The Canadian flag flies outside the Bank of Canada building in Ottawa on Wednesday, Oct. 23, 2013.Patrick Doyle/Bloomberg
We know through web traffic statistics here at the Report on Business that stories focusing on narrow issues of economic policy are rarely popular. But what if there were an economic concept forming a clear and significant danger to Canadians' two favourite asset classes – real estate and dividend stocks?
HSBC economist David Watt, who admittedly has been among the more bearish analysts covering the domestic economy, recently wrote that if the Bank of Canada was correct in predicting two per cent inflation in 2018, "[this] development brings up the issue as to how quickly the Bank would raise its policy rates to neutral, which is estimated to be between 2.5 per cent and 3.5 per cent."
The economic idea of a neutral central bank rate is a contentious one. The discussion generally revolves around the relevance of NAIRU -- non-accelerating inflation rate of unemployment -- and economists are split as to whether the concept can actually be applied in the real world or not.
We're not going to solve that argument here. I interpret Mr. Watt's remarks to mean that based on current and expected levels of economic growth, domestic interest rates are headed higher by between 175 and 275 basis points.
Thankfully, things are not as cut-and-dried as they first appear. As the Bank of Canada moves rates higher, growth slows, and the need to move them higher fades. The point remains, however, that after a 10-year period where Bank of Canada policy rates dropped from 4.5 per cent to the current 0.75 per cent, the pendulum appears set to move the other way.
Rising interest rates and bond yields will be headwinds for real estate values and dividend stocks in the same way falling rates provided tailwinds. We've had false starts on rising rates before in the post-crisis era, of course, and this could be another. Similarly, the initial 50 basis points of increases could cause enough economic damage that the Bank of Canada puts itself on hold for an extended period.
But if this is the third time the Boy Cried Wolf, and rates are truly headed imminently and sustainably higher, there are two reasons the transition will be painful for Canadian investors. One, demographic pressures have more investors than usual crowded into the income-generating assets that will be hit hardest by climbing rates.
The second reason, and one not to be underestimated, is that very, very few investors remember an environment of rising interest rates. Central banks have been consistently cutting since 1982 when the Federal Reserve Funds Rate was 19 per cent. For the majority of investors, a sustainable jump in policy rates would provide a uncomfortable, unfamiliar market backdrop – what worked before will stop working, and sectors that seemed ludicrously risky will outperform.
-- Scott Barlow, Globe and Mail market strategist
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Stocks to ponder
H&R Real Estate Investment Trust. This REIT is the Rodney Dangerfield of the Canadian REIT space. It "don't get no respect," says Desjardins Capital Markets analyst Michael Markidis. Despite its solid balance sheet, well-diversified property portfolio and improving performance, H&R's units are trading at roughly the same level as they did four years ago. For investors who believe in buying solid companies when they are out of favour, H&R – which now yields 6.5 per cent – may present an attractive opportunity, analysts including Mr. Markidis say. John Heinzl explains.
Bank of Montreal. It's a major Canadian bank stock with a yield over four per cent and it's technically oversold. This doesn't happen often, writes Scott Barlow. If this were anything other than a big domestic bank stock, he'd be reticent to say the technical outlook is positive. But as long as the fundamental outlook is ok – fundamental research should always accompany technical analysis – investors can be reasonably positive in the short term on the stock. Read more of Scott Barlow's analysis.
The Rundown
David Rosenberg: With Canada's economy on fire, I'm turning more bullish on the loonie
On Thursday, that was quite the "supersize me" GDP number, helping forestall what had seemed like an inevitable corrective phase in the Canadian dollar (the loonie rallied a full penny after the numbers were released, to 80 cents (U.S.) from 79 cents). David Rosenberg gave this GDP report a mark of A+. The economy is firing on all cylinders, he writes. There are some very positive supply-side developments taking place that are telling him that potential GDP growth may be improving. This should have important long-term implications for monetary policy, the currency and the rate of return on assets. Click here to read David Rosenberg's view.
The gold rally is overdone – and these charts prove it
The gold price has jumped almost 8 per cent since July 10, providing further proof that "U.S. dollar down, gold price up" is more or less all investors need to know about the price of bullion. Gold appears overvalued versus the most reliable trading indicator, likely reflecting the extreme degree of bearishness on the greenback. The extent to which the selling in the U.S. dollar is overdone will determine the short-term course of the gold price. Scott Barlow explains.
New disclosure rules signal new era of clarity for ETF investors
Investors in exchange-traded funds will now receive easier-to-understand documents that will provide greater transparency on the risks, past performance and cost of investing in an ETF. Beginning Sept. 1, the Canadian Securities Administrators (CSA) requires all ETF providers to produce and file a summary disclosure document called "ETF Facts," similar to what the mutual-fund industry introduced in 2011. Comparable to the mutual-fund "Fund Fact" document, ETF Facts will be delivered to investors in plain language and be no more than two pages, double-sided. Clare O'Hara explains.
Noteworthy read:
Adviser, advisor or financial planner? Does the name matter?
Number Crunchers
Twenty stocks with the best mix of fundamentals
Nine consumer stocks with strong earnings, low debt and reasonable valuations
Ask Globe Investor
Question: I have an LIRA (locked-in retirement account) and I am wondering how do I go about accessing the money in it? Also what is the tax rate when money is withdrawn from the LIRA?
Answer: You cannot withdraw funds from a LIRA until after age 55. If you are past that age, you can withdraw by converting the account to a LRIF (Locked in Retirement Income fund). At that time, depending on the province you reside in, you can transfer 50 per cent of the LIRA into a non-locked in RIF. This will allow you the option deregister some or all of that portion and pay the applicable tax on it. The amount deregistered is added to your income for the year it is withdrawn and taxed accordingly. There will be a withholding tax taken when it is deregistered.
Once you convert the LIRA into a LRIF, similar to a RIF (Retirement Income Fund) account, you are required to withdraw a specific minimum amount each year. There is some allowance to increase that amount to a specific maximum. The amount is a percentage of the market value at the beginning of the calendar year based on your age.
There are other unique situations that will allow you to withdraw funds such as financial hardship. Depending on if the LIRA is federal or provincial regulated and which province you reside in will determine the process required to request the exception.
-- Nancy Woods is an associate portfolio manager and investment adviser with RBC Dominion Securities Inc.
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Compiled by Gillian Livingston