Canadian Market Outlook

Canadian Stocks

Maybe you've heard... Canada isn't in a great place. Interest rates have started biting the Canadian economy & without a change in course, that will get worse by the month as mortgages reset for the next 2-3 years. Further still, the Bank of Canada is still deciding if they want to make it worse or not.

Productivity is bad & inflation has been staying higher than wanted. We should probably be in a pretty bad recession already... which should in turn cause worse damage and rate cuts, further damaging the currency... causing more stagflation etc etc etc....

But we're not... and honestly the same reason we're not is why we might not. Population growth.

People want to blame population growth for stress on the housing market and rental affordability. The reality is they're bailing out a financially sinking (because of increased rates) property owner. The fact is... and many people need to hear this... despite the averages "Top 10% salary can't afford the average house!!! (*with no trade up equity and average heavily weighted by most expensive markets... but let's avoid talking about that*)" and what you hear about Canada, Toronto and Vancouver. You can still buy a brand new 3 bedroom, 2.5 bathroom house for 450k (USD$330k) near Calgary, Edmonton, Regina, Saskatoon, Atlantic Canada etc. That's because despite the "immigration making housing unaffordable," when builders can build, prices follow the cost of production. As a reminder, this is EVEN AFTER a decade where "low interest rates made housing unaffordable." In my opinion, at 2.5% interest, $1800/month as a mortgage payment on such a home is affordable. Immigration is obviously not the problem... but it does amplify what the actual problem is. The actual problem being the time, cost and difficulty of building. Also, it's crazy how many people will complain about affordability but when given 5 affordable options, look down on those locations in some form. The averages are warped by people's perceptions about frankly what's not Ontario & B.C. Another issue the MASSIVE take governments reap from inflated land transfer taxes and other such costs. The problem is almost entirely artificial and self induced. Population growth is bailing out our economy from home made stupidity. It's 'easy' to point the finger but it's not the problem. Same with "low interest rates."

Recession or Not

I don't know if we enter a recession. GDP growth has sucked for 6 months & could easily slip negative. On the other hand with adding 25k jobs per month (probably hurting productivity) we've already added 0.5% to our unemployment rate. By year end, that could easily be 1% off the lows without a recession. If we had 0 job growth, unemployment would rise 0.2% per month which would be a similar pace to the GFC. If you believed that inflation was caused by tightness in the labor market... this sounds deflationary... even adding 25k jobs per month sounds deflationary. Also, if we're going to look at wage growth with immense fear "omg still 5.2%" well, I believe we are about to witness some favorable base effects in that regard. 

In the last 8 months January to August, wages went from 33.01 to 33.47. In the last few months of last year, wages went from 31.67 to that 33.01 in January. That's a 1.34 increase that gets lapped vs a 0.46 increase over the majority of this year.

In any case, recessions are transitory. Plus, most of the time by the time everyone agrees it has arrived, the market is looking past it.

We're already in a non-recession... recession.

Believe it or not, I started this not really wanting to discuss macro factors. I wanted to talk about some stocks. I did however want to make an important point. That is, in the discussion about Recession... economic collapse... bubble bursting etc. It's important to realize that the pain & stress is already being felt. We are adding growth potential... companies are adding long term value... the economy is stagnating for now but adding potential. We're not growing but in suffering this (higher rates and higher unemployment) without collapse... we gain the potential value of; 

What if yields normalize at inflation +50bps... 

What if more people find jobs... eventually 

That could mean higher growth, higher cashflows, higher valuations.

I don't like the near term Canadian economy... and think there are real risks there but also think... to use a horrible cliché... what doesn't kill us, makes us stronger... now the key of course is... not dying. (Or suffering permanent damage). I think we need to look South... and West... if the Fed can be done and investment in Oil can bail out our currency we could be surprisingly ok. If the Fed presses onward and our currency gets caught between a rock and a hard place it could push a bad situation towards a very bad situation.

Banks

Ok so... housing bubble... inverted yield curve... possible recession... economic stress etc... who in their right mind would go out and want to buy bank stocks? That's a valid question that many are probably asking. I don't have a good answer... or I should say wouldn't have a good answer if we were talking small 1/10000 banks at full price with marginal equity cushions.

In Canada we have maybe 10 worth a look... 6 that every Canadian has hear of... all heavily regulated and capitalized like a GSIB ( Global Systemically Important Bank) most of these have been adding to their PCL (Provisions for Credit Losses) aka reduced earnings and is at a P/B multiple comparable to COVID or mid GFC. So yes... we may see the implosion of the Canadian economy through gross incompetence... but a normalization of bank performance over the next 5 years could generate something like a 25% IRR... from owning the big banks. That would mainly require enough population growth to avoid a Recession. 

The Canadian banks have been around for many years:

Bank of Montreal 206 

Bank of Nova Scotia 191 

Royal Bank of Canada 159

Toronto Dominion 68 [merger of Bank of Toronto (would be 168) and The Dominion Bank (would be 154)]

Canadian Imperial Bank of Commerce 62 [merger of Canadian Bank of Commerce 156 & Imperial bank of Canada 150]

National Bank of Canada 164 (or 43)

Not to mention Laurentian Bank which has achieved much less in their 177 year history. 

The point being that these banks survived the great depression and the GFC along with 20% interest rates and many difficult environments. That's not to say that they're invulnerable... but they are pretty resilient.

Canada doesn't have the same MBS problem that the US had in 2008. We also regularly have 1/5th to 1/10th the mortgage delinquency rate of the US. Further, a large percentage of mortgages are insured or have a large equity cushions. Then remember we've already seen some decline in construction as prices don't satisfy return thresholds for new supply. 

