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The Canadian economy continues to draw crowd-pleasing performances out of its long-running, two-trick magic act. Resource producers and banks combined to account for more than half of the total profit and nearly a third of revenue chalked up in 2011 by the 1,000 largest publicly listed companies. No other sector came close. But even as these traditional creators of wealth extend their multi-year dominance in Canadian corporate life, their throngs of admirers have to be wondering how long they can keep pulling fat rabbits out of their respective hats. As their ability to conjure up more profits by the usual means—cost-cutting, productivity gains and strong foreign demand—wanes, the answer to that question lies increasingly with that final factor: troubled foreign economies beyond the control of hopeful Canadians.
In the not-too-distant past, the only foreign market whose shifts, swerves and stumbles really mattered to Canadian executives and investors alike was the giant one to the south. Every American sneeze or hiccup could turn into a hospital admission north of the border. The uncertain economic fortunes of the United States remain important, particularly for the Canadian banks that have been aggressively expanding their American footprint. But these days, China and other markets have become critical components of corporate Canada’s good-news story and a key reason profits exceeded expectations even when domestic economic growth didn’t. So when China’s prospects begin to dim, Spain’s banking woes worsen and Latin American governments turn more protectionist, it merely underscores the global threats that could derail the Canadian express. “At this particular stage, there is probably more in the way of downside risks than upside risks to the outlook for earnings and the economy,” says David Rosenberg, chief economist at Gluskin Sheff + Associates.
Those risks start in Europe, where austerity-first policy-makers have failed miserably in their efforts to contain a confidence-crushing banking and fiscal crisis that threatens to blow up the monetary union and unleash havoc on a global financial system still recuperating from the Great Crash of 2008-09. “No solution in Europe means lower commodity prices, which affects roughly half of the earnings in the TSX,” says David Prince, the principal of Harbinger Capital Markets Research.
A battered Europe means more trouble for China, whose economy was cooling anyway, and with it demand for the resources that have underpinned a Canadian economy that is still not fully engaged. Indeed, it already appears that 2012 will see shrinking profits and a less happy ending for both the resource and banking sectors. Unless, that is, China returns to its strong growth trajectory, the Europeans get their house in order, and Canadians continue their recent American-style habit of borrowing up to their eyeballs. All are possible, but none is likely.
Still, the banking-resource duopoly has worked to Canada’s singular advantage, particularly since the 2008-09 collapse, which rained misery on much of the developed world and pummelled financial heavyweights in the U.S. and Europe. Fearing they would be next, surplus-rich China and a handful of other big emerging countries shifted into aggressive stimulus mode, driving up infrastructure and consumer spending, slashing loan costs, stoking price inflation and juicing profits for all manner of commodity suppliers. The result was booming demand for the stuff Canadians dig up or pump out (with the notable exception of natural gas), and new opportunities for the banks. As Arthur Heinmaa, managing partner with Toron Investment Management in Toronto, puts it: “The great boon to Canada’s economic fortunes is that they’ve been focused on two areas, and both have been big winners.” Listed energy and mining firms saw earnings climb 17.7% in 2011 to just under $31 billion, while the banks jumped 16% to $24.6 billion on only 7% higher revenue. As a result, the 1,000 public companies in our annual survey managed to post combined profit in an otherwise tepid economy of $105.8 billion. That was up 5.3% from a year earlier, and the best tally since the record $109.9 billion racked up in 2006—the year before the U.S. housing bubble burst spectacularly and a wave of mortgage defaults in the U.S. spread chaos throughout the global financial system. Total earnings for public and private companies rose 15% before taxes, but are expected to climb only 5% or less this year.