Current Portfolio-13 Year Track Record

 

Sacola                   182%

TSX                           76%

DJIA                          97%

S&P 500                   107%

Past trades total 29 wins and 3 losses with an average gain of 34%. The average holding period was 2.3 years.

Tuesday
Aug152017

Something is not right.  After raising interest rates for the 2nd time this year in the U.S., markets rates have fallen.  The 10 year U.S. Treasuries were around 2.45%.  After the rate increases they have fallen back to the 2.3% area.  We believe this signals weak demand by business to borrow and suggest deflation is gaining strength.  To be fair, American business is cash rich, led by Apple, which has $240b in the bank.  Total cash hoarding by American business is $2 trillion.  One has to ask, why are these companies not investing in new plants and research and development?

Stock market values bear no relationship to corporate earnings.  On July 24th, 2015 the companies in the Dow Jones Industrial Index combined earnings were $107.58, NASDAQ $21.98, and S&P 500 $9.82.  Today, those earnings are $104.41, $24.21, and $10.15, respectively.  Yet, all three indexes have increased by 23%, 26% and 19%, respectively (the TSX is up 7%).  This means the stock markets have been going up based on speculation that Trump is going to save the country and make corporate earnings double in 3.4 years.  This is next to impossible due to lack of new investment, the ever growing debt by governments and individuals, numerous leaderless governments in the U.S., Britain, Canada and Japan, and, the threat of China falling into a recession.  Plus, there are surpluses of just about everything mined, harvested, and manufactured. 

There is surplus of housing. Calgary has 23,600 empty homes.  Condos make up 45% of the total.  Toronto and Vancouver have around 60,000 each.  In Penticton, homes under construction equal a 10 year supply based on population growth.  While not as big, overbuilding is taking place in Kelowna and most of the Fraser Valley.  Where are people going to come from for all these homes? Increased immigration?

Without immigration Canada’s population is shrinking, as are most Catholic countries.  The shortages will not be noticeable for about another 10 years when the Boomer generation begins to decline.  Canada is going to need massive immigration to offset the coming shrinkage.  Japan is the first country to feel the effects of a declining population.  Japan already has surplus housing. Just like Canada is going to have for years to come.

Stock market growth is limited for the rest of this decade.  By every yardstick they are very expensive.  Portfolio growth will be coming from cash and from dividends.  Our 7.7% annual return from dividends will be one of the highest rates of return for all investments over the next couple of years. Not to be cocky, but the 7.7% will be higher because most of the companies on page 6 will increase their dividends.

Stock markets are warning us to be careful, risk little and pay down debt.  There will be another interest rate hike later this year, and probably two more next year.  Stick to terms of 1 year or less on all money market assets and ride the interest rates up.

All bonds with terms greater than one year should be sold immediately.  Like preferred shares, they trade based on the going rate of interest.  Bond prices for the next few years will be heading lower.  They will be a horrible investment.  

Saturday
Jul152017

Human nature loves to follow the crowd, especially when it comes to investing.  Years ago mutual funds were the road to riches for Bay and Wall Street.  Few investors made money.  Then came the ETFs which have been a gold mine for the companies managing as each trading day all funds must be reset to maintain the balance as required by the ETF.

This decade the road to riches has been buying real estate.  Stock markets have also been very kind as they are trading at their all time highs in the U.S. even though corporate earnings are down from two years ago. Real estate and stock markets have benefited from zero interest rates. Falling interest rates push up asset values.  Investors have benefited from this, but only on paper, unless they sold to rent or to downsize. 

People either believe the good times will never end, or, they will be smart enough to get out the day before the correction begins.  If they are correct then this will be the first time in economic history.  Unfortunately, history and common sense says, once again, these people will be wrong and lose a large portion of their savings.  They will end up deep in debt, and will have a poor future for their retirement.

Today, yellow lights are flashing.  Personal and national debt around the world is skyrocketing with not one government attempting to bring down their wasteful spending.  Consumers have been on a record spending spree, with a large portion of the spending via debt.  When in Canada the debt is at $169 versus $100 of income, trouble is coming for the consumer and the economy.

