SHI 10.16.24 – A Tale of Two Nations

SHI 10.2.24 – Sweating the Labor Market
October 2, 2024
SHI 10.23.24 – Ebbs, Flows and Trends
October 23, 2024

 

It’s hard to prove a counterfactual.

 

Consider this statement:   “Fred forgot to set his alarm, and consequently he was late.   If he had set his alarm, he would have been on time.” 

The fact remains, Fred was late.   The counterfactual, of course, is the statement that he would have been on time if, in fact, he had set his alarm.   Is this statement true?   We’ll never know, inasmuch as (1) the event has already occurred, and (2) we don’t know if Fred was late due to his failure to set the alarm.  His tardiness may have been caused by some other, completely unrelated, issue.  

But I say we throw caution to the wind.   Let’s attempt to prove a counterfactual today!  🙂

 

Canada is falling behind, economically. 

 

 

A couple weeks ago, the Economist Magazine published an article entitled Why is Canada’s economy falling behind America’s?

The subtitle was even more damning:  “The country was slightly richer than Montana in 2019.   Now it is poorer than Alabama.”   Ouch. 

Why is Canada’s economic growth falling far behind that of the US?   Let’s take a look.

 

Welcome to this week’s Steak House Index update.

 

If you are new to my blog, or you need a refresher on the SHI10, or its objective and methodology, I suggest you open and read the original BLOG: https://www.steakhouseindex.com/move-over-big-mac-index-here-comes-the-steak-house-index/


Why You Should Care:   The US economy and US dollar are the bedrock of the world’s economy.   But is the US economy expanding or contracting? Expanding ….  By the end of Q2, 2024, in ‘current-dollar‘ terms, US annual economic output rose to an annualized rate of $28.63 trillion.   After enduring the fastest FED rate hike in over 40 years, America’s current-dollar GDP still increased at an annualized rate of 4.8% during the fourth quarter of 2023.  Even the ‘real’ GDP growth rate was strong … clocking in at the annual rate of 3.3% during Q4.

According to the IMF, the world’s annual GDP  expanded  to over $105 trillion in 2023.   Further, IMF expects global GDP to reach almost $135 trillion by 2028 — an increase of more than 28% in just 5 years.

America’s GDP remains around 25% of all global GDP.  Collectively, the US, the European Common Market, and China generate about 70% of the global economic output.  These are the 3 big, global players.   They bear close scrutiny.

 

The objective of this blog is singular.

 

It attempts to predict the direction of our GDP ahead of official economic releases.  Historically, ‘personal consumption expenditures,’ or PCE, has been the largest component of US GDP growth — typically about 2/3 of all GDP growth.  In fact, the majority of all GDP increases (or declines) usually results from (increases or decreases in) consumer spending.  Consumer spending is clearly a critical financial metric.  In all likelihood, the most important financial metric. The Steak House Index focuses right here … on the “consumer spending” metric.  I intend the SHI10 is to be predictive, anticipating where the economy is going – not where it’s been.


Taking action:  Keep up with this weekly BLOG update.  Not only will we cover the SHI and SHI10, but we’ll explore “fun” items of economic importance.   Hopefully you find the discussion fun, too.

If the SHI10 index moves appreciably -– either showing massive improvement or significant declines –- indicating growing economic strength or a potential recession, we’ll discuss possible actions at that time.


 

The Blog:

 

That Economist article contained this image:

 

 

Thru the lens GDP, the image compares what is known as the ‘purchasing-power parity‘ — or PPP — of the two countries.    It’s easy to see that the relationship was fairly stable from 2000 to about 2015.   But then, for some reason, Canada’s GDP began to slide when compared to the US.   Even worse for Canada, according to the International Monetary Fund (IMF), the future looks even more bleak:   What was hovering around 85% PPP is now forecasted to slip below 70% by the end of this decade.  

That is not a great outcome for Canada’s GDP or its citizens.   In fact, according to the IMF, “Were Canada’s ten provinces and three territories an American state, they would have gone from being slightly richer than Montana, America’s ninth-poorest state, to being a bit worse off than Alabama, the fourth-poorest.”

Ouch again.  What’s the cause of Canada’s economic weakness when compared to the US?

Well, it’s not inflation.   Their “inflation experience” from 2019 thru today was very similar to ours here in the US:

 

 

The shape of Canada’s CPI increases (year-over-year) is almost identical to ours.   Both peaked near 9% in early 2022.  Both have declined meaningfully in the past 2 years — in fact, Canada’s CPI is now significantly lower than ours.   Canada’s consumer is better off than ours, by this metric anyway. 

So, if the inflation experience was almost identical, what’s the cause of the divergence? 

Therein lies the root of our counterfactual proof today.  

Here are the facts:   The majority of Canadian homeowners either have a fully variable-rate home loan or they must ‘renew’ their mortgage every 3-5 years.   According to another Economist article from 2022, variable rate home loans accounted for more than half of all home loans in place in Canada. 

