May 16, 2022 | The Rout is On

It was another volatile week for financial markets. Nearly $11 trillion was erased from global equity values. If you start adding the bond and crypto markets we have $35 trillion in wealth that has evaporated. I’m often asked where is all the money coming from? How are people coming up with the down payments for $2M homes in Vancouver? I can assure you they are not working a 9-5 job and saving for twenty years, they are often cashing in gains from other financial assets. In other words, the correlation between falling stock prices and housing demand is not zero.

What’s more concerning is this is all par for the course, according to the worlds most influential central bank. The Fed is targeting a reverse wealth-effect, explicitly trying to drive down asset prices in order to slow inflation. You see, the Fed can’t pump more oil, harvest more wheat, or fix supply chains, but they can influence financial conditions by raising rates, lowering asset prices and ensuring people have less money to spend. Remember, last month Bill Dudley, the former president of the Federal Reserve Bank of New York, said if financial conditions don’t tighten on their own, “the Fed will have to shock markets to achieve the desired response”, that is, “it’ll have to inflict more losses on stock and bond investors than it has so far”. If that wasn’t clear enough, the former vice chair of the FOMC closed by saying: “one way or another, to get inflation under control, the Fed will need to push bond yields higher and stock prices lower”.

And so the rout is on.

For anyone reading this newsletter, you’ll remember we didn’t fight the central banks on the way up, and we certainly don’t plan to fight them on the way down. Prudent investors would be wise to accumulate cash and wait for upcoming opportunities. As we’ve talked about, housing activity has already slowed considerably and prices are coming off in some of the frothiest segments (suburban houses and townhomes).

We will get the latest national sales data later today which will confirm the nationwide cooling in home sales. We already have a sneak preview with Vancouver down 34% and Toronto sales off 40% from last year. These are the two largest housing markets and account for the bulk of national sales data.

We should start to see developers pause projects as they weight the risk/ reward of launching new supply in a slowing market. Remember, under current government guidelines, developers in BC have 12 months from the date they launch their marketing/ sales to secure construction financing. Lenders typically require about 60% of units to be pre-sold. In other words, the developer has to ask themselves, can we successfully sell 60% of the building in 12 months and is the risk/reward worth it?

So new housing supply will surely slow as housing demand declines in the near term. Things get more interesting when you consider that the Canadian Government is still planning for record immigration again this year, and they’ve actually proposed to increase it to nearly 500,000 new immigrants per year, according to their latest proposal circulating in parliament.

The takeaway here, liquidity, or the lack thereof is going to slow everything. Policy makers want house prices lower, at least a little bit. This is will create opportunities moving forward, both on the purchase side and on the supply side several years from now.

Three Things I’m Watching:

1. $35 TRILLION in global market value erased since the beginning of the year. (Source: Cullen Roche)

2. Housing still historically affordable in Alberta, even with rising interest rates. (source: Ben Rabidoux)

3. Canadian dollar has departed from its link to oil. (Source: Trevor Tombe)

Steve Saretsky May 16th, 2022

Posted In: Steve Saretsky Blog

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