Short the banks?!

RYAN By Guest Blogger Ryan Lewenza

Here we go again! For a number of years now investors have been trying (unsuccessfully) to bet against the Canadian banks by “shorting” them (shorting involves selling shares first with the expectation they will decline in price then buying them back at lower prices). The most recent big player to jump on this trade is US portfolio manager Steve Eisman. Anyone who has seen the movie (or read the great book by Michael Lewis), The Big Short, may recognize this name, as he is famous for calling the US housing market top and made millions by shorting the US banks before the financial crisis. The actor Steve Carell portrayed him in the movie. Well, he’s back at it, this time shorting the Canadian banks, largely based on his concerns around the Canadian housing market. Will he be right again?

The short thesis on our banks is that our 20 year plus housing bubble will inevitably burst, taking the Canadian banks down with it, similar to the US experience during the 2008 financial crisis. I believe this thesis is overly simplistic and misses the mark on a number of fronts.

First, there are a number of differences between US and Canadian mortgages, which I believe make us less vulnerable to a 2008-like US housing crash. In the US most mortgages are “non-recourse”, which means the homeowner can simply walk away from a home that is underwater (outstanding mortgage is higher than the home value), with little additional consequences. In Canada most of our mortgages are recourse loans, which means the lender can go after the homeowner for any shortfall if they default on the mortgage. This could include garnishing future wages, for example. Additionally, most mortgages are insured by the CMHC putting the Federal government, rather than the banks, on the hook for a mortgage default. These two important differences help to reduce risk for our banks.

Second, the Canadian banks are less leveraged to the housing sector and overall Canadian economy than they once were. During the financial crisis our banks were able to take advantage of their relative strength and stability by acquiring large US financial institutions on the cheap. TD Bank, Royal and others made large US acquisitions, which has significantly increased their exposure and revenues to the US markets. Roughly 25% of Canadian bank revenues now come from the US. TD Bank, for example, now has more branches in the US than in Canada!

Third, the banks are trading at attractive valuations making them less vulnerable to significant downside pressure. Currently the Canadian banks are trading at an attractive 10x earnings, which is more than one standard deviation below the long-term average. Shorting Tesla at 60x earnings makes more sense to me than shorting the Canadian banks at 10x earnings.

Canadian Banks Trade at an Attractive 10x Earnings

Source: Bloomberg, Turner Investments

Fourth, current valuations suggest good upside over the next few years. Below is a great chart that overlays 2-year forward returns with bank P/Es. At 10x earnings currently it suggests returns of 20% plus over the next few years based on this historical relationship (Note: the P/Es are inverted to better capture this important relationship).

Attractive Valuations Suggests Good Upside over the Next Few Years

Source: Bloomberg, Turner Investments

Fifth is earnings and I suspect this is where the short sellers believe they are going to make their money. Having worked at one of the big banks for 15 years (the green one), I had first-hand knowledge of their incredible earnings power.

You know how you gripe every month about your banking fees and high credit card charges. You can hit back at them by owning and profiting off them. Speaking about profits, banks make a lot of them. Below I show the total annual bank earnings over the last 25 years. See a trend here? Earnings have grown 13% annually since 1995 and are approaching the $50 billion level in total annual profits. Barring a complete economic meltdown, which we believe is highly unlikely over the next few years, I don’t see this trend ending anytime soon.

Annual Big 6 Bank Earnings

Source: Bloomberg, Turner Investments

Lastly, short sellers need to cover the dividend yield, which is roughly 4% for the Big 6 banks. Add in the margin loan expense in shorting stocks (roughly 5%) and the short seller would need bank stocks to fall 9-10% before they even make a dime!

We’ve written ad nauseam about our concerns over Canadian housing, buy don’t misinterpret these concerns for some deep seated worry around our banks. We don’t foresee a 2008-like US housing crash and, as we’ve laid out in this blog post, we believe the banks remain very strong and should be core holdings for long-term investors. We, of course, get our bank exposure through broad-based ETFs and, in fact, have been adding to beaten up dividend ETFs in client portfolios, which include the banks as top holdings. If my chart above proves correct, we could be looking at decent returns from the banks over the next few years. So Steve Eisman, take that!

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.


