The week that was; Economics is all about "demand and demand"; Sherry Cooper sees positive demographic trends?
OCTOBER 14, 2011
What a week!
The risk trade has been firmly re-established this week as positive data poured out of the US and Canada. It seems for now that Canada will likely avoid a technical recession in Q3 (probably a 75% likelihood), while the US seems more likely to narrowly avoid one later this year (I’d put the odds of the US avoiding a recession at 60%). Despite the ECRI last week saying that a recession is a ‘done deal’, the most recent economic data certainly suggests that there may be some hope on that front. However, leading indicators are still signalling a slowdown, so it will be interesting to see how things play out.
The Canadian dollar has rallied back to $0.99 to the greenback while oil has shot back up to $87/barrel after hitting $75 two weeks ago. The TSX has rallied hard on this bounce, with the energy sector surging 8% on the week. The TSX itself finished the week up 4% and is now down less than 3% on the year.
All of this happened despite no real solution coming out of Europe. Yes, the stability fund has been expanded, though it still has massive hurdles to clear. Bond yields are moving higher, with French spreads over German bunds reaching new highs, Spanish and Italian bonds again showing signs of stress, and Greek one year bonds surging to 170% (that’s no typo). The only lasting solution to the Greek drama is finally on the table as the EU is mulling over a 30-50% write down of Greek debt. While the proposal suggests that the EU can somehow backstop the banks, which would otherwise take major capital losses on such a move, I have a hard time seeing how there could not be a complete riot over that decision: “We know your pension just took a massive hit from the Greek write down, but don’t worry, the government is here to backstop the banks with your tax dollars so they don’t have to take a similar loss.” Sounds reasonable. How could it not go well?
Meanwhile in China, the data continues to suggest that the risk of a hard landing is increasing. Copper, which economists like to say has a ‘PhD’ in economics, is still reeling, despite a nice rebound today.
It’s been a nice week for investors, though I’m certain there are still major economic issues to contend with on the domestic and international front. Enjoy the bounce, but don’t expect the volatility to be over.
We all know that economics is about demand and demand:
At least that’s what you’d think listening to some of the housing bulls. Those who actually understand economics recognize that it’s actually all about SUPPLY and demand. I hate having to rehash old posts, but sometimes it’s necessary to drill the point home. Consider this gem of a comment from earlier today regarding the Toronto condo market:
“If you want solid data, look at immigration, roughly 90.000 new Canadians settle in the GTA every year. And as far as I know, they don't bring their own tents, they rent or buy condos until they can afford a house. That's is called demand. And yes, there is a RE bubble and it can burst in 20 years from now when prices in TO reach $1.000.000/unit.”
There you have it. There’s demand, therefore, price rises. And because there is demand, prices are justified at any level relative to incomes, economic growth, rents, inflation, etc. It's all about demand, baby!
Not quite. There is one sentence in this particular comment that should catch our eye: “they (immigrants) rent or buy condos until they can afford a house.” True. In every sense. Some rent and some buy. So the next logical question is, why haven’t rents come anywhere close to pacing the rise in condo or house prices?
If the argument holds water, and if there is such a massive increase in immigration that our building industry can’t keep up, shouldn’t that exert pressure on house/condo prices and rents as well? After all, the same dwelling would be in demand by owners and renters, meaning that yes, the sale price would be higher, but so too would the rent. It certainly hasn't been the case (see yesterday's post), and that should cause us to question what's really driving this market.
But even that’s getting ahead of ourselves. We still are making the massive assumption that the rise in population has been so extreme that it has outstripped the ability of the construction industry to keep up. Is that even true?
Let’s not speculate. Here’s the truth: The population growth rate in Toronto is 2.4%. There has been no ‘surge’ in population growth that can possibly account for house prices that have nearly doubled in 10 years.
Furthermore, if we look at housing starts and compare them to the increase in total population (which includes net migration and net ‘organic’ growth), we find that Toronto has built an average of 1 new dwelling for every 2.5 new people added to the city over the past decade. Not much of a housing shortage. This in no way justifies the pace of house price appreciation. This increase is right in line with the long-term average, again begging the question of what has really moved this market. Take the blinders off! Turn over a few more rocks.
Pretty hard to say that the increase in house prices has been due to demand...at least not without taking a serious look at the supply side.
For a more detailed analysis of the ‘population growth drives house prices’ fallacy, check out these two posts:
“Canada boasts a positive demographic situation” for real estate? Did Sherry Cooper really just say that?
It appears she did in a research note from BMO Capital Markets titled, “US and Canadian housing markets supported by demographic trends.”
“Demographics will help (the US housing market). Housing starts have been running at about half the pace of household formation for almost 3 years and the number of household formations has been depressed by the weak economy and is starting to edge upward. The overall U.S. population has grown by 7% over the past five years; and, over the next five years, the number of 20-to-34-year olds will increase by 4%. These first-time homebuyers will be the big winners in the home sweepstakes where home affordability will be the highest in decades.
This is a far better situation than in most of Europe or Japan where the population is growing minimally and the number of young adults is plummeting. Canada boasts a similar positive demographic situation to the U.S., which should keep our housing markets simmering as well. To be sure, the aging boomers will be downsizing; but, for many that means moving into pricey condominiums that cost more per square foot than the homes they sell.”
I’m no genius, but it seems to me that demographics are decidedly against us. We know that the strongest buying of real estate is in the 25-35 age group, beginning at age 25, while people become net sellers of real estate after the age of 65. It doesn’t take a rocket scientist to see why this is somewhat problematic:
Latest estimates from an RBC poll suggest that nearly 60 percent of near-retirees plan on at least partially funding their retirement through existing home equity. That may take the form of downsizing, selling and renting, or the use of a reverse mortgage, but the reality is that there will be some portion of current homeowners in that age cohort looking to lock in these gains by selling and downsizing. There’s one small problem that is nicely captured in the above graph, but brilliantly explained in a 1998 paper by the US Fed:
"In an economy with a stable age distribution, this would have no effect on capital markets. When each cohort reached retirement age, it would sell its assets to younger cohorts who were accumulating wealth, and with steady population growth there would always be enough of the latter to absorb the sales of the former.
But what happens when population growth isn't steady and the economy's age distribution isn't stable? In particular, what happens when the old-age dependency ratio rises, and there are proportionally fewer young savers to buy up the assets of the older retirees? In this case, by the law of supply and demand, one would expect the price of assets to fall.
As aging baby boomers begin to sell their financial assets, they will presumably be selling to the next waves of savers, the so-called Generation Xers and Yers, which are significantly smaller population cohorts. With relatively fewer buyers than in the past, boomers may find themselves selling into a weak market when they retire."
And to further drive home the point, a recent article in the Journal of the American Planning Association summed it up as follows:
What have not been recognized to date are the grave impacts of the growing age imbalance in the housing market.
If the elderly are more often home sellers, and are more numerous than the young who are buyers, a market shift could come on quickly after 2010, causing housing prices to fall. Even if prices remain flat, without the investment incentive young households will likely slow their entry into homeownership, worsening the imbalance between sellers and buyers.
Once past the tipping point, market adjustments will cascade in virtually every community, as the ratio of seniors to working age adults will increase for the greater part of two decades.
It certainly looks like the current demographic situation is ‘positive’ and ‘supportive’ for sales of Depends and Viagra. Housing....not so much.