Title: Will slumping stocks hit real estate prices?

Sub-title: Shrinking retirement portfolios may make some Canadians feel less wealthy, however the effects are unlikely to spread to the housing market.

 

The recent bear market in Canadian stocks has hit investment portfolios as never before. As of this writing, the benchmark S&P/TSX index was trading at just over 9000, down almost 40 percent from its 52-week high. Hundreds of billions of dollars have been wiped out in a fairly short time and worse, experts remain unsure of whether the market has yet hit bottom.

 

The drop in stock prices, -- which comes on the heels of a slew of bad economic data, tighter bank lending standards and sluggish personal consumption trends south of the border, where Canadian businesses sell the lion’s share of their exports, -- has housing sector analysts wondering what effect if any, these developments will have on sector activity.

 

One major worry is that Canadians, who now have fewer assets in their mutual fund and other equity accounts, will have less money to spend on housing. At worst, that would mean fewer apartment dwellers would be tempted to jump into the housing market and those that do own homes, may be less interested in trading up to more luxurious properties. 

 

Is there such a thing as a negative “wealth effect?”

So will the effects of slumping Canadian equities indexes spill over into real estate prices? Economy watchers have long argued about what they call a “wealth effect,” which is the tendency of consumers with rising stock or real estate portfolios to spend more on their personal consumption. The question is whether the wealth effect, if it indeed exists, might actually work in reverse too.

 

Ironically, it was concerns regarding a possible “negative wealth effect” that are in large part responsible for much of the mess we are in right now. After the Internet stock bubble crash during the early 2000s, global monetary policy experts, such Federal Reserve Board chairman Alan Greenspan, worried that the lost wealth would lead U.S. consumers to curtail spending, which would send western economies into recession. So, led by the Fed, the world’s central banks drastically cut policy rates, and kept them low. This widened access to easy credit and sparked the first steps of many of the excesses that we see today. 

 

Although the U.S. economy did enter a mini-recession during the early 2000s, a housing bubble, sparked by all of that cheap and easy credit quickly emerged, which meant that western consumers for the most part never really did feel poorer. The upshot was that talk of a possible “negative wealth effect,” died down.

 

Little recent evidence

That said, recent information does suggest that the wealth effect exists, though analysts still argue the extent of its influence. For example early last year the U.S. Congressional Budget Office put out a report that suggested when a family’s house value changes by $1,000, then its consumption changes by between $20 and $70 per year. It would not be a stretch to argue that changes in real estate wealth spark similar effects.

 

The good news is that here in Canada there is little evidence yet that this is occurring. For example according to the Canada Mortgage Housing Corporation housing starts here increased slightly in September compared to the previous month to a seasonally adjusted pace of 217,600 units. And while Canadian Real Estate Association data show that the number of new listings fell slightly during the third quarter of this year as did the average price of homes sold (by 6.2 percent), both declines came off of historically high levels.

 

Furthermore, much of the reason that Canada’s housing sector is not doing as well as it has in previous years can be traced to spin-off effects from the economic troubles facing our southern neighbour. Weaker equities prices are rarely cited as a major factor.

 

In fact one of the ironic effects of the bursting of the Internet bubble earlier in the decade is that it sparked renewed confidence among many consumers that real estate is among the best places to put their money. Because even though real estate prices may not rise every year, houses are far more comfortable to live in than stock certificates.

 

Peter Diekmeyer (peter@peterdiekmeyer.com) is a Montreal based freelance business writer.

 

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