Zero Interest Rates

Not one politician understands what destruction the zero interest rate policy is doing to the economy.  All they see is that people, businesses and governments can borrow cheaply.  Not one sees the opposite effect; low interest rates discourage savings.  Savings is the foundation of the economy.  Without it banks would not lend to consumers to buy houses and businesses to build plants.  An economy that lacks savings eventually creates poverty.

Low interest rates act like a tax increase on savers and pensioners by reducing their income. Today’s monetary policy has transferred income from older savers, to younger borrowers and banks.  For example, since 2008, borrowers with a $100,000 mortgage are over $2,400 better off every year. However, savers with $100,000 in cash or fixed-rate bonds are over $2,750 a year worse off.   How can our politicians expect these people to rush out and buy new homes and cars?  The reality is, savers cannot afford to spend without depleting their savings.

Many corporations and governments have taken advantage of the low rates to borrow and stick the cash ‘in the bank’, whereas the consumer has chosen to borrow more to spend.  As a result, the average Canadian consumer debt is at historical highs which will be a threat to the economic recovery when interest rates do rise.

Corporations are sitting on trillions of cash doing nothing.  If these businesses did see savers spending their money they would be building new plants, expanding markets and hiring skilled people.  Instead, they are hoarding cash for future opportunities rather than investing it today. 

The longer interest rates stay at zero the longer the economy will stay flat.  Even if interest rates were to rise next month it will not help much because too much of the saver's cash is tied up in 1 to 5 year GICs.  If rates do start to increase it will benefit savers in no less than a years’ time.

Today, corporate profits are healthy.  However, a year from now profits will be in a slow decline due to savers being squeezed by low investment returns.  This will be compounded by the over-leveraged consumer.  Stock markets, over the long term, follow the direction of corporate profits.  As a result, a year from now they will begin a slow decline as long as interest rates stay where they are.  The current interest rate policy, which is well into its 6^th year, has proven to offer zero benefit to the economy.  As long as our politicians continue to protect the borrower rather than the saver our economy will go nowhere.

Remain on the sidelines until the CEO’s of the world stop building cash reserves to historic highs and put their money to work. 

All Canadian pipelines will be working at full capacity until the end of 2015.  The producers and the pipeline companies are now in negotiations for space until 2020.  Some producers are asking for contracts to last into 2022. 

                With Gateway not going to be built until at least 2018, and maybe never, plus the Keystone decision being delayed until year end at the earliest, the demand for pipeline capacity will increase substantially.  The earliest Keystone could be in operation is mid-2016.  The southern portion has already been built and is in operation. 

                Especially throughout Alberta, lots of small pipelines are being built today.  These pipelines will be full for the next 6 years at least.  This should result in higher earnings for the pipelines.  And hopefully more dividend increases. 

                We do not see oil rail tanker cars fulfilling the demand.  Plus, railroads are more expensive than pipelines.  If there is another accident like that a year ago in Quebec the demand to use the rails will collapse. 

                The only negative for the pipelines, and it is a small one, is that America is discovering oil via shale rock.  As a result, sometime over the next year Americas demand for Canadian oil will temporarily decline.  However, over the long term America will need as much of our oil we can pump.  Hopefully Ottawa and Victoria will realize this and expedite the approval of the pipelines.  

                We have been holding pipeline shares for 6 to 9 years.  We can see holding for another five due to potential for rising dividends.  We see foreign demand growing with each passing year.

FATCA

On July 1^st, the destructive Foreign Account Tax Compliance Act (FATCA) becomes law.  Twelve countries, including Canada, have agreed to hand over to the IRS all personal information requested.  By 2017, 47 countries will “automatically exchange information once a year dealing with bank balances, interest, dividends, and sales of goods which can result in capital gains taxes”.  No warrants or court orders will be needed under FATCA. 

FATCA will affect anyone who has the slightest connection to America even if they have never stepped foot in the country.  For example, if a parent was born in the U.S. and a child was born in Canada, that child for tax purposes is both an American and a Canadian.  It is expected this law will affect roughly 20 million people from across the globe.  In Canada, there will be roughly one million citizens affected, most of whom do not know it will.  The effects of FATCA will not be so noticeable for a few years but a significant change is coming.  Specifically, it will scare away investment. 

Just on estate taxes alone, which more than 1m Canadians will now have to pay, could see a large chunk of one’s estate handed over to the Internal Revenue Service (IRS).  U.S. estate tax varies between 18 and 40 percent, depending on one’s net worth.  Those who have a net worth of over $3m will be taxed at 40%.  Penalties for not reporting under FATCA can be double the amount owed, plus any interest charges that have accrued.  These Canadians will also have to pay estate taxes to Revenue Canada.

