Secondary Mortgage Market in GTA – Weighing the Pros and Cons

Home sales in the Greater Toronto Area (GTA) have decreased this year compared to last. The Toronto Real Estate Board reported that sales were down almost 35 percent in February 2018 compared to February 2017. In addition, prices have dropped, with the average sales price falling 12.4 percent for all housing types.

As 2018 moves forward, buyers are getting used to the new mortgage rules and the government regulations that went into effect on January 1 of this year. Home buyers are adjusting to the new housing market measures and have had to recalibrate their plans because of the higher interest rates and new mortgage stress testing guidelines.

What that means is that realtors have to be creative if they’re going to make sales in this market.

For both buyers and realtors, the secondary mortgage market can provide an alternative to traditional bank mortgages, one that in many instances, should be considered. Obtaining a mortgage from an alternative lender is frequently easier and quicker than getting a traditional mortgage. While it is true that buyers often need to have a larger down payment, and the loans are generally more expensive, the secondary mortgage market can provide a solution for buyers who are looking for a different course of action and for realtors who want to help their clients.

One of the great advantages of the secondary mortgage market is that it can provide a short-term solution for buyers who can then, at a later date, make different arrangements, perhaps through a traditional bank mortgage.

For example, a GTA home might have been selling for $1.4million a year ago, and today that same home will likely go for $1.05 million. If a buyer is putting 25 percent down, they will carry a mortgage of $787,500. Most secondary mortgages have a duration of one year or less. So, at 8 percent per year, the buyer is paying in one year 4 percent extra on the mortgage, or $31,496. That means effectively that the property costs an extra $31,496. That’s not really significant since the buyer could close in a buyer’s market that’s discounted. In a year’s time, the buyers can investigate refinancing with a traditional bank mortgage, and will hopefully be in a much better situation.

Realtors who want to guide buyers towards the secondary mortgage market should exercise caution, however, and recommend alternative lenders only to those buyers who can carry such a mortgage and have the financial resources and income ability to refinance within a year.

I would also recommend that GTA realtors who are interested in offering advice about the secondary mortgage market establish direct relationships with alternative lenders rather than with mortgage brokers; brokers will often charge substantial fees, which can add to the costs incurred by the buyers.

Although sales in the GTA market have taken a downturn, there are still a number of ways for both buyers and realtors to take advantage of the market conditions.

Why so much ado about interest rates?

Mal Spooner
Mal Spooner

Why the popularity of shorter-term interest-bearing securities among Canadians, in particular GIC investments?  In fact, we in Canada are not the only investors who seem satisfied investing our money knowing that the rate-of-return might just barely cover the rate of price inflation, with a significant risk of actually losing money if inflation should rise even modestly.  And it is not just people who are content with the arrangement between ourselves and the borrowers of our money – banks, insurance companies and credit unions alike – corporations have been hoarding cash since the Financial Crisis too.

This past summer, Statistics Canada reminded us that corporations in Canada continued to grow their cash hoard rather than invest the funds in their businesses.  Of course, like people, companies don’t actually hold cash, but rather invest the money in low risk short-term interest bearing securities, often in Government of Canada T-bills and bonds, as well as commercial paper offered by financial institutions.

At the end of the second quarter of 2008, corporations held $373.4 billion in cash balances (Statistics Canada November 17th, 2009 study: Indebtedness and liquidity of non-financial corporations).  By the first quarter of this (2014) year the number had grown to a whopping $629.7-billion. So why the stubborn tendency to tolerate a near-zero rate-of-return?

There are at least two factors at work in my estimation.  One has to do with the economics of interest rates in the current environment, another with human nature and demographics.

First of all, what is an interest rate?  It embodies three important expectations-related factors: Real returns, inflation and risk.  We all are reluctant to part with our cash unless we’re able to earn what economists call a ‘real’ return.  Ask yourself, what rate-of-return would make you happy if there was essentially no risk (default, volatility) to speak of and no price inflation.  Whatever you buy today, will in theory cost you the same price next year and every year after that.  Most agree that the very long-term real rate of interest is somewhere between 2% and 4%.  Real Rates Canada 2004 to 2014However, you can easily see from the graph that the real rate of return provided by Government of Canada (as low risk as you can find) long-term real return bonds over the past ten years has been driven down since the Financial Crisis, as all governmental central banks strove to fight disinflation by dampening the general level of interest rates.

