Real estate, alternative real assets and other diversions

The Canadian house price bubble has now burst Plus the latest on Morgan Stanley and emerging markets

The Macro View

A house roof with two dormer windows and the sun shining between them

The Canadian housing bubble has gone so ballistic that the Ontario government is considering a 15% tax on foreign buyers to cool down the speculative spiral in Toronto condominiums. The smart money on Wall Street’s latest trade is to short Canadian banks and property developers, the fabled hedge fund Great White Short. Canadian property prices have doubled in the past decade, thanks to low interest rates, high end immigration and flight capital from China/Southeast Asia, with Toronto and Vancouver the epicentre of the housing bubble.

A housing bubble is a money-spinning feast for speculators since they only put down 10–25% as an initial downpayment. Yet as the Gulf learnt the hard way, leverage wipes out investor equity when a housing bubble bursts, often taking down entire banking systems and consumer economies. Since the GCC criminalises bankruptcy, the choice for a leveraged home owner when a bubble bursts is to either face jail or flee. This is not the case in the US, where non-recourse mortgages make home price speculation a one way bet when prices soar in a speculative bubble.

Canadian home prices have gone parabolic since 2010, up 60% despite the plunge in crude oil prices and the election of a Liberal Party Prime Minister in Ottawa. Yet there are now unmistakable signs that the Canadian housing bubble is about to pop. New home sales have plunged even though prices are at record highs. The governor of the Bank of Canada and the CEO of the Royal Bank of Canada have warned investors about the lethal risks of leveraged home price speculation. Affordability ratios are in the stratosphere. Canadian household debt to disposable income is at all-time highs, at a staggering 169%. Flippers boast about their offplan ‘profits’ at cocktail parties. I have GCC based friends who refuse to rent out their Toronto condos because they believe 20% price rises will continue forever and friends in Canada whose suburban McMansions consume 40% of their annual income in mortgage, taxes and insurance costs. Ottawa and the provincial governments in Canada are now determined to burst the speculative credit Frankenstein that caused the boom. Ontario’s Fair Housing Plan only tells me this time the wolf is here. The near collapse of subprime mortgage lender Home Capital Group has eerie echoes of the failure of Lehman Brothers. Home Capital shares fell 90% before Warren Buffett financed C$ 2.4 billion lifeboat.

A decade ago, Canadian housing was a relative safe haven in the 2008 financial crisis. Home prices in Canada fell a mere 7%, compared to 30% in the US and 50-70% in high beta markets like Dubai and Spain’s Costa del Sol (or Britain’s Costa del Dole!). Canadian home prices have risen 60% since the crisis, which left its Big Six banks unscathed. This is a far better performance than even the hottest markets in the US, which have risen only 25% since their bottom and took six years to recover their crisis losses.

Unlike the property markets of the GCC, Canadian home prices have structural safety nets. No less than 50% of home mortgages are insured by state agencies. The big six Canadian banks are some of the world’s most transparent and best governed financial institutions. All immigrants are granted citizenship. There is no geopolitical risk and the banking system is not in the grip of a credit crunch or forced mergers. Oil is only 25% of Canadian GDP and the entire population is not on the state payroll, apart from Alberta. However, Toronto witnessed a 40% price crash in the early 1990s that wiped out several friends of mine who speculated on new build condos. When supply overwhelms demand, when new sales values plunge, when cranes dot the skyline and offplan launches scream out in newspaper ads, a crash is imminent. The coming interest rate rise will be property’s kiss of death. There are rumours of systemic fraud and more mortgage lender failures even as I write. Yes, this time the wolf is here.

Unlike growth companies on a stock market, a housing bubble is destined to collapse since homes lose value over time due to depreciation and shifts in consumer preferences. Home price spirals destroy, not create, economic value and can often gut the stability of banking systems via default and retail sales due to negative wealth effects on consumer spending. As Santayana said, ‘those who refuse to learn the lessons of history are doomed to repeat them’ – especially when debt is the high-octane fuel that burns home owners alive.

