Weekly Comment - April 30, 2018

Apr 30, 2018 | Nick Foglietta


My goal is to follow trends, try to assess positions relative to trends and how they change. This week, however, I am going to step outside the trend following approach and spew out a number of opinions.

Summation of Year So Far

Friday, April 27, 2018, was supposed to be the highlight of US earnings season.

Intel, Microsoft and Amazon…wow, what a lineup of powerhouse tech companies announcing their greatness. If the US Gross Domestic Product (GDP) number was better than expected then markets were going to “rip” higher and the party was to begin again.

Thursday afternoon it all looked like a lock—the three tech powerhouses did not disappoint. Friday morning the GDP number was “better than expected.”

But the markets took it all in stride, with not much of a move at all.

What is going on?

As you know, my goal is to follow trends, try to assess positions relative to trends and how they change. This week, however, I am going to step outside the trend following approach and spew out a number of opinions.

  1. The landscape for investors has changed from “low inflation, low interest rates and high asset prices” to “higher inflation, higher interest rates and flat asset prices.”
  2. The percentage advantage of stocks over fixed income has closed dramatically as interest rates have gone higher.
  3. There is too much debt in the world.
  4. Volatility is back and liquidity has dried up along with it.
  5. Tax cuts in the US have created a structural deficit.

As I look forward into the rest of 2018, my expectation is for a choppier, trend-less stock market. During the next nine months my expectation is for the US Federal reserve to continue to:

  1. Raise interest rates, and
  2. Quantitatively “tighten” by selling off $10 billion per month of their $4 trillion balance sheet.

Due to these actions, at some point, stock markets will weaken.

My personal belief is the central bankers of the world will lose their conviction to keep raising interest rates and reverse the quantitative tightening at the same time.

If I am correct in this assumption, my expectation would be for:

  • A quick drop back down in bond yields and mortgage rates,
  • A strong stock market rally,
  • A ramp up in commodity prices, especially precious metals, and
  • A weaker US dollar vs. most other currencies.

We will have to wait and see if this prediction is correct AND, if correct, what amount of stock market decline will elicit the response.

While we wait, the older readers in the crowd might remember these financial conditions from the 1970s…although at much more extreme levels. There was a word associated with that era…

David Rosenberg, one of Canada’s leading economic minds, believes all of the above will make very little difference to the trajectory of interest rates in the US.

Last week David Tweeted: “We have real domestic final sales growth at a two-year low, core PCE inflation at a seven-year high, and total labor compensation at over a ten-year high. In a word, stagflation. To combat “stagflation” interest rates will have to keep rising regardless of how much stock prices fall.”

This is a much less BULLISH forecast than my view of a ripping rally for asset prices later.

In summary, the idea I am holding to is the stock markets around the world are in the process of building a right shoulder and downside protective strategies should be in place for portfolios.

But the right should has been sufficiently built that holding high dividend paying companies above a minimum exposure can again be employed. The repurchase of tactical positions is advised for those who are comfortable with a stop loss on Canadian positions at the 15,000 level.

If interest rates stop rising counter to my forecast above, collecting dividends might be a great way to spend the rest of 2018.

In Bankruptcy in Canada Do You Automatically Lose Your House?

Scott Terrio wrote an article in McLean’s summarizing a litany of myths about bankruptcy in Canada. The article is hyperlinked above.

I have included the two points specific to homes and real estate below:

1. I will lose my home

Very few people who file bankruptcy in Canada actually lose their homes these days. The net equity in your home is what is of interest to the creditors, specifically. And there are even exemptions for this depending on the province you live in ($10,000 in Ontario).

If there is non-exempt equity in your house when you file for bankruptcy, you make a settlement payable to the estate (via the Trustee). Upon discharge, the trustee would release its interest in the property. Or you could file a Consumer Proposal as an alternative to bankruptcy (in which case your assets are yours to keep, anyway). Either way, you would keep your home. Or you can choose to have the Trustee sell the home and use the proceeds to pay the creditors only the amounts they are owed by proven claims.

2. Mortgage shortfalls can’t be included in bankruptcy in Canada

Wrong. Mortgage shortfalls certainly can be included in a bankruptcy (or consumer proposal). But it only matters in the provinces with power of sale legislation: Ontario, Newfoundland, New Brunswick and PEI. Let me explain by way of some background.

In Canada, certain provinces have power of sale legislation in place. In that system, a lender will commence proceedings when the homeowner defaults on their mortgage. The borrower remains responsible for any losses the lender may incur from the sale, and the lender will then commence legal action to recover the shortfall.

By contrast, a foreclosure (also the prevailing law in the U.S.) is undertaken by a lender when the homeowner defaults on their mortgage, but in this case the borrower is not liable for any loss incurred by the lender. In the U.S., many homeowners walked away from their properties during the 2008 housing crisis and were not liable for the shortfalls.

A bankruptcy (or a consumer proposal) stops or prevents any legal action taken against a homeowner for the shortfall incurred by the lender. It becomes a debt fully dischargeable in bankruptcy or via a completed proposal. This includes any type of mortgage (first, second, HELOCs, privates). The secured debt gets paid out as much as possible from the property’s sale, and any shortfall is unsecured, and therefore eligible for discharge in any insolvency proceeding.

So if you are upside down on your mortgage (you owe more than the home’s value), you could file a bankruptcy or proposal and include that shortfall amount amongst your other unsecured debts in that insolvency. That is a sizeable advantage to a debtor versus being on the hook for any loss in a foreclosure.