Canadians are still overly enthusiastic about real estate prices. US Federal Reserve Bank of Dallas (a.k.a. the Dallas Fed) indicators show buyers actually became more irrational in the prices paid in the fourth quarter of 2017. Analysts from the reserve bank warn prices are still overheated across the country.
Exuberance, and Measuring It
Exuberance means “with excitement” in normal English, but is bankster for driven by emotion. When asset prices are driven by emotion, fundamentals are often disregarded. The enthusiasm is further driven by a “can’t lose” feeling, driving widespread speculation. Asset classes driven by enthusiastic speculators disregarding fundamentals, are better known as “bubbles.”
Since the Great Recession, the US has worked on a “smoking gun” indicator to identify bubbles. Efthymios Pavlidis of Lancaster University, and the Dallas Fed teamed up to measure “explosive dynamics” in pricing. They then figured out the longer the these dynamics persist, the more likely you can be sure it’s a bubble. Since then, the Dallas Fed has been monitoring global markets to identify bubbles.
How To Read The Exuberance Indicator
Pavlidis and the Dallas Fed do the hard work, you just need to understand how to read the indicator. Despite the complicated documentation geared towards academics, it’s pretty easy to understand. There’s two sets of numbers, a threshold value and an exuberance indicator. When the exuberant indicator passes the threshold value (set at 95%), you’re in exuberant territory. If the market stays in this territory for over 5 quarters, you have an exuberant market. Here’s where we are.
Better Dwelling. Source: Efthymios Pavlidis et al., The Federal Reserve Bank of Dallas.
Canadian real estate exuberance is dropping, but it’s still very high. The fourth quarter of 2017 is up 1.57% from the third quarter, but is down 33.81% from the peak obtained in Q2 2017. We passed the threshold in the second quarter of 2015, and have remained in this territory for 11 quarters. Remember, anything above the threshold is high. Just because it’s declining, doesn’t mean buyers are now rational.
Better Dwelling. Source: The Federal Reserve Bank of Dallas.
Periods of exuberance are followed by periods of deleveraging, and price corrections. Assets are never priced perfectly, so expect a period of price exploration to occur. Often this leads to a drop below fundamentals, but sometimes not. Buyers aren’t great at deciphering how much emotion was used by previous waves.
Sure, demand is higher than supply, populations are increasing, and land is expensive. It doesn’t mean people aren’t overpaying for the luxury of owning a house today. That also doesn’t mean that people won’t stop overpaying soon.
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