Gold is telling us deflation is coming.  Platinum prices are telling us car sales are about tumble.  We have record surpluses in natural gas and oil.  Farmers are producing too much food.  Stores are over flowing with goods.  The Baltic Dry Index confirms weak world trade.  President Trump is doing everything possible to destroy free trade.  The CRB index continues to slide as weak prices are a sign of deflation.  Until this decade it was rare for the index to go below 200.  Since mid 2015 it has been rare to be at or near 200, trading mostly around 185.  The all time low was set on February. 11, 2016 at 155.53.

Any real estate and stock market pull backs will wipe out trillions of dollars, again 100% deflation.  It will take years, maybe over a decade, to recover most of this lost money.

Asset values have peaked and are about to tumble.  Thanks to debt, consumers have less cash to sustain the economy.  All this means is time is running out for the average investor.  Today, as deflation grows, cash becomes the best investment followed by strong companies that have cash and a reliable dividend.  

Thursday
Jun152017

It was between 1929 and 1932 when depression slaughtered the stock markets and real estate.  Back then the economy was based on the rural segment and the stock market.   The real estate collapse was mostly through the prairies of North America where most people lived in the countryside and in small towns.  It was this financial meltdown that changed North American life.  People began the exodus from the farm to the cities. 

In the 1920’s the New York Stock Exchange was a gambling casino.  Like real-estate today, you could buy shares with 10% down.  Investors were required to keep a cash-to-margin ratio of 90:10.  This worked well until August 1929 when the collapse began.  Investors did not have the cash to maintain this ratio.  This caused forced selling which drove the stock markets even lower as it fed upon itself.  To make matters worse, the Federal Reserve pulled money out of the financial system bringing real-estate down in the process.  This made it impossible to borrow, so prices for everything collapsed. 

Between August 1929 and May 1932 the Dow Jones Industrial Average lost 89.9%.  This drop has been repeated only once since.  It was when the NASDAQ dropped 89% during the-hi tech implosion in 2000.  

It is so obvious that Canadian house prices are in the stratosphere. They bear no relationship to family income. For years prices have soared faster than wages and inflation.  At the same time families have piled up personalized debt to record levels to match these house gains.  The market is now changing as sales have peaked and are down double digits in many of the hot markets today.  Falling sales result in price drops leading us to believe prices will begin to decline by late summer, if they are not already.  It will be amazing how many potential buyers will disappear and how many homes will go up for sale. 

Stock Markets are based on profits.  Nothing else!  Because of this, stock markets are the second most expensive on record.  They are up slightly from two years ago while the markets are up over 10%.  The Dow Jones Industrial Average is currently trading at 20.5 times earnings.  The 97 year history of the index is between 13 times (set mostly last century) to this century’s average of 15 times earnings. 

In order for homes prices to return to their norms, prices must drop between 20% and 40%, depending on the location.  Stock markets face a potential decline of 25%.  The danger today is if the stock market and house prices decline at the same time.  If this takes place the economy will contract. You will want income (dividends) and to maintain a cash reserve that you can use to take advantage of the deals that will be out there. 

History has shown that when the average person is buying the same thing and getting rich at it, all the wealth gets taken away at some point rather quickly.  Even worse, it takes years to recover.  Just a few samples of this, the Tulip Bulb craze, American railway bonds in the 18th century, the Great Depression, the hi tech during the nineties, and the Financial Crisis of 2007-2008.

Both corporate and household income do not justify current prices.  Real-estate and stocks markets need to clean themselves of the rampant speculation taking place. This will occur. It is a given.  Let’s just cross out fingers both do not occur at once.

Wednesday
May102017

House prices in Toronto might seem overvalued, “but the fact is that fundamentals have all changed” (such as jobs and population growth), said Stephen Poloz, Governor of the Bank of Canada, in April.  Does that sound familiar?  It should.  Back in 2006 we heard Ben Bernanke, Former Federal Reserve Chair, state pretty much the same thing; rising house prices in the US “largely reflect strong economic fundamentals such as jobs and population growth”.  Canada could be different, but we doubt it.  

