Entries from April 2019 ↓

The problem

Let’s start with Vivian. I think she hates me.

“My husband has been reading your blog for a while now,” she writes. “I have a problem.”

Oops. Okay, Viv. Get it off your chest.

“All of your posts about “don’t buy a house” always only take in consideration the money aspect of things. What about the whole comfort side? Knowing you aren’t going to see your entire life go up in flames because the stoned neighbour kid dropped his weed smoke on the carpet and was too stoned to put it out? Or because the old man on the other side fell asleep while cooking? You pay rent for 30 years and after that, what happens? You have nothing. You pay mortgage for 20 years, you can then turn around and sell it and get some of that money back.

“Living in an apartment or townhouse causes stress. Instead of constantly saying buying a house is bad, maybe you should try giving usefull advices on how to do it.

“Dont get me wrong, I have tried investing. I’ve tried placing $100 in a TFSA 3 years ago to see what would happen. I only put this small amount because I was skeptical. Over the years, it dropped down to $97 and now own $100.04. Same with my RRSP. I’ve put more money in it for the last 3 years than what it is currently worth. WOOPDEDOO. Investing is sooooo exciting. I feel like I’ve earned so much money /sarcasm. Investing feels like a risky money scam much more than buying a house to me.

“I have 30k in a regular savings account ready to be used for a downpayment. I fear if I listen to you and my husband and “invest” with it, I will just lose more money. Also, I hate hearing the neighbours yell when I am taking a bath.”

Now, aren’t you happy you’re not married to her? Lord knows what she does in the tub to attract the neighbours’ attention. But she got mine. And this is why we’ve been teetering on the edge of a real estate meltdown. When people who have no money (and thirty grand these days is nothing) think it’s only a blog standing between them and home ownership, disaster is but a few unexpected events away.

Vivian’s right that renting an apartment in the wrong building sucks. But lacking the money to own (clearly the case), she and her poor husband can always rent one. Trying to buy would financially cripple them, and any housing correction would quickly drown their meagre equity and send them deep underwater. But the fact this woman thinks it’s some weird, old guy on the Internet standing between her and heaven is the real concern. How many people believe they’re entitled to real estate? Is it everyone now?

Plus, note the reference to her prolonged and detailed experiment with investing. She lost three bucks. So it must be a scam. Most likely this involved a few units in a high-fee, low-risk, meagre-return mutual fund flogged by [email protected] So combine the two – feeling a house is an entitlement and financial illiteracy – and you get this. The seeds of a market meltdown if anything big goes wrong. A recession. Jobless jump. Rate spike. Trade war. Climate crisis. Unfortunately, we’re closer to this now than a year ago.

The Bank of Canada knows. No coincidence that while holding interest rates steady last week and removing the possibility of any hike for a long time, it dropped a real estate report with a shocking conclusion. The bubble that’s made housing so damned expensive and dangerous to people like Viv, the bank says, was not caused by foreign money. Not by speculators, either. Or the mortgage stress test.

Nope, it was us. Just as this pathetic blog has yammered about for years. The above may have been contributing factors, but it was FOMO and greed which shot values to unsustainable levels, just as fear and debt are bringing them back down.

Because so many people believed Chinese dudes and rich 1%ers were snapping up all the houses and driving prices to the sky, they rushed in to purchase even when (like Vivian) they could ill afford it, taking on huge debt. Then when foreign buyer and anti-speculator taxes hit, people panicked thinking real estate would tank. So it did. When emotion rules, wise decisions vanish.

“Overall,” says the bank’s report, “the evidence presented in this section suggests that the unexplained strength in resales reflects extrapolative expectations, which drove up speculative demand and caused some households to pull forward purchases in fear of later being priced out of the market. Importantly, the provincial housing measures appear to have played the dominant role in eliminating these sources of demand. This is mainly because the measures, while directly targeted at the relatively small portion of home purchases by non-residents, altered the expectations of residents and generated an outsized response in the housing market.”

“The largest impact of the policies,” it concludes, “came through shocks to expectations of domestic homebuyers.”

And what next? No rebound. Too late for that. Prices are still too high. Household debt has exploded to untested levels. The jobs boom is likely over. The economy has done nothing for six months and that is exactly why the Bank of Canada’s jumped on the brakes. The housing market, it says, “is in uncharted territory.”

So, Viv, give it up You cannot afford a house and shouldn’t try. Even if you had funds, this is a poor time to buy. If you don’t like your neighbours, move. And please try to behave in the bath.

About the picture...

Drew in Stoney Creek ON writes: “Kodiak (the dad) is a 6-year-old 140lb purebred  and Tamaya (mom) is a 7-year-old 140lb English Mastiff / St Bernard. They had one litter of 13 pups. Mom had a terrible labour taking the better part of 36 hours to deal with all of them. Due to the birth being so hard on her (and us), that was the first and last litter. Sadly she lost 5 during the birth. The pup here has gone to live in Bowmanville. Thank you for all you do. Give Bandit a tummy rub.”

What comes next

RYAN By Guest Blogger Ryan Lewenza

What a great start to the year! The global equity markets have done a complete 180 from the disastrous fourth quarter with the S&P 500 and TSX both up roughly 17% year-to-date, as of April 22nd. I don’t know who to thank first – the Federal Reserve or President Trump?

