Last month, I explained how some economists are predicting a Canadian home price correction based on a combination of math, a relationship between average price and income, and a belief system. Having already delved into the first two, let’s now consider the belief system.
It starts with Wall Street legend Bob Ferrell’s “Ten Market Rules to Remember”, the first of which is that markets tend to return to the mean [a.k.a. average] over time.
It’s crucial to remember that his rules apply to stock markets. As every REALTOR® knows, there are some very fundamental differences between the stock market and housing markets. Differences between the two markets relate to how share equities are small fractional and relatively lower-priced claims on an asset, whereas homes are singular, high-valued assets with specific geographical locations. These differences are overlooked by economists who assert that a sharp price correction is how the average home price-to-income ratio will return to its long term average.
Speaking of which, the ratio of average price-to-income will undoubtedly return to its long-term average. At issue is how it will get there. Evidence shows that the ratio has already started returning to its long-term average since having peaked in the second quarter of 2011. Since then, the national average price has climbed by less than five per cent while after-tax income has risen by nine per cent.
Although the ratio is above its long-term average, it will continue to return to it in the absence of a price correction as long as incomes grow faster than average prices. CREA’s average price forecast suggests that this will indeed be the case.
In a nutshell: predictions of a Canadian home price correction overlook fundamental differences between share equities and homes, and their respective market dynamics. For that reason, I consider such predictions to be the product of a marriage between math and bad religion.