The Man Who Shorted Canada on why his view hasn’t changed

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The Man Who Shorted Canada is as pessimistic as ever about the country's prospects.

In fact, Vijai Mohan foresees a downturn for this country that could rival the early 1990s recession in its severity.

In April, 2013, his San Francisco-based hedge fund, Hyphen Partners LP, had made a big bet against the Canadian economy, amassing short positions against bank shares and the loonie, betting their value would fall sharply. At the time, he was an outlier, although others joined the "Sell Canada" bandwagon.

Now, with oil prices and bank shares in a downdraft, the economy potentially in recession and global stock markets doing the funky chicken led by China, Mr. Mohan's view hasn't changed.

If anything, his outlook is darker. "I'm more convinced this is the beginning rather than the end" of bad news for the Canadian economy, he warned . "You could be set up for a very nasty downturn" akin to the early nineties recession.

The Canadian dollar has certainly traded down sharply since we first spoke with Mr. Mohan – to about 75 cents (U.S.), from 90 cents – but housing prices have continued to rise and most Canadian banks are trading at higher levels than they were 20 months ago, even after a sharp sell-off over the past year. He may eventually be right on all three counts but some would argue that being right too early is equivalent to not being right at all. Still, many of the data Mr. Mohan uses for his analysis remain troubling when presented in aggregate.

Canadian consumer debt remains uncomfortably elevated with housing prices much higher and affordability much lower than the 35-year trend; household debt as a share of gross domestic product has risen faster than that of any other developed country since 2006, and Mr. Mohan argues the Canadian economy is much more leveraged to housing than the United States was in 2006, prior to the subprime mortgage meltdown that triggered the global financial crisis. Real estate, he points out, accounts for 7.1 per cent of Canadian GDP, its highest level since before the early 1990s recession. "Housing is getting more and more unaffordable."

Mr. Mohan and others have questioned some practices and lax standards in the Canadian alternative mortgage-writing market, and he received some validation when Canadian lender Home Capital Group last month disclosed it had suspended its relationship with 45 mortgage brokers for allegedly committing fraud on mortgage applications. The company's stock has lost more than 40 per cent of its value since the beginning of July.

Meanwhile, the stock of unsold housing inventory has risen sharply in the past five years. Mr. Mohan says Canadian borrowing rates are closely correlated to U.S. rates, and if the U.S. Federal Reserve Board begins to increase rates as it has signalled, borrowers will likely feel a similar squeeze here.

How a housing downturn would affect Canadian banks is not a massive cause for concern for most analysts, who argue the big lenders are generally prudent and largely shielded because Canada Mortgage and Housing Corp. insures most Canadian mortgages. Still, a sharp rise in loan losses and a reduction in profits would no doubt weigh on bank shares.

While Conservative Leader Stephen Harper has been boasting on the election campaign trail about Canada's economic record since the Great Recession starting in 2008, the recent drop in oil prices has taken its toll here: GDP growth has dipped below that of the United States and there are signs Canada may have been in a technical recession this year.

As the Fed prepares to raise rates, the Bank of Canada has cut them – putting the country in the company of Uzbekistan, Romania, Turkey, Pakistan, India and Russia. Mr. Mohan maintains the resources boom has kept Canadian unemployment from rising for years. "The economy is dangerously unbalanced," he said. "If the two key legs of energy and housing go the wrong way, you have dire consequences."

The biggest threat could be a spreading emerging-markets crisis triggered by China's woes, which could include a downgrade of Brazil's credit rating to "junk" status. Granted, Mr. Mohan has been warning of an emerging-markets crisis for well over two years, and admits "it has played out slower than I thought."

He is less concerned with gyrating stock prices and more focused on the $2-trillion-plus (U.S.) that bond investors have poured into emerging-markets debt over the past decade. If bond investors start to pull out en masse – as has happened in past emerging-markets crises – it would lead to "a considerable increase in distress" with knock-on effects for Canada. Mr. Mohan foresees a further tumble in oil prices, to $20 a barrel, forcing the Bank of Canada to cut rates even further and send the loonie tumbling, even below 60 cents.

The San Francisco hedge fund manager who shorted Canada remains on the extreme end of the prediction scale with a view that would translate into a lot of pain for Canadians were it to come to fruition. But if Michael Lewis's book about the lead-up to the U.S. subprime mortgage crisis, The Big Short, taught us anything, calling for the sky to fall may make investment professionals outliers, but when their predictions come true, it usually means a downpour of dollars for them.