Price-to-Earnings

The Price-to-Earnings ratio (P/E) is used to help value a company or index relative to its per-share earnings. For example, if an index has a P/E ratio of 14-times, investors are paying $14 for every $1 in earnings,  A high P/E ratio could mean that a company's stock is over-valued or else that investors are expecting high growth rates in the future. 

The Dow Jones Industrial Average (DJIA) in its present form is beginning its 101^st year.  It is actually124 years old (May 1896), however, accurate records only began in 1920. According to Value Line Publishing, between 1950 and 2000 the average P/E was 12.4.  Whenever this number went up to near 20 it was due to falling earnings.  Shortly after that the economy slid into recession.

This century the average P/E has soared.  Between late 1999 and 2005, the average P/E ratio jumped to 14.4.  Since then the trend has been rising.  We estimate the historical average today is running at just under 16-times, or roughly 25% below today’s numbers. Todays P/E is warning us that the stock markets are overvalued.

Assuming a P/E of 12.4, 14.4, 16 and 19.6 means investors believe corporate profits will double every 5.8, 5, 4.5 and 3.7 years, respectively.  The 3.7 years is impossible to meet.  It would require massive wage increases that are then leveraged, followed by a major spending spree like none other before. Inflation would most likely takeoff, pushing interest rates up in the process.  This would cause the U.S. economy to contract.  Plus, every politician would be busy raising taxes to cover the higher interest expense on their debt.  It would drag down most of the world economy. 

It is easy to see why the Toronto stock market (TSX) has done little for the past four years.  It was, and still is, because of politics. While America has stressed business, jobs and lower taxes, Ottawa has been telling the world do not invest in Canada. One example is Bill C-69, which guarantees no infrastructure can be built for at least the next 10 years.  Ottawa has been successful in destroying one of Canada’s biggest industries and taxpayer, the energy sector. 

Ottawa has wasted the past four years listening only to the environmentalists and turning a deaf ear to all businesses.   It is business that creates the money that finances most environmental organizations, no matter which side of the debate.  It should be noted that it is also business that finances the research and innovation needed to make the world a better place. Ottawa has been 100% lucky because America has its lowest unemployment rate on record.  Canada’s numbers are not bad, but we must wonder what they would be if America was in a recession since they are our biggest trading partner. 

We are into the longest bull market in history.  How much longer can it last? One week, a month, a year – nobody knows.  But, outstanding debt for all levels of government and the average consumer is a ticking time bomb.  Canada’s consumer debt is $1.77 per $1 of income, one cent off its record high.  The U.S. Debt Clock states that their total debt is equal to just under $70,000 per person - a record that grows every second. 

As the debt grows cash becomes king.  For the stock markets we can see a potential 30% downside based on its current P/E.  Earnings in the next recession will be falling so the market could fall further than the 30%.  Until we see a noticeable change of attitude out of Ottawa, our recession will be worse than in the U.S. 

Fortunately, most of the companies we invest in are cash rich and will weather the coming storm.  For the next two years we predict it will be dividends and money market investments that will be the main source of returns; the same as the past three out of four years.   

Based on the dividend yields on our purchase prices it will mean we should easily be near the top for all investment returns.

Note of Interest: During July the Bloomberg Baltic Exchange Dy Index, an index that measures the price of shipping raw materials across 23 global marine shipping routes, traded around 2,440.  On Friday January third, the index fell 16.6%, which is one of the biggest one day drops on record.  On the eight there was another 6.9% decline, followed by a further drop to 773.  This is a warning that world trading has fallen off a cliff.  If this trend continues a recession is almost imminent. Let’s hope it had more to do with the Christmas season rather than Trumps destructive tariffs, and it reverses upon signing of a new trade agreement between the US and China.   

Brian Abroad

Last month I was in New Zealand hiking the Tiki Trail located near Queenstown.  It was a climb of just over 450 vertical feel and about 2.5 miles long.  I enjoyed the hike even though it was brutal.  I was the oldest on the trail by about 30 years.  After recovering for a day or two, I then went to Auckland.

For the next four years Auckland will be a horrible place to visit.  With help from the Federal government, the city is rebuilding the whole downtown. They have just finished renovating the main train station.  Now three subway lines will be built from the station over the next four years.  The road along the harbour, plus a couple of streets, will be converted into walking malls. While accumulating massive debt to construct, these projects will create high paying jobs for a few years.

During my visit they announced that a new port will be built immediately to replace the existing one because there is no more room to expand.  To go along with this, there is a steady stream of new construction for high rises and businesses.  Unfortunately, these new buildings are destroying the view.  Like most Canadian cities, there is an acute shortage of affordable rentals downtown.  It is normal to have more than two people share a one-bedroom apartment.  I saw one listed at $450 a week.  New hotels are going up to meet the ever-growing tourist demand.

These government projects will cost hundreds of millions of dollars, most of which will have to be borrowed.  This will probably cause their currency to fall between 2 to 5 cents versus the U.S. dollar temporarily, however it should recover quickly.

