Good afternoon everyone and thank you for joining us today for our 2022 Economic Update With Benjamin Tal. My name is Josh Melchers and I will be your moderator for today’s event.
We asked that you submitted your questions prior to the call and will be posing those questions to Benjamin during the Q&A portion at the end.
With that said, I’d like to turn things over to Peter Lochead, Founder & Principle of One London Group and Senior Wealth Advisor.
Good afternoon and Happy New Year!
Happy Robbie Burns Day for those of you of Scottish ancestry
Thank you for joining me and my team One London Group for our annual economic update with Ben Tal, Deputy Chief Economist with CIBC Capital Markets. I look forward to the day, hopefully in the not too distant future, when we can hear Ben in person again. As indication of the interest from our clients for Ben, it is by far the largest attended video conference that we've had since the start of covid.
Before I turn things over to Ben, I would like to start by welcoming the two newest members of our team, Celine Charles and Carly Stewart. We are excited to have them onboard. Their positive and upbeat energy has already had a tremendous impact. They are both eager to start engaging with clients and adding to your depth of service.
We’re thrilled to have such a diverse administrative team with an unrivalled aptitude for client service. Celine and Carly join Natasha Arca who heads up our administration team, my wife Sandy Lochead who continues to offer her expertise in financial planning and guidance on team management, Phyllis Knost who continues to do an outstanding job of trading, Candice who handles many of our larger projects and tax reporting, and Emma who handles most of our review prep and is excited to no longer be the newest member of the team.
I would be remiss if I didn’t acknowledge my longtime partner and associate of over 30 years, Barry Gray. Barry and I have had the honor of working with many families over the years with our longest relationship stretching back 5 generations.
Looking forward to the future, Peter McIntosh joined One London Group 6 years ago and has recently become a partner. The newest addition to our advisory team, Josh Melchers, joined us two years ago only to be kicked out of the office 3 days after he started because of COVID. Peter and Josh have helped enhance our depth of service and offer continuity for clients and their families going forward.
It is our immense honor to share with you that One London Group has been recognized as one of the Top Wealth Advisory Teams in Canada by the Globe and Mail’s Report on Business. This is the inaugural issue from the Globe and Mail announcing the industry’s 150 best advisors in the country. This recognition would not have been possible without the continued trust and support of our valued clients. We understand the unique challenges that the past two years have presented and we appreciate the continued confidence that you have placed in our team to guide you through these unprecedented times.
Our philosophy is “winning by not losing”. We’re not looking to out-perform the market; we aim to provide the best risk-adjusted returns for our clients. An investor who loses 35% in a down market needs to make 54% to breakeven whereas an investor who declines by a more modest amount can recover in a much shorter period of time and is far less likely to sell at the bottom. Our objective is to implement strategies that help clients preserve their wealth, generate consistent income, and achieve steady capital appreciation over time.
Warren Buffet positioned this in a slightly different manner:
Rule # 1- Don’t lose me money
Rule # 2 -Don’t forget rule #1
A successful advisor is a function of having successful investors as valued clients. So what makes a successful investor?
It requires discipline not to capitulate during turmoil like we experienced the last 2 years when the markets declined by 35%. At that time, when everyone was moving to one side of the boat, smart investors moved to the other side. As Sir John Templeton so wisely phrased it, “Buy Straw Hats in the middle of winter when no one wants them”.
Conversely, after such a significant appreciation in equity markets over the past 2 years, investors need to avoid getting caught up in the positive euphoria. Be careful not to let emotions drive our investment decisions. Now is not the time to be overweight high multiple, high beta stocks or overweight equities period.
Staying focused on the long-term picture is another key trait of a successful investor. Yesterday is a prime example of not getting caught up in short-term trading volatility. The Dow Jones declined over 1,000 points in early trading Monday. An undisciplined investor may have panicked and sold only to watch the markets fully recover by late afternoon, the market was up over 100 points. Similar sort of activity happened in the trading earlier today.
Long-term investors see a market correction as an opportunity and investment managers like Walter Scott take advantage of those opportunities by buying great companies at discounted prices. In the end, great companies will outlast bad economies, poor leaders and geopolitical issues.
Successful investing also requires a well thought out financial plan. Trying to navigate the through the market without a financial plan is like trying to find your destination without a map. That is why we work closely with our in-house financial planning specialists to craft customized plans to help investors stay on the right path.
Lastly, successful investing requires a well-diversified portfolio. Construction of a portfolio focused on diversification and risk reduction should include holdings that incorporate various investment management styles. This approach helps to reduce risk and leads to more consistent returns over time. Further to that, defensive investments such as bonds and alternatives - which have underperformed recently - serve as a hedge against market volatility and will continue to be an important component of your portfolio as we are certain to experience more challenging times in the future.
In closing, a successful Investment Advisor realizes that they are not economists and take direction from bright people like our special guest today Mr. Benjamin Tal. With that, I ask that Josh Melchers introduce Ben
And before he introduces Ben, I would like to introduce you to Josh Melchers. Josh is a welcome addition to our team, providing additional investment depth advice to our clients. Josh is an Ivey business grad, he’s earned his CA and his CPA when he worked for KPMG for four years in the accounting world before joining CIBC Imperial Service as an investment advisor so we are certainly welcomed and proud to have Josh as a part of our team. Josh.
