It is no longer a surprise that following real-estate frenzies, home-owners, developers and major financial institutions end up seriously overleveraged in real estate and real-estate related assets. Credit ratings by major rating agencies are inadequate prediction of bubbles leading to underestimation of the risk involved in subprime and other mortgage instruments.
Ultimately, responsibility for the fate of many failed financial firms must fall on the CEOs who were blinded by the seemingly high profitability of financing the housing market and failed to control risk and leverage of their institutions.
The real estate market is a two-sided mirror, posing grave risk and dangers but also promising great returns when they do deliver. As history has shown, real estate boom leads to bullish stock markets, stronger consumer spending and growth in related industries. Who wouldn’t want a real estate boom?
However, the underlying principle to a sustainable and healthy economy and financial system is that prices need to be justified. Evidence should be readily available to prove the market value is reasonable and affordable by means of true demand and supply. True demand and supply are often hidden under the guise of profitability. It is important to recognize market manipulation, and effectively analyze the effect it has on demand and supply.
Dubai offers an example of things to come if a property bubble develops and then bursts. Dubai real estate, leaping skywards both physically and financially, enjoyed a final blowout in early 2008. It seemed an exciting alternative to wobbly stock markets for what investors' cash remained in the system. But after September, it all turned out to have been a Ponzi scheme in disguise. Dubai's trademark developers had been encouraged to sell off-plan sites low to create a feeding frenzy of "flippers" who sold unfinished properties to each other at ever higher prices.
Now leading in real estate price drop, Dubai real estate is down over 47% by the second quarter of 2009. Some of Dubai's most celebrated companies teetered on the brink of bankruptcy. Do I dare draw comparison to Canada? Multiple offers are back and there are hints of a shift to a sellers’ market. The financial crisis has pushed interest rates down to unthinkable levels but unlike US counterparts, Canadian mortgage credit is still flowing. Housing demand will be dampened if full-time employment continues to decline. The uptrend in part-time employment is not an effective substitute as far as housing markets are concerned. The condo-market is over-supplied. In contrast to the low-rise market, the number of completed but unsold condos is up sharply. Developers are resorting to large price reductions to move condo sales. New construction financing is hard to find. Securitization is still shut-down in Canada and bank lending terms and conditions are expensive for both condo and commercial real estate developers. In the commercial sector, office rents are declining and vacancy rates are rising. Existing tenants are downsizing in an effort to control costs and sub-lease space is up sharply.
The recession in US is likely over in August. The current stock market rally will not last and a second-guessing in global stock markets will probably be kicking in soon. While this should not signal an impending economic stall-out, it would be a reassessment of economic prospects. Note that there has been a discrepancy between stock market and bond market behaviour this summer. Stocks have reflected expectations of a robust V-shaped and a sustainable economic recovery. Bonds have been signaling slow growth and non-existent inflation risk.
Also note that consumer spending and inventories are currently growth drivers, having revived respectably in Canada and US. Unfortunately, inventory levels are still far too high in Canada and inventories will not provide an additional growth boost. Even though consumer finances and the retail outlook are in better shape in Canada, surplus inventories will dampen the initial upturn in output.
Employment, always a lagging indicator, would be helped by less extreme payroll downsizing. Yet faced with a balance sheet recession and the need to remain solvent, companies might continue to cut payroll headcounts and reduce per-worker wage levels, albeit a more comfortable pace.
Canada’s current account balance of payments deficit is running at $44.8 Billion (annualized). This is 3% of GDP, back to the early 90s levels. Normally a C/A deficit this large would be bad news for the CAD as the foreign exchange market does not appreciate C/A deficits this large. However, the CAD has been rising as there has been a big increase in net capital inflows that has more than offset the increase in the C/A deficit. However, the surge in net capital inflows is likely to be temporary while the C/A deficit could be longer term. This translates to downside risk for the CAD as foreign investors might not be as willing to invest heavily into Government of Canada bonds when they realize how far Canada’s government finances have deteriorated (Budget deficits for next 5 fiscal years).
Canada’s leading economic indicator index is not as robust as the US index. More of concern is the decline of Canada’s exports of goods , some 35% over the 12 months ended July. Exports of energy products, down 50% year to year are the largest losers. Given the large continuing surplus in natural gas markets, and historically low natural gas export prices, Canada’s trade performance in energy is unlikely to improve anytime soon. Looking beyond the government induced jump in US auto sales, Canada’s export outlook for automotive and industrial products also remains soft. Job market weakness may therefore rein-in consumer spending growth and home sales. The August increase in employment was entirely attributable to part-time hiring.
Meanwhile, the US economy is growing again but the “recovery” is misleading. Full employment would be delayed until 2013 with improvement in economic conditions hard to detect. Many lagging indicators such as bankruptcies and bank failures will continue to give negative signals. GDP and growth rates have been positive with strong federal government spending and a swing to inventory accumulation. Consumer spending has stabilized. Auto sales, a major industry, will decline rapidly. Residential construction activity is beginning to edge higher while house prices stopped declining in many cities. Business capital spending is also inching higher. Export numbers are at their highest level since last December.
Domestic spending is providing an increasingly important economic boost in the emerging economies. China, being on the center stage is showing huge year to year gains in crude oil consumption and industrial production. Meanwhile China’s exports are running 20% below year-earlier levels. Motor vehicle market in China, India and Brazil is now running well in excess of the trend in US market. As such, unemployment is declining in emerging economies.
The mature overseas industrial countries are beginning to join the emerging country recovery with Germany and France recovering earlier than expected. Starting with noticeable improvement in export order, economic conditions are stabilizing and confidence is improving both for consumers and businesses. This has led to a higher floor for a wide range of commodity prices. Energy and oil are still at desperate levels reflective of weakened demand from US markets. Meanwhile Gold has broken the $1000 mark as nickel and copper are setting new heights, a clear indication that inflation is in progress.
