Understanding this week’s markets: April 2, 2023

Kyle Prevost, Editor of Million Dollar Journey and Founder of the Canadian Financial Summit, shares financial headlines and provides context for Canadian investors.

Freeland shoots Canadian Banks again

There are several overall looks at the important aspects of Canada’s federal budget unveiled on Tuesday. In this week’s column, “Making sense of the markets this week,” we focus on two lesser-known points buried in the details: a new measure targeting Canadian banks and another targeting corporate shareholders. (Read MoneySense’s full coverage of the 2023 federal budget.)

Federal budget 2023 and banks

If you’re a shareholder in a Canadian bank, you might already be resentful of the hit you took in the last budget when the Canada Recovery Dividend was announced and an additional 1.5% corporate tax was levied on banking and life insurance companies.

On Tuesday Treasury Secretary Chrystia Freeland announced that the income tax law would be amended and that dividends received on Canadian stocks from Canadian banks and insurers would be treated as business income. This change is expected to elute $3.15 billion from shareholders over the five years beginning in 2024.

Given that the banking sector as a whole is a relatively inelastic commodity and Canadian banks and insurers operate in an oligopolistic market structure, it is reasonable to assume that the vast majority of these tax losses will be passed directly on to consumers.

In other words, banks and insurers know that Canadians need their banking services and have (almost) nowhere else to go. These institutions will only increase the prices of financial products and services instead of bringing the profit to the bottom line.

All of this comes at a time when banks are likely to find it more expensive to capitalize themselves given the global publicity over the past week about the risk associated with convertible bonds.

You can read more about Canadian bank stocks at MillionDollarJourney.ca.

The 2023 federal budget and corporate shareholders

The other interesting budget detail: The 2% share buyback tax. Those unfamiliar with the term “buyback” should know that a company uses its earnings to “buy back” its stock. This activity drives stock prices higher, allowing shareholders to potentially sell their shares for a profit. It’s about passing profits on to shareholders in a tax-efficient manner. Investment titan Warren Buffett recently defended the practice.

The Liberal government is proposing that this new tax will encourage companies to reinvest profits rather than rewarding shareholders. Predictably, the Canadian Chamber of Commerce is not a fan of the tax law changes.

If Canada’s federal government wants individuals and businesses to invest more money in Canada, perhaps it should encourage investment — not make it less attractive.

BlackBerry continues to fade while Dollarama thrives

Three Canadian companies from very different economic sectors reported earnings this week as BlackBerry, Dollarama and Lululemon opened their books. (All values ​​are in Canadian currency unless otherwise noted.)

Despite a meager profit in the fourth quarter of 2021, BlackBerry reported a loss of $495 million. CEO John Chen blamed delays on several major government cybersecurity contracts for the negative earnings results. Shareholders are likely to become increasingly restless as the company continues to attempt to return to profitability based on its cybersecurity specialization. BlackBerry still has about three years of solvency given the current cash burn rate.

Lululemon shares (which have traded exclusively on the NASDAQ exchange since 2013) rose more than 14% on Wednesday. That came after news of its earnings and a very strong 2022 holiday shopping season. Lulu’s overstocked inventory problem from last year’s third quarter appears to have resolved itself. Overall, the company appears to be on solid footing, with same-store sales up 27% year over year.

Meanwhile, Dollarama should be excited to report that its profits are up 27% year over year in 2022, attributing the increased foot traffic to inflation-conscious shoppers. And now, Dollarama shareholders can look forward to a 28% higher dividend. With 60 to 70 new openings next year, Canada’s leading dollar store should continue to grow.

The bank run could lead to a creeping inflation

First we had the Silicon Valley Bank (SVB) and cryptobank debacle a few weeks ago (since stabilized after First Citizens Bank took over operations); Last week it was Europe’s turn to worry about the collapse of its banks.

Confidence in the structural integrity of the broader financial system seemed largely restored this week.

