Conference Board weighs in on housing
The Conference Board of Canada has published their Metropolitan Outlook for 2011 (subscription required to read report). While the outlook for each city is interesting, I was drawn to their macro outlook for Canada as a whole where they chimed in on two topics that I often discuss on this blog: Consumer spending and housing.
On consumer spending…
“Household spending was the predominant factor in lifting Canada’s economy out of recession, but the overexuberance that ended 2009 and started 2010 is now fading. The Conference Board’s Index of Consumer Confidence, which had returned to near-normal levels at the beginning of 2010, has trended down steadily over the past several months. Nonetheless, steady employment gains and increases in real wages will help sustain real consumer spending at a pace of about 2.5 per cent in 2011, edging up to 2.6 per cent in 2012.”
It is hard to overstate the significance of household spending in lifting the economy out of the recession. David Rosenberg has calculated that virtually all gains in GDP for the two quarters after the recession trough were attributable to increased house prices (i.e. consumer spending driven by HELOC growth), fiscal stimulus, and inventory restocking.
Whether or not their forecast of consumer spending recording 2.5% growth proves accurate will largely depend on the plight of the national housing market and interest rates. While consumer confidence is eroding, I would suggest that a drop in house prices would very cause consumer confidence to crumble and HELOC growth to grind to a halt.
Recall that HELOC growth is the fastest growing form of debt with lines of credit now amounting to 12% of all outstanding debt. This has served to goose consumer spending…
Recall also that HELOC growth is highly correlated with house price increase or decrease as can be seen in the US experience…
“Softer consumer confidence, stretched balance sheets, and rising interest rates will take some of the heat out of Canadian housing markets in the near term. Existing home sales and prices are forecast to ease in 2011. In 2009, with the economy battered by the recession, prudent developers called a halt to new home construction. However, housing demand held up well in Canada, and the lack of new supply led to a surge in existing home prices— even during the worst of the recession.
While real GDP fell 2.5 per cent in 2009, average home prices advanced by more than 5 per cent. Home prices continued to rise in 2010, as homebuyers continued to take advantage of record-low mortgage rates. The market is now set to soften, and resale home prices are forecast to decline by 0.7 per cent in 2011. Developers will pay heed to the softening market, which is expected to cause housing starts to fall sharply once again. After exceeding 190,000 units in 2010, starts are forecast to fall to 175,000 this year before regaining strength in 2012.
All in all, total real residential investment, which grew by an estimated 11 per cent in 2010, is expected to decline by 2 per cent in 2011.”
Given that the upcoming mortgage rule changes will have the immediate effect of reducing available credit to the tune of 4-8% while further interest rate hikes (either via a repricing of the 5 year GoC bond or hike by the Bank of Canada) are set to sap credit availability further, it suggests that a decline on the magnitude of 0.7% is very conservative. Home price appreciation has been fueled not by income gains (or by rich foreigners….) but by the rapid and unsustainable expansion in mortgage credit as interest rates and lending standards have been consistently lowered over the past decade. The steady erosion in the price to income multiple across Canada bears this truth:
It’s a topic I’ve addressed in posts like ‘Canada’s Credit Bubble’ and ‘Housing: A Bug in Search of a Windshield‘. It’s very obvious to me that a housing market that has relied too heavily on an expansion of credit and an influx of new buyers is also just as prone to reversals in these same trends. With mortgage rules and interest rates serving to squeeze the buyer pool and simultaneously reduce available credit, it is very difficult to see how the market will not experience a reversion larger than 0.7% after the new rules are implemented in less than 4 weeks.
OECD leading indicators point to slowdown in emerging markets
OECD’s leading indicators continue to suggest that China’s and India’s economies are set to slow, Europe’s and Canada’s is stable, and the US is set to expand. The OECD uses leading indicators (things that tend to change before the broader economy) to provide qualitative insights into the direction of economies in general.
It typically provides a snapshot into economic activity 6-9 months ahead:
On the positive front, our largest trading partner is seeing strong readings on the back of renewed tax cuts and strengthening consumer confidence and consumer spending.
Just how long the government can sustain their fiscal imprudence in the US is the trillion dollar question. With a $1.3 trillion deficit pending, it begs the question of just when the debt chickens will come home to roost. But for the time being we’d might as well party like it’s 2007.
Somehow the Eurozone is signaling stable expansion despite a debt contagion rotting the periphery and threatening the core. With the bond market calling the EUs bluff and flatly rejecting the notion that a bailout has solved the PIIGS debts problems, yields have continued rising, virtually ensuring a bailout of Portugal by the summer and increasing the prospects of an extremely expensive Spanish bailout. Yet against this backdrop things are expanding, no doubt pulled higher by positive readings in the core countries of Germany and France…..for now.
Likewise Canada is set to see stable growth according the leading indicators, benefiting from renewed strength in the US and Eurozone.
Tow key emerging markets are showing substantial slowing: China and India. With Chinese demand (and arguably Fed-created liquidity) having driven the commodity boom since the end of the recession, one has to wonder how a hard landing in China would impact such prices and how it would impact the commodity-laden TSX by extension. Indeed with China increasingly backed into a corner and trapped between the prospects of rampant inflation (controllable by increasing margin requirements and/or interest rates) and a potential hard landing in their centrally controlled economy (caused by the same inflation reducing factors), it certainly merits close attention.