Monday, September 10, 2007

Market Cycles

A regular reader sent me a fantastic article from the early 1990s written by economist Patrick Foley of Lloyd's Bank of London. The article, A market like no other is unavailable online these days, and out of respect for its source, I won't post it here, for reasons of identification. But I'll give you a synopsis of his arguments for your debate/commentary.

Foley's argument is based on the RE market in England back in 1990. At that time, prices were stable, but sales were stagnant. How can this be? As Foley suggests should be the case "the seller would simply reduce the price until buyers were attracted." The RE market is different though, "many sellers would prefer to take their house off the market rather than lower the price."

Maybe we bears should pay closer attention to the number of expired listings happening lately? If we see more listings removed prior to sale, then we know what is happening is similar to what Foley describes. What about the other's though, the ones who must sell? Foley says those indicate the next shift in the cycle.

When that happens, we see a reduction in prices. Who are forced to sell? There are plenty of reasons why someone might be forced to sell, but perhaps the first indicator would be broad reductions in new home prices, especially in completed condo developments with unsold units.

The first sign we'll see is a reduced number of sales. And the number we need to focus on is year-over-year sales, not month-to-month because the market is so seasonal. When the number of sales is reduced, so is the corresponding sales prices, so we must be careful that the weakness in the market isn't over-stated--the same factor exists on the upside, and we see it every time a high priced home sells in Victoria.

What part of the cycle is Victoria in according to Foley? Foley says prices are slower to react. In fact, when volume falls, sometimes prices spike before they begin a decline. But we witness a sharp decline in price inflation. (Considering that inflation is roughly half of what it's been over the past 2-3 years, I'd bet we fit somewhere in this part of the cycle).

What has been the trigger for cycles to end according to Foley? "...the end of the boom for all three of the most recent cycles coincides with a tightening of macroeconomic policy by the government of the day."

Foley's study period had governments raising rates due to exchange rate weakness, rather than domestic demand. Today we see the opposite: the BoC is concerned about domestic inflation, not exchange rate weakness. Foley felt that the previous economic policy would contribute to a deeper than normal trough.

Today's situation is not so black and white. In the US, it's expected that the Fed will reduce rates due to weak economic fundamentals, while their currency takes a hammering on the world market. But in Canada, it's expected that the BoC will have to reign in inflation and potentially drive the $CDN to parity. Both of these could have considerable economic constraining effects.

Based on Foley's example, it isn't clear where this Victoria market sits.


Prairieboy said...

Great analysis HHV. It's funny how our's and the Lower Mainland's market have defied logic thus far this year.

It appears that Alberta's markets have been more predictable. Low inventory, prices rise. Now that inventory has exploded, prices are falling.

If only we all had crystal balls... but shoot, then there'd be no point to our blogs!

vg said...

I am not in the camp that believes the year over year is the sales number to follow. When at the end of a cycle where interest rates are on their way up eventually then that is the main cause for the record sales spike this summer. Most importantly it is not driving prices the past month to anything that I would expect for such an increase in sales.

I'm no economist but that tells me we are emptying the pool of greater fools cause of fear alone of missing out forever. Seasonal numbers that pertain to the usually high demand months has to be taken into consideration as the affordability and ability to qualify has shrunk big time the last couple of months,the last month in particular,we just havent had the time for the effect to filter all the way thru since it's only been the last few weeks that Canada woke up to whats happening in the USA and the recession word is a real possibility. Most new buyers have never lived thru a recession and don't know how ugly it can get.

Village said...

Hard to say, this summer we saw a surge in sales volumes that ate up the additional inventory the market saw.

Buy now or be priced out forever, rates are going up and consciousness of the US market tanking taking out the marginal buyers may have pushed the last fence sitters into committing.

Generally I've always figured we follow US trends about 1-2yrs after the fact.

Anonymous said...

Someone on the bull site I'm on posted a question:

"If the housing bubble bubble pops will lower rental rates be next?"

I said yes but other than construction slowing and all the people who flowed in here for jobs in the construction industry will then move away to the next big job or back to their home towns which will open up rentals I can't for the life of me remember why.

Does anyone want to provide some commentary on this.

So, when the housing bubble pops will lower rental rates be next? If yes, why? If no, why?



olives said...


From what I have read, in the U.S. the investment properties that can't be flipped are now attempted to be rented in order to cover at least some of the costs. The rental market is flooded in many areas where there has been overbuilding, and rents come down to compete for tenants.

Anonymous said...

Thanks olives.


Village said...

Rents should go down. It does appear that's the case south of us.

It's really a supply and demand equation, with a healthy dose of actual economic affordability.

As investors buy up all the dwellings to flip/hold they lower availability and drive up rent. As they sell/cut loses they rent and put more on the market driving down rental prices and increasing availability.

Of course, what the market can actually afford to rent keeps things in check as well. I do wonder if those that are renting at high prices, face a lot of renters moving out and missed/late payments.

Anonymous said...

Nice analysis.

The "wild card" in this market is the "specu-vestor", much like it was in the early 1980's. People were hoarding real estate and more than willing to absorb the loss between the mortgage and rent while prices were increasing.

When the market slowed, panic struck and the specu-vestor started to dump their surplus housing on the market.

The 1980's market fall was "UGLY".

The specu-vestor was chasing the market down in order to get a buyer for his/her surplus property.

People did not want to buy a declining asset and the prices fell off a cliff and remained stagnate for years.

So, when we see single digit annual increases and a big spike in listings then the market will correct. Fear and greed work both ways.


Anonymous said...

My husband just sent me this.

Recently, Sir John Templeton — the world's most successful investor, billionaire philanthropist, and the man Money Magazine called the "greatest global stock picker of the century" — invited me to meet with him in The Bahamas where he lives. In our private meeting, he personally warned me that a U.S. real estate crash was imminent.

And he's not alone.

Former Fed chairman Alan Greenspan had also warned of real estate "froth." Former Fed Chairman Paul Volcker had also warned "a crisis is likely" in the U.S. economy.

Even America's greatest stock investor Warren Buffett recently sold his California home and warned of dark clouds in the real estate market.

For over 2 years now, we at Financial Intelligence Report have been warning that soaring U.S. real estate prices were unsustainable and that a collapse could soon occur.

Today as 2007 is winding down the sub-prime mortgage debacle is spreading like wildfire, housing prices are set to experience their first annual decline since the Great Depression, and retailers just witnessed their worst month since March 2003. Meanwhile, and stock prices have broken through major price-support levels and appear to be headed lower.

Now scores of major U.S. and international newspapers and magazines — including the New York Times, Fortune, and The Economist — are echoing those same sentiments on their page-one stories.

In fact, The Economist magazine bluntly declared that the current worldwide boom in residential real estate prices is "the biggest bubble in history."

It is important to note that Templeton, Buffett, and Volcker all warned in the late 90s that the dot-com boom was dangerous and unsustainable.

Back then, none of the three were given much coverage in papers like the Wall Street Journal, nor did they get any significant airtime on channels like CNBC.

But their predictions turned out to be dead-on. And we fear they may be right again.

Is this the beginning of a major real estate crash? Have you taken steps to protect the value of your real estate and other investments?

Anonymous said...

What would you suggest we DO to protect our investments? Should everyone try to sell off all assets ASAP?

hhv said...

Anon at 5:41,

Seek the advice of a pro...

vg said...

Home values may be next victim of pine beetle

What happens when the wood is gone?

Once the mountain pine beetle has chewed its way through Interior forests, real estate values in the province's booming resource towns are likely to tumble, warns a report released Tuesday by the Real Estate Investment Board.