FINANCIAL ICEBERG

Always consider hidden risks

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MARKET INSIGHT

Canadian Housing Correction Has Already Begun

( From MacroBusiness, CREA,​ Canada s Housing Bubble, The Atlantic, Teranet , IMF, Statistics Canada, BOC, Globe and Mail, CMHC )

The Concerns



Canadian economy is slowing quickly

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The slowdown in the Canadian economy in the second half of 2012 was more pronounced than the Bank of Canada had anticipated at the time of the October Report. In particular, exports and business fixed investment have been weaker, reflecting both foreign and domestic developments. While global tail risks have diminished, foreign demand has been more subdued than expected. The Bank of Canada has also become increasingly worried about the level of household debt and the unbalanced nature of Canada’s economy.

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Level of Indebtedness​​



​​ Canadian household debt is far higher than previously thought relative to income, Statistics Canada’s historical revisions showed on Monday .The household debt-to-income ratio jumped to 163.4 percent in the second quarter from 161.8 per cent in the first quarter, according to revisions made to bring the agency’s methodology in line with updated international standards.



​​ The soaring debt levels, fueled in part by a hot housing market, have led Bank of Canada Governor Mark Carney and Finance Minister Jim Flaherty to warn Canadians repeatedly against getting too deep into debt at a time of ultra-low rates.





Construction Industry



​​​Even if the construction industry represent 7% of total GDP, it is very important in terms of economic development and investments. If that sector is starting to see a slowdown in coming years, and coupled with the export sector already weak, it can be a tremendous drag on Canadian GDP.





Spill Over Effect on Consumers

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What history told us especially from the US and UK, is that the household net worth, mainly houses, can have an huge impact on consumers attitude toward spending. Lower net worth can hurt the economy. When people feel poorer, they spend less. That slows growth. Businesses typically then cut back on hiring and expansion.

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Although its exact contribution is hard to assess, the potential destruction of wealth cause by the price correction on houses is likely to contribute to a rise in the household saving rate and weakness in consumption in Canada

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And because in Canada, total consumers consumption are 69.8% of total GDP​​, anything that can change the behavior of consumers is woth noticing...

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Conclusion

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It looks to me like the Canadian housing market is facing some sort of correction. It’s just a question of whether it will unwind gradually or in a disorderly manner.

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​​​Canada is quietly trying to deflate its bubble without any eye-catching headlines. And that means keeping interest rates low while making mortgages harder to get.

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“A slowing in credit growth is a welcome development for Canadian policy makers who have long been ringing the warning bell about the potential danger that excessive leverage poses to the financial system and, more broadly, the economy as a whole,” Royal Bank of Canada economists wrote , adding that the slowdown “allows policy makers to focus their efforts on supporting the tenuous economic recovery.”

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​But the level of house prices, the extremely high level of household indebtedness, the slowdown in the economic activity and exports​​ are all serious warning signs that a potential huge correction can take place.





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Though we Canadians like to convince ourselves that it's different here and house prices will rise incessantly despite overwhelming evidence to the contrary, history remind us that this belief is as irrational as it is dangerous.



Canada is not immune of an economic and housing slowdown...

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Residential and non-residential sectors

Building Permits $​

The Situation



​​For the past few years having watched with interest the Canadian housing market’s continued rise in value. Whereas most other housing markets, including Australia’s, have taken a breather, Canada’s has powered-on, rising in value by over 20% nationally since its April 2009 low, according to the Teranet house price index.



But ​​there are tentative signs that Canada’s housing market may finally have peaked, like we will see below, either in terms of activity, construction...



Valuation



​​House Prices to Rental Valuation​

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And the house price-to-rent ratio has increased from 1.3 to 2.3 ( see graph below ). Both of these measures are now well above their historical averages.



House Prices to Rental Valuation​ - Comparison

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​The distinction between higher prices and bubbly prices isn't as subjective as it might sound. Like any other financial asset, there should be a fairly steady relationship between the price of housing and the stream of income -- rent -- it produces. Should be. The chart below, from The Economist, looks at the price-to-rent ratios across different countries, and measures how under-or-overvalued housing is, with negative numbers corresponding to the former and positive ones to the latter.

