Q3 Canadian Market Update

Head of Investment Strategy Neil Linsdell joins the podcast to discuss the Canadian economy, inflation and interest rates, including:

• Inflation
• Is the rate hiking from the Bank of Canada having the desired effect on tackling inflation?
• The federal government has set lofty goals for immigration. Is that helping or hurting inflation?
• Housing affordability
• What does affordability mean?
• How does all of this work back to inflation?
• Does that mean interest rates are expected to stay higher for longer?
• Recession?

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Transcript

Chris Cooksey: Hello and welcome to The Advantaged Investor, a Raymond James Limited podcast. A podcast that provides perspective for Canadian investors who want to remain knowledgeable, informed, and focused on long term success. We are recording this on September 18, 2023. I'm Chris Cooksey from the Raymond James Corporate Communications and Marketing Department and today, Head of Investment Strategy, Neil Linsdell returns to the podcast. Neil and I will be discussing the Canadian economy, inflation, and interest rates and all that fun stuff. So welcome back to the Advantaged Investor, Neil - I hope you're doing great.

Neil Linsdell: Yeah. Thanks. Great to be here.

Chris Cooksey: Well, as always, when it comes to the economy and all this stuff there's lots to get to, so let's jump right in and let's start talking about inflation. I'm sure your favorite topic, all your friends and family asking when are things going to be reasonable again? And so let's start there for fun.

Neil Linsdell: Well, I mean, everything's about inflation nowadays. So I mean, if we go back and we think about the causes of inflation, if we go back to the pandemic, which is where really where everybody, where everything started, a lot of supply chain issues. Obviously if you remember trying to go out and look for a new car, a used car, you couldn't get car parts. You couldn't get vehicles. You couldn't get toilet paper on the store shelves at certain points. And you know, partner that up with, you had fiscal measures, which were being in place in the, in that time, putting a lot of cash into the economy, into people's pockets. So they had a lot more to spend. And obviously if you've got more demand than supply, you're, you're driving up prices. So you know, all those factors combined, we ended up with a lot of inflation on the cost of goods and, and now we're seeing, you know, other things on, on wages and such.

Chris Cooksey: Now the Bank of Canada has been fairly aggressive, I want to say, because I don't ever remember that. I've been in the business for a while now, since the 90s, and I don't ever remember them doing sort of as quickly as they did. I'm sure they have, but you know, it's all this rate hiking, is it having the desired effect on tackling inflation? Are you going to give me a maybe?

Neil Linsdell: That's a good question. Well, obviously we are seeing some major declines. So we saw peak inflation back in June, 2022, right? We saw that up to 8. 1 percent in Canada. So we have seen some dramatic declines. This is off the back of, you know, the large, the very significant rate hikes and cycles from, from the Bank of Canada. So they started hiking rates in March 2022, if you remember. And at that point you know, inflation had already moved out of the comfort range. So the target inflation rate is 2%. And usually that's a one to three percent range that the Bank of Canada likes to see it in. So inflation had already been 5.1% at that point, right? So you have to remember when the Bank of Canada raises interest rates, there's a lag between when they raise interest rates and when that starts to hit the, the economy. When we get into the rate hikes that started in March, like we said you've got about six or 24 months. So those interest rates hikes are only really starting to hit the consumers business spending and that type of thing now, and then we're going to see more of that impact through 2024. One of the big things, obviously, you've heard a lot of people talking about mortgages, right? So a lot of people in Canada are on five year mortgages. Well, as those roll through their renewals, you start to see some of that impact into consumer spending into pocketbooks. So there's been a lot of excess savings that we we've seen over the last couple of years, specifically in the U. S., but in Canada, you've seen the same thing.

Remember during the pandemic, you couldn't go out and spend money on anything, right? So, you save money and then you've got fiscal measures, putting more cash. So that's all waning down. So that's having a positive impact on inflation. But there's also a difference you got to think about between goods, the price of goods. So that's come down more dramatically as supply chains have improved, but now we've got wage inflation. I don't know if you've been following in the news, the United Auto Workers strikes going on. Everybody's being very demanding on wages and such. So that's been that that's been a major factor.

