Steve Eisman, a hedge fund manager famous for predicting the US housing market crash of 2008, as portrayed in the film The Big Short, is now placing a new bet against the Canadian market.
As a portfolio manager at US asset manager Neuberger Berman, Mr Eisman has joined a group of investors short selling Canadian banks with expectations that the stocks will be hit if the housing market falters.
Mr Eisman was part of a small group of investors that discovered how unstable, flawed and corrupt the US housing market was and successfully bet against it prior to the Global Financial Crisis.
He was the inspiration for the protagonist Mark Baum in the book The Big Short, later played by actor Steve Carrell in the 2015 film adaptation.
The movie details the events leading up to the GFC and how those that saw the writing on the wall before everyone else, were able to profit from it.
What is short selling?
Short selling, or shorting a stock, involves an investor borrowing shares of a company from an existing owner, usually through a brokerage, to sell at the current market price while predicting a downturn in the market.
The aim of the game is to wait until the stock falls then buy the shares back at the lowered price, returning the shares to the brokerage and pocketing the difference.
It is a strategy that investors have employed to still benefit from a falling market with the move really taking off during the 2009 GFC.
In Australia, the Australian Securities and Investments Commission (ASIC) temporarily banned short selling of the nation’s financial institutions in 2008.
Nowadays, covered short sales are permitted in Australia, but are subject to certain reporting and disclosure obligations.
At the start of last month, Macquarie research showed a $2 billion increase in the value of shorts against the big four banks, with investors hoping to make money from plummeting stock once the Hayne Royal Commission findings were announced.
However, this strategy backfired with the commission not impacting the big banks as harshly as predicted.
Eisman’s latest predictions
Following years of low interest rates and relaxed foreign ownership rules, policy makers in Canada tightened mortgage lending at the start of the year to slow a boom and as a result, new property prices have slipped for the first time in about a decade.
While Mr Eisman has sounded the alarm on the Canadian housing market, he is not expecting it to be as severe as the 2008 US market crash.
“This is not The Big Short: Canada – I’m not calling for a housing collapse,” he told reporters.
“I’m calling for a simple normalisation of credit that hasn’t happened in 20 years,” Mr Eisman said, adding that he believed Canadian lenders were not “mentally prepared”.
Mr Eisman has declined to name the banks he is targeting or the positions he has taken.
However, research from financial analytics firm S3 Partners has shown bets against Canadian banks have increased by 19% this year to positions worth US$12.3 billion (A$17.38 billion).
According to reports, Toronto-based TD Bank is the biggest target for short-sellers with bets against its stock rising 17% to US$3 billion since January.
Meanwhile, short positions in CIBC have increased 26% to US$2.3 billion and are up 37% to US$1.3 billion at the Bank of Montreal, S3 Partners said.
However, Bank of Montreal chief economist Doug Porter isn’t buying Mr Eisman’s claims that Canada’s housing market will threaten the country’s banks.
“While there are no doubt legitimate concerns about the outlook for Canada’s housing sector, we can readily point to three factors that could provide support,” he said in a note to clients last week.
Mr Porter said dropping bond yields, strong population growth and measures introduced in Canada’s newly announced federal budget could act as stimulants for the housing market.
“One of the reasons that housing demand looks so soft in some key markets is because Canadian policymakers have been applying a full-court press for the past two years to dampen activity,” he said.
“The surprise would have been if housing had not cooled,” Mr Porter added.
The UK and Brexit
Mr Eisman is also betting against two UK banks in anticipation that Britain falls out of the European Union without securing an exit deal.
Again, he hasn’t identified the banks that he is short selling but told media the bets made up 6% of his strategy and he has no other UK positions.
He has also been reported as saying that “nobody has a freaking clue” about the UK’s situation so it would be “foolhardy to take a large position either way”.
“Nobody can have a long-term view about the health of the UK economy if there’s a Brexit,” Mr Eisman told reporters.
“But I do know that the assumption of UK investors is that if there’s a Brexit, the UK will go into a recession,” he said.
According to media, Mr Eisman expected the UK to secure a deal with Brussels that the UK parliament would reject, resulting in the nation being forced out of the union without agreed-upon terms.
Mr Eisman has been a vocal market commentator since gaining recognition after the book and film’s releases.
In recent years, he has frequently warned about the health of European banks, especially in Italy, as well as Germany’s largest financial institution, Deutsche Bank.
Is Australia next?
With Australia’s economy beginning to slow and property prices recently plummeting, you might start to wonder if it will be next?
The economy only grew 0.2% during the December 2018 quarter, chopping the annual rate for the year down to just 2.3% (compared to the 4% annualised growth rate recorded earlier in 2018).
If you take out immigration from the equation, the country would technically be in a recession, with economic output per person actually decreasing 0.2% during the quarter instead of growing by the same percentage.
Meanwhile, data collated by property analytics firm CoreLogic for January 2019 shows Sydney property prices are now 12.3% lower than its peak in July 2017. Melbourne prices were also down 8.7% from its November 2017 peak.
In addition, LF Economics founder Lindsay David recently made quite a bearish prediction that prices in these capital cities would fall by 40% from their peak, potentially resulting in Australia’s worst real estate collapse since the 1890s depression.
Similarities with Canada
Like Canada, Australia recently tightened its conditions on foreign ownership of property, with a 50% limit introduced in the 2017-2018 Federal Budget. This mostly impacted China, the host of Australia’s largest source of international property investors.
According to government figures, foreign investment in residential property dropped 58% to $12.5 billion in the last financial year.
Meanwhile, the Reserve Bank is being pressured to cut interest rates, which have remained unchanged for more than 2.5 years now.
However, it is so far staying firm at the current level of 1.5%, citing continued strength in employment, rising business investment and higher public infrastructure spending.
While it is sounding a little too similar to Canada’s situation, other market analysts have compared Australia’s economy to Ireland prior to its own housing collapse in 2007.
Australia’s banks at risk
Reserve Bank figures have shown more than two third’s of Australia’s net household wealth is invested in real estate and 60% of all lending by Australian banks is in the property sector.
According to UK-based firm Absolute Strategy Research, the banks of Australia, Canada, as well as Sweden, pose a risk to the global financial system, with their combined value of global share markets being four times bigger than their share of global GDP.
Australia’s big four banks account for more than a quarter of the ASX200 index, which the firm warns is a “danger signal” in developed markets.
In addition, economist John Adams has argued that any sharp falls in property prices could lead to widespread job losses in construction, real estate and retail, consequently affecting consumer confidence, spending and Australians’ ability to service their mortgages.
“We could see a domestic property and household debt crash starting to spread throughout the Australian economy and adversely impact the solvency of Australia’s banks,” Mr Adams said.