It is worth elaborating on a few of the points in our email message from last week.
We mentioned that we fall into the camp of those who believe that a slowdown in the Chinese economy will have less effect on the Western economies than is currently feared. China is a net supplier to the world, and its economic decline will affect the cost side of developed economies more favorably than it will affect the demand side unfavorably. We also believe that the Shanghai and, to a lesser extent, the Hong Kong stock markets are not interconnected enough with Western markets to drag them down in a collapse. The upward ‘spike” in the Chinese stock markets that started in 2014 was seen by many as artificial and a complete reversal to “normal” prior levels seems likely.
However, as we mentioned, China will continue to have a profound effect on commodities, particularly oil and copper. The price collapse in these two commodities will have obvious effects on the economies of Canada’s western provinces. However, they may also trigger a reversal of the speculative house price boom, particularly in British Columbia. Should the Renminbi weaken relative to the Canadian dollar, reversing its five year trend, or if China enforces capital controls, the BC housing market could generate significant real estate loan losses. It is not well known that uninsured mortgages in Alberta are non-recourse, an unusual legal circumstance that can lead to large write-offs for banks that have originated such loans. While most banks are at or close to their required equity ratios, and are planning to maintain or increase them through earnings retention, loan write-offs in oil and gas and mortgage lending categories could require them to raise more equity at adverse times in the market. We presented last year on the risks of new regulations on issues of bank obligations, and indeed the banks’ cost of capital has been rising for reasons that include these new restrictions. This may push banks to issue equity capital rather than subordinated debt. Many students of the market feel that there is no good part of a stock market when the bank stocks are weak. This may or may not be so, but we can at least affirm our significant underweighting in bank and resource stocks. Our cash holdings are higher than we indicated to you in our last message at roughly 13 to 15 percent.
It takes toughness to hold on to good companies in bad markets, but that is our strategy and we have the cash reserves to take advantage of a “crash” should this downdraft get worse.
Your team at Heathbridge
Rob Richards Rupel Ruparelia Richard Tattersall
We will stay in touch.