What Does the Bank of Canada Do?In a previous post, quite a while ago I wrote about the fact that US has a good chance of having a soft landing but in Canada that is less likely to be achieved. The reason for my thoughts are centred on the differences between the two countries in the housing market. At the latest News Conference, the US Fed Chair seemed pretty confident that baring some major international upheaval, the US will have a soft landing - in line with my earlier prediction.
So what are the key differences in the housing market?
In the US, 95% of all mortgages are fixed rate and more importantly, 75% have a term of 30 years. This means that few American homeowners will need to renew their mortgage in the next couple of years at higher interest rates. In fact over 40% of US homeowners renewed their mortgages in 2020 and 2021 with a 30 year term when interest rates were at a historic low.
The situation in Canada is essentially the opposite. More than half of Canadian home owners will need to renew their mortgage in the next year and a half. The weighted average increase in interest payments is expected to be over 50%. More than half of homeowners in Canada are paying an average of 37% of their income to keep a roof over their heads when the recommended maximum level is 30%. A 50% increase in interest payments will make most payments unaffordable for a significant proportion of homeowners in Canada. This is a big deal!!
Problem does not just exist for homeowners. The unaffordability of housing also extends to the rental market as more people are forced to delay a home purchase. Year over year, rental costs have risen 11% - much higher than wage growth.
For investors in Canada, this is something that needs to carefully considered when making investment decisions.
This also leads to a quandry for the Bank of Canada.
If all this leads to a significant difference in economic activity between Canada and the US, the BOC may be forced to lower interest rates more agressively than the US Fed if economic growth is slower in Canada. This would lead to a lower Canadian dollar vis a vis the US.
Soooo...what does that mean?
Well for SU shareholders it is actually good news as the CAD WTI price will be higher than it would otherwise be. But it also means higher gasoline prices and lower economic growth and hence less gasoline sales for PC and lower refinery output. So it is a mixed blessing.
Soooo what does that mean for asset allocation?
In my case and investment objectives, I put more money into preferred shares a couple of months ago. The balance of probabilities are that that the US Fed will lower interest rates this year and for the reasons I stated above, the BOC will have to cut rates more agressively. Lower interest rates mean more capital gains for preferred shares on top of the interest income. A pretty safe way to make lots of money IMO. So far my preferreds shares on average are up over 11% and the coupon rates are around 9% on high quality preferreds such as ENB.
Is it too late to buy preferreds?
IMO the simple answer is no. This is especially true if we see lower interest rates over the next year.
Will preferreds outperform straight equities over the next year?
IMO the answer is yes and with less risk and volatility.
Up to you what you decide to do based on your financial objectives. I have made my choice.