Cash in as yet another housing bubble bursts

Canada is one of the few Western economies to have rebounded strongly from the Great Recession.

Indeed, in some ways it’s as if it never happened. Annual output has surged above the previous peak in 2008. The trade surplus in December rose to a three-year high. And all the jobs that were lost during the downturn have been recovered. 

What’s more, Canada has managed to pull this off without spending money like mad. This year’s government budget deficit (the shortfall of tax revenues against state spending) will only be about 2.5% of GDP.

And in fact, the final figure looks set to be even better than official forecasts. Compared with the near-double-digit deficits that seem the norm these days, that’s quite remarkable.

There’s just one problem. The country has been inflating its own massive housing bubble. This could undo all the good work done elsewhere – and present smart investors with some profit opportunities…

Canada’s house price bubble is set to burst

House price mania has been a major feature of the global economy over the last ten to 15 years. Canadians joined the party several years later than their counterparts in other Western countries. The early-1990s recession was still taking its toll on the country’s dole queues, and also on its domestic property market, right through to the middle of the decade. 

But as interest rates tumbled, Canada caught the bug just like everywhere else. And how. The ‘real’, ie inflation-adjusted, price of the country’s homes has increased by an average of 85% since 1998.

Sure, house values stagnated at the height of the financial crisis in 2008. But by 2009, property prices were back on a roll, rising by almost 20%. Canada’s current housing boom has now become one of the longest lasting in the world, says the Bank of Nova Scotia.

Indeed, Vancouver is the second-least affordable city anywhere on the planet, according to the annual report from the Demographia International Housing Affordability Survey 2012.

Like every other housing bubble, it’s been inflated by loose credit. Canadian household debt hit a new high last year. The average borrowing burden of Canadian families now stands at 153% of disposable incomes, according to Statistics Canada. To put that in context, that’s almost as much debt as US households had taken on at the peak of their own housing bubble.

In other words, the warning signs are everywhere. Canada’s housing market is plagued by “overvaluation, speculation and over supply”, says Merrill Lynch. The Economist conducts a survey that compares house prices with the rents that property owners can charge. On this basis, Canadian residential property is overvalued by more than 70%. Even the central bank admits there’s a problem.

In short, the country’s property prices won’t be able to defy gravity for much longer. Canadian lenders, including Toronto-Dominion Bank last week, are already lifting home loan rates to try to cool off the housing market. That’s seen prices start to drop in some areas – and there’ll be plenty more of that to come.

Canadian economic growth is slowing down

Why? Because despite its great recent export performance – boosted by a nascent recovery in the US – Canadian economic growth is slowing down. Unemployment is on the rise again.

That means that even if the Bank of Canada can keep interest rates at their current low levels, Canadian households have no scope to take on any more debt. If the dole queues get any longer, many homeowners may struggle to keep up with their existing payments.

What’s more, as we’ve written about several times, the omens for commodity markets this year aren’t good. If China really does slow down as much as we expect, raw material prices could be set for a lengthy period in the doldrums.

As we explain here, the Baltic Dry index of shipping rates is also pointing to a drop in demand for raw materials. Again, this would be bad news for Canada’s export-driven economy. In turn, that would hit the country’s housing market even harder.

Short the Canadian dollar

Sounds familiar? If you’re a regular reader, it will be. Because we said something similar about Australia recently. And with the housing bubbles set to burst in both countries, our advice is along the same lines.

A country’s – or region’s – currency is a useful barometer of investor confidence: just look at the eurozone. The Canadian dollar (CAD) is also known as the loonie (after the picture of the common loon bird on the reverse).

As markets begin to ‘price in’ what slower Chinese growth really means for commodity prices, the loonie is likely to come under pressure. A housing market crash would drive it down much more.

One way to take advantage is to use spread betting. Here you can ‘short’, ie sell, the loonie against the US dollar. It’s risky of course – currency markets can be very volatile – so you might like to take some advice. If you haven’t already, sign up for our free email MoneyWeek Trader to learn more about spread betting tactics.

If you’re not keen on the trading risks, you can buy the ETFS Short CAD Long USD (LSE: SCDP) exchange-traded fund. This gives you a built-in short position in the loonie against its US equivalent. It’s still risky, and only suitable for taking relatively short-term positions, but it’s not quite as high-octane as spread betting.

• David Stevenson also writes for The Fleet Street Letter, Britain’s longest-running investment newsletter. Read more about The Fleet Street Letter and David’s research here. The Fleet Street Letter is a regulated product issued by Fleet Street Publications Ltd.

• This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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18 Responses

  1. 14/02/2012, alex wrote

    The problem is that the etf is really no differnent to a spead bet. You still have to pay the cost of rolling the position over every time the monthly futures contract expires. The spread bet having the advantage of being tax free, and also requiring a margin which will be only a fraction of the total value of the exposure.

  2. 14/02/2012, NeutronWarp9 wrote

    Canada and Australia are self-evidently very different from the UK and both have benefited massively from the demand for natural resources. Therefore for Cameron and others to offer up Canada has a model for cutting state outgoings and relying upon private business to rally a recovery is a serious error.
    Australia too has had a housing price boom and surely it is part of the economic cycle for peaks to be followed by troughs if a long enough time-frame is adopted. I prefer ETFs to spread-betting because too few people have the discipline to keep their potential margin call cash reserves readily available. That is, they greedily commit funds elsewhere and run the risk of becoming forced sellers. Keep a running stop-loss on the ETF and leave betting to the dogs.

  3. 14/02/2012, DAVID PYLYP wrote

    Thank you that another person, business, economist has elected to comment on something.

    UMM The vacancy rate for residential homes in Toronto Canada is less than 1%. Let me say that again for you slowly. The vacancy rate is lower than 1%. Where did your article discuss that?

