Entries from February 2017 ↓


Young Dorothy and I built our first house decades ago. On the cheap. So much alum siding it looked like a giant can of tuna. But it was home. And we could come up with the mandatory 10% down payment – ten grand. Of course, the mortgage rate was 12.5%. And then, three years later, we had to sell and chase better jobs. Lost money. Real estate had fallen. The mortgage break fee alone was excruciating. There was a recession at the time and getting out was a narrow escape. “Well,” I remember saying to her when it was all done, “that sucked.”

Lately money’s been cheap and houses dear. In fact, Canada has a real estate bubble – at least in a couple of cities – that’s made headlines around the world. No generation prior has paid so much for a home nor been willing to shoulder so much debt. Never before in history has the cost of a house detached so seriously from what people actually earn. Never have we seen young people so hungrily make up the difference with borrowed money.

Apparently it’s about to get worse. Think of Isaac Newton. More on that dude in a minute.

Many blog dogs felt pooched yesterday by a new survey from HSBC on our needy Millennials. The kids are lining up to step off the cliff. Among the two-thirds who don’t presently own real estate, a staggering 82% indicate they intend to buy within the next five years – yes, salivating to grab assets that have never cost more. But 73% of these same people admit they’ve saved nothing and have no plan. That’s where Mom comes in.

Close to 40% of the owner-kids say they bought thanks to a withdrawal from the Bank of Mom, with half of them having to ask for more to cover unexpected costs. Oops. But why are the Mills so house lusty? First, their parents facilitate and encourage this behaviour, because real estate worked for them. Second, houses always go up (see the underwhelming blog post on recency bias yesterday). Third, financial illiteracy is rampant and most moisters wouldn’t know an ETF from an STD. Fourth, peer pressure. When everybody’s doing something, everybody wants in. The herd speaks with a single voice.

So, on to Newton. Trust me. It’s relevant.

In 1711, shortly before most Boomers were born, the South Sea Company was created and given a monopoly on trade with Spanish colonies in South America by the British government, in return for absorbing that country’s war debt. Cool deal, it seemed. Innovative. Investors loved it and bought in.

By 1720 the shares were £128 when evil insiders circulated false claims about revenues. That drove the stock to £175 and attracted a lot of new investors into this sexy play, including Sir Isaac Newton, the gravity-discovering guy and primo scientist of his day. Great move. Within months Newton had doubled his money with the price rising to more than £330. Like the supremely wise person he was, Newton decided to get out, pocket his profits and move on.

However, like a slanted semi in Leslieville or a Vancouver Special, this puppy continued to rise in value as more and more greater fools piled in and made huge returns. In fact, by the summer of 1720 shares had surged to £1,050. Newton’s buds were rolling in it. So, envious, back he went – buying into the venture at a level thrice that at which he’d sold – just a matter of weeks before the peak. By that autumn the bubble had burst – since pure speculation, recency bias and greed were behind it. Shares crashed to £175. Newton lost twenty thousand pounds – the equivalent of more than $3,000,000 – and exited the investment broke. His journey had been comprised of four stops: greed and satisfaction, followed by envy and despair.

Okay, so that was 300 years ago, and you don’t care? Well, the same happened with Toronto property in 1989. Dot-com and tech stocks in 2000. Gold in 2011. Vancouver in 2015. Houses in Markham, 2017. Whenever assets erupt in value, driven not by fundamentals but by emotion (and especially when supported by debt), it does not end well. The last in are the first to be squished. Those who don’t take windfall profits risk lasting regret. Fools who trade up in a rising market become greater fools. And parents pushing kids into real estate they have not earned and debt they don’t deserve do them no favour.

Stuart is a seasoned, experienced, big shot portfolio manager with one of the bank-owned wealth management outfits. It was he who this week reminded me of Newton’s putz.

“Time will tell,” he says, “but I couldn’t help but ponder the potential similarities that may occur with our Vancouver (and Toronto) real estate valuations; psychology and end points.  I think that guys like you and me see these things in a different manner because we deal with “bubbles” in many forms on a constant basis.