That's a lot stickier, trying to get that down.

Chris Cooksey: Now, in terms of immigration, obviously you know, as a lot of Western economies native population growth is negligible at best so immigration has to fill that in a lot of ways. Now our government has set some pretty lofty goals, is that going to hurt inflation or help it out?

Neil Linsdell: The answer is yes. Well, you know, to put everything in perspective, over the last 20 years, Canada has been accepting around 250, 000 0. 75 percent growth to the population every year. So now we're at 40 million people in Canada. For the next couple of years, the target's close to 500, 000 new immigrants per year. So this is, this is really a doubling of what we're, what we're used to. So this has been a positive to a certain extent. So obviously we're in a very tight labour market and that's been a big problem. And that's part of the things that are impacting inflation. If you look at it from most immigrants would be in their twenties or something. So they're, they're adding to the working age population. So that's good for the labor force. And if we look at a good high immigration rate, that's going to be good for demographics. So you don't start to get into the problems of rapidly aging populations. So if we look at it over the next few decades, that's all very positive. You know, we've had an unemployment rate right now, five, five and a half percent. So that's been picking up a little bit from the, the 4. 9 percent as you get more people into the labour force then that's you have to look at the labour participation rate as well. And again, you've got your pluses and minuses, right? So as you get more people in the country, there's more consumption, so more demand for goods, but also you've got more. people producing goods. And if you, you know, one of the concerns right now is housing. So new immigrants also need somewhere to live so that that's affecting the can affect the housing availability.

Chris Cooksey: All right. Well, let's keep going on housing because obviously affordability and that's such a silly word when it comes to housing in Canada, I think you need the word ‘un’ in front of that word. But let's just talk about that and you know, maybe go over it. And is there any hope?

Neil Linsdell: Well, I mean, it's been in the news lately. You know, CMHC has put out a an update just recently where they do address affordability. And you may have seen some of the headlines and they have a target to 2030. So call it three years from now they're saying we need three and a half million homes. Well, so that headline, what it really means, they're talking about three and a half million homes above what the regular you know, the rate that we're seeing right now on new home development. In that number, so 1. 7 million of normal growth rate plus 3. 5 million on top of that. So start to think about what that means. So normally you would see about 250, 000 new dwellings. You know, put into the marketplace every year, so that brings us up to 750 to 800, 000 units. So we're talking about triple what we would need. So when, when you start talking about affordability, which is what the CMHC is talking about now. I don't know if you remember this far back, but in the seventies, there is a convention that you should have about 30 percent of your disposable income goes to your housing cost. Is it right? So, over the last 20 years, we've seen it more 35 to 40 percent on a national basis. And if you live in British Columbia, you, you've seen, for the past 15 years, it's been more 50 to 60%, so it's been quite elevated. And it seems pretty significant. Ontario has actually just moved into the 50 percent plus range over the last seven or eight years and, and Quebec has actually been picking up. So that was usually a pretty reasonable place, but now we're picking up over 40 percent in Quebec. So the CMHC wants to get that ratio down to 30 to 40 percent in most provinces and their target is 37 percent Ontario, 44 percent in British Columbia. So those would be pretty significant achievements. And that's all based on the idea of getting those affordability levels back to 2003, 2004. Which was, there wasn't a boom, there wasn't a recessionary period, but that's, that's what they define as affordability.

Chris Cooksey: Now there's an inflation story here, obviously, if you have to pay more for mortgage, more for rent, more for everything else. So let's, let's touch on that now.

