Rising interest rates are going to be a disaster for most no matter the nation simply because the amount of both government and consumer debt outstanding is at record highs.  For the average household even a $100 monthly increase in interest must come at a loss to another part of the economy, whether it Tim Hortons or travel.  While painful for most, it will be welcomed by savers who will earn a higher return.  After all, it is the saver who is responsible for investment across the economy.

American stock markets are in record expensive territory based on profits which, to the surprise of most investors, have been declining for six quarters.  Earnings are now below what they were two years ago on the Dow Jones.  Likewise, profits for the S&P 500 are currently $9.08 per share compared to $10.47 in December 2014.  This is after record share repurchasing by companies which increases the earnings per share.  There is no way corporate earnings will grow if Trump carries out his campaign promises. If anything, it is going to scare capital away. Even huge tax cuts cannot justify today’s valuations.   

The Dow Jones Industrial Average broke 19,000 for the first time in November.   The index is the second most overvalued in its 97 year history, based on corporate earnings.  Until the beginning of this century the average price earnings ratio averaged around 13 times.  This century it is now close to 16 times earnings due to low interest rates.  Today, the price earnings ratio is at 21.5 times.  Earnings are lower than they were two years ago.  Based on current earnings, the stock market is saying that profits are set to double over the next 3.6 years.  This will not occur.

For the stock markets, they are vulnerable to sizeable correction just to get down to normal.  There is absolutely no reason for their current activity.  Companies are stockpiling cash and very few are investing significant amounts of money.  A common practice today among companies is purchasing their own shares.  This improves the earnings per share, the most favoured metric on Wall Street,  since there are fewer shares to spread the profits across.   More importantly, earnings are falling behind and interest rates are rising leaving stock markets in very expensive territory. 

For us in Canada, as has been the case for the past couple of years, dividend income will be the main source of investment returns.  The TSX is trading at around the same level as two years ago.   We expect more of the same for 2017 because there is no reason for markets to climb.  There will be no change until Ottawa decides to walk the talk.

For months we have stressed keeping the majority of one’s investment monies within Canada.  We maintain this stand.  Stock markets are going to be extremely volatile until profits improve and Trump has been in power, allowing the world to properly assess his governing of which they will most likely disapprove.  The markets are overvalued and require a 35% decline to bring them in line with this century's average price earnings. Continue to favour cash and collect those dividends.

There were two horrible candidates running for President and unfortunately one had to win.  As a result, we are now stuck with the one with the most extreme ideas out of any recent President.  From breaking trade agreements to radical ideas such as building a wall to keep illegal immigrants out, it will be interesting to see the outcome of Trump as President. 

During the race to the White House neither of the candidates mentioned what needs to be done to fix the many problems the country faces.  Instead, both Donald and Hillary would name call and throw fits better than most guests on the Jerry Springer show.  No matter who won, America cannot move forward without fixing the many issues that the country has been facing for decades.  Medicare, budget  and trade deficits, addiction to military, crime, poverty and national debt are just a few issues that need to be addressed. 

It is far too early to make predictions on the outcome of Donald Trump’s presidency.  What we do know is that Trump is going to hurt Canada if he tears up all the trade agreements both Canada and the US worked hard to create.  Plus, he does not believe in climate change and is 100% against carbon taxes.  This alone makes almost all Canadian industries non-competitive with our largest competitor.  One possible benefit we will realize under Trump is we may become the gateway to North America for foreign capital.  Capital hates risk and will avoid the States if Trump carries out his campaign promises and will flow into Canada instead.  

Stock markets in the States are in record expensive territory based on profits, which have been declining for six quarters.  Earnings are now below what they were two years ago.  There is no way corporate earnings will grow if Trump carries out his campaign promises. If anything, it is going to scare capital away. Even huge tax cuts will not justify today’s valuations.  

The truth is America is broke and needs almost $2.5 trillion every year just to pay interest on the debt of $19.2t.  Wages are not growing, nor will they under a Republican government.  Under Trump, look for unemployment to move higher, especially if he does away with trade deals.  Interest rates, while up .2of 1% since the election indicates interest rates are heading higher in the year to come.  

For months we have stressed keeping the majority of one’s investment monies within Canada.  We maintain this stand.  Stock markets are going to be extremely volatile until profits improve and Trump has been in power for a while, allowing the world to properly assess his governing.  The markets are overvalued and require a 10-15% decline to bring them in line with their historic averages.  Continue to favour cash and collect those dividends.  

The International Monetary Fund (IMF) figures 2016 will be the 5^th straight year of global growth below 3.7%, the average for the past 20 years.  It was 8 years ago that interest rates began the slide to zero interest rates (ZIR).  During the Dirty Thirties interest rates rarely went under 3%.  We are today in the position where world growth will continually get weaker as ZIR does its destructive work. 

ZIR have created a bubble in the stock markets and in real estate.  Based on corporate profits, the New York stock market is the third most expensive since WWI.  The Dow Jones Industrial average is bouncing along at around 20 times earnings, while the S&P 500 index is above 24 times.  During the last century the norm for the Dow was 14.4 times earnings.   Since 2000, the average has climbed to roughly 16 times earnings.

The average Canadian household income is $88,000.  Interestingly, Vancouver, the city with the most expensive home prices, has an average family income of just under $80,000.  The average selling price of homes throughout Canada is $440,000.  To purchase this house it means the buyer must put down a payment of $132,000 to qualify for a CMHC mortgage.  Very few Canadians have this kind of savings.  We have to assume most buyers today are going outside of banks to get mortgage money and get away with low down payments.  This is what triggered the 2005-08 housing bust.The housing market is an accident waiting to happen.  Not just in Canada, but in Hong Kong, Sydney, many American cities, London, and so on.  Mathematically, house prices do not add based on wages and savings.  

