Juggling Dynamite

Mining and commodity stocks have been hit hard again the past month, with the TSX Venture composite now below support and flirting with the lows of last fall. Venture along with Chinese stocks have served as leading indicators for the demand cycle and global growth. The weakness in both over the past year (and even 4 years, still down since they peaked in 2007-08), bodes ill for broader markets that have recently vacillated in fits of liquidity levitation all on their own.  The chart below shows the Venture composite top compared with the broader S&P 5oo price action below.

Dangerous for their investors, this follows a time when commodity and mining stocks have been the greatest story ever sold with a classic surge of sector specific funds, ETFs, products and managers in this space (reminiscent of the tech/telecom fervor of the late 90’s). All of which begs the question unfathomable to many today: could demand for commodities, their companies and shares have hit a cyclical peak with the consumer credit bubble in 2007?

Source: Cory Venable, CMT, Venable Park Investment Counsel Inc.

Stock markets are roaring (at least so far this morning) in another day of madness and mayhem.  Meanwhile North American bond yields are not joining in as bonds remain bid with the barometer US 10 year yield still holding below 2%.  Everyday is one more scene from One Flew Over The Cuckoos’ Nest, as bankrupt entities announce tranche after tranche of financial support for one another.  A glaring example today, was Japan’s promise to toss another 60 billion onto their own line of credit in order to give more to the IMF to help bail out Europe.  “There must be one more credit card that we haven’t filled around here somewhere” seems to be the thinking.

The trouble is this: more debt, creates more cash flow drag, creates slower growth, creates larger deficits, creates more debt.  The velocity–movement of money through the real economy–plummets further with each round of debt-fueled stimulus and “rescue”.    The below chart shows that money velocity today in the US (same for other countries) continues to contract, not in spite of all the intervention efforts, but precisely because of them.

Today Lacy Hunt’s Hoisington Q1 Review reminds anyone who is interested of the truth about debt-rescues:

“In 2011, the U.S. private and public debt to GDP ratio was about 174 percentage points higher than the post 1870 average. Comparably measured debt to GDP ratios are substantially higher in the Euro zone, the UK, Japan and even Canada, indicating that the debt issue is a global depressant to growth. To remove this growth impediment, debt needs to decline dramatically relative to GDP for a prolonged period. Contrary to common wisdom, monetary and fiscal policy actions that spur growth by increasing debt may buy transitory gains in some measures of economic activity, but they perpetuate this disequilibrium. Increasing debt merely makes the economy more vulnerable to economic weakness and potential instability because income growth is stunted or, as previously stated, over-indebtedness cannot be cured by more debt. Periods of over-indebtedness change the sacrosanct rules of thumb of business cycles. The conventional wisdom of business cycle analysis that suggests five to seven good years followed by one to two bad years is broken. Normal risk taking is not rewarded.”    Read the whole article here.

The Loonie is up a cent this morning (at least at the outset) on word from the Bank of Canada that it may have to raise interest rates sooner than previously expected:  “In light of the reduced slack in the economy and firmer underlying inflation, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 percent inflation target over the medium term” the BOC said in a statement today.

But we have seen this movie a few times before, as the BOC moved to a tightening bias both in the fall of 2010 and mid 2011, only to quickly retreat again as the European debt crisis blew out to threaten global recovery hopes once more. If the next global recession is already underway, then the BOC is certain to wax more dovish again in the months ahead.

I think the real concern for policy makers (and tax payers who backstop the Canada Mortgage and Housing Corp) in Canada is our froth-filled housing market.  See Mortgage market tiptoes toward subprime:

As the big banks get choosier about who they’ll lend money to in this hot housing market, people with questionable credit are benefiting from Canada’s once-small but now booming subprime mortgage industry.

The Canadian Real Estate Association released figures Monday showing Canadian home sales rose 2.5 per cent in March, and the average Canadian home sold for $369,677 last month.

That was actually a slight decline from the level of a year ago, but it comes on the heels of almost uninterrupted strong gains over the previous two years.

Fuelling that boom is a growing pile of mortgage debt, an increasing amount of which isn’t coming from Canada’s major lenders. That’s largely because of recent developments at the Canada Mortgage and Housing Corporation.

The CMHC is the Crown corporation mandated to oversee Canada’s housing industry. The vast majority of Canadian mortgages show up on its books, because CMHC insures the mortgages approved by banks.

In 2010 and again in 2011, hoping to slow down a red-hot housing market, the Department of Finance tinkered with the rules surrounding who can qualify for CMHC-insured mortgages. Moves to shorten the maximum length of the mortgage and raise the minimum percentage a borrower must have as a down payment combined to make CMHC insurance harder to come by.

“The banks don’t want to take on anything that’s not insured by CMHC,” Toronto mortgage broker Marcus Tzaferis of Morcan Direct says. “So that’s pushing borrowers farther and farther out of the mainstream to find financing.”

Industry experts suggest the big banks are currently rejecting as much as 20 per cent of mortgage applications because they don’t qualify for CMHC insurance.

But alternative lenders like Home Capital Group, Equitable Group and Counsel Corp. have stepped in to fill the market niche of funding borrowers who don’t meet traditional lending requirements — known in industry parlance as “subprime” borrowers.

‘There’s a perception that Canada avoided the subprime mortgage crisis because we’re conservative and we have a good system. But it’s not really the case.’—Benjamin Tal, CIBC economist

I think the BOC has very good reason to be worried about Canada’s over-indebted consumers and over-valued realty markets. The inevitable downside is ominous for the Canadian domestic economy. The reality is however that ongoing export weakness is still likely to trump domestic mortgage worries as our commodities-dependent economy turns down in the next global recession. The BOC has premised its bias toward tightening on expectations for firmer-than-expected growth and inflation as well as a less hostile global backdrop. We shall see.  My concern is that global hostilities are likely to worsen for a while from here and the BOC will be forced to backtrack some more.