Canada's Housing Bubble

May 24, 2010 Jason Farkas seekingalpha.com

Since Canadian banks were able to avoid most of the credit bubble implosion, due to regulations on what securities they could hold, many people think that Canada must be in fine shape financially. Certain factors lead some market forecasters to proclaim that Canada's future looks bright in the near term: (1) the lack of a banking disruption, (2) new highs in Canadian home prices, and (3) strong stock, commodity and currency markets. However, both the housing situation and the Elliott wave counts in Canada's currency and stock markets should give pause to those who forecast a sizzling summer for our Northern neighbors.

Housing - House prices in Canada are subsidized by the government via its sponsorship of Canadian Mortgage Housing Corporation, the Canadian equivalent to Fannie Mae. The five largest cities in Canada, which represent almost 40% of the population, have a median home price/median income ratio of 5.62, according to a survey bywww.performanceurbanplanning.com. This ratio only reached five times at the U.S. bubble peak. There are also other factors that put this market squarely in the bubble category: record debt levels, low down payments and securitization of 90% of mortgages (hence lower underwriting standards). Sound familiar? Prices have hit new highs in most markets recently, with the median house price in Vancouver now more than nine times the median income, similar to where Miami was in 2006. How far have prices risen? The websitewww.crackshackormansion.com challenges visitors to distinguish a rundown crack house from a million-dollar home in Vancouver, which shows just how little one can get for a million. This situation will likely end in a collapse.


Stocks - The Canadian stock market looks similar to the chart of crude oil for at least the last 10 years. That’s not surprising since Canada is the seventh largest oil-producing nation. While many analysts suggest that Canada will continue to benefit from strong commodity prices, we contend that it's in a vulnerable situation, because it relies on commodity exports and because 80% of those exports go to the U.S., whose economy is having its own problems. That aside, the weekly chart of the DJ Canada Stock Index shows all one needs to know: the five-wave decline in 2008. The chart also happens to reveal a corrective rally of that decline into the .618 retracement level, which could mean that prices are primed to turn down again in wave C (circled). The MACD shows a bearish divergence now, which suggests that it’s a good time to exit Canadian stocks.

Currency – The most exciting opportunity, however, may exist in the Canadian currency. Since early 2009, the Loonie, as the Canadian dollar is affectionately called, has recovered almost all of its 2008 losses. We see some compelling technical reasons for a weaker Canadian dollar:

1. Rally – A five-wave rally unfolded from late 2007 complete with a third-wave acceleration and fourth-wave triangle.

2. Decline – The choppy June 2009-February 2010 period highlights the corrective nature of the entire 2009/2010 decline. The triangle in the X wave position means that the current downward thrust should be terminal, so an upward reversal should soon develop.

3. Divergence – The failure of the RSI and ROC to make new lows along with prices is a bullish momentum divergence because they haven’t confirmed the downtrend. The lack of confirmation puts the indicators in a position to turn up along with prices. Many turning points, like the 2009 high, are marked by divergences of this sort. A break of the down trendline would signal a reversal in the trend.

Our opinion is that Canada’s recent bullish environment is hardly a reason to assume that it will continue unabated. A housing bubble, bearish stock picture and a weaker Canadian dollar are all reasons that the recent rosy environment may wilt in this summer’s heat. The evidence suggests that major turns are about to take the majority of Canadian investors off guard, just as they did one year ago.