Fed’s Exuberance Index Shows Canada’s Real Estate To Be A “Bubble On A Bubble”

The U.S. Federal Reserve’s latest Exuberance Index (Q2), considered a “smoking gun” for bubbles, shows Canada is well into a real estate bubble – a bubble on a bubble.

This article by Lorimer Wilson, Managing Editor of munKNEE.com, is an edited ([ ]) and abridged (…) version of an article by Daniel Wong of betterdwelling.com

The U.S. Federal Reserve Exuberance Index, considered a “smoking gun” for bubbles, seeks to identify…persistent growth in prices in excess of fundamentals to help policymakers act on bubbles early so countries can minimize the damage. Such exuberant price growth is considered irrational and based on emotion and prone to rapid corrections which can become a threat to more than just one buyer.

How do we use this tool? The index makes understanding market exuberance straightforward for analysts. They provide two sets of numbers, a country’s index and a 95% critical value threshold. If the quarter rises above the threshold it’s an exuberant quarter. After five consecutive quarters of exuberance, you have an exuberant market. That’s a bubble and the Canadian real estate just logged its sixth consecutive quarter as an exuberant market, rising to 3.08 and is now more than double the threshold value of 1.37 needed to be considered as such but it might be a lot worse than that just six quarters.

Starting in Q2 2015, housing saw 14 consecutive quarters of exuberance and then 4 out of 5 following quarters marginally below the threshold but that isn’t enough time for a period to be considered non-exuberant. Canadian real estate is either one longer bubble or a bubble on a bubble since it didn’t correct between. In either case, the gap between fundamentals and prices has expanded this whole time.

Conclusion

A  large correction is needed although the Fed can’t tell you when as policy interventions to extend a bubble can delay a correction and any such action is essentially passing on a deficit of market inefficiency, meaning it has to be paid back later – with interest.

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