Ultimately, responsibility for the fate of many failed financial firms must fall on the CEOs who were blinded by the seemingly high profitability of financing the housing market and failed to control risk and leverage of their institutions.
The real estate market is a two-sided mirror, posing grave risk and dangers but also promising great returns when they do deliver. As history has shown, real estate boom leads to bullish stock markets, stronger consumer spending and growth in related industries. Who wouldn’t want a real estate boom?
However, the underlying principle to a sustainable and healthy economy and financial system is that prices need to be justified. Evidence should be readily available to prove the market value is reasonable and affordable by means of true demand and supply. True demand and supply are often hidden under the guise of profitability. It is important to recognize market manipulation, and effectively analyze the effect it has on demand and supply.
Dubai offers an example of things to come if a property bubble develops and then bursts. Dubai real estate, leaping skywards both physically and financially, enjoyed a final blowout in early 2008. It seemed an exciting alternative to wobbly stock markets for what investors' cash remained in the system. But after September, it all turned out to have been a Ponzi scheme in disguise. Dubai's trademark developers had been encouraged to sell off-plan sites low to create a feeding frenzy of "flippers" who sold unfinished properties to each other at ever higher prices.
Now leading in real estate price drop, Dubai real estate is down over 47% by the second quarter of 2009. Some of Dubai's most celebrated companies teetered on the brink of bankruptcy. Do I dare draw comparison to Canada? Multiple offers are back and there are hints of a shift to a sellers’ market. The financial crisis has pushed interest rates down to unthinkable levels but unlike US counterparts, Canadian mortgage credit is still flowing. Housing demand will be dampened if full-time employment continues to decline. The uptrend in part-time employment is not an effective substitute as far as housing markets are concerned. The condo-market is over-supplied. In contrast to the low-rise market, the number of completed but unsold condos is up sharply. Developers are resorting to large price reductions to move condo sales. New construction financing is hard to find. Securitization is still shut-down in Canada and bank lending terms and conditions are expensive for both condo and commercial real estate developers. In the commercial sector, office rents are declining and vacancy rates are rising. Existing tenants are downsizing in an effort to control costs and sub-lease space is up sharply.
The recession in US is likely over in August. The current stock market rally will not last and a second-guessing in global stock markets will probably be kicking in soon. While this should not signal an impending economic stall-out, it would be a reassessment of economic prospects. Note that there has been a discrepancy between stock market and bond market behaviour this summer. Stocks have reflected expectations of a robust V-shaped and a sustainable economic recovery. Bonds have been signaling slow growth and non-existent inflation risk.
Also note that consumer spending and inventories are currently growth drivers, having revived respectably in Canada and US. Unfortunately, inventory levels are still far too high in Canada and inventories will not provide an additional growth boost. Even though consumer finances and the retail outlook are in better shape in Canada, surplus inventories will dampen the initial upturn in output.
Employment, always a lagging indicator, would be helped by less extreme payroll downsizing. Yet faced with a balance sheet recession and the need to remain solvent, companies might continue to cut payroll headcounts and reduce per-worker wage levels, albeit a more comfortable pace.
Canada’s current account balance of payments deficit is running at $44.8 Billion (annualized). This is 3% of GDP, back to the early 90s levels. Normally a C/A deficit this large would be bad news for the CAD as the foreign exchange market does not appreciate C/A deficits this large. However, the CAD has been rising as there has been a big increase in net capital inflows that has more than offset the increase in the C/A deficit. However, the surge in net capital inflows is likely to be temporary while the C/A deficit could be longer term. This translates to downside risk for the CAD as foreign investors might not be as willing to invest heavily into Government of Canada bonds when they realize how far Canada’s government finances have deteriorated (Budget deficits for next 5 fiscal years).
Canada’s leading economic indicator index is not as robust as the US index. More of concern is the decline of Canada’s exports of goods , some 35% over the 12 months ended July. Exports of energy products, down 50% year to year are the largest losers. Given the large continuing surplus in natural gas markets, and historically low natural gas export prices, Canada’s trade performance in energy is unlikely to improve anytime soon. Looking beyond the government induced jump in US auto sales, Canada’s export outlook for automotive and industrial products also remains soft. Job market weakness may therefore rein-in consumer spending growth and home sales. The August increase in employment was entirely attributable to part-time hiring.
Meanwhile, the US economy is growing again but the “recovery” is misleading. Full employment would be delayed until 2013 with improvement in economic conditions hard to detect. Many lagging indicators such as bankruptcies and bank failures will continue to give negative signals. GDP and growth rates have been positive with strong federal government spending and a swing to inventory accumulation. Consumer spending has stabilized. Auto sales, a major industry, will decline rapidly. Residential construction activity is beginning to edge higher while house prices stopped declining in many cities. Business capital spending is also inching higher. Export numbers are at their highest level since last December.
Domestic spending is providing an increasingly important economic boost in the emerging economies. China, being on the center stage is showing huge year to year gains in crude oil consumption and industrial production. Meanwhile China’s exports are running 20% below year-earlier levels. Motor vehicle market in China, India and Brazil is now running well in excess of the trend in US market. As such, unemployment is declining in emerging economies.
The mature overseas industrial countries are beginning to join the emerging country recovery with Germany and France recovering earlier than expected. Starting with noticeable improvement in export order, economic conditions are stabilizing and confidence is improving both for consumers and businesses. This has led to a higher floor for a wide range of commodity prices. Energy and oil are still at desperate levels reflective of weakened demand from US markets. Meanwhile Gold has broken the $1000 mark as nickel and copper are setting new heights, a clear indication that inflation is in progress.
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