Thank you Peter. Now I know most of you can't see me, but I'm blushing after that introduction. So thank you very much! Ben is the economist that needs no introduction. He is a member of the CIBC economic team that is responsible for analyzing macro-economic developments and their implications for fixed income, equity, foreign exchange and commodities markets. Ben has more than 20 years’ experience in the private sector advising clients, industry leaders, corporate boards, trade associations, and governments on economic and financial issues. Ben is a highly sought after guest speaker and makes frequent appearances on BNN. We are very fortunate to have him join us today to share his insights as to what investors can expect for 2022. So with that, I will turn things over to Ben.
BENJAMIN TAL -
Thank you very much, Josh. Of course I have about 30 minutes to tell you everything I know about the situation. That's probably 29 minutes too long because nobody knows anything, but, we can make some educated guesses here and I think we can make sense out of this madness if we ask the right questions and makes some assumptions, which I think are reasonable
2022 is the year of the Tiger, the most unpredictable creature out there. It can move from a sleep mode to an attack mode at the speed of light. But I suggest the 2022 when it comes to the economy, the trajectory of the economy, 2020 is relatively predictable. The way 2021 was predictable when it came to the economy; the first quarter the winter is bad, we are in it. The spring will be better, the summer will be on fire and then you have the fourth quarter which will be unknown. Exactly what happened in 2021.
That's something that we have to recognize because now we know that there is an element of seasonality to this virus. So the spring will be fine, and we know that consumers will be celebrating in the winter and then the fourth quarter is the question mark. We might get another variant and of course nobody really knows how severe it will be. Six months ago, before Omicron, I spoke to one of the professors at Mount Sinai Hospital and he told me you know, it's good that delta is very vicious and I said why and he said because the next variant has to be like a super variant in order to out do it. And guess what? We got it so you really don't know. At the same time what we do know, although we might be discussing another variant, another name, by the way, by the end of this crisis we will we all be fluent in Greek, I think.
By then we might have more and more understanding of this virus and more ways to treat with it. So it's reasonable to assume and we'll discuss it. That 2022, let's hope, will be a transition year formed a pandemic to endemic. Endemic doesn't mean that it's over. We will be with it. It will be with us, but it will not be as disturbing as it is now or clearly last year. That's more or less what we are seeing. So if we go to the first chart, let's see what we can discuss here.
First, the virus and the economy, the tug of war between the virus and the economy. Clearly good defense, improving offense. We’ll discuss inflation, the elephant in the room, how much sleep should we lose over it? Granted, if you are under the age of 30 you don't know how to spell the word inflation but there is such thing. Let's discuss.
How much sleep should we lose over it or where have all the workers gone? Try to find somebody. Good luck.
Wages are rising, we cannot find people. The vacancy rate in the job market in Canada and the US are record high. Where are they? We’ll discuss interest rates of course; when you have inflation, when the economy is improving, when the spring is coming, what will happen to interest rates? how quickly, how high? Much more important is how aggressive the Bank of Canada will be, and we know that they have to make a decision tomorrow and I really don't envy them because it’s not an easy decision.
We’ll discuss real estate. We all know the story, we all know the story. Real estate prices went crazy during Covid. How can you explain a situation in which we are in a pandemic and the real estate market is on fire? Our sustainability’s and our sensitivities to higher interest rates, we’ll discuss. And then, the demographic picture especially immigration much larger than expected. Why are we seeing a change in the composition of new immigrants? What does it mean for the market as a whole? And then of course, market implications; bonds versus stocks within the stock market, where you want to be, we’ll discuss.
Let's start with the next chart. That's something that I put together last year. Exactly a year ago I was looking for an image that will capture the mood and I found this image exactly a year ago. When you move from 2020 to 2021, we were talking about the vaccine, we were talking about things improving, the end game. There was light. Fast forward a year now before this presentation I was thinking very, very hard. What image can capture the current mood? I was thinking and searching and thinking and I found the next chart which is basically the same I just changed the years… we are in the same position. We are basically seeing the light. We know that there is a booster. We know that there are pills already. We know that the spring will be better. We are just seeing the light, we are in the exact same situation but more educated about the virus.
That's more or less where we are. We know that Omicron is not as bad in terms of the impact on our health but it's very widely spread, we know that. We also know that now the government when it comes to policies, restrictions, does not care about the number of cases. They care about the hospitalization rate.
So let's go to the next chart and see why Canada is challenged because look at this.
Spare capacity of acute beds per 1000 population in Canada, the lowest, the lowest in capacity with the exception of Mexico. Usually you’re supposed to operate at 85%. No Covid, just normal times. We usually operate at 97% so you have covid immediately you reach capacity. If this is not a wakeup call to inject and improve the health care system I don't know what it is. We need more money into the system we need to make it more efficient and that's something that is a clear wake up call.
It means that the Canadian government and the provinces have to introduce all kinds of restrictions much faster and a more aggressive way relative to the US and high density countries because of the situation in the health care system and that's exactly what we are seeing and if you go to the next chart you can see what it means because you can translate this to economic activity and you can see that for a given level of hospitalization since the beginning of this madness the Canadian economy was much more restricted than the US economy. And we are seeing it now as well.
