2011 Mid-Year Canadian Economic Update & Outlook


Economic activity in Canada during the first half of 2011 has increased with a rise productivity, business investment, and exports.  However, a weakening U.S. dollar and strengthening commodity prices has increased the value of the Canadian dollar.  This can be expected to put competitive pressure on non-commodity exports.  Canada is not immune to the U.S. economy either.  A weak U.S. economy also means demand for Canadian goods & services will remain modest.  Although first quarter exports increased, so did imports.  This may be partly attributed to the strength of the Canadian dollar, making import prices more attractive (cheaper).  The unemployment rate remains very high, while consumer spending remains relatively unchanged.  However, household debt continues to climb, increasing the risks to the growth of the economy.  Overall, the first half of 2011 has not shown too much in terms of significant change from the 2010 Outlook.  It is expected that the remainder of 2011 will be a continuation of what we have already seen, with modest growth but increased pressures on the economy.


Canadian Unemployment Rate Still High

In Canada, the employment picture has improved slightly from 2010, but we have yet to see sustained long-term employment growth. Canada added more than 58,000 new jobs in April 2011, but most were part-time and in lower wage services sector.  The Canadian unemployment rate declined to 7.6%.  According to Statscan, 283,000 jobs have been added since last April (2010). However, that is only a small 1.7% increase.  The unemployment rate (7.6%) is still very high. Many jobs have been lost since the onset of the financial crisis, with numerous factory closings across several industries. Jobs in the manufacturing sector, had been hit particularly hard with the financial difficulties that were faced by the big three automakers.  The jobs that have been lost, have not yet been recovered.


Productivity Improves, With Increased Business Investment

According to Statscan reports released in May 2011, Canada’s real gross domestic product (GDP) advanced 1.0% in the first quarter of 2011. This follows a 0.8% increase from the fourth quarter of 2010. Real GDP by industry increased slightly in March 2011 by 0.3%.  Real gross domestic product grew at an annualized rate of 3.9% in Q1 2011, which was the biggest increase since Q1 2010 (where it was 5.6%, afterwards which dropped to 2.3% in Q2 2010).   All major industrial sectors in Canada increased their output modestly in the first quarter of the year, except for retail trade and the arts, entertainment & recreation group. In terms of dollars, output increases were led by goods production ($360 billion, 1.8%) and service-producing industries ($903 billion, 0.7%). Manufacturing and mining, oil, and gas extraction were the largest contributors to growth, while energy, construction, transportation and wholesale trade also contributed.

Canadian businesses have been continuing to unlock their cash hoard as the economy slowly improves, and corporate profits continue to strengthen. Business investment in plant & equipment increased by 3.2% in the first quarter of 2011, which was the fifth consecutive quarterly increase.  Businesses increased their investments in engineering structures as well as in machinery & equipment.  Recent Q2 2011 corporate earnings and activities from the first half of the year suggest that this can be expected to continue at same moderate pace going forward, and be primarily driven by energy and mining & gas exploration sectors. However, earnings and business activities from the largest banks in Canada, as well as other sectors (retail, manufacturing, etc) show increasing competitive pressures may soften business investment in these particular sectors for the remainder of 2011.


Exports & Imports (Export Rise, But So Do Imports)

Canada’s current account deficit declined for the second consecutive quarter to $8.92 billion, in Q1 2011. The $1.37 billion decline in the current account deficit was largely due to strong export volumes of energy products. Both exports and imports rose in the first quarter, as most sectors recorded gains in dollar terms.  Exports continued to increase in the first few months of the year with a 1.6% rise.  Imports also increased by 2.2% after a 0.1% decline in Q4 2010.

During Q1 2011, exports of energy (8.9%) and automotive products (6.5%) were the main contributors of the increase.  Crude petroleum led with a $3.6 billion increase on record volumes, while industrial goods slowed, and exports of machinery & equipment and agricultural & fish products declined in Q1 2011. However, March export volumes were up 2.5% and increased in all sectors (energy, industrial goods & materials, machinery & equipment, forestry) except agricultural & fishing products. At the same time, prices advanced 0.9%. Export gains in March were led by energy products (exports +5.0%, prices +2.9%, volume +2.1%) and industrial goods & materials (exports +3.7% led by nickel and iron ores). Overall, exports have continued to improve since May 2009.  March exports to the U.S. increased 1.9%, led by crude petroleum.  Exports to countries other than the U.S. increased 7.8% mainly to the European Union.  Canada is a major exporter of commodities, especially in energy products and industrial goods & materials. We expect exports to continue to increase at a moderate pace in-line with continued foreign demand in those areas. However, we need to see sustained improvement in other export areas in order for exports to improve overall.

