Housing market poised for ‘severe correction,’ finance professor says

By Doug Alexander and Ilan Kolet
Canada may be on the cusp of a “severe” housing correction as real estate investment surges above a tipping point relative to economic output, according to George Athanassakos, professor of finance at the Richard Ivey School of Business.
The chart of the day shows Canada’s housing investment as a percentage of gross domestic product, and the declines in inflation-adjusted house prices that follow when this ratio tops 7%.

“Eventually, everything boils down to demand and supply,” Mr. Athanassakos said in a telephone interview from Western University in London, Ontario. “Whenever this ratio goes over 7%, it signifies over-investment in housing and two or three years later, we have a severe correction.”
Canada’s housing market is booming as historically-low interest rates fuel purchases, driving up home prices and adding to record household debt. Canada’s ratio of housing investment to GDP has averaged 5.8% over the last 50 years and is currently at about 7%, based on Statistics Canada figures as of the third quarter of 2011, Mr. Athanassakos said. Housing investment includes spending on new homes, renovations and real estate transaction fees.
U.S. housing prices plunged by a third between the peak in July 2006 and November 2011, according to the S&P/Case-Shiller Composite-20 Home Price Index. By comparison, Canadian housing prices rose 30% in the same period, according to the Canadian Real Estate Association.
“We have experienced bubbles and busts before in Canada, it’s nothing new,” Mr. Athanassakos said. “I don’t know why this time would be different.”