What I think happens is somewhere in the middle. A few years of reduced earnings before gradual improvement. I don't think dividend cuts are likely so when I run through some possibilities it's an area that looks interesting from a DCA, collecting a few shares perspective. Particularly because my portfolio is light on the yield. I don't like buying things exclusively for their yield but I think that in a few years those dividends will return to growth in that environment I think there's relevant capital appreciation potential.

Oil

There's a lot to like about Canadian oil. (...but)

Maybe OPEC extends cuts or is near their production limits... maybe the Permian has peaked... maybe the Canadian dollar falls apart. I honestly have no idea... but with a bunch of these companies continuously saying they can make money at $45 oil... I continuously wonder why they aren't putting even more capital to work at $70+

In Q2 we had 10.4B of capex... that was the third most of any quarter since the big oil collapse of Nealy a decade ago. Plus, now their balance sheets are much stronger. Capex is still at roughly half of last cycle. Frankly as a Canadian & someone with significant investments in Alberta, I hope the capital keeps going in. The alternative is basically worse on all fronts.

The problem from a stock perspective is that the volatility of earnings and the depletion type of business isn't necessarily a good long term idea. Now they can grow assets and long term value quickly but that won't always be the case. Investments currently pay back quicker and leave income streams beyond that so it makes sense to invest... and leave the company with more residual value when it no longer makes sense to. This won't remain the case forever because it's a cyclical industry. That's why for energy companies I think one metric that you can't lose sight of is book value. If an oil company trades at 2x book (it's more so asset value than book but...) it might be possible to put a fresh $1B to work and have it be worth $2B. Eventually someone will do that. Whether that's capex from an existing company or a pool of investors putting their dividends to work or a management team with their buyout proceeds... it doesn't matter someone will eventually do it and make a ton of money. Doing it sooner will allow you/your company to make more of the excess profits... doing it later is more likely to miss some excess profits...that's the only difference. Maybe the company can quadruple it's long term value first... maybe more or less is lost to taxes, maybe it takes 1 year, maybe 10... maybe price goes high enough to reduce demand... maybe price is flat... I have no idea but eventually the investment gets made... and at a company level it makes much more sense to do it early.

The stocks are probably a decent hedge for more pain in Canada but too much pain here or globally can backfire in many ways. I like the sector and think there's a lot of profit left to be had in Canadian Oil. I don't think it's as cheap as some nor am I a believer in sustained $100+ oil. But I think the sector is well positioned especially for as long as Saudi wants to give up market share.

Rails

One area of interest for "permanent capital" in Canada might be an investment in one (or both) of our two railroads. Ideally an entry point with a mid teens multiple starts getting quite interesting from a long term perspective. Both rails have been around nearly 100 years and stand a shot of being around for another hundred.

Grocery Stores

Grocery stores are another Canadian oligopoly that's been moreso in the news recently. On one hand I believe they're very stable business and probably have some upside with population and GDP growth longer term. That said, I've continued to be skeptical that the recent pace of growth is realistic. These are very low margin business. That means they do and must pass on price increases quickly. So any nominal price increase that's not their fault results in earnings growth. The hilarious irony of our current government blaming grocery stores for higher food prices is that their very carbon tax has pushed the cost of food higher... and... higher nominal prices mean more profit (although a similar minimal margin). Then the government threatens 'take prices down' (they can't) "or we tax them more." Which could arguably push prices even higher. Before I turn this into a political commentary I'll move on.

The good news is that 'whatever' the factors that pushed food prices this high, globally, food inflation is fading HARD... at least... good news for us, perhaps less for food stores. Supply has responded to higher prices. Part of this feeds in to why I suggest inflation is likely less of a concern than some suggest. Food inflation at 7.8% YoY is roughly 1.2 of the 3.3% add in 0.8 from mortgage interest cost... both of which should quickly roll off should more than offset some rebound in some other components. In fact most other components that went up as quickly as food eventually saw negative YoY numbers. Then figure that if inflation was deemed to be under control, and rates were reduced, that +0.8 could flip to negative too... then new development makes sense and rents don't need to increase anymore... more inflation gone.

Reflexivity. If we believe inflation is gone it will be (with some time). If we keep creating our own inflation it'll stick around. (Higher rates = inflation + need for higher prices = inflation= taxes = higher prices = inflation= rate hikes = inflation.

I got slightly off topic in my attempt to say that food price inflation disappearing will likely mean slower growth for supermarkets. But with reasonable valuations I think the outlook is fine.

Utilities

The utilities and pipelines are another interesting sector. They have been double hot by the rise in interest rates. The highly levered utilities now face a wall of more expensive capital upon maturity. They also face the fact that with higher rates and the availability of yield on GICs, there's less value/demand for high dividend stocks. This is a similar challenge for real estate. Both may now be in a position to reset with a new baseline of assumptions which they can perform against... in other words, if rates peaked and decline, you get the revaluation higher & improved cashflow fundamentals from lower refinancing cost. I think we're somewhere in the repricing. I don't think all of them have fully priced in higher rates persisting but I think most are in the process of slowly assuming that maybe rates will remain a bit higher for a bit longer. I don't think they should fully price in higher rates (that view comes from my personal opinion on rates). The more that they do price in, the more asymmetric the investment. The companies are mostly fine but the appeal of the price of years ago wasn't what investors hoped. There will probably be a stretch of less growth while debt is managed. It's a place where there's probably some time but may be worth picking up some long term holdings over a few years.

REITs

Real estate is in a weird spot. From a price to book/NAV perspective, it's extremely cheap. (There's a rather significant discrepancy between public and private prices.) From a 'I can get a 6% GIC' perspective... less so. 

The two things that matter most are interest rates and NOIs. If rents/incomes keep rising then existing debts can incrementally be retired and long term values can be fine. If occupancy or rent falls then we have a more complicated situation... especially if funding becomes more expensive.