Imports during the first few months of the year increased after Q4 2010’s small decline.  Imports were led by automotive products on higher volume for vehicles & parts, as well as energy on high crude petroleum prices.  Data for March indicated that import volumes rose 3.2% while prices decreased 0.4%. Imports of automotive products (imports +6.5%, volume +7.1%) were main contributor in March after a February decline. Increases were also recorded in imports of industrial goods & materials (record high imports, 30.4% precious metals) as well as a slight increase in machinery & equipment.  Imports increased for energy products (3.7%) as well as agricultural & fishing products (imports +3.4%, volume 5.6%). March imports for consumer goods fell 2.8%, led by apparel/footwear.  Imports have been trending upwards since June 2009.  However, during the same period import prices have declined. Imports from the U.S. rose 3.2% in March, mostly from automotive products, while imports from other countries increased 2.1%. We can expect that the import trend will continue for the remainder of the year and into 2012, as a strong Canadian dollar will be offset by larger volume and demand.


Consumer Spending Flat

Consumption growth in Canada remained relatively unchanged during the first quarter of 2011. Statscan figures indicate that purchases of both durable and non-durable goods decreased slightly, with slight increase in services and semi-durable goods. Data for March 2011, indicates that retail sales (in terms of dollars) were higher in gasoline, general merchandise, electronics & appliances, and motor vehicle & parts subsectors, due to higher prices. Gasoline station sales have increased over the last 2 years as the price has risen nearly 40% since March 2009’s CPI reading.  Although prices were higher, there was only a small 0.8% increase in sales at general merchandise stores (department stores, and other general).  After three months of decline in late 2010 and early 2011, electronics and appliances store sales increased 2.1% for the second consecutive month.  It is important to note that sales at electronics & appliance retailers have not returned to pre-economic downturn levels. Spending on motor vehicles declined by 1.7% during Q1 2011, but experienced a small 0.3% increase in March.

During the first quarter furniture, furnishings, and household equipment & maintenance, continued their downward trend with the third decline in four quarters.  Furniture stores experienced a huge 4.4% drop in sales in March. Sales have been on a downward trend since early 2010.

Consumers significantly increased their purchases of clothing & footwear, more than doubling the Q4 2010 pace to 1.7% during the first few months of the year. But March showed a slight 0.9% decline with overall lower sales at all types (shoes, clothes, jewellery, etc).  Sales at sporting goods, hobby, book & music stores fell for the fourth consecutive month by 1.9% in March, as consumers spent less on recreation and leisure products.

For the month of March, food and beverage stores declined slightly due to lower alcohol sales as well as slight declines at convenience stores, and specialty food stores.  This was offset by higher supermarket/grocery store sales. However, sales at grocery stores reflected rising food prices.  Rising food prices has been a growing global concern during the first half of the year, and is expected to continue to put pressure on food sales in terms of volume. Health & personal care, building material & garden equipment / supplies, and other miscellaneous store retailers, all saw slight declines in March.

It is important to note that even though sales may have risen in four subsectors in March, they were offset by declines in seven other subsectors.  In addition, the increase in sales reflected mainly higher prices.  In terms of volume, retail sales inched lower by 0.8% to $37.3 billion in March. It is expected that retail sales may experience pressure due to high consumer debt levels, increasing costs, and a slower economic recovery in the second half of the year.


Canadian Debt Situation (Canadians Just Don’t Get It)

The debt situation is slightly different than in the U.S., but still include the usual suspects, high pension & benefit entitlements and government spending at all levels of the government (federal, provincial, municipal). Data released in March 2011 show that government net debt (expressed at book value) increased by $19 billion in the fourth quarter of 2010, with total government gross debt at $1.742 trillion. The ratio of net debt to gross domestic product stood at 45.1%, continuing its upward trend since the third quarter of 2008 when it was 35.4%. The federal government continued to borrow through treasury bills and bonds, while at the provincial level debt increased largely through short-term paper financing.

The larger concern in Canada is that already high credit card and household debt levels inch even higher. The Bank of Canada has warned Canadians on a number of occasions that it expects to increase rates over the next two years.  Despite the warnings, Canadians have been much slower than our American neighbours to show debt restraint, spending like drunken sailors. Perhaps one reason the for “feel good” attitude of consumers has been that the affects of the financial crisis were not as visibly pronounced as in the U.S.  Banks in Canada have not collapsed as in the U.S. and the housing market remained strong, leading Canadians to have a false sense of security.

