BY ROB EDEL, CFA
Highlights This Month
- VOLATILITY CONTINUES TO CLOUD INVESTORS VISION BUT THE FORECAST IS FAIR
- IS THE APPARENT STABILIZATION IN THE CHINESE ECONOMY SUSTAINABLE?
- THESE ARE THE FACTORS CHALLENGING U.S. VALUATIONS
- AMERICAN CONSUMER SPENDING AND DOMESTIC ECONOMY STABILIZES THE U.S. THROUGH MARKET VOLATILITY
- JOB GROWTH FEEDS OPTIMISM IN THE U.S.
- A RECOVERING HOUSING MARKET LOOKS GOOD ON THE U.S. ECONOMY
- THE WEAK LINK: AMERICAN RETAIL MARKETS
- PLUMMETING OIL PRICES CONTINUES TO IMPACT CANADIAN JOBS IN RESOURCE AND CONSTRUCTION SECTORS
- CANADA’S HOUSING MARKET APPEARS BALANCED, FOR NOW
- A STRONG U.S. ECONOMY IS CANADA’S BEST BET
THE NWM PORTFOLIO
NWM Core Portfolio returns increased 2.0% for the month of October. The NWM Core Portfolio is managed using similar weights as our model portfolio and is comprised entirely of NWM Pooled Funds and Limited Partnerships. Actual client returns will vary depending on specific client situations and asset mixes.
The Canadian yield curve backed up, and steepened, with 2-year Canada yields increasing from 0.52% at the beginning of the month to 0.57% at the end of the month, while 10-year Canada’s rose from 1.43% to 1.54%. The U.S. yield curve acted similarly, with 2-year treasuries starting the month at 0.63% before finishing at 0.72%, while 10-year treasury yields ended the month at 2.14%, up 11 basis points. NWM Bond performed well in this environment, up 0.4%, with all our alternative managers in positive territory. Predictably, the PH&N Short Term Bond Fund, which has minimal credit and interest rate risk, was flat.
High yield bonds were also higher in October, with NWM High Yield Bond up 0.4%. All of the gain is attributable to a rally in credit spreads as the Canadian dollar actually increased last month and our U.S. dollar credit investment lost ground when translated back into Canadian dollars.
Global bonds also benefited from a global rally in credit, with NWM Global Bond up 0.6%.
The mortgage pools continued to deliver consistent returns, with NWM Primary Mortgage and NWM Balanced Mortgage returning 0.3% and 0.4% respectively in October. Current yields, which are what the funds would return if all mortgages presently in the fund were held to maturity and all interest and principal were repaid and in no way is a predictor of future performance, are 4.5% for NWM Primary Mortgage and 5.8% for NWM Balanced Mortgage.
If fully invested, the Balanced fund’s current yield would be 6.0%. NWM Primary Mortgage had no cash at month end and was actually into its bank line of credit by $2.6 million. We would expect this situation to correct itself over the next 90 days as six existing loans are coming due and expected to be re-paid. NWM Balanced Mortgage had 3.1% in cash as 12 new loans for a total of $23.6 million were added last month.
The preferred share market rate reset posted a positive 6.5% for the month of October while NWM Preferred Share returned 6.3%. October was the first month this year where rate resets had a positive month, hopefully marking the bottom of the market. Banks took center stage during the month as BMO announced a $600 million private placement at 5.85%. Although the BMO issue was purchased privately and did not trade on the exchange, market participants were quick to re-price outstanding issues and other banks fell in sympathy. The new deal also highlighted concerns over bank capital ratios and regulatory oversight on maintaining strong balance sheets for critical financial institutions. Royal Bank may be next on deck to issue a new preferred share to shore up its capital ratios although some of the risk has abated after they were not included on a list of globally systemically important banks.
Canadian equities were stronger in October, with the S&P/TSX up 2.0% (total return, including dividends). As we will discuss further in the market commentary, Valeant had a material impact on the performance of the S&P/TSX Index during the month, which without Valeant, would have increased over 4%. NWM Canadian Equity Income (former Strategic Income Fund) and NWM Canadian Tactical High Income gained 4.5% and 3.7% respectively last month. Both benefited from not holding any positions in Valeant. The cash position in NWM Canadian Equity Income is currently just under 4% and approximately 5% of our positions are covered.
