Why investors are running away from fastest-growing Group of Seven economy
CANADA’S economy is flexing its muscles. Investors are not impressed.
The country’s economy expanded at an annualised 3.7 per cent pace in the first quarter, Statistics Canada reported last Wednesday, easily tops in the Group of Seven.
Meanwhile, in a year when stocks are rising everywhere, Canada’s benchmark index is the second-worst-performer in the developed world after Israel, according to Bloomberg data. It’s a similar story in currency and bond markets.
The performance underscores how, even with the improving economic performance, caution prevails. Investors remain concerned about geopolitical risks, the outlook for oil prices and a housing market that some analysts say is on the verge of a correction.
“It is a tad curious to say the least that the Canadian economy arguably has been one of the bigger pleasant surprises in 2017 and meanwhile the equity market has done a belly flop,” said Doug Porter, chief economist at Bank of Montreal, who highlighted the disconnect between Canadian growth and market performance in a May 26 note.
Energy shares are down 10 per cent year-to- date, while fears about contagion from a run on deposits at troubled mortgage lender Home Capital Group Inc. have weighed on financial shares, which are down 1.2 per cent.
While the benchmark S& P/ TSX Composite index is up a slight 0.6 per cent, that’s well below returns in other markets. The S& P 500 Index is 7.8 per cent higher this year.
Ironically, oil and housing are the two key reasons why Canada’s economy is doing better. Crude prices have rebounded from last year’s lows, giving energy-producing regions some life. Second, a housing boom in Vancouver and Toronto is fuelling construction and creating new-found wealth for inhabitants.
In fact, the figures released last Wednesday show growth – at least on the domestic side – couldn’t be more broad based.
All major components of domestic demand posted increases in the first quarter – the first time that’s happened since 2010. Canada’s strong economic growth suggests investors’ fears are overblown, said Vincent Delisle, portfolio strategist at Scotia Capital Inc.
“Housing markets do not collapse when the economy is growing at four per cent,” Delisle said in a phone interview before the gross domestic product figures were released.
It’s not just equities that are disconnected from the economy. Canadian government bonds returned 2.1 per cent in US dollar terms this year.
While better than the 1.7 per cent gains of US peers, they lag behind sovereign bonds globally, which are up 4.4 per cent, a Bloomberg Barclays Global Treasuries index shows. The Canadian currency meanwhile is the worst-performing major global currency of 2017, declining 0.30 per cent against the US dollar.
“That’s a big disconnect,” Delisle said, referring to the loonie’s performance relative to the economy. “The GDP report should shock everybody outside Canada.”
Part of the problem is that Canada’s stock market isn’t
It is a tad curious to say the least that the Canadian economy arguably has been one of the bigger pleasant surprises in 2017 and meanwhile the equity market has done a belly flop. Doug Porter, chief economist at Bank of Montreal
totally reflective of the economy, since it’s heavily reliant on energy and financials, Porter said. Those two sectors account for 54 per cent of the S& P/TSX Composite Index.
But investors have been taking their cues in part from the Bank of Canada, whose policy makers have for months emphasised the negative, even in the face of improving data.
Global political developments aren’t helping, with renegotiation of the North American Free Trade Agreement due to start as early as August and a new spat with the US erupting over aerospace manufacturing.
There is also the subdued outlook for oil, which has traded below US$ 50 a barrel since last week, and the temporary feel of the recent growth upturn.
Part of it is the catch-up effect as the economy recovers from the oil price collapse. Continued growth in residential investment – which was up an annualised 16 per cent in the first quarter – is also likely to fade as the impact of government measures to cool housing markets kick in.
“There are a lot of factors that have been giving the economy a temporary boost,” Porter said. “Admittedly, this temporary boost has been going on for three quarters now.”
There may also be another type of pay back in play, according to Porter. Investors may already have priced in the good news last year, when Canada’s stock index gained 18 per cent, one of the world’s best performances.
“Often times the equity market is moving well before the economy does and of course the Canadian equity market had a robust year in 2016,” Porter said.
“One could argue that presaged this better performance by the economy.” — WP-Bloomberg