David's Weekly - February 10, 2023

This week we’ll take a twist, covering a different but important angle on international events. We’ll switch the debate between bulls and bears and cover another classic investing question: real estate vs stocks. Finally, we’ll round off with some thoughts on some very clear facts about achieving happiness.

Today is International Day of Women and Girls in Science. Here's to all of the brilliant women I studied with in engineering!

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In this week’s letter:

In this week’s letter:

? International Tensions: These are not your regular everyday balloons

? The great Canadian debate: stocks vs real-estate

? Food for thought: How to achieve happiness – just the facts ma’am

When the world comes together

We don’t see this often, but the tragic circumstances in Syria and Turkey with the loss of over 20,000 lives in only three days has brought out some of the best in humanity. Overlooking their differences and allowing for cooperation between countries technically at a state of war, the international community is coming together rapidly to provide assistance to the multitudes affected by massive earthquake. It’s sad that this is what it takes to build bridges, at least temporary ones, but it gives hope that we can look past our differences.

International Tensions: these are not just your regular everyday balloons

The war grinds on in Ukraine and NATO and its partners continue to open the floodgates to extensive weapons training and contributions. Now that Germany is feeling a bit more comfortable, they have announced the contribution of 100 old-school Leopard I tanks from their inventory. They offer thinner armour but substantial fire power, adding to the overall Ukrainian ability to maneuver. Again, we suspect that fighter jets will soon be approved and delivered. In the meantime, Russia has clearly regained the initiative while the Ukrainian momentum has slowed after a string of successes. The body count is growing at a staggering rate on both sides.

In the meantime, the U.S. has caught China flat-footed in a brazen act of spy craft. Floating well above the path of regular air travel, the U.S. discovered a balloon the size of three school buses and 200 feet high making its away over a string of sensitive U.S. military sites.

Kramer – “These are just my regular, every day balloons!”

There was much teeth-grinding about whether the balloon should have been allowed into the American air space at all and the value of letting it travel further vs shooting it down before it reached U.S. shores. But in the end, the Americans decided to wait for an opportunity to shoot it down over a body of water that would allow the technology to be recovered rather than smashed on hard ground. The balloon was eventually taken out of the sky courtesy of an F-22 fighter jet. Overkill? They are now attempting to collect the 2000 pounds of technology associated with the balloon. China has now demanded the return of the balloon. The chutzpah!

To make a point, the Americans publicly announced a meeting with 150 diplomats from 40 countries to update them on the potential risks to their own nations. It seems that the Chinese have been caught with their pants down with an additional balloon detected over South America. 

The Chinese indignantly indicated that it was simply a weather balloon gone off course and then bristled at any suggestion that it was for intelligence gathering. We know at this point that the balloon ran on solar power and was not floating aimlessly along wind corridors but was in fact powered and guided by propellers and rudders. It will be interesting to learn more about exactly what it was actually doing up there. What needs to be understood is the apparently enormous effort and risk-taking being employed to gather intelligence by some western adversaries.

Going, Going, Gone: couldn’t they have just used a big pin?

The great Canadian debate: stocks vs real-estate

In place of our usual Bull/Bear cases, this week we are going to focus on an alternate and long-running debate, and that is the one between whether real estate or stocks are the better long-term investment.

We often hear the phrase, “the poor own real estate while the wealthy own stocks”. It’s hard to know where to begin refuting this supposition because, from a wealth management perspective, many of the most financially successful families have considerable exposure to both asset classes, often having an oversized weighting in real property relative to their holdings of public securities. On the other hand, in discussions with clients and prospects, it is not unusual at all to learn that families living in upscale neighbourhoods are “all in” when it comes to property with little left over to invest in longer-term accounts. In support of the above statement about the “poor” owning real estate, given the extreme prices of real estate in bigger cities, it is not surprising to find a strain on retirement account funding.

So, over the long term, which is a better investment? The answer might surprise you.

The case for real-estate

When we’re talking about real estate here, we’ll focus on residential. Many Canadians have witnessed and benefitted from the secular downtrend in interest rates we’ve experienced over the last decades. Nothing makes real estate go up faster than low rates, bouts of which have caused some serious overheating of the real estate market as we most recently witnessed during the COVID pandemic.  The opposite is also true: when rates go up, real estate market activity falls and prices retreat. We’ve seen the market become illiquid with prices falling considerably from the highs.

