After the 2007 crash, the US Federal Reserve created a “Exuberance Index” tool as an early bubble identifier. It is meant to help central banks and politicians act on bubbles early to reduce the size of a crash. When central banks reduce interest rates and engage in quantitative easing (printing of money), they tend to create or inflate bubbles in assets such as stocks and real estate. Those bubbles can pop when interest rates are moved up by central banks to counter inflation, triggering recessions, or when the psychology of buyers suddenly changes from one where it is assumed that real estate always goes up in value.
Canadian real estate buyers are getting more irrational according to the Q2 2021 exuberance index. The index indicates that Canada is well into a real estate bubble. Markets that become exuberant tend to eventually experience a correction. The longer the delay before the correction, the bigger the correction.
Exuberance Means Bubble
When a market exhibits exuberance over many quarters, the market is considered exuberant. An exuberant market, like Canada’s, is in a bubble.
The index provides two sets of numbers: a country’s index and a 95% critical value threshold. If a market is above the threshold during a quarter, it is an exuberant quarter. After five consecutive quarters of exuberance, a market is exuberant; i.e., in a bubble.
Canadian Real Estate is in a Bubble
For Q2 2021, Canada’s real estate market has more than double the threshold value of 1.37 needed to be considered an exuberant quarter. This is the sixth consecutive quarter, so Canada is an exuberant market. In other words, Canada’s real estate is in a bubble.