In this issue: President's Message | Death, taxes and recessions – the bigger picture | Recession whispers are getting louder…what could this mean for you? | What do I do with my corporately owned life insurance when…? | Thriving through it all
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President’s MessageMatt Evans, CFA
President & CEO
Will the Canadian economy enter a recession in 2023? It’s the million-dollar question that seems to be on everyone’s mind. At the moment, GDP growth in North America is positive, labour markets are strong, and consumer spending is holding up.
But we all know that policymakers are fighting a pitched battle against inflation. Persistent inflation is worth fighting – we’ve previously explored the damage it can cause – and central bankers remain steadfast in their view that there’s more to do. In other words, interest rates may go higher yet, and stay there until the inflation battle is won.
A recession represents lower economic activity, less trade, fewer jobs, and less prosperity. It may take outcomes along these lines to lower inflation. This is currently the cause of much speculation, with pundits in the financial media exchanging daily arguments for a soft economic landing, a hard landing, a bumpy landing, and even no landing. We’ll see what happens.
Taking a step back, and leaving the many potential causes aside, recessions are normal. So much so that our Chief Investment Officer, Scott Blair, likens them in this issue with death and taxes. And happily, unlike death and taxes, recessions are temporary. They always end. Bernadette Churchill further reframes the recession conversation by looking at both challenges and opportunities available to people in varying age demographics during such an environment. And Kim Stevens answers the question of what to do with your corporately-owned life insurance policy if your business is sold, winds down, fails or your key employee leaves.
Our job is to help you prepare for, and prosper through, a broad range of market and economic scenarios. This includes both economic expansions and the recessions that set the table for them. As I’ve said before in these pages, we are pragmatic optimists. Because we are optimists, we plan and invest to benefit from positive long-term economic growth and rising markets through time. Because we are pragmatic, we prepare for volatility, both financially and emotionally.
This time, policymakers may get lucky and we might remain on an expansionary economic path with decreasing inflation. Or we may need to endure further interest rate increases and an economic pause that refreshes. Either way, we can choose to sustain the optimism that has served us well and take pragmatic steps to prepare for a range of outcomes.
That is the spirit of the current issue of Grow Together. As always, our experts share their unique perspectives on the specific challenges and opportunities we face today. It’s a balanced set of views. I was particularly inspired by the insights shared with us by the management team at Canadian Mat Systems (CMS) in our final piece in this issue, Thriving through it all. When asked for their advice on navigating volatility, their paraphrased response is refreshingly straightforward:
“Understand your clients’ challenges and provide them with solutions. Put them at the centre of your work. Know your numbers, and always have a plan for the worst-case scenario. Navigate one day at a time – don’t borrow trouble.” And the part I love most is their credo to, “have fun with it.”
It’s sound advice, and we take it all to heart in the work we do for our client families.
Thank you for the time you will spend with this issue. As always, we’re happy to hear any thoughts you have on these stories, or any other aspect of wealth wellness.
Death, taxes and recessions – the bigger pictureScott Blair, CFA
Chief Investment Officer
It’s often said that there are two things you can’t avoid in life – we’d like to remind you of a third. Like death and taxes, recessions are an inevitable stress event, but they too play a role in the grand scheme of things and can be planned for to reduce their financial impact.
Death gives way to birth in nature, and taxes help fund things like roads, schools and other essential services. Similarly, recessions are a necessary part of normal market cycles within an expanding economy. And like death and taxes, knowing they’re eventually coming means you can financially prepare for them. Are we headed for a recession now? Time will tell, but here’s how things look in our view today, and what you can do to be good in the long term.
Recession or soft landing?
Although each business cycle is different, none compares to the one we’re in now. The recession that started with the initial COVID-19 lockdowns was short but severe. We’ve now gone through the recovery phase and are past the peak of economic growth for this cycle. Economic growth slowed significantly in 2022 and the main question on economists’ minds now is whether we’ll we see an outright contraction or a soft landing, where the economy slows but doesn’t shrink before it starts to grow again.
From our standpoint, it looks like a soft landing is unlikely and a short, mild recession at some point late this year or early next year is likely. The pandemic, and its aftermath, have made forecasting the economy extremely difficult, so we’re cognizant that we could be wrong. Whether or not we get two successive negative quarters of GDP growth (a typical recession definition), some will undoubtedly feel the pain of slower growth ahead.
