Benjamin Tal, deputy chief economist, CIBC in Toronto on October 20, 2009.Anne-Marie Jackson/The Globe and Mail
The "short Canada" trade has reached a fork in the road. One path is the one that it's already on: A contrarian play deployed by relatively few fund managers willing to bet against Canada's financial institutions and government debt. The other: Mainstream, which would see a wave of big-money investors join those hoping to profit from a sharp decline in a key sector of the Canadian economy.
Thursday in Washington hedge-fund managers and other investors at a closed conference on the sidelines of the International Monetary Fund's spring meetings will spend on a couple of hours on the case for betting against a soft landing for Canada's housing market. The inclusion of a "short Canada" segment on the agenda of a conference that features former chairman of the U.S. Federal Reserve Alan Greenspan and celebrated economist Myron Scholes is the latest – and perhaps the best – evidence that this trading strategy is gaining moment among international investors.
We know a bit about the agenda from Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce, who is down here in DC to take the other side of the debate – that betting real money on U.S.-style financial meltdown in Canada is crazy. Mr. Tal's opponent is Seth Daniels of JKD Capital, who sees bad things in Canada's future.
"It's telling," Mr. Tal said of his invitation. "These are not marginal players. For the `short Canada' theme to make their agenda shows it is on their radar screens,"
Mr. Tal has done a considerable amount of work on housing dating back to the U.S. bust. In an interview Thursday before his presentation, he said he's no "Pollyanna" when it comes to the Canadian housing market. He said he believes the market has overshot and that an "adjustment" is coming that will crimp economic growth.
Where he parts with Mr. Daniels is on the question of whether there is money to be made by using financial instruments to profit from the decline of (or "shorting") companies and assets that track the Canadian housing market. . Mr. Tal's answer: Only if you have a large enough stockpile to wait for a payday that will be nowhere near as spectacular as it was for the lucky ones who called the U.S. housing crash.
Mr. Tal said the "short Canada" crowd is guilty of poor data analysis. The widely noted price-to-rent ratios that suggest Canadian houses are wildly overpriced rely on the Consumer Price Index, which Mr. Tal says does a poor job of capturing what really is happening in the rental market. (Rents are higher than the CPI indicates, meaning the gap between them and home prices is less exaggerated than some measures suggest, Mr. Tal argues.)
Not long ago, an American client arrived in Toronto for a meeting with Mr. Tal, he says. The client declared immediately that Canada was headed for a crash. Why? Because this client had counted 33 cranes between the airport and Mr. Tal's office. "Counting cranes is not enough," Mr. Tal said.
The case against the short-sellers starts with the fact that Canada's population of people aged 25 to 45 – the demographic that buys houses – is growing faster than every other major economy other than India, Mr. Tal said. Another piece of evidence against predicting the worst: A household debt-to-income ratio of 160 per cent is not the sure path to destruction that it is made out to be. Several countries have higher debt levels. In a growing economy, Mr. Tal argues that it is perfectly natural for debt to increase. As long as individuals and companies can comfortably finance it, there is little reason to panic. In fact, the only time debt levels fall markedly is during recessions, Mr. Tal said. Credit and growth are linked.
And that's the ultimate reason the shorts will lose – Canadians are taking on credit at an unusually slow pace, and at the same time, the economy is growing. The U.S. crash was so dramatic because it was followed by one of the deepest recessions in history. Household credit was still growing when the crisis hit, and interest rates were rising.
None of those conditions are present in Canada. That's why Mr. Tal argues the "short Canada" trade could be a long, "boring" one. That's not how shorts make money – they need a crash. "If you want to short Canada, you need a recession-type scenario," Mr. Tal said.
With the U.S. economy picking up speed, a recession in Canada is a high-risk bet, even if the housing bubble pops.