Since the start of the year, I have been hard pressed to meet anyone on my travels across Canada who is bullish about the outlook for the Canadian economy and financial markets. Global investors would appear to agree.
The US administration is pursuing a highly protectionist trade agenda, threatening to withdraw from NAFTA and imposing steep tariffs on steel and aluminum imports. Canada may have dodged this most recent bullet, but the administration has now tied a successful NAFTA negotiation to the metals tariff exemption. The Republicans passed a sweeping round of tax cuts and spending increases, boosting the competitiveness and strength of the US economy. Washington has sought to roll back burdensome regulations at a time when provincial and federal governments here are raising minimum wages and rolling out carbon emission reduction policies. Meanwhile, Canadian oil sits trapped in Alberta at a steep discount to global crude prices. And just this week in its Quarterly Review, the Bank of International Settlement is again sending an early warning signal about the potential vulnerabilities related to the sharp expansion of credit in Canada in recent years.
The combined effect of this uncertainty overhang – from global trade tensions to domestic debt growth to tax law changes to interprovincial disputes over east-west pipeline access – has weighed on Canadian investment activity. According to Statistics Canada, new foreign direct investment has fallen for the second year in a row, declining 27% between 2016 and 2017 (see the chart below).
Reflecting the sour mood over Canadian investment opportunities, the loonie is one of the worst-performing major currencies versus the US dollar over the past year. Although the Loonie has, in fact, strengthened versus the US dollar over the past year, it has weakened versus most major global currencies (see the chart below). Whereas the Canadian dollar is up just over 3% versus the US dollar in the last 12 months, the Swiss franc, Japanese yen and Chinese yuan have appreciated in the high single digits, while the euro and British pound have strengthened in the teens. In general, we would expect the Canadian dollar to appreciate versus the US dollar amid an improving global equity market, and this time is no different. But the loonie’s resilience doesn’t appear to be a sign of a robust competitive landscape in Canada.
As my colleague, Richard Turnill, notes in a recent blog post, the US dollar has been steadily weakening because of an improved outlook for investment activity globally and a reduced need for precautionary savings to be tucked away in US dollar safe-haven assets. Clearly, if this is the case, Canada has not exactly been a standout beneficiary of this more constructive global investment view.
A quick survey of global equity indices over the past year also supports this rather dim view of the Canadian investment opportunity set. While Canadian stocks aren’t the worst performers over the past year (the Brexit-beaten UK stock market has done worse), they’re pretty close to the bottom of the pack (see the chart above). Although Canadian earnings have been holding up well, the market has cheapened relative to global stocks likely on account of the uncertainty overhang.
The relative underperformance of the Canadian dollar and stocks are sending a similar message: there are better opportunities elsewhere. In our view, we prefer emerging markets, Japanese equities and US stocks given the healthier earnings prospects. That said, we would caution against taking too negative a stance on the Canadian stock market, given that there’s already a lot of bad news reflected in the price. At this stage, as long as conditions don’t get materially worse (a rather herculean assumption perhaps, given the trade tensions along our southern border), we think Canadian stocks could start to finally attract some investor interest.
Correction: an earlier version of this post included a chart of net flows into Canadian securities, which has since been removed due to data irregularities.