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4 Ways The Liberal Election Victory Could Affect Our Investments

November 2nd, 2015

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This blog post was originally published on the MoneyGeek.ca blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.

At the beginning of every month, I brief members on how MoneyGeek's regular portfolios have performed and comment on the state of the financial markets. In this update, Ill comment on how the Liberals' policies could affect the prices of our investments, namely our stocks, bonds and the real estate market.

Performance of Regular Portfolios

The performance of MoneyGeek's regular portfolios for the month of October 2015 were as follows:

Last MonthLast 12 MonthsSince Apr 2013
Slightly Aggressive +5.8% +14.1% +48.9%
Balanced +4.9% +12.1% +40.2%
Slightly Conservative +4.0% +10.0% +31.9%
Moderately Conservative +3.1% +8.1% +24.0%
Very Conservative +2.3% +6.0% +16.4%

I've chosen to list below the performance of some of our competitors. For the sake of brevity, I've decided to show only those portfolios that have a similar risk profile to MoneyGeek's Regular Slightly Aggressive portfolio.

Last MonthLast 12 MonthsSince Apr 2013
RBC Select Aggressive Growth +3.8% -0.3% +26.4%
TD Comfort Aggressive Growth* +4.7% +5.6% +28.0%
CIBC Managed Aggressive Growth* +3.8% +2.0% +25.1%
Canadian Couch Potato Aggressive +7.0% N/A N/A

MoneyGeek's regular portfolios outperformed their mutual fund competitors in October. In comparison to our competitors, our regular portfolios allocate a higher proportion toward U.S. stocks (i.e. CAPE and BRK-B), as well as towards Canadian oil and gas stocks (i.e. XEG). Both U.S. stocks and XEG went up more than the broader Canadian stock market, which explains why the regular portfolios outperformed last month.

Canadian news briefly made headlines around the world last month as we elected a new government. Trudeaus Liberals ended ten years of Conservative rule, and with the new government has come the sense that things in our country are about to change.

Some people have asked me how the new government could affect them financially. Several journalists and bloggers have done a good job summarizing the potential changes we could expect to see with regard to our personal finances. Rather than duplicate their efforts, let me talk about how the new government could affect our investments.

Liberal Promises and Potential Consequences

When I look at the Liberal partys election platform, I see four main ways the new policies could affect our investments.

First, the Liberal policies could drive mid to higher end home prices higher through a revamp of the Home Buyers Plan (HBP).

Currently, HBP will allow us to borrow from an RRSP in order to purchase a home only if were first time buyers. The Liberals have pledged to change the HBP so that we can also borrow from an RRSP when we go through significant life changes, such as having to relocate for a job.

Of course, this change will benefit only those who have enough savings in their RRSPs to make down payments on homes - namely, those in the middle middle-class and up. Since these Canadians tend to buy mid to higher end homes, this policy will probably help lift the prices of those homes somewhat.

Second, the Liberal policies could drive lower end home prices lower.

The Liberals have pledged to remove the GST on the construction of affordable houses, and to also set up a new Canadian Infrastructure Bank which will finance the construction of new affordable houses. If these policies work as intended and if Canada builds a lot of lower end homes, the increase in supply will drive down the lower end house prices.

Ironically, I believe this policy could end up hurting many of those the Liberals are intending to help. Since lower end homes are usually owned by lower middle class households, and since real estate represents the bulk of such households savings, this policy could actually end up making such people poorer. That said, the policy could also help those in the lower middle class who havent bought homes yet. Im not sure if this is a net positive or negative for the lower middle class.

Third, we could potentially see higher interest rates on bonds because of the Liberals plan to run budget deficits.

The Liberal plan calls for higher expenditures, especially in order to finance $5 billion per year worth of new investments in infrastructure, such as public transit. At the same time, theyve pledged to cut income taxes for the middle class, which will lower the governments tax revenues. As a result, the Liberals are projecting that total government expenditures will exceed total tax receipts by almost $10 billion per year. To put this number into context, the Canadian federal government is expected to spend and collect roughly $290 billion this year.

