Friday, October 28, 2011

Calgary real estate prices down while Canada's is up?

Over the last couple of years, we, Calgary real estate investors experienced the frustration of no or little real estate price appreciation. Not only that, to rub some salt in those wounds, Canada's overall real estate prices seems to reach every month new highs. There is even 'bubble talk'!

How come, despite Alberta's population growth and spearheading Canada's economic growth that Vancouver and Toronto seem to outperform us?  Also, these two markets form the bulk of Canada's real estate and if they rise, then Canada's real estate prices rise.

The answer to Alberta's real estate pricing conundrum is clearly displayed in yet another gem of a graph from ATB's Weekly Economic Bulletin. The graph (see below), compiled from CMCH data shows the story at a glance. 'Just one look is all it took'.

When normalized for January 2004 (all markets are priced at 100), you see that Toronto's prices increased over time at a very gradual pace from 2004 until today. Remember the shape of a 'bubble market'? Well there is nothing asymptotic about the Toronto market appreciation.  In fact, Toronto prices rose at 3.33% per year similar to the inflation rate. Meanwhile, including the recent disappointing performance, Calgary's market averaged 7.25% per year.

An earlier post showed that Calgary real estate prices rise based on a combination of inflation and oil price changes. Around 2005-2007, high gas and oil prices resulted in Alberta's oil industry to boom and so, as you can see on the graph above, did housing prices. REIN's Don Campbell calls the years that followed Tiger Wood's years. Lucky for us, the analogue did not persist until today;  we all know what happened after Tiger's meteoric rise!

Alberta's real estate market exploded and in 2005-2007 it caught up with real estate prices in large cities elsewhere. In fact, it overdid it a bit and thus now the Alberta, in particular Calgary and Edmonton's markets, swung back into a more stagnating pattern while Toronto stayed on its 'Steady Eddie' track. (Oops, no Stelmach pun intended).

Now that the overbuilt inventories in both Calgary and Edmonton start to even out and rental rates along with economic growth are again on the upswing, Alberta's lack lustre real estate market is set to take off once again. When exactly? I don't know but I would not be surprised if we're close to a turning point and that Alberta's real estate prices would appreciate again with inflation at an annual rate of 3 to 4%.

Thursday, October 20, 2011

In Toronto, 70% of buyers in an overbuild condo market are speculators

I have been thinking lately - truly painful for me :)

News papers mention an overbuild Toronto condominium market where more than twice the units needed for population growth are flooding the markets and 70% of buyers are 'investors' (I say speculators). Vancouver, supported by overseas investors is in a similar situation with housing prices so expensive most 'locals' can't afford to buy.

The current stock market seems akin to the 1970s. So retiring baby boomers may not be able to get the returns to finance their golden years. Neither will they do so when lending their money to the government - in fact they may loose that money if said governments default. Where would they go?

With liberals and NDP in charge in Ontario and consumer demand low; the glimmer for more economic growth lies in a recovering U.S. housing market which appears to be at least a year away.

The only bright spots with better demographics, an exploding project portfolio ranging from up-graders to pipelines is the West. Yes, the BRIC economies may slow down but I don't think their growth will go down a lot. BRIC growth may moderate even more so with the world addressing the extreme savings and trade imbalances. So demand for commodities may grow less but I dont see it going down.

So where can investors, especially investing babyboomers, get the most bang for their buck? I would say in Western Canadian real estate - in particular in Alberta. When once again looking at the 1970s, I would expect that after adjusting for the building excesses of 2005-2007, Alberta real estate will appreciate with Alberta's inflation rate (I guess 3 to 4%) . Also, rents are starting to improve while low interest rates are here to stay for the foreseeable future. We're moving into real estate spring!

So, let those Toronto speculators lose their shirts on Condo's while we invest happily in Alberta rental real estate which will likely outperform everything else. Just in case I am wrong - I've been that before, make sure you are diversified!

There are still lots of dividend earning business for sale on the stockmarket paying 3 to 5% tax advantaged dividend while outperforming the overall market. Buy also Dow Jones companies, or better the entire index (ETFs). We're all forgetting that those best-in-class companies operate worldwide and are only partly dependant on the U.S. economy. Their current profits are once again surpising the doom & gloomers on the upside

To optimize your ROI use leverage in real estate --- NOT in the stock market. On the other hand, to optimize cashflow reduce debt. Short term cash,or readily available cash, is once again king. Leave Toronto Condos to the speculators.



Monday, October 17, 2011

Possibly better times ahead!- Not yet a screaming buying opportunity for stocks!