Watch a basketball game in Canada versus the US and you know the difference. This is being translated immediately into economic activity, and that's why Canada will underperform in the first quarter the way we underperformed over the past two years relative to the US. So that's basically the story. How you translate healthcare activity and the capacity situation into economic activity. At the given point in time, economic growth during Covid is a function of two things: one, clearly the openness level. The other is what we call the fear factor, namely the restaurant is open, but nobody is showing up.
Let's go to the next chart and see what I mean by that. Look at this. This is the example from Europe. Now as we talk, the UK is basically open, completely open. They gave up. Germany is not, as you can see from the chart on the left. Look at the chart to the right and you can see that restaurant activity is basically the same. So the restaurant is open but nobody is going, or at least not the same amount/number of people that used to go. That's important. The fear factor dominated the first wave and the 2nd wave. It's here with us now, but I suggest with the very specific nature of Omicron, I think that the fear factor, especially in places like the USA is diminishing, and that's something that will help them to recover. So overall, we have this tug of war between the virus and the economy.
We have this openness level that is extremely important to understand and the fear factor together, you combine it and you get the economy in the US, maybe expanding by 4% in 2022. Canada about 3.5%. Both of them better than expected. Most of the activity will be in the spring and the summer.
Of course there are side effects to this relatively strong growth, and that's of course, inflation. So, we know this story and when you talk about inflation the question is where it will be six months from now. Now, let me tell you one thing, nobody. Nobody knows where inflation will be six months from now and when I say nobody, I include the Fed and the Bank of Canada in that nobody.
However, we can make some educated guesses and see what makes sense and what doesn't and basically invest based on that. Let's see what makes sense; first, of course, we are talking about a situation in which you have this huge amount of money sitting on the sideline. Let's go to the next chart and discuss it. We are all familiar with that. However, the question is how much? I'm sure that all of you read and watched reports about the amount of cash that Canadians are sitting on. But how much? The red line is basically the excess savings. Basically, take how much income minus how much you consume, the difference is your savings, and we are talking about roughly 300 billion dollars of excess cash, excess savings. Now this money can be used for many purposes, not just spending. It can go to mutual funds, it can go to stocks, can go to bonds. It can go for a down payment on a house and it does, we'll discuss it later. So remember this red line when we discuss housing, so remember that.
But how much money is available for actually investment? That's the gray line, actual consumption, that's the gray line. About $90 billion dollars, and as you can notice it reached peak early in 2020 and it's basically flat since then, and that's something in late 2020 and that basically something that is very interesting because this money is waiting. This money will be there the minute we open up and that's one of the reasons why we believe that the consumer will lead the way with major implications even on inflation. But it's not as large as the 300 billion dollars that you see in the media, because a lot of this will go to investment and the housing market, will discuss later.
So that's one aspect. The idea is the supply chain story that you all know about. Economists have many faults but amnesia is not one of them. We all remember the 1970s and what it meant in terms of the oil embargo and what I'm telling you now is that comparing today's situation to the stagflation of the 1970s is not only wrong, but also irresponsible. I will not invest based on the stagflation scenario because that will be a negative factor that is not going to materialize. The conditions are very different, however clearly supply chain issues are real, so let's go to the next chart and discuss.
The point that I'm making here in this chart is that the number one factor impacting the supply chain story is actually demand. We all know the story. Look at the chart on the left, that's how much goods we are buying, that's US numbers. You got four times the amount that you get in a normal year, so you squeeze four years into one year in terms of buying goods. Why? Because it's easy. You press a button and you get your exercise bike. Just to put things in perspective, this huge increase in spending in one year in 2021 is equivalent to a situation in which overnight you parachuted 75 million people into the US and the minute they landed they started spending. That's what we are talking about.
This is a demand shock and the point that I'm making is that even a normally functioning supply system will face difficulties dealing with this demand shock and this of course is not a normally functioning supply system. It's very sick, we all know why. So you have a demand shock being met with a sick supply system. That's exactly what we're seeing here, but there is a limit to how much stuff we can buy. Even the American consumer, there is a limit and I suggest that this limit will be reached in 2022 where consumption of goods will go down. Why? Because you will spend a lot of your money on services.
Now, when it comes to services and that's very important from an inflationary perspective. Prices will rise, you go to get your haircut, you pay more. But then I can start my own place; I can start a new restaurant. It's much easier to start a new restaurant than to start a new manufacturing facility. So, you don't have the same supply chain stories in the service sector that you have in goods, and therefore it's less inflationary or the demand would be there.
So when it comes to supply and the supply chain issues, take Covid out of it and you don't have it. It's all Covid,100% Covid. All the buying of goods is because of COVID. You remove restrictions, you remove the fear factor and you have people switching to services and this number will go down dramatically to where it belongs. You ease the pressure on the supply chain. The supply chain system will go back to normal because Covid will not be there. So if I'm right or even semi right and the supply chain issue is a Covid story and I'm telling you that, let's assume that Covid will be an endemic, as opposed to pandemic by mid-year, which is a reasonable scenario. Then the supply chain story will come to an end by the end of the year. The only mistake that the Bank of Canada and the Fed Med was that they underestimated how long it will take and clearly they did not predict Omicron. But the story remains. That's very important. The minute you remove the supply chain story 60-70% of your inflation story disappears.
