Capital flees Canada | the morning star
Markets had a volatile start to the year, spooking investors. Canadians, especially those in debt, are keeping a cautious eye out for the inevitable Bank of Canada rate hike. And the National Bank is sounding the alarm on our spending.
In a report titled “Canada Can’t Afford to Bleed Capital Like This,” author Stefane Marion, chief economist and strategist at National Bank, says the near future presents many challenges for countries that , in a post-pandemic regime, need to rebuild their resilience and address investor concerns about the energy transition as well as environmental, social and governance (ESG) considerations. This will require a major effort to replace the existing stock of capital in OECD economies at a time when many governments are already deeply indebted. The ability to retain and attract capital will therefore be essential to avoid a sudden transition to this new regime.
“Unfortunately, growth-enhancing investments are lagging in Canada,” says Marion flatly, a trend that was evident even before the pandemic.
“Insufficient capital investment is nothing new,” said Anil Passi, Managing Director, Global Corporates, DBRS Morningstar. All economists would agree that we need more capital investment. Of course, this is what enhances your future prosperity.
Weak manufacturing investment
The report highlights some concerns. First: the stock of capital in the manufacturing sector is at its lowest level in 35 years. After peaking in 2000, it has since fallen by around 20%. In that time, our closest neighbor and competitor, the United States, has steadily increased by 19%. With 1961 representing a value of 100, the US capital stock index now sits at 450, Canada’s at 250, a whopping 200 points between the two countries.
What is particularly troubling is that, from 1961 to 1990, manufacturing capital in Canada and the United States evolved very closely. In 1990, the two sectors separated irretrievably: it continued to grow in the United States and, in Canada, after reaching a very temporary peak in 2000, it continued to decline until the trough of today. today.
“For more than 20 years, manufacturing capital has gone to Asia, Passi recalls, and now, on top of that, nobody wants to invest in dirty energy.” And offshoring seems to have been even more acute in Canada than in the United States, although “offshoring” and “reshoring” were certainly not major talking points in Canada as they were in the United States. -United.
Low stock of private capital
The second concern is that the growth of private capital stock, which accounts for 75% of fixed non-residential capital stock, is at its lowest level, having shown an almost constant decline since 1966. It has reached a low of 0, 2% in 1993. , then hit highs of 4.6% and 4.1% in 2006 and 2014. Now, after hitting a new low of 0.2% in 2016 and climbing as high as 1% in 2019 , it fell into negative territory in 2020 at -0.4 . “While the pandemic has most certainly accentuated this decline, recognizes Marion, we can see that the 5-year moving average has been on a downward trend for several years. In fact, this downward trend has been happening since 1965, currently bottoming out.
Canada’s current account, which has been deeply negative since 2009 and showed a tiny positive hit in 2020, is expected to fall back into deficit in coming years. And Canada is very dependent on foreign money to fund its current account, notes Marion, who warns: “If our growth prospects look unattractive in a post-pandemic world, capital flight could ensue. This is the kind of warning that international financial institutions are accustomed to issuing to Third World countries.
Residential capital upside down
Third alarm button: the volume of residential capital stock now exceeds non-residential capital stock for the first time since 1961, when the data was first recorded. The two amount to approximately $2.3 trillion, with the number of residential capital stocks now exceeding non-residential.
“Residential real estate has received a lot of capital, but it’s not a productive asset,” says Passi. “Is this going to harm our future prosperity, he continues? May be. It would be better if the housing could be more stable; the money could go to higher value companies in technology, healthcare, services, etc.
Exodus of pension money
Canadian pension funds, whose asset base is now as large as Canada’s GDP, are shunning domestic equities, with their holdings of domestic equities falling from a high of 77% in 2000 to a low of 27% in the end of 2020 (however, their holdings still favor Canadian bonds, with an allocation of 86%). The fall was particularly steep over the past year: purchases of foreign stocks jumped to $130 billion, or 5.2% of GDP.
Although Canadian purchases of foreign equities have somewhat tracked foreign purchases of Canadian equities, the surge in Canadian purchases of foreign equities overshadows foreign purchases of Canadian equities. For the first time ever in the first quarter of 2021, the total market value of Canadian pension fund foreign assets exceeded that of Canadian assets.
“This is justified under the guise of so-called ESG considerations, specifies the report. But who exactly are the net beneficiaries of Canadian capital? US companies, primarily in the information technology sector, that benefit from index investing. While some of these companies may pass the ESG “E” test, we would argue that many of them have questionable track records when it comes to passing the ESG “S” and “G” tests. The same is true for some emerging markets that also receive Canadian capital.
Canada is not an attractive destination right now
“Capital flows where it will get the greatest return,” says Passi, pointing out a classic economic law. Canada does not seem to offer this destination, at least not at this time. Passi considers that Canada certainly should not try to compete with the low-value manufacturing economies of the world. It should aim for high value-added levels: pharmaceuticals instead of vacuum cleaners and software instead of refrigerators. “Canada would certainly like this change, adds Passi, but is it doing enough to make it happen? “.
Such questions involve “long-term thinking and vision,” says Passi, of things that relate to increasing productivity, improving human capital, lowering taxes on developing industries, investing in infrastructure. But the report “seems to point to a lack of such vision, he adds. Yes, we want more capital. But can we do what it takes to attract it and guide it to the right places ? “
There is probably a bright side to the situation that the NBC report denounces: “Currently, the earnings yield of the constituents of the S&P/TSX is 40% higher than that of the companies of the S&P 500 (6.5% against 4, 6%). (…) of the best performing stock markets in 2021, the S&P/TSX is therefore trading at a record discount to the S&P 500.” This raises the following question for investors: the long-term outlook for the economy encourage investment there?