Has the return we expect from lending our funds really adjusted downward, or is it that the availability of securities providing the returns we normally demand has changed?  My guess is most folks would agree that the adage ‘once burned, twice shy’ aptly summarizes our tendency to be  biased by recent experience.  It is human nature to be sensitive to bad or good things that have just happened and to oftentimes unreasonably expect them to continue.  Also, we are confronted by a lack of options.  Securities available to us are not promising the rates-of-return we want, given the amount of risk we are prepared to stomach.

In fact, a quick look at one of many high-dividend oriented ETF’s, the iShares Core S&P/TSX Composite High Dividend Index ETF suggests that a collection of dividend paying stocks yielded 4.31% (as of October 2, 2014) over the past (trailing) 12 months.  As a bonus, the tax treatment of dividends is more generous than it is for interest income.  Indeed the stock market has done perhaps too well over the last few years, but judging by the massive dollars invested in short-term securities those equity returns have not been earned by everyday people. The issue is people just don’t seem to want the volatility that comes with investing in stocks; even when the selection of stocks is less risky than the overall stock market.  A real return with some risk is less attractive than no return at all, and it has been like this for quite awhile now. The second ingredient to interest rate levels is inflation expectations.

Source: Bank of Canada
Source: Bank of Canada

Admittedly, we haven’t seen a whole bunch of price inflation have we?  Central bank policy around the world has been more interested in creating some inflation, fearing that disinflation would prove devastating to our economic welfare.  These efforts are in fact evidenced by the historically low level of administered interest rates we have.  If our collective expectations concerning future price inflation are significantly different from what we are experiencing then our behaviour will reflect it. Could it be that the extraordinarily high commitment to GIC’s and equivalents is that Canadians, and Americans are doing it too, are content to simply keep their money (even at the risk of a small loss) intact until rates of inflation and returns get back to levels they think they can believe in?

The third important determinant of interest rate levels is our toleration for risk, and it exists in many different forms.  Our appreciation for the risk of default was certainly modified during the Financial Crisis; and in short order we’ve been willing to tolerate none of it.  We’ve turned a blind eye to significant stock market appreciation and even bond returns preferring to ‘check’ rather than ‘raise’ and ‘all in’ has certainly been out of the question.   But this intolerance to take risk has become very sticky at the individual level and at the corporate level.  This might have more to do with demographics than anything else.

Younger people are quite surprised to learn that real interest rates got as high as 6% – 9% during the mid-1980’s, and during the 90’s and up to the turn of the millennium ranged around the 4% level. (Source: I was there!)  There is a large proportion Canadians who lived through those times.  According to Statistics Canada there is roughly an equal number of young people as there are older people.  Ratio of old to young in CanadaHalf of us in Canada might consider those times ancient history (or have no interest at all in history), and the other half feel as if it was just yesterday that mortgage rates were in the double digits.

These more seasoned citizens look at the rates of return offered by the bond market and similar investment vehicles and say to themselves: “Hey, if I buy a longer term bond, I’m earning next to nothing anyway, so I’ll just put money into shorter term GIC’s and term deposits that are effectively earning nothing and avoid the risk of having my money tied up.”  Having experienced periods of rising inflation and higher real rates, they (and yes, I’m a member of that distinguished group) are inclined to wait until more generous returns come back – if they ever do come back.  And don’t forget, these same folks might actually have to spend their savings sooner rather than later suggesting that any risk of a big loss in the stock or bond market is simply untenable.

Most people when they think of Canada bonds, immediately think of Canada Savings Bonds.  They are not the same at all.  Normal Government of Canada bonds, held in mutual funds and pension plans for example, rise and fall in value as interest rates change.  Although we’ve been through a very long stretch of falling interest rates, which made bond prices steadily go up in value, there have been and will be periods when interest rates rise and people lose money in bonds.  It is smart to learn how the time value of money works and how and why bonds can make or lose money.  There is a plethora of online videos that can help you understand bond valuation and the investment in your time to learn bond dynamics is well worth the minimal effort.