It will not happen tomorrow. In fact, inflation will accelerate over the next few months and people will get nervous, but if we are right about COVID. And again, we're not saying that Covid will disappear, but if we reach a point in which we can coexist with Covid, and the economy coexists with covid then the supply chain story will disappear. That's extremely, extremely important. Then we have the labor market. And we know the story. In the US, people are quitting like there is no tomorrow. We all read about the great resignation trend. By the way, in Canada it's not happening. In Canada in a recent survey a record high number of Canadians said that they're thinking about quitting so in the US people are quitting, but in Canada, we are thinking about quitting, very Canadian, but still suggesting that the Canadian labor market is tight. The next chart is also something that we are seeing in the labor market.
If you will go to the next chart.
And that's something that has to do with older people. Older Americans over the age of 55 are exiting the market at a rate we haven't seen before. And I suggest that if you are at the age of 60 to 65 and you decided to exit the market then, you're not coming back. And if you are not coming back, it means that the supply of labor is limited. So you have people quitting and you have people leaving all together the market and that's why the participation rate in the market is actually not at the level that we have seen before the crisis, and therefore you have this shortage of labor in the US and upward pressure on wages. In Canada, the opposite is the case, people are postponing their retirement, their staying longer, and therefore you have more supply of labor because of that. But, the big difference between Canada and the US, when it comes to labor supply is actually immigration, which is the next chart.
Late 2020 the Canadian government announced that they are going to see 400,000 new immigrants in 2021. And people said impossible. How can you get 400,000 new immigrants in an environment in which you cannot travel, covid restrictions… crazy, impossible. Guess what data as of November suggests we are getting 410,000 new immigrants 2021. Look at the chart to the right, in the US altogether, they got last year 500,000, we got 400. The last time I checked we are still 10 times smaller than the US. So, relatively speaking, the number of new immigrants in Canada is 6 times higher than in the US. That's a wave of people entering the labor market that the Americans don't have.
Now let's continue with that and that's very important. Which country did the vast majority of new immigrants to Canada arrive from? Think about it for a second, which country? The country that most new Canadians arrived from was Canada. People arrive to Canada from Canada. How is it possible?
Let's go to the next chart and see.
70% of new arrivals to Canada arrived from Canada. Those are non-permanent residents that became permanent residents; for them this was just a change of status, not a change of address. And that's why the Canadian government was able to reach that target. Now, for next year or this year, 2022 and 2023, you will not see 70-75% of new Canadians arriving from Canada. But, the Canadian government and that's extremely important, announced that they would like to see this threat rising from 40% to about 55%. So we are focusing more and more and more on people that live in Canada, so we provide them with the option, instead of going back home with expired visa to apply for a permanent resident. Now, on average those non-permanent residents, they are younger, they are educated, they have Canadian experience, they speak the language, their employability is higher. That does major implications to the labor market. Not only are we getting more people, but we are getting more people that are familiar with the Canadian labour market. In addition, we all estimate until now that it takes a new immigrant about seven years to buy a new house after arrival. I suggest that this duration will be shorter because they have been in Canada already and that's exactly what we are seeing. Now I was curious to see to what extent those new immigrants are able to help the labor market and let's go to the next chart and see what I mean by that.
Basically, this is a mapping of the number of new immigrants arriving in 2021 and then, job vacancy rates. Basically how many jobs we need in what sectors and you can see that there is a positive correlation. Which means that on average the occupations of the new immigrants is consistent with what we need, with some exceptions. For example trades, construction, we cannot find construction workers, trades, simply not there. The number one reason why supply of housing is not rising in Canada is labor. We simply cannot find people. Speak to any developer, it's really postponing the length of completion because they cannot find people.
Health care, we need people, we need nurses, we need doctors, we don't have them and zero new immigrants are coming in this field. So, we have to do some fine tuning, but overall new immigrants are clearly easing the labor shortage in Canada, and that's the number one reason why if you go to the next chart.
You can see that wages in the US are rising faster than wages in Canada, so we have the following; The US economy is rising faster than the Canadian economy because of the reduced restrictions due to the health care system. Their wages are rising faster, their inflation is higher, economically speaking, they are doing better. You will expect in this environment that the Fed will be more aggressive than the Bank of Canada in raising interest rates. But if you go to the next chart you can see that the opposite is the case.
Not only against the US but against many other European countries, our inflation is more or less in the middle, but the market for some reason is expecting the Bank of Canada to be more aggressive in terms of hikes and raising interest rates than most other European countries. That's something that is puzzling me. It simply does not make sense. The market is very aggressive on the Bank of Canada and some people in the market expect the Bank of Canada to move to 2% during the course of this year. And the market as a whole is expecting about 6 moves which is also very aggressive, much more aggressive than the US and other countries, despite the fact that our inflation performance is basically in line and actually lower than what you see in the US. So we'll discuss it, but before that, let's go and look at the inflation story.
