Jason Kirby with Erica Alini of Maclean's report on The Canada Bubble:
Bob Haber and David Madani are foreigners who have spent a lot of time studying Canada. Haber, an American, was chief investment officer at fund giant Fidelity Canada for 12 years and tracked Canadian stocks from his base in Boston.
Meanwhile, Madani, a New Zealander, spent a decade with the Bank of Canada as a forecaster and policy analyst. Both are outsiders with an acute understanding of the inner workings of the Canadian economy. That is where the similarity ends.
Last December, Haber’s new book, Go Canada: The Coming Boom in the Toronto Stock Market and How to Profit From It, hit bookstores. Haber, who now runs his own investment firm in Boston and manages a series of Go Canada funds for
Toronto-based Canoe Financial, has emerged as one of the most enthusiastic proponents of Canadian investments at a time when the world can’t seem to get enough of us. With Canada’s strong economy and wealth of resources, Haber predicts the S&P/TSX Composite Index could double to 30,000 points within 10 years. “Global growth and all the free money out there are coming together and investors are realizing the best place in the G7 for them to put their money is Canada,” he says. “Things are in gear for Canada to really outperform.”
Madani’s outlook couldn’t be more different, though it tends to get drowned out amid the Canuck euphoria. Last fall, he joined Capital Economics, a prominent U.K. investment research firm, to cover the Canadian market from Toronto. He says the boom in commodities is due for a reversal. More importantly, Canada’s red-hot housing market has soared into the danger zone. By his estimates, house prices are set to plunge at least 25 per cent, and will drag the economy down with them. “Housing has gotten crazy, it’s a bubble,” he says. “These things always have an unhappy ending, and Canada is not going to be any different.”
So there you have it. Canada is either primed to be a world beater, or we’re about to go down the tubes. There’s arguably never been a time when forecasters have been so divided in their views of Canada’s economy. That’s partly due to the seemingly Herculean way we shrugged off the global recession while almost every other developed nation tanked and continues to struggle—a feat that can’t help but arouse a bit of too-good-to-be-true anxiety.
But the division of opinion has to do mostly with the two particular engines that have driven our success—resources and real estate. Both are cyclical. Prices rise and fall as supply and demand shift. Only that’s no longer seen to be the case in Canada. Never mind that some experts now say the surge in commodities exceeds anything we’ve seen in two centuries, or that by many measures the housing market sits at multi-decade highs. Those who see good times ahead are convinced the phenomenal gains reflect a fundamental shift in the global economy. In short, it requires one to ascribe to the four most dangerous words in the world of investing: this time it’s different.
As it is, the love-in for all things Canadian is in full swing. In January, giant U.S. retailer Target announced plans to take over hundreds of Zellers stores in 2013, its first expansion beyond America’s borders. The company expects big things from shoppers here; Target believes its new Canadian stores will help drive annual revenue, now around US$67 billion, to more than US$100 billion over the next few years. And Target is just one of many big name U.S. retailers, including J.Crew, Kohl’s and Marshalls, banking that Canada’s prosperity can make up for sagging sales on their home turf.
Canada is also the toast of international think tanks and world leaders. They praise our sound financial system, which seemingly avoided the traps that engulfed other nations’ banks. Conservative legislators in America and Britain sing the virtues of our relatively sound government finances. Like a cherry on top, the Economist magazine once again just selected Vancouver as the world’s most livable city, with Toronto and Calgary also making it into the top five.
You can read the rest of this long article by clicking here. So is this time different? Is Canada going to coast right through the next decade unscathed? Of course not. I have already referred to a Canadian bubble back in October 2009 when I stated another bubble sooner than you think. It was a very wise senior pension fund manager who opened my eyes to the one bubble that escaped me because I live in Canada and never thought that a major bubble is brewing right in our own backyard.
Of course I never bought into the real estate hype and totally missed the boat on the spectacular run-up in housing prices. My friends were all laughing at me because I preferred renting and waiting for a major correction in housing, which has yet to materialize. But it will and when housing corrects, the Canadian economic miracle will be exposed for what it truly is, lots of hot air driven mostly by speculative flows, not by solid fundamentals.
Canada’s hot housing market may not be in the red zone for prices yet — but it’s getting there, says a new report issued Friday by the Bank of Montreal.
And unless there is some moderation in sales and prices, the market could be setting the stage for a major correction, the B of M report warns.
“While we do not expect a significant correction nationwide, the risk of such would increase, especially in some regions, if prices were to continue to outrun incomes or if interest rates were to increase rapidly,” B of M economist Sal Guateri says.
He says that after slowing last summer, Canadian home sales rebounded in the fall and house prices have kept rising.
On average, home prices are 10 per cent higher now than they were before the recession, when they were at an all-time high.
He notes that after slowing last summer, Canadian home sales rebounded in the fall and house prices have kept rising.
The U.S. realty market may be plagued by falling or stagnant prices, but not Canada’s. Thanks largely to stricter Canadian bank lending standards, Canada hasn’t had a real-estate bubble. Not yet.
