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.

Wednesday
Jun152016

A friend of mine sold his 1970’s, 3 bedroom North Vancouver teardown for $1.25m.  He bought it eight years ago for $650,000.  It is located on a busy street, but has a slight city view in the winter when there are no leaves on the trees.  Property taxes cost him $5,000 per year plus an additional $3,000 annually towards insurance and repairs.  The house was generating $35,000 annually in rental income.

After subtracting property taxes and repairs, his cash-flow generated $28,000 annually (I assumed he had no mortgage), or a yield of 1.8% - hardly something to brag about.

The house had also built up $75,000 per year in additional equity.  So upon selling he realized a capital gain of $600,000, or 92%.  This is an excellent capital gain no matter what the asset.  Combining income earned and capital gains he profited $824,000 (123%) in eight years, assuming there were no extra costs. 

Prior to selling he asked my opinion if he should sell and invest the money elsewhere, or keep it and continue to rake in the capital gains.  Obviously, I told him to sell.  Look at the graph above.  There is so much similarity to other bubbles in the past.  It is amusing that people think this can continue.  But, one cannot underestimate the effect that emotion has on commonsense.  

One rule of buying a home is to never take out a mortgage greater than three-times your household income.  The sole reason is to limit you from interest rate shock.  

Monthly Payments on a 25-year, $240,000 Mortgage

 
 

Interest Rate %

2.1

5

6

7

 

Payment $

1,028

1,396

1,536

1,681

 

As most surveys over the past few months have found, the majority of borrowers will be able to handle a normalization of interest rates.  However, it is the estimated 23% of Vancouverites who cannot afford an increase in interest rates, or any expense for that matter, that is the concern.  Where do the 23% expect to get the extra $4500 per year to cover higher interest rates (assuming a return to 5% mortgage rates)?  The answer is simple; they won’t be able to.  People will either be forced into foreclosure or it will come at the cost of other expenses such as vehicles, travel, and dining out.  Either scenario will have a large impact on the local economy.

Let’s put Vancouver house prices into to the context of the stock market.  Using my friend’s house as an example, the rent he was able to earn would give the house a price-to-earnings ratio of 35-times and a dividend yield of 1.8%.  The general rule of thumb in the stock market is to never pay more than 20-times earnings and invest for a yield of no less than 3%.  Anything outside of this, one is creating opportunity costs.

Don’t get me wrong, Vancouver is a beautiful city and its real-estate demands a premium, just not the one people are currently paying.  This summer will prove to be the peak in Vancouver’s real-estate market.  There is not one city in the world that has been correction free after a run-up in prices like Vancouver experienced.  If you or someone you know wants to enter the market, it is prudent to wait on the sidelines.  If you are one of the many Vancouverites who are nearing retirement and banking on your home to fund your golden days, the next few months will be the last time to take advantage of today’s prices.  This is the time to reap your profits rather than speculate.

Other than herd mentality, there is not one reason to justify today’s prices.  All lower mainland real-estate is going to correct.  It will then recover to levels that the average income can justify under normal frenzy-free conditions.  There is no doubt in my mind Vancouver will see today’s prices again, but not for a generation.

Sunday
May152016

For the past few years we have warned about the growing surpluses of just about every thing we produce, farm, mine and harvest.  A few years ago these surpluses were not a big problem because China was buying it all, mostly to stockpile.  They stored iron ore, wool, cotton, oil and rare earth metals even though they have the world’s biggest reserves.  They also invested heavily in Botswana to add to their source of food.  Today, China has stockpiled so much they have no need for most goods.  The end result is that the world economy is stuck in neutral and will be for months, and maybe for years, to come.  

China has 400 years worth of natural gas but they prefer to use up everyone else’s first and keep theirs for as long as possible.  This is known as long term thinking and planning, something that is unheard of in the West.  This will one day make China self-sufficient and the economic powerhouse of the world.  

Another surplus which gets no discussion is cash.  Governments and central banks everywhere are printing money like it is going out of style.  Printing of cash by the central banks to create zero interest rates was supposed to be a quick way to create inflation and raise rates shortly thereafter.  All that has occurred are asset bubbles, such as the commodities bubble three years ago and today’s real-estate market.  

Low rates reward the borrower because it allows them to finance more debt.  This is at the expense of the saver.  The saver is the foundation of our economy since it is their cash that is needed to create the mortgage and the line-of-credits many of today’s consumers survive on in the first place.  People with cash instantly cut their spending and investing as soon as they see their returns start to shrink.  This is a slow and painful trip to the poor house.  

