Need a last-minute holiday gift for that hard-to-buy-for relative, friend or coworker? Go retro that will tie them in knots. Amazon.com has it for $33.99 and it arrives before Christmas. Of course we’re talking about Stretch Armstrong, product of the brain trust of Jeep (James) Kuhn and Jesse Horowitz! Introduced by Kenner in 1976, it was Kuhn’s chemical engineering background that helped him dream up a liquid sugar that was the key ingredient in Stretch’s stretchiness. As the story goes, tremendous quantities of Karo corn syrup were purchased from an A&P supermarket and boiled down to get the proper viscosity. Kuhn and Horowitz then flew to Kenner’s headquarters in Cincinnati, Ohio, and presented the concept to the toymaker’s president, Bernie Loomis, who was riveted. A toy icon was born. Stretch Armstrong’s most notable feature is that he can be lengthened from his normal size of about fifteen inches to between four and five feet. Stretch’s fame even extended to the big screen with his cameo in 2013’s The Secret Life of Walter Mitty.
All this talk of being overextended has us thinking about North American household balance sheets. While U.S. households are nearly 25% more indebted than they were in 1990, they don’t hold a candle to their counterparts north of the border. After two decades of leveraging in the 1990s and 2000s, the aggregate debt burden for Canadians (red line) crossed over that of Americans (blue line) in 2010 and has since maintained the ‘advantage.’ On the heels of the painful balance sheet recession that ended in 2009, a decade of ultra-low interest rates and ultra-tight lending standards spurred a deep deleveraging. Canada went the opposite way. Households’ debt-to-GDP ratio pierced 100% in 2015 and remains there today.
A balance sheet recession is a clear and present danger for the Canadian economy. The interest rate shock to the dynamic has amplified the risk to the Canadian consumer sector. The quarterly change in interest paid by households (purple line), which normally runs below sequential growth in disposable income (orange line), galloped past it in 2022’s third quarter. In turn, the interest paid to disposable income ratio spiked from 6.7% in the second quarter to 7.7% (green line). Sharp rises in the ratio are late-cycle and usually develop over a period measured in years. The 1% sequential jump last quarter was unprecedented.
QI friend, Toronto-based David Rosenberg, echoes our concerns about the “extreme level” of indebtedness in his home country: “Consumers are shelling out more in total debt-service payments out of after-tax income today at a 4.25% Bank of Canada (BoC) policy rate than they were three decades ago when the policy rate was 13%.”
And then there’s the structure of the Canadian mortgage market. It is, by far, the biggest threat to what some consider to be the world’s most inflated housing bubble. Mortgages are only fixed for the first two to five years. At reset, borrowers must take out new loans based on the principal outstanding leaving borrowers susceptible to payment shocks. Looking ahead, Fitch Ratings expects mortgage rates of 6.5% to rise to 7.25% next year, before retreating to 6% in 2024. Per the BoC, the distress is already being felt as roughly half of all variable-rate mortgage rate holders, 13% of mortgages, have already experienced a reset. Those who bought in 2021, when variable rates were 1.5%, saw payments spike by 20%.
Canadian small businesses are also suffering the shock. In November, a record 36% of surveyed proprietors bemoaned onerous interest expenses, up 20 percentage points from November 2021’s 16%. In a vacuum, the current number may not appear large, but when applying our favorite normalizer, it translates to a +4.1 z-score. Very large, indeed.
Interest rate shock stretching from household balance sheets to small businesses makes sense — owners are consumers and consumers are owners. That brings us to peak in Canadian Retail Sales, which occurred in nominal terms this past summer. While a bumpy ride, October’s level stood 1.1% below that of June. While October matched the consensus forecast, most of the gain was driven by prices of gasoline and food and beverages. Statistics Canada noted that real sales were unchanged on the month. Adding the usual disclaimers that the sample was small (42% response rate) and prone to revision, the agency also released an unofficial figure of -0.5% for advance November nominal sales.
The deterioration in small business expectations for the Canadian retail sector from the Canadian Federation of Independent Business (CFIB) validates the move. The short-run (3-month forward, light blue line) and long-run metrics (12-month forward, pink line) have fallen to levels concomitant with Canada’s 2008-2009 recession (not illustrated) and 2020’s COVID flash recession (illustrated).
This month, 65% of Canadian economists surveyed by Bloomberg predict recession, up from 45% in November. The turn in the labor market would up the probability further. As was the case with Retail Sales, the number of unemployed stopped falling in June (blue line). In addition, the Nanos consumer confidence report reported a May trough for negative responses on job security (somewhat not secure plus not secure at all, yellow line). Uncertainty about job security also has picked up from August’s interim low of 20.2% to 25.1% thus far in December (red line). It’s safe to say that a loss of income coupled with a mortgage reset would be enough to break already-stretched Canadian households.