More on demographics and the Canadian housing bubble; Rosenberg’s new love affair with Canada

Demographics and the housing bubble

In one of the primers, I outlined the issues I see with Canadian demographics and our current housing market.  My position remains that many near-retirees are not adequately prepared for retirement when one looks at their liquid investment assets such as savings, stocks, bonds, and mutual funds.  The largest holding of the typical Canadian household remains their home at 48% of the average net worth.  There is no doubt that there is a segment of the population expecting to downsize their home and use the proceeds to at least partially fund their retirement.  There is an additional segment that will choose to downsize as a lifestyle choice rather than monetary considerations.  The million dollar question is just how how large a segment this represents.

With 1000 boomers turning 65 every day in Canada, it need not be a huge percentage to significantly affect supply.  With sales remaining weak across most of the country, a trend I expect will continue, added inventory will only put downward pressure on prices.

This reality is starting to sink in.  Today the Globe and Mail ran an interesting article:

Pop goes the housing bubble

“We all know about the demographic monster the boomers represent – a generation that far exceeds, size-wise, anything coming up behind it. Those wanting to enter the market in the coming years may not have the money to buy single-family detached homes, either. Thus the dilemma: Who will boomers sell to when they’re ready to move into some swank condo downtown or on a golf course somewhere?”

“It’s a question that Dowell Myers of the University of Southern California has pondered, too. He is among a number of urban planners and demographers predicting another housing crash, this one caused by the massive sell-off by boomers wanting to downsize.”

“An oversupply of homes generally means prices fall. But as home values decline, so will home equity, diminishing retirement savings in the process. Home equity is the single largest component of net wealth for most people.”

Tsur Somerville, an associate professor at the University of British Columbia’s Centre for Urban Economics and Real Estate, isn’t as pessimistic….“I know it’s one of those theories where the numbers add up and the underlying fundamentals are correct, but I think in Canada, at least, it’s too early to say how it’s going to play out. I think immigration is the key.”

Certainly immigration will help alleviate the problem, but despite the current pace of immigration into Canada (4.8 per 1000) population growth is still an anemic 1.3% per annum, while our overall population continues to age.  I believe that two themes in Canadian real estate will play out over the next decade:

1)  Deflation will pull at all house prices.  Real house price growth will be negative for the better part of the next decade as savings rates normalize, debts are paid down, and real estate descends from it’s lofty heights.

2)  The era of the McMansion is over.  In addition to widespread monetary deflation that will weigh on all types of real estate, there will be considerable price compression in the upper end of the market.  In smaller retirement communities where condo development has not run rampant, expect small homes and condos to hold their value better than larger homes.

Rosenber loves Canada

In today’s daily economic commentary by Dave Rosenberg, he outlines the case for Canada’s relative economic strength when compared to our southern neighbours.  Rosy also outlines why he feels the TSX presents better long-term value than the US exchanges.  It’s well worth the read.

I have a lot of respect for Rosenberg and I don’t disagree with the long-term economic outperformance of Canada vs. the US, though I suspect our economy will underperform theirs in the short to medium term.  I also agree that the TSX in general presents a better buy than the US indices.  All that being said, I’m not nearly as comfortable as Rosenberg is on the following:

1)  The possibility of a hard landing in China at some point in the near future.  This would put strong downward pressure on commodity prices, exports, and the commodity laden TSX.  Rosenberg acknowledges this risk in the first paragraph, though he doesn’t weigh in on the likelihood of such an event.

2)  The realignment of Canadian house prices with long term measures of fundamental value.  By all accounts, we are well above historic trend lines when measured in price/income, price/rent, and affordability.  As I so often warn on this blog, a slowdown in house prices would crimp consumer spending and clamp down on HELOC growth.  At 65% of GDP, such a slowdown is hard to absorb and still experience real economic growth.

3)  Consumer debt levels, which Rosenberg notes are ”clearly problematic, but for now, completely serviceable”.  Should the strong rebound in economic growth materialize, the accompanying rise in interest rates would reveal just how serviceable debts really are.  Without an impressive rise in income levels and a stabilizing of debt levels, I see a catch 22 here.

All that being said, it’s important to remember that the economy and the stock market are not entirely joined at the hip.  While I see economic storms on the horizon, I’m still happy to add to my stock portfolio, particularly when I see gems that meet my investment criteria.


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13 Responses to More on demographics and the Canadian housing bubble; Rosenberg’s new love affair with Canada

  1. Jordan says:

    Nice post. A further complication will be the effect of the retirement boom on vacation properties… my financial advisor reports that a significant number of his 60-something clients are opting to sell their homes in the city and move permanently to their cottages or other vacation properties outside of T.O. That’s downsizing of an entirely different sort.

    • John in Ottawa says:

      That’s exactly what we have done. However, we may have to move back into town in 20 years or so to have better access to hospitals, clinics, doctors, etc.

      We expect our country home will eventually become too difficult for us.