Japan has had zero interest rates for over 20 years.  The Japanese stock market is trading at the same level as 2006.  House prices on the landlocked nation still remain below their 1989 highs.  Now I know it this is hard for most Westerners to believe, but real estate can been a money losing venture like it has been in Japan nearing thirty years now.  Clearly, this policy has proven to be a failure.  Sadly, not one expert can see how bad this policy has been for Japan, nor conclude this is the direction we are headed. 

Until we get a complete change of economic thinking, the world is set to become poorer.  All those surpluses, including cash, will be losing value.  Soon it will be the housing market.  There is a surplus of homes around the world. Forget downtown London, Vancouver, Hong Kong, and so on, the further you get away from downtown the greater the number of homes that are available.  In many centres, like Vancouver, too many people are buying 2nd and 3rd homes as protection for their savings.  These people have already forgotten 2007-2009 when there was that same train of thought in the U.S. 

There is an old investment saying when everyone is jumping on the same train, get off as fast as possible.  The world economy is changing.  Sadly, most people will not realize this until it is too late.  Today, the advice is to get off the train now.

Friday
Apr152016

Quantitative Easing (QE) put the world into unchartered territory.  It is like being in the open seas alone to learn that your boat has sprung a leak and all you have is your finger to plug the hole leaving your boat to float freely - you just don’t know how it will end. 

The easy part of QE was forcing money into the system by printing money out of thin air to purchase bonds from the banks.  This was supposed to be a temporary measure used to free up cash to lend by pushing down interest rates, boosting the economy in the process. We admit that it worked, but only for a short period by pushing interest rates to historical lows.  This allowed people to rush out to buy stuff they didn’t need like larger homes, Alberta sized trucks, first class trips and other stuff they cannot afford under normal monetary conditions.  The end result has been debt at historical highs.  

Monetary theorists believed QE would make all corporations rush out to borrow and invest in new assets. Unfortunately, this plan has backfired because management understands their targeted customers have little money left over after they pay their monthly bills.  Instead, corporations are taking advantage of today's  interest rates by parking the borrowed funds in the bank for future needs.  In most cases, the end result has been an improved corporate balance sheet. The Central Banks are against this because they want all that borrowed money spent.

Governments, on the other hand, have been listening to these so called experts and are rushing to max their line of credits.  In Canada, our debt by decades end will soar by over $150b, which Ottawa will end up wasting most of.  Sadly, this nonsense is going on around the world.  Only one country is cutting spending, paying down debt, and building up a huge currency and precious metals reserves;  this is Russia.

Zero interest rates are destroying savings for the Boomers, which represent 30% of our population and claim nearly 85% of the wealth.  Today, a savings of $100,000 results in an after-tax income of around $500, or enough to feed a family for 1.5 months if their diet consists of cat food.  As a result of this failed policy, the saver is being forced into spending the capital or cut back on ones spending, both of which shrink the economy.  Spending by those who have savings will not increase until rates return to 4% or higher. 

After 6 years, Quantitative Easing has been a complete failure, something the central bankers, economists and politicians will never admit to.  The end result has been interest rates are slowing the world economy.  The longer we are stuck with zero interest rates the weaker the world economy will become.

Pumping money into the economy was easy. The painful part is going to be pulling that money out of the system, because the Central Bank must sell these bonds back into the market which will push down the value and increase interest rates in the process. Whenever the Central Bankers and economists suggest new economic policies, grab hold of your wallet because it is going to cost you huge.  Stock markets will not return to bullish mode until corporations start investing their war chest of cash.  This will not occur until the consumer has the disposable income to buy their products.

Ben Bernanke joked that "the problem with QE is it works in practice but it doesn't work in theory."  Once we try to unwind QE Central Banks will learn that it worked in theory but not in practice. 

Monday
Mar142016

“When you combine ignorance and leverage, you get some pretty interesting results.” …Warren Buffett

 

Canada’s ratio of household debt to disposable income rose to 165.4 per cent in the final quarter of the year.  For all of 2015, household debt rose 4.9 per cent, the fastest pace in four years, to a record $1.92-trillion. That included a 6.3-per-cent surge in mortgage debt, also the fastest since 2011.  The bulk of this debt has floating rates. As a result, once rates start climbing, so will the burden.  As touched on last issue, a survey conducted by BDO in Canada found that 62% of respondents would not be able to afford a $300 monthly increase in their debt payment, or anything for that matter.  All this would take is the interest rates to go from 3% to 4.25% on a $250k mortgage.  This will likely take place over the next few years.  In fact, we are betting it will.