Our top performing names in October were Canfor, Methanex, and Rogers Communication. No new names were purchased, though we added to our existing holdings in Canadian Tire and Progressive Waste. As for NWM Canadian Tactical High Income, we added a position in Diversified Royalty Corporation and added to our existing positions in KP Tissue and Ag Growth. The fund’s top performer was also Methanex, both the long stock, and a short put position.
Foreign equities were stronger in October, with NWM Global Equity up 4.6% compared to a 5.4% increase in the MSCI All World Index and a 5.8% advance in the S&P 500 (in Canadian dollar terms). Of our external managers, Pier 21, Carnegie and Edgepoint led the way with both up 4.6%, followed by BMO Asia Growth & Income +3.6% and Lazard Global Small Cap +1.2%. NWM U.S. Equity Income was up 8.5% in U.S. dollar terms and NWM U.S. Tactical High Income +6.7% versus an 8.4% increase in the S&P 500 (all in U.S. dollar terms).
Strong performers in the month included Blackrock and Ingersoll Rand, which bounced back after a difficult September. There were no new purchases in NWM U.S. Equity Income. The fund has a cash position of 3.5% and 9% of the fund is covered. As for NWM U.S. Tactical High Income, U.S. Silica and Microsoft were top long stock performers, while short put position in Microsoft and Blackrock also benefited the fund in October. No new long positions were added during the month.
Real estate had a strong month in October, with NWM Real Estate up 0.9%, same as the iShares REIT ETF.
NWM Alternative Strategies was down 1.3% in October (these are estimates and can’t be confirmed until later in the month). Of the Altegris feeder funds Winton, Millenium and Brevan Howard, were down 3.3%, 2.2%, and 2.7% respectively. We have exited our position in Hayman and directed the proceeds towards a new manager, Citadel, which was down 1.4%. All the Altegris managers are priced in U.S. dollars. This does not mean that they only hold U.S. dollar assets, though it is likely the performance of the U.S. dollar does impact the performance of these managers when translated back to Canadian dollars. Winton, for example, trades exclusively in futures contracts, both long and short. While their actual positioning may be positively or negatively correlated to the U.S. dollar, the collateral on their futures positions is held in short term U.S. treasuries.
With the U.S. dollar down 1.8% versus the Canadian dollar in October, Winton’s performance in Canadian dollar terms was negatively impacted. Our other alternative managers fared better in October, with MAM Global Absolute Return Private Pool +1.9%, RBC Multi-Strategy Trust +1.3%, RP Debt Opportunities +1.2%, and Polar North Pole Multi Strategy +0.9%.
Precious metals also had a good month, with NWM Precious Metals up 1.2% in October. For the year, the fund is now back in positive territory, +0.9%. Helping the fund in October was the positive price action in gold bullion. Gold was up 2.4% in U.S. dollars and 0.6% in Canadian dollars. For the year, gold is now up 8.5% in Canadian dollars. Near term, gold will likely come under pressure as the Federal Reserve prepares to raise interest rates. Because we expect the increase in rates to be gradual, we expect the impact on gold to be short lived. Also, while the U.S. may raise rates, Japan and Europe continue to print money.
OCTOBER IN REVIEW
After a volatile August and September, that included a five day span that saw the S&P 500 decline nearly 11%, markets regained their footing in October with U.S. markets regaining nearly all the losses incurred the previous two months. Up 8.4%, the S&P 500, in fact, turned in its best monthly performance in 4 years and drove year to date returns back into the black by 2.7%. Canadian stocks also rallied, gaining nearly 2%, but were weighed down by the unfolding drama at pharma behemoth Valeant. At its peak, Valeant’s weight in the S&P/TSX topped 6%, however the stock’s 50% decline last month lopped over 2% off Canadian Equity Index returns in October. Valeant has continued to come under pressure in early November. Of course the Canadian equity market has more than just Valeant to blame for its -5.2% year to date return, with the materials and energy sectors down 15% and 19% respectively.
