Juggling Dynamite

The Canadian housing bubble has been deflating since February 2022, and there’s room for it to run.

We highlighted the mania and frenzy of financially destructive behaviours in real time, noting that once bubbles pop, property prices typically take years to recover.

BMO Senior Economist Robert Kavcic apparently agrees. In a recent note highlighted on Better Dwelling.com, Kravcic observes that “While many are searching for bubbles in the equity market, one continues to undo itself as we speak—Canadian real estate… We’ll reiterate, as we have from the start, that this cycle will be measured in years, not months or quarters.”

Kavcic notes that the current nominal home price decline, led by Ontario (in dark blue below), is tracking the 1990s Ontario-led bust (light blue below), and US price trends after the 2007 bubble burst (in orange).If prices continue this trajectory, it could take another 5 years to recover the levels seen in 2022. Kravcic adds: “The bear market in housing staggers on until affordability and investment dynamics reset themselves.” 

We aren’t there yet. Any homeowner who is struggling today and considering options, or anyone who is thinking of buying, would be wise to consider long-standing affordability norms:

• An ‘affordable’ home price has long been considered 3 times the pretax household income.

Even though the median Canadian home sale price in July ($673k) was 20% lower than the $840k in February 2022, it remains more than 7.2x the median pretax household income nationally of $93k. In major centers like the Greater Toronto and Vancouver areas, the median home price is still more than 11 times and 14 times the median household income.

• Affordable shelter costs (rent or mortgage payment, utilities, taxes, insurance and maintenance costs) are less than 30% of pretax household income.

For example, affordable shelter costs (rent or mortgage, utilities, taxes, insurance, and maintenance) for a household that earns 100k annually pretax would be 30k a year (2500/month).

• From an investor’s perspective, annual rents that yield more than 6.7% of the home price.

For example, a home priced at 800k would need to yield a minimum rent of $53,600 a year ($4,467 a month) to be considered a favourable investment.

BMO explains that Canada’s late great property bubble was fueled by a rare confluence of record immigration, pandemic migration, excess liquidity, ultra-low rates, maxed-out valuations, and—most importantly—speculative market psychology. None of that is likely to return in the near future.

Happy Canadian Thanksgiving!

Canada’s economic bubble is starting to burst. Portfolio manager Danielle Park joins Jay Martin to unpack why Canadian housing is cracking, why boomers and millennials alike are overleveraged, and how investor psychology mirrors the final stages of every bubble. From soaring household debt and collapsing home equity to U.S. tech overconcentration and the “fragile decade” before retirement, this is a sobering look at what’s next for North American markets and how investors can protect themselves before the music stops.
Here is a direct video link.

OpenAI currently has a market value of $500 billion, with annualized revenue reported at $10 billion per year. It is not expected to be profitable for another 4 or 5 years and is preparing to raise tens of billions of dollars in debt to fund infrastructure plans.

Moody’s has recently flagged the extent to which Oracle’s future data centre business relies on OpenAI and its unproven path to profitability.

The FT connects the circular business models that are fomenting epic FOMO in capital markets, in OpenAI’s computing deals topping $ 1 trillion. Here are some takeaways:

To fund its expansion, OpenAI has raised huge amounts of equity and started to tap debt markets. It secured $4bn in bank debt last year and has raised about $47bn from venture capital deals in the past 12 months — though a significant chunk of that is contingent on a tricky negotiation with Microsoft, its biggest backer.

OpenAI’s arrangement with Nvidia is likely to help investors get more comfortable making large loans.

The chip giant, which recently surpassed $4tn in market cap, has routinely used its mammoth balance sheet to invest in companies within its supply chain or among its top customers.

The beneficiaries of these deals in turn use the new liquidity to buy more Nvidia chips or borrow money.

Nvidia has invested in CoreWeave, which is also a customer and supplier. CoreWeave has also raised raise more than $12bn of debt secured against its Nvidia chips.

…OpenAI and its growing number of partners are betting AI usage will keep growing exponentially. If growth plateaus, or even slows, the investor enthusiasm that has boosted share prices on the back of these deals could quickly falter.

One Silicon Valley investment veteran said: “The company is in a far more capital-intensive business than Google or Microsoft ever was, and was born with no cost discipline.”

Amazon founder Jeff Bezos and Oracle founder Larry Ellison “only found religion” and drastically cut business costs, “after nearly going bankrupt”, the investor added.

The graphic below provides a visual representation of all this and reminds me of the 19th-century children’s rhyme “Pop Goes the Weasel,” where the chasing monkey ends up having to pawn ‘pop’ their coat for cash in the end.

“Round and round the mulberry bush,
The monkey chased the weasel.
The monkey thought ’twas all in fun,
Pop! goes the weasel.

Doubtless, AI will continue to evolve with both beneficial and detrimental impacts. But how will investors in today’s highly correlated and extraordinarily inflated valuations fare from here? There are only a handful of historic comparables, and all of them included periods of legendary pain and loss. Maybe this time will be different.

Valuations are timeless mathematical measures that assess investment risk, but if participants are ignorant or don’t care about evaluating investment risk, do valuations matter? We each make that decision based on our investment choices, knowingly or not. The discussion below considers this and more.

Has the growth of indexing broken the market? What fundamentals are important when the market doesn’t care about value? In this fireside chat, Michael Green and David Einhorn of Greenlight Capital discuss the impact of indexing on fundamental stock picking and how Greenlight’s methodology has changed in recent years to meet this new reality. Here is a direct video link.

Footnote to this discussion: POD shops mentioned are ‘point of distribution’ shops. In reality, most retail participants get their investment recommendations or ‘advice’ from POD shops of one form or another. CHATGPT explains as follows:

In large financial firms — especially banks, broker-dealers, or investment managers — a POD refers to an organizational unit or branch through which products and services are distributed to clients.
A POD shop, then, is a sales or advisory operation focused on product distribution — not manufacturing (asset management) or research.

In other words:

• “Manufacturers” design investment products (mutual funds, ETFs, structured notes, etc.).

• “POD shops” are the distribution arms that place those products with end clients or advisors.

• The focus is sales and client servicing, not portfolio construction or fiduciary advice.