For the past 10 years, I was a strong proponent of dollar cost averaging. But our bull market will come to an end in this 4th turning.
As of this writing, Bank of Canada rate is only 1.25%. In 7 months we expect it to be at 1.75%. With historically low-interest rates housing prices have been increasing as it was easy for Canadians to afford more expensive homes than they should have. It also discouraged people from saving money in savings accounts and GICs in favor of riskier investments (Cannabis, Tesla, Facebook). All of this has artificially stimulated the economy and created jobs but as with any intervention in an empirically complex system, it is not a simple cause and effect but a multiplicative chain of unanticipated effects. Increases in household spending keep the masses from the pain of living beyond their means.
Still, at 1.75% there is no reason to panic. But the higher interest rates the quicker there will be a series of multi-dimensional interactions:
1st order effects:
- It will cost more to borrow: increasing your mortgage payment and increasing the number of people that can not get financing (an increase in the rate by 40% would result in a 20% increase in people who can not get financing).
- There will be more incentive to pull out of riskier investments and earn sub-4% in a CDIC insured GIC
The 2nd order effects:
- Real estate prices will go down
- People will feel less rich
The 3rd order effects:
- Household spending and stock market investment decreases
- The government will raise taxes on the “haves” to re-distribute to the “have-nots”.
The 4th order effects:
- Real estate and equities will be down 20-40% from the maxima
- Consumer products more expensive due to inflation and depreciation of the Canadian dollar as the trade deficit widens. If the mortgage rate is low enough it would be logical to take out a HELOC to build your business/real estate empires. Even if the real estate has not bottomed, you could make money as a debtor if the Canadian dollar loses more value than the real estate/business since the debt is repayable in cheaper dollars. Pay 10% less than the city assessed value. For example, put down $100K on the $500K purchase price (avoid CMHC). Put another $125K of labor and materials in the home and sell it for $750K, thereby doubling the $125K investment.
The 5th order effect weak economy, falling asset prices, and increased taxed historically created wars between debtor and creditor countries (hopefully now it will just be a trade-war, that will at worst lead to a currency war which will transform everything.) This is the best time to buy things at rock bottom prices and acquire debt.
- DO NOT buy a house/building pre-crash. Big purchases should be made in the 4th and 5th order of the short-term and long-term debt cycles (2020-2023) when they are 20-40% cheaper from 2018. With GICs paying nearly 4%, you would be wasting a risk-free extra $40,000 per year (on $1m). You don’t want to be servicing a high mortgage with after-tax earnings when the government raises taxes in the upcoming 3rd order.
- Cash in all your shares/mutual funds, the surplus real estate now at the ATH by 2019 and protect the proceeds by CDIC protected by staggered GICs.
- History is inflationary and inflation reduces purchasing power. Prioritize building a scalable business (includes multi-tenant real estate) . By owning a business your income streams and net-worth rise to offset inflation.
- Businesses ideas starting with the best: 1) B2B, 2) e-commerce 3) quick food restaurants, 4) nail salon. If you are young, skip school and exhaustively learn code online or a trade (90% doing, 10% learning).
- After investing to increase your business productivity, then just collect 100% of excess cash in sub 4% GICs. Just don’t upgrade your house a to the point it costs over 20% of your net worth ($500k).
- Only acquire business vehicle if it makes you more PROFIT than it costs.
Postcrisis Framework: “Buy when blood flows in the streets.” – Freiherr von Rothschild
- Buy small-cap stocks (Canadian oil destined for Mexico, Brazil, and Korea) and multi-tenant real estate (higher rental yields per square foot/unit) after the market crashes.
- If you know which city you will be in for the next 10-years, buy a home no more than 4x your gross annual household income with no less than 30% down. Ideally, your personal residence should not be more than 20% of your net worth. If your worth $2M ($1M cash + $500k residence + $1M business), then don’t upgrade your residence. If you want more real estate exposure then all this example can afford is another $250K equity in some rentals.
- Since only half the gain is taxed, and you can pay yourself tax-free dividends out of your Capital Dividend Account, capital gains are the most tax-efficient corporate passive investment. Even pre-crash there are distressed properties. In this example put down $100k on a $500k purchase price to avoid CMHC. Put another $125k of labor and materials if you can sell it for $750K, thereby double your $125k investment. If your transaction does not add value to a distressed property, then ensuring your income is twice your mortgage payment will hedge against any drops in value.
- When Bank of Canada can no longer lower the interest rate and starts PRINTING MORE MONEY to fund the deficit, the money you hold will have less and less value. YOU WILL LOSE by not acquiring debt to acquire assets. You will make money as a debtor at this time since the dollar will lose more value than the asset, giving you a profit. When the Bank of Canada prints money, your debt becomes repayable in cheaper dollars from your future self.
- Once your net worth exceeds $6 million CAD then consider setting up a trust.
Background of the 4th Turning
- Canada’s trade deficit increases to $2.7B!This further confirms what reports have been saying for years. Canada is losing its competitiveness
- Canadians are living beyond their means and accumulating too much debt (Canada has the highest household debt of the G7 and the ratio of federal debt to GDP is the deepest within the G7)
- High demand for imports means more jobs are going overseas.
- As our exports continue to decline so will the value of our currency which in turn contributes to already rising inflation which will compound the housing cycle which is already in progress.
- Canada and its provinces have paid interest totaling $ 61 billion in 2014/15, which accounted for 8.1% of total income. The amount Canada pays in interest was only slightly smaller than what is spent on all primary and secondary schools throughout Canada. The amount Canada pays in interest was greater than all the pension plans of the Canada Pension Plan (CPP) and the Quebec Pension Plan (QPP), which amounted to around 51 billion USD. In the province with the highest debt, the interest payments this year are expected to be about three times the expenditure on health care and education.
- Other organizations such as the International Monetary Fund (IMF), the OECD, the rating agencies and the Bank of Canada have also warned that the indebtedness of the Canadian private households appears to be at a serious level, especially thanks to record interest rates. If this trend continues for a while, then a disruption of the interest rate is likely to be more serious.