Canada’s Steady Rebound

By Ari Charney • October 2, 2013 • Canadian Edge Weekly

Canada’s economic growth picked up in July, as gross domestic product (GDP) grew 0.6 percent month over month, beating economists’ expectations by a tenth of a percentage point. That number largely offsets the prior month’s decline of 0.5 percent, which resulted from historic flooding in Alberta and a province-wide strike in Quebec. Among the underlying numbers, construction showed the strongest gain, up 1.9 percent after June’s decline of 2.1 percent.

According to Bloomberg’s weighted average of economists’ forecasts, Canada’s third-quarter GDP is expected to grow at an annualized rate of 2.24 percent, while full-year GDP is forecast to come in at 1.7 percent, flat compared to last year’s result. Over the medium to long term, Canada’s central bankers still anticipate the country’s rotation toward greater export activity and business investment.

In his remarks on Sept. 18 before the Vancouver Board of Trade, Bank of Canada Governor Stephen Poloz discussed what is necessary for the Canadian economy to return to natural growth–the sort of economic growth fueled by entrepreneurialism as opposed to monetary easing. Though he noted that Canada is in the enviable position of having regained all the jobs lost during the global downturn, while adding 600,000 new jobs since then, the creation of new firms has been sorely lacking.

In fact, Poloz observed that in the five years since the Global Financial Crisis, the population of companies in Canada has been essentially static, with virtually no net increase. Meanwhile, the number of Canada’s exporters, particularly manufacturers, declined during the recession and have remained flat since then. Prior to rejoining the Bank of Canada, Poloz served as the CEO of Export Development Canada, the government’s export credit agency, so he is understandably focused on restoring growth to this sector of the economy.

The central bank chief then proceeded to describe the creation of new companies as a “natural engine for growth” via job creation and the resulting spending from new incomes. This comports with studies conducted in the US that examined the types of companies that are the biggest drivers of job growth. Researchers discovered that contrary to the conventional wisdom about small companies leading job creation, the size of the company is less important than its relative youth. In other words, a proliferation of young start-up firms is necessary to engender what Poloz described as “a virtuous cycle of self-sustaining growth.”

And while Canada’s resource sector has invested substantially in projects and infrastructure, accounting for three-quarters of the growth in business investment during the recovery, Poloz lamented that other sectors have held off on such investment. In particular, companies cited concerns over the health of the global economy, as well as uncertainty about the strength of Canada’s domestic demand, as key contributors to their caution.

But Poloz shared some heartening data, including a stronger-than-expected pace of new firm creation over the past year, as well as the fact that most of the new jobs created since the downturn have been high-skilled jobs with above-average levels of income. And Poloz concluded his talk with an upbeat tone, as he sees many of the preconditions for a rebound already in place, including exporters diversifying toward faster-growing emerging markets.

In similar remarks delivered before the Economic Club of Canada on Oct. 1, Poloz’s deputy, Tiff Macklem, zeroed in on the precise contribution exports and business investment will have to make toward economic growth for a resurgence in the economy. He said that the economy will have to grow at least 2.5 percent annually for demand to outpace supply, and given that household and government spending are expected to contribute about 1.5 percentage points toward that end, business investment and exports will need to deliver at least a full point. Unfortunately, as Macklem notes, over the past year the latter two components have made no contribution to growth.

Both central bankers pointed toward a nascent recovery in the US economy as a source for optimism. But in the near term, the US economy perhaps faces a significant challenge from the government shutdown, which analysts at Goldman Sachs believe could shave 0.2 percentage points annualized to 0.4 percentage point annualized from fourth-quarter GDP, depending on the shutdown’s duration. And, of course, it’s impossible to quantify how the resulting uncertainty from the shutdown will affect business decisions.

For now, economists predict that Canada’s growth trajectory will improve incrementally over the next two years, with GDP finally exceeding Macklem’s threshold of 2.5 percent annual growth in 2015.

Here’s where to find our analyses for Portfolio Holdings that have reported earnings for the second quarter of 2013:

Conservative Holdings

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