Over the last several weeks investors saw a 10% correction in the Canadian stock market, and a 9% correction in the U.S. Someone with a $100,000 portfolio invested in index funds could have just lost $10,000. Ouch. Is this market sell off justified or is it simply an overreaction to some recent bad economic news? First, let’s review what those news are.
The Canadian dollar has dropped to a 5 year low
Germany’s economy is weaker than expected
The rest of Europe is still in a mess of unemployment and stagnation
Last week the Athens Stock Exchange in Greece tumbled more than 6% in one trading day.
ISIS is causing havoc in the Middle East
I currently own shares in the Bank of Nova Scotia (BNS.) It’s one of the largest companies in the country and has been around for over 180 years. Over the last month the price of this stock fell 8%. Instead of asking where the stock will go from here, we should instead be asking does all the recent bad news justify an 8% drop in value for one of the largest banks in Canada? My answer is absolutely not. It’s important to remember that when we buy a stock we are literally owning a part of that company. This means we, as stakeholders in Scotiabank, are still entitled to split the $6.5 billion profit that the company makes every year, regardless of how the price of BNS shares performs in the short term.
A lower loonie will likely spur economic growth and will not hurt Scotiabank’s profitability. Europe’s stalled economy is nothing new and Canadian banks don’t lend that much to Europeans anyway. The media has succeeded in sensationalizing the threat of Ebola in the U.S. Yes it’s a terrible disease, and there’s an outbreak in Africa. But Ebola will not hinder businesses in the U.S. and Canada from continuing to rake in profits. Literally more Americans have been married to Kim Kardashian than have died from Ebola – both a terrible fate.
For the intrinsic value of Scotiabank to actually fall by 8% substantial circumstances would need to be met, such as major accounting fraud or a 10% national unemployment rate, that would legitimately jeopardize the company’s ability to make money. The recent news is relatively trivial so an 8% correction of BNS shares seems like an overreaction. Imagine selling our stocks now only to see the markets rebound next month and regain all its losses.
What to do when the stock market goes on sale? A smart option would be to double up on some current positions. A couple months ago I bought 50 shares of Avigilon Corp for $25 each. However due to the negative sentiments in the overall financial markets recently AVO’s share price is down. But there’s no need to be alarmed because the company makes high definition security cameras and software. Now is the perfect opportunity for me to turn a current paper loss into a capital gain in the future! I noticed over the last week AVO has bounced around the $13 to $14 range but has never fallen below $13, which to me signals a strong support and a good time to average down. So earlier today I deposited $1,500 of savings into my brokerage account and picked up 100 more shares of AVO.TO.
It has been said that if we cut taxes for the rich and help profitable businesses make even more money then the economic benefits would trickle down from the top to the rest of us. But for many in the working class this has simply not been the case.
The top 1% have never been wealthier, but the rest of us still face many financial roadblocks. Both consumers and governments of all levels are still carrying a lot of debt. However real incomes in the U.S. have been slowly declining since 2008. Up here in Canada our debt-to-income ratio is near an all time high.
We often receive conflicting messages from policy makers. The Canadian Central Bank is keeping rates low to encourage consumers to spend and stimulate the economy. But at the same time it says that rising consumer debt is a major risk in this country. That’s right, patronize consumers for their debilitating debts when the Central Bank is responsible for creating the cheap money in the first place. Sound logic, Mr. Poloz.
In September 248,000 new jobs were created in the U.S. The national unemployment rate dropped from 6.1% to 5.9%, the lowest since 2008. This must mean we’re almost back at pre-recession, full employment right? Well if you ask people on the streets how they feel about the strong labor market recovery, many of them will not know what you’re talking about.
The Chicago PMI which is a confidence indicator for businesses dropped to 60.5 in September from 64.3 in the previous month. The Conference Board published its Consumer Confidence survey and they were expecting 92.5 in September. However the actual number was only 86 So why is there a disconnect between the employment data and how people really feel about their finances? To understand this we simply have to dig a little deeper into the numbers.
Read Between the Lines
Compared to Canada’s high unemployment rate of 6.8%, the U.S. appears to be quite smug sitting at just 5.9%. However the unemployment rate does not account for people who are no longer looking for a job. And in September 315,000 people in the U.S. dropped out of the labor market. The labor force participation rate is now at 62.7%. This is the lowest it has been in 36 years! The last time this many people was out of work relative to the population size was back in 1978. This is why so many people are still frustrated with the job market, and don’t believe that the U.S. economy has recovered. The number of jobless people rose to an all time high of 92.6 million last month. That’s 92.6 million people not paying any income tax. That’s more than 1/3rd of everyone who could be working, but aren’t.
