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Notoriously indebted Canadian households are finally addressing their financial health, but while this is a positive for the economy’s long-term outlook, it will not be without economic pain that is already visible in cratering auto-sales data.

The clearest sign of improvement in domestic household balance sheets is the significant change in trend for the ratio of debt to disposable income. Until recently, the postfinancial crisis time period has seen Canadian consumer debt rise considerably faster than income. Between March, 2009, and December, 2016, household debt went from 150 per cent of disposable income to 172 per cent.

The first chart below compares the year-over-year change in debt to disposable income, in blue, with the annual change in domestic home prices, represented in purple. A sharp jump in the growth of debt relative to disposable income – and subsequently a rapid deterioration in household financial health – is apparent from June, 2014, to December, 2016.

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Canadians, however, appear to have started addressing their debt situation as 2017 began. The steep drop in the blue line indicates that the pace of debt accumulation slowed dramatically relative to income growth.

It is likely not coincidental that the pace of housing-value appreciation began to drop six months later. As it stands, the annual rate of change in debt to disposable income has been negative since the beginning of this year – income is now growing faster than debt for the first time in over a decade.

The second chart shows that Canadian retail spending and overall gross domestic product growth are also slowing along with the improvement in debt to disposable income ratios. There is nothing dire in recent results, but it’s still notable that annual retail spending growth slowed from 7.3 per cent to 3.7 per cent in the first six months of 2018. GDP growth dropped from 4.1 per cent to 2.4 per cent in the same time frame.

The trend in which household-debt deleveraging crimps growth in real estate prices, consumption and gross domestic product growth could continue for a long time. Despite recent improvement, the debt to disposable income ratio remains elevated at 171 per cent, well above the 20-year average of 142.4 per cent. National growth is likely to disappoint as long as the household debt situation is being addressed.

National vehicle-sales results present what is likely the most obvious evidence that the consumer deleveraging process is already biting the economy. The year-over-year change in vehicle sales is admittedly a volatile data series but even with that said, auto sales appear to have fallen off a cliff. May of 2017 marked an 11.3-per-cent jump versus the year prior but September, 2018, vehicle sales came in 7.4 per cent lower.

The Canadian economy is a modern, services-oriented operation and will remain sensitive to changes in consumer spending. There are, however, other factors like rising oil prices and potentially higher exports to the United States, now that a trade deal has finally been struck, that could offset the damage lower consumer spending does to the overall economy.

That caveat aside, Canadians should not underestimate the potential negative effects of debt deleveraging on their portfolios or businesses. After a decade of debt-fuelled growth, the party may be over and the financial hangover just getting started.

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Scott Barlow, Globe Investor’s in-house market strategist, writes exclusively for our subscribers at Inside the Market.

paying down debt:

a double-edged sword

Canada debt/disposable income ratio YoY % chg.

Teranet NB Composite 11 Housing

Price Index YoY % chg. (rhs)

6%

20%

5

15

4

10

3

5

2

0

1

-5

0

-1

-10

2009

2011

2013

2015

2017

Canada debt/disposable income ratio YoY % chg

Canada retail sales YoY % chg. (rhs)

Canada GDP YoY % chg. (rhs)

6%

10%

8

5

6

4

4

3

2

0

2

-2

1

-4

0

-6

-1

-8

2009

2011

2013

2015

2017

Canada domestic auto sales YoY % chg.

20%

15

10

5

0

-5

-10

2013

2014

2015

2016

2017

2018

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: scott barlow; bloomberg

paying down debt: a double-edged sword

Canada debt/disposable income ratio YoY % chg.

Teranet NB Composite 11 Housing

Price Index YoY % chg. (rhs)

6%

20%

5

15

4

10

3

5

2

0

1

-5

0

-1

-10

2009

2011

2013

2015

2017

Canada debt/disposable income ratio YoY % chg

Canada retail sales YoY % chg. (rhs)

Canada GDP YoY % chg. (rhs)

6%

10%

8

5

6

4

4

3

2

0

2

-2

1

-4

0

-6

-1

-8

2009

2011

2013

2015

2017

Canada domestic auto sales YoY % chg.

20%

15

10

5

0

-5

-10

2013

2014

2015

2016

2017

2018

JOHN SOPINSKI/THE GLOBE AND MAIL

SOURCE: scott barlow; bloomberg

paying down debt: a double-edged sword

6%

20%

Canada debt/disposable income

ratio YoY % chg.

5

15

Teranet NB Composite 11 Housing

Price Index YoY % chg. (rhs)

4

10

3

5

2

0

1

-5

0

-1

-10

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Canada retail sales YoY % chg. (rhs)

Canada debt/disposable

income ratio YoY % chg

Canada GDP YoY % chg. (rhs)

6%

10%

8

5

6

4

4

3

2

0

2

-2

1

-4

0

-6

-1

-8

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Canada domestic auto sales YoY % chg.

20%

15

10

5

0

-5

-10

2013

2014

2015

2016

2017

2018

JOHN SOPINSKI/THE GLOBE AND MAIL, SOURCE: scott barlow; bloomberg

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