Although there isn’t any data released by Statscan that is more recent, it can be expected that the picture has not changed much from the data released in March 2011 for the fourth quarter of 2010.  Household mortgage debt and consumer credit debt increased in the fourth quarter of 2010.  Credit card debt increased due to increased purchases of durable goods. The ratio of household credit market debt to personal disposable income decreased slightly but remains significantly elevated at 146.8%. A 1.8% gain in personal disposable income slightly offset the credit market debt.  However, debt to personal disposable income was at an alarming 148.77%, which is higher than that of the United States. Debt to personal disposable income in Canada has increased steadily over the last two years from an already high level of 145.7% in the third quarter of 2009.  Canadians have been spending much more than they can afford, racking up larger amounts of debt.  A more reasonable level would be closer to 100%. Household debt in Canada reached an unprecedented $1.526 trillion in Q4 2010.

The Office of the Superintendent of Bankruptcy Canada report released in May 2011, indicates that the total number of insolvencies (bankruptcies & proposals) in Canada increased by 19.2% in the month of March from the previous month.  Bankruptcies had increased 19.2% and proposals increased 19.1%.  For the 12-month period ending March 31, 2011, the total number of insolvencies decreased by 11.9% compared to the same period a year ago.  However, it warned that “the total volume of insolvency still remains 18.5 percent higher than the 12-month period (October 2007 – September 2008) preceding the recession”.  This data should not be surprising, as there are still numerous television & radio commercials of companies offering their services in consumer bankruptcy and credit restructuring matters.

We should expect debt levels to be stubbornly maintained and even increase, which may be a cause for concern when rates increase. It is expected that after rates rise, debt levels will decline moderately for the last few months of 2011 and into 2012 (assuming rates increase before 2012).  On 5/31/2011, the Bank of Canada (BoC) held the overnight lending rate steady at 1%, but again hinted that a rate hike may be coming soon.  Although Canada may not experience the same catastrophic problems of the U.S., these levels are undoubtedly a concern. It is perhaps the notion that Canadian banks have remained strong throughout the crisis, and we are unlikely to experience the type of crisis in the U.S., that has led Canadians to ignore rising personal debt levels. Prices and costs (food, energy, goods, taxes, fees, etc) are expected to continue to increase significantly across the board, along with increases to interest and retail lending rates. We have yet to see rate increases by the Bank of Canada, and there have been few by retail banks.  However, with the combined effect of cost and rate increases, along with high levels of debt, we can expect Canadian households to feel financial strain closer to the end of 2011 and into 2012.


The Canadian economy is highly affected by the health of U.S. economy, Canada’s largest trading partner.  A weak U.S. economy in 2011 will translate into weaker demand and will undoubtedly have a negative effect on exports. It is expected that productivity will improve slowly for the remainder of the year with GDP growing at a softer pace than it has during the first quarter.  With government spending & stimulus also winding down this year, tepid retail sales, and the sustained strength of the Canadian dollar, competitive pressure will mount on the economy.  This combined with expected financial pressure on households with increasingly higher debt levels will result in increased risks on growth and the economic recovery closer to the end of the year.


Recommendations To Individuals & Investors

This time, my recommendations are all about risk reduction and limiting effects of negative economic events, especially if another downturn occurs in another two years:

• Reduce bad debt now! That is debt that is not used for income generating (investment or business) purposes.  This will likely be the leading source of financial problems when credit tightens. [This applies mainly to individuals].
• Hold off on major purchases that are not necessary, and spread out purchases that are necessary.  This will maintain cash flow, and reduce the risk of them becoming financially overburdening especially if the purchases need to be placed on credit.
• Reduce spending on luxuries and non-necessities.
• Increase emergency & maintenance funds.
• Increase your cash holdings. This will allow you to be able to take advantage of the current low lending rates, while at the same time ensuring you are able to quickly reduce the balance on good lines of credit down the road, when and if necessary. This will reduce the risk of being impacted negatively by rate changes.  It allows you to take a “wait and see” approach.
• Apply for lines of credit, but don’t use them. Lending is expected to tighten and will be more difficult to obtain.
• If you are thinking of purchasing a home or moving within the remaining half of 2011, apply for mortgage pre-approval, and also talk to your bank about rates, before any increases occur.


Note: Keep in mind the information in these articles are not meant to be a set of predictions that are set in stone.  It is meant as a discussion of a range of probable scenarios of what we can expect to see happen, based on the information available today.  By knowing the likely possibilities, we can plan for them.  We can also capitalize on potential opportunities, and not be caught off guard by possible negative events.

Thanks & Happy Investing! — The Investment Blogger © 2011


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