What helped the markets rally in October was a more bullish view of the main issues worrying investors over the past few months, namely Federal Reserve interest rate tightening, declining corporate earnings, and a slowing Chinese economy. The first one should be a non-issue.
Federal Reserve chairwoman Janet Yellen has been doing her best to be as transparent as possible regarding the intentions and strategy of the Federal Reserve so markets will have time to adjust. Why then have Traders been betting against a rate increase before the end of the year until just recently, despite top Fed officials, including the women herself (chairwoman Janet Yellen), indicating for months the U.S. economy was nearly ready for short term rates to rise from near zero percent? Because traders don’t believe that the Federal Reserve, despite their best intentions, will be able to pull the trigger and raise rates this year.
The biggest stumbling block continues to be inflation, which has remained stubbornly low. With inflation stuck below the Federal Reserves 2% target, many feel the risks of tightening too soon and driving the economy back into a recession far out weigh the risk of tightening too late and having to more aggressively tighten monetary policy if the Fed falls behind the curve and inflation accelerates.
Another consideration is the U.S. dollar. While the U.S. ponders a rate increase, China, Japan, and Europe have been doing everything they can to lower interest rates. China, in fact has cut short term interest rates six times in the past 12 months, while Japan and the Euro-zone, having already cut rates to zero (or in Europe case, below zero), continue to buy government bonds in an attempt to lower bond yields and increase money supply. That their currencies might be negatively impacted is an added benefit.
If the Fed ends their Zero Interest Rate Policy (ZIRP) capital will find the stronger U.S. economy and higher interest rates very appealing, resulting in an increased demand for U.S. dollars, which would be bad for U.S. companies exporting goods overseas.
A stronger dollar is also particularly hard on emerging market economies that run current account deficits and need the foreign capital, or even worse, have borrowed in U.S. dollars. While higher U.S. interest rates are the last thing the emerging markets want to see, the uncertainty created by the Federal Reserve’s indecision is potentially even more damaging.
Most realize rates will need to rise at some point and want the Fed to just get on with it. Emerging market securities and commodities, in general, rallied last month as the odds of a Fed rate hike became more remote. A strong October U.S. jobs report released in early November, however, turned the tide, with most traders and economists now believing the Fed will move in December, which will likely put the spotlight back on the developing world, which according to the IMF, now accounts for 40% of global GDP.
Janet Yellen and the Federal Reserve desperately want to raise interest rates. By getting rates off zero, the U.S. leaves open the option of cutting interest rates if the economy does slow, which it will at some point. Right now, the only option open to the Fed is more quantitative easing, or perhaps following Europe down the road of negative interest rates.
Janet Yellen’s credibility is also at stake. She has continuously indicated the economy is almost ready for higher rates and explicitly points to December as the likely date for lift off. Further delays would lead investors to believe the Fed’s strategy had changed and the economy is weaker than expected. For this reason, U.S. interest rates probably will increase in December, and the capital markets will probably react poorly, but not for long.
Even if the Fed does begin tightening in December, they will go very slowly. 25 basis points in December, and then maybe another 25 basis points in January. Maybe. Remember, interest rates are at zero, and have been for nearly seven years. Does it really matter when or if they raise 25 or 50 basis points? A recent WSJ poll of business and academic economists shows an over whelming 92% believe the Fed will raise rates in December, but more and more traders are getting tired of the question and see the issue as more of a distraction. We agree.
Of more immediate concern are corporate earnings, which are on track to contract for the second consecutive quarter. Even more concerning, revenue and earnings are both forecast to decline, the first time this has happened in six years.
The energy companies are a major reason why, with sales in the oil patch expected to fall by a third and earnings forecast to decline nearly 70% year over year. It’s not all about oil and gas, however, the strong U.S. dollar and weak global growth are also factors in driving corporate revenue and earnings lower.