    David Pylyp
    Living in Toronto and sick of hearing about a bubble

  4. 14/02/2012, Gary Johnston wrote

    Hi does this mean you would go long on USD/CAD?

  5. 14/02/2012, Bad Wolf wrote

    Swedish home prices have increased by some 3-400% during the same time period (since -98). However, it’s very interesting to see what an increase like that does do a market sentiment. No one is careful, borrowing have increased by some 30% since 2008 (lowering of rates, remember), and there is a “knowledge” that prices just can’t go down. Not here! somewhere else maybe, but not here…;)

  6. 14/02/2012, Mike wrote

    Such dangerous advice, No. 1. Alex is right, but the whole spread betting thing just strikes me as something Money Week shouldn’t be getting into , is this becoming the Racing Post.

    You haven’t explained any of the risks in the ‘trade’ properly.

  7. 14/02/2012, Rastaman wrote

    let me get this straight … you’re going to denominate in the brit pound to short the Canadian dollar? Britain? the economy literally teetering on destruction?

    baaaaaaaaaahahahahaha……you’re clueless!

  8. 14/02/2012, Christophe wrote

    The conclusion is terrible: what reason is there to have confidence in the USD? MF Global and rehypothecation? Rampant banking scams? War with Iran? A bigger real estate bubble? OWS?

    Nope: you are best off selling your fiat $ for gold or silver and holding it.
    => if you had put your money in gold 10 years ago, you would have been protected from ~84% (six-fold!) devaluation of the USD!

    All the crooked private central banks of the world (incl. Canada’s) are printing their fiat currencies like mad, in a bid to temporarily keep the ponzi scheme going. Any money kept in a ‘legitimate’

  9. 14/02/2012, IJ wrote

    I agree with the sentiment expressed by many of the commenters here. It is irresponsible for Moneyweek to be advocating spreadbetting. Moneyweek is forever calling the bursting of bubbles everywhere. You will no doubt be right eventually. But you never know when: it can take years. With spreadbetting and trading generally, being early is the same as being wrong. You can get absolutely creamed. Just ask anyone who shorted the Nasdaq a year too early.

  10. 14/02/2012, Trevor wrote

    It’s so easy to yell “It’s gonna burst! We’re all gonna die!” The author is really scared, and he seems to be in this state for a quite a while now, just take a look at the headlines of his other fearful yellings. Let’s ask ourselves a critical question: does this yelling and fearmongering help us feel better? It aims to cause panic, maybe, but does panic help?
    I will never come back to this site again.

  11. 14/02/2012, Bob wrote

    Look folks, this is an investment type site for people who want to play the financial markets, so not all the advice given here will be right for everyone. But for sure, if you sell your overpriced house in BC now, you will be smiling in a couple of years. Short the canadian markets without leverage and without using financial interments like options, and you should be safe, and don’t have to time it exactly.

  12. 14/02/2012, Fred wrote

    Sorry no Bubble Burst…The Bank would be broke, Burst means 100% loss in Value right.. Real Estate Values are Local and always have been over my 40 years in the business. as for loose credit hug wash, people in Canada had to have good credit and the income to support a mortgage to get qualified.

  13. 14/02/2012, Carl Asaba wrote

    Looks like someone read and repeated The Economist magazine from last week.

    http://www.economist.com/node/21546057

  14. 14/02/2012, Bob in Oz wrote

    We still have the same level of denial here in Australia even though nationally housing has been falling for more than 12 months.

    The same old tired excuses are always trotted out by the vested interests letting us know just how different (and clever) we are. However with low unemployment now showing definite signs of capitulating the trend is set for an upward trajectory. Our papers are full of the latest round of layoffs now plaguing the country.

    Aaaah, the pundits tell us the mining bubble will save us from a bursting housing bubble !

    Bubbles – they always burst, no matter how different those in denial would have us believe.

  15. 14/02/2012, Mike wrote

    Not in Vancouver. Its different here.

  16. 15/02/2012, Tudor wrote

    It is all relative. Currencies , goods and services denominated in a currency or gold,silver priced in said currencies and so on.
    So when you say your house price is goind to drop, you basically say that it drops relatively to your national Currency.
    So if your house price of 100 000 Dollars drops by half, this means your national currency doubles in value relatively to your house. So Real Estate bubble Burst , means save and keep your money in cash outside of the banking system leveraged and exposed on said HOusing Market.
    If you really want to make a safe and potentially profitable bet, just buy your national currency.
    Of course economic sites will advertise their own products, and can’t simply say buy and keep dollars. They would go out of bussiness.

  17. 16/02/2012, W.Todd wrote

    As I own two properties -one in Edmonton and one in Calgary I would like to say Canada is not just two housing markets. Every article I read about Canada’s housing bubble over looks the rest of Canada and looks only a Vancouver and Toronto. Vancouver is being affected by the Chinese – Toronto new Canadians and simple growth. The house prices in Edmonton and Calgary are not screaming higher if anything they are steady or backing off. And unlike the US we actually have to qualify to borrow – the Banks here keep the Mortgage.

  18. 19/02/2012, Mike from Vancouver wrote

    The commenters are right. It’s just as difficult to qualify for a mortgage in Canada at 2% interest rate as it is at 8%. ‘Loose’ credit does not exist here despite the low interest rate. Borrowing is only available thru credit cards, who can raise their rates overnight. This is a more likely “bubble” than the housing market. Luckily, they are competing for balance transfers, so they will keep their rates comparatively low for a while, hitting only the ‘high-risk’ clients they wish to discourage. In the end, though, everything depends on what happens to the elephant next door after the coming elections. It’s a flip of the coin after that circus is completed. Wish us luck!

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