Canada's Housing Bubble

Aug 8, 2011 Ben Rabidoux theeconomicanalyst.com

S&P Slaps US sovereign debt

What a crazy weekend.  For those who may have been living in a cave for the weekend, you may not have heard that S&P downgraded US sovereign debt from AAA to AA+ with a negative outlook.  In addition, the official statement included a rather scathing rebuke of US governance and policy making, a move that somewhat surprises me given that the US is not nearly in the worst shape of the AAA rated countries.  The UK and Japan take that prize.

Europe continues to struggle with massive sovereign debt issues of its own as the vigilantes in the bond market have taken the whip to Italy and Spain.  Expect central bank intervention to purchase Italian bonds this week to try to stem the tide.

With all this as a backdrop, it’s no wonder that global stocks are selling off as I write this, with US futures markets decidedly in the red by about 2% across the board.

This week will be interesting indeed.  Expect some US dollar weakness, though I wouldn’t be surprised if it doesn’t last.  Gold will be strong.  Stocks will continue to price in heightened risk.  But what about Canadian bonds?  That’s a tough one.  With the US now losing the coveted AAA rating, it creates problems for large pension funds and some central banks that must hold AAA rated sovereign debt.  No doubt they will be selling.  Expect interest rates in the US to rise, which would normally be followed closely by Canadian rates.  But that capital must be reinvested.  Will it find its way into the Canadian debt market, pushing yields lower and driving up the spread between US and Canadian bonds?  I expect so....but nothing will be predictable over the next few weeks.

My experience with BNN

I was also on BNN on Friday for what in hindsight was a somewhat silly interview.  What else can be expected from a 6 minute interview in which I am expected to outline the case for a Canadian housing market bubble (or significant overvaluation issue at least), explain the psychological factors at play, and detail why I think a soft landing is not the most likely outcome.  In six minutes.  I realize now that segments like this are really only interested in ‘talking points’.  “Just give us your opinion....none of that explaining stuff....just the points....preferably in 6 words or less....”

But how do you say no to BNN?  I am grateful for the opportunity, but I’m not sure that in the future I would agree to such a short interview dealing with such complex topics.   Here’s the clip...You’ll see what I mean.

After the interview, I received a few emails from people asking me if I had softened my stance on the existence of a Canadian housing bubble.  My answer is an emphatic ‘no’.  I still firmly believe that the data suggests that on a national basis, Canadian house prices have to fall 20-25% to realign with underlying fundamentals.  Of course that decline would not be uniform, as we should all be acutely aware by now that different cities have seen house prices diverge from fundamentals to a far greater degree than others.  Please refer to my posts showing house prices and rents, house prices and per capita GDP, and house prices and disposable incomes, as they all confirm this.

Here’s what I’m learning.  Try telling someone that you think Canada is experiencing a housing bubble.  What is their response?  My experience is that the word ‘bubble’ conjures up all sorts of images of the hardest hit areas south of the border.  It evokes extreme emotions and generally causes people to close their minds.

Instead, try telling people that you believe that there is a significant overvaluation issue in Canada and you’re concerned with what it implies for the future performance of real estate as an asset class.

Have you not just said the same thing?  But isn’t it interesting how much easier it is to have an intelligent conversation with people when you frame the issue in this way?  We’re such strange creatures...

Cheers,

Ben