Housing market ‘alarms' Merrill
LORI MCLEOD
Globe and Mail Update
October 28, 2008 at 2:15 PM EDT
Merrill Lynch & Co. economists are becoming more “alarmed†about the Canadian housing market every day as their data suggest it is tracking the United States with a two-year lag.
Falling prices, overbuilding and too much unsold inventory in Canada are creating a trend similar to that in the United States a couple of years ago, Merrill economists David Wolf and Carolyn Kwan said in a research note Tuesday.
“Though the consensus does seem to be gravitating towards our view of a sustained downturn in the Canadian housing market, we still do not sense any particular alarm in either the policy-making or forecasting community. We ourselves are getting more alarmed by the day,†Mr. Wolf and Ms. Kwan said in their report.
Many other economists believe Canada is in for a moderate downturn next year, but is differentiated from the U.S. experience by more prudent lending practices for both home buyers and developers.
There are a number of reasons the risk of lower house prices is not as magnified in Canada as in the United States, said Derek Holt, economist at Scotia Capital Inc.
“I still agree that Canadian housing markets have been in correction mode all year long, and that further downsides lie ahead. But the macroeconomic implications are not as stark in Canada given a lower degree of leverage on household balance sheets, on bank balance sheets through a much healthier banking system, and through the avoidance of heavily leveraged off-balance-sheet instruments that caused much of the troubles in the U.S.,†Mr. Holt said.
Merrill has a more bearish view, and made headlines recently with a report suggesting Canada's high household deficit level could make it vulnerable to a U.S.-style housing collapse.
“In our ‘tipping point' piece a month ago, we presented a chart showing the ominously high correlation between the price action in the Canadian housing market and that of the U.S. market two years earlier ... Evidence from the supply side further reinforces that Canada's housing market seems to be tracking the U.S.' with a two-year lag,†Tuesday's report said.
The earlier report raised hackles in the real estate community, and questions during the election campaign even prompted Prime Minister Stephen Harper to say Canada's housing and construction markets remain stronger than those in the U.S.
The same two-year lag idea was raised this summer by Douglas Porter, deputy chief economist at BMO Nesbitt Burns Inc., who called the apparent trend “unnerving†in a report in July.
At the time, Mr. Porter said there were many reasons why the two markets were different, but said even a pale version of what had happened in the United States would be bad news for Canada.
House prices posted a record 16.6 per cent year-over-year decline in the United States in August, according to the benchmark S&P/Case-Shiller Home Price Index report, also released Tuesday. The index has now shown year-over-year declines for 20 months.
Taking into account the two-year lag, Merrill's data suggests the ramp-up in construction of housing units in Canada may be even larger than it was in the United States.
The number of units under construction currently is just off the peak hit in May, which was the highest recorded in 36 years of available data and 97 per cent above the long-term average, the report said.
By contrast at its peak in 2006, U.S. housing construction was 54 per cent above the long-term average, it added.
As of August, there were more condos under construction in both Toronto and Vancouver separately than there were in all Canadian cities combined a decade ago, Mr. Wolf and Ms. Kwan said.
“And as in the U.S. two years ago, we are now seeing completed units pile up unsold in Canada, a clear sign of overbuilding and an ominous sign given the voluminous supply still in the pipeline,†they said.
Inventories of unsold new single-family homes in Canada rose by 56 per cent year over year as of last month, close to the maximum increase in July 1990, which marked the last housing market downturn, the report said.
At the peak in April 2006, inventories of unsold new single-family homes in the United States were up 26.5 per cent over a year earlier, the report said.
The two-year lag could be the result of Canada having more room to run up because its recovery started later than that of the United States. Strong commodity prices and looser lending standards initiated in 2006 may also have contributed to the lag, the report said.
