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Some Good News

By Dr. Peter Andersen

The stock market is one of the best leading indicators for the economy and it is also closely related to new home building and residential renovation. It provides down-payment help for home buyers and helps to finance renovation projects. Stock market performance is therefore an important determinant of both the ability and willingness to buy homes and commit to renovation projects.
The good news is that the S&P/TSX is at an all-time high and about six per cent above its year-end close. Mergers and takeovers - the product of the liquidity boom - are partly responsible. News that American consumers have not been held back by either the sub-prime mortgage meltdown or the bounce in oil prices has also helped. The S&P/TSX has benefited from the revival in commodity prices and widespread indications that the growth surge in the world economy seems immune to the U.S. slowdown.

The global economy
Emerging economies are now the dominant force in the global economy. They account for more than half of the world's GDP and are growing at more than twice the rate of the older industrial countries. Developing countries have gone through profound structural changes this decade. They have adopted market capitalism, integrated their economies into the global trading system, used information technology to become part of the world's supply-chain, and effectively expanded the world's labour force. In addition, they are generating a global demand shock as their purchasing power increases.
Perhaps the most important economic news over the past month is the release of the International Monetary Fund's semi-annual World Economic Outlook Report. Its estimate for world real GDP growth in 2006 was raised to 5.4 per cent. In addition, growth in 2007 and 2008 is now forecast to be much higher than expected six months ago: 4.9 per cent in both years. We have not seen a growth run this strong since the 1960s.

Canada's economic outlook
The Bank of Canada's Business Outlook Survey covers senior management of about 100 firms, selected in accordance with the composition of Canada's economy. It is carried out on a quarterly basis. It shows a clear-cut improvement in a number of business activity indicators (future sales, expected employment and investment intentions). Hiring intentions declined in manufacturing, but overall are strong across Canada.

The U.S. economy
Our view is that the U.S. economy is stronger than generally perceived. The main risk is that the sub-prime delinquency problem might spread and produce a credit crunch for lower-income American consumers. A large number of sub-prime mortgage loans were originated in 2005 and 2006, and they will see rates reset this year and next. Mortgage lending standards in the U.S. are also being tightened now.
One reason the mortgage problem in the U.S. is unlikely to spread is the government's response. Mass foreclosures are not welcome, especially with the approach of the 2008 elections. Testifying to the House of Representatives Financial Services Committee, Fannie Mae and Freddy Mac, the two largest sources of financing for U.S. residential mortgages, pledged to help sub-prime borrowers refinance into more affordable mortgages and avoid foreclosure.

No sub-prime mortgage problem in Canada
The question of whether Canada faces a sub-prime mortgage problem has surfaced because of what is happening in the United States. Fortunately, Canada's non-traditional mortgage market is much smaller than that of the United States. It accounted for only about five per cent of total originations in 2006, compared to over 20 per cent in the United States. Canada has not experienced the aggressive lending practices seen in the U.S. and default rates in Canada are currently at a low level.

The resale housing market
Another way of comparing Canada's housing outlook with the U.S. is to look at what is happening in the resale market. In the U.S., existing home sales in the latest month are down by 3.6 per cent from the same month a year ago. Average U.S. resale house prices are down by 1.3 per cent year-over-year.
Resale activity in Canada is still very strong. Seasonally adjusted transactions in the first quarter were at an all-time high. Nationally, average resale house prices are up by almost 10 per cent. This positive news from Canada's resale market bodes well for the new housing market. The resale market typically sets the tone for new home sales.

Warning signs for builders
There are some warning signs for Canada's new home builders. The inventory of newly completed but unoccupied single and semi-detached homes has increased to its highest level in more than five years. This suggests that supply is beginning to outpace demand.
Housing starts are also trending lower now. They were down by more than 10 per cent year-over-year in urban areas in the first quarter. The decline is particularly pronounced in the single-detached category. They were down by 16 per cent, while multiple-unit starts were down by only five per cent. These latest developments are in line with our forecast, which calls for a 10 per cent decline in total housing starts in Canada this year to 205,000 units from 227,395 in 2006.

Peter Andersen, a CHBA economist, is president of Andersen Economic Research Ltd. of Toronto. The firm specializes in economic research and forecasting for the Canadian home building industry.

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