Thursday, October 30, 2008

The Government Did Something Right?

With the recent market upturn, I imagine many people are thinking that "life is returning to normal". I for one, do not aspire to that notion - in fact many people believe that what we are seeing in the markets lately is the "new normal".

How are people reacting to the market ups and downs? A recent survey found most people are still contributing to their RRSP's and only 8% were planning on saving less. This may change slightly as 2009 brings about the introduction of the Tax Free Savings Account (TFSA). This new product, which you have undoubtedly started to hear about, will alter the way we "save" for our futures. Please note that while this product will benefit most people, the way it should be implemented with vary from person to person, and family to family. Since everyone's situation is different, we will need to consider all the facts before designing a plan.

Jonathan Chevreau described in his National Post column that the TFSA would shake up the investment industry. Ellen Roseman writes in her Toronto Star column that the TFSA will really complement the RRSP. Tim Cestnick made a "comparison" of the benefits in his Globe and Mail column.

So what should you do? Over the next two months I plan to present the product in greater detail and explain how it will benefit people in different ways. Here's a quick example:

A young couple (mid 20's) with one child, who are saving for their first home versus an older "empty nester" couple (mid 50's) with high incomes.

  • The younger couple need an emergency fund, and an account to save money for big ticket purchases. They can also use the account as collateral for borrowing. This could be invested in a high interest savings account.
  • The older couple need a way to save outside of their RRSP's without incurring added taxes. The TFSA offers additional tax sheltered contribution room. They could invest up to $500o each per year (the contribution limit will grow over time), and TFSA's are not subject to "attribution" rules where one spouse earns most or all of the income. They could invest in a range of non-registered mutual funds, trading as often as they wish, and not subject to capital gains taxes, or having to claim dividend or interest income.

Here are a list of the top 10 things to know about the TFSA.

  1. The Tax-Free Savings Account lets you invest while not being taxed on interest or investment earnings.
  2. You can contribute a maximum of $5000 a year. A couple can each contribute $5,000. If you contribute $5,000 each year for 5 years you’d have more than $25,000 earning interest Tax-Free!
  3. You can have more than one Tax-Free Savings Account and you can also have Tax-Free Savings Accounts with more than one financial institution. Like RRSP’s you will need to keep track of how much you’ve contributed so you don’t exceed your limit.
  4. Unlike an RSP, you don’t have to pay any tax on money you take out of your Tax-Free Savings Account, and withdrawals from your Tax-Free Savings Account don’t affect your ability to qualify for Federal benefits like the Child Tax Benefit, Guaranteed Income Supplement, Old Age Security benefits, Age credit, or Goods and Services Tax credit – so you’re not penalized for saving.
  5. You’ll be able to open savings accounts, GIC’s and mutual funds tax-free.
  6. Unlike an RRSP, money you put into your Tax-Free Savings Account will not be deducted from your income on your tax return.
  7. Just like an RRSP, when you file your tax return each year, the government will determine your remaining available Tax-Free Savings Account contribution limit for the coming year.
  8. If you take money out of your Tax-Free Savings Account, you don’t lose the contribution room. You get it back in the following year. If you don’t make the maximum contribution you don’t lose the contribution room. The unused contribution room gets carried over to the following year. There is no limit to how much or how long contribution room can be carried forward.
  9. You can open a Tax-Free Savings Account if you are 18 years of age and a Canadian resident.
  10. The Tax-Free Savings Account comes to Canada January 1, 2009, but we can arrange the paperwork now.

Wednesday, October 29, 2008

What Floor Would You Like?

Have you ever got onto an elevator where they have someone who sits on a little stool and presses the buttons for you? While I question the wisdom of paying someone to simply push some buttons from a financial perspective, with the recent ups and downs in the markets of late I sometimes want to ask them to take me to another building.

Nouriel Roubini is an economist who actually predicted much of what we are going through back in 2006 (I wish I had seen this back then). In an interview on Bloomberg today, Roubini expects US markets to remain flat or drop further through the end of 2009. He believes there is still some downside risk in the markets as earnings for non-financial companies drop and as companies default. He made an interesting comment that "Americans can no longer use their home as an ATM". He expects the recession to end by the end of 2009 assuming the financial system issues get fixed.