The Economist’s house-price indicator shows that Canada’s home prices are the second most overvalued when compared to rents, and the fourth most overvalued when compared to incomes.  This does not only confirm that house prices are overvalued, but shows that renting is the better option.   Of the fifteen countries they track, only half of the markets favour buying, based on incomes.  The indicators show that only four markets (Italy, Germany, Switzerland, and Japan) offer the potential for a decent investment going forward.  

Prem Watsa, the founder and CEO of Fairfax Financial, recently insinuated that Toronto’s market could face a substantial drop in prices when he stated that our financial institutions could not withstand a 50% correction in Toronto’s house prices.  He has raised subtle hints that Canada’s prices are out of whack for years.  Only this year did he raise the alarm bells. 

Either Statistics Canada’s data is 100% wrong or the banks and mortgage lenders are giving out loans with nothing down or very little.  Obviously, risky mortgages are a problem given Home Capital’s, Canada’s largest alternative lender, most recent meltdown.  Either way, house prices in Canada bear no relationship to family income and will correct. 

In Canada, the average house price ($460,000) is roughly 5 times family income.  This does not include lawyer fees, transfer taxes (up to $27,000 in Toronto), moving costs, and so on.  We are baffled trying to figure out where the money is coming from to buy the average mom and pop home.  The rule of thumb is, with or without a down payment, to never pay more than 3 times income for brick and mortar.  In big cities like Toronto and Vancouver families are paying up to 10 times income.  Even if these people put down 50% they are still heading for a financial nightmare.

The household debt-to-income ratio now stands at 169.4, up 23 per cent from a decade ago, and on par with the U.S. at the peak of its housing bubble.  Wage increases are around 1% annually.  This is before taxes which continue to creep up.  Cash pays anywhere from .05 of 1% to 1.25%, before tax.  In order to stick to the 3-times income rule, a family trying to purchase an average house, while maintaining a healthy balance sheet, must save at least $10,000 a year for 18 years to get a down payment in todays low interest rate environment.  In Toronto and Vancouver it will take up to roughly 35 years.  Given Canada’s low savings rate, how many Canadian families are actually saving $10,000 a year? 

A TD branch had an ad that the customer could pick the type of mortgage they wanted.  One choice was interest only.  In other words these people will be hoping house prices will continue the price appreciation of the past decade, which is literally impossible.  What the borrower does not think about is if they cannot make the full interest payment for one month, the difference is added to the principal.  This means future monthly payments will be even higher.  This is also a road to a financial nightmare.

Canada has a home ownership rate of 70%, the highest on record.  Like household debt, this is on par with the US in 2006.  Today, US home ownership is at a 50 year low.  Part of the reason US home prices started to decline was because too many people owned, equating to fewer potential buyers to hold up prices.  This resulted in a large price decline that tried to attract the few potential buyers.  It was a perfect house of cards.  Stocks cannot increase in price with few buyers.  Brick and mortar is no different.

Contrary to popular belief, we believe there is no shortage of housing.  If there is, it will only be temporary.  In fact, we are willing to bet that homes are being overbuilt.  Everywhere one travels they will see numerous cranes across the skyline.  So many people are becoming amateur landlords and buying second homes speculating that prices will continue to rise.  This is confirmed by a CBC report which found that 50% of condo units in Toronto and Vancouver are bought by investors.  Basic finance dictates that anyone who bought a rental property at current prices is losing cash because rents cannot cover costs unless one puts a significant down payment on the property. 

The most recent data released by CMHC also confirms our surplus belief.  The report highlights an epic proportion of new construction underway. As of February 2017 new homes under construction across Metro Vancouver are up 30% year over year.   Home sales are down over 20% from last year.  Falling sales and increased inventory does not make a healthy market.  The markets that are representing the bulk of Canadians are most likely similar.

