“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.

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.

Oil's Bullish Future

The majority of predictions for oil are dismal.  Some have gone as far as to say that black gold will see $20 per barrel.  While possible, any fall to this level will be short-lived and driven by fear rather than fundamentals.  We expect a gain to the $45-$50 area to occur later in the year.  Our reasoning is simple; production for the first time in years will decline while demand will remain strong.  This will be in spite of world economic growth being slow.  

Oil prices can only increase as shortages will begin sometime during the next decade.  Out of all fuels it has the smallest reserves, roughly 80 years’ worth.  Furthermore, any huge new discoveries that might be found, especially at the poles, will only flat-line world reserves for a short period.  Given the importance of oil in our society, hopefully we can find a replacement within the next century. 

There are three countries holding the bulk of reserves.  They are Canada via the oil sands, Venezuela, and Saudi Arabia.  Russia is probably close, but like China it is hard to trust any data they release.  Evident in their attempt to diversify their economies, most OPEC countries will only have enough reserves left for their domestic needs within the next 40-50 years. 

Tesla and the like will never eliminate the need for oil because transportation is only a small use of the commodity.  Oil is literally everywhere. We use it for medicines, clothes, heating and manufacturing homes, plastics, fertilizers, lubrication - the list goes on.  So even if the world does evolve into a planet where transport no longer relies on oil, demand for the stuff is never going to come to a halt.  In fact, the only thing that can slow the demand of oil is a drastic change in consumer habits and progress in recycling and technology.

 

Contrary to what you hear in the media, the outlook for oil prices looks very bullish.  The demand for Canadian oil is going to grow for years, as it is today.  American shale reserves will only curb demand for foreign oil slightly, and by next decade America will become more dependent on Canadian and Mexican oil.  Yet, during the next decade, Mexico’s reserves will be falling and domestic demand will be increasing as the country continues to prosper, mostly at the expense of our southern neighbour. 

Like most commodities, the price is reflecting the above ground supply.  We spent the first half of this decade drilling and mining anything we could possibly get our hands on.  Naturally, the price is finally beginning to reflect this.  Prices are dropping making it impossible for many companies to operate.  The big guys will use this as an opportunity to swoop in and scoop up the assets at a discount, giving them more influence in the market.  Once this begins, the next bull market will begin.  Market forces are already correcting the imbalance.  In 2015 the number of oil rigs in operation across the globe fell by 40%. 

It is the future of other fuel prices that is bearish.  Both coal and natural gas have roughly 400 years’ worth of reserves, and demand for these fuels will also remain strong.  But, the supply of these two will keep a natural cap on prices.  Germany recently announced that their nuclear power plants will be replaced with coal fired ones.  America, the second biggest coal addict in the world, will also not cut back on its demand, and every day Australia ships greater amounts of coal to Asia.  For some unknown reason the politicians at the Paris Climate party did not protest, let alone mention a word.

Fortunately, Canada’s reserves will continue to grow in importance.  Our energy industry has a very promising future.  The only negative is that we are not immune to price drops and we must sit patiently until market forces create the next bull market, sometime before the end of this decade.

11 of our 14 current holdings increased their dividends in the last year. Subscribe to find out what two of our stocks increased their dividend over 10% in January. 

2016 in Preview

2016 is fast approaching and it appears that the year will be a repeat of 2015 where the world economy bounces along.  Global GDP will be lower but remain positive.  Last December we predicted the stock markets would trade in a 5% band which it has.  For 2016, we are extending the band to 7-8%, up or down from todays levels.  The increase will be due to an aging population coupled with the never-ending zero interest rates which are destroying savings.

Both the Baltic Dry Index (BDI) and the CRB Index are telling us the world economy will be weak.  The BDI tracks shipping rates which are currently setting new all-time lows, meaning world trade is slow and will be for most of 2016.  Likewise, the CRB Index, a basket of commodities, is trading at its lowest level in the 39-years of its history.  It too is forecasting a slow economy. 

Canada will continue to feel the effects of lower oil and natural gas prices, but that is to be expected.  Due to an abundance of natural gas we see the price falling to $1.50, a level experienced in the late sixties.  We feel the price of oil is nearing the bottom because global demand continues to grow.  More importantly, the Middle East needs more oil revenue.  At today’s price, it will take less than two years for Saudi Arabia to go bankrupt so it is in their best interest to have higher prices.  Oil will hit the $50-$55 range, but not overnight. 

