Juggling Dynamite

A worthwhile review in this 1-hour segment.

Legendary economist Dr. Lacy Hunt joins Julia La Roche on episode 115 for a wide-ranging discussion on the economy and why we’re facing an impending recession. Here is a direct video link.

The average home price in Canada ($757k) is about 141% higher than what is considered affordable for the average household income. In the highest-population areas, like the Greater Vancouver and Toronto Areas, where incomes and home prices are higher than the national average, the affordability numbers are much worse. Price-to-income ratios in the mid-west and east are less outrageous, but only Edmonton has an average home price that measures in line with income ability (see chart below from RatesDot.ca). Not only does this math knock out most would-be-buyers, but it’s also a big hurdle for the millions who took out mortgages when interest rates were abnormally low/prices ridiculously high in 2020-22.

60% of Canadian mortgages are set for renewal within the next three years (chart below) courtesy of Royal Bank. See Payment Shock Coming for Most Canadians with Mortgages, RBC says. At current rates, this would equate to a payment increase of 32% for the half trillion in mortgage debt that is up for renewal over 2024-2025.

By 2026, when another $400 billion worth of mortgages are set to renew — including a large proportion of so-called negatively amortizing loans — the increase in monthly payments could be as high as 48% on a weighted average basis, while variable-rate mortgagors could face a payment shock of 84% by 2026 if interest rates do not decline significantly (RBC data).

Yes, the Bank of Canada is likely to ease overnight interest rates starting in 2024. But it is unlikely to move back towards the zero-bound madness of 2009-2022 and even that would not solve the problems here. RBC calculates that to reduce payment shock to 20% for the variable-rate cohort, the Bank of Canada rate would need to fall to 0.25% by July 2026, and this is “perhaps an unreasonable expectation at the moment.”

A significant number of current owners will look to sell and new listings are already multiplying like measles. Unfortunately, the bid that would-be buyers can offer is much lower than would-be-sellers have in mind. Market prices are a lot lower now than they were. As shown below (courtesy of @GRomePow), the same $1850 in monthly mortgage payment can afford a home price of $252k at 8% compared with $456K when rates were less than 3%.

This mathematical reality is now confronting owners and lenders alike. As the RBC report observes, payment shock “represents a tail risk to Canadian banks.”

The International Monetary Fund warned this month that the downdraft in China’s real estate sector has contagion implications globally:

In the near term, the sharp adjustment in China’s heavily indebted property sector and the resulting slowdown in economic activity will likely spill over to the region, particularly to commodity exporters with close trade links to China. Beyond this, an aging population and slowing productivity growth will further temper growth over the medium-term in China, amid rising risks of geoeconomic fragmentation, and bear upon prospects in the rest of Asia and beyond. In a downside scenario where “de-risking” and “re-shoring” strategies take hold, output could decline by up to 10 percent over five years in the Asian economies most closely linked to China’s economy.

The latest data shows that property investment — the largest driver of China’s economic activity — continues to slump, with home prices and consumer sentiment falling. (Sound familiar, Canada?)

Notwithstanding intervention efforts from Chinese authorities, China’s primary CSI 300 Stock Index has erased all its gains during the so-called reopening rally in the final quarter of last year. See China’s Property Woes Pour Cold Water over Efforts to Boost Stocks. The Chinese stock market is today 40% below its manic cycle peak in October 2007, 16 years ago. When asset prices dramatically overshoot reasonable valuation metrics, it is typical for them to halve and not recover prior peaks for many years. Word to the wise.

The video report below offers a worthwhile overview and update.

China’s real estate industry is collapsing in slow motion. Major developers like Evergrande and Country Garden remain stuck in spiralling debt problems. So-called ‘ghost cities’ dot the Chinese countryside. And now the International Monetary Fund just cut its global growth forecasts for 2024 and called out China’s real estate crisis as a big reason why. Here is a direct video link.