Trudeau and the Prime Minister Ardern of New Zealand have one thing in common; both are dedicated Greens and hate the energy sector.  New Zealand today imports almost all the fossil fuels it needs.  There is a small field off the coast with about 7 years worth of natural gas.  For the second time this year, at least, Prime Minister Ardern announced she will never issue permits to develop this field.  She, like Trudeau, believe in transferring money and jobs to foreigners by purchasing their oil.  For some reason they believe this lowers greenhouse gases.  After this, Ms. Ardern is different.  She is a doer while Trudeau talks the talk and usually does nothing. 

Trudeau’s only claim to fame is legalizing marijuana, of which he has made a complete mess of. Almost every pot company is losing money and will continue to do so.  Why you ask? Because Ottawa sets the marijuana price, which is substantially higher than what the native bands and the black market sell for.  These two groups are making money and paying no taxes.  Ottawa has yet to charge one illegal dealer - such kind souls they are are in Ottawa.

We suggested not to invest in this market when it became legal.  We continue to hold that recommendation as many are now going bankrupt.  Plus, sales are much lower than what was anticipated.  For the year ending in October, sales came in at $908m, rather than the forecasts that ranged between $2b and $5b.  This sector will continue to be a poor investment for the foreseeable future.    

Prime Minister Ardern is moving forward creating wealth for her country, while Trudeau will spend the next four years accomplishing very little or nothing. Trudeau can learn lots from other politicians such as New Zealand’s. Unfortunately, he does not care to. He knows he is safe being Prime Minister for the next 24 months when all re-elected politicians will get one of the worlds best pension plan after just 6 years of work.  So, he can coast until then.  This carefree attitude will continue to make Canada an unattractive place for foreigners to invest.

A few notes on my visit: 

• This is one of the few times over the past 20 year of visiting New Zealand that Greenpeace was nowhere to be found.  They have always been trying to raise money for themselves by telling the world such things as Canada is evil for destroying the planet with the tar sands.  Not once did they ever blame China, Russia, India and the U.S., who each create15% of the worlds GHG, versus Canada’s which is just under 2%.  Only Canada is the devil in their eyes. Plus, they were always telling how we are killing off all the polar bears, even though scientists have noted a year ago their population is growing. 

• Ending on a positive note, the main department store on Queen Street has all its show windows full of Christmas themes exactly like Eaton’s and Simpson’s used to have every year that I and many other kids use to enjoy in the 1950 and 60s.

We wish you all a happy holidays.  

The election has destroyed any hopes of a robust TSX for the next four years. It will basically be flat. This will hurt all retirement plans, as few investors go for dividends, but prefer expensive useless mutual funds. Our portfolio will continue to outperform the TSX due to all the dividends we receive. Plus, we expect most of the shares on page 6 will continue to raise their payout over the next 4 years.

Trudeau wants to close the whole energy sector, but after this election he will not even try. The Bloc Quebecois Party will keep the Liberals in power for the next 4 years, so long as they continue to receive their yearly transfer payments, mostly coming from Alberta. This year around $13b. The leader has said he will never allow the Trans Mountain Pipeline, which means he will not object when the transfer payments are stopped (joking).

This election was a disgrace. Was I the only one to notice not one political party leader made a speech saying what would be good for all of Canada? Instead they all promised to bribe voters with our own money. Shame on them all.

On election day the Federal Court threw out the last appeal against the Trans Mountain Pipeline. Trudeau is now forced to allow the building it. If he attempts to cancels it, which is possible, Alberta will stop transfer payments. Bloc Quebecois is only interested in getting free money to waste on themselves.

We can expect Trudeau to try and delay the laying of the pipeline, but not stop it. Trudeau will desperately need all the energy industry’s tax dollars he can generate. We are heading into a multi year recession. He has stated that he intends to borrow as much as possible and of course spend it recklessly. This means future tax increases are coming. Trumps disastrous tariff war coupled with slowing world trade will also mean less tax revenue for Ottawa.

The latest stupid move was that in August Trudeau had the Federal Finance Department “grant a rare exemption on certain Canadian anti-dumping and countervailing duties”. This was solely design so that China can get the $1.6b Woodfibre LNG plant contract being built on our West Coast. This means Canadian steel companies will not be able to compete. This change was announced on October 19th. Canadian steel producers have already started to lay off workers. It is clear Trudeau is not working for Canadians.

On the plus side, the Canadian dollar did nothing on the news of the election results. This means money is prepared to stay in Canada until we find out if Trudeau has changed his negative attitude and wants foreign investment.

We cannot stress enough, especially after this terrible election, everyone re-do their retirement plans. This election guarantees rising taxes, low interest rates, probably rising unemployment and a divided country. Canada, with the best prospects in the world, has a great future, but it has now been delayed another four years. Fortunately, Canada is strong and will outlast our terrible destructive politicians.

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.