I sat in a sun-drenched coffee shop on Vancouver’s trendy Granville Island last month with an old American friend from Portland, OR., who also happens to have a Canadian passport. “The main thing that makes it hard for me to move up here,” he told me, “Is the housing prices. They’re crazy. It’s over $1 million now for a home in Vancouver.”
Prices just keep rising
According to a report in the Toronto Globe and Mail headlined “Home prices nearing bubble territory,” Canadian home sales rebounded in the fall and house prices have kept rising.
“On average, home prices rose 5 per cent in the past year to January, while in Vancouver they rocketed 20 per cent. On average, home prices are 10 per cent higher now than they were before the recession, when they were at an all-time high.
“The problem is that the value of homes have increased much faster than incomes.”
The cautionary Bank of Montreal report says average home resale prices compared with personal incomes are 14 per cent above the long-run trend, up from last summer, although still below the 21-per-cent peak that preceded the 1989 crash.
But that is not the case in all Canadian real-estate markets. Five provinces are currently in the danger zone, led by Saskatchewan, where the ratio is 39 per cent above historic norms. That province has a booming commodities industry, centered around potash and oil.
Also well above the long-run levels is Newfoundland, 34 per cent higher; British Columbia and Manitoba, 31 per cent, and Quebec, 23 per cent above.
By comparison, in the wealthiest province, Ontario, the price-to-income ratio is only 10 per cent higher than historic norms, suggesting prices are moderately overvalued but not in bubble territory.
Outlook could improve
The Globe and Mail piece explains that historically low interest rates, which have allowed Canadians to carry bigger mortgages, have made such realty prices possible. As a result, mortgage payments for the typical owner consume 35 per cent of disposable household income, about the same as the 23-year average of 34 per cent.
The bank says there should be no major correction if incomes increase faster than home prices in the future, as expected.
It says sales are expected to cool and prices to stabilize this year in response to higher interest rates and tighter mortgage rules that go into effect later this month.
As for Vancouver, given that city’s high rate of Asian immigration and investment — plus its scenic beauty and solid infrastructure — who knows? The sky seems to be the limit right now.
No major correction if incomes increase faster than home prices in the future? Come on, who are we kidding here? Australia's Business Spectator posted an excellent article, Is Canadian housing the next domino?:
Canada and Australia have a lot in common. Both economies are commodity exporters. Both countries have experienced similar rates of immigration. Both countries largely dodged the global recession that has recently shocked the developed world. And both are said to have world-beating banking systems, with Canada’s ranked as the strongest and Australia’s ranked third strongest in the world by the World Economic Forum’s Global Competitiveness Report.
As in Australia, there is also widespread debate about whether Canada is experiencing a speculative housing bubble or asset inflation based upon sound fundamentals.
Canadian home values have risen strongly relative to incomes and rents over the past ten years on the back of sharply rising debt levels. The key charts pertaining to the Canadian housing market are below, taken from Capital Economics’ recent Canadian housing and economic updates.
As you can see, there are some striking similarities between the two countries' housing markets. First, the two mineral rich cities of Perth and Calgary experienced their own unique house price booms during the 2006/07 commodities bubble. Second, both countries' governments and central banks were highly successful in reflating their respective housing markets after brief falls during the onset of the global recession.
In Australia’s case, the housing market was reflated by a combination of significantly reduced interest rates, the temporary increase in the first home owners' grant, cash handouts to households, and the temporary relaxation of foreign ownership rules.
Canada’s central bank and government also provided significant stimulus to the housing market. In addition to the Bank of Canada lowering interest rates to record lows (click to view chart), the government significantly loosened mortgage eligibility criteria, culminating in the introduction of the zero-deposit, 40-year mortgage in 2007. Further, the amount that Canadians could borrow was increased, with many individuals in 2009 being granted loans in the $C500,000 to $C800,000 range, provided their household income ranged from $C110,000 to $C170,000.
Finally, in an effort to support the housing market in 2008 (when affordability fell sharply and the economy stalled), the Canadian government directed the Canadian Mortgage and Housing Corporation – the government-owned guarantor of high loan-to-value-ratio mortgages (explained here) – to approve as many high-risk borrowers as possible in order to keep credit flowing. As a result, the approval rate for these risky loans went from 33 per cent in 2007 to 42 per cent in 2008.
By mid-2007, the average Canadian home buyer who took out a mortgage had only 6 per cent equity in their home, suggesting the risk of negative equity is high even if there is only a moderate correction.
The Canadian government has since raised the mortgage eligibility criteria. In October 2008, it discontinued the zero down, 40-year mortgage, reverting back to the 5 per cent down, 35-year mortgage requirement that was in place prior to the global recession. Then, last month, the Canadian government announced that it would reduce the maximum amortisation period for mortgages to 30 years from March, adding around $100 in extra loan repayments to the average mortgage. The government also reduced the maximum amount that Canadians could borrow against the value of their homes – called a Home Equity Line of Credit (HELOC) – from 90 per cent to 85 per cent.
Last week, Capital Economics released its Canada Economic Outlook Report (Q1 2010), which predicts sharp falls in Canadian house prices, household deleveraging, and anaemic economic growth into the future.
