We also need to add expected maintenance costs, which we’ll estimate at 1 per cent of the property value per year, or $375 per month.

Total unrecoverable monthly costs (interest, plus property tax, plus insurance, plus maintenance) = $1,990

The unrecoverable costs for the renter and homeowner are nearly identical. The total monthly payment for the homeowner, including property taxes, insurance, and maintenance, is $3,005. Just $1,015 of that is building equity in the home. So, back to the rent vs. buy argument.

Rent and Invest the Difference

We have to assume our renter has an extra $1,015 available in their cash flow each month to invest. What are the expected returns for a 60/40 balanced investment portfolio over 25 years: maybe 6 per cent? Continue Reading…

8 habits that are killing your Retirement dreams

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A growing number of Canadians plan on working longer because they haven’t saved enough for retirement. We see it at a macro-level; Canadian households owe a record $1.69 in debt for every dollar of disposable income, meanwhile the personal savings rate in Canada stands at a paltry 3.4 per cent.

There are plenty of reasons why we owe too much and save too little. The economy stinks, people get laid off, and salary increases are few and far between.

That said we’re often our own worst enemy when it comes to taking care of our finances. Here are eight bad habits that are killing your retirement dreams:

1.) You don’t watch your spending

It’s tough to stop a money leak when you have no clue where your money is going. Small daily purchases do add up (latte factor, anyone?), but these spending categories can bust your budget much faster – big grocery bills, dining out too frequently, filling your closet full of new clothes, one-click online shopping, and expensive hobbies, to name a few.

The solution: Write down everything you spend for three months. I guarantee you’ll have an ‘a-ha’ moment at best, and at worst discover something useful about your spending habits that you’d be willing to change.

The goal of course is to spend less than you earn. It’s one of the major tenets of personal finance.

2.) You want the newest ‘everything’

Fashion and décor trends change, technology constantly evolves. Staying ahead of the curve means shelling out big bucks for the latest and greatest products. The problem is your capacity to buy new things will never keep up with the pace of innovation and change. It’s an endless cycle.

The solution: Wait. Early adopters pay a hefty premium to be first. Look no further than televisions, where the latest innovations can initially go for between $5,000 and $10,000: 10 times what they’ll cost in a year or two.

The bigger issue is the psychological need to always have the latest gadget or be at the cutting edge. Ask yourself whom are you trying to impress.

3.) You have the constant need to upgrade

Fewer than half of all iPhone users hang onto their smartphones until they stop working or become obsolete. Most want to upgrade as soon as their provider allows it: usually every two years. A small percentage upgrades every year whenever a new model is released.

While spending a few hundred dollars on a new phone every other year might not hinder your retirement plans, it could be a symptom of a bigger problem. The constant need to upgrade your technology, your car, and even your home can be a big drain on your finances.

Nearly three in 10 homeowners get the urge to move every five years, and 14 per cent actually want to move every year.

The solution: The same buy-and-hold approach that you take with your investments can also apply to your major purchases. The Globe and Mail’s Rob Carrick suggests a 10-year rule for homeowners to combat the odds of a housing crash and to save on transaction fees. Continue Reading…

How the USMCA affects Canadian homebuyers

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By Jordan Lavin, Ratehub.ca

Special to the Financial Independence Hub

Goodbye NAFTA, hello US-Mexico-Canada Agreement (USMCA).

The new trade deal with our neighbours to the south will have wide-reaching effects across all areas of our economy, and housing is no exception. While the agreement is said to be good for our economy overall, it’s not necessarily good news for your ability to afford a home.

What is the USMCA?

Canada recently reached an agreement with the United States and Mexico to replace NAFTA, the decades-old trade agreement that has stood since it was signed by Brian Mulroney, Bill Clinton and Carlos Salinas de Gortari.

The new agreement looks much like the old one, with some changes. Key differences include changes to the way the three countries approach auto manufacturing, fewer restrictions on trade of dairy products, and stronger measures against counterfeiting and media piracy. Like NAFTA, the USMCA makes it possible for the three countries to exchange goods without barriers.

For now, the US, Mexico and Canada will continue trading under the rules of NAFTA. The USMCA will come into effect once it’s ratified by its members, a process that could take months. In the United States, congress won’t vote on ratification until some time next year due to that county’s mid-term elections. Here in Canada, the looming Federal election means that if the USMCA isn’t made official by June, it could be delayed until 2020.

How does this affect Canadian housing?

If you’re wondering how having access to American milk at your local Superstore can possibly affect how much mortgage you can afford, you’re not alone. The implications for home affordability are driven by the market’s reaction to the uncertainty of the negotiation period, the removal of uncertainty brought by a signed agreement, and the actual economic growth that’s expected to occur because of the USMCA once it’s in force.