We haven't seen yields like this out of REITs in many years. It is possible that they stay here... or are cut. It's complicated and can't be answered with blanket statements. I suspect with catch up rents and incremental deleveraging, the new set of expectations is probably pretty low. The discount to NAV simply means they are much cheaper then their private/I traded alternatives. They may or may not be extremely cheap... it depends where interest rates settle.

Miners

At the risk of repeating myself, mining is a difficult business. While not apparent in the same way as for REITs and Utilities, miners are similarly worth less in this kind of environment. Inflation = cost inflation too. And interest rates make the capital more expensive.

On the other hand, and this is something I've been mentioning for a while but goes directly against traditional economic thinking... in commodity -like capital heavy industries, capital is your most. It's not a great moat and it will be overcome eventually but it is some moat. This is because you need (Risk free rate +) for the investment to be worth it. The more capital costs, the bigger that number needs to be. Higher rates need higher prices to get the same returns... and higher rates mean even higher still prices are needed to justify taking the same risk.

I want to be clear, I'm not saying higher rates are purely Inflationary... they remove capital availability too (that's deflationary) what they do is make people poorer and life less affordable.

Gold, I don't have a strong view 

Silver is roughly fair value

Copper, I'm bullish on demand longer term but think price is higher now than bulls give it credit for & has two way risk short term. My history has taught me that you really only need to buy these when the metal has been flushed.

Lithium there's very little on the TSX but I'll say. Lithium price was ridiculously too high, it's now decently high. It's demand longer term is pretty obvious but I'm less sure how much that translates into price from here. Most companies can make their projects work with prices at half of current levels, so the odds are pretty good that eventually prices fall by more than 50%. Maybe the stocks make 1000% first, that I don't know.

Exporters

One area that I think has more potential is export companies. In the Oil segment, I mentioned in passing that maybe the CAD falls apart. A weakening currency would be a tailwind to companies that cost in CAD and sell in USD. It's funny actually, the other day, prior to a discussion that got to this point, I saw someone tweet a weird boast. They said they converted a bunch of CAD to USD at 0.65 back in the day but that's good because now they have USD investments that give them USD cashflow. I immediately thought... ok... why not just own Canadian businesses that sell into the US (oil qualifies) if you want protection against a falling CAD. It's hard to find many pure-plays of this as most have diversified operations as well as sales. Still, at present it's a more interesting area because A: you don't have to deal with struggling Canadian clients... B: if the currency sucks more, you're hedged as margins should improve.

That said, I don't know if I've ever gotten a currency related trade right... there's always more to it or expectations than what I imagine and I have no idea how to measure prices or what the market is saying. There's economic strength, rates, trade, inflation and so on already built in and evolving, most of the time I just figure, currencies go up, currencies go down... I'll never know why. Even still, there are times when I appreciate a more global sales exposure & other times when being regional is nice.

'Cheap'

On a price to earning basis... as well as a price to book basis in many places... the Canadian market looks cheap. Or at least, cheap relative to recently or relative to the U.S. That is however, not the be all end all of security analysis (despite what some may say). It's the market's message that current earnings or asset values are in danger. Maybe that's transitory earnings capabilities, margin normalization, pending recession-related losses, maybe end of cycle pricing...etc

This pessimism may or may not be misplaced. I would suggest that, commodity companies and tech stocks shouldn't trade at similar multiples. Asset heavy businesses have growth constraints that other companies don't. Being that capital and balance sheet capacity is often the limiting factor, the risk for such business is often tied closely to marginal changes in the economy. I mention this because Canada has a lot of asset/balance sheet heavy businesses. First and perhaps most relevantly when looking at Canadian stocks... the banks... then oil etc.

I think that a lot of Canada is set to perform well at some point but I think things need to point in the right direction first... or at least stop pointing in the wrong direction. This can be especially annoying because some things are moving in the right direction but sentiment is not and has capped them. There's a lot of torque in the Canadian market's earnings. With bad things happening they can easily fall a lot more that the US and that what central banks keep trying to cause. If we could get past that to an actually good economy like the late 90s or mid 00s the entire picture can flip. What is now '20% discount to book because of losses coming' can become '2x a 40% higher book' the difference there may be 2 or 3 x in earnings multiples (more in some cases) but 300% in stock price. We could be at the start of a decade of outperformance or the start of a multi year brutal underperformance. I think the current expectations are skewed to the pessimist side, but I also think at these rates, our economy is in an awful position in the short term.

Bonds

Bonds are tricky too.

I think short rates need to move lower... but I don't know if they will. (Yes you heard that right)

I don't think the long end needs to go lower... but I can't bet on the front end going lower without thinking the same event would push the long end lower.

I also don't know when or how much because the whole thing isn't a bet of what should happen or what makes sense, it's a bet on the choices of parties that seem completely illogical. 

I don't believe low rates are bad. I think there's a massive "back in my day rates were" bla bla bla ... "those were the good ol' days of 11% unemployment and 10% interest rates when we nuked our own economy because of an exogenous oil shock," out there by people in positions of authority. When you get into logic of how rates actually helped anything be better back then, the arguments fall apart... they turn into "well if nobody could afford it and everyone was struggling then things would be better for everyone." The honesty of the matter is most people should just say "I want to make 5% on my money for taking no risk; because I have money."

The problem is, with today's taxes, costs, demographics etc I don't think the country functions at +3.5% interest rates. I think it leads to very bad things, economically, socially, politically etc. I also think that things are comparatively fine at 2% interest. We could have great growth and prosperity without problematic inflation.

