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Global Economies 2015 – Once More Off-the-Cliff, Dear Friends…III-b (#38)


Canada is entering into its autumn of economic growth, and that seasonal change was brought on by the prolonged collapse of commodity prices, the significant slowdown in China, and the general weakness of the American Economy. On top of all that, the dramatic collapse in the global price of oil only hastened the oncoming change in the seasons for Canada. Endowed with abundant natural resources and being a primary exporting country, and heavily dependent on the U.S. (its primary trading partner), and on Europe’s and China’s economies, Canada is now being increasingly impacted internally, as exports continue to shrink due to the general global contraction.

After the 2008 crisis, Canada became the poster boy of economic well-being when most other advanced economies went into severe tailspins, from which some of them are still struggling to come out of. Canada during most of those years seemed to sail through relatively unscathed. Well, those good days are seemingly over as the global deflationary cycle catches even the strongest of economies, sweeping them into a deepening vortex of other sinking economies, in spite of the major Central Banks’ expanding stimulus programs, and shrinking interest rates. The weakening global growth rates along with strong and steady contraction of China have since 2011 depressed commodities demand from their previous super-cycle highs, negatively affecting Canada.

With the price of commodities collapsing, particularly oil, of which Canada is a major exporter, and with general demand muted in the U.S., its largest customer by far, and in the rest of the World, including China, Canada’s seemingly invincible economy is starting to show signs of increasing stress. Economic output has turned down sharply due to the growing weakness in commodities and manufacturing.

A lot of what Canada manufactures goes to the U.S. Of its total exports almost 79% is sold in the American market. The less than robust markets south of the border have sharply and negatively impacted Canada’s manufacturing activity this year.

With most sectors of the economy slowing this year, inflation rate has dropped to an almost uniform 1%. The long term average inflation rate of Canada has been well above 3%. As the economy tightens further and prices continue to soften worldwide, we expect the inflation rate to continue to drop.

Jobs growth, which had held fairly steady for most of the year, is starting to stall and unemployment rate is starting to climb as the ongoing slowdown starts to bite and companies start to shed jobs, particularly in the oil patch.

While Canada’s economy is heavily export dependent, internally Canadian consumers have been most helpful in keeping the economy humming, even post-2008 crisis, with nary a break in taking on debt. Meanwhile, the American counterparts have been deleveraging (See Chart below). The fact that Canadians are indebted as never before makes them particularly vulnerable in a serious downturn.

Canada’s hereto hot and famed real estate market has strongly and steadily contributed to job creation, with barely a dip post-2008, and it continues to show strength for now. But Canada’s housing market is considered one of the most expensive in the World, and by some too inflated, and overdue for a correction. We agree with that sentiment. Canada’s real estate market was buoyed by ultra low interest rates and foreign investment; capital that sought political safety and stability. Low interest rates may persist, but foreign capital flows may ease as wealth shrinks abroad. That and internal general economic tightening are setting up Canada’s real estate for a correction.

One of Canada’s hottest real estate markets starts to cool. We expect the rest to follow.

Business investment has been on a downward trajectory since the break in commodity prices, in 2011. And while Canada’s economy is well diversified, with a very strong service sector, the weakness in manufacturing and mining, coupled with external tightening, are contributing to the steady decline in overall business investment.

Canada is a major trading nation, with exports making up approximately 45% of its GDP, and almost 80% of its exports going to the United States. Still, Canada is a net importer, running a monthly trade deficit of approximately $3.0 Billion. Canada’s declining exports speak to the weakness in the U.S. and the global economies, and more lately, its declining imports speak to the growing weakness in Canada’s economy, and hence consumer spending.

Canada’s economy had an almost charmed life, along with Australia’s, post-2008 crisis, when compared to the other advanced economies and their struggles. Both countries benefited from the over-shoot of China and the other Emerging Markets (EM) after the crisis, and both are now feeling the downdraft of China’s and other EMs’ economic contraction.

Compared to most of the advanced economies, including the U.S. and the U.K., which have been posting positive growth in the past years, albeit modestly, Canada has not had to struggle mightily to maintain growth, and also did not have to take on a lot of debt to stimulate its economy, unlike the others whose Debt to GDP ratios are far higher than Canada’s. This bit of good fortune has stood Canada in good stead and its dollar has reflected it. But, this year with global conditions deteriorating further, the Bank of Canada preemptively (and surprisingly) lowered its key lending rate twice this year to try and forestall the slowdown, and lower the exchange rate of the Canadian dollar versus the U.S. dollar, which of course helps the exports, which are under increasing pressure.

Additionally, and perhaps even more startlingly, the Governor of the Bank of Canada, Stephen Poloz, during a recent speech, just happened to mention that the Bank of Canada would be willing to lower its key lending rate to below zero (negative rates) if Canada faced another crisis.

