North of the world’s largest economy sits Canada, a wealthy, peaceful, nation that is often overlooked in discussions of the global economy and financial markets.
It’s a country that policymakers and investors ignore at their peril.
Contrary to popular belief, Canada is far more than its relationship with the U.S. In many ways, the nation runs counter to many global trends –what Canada enjoys in abundance, much of the world lacks.
Here’s why everyone in the world should be paying more attention to Canada.
1) A pulse for the global economy
The Canadian economy and financial markets are one of the most underutilized barometers of global economic activity.
When global growth exceeds 4 percent, Canada’s benchmark equity index, the S&P/TSX Composite, has tended to outperform the S&P 500.
And over the past ten years, the TSX/S&P Composite has moved in near-lockstep with the MSCI Emerging Markets index (in Canadian-dollar terms):
Canadian equities, one can infer, are similar to those in emerging markets –but without worries over political upheaval or accounting irregularities that cause investors to be wary over investing in those locales.
Given the Canadian equity index is heavily skewed towards commodity-producing companies, this relationship may not be all that surprising.
However, Canada’s connection to global economic trends is also manifested in far more subtle ways. Vancouver, for instance, is hailed as the “most Asian city outside of Asia,” and continues to attract tens of thousands of immigrants from the continent each year.
As such, luxury real estate valuations in this metropolitan area have come to be viewed as a proxy for Chinese capital flight.
2) Burgeoning Silicon North?
Tyler Cowen, professor of economics at George Mason University, caused much consternation in Canada by recently quipping that the nation probably would not be a big player in the knowledge economy.
Nortel’s bankruptcy and BlackBerry’s fall from grace are scarred into the Canadian public consciousness, overshadowing a number of technology success stories.
Software and services provider Open Text Corporation, for instance, has increased adjusted revenues to $1.6-billion in 2014 from $152.5-million in 2002 to become the third-largest information technology company in Canada by market capitalization.
Meanwhile, Shopify, which has developed a widely-used e-commerce platform, is slated to go public on the New York Stock Exchange this week.
Sam Altman, chief executive officer of Y Combinator, paid tribute to the quality of the Canadian tech scene in a recent interview with the New York Times.
Altman, an alumnus of Stanford University, highlighted the University of Waterloo, located in Ontario, as a school whose students and graduates produced stand-out ideas.
Canadian-born Chad Rigetti is at the helm of one of those Y Combinator-backed firms. The founder and chief executive officer of Rigetti Computing attended the University of Regina before getting his PhD at Yale. He's currently developing quantum computing hardware in Berkeley, California, competing against the likes of Google, Microsoft, and IBM.
“In quantum computing, Waterloo has done great,” said Rigetti. “Whether that will lead to the development of significant enterprises is an open question.”
The venture capital network in Canada is nowhere near as robust as that of its neighbour to the south, so much so that OMERS Ventures, a branch of a pension fund, the Ontario Municipal Employees Retirement System, has become a key partner and source of funding for Canadian technology start-ups.
While Canadians might bemoan the recent loss of some promising tech firms, the basket of potentially viable projects under development in Canada, particularly Waterloo, provides an opportunity for deep-pocketed foreign venture capital firms to fill the funding void.
3) A cutting-edge central bank
Though it typically fails to capture the world’s attention, Canada’s central bank has been an innovator in monetary policy since the early 1990s.
The Bank of Canada was among the first in the world to adopt a formal inflation target, and has generally enjoyed success in achieving this goal.
During the financial crisis, then-Governor Mark Carney also pioneered the use of calendar-based forward guidance in April 2009 by stating that the policy rate would remain at 0.25 percent through the second quarter of 2010, which helped depress yields across the curve.
The Bank has also been at the forefront of how central banks are attempting to condition markets for policy normalization. In October 2014, Governor Stephen Poloz published a discussion paper revealing that the Bank would be abandoning forward guidance after a period of moving towards increasingly vague descriptions of the economic variables that would influence monetary policymakers. These moves have served as a template of sorts for later communication shifts by the Federal Reserve and the Bank of England.
Known for his folksy, off-the-cuff style, Poloz has managed to inject volatility not only into foreign exchange and fixed income markets, but also into Canadian socioeconomic debates when he suggested that unemployed youths should seek unpaid work.
The Bank of Canada shocked markets by cutting its policy rate to 0.75 percent on January 21, and this won’t be the last time the institution is front-and-center in monetary policy circles.
In preparation for the renewal of its inflation-control agreement in 2016, the Bank will be investigating, among other matters, whether a 2 percent inflation is still the most appropriate target and how much monetary policymakers should take financial stability concerns into their decision-making process.
