Spring is in the air – what’s that fragrance I smell?

Spring is in the air – what’s that fragrance I smell?
Dian Cohen (Photo : Courtesy)

By Dian Cohen

This Spring Equinox foreshadows a world we can’t recognize from history, but one in which we have to reside. Although we keep hoping for a return to a world similar to what we remember, the likelihood is that we will have to get used to making up new rules as we go along – that’s certainly what governments have been doing for the past 12 months and what we have been reluctantly stumbling toward.
Just think of some of the truths we used to use (and maybe still do) as guideposts for our financial decisions:
A recession and an economic boom cannot happen at the same time.
Yet that’s exactly what we have in our newly bifurcated world – a recession in the food, beverage, travel and accommodation industries (down 11 per cent ), with people now being laid off permanently, and a boom in real estate in general and housing in particular. New home construction is rising, with housing starts up 17% from last February. Strength in the housing market has a multiplier effect, with rising sales leading to more spending on home improvements, new appliances and other household goods. Never before have we seen such high unemployment (currently 8%) accompanied by rising personal incomes, a savings rate that has doubled in one year, lower credit-card balances and higher net worth. Spending patterns have shifted, as professionals bet on a future in which they will be working from home, rather than making daily commutes to the office. Buyers are seeking bigger properties in suburbs and smaller cities, spreading the mania that has long gripped Montreal to places such as Sherbrooke. This has been aided by real estate agents who jumped on the virtual open house bandwagon to “walk around” homes while chatting with clients. The result: more than half of buyers in 2020 made an offer on a home they never saw in person, according to research by Redfin, a US real estate brokerage firm. Whatever happened to building inspections?
Unemployment cannot go up and down at the same time.
Sure it can- now. The truth here is that we shouldn’t talk about “the” job market. It is a bunch of different markets in different stages of recovery or growth. The “long-term unemployed” are those who have been jobless more than 27 weeks. The number of long-term unemployed (as a percentage of total unemployed) has surpassed its Great Recession peak. There are more men who are long-term unemployed right now compared to women, with around 272,000 of the former compared to more than 200,000 of the latter, although the rate at which this number shot up is much higher for women — more than triple compared to December 2019 while for men it more than doubled. The long-term unemployed are just under a third of all unemployed individuals, and many of their jobs are not coming back – – ever.
A good investment portfolio includes a significant percentage of fixed income (bonds).
For as long as I can remember, asset allocation for your investment portfolio was based on the Rule of 100: subtract your age from 100 to figure out how much exposure you should have to the riskiest asset class: stocks. For example, if you’re 25 years old, you should have 75 per cent of your assets in stocks. If you’re 60 years old, then the percentage devoted to stocks should fall to 40 per cent. The remainder should be tied up in bonds, along with your homeowner’s equity. With interest rates on government bonds or GICs hovering around one per cent, that rule has become a swindle – why would an intelligent investor tie up money that is yielding around one per cent when central bankers in Canada and the US actively encouraging inflation? Canada’s inflation rate is currently one per cent, so your bond income is zero, and you haven’t even paid taxes on your interest income. Once you do, you are losing money on this part of your portfolio. If inflation goes to two per cent, you are losing even more money. How is this good decision-making?
Interest rates and the stock market don’t go up together.
The long-term annual rate of return on the S&P/TSX Composite Index (TSX) has been eight or nine per cent/year for the last 50 years and average returns for long-term fixed- income investments have been 3.0 per cent to 3.5 per cent over the long term. Historically, the stock market goes up when interest rates go down and vice versa. The logic is impeccable: lower rates mean lower risk-free income; therefore people turn to riskier assets to grow their income. When an investor can make three or four per cent risk-free on a bond, there’s less incentive to purchase higher risk stocks. This impeccable logic stops working when interest rates are near zero. A bond yield can go from one per cent to two per cent and is still no competition for the long-term return of the stock market, even if it’s a little lower that the aforesaid eight or nine per cent. Riskier investments – that is, the stock market — is the only game in town if one wants an after-tax income. The Bank of Canada and the government are committed to keeping interest rates low long term. They can say that till the cows come home, but the market has been bidding up interest rates because it believes the fiscal and monetary stimulus to which the authorities are committed will eventually lead to inflation.
Dian Cohen is an economist and a founding organizer of the Massawippi Valley Health Centre.

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