Reverse Mortgage

Unlike a Home Equity Line of Credit (HELOC), which requires income verification and regular payments, a Reverse Mortgage (RM) allow senior homeowners (55+) to borrow up to 55% of the value of their home, with pretty much no questions asked.  The mortgage is secured by the equity in their home. If you take out a reverse mortgage, you can use the money to pay for anything you want (home repairs, bills, the good life, etc.).   You don’t even have to pay back the loan or interest until you sell your home or pass away. Utilizing this financial instrument can be one of the costliest mistakes a homeowner can make.

Perhaps the only benefit to the RM is that it allows one to cash-out at the peak of the market without moving since one can stay in the house.  Upon the sale of the house, the lender gets their money back.  However, if the selling price is less than the mortgage then the lender eats the loss, while the homeowner already received the cash, and any capital appreciation goes to the homeowner. 

Reverse Mortgages carry a higher lending rate than a regular home mortgage.  Today, the average is around 5.7% and will increase with interest rates. If the homeowner decides to not make any payments during the loan, each month the interest paid on the mortgage is automatically added to the outstanding debt.  This interest then becomes principal on the outstanding loan causing the interest expense to increase.  Once the mortgage is up to the initial value of the house, the mortgage outstanding never changes until the home is sold.

Most people using this type of mortgage simply want to stay in their home or are gambling that house prices will continue to rise. Your guess is as good as the next persons what house prices will be in 5 years time, let alone 20 years from now. From a financial perspective, given the market we experienced in the last 10 years, and that interest rates can only increase from current historical lows, it is more than likely prices for homes will be sticky on the downside for the foreseeable future.

Economically, chances are also that house prices will not be higher in 5 years time because every Catholic country has a shrinking population.  Within a decade it will become obvious.  In Canada, wages must skyrocket, and we will need an additional half-million people to immigrate to Canada every year to keep house prices up.  Today, the average household income is around $90,000.  With a 20% down payment, a buyer can safely afford a $360,000 home.  Yet, most homes are around $500,000.

Due to illness, the cost of maintaining a house, or the death of a partner, people must sell their home or borrow to keep it.  With a RM, and no change in prices, the seller ends up with no equity left and probably no savings to survive the rest of their lives.  The Canada Pension Plan monthly payments will rarely cover a small apartment rental.

The cons outweigh the pros when it comes to taking out a reverse mortgage. We feel it is better to sell the house and downsize, or sell and invest the equity elsewhere to earn income.  If money is needed for an emergency but you do not want to sell, borrow directly from your bank.  Most banks will be of help and it will be cheaper. Plus, one will end up with the equity in their home if forced in the end to sell.

Based on price earnings ratios, dividend yield, and book value, all three American stock markets are in expensive territory.    Outside of a few times we have added to our positions, we have been sitting on the sidelines for months, preferring to collect dividends and not speculate.  We continue to stay the course.

Trumps trade war with China in having unintended consequences.  He wants American firms to leave China and return to the U.S.  Many are leaving China due to two reasons; China has told every business that if they want cheap loans and favourable treatment from the government, they must sign over all information, plus give free access to all their computers.  Failure to sign the agreement means future trouble for the company.  Rather than returning operations back to the U.S., many of the companies leaving China are not going to America, but to Mexico where labour costs are lower and there is no Donald Trump.

Today, 11 European countries, the European Central Bank and Japan have negative bond yields.  Germany, Switzerland and the Netherlands all have negative yields on their 30-year term bonds.  That is, bond holders are losing money every day.  It is worth noting that during the Great Depression not one country had negative interest rates.  The lowest yield in North America was just under 3% at the time.  Today’s negative rates are warning us something is seriously wrong in the world of finance.

One casualty of negative rates is savings.  Without savings there can be no economic growth.  The longer negative rates are around, the bigger the fall in savings.  This means for many investors they will be forced to work longer to build up their retirement account.  Another issue with negative interest rates is it forces savers to speculate when they should not be. Specifically, someone who is retired and does not want to speculate should be able to find a decent return in cash equivalents, which they cannot do today. As a result, they will often be forced to move all their savings into the securities, increasing their risk substantially.

