I don’t know where the people, the government, and businesses got the idea that housing prices can’t go down. It seems to be pretty much the dedicated object of government policy, to keep housing inflated. Tax dollars from the upcoming federal budget, Bank of Canada interest rate policies, and personal interests are all aimed at keeping what is generally regarded as an over-inflated housing sector at sky-high levels. So much for a free market.
The good news for savers and would-be home buyers is, though, that historically low interest rates and the asset inflation they produce are usually followed by sharp price declines when these assets begin to deflate. If you are an investor who is actively cautious about debt levels, you must make sure that you avoid investments that will likely be hit hard if prices come down fast.
It would be nice to be able to short the Canadian Mortgage and Housing Corporation (CMHC) since it does insure the majority of Canadian mortgages. Unfortunately, that entity is funded with your tax dollars. Unless you are willing to move out of the country and declare non-residency until after a housing collapse, your hard-earned dollars are going to be put to work insuring bad mortgages (and now for funding over-priced houses for new home buyers) until there is some sort of government policy change.
You can make a choice to stay away from private insurers, though. At the top of the list are the private mortgage insurers and lenders like Genworth MI Canada (TSX:MIC) and Home Capital Group (TSX:HCG). These companies fully benefit from housing and mortgage growth, especially in the larger, more expensive centres such as Toronto and Vancouver. As a result, their share prices will likely be impacted heavily if housing prices in those regions come off significantly.
It can be tempting to buy these stocks, since their fundamentals are quite good at the moment. Genworth is trading at a very attractive eight times earnings and Home Capital is not far behind under 10 times earnings. While Home Capital does not pay a dividend at the moment thanks to its own crisis in 2017, Genworth pays a 5% dividend at current prices that might be tempting for some income investors.
But even in the quarterly results, there are some warning signs that should not be ignored. Total premiums written were down 4% over 2017, and net income was down 14% year over year. As a lender, Home Capital fared somewhat better with its 2018 mortgage originations up 15.2% and net income up substantially over the previous year. But you have to remember that 2018 is being compared to Home Capital’s disastrous 2017 year, so the report should be taken with a grain of salt.
These are not bad companies. They simply operate in a commodity business, where the commodities are home prices and interest rates. This is similar to the oil and gas industry. A few years ago, when oil was over $100 a barrel, few people thought it was going to go down. But when it did, well, you saw what happened to practically every oil- and gas-related stock. It was devastating.
Right now, mortgage rates are still close to record lows and housing prices are at inflated levels worldwide. While this does not mean there will be a housing collapse, there is definitely more downside risk than there is upside potential for either of these factors. And if these turn significantly, there will most likely be a reckoning, and the insurers will likely suffer.
If you fear a downturn in housing, do not buy either of these companies. Look no further than what happened to Home Capital in 2017 to get an idea of how quickly the fate of housing-exposed companies can change. After a housing collapse, Genworth might be worth a look, as it is a strong business, but not right now. Don’t expose yourself too heavily to housing, and that includes these lenders and insurers. The fact that the government feels it has to support it should be reason enough for caution on its own. It’s a brittle market that is not worth the risk.
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Fool contributor Kris Knutson has no position in any of the stocks mentioned.