The yield curve is simply a plot of interest rates corresponding to varying maturities at a point in time.  Ordinarily, we expect to earn higher returns the longer our money is lent to someone else.  GIC rates are lower when the hold period is 3 months than they are when your money is tied up for 3 years.  The same should be true for bonds.  But consider where we’ve come from:  US Treasury Dept. Yield CurvesThe graph shows the yield curves for US Treasury bonds as of October 2007 compared to the same today.  The 2007 yield curve reflects the uncertainty at that time about, well almost everything.  We didn’t know if we should accept lower rates for shorter investments or high rates for longer term bonds so the curve was somewhat flattish.  What would inflation be?  Which financial institution would be solvent?  Would the US government even be solvent?  Many questions but few answers in the midst of the financial turmoil.

The more current yield curve reflects today’s reality.  The only interest rates we can earn in the short-term are hovering close to zero, and since longer-term risk-free bonds are paying us barely one percent over inflation why assume the added risk.  If interest rates do rise from these low levels, then you will certainly lose money owning the longer-term bonds.

In a nutshell, people have doing what they should be doing – seeking shelter and waiting it out.   A side-effect of this behaviour is that our willingness to tolerate no return for lots of safety has stalled the return to financial market normality.  By stubbornly remaining in GIC’s, term deposits and money market funds we are inadvertently delaying what we desire – a decent return for taking some risk.  It’s only when money moves freely and to a large extent greedily that financial markets function properly.  This presents quite a conundrum for policy makers around the world, who’ve been praying that businesses invest in business instead of hoarding their cash, and people begin spending more and taking on more risk by investing their savings in more diverse ways.

There are many pundits who have suddenly jumped on the bandwagon predicting a stock market meltdown and impending bond market rout.  If they are right and this happens then we might finally get what we want after-the-fact; returns that compensate us fairly for inflation and risk.  In fact the stock market is suffering of late, and a shift (or rather, twist)  in the yield curve is already causing some havoc for bond managers.  The longer-term rates have declined rather than risen as expected, and mid-term bond yields have surprisingly risen – causing grief even for gurus like Bill Gross, who co-founded PIMCO and until recently managed one of the world’s largest bond portfolios.

If investors have been doing the right thing to feel secure, what should they be doing next?  Over my own lengthy career I’ve found that at some point it is important to combat inertia and begin moving in a different strategic direction.  As stock prices adjust downwards, take advantage of what happens.  The dividends paid on the increasingly lower stock prices become more attractive quickly, and remember they are taxed at preferential rates.  The world economy may continue to grow at only a snail’s pace, so why not test the waters so to speak and begin putting some funds into longer-term interest-earning bonds.  If inflation does creep up and interest rates increase some, then put even more funds to work at the higher yields.    Having done the safe thing during turbulent times, perhaps it’s time to do the smart thing.  Experience teaches us that the best time to be doing the smart thing is almost always when it is most difficult to do it.  The longer you earn nothing, the poorer you get.

 

To Be or Not to Be – (or which is better, pay-off the mortgage or buy an RRSP?)

Lee and Daphne are asking this very question – which is better for them? They are aware of the huge interest cost on their mortgage but also would like to be able to retire in their late 50s or early 60s. Can they do both at the same time or must they choose?

Through diligent saving before they purchased their condo, their mortgage is only $150,000. They are able to afford higher-than-normal payments so decided on a 20 year term at a fixed rate of 5.0%. Over 20 years, they will pay about $87,000 in interest, assuming rates don’t change of course. If they decide to make a principal payment of $6,000 on each mortgage anniversary, they would pay it off in 11 years and reduce their interest cost to about $46,000. In theory, they would then begin contributing that same $6,000 to their RRSPs after the mortgage was paid. But is this the best option?