Taking Back Globalization

DAVOS – The World Economic Forum’s annual gathering is normally little more than a toast to the benefits of increasing global GDP, trade, and investment. But this year’s meeting comes at a time when economic expansion can no longer be taken for granted, and when the uneven benefits of past growth are sparking mass social unrest.
So it is little wonder that doomsday scenarios about the “seeds of dystopia” and the risks of “rolling back the globalization process” are being dangled in Davos. The world’s economic and political leaders stand warned: do globalization better, or it will be derailed by the growing legions of the discontented.
Leaders would be unwise to ignore this warning. Discussions in Davos must go beyond how to rectify the imbalances in developed countries’ debt-to-GDP ratios. They must finally pay attention to the wider imbalances generated by unfettered globalization.
Popular anger is directed not only at the bank bailouts, soaring public debt, and bleak employment prospects of recent years. All around the world, people have fallen afoul of a two-track economic process whereby whole industries have been sacrificed to cheaper imports, whole regions have been consigned to abandonment or degradation, and whole populations have been frozen out of economic progress.
Nowhere are these imbalances more evident than in the global food system. Globalization has been wholeheartedly embraced in the service of feeding the world: bilateral and multilateral trade agreements have been put in place to allow food to flow from food-surplus to food-deficit regions.
Yet this model has failed spectacularly. The food bills of the Least Developed Countries (LDCs) increased five- or six-fold between 1992 and 2008. Imports now account for around 25% of their current food consumption. The more they are told to rely on trade, the less they invest in domestic agriculture. And the less they support their own farmers, the more they have to rely on trade. Countries that fall into this vicious cycle leave their citizens vulnerable to historically volatile prices on international markets, which means increased hunger and insecurity.
Despite the persistent challenges of hunger and food inequality, people are told to embrace more open markets, more trade, and more globalized economic processes. Yet open markets do not function as perfectly as many at Davos would like to think. Food moves where purchasing power is highest, not where the need for it is most urgent.
This blind embrace of globalization from above means missing out on key opportunities that do not fit the dogma. If we were to support developing-world small landholders, who are often the poorest groups, we could enable them to move out of poverty and enable local food production to meet local needs. Trade would complement local production, rather than justifying its abandonment.
Trade and investment agreements are the gateways through which globalization passes on its way to redefining a country’s economic landscape, and they are increasing at an impressive pace. There are 6,092 bilateral investment agreements currently in force, with 56 concluded in 2010 alone.
That growth reflects the flawed economic model of the pre-crisis years, which relied on indifference to where growth came from, how sustainable it was, and who was benefiting from it. If we are to learn anything from the ongoing crisis, it must be to start asking the right questions.
Every new bilateral agreement, every chapter of globalization, should be measured against new criteria. How sustainable and how evenly spread will the macroeconomic benefits be? Will they facilitate genuine development and provide dignified opportunities to those who become economically displaced?
An EU-India free-trade agreement is now imminent – and could be the litmus test for how we reengage with globalization in the wake of the crisis. Some estimates suggest that the proposed tariff liberalization in the dairy and poultry sectors could threaten the livelihoods of 14 million very poor households in India, half of them landless.
Globalization involves winners and losers – that has been established. But losing out, for a subsistence farmer, means sinking into dire poverty and hunger. Is the denial of a vulnerable population’s right to food an acceptable byproduct of a trade deal? Should the primary goal be to multiply the interests of powerful multinationals? Are these the economic processes that we want, or need?
These are the questions that leaders must ask at Davos. Globalization can survive the crisis. But not as we know it. Globalization must be taken back for the interests of the many.
Olivier De Schutter is the United Nations Special Rapporteur on the right to food. On March 6, he will present to the UN Human Rights Council in Geneva a set of guiding principles for assessments of trade and investment agreements’ impact on human rights.
I think there are some points we need to explore deeper.
1. Globalization is a not a process that is in our hands and we could switch it on and off as we like. Globalization is an evolutionary process, where through multuiple factors mainly driven by inherent, expansive and pleasure oriented, basic human nature and population growth we have evolved into a totally interconnected and interdependent global network. The presence of this closed network is a well establisehd fact, we have the connections in between us, the only question is how we use them.
2. Our inherent nature is subjective, we always make self calculations and in every situation within any condition we are looking for more profits, rewards for ourselves even if we have to exploit others or our environment in the process.
This selfish and greedy human nature in a closed, interdependent system, with limited natural resources has become harmful to the point of destructive. Again it is objectively established, and the deepening crisis is providing evidence with every passing day.
The problem is how to convince ourselves, especially those who make decisions about this situation, and initiate wholesome changes.
Even if we start to understand how harmful our present attitude and lifestyle is in theory we still behave like the alcoholic who was told to stop drinking based on minimal symptoms and some blood results, but still thinks that 1-2 more glasses, or maybe another week of heavy drinking should not be a problem. He sort of understands in his mind the problem and the recommended solution, but his discomfort, pain is not strong enough to turn him off drinking.
This is the question today: are we wise enought to start changing and start planning, living and acting mutually and equally, taking the well being of the whole global system as our priority ahead of our self interest based on the clear information around us, or we wait until things turn really bad, with complete economical collapse, violent riots even wars to convince us we "need to stop drinking"? Zsolt 10:53 25 Jan 12
 

