Household wealth soared over the past couple of years, thanks largely to fiscal and monetary supports deployed in response to the pandemic — but that surge is now receding, signalling tougher times ahead for household finances, according to a new report from Desjardins Group.
As interest rates rise and the value of real estate and financial assets that have swelled over the past couple of years reverse those gains, the outlook for household wealth is “bleak” the report said.
With central banks hiking interest rates to combat inflation, the result is to “lower the value of risky assets, reduce household consumption by increasing debt servicing costs, and keep savings in the bank by offering comparatively better returns on fixed income products and traditional savings,” the report explained.
With equity valuations boosted by rock bottom rates, markets became highly valued – now that has started to unwind alongside rising rates and revised expectations.
“Even after the recent drop, risks to equity markets remain tilted to the downside,” the report said. “With the economy slowing down and the possibility of a recession increasing, corporate earnings could take a hit.”
Moreover, it warned that there could more downside for stocks, even if the economy holds up, as stocks remain relatively expensive.
“The S&P/TSX’s low average price-to-earnings ratio is quite misleading,” the report said. “If you take out the energy and materials sectors, both of which are generating substantial earnings at the moment, the average price-to-earnings ratio for Canadian stocks is still above the average seen in the last cycle.”
And, as returns on fixed-income assets rise alongside interest rates, “investors could continue to snub stocks with low dividends and low growth prospects,” the report said.
At the same time, rising rates are expected to chill real estate values too.
Nationally, Desjardins expects housing prices to drop by about 15% by the end of 2023, the report said. The largest declines are forecast in the Maritime provinces, Ontario, British Columbia and Quebec.
However, the report noted that housing prices aren’t expected to drop below their pre-pandemic levels in any region.
“As such, while the value of household real estate assets will decline, we don’t expect the bottom to fall out of the Canadian housing market,” it said.
The poor prospects for household wealth aside, the report said that income growth is expected to stay strong amid rising rates, which should underpin consumption.
“At the same time, the savings rate should gradually trend lower while still remaining elevated relative to pre-pandemic levels,” it said. Desjardins predicts the savings rate will remain above 4%, which “reflects relatively strong earnings growth, weaker demand for new consumer goods, and uncertainty about the Canadian economy.”
As savings decline and debt service costs rise however, some households will see their finances deteriorate, the report said.
And, while delinquencies are projected to rise as a result, “most Canadian households should weather this correction,” the report concluded.
Eventually, it sees more balanced conditions to return by the end of next year.
“With the Bank of Canada likely to begin cutting interest rates before the end of 2023, asset prices are ultimately expected to stabilize.”