Any prediction needs to be a mix of will and should... so if I were going to make one it would be something like: YoY is probably almost 4 before October data... so they may panic and do one more hikes before realizing in ~March that inflation is falling very quickly and by ~April that they're way too restrictive. Then they start cuts around then... probably (as I mentioned above), once they start cutting there's probably a long way to go. Probably +250bps of cuts over many quarters because they'll stay concerned about a rebound. However, this basically assumes they act like headline chasing trained monkeys. If thought goes in to other data, they could easily move the timeline up 3 months... I mean if they really were concerned with data they could move the timeline up 8 months... but evidence suggests that's unlikely.

Wrap Up

When I talk to people, many seem to think we are in a lose lose situation. For lower rates, they believe we need a recession. A recession has historically meant catastrophe earnings felines/losses by sensitive companies. In other words it is believed that companies need to do poorly in order for the pain & unsustainably higher rates to end. I don't know if that's accurate. It does seem to be what the market is looking at in a few places. I think Canada is buffered by the ability to export to the US... and simultaneously at added risk because of Currency on imports. Buffered by population growth and at risk because that masks the true pain some are experiencing. This might mean no recession or a very mild one... or cause the BoC to go massively overboard and do severe damage. I do think that there is a tremendous amount of pent up demand in some of our more rate vulnerable areas. The incremental relief at some point could do wonders.

Everything is to a large degree... interest rates. So far that has been a running shock. In some ways the economy handled it well, in others we've handled them terribly. Led by our debt and mortgage resets I think that rates are already too high for much of the country. I've given up on believing that what should happen will or that there's consideration of factors beyond headline inflation. There was plenty to suggest that we should have stopped before 4%... it seemed insane to resume after the pause at 4.5... they did. So yes, I think we've gone far further than necessary. If food reverted to global averages and we excluded Mortgage Interest Costs we'd have BELOW target inflation... I digress. Other parts of the country/economy are completely survivable and doing fine. The yield curve also matters, what discount rate is used? 5% or 3.5%. The higher a number you can make work, the better the odds of success. 

That said, if you're asking my opinion of what eventually happens. 

Let's look at it this way. The people who currently own the 10 year bond at 3.65% probably think that short end rates are going lower (if not they'd roll short treasuries). When that happens they believe that long rates will go lower and long bonds will become more valuable. In other words, they expect long rates to drop and short rates to drop to an even lower level than that lower long end level. So a 3.65 10 year is probably a suggestion that the short end may go to 1-1.5% and the long end would be 2-2.75% or something. This is basically what bulls of the 10 year are thinking. If that happens, real estate and other supply can react, affordability can improve and the economy can function properly. The one thing preventing us from getting there is patience (inflation). I say patience because, there are no signs of a wage price spiral, the economy is incredibly clearly not overheating... so what we need is time for the volatile/incentive prices to roll off and stability to return to the supply side. You know, it's ironic that central banks claim they want to achieve price stability yet their actions are essentially trying to crash some prices thereby creating volatility.

We're clearly not overheating... we may be stagflating but I think at some unknow point the Bank of Canada will regain sense and stop intentionally hurting the economy. On a lag from that point there are a lot of companies out there that to varying degrees are pricing in the pessimism that I spoke about. I don't know exactly when the point of peak pessimism will be but keep trying to look beyond that at the 'next cycle' and think we're starting to see some interesting longer term prices.

Canada may not be in a great place right now... but you really can't find many people that think it's doing too well... and it shows.

Quarter End Thoughts

Hello Again

I haven't done a market update type of thing in a while. That's mostly because I haven't felt like I had something worth saying. But given that I've got a few suggestions that I should do this type of commentary, I'll see what I can come up with today.

Recently I've noticed a somewhat inexplicable (at least on timing) pivot beneath the market. It's almost as if some economically sensitive parts of the market are doubting that they should be pricing in a recession. It has seemed like the money flows that move the market are shifting from recession to recovery. This has been more so the case in US exposed sectors. It also feels like we're seeing a shift in trajectory of some sectors and economic priorities.

Is it done? Well that's the million if not billion dollar question. I don't know. I believe there are some things with very optimistic prices other things have a long way to go to reach historical average valuations... That's all within what I'd call cyclicals, not even AI related stocks. Cruise lines at these prices are extremely confusing. I'd contemplate a short position there to reduce the 'cyclical' factor of my portfolio but... With the market acting mechanically on narrative of cyclical recovery into a heavily shorted sector... I mean that's how value investors (and people who ignore market mechanics) die. Mostly I like some cyclical areas.

Lumber

Many commodity producers remain below book, including a number who more often than not fare well within their field. I think some are past the cyclical trough in margins and are likely into early stages of what's effectively 'next cycle.' things that went into the cost curve and had supply come out. One that I've spoken about here is lumber for instance. It's particularly interesting because the US homebuilders (a different type of cycle) have been telling the story of a recovery for a while as the market kept talking crash. From here, I believe if their starts volumes increase it should disproportionately help the lumber recovery. I'm not in the 2021 $1000 lumber camp at this point but in 2018 the group had +20% ROEs and traded at 2x book... Vs now 0.7-0.9x book... Whatever the market decides, breakeven is roughly $500 so time above is some decent cashflow, we don't seem to be pricing in a ton. It's interesting (disclosure long). I still think incremental demand should be strong while most of the market is more locked in place with their old mortgages as that doesn't help/matter to those looking for a first time home. Family formation is actually stronger in the 'good times' periods that would coincide with higher rates. Either way there was a lengthy stretch where building was depressed and I believe some higher level/catch up is necessary.

