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Be skeptical of those predicting Canada’s economic doom

According to the doomsayers, Friday's report on domestic GDP will be the high water mark, before the Canadian economy begins a prolonged slide into slow-growth misery.

The consensus estimate for fourth quarter economic growth is 2.5 per cent on an annualized basis. Forecasters then expect the economy to slow to 2.1 per cent and 2.2 per cent for the first two quarters of 2014.

The reliability of economic forecasts being what it is – suspect – it's fortunate that there are leading economic indicators that have historically predicted the course of Canadian growth. If the components of Statistics Canada's Composite Leading Indicator Index weaken sharply, investors can start believing dire predictions for Canadian growth.

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Since 2000, these have been the most accurate indicators, in order: U.S. Leading Economic Indicator; Changes in domestic hours worked in the manufacturing sector; and the shipment-to-inventory ratio.

Over the long term, the U.S. Leading Economic Indicator Index has been the best predictor of Canadian GDP.

The Shipment to Inventory ratio, which measures asset turnover and warns economists when production is piling up in warehouses, has been the second best indicator. This is an inverse correlation – when the ratio declines, it means inventories are growing, which suggests GDP growth will slow.

Changes in hours worked in the manufacturing sector have generally been the third most accurate forecaster of economic growth over the long term. But, interestingly, the connection between manufacturing labour activity and GDP has all but disappeared in the past three years.

Together, these indicators paint a reasonably constructive picture for the Canadian economy, suggesting a collapse in domestic growth won't happen soon. U.S. LEI has improved substantially over the past twelve months, and the dip in domestic hours worked appears to have bottomed.

The shipment-to-inventory ratio might be the one to watch most carefully. 2013 saw a weak trend with inventories climbing. It has improved since October of 2013, but remains at reasonably depressed levels.

Canada GDP vs Shipment/Inventory

SOURCE: Scott Barlow/Bloomberg

Canada GDP vs U.S. Leading Economic Indicator index

GDP: year-over-year per cent change

SOURCE: Scott Barlow/Bloomberg

Canada GDP vs Manufacturing hours worked

GDP: year-over-year per cent change

SOURCE: Scott Barlow/Bloomberg

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