"Millions? Than what?" Happy New Year Everyone.

An American tourist was at the pier of a small coastal Mexican village when a small boat with just one fisherman docked.
Inside the small boat were several large yellowfin tuna. The tourist complimented the Mexican on the quality of his fish and asked how long it took to catch them.
The Mexican replied, “Only a little while.”
The tourist then asked, “Why didn’t you stay out longer and catch more fish?”
The Mexican said, “With this I have more than enough to support my family’s needs.”
The tourist then asked, “But what do you do with the rest of your time?”
The Mexican fisherman said, “I sleep late, fish a little, play with my children, take siesta with my wife, Maria, stroll into the village each evening where I sip wine and play guitar with my amigos, I have a full and busy life.”
The tourist scoffed, ” I can help you. You should spend more time fishing; and with the proceeds, buy a bigger boat: With the proceeds from the bigger boat you could buy several boats. Eventually you would have a fleet of fishing boats. Instead of selling your catch to a middleman you would sell directly to the processor; eventually opening your own cannery. You would control the product, processing and distribution. You could leave this small coastal fishing village and move to Mexico City, then Los Angeles and eventually New York where you could run your ever-expanding enterprise.”
The Mexican fisherman asked, “But, how long will this all take?”
The tourist replied, “15 to 20 years.”
“But what then?” asked the Mexican.
The tourist laughed and said, “That’s the best part. When the time is right you would sell your company stock to the public and become very rich, you would make millions.”
“Millions?…Then what?”
The American said, “Then you would retire. Move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siesta with your wife, stroll to the village in the evenings where you could sip wine and play your guitar with your amigos.”

Most Useful & Universal Mental Models

So what is a mental model? It is a process or way of thinking for solving a problem through using a representation of the environment. Because there are different ways to represent the environment and use intuition, there are alternative mental models. Some are focused on specific tasks while others may be more general. 

The great chart below provides a number of examples of effective mental models. Some are easily employed for investment decisions while others may help with productivity and work flow.

This weekend spend some time with people you love, you'll never regret it !

         love, joy, peace, patience, goodness, kindness, faith, mildness and self-control,                 to all

Equities versus Commodities

Equities are overvalued! Bonds are overvalued! In the minds of many investors everything is overvalued given central bank distortions, yet there may be an exception. Look at commodities. The difference between financial and real asset could not be larger. Financial assets have steadily moved higher while commodities have fallen or at best moved sideways relative to risky stocks in the last 5+ years. This relationship has applied to all equity indices around the world to varying degrees. 

One can argue that commodities are more closely tied to current economic growth while equities are tied to valuations of long-term discounted cash flows as one explanation. Equities have positive carry while commodities as measured through futures have seen mixed carry with market contango for the last few years; however, there are now switches to backwardation in some markets. The business cycle relationship with commodities suggests that these real markets peak late in the cycle not when there is a new surge in growth. Still, on a relative performance basis, commodities as an asset class looks like a better value.

Canada. Time for a refresher course?

The adage that “trees don’t grow to the sky” is being put to the test in the Great White North.   Despite a pullback in Toronto-area home prices in recent months, the Canadian housing market stands out even in this bull market-in-everything world:  The Canadian Real Estate Association’s MLS Home Price Index has risen by 130% since the beginning of 2005, more than double the 53% rise in nominal GDP over that period.  

As night follows day, rising prices are met with increased supply.  Thus, Bloomberg reported on Friday that Canadian developers are undertaking a record number of multiple-unit construction projects as they seek to participate in the boom.  Robert Kavcic, economist at BMO Capital Markets, commented that: “Canadian home building activity remains rock solid. Builders in the biggest cities appear to be responding to supply shortages as best as possible.”  The severity of these shortages, in Toronto at least, is disputable. Supply of new listings in Canada’s largest metro area has jumped by 37% year-over-year in November.

Local regulators have likewise moved to slow down the housing market’s ascent.  Canada’s Office of the Superintendent of Financial Institutions (OSFI) is introducing new regulations, set to take effect on Jan. 1, which aim to tighten lending standards. 

It may come as no great surprise to learn that the great Canadian housing bull market has been built on a foundation of debt.  Consumer debt as a percentage of disposable income has undergone a near-constant uptick since the turn of the century, reaching a fresh high water mark of 167.8% as of the end of the second quarter, compared to 144% in the U.S. in 2007. The encumbrances are particularly concentrated in home equity lines of credit, or HELOCS.

HELOCs, as a percentage of GDP [13.5% as of year-end 2016], are roughly three times higher in Canada then in the US at the peak of our housing bubble in 2006. In addition to consumption (“using your house as an ATM”) and borrowing to avoid delinquencies on other debt, Canadians have been using HELOCs to fund mortgages in the shadow banking market and buy additional speculative properties.
“People in Canada have been borrowing against their home equity line of credit - to lend to subprime borrowers directly.” Indeed, this linked piece from the Toronto Globe and Mail provides a detailed roadmap for readers who wish to use their home equity for investment purposes, in service of “leveraging their real estate assets to increase their net worth.”

Back in June, executives at Home Capital Group, Inc. agreed to pay upward of C$30 million in settlements over alleged disclosure violations related to mortgage fraud in 2015.  On Nov. 30, Reuters reported that “compliance officers at the Financial Services Commission of Ontario had evidence that syndicated mortgages were being marketed and sold in ways that broke the law . . . From 2011 to 2015, senior FSCO investigators rejected or ignored compliance officers’ multiple recommendations that the agency investigate or take action to rein in the marketing and sales of Fortress [Real Developments] syndicated mortgages.” Last week, Montreal-headquartered Laurentian Bank disclosed that it will need to buy back as much as $180 million of mortgages after discovering “documentation issues and client misrepresentations."
François Desjardins, president and CEO of Laurentian, defended his bank: “We’re very different organizations and this is a very different situation than what happened at Home [Capital]. This, to us, is really a process and paperwork issue that we have to resolve.” This morning, Laurentian issued a follow-up press release stating that: “Given recent reports in the media, the Bank wants to clarify why it does not believe these matters are material to its business, capital, operations and funding.”

Some see things differently and saying that:

The mortgage inconsistencies reported at Laurentian Bank (the third major Canadian financial institution to fess up to this problem) underscores what we have long believed to be a systemic problem with Canadian underwriting practices. 

Canada hasn’t seen a true credit cycle in nearly three decades, which warps the judgment of market participants and regulators alike.

Time for a refresher course?