The report warns that Canadians' belief that their economy is somehow invincible after emerging from the crisis relatively unscathed is "disconcerting" as house prices lose touch with fundamentals.
"Relative to incomes, our calculations suggest that Canadian housing is now just under 40 per cent over-valued, which is about the same level of excess that the US market reached before it collapsed. We have pencilled in a 25 per cent cumulative decline in house prices over three years, mirroring what happened south of the border.
"The biggest downside risk is that an adverse feedback loop could develop, as it did in the US, with rapidly falling house prices leading to a contraction in both output and employment, which puts even more downward pressure on house prices."
Capital Economics also warns that the government-owned CMHC could be exposed to significant losses should house prices fall significantly.
"According to our reading of CMHC financial statements, insured mortgages and securitised mortgage guarantees total an amount close to $C800 billion. The total equity of CMHC is $C10 billion.
"If house prices collapse further than we predict, say by 35 per cent, with a default rate of 10 per cent and average home equity of 10 per cent, then the potential capital loss amounts to $C20 billion.
"Even if we assume that half of this amount is eventually recovered, that still leaves an expected loss of around $C10 billion. Under the same assumptions, the 25 per cent decline in house prices that we expect over the next few years would still result in a considerable loss of around $C6 billion."
Only a year ago, the mainstream view in Canada was that the housing market was bullet-proof and that a US-style meltdown was highly improbable. Now sentiment appears to have changed following a collapse of sales, a build-up of inventory, and three consecutive months of price falls between September and November (December recorded a 0.3 per cent rise).
Will Canada be the next housing market to fall? Watch this space.
Yes, it's only a matter of time before the Canadian housing market gets hit hard. It's worth noting that the CMHC recently came out to publicly defend itself against its critics. Why such a public response from an agency that's typically very low key? Are they worried over at Canada's Moral Hazard Corporation?
If they aren't, they should be. We should all learn the lessons from housing bubbles worldwide:
Whether we are talking about people, trees, or real estate markets, this same idiom holds true. Since the recessionary period in the 1990s, the economies of most developed nations have been growing at a rapid pace and their real estate values have followed. Home values in some countries have grown more quickly than others, and due to this rapid growth, many of them also experienced rapid declines following the credit crunch.
Prices in perspective
To provide some perspective on the “bubbles” which supposedly formed in global real estate markets over the past decade, here is a housing price index from The Economist showing home prices in Australia, Britain, Canada and the United States over the past 10 years (see chart above).
During the past decade, global economies recovered from the dot-com crash and real estate values went on a tear in most of the developed world. What we can see from this graph is that the countries who showed the greatest growth were later hit by the greatest declines. Australia and Britain had a great run over the first 7 years of the new millennium, but were stopped in their tracks as the global financial crisis unfolded. Things started to unravel a little quicker for the United States where the mortgage defaults started to occur first. In Canada, price growth was much more modest, but the decline in house prices that followed was the smallest of the bunch.
Another interesting observation that may not be apparent from media headlines is that even in real (inflation adjusted) terms, house prices in each of these countries are still ahead of where they were at the beginning of the last decade.
Learn From History
It’s easy to get caught up in the hype, especially when things are going well. With double digit growth rates, who wouldn’t be excited to get into the market? When things start to heat up, here are a couple lessons we can take away from our recent recession.
1. Look for Sustainability
The important thing is to ensure you are investing in properties which offer sustainable growth potential for the future. Take a look at the national and regional economies to determine whether they are poised to grow. Beyond that, drill down to the individual property and look at whether your monthly cash flow should be expected to grow or shrink based on economic trends.
2. Be Prepared for Price Dips
Now that we know that prices don’t always go up from recent experience, we need to make sure we can hang onto our properties through any price corrections so we are not forced to sell. As long as we have enough cash flow to ride out price fluctuations, we won’t be forced to take a loss while the real estate market hits a temporary bottom.
The problem is that Canadians are indebtted up to their eyeballs. Canadian household debt continued to grow at a faster rate than assets in the fourth quarter of 2010, Statistics Canada reported Monday:
The average debt-to-personal disposable income ratio edged down to 146.8 per cent in the quarter, but only because a 1.8 per cent gain in average personal disposable income outpaced a gain in credit market debt.
The ratio of household debt to assets remained high, by historical standards, and homeowner's equity, or market value minus debt, continued a three year slide, reaching the slowest level since 2001.
But the rate at which Canadians piled on debt slowed, with nonmortgage credit, such as credit cards, slowing the most, at 5.8 per cent from a year ago. That was its slowest growth rate since the mid-1990s.
Overall household liabilities grew by 6.5 per cent from the same period a year ago levels. That was its slowest annual growth rate since the fourth quarter of 2002.
The value of financial assets, including investments in stocks and bonds, grew by six per cent from the same period a year earlier.
Someone recently told me that our policymakers are "smug" about the Canadian economy and believe that we will escape the hardship that the US suffered. I wish I can share their optimism but it's a fool's paradise. Sooner or later, we're going to find out the harsh lessons of worldwide real estate bubbles and when Canada's housing bubble pops, the fallout will be felt for years.