More recently, analysts have also started to point to higher wage gains as a future risk, concerned they could weigh on profit margins, which excluding financials and energy, continue to hit record highs. Corporate America has done a good job keeping wages low and cutting expenses to the bone. The fat has been trimmed. Many also fear earnings have been supported artificially by mergers and acquisitions, and big deals are becoming harder for companies to find.
According to data compiled by the University of Southern California, it is estimated nearly 33% of the industries U.S. companies compete in are too concentrated, and nearly 66% of all publically traded companies in 2013 face more concentrated markets than they did in 1996. Household appliances, mobile phones, air travel and grocery stores are all cited as examples of industries where consumers are faced with a dearth of options.
If the decline in corporate earnings continues, does it portend a slowdown, or even recession, in the overall economy? Not necessarily. While 68% of S&P 500 corporate earnings come from the manufacturing and goods producing sectors, it actually only employs 14% of the U.S. workforce.
The statistical decline in S&P 500 earnings is not necessarily giving a clear picture of the overall U.S. economy where service industries supply the bulk of the jobs. Still, it is a concern, especially given the expected rise in interest rates and elevated stock valuations as a result of the recent rally in stock prices. A recovering U.S. economy and low (but very gradually increasing) interest rates mean equities should continue to provide decent returns over the near term. We worry more about earnings and stock valuations than higher interest rates, but both should be manageable for the markets. Volatility will remain elevated, but traders should generally read through the noise.
THE CHINESE ECONOMY
China is another matter. China scares traders. Not just because they suspect growth might be slowing more than the Chinese government is letting on, but because they have no real visibility on whether this is true or not. Like with the timing of the Fed’s first hike in rates, the markets hate uncertainty and nobody does uncertainty better than the Middle Kingdom.
In mid-October, China reported third quarter Chinese GDP of 6.9%, below the 2015 target of 7% set by Chinese leaders at the beginning of the year, but higher than the 6.8% most economist were forecasting. With exports falling 6.9% in October, now the fourth consecutive month of declines, many were expecting much worse.
The manufacturing sector has seen 44 straight months of deflation and industrial production continues to decelerate, growing a worse than expected 5.6% in October, its slowest pace since the financial crisis.
Perhaps an even more damning sign that China is slumping is the fact imports fell 18.8% in October after plummeting 20.4% in September, and are down 15% year over year in the first nine months of the year. According to the Li Keqiang Index, which tracks electricity production, rail-freight, and bank lending as a proxy for Chinese GDP growth (given it is easier to obtain the data and harder for Chinese officials to fudge), China’s economy grew closer to 3%. We think this might be a bit extreme, but we suspect growth is a lower than 6.9%.
Not to worry, China has lots of options to prevent the economy from suffering a hard landing. After all, only last June China’s foreign exchange reserves topped an unheard $4 trillion – more than enough to shore up any domestic stimulus ventures. Fast forward to today, however, and China’s reserves are reported to be $500 billion lighter, falling 12 of the past 15 months and nearly $100 billion in August alone.
In fairness to Chinese policy makers, $3.5 trillion is still a very large amount of money, but it is unlikely all of it is held in liquid investments, such as government bonds, and thus cannot all be counted on in a crisis.
In addition, the IMF recommended foreign exchange holdings for a country the size of China, with capital controls and a fixed exchange rate, is estimated by the Royal Bank of Scotland to range between $1.6 to $2.6 trillion, meaning China might not have as much of a runway as once thought.
The Chinese Academy of Social Sciences, a government think tank, is worried that if China continues to loosen capital controls before more attractive investment opportunities are created, the flow of capital will accelerate. In a worse-case scenario, they estimate nearly $5 trillion in capital could leave China.
No wonder investors are concerned. Slowing growth, increasing debt, and capital outflows, these are not good signs. One can get too pessimistic, however. Remember, China is in the midst of rebalancing its economy away from heavy industry and investment and towards domestic consumption. Slowing growth was always going to be part of the program, and there are signs the plan is working.
While third quarter’s 6.9% GDP growth was the slowest since the global financial crisis, the service sector expanded 8.4% and accounted for more than half China’s economic growth for the first time ever, a conservative measure given most small businesses are not included in governments numbers.
