January 30, 2020 | The Contagion

Mr. Market is having second thoughts about the virus thing. Flights to China now cancelled. More US cases. Fifty million under quarantine. The threat’s not that thousands (or even hundreds of thousands) will perish, but the world’s second-biggest economy will take a kick. GDP could tumble from 6% to 4.5% this quarter. That’s a big deal.

That has equity markets wavering after hitting record highs with more money flowing into safe stuff. Bonds. Always a refuge in times of uncertainty, even when they pay peanuts. This is one good reason why every prudent investor should have about 40% of their overall portfolio in fixed income, including government, corporate and provincial bond ETFs. Not only do they provide shelter in a storm, they can be profitable. One nice bond fund we like plumped 10% last year, for example.

When money moves into bonds from stocks, demand increases and prices rise. So bonds become more valuable. As that happens they pay less. Yields fall as capital values jump. (A bond always pays you 100 cents on each dollar of face value when it eventually matures. But along the way the price fluctuates. That can be caused by a change in rates, by demand or risk. A bond that’s worth more in the market sells at a premium to its face value, so it pays less. Bonds selling at a discount have a higher yield, typically because rates are rising. Clear as mud, right?)

Since the virus infected the media, bond demand has risen, yields plopped, and it looks like this will translate into lower mortgage costs. The yield on five-year Government of Canada debt has dropped over the last two weeks, and is weakening again. If this continues (seems likely at the moment) five-year mortgages could drop widely to 2.5% in February – just in time for the Spring rutting season.

This is cheap, cheap, cheap. Recall that the inflation rate is 2.2%, so locking in to a loan for half a decade at 2.5% is a gift. The cost of money will not stay at these levels, and it pretty much eliminates the logic in paying down such a mortgage. Most people will be far better off throwing their extra monthly cash flow into their TFSAs, in nice growthy equity-based ETFs, where they can enjoy a higher long-term pop.

As for morbidity and mortality, well, Mr. Market cares more about corporate earnings, US economic growth and Trump. They will prevail. Just be glad you’re not a prisoner on a damn cruise

Now, speaking of mortgages, remember that Trudeau mandate to Chateau Bill to make the stress test “more dynamic”?

Some Lib MPs are getting antsy, speaking out in favour of gutting the thing. Now we have word the bank cop – OSFI – may be considering exactly that. What an uncanny coincidence!

The current stress test for buyers who don’t need mortgage insurance (at least 20% down) is the rate the bank offers +2%, or the posted benchmark rate (now 5.19%) – whichever is greater. Given you can get a fiver now for under 3%, this becomes a high hurdle – one that will be even steeper if the virus discount takes hold in the bond market.

OSFI gets this (the real estate industry has been squawking in protest for months) and a recent speech by the No.2 guy there has opened the door to change. Seems the bank regulator will allow the test to be based on the contract price plus two per cent, and ditch the benchmark hurdle. The result? A decrease by about a third of a point – which increases the purchasing power of buyers. By the way, this is not an unreasonable position, given that the spread between the benchmark rate and on-the-street mortgage pricing has been gapping a lot lately. But you know the likely result, of course. A hormonal spring.

Now, what else can we expect?

Ah yes, the political diddling. It’s contagious.

As you know, governments have played a key role in helping make residential real estate unaffordable. The last election campaign was shameless, as all parties scrambled to woe Mills with housing bait. The Libs enhanced their silly shared-equity mortgage plan, raised the RRSP buyers plan limit and showered owners/buyers with new credits and green money. The Cons essentially matched the gifts and vowed to whack the stress test. The Dippers and Greens said, well, who cares?

While OSFI – not Morneau – is technically in charge of this thing, the fact Trudeau gave him the mandate for change shows what’s coming. The benchmark hurdle of 5.19% will not be around much longer, along with changes again seducing our glorious youth to become pickled, immobilized, paralyzed and hollowed-out by unrepayable mortgage debt. Just like they want.

Looking for something to worry about? It’s not a virus.

Garth Turner January 30th, 2020

Posted In: The Greater Fool

Next: World Commerce to Slow Dramatically Soon! »