Today's US Federal rate question is no longer an "if they drop rates" but by how much. Experts are split between a 50 and 75 basis point drop but it seems safe to expect a 50 basis point drop to leave room for future decreases. Along this point, expect a sideways shift in US markets today until the Fed rate decision release this afternoon.

On the home front, members of defined benefit pension plans may need to wonder how this affects them. A defined benefit plan (as opposed to the more common defined contribution plan), needs to have sufficient assets on hand to pay pensions current and future. If they do not have enough money (deficit), then they are required to increase funding. With recent market declines, a Globe and Mail article explains how forcing them to make up deficits could in theory bankrupt the companies. They are currently appealing to the government to relax rules due to extraordinary circumstances.

Lastly, Fidelity Investments provided an interesting history of the Toronto Stock Exchange. Going back to 1970 and up to September 2008, what would you think the value of a $100 investment would be? Would you believe $38,500? In that time, we have experienced six bull markets with an average return of 174% over 58 months and six bear markets (we're in number seven right now) that returned -31% over 10 months.

The 38 year history is of interest as it clearly defines a normal "working career" in length and explains the importance of not only early investing but consistent investing. Picture someone born in the year 1952, graduated from high school in 1969 and receiving a "gift" of $1,000 from a wealthy relative. Properly invested, with no further contributions, it would grow to $385,000 and produce approximately $2,000 in retirement income.
This is in spite of recent market declines.

One last thing - with Halloween coming in a couple days, I thought you might appreciate the humour in this...

Tuesday, October 28, 2008

Spooky Things Are Happening...

Have you ever watched a "scary" movie - you reach the last minutes of the movie and the hero/heroine have survived only to discover that Freddy or Jason isn't really dead. Are we coming to something like that in Canadian real estate market?

For the past several years, I have been stating that I fully expect the Canadian housing market to go into a deep slide. How much remains to be seen, but a drop of between 10% and 30% would not be out of the question. With the real estate markets in the US already teetering on the brink, we are now seeing signs of what is to come in Canada.

When governments decrease lending rates to battle the "axis of evil" (thanks GDub), ultimately they will need to eventually raise them to combat inflation. For those who have never done a mortgage for over 8% interest rate, heed this warning - currently people in variable rate mortgages could be paying as low as 3%. What would you do if the rates went up to 8%?

On a mortgage of $300,000 (not an unusual amount in the GTA), your bi-weekly payments would go from roughly $650 to $1050. Think it couldn't happen - obviously no one can be certain, but we are in uncharted territory and we have seen rates that high in the past 15 years so why not now?

A recent Globe and Mail article highlights the similarities between the Canadian and US housing markets. Any further recessionary pressures will eventually lead to a decline in housing prices especially in locations that have seen rapid price increases (Alberta). Luckily, Canadians have to actually qualify for mortgages as opposed to the US which eventually led to the sub prime collapse. Yet we are already seeing trends emerge - no more 100% financing and dramatic changes to variable rate mortgages. Refinancing becomes more difficult as bank funds dry up; imagine how much equity you can borrow once you reach that wonderful point that 20% of US homes are at - negative equity (meaning they owe more than the value of their home). Recent blips in US housing markets should not be interpreted as meaning all is well in the world - Barrie McKenna believes that all is not well and may not return to normal for two more years.

What should you do? When clients ask this, I always use the same refrain - Upgrade in a down market and downgrade in an update market. If we go into a decline of 20%, then the more expensive home becomes "relatively cheaper". If you're a first time buyer, then when markets drop will represent a tremendous buying opportunity. The only question then becomes when will they hit the bottom. One last point to all the people out there who watch television shows that deal with buying 10 homes and renting them out - a client of mine purchased an investment property to supplement his retirement income. Five years later he sold the property. He said something that has stuck with me to this day;

The only people I was able to rent to were people I didn't want to rent to.