However, these scary weeks could very well work out thanks to some unintended consequences for the world’s central bankers. In my commentary on convertible bonds “Coco” I postulated that the financial instruments were not correctly valued from a risk/return point of view. It seems many investors from around the world agree.

S&P Global Ratings agreed:

“Increased focus on downside risk could increase banks’ cost of capital and make it more difficult and expensive to issue new AT1s. Nervous investors will need some time to revise their risk perceptions for individual banks and instrument structures.”

Basically, for retail banks and lenders, this means it will cost more money to raise Tier 1 capital needed to ensure 2008 doesn’t repeat itself. So you have to pay investors a higher yield to get them to buy convertibles. And that means they probably won’t be issuing as many of these bonds as they have in the past. All of this leads to less lending in the long run.

It’s also true that as regulators become more meddlesome in the banking sector and emphasize safety over profits, bank managers will be forced to retain more deposits as they come in.

Less lending means less spending on everything from houses to skyscrapers. This credit crunch is likely already being felt by large corporations and retail customers. It could be particularly tough for people in America’s commercial real estate industry, since nearly 70% of US housing loans are generated by the same regional banks that are now under the watch of the regulator thanks to the collapse of the Silicon Valley Bank (SVB).

Finally, although difficult to quantify, it remains no less true that an economy’s “beast spirits” – how people think about financial matters – make a major contribution to the direction in which it moves in the short and medium term.

When all North Americans hear and read about record-low unemployment and inflation headlines, they are more likely to ask for a raise or accept higher prices in their usual business. If that cycle of information is suddenly replaced by negative sentiment fueled by panic, we’re more likely to spend less and not feel as comfortable negotiating our salaries and benefits.

All of these results are great news if you’re a central banker looking to slow the economy without damaging anything else. It’s also pretty good news if you’re a stock market investor who’s feeling increasing stress from ever-rising interest rates.

Money makes happy people happier

“Money doesn’t make you happy, but lack of money makes you unhappy.”

– Daniel Kahnemann

In 2010, Nobel Prize-winning researchers Daniel Kahneman and Angus Deaton published a landmark study to show that a household income of $75,000 ($103,000 adjusted for inflation, which is about $139,000 in Canadian dollars) was the best predictor of happiness.

Her research showed that families earning less than $75,000 could benefit from more money. But those with more showed no correlation with increased happiness. The results fit well with the belief that “money can’t buy happiness” and that people might think “Rich people are unhappy, so I’m fine with not being rich.”

Then, in 2021, Matthew Killingsworth, a senior fellow at Penn’s Wharton School, came along and ruined this feel-good story about more money, which means more problems. He noted that happiness picked up quite sharply after that $75,000 level, and “there was no evidence of an experienced plateau of well-being above $75,000.”

To settle their dispute, Kahneman threw down the gauntlet and challenged Killingsworth to a cage fight — for researchers, that means working on a new paper.

Killingsworth’s name comes first in the quotes, so maybe that means his hand was raised at the end of the fight.

What the authors discovered as they tested their respective theories was an interesting nuance. It turns out that making more than $75,000 is likely to make you happier, but only if you’re in the happiest 80% to begin with.

Kahneman and Killingsworth together concluded:

“There is a plateau, but only for the unluckiest 20% of people, and only when they start making over $100,000.”

If you’ve had a base level of luck, then the diminishing returns of high income don’t start to kick in until after $500,000.

The intuitive feels more right.

It would be great to have a follow-up research paper that looks at people’s total wealth or savings related to happiness. I would pay to read this, especially if they wrapped it up with a rematch for the Econ Academic-Weight Championship Belt.

Kyle Prevost is a financial educator, author, and speaker. When he’s not on a basketball court or in a boxing ring trying to reclaim his youth, he can be found helping Canadians with their finances MillionDollarJourney.com and the Canadian Financial Summit.

The post Understanding the Markets This Week: April 2, 2023 appeared first on MoneySense.

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