Auto Parts

Auto parts is another cyclical that I remain long and optimistic about. They're historically cheap because economic sensitivity... As best I can tell. If the structural earnings recovery & growth doesn't revalue them higher, I hope they're able to buy shares off the unappreciative shareholders to compound at +20% most years. Less of a clear catalyst there for what would make the market revalue but history suggests it should happen eventually. Stocks with those kinds of track records don't trade that cheaply forever. Yes, I know someone out there is rolling their eyes at the thought of this value moron talking about cheap cyclicals. You might me right... But I'm talking (or trying to talk at least) about the assets from a full cycle earnings power perspective. Sub book vs 1.5-2x book average. It's not flashy but if it works as historically it's probably a double+ on a decent company. One which can hopefully add value to move the target further forward along the way. It's the type of thing that feels like it deserves more than the decent allocation I've given it because the risk reward feels like it makes a lot of sense. While people would rightly point out that autos are interest sensitive, I find it interesting that the last time we had sustained higher rates (the 90s) auto parts companies were absolutely rocking. perhaps it was the strong economy, perhaps the high cost of capital just increased the required returns to make investments acting as an artificial moat. It's not my thesis, just something I found interesting and counter to conventional thinking (or this market's assumptions at least).

The point of most of these is that things have long histories of being less dramatic than people expect. It makes investment interesting when the market basically assumes trouble. When there's upside in continued difficulty it's easier to be patient enough to stick through the potentially not ideal but survivable situation.

Real Estate

Personally, I'm well versed in entering the pain trade. It's probably where I've entered the most asymmetric investments historically. I have benefitted from the fact that I don't have to report my performance to anyone in this way. Being rate-exposed has been painful. Unfortunately, at this point most of my favorite sectors value-wise are places negatively impacted by the same hike-resumption environment.

I think some of the fear in the real estate is misplaced. People frequently discuss cap rates as negatively impacted by rates. What gets lost in that discussion is the rising rents, replacement costs and economic values of prime locations in decent economic environments. The last time we had a rate hikes cycle, real estate values rose substantially... In the 70s too. Further still people seem concerned about interest rates and leverage profiles. On some assets that could be an eventual issue. On the sector from a very broad perspective... The math if actually done on the leverage is closer to a shrug.

40% leverage and 5-6% cap rates while you can fix 6+ year debt at 5.25% or lower for longer term. There's a monumental difference between a 40% levered 10-15 year amortization debt load with laddered maturities and a 20+ year amortization individual mortgage jumping 40% all of a sudden when it comes to interest service. I mean a RE developer spoke about accessing 10 year debt near 4% too.. that's less than most cap rates and we'll below what's available for consumer mortgages. I wouldn't go overboard on pushing all expirees to the same time but if you're concerned about RE that can tap fixed rate capital below 5% for 10 years you basically cover the whole amortization period while gathering the cash you sit on and earnings +5% on shorter term cash... It doesn't sound tremendously concerning. They could essentially flip their balance sheets to be net beneficiaries of higher rates while reducing risk. I've basically come to the point where I've decided that what I think should be done doesn't matter... the central banks are intent on being a danger to everyone so protection from the 'risk' that they could be incompetent morons who are willing to blindly wreck the world must be considered. If rates go down they'd get a valuation bump and have plenty of capital and access to more. If rates go higher you make more on the cash & probably higher NOIs plus gain flexibility to deploy cash at higher rates of return.

That ~4% 10 year debt is probably a blessing for the country of the market priced a flat yield curve more in line with 'higher for longer' we could easily start facing other problems.

This slide from one of Canada's largest REITs basically explains it. For all the expensive living, high rent etc, their yield on cost is under 5%. If bonds or cap rates were pushed above 5% for duration you'd make less money adding supply than sitting in cash or buying existing assets. That would further shut down very much needed rental development. As is, most non-pre-sold development is rapidly slowing. According to central bankers that's the way to cool rent inflation... Incase you were wondering what caused my lack of faith in central bank logic.

Meanwhile... And this is the weird part... A bunch of these things have long term rental contracts often with rents well below market that roll into NOI growth. More economic growth or inflation doesn't hurt them in the long term. So, while I look cautiously at the potential for further cap rate raises, I think that with proper maturity management plenty of REITs are actually looking at some of this market backwards. Leverage is normally a structured bet on improvement or value creation. Here the market jumped straight to the concern that things keep going so well that it would be expensive to repeat the same bet.

As you can see, rising real estate prices have been a lowering rates phenomenon for 40 years... Before that they were a rising rates phenomenon. :)

Oddly, for REITs in the last rate hiking cycle they were compounding in the high 20% total returns.

Whatever the rhyme or reason or market thinking it's another area where I think you're able to pick up discounted assets. It wouldn't surprise me to see tactical deleveraging in response to higher debt service costs and perhaps different investor yield expectations. The fear is really that central banks are completely incompetent and hike into a declining economy. That's why I look at inverting the rate exposure on the balance sheet to any degree that flexibility allows. If they're going to further invert the yield curve...

Also I mean, let's say you're a company with access to long term debt near or sub 5, I may sell assets to de-risk but I'm not paying off the debt. I'm setting up maturities at better terms with my newfound flexibility and making the spread sitting on cash until something changes. If you can develop for a ~5% yield, your floor is somewhat hedged grab increased debt at 4.5, on assets that pay for themselves sit on excess cash at 5.5 or 6 or whatever stupid level they decide. Make the spread, benefit from the rent growth lunatics can cause & once they figure it out and put rates where it makes sense to develop you have cash (when you ironically don't need it). Point being fresh rates are the floor & as long as an eye is kept on debt roll/pay down schedule there's an intrinsic & logical hedge available here. There's always a spread somewhere, in a healthy market the spread rewards usefulness most (developing a new building) in a well supplied market it might be on buying a asset at a higher yield... On a demented market it's being useless/wasteful and accumulating cash... But that's where we are.

I hate suggesting this strategy of grabbing term in debt because I believe it *should* be perfectly wrong. Rates should have peaked and in terms of what's best for growth of humanity and what's best for most people, should come down. Not only that, I think inflation is falling and will normalize without further hikes. What should happen and what will happen don't necessarily have any relationship with each other. Protection and ability to survive stupidity is more important.