Three tax resolutions for 2012

While tax season is still a couple of months away, there is really very little you can do to reduce the tax bill on your 2011 return, which will be due on April 30th. That being said, January is the ideal time to start thinking about tax savings for 2012.
Here are three tax resolutions to ponder over the weeks and months ahead:
1. Get Organized
If you’re one of those people who is always scrambling to hunt down receipts, T-slips and other important tax info, now is a great time to set up a tax filing system. It need not be complicated and it can be in physical or electronic format.
For example, I often get e-receipts for charitable donations I make online throughout the year to various friends’ fundraising events or charity runs. I set up a separate folder in my e-mail program to store all these e-receipts such that come tax time, I can simply print them all out at once.
Many T-slips are also available electronically. My employer, for example, posts employees’ T4 slips on a secure internal website. The slip can then be printed off anytime or saved electronically in a tax folder on your computer.
If you use part of your home for business, be sure to also keep records, either paper or electronically, of bills for electricity, heating, maintenance, property taxes, and home insurance, all of which will come in handy in tax season.
Finally, if you’re a non-registered investor who is buying and selling securities throughout the year, ensure that you have a good place to store all your buy/sell trade confirmation slips so that you can properly calculate both the adjusted cost base of your investments when you come to sell them and accurately report your proceeds of disposition.
2. Maximize tax-free/deferred savings
With four types of registered accounts to choose from, ensure that you are prioritizing the order of your tax-free or tax-deferred savings. While each person’s situation is different, my general prioritization order for registered savings goes as follows: RDSP, RESP, TFSA and/or RRSP.
If you are saving for someone in the family with a disability and who qualifies for the disability tax credit, then the Registered Disability Savings Plan (RDSP) is clearly the first priority. Not only can up to $200,000 of contributions grow tax-deferred, but the RDSP may be entitled to receive up to $3,500 annually in Canada Disability Savings Grants and an additional $1,000 annually in Canada Disability Savings Bonds up to a lifetime maximum of $70,000 in CDSGs and $20,000 in CDSBs.
Next in line would be contributing to a Registered Education Savings Plan (RESP) for each minor kid to save for their post-secondary education. By contributing at least $2,500 for each child annually, you can take advantage of the 20% matching Canada Education Savings Grant (CESG). If you are catching up and trying to collect prior years’ CESGs, consider contributing $5,000 per child to the RESP such that you can collect the annual maximum of $1,000 in CESGs per child.
Finally, to save for retirement, consider contributing to an RRSP or TFSA. Can’t afford to do both but having trouble deciding which one is best for long-term retirement savings? My broad, overly-generalized rule of thumb says if you make $53,000 or less, maximize your TFSA contribution first since you are in the lowest bracket ($42,707 + $10,822 of basic personal amount) and likely pay combined federal and provincial taxes at about 20%. Chances are your marginal effective tax rate upon withdrawal will be higher, especially taking into consideration the effect that if you had directed those savings to an RRSP, when withdrawn, that income inclusion could put you into a higher effective tax bracket once factor in the claw back of various income-tested government benefits.
3. Plan your charitable giving in advance
Consider setting up a charitable donation budget for 2012 so that you can give in the most tax-effective way possible by donating appreciated stock or mutual funds directly to charities. Not only will you get a tax receipt for the fair market value of the stock or funds donated, but you also will eliminate any capital gains tax bill on the accrued gains.
An easy way to do this is to establish a donor advised fund (DAF) through a public foundation and transfer the appreciated stock or mutual funds to the foundation at the beginning of the year. Then, as requests for donations come in during 2012, you can direct your DAF to write the cheques. You’ve got the tax break up front and made the donation in the most tax effective way possible by donating “in-kind” and eliminating a future capital gains tax liability. Practically, it simply wouldn’t be feasible to donate $50 worth of stock every time you wanted to help a co-worker raise funds for her favourite cause.

