New era of the kicked-can economy

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

- Edited from an article by Sunil Vidyarthi, M.B.A., PhD

 

What’s your take on the umpteenth version of the political shenanigans that recently went down in Washington?

To us, reality is one thing and noise is another. Mostly, the noise is simply the chattering classes wasting paper and using up electricity. In effect, it’s much ado about nothing.

In the overall scheme of things, is it really a catastrophe if a million or so U.S. government workers get a paid vacation for a few days, or even a few weeks?

Yes, the poor  won’t get their checks on time. But, hey, whoever cared about them in the halls of government anyway?

Yet, why are the pols in the U.S. riled up about government debt in the first place? It’s not as if the problem emerged yesterday.

When America, for example, went off the gold standard many years ago, most currencies, including the U.S. dollar, became nothing more than pieces of paper – in effect, IOUs  backed by government printing presses.

Today, the world’s money problems take many forms. But  they all share a common virus:  the expectation of inflation.

This is an unfortunate consequence of capitalist democracies everywhere. Indeed, no country has been immune to the contagion since the Berlin Wall went down back in 1990.

Yet, even before that event, there were fiscal problems – in socialist economies, as well as capitalist ones.

So, let the philosophers figure out why we as a society keep sliding down this hill. What surprises us most is why there’s so much noise about who, what and why?

We can knock ourselves out over all of this, as many of us will do at the local pub, or at a cocktail party.  But we’d  prefer to focus on what it means for investors.

First, you have to realize that this sickness isn’t about to end anytime soon. There’s no one out there with a solution.

The folks who are charged with solving the problem – the U.S. Federal Reserve and the world’s central banks – have tried, but failed, to get governments to rein in their spending.

So, these bankers have done the only other thing they can do to deal with the problem: they’ve kicked the can down the road. Welcome to the end of trickle-down economics and the new era of the kicked-can economy.

But it’s not just governments that are doing this. Corporate executives are just as guilty, jumping ship, while collecting their million dollar bonuses in the process.

Even at the local level, small businesses continue to raise their prices without any regard for what tomorrow might bring. Inflation, deflation, depression or stagflation? Who knows? The only thing we seem to know is how to take a kick at the can.

And in that context, it’s  no surprise that the pols down in Washington are doing the same thing. Let the next guy deal with the problems, they seem to be saying. For now, let’s get Obama.

But for  investors, this can be a disaster just as it was back in 2008. The excesses will again find some sector players with their hands in the cookie jar and confidence will all but collapse.

Yet, this may still be  some years away.  Although the can may be in motion, it hasn’t yet reached the edge of the cliff. Until then there are a few things you can safely assume. One is that interest rates aren’t likely to go up all that much.

Think about it. Even with our present low rates, consumers don’t want to spend, while  corporations don’t want to make things that consumers don’t want to buy.

Moreover, all levels of government owe a ton of money on which they have to pay interest.

So, any way you look at it,  higher rates just make things worse. In other words, the only solution to problems created by the spectre of rising rates is to lower rates once again.

Indeed, we recently saw what happened when rates were hiked to three from two per cent. Everyone fled, forcing the powers – you guessed it! – to lower rates.

Nonetheless, in all this see-sawing, opportunities exist for investors.  So, get greedy and prepare to scoop up all the good stuff other folks throw overboard  in the hope that interest rates will rise to five or even six per cent.

And there are plenty of securities and sectors that have been smashed because of this fear.

For example, yesterday’s heroes – specifically, dividend-paying stocks – now face downward pricing pressures.

If you’re  adventurous, that is, if you can stomach some volatility, consider dividend-paying equities in such sectors as utilities, telecoms, pipelines, REITs and selected names in financial services.

All these sectors potentially offer a return to their previous highs as rates once again subside.

But if you’re more cautious – that is, if you look at your portfolio every day, if not every hour – you might be better off choosing fixed-income plays such as  corporate bonds and preferred shares.

Then, there are closed-end funds. One of our favorite investment types, these funds tend to tumble when fear takes hold, falling far below the value of their assets.

Although closed-end funds are as safe as stocks and bonds, they offer a few more percentage points if and when the smog clears.

But where should you invest? Canada or the U.S.?  Well, the bulk of those stocks that have been trashed, but are still likely to recover, pay dividends.
So, your preference should be Canada since you get the extra benefit of a dividend tax credit.

Unfortunately, with closed-end funds, the pickings are now slim. Moreover, whatever funds are available are illiquid, making buying extremely dangerous.

Put another way, your little order for 1,000 shares of XYZ can move the market price of close-end funds. So, if you want to play this sector, focus on the U.S.

In utilities, nearly all the electric power stocks – Emera Inc. (EMA-TSX, $30.02), Fortis Inc. (FTS-TSX, $31.20) and TransAlta Corp. (TA-TSX, $13.47) – have been hit hard.  Indeed, one or more of these names may be in trouble if power prices don’t rise.

So, rather than buying any of these companies’ shares, it might be better to buy an exchange-traded fund that holds their names. We recommend the BMO Equal Weight Utilities Index Fund (ZUT-TSX, $14.03),  although you might also consider iShares S&P/TSX Closed Utilities Index Fund (XUT-TSX, $18.49).

Either one of these ETFs will do, since a difference of a few basis points in expenses should  only be a concern if you belong to the buy-and-hold crowd.

But we’re not advocating a buy-and-hold strategy. Nor is this the time to get married to something when the kicked can has yet to hit a flat spot. And that could be a while.

In buying REITs, we’d  take the same approach, choosing such ETFs as the BMO Equal Weight REIT Index (ZRE-TSX, $18.29) or iShares S&P/TSX Capped REIT Index Fund (XRE-TSX, $14.97).

But since there are only a few telecom stocks in Canada, you might buy a bit of each of the following: BCE Inc. (BCE-TSX, $43.34), Rogers Communications Inc. (RCI.A-TSX, $46.75), Telus Corp. (T-TSX, $33.84), Manitoba Telecom and Services Inc. (MBT-TSX, $32.36) – even Bell Aliant Inc. (BA-TSX, $25.88).

Meanwhile, in financial services, banks are doing famously. And if you don’t own them, you haven’t been paying attention.

So, don’t sell Canadian banks; they literally have the licence to make money for themselves and for their shareholders.

But wait a while before you indulge such insurers as Manulife Financial Corp. (MFC-TSX, $17), Sun Life Financial Inc. (SLF-TSX, $32.66), or Industrial Alliance Insurance and Financial Services Inc. (IAG-TSX, $43.66). None of these guys particularly like falling interest rates.

There are also ETFs for bonds and preferred shares, among which our favorites are BMO High Yield U.S. Corporate Bond Hedged-to-CAD Index (ZHY-TSX, $15.59)  and iShares S&P/TSX Canadian Preferred Share Index Fund (CPD-TSX, $16.21).

They both provide good income, along with the  potential for  capital gain. More important, they’ll only run into temporary trouble if we suffer a repeat of the 2008 market meltdown.

Investor’s Digest of Canada, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846