Juggling Dynamite

Many factors have earned us a much deserved and necessary mean reversion in North American realty prices including: ludicrous pricing/record low affordability, flat wages, aging demographics, low investment yields, unsustainable levels of speculation, necessarily tougher mortgage lending standards and in some of the hottest markets like Vancouver and Greater Toronto Area, the adding of a Non-Resident Speculation Tax.

While recent studies confirm that domestic residents continue to make up the lion share of buyers, an estimated 10-20% (depending on the area) have been non-nationals. And for that portion, the latest Chinese government curbs on capital leaving the country also seem to be taking a bite out of demand.  See: China’s outbound real estate investment plunged 82% in the first half of 2017.

Other domestic Chinese initiatives have been aimed at crimping the debt-fueled property bubble there as well.  Apparently, similar habits and behaviors have fueled similar problems all over.  No surprise there.  See  Chinese top official warns economy ‘kidnapped’ by property bubble:

Strong growth of real estate prices, sales and construction has powered China’s economy this year, putting gross domestic product on the path to its first annual growth acceleration since 2010…But authorities are increasingly concerned that the reliance on property for growth is fuelling financial risk and encouraging speculation rather than investment in the real economy.

“The real estate industry’s excessive prosperity has not only kidnapped local governments but also kidnapped financial institutions — restraining and even harming the development of the real economy, inflating asset bubbles and accumulating debt risk,” Yin Zhongqing, deputy director of the finance and economics committee of the National People’s Congress, said in a speech on Thursday. “The biggest problem currently facing the country is how to reduce reliance on real estate,” he added.

Speaking with some realtor friends the past week about the softening market this summer in Ontario. Sellers who need to move or downsize their costs are finally starting to reduce prices, but the realtors are complaining that many are so far still holding out for that one last dumb price-indiscriminate buyer to arrive from Asia or Toronto or anywhere else.

The buyer madness of April has sobered since. The average sale price in my home town of Barrie, 1 hour north of Toronto, has retraced nearly 22% from a peak of $562k in April to $440K at the end of July. Apparently August has weakened furthered. But having spiked a crazy 40% in just the 8 months from August 2016 to April 2017, the mean reversion cycle here must be barely started.

Nationally, we have this interactive chart from the CREA for some comparables on each province as at the end of June. The national price year over year was nearly flat in June, so August data may well bring a slightly negative year over year number when the data is updated.

Certainly a -40% style price correction nationally like we saw in the US 2004-12 cycle is due here. Unfortunately, Canadians are the most unprepared– indebted and under-saved–they have ever been.  At the same time, what little savings they do have is once more wagered in precariously priced financial markets. All risk, little cash, no cushion= rough ride ahead for the masses.

For anyone disciplined in investment valuation and probability assessments, the past 5 years have been taxing.  Since 2012 when Q-ever euphoria re-inflated animal spirits in world markets, those with the least care and concern for capital have looked like they have the most investment ‘talent’ just as they did in 2005-07 and 1997-2000 and every other speculative frenzy since markets began.

But the road to financial strength is a long and winding road, and this cycle’s performance race is far from over. Fools and their money will once more be parted, this time will be no different.  Each of us must chose how we wish to use market and business cycles, no one gets it all their way throughout.  Durable capital requires:

1. 1. understanding that every investment trend is a cycle
   2. choosing how we wish to navigate each, and
   3. the mental strength to stick our chosen course for however long completion takes.

We can either look dumb for missing out now or look suicidal and reckless for staying in, later.  We pick our poison: one feels bad for a bit, one is bad with long lasting harm.  See:  Hot stock rally tests patience of value investors:

While value investing appears to have lost some luster now as the so-called FAANG stocks— Facebook Inc., Amazon, Apple Inc., Netflix and Google parent Alphabet Inc. —have surged in value, the most steadfast devotees to value-style investing are often the ones that benefit most in market downturns.

The market’s attraction to highflying stocks punished value investors in a similar fashion in the late 1990s during the dot-com bubble. Growth stocks beat their value peers toward the end of two major bull markets that peaked in 2000 and 2007, before large market selloffs reversed the trend, putting value stocks ahead.

Some investors today worry that the longer growth stocks are viewed as nearly invincible, the worse the likely pullback will ultimately be.

History assures us that value’s bear market will end in a spring of high yield return opportunities with much lower risk, while those riding high on hopium today will give back 10 plus years of what they thought was ‘growth’ in a matter of months.  Dreams will be dashed, retirement plans capsized and lawsuits plentiful. Very few will exit this cycle with capital in tact and the cash to buy as others are liquidating in panic.

This extra-long indiscriminate buying cycle has convinced many that value discipline and managers are worthless.  But as Jared Dillion wrote last month:

But do you think it’s more likely that:  a) a bunch of smart people became stupid, or b) that the environment suddenly changed?  If you’re one of those smart people, do you completely abandon your process and just buy FANGS? Or do you stick with what has worked your entire career in the likelihood that it will one day work again? This time is (probably) not different.

Unlike central bankers, individuals in the real world with real savings to lose, don’t get to work in theory.  There are no do-overs or endless lines of credit, no one will bail us out from bad choices.  We don’t get to chose the cycles we live through, only our own responses to them. Every financial decision we make is real time in our finite lifespans and we must govern ourselves accordingly.