They are both 30 and by waiting until age 41 to start their RRSP contributions, and assuming they are able to obtain a consistent 7.0% rate of return each and every year up to age 60, they would accumulate about $230,000. Really a very modest amount. At current rates that could pay them a lifetime income of about $1,300 per month. Even including OAS and CPP at current maximum rates, and applying the effects of inflation for 30 years up to retirement and beyond, this is not going to be much of a lifestyle.

So let’s examine this more closely. To pay down their mortgage by $6,000 annually, this young couple has to earn just over $9,100 before taxes (BC rates are used for 2013). If they made $9,100 annual deposits to RRSPs after the mortgage is paid, and using the same 7.0% interest assumption, they could have nearly $350,000 at age 60 – which could mean a monthly income of about $2,000, again based on current rates. Better – but not by very much.

So, by doing some reverse math, if the agree to pay off the mortgage in 15 years and starting with $9,100 of pre-tax earnings, they could deposit $6,800 into their RRSPs every year starting now. The estimated tax savings (in BC at 2013 rates) would be about $2,300. This $2,300 is then used as the annual prepayment on their mortgage. The mortgage would then be paid in full after 15 years with interest paid now being about $64,000. By putting $6,800 per year into RRSPs now and increasing it to $9,100 when the mortgage is done, they would accumulate nearly $710,000 at age 60! At current rates, this would provide a lifetime income of nearly $4,100 per month!

To summarise, their choices come down to 3:

a) Eliminate the mortgage in 11 years by making $6,000 annual principal payments then put the $6,000 into RRSPs each year until age 60. This reduces total mortgage interest to $46,000 and has an estimated total RRSP savings of $230,000 and an income of about $1,300 per month at age 60.

b) Pay off the mortgage in 11 years and then start RRSP deposits of $9,100 each year until age 60. The mortgage interest still totals $46,000 but their RRSP totals $350,000 and a potential lifetime income of $2,000 per month. Better than the first choice, but they can still do better.

c) Finally, they could decide to clear the mortgage in 15 years by contributing $6,800 to RRSPs each year and applying the tax savings of $2,300 to the mortgage principal. When the mortgage is gone, they then increase their RRSP deposits to $9,100 per year. Mortgage interest will total about $64,000, but their RRSPs can grow to $710,000 and generate about $4,100 per month.

Time to think things through – Lee and Daphne decided that choice c) gives them the best of both worlds. While option c) does result in higher interest paid on the mortgage and extends the payment period from 11 to 15 years, there is a very significant difference in both their RRSP savings and potential lifetime income. This does require they pay about $18,000 more in interest but their RRSP total more than TRIPLES – increasing by $480,000 and their retirement income goes from $1,300 per month to $4,000 per month.

Doesn’t it make sense to do this same series of calculations on your mortgage? Happy crunching!

It’s time to lock in your mortgage rate…ASAP!

Most of us dream of the day when we can burn our mortgage. Few of us are prepared for the day when the mortgage burns our dreams of home ownership.

For some, the added expense of renewing their mortgage at a higher rate of interest can come as a shock. The rates offered today are crazy low by historical standards. Young homeowners weren’t subjected to skyrocketing mortgage rates during the early 1980’s and God willing they never will.

I recall being asked – long ago when friends thought I was prescient just because I worked in the financial industry – whether or not one should lock in the mortgage rate for the long term since it seemed like they’d just keep going higher. After all, in 1982 the trajectory of interest rates and mortgage rates had been straight UP!

As you can imagine, my answer at the time was an emphatic “NO!”

Today the opposite is true. The cheapest posted mortgage rates are the ones with the shortest terms or are variable. Plug those rates into your calculator and the payment schedule seems like a dream come true. Unfortunately interest rates over short time horizons can be surprisingly volatile. It’s possible just one or a few years later you’re burdened with payments that are no longer manageable.

In March of 1987 the average mortgage rate was close to 10%, but by March of 1990 had climbed to 13.5%. The monthly payment for a $500,000 mortgage at 10% (crude calculations but I am lazy) might have been around $4800. But at 13.5% would be nearly $6000. If you or your partner were lucky enough to get a $15,000 raise over the course of the term (say 3-year in this example) then things would be okay, but otherwise your consumption (food, child’s education, gasoline) or savings plan would suffer. Worst case, you’d have to sell the house.