Movie box-office sales are up over 50% in 2015, as is internet traffic on mobile devices. Civil aviation and railway passenger traffic are also showing nice growth. Even the downtrodden commodity sector is showing the transformation is on track.
Goldman Sachs recently pointed out consumption of commodities such as gasoline and coffee, which are more consumer oriented, are increasing, while industrial related commodities, like cement and steel, and are declining. In perhaps the best example of the Chinese economy’s split personality, while industrial production grew a disappointing 5.6% in October, retail sales have tracked higher the past six months and grew 11% in October, with car sales up 13%.
Perhaps Chinese stocks have started to reflect the strength of the growing consumer sector in China, as the Shanghai Composite was up 10.8% in October. In early November, in fact the Shanghai Composite hit bull market territory, increasing more than 20% off of lows hit on August 26th. Chinese stocks are still down over 30% from its high of June 12th, however.
Recent economic news from China has been more positive and the economy appears to be stabilizing. This likely helped market sentiment in regards to Chinese stocks. We don’t know how sustainable this is, however, and remain concerned with the lack of visibility in China and the impact on the markets this uncertainty will bring.
We would become more concerned if Chinese leaders start to roll back reforms and go back to relying on investment and exports to drive growth. This would be a sign the economy is slowing faster that China feels comfortable and the transition is failing. With China’s growing corporate debt levels, the old way is not sustainable.
Market volatility could remain elevated as the U.S. starts to raise interest rates. In combination with a stronger dollar and higher wages, increased pressure on corporate earnings will put further scrutiny on already high valuations. A recovering U.S. economy should carry investors through the uncertainty, however, as long as China is successful in rebalancing their economy and engineering a soft landing.
THE U.S. ECONOMY
Third quarter GDP came in at a modest 1.5%, decelerating considerably from the previous quarter’s 3.9% pace with a drawdown in business inventories detracting nearly 1.5% from growth. The decline in inventories could be seen as either a one-time event that may result in growth snapping back in Q4 or indicative of a cautious business sector trying to slim down in anticipation of lower demand and sluggish global growth.
Manufacturing and the industrial sector in general, were weak, mainly due to weaker exports and a declining energy sector. The Institute for Supply Managment (ISM) Manufacturing Index hitting a two year low, and while it is still in positive territory, this is the fourth month in a row it has declined.
What is working for the economy, however, is consumer spending, which increased a reasonable 3.2% in Q3, and residential investment, which increased 6.2%. Backing up these numbers was the ISM Non-Manufacturing Index, or Services Index, which is more closely influenced by the domestic economy and continues to move higher.
While the domestic U.S. economy continues to trend higher, the picture for the rest of the world is a lot murkier. In early October, the International Monetary Fund (IMF) cut its growth forecast for global growth this year from 3.3% to 3.1% and next year from 3.8% to 3.6% and believes there is a 50% chance growth could drop below 3% in 2016, a level it has said in the past is “equivalent to a global recession”.
The IMF is particularly concerned with emerging market economies and fear we could see the first net capital exodus from the developing world in 27 years. Brazil was highlighted as suffering the biggest downward adjustment in their forecasted GDP growth rates for 2015 and 2016, with Canada taking the number two spot.
Other forecasters are not so gloomy, with Lombard Street Research recently turning bullish on global growth, believing the Western world is just at the beginning a long recovery with the JP Morgan/Markit Index of global factory orders hitting a five month high in October.
Backing up this indicator, strength can be seen in a number of European manufacturing indexes, especially Britain’s which hit a 16 month high, despite sporting what many consider to be an over-valued currency. Japan also reported stronger industrial numbers, as has China to a degree. Of course, as noted above, China remains somewhat of a black box and much of the recent rebound could be as a result of recent government stimulus.
A bit of a mixed bag for the U.S. economy. Consumer spending and the domestic economy remain sound.
October was a good month to be looking for a job in the U.S., with just over 270,000 new workers finding work. August and September’s gains were also revised a combined 12,000 jobs higher, bringing the average monthly job tally this year to 206,000.
