Juggling Dynamite

Over the last 5 months the Bank of Canada has gone from worrying about flat wages and high household debt to planning a series of rate hikes into 2018.  With the US Fed too afraid to hike, this has led to a rally in the loonie and a sell off in Canadian bonds relative to our biggest trading partner, year to date. (See: Rate Hike Imminent as Poloz takes Hawkish Turn.) The last thing an export-needy Canada wants right now is a stronger currency.  And yet here we are, with the US/CAD Index back near a 2-year low.

Central banks have a really bad forecasting record, and the Bank of Canada in particular has a habit of hiking late in credit cycles only to quickly reverse as consumption weakens.  This time is unlikely to be different, and especially since interest rates have never been lower nor Canadians more indebted, nor our economy more reliant on the continuation of outrageously high consumer and housing expenditures.

Since January 2014, consumption and residential investment have accounted for 90% of Canadian economic activity.  This compares with a long term average of 59% since 1961.  Over the last year, finally, spending in these sectors has weakened to about 62%.  But after nearly 5 years far, far above mean, an extended period of below average spending is in order here.

Even when the Bank of Canada blinks in the next couple of months and backs away from a tightening mode (which we think is likely), indefinitely flat policy rates are not able to promote rising consumption for already maxed out households. Only rising wages and spending appetite can do that.

The truth is that subterranean loan rates can prop up zombie-companies and consumers for a while, but they’re innately self-defeating because they promote dumb waste and indolence while undermining productivity, innovation and rewarding investment opportunities. (For a great recent primer on all of this see Charles Gave’s ‘The Strangulation of Enterprise.‘)

With the madness of King Trump to our south, and a host of counter-productive policies undermining strength and stability in the free world at the moment, wage growth for the masses is going to continue to be elusive in Canada.  The BOC can talk big on monetary policy, but at this point, they are carrying a minuscule stick.  Canada has earned itself an extended rough patch and most Canadians don’t see it coming.

Everyone with life savings to lose must continually remind ourselves of what financial course is prudent for us and our goals and then not allow ourselves to be distracted off plan by those around us.  This article articulates the issues and risks facing individuals extremely well:  Real talk.  Read the whole thing here:  The reasonable formation of unreasonable things.  Here’s a taste:

Bubbles do damage when long-term investors mistakenly take their cues from short-term traders. It’s hard to grasp that other investors have different goals than we do, because an anchor of psychology is not realizing that rational people can see the world through a different lens than your own. When momentum entices short-term investors, and short-term investors dominate market pricing and activity, the long-term investor is at risk of seeing rising prices as a signal of long-term worth. Rising prices persuade all investors in ways the best marketers envy. They are a drug that can turn value-conscious investors into dewey-eyed optimists, detached from their own reality by the actions of someone playing a different game than they are.

Few things matter more in investing than understanding your own time horizon and not being persuaded by the price actions caused by people with different time horizons.  No matter what kind of investor you are, the key to success is not participating in a game other than the one you intended to play. And you can only do that if you make an effort to identify what games the people surrounding you are playing, separating them from your own. It is the only way I know of to have a reasonable shot at not getting sucked into bubbles in the first place.

Worthwhile article and big picture charts on our Fed-elongated, late-stage credit cycle from independent bank analyst Chris Whalen.  Read:  The Fed Fueled Bubble in Residential Real Estate:

Fed Chair Janet Yellen’s defense of the benefits of regulation last week in Jackson Hole probably killed her chances for reappointment, but the more pressing reason to see Yellen return to the private sector is visible in the US real estate market.  Chair Yellen and her colleagues have created large bubbles in many assets classes from residential homes to commercial real estate to construction lending.  As in the 2000s, this latest bout of asset price inflation will not end well for banks or investors.

…the biggest challenge facing Yellen’s successor as Fed Chair is having the courage to admit that inflating asset bubbles does not create jobs or prosperity, just future financial crises.