Canadian and US share of Residential Investment in GDP

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​Residential investment is projected to continue to contract, with its share of the overall economy declining gradually over the

projection horizon according to Bank of Canada... Each time the proportion of resudential investment reached 7% of GDP,we had a correction in the residential home construction...

Very interesting to note is that in the US, in 2006, residential investment reached a little over 6% and crashed after that because of the financial crisis as shown by the graph below... At 2.5% now compare to Canada at almost 7%...

Private Residential Fixed Investment , Seasonally Adjusted Annual Rate

Over​

​Gross Domestic Product, , Seasonally Adjusted Annual Rate

%​

Existing Home Sales



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​​Level of Sales

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​Sales of existing homes in Canada fell in February from January while year-over year sales plummeted, the Canadian Real Estate Association ( CREA ) said in a report that bolstered evidence Canada’s once-hot housing market is slowing.



The industry group for Canadian real estate agents said sales were down 2.1% in February from the month before, reversing the small gain recorded in January. Actual sales for February, not seasonally adjusted, were down 15.8% from a year earlier but still above the

​400 000 mark units as shown by the graph below.



​​Almost 80 per cent of local markets posted year-over-year declines in sales activity in February.





Prices

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The real estate group said the national average price, not seasonally adjusted, for homes sold in February 2013 was $368,895, representing a 1% decline from the same month last year.

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CREA cut its forecast for the national average house price this year, after February’s average sale price came in 1-per-cent lower than a year earlier. It now expects a national average of $362,600, down 0.2 per cent from last year.

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The association’s MLS Home Price Index, which seeks to give a more accurate gauge by accounting for changes in the types of homes that are selling, rose 2.7 per cent in February, its smallest increase since the spring of 2011.

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Year-over-year price gains decelerated for one-storey single family homes (+4.2 per cent), two-storey single family homes (+2.9 per cent), and apartment units (+0.8 per cent). In contrast, year-over-year price growth picked up for the fifth straight month in the townhouse/row segment (+2.4 per cent).

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New Listing

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The number of newly listed homes fell 1.2 per cent month-over-month in February, leaving them at their lowest level since November 2010. New listings have been trending down in tandem with a slowdown in demand. This has kept the housing market in balanced territory and held the overall number of homes for sale in check.



New listings were down in about 60 per cent of local markets in February, with the largest declines reported in Greater Toronto, Montreal, Greater Vancouver, and Saskatoon.







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Inventory

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The number of months of inventory is another important measure of balance between housing supply and demand. It represents the number of months it would take to completely liquidate current inventories at the current rate of sales activity, and it too was little changed in February.



Nationally, there were 6.8 months of inventory at the end of February 2013, up from 6.6 months reported at the end of January.

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​Compare that to a 4.2 month supply in the US...

Sales Outlook

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Last month’s declines were significant enough to prompt the Canadian Real Estate Association (CREA) to cut its sales outlook for 2013 last week for the third time since last summer ( Just two months ago, it had said it expected 447,400 sales this year, and in September it had estimated 457,800 – a figure that it had already cut. ) : 2013 sales are expected to total 441,500 units, down 2.9% from 454,573 in 2012. The revised outlook compared with earlier expectations for a 2% drop in sales.

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Housing Starts in Canada

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​The standalone monthly seasonally adjusted annual rates ( SAAR ) was 180,719 units in February, up from 158,998 in January. The SAAR of urban starts rose by 18.4 per cent in February to 161,631 units, led by a 27.7 per cent increase in multiple urban starts to 99,022 units. Single urban starts rose by 6.1 per cent to 62,609 units in February.

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Housing starts in Canada were trending at 195,087 units in February, according to Canada Mortgage and Housing Corporation (CMHC). The trend is a six-month moving average of the monthly seasonally adjusted annual rates (SAAR) of housing starts.



“The trend in total housing starts continued to moderate in February. Moderation in economic fundamentals in the second half of 2012 has led to more modest housing demand and builders are adjusting accordingly,” said Mathieu Laberge, Deputy Chief Economist at CMHC.









