Friday, April 2, 2010

Canadian Consumer Confidence - Delusional

CIBC economist Benjamin Tal released a report this week outlining the massive divergence of Canadian consumer confidence with the reality of their financial situation.  Basically, he introduced a new metric a "Consumer Capability Index" which roughly is meant to gauge a consumers ability to consume as opposed to their willingness to (via debt typically).  Full report here, it's well worth a read, and it's a pleasant surprise to see anything meaningful coming from the banks on this.

A few highlights:

Does this look sustainable?

Not only is the debt to income ratio increasing, the rate of increase as at about the highest level it's been at in the last 20 years.  As mentioned in the article (emphasis mine):
Despite Canadian consumers’ high spirits, their recent
consumption pattern has not been supported by an
equivalent increase in income. In fact, growth in real
disposable income has been trending downward over
the past year (Chart 2), and to a certain extent debt is
replacing income as a major driver of consumer purchases
The rising importance of debt as a determinant of
consumption can be seen in the fact that the 2008-09
recession was the first economic contraction on record
to show overall expansion in real household credit. As of
February, overall household credit was up by more than
7% on a year-over-year basis—more than three times
faster than income growth.
 People aren't making more money, they're simply spending more, due to the ease of credit cards, consumer lines of credit (including HELOCs).  That debt eventually has to be paid, and the cost is that the consumer has to service the debt in the meantime.

Note that the debt service ratio is around the same level as mid 2006, even though borrowing costs today are significantly lower.  When rates rise, the DSR will rocket higher as well.   This is when consumers are going to feel the pinch (along with increasing taxes as well due to poor public finances).  Ouch.

How bad are things?  Apparently the consumer either hasn't noticed the problem, or are hoping it will go away.  Canadian consumers seem to be wildly optimistic...over what no-one can seem to say.  Reality vs. fantasy:

 Ie, Canadian consumers haven't seen their finance in such a piss poor state of affairs in over 20 years, but you wouldn't know it to ask them.

A brief timeline:

Up until around 2001: Canadians expectations were basically in line with reality with some minor fluctuations from the mean.

2001 - 2008: The bubble years.  Canadians become completely disconnected with reality and are wildly optimistic due to their rapidly appreciating home values.

Late 2008-Early 2009:  Market implosion.  Canadians briefly wake up and face reality as their savings in the market (RRSP's or otherwise) get absolutely hammered as the market crashes

Early 2009 - present: Bank of Canada makes money free, drops rates to zero, and the great Canadian reinflation begins.  Idiots bid over houses driving record housing prices after the biggest financial collapse since the Great Depression.   Market rallies massively on fumes.  Happy delusional days are here again!

Future:  Rates rise. Canadians wake up with a massive debt infused hangover.  Consumer spending dries up as the majority of disposable income is directed towards debt service with rising rates.  Economy enters the next dip of the next recession...presumably at some point people wakeup and face reality and a REAL recovery can actually begin.

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