Is the Canadian economy in trouble?

By Kevin Press, BrighterLife.ca

Bank of Canada Governor Mark Carney [l] & Finance Minister Jim Flaherty

“Conditions in the international financial system are fragile.” That is how the Bank of Canada chose to begin its latest Financial System Review, released on June 14. The report goes on to note that our domestic financial system “continues to be robust.” But that good news comes despite a host of risks to the system and to the Canadian economy, including the eurozone sovereign debt crisis, a slowdown in other advanced economies and potential trouble in the Canadian residential real estate market. Consistent with December’s report, the Bank says the risks facing the Canadian financial system are “high.”

I was in to see Sadiq Adatia, chief investment officer of Sun Life Global Investments, last week so I asked him what he thinks about the outlook for Canada. He wasn’t optimistic. After talking about his confidence in the U.S. recovery, he told me: “Canada is turning a corner too, but in the opposite direction.” We may not see gross domestic product growth above 2% this year.

Adatia sees five problems:

• Household debt. “We’ve had a great run in our markets, fuelled by consumer spending,” Adatia told me. “Consumers have added a ton of debt to their balance sheets.” Indeed, we learned on June 15 that Canada’s household credit market debt (consumer credit, mortgage and loan debt), measured as a percentage of personal disposable income reached 152% in the first quarter of this year. That’s a new record. Actual borrowing has slowed, but income has too. According to the Bank of Montreal (BMO), the percentage of Canadian households with debt-service ratios above 40% of income – a level considered to be vulnerable by lenders – has risen over 6%. That’s “slightly above the past decade norm,” reports BMO.

• Housing prices. Adatia thinks a double-digit drop in prices is possible. “We think there’s going to be a pullback across the board,” he said. “Some regions may be hit harder than others, but I think a 5%-to-15% drop is definitely in the cards.” That may be a conservative call. Across Canada, home prices are up 12% relative to where they were before the most recent recession.

• Global factors. No surprise here: There’s trouble in Europe, a slowdown in China and the U.S. recovery (while it gives Adatia reason for optimism) remains vulnerable to global economic factors. These are all potential threats to Canada. By the way, Adatia does not believe there will be a hard landing in China.

• Rising interest rates (eventually). Adatia doesn’t expect the Bank of Canada to move on rates this year, but they may start to come up in 2013: “Until we see a better resolution in the eurozone and a stronger U.S. economy, the Bank of Canada is not going to jump out too far ahead, particularly given that the U.S. Federal Reserve has already said it’s not going to raise rates until 2014.” When it happens, higher rates will dampen spending by a lot of highly indebted households.

• Unemployment. “We’re probably going to see unemployment move up,” said Adatia. “I’m not convinced the employment picture is really as strong as it looks right now.” The four points listed above could each contribute to job losses.

Are we headed down a path similar to the one Americans took toward the end of the last decade? “These are the same things that were going on in the U.S. economy before it faltered,” Adatia told me. “We’re probably where the U.S. was a few years back.” Meanwhile, the U.S. housing market is showing signs of stabilization and according to the Federal Reserve Bank of New York, Americans have slashed their debt by about $100 billion since the fourth quarter of 2011.