Did cheap money spoil us?

That’s rhetorical. Of course it did. Assets values went up as the cost of cash went down. Yesterday we detailed how that impacted residential real estate. The change in valuations in one single 10-year period was epic. Houses became unaffordable, even with crazy-low loans. Now that interest is normalizing, it’s a deeper crisis.

Cheap money also messed with our heads. Now people truly, deeply believe real estate should go up every year. And their incomes. Plus their TFSAs. This inflationary psychology turned into the real thing, sweeping the price of bananas, life insurance premiums, building materials, puppies and iPhones along with it.

Concurrently, we’re becoming a paunchy, egocentric society with the largest cohort telling is they care more about experiences than accomplishments. As this paleo blog has moaned, it’s WFH, quiet quitting, FIRE and the great resignation which have helped create to record job openings, distraught employers, workplace wastelands and the feeling so many people have that the world owes them a living. After all, didn’t your house make more money than you last year? And if you don’t own property, why work? Because you never will.

Oy. It’s a mess. And now we have this – an abrupt, shocking, aggressive pivot in monetary policy. Rates are going up fast. More to come, And they will stay high in order to crush inflation. On average, it’s taken 10 years for economies to accomplish what the Bank of Canada and the Fed have vowed to do. Will this then be a lost decade?

Click to enlarge. Source: Bank of America; IMF

So everything is being whacked now. Gold. Oil. Equities. Houses. Bonds. Crypto. NFTs. The loonie. Europe. And the old guy across the street on a fixed income.

Friday was ugly.

The S&P 500 has dribbled back down to its June low, erasing the saucy little rally we saw late summer when lots of people thought central banks would cave. They didn’t. Rates are surging higher and risk is off the table. We’re back in the bear.

On Bay Street that $120 barrel of oil is now worth $78. Gold – once touted as an inflation hedge – has faded from two grand an ounce to $1,600. Commodity prices across the board are lower on expectations that the global economy will stall out or retrench as CBs turn the screws and Putin has a loose one. As a result, our market – heavy in commodities and financials – is also laying an egg.

In summery, everything sucks. The good news: it’s temporary, not permanent.

Central bankers know the pain they’re causing, and will eventually pause the rate hikes. Look for that to occur in Q1 or Q2 of 2023. Markets will love it. Additionally, if recession causes inflation to start tanking, more love from equities – which will then look forward to recovery and growth. Meanwhile Russia is losing the war in Ukraine and even a few hundred thousand more kids in uniforms won’t likely change that. At some point next year this conflict will wind down. Markets will surge.

In fact, analysts surveyed by Bloomberg predict nearly 26% returns for the S&P 500 benchmark index over the next 12 months.

What to do?

The best answer is nothing. Never sell into a storm. Do not turn paper losses into real ones unless you actually need the money right now or in the next few weeks or months. Don’t get emotional. Stop looking at your investment accounts every day, week or even month. Never, ever watch BNN. Wean yourself off the comment section. Ignore the professional market bears trying to scare you into subscribing to their newsletter or buying their latest terrifying book.

Instead, keep investing. When you have the money, buy an excellent but battered asset with it. Fill your TFSA and your RRSP, collect the free government money on your kid’s RESP, jump on the new FHSA when it arrives, put that spousal loan into operation and abandon your high-fee mutual funds for superior ETFs.

Remember the rule: buy low, sell high. This is low. Like Fiona, it shall pass.

About the picture: “Bella loves biking and the outdoors,” writes Andy. “She is interested in chasing squirrels over interest rates. She is enthusiastic about investing….her time in going for a run. Thank you for the blog day in and day out.”

Fed dread

Stephen Harper was the PM. Jack Layton passed. So did Osama bin Laden, as President Obama solemnly announced.

It was 2011. Just over a decade ago. The oldest Millennial was turning 30.

Eleven years ago the average five-year mortgage rate was about exactly where it sits today – 5.4%. But house prices were far, far detached from 2022 reality. The average Toronto property, for example, was trading hands for $464,989.

