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We just keep firing on all cylinders

Jacqueline Thorpe, Financial Post
Published: Saturday, July 14, 2007

For 14 years Norm Fisher worked contentedly in the steady if somewhat sleepy world of Saskatoon real estate. Then, late last year, the market suddenly began to act like a teenager left home alone for the first time.

Active listings began to shrivel up so quickly that there were only about 300 properties for sale in December, compared with a normal range of 600 to 800. Then, prices began to shoot up. By spring, the market was on a full-fledged bender with houses going $20,000 and $25,000 over asking price in fierce bidding wars.

"I moved a young couple into a condo they purchased last August for $63,000," said Mr. Fisher, with Royal LePage. "I sold it for them in February for $120,000."

Gains like that made Saskatoon the hottest real estate market in country in June, with prices up 57% over the year. A surge in prices for the oil, potash, uranium and wheat washing through its gates from the surrounding province has created a rush of migration to the city and lit a fire under house prices.

The story is similar across much of the country. As the economy heads into the second half of 2007 it is on a roll of epic proportions, one that many analysts had expected to fizzle long ago but somehow seems to gain sustenance from each short-lived pullback.

Consider the parade of statistics over the past two weeks that highlight the all encompassing nature of the boom:

-Rio Tinto PLC made a US$101 per share offer Alcan Inc bringing the total all-cash bid to US$38-billion, the largest takeover deal in Canadian history.

-The bid helped drive the Toronto Stock Exchange to a new record of 14,496.50 and pushed the Canadian dollar to a new 30-year high of US95.72?.

-Prices of existing homes rose to a new record of US$335,180 in June, up 10.4% over the year.

-The unemployment rate held steady at a 30-year low of 6.1% in June, while the employment rate nudged back to a record high of 63.5%. Wages, meanwhile, rose 3.2% in June, up from a recent trough of 2.0% in January.

Invoking the financial adage that central bankers like to take away the punch bowl just as the party gets started, David Wolf, Canadian economist for Merrill Lynch, said, "Given the environment we're in you'd have to say we're probably hip deep in that punch bowl."

"This environment ... really is the best we have seen in a generation and certainly in recent memory -- 30-year low on the unemployment rate, 30-odd-year high on the Canadian dollar, house prices are going up, stock prices are going up, incomes are going up," Mr. Wolf said.

It is the longevity of the cycle in the face of stiff odds that has surprised economists. Despite the scorching run in the Canadian dollar from a low of around US62? five years ago and the loss of 300,000 manufacturing jobs, the economy has posted average quarterly growth of 2.8% since 2002.

Growth has certainly been erratic and has not reached the 5%-plus rates reached during the 1990s, but crucially, it has been accompanied by a substantial increase in personal wealth, due to rising house and stock market prices and most recently, wages.

The housing and job markets in particular continue to defy predictions of a slowdown. Figures last week for June show the property boom in full swing with 11 of 24 reporting cities sporting double-digit price gains of existing homes and major metropolises such as Ottawa and Toronto up 7.3% and 6.7% respectively.

While the Bank of Canada has started to take that punch bowl away --it raised interest rates to 4.50% from 4.25% last week in its first change in more than a year -- and mortgage rates had already risen in anticipation, financing is still affordable compared with historical norms. Five-year posted rates now stand at around 7.24%, up from 6.64% at the end of April, but actual rates are 75 to 125 basis points below.

Jobs growth, meanwhile, -- the key driver of real-estate trends -- continues unabated. Statistics Canada estimated the economy generated 197,000 new jobs in 2007, up 1.2% from last year and similar to last year's pace.

Despite the bleeding in the high-paid manufacturing sector, job quality also rose in the first half of the year, according to CIBC World Markets.

Benjamin Tal, senior economist at CIBC, said in his report that the gain was driven by jumps in job creation in high-paying sectors such as oil and gas extraction, telecommunications and public administration. Jobs in low-paying sectors such as clothing, general-merchandise stores and repair fell. Even in manufacturing, quality rose with jobs in the higher-paying mineral, paper and computer manufacturing sectors rising.