And that's the next stop, this chart, and you can see that clearly we are overshooting now and the Bank of Canada and the Fed are willing to allow inflation to overshoot. We expect inflation by the end of this year to be close to about 2.5%, maybe 3% but not in the sky. The numbers that we are seeing now are extremely elevated because there are so many forces. There is a supply chain story, there is the wage story, there is the consumption story. All those forces will ease especially the supply chain story and therefore you see inflation going back to semi normal. There will be some pockets of inflation that will continue with us. I believe that wages will just remain elevated.
The shortage of labor is more structural. I believe that rent inflation will be rising because home prices went up, but rent inflation did not, so they will have to catch up. That will happen as well but it doesn't mean that we are talking about 7-8% inflation in addition, and that's extremely important to understand, if you are investing and you care about interest rates.
At the end of the day this is not about inflation. This is about how much cost the economy will have to endure in order to bring inflation back to 2% visa vie higher interest rates, namely, what will be the reaction curve of the Bank of Canada? Because for the past 40 years, both the Fed, the Bank of Canada and of course, the European Central Bank all build their reputation as inflation fighters. Believe me they are not going to throw away this reputation so they will do whatever it takes to make sure that inflation goes back to normal and they will do it. So it's not about inflation, it's about what it will take to bring inflation back and that of course is a major issue.
Now, in this environment consumers and corporations will not just sit and do nothing. When you see inflation rising, consumers will start adjusting their basket. They will start buying less expensive items. Items that haven't seen their inflation rising so rapidly; that by itself will be deflationary, but much more important, much more important is what companies will be doing. You see, you are a company, you see your wages rising, you see inflation rising. What do you do? You respond. And if you go to the next chart, you can see how you can respond.
This is an example of the 1990s. As you can see the circled area, there was a lot of wage pressure back then, wages went up dramatically. Look what happened to inflation, nothing. Why? The chart to the right is the answer, the productivity went up, you see if I give you a raise of 10% and your productivity is up by 10%, that's not inflationary. So you need to raise productivity in order to compensate. Basically, productivity is the number one protector of inflation. And that's exactly what happened during the Internet revolution of the 1990s. So inflation did not take off and I believe that will happen again to an extent. Why? Let's go to the next chart and see.
Something big is happening. Labor is becoming expensive; until now labor was cheap and available. Now all of the sudden labor is unavailable and relatively expensive. The share of labor compensation in output is rising relatively strongly. So you always see of a company, you say labor is expensive. What do I need to do? More capital? So you basically switch from labor to capital and we start seeing that with manufacturing technology orders rising at the rate we haven't seen in years. So, when you move from labor to capital guess what happens to productivity? It goes up. And guess what? They have the money to do, so let's go to the next chart and see what I mean by that.
We always talk about how much money consumers have. Corporations have more money sitting on the sideline waiting, looking for direction. And yes, corporations, when we have the green light, will use this cash to buy back stocks. They're already doing so to increase dividends. They're already doing so they will continue to do so, but also for investment. The correlation between investment and productivity is basically 90%. So if in the past, Mark Carney was talking about dead money that corporations are sitting on a lot of money now they’re sitting on much more money so it's even more dead and this money will be utilized, especially when you see labor so expensive and unavailable. To me, that's the secret behind the success of the next two years when it comes to productivity and I believe that productivity will be rising, providing another level of protection from inflation and if you go to the next chart…
…you can see that they can still use the profit to generate even more investment because profit margins were maintained during this crisis. Why? Because consumers are willing to pay more and therefore many companies are able to transfer their cost to the consumers especially in Canada relative to the US where you have more concentrated market. That's very, very important. Now, all this of course means a lot to another asset class and that's real estate. And we know the story. We know the story. The real estate market has been on fire. We all know the trajectory. The question is why? Why in the middle of the most significant event, health event in generations you have the housing market on fire? That goes to the asymmetrical nature of the crisis, all the jobs, not some, all the jobs that were lost were low paying jobs, young people renters. That's why rent went down, but not home buying. In fact, the opposite is the case; potential home buyers and home buyers benefited financially from the crisis because their income was there, their job is there and their spending went down. We have never seen anything like that. If you think about this for a second and that's the key, home buyers and potential home buyers got the benefit of a recession visa vie extremely low interest rates.
Without the cost of recession visa vie a broadly best increase in the unemployment rate, we have never seen anything like that. That's the reason why the housing market went up. And if you go to the next chart you can see what I mean by that.
You can see that sales before the crisis were about 40,000 per year. Per month it went up to 70, now it's stabilizing at 50, which is 10,000 more than before the crisis. Supply is back to pre-crisis level which means that demand is rising faster than supply and that's exactly what we're seeing now in this very low interest rate environment. There is another factor here that we have to take into account and that's something that people are not thinking about but it's becoming extremely important in understanding the market. And that’s the next chart.
Gifting, family money going towards helping kids. Until now I said gifting, gifting interesting, but not very interesting. It's very interesting when you look at the numbers.
1/3, almost 1/3 of new home buyers are receiving a gift, the average gift is about $80,000. That's the average in Canada. You go to Toronto, Vancouver, Montreal, the average gift is close to $200,000. Then you have a situation in which mover uppers, 10% of them are getting a gift and in Vancouver the average gift for mover uppers is $340,000. That's a gift.