It starts with interest rates – which have risen substantially in the past year. Floating rate debt (like a variable mortgage) or debt that’s maturing today either needs to be paid down or the borrower will have significantly higher costs going forward. This will lead to increased foreclosures on houses, companies tightening their belts and laying off workers, and a higher hurdle rate for new projects resulting in less economic activity.
Ordinarily, once the economy starts to slow towards a recession, central banks cut interest rates in an effort to stimulate the economy. This is unlikely to happen (in a significant way) today as central banks are focused on getting inflation under control and know from past experience (like in the ‘70s) that lowering rates too soon can bring on a second more powerful wave of inflation that’s even harder to control.
No one likes a slowdown, but there are some good things that come about. Economic expansions almost always lead to excesses in the economy. In 2008, it was a housing bubble, particularly in the U.S. with ramifications that spread across the globe. In 2000, it was the dot-com bubble that saw anything technology related soar to prices that were unjustifiable. Today, it’s excess inflation. The longer it goes unchecked, the worse the problem becomes and the more painful the cure.
Recessions aren’t good for corporate earnings. Stocks tend to rise when earnings do, and fall when earnings stagnate or decline. Rising rates and a slowing economy are a headwind on corporate earnings. We’ve seen significant rate increases in the past 12 months and investors have accordingly lowered their expectations for earnings this year, and will continue to do so if the economy weakens further.
A pivotal point in the markets
Psychologically speaking, investors are now in a pivotal part of the economic cycle. After a difficult 2022 for stock markets globally, we’re still faced with the possibility of a recession ahead. For many, it’s tempting to sell now and get back into the market when things seem safer. After all, it’s easy to invest when markets are rising but tough to stay invested when markets fall or uncertainty has risen.
But investors should also be asking themselves what happens if there isn’t a recession or if the recession is very short and mild. They could miss out on a powerful rally. Perhaps we’re already in the next bull market and those who sold at the end of 2022 will miss the powerful returns that come at the start of an upcycle.
Recessions are inevitable and sometimes occur out of the blue (like the pandemic) or don’t happen at all (like a soft landing). Trying to predict or time them – or the market – can be devastating to your wealth. For investors with a plan, recessions and market downturns are an unpleasant reality of investing in stocks, but staying invested puts you ahead in the long term. For example, let’s look back to the start of 2008 (see figure 1).
Figure 1: Canadian Market S&P/TSX Total Return Index (including dividends)
A new investor in Canadian stocks at the start of 2008 would have lost 40% of their money over the next 14 months! It’s a level of loss that would test any investor’s confidence and patience. For those who exited the market at the bottom, the losses were crystalized. However, those who stayed invested not only recapped their money but more than doubled their initial investment over the next 15 years. In fact, Canadian stocks returned over 8% per year over the entire period despite huge losses up front.
While we don’t know for certain whether there’s a recession around the corner, we do know that once one ends it’s only a matter of time until the next one begins. This is a normal part of market cycles in an economy that expands over time. The best protection for investors is a diversified portfolio that includes both stocks and bonds based on your risk tolerance, a sufficiently long time horizon, the confidence to stay invested and a knowledgeable advisor who helps you stay the course.
Sources: FactSet, Bloomberg
Recession whispers are getting louder…what could this mean for you?
Bernadette Churchill, MBA, CIM®, FEA
Private Wealth Advisor, Portfolio Manager, CWB Wealth Partners
With talk of a possible recession on the horizon, many are wondering how this might affect them. While we can’t say for certain whether a recession will occur, we do know there are both challenges and opportunities that present during such times. These can vary depending on your life stage.
How did we get to a possible recessionary state?
Recessions are caused by market imbalance, triggered by either internal or external factors – or a combination of the two. The pandemic, and its consequences (supply chain issues and monetary policy), as well as ongoing geopolitical devastation brought about by the Ukraine-Russia war both served to exacerbate market imbalances. Each have fanned the fires of inflation, leading to action from central banks around the world.
To cool the hot inflationary environment, interest rates have risen rapidly. The accelerated rise in rates has direct and indirect impacts on both households and businesses. Overall, recessions are a time of economic disruption on many levels and include rising unemployment, falling retail sales, and broader economic contraction.
