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February 2, 2018 | The Ride

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.

After surging 6,000 points over the past year, the Dow bled 600 on Friday. This week the market lopped off 3%, the first time that’s happened in more than 400 days.

Why? Well, nothing goes up forever and corrections are like diets. Healthy. We’re overdue. After a 30% advance in 12 months, a pullback of 10% or 15% would be reasonable. But there’s more to chew on. Friday’s jobs report in the States was great (200,000 last month) and wages have taken the biggest jump since the credit crisis.

This has investors expecting more inflation, the beginning of a wage-price spiral and – for sure – higher interest rates. For the first time in years the yield on a 30-year bond popped through 3%, and Canadian bond yields are surging, too. Just look at what five-year Government of Canada debt has been doing lately:

So, looks like the Fed will raise rates thrice this year (starting next month), and our guys will follow with two or three of their own. Stocks sell off, in part, when investors can collect decent interest on bonds without taking any risk owning stocks. The strong jobs report hands the central bankers another reason to do what they want – end the days of cheap money that have so distorted asset values.

Like, of course, Canadian houses.

Bonds have posted their biggest monthly move since the Trumpster burst into our lives. Prices have plopped and yields popped. Inflation is back, supported in Canada by ever-higher federal taxes, government over-spending, historic debt, $15 minimum wages and silly real estate values. US rates have risen four times in a year, and Canadian ones have popped three times in little more than six months. Mortgage rates have risen and are now poised to plump further.

Five-year Canada bonds help determine five-year fixed mortgage rates, which now sit above 3.3% at the chartered banks. It’s no stretch to think they could be 4% by the end of the year (or sooner). Add in the stress test premium dictated by the federal B20 rules, and borrowers (plus renewers who switch lenders) must qualify at the 6% level. Yes, that’s three times the cost of a mortgage back in the halcyon, bubblicious, FOMO, houses-always-go-up days of your youth – 10 months ago.

In case you were wondering, this is a potential disaster for Canadian real estate.

Between 42% and 47% of outstanding mortgages (depending whose numbers you believe) come up for renewal in 2018.  Almost all of them will be refinancing at a higher rate, putting pressure on owners in a land where household debt is off the charts. You can bet that many will try to bail out and take their profits at the same time the pool of available buyers is shrunk by rates and regs.

Then there are the lines of credit, discussed here yesterday. That $220 billion ocean of debt is almost all at floating interest rates, so the cost of servicing it will rise with each Bank of Canada decision pushing up bank prime. Already (as stated) 40% of borrowers are paying nothing and another fifth merely cover the monthly interest charges. More stress on family finances.

If you’d like a preview of what happens when bubble meets prick, consider Bitcoin. The cryptocurrency that this paleo blog warned you about last year (made up of man buns and faerie poop) has crashed from $20,000 to $8,000, losing almost 60% of its value. All those poor moisters who bought this junk on their credit cards, thinking ‘it’s different this time’ just learned it never is.

The same goes for houses in Vancouver or Toronto that have jumped 50% in value in a few years. Buyers have used extreme leverage to get into everything from newbie urban condos to suburban trophy homes. The cheapest money to ever exist was not used to extinguish debt, but to run it to the sun. How this turns out is unknown, but no economist a year ago was predicting bond yields would swell like a horny blowfish.

Stocks may well erode further, but the jobs, growth and profits that fuelled them remain. Real estate, on the other hand, is having its sole crutch – cheap money – kicked out. The ride begins.

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February 2nd, 2018

Posted In: The Greater Fool

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