Dwelling on China’s Housing Risks

Eric Lascelles

  • China’s housing market generates a remarkable 19% of the country’s economic output, and has been the subject of bubble worries.
  • It merits close examination given stress testing that shows even a moderate housing correction would halt the country’s economic progress.
  • The near-term outlook is fairly benign, with the pace of home building arguably running slightly below steady-state demand.
  • Medium-term risks are quite negative, revolving around the fact that 29% of China’s housing stock is vacant.
  • In contrast, the long-term risks point upwards given what appears to be an inadequate number of homes relative to the number of urban households.
  • Affordability is atrocious on the surface, but more nuanced beneath it.
  • Overall, Chinese housing still warrants a place in our pantheon of risks, but in a location of slightly diminished prominence relative to our prior assumptions.
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Economic Compass: The Future of Productivity and Innovation

Eric Lascelles

  • Global productivity growth has slowed since the financial crisis, worrying many.
  • Much of this productivity deceleration represents an inevitable slippage after a period of unusually rapid gains. But some also reflects temporary cyclical depressants that have taken hold since the crisis.
  • Looking forward, productivity growth should manage a gradual revival as the rate of innovation accelerates across a range of sectors.
  • However, unusually fast productivity growth is unlikely given slightly less help from capital investment, labour quality and technological diffusion.
  • As part of this exploration, we evaluate new technologies and their potential effects by sector.
  • We also consider whether productivity growth is being mismeasured, whether the world is shifting toward a “capital light†economy, and whether there might be significantly more structural unemployment in an increasingly automated world.
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Economic Compass: Vetting Debt Hot Spots

Eric Lascelles

  • As Fed tightening nears, the prospect of higher interest rates demands a closer inspection of the world's debt hot spots.
  • In the near term, the risks are "high" for Chinese credit, exuberant housing markets in a scattering of countries, and Greek public debt.
  • Meanwhile, the risks are "elevated" – but somewhat lower than we had feared – for the world's external, corporate and oil-oriented debt.
  • Over a longer timeframe, these risks fade, only to be supplanted by mounting concerns over the developed world's public debt – due more to untenable demographics than rising borrowing costs. Japan is an extreme example.
  • Going forward, rising interest rates will undoubtedly ignite a debt brushfire somewhere in the world, but an inferno is less likely.
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Economic Compass: Dissecting Deflation

Eric Lascelles

  • Developed-world inflation has declined for three straight years, to the extent that the Eurozone, U.S. and U.K. now flirt with deflation.
  • The threat is clearly greatest for the Eurozone given the breadth of the group’s deflationary impulse along both geographic and price basket lines.
  • Fortunately, any economic damage from deflation in the Eurozone should be more limited than commonly imagined, as a mere 41% of the deflationary impulse is rooted in “bad” causes, and 59% comes from temporary rather than persistent forces. The figures are even better for the other countries.
  • We construct five inflation forecasting techniques whose collective wisdom argues that total inflation should be higher next year in the Eurozone, U.S., U.K. and Canada.
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Economic Compass: Seeking New Growth

Eric Lascelles

  • Emerging-market economies have recently suffered a bout of decelerating growth.
  • As a silver lining, this slowdown provides the motivation and recent elections provide the opportunity to deliver a major new round of growth-enhancing structural reforms.
  • Accordingly, we anticipate a broadly-based surge in reforms over the coming five years, with 14 of the 20 countries examined in this report set to accelerate their actions.
  • India tops the charts, both as the country set to deliver the most reforms and as the one set to accelerate its reforms the most.
  • Furthermore, we estimate the theoretical stock market benefit tat each nation will enjoy through these reforms, with potential returns as high as 30%.
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Economic Compass: Canadian Housing in Six Questions

Eric Lascelles

  • The Canadian housing market has long defied expectations of collapse, though fears linger.
  • The near-term outlook remains quite benign. There are no particular signs of household distress, affordability is fine given low mortgage rates and construction is running precisely as it should. Worries about excessive condo activities and the influence of investors are overblown.
  • Naturally, the medium-term outlook is somewhat more negative, dominated by deteriorating affordability due to rising mortgage rates. Still, the potential construction downside is surprisingly tame, limiting the likely economic damage to no more than a quarter percentage point of GDP per year.
  • While more bearish scenarios are conceivable, they remain unlikely. As such, the Canadian housing market arguably takes a back seat to more pressing Canadian economic impulses, such as a lower loonie (good), lower oil prices (bad) and a stronger U.S. economy (good).
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Economic Compass: Prophet Margins

Eric Lascelles

  • Global profit margins are extremely high by historical standards, raising concern that a regression to more normal levels could trigger a major stock market correction.
  • Ominously, several key margin supports are set to reverse, due in part to rising borrowing costs and rekindling wage growth.
  • Fortunately, there are several under-acknowledged structural supports that should prevent profit margins from falling much.
  • Both our scorecard- and econometric-based forecasts argue for roughly flat to slightly lower profit margins in the future.
  • The key point is that margins are not likely to fall precipitously, removing a major downside risk from the equation.
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Economic Compass: Wither Globalization?

Eric Lascelles

  • After decades of surging trade, global export growth has recently lost steam.
  • There are a combination of cyclical and structural reasons for this diminished performance.
  • Cyclical reasons include the lingering effect of the financial crisis, a subtle trend toward protectionism and geopolitical conflict.
  • Structural reasons include sustainably slower emerging-market growth, rising competitive parity, saturated foreign markets and current-account rebalancing.
  • The cyclical factors should partially rebound over the next few years but the structural components will not, imposing a slight but enduring constraint on economic growth, and leading to marginally higher inflation.
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Economic Compass: Measuring Economic Upside

Eric Lascelles

  • Traditional forecasting techniques focus so tightly on the day-to-day actions of policymakers that they lose sight of what policymakers are trying to achieve.
  • A radically different approach simply evaluates what would happen if policymakers achieved key goals such as balancing their budget, returning their economy to its full potential and nudging their currency toward a fair valuation.
  • As a general (though imprecise) rule, the resultant Economic Upside Index calculates that the countries that fared best through the financial crisis – like Canada and Australia – now have the least economic upside awaiting them over the next five years, while those that suffered horribly have the potential to zoom forward.
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Economic Compass: Setting the Stage for Higher Wage

Eric Lascelles

  • After trudging through a cold winter, U.S. hiring is primed to accelerate across the remainder of the year.
  • Wage growth similarly shows promise of further gains, in part because there is less slack in the U.S. economy than commonly imagined.
  • The combination of these two forces could double spending growth over the next few years, providing an important economic boost (and a minor challenge for profit margins).
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Economic Compass: Deflation Doubtful

Eric Lascelles

  • Improving economic growth has narrowed the spectrum of downside risks, but not eliminated them altogether.
  • In particular, one fresh and intensifying risk comes from extremely low inflation in the developed world.
  • Gaping economic slack and declining commodity prices explain a significant part of the softness, but not all of it.
  • Supplementary justifications such as the effects of globalization, automation or an aging population are tempting, but ultimately unconvincing.
  • We suspect inflation has temporarily sunk below fair value, and present a series of short-term and long-term reasons why it should begin to revive.
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Economic Outlook

Eric Lascelles

Chief Economist
RBC Global Asset Management Inc.

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