When the Trump administration demanded to renegotiate “the worst trade deal” ever, the market got spooked. As the trade war intensified, the US threatened to (and did) impose significant tariffs on imports from Canada. With repeated threats from our largest trading partner, there was a real chance that the Canadian economy could be jeopardized. Even though our economy was growing during that time, the Bank of Canada (BoC) was reluctant to raise interest rates, which it would normally do in that situation. Continue Reading…

Bank of Canada: As expected, Poloz still the Number Two hawk

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By Jeff Weniger, WisdomTree Investments

Special to the Financial Independence Hub

There was little surprise in the October 24 decision by the Bank of Canada (BoC ) to raise its overnight interest rate a quarter point to 1.75%. There hadn’t been a sell-side strategist on Bay Street prognosticating anything but that action. BoC governor Stephen Poloz’s stop-start hiking program reinforces what we have been saying for some time: even with this tepid pace of interest rate increases, Canada is still Number Two in the “hawkishness” rankings of developed market central banks.

More important than the actual rate move is Poloz’s signaling, especially given NAFTA’s recent reconfiguration into the U.S.-Mexico-Canada Agreement (USMCA) and October’s generalized stock market malaise.

With the NAFTA overhang quasi-resolved, and the realization out west that shipping LNG to East Asia is not only politically palpable but a matter of national security, Poloz and the Canadian public finally have some good economic news in what has been a tough year for the country.

For an idea of the BoC’s relative position, consider the actions taken (or not taken) by several other major central banks of late. After hiking to 0.75% in August, the Bank of England appears to have its hands tied. It is hard to see how the Brits can make any moves between now and March 2019, the deadline for the to-be-determined “soft” or “hard” Brexit. Even if Brexit goes well, the BoE would seemingly need to take a cautious approach next spring and summer, meaning GBP rates will likely be a full 100 bps or more south of CAD’s throughout 2019.

The European Central Bank is also in no hurry to do much regarding interest rates. Given the VIX’s recent spike to 231amid China slowdown fears and Italian budget risk, any forecasts of a one-off rate hike by the ECB next year must be called into question. That is truer now than at any time in the last year or so, as Italian bonds maturing in 10 years have gapped up to 3.60%, a striking 320 bps spread over 10-year German bunds (0.40%).

The fear in southern Europe is of a “doom loop.” In this scenario, Italian banks, which are heavy owners of Italy’s sovereign debt, see the country’s yields rise, which weakens the banks’ capital base. That, in turn, sends government bond rates higher. A dog chasing its tail.

Of interest to the BoC, the Toronto housing market has somehow managed to pull off the sweet-spot slowdown, at least for now. This has surprised us, given the rarity of asymptotic price surges giving way to post-peak gentle, sideways slopes. The Teranet National Home Price Index for Toronto has managed to curve ever so slightly downward since summer 2017, witnessing total price depreciation of just 3.8% from the peak to September 2018.

If Street consensus is correct, the BoC will bring the policy rate to 2.25% or 2.50% at the end of 2019. There are some observers out there with calls for 2.75% or 2.00% on both sides of the bell curve. In order to have the confidence to hike three or four times, Poloz will want to see GTA home prices continue to click sideways with each of the Toronto Real Estate Board’s monthly reports. And that means no big swoons in activity like in Vancouver, where buyers and sellers are engaged in a staring contest that is becoming disconcerting.

Aggressive BoC rhetoric

In the Monetary Policy Report, the central bank went heavy on USMCA references, opening with the trade deal and then coming back to it again just a couple of paragraphs later. They were keen to make mention of British Columbia’s natural gas pipeline announcement as a one-two punch for justifying a confident onslaught of 2% on the overnight rate.

We are focusing less on the BoC’s forecast of around 2% CPI inflation from now to 2020 and more on the bank’s assertion that the economy is operating “at capacity.” This is critical. The U.S. still has some room to challenge its capacity utilization precedent, set just short of 80 on the eve of the 2015–2016 China scare. But for all intents and purposes, American capacity utilization at 78 is a rounding error compared to its limit (the 80 area).

If Poloz believes Canada is “at capacity,” and it looks to us like the U.S. is there too, then this is the stuff of inflation scares. Of the forecasting outliers (those penciling in 2.0% or 2.75% for year-end 2019), we think the latter camp has a better chance of being proven correct, on account of our thesis that the global trade war concept is overblown and “priced in.”

Items to watch, next 6 to 12 months

While we would be foolish to not focus on “classic” central banking metrics such as inflation and employment a few other idiosyncratic issues are also critical:
Continue Reading…