Strangely enough, housing prices can rise during the early stages of rising interest rates as people who were planning to buy a house begin to hurry up the process, hoping to get a more attractive mortgage rate (before they go any higher). Unfortunately, the panic to buy is short-lived and soon there is a veritable drought of buyers who can’t afford to hold mortgages at the higher rates. Suddenly, there’s a glut of houses for sale, and if you can’t manage the higher monthly payments you have to sell the house at a loss. OUCH!

The process of rising interest rates has already begun in earnest. Historically, mortgage yields are slightly above bond yields. Bond yields go up, mortgage rates go up too. Financial institutions have responded to rising bond yields (see graph) by raising their mortgage rates in recent months as I’m sure you’ve noticed. At present, mortgage rates haven’t risen as much though, because these institutions continue to compete with one another by offering incentives and there’s also a bit of a lag as head office communicates its changes in corporate strategy down to the marketing departments.

There is still a bit of time to buy your dream home and walk away with a low-rate mortgage, but not nearly as much time as you might think. You might be reading that governments are inclined to keep the ‘bank rate’ (or discount rate which is the rate of interest the central bank charges the commercial banks to borrow money) low, in order to help the economy along. This policy is long-in-the-tooth already, and central banks cannot continue lending money to the banking system at a ridiculously low rate, when the interest rates the central banks have to pay to raise money for government spending (bond rates) keep rising. The strain on the country’s finances will become too onerous, and unwanted inflation inevitable.

If you haven’t taken advantage of low mortgage rates yet, go ahead and lock up your rate at the lending institution for as long a term as possible. And if you’ve been holding off buying that new car, don’t wait. I’ve been in the financial industry long enough to know a good thing when I see it and I took advantage of one of those generous 0% financing offers – I figure I may not see another opportunity like it in my lifetime.

Mal Spooner

 

 

 

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Investment Industry needs independent players!

The most recent print issue of Money noted that the big Canadian banks managed to earn $31.7 billion in 2012, just a few years after there was grave concern that they’d even remain solvent.

“There is no question that Canadian banks play a vital role; locally, provincially, nationally and inter-nationally. Without the banks, our economy could simply not function efficiently or effectively. But are the banks getting too big and going too far to gain market share and profits at the expense of their own customers?” (Quote from Spring 2013 issue of Money Magazine.)

In November of last year I published a piece entitled Banks own the investment industry! A good thing? In many respects allowing the banks to provide everything from our mortgage to investment services is incredibly convenient. But at what price? It has become near impossible for many smaller investment dealers to stay in business. Fraser Mackenzie is a recent victim of an industry that requires scale in order to compete:

At their shareholder meeting on April 29th, 2013 it was decided: “Our assessment of the current business climate has led the owners to conclude that deploying our capital in the continuance of our regulated investment dealer businesses can no longer generate an acceptable rate of return. Institutional interest in early stage mining and oil & gas companies, sectors to which we have been heavily committed, has dried up: as has the associated trading in the equities of early stage resource companies. Furthermore, the regulatory cost burden is increasing at a time that industry-wide revenues are declining. On balance, it makes sense for our shareholders to re-deploy their capital.”

Indeed, well over half of the total value of trading done on the TSX in a typical month is conducted by the banks.

My guess is their actual market share of all trading is far above half if we were to also include trading platforms not part of the Toronto Stock Exchange. The banks keep growing, and the regulatory burden also grows more onerous. In my estimation, the larger financial companies relish regulation as an additional barrier to entry. Regulatory oversight is a minor inconvenience to the big banks, whereas for less diversified specialty businesses (mutual fund companies, standalone investment dealers, investment managers) the added expense can be devastating.

Obviously there are huge benefits to scale – but do consumers really benefit or are these economies of scale all kept as bank profits? MER’s for their proprietary mutual funds might appear very reasonable, but it’s impossible to determine whether or not the plethora of fees I pay for other services are subsidizing these seemingly lower expense ratios. Transparency is near impossible. Although many banks did collapse as a result of the the financial crisis, the massive rebound in the profitability of those surviving banks (even though they lost ridiculous amounts of capital doing stupid things with asset backed securities, derivatives trading etc.) suggests that those everyday fees paid by consumers and businesses must exceed the marginal cost of providing these services by quantum leaps and bounds.

