THE FORT McMURRAY EFFECT
Fire shows economy not so fragile
In some ways, the impact of the fires ravaging Fort McMurray demonstrates the fragility of Canada’s economy.
For a time, at least, it seemed that all those oil operations coming off-line might have tipped us into zero or even negative growth for the quarter.
Even now, when there’s a better and more moderate handle on the extent of the damage, and oilsands operations seem poised to restart more quickly than feared, it looks like a thing as simple (but devastating) as a wildfire might shave nearly a percentage point off the second quarter’s annualized GDP growth rate.
The Fort McMurray effect underscores the susceptibility of our economy to risks. Of course, nobody sees an out-of-control forest fire coming. But there are plenty of other risks that we hear about every day in a steady drumbeat of fear: China slowing down, maybe crashing; the flood of easy money from central banks; oil over-supply and price volatility; low productivity, declining corporate earnings; the ever-present threat of another recession.
And yet, despite all those risks, things are not really so bad, are they?
For investors, the past few months have been downright calming. Oil prices seem to have found a plateau at above US$40 — hardly high enough to jumpstart the industry, but far better than US$25. The S&P/TSX has returned double-digits over the past three months, though it’s nearly 10 per cent down over the past year. Still, no crash.
China, meanwhile, might be stabilizing as well, and the “hard landing ” many feared hasn’t really come to pass. The most recent official government estimate for first-quarter growth in China is 6.7 per cent. True, that’s a long way off from average growth of nearly 10 per cent since 1989, and we might never see the outrageous expansion (and commodities demand) that defined China in the 1990s. But look at it this way: even at 6.7 per cent annual growth, the country’s economy will double in size in a little more than a decade.
In the United States, the feared impact of the Federal Reserve’s tightening hasn’t come to pass, either. Fed chair Janet Yellen has been downright dovish lately, citing all the risks out there; the U.S. dollar has weakened, taking pressure off emerging markets, which had been battered late last year, and high-yield debt, which has rebounded over the past few months after crashing in December.
In short, many of the worstcase scenarios we’ve been hearing about for the past few months have not come to pass. So why is there so much noise about the bad news?
In part, it’s a matter of perspective. If we were running at four or five per cent GDP growth, as Canada was in the late ‘90s, then exogenous shocks like the late-2014 crash in oil prices, or a wildfire in the oilsands, might not have plunged us into recession. But when GDP is barely beating one per cent — well, that’s a different story. It doesn’t take much to tip the balance to the negative.
That also means, however, that the real impact of a tip of that balance may be more muted. Does anyone remember the recession of 2015?
Technically, Canada had two successive quarters of negative growth. But it was a mild recession by any standard — jobs continued to grow, for one thing. And we were soon back to the steady, boring pace of low but positive growth.
Bank of Canada governor Stephen Poloz once called that low growth a “serial disappointment.” Yet for better or for worse, that is the world we live in, despite the best efforts of central bankers, and latterly the Canadian government, to kick-start their respective economies. For investors, despite all the attention paid to shocks to the system, this may be the one salient fact of life, for the foreseeable future at least. And they might need to start thinking differently.
One area to recalibrate: expected returns. Historical averages in the Canadian market are somewhere around 8.5 per cent, but Canadian stocks are poised to come in well below that over the long term if economic growth continues in the low single digits. With growth low in much of the developed world, the same may well apply for ex-Canada stocks too.
No doubt, this is a challenge for investors who have been brought up on higher expectations. If they’re investing for retirement, they may have to save more, or plan to make do with less. They’ll have to pay more attention to transaction fees and management expense ratios. And investment bankers might have to live with lower bonuses.
But hey, worse things could happen. If we are indeed settling into a band of steady, unspectacular economic growth and market returns, then there’s an upside, too.
For one thing, inflation will likely be kept in check, so even with low returns you should still be better off every year. For another, you might not have to worry as much that your wealth will evaporate tomorrow, like it might have in 1987 (Black Monday), 2000 (the dot-com collapse), or 2008 (Lehman Bros. collapses).
You’ve no doubt heard the mantra of “no risk, no reward.” We usually think of it as applying to pursuing risk to reap returns. The higher the risk, the greater the expected return. But maybe it works the other way round as well: in a world of lower rewards, the risks might be lower, too.
Many of the worst-case scenarios we’ve been hearing about for the past few months have not come to pass.