More red lights in China; House prices at a stalemate?

Tomorrow we’ll do another monthly round-up of the big real estate board stats.  Victoria and Calgary are out already.  Toronto and Vancouver come out tomorrow.  Should be fun!

Red lights in China…What’s next for commodities?

Hat tip to Donald for emailing me this story.

China leading indicators flashing red lights

It appears that the leading indicator indexes calculated by both the OECD and the Chinese National Bureau of Stats are both signaling strong coming weakness in China’s economy.

“Once again, investors see China plays as the only investment game in town. (We) remain convinced we are witnessing a bubble of epic proportions which will burst – catching investors as unawares as the bursting of the Asian bubbles of the mid-1990s”

“Once again, China’s leading indicator is pointing towards a very significant slowdown in economic growth ahead.”

The last time we’ve seen Chinese leading indicators plunge at this rate, the commodity bubble was about to burst.  The graph below shows the OECD leading indicator for China in red, with commodity prices in black.

China’s own stats agency confirms this slowdown.

I’m bullish on commodities over the longer term, without a doubt.  But it’s also my conviction that the sharp rise in commodity prices of late are largely based on demand out of emerging markets and continued speculation in futures markets (see CFTC’s commitment of traders reports).  This surge in prices has been bullish for the Canadian stock market and to an extent it has helped pad Canada’s export totals.

I’m not convinced that the current rise in prices has been driven by underlying fundamentals.  If I were a betting man, I’d be inclined to say that the odds of a commodity repricing is above 50-50, meaning more volatility for the commodity-heavy TSX.

Keep in mind that the current moves in gold and silver strongly suggest that it is being priced as a currency rather than a commodity.  Though we may see some strong pullbacks in both gold and silver, these are only buying opportunities.

House prices at a stalemate?

It won’t be until mid December that CREA releases their final November numbers.  It’s going to be close as to whether or not the aggregate home price will be up or down.  The reporting boards so far are showing either flat or falling prices.  Vancouver and Toronto will be the big news.  I expect both to be relatively flat year-over-year, though Toronto had some mind-boggling mid-month stats.

I’m sure sales will continue to be near decade lows in all the bog boards, with listings also cratering. It’s at times like this, where buyers and sellers seem to be in a stalemate, that looking back at how housing booms and busts have played out in other countries may offer insights for both camps.

Robert Shiller may well be the world’s leading expert in bubbles and bubble psychology.  It’s worth reading anything of his that you can your hands on, particularly his books.  Back in August of 2005, at a time when the US national real estate market was experiencing just a minor 3 percent fall in sales with prices still rising, Shiller gave this interesting interview for Fox news:

Is the housing market about to bubble over?

“(A bubble is) a social contagion,” he says, “An epidemic whose mode of transmission is word of mouth. It’s emotional. People keep hearing about price increases. There’s a tinge of envy about other people who have done well, which brings more and more people into the market. This, in turn, pushes prices up.” In other words, it’s a self-fulfilling prophecy.”

But…

“It’s naturally self-limiting.  Prices can’t continue to go up forever.”

As Shiller notes, a bubble is a social contagion.  For a bubble to grow, it requires a widespread belief in an asset class and widespread participation in it.  Now how might one know whether or not we’ve experienced this here in Canada?  Let me suggest that there are two gauges to measure this: ownership rates and consumer sentiment/expectations.

With regards to ownership rates, we know that it has risen across all demographics since 2000.  It has now surpassed the US high water mark, currently sitting above 70% here in Canada.

This participation lasts only as long as people are convinced that real estate prices will increase substantially.  So it is worth keeping an eye on bullish sentiment within the broader population.  This is also at extreme levels.  RBC periodically runs consumer sentiment polls related to housing.  Back in March they reported that 92% of Ontarians consider real estate an excellent investment.  With perhaps the exception of Alberta, which is well below its peak, I don’t see any reason why people in other provinces would feel differently.

Shiller adds these thoughts:

“(Owning a home) has become a self-respect issue. You have to own your house now. It’s humiliating not to own a home. It’s a frightening thought.”

Indeed.  As a lowly renter, I can personally attest to this social stigma.  I’ve been asked numerous times why I don’t buy.  By the time I get into total cost differential, investment returns, and opportunity costs, eyes typically glaze over.  People seem to give more thought to the colour of a vehicle than they do to the actual merits of buying a home.

“In fact, except for two periods — the early 1940s and the late 1990s — when adjusted for inflation, home prices in this country “have been mostly flat or declining.”

“This trend holds true even in what Shiller calls the “glamour cities” such as Los Angeles — where you hear of recent double-digit price increases. That’s because while these areas get a lot of publicity when real estate prices skyrocket, they also tend to experience periods of significant price declines (which get less media coverage). As a result, the average inflation-adjusted price increase in Los Angeles real estate since 1980 isn’t much higher than that seen in Milwaukee.”

Yup….it’s true.  Despite the influence of immigration, demand, unique features, etc, real estate returns are overwhelmingly dictated by inflation.  It makes sense when you consider that inflation is what puts upwards pressure on wages over time and what causes raw materials to increase in value.  This finding is consistent with EVERY academic study that has looked at long-term price appreciation, regardless of the country.

So what does that suggest when we see graphs depicting real home prices (real = adjusted for inflation)?

 

“Though he admits there are so many variables it’s impossible to forecast it precisely, Shiller says he senses that the housing bubble is “more likely to turn out badly.”

He was bang on on that prediction.  Will his predictions for our markets bear similar results?

“The Canadian housing market could face a similar housing bust to the United States, particularly in more bubbly markets as Vancouver and Calgary…Canada has been caught up with home buying fever just as the United States and other countries around the world.”

We won’t know until there is a decisive break in the current stalemate.  Tomorrow’s board data may give us insight.

Cheers,

Ben