Juggling Dynamite

Our September 30, 2021, client letter “Shifting Foundations” highlighted the default of Chinese property developer Evergrande as a turning point in the real estate-centric China growth story with broad implications for the global economy:

China’s property sector has been the largest driver of its economic growth over the past decade and a significant driver of global growth. Concerned about overbuilding, speculation and lofty debt levels, Beijing introduced rules to limit the amount that developers can borrow. This has triggered insolvency in the sector and one of China’s largest property developers defaulted on bond payments to foreign investors this month. The story has broader implications for the global economy, commodities, and especially Canada.

Since 2019, Chinese property shares have fallen about 65% and counting, this month taking out the 2020 crash low to revisit the 2008 financial crisis bottom.

Perma-bullish Wall Street and late-to-act credit rating agencies have only recently been downgrading China’s economic outlook, as discussed in the segment below.

Shehzad Qazi of China Beige Book says the Chinese government’s priority is creating stability, not growth. Here is a direct video link.

After Japan’s legendary real estate bubble burst in 1989, property prices plunged for several years and have not recovered peak prices in the 34 years since. During the mean-reverting process, banks and other financial intermediaries took years to write down bad loans advanced during the bubble.

In related news, see: Housing accounts for an unhealthy 40% of Canada’s GDP.

Danielle was a guest on the CBC Weekend Business Panel, talking about the Bank of Canada rate decision, grocery prices and McDonald’s efforts to increase sales. You can watch a video clip of the segment here.

Equifax Canada reports that Canadian households added $80 billion of additional consumer debt over the past year, making the total outstanding an eye-watering $2.4 trillion.

Well beyond paycheck to paycheck, many are living credit card to credit card. Money owed on credit cards climbed to a new high of $113.4 billion in the third quarter of 2023, up 16% from last year. More than six million new credit cards were opened in the past 12 months, up 13.7% from last year, with the average card balance rising to $4,119 and beyond pre-COVID levels. The percentage of cardholders making the minimum payment rose by 3.4%, while the percentage of those paying off their balance in full dropped by 1.5%.

Equifax vice-president Rebecca Oakes noted that increased rent and mortgage costs mean more people are relying on credit to cover their living costs, and “As more mortgage renewals continue to happen, we’re going to see more Canadians begin to experience payment shock, and that’ll continue over the next year.”

It’s not just households struggling to stay afloat; corporate debt is also at historic highs, with loans coming up for renewal at significantly higher interest rates every month.

Forty percent of the economically sensitive Russell 2000 companies are unprofitable today compared with 20% pre-COVID. Many have relied on cheap credit and government handouts for years to keep the lights on, and neither is on offer now.

In the latest Canadian Business surveys, insufficient demand has overtaken labour shortages as a primary concern. It is little wonder that new hires, job openings and average hours worked are declining while layoffs are rising. Labour’s share of national income has tumbled toward the 2011-2015 all-time-lows of 55%–the least since at least 1945.

Deflation is back on deck as financial mania sobers to the brutal math of high leverage and mean-reverting asset prices. The segment below offers a worthwhile update.

Is 2024 likely to be the year the Lag Effect arrives in force? To find out, we’re fortunate to speak today with CEO & Chief Strategist for QI Research LLC and the author of the book “Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America.” Here’s a direct video link.