Canadian Housing, Banking System Vulnerabilities and Wikileaks - by Jeff Fitchett

Recently, I’ve had a number of requests from clients for my thoughts on the Canadian housing market.  To put it simply; I think Canadian housing prices are extremely over valued.  Incomes have not kept pace with the drastic increase in real estate prices. As well, foreign investors have piled into specific housing markets and this has helped push real estate values higher.   

Interest rates are at historic lows and this has increased ‘affordability’ so to speak.  As you are likely aware, debt is increasing exponentially and this has triggered an uptick in the value of  assets such as stocks, bonds, real estate, art, etc.  

Some people argue that ‘this time is different’ and the good times will continue unabated.  Fractures in the global real estate market are beginning to appear in places such as New York.   A recent report from Elliman noted a drop in  the rental markets in Manhattan, Brooklyn and Queens.  In a recent ZeroHedge article titled: Manhattan Retail Vacancies Soar the article highlights the decline in commercial real estate.  

Richard Hayne, CEO of Urban Outfitters, stated in the latest earnings call that “retail square feet per capita in the United States is more than six times that of Europe or Japan. And this doesn't count digital commerce. Our industry, not unlike the housing industry, saw too much square footage capacity added in the 1990s and early 2000s. Thousands of new doors opened and rents soared. This created a bubble, and like housing, that bubble has now burst. We are seeing the results: doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate.” Source

The 2008 financial crisis was triggered by a drop in the US housing market.  I think the analogy that if the US sneezes, Canada catches a cold is appropriate in describing the predicament we find ourselves in here in Canada.  As I have chronicled numerous times over the past number of years, debt levels have continued to march higher all the while incomes have remained stagnant.  The fact that many retailers are shuttering stores, there are mall closings and a decline in the value of  commercial real estate all should be noted. Canada is not immune to the ebbs and flows of global commerce. I’m of the opinion that global monetary policies have been the key catalyst for propping up asset values.  

What does this mean for the banking sector in Canada and how do are banks compare with those of other nations?  On March 6th, The Bank of International Settlements (BIS) released their latest report on global financial flows.  The report highlights that debt has continued to rise globally and that a number of countries are at risk.  Canada was highlighted not in a good way:  

Early warning indicators for financial crises continue to signal vulnerabilities in several jurisdictions. Table 1 summarises the early warning indicators for domestic banking risks produced by the BIS, with data up to Q3 2016 for most countries.7 Relative to previous readings,8 the set of countries showing large and positive credit-to-GDP gaps remained the same (first column). The credit gap for China remained high at 26.3% of GDP, well above the threshold of 10%.9 Canada, as well as a group of Asian countries, saw increases in the credit gap since September 2016. The size of the property price gap (second column) remains in line with historical trends in many jurisdictions, with the exception of Canada, Germany, Greece, Japan, Portugal and a group of central and eastern European countries, for which the gaps remain relatively large. However, a high reading need not indicate accelerating price growth - for Greece, Japan and Portugal, the high property price gap does not necessarily indicate vulnerabilities, as it is driven by property price growth returning to normal levels after long periods of decline.”  

“The last two columns of Table 1 present two alternative measures of debt service ratios, which aim to capture aggregate principal and interest payments in relation to income for the total private non-

financial sector. For most countries, debt service ratios stand at manageable levels under the assumption of no change in interest rates (third column). Under more stressed conditions - a 250 basis point increase in rates - and assuming 100% pass-through, the numbers point to potential risks in Canada, China and Turkey (fourth column). However, the figures are meant to be only indicative, and are not the outcome of a proper stress test: a rise in rates would take time to translate into higher debt service. The degree of pass-through depends on the share of debt at floating rates, debt maturities and possible changes in borrowing behaviour.”

From my perspective, I think that the path Canada is on will lead to a crisis.  The continued growth of debt is fuelling a housing bubble all the while macro-economic issues & geo-political tensions are increasing.  Did you notice in the table on the second page of this report that Canada is the only country that had three of the four "financial crisis early warning indicators” highlighted in red?

Update on Caterpillar 

Two weeks ago I highlighted the disconnect in underlying economic fundamentals of Caterpillar and the company’s share price. On March 7th, the New York Times published an article titled: Caterpillar Is Accused in Report to Federal Investigators of Tax Fraud. “Leslie A. Robinson, an accounting professor at the Tuck School of Business at Dartmouth College and the author of the report stated; “I believe that the company’s noncompliance with these rules was deliberate and primarily with the intention of maintaining a higher share price. These actions were fraudulent rather than negligent.”  

In last weeks missive I highlighted the disconnect between macro-economics and broad based market indexes such as the Dow Jones Industrial Average and the S&P 500.  Perhaps we will learn that government statistics have been ‘massaged’ to give the appearance of a healthier economy. Statistics  relating to inflation, unemployment, debt, budget deficits, economic growth expectations are questionable in my opinion (I have highlighted discrepancies in economic data for years).

Interesting Geo-Political News Item

Earlier this week Wikileaks once again made headlines following its release of the “largest ever publication of U.S. Central Intelligence Agency (CIA) documents.”  I highly recommend you spend a few moments and look into this because it is alarming to say the least. “Recently, the CIA lost control of the majority of its hacking arsenal including malware, viruses, trojans, weaponized "zero day" exploits, malware remote control systems and associated documentation. This extraordinary collection, which amounts to more than several hundred million lines of code, gives its possessor the entire hacking capacity of the CIA.”  Click here to read a summary  It is very important for everyone to protect their digital property and be aware of what is occurring in the cyber world.  

In Closing

There never seems to be a dull moment these days.  The topics to write about are almost endless and every day new stories emerge.  Like many of you, I too wonder how things are going to play out in the coming years.  I think it safe to say that populist movements around the world will likely intensify and the news coverage of these movements will continue to be biased towards the status quo.  As economic and political instability worsens the likelihood of another financial crisis increases.   

I think it is important for people to be cognizant of what is going on in the world because it allows each of us to make decisions that can better our own unique situation and help the world at large.  Small steps can travel a long path.  This weeks video is a 10 minute motivational compilation focused on retraining our minds.

Have a great weekend!

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