So you tell me that's not a game changer. And this is just the beginning. We are in the midst of the largest transfer of wealth in Canadian history, and usually what we are seeing is that the wealth is basically skipping a generation. The older people are providing the inheritance to their grandchildren that are now buying a home. That's what you're seeing more and more, and this is just the beginning.
So you cannot understand the housing market without understanding this trajectory. Of course, the main question is to what extent the housing market now is a bit too much. Maybe a bubble. 10 years ago people were talking about the bubble and since then the market doubled in value. Is the 20% increase that we have seen during covid reasonable? Maybe not, but given the dynamics in the market and the fact that we have been borrowing activity from the future and taking advantage of extremely low interest rates, that's something that I can understand.
It means that when interest rates start rising, we are going to slow down, and that's exactly what we're starting to see. You see usually when interest rates go up you see a situation in which people get into the market very quickly and it's happening now. That's why things are accelerating now. Because people want to take advantage of the last second as long as this window is open.
Which means that the second half will see the market actually slowing down because a lot of it is front loaded. But it's not a bubble, it's not something that would crash tomorrow, because we simply don't have enough supply. And just to illustrate the fact, we have to remember that those new immigrants that are coming. That's new supply for housing, even though they were in Canada, they did not leave Canada, and therefore they represent new supply. We are under estimating the demand for units, especially in the lower segment of the market. So, I'm convinced that the fundamentals of the market are very, very strong. Yes we can adjust, and that's the key. The key is interest rates. The enemy of the market and the enemy of the housing market in particular is not rising interest rates, its rapidly rising interest rates.
If the Bank of Canada listens to the market and go 6-7 times in 2022, that can derail the market. And that's why when I meet with the Bank of Canada and I meet with the Bank of Canada very often, unfortunately. I can tell you that they listen, they really don't want to repeat past mistakes in which central bankers raise interest rates way too quickly and kill the economy. Go baby steps, go 3-4 times, test the waters and see what happens. I think that's the direction we are going.
Given this environment, where do we want to be? So first of all, let's discuss the volatility of the last few days, I will say that this volatility is very, very reasonable, we expected it. Everybody expected it. Clearly nobody expected this kind of crazy volatility on a daily basis where you have 3% down, 3% up all in one day. That doesn't make sense but that's volatility, that's the nature of volatility and it's a reflection of a transition from free money to cheap money. And whenever interest rates go up you get this kind of volatility, so I'm not losing sleep over it. It makes sense to me. In fact, it's very, very healthy. The next question in this environment, bonds versus stocks. It's very interesting that despite the volatility in the market, despite the nervousness in the market you look at junk bonds. Their spirits are not went up dramatically which tells you that the bond market is not extremely nervous. You look at five year expectations by the bond market regarding inflation, exactly 2%. So the bond market is not expecting inflation to stay much higher than the 2% threshold for a long period of time. That's very important.
But given this environment in which interest rates will be rising and the only debate is how quickly, I suggest that the stock market is probably the place you want to be relative to the bond market. The bond market, I believe is expensive. And clearly cash is the most mispriced asset class out there and you have to adjust it, and that's exactly what's happening. Then within the stock market where do you want to be? Canada versus the US? We have to remember that in both cases when you look at the PE ratio, the price to earnings ratio, most of the advance in prices until now came from the P. The prices not the earnings and it would be very difficult for earnings to catch up to bring you back to the same level of activity. Therefore, we see some slowing in earnings and therefore the ability to generate evaluations. In this environment, dividends are becoming very, very important. And if you go to the next chart you can see why Canada has the advantage.
Because the dividend yield in Canada, the TSX is actually double what you see in the US, so if dividends will become more important and they will. Then Canada actually looks relatively OK, especially if you consider the fact that when it comes to valuations, Canada is fully valued while the U.S. is still overvalued, despite the correction.
So all this suggests that Canada can actually outperform the US, especially if you focus on the right segments of the market that pay dividends and they will be paying dividends because as I suggested there is a lot of cash in the system that will be going towards a buyback and dividends. Within the stock market, where do you want to be? First of all, the elephant in the room is technology and do you want to own technology now? What we have seen in the technology sector was very predictable. We all know that because when you raise interest rates technology goes down. It was extremely expensive and it went down. I see it as a very healthy adjustment. If your time horizon is 5 minutes, I cannot help you, but if your time horizon is 2 years I believe that we are going to see some very good opportunities in the tech sector following the current correction because this correction is taking you where you should be and then you look at the long term and the long term belongs to technology. We all know that. So I will start digging and looking and take your time and find the right names. But there are some opportunities in the tech sector if your time horizon is 2 to 3 years.
Energy, high bullish energy. I think that prices can stabilize at about 75-80-85 in this environment, you can make money. But the reason why I like energy is because of the fact that many companies in Canada and in the US are preserving their cash and giving it back to investors. We see significant buy back, we see dividends, special dividends that will continue to be the case. So in this situation, in this environment I'm actually bullish on energy and I see prices stabilizing at 80 and if you get 85-90 that would be a bonus. Clearly in this environment you must like financials and I still like financials. It has been a good call for us for the past few months. I still believe that you can easily collect the dividend and take advantage of high dividends coming from this sector.
