Canada is rolling over.  It broke through its near term lows and appears to be making one of those head and shoulders top chart pattern thingies. 

The internals on the TSE are awful.  There have been 26 trading days since the first of the tops on May 20.  There have been only five days when the number of advancing issues outpaced decliners.  There have been 12 up days, but seven of those days had more losers than winners, including yesterday.  Over the past 26 trading days, the ratio of advancing stocks to declining stocks has been 0.87.

And as you can see, there has been negative divergence, with lower highs for MACD during the second and third tops. 

The graph looks worse when looking at the MSCI Canada index, as the May 20 high failed to break the January 21 high, and has been in a downtrend since. 

Energy stocks make up a third of the Toronto Stock Exchange index, materials 20% while financial companies are 25% of the index.  If commodities are topping out, then the TSE is going to get crushed.  I have no idea if it is a top, but we have to at least start looking for one, given that energy is hitting all-time inflation-adjusted highs. 

It is my opinion that oil has moved too far, too fast, and is now in bubble territory.  I have no idea if oil is topping, but the move feels reminiscent of the final move in technology during the 1999-2000 bubble.  However, one could have said it felt bubbly and toppy for the Naz at the end of 1999 when the Naz was at 4000, only to see the index move another 1000 points before topping at 5132. So maybe oil is going to $200 a barrel before it cracks.

A top in commodities will whack the Canadian banks, which account for 15% of the market’s capitalization.  Canadian chartered banks have both commercial and investment banking businesses. With the Canadian economy so reliant on natural resources, a significant decline will effect lending and demand for capital, which will hit the bottom line of the banks.

Home prices have gone through the roof in Canada, particularly out west.  For example, a nice home in Calgary could be had for $250,000-$300,000 five years ago.  Now, that home is somewhere around $500,000-$600,000.  And as we noted not long ago, home prices in Saskatoon have doubled over the past two years, making it more expensive to buy a home in Saskatoon than in Miami. 

Winter in Saskatoon

Winter in Miami

Canadian banks hold mortgages on the homes that have rapidly ascended in price.  When home prices reverse – and they will eventually – the banks are going to be holding a lot of paper on homes worth less than the value of the mortgage.

Royal Bank of Canada

People in Canada tell me that because there is no subprime market in Canada, home prices will not fall as hard as they have in America.  However, from 1989 through 1995 (or thereabouts), the average home price in Toronto fell from $300,000 to $220,000, and from 1994 through 1997, the average home price on the west side of Vancouver fell from $770,000 to $550,000. Yet subprime lending was not the cause of those housing corrections.

I am not necessarily calling for the top in the Canadian market but I do think we are at the top of a trading range.  Since last July, the TSE has experienced two declines of 10% and two declines of 15%, all lasting a month or less.  I expect such a decline over the next few weeks.

A 10% decline from the top would put the TSX Composite Index at 13500, or about 6% lower from here. A 15% decline would have Toronto bottoming around 12800, representing a 9% loss from these levels. 

I am short Canada through my ownership of the Horizons BetaPro S&P/TSX 60 Bear Plus Fund, ticker HXD.TO. A 10% correction would put the HXD around $19, a 15% correction around $21.