Neil Linsdell: Yeah. So when we look at inflation, the headline number that we get for inflation - shelter represents about 28 percent of that the inflation metric. So when you have higher interest rates, you have a limited supply that we've talked about and you've got those higher level of immigrations, you know, there's a lot of pressure there that we have to think about. So wage inflation, as we've said is another thing that's obviously affecting Inflation. So you've got those wage pressures. We've seen the auto worker strike that that we've just been talking about, we're pushing up costs. So what are these things going to do? So you've got higher wages, people looking for them, that's going to fast affect the cost of goods pushing up prices consumers are going to be looking at more. So not only could you have similar problems that we saw before of the supply chain, which we talked about automobiles, right? So you know, new automobiles you had or even used, you see less availability driving up the existing prices. But now if you're pushing up your costs, specifically your labour costs, which we already talked about being sticky, you're going to have a higher car prices going forward in six months, 12 months and such. So and then what do you need? You need a higher wage to be able to purchase a car. So you'd have more demands on your employees. So it's becomes a spiral of increasing costs. And then you have other things. So you've you had Jeremy McCree on, on air just recently speaking about oil. So oil obviously energy costs that goes into inflation measures. So I mean, you can adjust different inflation metrics. So you hear of these inflation metrics, you know, let's exclude energy and price of food or such. And because you don't have a lot of, you don't have a lot of control over oil or the bank.

Canada can't change interest rates to effect the price of oil, but you still have all these pressures on inflation, right? You, you have higher transportation costs because of oil and that's going to work into your cost of goods. So it's still going to be a lot of pressure on inflation and it's unlikely that the Bank of Canada is going to back off their goal of that 2 percent inflation target.

Chris Cooksey: Now one of the people I used to read a lot of this industry before he retired was Dennis Gartman. And Dennis Gartman always used to love to talk about how interest rates will remain lower for longer than you expect and they will remain higher for longer than you expect. So what's your expectation here?

Neil Linsdell: Yeah. Again, yes. So we have seen headline inflation take up a bit recently, right? So in July we saw inflation in Canada go up to 3. 3 percent for 2. 8 percent June. But, and we have to remember that that dramatic decline that we saw in the last year was really coming off really high spikes the year before. But that push to get from this 3 percent level down to the 2 percent target that I don't think the Bank of Canada is really going to have a lot of flexibility on. They really want to see that 2 percent, because the danger is you ease off too soon and you get these high spikes that we saw say in the seventies and that seems to be the biggest concern. So what are we going to see in, in the meantime? Because you've got a base effect where you have to look at what inflation was you know, 12 months ago, as we start rolling forward, you should expect to see a little bit of an uptick in the inflation rate. So this really shouldn't be a surprise, even if we get it down to an annualized rate of 2%, that still means that we're, you know, when you have this base effect, we could see seven pushing maybe closer to 4 percent in the short term before we really start to see these, these overall declines to that 2 percent level. And if we're, we're talking about that rate, then we shouldn't expect to see anything till the second half of maybe 2024. So yes, the Bank of Canada. is probably going to keep the pressure on.

When you start to see these little spikes, depending on these other kinds of black swan events, the, you know, autoworkers and rising the cost of vehicles and this type of thing, will there be more pressure to raise rates? Maybe. We're probably close to the end of the rate hiking cycle, but I think the, the anticipation that those rates are coming down anytime soon, those, those might be a little bit too optimistic.

Chris Cooksey: And recession, we haven't, I mean, recession was in the press a lot more than it has been recently, at least from what I was seeing. It's still percolating, but what are your expectations around the recession?

Neil Linsdell: Yeah. I mean, this is something we always talk about, right? So is it a mild recession? Is it a hard landing, soft landing and such. So we have seen slightly negative GDP numbers. We saw them in Q4. We saw them in, in Q2. Really it's pretty much flat, but it's slightly negative. We're still expecting probably a mild recession. There's a lot of optimism right now about this soft landing where we can avoid going into recession. The US specifically, but I think that we're still looking at a model recession. Hopefully it's short. We don't really want a recession. The whole idea is that the recession helps bring down the prices and it will bring down the inflation. So the whole goal is to get the inflation number down. As I said, it's all about at the end of the day. But again, I think we are looking at somewhat of a slowdown here. Yeah.

Chris Cooksey: Well, perfect. Thank you very much for joining us today, Neil.

Neil Linsdell: My pleasure.

Chris Cooksey: I look forward to having you join the podcast again soon. Reach out to us at theadvantagedinvestorpod@raymondjames.ca. Subscribe to The Advantaged Investor on Apple, Spotify, or wherever you get your podcasts. Please contact your advisor with any questions you have. On behalf of Raymond James and The Advantaged Investor, thank you for taking the time to listen today. Until next time, stay well.

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