One of the worrying aspects of FATCA is that every Canadian bank has agreed to give up all information on any citizen who falls under FATCA to the IRS if requested.  Failure to do so could result in a $100 million fine and a chance of losing their U.S. banking license.  Not one bank has filed a court case to block this invasion of privacy.  We wonder who Ottawa represents; it certainly is not Canadians.

We have come across some people who will get caught up in FATCA.  They have said that they are not worried because they have small estates of under $1m.  This is probably true for now because the IRS will go after those with larger ones.  However, once the wealthy are taken care of, the IRS will then begin to move down the ladder.  It could take years but everyone on the list will eventually be checked.

As the world becomes more aware of FATCA, we believe one will see more individuals selling off their U.S. assets, especially real estate.  Our reasoning is that it is very easy for the IRS to put a lien on any property within their borders.  There is no point in investing in the U.S. if the IRS might confiscate the assets you have spent a lifetime accumulating on their soil.  People fail to recognize the fact that Washington is bankrupt and desperate for cash so they are taxing everything and everyone. 

Money always flows to where it is most welcome.  The U.S. wants all foreigners’ money but they have neglected to make taxes fair.  This is why so many American corporations have moved trillions of dollars offshore.  Having favorable tax laws would bring this cash home and result in huge tax revenue.  However, after July 1^st we expect a slow but steady selling of U.S. securities and homes owned by foreigners.  European countries, Canada, New Zealand and Australia will become net benefactors of FATCA as these countries will be considered tax havens compared to the U.S. 

Beginning next week, a new era of tax grabs will begin.  It will be the taxpayer who will end up losing because governments will just waste any money found.  Investment will slowly leave America causing American debt to grow out of control even faster.  There are plenty of examples throughout history that shows tax grabs, (which FATCA is), affect governments negatively over the long term.  America has set itself on course to become poorer much faster than the one it was already on.

We suggest all American real estate be sold whether an individual falls under FATCA rules or not.  One should also limit their investing in U.S. shares.  If one owns American shares already, you should plan on selling the majority of them over the next few years. 

FATCA might have a temporary positive effect on the Greenback because it has the potential to lower the budget deficit over the short-term.  However, FATCA should force the Greenback lower against all major currencies over time because it will scare away investment dollars and will force down the value of U.S. assets.  It also supports our belief that Western Canada is, and will be for years to come, the number one place to invest in and live.  Western Canada will easily outperform the U.S. for many years to come.

Pension Plans

A recent study by the Pension Investment Association of Canada (PIAC), which represents 130 Canadian pension funds, found that the average asset mix of pension funds at the end of 2012 was 40% in Canadian and foreign equities, 10% in real estate, 5% in infrastructure, 35% in bonds, and the remaining 10% in various other assets. While a portfolio like this is understandable, it is one that offers little growth. It remains questionable whether or not this type of portfolio will meet demand over the long run.

In today’s low interest rate environment, 35% in bonds is a guaranteed loss. When interest rates start to climb, sometime next year after the midterm elections, the whole bond market will drop causing substantial losses in the process. This is a given because bond prices trade opposite to the rate of interest.

The term to maturity of the bond is proportional to the fall in bond prices that will take place. The chart above depicts this relationship. Who really wants to own a piece of paper that pays you 3% when you know your return will be 4% a few quarters down the road? Our other major concern with bonds is the level of risk they actually bear and what little return one receives from that risk. It will not take much for an investor to wipe clean the interest earned and a large chunk of their capital.

This would not be a concern if the majority of the bonds have terms of less than a year because they would be trading at par. However, this is most likely wishful thinking. Anything today with a term of less than one year should maintain a price of around par ($1,000).

Outside of the odd U.S. stock, we still believe investors need to avoid foreign securities for the following reasons;

We are bullish on the Loonie and expect a devaluation of other currencies against ours that will lower the rate of return on foreign investments.

Buying foreign securities tend to have high transaction fees.

Canadian companies offer investors the Canadian Dividend Tax Credit which adds an additional 1% to one’s return, if she/he qualifies. Plus, one can earn additional returns by enrolling in a Dividend Reinvestment Plan.

There is too much political and economic risk present across the globe. If you have trouble following what takes place in your own backyard, how can you keep on top of what happens an ocean away?

Very few countries offer the economic potential that Canada does. Why look elsewhere?

Hoping foreign securities will bail out a pension plan could easily end up making it poorer. Just management fees, currency exchanges, and brokerage commissions are a sure bet that zero money will be made, especially over the short term.