Though both Governor Stephen Poloz and Deputy Governor Agathe Côté have stressed that the “bar for change is high,” the Bank is poised to inform an important debate: how monetary policy should be altered in light of the financial crisis and the increased odds of revisiting the zero lower bound for interest rates once the next global economic shock hits.
And in the event that an upward adjustment to its inflation target grows more likely, the resolve of owners of Canadian sovereign debt would be put to the test.
4) The struggles of a would-be natural resources superpower
The path to North American energy independence runs through a pipeline that begins in Alberta.
However, progress along that path has met many roadblocks, as balancing the interests of citizens, governments (federal, provincial, and foreign) and corporations, is a prerequisite for resource development.
Because of a failure to adequately address the concerns of all these parties, access to markets has been a persistent challenge, resulting in a deficiency of transport infrastructure.
The collapse in oil prices is the latest challenge that threatens to dampen Canada’s quest to become a global energy superpower.
Peter Tertzakian, chief energy economist at Calgary-based ARC Financial Corp., highlighted 24 oil “megaprojects” have been delayed or cancelled as of mid-2014 – 18 of these in Canada.
Amid the boom times for oil, investors have pushed companies to invest in smaller developments with more visible returns on investment and shorter payback periods.
If the demand for oil sufficiently outstrips supply over the medium term –the opposite of the current situation –as global growth picks up steam, the lack of Canadian megaprojects will be a key contributor to that deficit.
As such, the stories of resource market dynamics of today and tomorrow will have an essential Canadian component –and that’s not just for oil.
Water shortages, already a severe problem in California (a state with a population roughly equivalent to Canada’s), will become more acute as time passes.
Canada, which possesses about 20 percent of the world’s freshwater resources, will be well-positioned to alleviate some global shortfalls in supply.
5) A real estate quandary
Canada’s financial system earned praise in the aftermath of the financial crisis, as real estate values north of the 49th parallel did not suffer the same collapse as those in the United States.
For several years thereafter, however, Canadians have received a barrage of warnings about how their overheated real estate market is slated for a collapse.
Construction employment as a percentage of total employment hit 7.9 percent in February, its highest level on record.
Investment in residential structures bounced back quickly after the recession and remains close to 7 percent of GDP, a height eclipsed only prior to the housing busts of the late 1980s/early 1990s and in 2007:
The Bank of Canada has warned that real estate is overvalued by up to 30 percent.
Most warnings about an imminent U.S.-style housing crash in Canada, however, come from outside the country, particularly the U.S.
Bets against Canadian real estate are typically expressed by shorting the Canadian banks.
The Canadian Imperial Bank of Commerce, the most domestically oriented among the big players in the space, has short interest as a percentage of float at 1.94 percent on its Canadian listing, but 3.63 percent on its U.S. listing.
All the while, the national median home price has continued to climb to all-time highs.
The headline national statistics, showing the MLS Home Price Index up 5 percent year-over-year in April, fail to demonstrate that this strength has become intensely localized to two major metropolitan areas: Toronto and Vancouver. Across the nation, values have declined on an annual basis in Regina and Saskatoon, have risen less than the rate of core inflation in Montreal and Ottawa, and are cooling quickly on a monthly basis in Calgary.
“Strength in two of the biggest markets, Toronto and Vancouver, have been well beyond what the underlying economic situation would justify,” said Bank of Montreal chief economist Douglas Porter. “Even relative bulls like us have got to be a bit concerned about how hot it’s become, especially in the single-family market.”
Though additional macroprudential measures to cool this two-legged market are not expected in the short order, continued robust home price growth in those two cities could force policymakers’ hands in late 2015 or early next year.
If Canada can successfully engineer a “soft landing” for the real estate market, the nation’s housing finance system and regulatory framework will receive a closer look from government
If not, Canada will become yet another cautionary tale of what awaits nations in which residential construction and home price appreciation become divorced from economic fundamentals.
6) Peak uncertainty
Lack of reliable foresight into the future course of events is one of the few constants in the human experience.
But in the case of Canada, the range of opinion on how the economy will fare over the next two quarters has arguably never been larger.
Standard Chartered Bank, for instance, is forecasting a technical recession for Canada, calling for the economy to contract by 2.4 percent in the second and third quarters. Deutsche Bank, on the other hand, sees strong growth of 3 percent in the second quarter followed by a 2.3 percent expansion in the third quarter.
This uncertainty is amplified by the upcoming federal election, scheduled to take place on October 19. At present, the daylight between the three major political parties on economic issues is not immense. However, the eventual winners will end up shaping the pace of infrastructure development, access to markets, and climate policy in Canada over the next five years, with their actions likely to outlive their time in power.