Keith’s rant: some animals are more equal than others

Every year around late December, I like to write a little off-topic, then draw similarities to the topic of investing. In the past, I’ve compared hands-on investing to driving a stick shift car. I’ve written about the disciplined approach of an athlete, and how the systematic approach to training is much like the systematic approach to trading. I’ve also ranted on the futility of projecting 1-year market levels that seems to be popular at this time of the year.

This year, I’m going to get a little political. So be forewarned; if you become incensed by pro-capitalist politics, you might want to skip todays blog and come back next week when we return to our regularly scheduled program. I would like to point out that this blog is based on my own opinion. It doesn’t reflect that of WorldSource Securities, or my staff. I’d also like to note that everyone is entitled to their own opinion, and this is mine. For those incensed – I won’t be opening up the comments board to heated discussions on the subject. Feel free to disagree by writing your own blog on the benefits of socialism if you wish.

Why I’m underexposed in Canada

Sometimes people ask me why I don’t spend much time analysis the TSX – my being a Canadian Portfolio Manager. My answer is that I’m bearish on the Canadian markets – and have been for a few years. The reasons behind that bearish stance are three fold:

1. Cap-weighted index

First, the TSX 300 and its counterpart the TSX 60 is largely focused on 3 sectors: financials, energy and materials. It’s not a diversified index, given that nearly 70% of the TSX 60 index is weighted in those 3 areas – see the iShares TSX60 index breakdown chart below. For this reason, I see little reason to make assumptions about the “Canadian market” when looking at this index. Really, all you need to do is look at those three sectors and you’ll have a pretty good idea what the trend for the index is. And those sectors don’t look favorable, beyond short termed trades, at this time. More on this below.

2. Reliance on energy

According to David Parkinson (Globe &Mail): “The energy sector makes up roughly 10 per cent of Canadian gross domestic product. That’s more than retail, construction, agriculture and the public sector’s contribution to the economy. Energy accounts for roughly one-quarter of Canada’s exports. And the sector has been punching well above its economic weight. In the first half of  2014 energy accounted for 30 per cent of Canada’s economic growth, and more than 40 per cent of export growth. Alberta contributed one-third of Canada’s economic growth last year, and was by far the fastest-growing province in the country in 2014. Since the beginning of 2013, nearly half the jobs created in the country were in Alberta.

The unavoidable conclusion is that much of the country’s economic health is tied to a mid-sized province whose overwhelmingly dominant industry is sneezing louder day by day.”

As you will note on the chart below, oil has not yet proven to have put in a discernible bottom – nor has Nat Gas. Meanwhile, Alberta’s NDP government seems to be kicking the industry when its down by choosing now – a time of incredibly depressed oil and gas prices – to be the time to implement new carbon tax laws. While many agree with this environmental initiative, I would question the timing of this policy.

Materials (chart below), are not doing any better. Canadian banks– currently the largest sector in the TSX, will be under pressure if the energy and materials sector continues to falter.

The banks, who have at least part of their fortunes tied to the success of those two major business sectors in Canada aren’t looking great either. We at ValueTrend hold a position in the banks, but view them as a trade –we don’t expect to be holding them beyond early January.

The current outlook for these sectors is unattractive technically and fundamentally, albeit ready for some sort of oversold bounce soon. Thus, the mid termed outlook for the TSX index is largely the same. The long termed outlook is questionable too. Here is a blog covering a chart of a 35 year commodity cycle – commodities have room to fall over the coming 5+ years if this cycle continues.

3. A shrinking environment for capitalism

One of my favorite books is George Orwell’s “Animal Farm”. There is something to be said about the lessons coming out of this book, and I must admit that I’ve seen some close parallels in the recent activities by Canada’s newly elected Liberal government to the happenings on George Orwell’s imaginary farm. Read on to see what I mean.

Savings

As a stock investor, I like to invest in a stock market environment where their government encourages, rather than discourages those who follow a disciplined savings plan. This removes the strain from future government retirement supplementation. Investors should prosper by having the discipline of saving some of their income, and thus reap the tax benefits of sheltered accounts and capital gains.  The recently elected left-wing Federal government in Canada has declared that it will reduce the benefits of two of the country’s key savings instruments: namely, a reduced level of TFSA (Tax Free Savings Account) contribution limits, and a potential reduction in the capital gains exemption for investors. Easy to do for those looking forward to government pensions. Not so much for private sector workers attempting to retire through their own savings. The higher savings incentives supposedly benefit only “the rich”. Really? Those who read this blog are investors and savers – are you all “rich”? Lowering investment incentives  places more strain on an already under-invested market, not to mention future government social payments.

Spend your way to prosperity?

I also like to be invested in a country where its leadership has a firm grasp on the realities, long termed implications, and numbers behind its budget. The current Liberal government promised to “spend our way to prosperity” by investing in infrastructure, and government expenditures. Its true — Keynesian economics can stimulate the economy – we just went through a round of such government spending in 2008. Such spending comes at a cost, however  – especially if they don’t work. Here are some questions investors should address:

• Will temporary economic benefits created by, for example building a bridge, help with Canada’s economic reliance on producing energy and materials?
• Is there a likely assurance that the dip in commodity prices is temporary, making eventual  payback on current spending a good bet? The 35 year commodity cycle noted above might disagree with the chances of such a recovery.
• Debt created by government spending must be paid back. Who will pay it back, and how?
• What will be the consequences to Canada’s credit rating, business environment and dollar under a higher debt load?