I think that for now the economy and in particular the stock markets are turning the corner or at least are stabilizing. However, I do not think that this is the time to invest full blast in stocks. Cash and cash flow should be number one priorities in today's portfolio!

I think a year-end stock market rally is possible and that we are not in a recession, but I am also sure that the European debt crisis and the paralyzed U.S. political environment are not disappearing overnight. Stick to a regular stock purchase program using whatever monthly amount you have planned to buy; but this is not yet the big 'once-a-year' buying opportunity where you spend all your cash. Possibly such an opportunity will not present itself this year at all. There may be better opportunities in real estate or in fixed income to come. Maybe we will go down in the stock market another 20% and you can buy stocks truly dirt cheap.

Stick to your overall investment strategy; be steady; don't sell off in a panic; collect your cash flow and have a higher cash position and short term income position than usual. Short term income would entail money market funds; short term government and corporate bond ETFs; or cashable short term GICs (1 year or less). My current cash and short term income portion is close to 30% of my paper (stocks; bonds) security portfolio.

If you have used your line of credit to finance real estate or other debt, you may consider paying them off - after all, you pay probably 3% interest on them. The same for margin loans that charge close to 5% interest. There are few short term income investments that will provide you such after-tax returns - and this is as close as you can come to a 'guaranteed' return. When the investment climate brightens and real opportunities present themselves, you can access these lines of credits and margin loans on a moment’s notice so you won't miss out on buying opportunities while you preserve more cash.



Friday, October 14, 2011

2011 correction over?

A picture is worth a thousand words, the saying goes. Although if you look at the 5 year chart of the TSX index it looked like we were entering a bear market while the charts of the Dow Jones and S&P500 (see above) shows a mere correction. If you turned on the news lately, you would have been hit by a deluge of bad news and pessimism. But the economy has not gone into recession and every day there are ‘glimmers of hope’ that the North American economies are still doing better than ‘expected’ and that there is even growth. You’d think Europe is collapsing but even there anemic economic growth has been observed. In Asia, the growth is finally moderating. The ‘Doom and Gloomers’ are now fearing a complete collapse of the BRIC economies, but really, this is exactly what the Chinese government has been aiming for; moderate growth and less inflation. At 6.1%, mostly caused by rising food prices, the Chinese economy is still a bit high on inflation, but ‘core’ inflation excluding food and energy is a modest 2.9%.


I predicted early in the year a moderately performing Canadian stock market, an outperforming U.S. stock market and the recurrent problems of the European debt crisis. Although overall stock market performance was less than stellar up to now and I actually did recommend for older investors to sell off some of their riskier investments so that they may sleep at night, the overall prediction, surprisingly, still stands. In fact, the above chart of the S&P500 suggests that I may have been dead-on (talking about miracles).

The 3year S&P500 chart shows that we just went through a significant correction and trading volumes suggest that in September we actually may have hit a high volume ‘capitulation’ pattern. However, we have been nowhere near a repeat of the 2008-2009 bear market. Yes, commodities have been hard hit, but the diverse S&P500 index shows that the overall market is still in a bull market trend. Last year between May and September we experienced a significant correction and we were all talking about a double dip recession. This summer, a broader and deeper correction from August until today occurred based on similar worries as last year but the overall bull market trend is intact.

These days, European, Asian or North American stock markets are all strongly ‘correlated’ or interconnected. We have learned that although some country indexes have been harder hit than others, virtually none has escaped the poor stock market performance. So in terms of diversification, it is no longer effective to diversify one’s holdings amongst countries. Individual markets sectors though have performed widely divergent or ‘poorly correlated’. Dividend paying communication stocks and that of dividend paying utilities and consumer staples have outperformed commodity stocks during the correction; bonds have been stable (although going forward over the long term they are likely higher risk than stocks). Apart from its recent retrenchment, gold has been outright stellar.

So, these days, when building a diversified stock portfolio, it is better to diversify amongst market sectors rather than amongst countries. Since Canada’s stock market is predominantly commodity, communications, real estate and financial sector driven, we should also look south of the border to add stocks from the consumer staple, high tech and health care sectors. I stick with my earlier recommendation to buy Dow Jones ETFs in U.S. dollars (Dow Jones Spiders).

The 3 year S&P500 chart is still above its 200 week average showing an intact long term trend; while the 1 year graph below shows that we’re back trading above the 50 day average – something technical stock analysts consider ‘bullish’. Even better, today the S&P500 has broken or is about to break out above its short term market peaks signaling an approaching year-end rally. Whether the rally will be as powerful and long lasting as last years’ remains to be seen but for now it looks like the worst is over (I certainly hope so).

