Tuesday, January 25, 2011

Mexican Mafia Tourista Tours

Mexico has been getting a lot of unwanted publicity because of crimes done to Canadian tourists. Several were killed in a hotel explosion, apparently caused by an illegally installed gas line. A couple was allegedly assaulted by the Mexican police: one claims she was raped by the police. Another was killed in the cross fire of a drug war. Based on these and other news stories, Mexico seems to be more dangerous for Canadian tourists that it was a few years ago.

Americans seem more attuned to this danger than Canadians. The drug war in Mexico has been an important media event in the American press for many months. Americans are avoiding Mexico in droves: tourism statistics reflect the danger that Americans perceive regarding Mexico’s organized crime problems. But Canadian tourists continue to flock to Mexican sunshine in spite of the higher incidence of Canadian vacationers’ problems.

Canadian Mutual Funds Investment Forays
The Canadian mutual funds business has been spared unwanted publicity regarding the long term rates of return on equity mutual funds. The Toronto stock market is up less than 1% per year on average, over the past 10 years. And we are the lucky ones: the US stock market is up even less for the same 10 year period. Both Canadian and US stock markets dropped about 45% in 2001/2002 and again in 2008/2009. It’s hard for equity mutual funds to achieve a good long term rate of return when they lost almost half their value twice in one 10-year period. Based on these statistics, it’s a wonder that anyone still buys mutual funds. Most equity mutual funds managers under perform the averages. For completion, both stocks and equity mutual funds often pay dividends, which would add to the low performance mentioned above. And mutual funds do charge management fees, which detract from long term performance. I wonder if Canadian RRSP savers will continue to buy mutual funds. Will they be like Canadian tourists, visiting Mexico’s sunny shores even though the risk has increased? Right now Canada is in the midst of RRSP season, where people make that decision: where will I invest my money?

For guidance in this area, I recommend that small investors observe what large investors are doing. Large pension funds are in an embarrassing position: they own too much of the lowest performing investments and not enough of the better performing investments. A recent study by the investment firm, Gluskin Sheff, revealed that the worse performing asset class in the USA for the past ten years was the stock market. The best two asset classes were gold and long term bonds. Since pension funds are obliged to be managed in a prudent manner, we can be sure pension fund managers will be quietly selling their excess inventories of stocks and accumulating long term government bonds and precious metals.

Tourist mentality
What should Canadian investors do about the stock market: own a lot to the investments that are going up most strongly and avoid the weaker ones? What should Canadians vacationers do about Mexico? Just how much risk is there? Trusting the Mexican department of tourism seems as unwise as trusting your mutual funds salesman. After all, they both want your money. Both have something for sale and both put their interest ahead of their customers’ interest. And both of their marketing departments use pictures of Canadians drinking cocktails under a palm tree.

Palm tree mentality
Maybe that’s the problem: investors are thinking like intoxicated tourists lounging in the tropical sun when they should be thinking like those Americans who are staying away from Mexico because they perceive it to be unsafe. Or those pension funds managers who realize that having so much exposure to the stock market is not really as prudent since the year 2000 as it was in the 1990s.

In my investment book, Beyond the Bull, I advise investors to refine their investment techniques by borrowing ideas from other investors. In this case, we should look at the actions of the pension funds managers. That’s what I advise ordinary Canadian RRSP investors to do: reduce risk. Sell off some of your stock portfolio and replace it with government bonds and precious metals.

To order your copy of Beyond the Bull and the Five Levels of Investor Consciousness CD, or to sign up for Ken’s free monthly webinar, visit www.gobeyondthebull.com (Bullmanship Code = SS32).

Contact Ken directly at ken@castlemoore.com.

Wednesday, January 19, 2011

High Risk Mortgages

If you’re out for a walk in the Canadian bush and you encounter a bear, what should you do? Some say you should make loud noises and make sure the bear knows you are there. Others say you should quietly retreat.

Finance minister Jim Flaherty is quietly retreating.

The Canada Mortgage and Housing Corporation (CMHC) went for a walk in the high risk forest of financial leverage. Only a few years ago, qualified borrowers could buy a home with 0 down payment and pay their mortgage off over 40 years. Our American cousins did much the same thing.

In 2007 and 2008 the Americans came across a bear in their woods: and they got mauled! American house prices were slashed and the banking system almost collapsed. Jim Flaherty is aware that the same bear could show up in Canadian forests. And he is beating a slow intentional retreat.

Last week he announced further retrenchment of CMHC policy. Borrowers would now have only 30 years to repay their mortgages. And home buyers would need a 15% down payment. And CHMC will insure high ratio mortgages for buyers of homes now – they will no longer insure borrowers who are re-financing their homes.

It appears that Canada has learned from the USA’s experience. Financial leverage means financial risk. And now the federal government is attempting to gently de-leverage the real estate market in Canada by quietly retreating from the forest of financial maxi-leverage.