Monday, October 27, 2008

Step Right Up and Ride The Market Coaster

Sometimes the nicest things happen when you least expect them. The first bit of news is a link to a fantastic chart from Invesco Trimark that shows a historical perspective on why reacting now is the worst thing to do.

Every morning I receive emails from several different media outlets with links to financial related issues. Monday morning's Advisor.CA link delighted me to no end. Essentially an interview with three different senior management at three investment firms, it reallt reflects the views of many people within the investment field. Here is the link to the article, but I pulled out the main points below.

The article deals with the issue of "capitulation" - that point when investors quit being investors.

"While we've had markets in pretty steady decline, volumes don't really suggest capitulation yet," says Norman Raschkowan, chief investment officer at Mackenzie Financial. "In meetings with investors and advisors, the sense I have is that people are maintaining focus on their longer term financial goals and their personal plans.
"I don't sense a degree of panic from the average investor that you might associate with these kind of movements in the markets."

"There are a number of investors out there and most of them are not informed," says Curwood. "They get panicked by headlines in the paper, so some people run for the exit. As people sell out, that's the point you talk about market capitulation, when retail investors throw their hands up and say I want out at any cost."

Jeffery Shaul, president and CEO of Robson Capital Management, says market capitulation tends to happen all at once. There's usually a large decline that occurs throughout the day, but he says we haven't seen that yet. And, that might not be a good thing.
"What often happens to mark the bottom is an oversold market where you get all these sellers going out at once and capitulating," he explains. "But this kind of steady decline means people are holding on, which suggests we're not at a bottom."
Shaul expects more problems to crop up in the American economy before the markets turn around. He's worried about rising credit card default levels in the U.S., and when major corporations are forced to re-evaluate their pension assets. "You're going to find significant deficiencies in funding, he says. "Then you're going to continue to see worsening in the real estate market and significant layoffs," he adds.

"There's definitely a bad psychology out there right now," says Bruce Curwood, director of research and strategy at Russell Investments Canada. Curwood is slightly more optimistic. He says markets always come back, and with government intervention, it's likely things will turn around; he's just not sure when that will happen.
But it's a good sign that Warren Buffett is still planting money into the market, he says, because if he's doing it then things can't be that dismal. "He's one of the best investors in the world and he's trying to take this as an opportunity to invest."

It's a strategy others should follow. Curwood explains that if your clients are already invested in the market, they are already down, so why sell? "It's not the time to make a major decision or do anything dramatic," he cautions. "Markets are moving; there are huge swings over the course of the day. Just hunker down, put the money in a strategy you can tolerate for a long time. Don't sell out after going down 35%."

(Note - not everone is down 35%. This depends on the asset mix you hold).

Curwood points out that there are still a lot of companies with great value, even in the financial sector. He explains that when things get bad they get tarred with same brush, which means entire sectors are down whether they should be or not.

For the average investor, dipping a toe back into the market is still a frightening proposition. Raschkowan says clients may be waiting on the sidelines until they can get a better grip on what is happening.
"I think it will be mild in North America, but I think we will go through a recession," says Raschkowan. "People will now be waiting to se how companies have fared as they've had to work through this period of capital market disruption and slowing growth."

So should the market fear market capitulation or not? For the savvy client, it can't come soon enough. "Some of the best opportunities in the marketplace occur when the retail investor is running and taking all their money out of equities," says Curwood. "But, on the flip side, when retail investors are throwing their money at the market, it's time to get out."

There's a Chicken Running Around Saying Something About the Sky Is Falling...

Frantic Friday on the financial markets

Trading on the Dow Jones industrial futures market has been stopped after Dow futures fell 550 points, the maximum daily price change. The move is pointing towards a sell off for Bay and Wall streets today. The drop on the futures markets comes on the heels of steep losses on Asian stock exchanges. They tumbled for a third day Friday on persistent worries of a global recession.

Wow - just what you needed to read going into the weekend. Instead of worrying about finding time to carve a pumpkin, and get little Johnny and Susie the "newest coolest costumes" in time for Halloween, we are left facing financial Armageddon.

