Wednesday, 9 November 2016

U.S. election, Black Swan and Post Mortem

The worst fear has materialized as a Trump presidency has become a reality triggering a massive selloff in the global financial markets.  Dow Jones Industrial Average futures are down by more than 800 points or 5 percent. The Mexican peso is down more than 11 percent.

This rare event called Black Swan in a book by Naseem Taleb talks about rare event as such with low probability of occurring but high risk or tail events in statistical terms.  In addition, financial markets are mostly ill-prepared for such event as can be seen by the huge selloff.  Brexit is another Black Swan, but the impact may not be as significant as the U.S election.

What did the political pundits who have been calling for a Hillary Clinton victory, albeit a narrow one, miss? Even key swing states such as Ohio, Florida and Michigan which y were supposed to be safe for Democrats evaporated into solid red Republican strongholds on election night.    

I think one exit poll said it the best. Most Americans, especially the have-nots, mostly male, White, non-educated, have suffered a lot economically in the past decade. As companies shut down plants and shutter production to low-cost labour countries such as Mexico and China, these people have not been able to transition to the new knowledge-based economy.  We only think of how much wealth is generated by Facebook, Netflix, Amazon and the likes, but the wealth is only concentrated in a few hands. And for the majority of the rural folks who have been left behind, Donald Trump represents the last hope of bringing back the jobs and the glory days. We know this is not going to happen. But when you are down, you don't think rationally. Hence the vote for Trump represents a hope for change.

I believe the email issues surrounding Clinton and the allegations about Trump's sexual abuse of women, may just be big red herrings clouding the real issue, as voters already made up their minds long ago and wanted change.  Don't get me wrong, though, as I am totally against what Trump had allegedly done.  My hope is that cooler heads can prevail and his advisers can charter a much more realistic path for his presidency.

Another lesson learned...... or not .   This will go down in history books as one of the most fascinating presidential race.    

Monday, 7 November 2016

The craziness of real estate in Toronto

Fact: In 1970, the average price of a house in Toronto was $30,000. Forty year later, the average price of a detached home in Toronto is well over $1.2 million. For all homes including condominiums, townhouse and semi-detached houses, the average price in Toronto in 2016 is well over $600,000.   

Conclusion: Based on the $600,000 figure, the average rate of increase is about 7.6% annually. 

Projection: It is estimated that by 2056, the average price of a home in Toronto would cost well over $3 million assuming a 4% average increase per year. I think I will include this article in my will to be handed down to my children and my grandchildren to see if it materializes. Better yet, put it in a time capsule to be opened on December 31, 2056 long after I am gone or if I am still alive at 92 years of age.

Fact: Over the same 41 year period from 1970 to October 31, 2016, the S&P 500 returned an average  10.2% , including dividends reinvested.

So, one can conclude that it would have been better to invest in the S&P 500 instead of real estate, right?  If one had rented instead of owning a home (with mortgage and interest payments, maintenance, and etc.), the math can get interesting.  I have yet to figure out how to best present  the analysis,  but have concluded that Investing in Real Estate by purchasing a home beats renting and using the down payment and additional costs of home ownership to invest.

And the difference is due to …… leverage.

Assume you put 20% down payment or $100, 000 on a $500,000 property  . If the property appreciates 7.6% per year, which is what the Toronto market experienced on average,  you gained $38,000. But on a $100,000 investment.  So, the true gain is 38%, which beats the 10% average return on the S&P  500.  

The opposite would also hold true if the property lost 7.6% in value, and you would have lost 38% on your initial $100,000 investment or down payment.  As in most financial literature,  I assume no transaction costs and ceteris paribus (everything else remains equal).

See  link to the Toronto Real Estate Board historical prices.