Yeah, I know I told you I was coming back with a good article for Wednesday, I needed extra time to finish it. You won’t be disappointed!
Last week, Canadians Banks were posting record profits beating all analysts’ expectations. 2012 will probably one of the most (if not the most) profitable year in the Canadian Banking Industry. Combined together, they racked up $8.2B in profit. This is huge considering the underwhelming economic environment. Definitely, the Canadian economy seems to be under the umbrella of the financial Gods as it quickly recovered from 2008 and hasn’t looked back since.
I’m rarely pessimistic regarding the stock market and the economy in general. I usually think that people are screaming the end of the world from the building tops just to draw attention (just think of how many “financial gurus & Black Swan Experts” were on TV back in 2008… I’m still waiting to read the obituary of capitalism… But I think that this time is different… lol! Another catchy phrase that we hear all the time! Still, I have a feeling that the next bubble is coming from Canada and it is going to touch everybody (even my dear US readers!). Here’s my first point:
I don’t even know if I have to comment this graph. I mean… the credit crunch, people losing their houses, banks losing money… all that happened back in 2008 in the USA while the debt-to-personal disposable income ratios hit 125%. We are now over 150% in Canada (source). To understand this graph completely, it’s important to look at the definition:
Debts: The total household debt includes mortgage debt on principal residence, vacation homes and other real estate, plus consumer debt. The latter includes debt outstanding on credit cards, personal and home equity lines of credit, secured and unsecured loans from banks and other institutions, and unpaid bills (including taxes, rent, etc.). (source)
Disposable income: The amount of money that households have available for spending and saving after income taxes have been accounted for. Disposable personal income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy. (source).
So if you are making 100K and living in Ontario, your after tax income (read disposable income) is $73,088. If you are in your 30’s and have a mortgage with a car loan totaling $325,000, your debt-to-personal disposable income ratios is at 445%… In the end, most people in their 30s and 40s have a mortgage and a few other loans. They are probably all hitting 300% to 500% with this calculation. But the key is that you have to factor the population as a whole, which also includes all people aged over 50 who should be free or almost free of debt. Since our population is currently aging, we should see this ratio going down. Since 2003, this ratio is following an Apple-like steep up trend.
It’s been a while since we started discussing the Canucks’ debt situation but nothing is really changing. We had several new mortgage rules implemented restricting new home buyers’ financing and refinancing but it seems that it’s not enough. The problem lies in the interest rate; we all know it’s going to stay low.
The Bank of Canada is Stuck with a Major Problem
On one side, the BoC should increase its interest rate to maintain inflation and restrain credit access. A slow and steady rate increase would persuade Canadian consumers to slowdown their party and start paying off their debts. But on the other hand, the FED and European Central Bank called a low interest rate policy until 2015.
So if the BoC increase its rate, the Canadian dollar will fly over parity compared to the US dollar. This would definitely hurt our exports. Remember that not so long ago; the Canadian economy was built based on a weak dollar with a $0.65 – $0.70 value to the US dollar. Now that we are at parity, the economic model has already changed leaving several company closing during this time. Another dollar value increase could be fatal for our economy. Remember that Canada is full of resources but they are more expensive to extract than in many other countries.
But if the BoC doesn’t touch its interest rate, it’s like parents leaving the house and unlocking the liquor cabinet with 2 teenagers in the house. The party will continue until someone breaks the living room expensive sculpture!
Why Should You Care About the Canadian Credit Bubble Bursting?
In my opinion, credit bubbles are the most dangerous. The technos can fail, the rest of the world will breath. Gold can go back under $1,000, this won’t prevent people from buying goods. But when credit is affected, it’s like having a seizure; you can’t function anymore and have stop and take a pause. Pauses ain’t good for capitalism.
Unfortunately, if the Canadian credit is affected, it will also hurt Canadian Banks. At the moment, they are among the most active players in the financial industry. They are the bank role models across the world, they are making major acquisitions and distributing heavy dividends. It’s a symbol of profitability and stability.
Canadian banks won’t go bust if we hit a credit crunch in Canada. They are more solid than that. However, as conservative as they are, they will stop their expansion plans and restrain their dividend distribution. In an economy that has run on idle for the past 4 years, this is definitely not good news. If banks apply conservative measures, they will also restrain credit. This will slowdown many companies as it happened in the US.
This is why you should care; because the whole Canadian economy will suffer big time and your investments will definitely be affected.
What Can You Do?