Ignore those fallible forecasts

Every New Year brings a bountiful supply of economic and market forecasts by investment pundits. Well-researched, analytic and often insightful, the typical forecast, whether it is bullish, neutral or bearish, is artfully constructed. In search of guidance, many investors (and advisors for that matter) seize upon a specific strategist’s prognosis as a rationale for their investment decisions. This raises the question: Just how accurate are the forecasts of experts?
Regrettably, the answer is not very accurate. The Congressional Budget Office (CBO) in the U.S. regularly assesses the accuracy of its forecasting track record and that of the Blue Chip Consensus Forecast, an average of 50 professional economists’ forecasts. From 1982 through 2008, CBO found the average error in its annual forecast of real gross domestic product growth was 1.1%. Now that doesn’t sound like much until you realize the actual real GDP growth rate was 3% per annum such that CBO’s forecasts missed the mark by more than 35%.
Well, that’s the government, you might say — certainly, the consensus view of 50 highly regarded economists will be more accurate. As it turns out, the average annual forecast error of the Blue Chip Consensus was also 1.1%, the same as CBO’s. With all of that experience, mountains of data and complex computer models, the professional economists’ average forecast of GDP growth also missed by a wide margin.
Making matters worse, the forecasting errors were largest at the key turning points in the economy. For example, in 2008-2009, the annual real GDP growth forecast by CBO and the Blue Chip Consensus was 2.3% and 2.4%, respectively. As the U.S. economy headed into a recession in 2008, the actual growth over this two-year period was negative — the real GDP contracted by 1% annually.
Just when an investor needs accurate guidance the most, the experts didn’t deliver.
Of course, every year some economists do get it right. In my experience, investors often gravitate toward the strategist who has made the best call over the past couple of years. Unfortunately, this is not a winning approach either. A comprehensive study by the Federal Reserve Bank of Atlanta found that not one single forecaster in the Blue Chip Consensus consistently performed better than the average of the 50 forecasters. As faulty as the Consensus view often is, it is likely to be more reliable than any single strategist’s forecast.
Several studies have found that analysts’ forecasts of the earnings per share for the S&P 500 are too optimistic. So if you are relying on some forecaster’s frothy market view, think again.
You also shouldn’t be waiting for market strategists to call the next bear market correctly. Earnings forecasts for the stock market are most flawed when a recession rears its head. Bianco Research LLC has calculated that market strategists’ earnings forecasts were 10% too high in the 1990/91 recession, climbed to a 25% high-side error rate in 2000/01, and missed the mark by a whopping 40% in the 2007/09 recession.
Investors should ignore the annual ritual of myopic fallible forecasts and accept that unpredictable recessions and recoveries are a fact of economic life. Since 1854, the U.S. economy has experienced 33 business cycles that have created a recurring sequence of bear and bull markets. Yet, over this entire span, the U.S. economy has grown on average by 5.5% a year while stocks have earned 8.9% annually.
Hence, serious investors should focus on the long-term and put their effort into what they can control — clarifying their goals, defining their capacity and tolerance for risk, diversifying accordingly and eliminating unnecessary costs and taxes.
John Kenneth Galbraith, the famous economist, quipped, “The only function of economic forecasting is to make astrology look respectable.” Investors may find their time better spent reading their horoscopes rather than following fallible forecasts.

Apple supplier audit reveals child labour, environmental violations

Apple revealed its once closely guarded list of global suppliers on Friday, taking a dramatic and unprecedented step in response to harsh criticism that it was turning a blind eye to dismal working conditions at partner factories.
The move, unusual in an industry that relies heavily on foreign component suppliers to drive margins but rarer still for an infamously secretive company, underscored some speculation that new chief executive Tim Cook has ushered in an era of greater transparency. Predecessor Steve Jobs, who died in October, kept an iron grip on the internal workings of the company he founded and made great.
“With every year, we expand our program, we go deeper in our supply chain, we make it harder to comply,” Cook told Reuters in an interview. “All of this means that workers will be treated better and better with each passing year. It’s not something we feel like we have done what we can do, much remains to be done.”
Apple said it conducted 229 audits last year, representing an 80% increase over 2010. From 2007-2010 the company only conducted 288 total audits. The company said it looked at all levels of its supply chain, including final assembly and component suppliers.
The audit found a number of violations, among them breaches in pay, benefits and environmental practices in plants in China, which figured prominently throughout the 500-page report Apple issued. Other violations found in the audit included dumping wastewater onto a neighbouring farm, using machines without safeguards, testing workers for pregnancy and falsifying pay records.
The report titled “Supplier responsibility progress report” also said it asked suppliers to repay workers after it found 67 facilities had docked worker pay as a disciplinary measure.
“I would like to make a significant improvement in the overtime area. I would like to totally eliminate every case of underage employment,” said Cook. “We have done that in all of our final assembly. As we go deeper into the supply chain, we found that age verification system isn’t sophisticated enough. This is something we feel very strongly about and we want to eliminate totally.”
Apple said it found six active and 13 historical cases of underage labour at some component suppliers but said it did not find any underage workers at its final assembly suppliers.
Apple said it will grant access to an independent auditing team from the Fair Labor Association in an effort to overcome criticism regarding working conditions at factories in its supply chain. It also terminated business with one supplier and was correcting the practices of another supplier. Both were repeat offenders, the report said.
Apple has made major efforts to improve and communicate its policies following high-profile labour problems at its foreign suppliers and manufacturers, including worker suicides at Foxconn facilities in China.
The suicides at the plants associated with Apple cast a harsh spotlight on what critics dubbed a militaristic culture that pushed workers to the brink to meet unceasing demand for the company. In response, Apple stepped up the number of supplier facilities it audits, to ensure they meet its code of conduct.