Saturday, October 8, 2011

Paper securities not enough for a diversified portfolio

Are you buying a share of a company or do you speculate in stocks? When buying shares in a company you could use technical analysis – the analysis of stock price seasonality and current buy and sell trends as reflected in trading volume and price chart patterns. Technical analysis basically measures the emotional state of the stock market and in today’s market there is very little relation between the actual financial performance of many companies and the price the emotional investing public pays for those company shares.

Technicians are euphoric because their method of stock analysis helps them predict short term share price movements. Many claim that we are in a trading range or in a bear market. No matter which is right, this means we’re in an emotion driven market. If you are a day trader or speculator you might be able to take advantage of the technical trends and make some money after all.

Last night’s episode of BNN’s Market Call featured Don Valioux. Don’s past picks clearly illustrate my point. Don’s picks all got ‘buy’-signals in late June, 2011. Initially the picks did well, but within a month or two the trends changed. Don claims that by monitoring stocks every day and possibly more often, he detected the changes and sold with minor gains. Now in October the average picks were down 10.8%. Ouch! BNN’s Michael Hainsworth exclaimed “Every day? We’ve got daytime jobs, Don!”

What Don Valioux does is speculating on seasonal trends or price and volume trends. The trends may happen but then they also may ‘turn on you’. Many technical analysts are so focused on the squiggles they analyse that they often don’t even know what the companies that underlie the stocks are about. Ron Meisels is the perfect example he seems to have no clue what the company whose shares he buys does.

Investing, in particular buy and hold or value investing, is quite different. As Peter Lynch and the likes of Warren Buffett say you’re buying part of a company or the whole company. You share in its profits (and losses). Part or all of those profits are reinvested in the company, used for acquisitions, share buy backs or dividends.

The notion that you own a company is false, though. Just try to enter the head office and fire the CEO. Most long term investors have no control over the company they ‘own’ other than when they vote on an AGM or on a take-over deal. You’re literary along for the ride – not only the corporation’s financial ride but also the stock market ride. You’re only the passenger on this roller coaster and that is what makes stock market investing so difficult. The best chance to make money is to hold on and sell at market highs while trying to buy said shares when they’re on sale.

If you invest in mutual funds or ETFs matters of control are even worse. You do not even vote at the AGMs of the companies you own. Worse, your mutual fund or ETF manager may do it or not. In previous postings we have shown that over the long haul, investing in stocks provides good returns, but in extreme cases you may have to wait a decade, yes that is 10 years, or longer before you actually realize a good return. This is why dividends are so valuable! They not only constitute nearly 50% of your total profits, they provide you cash flow while you wait for the appreciation.

The 1970s (see earlier posts) was a time where there was very little appreciation but dividends would have pulled you through. Today’s stock market show a lot of similarities with the 70s and with dividend yields 3 to 5 times higher than long term government bonds, stocks are attractive to invest in. Especially Canadian dividend paying stocks are attractive because they qualify for the dividend tax credit.

From a corporate point of view, issuing shares is not much different from issuing bonds. One ‘pays’ out profits and the other pays interest. As long as a corporation has access to capital in one form or another to finance its acquisitions or expand operations and run its operations (working capital), it does not care. If it is cheaper to issue bonds then it will do so; on the other hand if it is cheaper to issue shares it will do that. Only when management and to some degree staff has interests similar to the share owners then they might care about stock prices. Often options are a tool to align management interest with that of the shareholders. But in falling bear markets that alignment gets lost (especially when the options are ‘re-priced’); also when management gets big financial incentives to merge or acquire regardless of the corporation’s financial merits or that of the shareholders, the alignment of interests may get lost. The board of directors in public corporations are in theory comprised of shareholders, but in reality many of those directors are buddies of senior managers. Rules of corporate governance may have improved a bit, but still the deck is stacked in favor of management.

So when investing in stocks, you do have a long term interest in a company and you should not get distracted by daily stock market movements. Yet the lack of control about your company’s performance is a major issue. Hence, a portfolio is not truly diversified if you only invest in paper securities. If you are still working, you should see your current job also as a part of your portfolio. How stable is it? How is your earnings performing? Then there is the possible lay-off (yet another bear market).

For retirees, holding real assets such as real estate, in particular rental properties should be a definite consideration. What other income streams could you add to your portfolio? Royalties, pensions, your own business? If the last 10 years and our extended life expectancy have taught us anything, then it hopefully is that paper securities alone may not be enough to create a diversified portfolio that allows us to live a full live to the age of 100.