What I find interesting is that real estate comprises such a small part of the pie. I do not find it surprising because it is smart to do so, but it is contrary to what the media continues to shove down our throats about how it is one of the greatest long-term investments. If this was the case, real-estate would be a much bigger holding. It would be interesting to see how much this weighting has declined over the past few years. I am willing to bet it has been a sizeable shift, given the vast number of empty store fronts and condo towers pension fund managers drive past on their way to the office, no matter the city.

Real estate trades like bonds. When interest rates rise, the purchase price will shrink accordingly. The one difference is that real-estate tends to be heavily leveraged equating to much higher losses. In this type of environment, the asset is hard to unload and lease rates are hard to increase. Therefore, this asset will prove to make many investors miserable for the foreseeable future.

Our readers can earn a minimum 5% on Canadian equities today. Yet, few pension and mutual funds have much money invested in these shares. If the funds were invested in these shares, the dividend yield would be much lower based on their volume buying ability alone. They would have bid up the share prices causing the yield to decline.

Instead, most pension funds are speculating they will be lucky and make huge capital gains. Unfortunately, most have not been successful for the past 6 years, nor will they be for the rest of this decade.

It is plain to see the majority of pension funds will not come close to meeting their future obligations. For example, it is public knowledge that both the Air Canada and the Canada Post pension plans are insolvent. The two combined have a shortfall of roughly $4b. In the U.S. most State government pension plans are also in the same boat. How many more are out there? Seeing that we are at the crest of the greatest demographic shift in history, time will certainly tell.

One of the world’s best funded pension plans is our Canada Pension Plan (CPP). Unless the world slides into another Dirty 30’s type depression, which is unlikely, the CPP is viable until around 2030. Furthermore, recent changes to eligibility will probably add another 5 to 10 years to the solvency of the fund.

Where is all this money going to come from to cover the pension shortfalls? Governments are the only possible source. Yet, led by Washington, the majority of world governments are bankrupt. In order to fix this ongoing mess, Federal governments will be forced to make a major devaluation of their currency in order to increase inflation and to enact tax increases.

What all this means is no one should count on getting the pension they are anticipating. Instead, everyone should build up their own pension plan. Whatever one gets from a company plan in the future shold be considered as a bonus.

We strongly recommend keeping all investment monies working in Western Canada. If these four provinces cannot be successful we doubt any other region in the world can be because this part of the country helps fuel the bigger engines of global GDP. Western Canada has all the resources to be successful. There is no other region in the world that has such a diverse selection and a vast quantity.

Pension plans will be big news for the rest of this decade. Avoid the mess that is coming and set up a proper plan for oneself. Make sure it is simple and built around the Sacola Strategy.

EBITDA-One of Wall Streets Greatest Gags

               Bay Street must be getting desperate for business as  they have returned to issuing buy recommendations based on EBITDA (earnings before interest charges, taxes, depreciation and amortization).  This makes corporate earnings appear better than they actually are by taking profit or loss and adding back interest charges, taxes, depreciation and amortization.  EBITDA is a dangerous measure to rely on because it can make a money-losing company look profitable.  Specifically, since very few companies have zero debt, the ability to pay interest charges is a necessity and without doing so the company goes bankrupt. 

                More importantly, there is not one company that Revenue Canada (RC) has told not to worry about paying taxes.  In fact, all taxes owed must be paid before wages, debt charges, and suppliers.  Failure to do so will equate to interest charges on taxes owed and on any penalties imposed.  Plus there is a chance the bosses could get a trip to jail. 

                To base a company’s future on EBITDA is a waste of time.  We strongly suggest you avoid all buy recommendations based on this metric because management and brokerage houses are trying to make the company look better than it actually is.  More importantly, EBITDA does not conform to generally accepted accounting principles (GAAP), the industry standard for financial reporting. 

                Both Bay Street and Wall Street love to dream up special definitions to make themselves more money at the investor’s expense.  We will give the real meaning of some of a brokerage firm’s lingo and practices. 

SELL:     This term is only used when there is no possibility of hiding that the company is in completely dire straits and recommending the stock becomes a liability

NEUTRAL/HOLD:           This either means hold the security or sell everything.  This interpretation is up to the investor.

 BUY:      This recommendation can mean that it is a quality company.  However, on far more occasions than investors realize, it will mean that management has built up a holding in the security or the brokerage house is responsible for underwriting the shares and releasing them into the market.  The company’s shares can be sold through the firms’ mutual funds, individual accounts, or hedge funds.  A “buy” recommendation is often intended to get the small investor to drive up the price so Bay Street may sell their holdings at a profit.

                 There are a number of financial instruments that were created over time that have benefited us greatly.  However, most of them were intended for enterprise rather than the consumer but Wall Street has offered them to the retail customer. To be continued...