Impact on businesses
Businesses are faced with labour imbalances, increasing input costs, declining manufacturing activity, and falling industrial production so to survive a downturn, they must adjust. This often results in job cuts as fewer employees are needed to meet reduced demand. Employers respond to the new environment initially by reducing hours, eliminating pay increases, or cutting bonuses. A prolonged downturn may evolve into more significant strategies and force management to layoff or terminate employees. New initiatives may also be introduced to reduce costs and improve agility. Technology may be employed to achieve better productivity at lower costs in the short term, but that could lead to more permanent changes.
Elevated interest rates are reflected in an increased interest expense on debt, which cuts into the company’s profitability. Increased financing costs may result in termination or changes to business plans, as the higher costs may no longer support the business case for various projects. Subsequently, a strategy change or decline in revenue will likely negatively impact the company’s earnings and asset values.
Impact on households
Since employees face an uncertain work situation, household spending is tightened. Negative consumer confidence will have households review their spending, finding ways to stretch their budget by purchasing cheaper substitutes and delaying or forgoing some purchases altogether. The high price of goods and services coupled with stagnating or shrinking incomes squeezes household disposable income. Higher interest rates make debt servicing on variable rate mortgages or lines of credit more expensive. Rising debt servicing costs, a higher cost of living, and limited to nonexistent income growth creates a stressful environment for households.
Household investors will witness company earnings and asset value declines leading to increased volatility in public equity markets and, other asset markets such as housing could also reflect the strained economy. On the other hand, a benefit of higher interest rates is better yields on fixed income investments which is a welcome scenario for many in retirement.
How could a recession impact your life?
Recessions can be deep and long or shallow and short in duration. Often, much of the pain is felt before economists officially confirm a recession is in place. The impact of a recession on an individual or family can vary, depending on their life stage and financial health. Figure 2 shows some opportunities and challenges that could be relevant to those who are transitioning into adulthood, are middle aged, or are seniors.
Figure 2: Economic opportunities and challenges faced in adulthood, middle age, and old age
What can you do to prepare for a recession?
While recessions are cyclical, and the duration or severity of recessions is unknown, it’s useful to take a look at your financial position in advance to be prepared. Some ways you can do this are:
- Plan ahead, make sure you have enough savings set aside and readily available for emergencies and for any big life events like a wedding that are in the near future
- Know what sources of funds are easily accessible to you (e.g., TFSA, line of credit, savings accounts)
- Revisit or prepare a budget so you know the sources and uses of income, and prioritize your spending to ensure the essentials are covered
- In any stage of life, in a high interest rate environment it’s prudent to pay down debt when possible
While recessions present challenges for business owners and individuals at all stages of life, there are also opportunities that might be open to you. For instance, it can be a good time to evaluate your career choice and think about alternative paths should you be faced with a layoff. Remember, recessions don’t last forever. With the help of your advisor and a sound financial plan, stay the course. Making impulsive changes to your investments can be detrimental in the long run. The road may get bumpy, but a smoother road lies ahead.
Sources: Forbes, McKinsey & Company, Equifax
What do I do with my corporately owned life insurance when…?
Kim Stevens, CFP®, CLU®, CHS
Wealth Preservation Advisor, CWB Insurance Solutions
As a licensed insurance advisor, I often get asked, “What do I do with my corporately owned life insurance if my business is sold, winds down, fails or my key employee leaves?” This question is coming up with even more regularity in our current economic environment.
When these situations arise, it’s often desirable to keep the life insurance in force and change the ownership from the operating corporation (opco) to either a holding corporation (holdco) or to a personal policy. Let’s look at the benefits of each.
Benefits of transferring to a personal policy
Personal life insurance can be a valuable financial asset and estate planning tool in various ways. Loved ones can have their lifestyle protected, tax obligations arising in the estate can be planned for, and estate equalization can be achieved. Also, heirs can receive a tax-efficient, confidential, almost immediate distribution of wealth if life insurance is in place.
Transferring a corporately owned policy to a personal policy is a valuable option, especially in situations where the life insured is no longer insurable. Keep in mind that most term life insurance policies in force are usually convertible to a permanent policy without underwriting.
