Invesco: Canada vulnerable to global risks

story_images_Canada-flagContinued deleveraging, weak global recovery and China’s lethargic growth have slowed Canada’s own recovery.

Developed economies will continue to deleverage for several more years. So policy interest rates will stay very low in these markets, said John Greenwood, Invesco’s chief economist, at a breakfast presentation Tuesday.

In the past, when balance sheets were in good shape, central banks could cut interest rates to stimulate the demand to borrow. But those cuts didn’t work this time around.

“[This is] because of the balance sheet problem,” he says. “The developed world got into its current [mess] primarily as a result of overstretched and overleveraged balance sheets in their household and financial sectors.”

There are only three ways to repair the damage: raise household capital; sell assets and use the proceeds to pay down debt; and cut consumption and increase savings to pay down debt.

As a result, most advanced economies have been deleveraging vigorously.

“It’s a dramatic mind shift from everybody wanting to buy things to [where] all they want to do is pay back debt,” says Greenwood.

And Canada’s household sector, despite the supervision of the banking system and recent tightening of mortgage lending, is very exposed, he adds.

While strong commodity prices and income levels have meant there’s been no major deleveraging in Canada’s private sector, it “would be very vulnerable if either commodity prices, or the housing market, were to weaken sharply.”

Going by recent data, we appear set to face both.

“The weakness in Chinese and world demand caused commodity prices to fall sharply last summer,” he says. “Prices haven’t returned to their peak levels yet [while] the recovery in China is expected to remain more muted and less export-oriented than it was in the past, which means the demand for Canadian commodities will remain moderate.”

And it’s unlikely an impending surge in either liquidity or commodity prices will boost the Canadian economy or its housing market.

“We’ve already seen housing prices fall across major cities in Canada,” says Greenwood. “I don’t expect any near-term revival, particularly given the high leverage in the household sector of Canada.”

And for now, the demand for credit from the private sector remains weak as private sector balance sheets get repaired.

“That in turn means money and credit growth rates are going to be slow,” he says. “[Which] means we’ll have sub-par growth, low inflation and policy interest rates held down. That means the outlook is for the longer-term rates to surprise people by staying lower longer than expected.”

One way for investors to deal with this grim scenario is to focus on quality income flows, adds Greenwood.

“Hold equities with strong, growing dividends,” he says. “You could hold corporate or emerging market bonds with good coupons; and real estate, where emphasis should be on income, not capital gains.”

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