Now, he stressed that this was just a hypothetical situation he was addressing, and didn’t see it being at all necessary, but we think it is an important indicator of a possible eventuality. Heads of Central Banks are not prone to make careless off-the-cuff remarks about something that important, and possibly that negative. We think that in-spite of his customary reassurances as to the health of the Canadian economy, and its generally bright prospects for the coming year, Stephen Poloz just did another preemptive strike to prepare the business and financial community, about the possibility of another impending crisis. He assured the audience of the Bank’s preparations for it with its new and improved tool kit, that includes the possibility of taking interest rates negative. We don’t think we are reading too much into it when we say, it is the signs of the times for Canada.

Australia did relatively well after the 2008 crisis due to its proximity to Asia, which had the fastest growing economies, including China, India, Vietnam, Philippines, Malaysia, etc. Like Canada, Australia is a natural resource rich country with a well diversified advanced economy that has been resilient to global economic gyrations for the past decades. But, again like Canada, the accelerating external weaknesses in its major markets, particularly China, may now re-test that resilience. This year the pressure is starting to show in the initial down turn of its erstwhile and perennially upward climbing economic indicators.

The Chart on the following page shows the inherent strength and resilience of the Australian economy as an advanced economy, having an enviable record of not being in a recession for over 20 years. The current economic growth rate is still well in the positive territory, certainly on par with the U.S., U.K., and Canadian growth rates, but, at an annualized 2.5% growth rate (Reserve Bank of Australia) for 2015, it has certainly started to slow of late.

Externally, the danger to Australia comes from additional deterioration of its major export markets in Asia that by far represent the bulk of its exports. China’s sharp slump and Japan’s continued stagnation will weigh heavily on Australia’s growth possibilities. If conditions deteriorate further in China and the rest of Asia, Australia may find itself battling to keep the additional fall in exports from tipping its other internal industries, as revenues fall and ripple through the economy.

Evan though the average household disposable income has been declining since the 2008 recession, the trend downwards seems to be deepening.

Australia has had a red hot real estate market, very similar to Canada’s, that also has had predictions of an overdue major correction. But, like Canada’s, so far, it has defied the odds and has just kept on going. As in Canada, the warnings of the prices being too high are persistent.

But as the Chart below shows, loan approvals are still climbing in all categories, except in the ‘Investor’ category. The drop in the investor category could mean the banks are getting cautious about lending for speculative investment, and two, foreign investors, who were significant participants in Australia’s hot real estate, especially from China, may have retreated due to negative external and internal economic conditions, which would translate into less wealth for investment, and greater caution.

As conditions weaken in the economy, industrial production is reflecting that weakness in its dramatic drop this year.

The inflation rate has been on a downward trajectory since about mid 1970s, and is currently estimated by the Reserve Bank (RBA) to be at 1.5%. As a point of interest, Australia’s average rate of inflation is estimated at 5.16% from 1951 to 2015 (Australian Bureau of Statistics).

As we observe in the Chart below, since 2011 consumer confidence has been generally positive, albeit, the trend has been drifting downward. It would seem, the negative turn in the Australian economy and the various indicators that show it, are still not dramatic enough to cause the public any real worry. The consumer confidence rate shows a turn for the worse recently, but it is still higher than the drop in the month of September, and therefore may turn up again. The general sentiment in Australia seems to be still solidly optimistic, so far. But that will change quickly as the downturn accelerates.

Australia, with 58% of its economy being based on services, 9% on construction, 7% on manufacturing and only 7% on mining, is holding up fairly well up till now, although there are signs of stresses in various sectors and in the total output (GDP) numbers. The softening economy is resulting in generally lower prices (except in real estate in the large cities), but particularly in commodities, which is dropping the inflation rate far lower than the average long term level. The general consensus within the relevant authorities, however, is that economic conditions for Australia’s economy will be worse in the coming year. We agree.

We feel that Australia, very much like Canada, is particularly vulnerable to external economic deterioration, because of their relatively small populations and vast natural resources, which they export in large measure. Both countries are also home to the hottest housing markets (pardon the pun) that are generally considered to be overvalued, and overdue for a healthy correction. It will probably be an external event that will trigger such a correction, as internally the economies are still stable, and the interest rates are at all times lows. The overheated asset markets of the U.S., particularly the stock and bond markets, and or, the exceptionally over leveraged and swiftly deteriorating financial conditions within China, may provide such an event in the near future.

Of the three economies, the U.S., Canada and Australia, in our view, the U.S. economy is the more unstable of the three, and is the most vulnerable to an internal black swan event. Canada and Australia are more stable internally, but are vulnerable to external black swan events. Canada is most exposed to the instability of the U.S., and Australia to China’s continuing implosion.

To be continued…

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