This sector is insurance versus banks. I will take banks in this environment because banks take advantage of two things: one is in interest rates when they go up banks benefit. And by the way, Canada is benefiting more than the US. The US is riding the curve, that's the way they do their business. In Canada, it's really more short term and therefore the level of interest rates is more important as opposed to the curve and that's something that will benefit Canadian banks relative to the US banks. And then you have dividends and you have cash by backs and we know that banks are sitting on a mountain of cash. So that will continue so even if valuations are not wise, it's just collect the dividend.
I think that would be a good place to be, so usually in early stages of higher interest rates, banks and energy relatively do OK, and I believe that will continue to be the case, especially in the environment that I see unfolding in 2022. Consumer spending will be relatively strong with this money, I would like to be in the market, but where? For here you need two things to focus on, a company that has pricing power, namely, you can transfer the cost of the consumer and a company that is not relying too heavily on overseas supply chain like stuff from China.
And good candidates are the big Canadian grocers. They actually meet those conditions. I would like to be in this space, given the current environment that I'm seeing. Metal, I'm not too crazy about most methods at this point, with one exception, and that's copper. We know where we're going. We know that the share of electric cars will rise. If you have a long term time horizon we know that an electric car needs 3x the amount of copper that regular car needs; to me that's a no brainer, I would like to be in this space so that's something that I believe can happen. And if I sum up, the main message is that we don't know where covid will go, but we can assume that spring would be strong and the summer will be very strong and then the winter will be where we'll get confused again with the new variant. And let's hope that we have enough ammunition to deal with this variant and 2022 will be a transition here from a pandemic to endemic. This means that interest rates will be rising and I think that interest rates will be rising together, Canada versus the USA. I don't see a reason for Canada to move faster than the US given the fact that inflation is rising. In this environment, I believe that the economy as a whole can operate at a level of about 3.5-4%. The US will outperform us, just because of the fact that they don't have a very weak first quarter as we have given the restrictions that we are facing.
All this suggests that the stock market will outperform the bond market and within the stock market there are some subsegments, dividend paying stocks like energy, like banks will do extremely well as well as the consumer spending space where you have the profit margin, you can maintain that, then clearly not relying too heavily on supply chain. So I will stop here and see if we can have a discussion.
Great, thank you very much Ben. Really, really appreciate you sharing those insights. We do have a few questions that have been submitted by our attendees prior to the call. So what I'll do is I'll address the questions to you, Benjamin and Peter if you have any thoughts or insights that you'd like to add please feel free to unmute and jump in. And in respect to time, I'll probably limit it to just three questions.
Now this is more of a geopolitical issue, but I think still very relevant and prevalent certainly today. We continue to see tensions rise in Eastern Europe with Russia, mass significant amount of forces along the Ukrainian border. What do you see as the most likely outcome, and how could this potentially affect financial markets?
Yeah, so I didn't get too much into it because quite frankly I don't know. I'm not pretending to know what Putin will be doing tomorrow. I just don't know. It can go either way. One way of looking at it, many people are saying that it will not dare doing it because the sanctions would be so brutal that will kill Russia, but many people say you know what, he doesn't care about the sanctions so I really don't know. Clearly, that will be very bullish for energy and that's one of the reasons why I look at energy as a place to be because that will take oil prices, natural gas prices, relatively high. Putin can turn off the lights on Germany if he wants and that's something that we have to recognize. So this is something that can be very positive for energy, but clearly negative for sentiments. But I don't think it would be something that will derail the market and I believe that even if you have a conflict and non-conflict, you will find away after a few weeks to resolve the issue one way or another. So I don't think that will change or derail the market in any significant way. It might have shorter impact.
Great, thank you Benjamin. Peter is there anything you'd like to add to that?
The geopolitical instability is always going to provide some challenges that’s possibly why we're seeing the market volatility this week. Its just not Russia invading the Ukraine, it's obviously longer term we feel for the residents of the Ukraine, but as we talked to earlier, great companies out last bad politicians, wars, instability and so we're sticking to our allocation and be on dips. We're going to be adding to great companies in the future, and that's where some of our active managers, such as what we discussed, the Walter Scott's, the Beutels, Capitals, Internationals will look at these as opportunities to go in and buy as Ben talked about great companies like some of the technology companies when they're on sale. So as we've talked as working with our team for 42 years, adversity creates opportunities. So we've had a really strong market so it'd be great to be able to buy some of these companies that has been talked about, some of the financials and buy them at preferred prices with higher yields. So, longer term if you look at what's happened in the experience that we've had with Russia going into Georgia, Crimea, its worked itself through and hopefully this will be the case. We've gone through the instability a year ago of the invasion storming of the Capitol building in the US, Vietnam, Korea. There’s been lots of history and markets weather through it, so I think same sort of thing and long story short, I think we will get through this and markets will be higher as result, but it'll give us a great opportunity to buy some good companies at preferred prices.