Well that's what some in the media would have you believe. The opening statement was taken from an unnamed media source website (OK it's 680 News), AFTER THE MARKETS CLOSED. For anyone out there who wasn't watching, the Toronto markets opened down 700 points, and finished down 37 points. If George Bush passes wind, it affects markets more than this. Yet we are continually subjected to the media telling you the worst thing (The Sky Is Falling?), and ignoring any good news. I'm sure if markets had opened up 700 points and then finished down 37, the media would have simply spun it in a different direction. Here is where we cross swords. Should the media be forced to report accurately, or is the era of sensationalism (where Paris Hilton is a star and TMZ is a creditable source of information) the future of media.

In the advisor world, Dan Richards works with advisors. He does not use sensationalism to sell, but rather provides honest thoughtful insight. He recently added a very interesting link to his website that really explains the "sub prime" crisis and how it came about - the real beauty lies in the fact that it is designed for pretty much anyone to read and understand.

So where do we go next. The origins of the current market situation lay predominantly in the US mortgage markets, where people spent the value of their homes and more, and where others bought homes they could not afford. Now we have moved into the "recession" stage. As stated previously, a recession is stated to be two consecutive quarters of negative gross domestic product. What it doesn't mean is that everyone will lose their jobs. With current numbers at around 6%, it is expected that unemployment may reach 8%.

While those numbers look negative, we have seen much higher unemployment rates in the past. Here's an interesting thought - WHY NOT EXPRESS THE NUMBERS AS 94% CURRENT EMPLOYMENT. When we were in school and got a 94 on a test, most of us were thrilled.

Even though we are in uncharted waters, the majority of experts believe the following will happen:

  • Markets remain unsettled though end of 2008 and into 2009
  • Interest rates expected to be further reduced this week in US (and perhaps globally)
  • Recession to "end" in second quarter of 2009
  • Growth to come in second half of 2009 and strong economy into 2010

Obviously things could (and probably will) change. Knowing what to do in the future is predicated on two simple things right now - pay your bills (think this way - what I need versus whatI want) and realize how long you have until you spend your final retirement dollar. This last point is very important. At a meeting with a client last week, they expressed concern over contributing to their RRSP's. When I showed them how markets have gone through this in the past (several times), and will in the future, they said they wanted to retire in 10-12 years (around age 60). I asked one simple question;

"When you retire, do you plan to spend all of your assets the first day or over a period of 20-30 years"?

They obviously replied with the latter. As I explained, they then had a 30-40 year investment horizon. They have only been saving money for 20 years. In other words, THEY ARE ONLY 35% THROUGH THEIR MONEY PHASE.

Please provide any constructive feedback both on content and information for future blogs.

Sunday, October 26, 2008

We are entering into very scary times...

Next Friday is Halloween and apparently the global economy seems to believe in this whole "witching hour" stuff. For myself, this is one of my favourite times of the year. I thought you would like to see what Halloween past has meant to me, and perhaps in a couple weeks, we will show you what best represented Halloween 2008.
Enjoy....if you dare!!!

The Bates Motel


Captain Jack Sparrow

Bart Simpson


Wednesday, October 22, 2008

It is the best of times, it is the worst of times

Before I launch my latest tirade, I have a "contest" in mind. It is open to anyone (GTA area) who can reasonably and logically answer a simple question for me. The winner gets lunch with yours truly at one of the GTA's fine diners, and an opportunity to vent and scream to their hearts content. Please reply in the comments section or email me your response.

QUESTION? Name a product or service that when the price drops by 40%, you would be less inclined to purchase it (assuming you need it and it is an identical product or service) and would prefer to pay full price.

On to the news...

The other day I went to the bank machine to withdraw some money and the screen indicated "insufficient funds".

I wondered if that meant them or me.

There seems to be a perception that because of problems with banks in the US and globally, that Canadian banks may be in trouble. In reality, this could not be further from the truth. recently, the International Monetary Fund identified the Canadian banking system as the most stable and well positioned in the world. Yet when debit systems were not working on Tuesday, I wondered if there would be a run on banks.

