Canadians largely voted to keep the status quo in Ottawa with a seat count that is left virtually identical, led by Liberal minority which is likely to be easily supported by the New Democratic Party. For investors, the most likely outcome is the status quo on major economic and policy trends:
- Fiscal policy should continue to support economic activity through higher spending.
- Decarbonization efforts will continue with higher taxes on carbon emissions while renewable energy should continue to benefit from policy support.
- Scope for higher taxes for the energy companies, banks, and insurance sectors are likely to weigh on business investment.
- Wider than normal fiscal deficits over the foreseeable future are to leave upward pressure on long-term interest rates, but we do not expect any material impact on the loonie as most major economies are struggling with a similar backdrop of large deficits and rising debt.
- Households should largely avoid higher income taxes while social transfers will remain supportive of disposable income. Increased funding toward daycare should favour a higher labour-market participation rate for women.
Near Term: Focus to remain on COVID-19
We do not expect the policy agenda to change meaningfully at least until a new budget is presented to Parliament in about six months. The virus remains a key priority although the emphasis of the battle is shifting more toward measures to better live with the virus, such as vaccination passports and eventually a full re-opening of the border under COVID-19 scrutiny. We expect foreign policy to try to deescalate bilateral relations with China to preserve and even regain some market share in the Chinese market. Overall, continuity of the policy agenda means the outlook for Canada’s economic growth is unchanged after the election, as well as the Canadian equity and fixed-income outlook.
Fiscal Policy: Large deficits to require more revenues
As of the end of August, the Canadian Federal debt had risen to about $1.2 trillion, an increase of about $450 billion since the pandemic began in 2020. For fiscal-year 2021-22, the Parliamentary Budget Office (PBO) projected a $138 billion deficit (versus a $158 billion planned in the Budget 2021) despite a level of economic activity that is back to pre-COVID levels, on aggregate. While the debt load relative to the size of the economy, or Gross Domestic Product (GDP), remains below historical highs (Chart 1), a rising debt burden leaves public finances more sensitive to interest rates fluctuations while leaving the government hungry for revenues.
With little room to increase marginal income tax rates, the Liberals have proposed to raise corporate taxes, most notably on large foreign digital companies and on banks and insurance companies. While these measures might find popular support, the expected additional revenues, estimated well below $10 billion, are small versus the magnitude of the government’s funding needs. Households are currently feeling the pain from the inflation tax, but we suspect public support for loose fiscal policy could dwindle if it translated into rising interest rates and borrowing costs, especially if rising mortgage rates mean housing prices would face downward pressures.
Chart 1: Rising Federal Debt Load Will be Slow to Revert
The chart shows Canada’s federal debt to GDP ratio, which peaked in the 1990s and has fallen to low levels since. It is projected remain well above pre-pandemic levels over the next 5 years. Source: Haver, BMO Global Asset Management, as of September 20, 2021.
Households: Inflation tax fueling a boom in net wealth
Although Canadians are feeling the inflation tax when shopping, they have also greatly benefited from the surge in asset prices, from equities, real estate and even bond prices, thereby fueling a boom in household net wealth (Chart 2). With nearly 70% of Canadian households owning their residence, we doubt the Liberals would support measures that could risk triggering a housing price correction. We think their policy will continue with measures to increase the supply of affordable housing along with measures to ease access to property ownership, but for the most part, housing affordability issues are largely local (and big city) rather than national.
For workers negatively impacted by the pandemic, a key date to remember is October 23, when the Canada Recovery Benefit (CRB) are set expire, which we think could help ease shortages of labour. Another positive item on the Liberals agenda is the increased funding for daycare, which supports a higher women participation rate and would also help ease the scarcity of workers as job vacancies keep rising. (Source: Statistics Canada).
Chart 2: Canadian Households Benefiting from Asset-Price Inflation
The chart shows household net worth as a share of disposable income, which has increased in the past two decades and has more meaningfully increased since the pandemic. Household debt to net worth has steadily declined from its peak in 2008. Source: Bloomberg, BMO Global Asset Management, as of September 20, 2021.
Update on Outlook and Portfolio Positioning: Global markets and local elections
For investors, the noise around the Canadian election is a distant second compared to other global concerns. Equities have sold off in recent days over concerns about China, whose economy is cooling faster than expected while investors worry about how China will handle the Evergrande debacle. While we do not believe the Chinese authorities will allow for a “Lehman” moment, the stress around real-estate developers is adding to growth headwinds. We think Chinese equities could continue lagging their global peers for a little longer. Meanwhile, in the U.S., investors are watching the negotiations around the budget and debt ceiling. Although the timing of a deal remains uncertain and a government shutdown cannot be ruled out as the partisan posturing intensifies, we see those risks as speed bumps to the equity rally rather than something that could impact the economic and market outlook, although the final package could be lower than the proposed $3.5 trillion package.
The results of the Canadian Federal election does not change our outlook. Our portfolios have a small tactical overweight to Canadian equities, expressed against an underweight to emerging equities. Our positive view on Canadian equities is largely driven by our optimistic view about global economic growth, which we think will remain above trend over the next 12 to 18 months. Expectations for global infrastructure spending and renewable energy should continue to support commodity prices while the scope for gradually rising interest rates along with above-trend economic growth should support banks, thereby benefiting the core sectors of the Canadian economy and equity market.
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