Something I do not understand is that during August on the Toronto Stock Exchange, roughly 1/3rd of all preferred shares set new trading lows for 2019 with a yield of between four to six percent.  All preferred have a fixed interest rate and are redeemed at issue price. If interest rates go down, then all preferred shares should go up in value (technically, the same is true for common shares that pay dividends). This is not happening in today’s market.  Do investors prefer ¼ of 1% in savings accounts or a 2% Guaranteed Investment Certificate rather than a 4% dividend? Something is not right.

We continue to stress hold only blue-chip shares that raise their dividends every year.  Most corporations are hoarding cash at the moment. So should you be.

Both China and the United States continue their hissy fits. They are using bully tactics against any country that goes up against them.  They have destroyed trust amongst many countries, and everything is based on trust.  About the only countries China does trust are North Korea, Russia, Iran and Saudi Arabia.  One is always judged by the company one keeps.  It is going to take decades for China to restore trust with the rest of the world. 

It is so obvious that China does not want to have anything to do with Canada.  We are a target of China’s bullying, of which Trudeau has refused to do anything about.  After the G-20 meeting Trudeau should have showed China that Canada cannot be intimidated.  He should have remained in Asia with businesspeople and travel to countries in the Trans-Pacific Partnership (TPP) to drum up new business.  Earlier this year he should have been doing the same with Europe.  Trade agreements are great, but they are worthless if one does not work at taking advantage of them.

Six weeks ago, China and Russia had a meeting and both countries agreed that they will be dividing up Canada’s high north as their property. Two weeks ago, Canada and the US military had to escort a Russian bomber out of our northern airspace, again.  Notice not one word out of Ottawa.  Trudeau is telling China and Russia we do not care.

Known as China’s Silk Road project, it is where China lends other countries (usually those that are a financial basket case) billions of dollars of which they are expected to spend on Chinese goods. Kenya has been dragged into the Silk Road, and at a great cost.  They lent money to Kenya to build railroads. One of the railroads is now complete.  It goes nowhere, leaving it worthless.  Kenya is now stuck supporting the Chinese economy because they have no money to pay back their huge debts to them.   

The Europeans will look at kicking Italy out of the European Union since they have decided to join the Silk Road.  Italy today is essentially bankrupt, and their mess will only get worse with China’s help.  For China, Italy is now a gateway into Europe where they will try to cause future trouble.

We are probably in the beginning of a major change to world trade.  Just about every country is being negatively affected by the trade war between the U.S. and China.  While both countries have huge markets, they are becoming too expensive to deal with.  Eventually, the rest of the world will get together and form a strong new alliance without the two.  It could be devastating to both because most of the world’s population live outside of both countries. 

A new partnership will require hard work, but one can form between counties throughout Europe, South America, Africa, India and members in the TPP.  Thankfully, most of these countries already get along and have mutual trust amongst each other.  Therefore, a healthy trade union will work for all.

We strongly suggest do not invest in any Chinese shares or through the Hong Kong stock exchange.  Singapore is now the important exchange for all of Asia.  This is where the money is flowing to.    The China/U.S. mess shows there is zero leadership throughout the world.  Hopefully today’s events will bring a new bunch of leaders who understand economics, respect, trust and honesty.

If Trudeau gets re-elected, he will continue to do whatever it takes to close our energy sector and scare away foreign investors.  He would prefer to see most parts of Canada use American, Saudi Arabia, Nigerian and Venezuelan oil.  He wants to help these countries create jobs and get rich off Canada.

Now that Bill C-69 is about to become law, no major development will be started because it makes Canada uncompetitive on a grand scale. It will take roughly 10 years and cost billions to get a project off the ground. What business would be crazy to waste so much time and money before a project under these conditions?  Look for unemployment in Ontario to increase over the years if Trudeau remains in power, even though it could be easily avoided by eliminating the bill because Ontario is the biggest supplier of steel and other needed goods for the energy sector.

With the Trans Mountain Pipeline (TMP) given the green light (for now), this should alleviate some pressure on the energy sector as well as give a good boost to the national economy.  Three native groups want to buy TMP to make money for their respective bands.  The Alberta government is offering them up to $1b in loans to buy the pipeline.  No doubt whoever buys the pipeline Ottawa too will offer cheap loans.