But I’m wondering about those unfortunate Canadians who got in at the point of maximum leverage. We know what happened to the Americans. What about our Canadian neighbours who borrowed the maximum on their homes and bought into the old mutual funds leverage game.

Double Bears
2006 and 2007 were the days when you could refinance up to 100% of the value of your home and repay the mortgage over 40 years. And in 2006 and 2007 the stock market seemed like a good investment. Hundreds of Canadian Financial Planners (FPs) used high pressure sales tactics to persuade thousands of Canadian home owners to borrow millions of dollars against their homes and buy equity mutual funds. The sales pitch was: over the 40 years it will take you to pay off your new mortgage, the stock market will go up about 10% a year on average. At the end, you will own your home free and clear AND you will have a multimillion dollar portfolio of mutual funds. Average Canadians could retire wealthy, like that legendary barber we all read about.

Then the equities markets dropped in half from May 2008 to March 2009. “Not to worry!” said the FPs: “You still have 37 years left!” Now (January 2011), 2 1/2 years later, some of those high leverage mutual funds speculators are almost breaking even. And they still have 34 1/2 years left! Well, they are almost breaking even on the value of their mutual funds – but they’ve been making mortgage payments for 5 or 6 years: I’m not sure how long it will take them to break even on that part of the equation. And I hope their house values continue to hold up.

I am pleased that our government is returning Canada to mortgage normalcy. And I am pleased that the opposition agrees. It gives over-leveraged Canadians a chance to hold off the bear for a while. Restrictions on CMHC mortgage insurance are welcome.

But, what’s really required is some restriction on the high pressure high risk sales tactics that many mutual funds salesmen / financial planners use to persuade people to “max-out” on their capacity to borrow money to buy mutual funds. Investment dealers are regulated in this area, but mutual funds salesmen are not. Ordinary homeowners are being told that high risk leverage is low risk investing. It’s not. Our American cousins have taught us that high leverage means high risk.

When you walk in the woods, you need to keep your eyes open for bears. Mr. Flaherty has a good eye on the forest of high leverage borrowing. Now, I hope he’ll shift his focus to the bears in the stock market/mutual funds jungle too. It’s time to stop the leverage game there too.

To order your copy of Beyond the Bull and the Five Levels of Investor Consciousness CD, or to sign up for Ken’s free monthly webinar, visit www.gobeyondthebull.com (Bullmanship Code = SS32).

Contact Ken directly at ken@castlemoore.com.

Tuesday, January 4, 2011

Too much borrowing

Mr. Carney, the governor of The Bank of Canada, seems concerned about the high level of consumer debt being carried by the Canadian people. And so he should be. Expansion of the Canadian economy is directly related to expansion of Canadians’ debt.

The way money is created in Canada is directly related to Canadian banks lending money to the Canadian people. A healthy economy creates money through the mechanism of bank loans. When we borrow $20,000 to buy a car, the money supply grows by $20,000. When we pay off our bank loan, the money supply shrinks by $20,000. If we stop borrowing, the Canadian economy stops growing. If the citizens’ debt level is too high, it means someone else will have to do the borrowing that causes economic growth; someone other than Canadian consumers. If consumers are overburdened with debt, who will borrow?

Will the resource industry step up to the plate and borrow more money? Will oil companies or mining companies finance their expansion by borrowing from Canadian banks? Is this where future growth will come from?

What about manufacturing companies. Will they heat up our economy by expanding their operations with borrowed money? If you were a banker, how much money would you lend to GM, Ford and Chrysler?

What about the retail sector? How much wisdom is there in lending money to yet another developer to build yet another box store shopping mall?

This is the governor of the Bank of Canada’s dilemma: who will finance Canada’s future economic expansion now that consumers have borrowed too much?

Classical Keynesian economic theory has an answer: the government should be borrowing now. Under this theory, when the economy is healthy and expanding, consumers and industry borrow and expand the money supply. And when the economy is shrinking, the government borrows – they call it deficit financing. In this way, according to the theory, economic expansions would be numerous and long: economic slow-downs would be infrequent and short. It’s time for the government to expand our infrastructure with borrowed money. It’s time to regenerate those make-work projects from the 1970s. But, somehow, governments seem reluctant to do so. Politicians seem more concerned about controlling deficits that creating them. Politicians are out of step with the system’s financial needs.

No wonder Mr. Carney is concerned. He’s caught between over-burdened consumers who can’t borrow and reluctant politicians who won’t borrow.

To order your copy of Beyond the Bull and the Five Levels of Investor Consciousness CD, or to sign up for Ken’s free monthly webinar, visit www.gobeyondthebull.com (Bullmanship Code = SS32).

Contact Ken directly at ken@castlemoore.com.