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.
I have no worries about Morgan Stanley’s rankings on the Supplementary Liquidity Ratio (SLR) which Treasury (our man in DC Stevie Mnuchin!) will relax in any case. With a $5 billion share buyback, the SLR could well be 3.5%, thus at least a 70 basis point balance sheet cushion. The rollback of Dodd Frank, the rise in return on equity, the sale of a dozen low profit/low growth businesses, a steeper yield curve, higher volatility and securities trading/flow revenues, the reconfigured FICC revenue mix, the blowout global merger advisory franchise told me that Morgan Stanley was a no brainer buy after its 10% ‘Trump reflation’ angst sell off in March 2017. No guts, no glory, no bonus hunky-dory! This is my motto at Asas Capital in my daily dialogue with Mr Market. Wicked!
Macro Ideas: the good, the bad and the ugly in emerging markets
Like the old Clint Eastwood Western movie investing in emerging markets in 2017 was a classic case of the good, the bad, the ugly and down right fugly! A few dramatic macro themes I have tried to grasp. One, the meteoric rise of the Chinese internet and e-commerce. Alibaba ADR, profiled ad infinitum in this column since its New York IPO, is up a stunning 65% in 2017 alone after the company raised revenue growth guidance to 45–49%. Xie Xie (thanks!), Jacko Ma. You are the coolest thing to come out of Middle Kingdom since chicken chow mein. There is no other global business on this scale that can deliver revenue and EPS growth on this epic scale. This is the China I want to invest in, not the state owned Ponzi schemes listed in Shanghai, Shenzhen and Hong Kong!
Two, EM currencies can gut or groove a stock idea in the Third World. The Egyptian government was forced by a $12 billion IMF loan covenant to devalue the pound from its 8 to 18, inflicting catastrophic losses on GCC investors who cannot even get their money back in hard currency. Yet even the tightening of post-Crimean sanctions, the cyber-espionage scandal with the US and an oil crash did not prevent a rise in the Russian ruble from 61 to 58. The oil crash did take its toll on Moscow equities, the EM Cinderella of 2017!
Three, Donald Trump’s protectionism and the murderous Kim Jong Un missiles have done everything possible to make South Korea an investment no-go zone in 2017. Even so, South Korea, a classic cyclical exporter, was among the three best performing emerging markets of 2017. In contrast, political shocks like the Gupta brothers corruption scandal and Jacob Zuma’s decision to fire respected Finance Minister Pravin Gordhan led to havoc in the South African rand and the Johannesburg stock market. The resignation of President Dilma Rousseff led to epic rallies in the Brazilian real and the Bovespa, though the fairy tale has ended now that her successor is also mired in a sordid bribery scandal. Pakistan’s Prime Minister Nawaz Sharif was found to have squirrelled untold millions in Panama shell companies and Mayfair flats (who doesn’t) but this did not prevent Karachi from being the best performing stock market in Asia. When Narendra Modi won the UP state election, Indian equities and the rupee soared as financial markets immediately priced a Congress defeat in the 2019 general election. Politics is more critical than economics in emerging markets, even as the asset class’s volatility tanks 60% since its 2011 high.
I was not surprised that Poland is 2017’s winner emerging market so far, up 30% YTD. Poland is a leveraged proxy for the acceleration of German industrial exports, EU infrastructure largesse and its own property/banking asset revaluation, even though Warsaw is now governed by a populist political party. The Polish zloty has also risen from 4.2 in January to 3.71 against the US dollar now. As I expected, Prague property prices have risen 30% since mid-2015, a lot more than Business Bay or JBR, while the Czech kroner is the most undervalued currency in Europe.
The Turkish country index fund (TUR) rose from 30 to 42 in 2017 despite multiple political and financial shocks since last summer’s abortive military coup attempt against President Erdogan. The AKP government has purged 100,000 members of the Turkish elite, jailed hundreds of journalists, reopened a war against PKK Kurdish secessionists in Anatolia. Ankara has seen its diplomatic relations with Washington, Riyadh, Berlin and the EU plummet and endured multiple terrorist attacks. Despite these shocks 2017 was the year to go bottom fishing in Istanbul’s Bhosporus!
South Korea’s KOSPI was often dissed as the cheapest stock market in Asia. No more. Not even Comrade Kim McDuck’s ballistic missile tests or threats to incinerate Seoul, the election of the centre-left President Moon or the arrest of heir to the Samsung conglomerate (chaebol) could prevent a 25% paydirt on the Hermit Kingdom’s stock exchange. The markets expect a new paradigm of shareholder value and higher dividend payouts more than they fear Trump’s tariffs and North Korean invasion!
A no-go market for me in Asia? The Philippines as long as Rodrigo Duterte sits in Malacañang Palace. Thousands of dead drug dealers and criminals have not reduced the crime wave and the Makati business elite lives in fear. Brazil’s Bovespa could also plummet to 48000 as Michel Temer resigns and the far left seizes control of the Worker Party in the 2018 election. No lambada in Rio’s summer of discontent.
Image (c) Adobe Stock