Now, contrary to what some may think, I dont believe the deficits will result in higher interest rates due to people questioning the governments ability to pay. Because the federal government has the power to print money, investors in federal bonds will always assume that they will be repaid regardless of the governments indebtedness. As a case in point, the Japanese government carries significantly more debt relative to its economy than even Greece, but the Japanese 10 year bonds are still yielding a measly 0.3% per year today.

Rather, interest rates generally rise when governments run budget deficits because such deficits tend to either cause inflation or crowd out private borrowers.

Inflation tends to go higher if the central bank (the Bank of Canada in our case) funds the deficit by issuing new money. Such issuance leads to more money chasing the same amount of products and services, which generally ends up increasing the price of such products and services. Higher interest rates will often then force the central bank to lift interest rates.

On the other hand, private borrowers can get crowded out if the central bank doesnt fund the deficit. In this case, private investors fund the governments deficit, which means less of the investors money goes towards private borrowers. As private borrowers compete harder to obtain loans, they usually end up having to accept higher interest rates on their loans.

Therefore, regardless of the means with which it happens, budget deficits tend to cause higher interest rates. If interest rates go higher, bond prices will go lower and our portfolios could take a small hit. However, please keep in mind that budget deficits are only one of many factors that influence interest rates.

Fourth and last, the Liberals policies could stimulate the technology sector and change the composition of the Canadian stock market in the long run.

Though I dont think this policy will have immediate ramifications, I have decided to mention it because of the sums involved. The Liberals have pledged no less than $200 million a year towards expanding support for incubators and accelerators.

Incubators and accelerators are organisations that help new companies (aka startups) get off the ground. Heres a list of many such organisations in Canada. The Liberals hope is that such a large injection of money in this sector will hopefully lead to the creation of a new Microsoft or Google in Canada.

I do hope that theyre successful with their plan. I think its unfortunate that the Canadian stock market today is dominated by just three sectors - banking, mining, and oil & gas. Of the three, two of the sectors are at the mercy of commodity prices, which can swing up and down violently. I believe that the Canadian stock market could use some diversification.

Realistically however, I expect that a successful technology company, if the Liberal policies create any, will only enter the Canadian stock market many years down the road. I also suspect that the success of the policy will depend on the details of its implementation.

In summary, I believe the proposed Liberal policies will have some influence on housing prices, encourage interest rates to go higher, and perhaps change the landscape of the Canadian stock market in the long run. While its difficult to say just how big of an influence the policies will have, Im inclined to believe that they will have only small to moderate degrees of influences.

Sizing Up The Governments Influence

This brings me to an important point. I think that we, the electorate, can often be quick to lay blame or give credit to politicians for the state of our economy. However, if we analyze why the economy is in the state its in, we find that our politicians often have had very little influence over it.

For instance, take the recession that we currently find ourselves in. Everybody acknowledges that the recession was caused by crashing oil prices. When we dig deeper into why oil prices crashed, we find that it was because the U.S. started producing a lot more oil, and because Saudi Arabia decided to start a price war with U.S. producers. Canadian government policy had nothing to do with it.

Maybe some will argue that Harper shouldnt have let the oil sector become such a big part of the economy. However, I hope that those people really think about what it would have taken to limit the size of the oil sector. It would have meant preventing many thousands of people from finding employment, which I dont think any political party would have had the guts to do.

As another example, take the Great Recession of 2008-2009. As everybody knows, that recession was caused by the implosion of the U.S. housing bubble. Again, I dont believe the Canadian government had any role in causing the bubble, and while it did make an effort to stimulate our own economy somewhat in the throes of the recession, it was really the governments of the U.S., the E.U. and China that got us out of the economic downturn.

The truth is that while Canadian government policies do have an impact on our lives, we are far more affected by global factors beyond our control. This is true of our economy, and its also true of the prices of our stocks, bonds and real estate. Technological change, distant wars, and the state of large foreign economies have far more influence on the prices of our investments than Canadian government policies.

Thus, I believe we shouldnt overthink Canadian government policies and their effects on our investments. Mid to higher end home prices may go down despite changes in the Home Buyers Plan. Interest rates could stay down despite the federal deficit. Markets consider factors beyond those of the government.

This blog post was originally published on the MoneyGeek.ca blog by Jin Choi. The website no longer exists, but Jin has graciously allowed us to re-publish his research for the benefit of future investors forever.

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