In Q4/18 we saw the first 20% correction since the financial crisis with the global equity markets tumbling roughly 10% in October and December. With the weakness in the fourth quarter the S&P 500 and TSX returned -4.4% and -8.9%, respectively, in 2018. In our view, the two key factors behind last year’s decline were the Fed’s four rate hikes and Trump’s ongoing trade war with China (him “going off the rails” in December by threatening to fire the Fed Chairman and his decision to shut down the US government over funding for the border wall didn’t help things!). As I’ve been saying for a while now, Trump is a walking contradiction who brings both good stuff to the economy and stock market (e.g., tax cuts, deregulation) and bad stuff (e.g., tariffs that weigh on economic activity and at times his impulsive and erratic behavior).

The reason I want to thank the Fed and Trump is that they changed course in Q1, which has led to this great recovery in the equity markets. Let me explain.

First the Fed. US growth was strong last year (the US economy grew at a 2.9% pace in 2018) in large part driven by the incredible strength in the US labour market (the US economy added another 2.7 million jobs with the unemployment rate dropping to a multi-decade low of 3.8%).

As such, the Fed felt compelled to hike benchmark rates by 1% last year to 2.5% to avoid over-heating and to move away from the zero-bound interest rates that have existed since the financial crisis.

However, as the global economy began to slow late last year and market volatility increased, the Fed then backed away from future rate hikes stating they had become “data dependent”. This helped catalyze the quick turnaround in the markets and can be seen in the chart below. The chart overlays the S&P 500 with the Goldman Sachs Financial Conditions Index, which tracks interest rates, FX, stock valuations and credit spreads. Note how when the Fed backed off from further rate hikes, interest rates quickly dropped pushing the index lower (Note: it’s inverted on the chart to better show the relationship) and, in turn, the S&P 500 higher. Thanks Fed!

With respect to Trump and his ongoing trade wars, here we’ve seen some very positive developments, which assuredly have contributed to this year’s impressive rally. It appears talks between the US and China are progressing nicely and we could be just a few months away from a landmark trade deal between the two largest economies in the world. If a trade deal is announced, this could be a huge positive for both the global economy and Trump’s presidency. It would remove a lot of uncertainty in the markets, lead to increased purchases of US goods from China, and finally be a major win for President Trump. I believe if a deal is ratified that this could be the most significant achievement of Trump’s presidency, and he should be applauded for this.

Where do we go from here?

If my assessment of the markets are correct, then it’s possible that much of the gains are already baked in, and for the markets to advance meaningfully from here we’ll need something else to incite “animal spirits” and drive the markets higher. No we’re not talking about the arrival of the final season of Game of Thrones (which is awesome); we’re talking about improving fundamentals, particularly, a rebound in global growth and corporate profits.

Equities Rally on Prospect of Less Fed Rate Hikes

Source: Bloomberg, Turner Investments

Momentum in the global economy has been slowing since the summer of last year. This can be seen in economists’ expectations for global growth. Last spring economists were expecting the global economy to grow 3.7% this year and now they see the global economy growing 3.4%.

In our view the slowdown can be attributed to a number of factors including: 1) the uncertainty over Brexit and the impact on the European economy; 2) Trump’s ongoing trade feud with China, which has significantly weighed on the Chinese economy, and 3) the waning effect of the Trump tax cuts on the US economy. But I see reasons for optimism.

First, a mild slowdown, which is what we expect in 2019, is far different than an outright recession. Second, if Trump and China are able to hash out a trade deal this should remove a lot of uncertainty and likely lead to a stabilization of China’s economy. And lastly, many leading indicators that we track suggest a potential bottoming in global economic momentum. In particular, we’ve seen an improvement in some key purchasing managers indices (PMIs), which track manufacturing activity (e.g., China’s PMI increased from a low of 48.3 in January to 50.8 in March) and in the Citigroup Economic Surprise Index for the major economies. This great economic indicator tracks how economic data is coming in versus expectations. As seen below, this index has been steadily declining for over a year but is showing early signs of a possible bottom. If correct, we could be on the cusp of an economic inflection point with stronger economic activity possible in the coming months.

Citigroup’s Surprise Index Could Be Signaling a Bottom

Source: Bloomberg, Turner Investments

This potential turn in the economy couldn’t come at a better time with investor attention turning to US corporate earnings. I believe that for the S&P 500 and TSX to break above the all-time highs and advance further this year, fundamentals (e.g., corporate earnings) need to come through. And while it’s still early in the Q1 earnings season, results so far look to be exceeding expectations.

Currently Q1/19 S&P 500 earnings are tracking for year-over-year growth of roughly 7%. If the remainder of the results track this trend, then earnings will come in 4-5% better than expectations and we should hear a lot less about an “earnings recession”. We were never in this camp believing that earnings were going to slow from last year’s strong results, but still remain positive for 2019. Overall, analysts expect earnings to grow at 8% year-over-year in 2018, which is in-line with our expectations.

In summary, the markets have had a great start to the year and while in the shorter term we could see some consolidation, I believe the fundamentals (improving economy and positive earnings growth) could propel the equity markets even higher this year with the S&P 500 and TSX hitting new all-time highs. Here’s hoping!

Earnings Need to Come Through

Source: Bloomberg, Turner Investments
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.