This morning, Finance Minister Jim Flaherty announced Canada's government has pledged to temporarily guarantee banks' medium and longer term borrowing in a bid to keep pace with the multi-billion dollar financial rescues offered by other countries over the past couple of weeks. “This is a proactive step,” Mr. Flaherty told reporters. “There is this concern that our institutions could be disadvantaged competitively.” Canada's government has had to do less than other nations to salvage the financial system because the countries banks are relatively sound.

If our banks are sound, then why has the value of the Canadian dollar plummeted over the past month. In fact, it's values have dropped for two main reasons - increase in value of the US $ and Canada's economies being tied to natural resources. When a recession hits an economy, people buy fewer things which means they need less materials to make them. The continuing downward spiral of the price of oil also impacts our economy.

Lest you think we are in bad shape, John Williams, founder of the website Shadow Government Statistics, which offers alternative economic data to what the feds release, says the United States can expect to enter a period of hyperinflation sometime between 2010 and 2018, thanks to the copious amounts of money the government has put into the financial system.
"Federal debt is roughly four times the size of the GDP, and the government (US) has no way of paying this. They're not going to default on debt, so what most countries do when they're in this kind of trouble is rev up the printing presses and pay back obligations with debased dollars."
It doesn't help that 80% of America's net treasury issuances have been bought by foreign investors. But Williams expects foreign investors to unload their bucks soon. "We will see a flight from the dollar to a dumping of the dollar," he says. "That will spike interest rates as foreign-held securities are dumped and the Fed has the option of letting rates rise or buy securities. They will effectively monetize debt and that leads you to hyperinflation. I would look for a massive decline in the US dollar."

One person who believes that we are going to eventually head in the right direction is Derek de Cloet of the Globe and Mail. In today's column, he states "This is not necessarily a good time for the stock market. The stock market is a crummy place to be. But this will prove to be a very good time to buy stocks, if you view them as pieces of businesses and stick to the best. That's the lesson of '74. Those who find them, buy them and hold them should do just fine. Those who haven't got the guts have no business owning equities in the first place".

This is my fourth installment - I expect these to become less often in the future (perhaps twice weekly) and not only welcome, but really would encourage your feedback and suggestions on ways to improve.

Oh, by the way, here's a question to ponder.

What is the capital of Iceland?

Roughly $6.87 at last count.

Monday, October 20, 2008

Life, LIBORty and the Pursuit of Happiness

Apparently all you need is a bear market to effect changes in the way people learn about economics. It amazes me how many clients now watch BNN (Business News Network). Six months ago, I would not have expected a client to know what a LIBOR was and why it was important to the economy. I queried a client about this on Friday and he responded correctly (kudos to Chris). For those who are unaware, LIBOR (London Inter Bank Offered Rate) is a percentage rate that banks charge to each other (please see the humour in banks having to borrow money from other banks) to borrow funds for the short term. The fact that the rate has dropped dramatically over the past two weeks is an important sign of a lessening credit crunch, and means more money will be available for John and Jane Q Public to buy cars and houses and such.

While I don't expect people to suddenly go on a spending spree, the rate to borrow money (assuming you can or should) is going lower. The Bank of Canada dropped their rates again today by a quarter point and indicated more rate decreases to follow.

How will this affect Canadians? The Bank of Canada expects growth to be sluggish through the first quarter of next year, then to pick up over the rest of 2009 and to accelerate to above-potential growth in 2010. The recent drop of the Canadian dollar will also provide an important offset to the effects of weaker global demand and lower commodity prices. Overall, the Bank projects average annual growth in real GDP of 0.6 per cent in both 2008 and 2009, and 3.4 per cent in 2010.

The next question seems to be where do we go from here. While there are positive signs emerging, and though Canada is expected to lead the G7 nations in GDP for 2009, the weakening US economy saw another recommendation for a "stimulus". Federal Reserve Chairman Ben Bernanke testified Monday that Congress should consider passing a new stimulus package to try to jump start the economy. Bernanke, speaking before the House Budget Committee, came just short of an outright endorsement of a package to pump tax dollars into the economy. But he clearly said the economy needs additional help from Congress. The when and how of any such package coming to fruition is debatable, but perhaps after the November election and before the new Congress takes office in January.

