Entries from July 2017 ↓

Besides hockey, guilt and crappy donuts, we’re really good at irony. What better example than houses? When times were hard, jobs scarce and the dollar plopping we blew the mother of all real estate gasbags. Now that the economy rocks, a serious correction threatens to become a crash. Fear of missing out has become a scramble to get out. Greed, then panic. It’s so classic.

In this case, however, the better the economy becomes the tougher it might be for the value of your home. The odds of a second interest rate increase in 2017 shot up dramatically on Friday with the latest data. Markets now expect another quarter-point increase on Wednesday, October 25th.

That will raise the prime rate at the banks to 3.2%, move secured lines of credit to within spitting distance of 4% and increase the cost of variable mortgages. Fixed-rate home loans will likely move higher in the week or two prior, as bond yields plump ahead of the central bank move. By the way, this would mean the Bank of Canada benchmark would have doubled in 2017. With more to come.

By historic standards this is still stupid-cheap money. But real estate is fueled by hormones, perceptions and stirred loins. The last rate hike didn’t cause a flurry of offers by people with cheaper pre-approved mortgages, for example, the way many forecast. Instead, it just scared buyers. They smell risk.

The Toronto market continues to collapse. The latest stats build on the numbers this blog gave you a few days ago. Fugly. Bigly. Overall sales were down 39% in the first two weeks of July, with a 45% crumble in deals for detached houses. Semis dropped 43% and condos 35%. Listings are starting to shrink as owners understand the market’s turning toxic and gamble that conditions will be better in the autumn. They won’t be.

In terms of price, the GTA average is $760,356. In April it was $919,589. That’s a fade of more than $159,000, or 17.31%. The declines have been historic: down 6.2% in May, another 8.1% in June, and 4.2% in just the first two weeks of July. In the last 15 days alone the average house shed $34,000, or enough to buy eight or nine used Kias.

By every definition, this is a sharp, deep and ferocious correction. If it were the stock market under discussion, we’d be just days away from an official bear market. That makes talk of a rebound in September kind of comical. Or irresponsible. Any buyer jumping in now to take advantage of a 17% price decline might end up losing all of their equity by the end of the year.

The threats are growing. Higher retail sales in May, a strengthening dollar and robust GDP expansion north of 3% confirm the Bank of Canada was correct in raising its rate this month, and certain to do it again in a few more weeks. Ontario’s anti-bubble measures are only now starting to have a real bite, chasing away foreign capital, whacking amateur landlords with new rent controls and spawning myriad CRA audits.

In BC the lefties are now in control, destined to make the 4% price drop and 80% decline in new home starts even worse. Ottawa has just announced measures to raise $500 million more in taxes from the hides of small businesses and incorporated professionals. And the bank regulator still plans on subjecting all buyers to a new mortgage stress test, even if they have a big down payment.

So how, exactly, are things supposed to get better in six weeks? Household debt will still be off the charts, two-thirds of it in mortgages. The cost of servicing $211 billion in home equity lines of credit will go up again. Governments desperate to stop people from buying digs they cannot afford are not about to reverse course and reflate the bubble. And right around the world, we’re in an environment of tightening monetary policy. In other words, you will never again see a bank offer a five-year 2% mortgage.

Simply put, why would anyone buy a property? The 17% slash in prices has occurred in a short ten weeks. An equal loss could lie ahead between now and the end of September – leading into the next round of rate hikes. Yes, there are more choices, vendors are motivated, conditional sales are back and you can spend $160,000 less than your best friend did in March – who now looks like a moron.

The market will continue to descend until it finds a bottom. Not there yet.

Some months ago the fancy, trophy wife-owning, Porsche-driving, gay sock-wearing, omniscient portfolio manager dudes I work with (who are allowed to blog here occasionally, just to keep them real) had a message.

“We want to scale back on our US weighting,” they said. “Trump scares us.”

“But,” I said, waving the Amazons away from oiling my chiseled torso for a few moments, “the deplorables hanging out at GreaterFool love him. How can he be scary?”

“Risk,” they said. “We’re increasingly disconstructive on the realistic potential for his pro-growth, inflationary and GDP-enhancing expansionist fiscal agenda to actually be effected.”

“So, he’s screwing up?”

“Affirmative.”

And they disappeared back into their trading mosh pit, gold cufflinks glinting in the shards of light piercing the bank tower windows. The Amazons returned to peel grapes and buff toes.

So, exposure to American assets in our model portfolio was trimmed a few points, weighting to Europe was bumped up a little (“valuations are very tasty,” said Ryan) as was the ownership of maple (“relative strength analysis,” said Doug, “indicates a breakout.”). Of course this is not all about Trump, but he looms increasingly large in the minds of portfolio managers everywhere. In fact there’s a growing cadre of PMs who have recently reduced their US exposure to zero.

The reason is simple. After the 2016 election that shocked markets, stuffing Washington with Republicans and thrusting the unelectable billionaire into office, it looked like US public policy would turn on a dime. Trump was seen immediately as the Inflation President, goosing public spending, launching giant infrastructure projects, slashing corporate taxes, slicing through regulation and adopting an expensive, cost-goosing protectionist agenda of America-first. That looked bullish for corporations and profits, so markets rallied to record highs. Valuations went soaring. Investors rocked. And now markets are worth about 20% more than they should be.

Meanwhile, the president has choked – at least as far as many investors see it. No major legislation has passed. Even repealing and replacing Obamacare has proven impossible for a leader who can’t build coalitions. No budget has been enacted. No tax reform bill even drafted, let alone passed. No new bridges or airports built. And Trump has irritated key allies by walking out of the Paris Accord, the Trans-Pacific Partnership and, maybe, NAFTA.

All that is making people wonder if the post-election Trump rally was fueled by expectation and may be dashed by news.

In the past few days, concerns have swelled. The investigation into the relationship between Russia and the Presidential campaign has widened to include Trump’s past business dealings with oligarchs and Russian corporations. His family members will be probed over allegations they embraced shady Ruskies claiming to have dirt on Hillary. The president fired the FBI director investigating him. He just dissed his Attorney-General who refused to stop the Russia probe. And speculation is mounting he may ape Richard Nixon’s suicidal moves and fire the special counsel leading the Congressional inquiry.

“I think,” says Ryan, “there’s now a 50-50 chance he doesn’t finish his term. So, how good is it that we’ve sold off our American small-cap position, and reduced our US weighing by 5%?”

Does this cautious stance mean everybody should run screaming for the exits? Are those professional traders who have opted for a 0% US weighting the smart ones? If Trump blows up, will be take the S&P with him?

Nope. Of course not. Donald Trump is not the USA. He does not run the economy. The data points coming out of America are solid and strong. Corporate profits have been robust and rebounding, with significant future growth forecast. Job creation has been on a multi-year marathon, with most economists now proclaiming the country has full employment. Expansion has been sufficient to withstand three interest rate hikes in the past seven months. The real estate market is stable and expanding. Consumer confidence is near record levels.

Of course (like in Canada) debt is vast and the wealth gap is growing fast. Trump was elected for a reason, and his base remains steadfast.  Should the Donald implode and America polarize, the political and social damage could be as monumental as the man’s ego. But having no exposure to the US in your portfolio? Naaah. Bad idea.

In conclusion: weird times ahead. Be balanced and diversified. Stay invested. Don’t be extreme. Avoid deplorables. They’re gonna be ripe.