The votes are in and the man in the shadow is Canada’s new Prime Minister. Photo by Bloomberg/Getty Images.
Monday, the longest national election campaign in Canada’s history came to a conclusion, with voters flocking to the polls. In some cases, turnout was so strong Elections Canada ran out of ballots and had to delay voters for the better part of an hour. When all the dust settled, incumbent Prime Minister Stephen Harper’s nine years at the helm were over. The Liberal Party’s Justin Trudeau is in, bringing a fresh face, well-known political name, promises to stimulate Canada’s economy and a surprising Parliamentary majority. However, Trudeau is taking over at a time the commodity-heavy Canada’s markets and economy face stiff headwinds, and like his counterpart in Australia, he is likely powerless to change the tide soon.
Coming into Monday, most pollsters expected a Liberal win, but not a majority.[i] The degree of victory, like the UK’s May vote, was a surprise. It seems the Liberals succeeded in wrenching away more votes in Canada’s Atlantic provinces from the rising third party, the New Democratic Party (NDP), than most pollsters expected, giving Trudeau at least 184 of the House of Commons’ 338 seats. What results is not the bullish gridlock most competitive developed economies presently enjoy, suggesting a more active government may be at hand in Canada. Stocks hate when governments pass sweeping legislation impacting property rights in some way, shape or form, and a majority government does make that more likely.
But this doesn’t really change our view of investment opportunities in Canada. Perhaps the major issue on the campaign trail this year was Canada’s economy, presently in a mild recession. Trudeau championed increased deficit spending on things like infrastructure as a means to stimulate Canada’s economy, while Harper alleged running repeat deficits was fiscally irresponsible. In addition, Trudeau proposed hiking taxes by four percentage points on folks earning more than $200k annually, while cutting them for mid-range households—a mostly sociological move that is unlikely to materially affect the economy. As for deficit spending, it seems as though Canada has room to borrow, should the country see fit. Its net-debt-to-GDP ratio is a low 51.5%, and markets don’t seem to think Canada is a risky borrower, given 10-year bond rates are presently 1.45%.[ii] This isn’t a new development—rates haven’t topped 2% at any point in 2015. We also aren’t ones to quibble with the concept of fiscal stimulus when an economy is flagging from a dearth of demand. However, this isn’t really what’s driving Canada’s recession.
That is due to cratering oil and commodities prices. Canada, particularly in Western provinces like Alberta, relies more heavily on Energy and Mining than most developed nations. Weak oil prices since late 2014 have put a damper on many such economies worldwide, and Canada’s is no exception. Exhibit 1 shows Canada’s Energy output has dragged down Canada’s overall economy. While Energy bounced in June and July, we doubt its big rebound has staying power.
Exhibit 1: Canada Monthly GDP and Energy-Sector Components
Source: FactSet, as of 10/20/15.
To be clear, Canada isn’t Russia.[iii] Its economy is not a one-trick pony, near-totally reliant on the Energy sector. Energy comprises about one-sixth of Canada’s private-sector output. But it is enough to hamstring growth to an extent, not unlike Norway or Australia.
Not coincidentally, Norway, Australia and Canada are three of the worst-performing nations in the developed world. Exhibit 2 shows year-to-date returns for the 23 developed nations in the MSCI World Index in USD. (Exhibit 3 shows the same in Canadian Dollars, for readers a bit north of where we are sitting.)
Exhibit 2: MSCI World Constituent Country Returns in 2015 (in US Dollars)
Source: FactSet, as of 10/20/2015. Returns include net dividends except for the US, which includes gross dividends.
Exhibit 3: MSCI World Constituent Country Returns in 2015 (in Canadian Dollars)
Source: FactSet, as of 10/20/2015. Returns include net dividends except for Canada, which includes gross dividends.
A major consideration when investing in Canada is the universe of stocks is extremely sector-concentrated. Nearly 70% of the MSCI Canada’s market capitalization is in just three sectors—Financials (40%), Energy (21%) and Materials (9%). For this reason, Canadian investors should always invest globally (though we would admittedly advise investors anywhere to look globally first)—the market simply doesn’t provide enough opportunities to diversify. But also, consider: the global market has a far smaller dose of Energy and Materials. While Canada’s markets are about 30% commodity-based, less than 12% of the MSCI World is in Energy (7%) and Materials (5%). In an environment when oil and commodities prices have collapsed by half in the last year, commodities-heavy markets like Canada’s aren’t well positioned--a fact particularly true of Canada, given relatively high oil extraction costs in Alberta.
That is the scenario Trudeau faces stepping into office. We wish him luck in turning the economic tide, but we’d suggest that until oil supply ebbs and/or demand flows, the backdrop isn’t too bullish for Canadian stocks.
AN ADDENDUM – Canada’s Election and the Trans-Pacific Partnership
Another economic policy platform at issue in the vote was trade, specifically the Trans-Pacific Partnership. Trudeau and the Liberals demanded Harper reveal all the details of the Trans-Pacific Partnership (TPP) trade agreement for the public to see. Harper demurred, and it seems Trudeau and the Liberals capitalized by promoting his secrecy.
Trudeau has said he isn’t anti-TPP—he just claims to want to evaluate it. (NDP and its leader, Tom Mulcair, rejected TPP outright.) The trade agreement, however, is divisive within the Liberals’ ranks, and it remains to be seen whether Trudeau will request his party members vote en masse or freely exercise their view. Since Parliament will have to approve any TPP deal, this is a matter worth watching, though we remind readers that even if TPP is rejected, this is merely the absence of a positive we didn’t expect to hit soon in the first place, not a negative.
[ii] Source: FactSet, as of 10/20/2015. And yes that’s lower than the US.
[iii] Though both excel at hockey and are cold.