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November 19, 2017 | Causation

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

American stocks are over-valued by about 20%. So, a correction could carve 4,000 or 5,000 points from the Dow. Gulp. But, it’s not going to happen. At least not soon. There’s much more to come – great for those with careful US exposure and gnarly for the value of your house.

US corporations are on a role with robust, rising profits. Given the expectations for earnings in early ’18, stocks don’t look so nose-bleed after all. Then there’s the Trump tax cut. If business taxes fall from 35% to 20%, roughly 10% is added to the bottom lines of most organizations. Yep, up she goes. Then there’s unemployment, as we used to call it. Now its name is “full employment” – exactly how economists define it when 96% of the people who want jobs find them. In fact there are currently more vacant job openings in American than jobless Americans to fill them.

This gets better, says Goldman Sachs economists. The 4.1% rate will actually wither to 3.5% by the end of 2018. We haven’t seen that for almost 60 years, when people drove four-ton cars with fins on them. Meanwhile, inflation’s back. After the quasi-deflation and huge central bank bail-outs of the Obama years, prices and wages are rising again. So the Fed is cutting back on monetary stimulus.

What it means: US interest rates have increased four times in 12 months and will likely go up again in December. In 2018 (which starts in a few weeks) the consensus opinion is for three more increases, although Goldman said on Friday it sees four. The Fed rate – which was at zero little more than a year ago – will be 2% or more. Yes, a big deal. But a growing, robust, broad-based economy like that of the US can absorb higher inflation and rising rates when wages are also growing along with the job market.

What it means to investors: All good, basically. As the largest economy in the world expands in an orderly fashion, with rising corporate profits, broadening employment and buoyant consumer confidence, Americans continue to stuff equities into the 401k accounts (RRSP equivalents) and markets advance. Could the Dow ever hit 30,000? Of course. Expect some corrections along the way, but there’s nothing on the radar now to signal a crash, reversal, crisis or general OMG moment. In other words, a 20% drop between now and 2018 would be a big surprise. And a bigger buying opportunity.

Meanwhile it’s no serious coincidence most other markets – the UK, Britain, emerging nations, Japan, for example – are also bouncing around at record levels. The wusses among us recoil and say, “everything is in a bubble. We’re truly pooched this time.” But in reality the deflationary low-rate, low-growth, low-inflation switch was flipped about a year ago (yes, with Trump), and we’re now into the next phase. Higher prices. Improving incomes, at least in the States. Fatter equity values. A return to inflation. And swelling  interest rates.

What it means to houses: There’s no way the Fed hikes rates three or four times in 2018 (plus once next month) and our guys stay idle. The Bank of Canada rate will increase at least twice and more likely three times in the next 12 months. That will add at half or three-quarters of a point to all loans. HELOCs (about $280 billion are outstanding, most of them variable rate) will cost about 4%, as will five-year mortgages. Given the universal stress test, in place in about two weeks, buyers must qualify a year from now (or sooner) at about 6%. This is a 300% increase from early 2017.

If you don’t think that matters because your spouse is still house-lusty, immigrants are teeming in with bags of money, there’s no more land and everybody wants to live exactly where you are, look at this chart:


BMO economics simply charted the start of interest rate increases earlier this year, and the net impact on real estate values. The chart also shows you what happened to housing hormones back in 2015 when the Bank of Canada rashly chopped rates twice. As this pathetic blog has been yapping about the past few years, the correlation between the cost of money and property values is absolute and irrefutable. So guess what happens when people have to qualify at 6%?

It was instructive a couple of weeks ago when CMHC exec Michel Tremblay said, “the dream of home ownership may be fading for many Canadians.” Tremblay did not stop there. He suggested long-term renting might be a better option. CHMC. Imagine.

Maybe it’s started. Mid-November resale numbers in the GTA were awful. And new house sales have plunged by two-thirds as the price of a freshly-built home in the distant burbs soars past $1.1 million. The people rushing to ‘beat’ the stress test, to borrow more now than they’ll qualify for next year, give this blog its name. 2018 could be epic.

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November 19th, 2017

Posted In: The Greater Fool

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