Because the debt levels are so high and people having little to no savings, the collapse in real-estate will last for many years. Maybe even a generation given the amount of debt we are responsible for.  Lenders are not obligated to renew mortgages.  If prices fall many new owners may not be able to renew their mortgage without putting money down.  If they do not, they will be facing bankruptcy because their outstanding debt will easily exceed the value of their property.  This was also an issue in the US collapse. 

If politicians were serious about correcting the housing market they would make it law that there must be a minimum 20% down payment and the loan cannot exceed three times household income.  It should also be law that an audit should be conducted to ensure that the borrower actually saved the downpayment.   

When the correction comes house prices will fall back to their long term norm.  Just like they did in the late nineties, during the late seventies, and every other bubble in the past.   There will be few buyers around and lenders will quickly tighten lending.  It sounds unreal in today’s world, but every boom is followed by a bust.  This is just history repeating itself. 

We hope it does not take place but we can see no way to stop the coming correction.  History has shown prices always revert to yhr norm.  Tomorrow will be no different.  Cash is the number one asset to own.  Debt in any form is your number one enemy in this phase of the cycle.

Saturday
Apr152017

In the past twelve years we have recommended 42 stocks. Thirteen of those still remain on our recommendations list. Our past 29 trades have averaged a 34% return in just over two years.  There were three losses.          

Our current recommendations have returned 182% in eight years on average. We have outperformed the Dow Jones Industrial Average ( +97%), the S&P 500(+107) , the Teranet 11 Home Price Index (+125%)  and the TSX (+76%) since the first issue.  The NASDAQ closed five percentage points higher. 

The above returns do not include converting our US stocks into Canadian funds.  Doing so would bump the average return to 22.7% annually.

Dividends account for 46% of the above returns.  If you qualify for the Dividend Tax Credit, be prepared to tack on another 1 percentage point. 

Investing is all about patience.  A good portfolio should not have to be monitored on an ongoing basis.  The investor should be able to glance at their statements to watch the dividends roll in and not have to worry about the capital.  Boredom should also accompany a good portfolio because one should be able to buy and hold a stock, hopefully forever, resulting in very little to do once the company is found. 

Our strategy of buying and holding companies with a history of stable dividend increases is boring, but it works.  A stable dividend will place a natural floor below a share price.  As the dividend increases so does the floor. We continue to outperform the market year-over-year.

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“Money is better than poverty, if only for financial reasons.”

 

                ..Woody Allen

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It is probably due to tax season but we have had a few requests for information on what people paid for their equities.  Many have held a security for years and lost their paper work or did not keep records.  These numbers are required for capital gains, stock (share) exchanges, for estates and for personal curiosity.  Most brokerage month-end statements give a record of a persons purchase price so one should keep all month end records.  Unfortunately, we find some are incorrect.

For example we will use Interpipeline (IPL).  When the company changed from a Unit Trust to a common share there was an option for investors to record the conversion as a sale at $24 per share.  Everyone who took this option had to pay a capital gains tax and their new purchase price became $24.  Yet, many did not take the option (us included) so they still have a purchase price of $7.90 (our purchase price on page 6).  Today’s month end statement shows the purchase price of $24.  For those who did not change and put down $24 they will be hit with a reassessment.  The outcome will be pay back taxes and, more often than not, a penalty and interest on taxes owed.   So it is so important to keep accurate records.

Another common problem occurs when an investor adds to their position by purchasing additional shares.  Often the average purchase price on the month end statement is wrong.  We strongly recommend everyone keep a log of all securities one holds.  This should show date of purchase(s) and how many shares or bonds you bought.  If you made multiple purchases of a single security, you will need to find out the average purchase price (e.g. 200 shares of X shares in 2010 at $10 and 200 shares at $12 in 2014 for the average of 400 shares at $11.)  Then every January you update the list. 

The advantage of this is that you never have to go back through years of paperwork to get the numbers required.  Once you have set up this system it will take about an hour in January.  Going back years can take hours and might cost you money if you need the help of a lawyer or accountant.

We have clients that have held a security over 20 years. Going back all those years to find the right information will be a headache. Revenue Canada has access to all the numbers you might require but they do not give out this sort of information.    It is 100% your responsibility.