People walk past a closed restaurant in a quiet downtown, amid concerns about the spread of the coronavirus, in Vancouver, on March 17, 2020.DARRYL DYCK/The Canadian Press
2020 is not 2009, warns CIBC World Markets, and investors should not expect a lucrative, V-shaped recovery when the pandemic ends.
In a short but compelling research report published Tuesday, CIBC interest rate strategist Ian Pollick cautioned clients that the Canadian economy – and the domestic consumer in particular – is in a much weaker position now relative to 2009 and this will limit any postvirus rebound.
Mr. Pollick noted that the economic damage from the current health crisis is far more severe than what the financial crisis precipitated in 2008-09. During that period, the manufacturing sector lost 300,000 jobs while services sector employment actually gained.
The current halt in the economy is more focused on the service-oriented areas that account for 70 per cent of Canadian GDP. As a result, job losses are already much heavier – almost one million newly unemployed in March alone.
Bank of Montreal economist Benjamin Reitzes predicted that the employment situation is about to get much worse. BMO expects another four million to five million job losses in April.
This enormous shock to the work force occurs at a time of extremely weak household balance sheet strength, as the first accompanying chart highlights.
In March, 2009, when the previous bull market began, the ratio of household debt to disposable income was 155.5 per cent. The most recent data show debt to income near record highs at 176.3 per cent, thanks largely to mortgages. The ability of households to drive an economic recovery through borrowing and spending in 2020 is far lower than in 2009.
The combination of high debt and mass unemployment will create long-term problems for the economy. In Mr. Pollick’s words, “extant debt loads and the hit to confidence might render future consumption patterns nearly unrecognizable.”
Not only will millions of Canadians have to reclaim their jobs or find new ones, they will have to rebuild enough confidence to start spending for the economy to grow.
Mr. Pollick believes that market prices reflect too much economic optimism. The second accompanying chart highlights an investor community expecting a rapid recovery when quarantining ends.
The line on the chart represents the futures markets’ guess regarding the yield on banker’s acceptance notes in the future. Banker’s acceptance notes, usually issued with a 30- or 90-day term by corporations, represent short-term loans with repayment guaranteed by a Canadian bank. In this case, we are using banker’s acceptance yields as a proxy for the Bank of Canada rate and short-term yields in general. On the chart, for instance, the last data point shows that the March, 2023, futures contract price predicts a three-month banker’s acceptance note that will yield 1 per cent.
The line begins to slope higher in late 2020, indicating the resumption of economic growth and higher yields. For Mr. Pollick, this makes no sense. He says he believes the health crisis will create a wounded economy that will take far longer to heal – well into 2021 at the very least.
It is not a huge stretch to believe that the optimism in credit markets is also reflected in equity prices. Profits in the commodity sectors will be driven by global growth, but domestic-facing stocks – those dependent on domestic consumption and business activity – may still be overvalued if Mr. Pollick’s predictions for a longer, deeper, slowdown become reality.
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