Hate For Housing

It's amazing how much hate the Canadian housing market has. Plenty of renters are downright angry or gloating about rate hike putting homeowners underwater. I don't know what they think will happen when housing starts continue to decline due to lack of profitability. I don't think affordability will get better on that trajectory. I don't think rents will get much lower either. We lost 14000 construction workers last month which is a repeat of the April losses. Step one Price down. Step two Supply down. Step Three Price up... but with less people being able to afford it due to less supply. I for one would prefer the price to fall because we get supply for everyone than the price to rise because no one can rationalize building... but what do I know. Months if not years ago I was being vocal about the fact that rate increases make affordability worse... they did... when they moderated and we priced in cuts it started getting a bit better only for hikes to reverse that. That's without getting into supply destruction. Worse is coming on this trajectory.

Oil

I keep hearing that crude is underpriced, lack of investment higher cost, no profit at $70 etc.

I also keep hearing that offshore break-even are $40 and that seems to go with drill baby drill among offshore companies. The Canadian oil companies keep talking about ability to make good profit at lower prices while the Saudis seem content subsidizing the market. $70 is plenty for most of the world to grow but iffy for the marginal producer's full cycle returns. IMO the bear case is that $70 looks like good money in many places and the bull case is we need all the $70 oil we can get later. I don't believe we need sustained $90+ oil. I think in a reasonable environment $80 is more than adequate for all relevant parties... That said, the market is rarely so civil. I'm not a believer in $100+ oil. I mean if you look at the technological advancement since 2007 era... we've grown drilling productivity by something like 20% CAGR. There are resource quality offsets but I don't think we're near a place where sustained higher prices are needed. Looking at the cycle of equity prices leads me to similar conclusions. $75-$80 is my rough idea of right price. $60 to $90 wouldn't make me surprised. I do find in interesting how much the WCS spread has fallen.

Gasoline

Gasoline has remained, largely through elevated crack spread, significantly (unhelpfully) inflated. It would be a breath of fresh air if the futures got this right. Many perceptions of inflation are linked to gasoline plus if you're looking for short term CPI relief that could be where it pops up. The futures suggesting a ~20% decline in gasoline prices would certainly be a useful data point in suggesting that inflation is back at target quicker to avoid further damage.

This has been delayed enough that I really wouldn't count on it to be accurate.

Uranium

It amazes me how long a sector can go without me feeling like I have much new to say. The price is still below where I feel it must eventually go. The investment possibilities remain a different question altogether. Most, obviously don't trade strictly on uranium price or fundamentals. It leaves a huge basket of things that I don't know what to make of. I will say that we have seen a different psychology from what some early bulls hoped for. There was hope that companies would wait for a good price to move forward. What we've seen is companies rush forward with a minimum price. It doesn't change the end S/D math but it does change the irr hopes. There has been some positive demand developments but the big one (China) simply hasn't been progressing at the pace hoped years ago that would be required to make this an explosive bull market. It's been more nuanced than I or many bulls from years ago thought. There are some names within the space I find appealing and many more I have no interest in today given the other opportunities in the market in less risky companies. The uranium I own I sometimes question why... and other times think I should add more.

Data

Inflation has continued to decline but particularly in the US, the economic data has been improving.

In the US, data has probably been the strongest. It looks like the economy may be reaccelerating. GDP revisions are upward and payrolls look very strong. Housing hasn't been getting weaker since last year despite the continued hikes. This despite record profit spread between the 30 year treasury and 30 year mortgage rates further tightening the funding in that market. Builders are stepping in to offer their product with more reasonable funding to great effect. May had very strong starts and new home sales data. If that's a trend, I like the outlook in lumber.

In Canada the only data still looking very strong is the population numbers. Ironically... The weakest of data (in May at least) was housing starts. We're at like 1 housing start per 6 new inhabitants (trailing)... It's almost like as profit margins shrink you get less housing starts or something. The interesting thing is for a decade now people have been indoctrinated with the belief that low rates caused prices to increase yet if you look at 100+ years of history, it doesn't seem to suggest that. Anyway, housing starts are now down by ~33% YoY and back to pre pandemic pace. The most recent number was before the June rate hike (also before some positive US housing data). 

Canada has now seen back to back months of declines in full time employment. A few months ago, out main transports suggested volumes were consistent with a mild recession. These points are wild to me considering we're running at something like a 2.5% population growth. Adding a million people a year and the economy is still losing jobs and volumes declining. I don't know if the recent improvement in the US will drag us out of this slump or not. Either way, the BoC seems absolutely oblivious to this entire paragraph as they just restarted raising rates in June. They want more suffering so we may well get that.

In connection with the railroads saying in may that they're seeing a mild recession amidst 2.5% population growth, wages have now been flat since March posting declines in may and June from their April peak. Unemployment is 5.4% up from a cyclical low of 4.9% (5% two months ago). We are certainly in a per capita recession... not that that means anything. The economists who at the same time 'we need more hikes' & predict 20k jobs per month and call 60K a big beat while 250K population growth per quarter should (at average employment rate) mean 55k jobs per month are truly infuriating. 292k from last Q at a 62.2% employment rate would be 60.5K per month... so the last 3 months average of 28k is... not great.

Counterintuitively the CAD has been strengthening despite the weaker data. Probably the surprise hike. Ideally this helps trade prices and reduces inflation perceptions. We're trailing the US in many things but we are likely to be dragged around by their data on a muted and lagged degree.

