Much of the business section in recent weeks and months has been devoted to columns questioning the sustainability of stock market index levels. The S&P/TSX Composite Index closed the second quarter at its highest level ever, up 25% year-over-year, with the value at the end of the fourth week of September 10% higher than at the beginning of the year.
Some explanations offered for the recent run-up include stronger oil prices, surging bank stocks and industrials, discounts in relation to U.S. stocks, improving economic growth and central bank commitments to hold interest rates low for an extended period of time.
While most financial industry analysts see this recent rally as being in its final days and recommend portfolio adjustments to gear up for disappointing market returns in the future, the prospect for a significant correction remains uncertain. Robert Shiller, the Nobel Prize-winning Yale economist, has compared today’s market valuations to peaks in 1929, 1999 and 2007. However, many believe that the market is in store for a series of minor corrections, to be followed up by more buying as perceived ‘value’ grows against a backdrop of improving economic fundamentals.
So why are stock market movements important for the condo market?
While new condo sales have followed the general path of many economic variables over the past 10 years with various degrees of correlation, their fairly close relationship to the stock market is worth paying at least some attention to.
Over the past five years in particular, new condo sales have shown a strengthening, albeit still moderate, correlation to stock market values with a one quarter lag. While this may seem counterintuitive as condo investing is often thought of as a substitute for financial investments, it can suggest that condo buyers use financial gains to invest in condos, or buy units because they feel wealthier thanks to their rising financial portfolio. The same relationship occurs on the downside, where buyers feel more cautious as financial values slide. Whatever the reasons, more research on this topic would be welcomed. (As a side note, condo sales have shown a lower correlation to REIT index values).
The chart below shows that when new condo sales volumes in the Toronto CMA and stock market growth pull away from each other, they tend to tend converge in subsequent quarters. Sales often overcompensate when catching up, which is shown to be followed by a more drastic change in course for the market (as seen in 2012-2013). Recently, new condo sales have been rebounding alongside the run-up in stock market values. However, sales remain well below their recent peak in 2011 while the stock market is reaching new highs.
The questions then become: will condo sales continue to benefit from the ‘catching up’ phenomenon previously observed and, if there is a stock market correction of any magnitude, what impact will there be on the new condo market? The problem with answering these questions is that our historical point of view is limited as the new condo market is still growing off a relatively small base from 10 years ago. While Urbanation has been tracking the market for over 30 years, there lacks a sufficient volume of activity within the time series to conduct a more proper statistical analysis.
Nonetheless, we can tell from recent trends that the stock market now appears to be one of many indicators to look at when assessing condo sales trends. Whether the stock market ‘treads water’ or experiences an outright rout, repercussions for the new condo market can be expected. This suggests that paying attention to financial industry analysts may be (almost) as important as paying attention to condo industry analysts.