Update on the Canadian Housing Bubble

When we were doing our monthly update of Tracking Canadian House Prices, we found (Teranet – National Bank House Price Index  –  Communiqués, research tab, Economic News, click for more information) a link to a monthly 2-page newsletter that Teranet publishes for the National Bank Financial Markets. It had a graph that showed the marked divergence between the Teranet house price index for Canada and the Case-Schiller house price index for the US. Through research we found a comparable graph shown in Figure 1 (multiple source attributions shown on the chart).

Figure 1. Canadian and US house price indices.

We took this graph from an April 29 newsletter from Otterwood Capital Management titled: Canadian housing crash? Not yet. Otterwood’s argument is that the strong Canadian housing market is a product of a strong economy (more or less) that is a product of a recovering American economy. One might infer the reverse from this: a US in recession would drive Canada into a recession which would pop the Canadian housing bubble.

Subsequently we were made aware of this site, Wolf Street, and a current article: Is Canada Next? (A Very Ugly Chart). The chart in question is shown in Figure 2. Wolf Richter’s article is interesting from two perspectives. The first is he identifies some of the knock-on effects of house construction otherwise known as networked economic transmission (we hereby coin the phrase) (NET), a topic we are actively exploring in our series CAS: The Operative Principle Behind Everything.

Figure 2. Change in hours worked and GDP.

As Richter notes, Figure 2 (taken from Otterwood Capital Management July 14 blog article, Canada watch: Hours worked is back at recession levels. Concerning!), shows a degree of correlation between hours worked in the economy and econ0mic growth as GDP. As he comments:

This truly ugly chart (via OtterWood Capital Management) depicts growth in hours worked (blue) and annualized GDP growth (brown). On a quarterly basis, they track with a fair amount of correlation. While the magnitude may be off, the direction is almost always the same. Only twice since 2007 has one or the other been negative, when its counterpart was positive.

Rather than focus on the frequency of occurrence of a difference in sign between the two quantities we would focus on the size of the relative difference. Unless the largest difference going back to 2007 is to be be significantly exceeded, Canada’s Q2 GDP will be negative. Should this continue into Q3, we would look to see Canada in recession. The real result would be to confirm that Canada was already in recession in Q2.

The concern then is for a top in the Canadian housing market this summer or fall and an accelerating downturn if the US goes into recession.

Employment Implications

As Richter notes, growth in housing creates jobs in construction. Construction workers spend their wages creating further jobs throughout the economy as it expands. Conversely, a contraction or crash of the housing markets would not only wipe out construction jobs but jobs across the economy.

There is another less obvious impact of high house prices, however. Currently, the average house costs 60% more in Canada than the US with the currencies close to par. That means that for a comparable standard of living, a US worker can accept a significantly lower wage than a Canadian. In the US south this differential is even more pronounced. In a job market dominated by unions, Canadian jobs have a one-way ticket south and possibly right into Mexico as the Hershey workers in Smith falls Ontario discovered a couple of years ago.

Our analysis of June employment data in The Real Job Situation in Ontario: Ugly revealed a month over month increase of 15,300 construction jobs. However, the year over year figure was a loss of 4,200 jobs. The latter figure removes seasonal variation telling us that Ontario is losing construction jobs. A downturn in housing would simply accelerate this loss.

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