The Canadian economy recovered much quicker than other developed countries in the world, specifically European countries and the US primarily due to…
- Effective tax cuts
- Government stimulus program
- Healthy financial industry
- Resource based economy that is satisfying the needs of the US, China and other growth economies
- Federal government changing mortgage rules directing the Canadian Mortgage Housing Corp the key backstop for mortgages in the country
- Increased securitization of mortgages held by Canadian banks through National Housing Association Mortgage Backed Securities – taking risk off banks and keeping the real estate market vibrant
But times have changed as with the commodity bust and sky high consumer debt levels at over 165% debt to income, problems will escalate. We will see many energy and mining companies go bankrupt, causing stress at the Canadian banks. The economy is resting on a very strong real estate market, but on the surface, the market looks like a classic bubble. It has been driven by low interest rates and foreign buyers. Once these buyers pull back in an international recession, real estate should start its descent.
Recessions result in such realities as lower GDP, higher unemployment and falling corporate profits. So the question is ‘is the US and Canada moving into a recession’? Most economists say not but they are famous for being wrong, and generally on the too optimistic side. Some believe that a depression is inevitable. We watch many indicators and a number are scary. This does not mean a depression is inevitable but with historical highs in all levels of debt, derivatives outstanding, energy and commodity price depression and increased tensions worldwide – the risks are extremely high
So let’s have a look at the growth component of both the US and Canada to see how things are trending. We look at the US as well, as 75% of exports go south of the border, so their health is Canada’s health. First the US as they have the greatest impact on the world, and especially Canada:
US Real GDP growth rate came out this morning and was in line with expectations but expectations were very low. The Q4 2015 annualized rate is 0.7%. The US has show resilience over the last number of years but the driving force has been quantitative easing programs by the Federal Reserve and massive build up by government, households and corporations. The Central Bank stimulus ended in October 2014 and they are actually on the other side of the table now, as stimulus is done and interest rates are rising. There has been only one .25% rise so far but they do say that they expect a number of potential increases this year. We will be surprised to see any more, possibly one, as the US economy is slowing…quickly.
As you can see from the chart above, each decade has seen slower growth. There has been much volatility throughout history but the upper limits were higher in the 50’s than the ‘60’s which in turn was higher than the 70’s etc. Think you get the message. What is important is the current trend and as you can see from the chart it went from weak to down.
Growth leads profits, so clearly there is a reason that revenues and earnings have been falling steadily throughout 2015 to current.
Here is a chart that assesses actual growth (blue bars) from forecast growth (rust lines):
Two interesting things to note here:
More than not, forecast have been higher than actual. Analysts/economists have generally been more optimistic than they should have been
The current trend is falling and falling fairly hard. The most recent data as we noted is up only 0.7% which is a stead decline from the cyclical peak of 4% in mid 2014. It has been a steady line down since – not a chart for an optimist.
Now let’s have a quick look at Canadian GDP:
Canadian growth, like the US, has been weak and in reality, weaker than US numbers. It has either been flat or down since mid 2014. Retail sales struggle which is a huge component of GDP growth as you can see from the next chart:
If you average out the ups and downs over the last year, you are up only 0.1% – an environment of no growth from a retail perspective. Are Canadians tapped out as they have built up record debt – maybe, as Canadians are currently at the highest debt to income ratio in history. Not a good place to be with a slowing economy that looks at serious risk of entering into a recession. If spending is slow now, how will it be when a recession hits and more jobs are lost – easy answer is ‘much worse’.
One other important area to look at is Canadian wholesale trade as it may try to pick up the slack for lack of retail sales:
Unfortunately, this is not the case and this is just another sector that has been in a fairly steady downtrend since mid 2014. It did see a blip up in Nov 2015 but one month does not make a trend. We will need to see future months continued improvement and we do not see that.
In Canada, the construction sector has been the savior since 2009. But that movement appears to have stalled or even reversed. One of the key gauges in building permits issued and here is some facts on this:
Latest release in January 2016, permits were down 19.6%, dramatically weaker than anticipated and one of the worst months over the last 10 years
Four of the last five months have been down…an ugly trend
Over the last year, there have been 7 down months and only 5 positive months for permits issued.
Bottom line is that retail sales, wholesale trade and construction appear to have peaked and are falling. Clearly the energy and commodity sector are in disarray as we have been warning investors about for years. Contraction, bankruptcies and job losses will continue to be the aftermath of the commodity boom and it will be very difficult in Canada.
In the end, one of the keys to company profit growth is economic growth. In North America, the trend is going the wrong way and risks keep increasing by the month. We anticipate both the US and Canada to be in a recession at some point in 2016. If policy makers don’t get it right or some major external factor from another area of the world is triggered, like a European banking crisis, China hard landing, Emerging market crisis, a government going bankrupt etc., then the risk is much deeper than recession. Depression is still a strong possibility given we have never cleansed the excesses from the last growth cycle. Let’s hope that many of the potential messes are averted and we just go through a cyclical recession but we are not hopeful based on realities today….
Canada | USA | Europe | China | Japan | Emerging Markets