Canadian economy on 'thin ice' in the new normal, report says

Macroeconomic analyst says investors need to look offshore or risk exposure to slow, weak economic recovery

Canadian economy on 'thin ice' in the new normal, report says

A report from an international macroeconomic research firm says that Canada’s economy is headed for a long, difficult period catalysed by the effects of COVID-19 and driven by structural weaknesses, especially in the housing market.

The report “Canada on thin ice as it heats up” by Macro Research Board (MRB) Partners paints a bleak picture. It says that Canada has followed global trends in falling into a ‘sudden stop’ recession with high unemployment and a plunge in activity. It says that Canada is more exposed than most economies, however, because of “an unstable real estate bubble and household credit binge.” MRB’s founding partner Phillip Colmar told WP that Canada is due for a deleveraging cycle after years of a consumer credit ‘binge’ with widespread ramifications for Canadian equity markets and Canadian investors.

“Canadians have been living beyond their means to have a lifestyle they cannot afford on their existing incomes,” Colmar says. “They borrowed from their children to bring forward purchases. This is unsustainable over the long run, as experienced in the late 2000s within the U.S. and euro area. The process of eventually fixing household balance sheets will mean that Canadians will need to repay this growth to their children by spending below their means for a prolonged period, a process that usually keeps economic growth subdued for a decade.”

The report says that Canada’s housing market and overall economy are heading towards a “day of reckoning,” when hits to employment and incomes will precipitate a housing market crash and, with it, a slow economic recovery. Colmar says that such a turn, which will include a prolonged deleveraging cycle, may weigh down Canadian equities, especially Canadian financials. In turn, Colmar says that the Canadian dollar may suffer from chronic weakness during any deleveraging cycle. He says that Canadian investors should look offshore to safeguard against the market fallout of a housing crash.

Colmar says that the safe play for Canadian investors looking for greater diversification has been in the United States. MRB Partners has, in the past, advocated a U.S. strategy. In the current moment, however, Colmar says that after a decade of U.S. dominance, price action is beginning to outstrip corporate earnings and, in the long term, he says there is likely to be a rotation away from U.S. equities.

Rather than a U.S. focus, Colmar now sees better prospects in emerging markets, particularly emerging Asia. He says that the solid handling of the COVID-19 outbreak bodes well for the region’s growth prospects. As well, they remain a cheap asset market for the time being.

Colmar sees opportunities in Europe, too, on the back of cheap equities. He’s been observing policy moves from the European Central Bank as well as the Union’s governments that could see a deepening of the EU that could help catalyse earnings.

Within Canada, Colmar says that investors should look towards Canadian exporters who are less reliant on the domestic economy and will actually benefit from a weakening Canadian dollar. He says, though, that fundamental weakness in the housing market and its ties to the broader Canadian economy makes Canada a tough investment case.

While Colmar accepts that a v-shaped economic recovery and the continuation of ‘bridge’ policy decisions like CERB and mortgage deferrals could stave off the worst of a crash, he does not think a rapid increase in employment is likely before the wider ramifications of income hits are felt. As well, he says the tax bill from the pandemic will mount higher and higher, with higher income earners a likely target.

Colmar sees one major opportunity for Canada’s bounceback, though, driven less by Canada’s own policy decisions and more by the hard pushes against globalization we’ve seen out of the U.S. and United Kingdom in recent years.

“[One] approach is to take advantage of the isolationist policies that the U.S. and U.K. (and others) are pursuing,” Colmar says. “Opening the borders to business professionals and providing temporary tax breaks for international businesses setting up operations in Canada could provide a boost to growth and employment as well as help the housing market grow into its imbalances. Canada is a G7 country with quality infrastructure and education that is underpopulated. And foreign leaders are offering a competitive advantage ‘gift’ to Canada by pursuing self-destructive isolationist policies in their own countries.”