The Great White Oasis

By David Dittman • June 1, 2012 • Canadian Edge Weekly

In China a potentially tumultuous transition among top leadership as well as throughout the ranks of the Politburo Standing Committee casts a long shadow over policymakers as they consider next steps in what is sure to be a significant set of programs designed to stabilize growth.

In Europe aggressive demonstrations in Spain and messy elections in Greece are complicating efforts to “reform” banking systems saddled with loans gone sour in the aftermath of a burst property bubble and to rein in spending in the public sphere.

In the US a presidential election and a deal made a year ago to extend the federal debt ceiling make any attempt to address a deteriorating economic and employment situation dead on arrival, as partisan loyalties at this point are controlling. Thus a “fiscal cliff.”

In Canada, meanwhile, the domestic political ship is steady as she goes until Oct. 19, 2015, the tentative date of the next federal parliamentary election, and the economy, although still subject to external tumult, is in great shape relative to its developed peers.

Canada’s real gross domestic product (GDP) expanded by 1.9 percent in the first quarter of 2012, the same pace as the fourth quarter of 2011. The economy grew 0.1 percent on a monthly basis in March, according to a report today from Statistics Canada.

The GDP report is the last major data release before the Bank of Canada (BoC) makes its next interest rate decision on Jun. 5. The BoC’s target overnight rate–the rate at which major financial institutions borrow and lend one-day funds among themselves–has been 1 percent since September 2010, the longest stretch without a change in about half a century.

Way back in April Finance Minister predicted first-quarter GDP growth of 2.5 percent and suggested the BoC would have to raise its target rate before the end of the year. That prognostication looks rather silly at this point, given what may unfold in China, what’s transpiring in Europe, and the inevitable death march that will be lead-up to US elections in November.

Officials in the Middle Kingdom must contend with the pressures of an estimated 300 million-strong migrant labor force, a potential source of the dreaded instability that colors virtually all economic decision-making. Stable growth, in the eyes of China’s leadership, leads to a stable society–and preserves their station atop that society. Already steps have been taken to loosen bank reserve requirements, and the state planning agency has stepped up project approvals noticeably this spring.

Policymakers on the Continent still seem reticent to take necessary steps to create a unified fiscal authority that would cement a true common economic union. In fact some commentators have suggested that it will be Germany, which would shoulder most of the burden of rescuing the periphery and perhaps the whole of the eurozone, may be the first to depart. Leaders are creeping ever closer to a full commitment to fiscal unification, however, through mechanisms such as “Euro Bonds.”

The US Congressional Budget Office has estimated that letting current laws take effect would significantly reduce future budget deficits. At the same time, however, the CBO forecast in May 2012 that real GDP growth in 2013 would plummet to 0.5 percent versus 1.1 percent, with a high probability of recession–a 1.3 percent GDP contraction–during the first half of the year. We’ll set aside details of the sclerotic US political situation and the possibility it can cope with these complex dilemmas.

Suffice to say that the BoC won’t be raising its target rate on Tuesday. But all is not lost in the Great White North, where a long-term, bipartisan effort that got started in the early 1990s led to balanced federal budgets and a downtrend in the country’s overall debt until the Great Financial Crisis of 2008-09, which occasioned a traditional Keynesian response that had its intended, countercyclical effect.

While the world frets the decline in the official China Purchasing Managers Index (PMI) from 53.3 in April to 50.4 in May, the RBC Canadian Manufacturing PMI, also released on Friday, rose to 54.7 in May from 53.3 in April. It was above the 20-month series average of 54.3 and represented the fourth straight month the RBC PMI has increased. A PMI reading above 50 indicates expansion.

After hitting a three-month low in April the employment component of the RBC PMI showed that nearly 27 percent of employers added workers in May, the strongest rate since September 2011. This comes after Statistics Canada reported that Canada created 140,000 jobs in March and April, the biggest two-month gain in 30 years.

The output and new orders components of the RBC PMI also hit 2012 highs in May, while the rate of growth of new export orders was the fastest in more than a year on increased demand from the US and Asia. According to Cheryl Paradowski, CEO of the Purchasing Management Association of Canada, “Canadian manufacturing business conditions improved to the greatest extent since September 2011, with growth of output and new orders both at five-month highs.”

The report also revealed that inventories of pre-production goods grew at the fastest pace in the history of the RBC PMI.

The Canadian dollar has declined from a 2012 high of USD1.0199 on Apr. 27 to USD0.9626 today, its low for the year. Expectations are that slowdowns in Europe, China and the US will have a knock-on effect and decimate Canada’s resource-export-based economy.

Should the dominoes fall the BoC has capacity to reduce its target rate in a traditional way, and fiscal authorities have shown their willingness to use countercyclical spending to make up for losses in the private sector. Canada’s debt-to-GDP ratio is still among the best in the developed world.

The main Canadian equity index, the S&P/Toronto Stock Exchange Composite Index, fell faster and steeper than the S&P 500 Index and the MSCI World Index during the Great Financial Crisis of 2008-09. It also recovered faster and steeper.