Not poverty, but not retired either

In Saskatchewan, a couple we’ll call Edward and Nancy, both 61, fear they will be impoverished in retirement. Today, they live a simple life with few frills. Edward, who receives a small company pension and Canada Pension Plan disability payments of $1,103 per month, has not worked in his field for two years. Nancy, an administrative assistant, brings home $2,285 per month that boosts total monthly family income to $5,034 after tax.
Looking ahead to the day that Nancy retires, they worry they will not be able to sustain much of a life without her income. They want to sell their $300,000 house very soon, move to Alberta to be near their children and spend their spare time driving around the countryside to enjoy the simple pleasures of life.
“We have not built up enough retirement savings,” Nancy says. “My husband’s pension is not very large. We are thinking of downsizing our house and using some money we get to add to our income. Really, we need guidance to make the most of the time we have together.”
Family Finance consulted Graeme Egan, a portfolio manager and financial planner with KCM Wealth Management Inc. in Vancouver.
“This is a case in which the couple’s future is really about the resources they can pull together,” he says.” They have an outstanding six-figure mortgage and fairly limited assets. It’s late, but there are some things we can do to make the most of their opportunities. It is a question of timing Nancy’s retirement, timing the sale of their home and getting the most they can out of their investments.”
Timing Retirement
It’s not possible for Nancy to quit work yet, Mr. Egan says. Her combined pensions from her $84,000 RRSPs and CPP would be about $1,000 per month before tax, which is $1,285 less than what she brings home today from her job. Even if they were to harvest some capital from their house, say $150,000, and invest it, she could not make up the income loss from quitting work.
If she works to age 65, she will receive estimated CPP benefits of $530 per month in 2011 dollars, a little more if she gets a raise before 65, a little less if she quits and does not draw benefits until 65. At 65, Edward’s $1,103 monthly disability cheque will drop to CPP benefits of $960 per month in today’s dollars. At 65, they will each get full Old Age Security benefits, currently $540 per month.
Their total age 65 pension income, excluding any investment income generated by cash liberated through downsizing, would be $12,000 per year from Edward’s registered retirement income fund, $9,000 from his company pension and, allowing 2% annual inflation increases to CPP and OAS, a total of about $33,000 from the two public pensions, and $6,800 from registered savings for total age 65 income of $60,800 per year. If they sell their house and realize $150,000 after selling and moving costs, then, if they can get a 4.5% yield from a corporate bond fund or a portfolio of stocks with strong and sustainable dividends, they could add $6,750 per year for pre-tax annual retirement income of $67,550.
After tax at an estimated average rate of 20%, they would have $54,040 to spend each year, or $4,503 per month. If they take property tax, savings, mortgage and debt service costs out of their expenses and add back $1,000 per month for rent, their living costs would be about $3,100 per month. That would be a supportable level of spending. They would have a surplus with which to buy a newer car, travel and have extra funds to replace health benefits they currently receive from Nancy’s employment.
Nancy had hoped to retire very soon, perhaps this winter. That’s bad timing. Spring is usually a better time to sell houses. A move to Alberta would probably mean their equity in their present house, $172,000 less selling expenses, would not go far. It would be better to rent. That would allow Edward to skip outdoor chores, which are hard given his medical problems. For now, in financial terms, the best course is to stay put. If Nancy can find an Alberta job that pays at least 75% of her present $39,000 pre-tax salary, then it will be possible to reconsider the move.
Edward and Nancy owe $14,200 on credit cards, with annual interest of $1,420 per year. Repayment of purchases drives the bill up to $3,000 per year. They can borrow what’s due on their line of credit at a current rate of 4% and save $850 per year.

