Well, we knew things were bad. We just didn't realize they were this bad. Bank of Canada Governor Stephen Poloz doesn't want to say we're in a recession – he prefers the word "contraction", as if semantics made a difference. But if the second-quarter GDP numbers come up negative – and based on Mr. Poloz's comments and actions last week it appears they will – then yes, we are officially in a recession.
Unless you work in the energy industry, it doesn't feel like one, however. The malls are still busy. The unemployment rate is a little high at 6.8 per cent but that's certainly not enough to set off alarm bells. House prices in many parts of the country are still rising, which makes homeowners feel a little wealthier every day.
So it's a very strange recession. No one outside the oil sector seems to be panicking and the stock market is holding up surprisingly well. Maybe it's a case of summer tune-out. We'll worry about it in September, just when the election campaign starts to heat up.
The Bank of Canada is worrying right now, though – big time. The decision to cut its key lending rate by another quarter point, despite concerns over high household debt levels, says it all. After weighing the risks, Mr. Poloz decided that the negative economic impact of standing pat was a greater danger than the possibility of debt levels soaring even higher.
He's probably right on that score. Canada's household savings rate in the first quarter was 5 per cent, up 1.4 points from the previous quarter according to Statistics Canada. That means we were saving more money despite the Bank of Canada's January rate cut. Lower interest charges weren't tempting people to spend more.
It may be the same this time around, especially since the banks aren't passing on the full BoC rate cuts to borrowers. So far this year, the central bank's target rate has dropped half a percent. But the major banks have only cut by three-tenths of a percent, except for TD where prime is down just a quarter-point, to 2.75 per cent. And credit card companies, of course, haven't reduced their rates at all.
So it remains to be seen how much the Bank of Canada's move will spur borrowing, either by individuals or businesses. The real purpose of the cut, it appears, was to drive the loonie even lower. That happened immediately, with our dollar losing more than a cent in the hours after the announcement.
Mr. Poloz and his colleagues are clearly worried by the lack of export momentum in the country, despite the low dollar. The Governor called the numbers "puzzling" – and when you hear that word from a central banker, you know that something is badly amiss. These folks have access to more data than anyone else. If they don't know what's going on, we're in real trouble.
The latest report from StatsCan shows that exports were down 0.6 per cent in May, marking the fifth consecutive monthly decrease. But the actual numbers were worse than that. Volumes were off a disturbing 2.5 per cent. Only a 1.9 per cent gain on the price side kept the net figure reasonably respectable. The biggest losses were in metals and minerals – we actually saw gains in such key manufacturing sectors as aircraft, trucks, passenger cars, and auto parts. But the overall downward trend remained in place.
It appears Mr. Poloz hopes that an even lower loonie will spur an export rebound that will offset the on-going drag of weak oil prices, which are likely to continue for some time especially now than Iran is about to get back into the game. The question is: how low is low? The strategy didn't work with the loonie at 85 cents (U.S.) or even 80 cents. Now the target looks like 75 cents. Will that make any difference, or are we looking at basic structural problems that require more than currency devaluation to cure?
What to do
While we wait for the answer to such questions, here's what I suggest you do.
Change your currency now. If you're going to need U.S. dollars for a trip south, get them now. Although anything is possible when it comes to foreign exchange, there don't appear to be any forces in play that would drive the loonie higher in the short term. That won't happen until we see a combination of an oil price recovery, renewed economic growth, and an end to Bank of Canada rate cuts.
Underweight Canadian stocks. I've been saying this for some time but it's worth repeating. The TSX Composite is unlikely to make any significant gains this year. Its two major components, energy and financials, are struggling. The energy story is well known but what many people don't realize is that the profits of banks and insurance companies are squeezed by lower interest rates. That's why the big banks haven't matched the Bank of Canada's cuts. They want rates to move higher so they can improve their margins. That's not happening. The U.S. banks are in a much better position, with the Federal Reserve Board poised to raise its key rate.
Overweight overseas equities. Some U.S. stocks are doing well, even if the performance of the Dow and the S&P 500 has been mediocre. But the surprise winners this year have been Europe and Japan.
Avoid long-term GICs. Royal Bank was offering 1.5 per cent on five-year GICs at the end of last week. Do you really want to tie up your money for that long at such a low return? I don't think so.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.
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