headerwebWhy Canadians Should Be Careful

The Reality of Canadian Debt Levels

Dear Readers,

As a proud Canadian, I find it extremely difficult to read the investment opinions of Canadian journalists who have never invested a penny into the markets themselves.

Sure, they might have some ultra conservative mutual funds or GIC’s that are automatically taken from their paychecks every month, but the majority of them don’t even know what’s being purchased for them.

When the markets turned in 2008, they complained that their fund managers should’ve never put them into such risky investments. Now that the markets have turned, and their mutual funds climbing, they stand around cocktail parties bragging about their investment decisions – made by other people.

newspaperSadly, this is a scenario that applies to many Canadians. Our ultra-conservative (not to be confused with politics) views on life can sometimes be our biggest enemy. We’re too afraid, or too comfortable, to make decisions or bets that come with risk.

And when things appear risky, we simply turn to our Canadian journalists – who have never invested a penny into the markets – for their advice.

That’s a really dumb move. It’s like hopping on a plane with a pilot who has read about flying, but never flown.

What do you think of Canadian financial journalism? Share your thoughts by CLICKING HERE.

Newspapers everywhere are filled with reports on the Canadian housing market; how strong and robust it is, and why we should keep buying.

For every one negative article about the housing market, another ten positive articles follow.

I get it. They want the public to slowly – really slowly – wean themselves from the housing market in order to prevent a dramatic collapse. The big banks, on the other hand, want this housing trend to continue*.

(*Big banks in Canada are all seeing strong profits and their shares are all near all time highs as a result.)

But those who listen to the advice of these articles may have a lot to lose.

The Reality of Canadian Debt Levels

I have written about the rising rate of Canadian debt levels before; how we’ll soon come to a tipping point where consumers can no longer afford to meet their debt obligations, and how we’re awfully close to America’s debt level prior to their housing crash in 2008.

But when I pick up my local newspaper, I am reading the opposite.

A few months ago, I read an article featured in the Financial Post that included statements from an economist at a major Canadian bank telling us that Canada’s household debt levels are nowhere close to the U.S. peak – especially when you make them comparable:

“There are differences in the methodologies used to calculate both debt and income…Bringing the numbers more into line yields a Canadian debt level of 156%, compared with 152% in the U.S. However, that’s still far off from the 177% peak U.S. households hit in 2007.”

…All of a sudden, Canada’s household debt doesn’t look so out of control.”

But take a look at this chart (click it to enlarge):

household-debt-ratio-us-vs-canThis is a chart of the household credit market debt to disposable income in both Canada and the U.S, with an adjusted Canadian ratio to adjust for the differences in the numbers used to derive this data.

As you can see, when adjusted to make the data streams more comparable, Canada is indeed below the threshold that broke the American housing market in 2007, just as the economist had said.

But to tell us that we’re nowhere close to America’s peak levels? Well, take another look at the chart.

If the trend line is correct, Canadians will be reaching that threshold within one year.

That same Financial Post article ended with:

“…It should also be noted that Canadian households are deleveraging. Data from Statistics Canada showed that after households hit a record debt level in 2012, they have since deleveraged in both quarters this year.”

But has it?

According to Statistics Canada’s latest findings in October, the ratio of credit market household debt to disposable income has actually increased in the second quarter to 163.4 per cent, up from 161.8 per cent in the previous period.

That’s an increase of 1.6 per cent in one quarter alone.

Since this data came out, that same economist from the Financial Post article is now changing her tone.

Here’s her comment in a recent article published by CBC:

“Today’s (October 15) report indicates that Canadian households are more financially vulnerable than had previously been thought.”

The article continued:

“The changes in the historical data suggest that the increase in household indebtedness since 2004 has been sharper than previously thought, with credit growing an average of one percentage point higher per year than was originally reported.”

The biggest share of that increase? Mortgages.

Despite the Canadian Real Estate Associations (CREA) eagerness to pump out rosy data, their October data finally shows that sales of existing homes fell 15.1 per cent in September from a year ago.

But these numbers could be worse than people think.

In a recent column by the Globe and Mail, CREA’s data have been coming under scrutiny:

“Canada’s surprisingly strong real estate market is leading to heightened scrutiny of the data used to assess sales.

…As people try to make sense of the market’s twists and turns, some are raising questions about the accuracy of CREA’s statistics. One of the main critics is former Member of Parliament and blogger Garth Turner, who has recently been calling CREA’s numbers into question on his blog. He alleged, among other things, that the numbers are being distorted by real estate agents listing one house with two or three local real estate boards (so more buyers will see the listing).”

The next time you read stats from CREA, just remember that one of their core goals (directly from their website) is to support a vibrant real estate sector. You can’t achieve that goal if people aren’t buying homes.

If you’re looking at buying – especially as an investment – ask yourself this: “What will drive prices higher?”

Interest rates are already at all-time lows and housing prices are already at all-time highs. Foreign purchases can only sustain a small portion of the market. Unless we see a major surge in wage increases, what could possibly drive real estate further?

Do you think housing prices will climb? Click Here to Leave a Comment and Share Your Thoughts 

That’s why I am shocked to see Canadians – who are generally ultra conservative in their investments – still investing in real estate. When you look at it from an investment point of view, you’re borrowing hundreds of thousands of dollars to make a bet. If real estate drops 10-20%, you’re likely spending the next 5-10 years just paying the loss on your home.

That doesn’t make sense to me.

If you’re selling your home to buy another one, it’s relative. But if you’re buying for the first time or looking to make an investment, it just doesn’t make sense to me.

I am sorry, but there’s a better chance of the stock market in Canada going up than real estate.

Buying a home now might not be playing it safe anymore.

