Canadian Economy Contradictions Mean More Uncertainty for Investors

So, according to Statistics Canada, GDP growth for the recent quarter was the slowest in three years, grinding down to an annualized rate of 1.4%. The conundrum, however, isn’t the slowing GDP, since we knew that was happening, but rather how and if we can equate a decrease in the national output with Canada’s quite healthy labor market?

On the macroeconomic level, a country’s economy strives to reach equilibrium where economic forces are in balance. In other words, this means we want to achieve the maximum rate of sustainable output, given the country’s current resource base, technology and labor. The moment the equilibrium is violated, and that happens every time an economy goes through a business cycle swing, two “bad guys” raise their ugly heads: inflation and unemployment.

So, how can Canada have an anemic GDP and a robust labor market at the same time? Every so often, economic theory encounters periods of strange contradictions, primarily fueled by the presence of more geopolitical and global economic uncertainties than usual.

The list of factors impacting the economic equilibrium is a short, but powerful one. For example, if a country’s overall wealth increases, as must be the case in Canada considering our strong labor market, consumers tend to spend more as they buy more products. This is good for the GDP, as it increases output.

Also, if interest rates are declining, and currently Canada is enjoying a very low interest rate environment, credit is more easily available, again egging consumers to spend more, shifting the aggregate demand curve upward and increasing the output.

But, Canadians are also not a terribly optimistic lot. There is too much economic uncertainty, both at home and abroad, which adversely impacts the aggregate demand, shifting the curve downward and slowing down the GDP.

Furthermore, as many Canadian producers are painfully aware, our largest trading partner, the U.S., is going through a rough patch of its own. Meaning, trade is suffering. Adding more fuel to this pessimistic sentiment is the strong Canadian dollar, which makes our products and services more expensive to our trade partners. Sure, the strong dollar was good for businesses, which could spend more money on improving their fixed assets and technologies. However, while productivity might have benefited from these improvements, profits didn’t.

Perhaps the reason why Canadian economists have difficulty equating GDP slowdown with robust employment lies with how Statistics Canada calculates certain GDP components. Some experts argue that output from the services sector, including financial services, has been underestimated. This is relatively easy to explain. You see, measuring tractors and TVs is relatively straightforward, but how do you measure output of a newly hired bank teller or teacher, for example?

All this talk about the economy leads to one question: How will this conundrum impact Canadian investors? Well, contradictions of this sort hardly represent a positive influence on the stock market. We all saw the hit that the TSX/S&P Index took last week. Canada is hardly an exception these days, as evidence by the rollercoaster ride the global markets have put us through over the past week. What to do? Well, I believe the ride is still worthwhile, both domestically and in the foreign markets, although I suggest you hold on tight. It is likely to be a rough ride in the months to come.