I think the Canadian economy is in conflict between the mortgage holders (almost all of which have rates that will reset in 5 years or less at any given time) and the human QE of immigrants supporting the pending suffering. Unfortunately, whichever way you cut it I think we're going to see an increase of homelessness. You have one hand fighting the other and the net policy looks incompetent and disgusting. The interest payments are off the charts because the debt load is so much higher than in the past. The shock of it all is pretty ridiculous because there's not really time to adapt and recognize what's happening to try to stem the bleeding before the next assault. They aren't even giving the time necessary to see that inflation was already falling because they literally keep adding to it. Every month from August to February ~0.1% inflation worth of Mortgage interest cost (CORE) inflation will roll off (except if rates are sent higher first). I think the bigger risk is political response and to living standards of the average Canadian rather than 1% above target inflation being potentially sticky or having a few more tech workers. The market will figure it out... But probably not in the way that some are thinking.

In the meantime, the reset of rates will continue to put the incremental financially marginal Canadian in a position where they lose their house... And the non marginal to ship large payments to rich old GIC holders. The loss of productivity on this capital will likely be a negative to the economy and destructive to some people's lives. This differs from the US where most rates are fixed for 30 years at the time of purchase so rate hikes don't change the conditions of past deals. (Before you ask we just generally don't have the same options available)

Rates

What I think should happen and what I believe is likely are two different questions. Ignoring that I think rates are already higher than they need to be, I think the data has given cover to CBs for more stupidity. By this point I think it should be clear that interest rates don't do what some people thought. Places that didn't hike have seen inflation implode... But no one is talking about that. In Canada 1/4 of our core inflation is Mortgage Interest Cost... Few care about that. Capital and supply is now more expensive... nobody cares. Anything bought with financing is being inflated in CPI. Acceleration interest payments are stimulating the US economy and we're just gonna pretend that's not happening. But let's just keep pretending that raising rates is the only magic in the universe capable of bringing down inflation. The reality is I think inflation is probably running 2s which basically already disproved the 'sticky' fears and shouldn't be a reason to take rates higher. That said, we have 1 more month of helpful base effects here in Canada which should take inflation to 3.0 or 2.9 from 3.4... we then get effectively a season of negative base effects where inflation is likely to rise. (Before you tell me that 3 and rising is too high, I'd highlight that 3 is actually 2 + Mortgage Interest Cost and by rising I mean by 0.5 excluding Mortgage Interest Cost.) I have 0 faith in those at the helm to be any more prescient than the moronic hot takes one might hear on twitter... I really have no idea what they might do with that.

The US Might actually be a beneficiary of higher rates. I was cautious about this theory and don't know how fully sold on it I am... BUT. The US has $32 trillion in debt most of which is short term T bills. as that rolls over it's now $1.5 Trillion of unfunded interest payments being shipped out to the holders of US debt. US debt is an ASSET as well as a liability. The owners of those assets are getting paid more as the US treasury goes further into the red. IE new money being pumped into the economy. That should at least offset some of the theoretical slowing hikes are supposed to cause. I'm pretty surprised that the US is just paying out 2x their military budget in interest or 1/3 of their tax revenues and we're just acting like that's normal. It could be rather terrifying if it turns out to be the case that debt payments are accelerating the economy (if that proves to be inflationary)... but not bearish stocks.

We actually had 3% inflation back in 2018... We didn't freak out about it then and it naturally fell back down... with interest rates at roughly 1.5%-1.75%.

'Missed it by That Much'

It's pretty unfortunate... Being me at least... I've been calling for inflation to come down with or without rate hikes... It mostly has (and looking at how inflation has collapsed the places that didn't increase rates, I think there's more undiscussed validity there). I've been saying Canada should scrape by because of our immense population growth. Population has boomed and Canada has miraculously muddled along despite every rate reason not to. Despite being ok with those points my expression of these ideas have been junk. I failed to consider that the BoC would want to kill us for no reason. We could have had a very soft landing if we stopped rates a long time ago. Maybe we still can, maybe not. Maybe a soft landing is still a miserable outcome because the average Canadian suffers. 

Conclusion

It's difficult to plan your investment when you're having to base decisions on the market's response to irrationality. The market tries to fix problems while forces act to make them worse. There are tremendous risks in both directions... Will they kill the economy? Will the create more inflation? I don't know how much of each we get. What I have noticed is that most of the time people only discuss half the equation... the half that the market believed for a long time. "Interest rate hikes slow the economy and kill inflation," or "When rates do X, this market does Y." Often, when you follow the logic, there is none & the historical reference is based on a time where there was a bunch more going on. The economy & the market work things out. Supply is a big part of the equation. Profit and cost of production matter. Often relying on what 'people say' misses a lot of the other side. In physics you learn every action has an equal and opposite reaction. Economists seem to ignore that. It's becoming evident how dangerous that is. My response is caution. Spread factor exposures, company risk profiles, sectors etc out to avoid being at the mercy of poor policy. 

I'm critical of much of this stuff because I fear the consequences. I believe there is something deeply wrong with the premise of how things are being done. Tons of potential is possible for making it better but immense destruction is possible from making it worse too. I hope we don't go that direction but believe we're concerningly close.

Enough rambling for today, catch you next time.

Disclosure: At the time of this article I own stocks within sectors mentioned.
Not investment advice, please see (Can Do Investing: Ground Rules) page for more information.

Officially a Rambling Man... (Google it)

Catching Up

Years ago, I loved markets, back when it was fun. It occurred to me recently that it hasn't been fun in a while. That's not necessarily bear market blues talking either.

You see, the fun bit was learning about companies, sectors, strategies etc. That and thinking about a better future and where the investment and investment's potential returns would contribute to that better future.