After taxes of roughly $31,000 the average household income shrinks to $57,000.  The average mortgage payment leaves little for food, medical, a child’s sports, other debt obligations, and next to nothing for saving.   This means when interest rates go up or house prices fall many Canadians are heading to the poor house, and will retire with not enough savings.

Canadian housing is in trouble on another front.  The population is shrinking and will continue to do so for at least the next 2 decades.  This fact will probably show up during the coming decade when there will be a surplus of homes.  The only thing to stop this will be to open the border to millions of immigrants.

ZIR are making it impossible for savers to build up equity.  Soon, if it has not all ready begun, there will be few home buyers.  Instead, sellers will begin to dominate, which is the death spiral for housing.

This means there is going to be falling demand for stoves, tvs, cars, etc.  For the stock markets this means a slow retreat back to past norms.  The profits from investing will come from dividends.  The world economy is in what we call the ‘bounce along economy’.  Until savers are rewarded and can earn 4% on their savings, there is little hope for a return to a healthy economy.  

We believe most of our readers are at or near retirement, so the following will probably not affect you. But, for those aged 55 and under, it is something to consider and plan accordingly.  If you have a company pension it could pay less than anticipated, so building a portfolio for retirement grows more important daily.

Pension managers must put large amounts into money market investments because each month they need large sums to pay out. Today, through no fault of the pension funds, zero interest rates are beginning to eat into the funds returns.  Roughly 50% ($16t) of all pension funds in the world have money invested in zero interest rates money market funds, with some $2t of this earning a negative return. The other $14t is probably earning between 2 to 5% in long term government and corporate bonds. Unfortunately, this low yield mix is not enough to maintain today’s pensions.

Most funds need other sources of income.  As a result, they are playing the stock market which are trading at, or close to, their all-time highs, based on corporate earnings. Many funds have invested in infrastructure, such as roads and bridges, and in private companies. These are proving to be profitable but are very illiquid and require time and extensive planning to unload.

The future looks poor for pensions. It will take at least another two years before cash pays 7%, a rate of return needed to keep pension funds above water.  We are assuming rates will begin to rise early in 2017.  If they do, it will be 8 years of zero interest rates which has resulted in a steady decline in pension cash reserves. The longer today’s low rates remain, the worse the pension problem will become. It is not only in Canada but includes the U.S., most of Europe, the Far East and Japan.  The August 13th issue of The Economist stated “85% of the nearly 6,000 British pension funds covered by the Pension Protection Fund are in deficit at $530b at the end of July”.  

Today in Canada, 1 year T-Bills yield .52 of 1%, while the 10 year government bonds yield 1%. In the U.S., a 1 year Treasury pays .55 of 1% while the 10 year yields 1.49%. These terrible yields are barely enough to  pay pension management fees.

 

We estimate that next year many pension funds will start to cut monthly pay-outs to individuals. Once one firm begins the cuts many others will quickly follow.  Will governments make up the difference? We doubt it. All governments are more broke than the pension funds they will need to save.

During the Dirty Thirties unemployment exceeded 20%.  Yet, interest rates were between two and three per cent.  Today, unemployment throughout North America is between five and six per cent but we have zero interest rates.  At least back then you would be rewarded on your savings.  Today, after-tax and inflation, one earns not a cent and in most cases lose money.   Without savers being rewarded there cannot be any sustained long term economic growth.  Those with savings tend to spend more freely when their money is generating a return.  Businesses understand this and are making smaller investments as a result.  Savers are also being squeezed by higher energy, housing and food costs.  People are being forced to borrow or cut spending just to survive.   This is not good for the world economy.

Too many Canadians are house rich and cash poor.  This is about to change because house prices are set to fall, if they are not already.  Mathematically, it is impossible for house prices to hold up.  Fewer people have the necessary savings for a proper down payment and the pool of buyers is drying up as ownership rates continue to break records.  Wage growth is almost non-existent.  The California Department of Finance states personal income in the state is the same as what it was in 1995.   Considering California is one of the most prosperous states, how are other states doing? 

A Vancouver real estate agent on the radio stated that prices in downtown were off 3% while prices in the suburbs when down 7% over the past couple of months.  Hong Kong and Singapore have in place a foreign buyer’s tax like Vancouver has implemented.  Prices in Hong Kong and Singapore have dropped 7% and 11% in the past year, respectively.

There are surpluses of foods, iron ore, copper, all types of energy, soya beans, and many more commodities yet prices are holding up. Three weeks ago every New York city gasoline storage tank was full.  Two tankers full of gasoline were sitting out in the ocean as they had no where to unload.  New Jersey was selling gas at the pump at the lowest in a couple of decades.

Here in Canada, Ottawa and Alberta are doing everything they can to close down the energy sector.  A recent paper by Ottawa stated that Canada does not need any more pipelines until after 2025.  This just provides proof that politicians are out to lunch because every oil executive in Alberta says we need pipelines built today.  All existing pipelines are running at above 95% capacity.  Guess who will win this battle?  Ottawa's answer is to add useless carbon taxes.  Australia provides ample evidence that it costs jobs and generates very little revenue for governments.  Not one of our trading partners is implementing carbon taxes.  As a result, Ottawa is making us uncompetitive. 

All this says deflation is coming.  The biggest threat is in housing.  Oil prices are heading back into the low thirties.  Unemployment will be going up this fall due to zero interest rates destroying savers and we are over producing most goods.  The stock markets are trading near record highs based on price-to-earnings. Enjoy the rest of the summer and continue to favour cash.