Another concern I have – besides the demise of competition in the financial services industry – has to do with motivation. It’s true that every business is designed to make money, but in days of yore a mutual fund company, investment manager or stock broker had to have happy customers in order to succeed. If they didn’t help the client make money, the client would go somewhere else. I believe that as each independent firm disappears, so does choice. Making a great deal of money from you no longer requires you to be served well. What are you going do? Go to another bank?

The prime directive (to borrow an expression from Star Trek) of the financial services behemoths is profits. The financial advisor’s role is to enhance corporate profitability. Financial advisors today are increasingly handcuffed not just by regulatory compliance, but also ‘corporate’ compliance. Wouldn’t an investment specialist whose only mandate is to do well for his client be more properly motivated (and less conflicted professionally)? Would your investment objectives be better served by an independent advisor who is rewarded only because you the client are earning profits (and not because you are earning his employer more revenues)?

It isn’t necessarily true that an independent advisor is any better than one employed at a bank. I personally know of hundreds of outstanding advisors working at banks and insurance companies. But it must also be true that a satisfied, properly motivated, objective and focussed financial professional will do a better job whether he/she is at an independent or a bank.

We can’t begrudge the banks their success but left to their own devices, they’d all have merged into one by now. In December of 1998 then Canadian Finance Minister Paul Martin rejected the proposed mergers of the Royal Bank with the Bank of Montreal and CIBC with the Toronto-Dominion Bank. We know from our U.S. history that government and regulatory authorities are frequently frustrated by the political muscle (lobbyists, lawyers) of the large financial firms. Ultimately having one gigantic Canadian bank – providing all our financial services, investment needs, insurance requirements – might (or might not) be a worthy corporate ambition, but it’s hard to imagine such a monopoly being good for the likes of us. After all, just consider the progress that has been made in telecommunications since Bell Canada (or AT&T) was forced to reckon with serious competition.

The banks need independent players. Not only should banks discourage the obliteration (by bullying or by absorption) of non-bank competition, they should use their political muscle to keep the regulators from picking on Independent players. Government agencies cannot help themselves – if they are impotent against the strong they naturally attack the weak – even though when all the weak are dead the regulators would have no jobs. You don’t need a police force when there’s nobody you can effectively police.

Independent players create minimum standards of service and ethics, and fuel industry innovation. In every instance, the independent is a bank customer too. Mutual fund and investment managers pay fees to banks, buy investment banking offerings, custodial services and commercial paper and also trade through bank facilities. Independent dealers provide services and financing to corporations deemed too small to matter by larger financial companies; that is, until these businesses grow into large profitable banking customers. Put another way, why not adopt the Costco model where smaller independents can shop for stuff to sell to their own customers, and higher end specialty shops and department stores can all remain standing, rather than the take-no-prisoners approach of Walmart?

Let’s hope that the few surviving independent firms can be allowed to thrive, and if we’re lucky perhaps new players will arise to provide unique services to Canadian clients and homes for advisors who are inclined to specialize in managing and not just gathering assets.

Mal Spooner

 

 

 

 

 

Is it the 1950’s again? The financial war is over!

There is a plethora of articles and blogs out there desperately trying to find a period comparable to now, in order to get some understanding of what markets might have in store for us over the next several years.  After three decades in the investment business, the only thing I can say with certainty is that such comparisons just don’t work.

George Santayana (December 16, 1863 – September 26, 1952) the philosopher and man of letters, is often quoted: “Those who cannot learn from history are doomed to repeat it.

It’s true people will make the same mistakes over and again, but history never actually repeats itself.  Trying to forecast the future is absurd, and so it must be even more ridiculous to expect that the future will be similar to some time period long ago.  Nevertheless, it’s winter and all my friends are on vacation so I’ve nothing else to do.