OK, thank you Peter. A second question, Benjamin. You've spoken about the shortage being within the labor force. This question is more kind of pertaining to the children who will eventually be entering the workforce down the road. We see the huge impact on children, young children and their education, people postponing university or just children missing almost two years of in class schooling. What, if any, impact could this potentially have on the workforce in the future?
That's a very good question and clearly unknown. We know that the there is some long term damage due to covid and let's hope that this damage will be corrected over time.
We have to rethink education in a big way because I do believe that there is a mismatch between what we produce and what we need. We tell people study what you love, but I think that we have to also tell them to study something practical and we have to break the negative stigma associated with colleges, with thread and we have to rethink education in general.
I think that overall we are failing young Canadians, the labor market is changing at the speed of light and the education system is behaving like nothing happened. So we have to rethink education in a big way. But back to your question about the long term impact of covid. I think that the education system will have to rethink its way and basically adjust to accommodate the shortcomings due to Covid, and I think it's doable if you think in a very original way.
Great, thank you. Peter, anything you’d like to add?
Josh, education isn't our specialty, investing is our specialty and so I defer to some of the experts. We were fortunate to have some long time value clients who have been professional educators and we thank them for it. But I defer to a comment that was made recently by one of our clients who was a kindergarten teacher and she put it to us this way, she said “children always find a way to learn. Well, formal lessons are being impacted children are learning how to overcome adversity which builds character” so it will be different, but from what she's saying I by the time we get through this there will be different lessons that they've learned longer term on the way.
Josh Melchers (58:52)
OK, great, thank you and so just one more question. This is around the housing market. We obviously have seen housing markets start to skyrocket, and even though there is significant demand, the price increases certainly pushed a lot of people out of the market where a lot of individuals in the younger generations are likely facing the reality of not being able to own their own home. What implications do you see that this could potentially have longer term?
Yes, we have a major crisis and we have to deal with it and we have been talking about it for a long period of time. The number one issue facing Canada when it comes to housing and affordable housing is supply, no demand. We have been using demand tools to fight supply issues forever and it's not working. We need more supply and when I say supply I don't mean just land, I mean being more creative in the way we generate housing. I'm talking about more labor, we simply cannot find labor. I'm talking about a much more efficient process of releasing land and providing pyramids, I'm talking about the density, I'm talking about raising density in cities and allowing it to happen and then go and do it much more quickly. And I'm talking about innovation, basically factory build houses. You can do it, you do it in Europe, we can do it here as well.
Basically when you look at innovation you can see that real estate is the last on the list when it comes to innovation over the past 20 years. We still build the way we built 50 years ago, we have the technology to change it. There are startups in this space already and there are actually services supporting those startups because I think that innovation is a very important part of this solution. And then you have a rental solution, I don't believe that everybody in the country has to own a house. I think that we have to develop rental mentality in a way that you are 35 years old, you are married, you have two kids and you are renting, nothing is wrong with you. Like in London, like in Berlin, like in Manhattan where renting is basically part of life and I think that that's the way it should be. But, in order to make this change you need supply of rental units and not condos, but apartment buildings because the new wave of rentals will be families, young families that want to deal with a company as opposed to a landlord and that's an opportunity. And that's where the government has to provide incentives to those developers to shift from condos to purpose build apartment buildings.
Great, thank you. Peter, I’ll turn it over to you to maybe add some color there and closing remarks. Thank you.
Yeah, I think Ben covered off the real estate market in a lot of depth there and I look back at all the notes that I've taken Josh over the afternoon here in our presentation. I certainly thank Ben for his insightful presentation and helping to give us some perspective, economic perspective on where we go in 2022. You know the $300 billion in excess cash, his comments on inflation and it's great to hear the stock markets are going to be out performing the bond market and the fact that Canada might be great place to be with the increasing dividends on the bank stocks, certainly. And we don't lose sight of the fact that as much as technology has had a fantastic move over the last number of years, it's going to, as indicated, going to continue to be the place to be. And for Canada opportunities I think we've all (because of ESG concerns) everybody has given up on energy, but the fact that energy is going to continue, as Ben mentioned to be $75.00 to $80.00 and some of the great Canadian companies, the Sun Cores, the Synovus, Canadian natural resources have become much more ESG conscious. So there's great opportunities that have been indicated to us today.
So then we certainly thank you for your ongoing support to us as a team, Our One London Group here in London, and thank you for each year for your in depth insight to help give us as advisors and also as clients. Some debt better perspective to formulate our decision making and our planning for the year, and on that, I'd like to thank you as investing clients for the trust you placed with me and our team, Barry, Josh, and Peter and all the rest of team at one London group. We want to wish all of you the best of health and prosperity in 2022 and thanks again Ben for taking the time to join us here today.
My pleasure. Thank you. Good luck.
2022 Economic Update with Benjamin Tal
Jan 25, 2022 04:00 PM Eastern Standard Time - Jan 25, 2022 05:00 PM Eastern Standard Time
One London Group invites you to join our video conference call with Peter Lochead, Founder & Principal of One London Group – CIBC Wood Gundy, and guest speaker, Benjamin Tal, Chief Economist of CIBC World Markets Inc., for an economic update and insights as to what investors can expect for 2022.RSVP