Aug 042020
 

Past and future predictions

Last year I predicted rough waters for 2020’s economy, and suggested 4 investments to protect against uncertainty.

From November 2019

From a November 2019 blog post

How did those suggestions work out so far?

  • National real estate prices are +7% from last year.
  • Year to date my silver stocks (WPM.TO) is +79%.
  • Major telco stocks are down by about -3%.
  • XCB.TO, an ETF that tracks corporate bonds, is +8%.

An equal weighted basket of my picks would have earned a 23% return year to date. Not bad. πŸ˜€ Most index funds have only produced single digit returns during the same time.

What about for 2021?

Here are my top investment picks for the next 6 to 18 months.

  • North American real estate
  • Gold and silver
  • Large cap U.S. technology stocks

The rest of today’s post will attempt to unpack my reasons for choosing these investments. πŸ™‚

 

Mo money mo problems

Everyone agrees that we are in a recession. But how bad is it? Charts like this one paints a rather depressing picture.

But it’s somewhat misleading. The economy didn’t shrink by 8.2% in Q1 of this year. It actually fell by 2%.

The 8.2% in the chart represents the annualized rate. But for that to become a reality it would require 3 additional pandemics, one after another, to hit the economy. Possible. But not very likely.

What’s not misleading is the $343 billion deficit Mr. Trudeau plans to dump into our economy. For context, that’s nearly 20% of the country’s GDP. Here’s a 50 year chart to visually demonstrate how crazy this is.

Canada's deficit spending

But you can’t expect to push fiscal policy so hard without any help from monetary policy. πŸ™‚ The two are like PB&J, they work better together. So in comes the Bank of Canada – printing buttloads of money to fund the extra cost of government spending.

By comparison Canada’s GDP fell 3.3% during the great recession of 2008. As you can see from the charts above, the stimulus package in 2008 pales in comparison to this year’s QE program. So was all this government intervention this time necessary? You tell me. πŸ˜‰

Here’s the problem. Central banks can print as much currency as they want. But they can’t create real prosperity. That’s because wealth is produced through savings, investment, and productivity – not out of thin air or through debt-fuelled consumption. There are unintended consequences to these extraordinary policies. And we will witness the outcome over the next few years.

 

Prepare for inflationΒ 

Last year I used economic data to warn of the recession that we’re in today. This time I will use facts again to explain why inflation is coming next.

But first, why didn’t the extra deficit spending and money printing in 2008 cause higher inflation back then?

the economy needs to be balanced

The short answer is that the amount of government intervention was more or less equal to the slowdown of economic output. In other words, consumers spent less money. The government stepped in to make up the difference.

So why is this time different? Simple. πŸ™‚ The money supply is growing too fast.

M0 represents the total amount of physical cash (bank notes and coins) in circulation. This base money supply impacts M1 – which is M0 plus all the money in people’s chequing accounts.

Inflation is the product of the money supply and how quickly that money moves around the economy

Given how much new M0 has already been injected into the economy this year I expect M1 to climb a lot higher.

Back in 2008 the money supply was growing at a steady pace. So inflation was normal. But this time the money supply is clearly accelerating! The amount of money in people’s bank accounts is growing thanks to the CERB payments and higher household saving rates.

The velocity of money is still slow which is why we’re not seeing much inflation yet. In fact there are even deflationary pressures right now. Gasoline prices are down compared to last year because fewer people are driving. Tourist attractions and hotel room bookings are cheaper too. But don’t get use to it.

Once consumer confidence returns the cost of living will increase.

You can already see signs of inflation in commodity prices, such as lumber. Here’s a 1 year chart.

Food prices are also up about 3% year over year. Financial assets are on the rise too. When most investors sell an asset such as a property or stocks they don’t go out and spend the money on consumption. They either reinvest the proceeds immediately or keep it temporary in a savings account earmarked for further investments – causing asset inflation.

To combat this many investors have started to add precious metals to their portfolios. Silver has made a lot of gains lately. And gold is hitting new records!

This is just the beginning.

 

Unpopular opinion on the housing market

Wealthy foreign investors have practically halted all their buying activities in B.C. So why haven’t Vancouver real estate prices dropped amidst the pandemic? The mainstream media will get flummoxed when confronted with this simple question. But it’s actually easy to explain.