So where do we go from here. While the signs are there for a rise (dramatic) in the markets, we are rapidly approaching year end. This can often signal a time for certain investors to sell some of their holdings (non-registered) to trigger capital losses. Markets in November/December can be very uncertain, but an interesting chart appeared in Rob Carrick's column in the Globe and Mail on September 8, 2008. I guess that based on the data, that RRSP season that traditionally kicks off on January 2nd should really start in December.

S&P/TSX composite from 1985 to 2007

Average % return each month (% of time returns are positive)

January 1.8% (65)
February 0.8% (52)
March 1.1% (65)
April 0.4% (57)
May 1.7% (70)
June 0% (48)
July 1.0% (65)
August -.5% (48)
September -1.4% (35)
October 0.5% (65)
November 0.8% (61)
December 2.6% (96)

Please take a moment to answer the "poll" on whether your RRSP contribution habits will change due to current market conditions.

Sunday, October 19, 2008

Looking For A Rebound

Many of you may know of my affection for basketball, however the rebound I refer to is in the stock markets. No one can predict when the markets will turn (and stay turned), but history has shown that stock markets tend to rise before the general economy does. Many people wait on the sidelines until the economy brightens before investing. Unfortunately, that means they often miss some of the biggest gains in the market.

Predicting where markets will go is difficult, yet the accompanying chart from RBC shows how markets behave in a (dis)orderly fashion. While it remains difficult to believe given what we have experienced lately, the chart suggests the TSX will grow to between 20,000 and 35,000 points by 2014. While these numbers may seem like fantasy at this time, it only means a sharp bounce of 3000 points followed by 10-12% overall returns over the following years.

Since 1956, Canada has experienced 11 bear markets (defined as a 20% decline across the board for at least 9 months) that have lasted an average of 10 months. Excluding the current market situation, the majority of Canadian investors have only experienced the "tech bubble" of 2000-2002. Markets dropped 38% over a 13 month period. The numbers for the bull market that followed - a 90% increase over 5 years.

For older Canadians approaching retirement, they need to be somewhat cautious in their forward planning. Yet for younger Canadians, they don't want to miss out on what experts have termed "the buying opportunity of a lifetime". Burton Malkiel is a professor of economics at Princeton University. He had an excellent article in the Wall Street Journal last week on how people need to not "react". It is especially appropriate for older clients tempted to make changes to their portfolios now.

"The barn door is open and the horse is gone. Now is not the time to close the gate, lock it and burn down the barn. Instead, leave the gate open and try throwing some more hay in the barn".

Saturday, October 18, 2008

Finding Your Way In Tough Times

Let me start this off with a simple statement.

I am NOT an expert in the field of economics, but have spent the past 20 years working with people who have real problems and want answers to their questions. The intent of this blog is to allow people to ask tough questions and get real answers. For me, the purpose is twofold - to help my clients and others make sense of "financial issues", and to allow me to provide some insights that people may not get from the mainstream media.

Over the past three months, the Canadian (and global) economy has undergone dramatic changes. It is worth noting that few if any of the problems were "eye openers", as many economists had foretold our current situation several years ago. Yet with the media's negative pessimism and failure to point out any positives, your average Canadian finds themselves lost and struggling to find answers. As we watched our retirement savings crumble (I hate that word), people wondered "should I sell" and accept the losses already incurred.

One thing history has taught us is that markets rise and markets fall, but they inevitably rise again. Trying to decide when to buy and sell is a difficult proposal for the experts - how can Joe Average expect to do that? Several years ago someone explained that stock markets work like a yo-yo on an "up" escalator. While the yo-yo will go up and down, the escalator eventually goes up. What we need to remember at this time is simple - right now is the time when smart people buy from dumb people. Warren Buffett, the richest man in the world, said it best in a recent NY Times article "be fearful when others are greedy, and be greedy when others are fearful". Now is not the time to sell, but the time to buy.

The next time you have a "finance" conversation with a friend, family member or co-worker, remember Warren's statement. Better yet - bookmark this Blog and see where the markets are in 10 years.