Prices should not be the main concern in Canada’s oil market.  Getting the oil to the market place is the issue.  Canada must build more pipelines, not rail cars.  The pipeline is safer than rail, creates thousands of jobs and will open the European market to our oil faster and safer.  Today, there are 31 pipelines travelling between Canada and the U.S.  All of them are nearly full 24 hours a day, 7 days a week.  Shell Canada and Cenovus Energy have curtailed building their tar sands plant partly due to a lack of pipelines.  This alone has cost well over a thousand direct jobs.  The Trans Mountain Pipeline and the West to East Pipeline would prevent Alberta from heading into a typical contraction brought on by an NDP government.  But, the Alberta government does not care.

Interest rates are a tough call.  On one hand we have the Carbon tax; a brilliant marketing scheme for all governments to raise taxes.  The Carbon part is an easy sell because it makes consumers feel like they are spanking big business and protecting the environment at the same time.  This feel good moment will all come to end once the consumer realizes that all tax hikes on business are passed onto the consumer through higher prices.  This may cause deflationary forces and could be what keeps interest rates from increasing.  This is obviously what all governments want because it keeps their borrowing costs low.  You just know the politicians are all high fiving each other behind closed doors.  On the other hand we also have a weakening Loonie which increases the cost of everything.  This could be what the market needs to drive interest rates up.  One thing remains though; as long as there are low interest rates the economy will not be robust.  

It will still take a few quarters to decide where our heart throb PM is leading us.  Right now it does not look promising.  In Ottawa, the politicians prefer to talk instead of take action.  The potential for Canada remains amongst the best in the world because demand for resources will continue to grow.  Only the politicians can delay the future.  Today, they appear hopeless and do not know what direction to take.  In other words, be careful in your spending and investing.  2016 is not going to be a very profitable year.

We are not sure what Alberta was thinking when they voted in the NDP.  But, after decades of responsible fiscal management and pro-business policy that was admired by the rest of Canada, it is official that they have voted in a government that wants to try to close down their province.  Each day the dreamers in Edmonton decide to do nothing to help their businesses and citizens the slow down can only intensify.  After six months in office as premier, Mrs. Notley’s only accomplishment has been to get further into debt and raise corporate taxes, which are being passed on to the consumer.  To improve the Alberta economy she announced she will hire more civil servants.  Where is the money going to come from to pay them and what are these people to do?

Mrs. Notley wants to switch all electrical power from power stations to the very expensive solar and wind power.  It is too bad she has not taken the time to ask Ontario homeowners how their government’s shot at green energy has worked.  It has destroyed jobs, caused hydro bills to jump, and all excess power is sold to the U.S. at a huge loss.  She also wants to close up all coal mines in the province which are big exporters to Asian countries.  To do so will cost thousands of more jobs.  Thankfully, I doubt Ottawa will allow this to take place because they are big tax payers. 

Since becoming Premier I have never heard Mrs. Notley mention anything on their second biggest industry, the farmer and the rancher.  We're not even sure if she knows they exist? This might be a good thing since it’s something she cannot destroy. 

Thankfully, the loss of Keystone pipeline means little to Alberta and the rest of Canada because 8000 miles of pipeline has already been laid in the U.S. since 2010.  Keystone was simply a direct route, so it would have been a safer route technically.  The demand for pipelines is not going to disappear.  One common claim by oil companies in Alberta has been that Canada needs more pipelines.  They are the safest means of moving liquids but the Greens want to shut them down in favor of shipping by rail.

President Obama refers to our tar sands oil as dirty, even though a record amount of the stuff was shipped down south in August.  Not surprising though, after 7 years in office he has done nothing to clean up his own country’s environment.  After China and India, the U.S. is the world’s biggest polluter due to the use of coal, which is dirtier than our tar sands.  The U.S. is becoming an unreliable trading partner.  Thankfully, Canada’s future economic growth relies on Asia and Europe.

The oil and gas industry have given 37,000 people the boot with more to come by year-end.  The cut in income the loss of these jobs have created is forcing other businesses to lay off employees.  It is estimated that total job losses will reach 70,000 in the days ahead.  This will only force a larger house correction that is currently taking place in most of the province.  Alberta experienced the largest decline in house prices so far this year in October, with the average price in Calgary and Fort McMurray down 6.1% and 13% from a year ago, respectively.  Edmonton prices are flat. 

Thankfully, Albertans will wake up shortly, say “what were we thinking?” and vote the NDP out in four years.  Until then, Alberta’s economy will continue to contract and lose businesses and citizens to their neighbouring provinces.  These two provinces are the future of Canada and are open for business.  We remain super bullish on Western Canada.

Subscribe to the Sacola Financial Investment Newsletter to find out what three pipeline stocks we are recommending.