So, to get this discussion started: How could the Canadian economy be impacted by the global economic turmoil we have recently seen?
The biggest impact on the Canadian economy from global turmoil is through financial markets (weakness in commodities and stocks), rather than through direct trade. Canadin exports to Europe are about 9% of our total sales abroad, so the direct impact of weakness in Europe is not large. But, we have already seen some cooling in consumer spending this year, and even business investment as a result of the market uncertainty caused by the turmoil in Europe.
How could weakness in commodities hit the Canadian economy, especially when it comes to oil prices?
Commodities account for roughly half of our sales to the rest of the world, and weaker commodity prices hit corporate profits, government revenues, personal income and stock prices. Aside from some of the peripheral Euro zone countreis, the TSX has been one of the weakest equity markets in the world so far in 2012, largely due to weakness in the resource sectors. And, among commodities, oil is by far the most important to the Canadian economy, accounting for roughly 40% of the value of all commodities produced.
Notably, though, WTI oil prices averaged $98 in the first half of the year --- one of the strongest six-month averages on record. So, oil prices have hardly been "weak" so far in in 2012 (even with their recent sag to below US$90/barrel).
This has not been just another cycle for the U.S. economy; the recent recession was not caused by Fed tightening per se, but was instead driven by the financial crisis. And history has shown that recoveries from financial crises tend to be drawn out over a much longer period of time and are more muted. From that standpoint, this disappointing and lacklustre U.S. recovery is following the financial crisis textbook. Having said that, I do believe the U.S. will eventually regain much of its strength over the next 3-5 years.
And, to address the second part of the question, growth expectations have been gradually scaled back in recent years. 2% is the new 3% when it comes to potential economic growth, arguably for both the U.S. and Canada.
Mr. Porter, what do you think is the biggest challenge for Canada in this current global economic environment? Is it commodity prices, economic turmoil in the U.S., etc.
It appears that our biggest challenge will be generating decent growth in a growth-constrained world, and without relying on a big build-up in debt to generate that growth. While Canada has managed to grow faster than the U.S. in each of the past six years, it has come partly at a cost of record household debt and (as almost everywhere) a sustained rise in government debt.
Looking to earnings season - can you comment on what we may see in the latest earnings reports from Canadian companies?
Aside from the impact of slipping commodity prices on the resource sector, we expect one of the other major themes to be more sluggish revenue growth more broadly. This has been a theme so far in the U.S. Q2 earnings season --- decent bottom line results, but mildly disappointing sales figures. So, companies have done a good job controlling costs, but the underlying slowdown in global growth has weighed on revenues. We expect a broadly similar picture in Canada; decent year-on-year earnings growth, but sluggish top lines.
I would look at like this: The rise in Canadian household and government debts in recent years got us through a (very) rough patch for the global economy and the weak U.S. recovery. Now, we are either faced with much slower growth in Canada, or the rest of the world (especially the U.S.) must pick up the pace. Even with all the recent disappointment from the U.S. in recent months, i still believe the latter is possible in the next few years. But, at the same time, the outlook for Canadian growth is likely modest at best, given that there's not much more room for households to borrow,
We've talked a bit about what a troubled U.S. economy means for Canada, but what about Europe? How significantly could Canadian economy be hurt by economic trouble in Europe?
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Europe is still one of the largest economies in the world, with the Eurozone countries' GDP nearly as large as U.S. GDP. A more severe recession in Europe (it's already been in a downturn since last fall) would further hammer commodity prices, weaken equity markets, and hit confidence (both consumer and business) in much of the world. To some extent we have already seen that play out over the past year ---- at least some of the deeper-than-expected slowing in emerging economies recently is due to the drop in European spending.
I can't comment on Nexen specifically (BMO is advising CNOOC). However, average oil prices (at least measured by WTI) did drop almost US$10/barrel in Q2 from the prior quarter, which will weigh on many of the energy companies. As well, natural gas prices were at their lowest ebb since the 1990s in Q2. While they have revived somewhat in recent weeks (amid the heat wave), they will nevertheless weigh on many Q2 results.
Certainly there could be some opportunities in the rest of the world from Europe's issues. The financial services sector is actually one good example, as many European banks have been forced or compelled to rein in growth or even pull back in overseas markets (due to domestic problems), opening the way for others. However, on the flip side, the weakness in the euro is at the same time helping the competitiveness of some European companies --- the Canadian dollar has been at a record high against the euro in recent weeks. And, Japan's woes of the past two decades show that even if a country is struggling mightily, its companies can continue to thrive on an international stage.
We're running short on time, so we'll only be able to answer one more question before we wrap up.
Judging by mutual fund flows in the U.S. and sentiment surveys, it does seem like the small investor continues to shun equity markets. The combination of the 50% slide in 2008/09, the flash crash, and the persistent uncertainty surrounding the European debt crisis and the weak U.S. recovery have all kept small investors away. As is often noted, confidence takes the escalator on the way up, but the elevator on the way down, and it has been a very slow escalator ride up in this cycle. It's been a slightly different story in Canada, with the TSX doing much better than the S&P 500 in the past decade, but the broad strokes are similar.
And looks like we're out of time for today's discussion. Mr. Porter, thanks so much for joining us today and taking our questions. Any final thoughts on how the Canadian economy will fare in the midst of shaky global markets?
While there is no shortage of dire headlines these days, it is important to keep in mind that Canada is still relatively well positioned compared with most major economeis and we still have a lot of positives (notably strong corporate balance sheets, and relatively healthy government finances). However, it would be extremely helpful if the U.S. recovery could gather some serious momentum, and if the ugly news from Europe would quiet down. Hope springs eternal on the latter front!
Thanks again, Mr. Porter, and thanks to all of our readers for joining us today!