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?