That meant with a 20% down payment ($92,000) the place carried with a mortgage payment of $2,246. That’s about what a 700-foot, one-bedder condo rents for in urbanity these days.

By 2017 mortgage rates had drifted lower along with the bank rate. Newbie buyers could get five-year, fixed-rate financing for just over 2%. But that increased demand, sales and FOMO. The average Toronto property now cost $822,510. To buy it with 20% down required $164,000, but the mortgage payment was just $2,810.

Rates tanked more when the pandemic arrived. By 2021 a fiver had declined to just 1.4%. But cheap money and real estate lust had pushed the average price to $1,136,280. To buy now required a down payment of $227,000, with a monthly financing charge of $3,600. The mortgage debt on the same property had grown by a factor of three since 2011.

Now here we are. 2022. Rates are normalizing, as we told you they eventually would. The big monetary experiment with ever-lower interest is over. It helped the economy get through a credit crisis and a pandemic, but it completely distorted asset values and infected brains.

Now a five-year mortgage is again 5.4%. Prices in Toronto (as in Vancouver and everywhere) have softened, but the average still sits at $1,079,500. To buy that with 20% down requires $216,000 in cash and a monthly payment of $5,221. To qualify for this – even with a huge cash down payment – necessitates an income of more than $200,000. (The average household income in Ontario is just over $79,000.)

The above is self-explanatory. (a) As rates go down, houses go up. (b) Because we’ve just seen the cheapest interest ever, real estate is insanely priced. (c) Home ownership is now largely unattainable. Detached from incomes. (d) Central banks have indicated rates will rise more, and stay there. The Fed made that clear yesterday. (e) Therefore we may be on the cusp of one of the largest drops in housing equity ever.

This is going to be messy way beyond our borders. But Canada’s housing bubble was inflated far more than that of the US. Source: Bloomberg

The above is reflected in the latest stats on Canadian home ownership. The rate peaked at 69% in 2011 and has been fading since then. For kiddos under 30, it’s fallen from 44% a decade ago to 36%. Those in their thirties have seen a drop from 59% to 52%. Concurrently the cohort of renters has grown steadily to one-third of the population.

It’s hard to minimize the change now taking place. Seems all those sellers who withdrew their listings, waiting for a ‘better’ market next Spring, and the Re/Max execs who told you everything would be hunky by October, just don’t get it. Real estate was inexorably poisoned by monetary policy. Average people cannot afford average houses. Building more over the next ten years won’t change a thing – since a lack of homes was never the reason for escalating prices. The cause was low rates. The cure is high rates. Prices must, and will, reset.

This will take time. Most owners still think they won the lottery and are loathe to sell for what they perceive as a loss. Recent buyers refuse to believe they’re under water. Millions of families with mortgages taken at 2%, 3% or even 4% will be renewing soon at 5%, 6% or higher. This is happening while the cost of everything else (food, gas, insurance, Netflix, kibble) has shot higher and as we enter an engineered recession. Central bankers are telling us there’s some ‘pain’ up ahead. Unemployment rates will rise. Income gains will stall.

In other words, society is now paying the price for overly accommodative monetary policy (cheap rates) and fiscal policy extremes (CERB cheques, pandemic business subsidies and a $400 billion deficit). The pendulum swung wildly in our favour. It’s now swinging back.

Those who swarmed this pathetic blog for the past few years saying real estate could never go down and interest rates never rise – because the world was so indebted – were wrong. And – after the Fed’s stark message this week – we now have a glimpse into the next few years. For the indebted, the FOMO victims, the realtor-ravaged and the over-extended, it’s dystopian.

For the vultures, it will eventually be mealtime. Yum.

About the picture: “Garth, this is Louis,” writes Aaron, “a Retriever / Bernese mountain dog mix weighing in at over 100lbs, and Skittles, his older brother. As you can see, the extra large dog bed from Costco was a great investment, gives Skittles more room to stretch out.”