Thought of the Day - July 15 - Economic Update

I have held off on this for a while, but figure what the heck. Standard disclaimer, do not use for investment planning, this is not financial advice: "I know nothing of what I speak".

Okay let's start off with what we sort of know:

• Private sector economists expect the economy to contract 6.8% in 2020, which would be the sharpest drop since the Great Depression;

• Some 5.5 million Canadians, or 30% of the workforce, have either lost their jobs or seen their hours significantly scaled back during March and April. While there has been some recovery with reopening this is just the first step in massive employment displacement (https://clifffraser0.wixsite.com/covid-19/post/thought-of-the-day-july-7-coronavirus-and-employment-turnover)

• Direct COVID support to individuals and businesses will total $212 billion this year, driving Federal spending levels to their highest since 1945. The recession has also taken a toll on revenue, which will drop as a share of the economy to the lowest since 1929;

• Canada's economic response plan reflects nearly 16% of GDP in total support, a level not seen since World War II;

• Canada's Federal deficit (meaning annual increase in Federal debt) has swollen to $343 billion (most economists only expected a deficit of just over $250 billion). Moreover Canada's Federal spending (and debt increase) has been at record levels for a number of years, COVID just exasperated it. The federal debt-to-GDP ratio is expected to rise to 49.1% in 2020-21 from 31.1 % in 2019-20;

• And remember this is not only Federal story. The combined provincial deficit increases will probably surge six-fold to $100 billion. Yesterday, James mentioned BC is probably looking at a 12.8 billion dollar shortfall (https://clifffraser0.wixsite.com/covid-19/post/thought-of-the-day-june-24-the-bc-economy).

Fitch Ratings has already stripped Canada of its AAA status, making us the first top-rated country to be downgraded during the pandemic. Canada still has a AAA rating with S&P Global Ratings, making it only one of two countries left in the Group of Seven to hold that status; Germany is the other. Moody’s Investors Service also gives Canada its highest rating. “The question is what took so long. Canada’s excessively leveraged national balance sheet has looked a lot like China, Italy and Greece for quite a while,” said David Rosenberg, founder of Rosenberg Research and Associates and former chief North American economist at Merrill Lynch & Co. “This won’t be the last ratings cut, I can assure you.” He had predicted the downgrade in an April research note that said the “Great Canadian Debt Surge has come home to roost.”

The effect of a downgrade is that Canada needs to pay more money for financing and servicing our growing debt. Trudeau is justifying the shortfall as the lesser of two evils. The prime minister argued the economy would be in much worse shape were it not for the government’s response, in part it is needed to thwart households taking on more debt.

Oh and hey this is a worldwide story. Actually Canada is doing better than many (https://clifffraser0.wixsite.com/covid-19/post/thought-of-the-day-june-19-canada-will-do-better-than-most).

But let's take a quick look at the markets - they should be a reflection of how well economies are performing and an indication of things to come, right?

Concerning the US markets here is a great quote from Sven Henrich of NothmanTrader that summarises what is happening in the US quite eloquently: "12 years after the financial crisis the global economy is a debt-soaked subsidy held up by zero rates and "quantitative easing" (euphemism for Fed subsidies) showing zero structural growth while desperately hoping that a cheap money-fueled asset-bubble, heavily concentrated in a few monopolies, doesn't blow up".

No matter what fundamental indicators or ratios you use: market to GDP, labour market numbers, valuations to earnings multiples, share price alignment with corporate forecasts - the DOW and Nasdaq make no sense. In Q2 the US markets had their best quarter in the last 20 years. What happened to the old adage: "The markets don't like uncertainty"?

If you look at the TSX the same can be said, other than that the level of "quantitative easing" is lower and the fact that some of our bubbles monopolies in the energy sector have already burst (really only leaving telecom and banking). Together these both mean our rate of market "recovery" is lower than the US markets.

So besides those in the market getting bailed out with public funds, this has been a field day for smart short-term day traders. They are making out like gangbusters: volatile markets, heavily influenced by sentiment, that continue to see significant upside - wow.

One another front, future uncertainty, policies discouraging foreign investors, and the new CMHC mortgage restrictions should all mean Vancouver property values should continue to decline - but no, they were up 5% in the last month, 7% in the last quarter.

So in summary: free money, markets going up, precious metals & luxury items going up, against a backdrop of economic downturn and mounting government debt.

But what happens next? To be honest I am coming to the conclusion that no one really knows - we are way out in uncharted waters. For example EQ bank here in Canada offers 2% on their savings accounts, higher than their GIC rates. In contrast this level of debt assumption (a.k.a. money printing) should lead to inflation, and thus, higher interest rates should be expected in the longer term.

What it really says is the government, our financial institutions and even we, the people, are all now playing the short game.

Good luck one and all.

Cheers

Cliff