 

Alternatively, here in the United States, according to Sam Ro, a financial blogger:

 

“There are 146 million housing units in the U.S., of which 86 million are owner-occupied and 39% of which are mortgage-free. Of those carrying mortgage debt, almost all have fixed-rate mortgages, and most of those mortgages have rates that were locked in before rates surged from 2021 lows. 

All of this is to say: Most (US) homeowners are not particularly sensitive to movements in home prices or mortgage rates.

 

(NOTE:   Sam Ro embedded a number of ‘source’ hyperlinks in his statement above.  The bold text in the first sentence has 5 hyperlinks to his data sources.   You might want to check them out as well.)

 

Which brings us to the first half of our counterfactual argument for today:  

 

The majority of Canadian home loans are not fixed in nature; as Canada’s central bank raised interest rates along with the FED, Canada’s consumers were forced to commit more of their disposable income toward paying their increasing mortgage payment.  As a result consumer spending was adversely impacted in Canada, and their economy suffered.

 

And here’s the second half of the argument:  

 

Had the majority of Canada’s home loans been fixed rate, as there are here in the US, then their economy would have done far better over the past 4 years, and the Canadian PPP would have remained much closed to 80% than 70%. 

 

Is this true?  No one knows.   One can never prove the path not taken would have proven optimal.   The choice was made, the time has past, and the facts are now the facts. 

But the debate itself is interesting.   And it highlights another one of the exceptionally odd things about the past 4 years.   When the FED kicked off one of the fastest rate hike cycles ever, taking the FFR from close to zero to over 5% in less than a year, many experts expected the US economy to tank.   Most economic experts were forecasting recession within the year.   All those forecasts and forecasters were wrong.   Dead wrong.

Why?  Because the pandemic rewrote many of the rules.  

In previous cycles, historic precedents like the “inverted yield curve,” the inflation spike, and the FEDs super-fast rate hike cycle most certainly would have spelled economic doom — and if not doom, at least a moderate recession.   But not this time.   No, this time the US economy, as measured by GDP growth, kept churning higher and higher, even as most experts forecasted a recession.  

Interest rate hikes were less impactful here in the US because the majority of loan rates were low and fixed.  But not in Canada.  No, in Canada, the majority were variable or short-term.  And when the Bank of Canada raised interest rates, much like the FED, their consumers felt the pinch. 

Of course, the exceptionally high level of fixed rate loans at exceptionally low rates had an equally odd, pandemic-inspired outcome:   People stayed put.   Why sell when our home loan is at 3% many asked?   So with limited supply and relatively strong demand — mostly from ‘cash’ buyers, home values continue to rise against all expectations for the opposite.  Most experts opined that home values would decline.   The opposite occurred. 

 

 

Fixed rate household and corporate debt created an unusual general insensitivity to the FEDs huge rate hike.  Add to this mix about $5 to $6 trillion of US federal monetary stimulus post-Covid, and viola! — consumers spent, GDP grew, and households remained generally healthy.   No, not all households, of course.   Lower-income, non-homeowner households did not remain healthy over time.   They are struggling.   As are those Americans living under a pile of variable rate credit card debt. 

But overall, this segment is relatively small — especially when measured against that same group in Canada.   And this, of course, is my argument for my counterfactual.  Canada’s households and consumers did not have the same low-level, fixed rate debt that American’s enjoyed over the past 4 years.   If they had, I contend, Canada’s economic and financial health would be much better today.   

Interest rate levels matter.   However, higher rates matter far more in an economy pegged to variable rates.  Like Canada.   In this regard, the US is somewhat unique in the world.   Our “30-year fixed rate mortgage”, believe it or not, is not common across the globe.  No, the 30-year fixed rate home loan is a common US phenomenon, but rare in other countries.   And this fact, my friends, is probably one of the reasons the American economy is performing much better than in the economies of other developed nations.   Like Canada. 

Let’s head to the steakhouses.

This is interesting:   Take a look at the expensive eatery reservation demand in ‘The OC’ during 2024.   Early in the year, SHI demand was strong, peaking at a reading of 60 (out of a maximum possible 72) during Q1.   Since then, the SHI has steadily declined.   The most recent 4 readings have all been in the 20s.    Dallas, too, seems to be experiencing demand weakness as 2024 moved along.  Take a look:

 

 

But while reservation demand in the ‘west’ may have waned a bit recently, the other SHI markets appear relatively solid.   And, in fact, this week’s reading of 97 is fairly bullish for the economy.   Here’s the weekly chart:

 

 

All in all, I’d say the SHI10 is still supportive of continued economic growth.   Checking in with the Atlanta FED and their ‘GDPnow’ forecasting tool, it appear they, too, are feeling good about the third quarter’s GDP number.   According to the Atlanta FED, the most recent forecast is for a 3.2% growth rate for Q3, 2024.  Of course, we must wait until November 27th to hear from the BEA about actual results.  And remember:   Actual Q2 GDP ‘real’ growth was 3% — and the ‘current-dollar’ GDP metric increased at a 5.6% rate.  

These are stellar economic growth numbers.

Thanks for tuning in.

<>  Terry Liebman

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