You know the credit market is tight when the former Chair of the Federal Reserve can’t even refinance his mortgage. If that’s of interest to you, you’re not a loan. Ben Bernanke graduated with a Bachelor of Arts in economics in 1975 from Harvard University. He later received his Ph.D. in economics at The Massachusetts Institute of Technology (MIT.) Bernanke once even taught as a professor at Princeton University. He was also the chairman of the Department of Economics there from 1996 to 2002. But perhaps he is most notably known as serving 2 full terms as chairman of the central bank of the United States. He had control over the monetary policy of the world’s largest reserve currency. In other words he was arguably the most powerful and financially influential person on the planet.
So imagine everyone’s surprise when his request to refinance his mortgage was denied. As the Chair of the FOMC his salary was nearly $200,000 a year. However since he no longer has an impressive W-2 (T4 slip in Canada) he does not meet the requirements anymore of someone with a “stable income.” Nevermind he now makes $200,000 each time he presents a speech. Or that he currently has a $1 million book contract. Or that his net worth is over $2 million. All the bank sees is a person who was working over the last 11 years, and is now unemployed. The metrics by which financial institutions decide who to give loans to is flawed to say the least. Anyway the balance on Ben Bernanke’s mortgage back in 2011 was $672,000. It was a 30 year fixed-rate loan at 4.25% interest rate.
Many financial news sites have already discussed this story. However hardly anyone is talking about the most important question. Does it seem strange that a multi millionaire, who has always made a lot of money, still have a $672,000 mortgage at age 61???
Perhaps it shouldn’t.
The reason why Ben Bernanke likes to stay in debt
My investment strategy has always been to follow what the top 1% of the richest are doing with their money. Ben Bernanke’s behaviour of using leverage is perfectly in line with other like minded individuals.
Here’s why it makes sense to take on debt, even when he could pay off his mortgage at any time if he wanted to. It’s because interest rates are at rock bottom. He printed a lot of money during his position of power that insured rates will continue to stay low for years to come. Every dollar that the Fed creates out of thin air becomes a dollar of DEBT that the United States people have to bear. The only reason the economy is still holding itself together is because the cost to service debt (the interest rate) is low. Rates have been so low for so long that people and government alike have become addicted to cheap money. With a record amount of debt the country simply can’t afford the cost of those debts to increase any time soon.
Ben Bernanke bought his house on Capital Hill in 2004. Today his home has appreciated in value by $126,468, and the stock market has gone up by nearly 100%. This means by using the bank’s money to buy a property he was able to free up his own savings to invest in the profitable stock market.
Plus, by flooding the banks with so much money, Ben Bernanke made sure that the U.S. will have positive inflation. Most people don’t like inflation because it eats away at the value of their savings. But this same reason is precisely why it helps those who have debt. Inflation in the U.S. is currently at 2% a year. This means 2% of Ben’s mortgage balance of $672,000 will be paid off automatically by this time next year. That’s $13,400 of real wealth gain, created passively and discreetly thanks to the monetary policy that he purposefully designed, which is an environment of low interest rates with modest inflation. Inflation is created to help the U.S. government pay down its massive $17.8 Trillion national debt. However it benefits personal debts as well.
Printing money also has the effect of propping up the financial markets because: a.) it creates more financial transactions and activities. And b.) the market needs to build in future inflationary pressure. And using leverage in a rising stock market can multiply the returns! Furthermore. borrowing money to invest means the interest that one pays on the loan is tax deductible.
If Ben had paid for his house in cash (used no debt) then he probably couldn’t have bought one nearly as expensive. A smaller, cheaper home would not have appreciated as much as his actual, larger home did. So he would have missed out on part of that $126,468 tax free gain from his appreciating residence. Not to mention all the stock market gains he would have missed out on too.
In other words Ben has brilliantly engineered the financial system to reward those who use leverage and debt to build up their financial assets. His successor to the Fed, Janet Yellen, is most likely going to continue the monetary policy that Ben had put in place. So far Yellen has done nothing but print even more money on top of the balance sheet that Ben left behind.