Then... I got steered off course, somewhere in between there and here I got distracted by trying to achieve escape velocity from real life. Things went alarmingly well for a while and the situation changed. Good became not good enough. Anything less than unsustainable felt like a step down. "Quitting." It became a matter of competition. I enjoy the occasional competition but this became life. I felt I needed to be sharp, aggressive and singularly focused... All the time. I'd get too involved in the daily price movements and overly frustrated with the simplest of things. Holdings doing little silly things became painful and mentally consuming because I was relying too much on them. Companies not returning enough capital quick enough became a failing or frustration. Then after a lengthy period of misery it wasn't interesting or fun it was everything all the time. It was too much. I went from being disappointed about the weekend to needing it to have any peace of mind. The noise became all I could hear. I was trying too hard & it wasn't working. Plenty of good results came years after I found them in the past and I put myself in a place where I mentally didn't have the time.

I set unrealistic expectations for myself and assumed that others had too.

It wasn't about finding good investments, it was about compounding as quickly as possible. Seeing if I could handle different situations & risks. Testing limits. It also, obviously, hasn't been going well.

Remedy:

So, how do I fix this? Well, I need to move towards fun again. I'm sure I'll need to be less focused on markets going forward than I have been but I believe they'll probably always be a part of my life. At their core, they're fun, interesting and productive. I also realized that I enjoyed sharing some of my thoughts. Something I had been missing and contributed to my mental isolation. I need to do it differently but I think it can be done in a way that's positive. Being right isn't more important than being happy. I lost sight of that.

The response to my recent tweets blew up well beyond what I could have imagined. I forgot how many of you there were and met more of you than I considered. I'd been gone for so long and there were even more names, sharing, supporting and encouraging. The phrase "You are not alone" although cliché... Has been absolutely true. Thanks everyone I really appreciate it & hope you find something interesting here. A number of people mentioned something specific about what I did or the way I did things that they appreciated which was quite impactful. I'll try to stay true to that going forward. The thing about hitting a bottom, whether in markets or in life is that you're surrounded in negativity, and just when it feels like nothing can go right. That's when you wake up one day and realize that you're through the worst of it. Not to say everything will be fine but there's much more upside than downside in the future.

That said, I'm thinking about doing it differently. When I made videos the process often went,

1: Go on a long walk, have an idea of something to talk about, perhaps take notes

2: Get home and while alert and have energy make presentation

3: Find quiet time to record... And again because I suck at talking or don't say it right... Go on tangent etc (Only to have people complain that I speak too slowly)

4: Upload, tags, title, cover. 

5: Release at a time where hopefully I don't get rejected by the algo or ruin the algo's opinion of me for the next video.

6: Read and reply in long form to lots of comments.

None of which is the actual source material. As a side note, I can't tell you how many things got to step 2 that you never saw for a myriad of reasons. I want something more raw, less processed... But a bit more than a tweet. 

In any case it was quite a lengthy process and in the end if we're being honest, most of the potentially interesting stuff was in step one. The format wasn't anything special either... It was the boringest* (not a word except for what I was doing) of boring formats. My stance on public speaking is akin to early years Buffett & I felt some of that even buffered. I'm surprised any of you tuned in more than once. So why am I doing the rest that I enjoy significantly less? I go for walks anyways and I like them. My mind is... semi-functional anyways so maybe I can do everything on the move. So my proposal is this; I'll write, some long and some short posts while walking (at least predominantly). I won't be as competitive. No recommendations (never was). Less short term oriented investments. No schedule or deadline. Just thoughts, ideas, opinions and perhaps the occasional joke or meme. Sometimes there's a history or aspect of an investment that's on my mind with a point or two I believe is interesting. Exclusively the part I enjoy & only while I still enjoy it. Something more akin to a twitter thread. In a productive and time efficient manner.

I thought more about ideas that were shared with me by friends and acquaintances along the way. Some good ones, some less appealing to me. Even a number of the good ones had unforeseen or unforeseeable issues along the way. I never blamed the person who shared the idea. It wasn't even always management's fault. Many people also reminded me of this side recently. People can use whatever information (good and bad) but make their own choices. You can use whatever data, opinion, or lens you want to analyze something but in the end your choice, world view, outlook, timeframe, etc. will create your own unique decisions. Even still good ideas can go wrong.

I'm going to assume that half of you use this as you would use Cramer, so my net impact will be 0. That way when I inevitably get hit by a car and the blog stops there's no net disruption. (Just kidding, I always check before crossing.) 

I don't know how often or if there'll be any interest in this format but I think I'll give it another try.

Same rules as before, I'm not trying to push any ideas. I'll tell you if I own something I discuss. I'll probably answer less comment responses (time related, more in a minute) but you can't rely on me. I screw up a lot and even when I don't it often still looks like I did for a while. I'm also going to be taking a step towards the casual direction. Simply less 'hard mode' situations so no threading the needle situations or at least a step back on specifics. Things can still go horrendously wrong or amazingly right with reasonable investments. I'll still look at sectors and situations but avoid other things that I've decided to be more cautious about discussing. Even with that filter, mistakes are inevitable.

I came to another realization. I was focusing on my goal of wanting my investing to be good enough that it could be full time "retiree" style. I didn't solve some other things thinking when I did I'd have time for them. Essentially, I need to better manage time. I think this more casual format will allow me to post both half ideas & boringly long thoughts as I have them. Hence multitasking & cutting down on the tasks 2-5 that felt more like jobs than passions. On the comments; I did enjoy hearing and responding to most of them and will keep trying where it can be simply done but I was often spending way more time giving a full response (that I believed was deserved) than I had ever imagined going in. I doubt this blog will ever generate a relevant income so I need to have it compact enough that I can expand efforts in that direction & other fulfilling ventures.

I enjoyed building something, I enjoyed sharing ideas. I even enjoyed rambling... If you can believe it. So let's get back to building something here but something healthier this time. Thanks everyone for your support to date and hopefully in this venture going forward.