Poor Doug. My colleague, smarty-pants portfolio manager Mr. Rowat delivered a concise essay here on the weekend detailing the correlation between central bank largesse and the fact investors in equities have done well for the past seven years. He’s cool with that. And did I mention he’s a portfolio manager? As in, ‘making clients money’?
Doug understands how all the anarchists on this pathetic blog hate central banks for pumping out liquidity, debasing gold (and other commodities) while keeping capitalism and America afloat (plus rewarding investors). But his job is not to lecture central banks or even bay at the moon (which he does well). His job is to manage risk and grow portfolios for people. Duh. In this task he and his sidekick Ryan Lewenza are rock stars.
Meanwhile this blog has spent years lambasting central bankers for artificially depressing rates and encouraging people with no discipline to snorfle debt at an astonishing rate, thereby turning real estate into a gaseous Hindenbubble. So is this in conflict with PMs Rowat & Lewenzwa’s belief markets are still solid, thanks in part to the same bankers?
Nope. Here’s why.
Easy money, cheap rates and bank stimulus have helped economies avoid the deflation, decline and depression that lurked following the credit crisis – our greatest economic and financial calamity since the 1930s. In so doing, they’ve also aided corps. Businesses can borrow for less, pay lower interest, employ more people and sell stuff to working consumers who use enjoy credit. So they make money. Share prices rise. Investors are rewarded. None of that is a bad thing. It may be forced growth, but it ain’t a bubble. Inflation and economic expansion numbers prove that (as Doug demonstrated).
Now residential real estate’s something else. Dangerous. Emotion-based investing by people who overwhelmingly use extreme leverage and dump their net worth into a single thing – quite unlike investors in financial assets. This, above all, is where central bank actions to depress interest rates, bond yields and mortgage costs become potentially destructive – as we may now be seeing in Vancouver.
The main reason stock apples are not housing oranges is concentration. With a 70% home ownership rate and 50% of people one paycheque away from perdition, it’s obvious millions of Canadians have put all of their eggs into a single basket. So far (at least in some markets), it’s worked. Real estate rose. There’s a capital gain. But as I have said for a long time, having all of your net worth in one asset, on one street in one burg is courting risk. If the economy dips, rates rise or governments diddle, you’re screwed.
With financial assets – unless you have 100% of your wealth in one stock, one bond, one mutual fund or one ETF (which nobody ever would) – there’s always vastly more diversification and less concentration risk.
As Americans found when their housing gasbag deflated, the road back can be long and painful. It took an entire decade for average prices there to recover after the 2005 pop, and many middle class families will never have their lost equity restored. In Toronto, the housing collapse of 1989-90 was not rolled back in terms of average price until 2014. This can be devastating. Imagine if you had to sell and retire in the middle of such a dank period. Meanwhile stock markets also decline occasionally, with the average correction being a 14% dip lasting 17 weeks. In other words if you do nothing for 83 days (on average) you can ignore volatility. As Doug pointed out, there have been only 11 of these events in the last seven decades. Yawn.
The key difference between housing and equities, if you believe both have been goosed by central bankers, is debt. As far as real estate goes, we have over a trillion of it. About $1,200,000,000,000, in fact. In contrast total margin debt in Canada (as measured by IIROC) – money borrowed to buy liquid securities – is $21.4 billion, or 1.8% of the mortgage total.
More consequential, financial assets can be sold in a heartbeat to meet a margin call. In a declining market it could take weeks, months or a year to unload a piece of real estate to pay off mortgage debt. More risk. Add to that the fact mortgages renew regularly, and interest rates have only one direction in which to move. Buyers today cannot count on 2% mortgages in 2021, and as rates rise the value of real property will fall. We all understand that.
So, we know housing corrections are longer and deeper than those experienced by financial markets. We also know leveraged homeowners can be creamed because of an illiquidity that equity investors don’t face. And, yes, we know house prices go up because people get horny, get FOMO or listen to their moms. Stocks go up, mostly, because companies earn more and the economy’s growing.
In conclusion, both asset classes have been impacted, bloated and pumped by the cheap money central banks have caused. Both will eventually correct. Only one will be lethal.
Now I must go and hug Doug.