Contributor C. Cheng Asks:
“What are your concerns regarding the housing bubble forming in Canada and it’s potentially adverse effects on BMO?”
Our Response:
The timeliness of this comment regarding Bank of Montreal (BMO) is critical. On June 7, 2012 (found here), we posted an Investment Observation on Bank of Montreal which was one of our leading considerations as an investment opportunity. Keep in mind that our interest in BMO came after a 14-month declining trend in the stock’s price.
At that time we said the following of BMO:
“We are reticent to recommend any kind of banking institution due to the many unexpected risks that occur outside of the purview of regulators and accountants. However, Bank of Montreal is a reasonable banking investment if bought at the right price. We believe that the right price begins at $51.80 and below.”
Unfortunately, BMO never fell below $51.80. In fact, the day that were did our write up on BMO it only fell below the $53.57 price on the five subsequent trading days immediately afterwards, with the lowest price being $52.15 on June 11, 2012.
At the moment, BMO’s stock price has retested the previous high set in November 2013.
If there is a concern that Canadian real estate is in a bubble then it would be wise to sell only the principal in BMO while leaving the profits to compound. This would eliminate the guesswork associated with determining if there is a bubble. The remaining funds would be allowed to compound at a 5.50% rate until BMO has sustain a similar decline in price from April 2011 to June 2012.
Our initial impression is that even if there is a bubble building in the Canadian real estate market, there may be a long way to go before it bursts. We have a couple reasons for this assessment. First, the tendency is for markets to forget the immediate past by issuing/reissuing similar hazardous/toxic products that inspired the last bubble in real estate. While CDOs and other related mortgage debt securities have come back, they aren’t as pervasive or risk-overreaching as they should be in order to destabilize the system, at least not yet.
Second, as a commodity rich nation, Canadian real estate is most at risk of a bubble collapse when there is a full blown commodity bust after a commodity AND real estate boom. However, considering that the current real estate surge has come while most commodities have declined in value suggests that there may be more room on the upside for real estate. Any full fledged reversal of the Dow Jones-UBS Commodity Index to the upside could inspire a supercharged bull market in Canadian real estate.
One way to think about the prospects for Canada is to consider what happened to Texas in the 1970’s and 1980’s. Cities like Houston and Dallas (in fact much of the state) had housing booms as skyrocketing oil prices led to escalating real estate prices. The collapse in oil was a wonder never to been seen since, resulting in the Savings and Loan Crisis and the Mexican Peso Crisis as outlined in our “Richard Russell Review: Letter 854” (found here).
We’ve addressed the prospect of an end to the commodity bear market in our October 29, 2013 article titled “Has the Dow Jones-UBS Commodity Index Reached the Low?” (found here).