And consider this, too: In the cauldron that was the month of May for global equities the S&P/TSX shed 10.27 percent in US dollar terms, including dividends. Meanwhile, the Canadian Edge Portfolio Aggressive Holdings, where we house our energy exposure, generated a negative total return of 9.65 percent. And our Conservative Holdings’ collective total return was a relatively impressive negative 7.57 percent.

Of course these figures don’t shine compared to the S&P 500’s 6.01 percent negative total return for the month. But they do look good versus the MSCI World Index and its 8.54 percent loss.

The loonie went from USD1.0146 on May 1 to USD0.9682 on May 31, a decline of 4.6 percent. And the fundamentals supporting the Canadian dollar suggest a snapback that once this turmoil subsides, which will be reflected both in share prices and in the dividends paid by the high-quality Canadian companies in the CE Portfolio.

The Roundup

The second half of Canada’s Big Six banks reported fiscal 2012 second-quarter earnings this week, and the numbers posted by Bank of Nova Scotia (TSX: BNS, NYSE: BNS), Canadian Imperial Bank of Commerce (TSX: CM, NYSE: CM) and National Bank of Canada (TSX: NA, OTC: NTIOF) lend further credence to the idea that the Great White North is home to among the safest, soundest financial systems in the world.

Scotiabank and CIBC posted respectable numbers, but National Bank earned the best headlines by boosting its quarterly dividend 5 percent to CAD0.79 per share.

Second-quarter profit for the smallest of and the latest comer to the Big Six group grew by 69 percent from to CAD553 million (CAD3.22 per share) from CAD327 million a year ago. About CAD212 million was realized on National Bank’s sale of Natcan Investment Management in April. Adjusted net income was CAD347 million (CAD1.95 per share), 6 percent better than a year ago.

Revenue for the quarter was CAD1.49 billion, up from CAD1.18 billion for the three months ended Apr. 30, 2011. National Bank reported CAD49 million in provisions for credit losses to cover bad loans, down CAD6 million from the second quarter of fiscal 2011.

National Bank’s Wealth Management unit posted net income of CAD233 million, up from CAD49 million, helped by the Natcan disposition. The Personal and Commercial segment reported net income growth of 14 percent to CAD166 million. P&C reported higher net interest income due to growth in personal loan volume. Net interest margin narrowed to 2.19 percent from 2.36 percent, mainly due to a decline in the spreads on loans.

Financial Markets, meanwhile, generated CAD115 million, down CAD12 million from CAD127 million a year ago. Trading declined on lower revenue from equities, commodities and foreign exchange transactions.

Bank of Nova Scotia’s second-quarter profit was 10 percent lower than last year’s, which was driven by a one-time gain. Adjusted net income was up 16 percent, however, as Scotiabank’s international exposure, particularly its stake in Colombia’s Banco Colpatria, as well as cost cutting and ever-solid domestic banking results again set it apart from its peers.

Net income declined to CAD1.46 billion (CAD1.15 per share) in the fiscal 2012 second quarter from CAD1.62 billion (CAD1.39 per share) a year earlier. The fiscal 2011 second quarter included CAD0.33 per share in acquisition- and foreign currency-related gains.

Adjusted earnings, which add back non-cash after-tax intangible assets, fell to CAD1.18 per share from CAD1.41 but beat consensus expectations of CAD1.15.

Total revenue climbed 1 percent to CAD4.8 billion, while provisions for credit losses fell to CAD264 million from CAD270 million a year earlier. Domestic impaired loans fell 7 percent, reflecting improved retail and commercial loan portfolios, but gross impaired loans inched up 2 percent from a deterioration in its US and European wholesale book.

International banking drove net interest income, which rose 16 percent to CAD2.48 billion. Residential mortgages and consumer auto loans were also higher, but the international unit accounted for CAD169 million, almost half of increase.

Scotiabank’s Canadian Banking unit earned CAD461 million, up 23 percent from CAD374 million a year earlier. Net income for the bank’s global wealth management unit declined 40 percent to CAD298 million because of a one-time revaluing of its original 18 percent investment in DundeeWealth a year ago. Excluding items net income rose 14 percent on strong insurance and mutual fund sales.

Canadian Imperial Bank of Commerce reported second-quarter profit growth of 6 percent to CAD810 million (CAD1.90 per share) from CAD764 million (CAD1.80 per share) during the three months ended Apr. 30, 2011. Adjusted for one-time items, earnings per share grew to CAD2.00 from CAD1.83 per share.

Total revenue for the quarter was CAD3.08 billion, up from CAD3.02 billion a year ago. Provision for credit losses increased 26 percent to CAD308 million.

Retail and business banking revenue increased 4 percent year-over-year on strong volume growth and higher treasury allocations. Wealth management revenue was flat, as lower commissions from equity trading and new issuance activity were offset by income from investment in American Century Investments. Weaker results from capital markets and corporate and investment banking led to lower wholesale banking revenue.

Net interest income increased to CAD1.75 billion from CAD1.73 billion in the previous year. Non-interest income was CAD1.33 billion, higher than CAD1.28 billion in the preceding year. Net interest margin was 1.82 percent, up from 1.79 percent last year.

Here’s where to find analysis recent earnings numbers posted by Canadian Edge Portfolio Holdings.

Conservative Holdings

Aggressive Holdings

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