With the unemployment rate falling to 5%, the U.S. labour market is within a whisker of the long run normal rate set by the Federal Reserve. As if this were not enough good news, there were signs wage growth may finally be starting to emerge as average hourly earnings of private-sector workers rose 2.5% last month. With this strong jobs report, many now believe the Federal Reserve has the green light to raise interest rates in December.
It wasn’t just the topline numbers that were strong last month, the quality of the report was also very high as most of the gains were non-government and full time, with professional and business services adding 78,000 jobs, trade and transportation +51,000, and construction +31,000. Only manufacturing disappointed, with employment basically flat during the month.
In general, jobs growth has been more robust in domestically oriented and service related sectors. Retail, for example added 44,000 positions, and while some of this was likely seasonal, as merchants geared up for Christmas, the trend in retail hiring has been positive for quite some time. Employers, in fact, are beginning to find it harder and harder to find and keep qualified workers and this is one of the reasons wage growth has been moving higher. Same in the trucking and construction sectors. These are industries with less than ideal working conditions so in a tight job market, employers will have to increasingly entice workers with higher wages.
Overall, a very strong month for job growth, and further enforces our optimism in regards to the strength of the U.S economy.
With the stronger jobs report likely giving the Fed the green light to finally start raising interest rates, inflation continues to be the one indicator flashing red. Core CPI moved up to 1.9% in September, just below the Fed’s 2% target, but headline inflation actually fell 0.2% versus the previous month and is up only 1.3% year over year. Energy prices are the main reason for the volatile monthly numbers, but even the Federal Reserve’s preferred Core PCE Index has inflation increasing only 1.3%.
Food prices look like they might be firming and could add some future support, as could higher housing prices, but a stronger dollar would work the other way and lower the cost of imported goods. Given the low level of inflation, social security recipients will receive no cost of living increase next year, only the third time in 40 years this has happened. According to the index used to calculate the increase, recipients should have actually taken a pay cut, but this is not how the government rolls.
Consumer confidence receded slightly from preliminary levels reported earlier in the month but is still up from September’s reading and levels reported last year.
Retail sales in September came in below expectations, likely due to concerns over global growth and a sub-par jobs report. Overall spending remains reasonable, as can be seen by a 3.2% increase in consumer spending, but Americans are choosing to buy bigger ticket items like cars, furniture, and iPhones rather than general merchandise.
An early read on October sales shows trends continuing to deteriorate for department stores and apparel companies, despite the stronger consumer confidence and the robust job market noted above. This is a bit perplexing, and somewhat worrisome. There are many different trends impacting retail so the weakness isn’t necessarily a negative sign for the general economy, but it is a concern and warrants further scrutiny.
The housing market remains in good shape and is moving in the right direction, with existing home sales growing at their second highest pace in eight years and inventories remaining tight. Builder confidence hit a 10-year high and housing starts increased a robust 6.5% over August levels.
Given these numbers, it was a bit surprising that new home sales were down in September and inventories moved higher. The new home market is considerably smaller than the existing home market, comprising about 10% of total sales, so we’ll chalk up September’s weak result to timing and perhaps mix, as new home builders have been concentrating on the upper end market of late.
The biggest hurdle for home builders lately hasn’t been demand, but rather lack of workers. Given the industry has shrunk by about 676,500 workers since the peak in 2007, builders are finding it difficult to hire back tradesmen who have since moved on to other industries. CastleRock Communities LP estimates it now takes 155 days to build a home compared to 115 days before the housing bust given all the delays in scheduling work. This means profit margins are likely to compress as wages are going to need to rise, one of the reasons we like the housing market, but not the builders.
A continued recovery in the U.S. housing market is another reason we like the U.S. economy.
The U.S. trade deficit declined in September as exports grew 1.6%, its biggest jump since early 2014. Also helping shrink the deficit were imports, which fell 1.8%, mainly due to lower oil prices. Petroleum imports, in fact, hit 11- year lows in the month.
