- The Canadian housing market is providing a pro-cyclical boost
- Russia is now in a recession
- Twitter’s share collapse is emblematic of broader trends
- Corporations pay tax for a reason
Canada. I think Canada’s housing market is well overbought. One could reasonably argue that there is a bubble in places like Vancouver and Toronto. For the time being this doesn’t matter because the latest data show the housing market gaining strength, buoying homebuilding and aiding GDP growth via jobs and wages. We see bidding wars heating up in Toronto as mortgage rates hit historic lows. Bank of Montreal, for example, has lowered its 5-year adjustable-rate mortgage to 2.99%, which I should note is above government-unsubsidized rates near 2.65% in the US that I mentioned yesterday.
While a recent statistical analysis by the New York Times and the Luxembourg Income Study Database shows Canada pulling ahead of the US as the world’s top income earner’s, the data underneath is much murkier. Americans focused on the data as showing America falling behind. But Canadians were not buoyed by this analysis either. After the data release, the Financial Post headlined an article titled “Canada leading ranks of shrinking middle class”. The Toronto Star wrote another titled “Canada’s middle class is doing well? It’s not so simple.” If one extends the dataset back to 1980, median real earnings of full-time workers increased to $41,401 from $41,348 in the 25 years to 2005. That tells you that Canada has wage growth problems too.
On housing, what is driving the momentum in Canada are the typical housing affordability metrics. People think in terms of how much they can afford to pay per month rather than how expensive a home is in terms of income. The problem is debt. Consumer debt is at a record $1.4 trillion in Canada, up 9% in the past year, much higher growth than nominal GDP. Canadian household debt-to-disposable income ratio reached a record 163.4% in Q2 2013 and pushed even higher to another record 163.7% in Q3. Due to changes in the statistics, the 164.0% debt-to-disposable income in Q4 2013 was considered a slight decline from the revised 164.2% Q3 figure when data was released in March. But these figures make Canada one of the most heavily indebted household sectors in the world.
If you combine the debt figures with the longer-term wage stagnation picture and an understanding that Canada consistently ranks as one of the most overvalued property markets in the world, you get a sense that the housing market in Canada is providing a pro-cyclical impulse via debt accumulation that will come unstuck once no more debt can be accumulated. This will occur when interest rates stop falling or when a recession hits.
Russia. Georgia has said it wants a fast track to NATO membership, specifically because of the threat from Russia. Here’s my read of the issues here. It is ever more clear that the eastward expansion of NATO was not a benign event aimed at uniting Europe. Rather, it was an example of the West taking advantage of Russia’s weakness to increase their sphere of influence into the former Eastern Bloc and Soviet Bloc. Russia is still a military threat as the situation in Ukraine makes clear. But the Georgia fast-track request also makes clear that NATO is an alliance that is very much being used as a bulwark against Russia rather than some benign military alliance that might cooperate with Russia.
With the Ukraine situation drawing the lines ever more clearly, it’s hard not to see this as a new Cold War having re-emerged. But it is not clear where this is headed economically or politically. Russia is in a recession. Russia’s economy contracted in Q1 and the IMF expects capital flight of $100 billion in 2014. It cut the growth forecast for Russia to 0.2% this year from an already paltry 1.4%. Some US companies are also starting to feel pain from the situation. McDonalds, which imports half its food into Russia, is feeling currency translation pain due to the weak Ruble. And Ford sees its margins come under pressure as consumer demand dries up and the Ruble remains weak.
I expect Russia to press ahead with its geopolitical aims irrespective of the economic situation. This will demonstrate the weakness of the economic sanctions approach from the West, but also cause the West to double down on the economic sanctions route since there is no military solution. Therefore, I see an economic crisis as a distinct possibility arising from the political standoff over Ukraine. While the latest sanctions are not significant, expect pressure to ratchet up further in the days and weeks ahead.
Technology. Twitter beat earnings results expectations in Q1 with $250 million in revenue. It also picked up 14 million new monthly active users. But Twitter shares slumped on the earnings news, something I see as a sign that the tech decline that started after the Candy Crush IPO is real. Note that the Nasdaq Internet Index is down over 20% from a recent peak for the first time now. So we are officially in bear market territory. What this highlights is how much those telling us this is not a bubble are looking at companies like Apple, Google, Intel, Cisco, and Microsoft to make that determination. The bubble is in the shares of companies like Twitter, where the momentum has finally broken.
Now, Twitter’s stock fell more than 10% in after hours trading, going to $38.05, below its post-IPO low of $38.80 on November 25. At the peak in December, Twitter had a market cap of $46 billion on just $665 million of revenue in 2013, which is a revenue multiple of nearly seventy times earnings, a bubble-like metric by any standard. Shares have been cut nearly in half, and the market capitalization has now fallen to $24 billion. Even at the $1 billion revenue run rate of Q1 2014, that’s a revenue multiple of 25 times for a loss-making company. Excluding items, Twitter beat Wall Street expectations of a 3 cent per share loss. But its net loss under GAAP widened nearly fivefold to $132 million from $27 million last year. The Twitter saga is emblematic of a bubble in the technology sector that is now popping. I expect things to get worse before they get better. And as such, it is indicative of a market that is near its peak not in the middle of a cyclical bull run.
Taxes. On the taxes front, I have two thoughts. First, we see Apple raising $12 billion in debt at 77 basis points over Treasuries in order to avoid a tax hit from repatriating foreign tax earnings. At the same time, eBay took a $3 billion tax charge this quarter because it finally did repatriate $9 billion in earnings back to the US. So we can see how important this tax issue is for the earnings of these firms. Second, an article by Josh Barro in the New York Times highlighted how much international tax shielding was a part of the proposed Pfizer-Astra Zeneca merger. Josh endorsed a dubious tax policy proposal from Alan Viard and Eric Toder in doing so.
The crux here is the so-called double-taxation of corporate earnings. Viard-Toder’s proposal looks to eliminate double taxation by eliminating corporate taxes altogether and making all taxes pass through individual tax returns in the US at the standard personal income tax rate. In my view, this tax elimination scheme doesn’t work well at all if the corporation is US-domiciled but the individual is not. The tax is lost to the US government.
Moreover, this Viard-Toder policy is unworkable because it would turn the US into a tax haven as foreign multinationals would institute shell pass-through American companies to avoid tax on earnings as they presently do in countries like Ireland. But, more than that, corporate double taxation is baloney. Everyone faces double taxation. I earn income. It’s taxed. I spend it and it is taxed again. I own a house. I pay property tax. I rent a room in my house and I pay taxes again. If corporations are persons – who according to the Citizens United ruling can donate unlimited amounts to political campaigns, they must pay tax like all other legal persons.
Let’s remember that corporate taxes are avoidable simply by doing any activity without incorporating. The reason to incorporate is to derive benefit from that legal structure. One can pool monies and gain market power, economies of scale and scope that real individuals cannot. This falls to the bottom line. And real individuals acting on behalf of corporations are shielded from legal prosecution by their actions through the corporate veil. We saw this at the banks regarding mortgage lending fraud where no individual civil or criminal prosecutions were made. We saw it with the collapse of Lehman Brothers where yet again no individual prosecutions were made. And we saw it with MF Global where no individual prosecutions were made. These benefits are taxed as any legal person’s income should be.
Anytime a proposal suggests you eliminate corporate tax, you have to question motives. This proposal is corporatism, pure and simple. And it is bogus economics.