By Erik Sherman

It would be nice if the prospects of spring brought significantly better economic news than Canada has recently seen. Unfortunately, that’s not the case. Start with the numbers.

At the end of January, the Bank of Canada kept its policy interest rate at 5%. “The BoC again downplayed the contraction in Q3 GDP and still expects a soft landing for Canada, as well as for inflation to return to the 2% target by late 2025,” wrote Oxford Economics at the time.

There wasn’t a lot of cheering for the near-term outlook. “The only thing saving the economy from contracting more than the 1.1% registered in the third quarter was a surge in government spending and a modest rebound in residential investment,” wrote Deloitte in its 2024 economic outlook. “The final quarter of 2023 is expected to have shown much of the same, with consumer spending and business investment remaining flat and government spending slowing.”

As of writing, GDP figures for the fourth quarter still aren’t available, though according to Statistics Canada (StatsCan), Q3 GDP by expenditure was down month-over-month by 30 basis points. Unemployment was down 10 basis points, but still at 5.7%. The Consumer Price Index in December 2023 — January not yet available — was 3.4% year over year, up from the 3.1% in November. Retail sales in November, down 0.2% month over month. Manufacturing sales in December, off by 0.7% from November.

Oxford Economics projects a “moderate recession” with a “muted recovery” following. “Economic activity will continue to contract through mid-year, as soaring debt service costs from mounting mortgage renewals push indebted households to deleverage and unaffordability extends the housing correction. Consumers and businesses will gradually regain the willingness and ability to spend in H2 2024, but they will likely remain on edge as interest rates only slowly ease amid ongoing uncertainty.”

December international securities trades — again, the most recent number — showed a flight beyond borders to safety “Canadian investors acquired an unprecedented $29.4 billion of foreign securities in December, led by a record investment in foreign shares,” as StatsCan noted. “Meanwhile, foreign investment in Canadian securities totalled $10.4 billion, mainly in debt instruments. As a result, international transactions in securities generated a net outflow of funds of $19.0 billion from the Canadian economy in December 2023.”

“The real issues, we have some softening in Canada, much more than in the US,” Phillip Colmar, managing partner and global strategist at MRB Partners, tells CAiP. “And the problem with it is there’s a vast difference in the structural foundation” between the two countries.

In Canada, there’s been a “housing bubble with extensive household leverage and difficulty serving those debts,” Colmar says. At the peak of the global financial crisis, U.S. household debt was about 130% of income, he notes. In Canada, it’s running 180%. “There’s a bigger debt bubble. The foundations for the economy are considerably more fragile because of that.” Normalization of mortgage interest every five years means debts are being reset at higher levels.

“It’s actually pretty dramatic,” he says. “The number of mortgages that are greater than 30 years is about 25%. Before interest rates rose, they didn’t have any mortgages over 30 years.”

“Finance, centered around the housing market, for sure is going to have a problem,” Bob Elliott, CEO and CIO of Unlimited and a former investment committee member at Bridgewater tells CAiP.

Big banks have negative amortization, with 20% of mortgage portfolios not even covering interest alone, says Colmar. Banks are tacking on years to mortgages in the hopes that interest rates fall, and they can reset payments back to a level that consumers can afford and that will reasonably service the debt.

As for the two major domestic investment sectors, “you have financials, and you have energy” Colmar notes. Financials are under severe pressure.

“Energy underperformed last year,” he adds. “The multiplier effect of housing into the general economy is elevated,” with construction employment alone being about 8% of the labor force. “You have spillover effects because people are deleveraging and not spending.

“If you look at the economy in general, you basically have growth that’s slowed,” says Elliott. “There’s roughly a 0% GDP growth rate, depending on which measures you look at. For a Canadian economy with reasonably positive immigration, 0 growth rate is a problem for the economy.”

“A big part of that continued elevation of inflation is connected to rent or connected to home ownership costs that are keeping those numbers elevated relative to what is desired,” he continued. “I think that’s the real challenge. Those costs are continuing to rise at a pace that is keeping overall inflation elevated and creates real concern about whether or not the Bank of Canada can deliver the amount of easing that’s necessary.”

Elliott says that the combination of factors likely means weaker Canadian economic conditions for longer than many expect.

As for the pensions, “They are global investors already, but naturally that have home bias, because that’s how it works. This is probably going to create a further push for those investors that are structurally overallocated to the Canadian markets or economy look outside to other opportunities.”