While September’s results are good news for the U.S. economy, it should be remembered that exports only represent about 12% of U.S. GDP. In addition, the gain in exports was attributed to increased foreign purchases of artwork, antiques and jewelry, which is likely not sustainable. Many still fear the weak global economy will continue to hurt U.S. exports in the coming months.
The strong job market and recovering housing market both seem to be moving in the right direction for the U.S. economy. The only thing that worries us is the U.S. consumer and some weakness we are seeing in some retail markets. More about this next month.
THE CANADIAN ECONOMY
Canadian GDP increased for the third months in a row in August, following five consecutive months of contraction, and Q3 GDP is forecast to increase 2.5% after falling 0.1% in Q2. The Bank of Canada is forecasting growth of 2% for all of 2016, and 2.5% in 2017, with low oil prices continuing to pressure business investment. Manufacturing was stronger in August, but the services sector grew only 1.5%.
The Canadian consumer has been remarkably resilient but may be finally running out of steam. This could be an issue as it is questionable whether the manufacturing sector can pick up the slack. The new Liberal government’s campaign promise to increase infrastructure spending and reduce taxes (for everyone but you, of course) could provide a short term boost and give the recent interest rate cuts and lower Canadian dollar time to work through the system.
Canada added a sizable 44,000 new jobs in October, but the quality was low with an estimated 32,000 temporary election workers swelling the ranks. Still, Canada has now had four month in a row of positive job growth and the unemployment rate fell to 7%, and wage growth at a strong 3.1%. Ontario and B.C. led the way, adding more than 20,000 new jobs. Not surprisingly, Alberta remains the weak link, losing 11,000 jobs last month with the unemployment rate in the province increasing to 6.6%. Nationally, the resource sector shed 8,000 jobs while the construction industry lost 9,000. Overall, not bad considering the 50% drop in oil prices.
Headline inflation hit its lowest level since June in September as gasoline tumbled almost 8%. Ex-energy, however, headline CPI would have been 2.1% as every major segment outside of transportation, which contains the energy component, was higher than the overall Consumer Price Index (CPI) total and had a mean reading of 2.5%.
Core inflation is also pointing to higher inflation, coming in at 2.1%, though the Bank of Canada points out that the weak Canadian dollar is likely playing a role in the elevated core number and believes the impact to be transitory. The Bank of Canada thinks underlying inflationary trends in Canada to more like 1.5% to 1.7%.
Retail sales remain strong in Canada, increasing for the fourth month in a row, though falling consumer confidence in October could result in more mixed results later in the fall. As in the U.S., Canadian consumers are concentrating their spending power on big ticket items like cars and furniture, likely taking advantage of low interest rates.
Existing home sales declined in September, but only because recent sales have been unusually strong. Same for new home construction. Housing starts were down sharply in September, but August levels were at 3-year highs. At just under 200,000, Canada is still building more new dwellings than normal demographic trends would dictate. This is a concern, and points to a future slowdown in the construction industry. Fortunately, the housing market appears balanced, with just under a six month supply of homes available for sale. If the employment market remains firm and interest rates don’t spike higher, we would expect a gradual moderation rather than a crash.
The impact from lower the Canadian dollar was evident in Canada’s balance of trade in September as exports were driven higher with consumer goods leading the way. Imports also fell, with metal and non-metallic products driving the bulk of the decline.
So far, so good for the Canadian economy. The energy sector is impacting growth in the West (B.C. excluded) but manufacturing is picking up some of the slack. The big risk would be if the housing market suffers a hard landing before the energy sector recovers. Housing is punching above its weight class right now, and needs to normalize. Like the U.S., we also worry about the consumer. Canadians have been spending beyond their means and consumer debt remains high. We don’t see this continuing in the future. A cheap loonie will help, as will more infrastructure spending. The biggest thing the Canadian economy has going for it is a strong U.S. economy.
What did you think of October’s economic activity? Let us know in the comments below!This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information presented here has been obtained from sources believed to be reliable, but not guaranteed. NWM fund returns are quoted net of fund level fees and expenses but before NWM portfolio management fees. Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value.