Canadians have been building up their savings due to no vacation/travel, childcare expenses, concerts, etc. Monetary policy injected billions of dollars directly into the housing market to encourage additional mortgage lending. The economy is recovering. And interest rates have been slashed to record lows.

The median Metro Vancouver home price has never been higher than today.

On July 15th the Bank’s governor Tiff Macklem even reassured borrowers that these low interest rates are here to stay. He’s obviously a fan of this blog because that’s exactly what I told everyoneΒ just days prior to his speech.

If you’re thinking about buying a place, you probably shouldn’t wait until 2023. If inflation is running at 2% a year, and you can get a mortgage right now at 2% interest rate, then you’re basically paying nothing to use debt in real terms. πŸ™‚ #freemoney

 

Are there any downward pressures facing real estate?

Yes. But by my estimation they are very attenuated.

An economist with RBC, Robert Hogue, believes housing will become more affordable soon, as economic hardship causes potential buyers to delay their purchasing plans, and financially-strained owners sell their property once government support programs run out.

A columnist from the Globe and Mail also concluded that home prices will be falling. His reasoning is that 16% of mortgage payments have been deferred which suggests many owners can’t afford to live in their own homes anymore, and will be forced to sell soon.

However I don’t agree. πŸ™„

Call me a skeptic, but if so many homeowners are really struggling financially, why aren’t more of them listing their properties for sale?

There was a spike of new listings in April. Airbnb operators were probably panic-selling. 🀣 But the extra supply was quickly absorbed by the demand, and now the market is balanced again.

 

 

What about employment data

With a higher 12% unemployment rate & fewer people working there should also be less buyer demand, right?

Technically yes. But this is another misleading statistic. 😏 It’s true that millions of Canadians are out of work. However job cuts due to the virus disproportionately affect lower income workers in retail and food services.

On the other hand, potential real estate buyers are usually high income individuals who work in technology, engineering, education, or high finance. Some can receive financial help from family. Many existing owners want to upgrade from a condo to a larger detached house. All these people are by and large financially unaffected by the economic shutdown.

Vacation properties have also seen a spike in demand as Canadians look for safe getaways. And don’t forget about the investors. Given today’s economic climate you can expect to earn a very reasonable 10% to 15% annual ROI on a rental property in Vancouver, Toronto, or Montreal. This effectively puts a floor under the real estate market.

You can take advantage of leverage, low interest rates, and the growth on capital gains is not taxed until the property is sold. With so much potential upside it’s easy to see why home prices have not crashed. πŸ˜‰

 

Pessimistic predictions

Both the CMHC and RBC are forecasting a price decline across Canada’s residential real estate market next year.

Holy doom and gloom. I have no idea where these “experts” are getting their numbers from.πŸ˜…

Other than a temporary dip, the cost of rent is on the rise this year.

Higher rent encourages people to become homeowners. And the cost of lumber has already gone way up as shown earlier. So I don’t understand how the real estate market could possibly fall 7% to 18% given the reality of things. πŸ™„

 

IT stocks

Another way to fight inflation, albeit somewhat counterintuitive, is with a deflationary investment. I think major tech stocks such as Netflix, Facebook, Microsoft, and Amazon will continue to dominate in their respective fields.

Their advantage is having the pricing power to grow their revenues to keep up with inflation, and also reduce costs due to how deflationary technology is.

 

The bottom line

Liquidity drives markets. And things are about to get a whole lot more liquid! Financial and real estate markets will become even more detached from the general economy over the next 12 months. Home prices will probably climb higher, especially in major city centers.

Interest rates will remain low until at least 2030, blowing more air into existing asset bubbles. Bonds will have negative real returns so stay away from them. Buy quality assets with long term growth in mind. Inflation is a serious risk. So I hope everyone takes the appropriate steps to prepare themselves accordingly. πŸ™‚

 

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Random Useless Fact:

Modern dogs evolved from wolves between 20,000 and 40,000 years ago.

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Khan
Khan
08/05/2020 7:54 pm

Would you recommend REIT stocks for those who can’t afford to directly buy a house/condo?

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[…] stocks and real estate are inflation resistant so if there’s a major currency devaluation my purchasing power will be protected. All fiat currencies lose value over time. In ancient civilizations people used spices as currency. […]