Canada’s housing timebomb keeps ticking

Market recap

• Equity markets were mixed this week amid a thin run of economic data, while comments from both the Fed and Bank of Canada signaled we have a long way to go still before we get any rate relief.

• The S&P 500 added 1.1%, with technology and telecom services leading the pack.

• Meanwhile, the TSX slipped 1.0% as health care, materials and energy fell.

Housing

Recently, we’ve seen a decoupling of the Canadian and American economic outlooks, with Canada showing more weakness than its southern neighbour. Canadian consumers are more indebted, and from a housing perspective, their mortgage rates are higher and spread out over a shorter period of time than their American counterparts. This means that the consumer spending picture is more favourable in the U.S. than in Canada, and that the Bank of Canada (BoC) is likely to cut interest rates before the U.S. Federal Reserve (Fed); our expectation is that the BoC may well ease rates in the first half of 2024, while the Fed is most likely to wait until the back half of the year. What does this all mean for the Canadian housing market? We’ve already seen a pretty sizeable decline, but we believe there’s still further room on the downside. A drop-off isn’t necessarily imminent, but as the years progress, more and more people will experience the impact of higher mortgage rates compared to the relatively small segment that have renewed their mortgages in 2023 and already felt that pain. With more of Canadians’ income going toward mortgages, consumer spending will be affected, and some people will be forced to downsize. That means more homes will go on the market, likely depressing housing prices further.

Bottom Line: In our view, there’s still room for the housing market to decline further, with the risks greater in Canada than in the U.S.

Oil

At the onset of the Israel-Hamas conflict, oil prices spiked. Since then, however, they’ve declined significantly. While this is good news in the near term, we still view geopolitical conflict—in the Middle East and elsewhere—as a risk factor that will persist for the remainder of the year and likely into 2024. That’s one reason why more supply shocks, which could provide some support for oil prices, are still possible, even if they are likely to be temporary. There are a couple other factors worth considering when it comes to the crude outlook. First, OPEC is likely going to continue to monitor supply, keeping oil prices above $70 per barrel. And second, the economic environment continues to hold up fairly well, and we still believe that any recession will be mild. With demand expected to remain decent, our evaluation is that oil prices are likely undervalued, with $80-$90 per barrel probably the fair value.

Bottom Line: Recent declines in crude prices likely went too far, with healthy demand and possible supply shocks suggesting that oil is currently undervalued.

Hollywood

There was some good news out of Hollywood last week, as the SAG-AFTRA strike—which had kept actors off the job for four months—was resolved, while Disney beat earnings expectations. Our view is that streaming companies are currently a bit undervalued. Netflix, for instance, looks quite strong, having adjusted their pricing model and taken steps to prevent users from sharing accounts. That’s an example of the various ways streamers can increase revenue. The concern going forward is if we see the consumer continuing to weaken. So far, there have been cracks, but nothing has broken. With production shut down during the strikes but sufficient inventory to fill the gap, a lot of these companies actually saved money on costs, which had a positive effect on the bottom line. That said, users could eventually choose to downgrade from, say, four streaming subscriptions to three, which would have an impact on streamers’ revenue. This is why you want to own the quality companies that consumers cannot live without.

Bottom Line: The resolution to the SAG-AFTRA strike is good news, but it didn’t have a particularly negative effect on streaming companies, some of which may be slightly undervalued.

Positioning

For the first time this year, we’ve gone overweight equities. There are three reasons for this shift. First, the pullback in September and October made valuations more attractive. Second, the Fed’s most recent comments indicated their preference to stay on the sidelines and avoid any more rate hikes. And third, positive investor sentiment stemming from those two developments potentially sets things up for a Q4 rally.