Newsletter April 7, 2013
InvestorsFriend Inc. Newsletter April 7, 2013
The Joy of Owning Companies
Most people really enjoy owning things. People love to own houses, cars, trucks, jewelry, fancy cloths, cottages, travel trailers and all manner of toys and accessories.
You can also get a certain joy out of owning shares in companies. People who own businesses such as franchises, car dealerships, retail stores, farms, hotels and all manner of businesses certainly tend to enjoy owning them. The same can be true for shares of businesses.
Many investors think of shares as being simply blips on a screen. I prefer to think of shares as being tiny slices of businesses – which they are. I like owning a piece of some of the stores where I shop. If I can shop at a business in which I own shares and see that it provides good products or services at good prices and if I can see that it is busy and successful, that is great. Second best is to own shares in a business that perhaps I can see but where I can’t shop. That could include a business that caters to other businesses. For example I can’t shop at Stantec but I can see their building in downtown Edmonton.
My first concern in owning shares is to make a good return. But if I can add in the psychic income that comes from pride of ownership of a business that I can see and touch, that is certainly a bonus.
Also, we are often in a better position to judge the success of a business that we can see and touch.
So why not look to own shares in some of the businesses that you enjoy shopping at, if those shares are available at reasonable prices? And why not remember to think of yourself as an owner every time you visit or pass by a business in which you own shares?
The Recovery of the American Housing and Credit Markets
The U.S. housing market has recovered considerably. The latest Case Shiller index of house prices indicates that the average home across 20 cities has recovered 9% from the lows. Phoenix is up 26%, San Francisco is up 25%. The lowest increase is for New York at 3%.
Credit markets as measured by delinquent loans have also recovered substantially. The following discussion is based on delinquency data as at the end of 2012. You can see the data at the following link:
The one credit area that has not recovered much however is mortgage loans. 10.2% of U.S. residential real estate loans are at least 30 days delinquent. There has been very little decline from the peak levels of about 11% delinquent in 2010. I believe that the reason for this is that it takes a very long time to clear out the foreclosures. Also various government programs may be encouraging loans to remain in a delinquent state rather than move into a foreclosure state. This delinquency rate was historically about 3% and so it has a long way to recover.
Other forms of loans have seen dramatic reductions in delinquency rates. Credit card delinquencies are at 2.78% which is a record low. In the 1990’s this delinquency rate was running at about 4 to 5%. I suppose this much lower delinquency rate reflects tighter standards and follow-up on the part of the banks. But it probably also reflects a population that is better able to make the payments than was the case a few years ago.
Commercial real estate loan delinquencies had been falling rapidly and are at 4.08%, down dramatically from the 6.04% level of the previous year. And it is less than half the peak level of about 9% in 2010.
This data supports the contention that the U.S. housing, real estate and credit markets have markedly improved.
The Canada Pension Plan
It is sometimes suggested that the Canada Pension Plan is not sustainable or will not be available when people retire. This is false. The Canada Pension Plan in fact is in great shape financially.
The Canada Pension Plan is much more conservative and prudent than most defined benefit pension plans in the following ways:
- CPP is designed to pay out a maximum of only 25% of final wages. And eligible wages are capped at a wage of $51,100 as of 2013. Defined benefit plans can result in pensions that are 70% or more of final wages. And if there is a wage cap it is often based on income tax rules and depending on the benefits of the plan the wage cap is currently at least $120,000 for most DB plans.
- In order to collect the maximum amount of CPP you must have contributed at the maximum wage level for 40 years. This means that for each year worked your CPP pension is about 0.625% of final wages (up to a maximum). In contrast the best defined benefit plans provide pensions of 2% of wages for each year worked. That is three times the benefit.
- Most defined benefit plans allow a pension based on the final five years’ earnings even if the early earnings were much lower. CPP effectively prevents that as a year employed at half the YMPE amount only earns half a “point”. Only years employed at or above the YMPE earn a full point towards the maximum CPP.
- Most defined benefit plans include the ability to retire before age 65 with no reduction in pension as long as years of service and age add to a certain figure. CPP does not include this benefit. CPP can be collected at age 60 but there is a significant and actuarially sound reduction in the pension to do so.
- Defined Benefit plans include the ability to collect the commuted value of the benefits. The calculation of the commuted value is generous because it assumes that the money would be invested strictly in bonds rather than partly in equities. With today’s record low interest rates it takes significantly more money to fund a pension with strictly bonds. The legal requirement to provide these high commuted values places a financial strain on defined benefit plans. CPP does not allow for the collection of commuted values.
- CPP currently collects 9.9% of wages (up to the maximum eligible wage level of $51,100). The 9.9% is split equally between employees and employers at 4.95% each. However about 25% of this 9.9% goes toward funding survivor, disability and death payments. The contribution that is funding the 25% pension at age 65 (which requires 40 years of contributions) is about 7.5% of wages. In contrast many DB plans are targeted to fund pensions of up to 70% for 35 years of service at retirement ages as young as 55 and where the pension is based on the final five years salary rather than considering wage levels in all 40 years as does CPP. Today, contribution ates for BD plans are very high and include amounts to make up for past short-falls. In the past DB plans were projecting that they could achieve their generous payouts with contributions in the range of 12%. This has proved to be woefully inadequate.
The CPP money is set aside from other government funds and is professionally managed.
While most DB plans face large funding deficiencies the latest actuarial report on the CPP concludes that the current 9.9% contribution rate is sufficient. No increase in the contribution rate was called for.
In conclusion, the Canada Pension Plan is financially sound and fears that it will not be available when today’s workers retire are unfounded.
The Canadian Economy
We have updated our brief article that succinctly describes the Canadian Economy in terms of the components of GDP by industry and the imports and exports of Canada by product category and by country.
In the next newsletter I plan to update a number of articles that show the performance of stocks versus bonds over the years. While the last dozen years have been not been stellar, the evidence is that over the long term investing in stocks has been very rewarding. And I suspect that will continue to be the case.
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Shawn Allen, President
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