Related

• Watch our RRSP Savings Squad videos
• Read our full RRSP 2012 coverage

Investment Management
Edward and Nancy have about 80% of their registered savings in equity mutual funds and the balance in fixed-income funds. That’s too high an exposure to stocks, especially for a person of his age, health and dependence on savings. The portfolio should be moved over the next four years to a balance of 60% to 70% fixed income and 40% to 30% in stocks. Their present mutual funds carry high management fees. One of Edward’s funds, a resource play, has an astonishing 4.78% management expense ratio. He should switch funds within his fund company’s dossier of equity and fixed-income funds to a corporate bond fund with much lower risks and fees. For the future, the couple could study capital markets. If they use a discount broker and exchange-traded funds, they can save on fees.
It’s too soon to begin cashing in their retirement savings. Both Nancy’s $84,000 of registered savings and Edward’s $170,000 RRSP have lost value from declining stock values. If they did retire soon, they would have to draw more out of their investments, leaving less for the future. The accounts would deplete faster than if they drew money out when markets are more robust.
Nancy should therefore continue to work and delay her retirement to 65. Working another few years will boost her CPP and her retirement savings contributions. In four years, stock markets may recover at least some of their value, Mr. Egan says.
— Need help getting out of a financial fix? Email andrewallentuck@mts.net for a free Family Finance analysis.

Is real estate overheated? The bubble discussion rages on

Earlier this week several heads of Canada’s biggest banks warned about a possible correction in the housing market. The comments, delivered at an industry conference in Toronto, were perhaps not unexpected given that senior policy makers including Bank of Canada Governor Mark Carney have been saying pretty much the same thing for the past year. What was surprising was that only days after the comments were made Royal Bank of Canada, Toronto-Dominion Bank and Bank of Montreal have all chopped their mortgage rates.
In other words, they’re making it easier for consumers — who are already carrying record debt loads — to buy more houses, take on more debt and potentially drive prices even higher.
So is the housing market headed for a correction or not? It seems the debate is far from over.
Helmut Pastrick, chief economist for Central Credit Union 1, the main trade association for credit unions in British Columbia and Ontario, argues that the industry is just highly sensitive to potential dangers “because of where we have come from in the last three years, because of the financial crisis and what happened in the U.S. [housing market].” People are jumpy and that makes them more prone to putting up maybe more red flags than are warranted.
For his part, Mr Pastrick figures housing in this country is not over valued and due for a correction. Indeed, thanks to low interest rates, most consumers can afford to take on significantly more debt.
“I don’t believe we are in a bubble. I believe prices [including Vancouver] are high because of fundamentals,” he says.
While some consumers may have taken on more debt than they can handle, they are a small minority and “typically it’s around credit cards and lines of credit” as opposed to mortgages.
Mr. Pastrick acknowledges that Canadian households are holding record debt levels representing more than 150% of income, but current interest rates make it affordable.
“We’re going to have a low interest rate environment for a while and most of the debt is mortgages, backed by an appreciating asset, and most of the debt is issued by lenders who have pretty good lending criteria who are not fly-by-night operators, so generally it’s a sound form of credit.”
In Vancouver, home to the country’s most expensive real estate, prices are high because of factors such as limited supply of land and sky-high demand, he says. Homes maybe expensive but the valuations are justified.
Mr. Pastrick acknowledges that his views are not shared by everyone. But nor is he alone. He argues (convincingly) that despite what the heads of the big banks are saying publicly, their actions — for instance, cutting mortgage rates close to historic lows as they did this week — suggest they’re on side with him.