Post-War Reconstruction: In my simple mind, we’ve just fought a global war against financial corruption.  The weapon of mass destruction?  The ‘derivative!’ These things managed to infiltrate the entire global banking system and almost brought it crumbling down.  Like most wars, it’s difficult to put a pin into when things flipped from a crisis to all out war, but let’s say the seeds were planted when the U.S. Senate tried to introduce a bill in 2005 to forbid Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) from holding mortgage-backed securities (pretend capital) in their portfolios. That first cannonball missed the mark when the bill failed to pass.  By 2007 the two government sponsored entities were responsible for 90% of all U.S. mortgages, and the fly in the ointment was the use of ‘derviatives’ instead of real capital to hedge their interest-rate risk.   Banks did the same thing but much more aggressively. What followed is a long story we’ve been living for years.

Paul Volcker once said, “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth — one shred of evidence.”  Well, we’ve plenty of evidence now that financial innovation led only to the mass destruction of wealth.

When the foundation fell out from under us (value of the derviatives dropped) we went to war in earnest.  The list of casualties like Lehman Brothers Holdings Inc. (announced September 15, 2008 it was bankrupt) just kept getting longer.

I believe the war ended six years after that failed 2005 Senate bill – in the summer of 2011. You can disagree, but your opinion is as meaningless as this whole exercize. (Laughing out loud.)

Way back when World War II (1939 – 1945) ended, governments around the globe began to print money and spend to rebuild the wealth that had been destroyed.  Isn’t this precisely what we’ve been doing since our financial crisis decimated wealth on a global scale?

So maybe some of what happened in the 1950’s post-war period will happen again?

In 1949 there was a brief struggle with the threat of deflation (and again in 1954) but for most of the decade inflation remained steady between 0% to 3%. We too saw the threat of deflation briefly in 2009.  However since then inflation has been fairly steady:  1.5% (December to December) in 2010 and 3.2% in 2011 in the U.S.  Although T-bills are currently paying a negative real rate of return (yields are below the inflation rate) there will come a time soon when investors insist on earning something or they just won’t hold them.  Short term rates will climb as they did throughout the 1950’s.

Prediction #1:  T-Bills will begin to rise until their returns cover the rate of inflation (see chart).

What happened in the stock market back then?  Government spending to rebuild infrastructure and create jobs had a significant impact, because arguably the 1950’s was one of the best if not the best decade for making money in the stock market.  Unfortunately, we only have reliable data for the Dow Jones Industrial Average dating back that far (okay, there might be more data out there but I’m surely not going to go looking for it). 

At the end of 1949 the Dow was at 200.13 and by the end of 1959 it had climbed to 679.36.  Excluding dividends that equates to a (IRR) return of about 13% per year for a decade.  As always lots of volatility had to be endured in stocks, but in the long run the reward was not shabby!  On the other hand, in Treasury bonds you might have averaged a 2% return, but suffered an actual loss in 5 out of the 10 years.

Prediction #2: Global growth fueled by government initiatives will translate into healthy returns on average in stock markets for several years to come.

Are we doomed to repeat history?  Although the 1950’s turned out okay, a wild ride was to come during the following couple of decades.  Easy money and inflation would eventually get the better of us and although there were some very good years for investors in the stock market (and those invested in shorter term T-bills for sure), inflation mayhem was on its way.

All we can hope for is that today’s policy makers have studied their history.  If we allow inflation to get out of control, interest rates will skyrocket like they did through the 60’s and 70’s. Younger folks today will have to suffer rising interest rates (mortgages, car loans) of the sort that created havoc for decision-makers and choked economic growth to a standstill for us older generations back in the day.

It’s true that if we don’t learn from history, we can and will make the same mistakes over again.  But I also said history does not repeat itself.  Although we somehow managed to eventually wrestle the inflation bogieman under control before, this does not mean we will be so lucky next time around.  And it’s a wealthier more technologically advanced world we live in now….which means we’ve so much more to lose if we really screw things up.

Prediction #3:  If governments don’t slow down their spending, bond investors will really get burned.

My instincts tell me that 2013 will be a happy New Year.  And bear in mind that if none, any or all of these predictions come true it will be an unadulterated fluke.

 

 

 

 

Malvin Spooner.