Juggling Dynamite

Yesterday morning, a milder-than-expected US CPI number boosted hopes that the US Fed may soon start lowering its policy rate. Financial markets pooped on the headline, further loosening financial conditions for some publicly traded companies.

Then, a more hawkish Fed announcement in the afternoon lowered 2024 cut expectations from 75 basis points (bps) in the second half to just 25 bps in November, effectively signalling tougher for longer credit conditions for households and the vast majority of companies.

The Fed forecasts the US unemployment rate to rise to 4.2% in 2025, 80 bps above the 3.4% cycle low in 2022. There has never been a time when the US unemployment rate has risen 80 bps that the US economy was not already 4 to 5 months into a recession. The Fed is incongruently predicting US GDP growth of 2% in 2025.

At this point, the unemployment rate has already increased 60bps from the low and full-time employment (green line below) has contracted more than 80bps–again something that’s only happened during past recessions (purple bars below, since 1970).

Most importantly, as shown below, courtesy of Barchart, since 1974, the time lag from the first Fed cut to the stock market low has averaged 195 days with an average price decline of 23.5%. In the three incidents when the stock market entered the cutting cycle at valuation levels near as rich as today, the market decline was in the 30% to 50% range (see 1973, 2000, and 2007).
Market cycles tend to be hard on those who lack attention or understanding. Maybe this time will be different.

This interview offers a lucid top-down review of economic trends and asset markets.

Here is a direct video link.

As I explained here, I do not share the faith that immigration should prevent Canadian home prices from declining by more than ten percent.

It is wildly unpopular to say this, but Canadian home prices need to move much lower. And yes, I, too, stand to lose net worth as they do.

Immigration is unlikely to prevent mean reversion here. Immigrants need places to live, to be sure, but historically, it took an average of 7 years before immigrants were able to buy a home in Canada. And that was when prices were more affordable than today.

At the moment, home affordability is at its worst since mortgage rates were north of 18% in 1981. The driver of unaffordability today is not interest rates (historically average); today, unaffordability is driven by prices being impossible multiples of household income (i.e., 5 to 12 times the average household income versus long-term norms of 2 to 4x).

Where I live, one hour north of Toronto, new listings are up about 66% since the end of February. Properties are sitting on the market, and would-be sellers are still asking prices paid when mortgage rates were under two percent compared to the 5% range today.

Recently, “reduced” and “new price” listings have been popping up. This lovely custom home on my walking circuit in a premium area across from the lake was built on spec during the pandemic. So far, as shown below, the price has been reduced by 22% to $1.69m from $2.195m two years ago.

A vacant lot around the corner has been marked down 58% to an ask of $495K from $1.195m three years ago (see listing history here). This lovely home in the same neighbourhood sold for $1.8m in February 2022 and is now listed 17% lower at $1.49m after months on the market (see price history here).

The trouble is that even at the $1.49m asking price, with a 20% (299k) downpayment, the mortgage payment would be $7,387 a month, $8,195 a month, including property taxes. That requires $98,340 a year in after-tax income to cover the mortgage and property taxes (as shown below), let alone all life’s other expenses.
Less than 10% of Canadian households earn more than $100k a year before tax, never mind after (see Is a $100k salary enough for a comfortable life anymore?).

The reality is that most homeowners today would be hard-pressed to qualify for a conventional mortgage at current asking prices and interest rates to buy their current homes.

Yes, the Bank of Canada has started easing base rates in the banking system and is likely to respond to a weak economy and rising unemployment with more cuts in the months ahead. But that’s not all that’s needed here.