Bets against Canada piling up

As if Canadian fund managers didn’t have enough to worry about this year, a new pressure is beginning to weigh heavily on the country’s stocks: foreign short sellers.

Shares on the S&P/TSX Composite index fell for the seventh straight day Monday, down 1.3 per cent to 14,001, adding to what is the longest losing streak since 2011. Steep declines in energy companies, miners and banks — the latter being a popular target for shorts — were the main source of the selloff.

Fund managers say that foreign bets against Canada are set to add to the country’s stock market woes this year as the country faces recession and concerns linger about the housing market.

“Resources have weighed for a while, but now a lot of negative sentiment is growing toward the banks as well, especially from foreign investors,” said Robert Kavcic, senior economist, BMO Capital Markets. “I mean look at what the big six Canadian banks have done, even over the past six months, they’ve come down quite a bit.”

It has become increasingly clear that the collapse in oil prices is doing much more damage to the Canadian economy than initially predicted. Gross domestic product contracted by 0.6 per cent on an annual basis in the first three months of the year.

There was a broad pullback in many sectors, including oil and gas, wholesale trade and manufacturing.

Economists at the start of the year forecasted that the Canadian economy would bounce back in the second quarter, but now contend that it likely contracted then as well. If that pans out, Canada will have entered into its first recession, defined as two consecutive quarters of economic contraction, since 2009.

Statistics Canada this Friday will release May GDP numbers, which are expected to add clarity about whether the economy is now in a recession.

Finance Minister Joe Oliver said in a speech last week that he does not buy the re- cession thesis and reaffirmed that the federal Conservatives will run a budget surplus this year. But a report from the Parliamentary Budget Officer last week contradicted him, saying it is likely the government will have a billion-dollar deficit.

The deteriorating outlook for Canada has emboldened foreign short sellers who have for years targeted Canada’s red-hot housing market. Prices across the country have risen an average of 79 per cent in the past decade, based on data from The Canadian Real Estate Association. The hottest markets, such as Toronto and Vancouver, have had price increases of well over 100 per cent.

“There’s concerns about the housing market — whether there’s going to be a slowdown in some of the growth in lending, whether we’re going to see the end of the housing bubble, which has been called for for five-plus years,” said Greg Taylor, vice-president and portfolio manager at Aurion Capital Management Inc.

“Of course, the issue with things like housing collapses and financial crises is you don’t know who’s exposed to what until it comes down. So you’re seeing Americans coming in and shorting a broad section of the banks and lenders.”

The S&P/TSX Composite is now down 4.3 per cent this year, and is one of the few stock markets in the world to have a year-to-date decline. Financial stocks have especially felt the pressure, down 6.85 per cent for the year and 1.54 per cent on Monday alone.

Greg Newman, an associate portfolio manager at The Newman Group, ScotiaMcLeod, said there is likely more downside on Canadian bank stocks as talks of a recession and low oil prices keep both domestic and foreign investors bearish.

“I’d say the risks are a little bit higher this time, because you actually do have the fallout from energy,” he said. “The mechanics of Canada aren’t as strong as they were because of US$48 oil, so I think the shorts are more emboldened.”

But Newman isn’t on the side of the bears. He even expects a buying opportunity could emerge for the Canadian banks once some of the shorting pressure eases, especially if economic indicators turn more positive in the second half of the year.

“I think there’s going to be a pretty good opportunity in Canadian bank stocks at some point, but there probably is more downside in the near term than upside,” he said. “My opinion is we’re closer to the buying opportunity than not.”