High Prices Lead to More Debt

Rising home prices have contributed to a much bigger problem than just the housing market itself.

Canada’s growing housing unaffordability is starting to trickle directly into personal debt – which will have an overall effect on growth and spending.

In RBC’s recent annual debt poll, the average personal debt load, which doesn’t include a mortgage, jumped by $2,779 to $15,920 from last year.

That’s an increase of over 21%.

Albertans experienced the biggest jump in their personal debt load (likely due to the flood), with the average amount-owing coming in at more than $24,000 – a 63 per cent increase from the year prior.

B.C. followed with an increase of 38 per cent, Manitoba/Saskatchewan jumped 32 per cent, while Ontario saw a 13 per cent climb.

As I mentioned in The Truth About the Housing Market, British Columbians are the most highly leveraged Canadians, mainly due to unaffordable housing prices and lower wages:

“The average income in Metro Vancouver in 2009 was only $41,176, according to Canada Revenue Agency statistics. Richmond residents are barely scraping by at $33,350 a year – the lowest average income in the region, followed by Burnaby, with an average of $34,961.

According to Andrew Romlo, executive director of Urban Futures, only 0.56 per cent of British Columbians declared incomes higher than $250,000.”

Interest rates will remain at low levels and will continue to encourage homebuyers to over-extend their debt load capacity. And since most of our equity comes from real estate, and many are borrowing against it, a crash scenario is more serious than most economists make it out to be.

I love real estate. I studied it in University – everything from development to economic projections.

But in this environment, there are better places to put your money.

Canadian Stocks vs. American Stocks

With record injections of liquidity, I’ve been buying stocks.

Many readers have asked me why do I keep showing charts of the S&P and why do I keep telling my readers to invest in the American markets? Why not the TSX or the TSX Venture? Isn’t this a Canadian investment newsletter?

Yes, it most certainly is.

But that doesn’t mean you should only invest in Canadian stocks.

As a matter of fact, it’s just as easy to trade American stocks, as it is to trade Canadian. And if you would’ve invested in American stocks over Canadian stocks, well…take a look at this chart:

tsx-vs-sp
Clearly, American stocks have significantly outperformed Canadian stocks since 2008*.

(*except between 2008-2010, when the TSX Venture led the way. If you recall back in 2008, I told my readers to jump heavily in the junior resource sector, as well as the American markets.)

But Canada has a long history of following lagging American footsteps.

While many in the industry are running scared, both the TSX and TSX Venture have seen support lately and are actually climbing nicely in synch with the S&P on a relative basis over the last few months.

Here is a chart of the TSX Venture against the S&P, with the area shading representing the Venture and the dark line representing the S&P:

Screen Shot 2013-11-02 at 2.02.06 PM
This goes hand-in-hand with my prediction back in the last week of June where I said the Canadian markets have capitulated, especially for the junior miners.

While we’ve had our ups-and-downs, it seems that Canadian stocks are finally starting to react in synch with American stocks – more so with the TSX than the TSX Venture.

If American stocks continue to climb, as I expect they will, the general trend for both the TSX and TSX Venture is up.However, I’d be keeping a close eye on any Canadian gold stock holdings, as gold price wavers. The direction remains unclear in the near term.

Speaking of Gold…

While many technical analysts were calling for gold to break out last week, all it took were a few headlines of tapering for gold to be pushed right back down. This is exactly as I had mentioned would happen in a letter from a couple of weeks ago, when gold was looking to break out:

“The fundamentals for higher gold prices are all there, but there are obviously occurrences that suggest gold price manipulation. It’s going to take a serious probe by world organizations on gold price manipulation to truly send gold to the levels that people like Peter Schiff predict in the near term.

And since all buyers of gold would rather pay a cheaper price anyway, whose going to lead the way in a global investigation?”

Again, be weary of near-term gold prices.

We Can’t Curb Debt

Since we’ve been talking about Canadian debt, let’s look at American debt.

Take a look at this chart (in $US billions):

Credit-Trend
This is a chart of all credit market instruments and liabilities in America; in other words, debt.

As I mentioned last week, since the Nixon Shock in the early 1970’s, America (and the world) has continued to rampantly borrow more and more money.

A lot of experts – including some of the world’s most successful investors – have written extensive reports showing why this borrowing cannot continue, and why we will soon witness a financial crisis of epic proportions.

To which I have to ask, “Why won’t it continue? It has for the last 50 years…”

Inevitably, this debt trend will continue because the more debt that is created, the more debt will have to be created to service that debt.

The world’s financial system will have to break to buck this trend, but with the world so engrossed in American dollars, I find that a hard path to follow.

The Fed’s Real Intentions

The Fed’s plan isn’t to stimulate the economy, nor steer us out of a recession.

The Fed’s plan is actually the opposite.

They want us to borrow as much as we can, so that we – and our way of life – will be forever entangled into their financial system.

They don’t want to see deflation because that means America and the world is deleveraging, and thus moving further away from their banking system.

As economic conditions continue to recover – even at a slow pace – banks will be more comfortable lending, which will only cause debt to increase.

Even if the Fed tapers, there will still be record amounts of money sitting in the banks waiting to be lent out.

Credit will remain cheap, and thus consumers will be more comfortable borrowing. Since everyone will have access to easy cash, things will get more expensive.

When things become more expensive, it means our currency is being devalued.

We are already seeing a major shift from paper assets (stocks, dollars, bonds) to the ownership of tangible assets (gold, diamonds, art, collectibles). As this wealth transfer continues, it will make our dollars less valuable and increase the price of everything else that can’t be reproduced as easily.

And that is a trend that will not change.

Until next time,
Ivan Lo
The Equedia Letter
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