Monday, October 3, 2011

Cash, cash flow and real diversification for tough times

Gordon Pape discussed this week the ‘long term bear’ Eric Sprott of Sprott Asset Management. Over the last 10 years Eric Sprott warned that sovereign paper holdings would likely decline in value, while hard assets like gold and commodities were to appreciate relative to the paper. Mr. Pape notes that for the decade, Eric Sprott was correct and that his funds returned annually nearly 18.4%. But the ultimate Armageddon forecasted by Mr Sprott hasn’t happened (yet) and last month his fund surprisingly fell nearly 18.9% and it fell 25% year-to-date. That, while living in the throes of the European (and to a lesser degree) the U.S. sovereign debt crises.

My stock portfolio performance has not been inspiring either; it shrunk nearly 15% for the year since I was overweight in oil and gas. Commodities lately have been considered high risk in the stock market and it is the reason that the TSX has lagged the performance of the Dow Jones especially taking into account the rising U.S. dollar.

Professional managers feel that retail investors are very emotional and hence sell during panics and buy during market highs; nearly exactly the opposite of what retail investors should do. The U.S. based American Association of Individual Investors performs a weekly survey and professional investors use this survey sometimes as a contrarian indicator. On average (since 1987) investors are 39% bullish; 31% neutral and 30% bearish – the graph below shows investor sentiment and stock market performance (S&P500) from 1998 until last week.



It indeed shows that during bear markets investor sentiment drops dramatically with only 20 to 30% of investors being bullish and today that is also the case (we’re just below 28%). Typically, sentiment numbers don’t fall much lower, although there are individual spikes such as in the spring of 2005 that fell as low as 15%. But during bear markets we get a cluster of low sentiment troughs. Sentiment lows are now at a similar level as in 2003, just before the on-coming bull market that lasted until mid-2008. The sentiment lows of 2009 were worse (20%). The most bearish sentiments (10-15%) did not occur during the 2003 and 2008 bear markets; it occurred in the 1990 bear market.

Professional managers interpret the current low bullish sentiment to indicate a market turn around. So you may think that bullish highs of 50% mean an impending crash. Strangely enough, this not always the case. Finally, it may be noteworthy that during the 1988 -2000 secular bull market investor sentiment often was below 40% while most bullish sentiment was measured between 2000 and 2004. My conclusion is that we may or may not be near the end of today’s bear market – now how is that for enlightenment?

But whatever your bear market strategies, the number one issue to keep in mind is cash management and nearly just as important is diversification. I agree with Eric Sprott that real assets are often the key. Stock market valuations are, especially in the short term, sentiment indicators. Bond yields are expressions of confidence in the borrower’s capability to pay interest and repay the debt. This confidence level combined with the inflation expectation sets the final bond yield.

That Eric Sprott’s fund performance was so negative was due to the fact that he still invests in paper assets not in the assets themselves. He invests in shares of gold mines, bullion ETFs and, to a lesser degree, in shares of oil companies. Yes these are harder assets than say banks or engineering consulting companies, but their prices are still an expression of investor confidence, economic expectations and futures market speculation. Many of these companies make money hand over fist, but it is not reflected in their stock prices.

Strangely enough, the only paper investments that hold their value these days are those that provide the investor with cash flow and that are not related to lending money (such as banks and insurance companies). These are dividend paying companies such as utilities, phone companies and pipeline companies. Remarkably, these companies trade at much higher P/Es than most other stock market investments. Why is this remarkable? Well high P/Es used to be associated with companies that promised high growth but that is not the case any longer (look at high tech companies).

Real assets are assets controlled by the investor! A prime example is your own business or real estate (your house or your rental property). I wrote earlier about the underlying trends in real estate (baby boomer 2nd homes and rental properties). My overall investment portfolio comprises now 50 to 60% real estate in various forms. Yes recreational properties were hard hit in 2008 and many have not recovered (yet) but residential real estate and rental properties are as a minimum stable if not increasing in value. Simultaneously, they also provide cash flow or in the case of your own residence it saves you from paying rent. But be aware, even real assets may develop an overvaluation bubble as our neighbours to the South found out.

Although this year my stock portfolio declined in value by 15%, my overall portfolio dropped only 6.4%. Always remember, this is a ‘paper loss’ which only becomes a real loss once you sell. If your portfolio throws off enough cash, especially when combined with your salary, you will not be forced to sell and you can wait for better times. If you sold off some of your riskier holdings as I described last week, then your current cash position should allow you to take advantage of buying opportunities to come or as a minimum it should help you to sleep somewhat better at night. A good night’s sleep is the best medicine against panic!

To get through tough times, you need cash, cash flow and real diversification!