FORWARD-LOOKING MARKETS AREN’T BUYING BULLISH TAKES ON THE CANADIAN ECONOMY
Martin Pelletier unpacks how being proactive is better than being reactive
One of the biggest risks to investing is that many look in the rear-view mirror when making decisions. This can include buying a particular fund, making a market allocation based on the previous year’s returns or especially listening to those pundits offering their interpretation of the latest economic data.
The problem is many forget that equity markets are forward looking, and reflect expectations rather than what has already transpired. Making decisions based on backward-looking analysis can be quite costly. Take for example, those Canadians who listened to the reporting on economic data throughout 2015.
Oil prices were in the toilet, the economy was thought to be on the verge of a recession and the reporting was overwhelmingly bearish. Lo and behold, the year that followed proved to be one of the best years in Canadian markets, with double digit returns thanks to a recovering energy sector and a strong housing market that drove consumer spending.
Not surprisingly, this recovery showed up a year later in economic data for 2017 and now many of the same pundits are waving the flag, noting that on a year-over-year basis Canada lead the G7 in economic growth. This isn’t surprising as it is human nature to be reactive rather than proactive especially for those without direct market experience. It’s even harder to be a contrarian and to ask questions about the reliability of the underlying data, and most importantly, whether it’s repeatable or not. In regards to the latest bullish reporting on Canadian economic data, why not take a different approach by first asking why Canadian equities have been posting among the worst returns globally early into 2018? Perhaps investors are questioning what economic growth will look like a year out from a normalized base point? What about the impact of three rate hikes on debt-heavy consumers, who account for a record 57.5 per cent of GDP — up from just over 49 per cent in 2000 while wages as a per cent of GDP have remained flat at just under 44 per cent of GDP? How will the expectation for higher rates affect an economy that has become overly reliant on real estate given residential spending was responsible for nearly 60 per cent of last quarter’s economic growth rate? Then there is the serious risk that NAFTA negotiations pose to our economy, which is heavily dependent on exporting to the U.S. consumer. At the same time Canadian taxes have been going up — including our rollout of a national carbon tax and ongoing changes to the taxation of small business — while U.S. taxes are falling. Finally, our oil and gas sector continues to remain under pressure from rapidly growing U.S. shale output, existing pipeline constraints and a material pullback in foreign investment. This isn’t to say one should avoid Canadian equities, but on the contrary that there are some great opportunities in certain sectors that have been affected by an overly hawkish interpretation of the Bank of Canada’s rate outlook. This hawkishness also appears to be reflected in the Canadian dollar’s rise since last summer. Overall, when reading economic commentary be sure to look at the market experience of those being interviewed and even that of the author, especially if they happen to be offering their own interpretation of economic data. It also helps to take an investigative approach such as questioning the reliability of data that may not make sense such as a very large and unusual gain or loss in unemployment, and asking whether the reported data is repeatable in the current environment. This means mapping out all of the factors that you think will get you to your destination and keeping your eyes on the road ahead looking for obstacles to avoid.