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September 8, 2015 | Not So Bad

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

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I swear this will be the last post on interest rates until at least Wednesday. You can quote me on that. So let’s start with the news: our central bank is finished hacking. This is the bottom. Wave goodbye.

Five-year mortgages, still available for the ridiculous price of 2.5%, will not be here by Christmas. The recession is probably over, except in Alberta where it will linger for a long time thanks to a bad attitude. Plumped by the US recovery, improvements in China and commodity prices inching ahead, our national economy will slowly begin to expand. This is consistent with what the Bank of Canada forecast, and in 2016 it will begin raising the cost of money – before a beater Vancouver Special starts selling for two million.

In the States, markets now indicate there’s a 30% chance rates will increase next Thursday, a 60% chance by October and 100% odds by the end of the year. In other words, it will happen – for the first time since 2006. The increase will likely be a quarter point, kicking off a slow but steady normalization in the price of money which will extend out two or three years.

This is good. Embrace it.

Here’s why. First, higher rates mean hope for the same reason lower rates mean trouble. Central bankers do not increase the cost of money unless economies are growing, expanding, throwing off inflationary twinges with more people working and sniffing around for wage increases. They raise rates when corporate profits are robust and companies strong enough to withstand higher borrowing costs. They do this because things are getting better and need managing, as opposed to when things suck and need rescuing.

Second, higher rates kill asset bubbles. This is precisely the quandary the Bank of Canada has faced – trying to engender economic activity, but helplessly watching the real estate gasbag inflate at the same time. Because people have no self-discipline, with brains withered and pitted from watching Hilary on HGTV, Canadians have lapped up debt as never before. And that’s why average single-family detached houses in 416 or 604 cost over $1 million each. No, it ain’t the Chinese.

Third, financial markets are all primed and ready for rates to normalize. There’ll be no crash, correction or panic simply because the Fed is doing what it’s been saying it would do since last March. The doomer websites, apocalyptic newsletter hockers, breathless bullion-pushers and every clown with a survival book to sell are scamming you with fear. In fact, investors have found during times when interest rates tick higher that their portfolios do the same. It’s simply a myth that crazed central bankers are about to bring down the curtain.

Look at the facts.

Higher rates don’t kill stocks. They don’t even inflict a flesh wound. In fact during the four rate-increase cycles in the US over the past 30 years, corporate profits have marched higher and each time – save one (the dot-com bubble) – stock markets followed. This is because, as stated above, rates only go up when the economy’s growing. And these days growth is the US is unmistakable. Look at the GDP numbers. House sales. Job creation. Car sales. All the macro-economics are there, and the Fed’s move will not diminish them.

TIGHTENING

So how about bonds? Don’t they wilt when rates go up? Should you panic and bail?

Nope. The rate increase will be gentle, even if sustained. The bond market’s already been pricing this in, and yields are higher (prices lower) than a few months ago. But there’ll be no bond crash since there’ll be no unexpected rate spike. Besides, you can diminish the impact of higher rates by holding shorter-term bonds which are, like me, far less sensitive. And don’t forget why you bought bonds in the first place – to decrease volatility in your portfolio, hedge against temporary equity declines and prevent you from being an idiot and selling when things decline.

Finally, how do preferred shares behave when the cost of money rises? These puppies kick out a good yield, but lost some capital value this year as the Bank of Canada sliced its key rate and bond yields followed. What now?

Rate-reset preferred prices rise or fall with bond yields. There’s little doubt Canadian rates will follow those in the US, as they have for 93% of the time to date. So logic tells us preferred shares have a big upside. At the same time, they pay you to own them – a return these days of about 5%, plus the dividend tax credit. Compare that to the jam people. Add in the potential for healthy price appreciation, and these are things you probably want to own. Now.

So who doesn’t want rates to get normal again? The deflationists. Doomers. Mortgage brokers. People without money. Those with epic mortgages. Realtors. Or folks trying to get elected. Sadly for most of them, things aren’t so bad.

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September 8th, 2015

Posted In: The Greater Fool

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