Strong first-half growth likely to fade - The rebound to 3.7% GDP growth in the first quarter was a welcome sign, but we expect the economy to moderate back toward or below 2% in the back half of 2017. Oil prices are up 71% from early 2016, fostering a rebound in business investment and faster U.S. growth should continue to lift exports, which accounts for 32% of Canadian GDP. 1, 2 While we think stronger trade and manufacturing will help, notable imbalances in the domestic economy suggest to us that it is unlikely to maintain the same pace of growth witnessed in the first quarter. Sustained GDP growth above 2.5% will require faster wage growth (currently only 1.3%) to support household spending and further increases in business investment which in part will require a further lift in oil prices. Both will take time to materialize, in our view.
Less help from housing - The surging housing market has also provided an uptick to the economy. Not only has new residential construction grown to 2.6% of Canadian GDP (40% higher than it was 20 years ago), but the spillover effects have lifted consumer spending, with the two components combining for nearly two-thirds of GDP. Consumer debt as a percentage of disposable income has risen to 167%, which combined with the surge in home prices and regulatory changes suggests to us that housing's boost to economic growth has likely peaked.2 This is supported by the recent notable decline in housing starts and existing home sales. We don't anticipate a housing market collapse, but softer housing trends could restrain household spending and overall GDP growth.
Loonie lingers near current levels - The Canadian dollar (C$) has received a lift from stronger economic readings along with a shift toward expectations for less stimulus from the Bank of Canada. We don't expect recent gains to persist because slower GDP growth and more modest inflation will likely maintain the interest rate gap between Canada and the U.S. Additionally, the other driving force for the loonie — oil prices — is, in our view, unlikely to lead the C$ dramatically higher or lower as crude stabilizes in a range around $50. We think the C$ can continue to trend in the mid-US$0.70s this year, supporting export growth.
Action for Investors - Sustained, albeit below-average economic growth, should continue to support an ongoing bull market in stocks as well as low-but-eventually-rising interest rates. This warrants proactive rebalancing to the middle of your targeted equity and fixed income ranges. A softening housing market and more stable (but low) oil price environment warrant trimming overweight financial and energy sector allocations in favour of sector balance that positions your portfolio for increased volatility ahead.
1. Bloomberg, crude oil prices: 2/11/2016-6/30/2017.
2. Statistics Canada.