BOB: Hello, I’m Bob McKenzie, and this is my brother Doug. Good day.
DOUG: Good day, eh. This is my nephew Mike. We’re here today to talk about money and Canada, and Mike is the expert in our family. He even got past high school, which is a first in our family.
MIKE: Let’s start by considering the status of Canada’s housing bubble. Because of unprecedented increases in residential real-estate valuations relative to rents and incomes, particularly in Vancouver and Toronto, we run the risk of substantially lower Canadian housing prices during the next several years especially in real terms.
BOB: I’m a little confused. Could you explain that again?
DOUG: I think he said housing prices could go down.
BOB: No way. In Canada, houses only go up in price. Anyone knows that. Even my really stupid friends know that.
DOUG: Bob’s right. You don’t really think prices can go lower, eh? That’s like the Leafs winning the Cup.
MIKE: Perhaps you aren’t familiar with housing prices in Phoenix, Orlando, and Las Vegas losing an average of two thirds of their value during the past six years.
BOB: I have a friend who goes to Florida in the winter. And, yeah, he said something about that. But that’s the States. I mean, they hardly even know how to play hockey down there. That has nothing to do with Canada.
MIKE: Do you really think it’s that different south of the 49th parallel?
DOUG: Of course it’s different. It’s always different this time, eh? No two snowflakes are ever alike, and we sure know a lot about snow up here.
MIKE: The reason this is important is that we have housing bubbles in many countries, particularly in those like Canada. Australia, Brazil, and Russia with high ratios of commodities to people. The main consumers of these commodities are countries like China and India, where even more extreme real-estate overvaluations are especially dangerous since their collapse will likely lead to a sharp decline in demand for the goods that are produced by Canadian companies.
DOUG: You mean companies like Labatt’s, Molson’s, and Moosehead?
BOB: Don’t forget Kokanee. You know that’s my favorite.
MIKE: Of course beer is a sort of commodity, but I was referring primarily to mining and energy companies, as well as some major agricultural producers. Much of the aggregate marginal demand for the world’s commodities have originated from countries which are most at risk of being forced to reduce their consumption in the event of an unexpected disappointment in GDP growth. This will also impact the loonie, which is at risk of surrendering much of its gains of recent years.
BOB: You’re not saying the loonie is going to drop against the U.S. dollar. That’s ridiculous. Not more than a few cents, anyhow.
DOUG: Your mind is stuck in the old days. We’re never going to see the loonie below 80 cents again. It’s just not going to happen. I think you’re spending too much time reading those books and not getting outside enough. Put on your toque and go for a walk.
MIKE: There is also significant risk in Canadian banks, since they’ve made so many loans which are directly or indirectly connected with the ability of borrowers to repay in full. As housing prices decline, many people will owe more on their homes than they’re worth, increasing the risk of default and foreclosure. When a person perceives a decline in his or her net worth, this creates a psychological condition known as the negative wealth effect, in which this person will curtail present-day consumer spending. Multiply this by millions of Canadians, and a severe credit crisis cannot be easily dismissed.
BOB: I know you’re wrong there. We don’t let people buy houses on zero money down, do we, Doug?
DOUG: Not that I know of. So it’s nothing like the States.
MIKE: While you’re correct that down payments are generally more stringent here than they are south of the border, it’s also true that housing prices in many Canadian cities are far more overvalued relative to historic norms than they ever were at their peaks in the United States. So the advantage of lower leverage is unfortunately offset by a greater total price risk. In China, the down payment requirements are even more rigorous, but they have significantly higher relative valuations compared with rents or income. So, in the end, all of these bubbles are unfortunately all going to end the same way.
BOB: You forgot about peace, order, and good government.
DOUG: Yeah, they don’t have those in the States. They have life, liberty, and something else.
BOB: I think it’s the pursuit of happiness. Plus they have all those guns down there, so it’s a totally different situation.
DOUG: Besides, we’ve got some smart people here. I’m not pretending to be one of them, but wouldn’t one of those economists at the Globe and Mail or U of T figured this out by now? If they’re not worried, then I’m not worried.