  2. Absolutely agree, Jordan. Thanks for the insight.

  3. mac says:

    “Rosenberg acknowledges this risk in the first paragraph, though he doesn’t weigh in on the likelihood of such an event.”

    Yeah. He does. He calls it a tail risk. In other words it’s virtually nil.

    • Better check your definition of tail risk. It doesn’t mean it’s virtually nil. It means it has a higher chance of occuring than prior returns suggest.

      • John in Ottawa says:

        Isn’t tail risk better thought of as a 3-sigma event? Then in conversation, regardless of any specific distribution curve, it generally means a low probability event. A black swan, so to speak.

  4. Financial Newbie says:

    Hi Ben,

    I’m a big fan of your website, enjoy how you take a balanced approach to your writing style and avoid being overly sarcastic/dismissive like other popular contrarian bloggers today, and I like the variety your blog provides instead of always being focused on, say, the Canadian housing market.

    I agree with pretty much everything you’re suggesting on many of your primers and blog posts, and combined with the other blogs I read I now find myself living in world where the US has little to no hope for any serious economic turn-around in the next few years, China as a “Red Knight” is a lie and in fact could be an economic time bomb waiting to explode, the Euro is on the inevitable path to destruction, and Japan is almost bent to the point of no return due to poor fiscal/monetary policy over 20 years. Canada and Australia have not had their trial by fire yet, but everything I read tells me we’re no different from the rest of the world and our time of reckoning is quickly approaching (Aus probably even sooner than us).

    So, getting to my questions (which I really hope you can answer)…

    A) With the rest of the world imploding, what do you see happening in South American countries like Brazil & Colombia?

    B) In what circumstance can you see Canada continuing to avoid this dreadful fate for the next few years? I know we’re pooched in the long run – no need to convince me of that – but I’m wondering what you might come up with if you flipped your focus and tried to use your financial/economic wisdom to identify what COULD happen to keep what all of us contrarians believe will happen from happening in the foreseeable future.

    Basically I guess I’m asking you to be the contrarian’s contrarian for a moment (or for a whole blog post if you feel up to it), just out of curiousity to see what you might say. Could be interesting!


  5. @John

    “Isn’t tail risk better thought of as a 3-sigma event? Then in conversation, regardless of any specific distribution curve, it generally means a low probability event. A black swan, so to speak.”

    My understanding of tail risk is that it represents events that statistically are 3 sigma events but in reality are more likely to occur. I’ll have to reopen my textbooks to confirm. Regardless, my point is still that I’m less sanguine than Rosenberg is regarding the possibility of a hard landing in China.

    Thanks for the kind words. I’m on my way out of town. I’ll try to answer your questions next week.

    • Ah yes….what a marvelous creation

      As per your link:
      “A form of portfolio risk that arises when the possibility that an investment will move more than three standard deviations from the mean is greater than what is shown by a normal distribution.”

      My point exactly. How much greater he considers the risk is not indicated by Rosie. Obviously he sees it as a fairly small risk, though certainly not as small as a normal curve would suggest….ie not necessarily a 3-sigma event. My point remains that I’m not nearly as comfortable with an economy that is 60% dependent on building empty cities to grow, especially when they’re the ones buying our commodities and driving the price up. Enough said.

  6. ATP says:

    I read Rosenberg daily and was surprised, to say the least, to see him practically do a 180 in his Jan 13 commentary. It was not even 2 months ago when he was talking about all the Canadian rebound in GDP being due to housing and how the fair value of the Loonie is around 93 cents. Amazing.
    Comparing the current state of the Canadian economy with that of the US is truly comparing apples to oranges. The credit bubble in the US had burst whereas we are still leveraging up as a society. To be bullish on Canada at this juncture is to assume that our credit bubble will not burst. It’s different here, I guess.

    • LRM says:

      Yes ATP, I also read Rosie daily and wondered if he even wrote this or if he had a little talk with the big boys at GS . He backtracked a bit on the letter for the 14th but that Canada promo was certainly surprising. How can he say that his model says the $ CDN is overvalued then claim it will go much higher.
      Well I guess that is what makes a market and no one knows what way it will go.
      I still like Rosenberg but this break from his normal lets one know that you really can’t invest using the macro economic view as the sole basis for a position.

  7. mac says:

    Actually, it was about a month or two ago I posted a link on this site where Rosenberg praised F or Carney (can’t remember whom exactly) for managing to avoid a housing bubble in Canada. I kid you not. Imagine what he’ll say if Canada tweaks mortgage requirements?

    So he’s been on this track for a number of months now. He has a new normal. So does Taleb (Mr. Black Swan) whose daughter is now studying at McGill, rather than a US university. He sat for an interview and discussed how Canada’ favoured position in the world and seemed almost gleeful to be on the banks of the St. Lawrence, so close to such a sophisticated city. Even Roubini has lightened up–he’s bought an apartment in Lower Manhattan where he can resume his wall carvings.

    After too many quarters in the wrong, even the most bearish prognosticators have to switch gears or face obsolescence.

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