Over the past few years a cottage industry of US hedge funds betting on the imminent collapse of the Canadian housing bubble has sprung up. I used to subscribe to a prominent newsletter writer who described his short Canadian banks call as a “career making trade.” He bragged he would cover his short position in Canadian Imperial Bank of Commerce at zero. He would then complain when Canadians stopped subscribing to his letter, incorrectly assuming we were offended by his bearish forecast. I have never known a single Canadian in the finance industry who didn’t think the pace of our housing appreciation was anything but stupid. I doubt any Canadian was offended by this newsletter writer’s negative outlook, but we were probably just too polite to let him know it was something else. One of my New York brokers tells me that he loves dealing with Canadians, but it took some adjusting to get used to our inability to say when we are mad. Now he always checks whenever something goes wrong. “Are you sure it’s ok? Really? I mean, I want you to tell me if there is something that isn’t right.” I chuckle inside every time he double checks. I can tell he is worried I am being too “Canadian” and simply too polite to tell him I am pissed.
The 2008 credit crisis left deep scars on US investors. Lots of pundits throw words like “once in a lifetime decline” around, but in the case of 2008, it is appropriate. The US real estate market was hit with a perfect storm. The excessive leverage, the fraud, the hubris, the inability to grasp the enormity of the problem and the irresponsible monetary policy all came together to create a unique environment that will be hard to ever replicate.
Yet, ever since the US real estate crash, the only thing US investors can see is another real estate crash coming. And when they can’t find enough action in their own housing market, they comb the world to find the next great real estate bubble. This deep emotional wound pervades their thinking. That is why my newsletter writer was so confident he would cover his Canadian bank short at zero. After all, that’s what happened to US banks. Why shouldn’t it happen to Canadians as well?
We have been battling this overwhelming negativity from the Americans for quite some time now. Have a look at this ZeroHedge post. Then have a look at the date.
That was two years ago!
During this onslaught of American negativity, I argued they would be frustrated with our Canadian boringness. Sure, I knew Canadian housing was overvalued, but our decline would be slow and not nearly as “exciting” as our American friends’ real estate collapse. The short Canadian housing trade might work, but it would not be the “career making trade” like the US housing short.
Well, I was wrong. The Canadian housing short has not worked at all. And instead of being boring, Canadian housing has rocketed to the stratosphere.
Many Canadian housing bears were short banks and other equities, which obviously did not decline as forecast. But a bunch of hedge funds also shorted the Loonie. And proving once again some were lucky to be born smart while others were smart enough to be born lucky, these hedge funds were skated onside with the massive rally in the US dollar.
The irony is that many hedge funds shorted the Canadian dollar on the notion the Canadian economy was about to collapse due to the bursting of the housing bubble. The trade proved a winner, but the decline of the Loonie has actually extended the rally in the housing market.
There is no doubt some of the Canadian housing bubble has been traditional consumer euphoria. Low interest rates are driving too many consumers to reach for too much home. But the recent oil collapse and the commodity bear market of the past 5 years should have slowed the price appreciation. Yet here we are with Canadian housing prices hitting new highs every week.
What’s going on?
The answer is easy and can be summed up with one chart:
The Chinese Yuan is loosely pegged to the US dollar, so the Loonie’s large decline has resulted in the real price of Canadian housing for a Chinese buyer to be roughly unchanged during the past 5 years. Chinese money has flowed into Canada at an astonishing rate. I think this whole upward move of the past year has at the margin being driven by Chinese inflows.
Now before someone gets offended by my observations, make no mistake - I am proud of Canada’s multicultural society. Toronto is often cited as one of the most diverse cities in the world, and that is part of what makes it great.
I am passing no judgment on the Chinese inflows, but in the interest of just worrying about what is instead of what should be, it would be naive to not realize these massive inflows are affecting our housing market.
I am becoming increasingly worried my prediction about Canada’s housing remaining boring will prove incorrect. This element of Chinese inflows might prove extremely destabilizing. The rate at which Canadian housing is rising unsustainable. This is looking more and more like a Chinese bubble as opposed to a boring Canadian asset.
I don’t have any solutions, but for the first time, I am worried it is a real problem. Our housing boom is masking the real problems with our economy. We have become too dependent on the residential tail wind:
What will happen if the Chinese Yuan is devalued? Suddenly this surge of money flowing into Canada will cease. Even without a revaluation we might eventually hit a point where the rate of inflows naturally slows.
It wouldn’t take much for me to imagine real estate slowing and the Canadian economy rolling over. Hard.
As Canadians we have been fooled into believing our shit no longer stinks. Trust me, it still stinks. I love Canada and wouldn’t want to live anywhere else, but I think the risks to the downside are much greater than most believe.
I am shorting Canadian dollars. I was already leaning towards being long US dollars, but I am upping my exposure versus Canada.
My suspicion is that those hedge funds bearish on Canadian real estate will finally prove correct in the coming quarters. Well maybe not correct because being years early is still wrong. I don’t think it will be a “career making short”, but Canada will be ‘on offer’ versus the US for some time to come. I think the Canadian economic surprises will all be on the downside. Canadian rates and the Loonie will not rise anywhere near as fast as US rates and the US dollar. Not only am I shorting the Loonie, I will buy Canadian fixed income versus the US.
Let’s cross our fingers and hope the real estate correction is just a typical Canadian boring decline…
Thanks for reading,