And so the cycle goes

William Trainor, CFA profile picture

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Monthly home sales in Canada in September were -32% year-over-year and 12% below the 10-year average before the pandemic for September (chart below from 2007 courtesy of Martin Pelletier). October sales appear to have been worse.

Monthly Home Sales in Canada in September

Many of those who bought properties during the 2020-2022 frenzy is now underwater in terms of resale value. Others refinanced existing properties to extract capital that has since been spent. Private mortgages are harder to find as many previous providers borrowed funds against their own properties to lend to others and are now suffering too.

Still, as is evident from this GTA poster below, the hope is eternal that “Toronto shoppers” continue to have more access to credits than math skills. Ah, the good old days.

toronto shoppers

In the 2020-22 FOMO (fear of missing out), about 40% of purchases in the US and Canada were second homes purchased for ‘investment’, occasional use and short-term rentals. Suddenly negative carry has become lethal in mortgage and utility spending. At the same time, rPotential disinflation is expected to accelerate as more homeowners seek short-term and long-term renters. It is estimated that 50% of Airbnb rental listings were added in the last two years.

Since housing costs make up a third of the consumer price index (CPI), central banks need deflation there to lower the CPI to the target; and they are beginning to be successful. Their policies too flexible for too long allowed the inflation they want to kill, but that’s yesterday’s news.

On the business side, a survey of 7 million small American businesses found that 37% couldn’t pay full rent in October, up from 30% in September. See Bloomberg: More than a third of American small businesses were unable to pay their rent in October. Some 49% of restaurants were unable to pay their rent, along with 37% of real estate agents.

Then comes the rise in car loans and lease defaults, especially on the more expensive brands. It is typical for automobile inventories to increase during recessions. But like the math-free shopping in real estate in recent years, the financial harakiri in the auto space has also been extraordinary. As shown below, since 1996, the parabolic prices from 2020 to 2022 are mean reverting and suggest that prices should continue to fall until 2024. Certainly some of the loans made in this mess will not turn out to be good for the money.

Car price deflation looms

On the positive side, much lower housing and transportation costs will improve productivity and financial viability. Over time, liquidation prices will help fuel the next recovery from the ashes of the developing bust. And so the cycle goes.

Divulgation: No positions.

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Publisher’s note: The bullet points in this article were chosen by the editors of Seeking Alpha.

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