Juggling Dynamite

Good overview of the current cycle starting at 37:37 on the play bar.

David Rosenberg of Rosenberg Research begins at 37:37 on the play bar.  Here is a direct audio link.

As of yesterday, the S&P 500 is down 17% and Canada’s TSX about 10%.  This is pretty typical heading into a recession where the broad market comes down about 10% and then falls a further 20 to 40% as bullish sentiment finally capitulates.  The table below offers some historical context since 1929.

Bitcoin is off nearly 55% from its November peak, and 40% of holders are now underwater on their investments, according to new data from Glassnode.

That percentage is even higher when you isolate for the short-term holders who got skin in the game in the last six months when the price of bitcoin peaked at around $69,000.

40% of #bitcoin investors are now underwater, according to a new report. @JoeSquawk @andrewrsorkin and @BeckyQuick discuss: pic.twitter.com/fuvyTbCtgT

— Squawk Box (@SquawkCNBC) May 10, 2022

And it’s not just the cryptos, the whole sector that’s sprung up around them is getting crushed, see Coinbase shares plunge almost 80% from November, amid a sell-off of cryptos and funds.

As mentioned in the CNBC segment, ARK Innovation ETF (in white below)-which was buying Bitcoin, Tesla and other innovators without concern for price or valuation, has now fallen more than 70% and given back all of its much-hyped “outperformance” as against the S&P 500 index (in blue).  This was inevitable.  More mean reversion is yet to come.

Even when we don’t owe a mortgage, personal use real estate is negative-carry–we spend money to maintain it rather than it paying us.

As an investment property, real estate is supposed to generate enough cash flow to carry itself.  If it doesn’t, owners are out of pocket to keep it afloat.  This is the definition of speculation– where you own the asset because you hope it will go up in price enough over your holding period to pay back carrying costs and then some.  It’s a risky business for individuals because rental income and our income from other sources can fluctuate with the economic cycle, making negative carry harder and sometimes impossible to maintain during periods of stress.

In October 2019, I noted that a poll by investment-research firm Veritas found that only half of would-be real estate investors in Canada (primarily polled in the GTA and Vancouver) were earning net positive rental income. Of the other half, 18% said they were breaking even, and a third said they were losing money.  See:  Canadian Real Estate Investors are losing money, pose a risk to the system: Veritas.

With median prices doubling in the past two years, the math for many investment properties has grown even more negative.  Now interest rates have moved sharply higher. An estimated 15% of property buyers across developed markets are all-cash buyers (anecdotally, in Canada, it seems to be less), with 85% dependent on financing.  No wonder the Globe is reporting this week that Some new landlords are losing money, as shown in the charts below.

The average price of condos sold in 2020 that were subsequently leased within 12 months of the owner taking possession was just over $600,000, with an average annual property tax bill of $2,235 and average condo fees of $514 a month.

With a down payment of 20 percent and what was then a competitive five-year fixed mortgage rate of 2.29 per cent, the average monthly carrying cost of an average-priced property would work out to around $2,800, according to calculations by The Globe and Mail. But the average rent for the group properties tracked by Mr. Pasalis was less than $2,250, yielding a monthly loss of over $550.

It’s an even grimmer picture for investors who rented out homes, who could face an average monthly cash flow shortage of nearly $1,160, according to Mr. Pasalis’ data and Globe and Mail calculations.

When many people have negative carry, it magnifies the downside for the property market, lenders and the economy.