Tuesday, February 19, 2008

Did a Canadian recession start in December?

This is a question that few in the mainstream media are asking...

The question needs to be asked but won't since much of what passes as "economic research" in Canada is dominated by the Big Six banks, who have a vested interest in keeping up the bullish spin.

Let's examine the following facts:

1) The US is either already in a recession or dangerously close to one. 2007 Q4 GDP was about 0.6% and projections for 2008 Q1 are for similar numbers. Remember that it often takes a year or more, but these numbers are usually revised sharply lower, meaning that there is a decent chance that the US is already in recession.
2) The UK, Europe and Japan are also slowing sharply and recession is a definite possibility.
3) Canada skipped the 2001 US recession (barely) and has not had a recession for 1990/91. We are overdue as that was 17 years ago! Today's university students were still in diapers at the time.
4) All major stock market indexes are either in a steep correction or a bear market (only time will tell), including Canada.
5) Canada's economy is heavily export dependent. Over 70% of its exports go to the US. Therefore, a US recession has to have a negative impact on Canadian exports. It appears that unlike in 2001, the US consumer is finally slowing down (the 2001 recession was primarily caused by the tech bubble bursting/business investment recession- the consumer stayed relatively strong).
6) I have long thought that the strong Canadian dollar was in Canada's best interest and much of the move was justified and a net positive to Canada's overall economy. The strong loonie kept purchasing power high, and kept interest rates and imported good prices low. Also, since most of our exports are commodities priced in US dollars, the devaluation of the US dollars was more than offset by the huge price increases in those commodities. Look at oil. It was about $20US/barrel in 2002. Now it is at $100. A fivefold increase. Even though the Cdn dollar has appreciated, in Canadian dollar terms, the price of oil has risen from approx $32cdn/barrel in 2002 to $100Cdn/barrel right now. I will discuss later why the strong loonie will no longer be a help.

This recent quote taken from Bloomberg from one of those Big Six economists. At least Millan Mulraine of TD seems to be at least talking about negative GDP although the official TD forecast does not have a recession.

By Alexandre Deslongchamps ( Feb. 19 Bloomberg)

``This (wholesale sales) report adds to a long list of fairly weak economic reports for December, coming on the heels of negative manufacturing shipments and trade,'' Millan Mulraine, an economist with TD Securities in Toronto, said in a note to clients. Taken together, the data will ``drag December's gross domestic product growth significantly downwards -- quite likely into negative territory,'' Mulraine said.

Perhaps a Canadian recession is too extreme. After all, as long as commodity prices enjoy a bull market (CRB, gold, oil, wheat, platinum, silver are all near or at record highs), at least Western Canada should avoid a recession.

Perhaps only a central Canada recession should be on the table (easily more than half the population of Canada). A strong dollar is killing the manufacturing sector in Ontario & Quebec. In the long run, this hollowing out of manufacturing is likely inevitable, but in the short run, it could cause an Eastern Canada recession. When things were humming along in the US, the strong dollar effect on Central Can was offset by a multitude of factors (strong housing and retail sales, strong export markets, spillover from the Alberta boom, etc...). This is clearly a risk now.

And even Western Canada: It does not make sense to me that all these commodities are at record highs? There is a risk in the next few months, that all these commodities head lower and possibly way lower. Why? If much of the western world is at/near recession, there has to be some serious impact on demand. And at these prices, you know that supply will come on. I know about the BRIC and the lower US$ argument, but it does not justify these types of moves. It is eerily reminiscent of the tech bubble. I believe that all of the 2008 move in commodities is speculation. There is nowhere else to hide:

Google/Apple/RIMM/ all other tech: finished
Financials/Retail: dead
Healthcare/Defensive/90% of stocks: not much happening or in a bear market
LT Bonds: not attractive at these yields
Any non-government bonds: In a huge bear market

All this liquidity being pumped in by the central bankers is going into the "hot games", which are the commodities. Many of the charts (ie wheat) look parabolic. Similar to Nasdaq in early 2000. I suspect that the next downleg in the market will be brutal and will take out the commodity stocks, even gold (which should decouple from the rest later in 2008). This will bring out a wave of margin calls, hedge fund blowups etc...This coming commodities bear market (perhaps it is only cyclical) will help sink the Western Canadian economy as well. And once these prices start to fall, the at par Canadian dollar can no longer be completely offset.

If December GDP was negative and if we are negative in Q1 2008 in the US and Canada, the question should AT LEAST be asked: Is Canada in recession?

Instead, everyone says the same thing: A mild US recession will lead to a slowdown in Canada. OK, sure, then why is there talk about a 50 basis point interest rate cut by the BoC in Canada? You don't cut 50 for a "slowdown". You cut 50 because you are worried about recession. You are worried by the worst housing market since WWII. You are worried about the biggest credit crunch since WWII.

I think the answer to my question is: Yes, a recession started. My degree of confidence is definitely not 100%. However, at least the question should be asked by those in the media.All I'm asking is for a healthy debate...

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