Canada's Housing Bubble

Oct 11, 2010 Ben Rabidoux financialinsights.wordpress.com

Hello all and Happy Thanksgiving!

I hope this weekend finds you in the company of those you love.

On a day meant for giving thanks for all the blessings we have here in Canada (and we do have much to be thankful for), it seems almost wrong to post anything about the struggling economy and the coming housing bust.  Alas, this is a blog dedicated to serving up the straight goods.  No extreme doom and gloom…our economy will survive, but not sunshine and lollipops either.

So let me highlight a few articles that caught my eye today:

Canadians are the lucky ones

For the most part a good article, though a bit too in line with the ‘thank God we’re more prudent than our dumb neighbours to the south’ mantra we hear constantly in the news.

“This year’s celebrations just happened to coincide with the new (British) government unveiling plans for a festival of cuts that eventually might carve back government spending by a massive 40%, making for a bitter harvest of decades of excess.”

The article then goes on to suggest that we have fared better than our friends across the pond.  To which I would reply, “yes we have fared better…..so far”.  We haven’t had to harvest what we have planted yet, but there will be no crop failure.  Our consumer debt overhang and bubblicious housing market will ensure that growth remains tepid at best for the next few years.  And while our government debt is in slightly better shape, our households are almost equally indebted.

Bottom line is that as things begin to unravel, with the tipping point being either a loss of consumer confidence, a drop in house prices, or both, we will see government deficits rise as tax revenues fall and economic growth stalls.  It’s the much-discussed feedback mechanism of rising home prices buoying consumer confidence and consumer spending, buoying employment, buoying home prices, etc, except it’ll be working in reverse.  It’s why I’m confident forecasting a recession in Canada by Q3 2011.  People will clue in to the fact that as economic growth stalls, debt and ill-advised spending promises made during better times still linger.

With that, we’ll see a new embracing of frugality at all levels of society.  The Toronto mayoral race is an excellent example of what I believe will be one of the key election issue in the next few federal elections:  People are willing to throw their support for someone who promises to restore order to public finances, even if that person is a poorly-spoken buffoon like Ford.  So that means that we will see austerity bite deep at some point in the next few years, beginning at the municipal level and then creeping up. The public is not yet prepared to stomach the inevitable fallout from public sector unions, but let the reality of our economic prospects settle in for a couple years and things will get ugly.  Just look at New Jersey!  A few years ago a guy like Chris Christie would never have had a shot.  They’ve come a long way.  We will too.

Back to the article:

“I make the following predictions for a year from now: the S&P/TSX composite index will be around where it is now, or a little lower, as earnings advances become scarcer in still-struggling economies; interest rates will be a little higher, but not much; Canadian house prices will be 5% to 10% lower; gold and other commodities will hold their value as the U.S. dollar continues to weaken and emerging economies continue to grow; the loonie will be modestly over par against the greenback”

Actually not a bad set of predictions.  I’d agree that there is a greater than 50% chance of the stock markets being lower next year, particularly the financials.  I’d say there is at least a 10-20% chance of a significant correction of 20+ percent within the next year.  I think if house prices were only 5-10% lower, it would be a gift for homeowners and they’d be counting their blessings around the table next year at this time.  I’d say we’ll be 10+ percent down on a year-over-year basis by the new year.  Another 10-20% melt will follow in 2011, meaning that by this time next year, we should see closer to 15-20% off today’s prices.

Finally, the article notes that, “One of the things missing from this recovery and something many of us savers of a certain age will be hoping for by next Thanksgiving is a rise in yields on fixed-income investments.”

I would love to believe that interest rates will rise substantially, but that is just not in the cards.  That’s not how deleveraging cycles play out.  Lest you think that will put a floor under home prices or that home prices need an economic shock to fall significantly, allow me to point to both the US and the Japanese experience, as über low interest rates have done nothing to turn the tide.  Consumer deleveraging and deflation are killers.

The Grope and Flail understands this, as they carried this piece just today.  Key quote:

“The U.S. economy is mired in a slow, grinding recovery where record-low interest rates have failed to produce the borrowing and spending needed to support hiring.”

Yes, that is what happens when an economy relies on consumer spending for 70% of its ‘growth’, but those debtors consumers are maxed out.  Our day is coming.  Our consumers are carrying record levels of debt.  They could justify it as long as their largest asset (their home) continued to rise in value.  But when it stops rising, tapping that shrinking home equity stops looking appealing, and our consumer-driven economy sputters.

The Bank of Canada gets this.  It’s why there won’t be a serious round of rate hiking for at least several years, despite all the stern warnings from Governor Marky about consumer debt levels.  Scotia Bank gets this too.  It’s why they’ve recently changed their interest rate outlook.  They now believe that the Bank will hold the line until late 2011.  I agree.  Of course, that’s been my story all along.  I’ve been surprised that the Bank has risen their rates at all.  Nevertheless, interest rate sensitive investments like long bonds, long dated strips, high quality corporate bonds (non financials), and fixes rate preferreds (non financials), and quality dividend stocks with strong cash positions (I like utilities and some energy plays) will all do well in the near term, particularly on a risk-adjusted basis.  Housing….not so much.

Enjoy your turkey and your family time.  At the end of the day, there are far more important things in life than our finances.  Finances are a means to an end.  It’s your family, friends, and health that make your life what it is.  Don’t take any of them for granted.

Cheers and blessings

Ben