I’m not the type of guy that will short his stocks and go cash. So I won’t tell you that going for 2% bonds is a good idea. However, I’m going to tell you that there is definitely a bumpy ride coming in the next few years for your Canadian (and potentially US) investments. In the meantime, I’m making sure that my Canadian holdings are strong and can go through the recession while paying nice dividends. Since this money is invested for my retirement (in 30 years), I can wait and don’t mind my portfolio value as long as I get paid in the meantime. After all, getting a 4% dividend is a pretty good reason to wait. I’ll probably look to buy more US stocks in the future too. I like the fact that I can diversify my risk by picking international companies!
Is your portfolio “safe” at the moment? Are you planning to make any changes?
I think this credit crunch will hit us in the near future. Good strong blue chip dividend paying stocks, in my opinion, is the way to go. I’ve been there 15 years. And I’m a recently retired investor. My question: How will REITS react to this downturn?
Hey Michel,
I totally agree with you. Blue chips will hold still and will pay dividend in the meantime.
As far from REITs, I would pick REITs that had just renewed their mortgage rates for the next 20-25 years ;-). I guess that tenant REITs will do better if people start losing their houses, right? they still need a place to live. However, I would not be too keen on office tower REITs…
But if you really think that this would happen, would you maybe consider selling one of your two banks in your portfolio?
I could not agree with you more and finally we have someone (besides myself and Brian Ripley) blogging about the obvious. There were record profits in US banks too before credit contracted. The big difference is we can’t printo ur way out of it. We have a real problem. Remember how low unemployment was in the US when credit was at its peak? Almost less than 4%. What is it now. Likely 20% if you look at shadow stats. Canada will be hammered the same way. People really don’t understand addictions and governments sure as hell don’t. This is 30 years of cheap cash. How it wil be paid back? Who knows. When people aren’t working they can’t pay their debts. When their debts re this high after chasing returns with borrowed cash then you have a serious problem. The guy who caused it although not necessarily only his fault is leaving for England. We will now join our US and western world bankrupt nations. When you see housing rising prices rising with credit borrowing you know how it will end. How did it end in 1989? This will be a lot worse as rates are much lower now then they were then. I am no doom and gloomer either but to ignore the truth is foolish.
It’s interesting that you mention they will hold on credit because Carney was just mentioning that major corporations are hording too much cash right now which signals they would be able to borrow.
Small businesses and individuals would be caught in the tightening of credit lending.
Good post buddy.
Like you, holding onto my dividend paying stocks and looking to buy more to diversify. 4% portfolio yield ain’t too bad, mine is about the same 😉
Cheers,
Mark
So the banks are taking 30 billion out of the economy. What is the purpose of a bank and do they need to take that much out of the economy to survive? I would like to see how much they make via service charges and add on fees when compared to their primary activity of interest extraction on loans. Wouldn’t it be nice to borrow something, charge a service fee for doing that and then lend out your asset ten times over. That’s close to the definition of naked short selling. Trust a bank?
@Peter,
Since I only think it will affect banks temporarily (they are solid enough to go through this bubble), I rather keep their dividend payouts in the meantime and not looking at their market value for a while ;-).
@Cynic,
I rather have solid banks making profit than shaky financial institutions. More than 50% of their profit is coming from trading activities actually and about a third is coming from wealth management activities and commercial business. There is not much coming from fees and retails in general. As annoying fees can be, this is not their golden egg hen!
It’s time to add financial education to the school curriculum… Graduating herds of suckers for the credit institutions to milk dry ultimately isn’t doing anyone any favors.
In general I’m in agreement that buying and holding dividend paying stocks is the easiest way to go. Yes if the banks struggle a bit they might not raise dividends quite as quick but they won’t suffer the way the US did.
The question I’m asking is will bank stocks and such go “on sale” next year?
That’s where I’m stuck. I really like picking good stocks up on sale, problem is they don’t go on sale very often and for a good stock like Fortis they rarely do.
Very few people even look here for a bubble. When it comes to Canada it’s always cotton candy and unicorns. We have done a lot of work on Canada in the past year.
In my opinion — summing it up very simplistically — what lies ahead will make what happened in the US look like a “correction”. The major Can banks will ave to be bailed out. But so will the gov’t and non-reserve currency money printing by the BoC is not an option like in the US and Europe. Just my 2c.
I don’t think the banks in Canada will be much affected by a housing crash, unlike the States. I believe CMHC provides insurance to people who don’t have the minimum 20% down payment, which in turns package them into mortgage backed securities. These securities are guaranteed by our Canadian government, ie us taxpayers 🙂 So if RE does crash in the future, we’ll foot the bill. Bank stocks might have a slight hiccup, but not a crash.
I’d love to hear some different opinions from other readers.
Reading this begs the question – how did investors profit in the US? and can we repeat it now?