This leads to an important discussion of the implications of changing the ownership of a life insurance policy. When a life insurance policy is transferred from corporate ownership to ownership by a shareholder or employee, it results in a disposition of the policy. This essentially means that the CRA considers the policy sold for value and sees this as a taxable event. The proceeds of disposition are equal to the greater of the Fair Market Value (FMV) of consideration given, Cash Surrender Value (CSV) and Adjusted Cost Basis (ACB). The following issues are also at play:
- Even term insurance policies with no cash value can have an FMV if the life insured has had an impairment in health since the policy was issued, or is simply older so the that the coverage cannot be obtained at the same price. FMV is to be determined by an actuary.
- Any policy gain (calculated as CSV – ACB) is an income gain and treated as interest income to the corporation.
- If a shareholder or employee does not pay FMV for the policy, a taxable benefit can arise which, in the case of transfer to a shareholder, results in double taxation in that the amount is taxable to the shareholder but not deductible to the corporation.
- A transfer to an employee is less onerous in that the corporation would receive a deduction for the amount of the taxable benefit to the employee.
Benefits of transferring to a holdco
Transfers of life insurance from an opco to a holdco is often desirable as it creates an opportunity for the shareholder to pass some of the passive wealth held in holdco on to his or her heirs more tax efficiently.
The policy to be transferred to a holdco is often a term insurance policy and is usually convertible to permanent cash value life insurance, usually Whole Life. A Whole Life policy allows for the growth of a tax-exempt asset class that enjoys long-term Internal Rates of Return equivalent to a taxable balanced portfolio. The policy provides growth in both CSV and death benefit with any growth posted to the policy vesting immediately. Upon the death of the life insured, the death benefit is paid into the corporation tax-free. This creates a credit to the Capital Dividend Account (CDA) to the extent that the death benefit exceeds the ACB of the policy. The heirs then enjoy a tax-free capital dividend out of the corporation from the CDA, greatly magnifying the gift to heirs.
This type of transfer can occur without a shareholder benefit, by paying a dividend-in-kind of the life insurance policy, which may possibly be a tax-free dividend to holdco (see appendix).
An example of how each of these scenarios might play out in real dollar terms can be seen in figure 3.
Figure 3: Various scenarios for a policy transfer
The bottom line is that it’s usually beneficial to retain life insurance policies even after they’re no longer required for the original purpose. But in doing so, there are important tax considerations that need to be addressed when transferring a policy. So, it’s important to engage with someone who knows their way around these issues. Our CWB Wealth Preservation Advisors can help you determine the best course of action for your own situation.
A dividend in kind results in a disposition to the transferor at the greater of CSV and ACB but no shareholder benefit to holdco. The dividend should be tax-free to the holdco as long as there is sufficient “safe income” attributable to the shares of the operating corporation held by the holdco. Safe income is a complex calculation that basically approximates retained earnings adjusted for tax purposes, as calculated by the corporation’s tax advisor.
To be done properly, the FMV of the policy should be assessed by an actuarial firm. The FMV is at least the CSV of the policy, if any. The FMV could be considerably more than the CSV if the insured life is no longer insurable or insurable but with a rating.
Sources: PPI Advisory, The Advisor’s Guide to Life Insurance Taxation, 2022-2023
Thriving through it all
A conversation with Canadian Mat Systems
Thriving in a business can be challenging in any environment, but the past few years have thrown more wildcards at businesses than any of them could have imagined. In these moments, it’s inspiring to look upon those who can tap into their ingenuity and optimism to reimagine what’s possible.
CWB Wealth recently connected with two such individuals: Shawn Beamish and Kel Knutson, CEO and CFO respectively of Canadian Mat Systems (CMS). In our conversation, they share the challenges and opportunities of operating a global firm in today’s economy.
CMS is a leading manufacturer of temporary structural foundation panels commonly called “Mats”. These panels are used to support operational activity in areas of low weight bearing soil conditions. Based in Nisku, Alberta, CMS is a global supplier to customers throughout the U.S., Europe, the Middle East, and Southeast Asia. To learn more, go to www.matsystems.ca.
What challenges have CMS faced over the past 3-5 years, and how did you overcome them?
Being expropriated from our manufacturing facilities took nine years to resolve. On top of that, we lived through various oil and gas price wars. These had significant impacts on commodity prices, and the overall oil and gas sector took a big hit. Add in COVID-19, and it’s been quite hard over the past few years.
But we made it through it all! Our finance and legal teams were amazing in managing extensive details regarding the valuation of our facilities, the cost impacts of relocation, and the operational impact due to expropriation. Likewise, a team commitment to navigating through the oil and gas downturn helped us monitor key performances in a changing sector, manage costs, and diversify product lines beyond oil and gas.
