Irrational exuberance II

The North American stock markets continue to defy gravity, ignoring dire predictions that a Donald Trump victory would bring a catastrophic decline. Despite this new found optimism, warning signs are everywhere.

Share valuations are reaching new highs based on expectations for American personal and corporate tax cuts, heavy infrastructure spending and an uptick in growth.  However, stock valuations are in the high end of a typical trading range and are priced for perfection. How much longer can they defy gravity?

Interest rates have been extremely accommodative since the 2008 financial crisis. This has subsequently penalized savers, encouraged a “risk-on” approach to portfolio construction and allowed for unprecedented levels of debt.  Currently, Canadians have very high debt-to-income levels.  Therefore, any significant increase in interest rates will threaten Canadians’ ability to prosper.

Housing markets in Canada remain particularly susceptible to a downturn. It is axiomatic that Canadians feeling of wealth is very tied to home prices. Likewise, low interest rates have fueled the appetite for home ownership. Share price gains in the metro Toronto and Vancouver regions have been fueled by foreign buying, and attractive mortgage rates. Many estimates have house prices overvalued by as much as 20 to 30%.   Therefore, a price decline coupled with interest rate increases would threaten Canadians’ financial stability.

President elect Trump’s protectionist stance threatens current trade relations with both Canada and Mexico.  In Britain, the Brexit vote threatens EU trade relations with Britain, one of its biggest trading partners.  These and other potential barriers to trade will threaten economies globally.

Both Canada and the U.S. offer fiscal stimulus as economic salvation. New bridges, highways and public transportation will ease the movement and flow of goods, yet will not necessarily provide a significant uptick in GDP. In any event, how much can a program of economic stimulus provide a boost in the face of ever-rising government deficits and ultra-low interest rates?

China has been seen as a global economic engine. Yet despite Central Party control there is growing social unrest, with over-leveraged housing and stock markets threatening economic stability. India, which is also looked to hopefully, remains mired in a strangling bureaucracy and corruption. Global growth may not be what we would hope or expect from these economies.

We may well see a continued upward trajectory in markets for a while, but there are too many road signs warning of dangers ahead for us to ignore.


Bruce Whitestone