“I have noticed that most often I am too early on the sell side because of the self-fulfilling destiny of capital flows from the herd,  that drive simple overvaluation to absurdity.  Michael Burry of course was 100% right in shorting the CDS’s but was “early”  as valuations went from stupid to demented… eventually he was vindicated.  Anyway, the day will come…and as you have pointed out I suspect it’s begun already out here.

“As Buffett says ‘What the wise do in the beginning, fools do in the end’…..I also like ‘The decline in any bubble will be equal and opposite to the delusion which preceded it.’”

Be careful what you covet. It’s a long way down.

What could go wrong?

If you’ve never heard of recency bias, time to learn.

It’s simple. Makes people behave like dogs. It’s the expectation what just happened will continue to occur because, well, it just happened. This goes to memory. Since we recall recent events far better than past ones, they have more weight. Recency bias leads zillions of investors over the edge, since they expect stock markets that have gone up recently to go up forever, or falling assets to hit zero.

Ditto for houses. Even more so, actually, since real estate’s the very reason most Canadians exist. When property values rise, we anticipate more increases. When they erupt, we expect an endless boom. Recency bias is a dangerous thing as it crowds out logic, analysis or risk management – a daily event in hyperventilating places like the godless GTA.

We have stats to prove it.

Each week my pal Nik Nanos does a poll for Bloomberg on how Canadians feel about things. They’re shrugging off mounting risks and warnings about real estate and, in the wake of January’s epic 23% year/year Toronto price gain, doubling down on inflated houses. No matter that BMO now calls it a bubble, that Trump could easily blow things up (see below), that the odds of higher rates are rising, that affordabililty is plunging or governments  seriously considering more market-dousing actions, we’re horny, baby!

The Bloomberg Nanos Canadian Confidence Index has wobbled higher with just 10% now believing house prices could fall (the lowest level in three years) and the proportion of RE bulls climbing to almost 42%. This is even more interesting since a majority think their personal finances suck. A year ago 15% said they were worse off than twelve months earlier, now that’s almost doubled to 28%.

Why the discrepancy?

Yup, recency bias. The belief that what you see is what you’ll get. Logic tells us no asset class can rise at ten times the rate of inflation, be completely detached from economic fundamentals or so dramatically leveraged to a rising mountain of debt, but this is not about rationality. It’s all emotion. Expectation is running rampant. The last time the scent was this strong was 2000, and it smelled like Nortel.

What about stock markets and other financial assets? Aren’t they rising as dangerously, based on the sheer investor euphoria? Maybe. Or not. It’s important to remember people don’t buy mutual funds or ETFs with 95% financing, which would make any large downturn a lot less consequential. Equity values are also based on corporate earnings, not just hormones, providing some measureable metrics (unlike a $1.5 million semi in Toronto).

Having said that, look at this…

Tomorrow (Tuesday) the Trumpster gives a speech to Congress which has all the import of a year-end State of the Union address, and the potential impact of a federal budget. Since his election last November, markets have viewed this wacky guy as a pro-business pumper with a cabinet stuffed with billionaire buddies who’ll do whatever it takes to goose profits and make capitalism great again. The expectation of a corporate tax cut plus relaxed regulations and fatter bottom lines is rampant. He’d better deliver.

Since the November 8th vote stocks have shot up 10% with 17 record closes, making investors about $2.8 trillion wealthier. Yes, the economy’s been a good performer (great job creation numbers, for example, and rebounding corporate profits), but a big part of this surge has been Trumpism – the gamble that he’ll actually come through with the pro-business agenda. That has also boosted the US dollar while depressing bond prices and inflating yields. This has also boosted the odds of a Fed rate hike in March to 40%, and to over 70% by later in the year.

If Trump unveils a plan, there’ll be a large reaction. Volatility could spike from current low levels and equities pop. If he doesn’t have one and spends an hour talking about fake news, spend the day with your dog instead of watching BNN (which is always a bad idea, anyway). If the plan’s tepid, same result. Be very thankful your portfolio is balanced.

The message today is simple. You have no idea what’s coming. Unpredictability is rampant. Donald Trump is its face. If you put all your eggs in one basket – whether a mess of stocks or a McMansion worth millions – be prepared to learn what just happened probably means nothing. Your dog knows.