Ipsos Reid found that during the second quarter of 2015, 17% of those surveyed had debt equal to no less than 350-times household income, with the bulk of it being a mortgage.  This is an insane amount of debt to carry and 17% of the population to do so is not normal, no matter how good the economy is.  It’s harsh to say, but these consumers are toast no matter what happens to interest rates.   What is worrisome was that 23% of respondents were on the borderline.  These are the people on the fence who cannot afford the $300 monthly increase in their debt payment.  Thankfully, 57% of the households surveyed in the report are fine with very manageable debt levels.  Plus, a third have a paid off mortgage and have savings that are growing. 

A country who borrows is pledging the consumer’s future income tax.  The higher the debt climbs the more income tax the government will require, equating to less disposable income down the road.  This is why government debt continues to be the concerning issue for us.  Within a few days the U.S. debt will cross $19t.  But, since they like to apply accounting practices that put Enron to shame, if one includes “off-balance sheet” items their outstanding debt is actually $64.8t.  This works out to $200,496 per citizen or $792,943 per family.  Family savings is a meagre $9,052, or 11.4% of that debt.  There is no way they can ever pay this back so the demand to borrow will continue to grow.

The collapse in the price of oil has made many governments poorer. This is true for any oil producing nation, including Canada, but holds especially true throughout OPEC nations.  Thankfully, Canada has other industries we can rely on to soften the blow to our energy industry.  OPEC nations, on the other hand, rely on the one industry, and instead of working together to tighten their belts and lower the amount of production to push up prices, their solution has been to lower the price of oil and borrow more money.

When demand for loans exceeds available cash this pushes up interest rates because money flows to the highest bidder.  In a slowing economy the pool of bidders grow while the amount of cash available dries up meaning interest rates must go higher.  After all, the majority of governments, Canada included, are all chasing the same savings.

We are amongst the few who believe that interest rates in the U.S. can be above 4% by year end.  For one, the States are bankrupt and one day soon the world will wake up to the fact.  And secondly, the rest of the world is not far behind.  At the end of the day, all nations are fighting for the same savings the U.S. are, and considering the amount of leverage out there is breaking records,  interest rates can do nothing but be forced up.  Central Banks will never let interest rates climb, so the belief goes.  Unfortunately, most are naïve to believe that monetary policy cannot be overtaken by market forces.  If that was the case, Greece would be paying 1.5% on its national debt, not the 11% they currently do.

 

Friday
Feb122016

Economically the world is okay because it is growing - just not at the pace we have grown accustomed to.  Nonetheless, GDP is still growing.  Of the 58 countries the Economist tracks, only seven experienced declining GDP in their most recent quarter.  These were mostly countries that will always have economic difficulty and are located in Africa and South America – so, no big threat.  The same can be said about falling consumer prices.

Unemployment is growing in tandem with commodity prices across some economies. However, employment growth across the globe outweighs the losses.  That is not to say that we are out of the woods yet.  With record debt levels in a global economy where jobs are shrinking, deleveraging (debt reduction) is a guarantee.  With it comes a slower economy.   

The CRB tracks the essential ingredients of the economy.  The Baltic Dry measures the price of shipping these ingredients around the world.  Both are at all-time lows.  This means both consumer spending and business investment has contracted.  I live in North Vancouver and see the Port of Vancouver every day.  The shipping has slowed noticeably. 

CRB Index

Baltic Dry Index

The only thing that will speed up the deleveraging process is if the central banks start to reward the saver with higher interest rates, rather than accommodate the borrower with lower ones.  Let’s be honest, the average consumer is clueless when it comes to finances. If they weren’t, household debt in many economies would not be at record highs.  We can blame the lender, but at the end of the day it is the borrower that signed the dotted line.  It’s like giving my beagle, Julie, free access to food – she will pig out until she passes out.  It will be the over-leveraged who will ultimately pay the price for taking on too much debt.

The over-leveraged are going to suffer no matter what interest rates do – higher ones will just get it done and over with much faster.  Consumer debt levels are so high right now that it is literally impossible for them to pay it all back.  In fact, it is reasonable to expect that 20% of consumers will soon experience some form of default whether it be a car loan, credit card, payday loan or a mortgage.  Stock markets trade on future earnings and they are telling us that the consumer is tapped.  Avoiding higher interest rates are doing nothing but slowing the inevitable. 

So, what does one do in times like this?  First, ignore the markets when they are volatile.  There is nothing you can do about it.  So do you sit it out or convert to cash?  We are going to do both; not sell a thing and continue to allow the dividends to grow our cash holdings for future opportunities that lie ahead. This will be as soon as we see the CRB and Baltic Dry Index break their bear market.

History proves that markets bounce back within twelve months, three-quarters of the time.  This jumps to almost 90% when one has a balanced portfolio of blue-chip dividend paying shares.  Six of our recommendations have raised their dividend so far this year and we expect the majority to follow.  Sacola’s buy-and-hold philosophy has not changed one bit – it’s just far more fun when the markets are rising.