Editor's Note: Click the play button or read the excerpt below for insight from a new conversation between hedge fund manager and MacroVoices podcast host Erik Townsend and Hedgeye Housing analyst Josh Steiner.
Erik and Josh discuss the state of the Australian, Canadian and U.S. housing markets (Click here to get a special offer on Market Edges, our weekly macro newsletter.)
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Erik: Joining me next on the program is Josh Steiner who heads up the entire financials research department at Hedgeye. Part of that, of course, is housing sector research, and that’s what we’re going to focus on today. Patrick has been looking for a guest for some time who could really talk intelligently to the various different housing bubbles that we see forming around the world. And, Josh, I’ve got to hand it to you.
I love interviewing Hedgeye guys, because you always come with fantastic slide decks. Folks, you’re not going to want to miss this download. If you are a registered user at macrovoices.com, the download link is in your Research Roundup email. If you’re not yet registered, just go to macrovoices.com and look for the link to get the downloads, next to Josh’s picture on our home page.
Josh, before we dive into your excellent slide deck here, I want to start with a really high-level picture, which is what is the macroeconomic thesis of why is it that it seems like these resource-rich countries like Canada and Australia are very prone to having housing bubbles. And that these bubbles seem to just keep blowing up for a long time. What’s going on here with the big picture?
Josh: I think it’s a good question to start with, but I would actually disagree slightly with the premise. I think most people look at countries like Canada and Australia and tend to think of them as being resource-driven economies. And I think up until about 10–15 years ago that was definitely the case.
But our work has shown that really in the last ten plus years, especially in the last five years, these are largely finance-driven economies. We’ve looked at the contribution to both the economy at large – the share of growth in the economy from financing, insurance, real estate, construction, across both Australia and Canada. And we’ve sort of likened them to one-cylinder engines where, really, the bulk of growth is being derived from appreciation in collective property values, the financing of it, the insuring of it, the construction of it, and the wealth effect created thereby.
So I think, definitely, looking back through time, there’s certainly a resource-driven component, and that’s still there. But when you really dissect the source of new growth for these countries over the last half decade or decade, it is pretty surprising just how much of it has come from the property markets.
Erik: I want to cover Canada, Australia, and the United States in this interview. Why don’t we start with Canada and dive into your slide deck? It looks like starting on Page 3 you’ve got an excellent sequence of slides focusing on the Canadian real estate situation.
Josh: Yeah, absolutely. Just, if I can put in a little plug here, when we do these decks here at Hedgeye, they tend to be anywhere from 100 to 150 slides. I’ve selected 10–15 slides for each of these respective markets, but suffice it to say that there’s a lot more to it than what we’ve got here. But I think the slides I’ve selected are a pretty nice cross-section and a reference point, at least for starting to think about what’s going on across some of these different markets.
If we take a look at Canada maybe start on Slide 4. I think there’s a lot of slides out there, presentations that I’ve seen, that draw some sort of overlay between the Canada and US and other markets just for context. And, frankly, we’ve done that here as well, but I think we’ve tried to do it through a slightly different lens.
On Slide 4, basically what we’re looking at is residential investment, the share of GDP is expressed here in terms of standard deviation relative to the longer-term average. We’re basically looking at Canada relative to the US. You can see that Canada has been steadily grinding higher, really, since about 12–13 years ago and it’s now at a level just shy of where the US peaked in late 2005.
If we go to the next slide, Slide 5, I think this one speaks volumes to – when you think about property markets and you ask the question: Are they in fact bubbles? And, if so, how do I attempt to gauge when they’re at that peak point, ready to go the other way? Really what you’re looking for is what’s referred to as this Minsky Moment, meaning when things truly go non-linear or parabolic. And I think this chart on Slide 5 does a decent job of reflecting that.
What we’re showing here is the share of Canadian GDP attributable simply to ownership transfer costs, which are just broker commissions, real estate broker commissions. We show it in percentage terms on the left axis and in standard deviation terms on the right. And it’s relative to its longer-term 40-year history. Currently, we’re north of three standard deviations.
If you go to the next slide, Slide 6, and you look again, compare and contrast with the US, I think there’s an eerie similarity between what’s happened just in the last four years, which is where that Minsky component comes in, in Canada, and where the US was. The parallels are pretty uncanny. Third quarter 2005 ownership transfer costs relative to US GDP reached just over three standard deviations. And Canada as of early 2017 had reached a similar level. These are slides from our deck we put together in August of 2017, so we’re a few quarters out of date. But, obviously, there’s a longer-term phenomenon. And I think the message is very clear.
Nobody should be surprised by this next slide, Slide 7, which shows the growth in household or private mortgage debt in the US relative to Canada. Obviously, Canada continues up into the right here. And then, if we look at home prices on Slide 8, pretty much a steady trajectory in Canada really up until about a year and a half ago. And then just in late 2015 to 2016, 2017, you really started to see Canadian home prices begin to take off. And they certainly have moved well out of range relative to certain anchor points like DPI on Slide 9.
There’s a lot of policy change that’s taking place in Canada. We’ve laid that out on Slides 10 and 11. I think a couple of the bigger ones were these foreign buyer taxes implemented in Vancouver and then more recently across the Golden Horseshoe. But the one that’s top of mind at the moment are these B-20 guidelines or rules that have been put in place effective just about a week ago. And the B-20 rules, effectively make it harder to qualify for a traditional mortgage from an underwriting standpoint because the rate at which you need to qualify is now meaningfully higher – also harder to source down payments through non-traditional means.
Both of those factors are coming at a time when unaffordability is already at extreme levels and you’ve got a bit of a waning in foreign demand coming in. We’re sort of at a critical time here in thinking about Canadian property and whether these gains that have been realized over the last several years are even remotely sustainable. I won’t go into all the slides because I think there’s a lot here and I don’t want to put people to sleep. But a few things I would call out is that, in the twilight of these property cycles, historically, one of the things you see without fail is a wholesale shift in terms of the financing structure in these markets.
If you go to Slide 15, I do think it’s notable that when you look at, for instance, the share of loans being sourced by mortgage brokers. Even just moving from 2016 to 2017, those shares have risen very significantly. So, for instance, first-time buyers in 2016, just about a quarter of them sourced their loans through mortgage brokers. And then in 2017 that number had risen all the way to 35%. That’s a very marked shift in a relatively short span of time. And a lot of people talk about the foreign buyer component and what’s going on. This, in a way, comes back to the resource-driven component of the original question.
If you go to Slide 16, this encapsulates what’s happening there reasonably succinctly. Essentially what happened is in mid-2014 oil peaked. It basically sold off very aggressively up until around February 2016. During that timeframe, the Canadian currency lost a significant amount of its value relative. And so you saw, not surprisingly, foreign buyers really pile into the Canadian property market. Here on Slide 16 it’s showing the Canadian dollar relative to the US dollar and what happened coincidently in both the Toronto and Vancouver markets.
As you saw the blowback from that energy-driven weakness, it really attracted foreign investment. I think that’s something to keep in mind when you think about foreign investment. I’ll talk more about that later when we look at Australia. But I do think we’re sort of on the other end of that. On the wrong end, I guess, from a bullish housing frame.
