Despite the fact that Canada's economy has emerged as the strongest in the industrialized world so far this year, the currency and the local stock market have been huge underperformers. Investors are more concerned with the possible dampening effects of shifting trade policy stateside and what a bursting of the housing bubble in large urban areas such as Vancouver and Toronto will unleash on the banking sector and the domestic economy. These concerns are way overblown, but more on that later.
Let's look at the facts on the ground.
As for the currency, it should not be lost on the loonie bears that the trade deficit is narrowing nicely, having gone from $1.41-billion in February to $936-million in March to $370-million in April.
Export volumes are strengthening again, up 0.8 per cent in April month over month on top of a 3.2-per-cent gain in March. And the 5-per-cent annualized increase in machinery imports over the past three months and 8.1-per-cent runup in buying of foreign-produced electrical equipment over the same period attests to the view that capital spending growth is perking up and providing a solid antidote to any retreat in the once-hot housing market.
What about the economy in general? Well, after a 3.7-per-cent annualized GDP growth rate in the first quarter, Canada is set for something near 2.7 per cent in the second quarter. This would make it four in a row of surpassing U.S. growth and five of the past six quarters.
As of the first quarter, real GDP growth in Canada was 2.3 per cent, year over year, compared with 2.0 per cent in the United States; the comparison in nominal terms is even wider at 5.4 per cent and 4.1 per cent, respectively. Yet the Fed is raising rates and the Bank of Canada remains on the sidelines – but a 0.5-per-cent policy rate and 5.4-per-cent nominal growth are not sustainable.
The overnight index swap market is only priced for a 25-per-cent chance that the Bank of Canada nudges up rates a quarter point by year-end. Something tells me the Bank will have to do more – at the least, take out the two "emergency" rate cuts that were needed when oil was sub-$30 (U.S.) a barrel. A BoC move to take those out and oil staying range-bound would take the Canadian dollar back through 76.92 cents in fairly short order.
As for the fears over Mr. Trump's trade policies, all I have to say is that the duties thus far on softwood lumber and dairy products are tantamount to draining the grand total of 0.1 per cent off Canadian GDP growth. So no, I'm not losing sleep over it.
As for rewriting the North American free-trade agreement, here is the reality. Canada never wanted this tripartite deal to begin with, but was dragged into it by George H.W. Bush. Look at Canada's share of the U.S. market for imports since 1994 – a straight line down to historic lows. Mexico is a straight line up – they are the ones who should be worried.
So bring it on – there is not a shred of evidence that Canada benefited at all in this deal.
Finally, the hot Vancouver and Toronto real estate markets are cooling off. Sales have corrected and inventory is coming back online. That prices remain sticky only symbolizes that these two areas have been rerated on a global scale. In the meantime, Montreal is starting to act like a valve – prices are at a steep discount to these other two cities, but sales activity is firming up noticeably.
So here's the reality – 30 per cent of the country is in a housing bubble or mania, to be sure. And we will see how the various macroprudential policies take the froth out in Vancouver and the Greater Toronto Area. No doubt those with the most leverage and the least amount of homeowner equity will feel the pain once the BoC starts the inevitable process of raising short-term rates, even gingerly.
But unlike the United States of the past cycle, 70 per cent of the country is nowhere near a bubble, with most cities still seeing a situation in which it takes three to four years of income to buy an average home, which is normal.
The fact that five of the six Canadian banks smashed through their earnings targets for the past quarter with ease is another signpost that this is not a group that is typically worth shorting.
The U.S. hedge funds did not seem to learn that lesson with the energy price meltdown of a few years ago – in fact, the loan loss reserves set aside back then are in the process of being freed up today, and helping bolster the sector's financial results at the same time.
Let's just say that the Canadian dollar is ripe for a huge short-covering rally on any good news given that the net speculative short position in the futures and options pits has ballooned to a record 99,736 contracts as of the end of May, more than doubling since the start of the month. So at a minimum, the sellers must have completely exhausted themselves, and in the process of overdoing it on the short side, the Canadian dollar has very recently managed to break above its 50-day moving average. Colour me a bull on the loon.