Canada's Housing Bubble

Can the unprecedented boom in housing prices continue?

The largest increase ever seen in Canadian housing prices has wrenched real estate out of its usual alignment to people’s income, Capital Economics’ David Madani says. He believes the signs increasingly point to a housing bubble.

“The stories we hear about people buying homes to rent out as investment properties, and others buying homes fearing that if they wait they will be priced out of the market, only convince us even more,” he writes in a research note.

It’s mass psychology – “animal spirits” – that has driven up housing prices to unsustainable levels, he believes. The upshot: He expects house prices to fall by 25 per cent over the next few years.

In the short term, Mr. Madani sees any further gains as modest. “Housing affordability is already stretched, with costs accounting for a very large share of household income, over 40 per cent according to some estimates.”

The recent tightening of mortgage insurance rules may have a dampening effect on the market. Given the recent easing in the sales-to-listings ratio, housing prices could start to retreat late this year or early next year, he warns.

Emerging markets to the rescue?

As clouds of gloom gather over the economic outlook for North American and Europe, some experts point to relatively healthy growth in emerging markets as reason to remain optimistic about the global economy.

But not so fast, economist Neil Shearing of Capital Economics says.

In a research report, he acknowledges that emerging economies should grow by an average of 6 per cent annually over the next few years despite the problems in the West. In previous decades, the strong growth would have translated into a healthy demand for the developed world’s exports and helped to prevent the U.S. and Europe from slipping back into recession.

The hitch this time is that the emerging world will continue to run a large current account surplus – it will sell more to the developed world than it consumes.

Indeed, the size of the emerging economies’ surplus will increase this year, Mr. Shearing says. “In other words, far from helping the developed world out of its rut, emerging economies are becoming an increasing drag on demand in the rest of the world.”

Cars drive retail sales

Canadian retail sales were up in June – 0.7 per cent to $37.8-billion. A welcome bit of news.

But look more closely and the picture is mixed. Sales in sporting goods, books and building materials were up. But electronics and appliance sales fell 3 per cent. Spending on other big-ticket items – such as furniture and home furnishings, up only 0.4 per cent – was on the soft side, while electronics were below year-ago levels for the first time in 16 months.

The real boost to June retail sales came from a sharp bounce in auto sales due to steep dealer discounting, CIBC World Markets economist Emanuella Enenajor says.

Auto sales had been weakening since November of last year and June’s earlier and steeper-than-usual dealer and factory discounts were key to bumping up sales in this category, she writes in a research report.

Ms. Enenajor warns that June may be just a blip. “Although many of those discounts stretched into July, the Statistics Canada vehicle sales report previewed a decline in auto sales for that month, suggesting that June’s one-month upturn in sales activity is not the start of a sustained trend.”

Once auto sales are removed from the equation, retail sales actually fell by 0.1 per cent. “The shopping fever wasn’t widespread,” she concludes.