2018 Economic Outlook with Benjamin Tal_0_0
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[Host:] Hello, everyone,
[The Peter Pan Economy]
and thank you for joining us today.
On behalf of CIBC Investor's Edge,
I would like to welcome you all to this webinar.
My name is Dimple Sequeira,
and I will be your host for this event.
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before we get started.
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does not provide investment
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[SPEAKER Benjamin Tal]
Our topic for today's webinar
is Economic Outlook for 2018.
And to present this,
we have Benjamin Tal with us this afternoon,
and we're really excited
and thrilled to have him here.
Benjamin is the Deputy Chief Economist at CIBC,
a captivating speaker,
and a regular commentator on the financial
and economic trends
in Canadian and American media.
Ben is also responsible
for analyzing economic developments
and their implications
for North American markets.
With great pleasure,
please join me in welcoming Benjamin Tal.
[Speaker:] Thank you very much.
A lot to talk about and not enough time,
so I will go through this presentation
very, very quickly
[The Peter Pan Economy]
and see what makes sense and what doesn't.
And I would like to try to cover a few questions
that I think are relevant.
The first one, maybe the most basic one is simply
where we are in the cycle.
Now we know that this expansion is very long.
Where are we in the cycle?
Should we start thinking about
the late cycle investment strategy
at this point?
Another question, of course,
is what's happening in the Eurozone.
And basically, EU has been doing fine.
Should we trade in Europe
in a different way at this point?
That's a good question, we'll discuss it.
Energy.
You know, oil prices have been going up,
how should we trade energy at this point?
We'll talk about that.
Then, of course, we must discuss Trump.
And the question is really a very basic one.
How to trade Trump?
Maybe we should not trade Trump at all.
We'll discuss it.
The wage mechanism in the US
and in Canada is starting to change,
what does it mean for inflation for interest rates
and therefore investment?
The tax package introduced
by Trump is a game changer.
We'll talk about that.
What does it mean for investment?
I think it's very big, and we'll talk about that.
NAFTA, of course,
you cannot discuss 2018 interest rates,
stock markets without discussing NAFTA.
Are we totally out to lunch
when it comes to NAFTA?
Is the market mispricing NAFTA?
My answer is absolutely yes.
The question is how to trade it
and what does it mean for the TSX?
Of course, what is the reaction curve
by the Bank of Canada?
The Bank of Canada just raised interest rates,
but they're telling us that NAFTA is an issue,
we'll talk about that.
And, of course, if we have time,
we'll discuss the very important issue
of the Canadian housing market
and to what extent we're in a battle,
maybe note changes to regulations,
what it means for the trajectory
of the housing market,
and then of course,
try to put everything together
and see how we can invest given all this information.
So let's start very, very quickly.
And the first chart is
basically telling you
[The Cycle is Old]
that this cycle is old.
This is the third longest expansion ever,
and within two to three months,
it will be the second longest expansion.
And the only one that is still longer
is the one in the 1990s
that was benefiting
from the internet revolution.
So this is a very old cycle.
And when you have an old cycle,
usually people start investing using
that cycle philosophy,
and I say not so fast
[Cumulative Real GDP Per Capita Growth
During Expansions]
because if you look at the next chart,
you can see that, yes, it's long,
but during all those years,
it did not accomplished much.
Namely, the recovery has been
much more muted than in the past,
which means that if you look at cumulative GDP growth,
it's not really something to write on about,
it's something in between
which means that this cycle
is much younger than it looks,
and therefore, I will not jump so quickly
to a late cycle philosophy
because I think that the next recession
is not tomorrow,
namely this is not the ninth inning
or the seventh inning of this game
because, again,
we will be recovering very, very slowly,
so this is in the background.
This is not really the end of the cycle.
We still have time given
what we were able to accomplish.
Now clearly, from a cyclical perspective,
2017 was a very, very good year.
In fact, many,
[A Surprising Start]
many economies surprise on the upside.
We've seen it everywhere,
namely this chart is telling you
the difference between what the market expected
in the beginning of the year
and what we actually got.
And you can see almost everywhere
we have seen an upside surprise,
clearly in Canada,
we have seen a situation
in which the economy was doing better.
Now this is very important
because we have to try to figure out
what's happening in the stock market
and what happened in 2017.
And, you know, when it comes to Trump,
and when it comes to its impact on policies,
I would suggest that when it comes
to actually the impact of Trump
on financial markets in 2017,
in my opinion Trump
was nothing more than a blip.
Trump was unable, in my opinion,
to move markets.
We know that after the elections,
November 2016,
the market reacted in a very violent way.
We have seen the broad market correcting,
the 10 year rate went up dramatically,
and since then it started to go down,
and down, and down,
and the only reason why it's still
where it used to be, I believe,
is simply because of the fact
that the fed is moving
nothing to do with Trump.
Same goes for the US currency.
The US dollar went up dramatically
after the elections,
since then lost ground again.
Now it's below the level
we've seen before the election, again a blip.
The consensus for economic growth
in the US for 2017 was 2.1.
That's basically what we got. Again, a blip.
So Trump really in 2017 did not impact the market,
in my opinion, in any significant way.
But of course, you might say
"what about the stock market?"
Because the stock market did not reverse.
