Possible Bubbles to Watch Out for in Canada

Vanguard shares concerns on housing and crypto, and what to expect from the stock market in 2021.

Ruth Saldanha 6 May, 2021 | 4:28AM
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We’ve talked about bubbles a lot recently. But what’s worth worrying about, and what needs action?

In a column last year, my colleague John Rekenthaler pointed out that all over the world, assets have risen. American stocks are up, as are Japanese, British, and Chinese, along with just about every other country’s equities. Gold is 50% above its March bottom; crude oil has rebounded sharply from when it registered negative value; housing demand has soared; and bitcoin has reached its record high (and then fell, and then rose, and then fell). Meanwhile, ARK Invest’s Cathie Wood thinks there’s a bubble in bonds.

Does this mean everything’s a bubble? And if everything is a bubble, does that mean that nothing is a bubble?

“Bubbles are difficult if not impossible to predict. Unfortunately for investors, they are only observable after the fact,” says Ian Tam, Morningstar’s Canada’s Director of Investment Research.

Vanguard agrees in a recent post and adds that a fast-appreciating asset may seem overvalued, only for its price to keep rising.

Possible Bubbles: Canadian Housing, Crypto

Bilal Hasanjee, Senior Investment Strategist at Vanguard Canada points out that a bubble is an instance of prices far exceeding an asset’s fundamental value, to the point that no plausible future income scenario can justify the price, which ultimately corrects.

“Some specific markets, like Canadian housing and cryptocurrencies, seem particularly frothy. For housing in particular, there seems to be excessive exuberance.” Up until the start of the 2008 financial crisis, Hasanjee notes that Canadian housing affordability tracked that of the U.S. market. But since then, the two have diverged. “In a post-pandemic world, the price to disposable income ratio remains elevated and is the highest in the world (among 21 countries measured). Moreover, Canadian house prices have grown the fastest among the G7+Australia over the last one year,” he said.

On average, house prices especially in the Greater Toronto Area, have risen 25%, with many markets seeing prices rise even higher. These elevated prices have required higher upfront costs, and have reduced overall liquidity in the economy.

“High levels of household debt are causing concerns, especially with 90% or more of individual net worth being tied up in real estate. This is a worrying sign,” Hasanjee said.

Meanwhile, more money is being tied up in cryptocurrencies that have soared more than 500% in the last year. “It’s a curious rise for an asset that is not designed to produce cash flows and whose price trajectory seems like that of large-capitalization growth stocks—the opposite of what one would expect from an asset meant to hedge against inflation and currency depreciation. Rational people can disagree over cryptocurrencies’ inherent value, but such discussions today might have to include talk of bubbles,” Vanguard notes.

Stocks Not to Hot, Not Too Cold

Looking over the next ten years, Vanguard’s fair-value projections continue to reveal a global equity market that is neither grossly overvalued nor likely to produce outsized returns going forward, while bond return expectations have markedly improved over the past quarter.

“Our stock market outlook has further moderated during Q1 2021 due to growth in prices across Canadian and international markets,” notes Hasanjee, “Our median 10-year returns expectations for Canadian equities as of March 31, 2021 is in a range of 3.5% to 5.5%, about half a percentage point lower than our Q4 2020 estimate owing to an over 7% growth in Canadian equities during the quarter. However, our median 10-year returns expectations for global stocks (ex-Canada, unhedged) at the end of Q1 remain in a range of 4% - 6%,” adding that he anticipates median 10-year returns for Canadian and global bonds will range from 1.50% to 2.50%, compared to an approximate range of 0.5% - 1.5% range in Q4, 2020. 

Time to Get Tactical?

Investors assessing the outlook may be tempted to adjust course. First be sure you’re not heading towards any extremes, says Christine Benz, Morningstar's director of personal finance.

“One interesting thing about the rally that we've been living through is that there's been this self-perpetuating quality in some of the stocks that have performed best. If you've bought them, you've done well, and have continued to do well. My advice is to not expect that to continue to work as an investment strategy,” she says.

Benz recommends being careful with performance-chasing while also resisting urges to get too defensive.

“One thing we know from surveying the universe of professional tactical asset allocators who jockey among different asset classes is they don't do particularly well with those moves. To me, that really casts doubt on whether we as individual investors--who aren't doing this for a living--can successfully pull off those kinds of shifts. So, resist the either/or mentality,” she says.

If It Ain’t Broke…

For some investors, Benz says, ‘Do nothing’ is good advice. In general, it doesn’t make sense to frequently change your investment strategy.

“Ask yourself when you last made any changes to your portfolio. If you've been very hands-off, that has redounded to your benefit, especially if you've had stocks in your portfolio, but if you haven't rebalanced recently, that would be something to consider. Retirees need to be especially cognizant of what's called "sequencing risk" – meaning that your goal date is getting closer. For that group, I would say de-risking at least a portion of the portfolio is mission critical. For young investors, be careful not to be too active in terms of managing portfolio allocations. I do like the idea of them taking a broad look at their portfolio, mainly with an eye toward evaluating their global exposure,” Benz says.

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About Author

Ruth Saldanha

Ruth Saldanha  is Senior Editor at Morningstar.ca. Follow her on Twitter @KarishmaRuth.

 
 
 

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