The fraud

Five years ago this pathetic blog prattled on about the Frankenumbers realtors were churning out. Monthly, for example, the Toronto cartel would quietly revise old stats to eliminate deals that didn’t close, without public disclosure. Realtors would double or triple-list a home (ie. on multiple boards) and sales stats would plump as a result. Published selling prices would sometimes be greater than the actual amount, thanks to agent misreporting. And FSBO (sale by owner) listings materialized in the summer of 2013, padding the numbers.

Of course, we also got the infamous HPI – Home Price Index abomination – designed to smooth out monthly fluctuations, masking market momentum. Meanwhile monthly reports have routinely been designed to give a false impression of current conditions. Like this one from a few days ago:

TREB President Garry Bhaura announced that Greater Toronto Area REALTORS® reported 4,009 home sales through TREB’s MLS® in January 2019 – up by 0.6 per cent compared to January 2018. On a preliminary seasonally adjusted basis, sales were up by 3.4 per cent compared to December 2018.

“It is encouraging to see the slight increase in January transactions on a year-over-year basis, even with the inclement weather experienced in the GTA region during the last week of the month. The fact that the number of transactions edged upwards is in line with TREB’s forecast for higher sales in calendar year 2019,” said Mr. Bhaura.

The MLS® HPI Composite Benchmark price was up by 2.7 per cent compared to January 2018. The condominium apartment market segment continued to lead the way in terms of price growth. The average selling price was up by 1.7 per cent on a year-over-year basis.

But here’s the reality. As reported here ten days ago, the current average detached 416 price of $1.174 million is 13.3% lower than it was exactly 12 months ago. Someone needing to sell would have a loss of more than $180,000 plus $47,138 in land transfer tax (paid when they bought) and another $58,700 in commission. The total hit = $285,800, or 21%. The average detached house in the heart of the GTA is changing hands for 12% less than in the Spring of last year and a 25.6% below what it commanded the previous year.

 There may be more truthiness in a North Korean state TV broadcast than a Toronto Real Estate media release. Despite the fact Canadians have shoveled more money into residential real estate than any other asset, realtors routinely fudge, fabricate and lie. If they were selling a few hundred dollars’ worth ETFs or stocks instead of million-dollar properties, they’d be flamed, fined or barred.

Some boards have fessed up to their sad ways. For example, the one in Hamilton  published a mea culpa media release that begins: “The REALTORS® Association of Hamilton-Burlington has revised the 2018 year-end market data and reports. Inconsistencies were found within the 2017 data related to listings posted on multiple MLS® systems. These “double listings” resulted in the sales and listings figures being higher than what actually took place in 2017.”

One reason this admission happened was local disturber and former badboy realtor Ross Kay, who’s made exposing crap data his life’s work. Kay argues the industry’s deliberate attempts to inflate sales figures for the last five years materially gassed the housing bubble, led scores of people to buy in haste and pay too much, while polluting the very stats that are used by industry, analysts and governments to set housing policy.

This week, he adds, it happened again as CREA published national numbers for January. “Over 3.5 million families traded homes since May of 2013,” Kay says. “They made those trades using bad data and bad market intelligence. These inflated monthly sales stats are in effect a primary reason why Canada’s housing bubble had inflated as big as it had since 2013.”

“This means every housing chart in Canada posted by a bank, a ratings agency, an economist, a government or a realtor-blogger looking for attention was a lie.  The sales volumes governments relied upon to calculate their budgets were wrong.  The LTVs produced in bank quarterly reports were false.  The false narrative of the impact of B20 (stress test) is now debunked in that the national market turned in 2015 not 2018.”

And Kay adds this illuminating fact: “We are now into the 6th reporting week of 2019 and I can guarantee nationally home buyers have purchased fewer home each week as they did throughout all 52 weeks in 2018.”

Well, Mr. Kay’s voice is one the cartel would rather not hear. And yet the official admission of counting sales multiple times, plus the yawning divide between street prices and realtor stats gives him a growing cred. Dishonesty in data collection and dissemination is a big deal when the industry reports on itself. How many families were infected by realtor-induced FOMO, buying too fast or paying too much? How many sellers have kept prices high, based on a false narrative of the market? Are the regulators blind, or just incompetent? And how about the media outlets who print realtor states, word-for-word, as news?

There’s a special place in hell for those who trick and lead astray anyone who trusts. It will be a crowded house.