Juggling Dynamite

Thinking ahead is challenging and important to try…

The artificial intelligence “scare trade” erupted again on Monday as growing concerns about the disruptive power of AI dragged down shares of delivery, payments and software companies, and sent International Business Machines Corp. to its worst plunge in 25 years. It began after a bearish report was published over the weekend by a little known firm called Citrini Research. The report, released on social media Sunday, outlined the potential risks to various segments of the global economy, using hypothetical scenarios set in the future, specifically calling out food delivery services and credit card companies as ones facing trouble. Citrini Research, founded by James van Geelen, presented a scenario set in June 2028 where AI’s disruption has caused mass unemployment for white collar workers, declining consumer spending, software-backed loan defaults and economic contraction. Still, the report notes clearly — “What follows is a scenario, not a prediction.” Alap Shah, co-author of a Citrini Research report and CIO of Lotus Technology Management joined Bloomberg China Show to discuss. Here is a direct video link.

A Bank of Canada study estimated that for every dollar increase in home values, spending rose by 5.7 cents. A New Zealand study found that the housing wealth effect had an even greater impact in reducing spending when home prices were falling than when they were rising.

Prices in Canada have fallen more than 20% nationally since February 2022. And since housing activity accelerated by monetary and fiscal policies drove an unhealthy majority of Canada’s GDP growth between 2015 and 2022, the downside of declining prices and activity is also oversized.

The extreme price overshoot earlier this decade didn’t just give homeowners a psychological boost; it also enabled them to borrow more against the value of their homes. Now that debt is weighing heavily as prices fall and loan-to-value ratios rise. For many, the home equity ATM they had relied on is now fully closed.

As I have been noting for the past 5 years, housing-related downturns tend to be multi-year cycles that’ve historically led to the harshest economic contractions. The housing downturn unfolding packs a larger economic impact for Canada than tarrifs.

Recently, more analysts and industry experts have been sounding this alarm. CIBC economists published a report last week noting that “the decline in homebuilding and falling home prices have ‘clear negative’ implications for the economy — and it’s likely to get worse before it gets better”:

Canada’s housing correction drags on, data showed us yesterday, but with the sector representing a bigger chunk of our GDP than most other G7 countries, what does that mean for the economy?

CIBC economists Benjamin Tal and Katherine Judge looked at this question in a report out yesterday, and concluded that not only is the economic impact “not trivial,” the damage is deeper than some official statistics would suggest.

The segment below discusses the CIBC report and Canadian housing trends further.

CIBC Warns Canada’s Housing Correction Is Worse Than the Data Shows (Starts, Condos & the Wealth Effect). Here is a direct video link.

The benchmark Canadian home resale price has fallen more than 21% in nominal terms (25-30% in real terms) from the 2022 cycle peak (shown below since 2020).

But new home prices have fallen just 8% from the peak nationwide because builders have used incentives, including mortgage rate buydowns, to avoid top-line price cuts.

More price cuts are needed, as so far, home ownership costs as a percentage of household income remain far above historical affordability norms (shown below since 1985).

According to the latest CMHC report, new home construction in Canada is set to decline through 2028 as developers face high costs, weaker demand and more unsold homes. Condominium starts will be especially weak. Rental projects will continue to drive new supply but will moderate over the forecast period.

Rental markets are moving toward balance on a national level as new supply eases pressure and rent growth slows, giving renters more flexibility before buying a home.
Regional housing markets vary significantly.

A negative for economic growth and jobs, new construction and home sales in Ontario and British Columbia are projected to be weaker than their 10-year averages.

Economist Eric Basmajin explains leading indicators and the importance of real estate construction and home renovation to overall economic growth in this segment below.

EPB Research provides economic and business cycle education, analysis, and consulting to asset managers and business owners. Here is a direct video link.