"The combination of rising employment and improving quality is a sure recipe for rising personal income, which as of the first quarter of the year, rose by 8.3% on an annualized basis," Mr. Tal wrote.

To be sure, certain areas of the country continue to hurt, none more so than Ontario where the auto sector seems to be in free-fall as U.S. vehicle sales continue a six-month slide. National Bank of Canada said the country is poised to record a trade deficit in automotive products in the second quarter for the second time in a year -- the worst showing for the industry in more than 20 years.

Still the overall figures for the entire country remain comfortably in positive territory. If economists have been surprised by the strength, that is probably because they have also been surprised by the strength of the global economy, which is in its fifth year of growth above 5%, its longest winning streak in 30 years.

Last week, China raised its final assessment of 2006 to a 12-year high of 11.1% growth from 10.7% while India seems to have graduated to a higher 7%-to-8% plane from 5% and 6%.

"I think there has been a tendency to underestimate how strong global growth would be this year and how important that is to Canada," said Ted Carmichael, Canadian economist J.P. Morgan. "People continue to be concerned about the high dollar but the high dollar really is just a reflection of the improvement of the terms of trade, the higher commodity prices. These things at the end of the day tend to benefit Canada despite the real stress they cause in the manufacturing sector."

Importantly, Canada has adroitly turned its economy abroad and away from a struggling United States to take advantage of the trend. Exports to non-U.S. destinations are up nearly 30% so far this year.

With Canada flying high, the worry is it will only be a matter of time before it plunges back to earth.

Douglas Porter, deputy chief economist at BMO Capital Markets, has begun to notice one big crack in the housing market --affordability.

"It always concerns me a bit to see the market continue to blaze ahead even in the face of declining affordability over the past year, both through higher rates and higher prices," Mr. Porter said.

Mr. Fisher at Royal LePage, says the soaring prices in Saskatoon are starting to irritate locals.

"I think anyone who has been sitting on the fence is feeling they've been pushed out of the market almost," he said. "The average income in this area is $700 a week so when the average selling price reaches $250,000 it's pretty tough to get into the market."

But most economists do not see the kind of rapid demise in housing that has beset the United States over the past year. There has simply not been the overbuilding that swept such places as Florida and California. Canadians have also not got caught up in the dodgy loans that are now unravelling stateside. Subprime loans account for only 3% of mortgages outstanding in Canada, compared with 13% in the United States.

Most economists see a slow unwinding as potential purchasers switch to renting and higher interest rates slow construction.

The commodities boom could come to a screeching halt, but many analysts say that, too, is unlikely.

In fact, Martin Barnes, managing editor of Bank Credit Analyst, says commodity-related shares are a good candidate for a full-fledged mania in the next few years, if the macro-environment remains benign. That would maintain a solid foundation under Toronto stocks.

He said in a recent report that industry consolidation, as witnessed in this week's Alcan deal, and rising costs suggest the inevitable step-up in supply will be gradual. Commodity shares have not displayed the same frothiness as the commodities themselves, and thus, still offer good long-run investment potential.

"Past strong gains from commodity-related investments, combined with an environment of sustained economic expansion and decent liquidity, could create the perfect conditions for a final blow-off in the commodity complex," he wrote, filling Canadian pockets for some time to come.

All manias eventually end in misery and commodity shares will inevitably turn south, but a slowdown in the Canadian economy is more likely to be a less dramatic affair with higher interest rates, both at home and abroad gradually squeezing growth.

"I don't think they need to step on the brakes enough that they will drive the economy into recession," said William Tharp, economist at M. Mureenbeld & Associates Inc.

He sees more insidious factors potentially undermining the economy: Canada's notoriously poor productivity record and labour shortages as baby-boomers retire.

While the chances of a dramatic bust are low, under Mr. Tharp's scenario Canada would enter a period of slower growth but higher interest rates. In effect, a less flashy, more European-style economy.


Posted on Thursday, July 19, 2007 at 11:05AM by Registered CommenterElaine in | CommentsPost a Comment | References1 Reference

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