Today, the stock markets are near the end of the longest bull market on record.  We believe it will last until the end of summer. As a note of interest, two of the greatest stock market retreats began when the markets peaked on the last Friday of August. 

For the past few issues we have stressed building up a cash reserve.  We have been doing so with our finances.  Get rid of all debts.  Keep credit card limits to your monthly budget.  Eliminate and avoid a line of credit except to be used strictly for emergencies.  Sadly, because of bills C-69 and C-48, Guaranteed Investment Certificates will most likely outperform the Toronto stock market next year as capital flees the country, unless the bills are scrapped by a new government. 

Fortunately, we have invested for dividends because this will continue to be paid and the income will outperform the TSX.   At roughly 2.2%, interest rate yields are terrible for a 1-year term.  Still, investors should put money into insured Guaranteed Investment Certificates (GIC) to earn what little return on cash one can. 

Most of your equities should be Canadian dividend paying shares.  This is so you can take advantage of the Canadian Dividend Tax Credit.  Not to mention, with today’s interest rates, dividends paid are generally higher than GICs, resulting in a higher income. 

As in the past we prefer to wait for share prices to come to us.  Today, we see no buys.  Sit patiently and collect all those dividends.

During the Tulip Bulb Mania, each bulb was considered as good as gold. At its peak one was worth as much as a home in Amsterdam.  It took roughly one year before the bubble burst and people lost everything.  

Then there was The South Sea Company which was considered too big to fail. In the early 1700’s, investing in the company was the path to prosperity.  Even the Bank of England was a major shareholder.  In March 1720 the share price hit 300£.  By July 10^th the share price was 1,000£.  Not even two months later the shares were worth 400£.  Soon thereafter the company disappeared.  One large group of shareholders that lost their fortunes to the South Sea Company was British politicians. 

During the 1870’s the road to riches was U.S. railway bonds.  During this time the population was growing and business was expanding.  Rail lines were being built across the landscape to accommodate the economic expansion.  Banks and investors were throwing their money at any railway bond they could.  However, there was overbuilding and most of the railroads went bust, taking down tons of investors and banks with them.

Today there are two financial mistakes being made. The first is like the Tech Bubble. In fact, it is so similar that we will call it Tech Bubble Two. Hedge Funds, mutual funds, and individuals are throwing their money at companies like Tesla, Uber, and Lyft.  Uber and Lyft have lost $8.9b since 2009 and $2.9b since 2012, respectively.  Tesla has just made its first miniscule profit (it is questionable if it will continue).  Yet, all three are cash short and have a high share price which bears no relationship to their financials.  It is based solely on the hope that one day they will be the next Microsoft.  We see each of these share prices declining by at least 80%, or simply disappear like South Sea.  The result will be billions of dollars being wiped out of existence. 

The other mistake that we will never learn from is borrowing as much as possible to enjoy the good life.  Canadians are at the top of the most indebted consumer while having the lowest savings rate in the world . People are also paying historical prices for homes, even though it is far more profitable to rent than it is to buy. Today’s housing prices are declining and will do so until the average person can afford a home.  We will not see a repeat of the last ten years in the housing market for at least a generation.

Today we are now near the end of the longest bull market in stock market history.  We predict the beginning of the downturn will begin after August.  The world has an abundance of just about everything farmed, manufactured, housing, energy liquids, and more.  Prices should be falling, but they are not, yet.               

The world learns very little from past mistakes and history provides many examples of how we love to repeat them. One thing history tell us is that when everyone is in the same boat, trouble comes, and it wipes out wealth.  This is coming sooner rather than later.  It is silly we have companies worth billions that have no profits.  People think this time it will be different or that they will sell at the peak.  Unfortunately, this never happens.

Do something rare today; pay off debts.  Throw away credit cards and cancel lines of credit or reduce the limit to below your monthly budget.  Do not touch any Reverse Mortgages.  Build up savings and invest in companies with profits that pay increasing dividends only. We do not know when a recession will take place, but we believe today’s golden era is just about over. Deflation is the biggest threat to our system today. Cash is King. Build up a reserve and follow our recommendations in our monthly publication.