Stock Pick: Morgan Stanley’s greed and glory on Wall Street!

The brutal shift from growth to value on Wall Street was inevitable once the ‘momentum premium’ on FANG to Cinderella value sectors like banks and energy even exceeded the Silicon Valley dotcom mania of 1999, a year I spent more time in San Francisco/Palo Alto than in my home in Dubai. Hawkish central bank statements from the Fed, ECB, Bank of England and Bank of Canada meant a rise in G-7 government bond yields. This was the kiss of death for tech shares trading at nosebleed valuations such as Amazon, Netflix, Tesla or the Philly Semiconductor Index. The Federal Reserve’s stress tests were a $100 billion windfall in dividend returns and share buybacks for America’s largest banks. Note that Citigroup is now 67 and Goldman Sachs is 225. Brent crude upticked to $46 and led to a dead cat bounce in energy shares, the worst performing sector of the S&P500 index. As the Volatility Index rose to 14 on Thursday, the Dow suffered a mini-meltdown, down 257 points in midafternoon.

It would have been down 500 points were not for the strong rotation from tech/property to banks and energy. Amazon is now trading at its 50 day moving average as I write. This is serious, deadly serious. Are we on the eve of another March 2000, the month the internet bubble burst? I say yes. Silicon Valley deal hunting taught me “some fabulous yet bitter lessons. When greed swings to fear, leverage kills. Lord Keynes was so right. In the long run, we are all dead – but in the short run we get skewered in margin calls. Bond markets can and do go ballistic. Contagion in the debt market spreads at the speed of light. I remember the words of Nietzsche as I stare at the green (more red today) phosphorescent flicker of my Bloomberg screen. “Gaze not into the abyss, boyo, lest the abyss gazes back.” The evolutionary algorithms in my human brain spell danger. So I adapt. Adios le sayonara, FANG. Hello, big bad banks! But my readers and history will attest I never left you while your shares prices doubled since 2014.

Morgan Stanley shares have soared from 24 in early March 2016 to 44.60 as I write amid the carnage of Thursday 30th June. This global investment bank, a spinoff from the original House of Morgan after the Glass Steagall Act was passed in FDR’s reign in 1935, is a firm I have known and worked with since the 1990s, though its Private Wealth Group has sadly exited Dubai. Morgan Stanley was one of Wall Street’s biggest winners from the Fed CCAR stress test results. The Fed has now given chairman/CEO Jamie Gorman, a former McKinsey and Merrill Lynch GPC alum, the green light to hike the dividend by 20% and repurchase $5 billion in shares.

Jamie Gorman has transformed Morgan Stanley from the wham-bam high risk Habibi Mafia days in the court of John Mack that bought the fabled bank to the brink of failure in late 2008. I actually made serious money shorting the shares until Mack screamed to Congress to bank short-selling and begged for money at the Fed discount window.

Jamie Gorman slashed Mack’s institutional bond trading and merchant banking empire. He did a brilliant deal with Citigroup to acquire Smith Barney, making Morgan Stanley the biggest retail broker in America, with 18,000 brokers and $2.2 trillion in assets under management. He rebuilt the firm’s capital, liquidity, leverage ratio and slashed its value at risk metrics. He axed hundreds of millionaire managing directors, including some of my closest Wharton and Chase London/NY buddies from the 1990s.

The Macro View

About Matein Khalid

Matein Khalid

Matein Khalid is Chief Investment Officer of Asas Capital in the DIFC; he is responsible for global investment strategy and the development of the multi family office platform. He has worked in Wall Street money centre banks, securities firms and hedge funds in New York, London, Chicago and Geneva. In addition, he has been an advisor for royal investment offices in the Gulf for 8 years. Mr Khalid has four degrees in finance, economics, banking and international relations from the Wharton School, University of Pennsylvania. He is a director at the American College of Dubai and has taught MBA level courses in commercial/investment banking at the American University of Sharjah and British University of Dubai. He writes the Global Investing columns for Khaleej Times, Gulf Business and Oman Economic Review.

Articles by Matein Khalid

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