However, over the long run, real estate has many financial, tangible, and intangible benefits. It can act as a place to live, as an inflation protection vehicle, and for many, as a source of cash for retirement when empty-nesters downsize in the future. On the non-financial side, if we’re talking about a home, real estate is a place for family, friends, and memories, all of which are priceless.

In terms of numbers, real estate has in fact outperformed the stock market in the hottest markets over the 10-15 year period. Those who jumped in from around the time of the 2008 market crash have in fact outperformed equities, on average, by 2% which is a considerable amount.

The kicker on real estate is the tax-free status of the primary residence. For equities, transaction fees, taxes on realized gains, emotional trading mistakes and attempts at market timing, poor diversification, and fads can all negatively impact returns.

One final aspect of real estate is that even though it is illiquid, there are avenues to use leverage against a property when a source of liquidity is needed.

TSX Composite vs select Canadian real estate markets

The case for equities

Real estate comes with its costs. To really make a proper comparison, one would need to incorporate the cumulative impact of land transfer taxes, property taxes, legal fees, real estate broker fees, as well as out-of-control renovation and construction costs that are often unrecoverable. Sold homes are often valued based on the property and not the house. All of these costs chip away at the return one ultimately achieves.

Step in, equities. Looking at the chart above, the TSX Index handily beat the hottest markets and the national average by 1-1.5% on a 20-year basis although the spread narrows somewhat over a 24-year basis. A graphical view of the same is shown just below.

A graphical view of the TSX composite and select real estate markets from Feb 1999

Additionally, the purpose of long-term savings is largely to generate cash flows needed to retire. A diversified portfolio allows one to adjust the overall strategic asset allocation as well as the tactical allocation to target those goals. Equities offer the ability to diversify much more broadly and easily across industry sectors and geographies than real estate and also provide a source of immediate liquidity that housing cannot offer. However, there are plenty of opportunities to invest in liquid real estate assets in the public markets. Equities also provide a hedge against inflation.

Conclusion

Like all markets, real estate and equities have their ups and downs, triggering the same greed, fear, and market dislocations as everything we've seen in history from tulips to bitcoin to dot-com stocks.

But both equity and real estate have proven to be very good long-term investments. There is a considerable amount of nuance that is often left out of the equation and that we've tried to cover here. The main driver of both is, ultimately, economic growth.

Food for thought: Happiness – just the facts ma’am

Is there some kind of magic recipe to achieve lifelong bliss? Apparently. We are able to control far less about our lives than we realize, but in the case of happiness, it seems like there are things we can control, with most of them being very intuitive but requiring work and follow-up. 

As an aside, within wealth management there's a parallel - we focus on what we can control, recognizing that the market itself is not one of those things. We stick with the facts – what you’ve saved, what you earn, what you want to accomplish, etc. When it comes to happiness, it turns out we can control quite a bit, too.

Just the facts ma’am

There’s an amazing, very long-term study on happiness, encapsulated in the book, The Good Life, which has gathered some statistically significant facts about the components of a fulfilling life. The author, Dr. Robert Waldinger, a prof at Harvard, took the reins of an 84-year-old study that was kicked off in 1938. The original 724 participants included future President John F. Kennedy along with about 250 Harvard sophomores. The study also incorporates the descendants of the original participants and was expanded to include the less fortunate including about 450 boys living in inner-city Boston, with 84% retention of subjects over the lifetime of the study which continues to this day. All participants were tracked every 2 years with a questionnaire, every 5 years with a medical record review, and every 15 years with a face-to-face interview.

The number one lesson from the study: good relationships help us lead longer, healthier lives, regardless of one’s background. In parallel to physical fitness, Dr. Waldinger coined the term “social fitness” which he described as the maintaining and updating of relationships such as keeping in contact with friends, family, and community members. He also says that those at age 50 who stick with the plan will be healthiest and happiest in their 80s. He emphasizes that it’s never too late to start.

So, there you have it. Get happy and healthy not just on the treadmill and the organic food counter. Be friendly. Be friended. Be familial. Be communal.

With that, we'll wrap with PAGs Global Insight Weekly. 

In this week's issue...

• The Fed gives up the fight - From depressed levels, UK and European equities have enjoyed powerful rallies this winter as both regions avoided crises. Still, it would be prudent not to be overly optimistic, as higher interest rates impact economies with a lag. We explore the portfolio implications.
• Regional developments: Bank of Canada provides context on monetary policy; As the U.S. labor market powers ahead, what’s next for the Fed?; Bank of England and European Central Bank approaching end of hiking cycles; More accommodative Chinese policies to come

Thanks for reading and have a great weekend,

David