Canada and the United States have historically walked similar economic paths. The coming years, though, may see them take quite different journeys.
Investors should keep this in mind when planning their portfolios. We often hear that Canadian stocks are far cheaper than U.S. ones. That is true if you focus only on price-to-earnings ratios. Canadian stocks trade for about 12 times their expected earnings in 2024 compared to 18 times for their U.S. counterparts.
However, simple comparisons like this ignore the different trajectories of the two economies.
Canada is grappling with massive household debt, a metastasizing housing crisis and stagnant living standards.
The U.S. seems in considerably better shape. Granted, its yawning federal deficit remains a worry; so too is its poisonous politics. Despite all that, however, the U.S. economy retains a robust capacity to grow its output per capita, which is the necessary prerequisite for raising any country’s standard of living.
The recent performance of the two North American economies shows a stark contrast. In the U.S., economic output, or gross domestic product (GDP), bounded ahead in the third quarter at a 4.9-per-cent annualized pace. In Canada, economic growth slid to zero.
Investing like there’s no tomorrow
Could slow-growth Canada eventually catch a lift from its more vigorous neighbour? Let’s hope so. First, though, we have to work through the legacy of a couple of decades of bad decisions.
Our biggest vulnerability is our collective addiction to real estate and therefore to debt. On average, Canadian households are carrying $1.81 in mortgages and other loans for every $1 of disposable income, according to Statistics Canada. This is down slightly from recent highs, but is considerably higher than the norm 20 years ago.
Debt payments now consume nearly 15 per cent of Canadians’ disposable income – pretty much the same level that prevailed in Canada immediately before the financial crisis of 2008.
Americans were also deep in debt back then. Since the financial crisis, though, they have become a remarkably frugal bunch.
U.S. households now have only $1.02 in household debt for every dollar of disposable income, according to the Organization for Economic Co-operation and Development. They spend less than 10 per cent of their disposable income on servicing their debts, the Federal Reserve reckons.
The glaring difference in household debt levels means that U.S. households are better positioned than their Canadian counterparts to deal with today’s surging interest rates. So long as interest rates remain high in both countries, the U.S. is likely to continue outperforming Canada.
Certainly, Federal Reserve chair Jerome Powell sounded optimistic this week about the state of the U.S. economy. He reiterated that the Fed, which dropped its recession forecast this summer, is still not seeing anything that looks like an impending downturn on the horizon.
The same cannot be said for Canada. Signs of weakness abound. For instance, real retail sales per person are declining, noted Eric Lascelles, chief economist for RBC Global Asset Management, in a report this week. He added that the Bank of Canada’s Business Outlook Survey continues to get worse with every reading and is now approaching the threshold it hit in past recessions.
“If not for booming population numbers, the [Canadian] economy would be shrinking at a meaningful clip,” the Conference Board of Canada wrote in a recent report.
To be sure, it’s possible that at least some of the current difference between the Canadian and U.S. economies is temporary. Perhaps the U.S. economy will slump in 2024 as higher interest rates bite and pandemic-era savings run out.
However, anyone who wants to dismiss the current growth gap between the two countries as nothing more than a passing blip should think again.
Consider GDP per capita – the amount of economic output for each person in each country. Only by increasing GDP per capita can a country sustainably improve its living standards.
Canada has not performed well on this score for years. While the U.S. has grown its GDP per capita by a cumulative 16 per cent over the past decade, Canada has managed only a 6 per cent increase.
One culprit for Canada’s lacklustre GDP per capita growth is our dismal rate of investment in capital stock – things such as machinery, factories and technology that can boost future productivity.
Canada’s productivity now ranks a mediocre 18th among OECD countries. Between 2000 and 2022, Canadian productivity diminished by 9 per cent, falling to roughly 72 per cent that of the U.S., according to Barry Cross, a business professor at Queen’s University in Kingston.
Turning this trend around is not a quick or easy job. Just for starters, governments have to encourage more investment in technology. They also have to unclog the obstacles that discourage building anything in Canada – from homes to pipelines to transit projects.
I hope Canada will eventually get it right. Until then, though, investors would be well advised to maintain a relatively high level of international diversification. Yes, Canadian stocks are cheap. Unfortunately, there are some good reasons for that cheapness.
Ian McGugan