These are questions investors considering Canadian securities must ask themselves. Further, it is important that the government have a keen understanding of just how much their spending initiatives will actually cost. Not more than a few weeks in office, and the Liberal government – who’s leader actually didn’t know his own spending numbers prior to election (press reports here and here) and  is already finding its promises are costing more than anticipated. What a jaw-dropping shock!

Success penalty

As a stock investor, I wish to be involved in a market where business leaders receive fair encouragement to grow their firms, thus enhancing their own and their shareholders wealth. I like to be involved in an economy that encourages – rather than penalizes – individuals and businesses to increase their income, prosper, expand, hire employees and add to economic growth. It is vital that such pursuit of prosperity be conducted in a fair environment to all, with no special tax benefits or privileges to any group or individual.   Countries must provide a competitive environment  to encourage the individual to peruse as much wealth and prosperity as they are willing to apply themselves towards – in an equal playing field. Countries subscribing to socialism with less incentives inevitably  end in a depressed economy or in financial duress. Just ask any Cuban or PHIG (Portugal, Hungary, Italy, Greece) countryman how socialistic entitlements and the over-taxation of their wealthy worked out for them. Capitalism results in an unequal, but earned distribution of wealth. This is the nature of fair competition. Socialism results in everyone losing, except for those working for and supporting those in control of the country.

Favoring supporters

Specific tax credits or breaks going only to public sector workers and the middle class, and the reinstatement of redundant postal jobs are recent examples of favouritism towards specific groups of individuals – clearly to buy their votes.  As noted above, governments working within a socialistic agenda tend to reward those supporting that government – typically at a cost to taxpayers.

Unfortunately, enhancing the purses of the public sector  workers will not help a countries economy – it merely increases the tax burden. The public sector is not a creator of wealth, GDP, or taxable revenue resulting from new productivity – it is an expense. A necessary expense, but one who’s costs must be contained – not expanded. It was particularly alarming to see Trudeau’s  elimination of the childcare benefit for upper income earners while he simultaneously uses tax payer money to pay for two personal nannies. Like the favors to specific groups noted above, this too gave me an eerie recollection of George Orwell’s words in Animal Farm “All animals are equal, but some animals are more equal than others”.

Shop ‘til ya drop

The middle class tax shuffle (defined as those earning $43,000 to $132,000  by Statistics Canada – certainly not “the poor”) – pleasing though it may be to the recipients – does not encourage the pursuit of success. The justification of the tax-shuffle by the government was to help indebted middle class Canadians – who’s debt was often created by failure to exercise restraint when mortgaging an expensive home, buying that new SUV, or big screen television. Such spending  habits are typically engrained.   One has to wonder if  the recipients of these tax breaks will actually use the money to pay down debt, and/or save for their future – or will the extra cash just buy more toys? Further – it does little to encourage the efforts of the man or woman who is taking business risks to achieve higher income, having then to send more of that income (via higher taxes) to those who did not take risks to earn it.

Everyone wins a trophy

If we are to invest in a stock market, it is better to invest in an environment that favours the equal opportunity towards creation – not penalization – of personal income, wealth and business growth within the private sector. It’s true that in a competitive environment, not everyone becomes rich. As an athlete who races a bicycle, I accept that I may not share in the winnings of a race. I may even come last, or even get injured – much like business risk. But the idea of “everyone wins, nobody gets hurt” wont inspire me to train much – or develop bike handling skills. Why try – if I get a piece of the winner’s glory no matter how I perform? Below is a shot from the first stage of a 3-day bike race I was in this summer. I got 4^th place of 19 in my age class—one place off of the podium. The podium winners all got jerseys, trophy’s and other prizes, but I didn’t. Mr. Trudeau—under your polices, my middle class results demand the top performers send me part of their booty!

The same might be said about achieving high marks in school. Picture the student who knows that by getting an 80% mark she will end up with only 70%. That’s because 10% of her mark is sent to the student who needed his 50% upgraded to 60% to pass.  How motivated is the better student now – knowing that they will lose part of their “earnings” to those who didn’t achieve them?

Companies and individuals that are encouraged to attempt to prosper – rather than be penalized for it – will indeed compete home and abroad to do so. Such capitalistic policies, while not without their flaws, allow the USA to remain the wealthiest nation in the world. This, despite the occasional hiccup that any truly free country will experience. Individuals must be encouraged – not discouraged – to invoke discipline and invest part of their earnings towards retirement. Canada’s leadership is heading away from the capitalistic ideal of rewarding private sector investment, the acceptance of risk, hard work, self-reliance and self-discipline. Instead, we are moving closer towards the socialistic policies of George Orwell’s farm. This cannot help but add to the pressure that the Canadian economy is already faced with.

I continue to favor the US stock market over the Canadian market for the above reasons, with holdings only in very select Canadian companies.

As a final note–I would like to extend a very happy holiday season to you and yours. Thanks for reading the blog, and back next week with more ideas to prosper by!