The CPI

ADVISORY: This is the third in a questionable three-part series on the CPI, or Canada’s Poochedness Index©. It is not advisable for people with medical, debt, spousal or emotional issues to read past this point. Okay, you already went past it. Lasciate ogne speranza, voi ch’intrate. Seriously.

Recently the yield curve inverted. So what? So the bond market is betting the economy will be a lot slower in the future leading to interest rate cuts. Thus, long-term bond yields have fallen. Actually, they’ve plunged. You can make more money with a bank high-interest savings account than buying a 10-year government bond. That’s weird.

When this happens it often means a recession lurks over the horizon. Maybe a year away. Possibly longer. Perhaps not. But a slowdown isn’t unexpected after a decade of recovery since the last financial crisis. Houses, stocks, REITs and many other assets have pranced higher in value. This blog has chronicled that in 3,400 posts, which attracted 610,000 comments.

A recession doesn’t mean everything goes down but it brings negative economic growth, job loss and misery for people who are unprepared. The most pooched are those in debt. Lean times mean many asset values fall but the debt remains constant. Net worth takes a hit and especially with residential real estate – where most people use extreme leverage – the consequences can be painful.

Now, recessions usually happen across economic areas where activity is shared and the next one’s quite likely to touch both Canada and the States. Timing? The months following the 2020 US presidential election are a fair bet. Once reality sinks in.

Here are a few reasons (cobbled from past blogs, Bloomberg, StatsCan, the Fed and fresh data) why the downturn could hit the Land of Moose and Beavers (and Raptors) hard. This is also why de-risking your all-stock portfolio and dumping your rental condos might be good ideas. Oh, and be really nice to your boss.

We’re sitting atop a Himalaya of debt. Canadian households have racked up $2.3 trillion in borrowings, two-thirds of which is for mortgages alone. That’s more money than the value of the entire economy. Compare us to US families who owe $13.3 trillion – but there are ten times more of them. Yes, we’re the most indebted people on the planet, and you can blame residential real estate (and our house lust) for that. When the economy turns, we will therefore be more impacted.

With so much debt on the family balance sheet, debt servicing costs are high and savings are low. We’ve lost the capacity to weather a storm, living paycheque-to-paycheque. When a job goes how can you live on savings when you have none?

These days the savings rate has collapsed to just 1.1% of incomes. That compares with the long-term average of 7% in Canada. And it’s a fraction of the 6.7% savings rate in the US. The gulf between the Canadian and American rates has not been this wide for at least 40 years. In fact, Canada’s savings rate has never been this low for this long. It’s as if we have borrowed against the future to consume today. Which is exactly the case. So what if tomorrow is worse?

Incomes have barely kept pace with anemic inflation, while house prices have roared. Therefore families have borrowed more, and the debt-to-income ratio has climbed off the charts. At 178.5% it has never been higher, and this compares badly to the US, where the ratio is 133%. Meanwhile our economy grew over the last two quarters at 0.3% while the States clocked in at 3%. Our capacity to absorb an economic reversal is, yes, pooched.

The third number to reflect on is the amount of income needed to pay debts. These days it’s 15%, the highest since records have been kept. That’s almost double the American rate of 8%. We also know four in ten Canadians are one missed paycheque away from a personal emergency and half of us have less than $200 in disposable income at the end of each month.

Finally, what money we manage to scrape together, we put in the wrong places. Eighty per cent of TFSAs, for example, are invested in low-yielding GICs and high-interest savings accounts. Meanwhile the asset of choice for the majority of American retirement plans – like the 401k – is equities.

A preponderance of Canadian net worth sits in one asset – residential real estate, which also represents the lion’s share of debt. Despite recent weakness in markets like Vancouver, house prices remain near all-time highs. Most families have almost no diversification or balance in their financial lives, pursuing a one-asset strategy, increasing their risk. A recession bringing fewer jobs, lower incomes and a weaker housing market is an ill wind, indeed.

The good news? It’s not here yet. Don’t wait.