Delaying the day of reckoning

On the Contrary

One of the toughest lessons I’ve learned in life either as a parent, entrepreneur or portfolio manager is when to act and when not to act. I’ve come to the realization, quite often the hard way, that there are times when we do not have real control over certain events and/or circumstances and that by acting it can make things worse rather than resolving the problem at hand.

The same can be said about today’s market environment, which is dominated by people and institutions that are trying to control the direction of future events by whatever tools they have at their disposal. Consequently, equity markets are not allowed to naturally correct, economies are not allowed to cycle and corporate growth rates are not allowed to abate.

The problem is that history has shown that the longer we try and inflate assets, the greater the magnitude of an issue we face when we can no longer kick the can further down the road.

In the meantime, we become more and more accustomed to intervention whenever a problem arises.

The latest actions taken by central banks, governments, companies and organizations like OPEC, each working diligently to manipulate their respective situations, all illustrate this tendency at work.

Central banks around the world have been doing whatever they can to stimulate their economies via aggressive monetary policy. For example, the European Central Bank and the Bank of Japan have been relentless with their bond-buying programs, keeping interest rates at record low levels.

The Bank of Canada may also have to take a similar course of action given fiveyear Government of Canada bond yields have recently doubled in response to the U.S. bond sell-off, thereby causing two banks to hike mortgage rates. This is an important development: As a result of depressed oil prices our economy is now being driven by borrowing and real estate, which now account for up to one-third of our GDP growth — something our central bank is keenly aware of.

To add some further perspective, when measured as a per cent of GDP, Canadian households are now the fifth-most indebted in the world while our corporations are the 12th-most indebted globally, according to recent Scotiabank figures.

Interestingly, the equity market pundits have pulled a 180-degree turn south of the border and are now cheering the U.S. Federal Reserve’s upcoming December rate hike by selling bonds, buying U.S. dollars and pushing equities to new highs.

This is all based on the expectation that U.S. president-elect Donald Trump will inflate the U.S. economy via his planned fiscal spending program — so much so that the Fed will have to raise rates up to four times to stem the resulting surge in growth. Somehow this, along with greater protectionist measures and a higher U.S. dollar, is supposed to Make America Great again.

On the corporate side, companies are reacting to modest organic growth rates by seizing control over earnings growth via financial engineering. Goldman Sachs is now expecting a 30-per-cent bump in U.S. share buybacks to a whopping US$780 billion in 2017 on the basis of potential tax reform by Trump. Additionally, they also expect a five-per-cent gain in M&A activity to US$335 billion, a material gain from the 20-per-cent drop this year cited by ValueWalk.

Finally, oil prices have been on a real roller coaster as OPEC appears to be onagain, off-again with production cuts. We find it surprising that many appear to be missing the fact that Saudi Arabia has a vested interest in controlling oil prices ahead of the planned Saudi Aramco IPO, which stands to be the world’s largest IPO of all time if it goes ahead in 2018. Wall Street also has a vested interest in this transaction, given that there is an estimated $1 billion in fees up for grabs.

We wonder if former U.S. president George W. Bush was on to something when he said: “I had to abandon free market principles in order to save the free market system.” Strangely, eight years later, everyone still thinks it needs saving.