We were declared “Essential Services” when COVID-19 hit, so we continued operating through lockdown. Establishing work processes and tracking systems to ensure all staff were given the tools to remain safe and productive were high priorities for us.
Success amid all these challenges required vision, planning and forecasting, along with close communications with our lender and investors. Above all, it comes down to people. We have a seasoned and talented team that we would take into any business challenge, anywhere in the world.
In 2023, with a possible recession on the near horizon, what are you doing to navigate economic uncertainty?
We draw on lessons learned from the past five years. Notably, that means understanding our clients’ challenges, and communicating with them early and often to create and build confidence in our forecasts.
Based on our collective experience, we can determine key indicators specific to our market as we anticipate the depth and length of disruptions ahead, then nimbly take appropriate steps to mitigate those disruptions. This takes a great team. At the CMS Group, we believe that “A-level players attract A-level players”. Our team is stacked with them, and it makes a huge difference.
Looking further ahead, what do you see as the firm’s greatest opportunities?
We’ll continue to evolve as a best-of-breed operator by capitalizing on our vision and plan, scaling the business in terms of products and geography.
This started years ago when we began pivoting to advanced manufacturing and technologies. Initially, it was an opportunity to innovate in the mat industry by manufacturing lighter composite mats that don’t absorb water and are easier to clean – thus saving money and reducing environmental and social governance (ESG) impacts. This opened opportunities to provide composite products for other applications.
Through Composite Manufacturer of Sustainable Infrastructure, known as CMS Infrastructure (CMSI), we’re positioning ourselves to offer ESG solutions to several sectors, including infrastructure, transportation, civil, marine, and military sectors. Composites offer the opportunity to shift global usage of concrete towards composite products. Concrete is very energy-intensive to produce and the process emits high levels of pollution. It also raises temperatures in city cores and is prone to cracking with extreme shifts in temperatures, causing life expectancies of infrastructure to decrease. By contrast, composite will not crack, takes less energy and pollution to produce, doesn’t retain heat, and has a longer life span.
In thinking about the value of composites, think about bridges. Many were built out of concrete after World War II and their life spans are now coming to an end, as highlighted by a series of collapses across North America. Composite-based bridges have a big role to play here. That’s one reason why CMSI aims to capitalize on the trillions of dollars committed by federal, provincial/state, and municipal governments in Canada and the U.S. to rebuilding aging infrastructure. Composite or Fibreglass Resin Polymer (FRP) is the environmental solution to these problems. In other words, CMSI is equipping Canada to meet these 21st century infrastructure challenges.
We plan to reach into American markets as well. CMSI was recently awarded a large project in Pearl Harbour, Hawaii for the U.S. Military. This led to several additional enquires for other composite innovations. CMSI has also been approached for large overseas infrastructure projects that will see us expand into international markets.
Over the past few years, how has CWB helped CMS position itself for growth?
Through multiple in-person meetings and onsite facility tours, our CWB Account Managers took time to understand the complexity and potential of our businesses in supporting our growth plan. This rare attention to detail and personal connection is very refreshing, and it’s a strength in banking that sets CWB apart. We’re thankful to our CWB team for their talent and dedication.
What advice do you have for business owners trying to navigate volatility?
Understand your clients’ challenges better than they do and provide them with solutions. This puts them at the centre of your work, and helps ensure that you'll be their supplier of choice through good times and bad.
It’s vital to build your best team possible and communicate closely with your lender and investors. Also, know your numbers and always have a plan for the worst-case scenario. Plus, given the pace of things today, navigate one day at a time – don’t borrow trouble. And through it all, have fun with it!
Information presented herein is for discussion and illustrative purposes only and is not a recommendation or an offer or solicitation to buy or sell any securities. Views expressed are as of the date indicated, based on the information available at that time, and may change based on market and other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of CWB Wealth or its affiliates. CWB Wealth does not assume any duty to update any of the information. Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk. Nothing in this content should be considered to be legal or tax advice and you are encouraged to consult your own lawyer, accountant or other advisor before making any financial decision. Quoted yields should not be construed as an amount an investor would receive from the Fund and are subject to change. Investors should consult their financial advisor before making a decision as to whether mutual funds are a suitable investment for them. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments.
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