June 16th - 2010

ON THE MARKETS: Canadian economy’s growth will slow

Almost halfway through the year and the recovery in the Canadian economy is strong, but to what extent is this recovery the real thing and to what extent is it sustainable at the current rate?

Almost halfway through the year and the recovery in the Canadian economy is strong, but to what extent is this recovery the real thing and to what extent is it sustainable at the current rate?

Benjamin Tal, Senior Economist, CIBC World Markets, will tell you it isn’t. Tal told delegates at the Land and Development Conference in Toronto in April that this recovery is fuelled by government spending, and it cannot continue to grow at five per cent GDP for the balance of 2010 and into 2011.

Looking at the housing market, Tal predicts that the accelerated buying activity of early 2010 will cool in the latter half of 2010 and into 2011. Housing prices in Canada are “overshooting”, but not by much, he said, and only by about five or six per cent in Ontario.

“It is possible that housing prices in Ontario will fall by five or six per cent, but I think that the story is that it will stagnate over the next three to four years. I think we will have a situation where we should allow the fundamentals to catch up with prices. I think that is the most likely scenario.”

The current improvement in the Canadian economy is the strongest ever for the first two quarters of a recovery. The only slow growth is trade, which is connected to the US market.

To get perspective on the Canadian economy, we should look at what is going on in the US economy and that, Tal said, means looking at the US housing market.

Existing home sales in the US are experiencing a “nice improvement” almost back to 2007 levels, mostly due to one factor, he said, the first time homebuyer tax credit, and it ended April 30th. Existing home sales will decline now that the tax credit has ended, Tal predicts.

Fifteen million households are in a negative equity position meaning the mortgage is larger than the value of the house: 10 million are in a negative equity position of more than 20 per cent. With that much loss, some homebuyers choose not to pay the mortgage, because they believe the home prices won’t bounce back in their lifetime, says Tal.

“We call it strategic defaults. You can finance it but you choose not to.” Strategic defaults are rising. According to Tal, almost one out of four of all defaults in the US are strategic defaults. In Canada roughly about three per cent of the market is vulnerable to default, compared to 22 per cent in the US, Tal said.

Inventory is also a concern because there are millions of units sitting unoccupied. Prices are not falling because the banks are sitting on this inventory, keeping it out of the housing market to prevent the market from softening.

The picture may look bleak, but Tal said: “I’m not saying the market will collapse… but this picture is totally inconsistent with an improving housing market. If we are lucky, the housing market will stagnate.

“It’s not about to recover anytime soon…. If you are in the market for property in Florida, take your time. There is no rush.”

Other factors
Another important factor affecting the state of the US economy is the labour market. It is still a long way to full employment, because companies not only laid off employees but also asked the people they kept to work fewer hours.

The first wave of improvement will be to ask people to work full hours again, not creating new jobs. The probability of finding a job in the US if you are unemployed is currently 20 per cent. Usually it is about 40 to 50 per cent. “The labour market is not strong by any stretch of the imagination,” said Tal.

If you look closer, the manufacturing sector is booming. It has a seven per cent increase, which is the strongest in more than 20 years. But employment in the manufacturing sector is declining, because all of the improvement in the manufacturing sector is in capital intensive industries. American corporations are taking advantage of this crisis to improve their productivity by investing in capital intensive industries such as chemicals, primary metals, textiles, and apparel.

“I am extremely optimistic about the mid term prospects of the American economy because what I’m seeing now is a renaissance in the US manufacturing sector. They are doing the right thing by improving productivity.”

All of the improvement in the manufacturing industry in Canada is in labour intensive industries, said Tal. “So yes, we are winning the job game of today, but we are losing the productivity game of tomorrow. That’s why I think that a year or two years from now, the US economy will emerge as the winner here.”

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