BOB: I mean the first time someone told me my house was worth a half million dollars, I called him a hoser. But then I found out he was right. Now it’s worth a million dollars. Things change. Sure, it doesn’t seem to make sense, but the world is a confusing place. Almost nothing makes sense these days. I can barely keep track of my favorite TV programs.
DOUG: We have a bunch of geniuses in the government and the schools, and one of them would have figured all of this out by now. If the house next door is worth a million, and the one across the street is worth a million, and I put that extra bathroom in a few years ago, then I know this house is worth more than a million.
BOB: Yeah, that’s why we don’t bother with the RRSP or that other recent thing which is never taxed, since our house is our retirement plan. You don’t need anything else. I’m gonna have to talk with my sister about the people you’re hanging around with.
DOUG: So let me get this straight: you think the loonie is going to lose value? Like this week?
MIKE: In the short run, the loonie will probably actually go higher, because everyone expects the U.S. dollar to keep rising, so it won’t. Within a few months, everyone will be convinced that the loonie will keep on climbing, which is when it will begin a significant downtrend.
BOB: Do you just do the opposite of what everyone is thinking? That’s crazy, eh?
MIKE: It’s known as contrarian logic.
DOUG: I agree with you, brother. This guy might be our sister’s kid, but he’s a little off. You can’t mean to say that if everyone agrees on something then they’re all wrong.
MIKE: When it comes to financial matters, that actually sums up the situation quite succinctly.
BOB: I’m trying to understand this myself. I think you’re telling us that the prices of oil, gold, beer, and the loonie are going to first go higher because everyone thinks they’ll go lower. And then when everyone changes their mind and expects them to keep going higher, they’ll go lower.
MIKE: That’s it exactly. You picked it up quicker than all of the university and government economists I’ve met during the past several years.
DOUG: This is insane. So we should sell this house and rent for a few years? Can you imagine what our friends and family would say about that?
MIKE: In the United States, many people didn’t sell their homes because of perceived public ridicule. Because U.S. housing prices have been declining for the past six years, it’s now considered trendy to rent instead of buying. More importantly, many people have friends and family who have lost hundreds of thousands of dollars with real estate, so even those who can afford to buy aren’t doing so out of fear. This has caused a huge demand for apartments and other rental units, at the same time that the oversupply of single-family homes could persist for another decade. Some enterprising folks have finally begun to convert foreclosed single-family homes into rental homes to rectify this growing imbalance. The problem is that by the time it becomes trendy in Canada to rent instead of buy, it will be far too late to sell at a good price.
BOB: That’s awesome, dude. I’m almost starting to believe what you’re saying, even though it’s impossible for you to be right.
DOUG: This is like a bad trip. But we sure could use the money from selling this old place which our parents bought for like fifty thousand dollars way back when, and we’ve gotten lots of offers even though it’s not on the market.
BOB: You reminded me of a true story. One guy I know from way back, a rich fellow who bought a house in Vancouver, had an offer from a Chinese family to sell his place for three million dollars. Three million–unbelievable. The only catch was that his wife didn’t want to sell. So whenever we would talk on the phone, I would ask him how everything was going, and he would tell me that they still hadn’t worked things out. Finally I got a phone call from him. He shouted with excitement, “Sold. 3.1 million to the Chinese.” And then he hung up. So I called him back and asked him, “How did you get your wife to agree?” So he told me, “I couldn’t convince her.” “Wait a minute, didn’t you tell me you sold the place?” “Yeah, I did. And I forgot to also tell you that we’re getting divorced.”
DOUG: No way. I know that guy. I’ve heard so much today. My brain doesn’t usually think this much in a month.
BOB: Mine neither. I know we’ve got a few bottles of Labatt Blue around here somewhere. Let’s stop thinking and start drinking.
DOUG: I’m with you, brother. Mike, I hope you’ll join us for one or two.
MIKE: Why not. By the time this stuff gets around to killing me, I’ll be dead from something else anyhow.
– from Steven Jon Kaplan’s update to his subscribers, #1604, for Thursday night, January 12, 2012. Steve is a wise contrarian market analyst who can be followed at his website, ‘True Contrarian‘. He correctly predicted many of the major market moves of the last 12 hectic years. He also plays the piano.
Afterthought: Is ‘wise contrarian’ tautological?