Every day it's reaching a new high,
and just two weeks ago,
Trump basically tweeted saying,
it's all me.
And you know what, yes,
the stock market in the US is reaching new highs,
but also the German stock market,
also the Japanese stock market,
also emerging markets
and the global markets in general.
Basically, it's a global story,
not a US story, nothing to do with Trump.
And we are seeing it actually in this chart
because the global economy
is actually surprising on the upside.
And the question is why,
and the answer is very simple, easy money.
When you have
the Japanese Central Bank printing money
with negative interest rates,
that's a boost.
When you have the European Central Bank,
negative interest rates printing money,
same here, interest rates in North America
have been very, very low for a long period of time.
That's a lot of momentum
in the economy in terms of liquidity.
And if you generate enough wind,
even pigs can fly,
and that's exactly what we are seeing.
We are seeing a situation
in which this recovery is a mirage.
It's basically all about very easy money.
And the big question
is to what extent it is sustainable
when it comes to a situation
which it is surprising,
and then we'll see how significant it is.
We'll talk about it in a second.
Now from this chart,
you can also see that Canada led the way.
In fact, Canada
was the best performing economy in 2017
in terms of the surprise
and absolute improvement.
And clearly, that's the main reason
why Trudeau is now smiling
because the government got
just $10.5 billion of extra money
just because of the fact
that we got extra 1.2 GDP growth
which is very, very significant.
Now this improvement
could have been even better
if oil prices were, you know, back to 100.
If you remember back then,
when we had GDP growth
expanding at this rate,
the impact was very significant
because when we ship all those barrels of oil
and they were worth $100 per barrel,
then you get a big lift.
Today, it's less than that,
so the lift is not as significant,
so it's not as significant positive contribution
as it used to be.
Basically, what I'm telling you is that
opposed to what the Scotiabank is telling you,
you're not richer than you think.
But what I'm telling you is that we'll take it,
and that's the big surprise of 2017,
and that's why the Bank of Canada
is basically touching interest rates,
we'll talk about it in a second,
but that's the background.
Now we have to remember
that when it comes to investment,
when it comes to the cyclical story,
we have to remember the background,
and the background is actually this chart,
[Slower Speed Limits:
GDP Bar is Lower for Full Employment]
which is the potential growth of the economy,
namely the speed limit
or the ability of the economy to grow.
And yes, we are getting a nice rebound in 2017,
but it's against the gravity force
here of potential GDP,
the ability of the economy to grow
that is going down.
The reason, of course, is demographics.
We see everybody getting older.
Clearly, even in China, in the Eurozone,
North America,
people are getting older,
therefore, the ability of the economy to grow
because of demographic forces
is a very, very significant
force slowing down the ability
of the economy to expand.
And yes, Trump can do a lot of things,
but Trump cannot make America young again.
And this is something
that we have to take into account.
Actually, the fact that productivity,
almost everywhere, is slowing down,
so you have reduced potential growth
is something that will impact
the ability of monetary policy
to impact the market
and also how high interest rates
will rise at the peak.
And that's something to keep in the background
because it will influence everything,
the TSX, S&P 500,
and of course monetary policy.
Very, very quickly,
let's talk about some other pockets,
[Eurozone: Progress Made But Still More To Come]
one of them, of course, is the Eurozone.
I've been longing the Euro for a while,
especially against the British pound,
and I will continue to do so, why?
The Eurozone in fact is improving.
It's surprising on the upside,
and we have survived
all the election cycles in the Eurozone.
Of course,
we have something happening in Italy,
Spain is an issue,
but overall I think that the political climate
in the Eurozone is not as scary
as it used to be from an economic perspective.
Clearly, they are doing better than expected,
and that's really positive.
So I will long the Euro,
I will continue to long the Euro,
especially against the British pound
because when you speak to British officials,
nobody can give you one sentence telling you
where this economy is going.
This Brexit business is one big headache.
They really cannot give you one sentence
where are we going from here.
And this kind of uncertainty is starting to impact
the ability of their economic to grow,
the labor market,
and therefore when it comes to assessing
where I want to be,
clearly I will long the Euro against the pound.
And why is it so important?
Why the focus on Europe is so important?
[ECB QE Announcements Impacting Cdn 5Y Yields (L)
Taking a Slow Approach to Tapering as Slack Remains (R)]
Because it's beyond the Euro,
it's actually your mortgage rates.
Clearly what's happening in the Eurozone
is impacting the North American bond market.
And if you look just at the chart at the left,
you can see what I'm talking about.
This is basically a measure
of the reaction of the market,
the five-year bond rate
which will impact your five-year mortgage rate.
And you can see
how the markets reacted to different events.
You know, when the Bank of Canada
raised interest rates in July last year,
the reaction was nothing to write on about.
Even when the Bank of Canada
changed direction
in a very famous speech
by Senior Deputy Governor Wilkins,
the markets reacted but nothing big.
When the president of the European Central Bank
tweeted about the possibility
of slowing down the rate at
which they are, you know, buying bonds,
the market in Canada
reacted in a very significant way
with a five-year rate actually moving.
The reason is that one of the factors
that impacted the bond market
in the US and Canada
is the fact that interest rates in Japan
and the Eurozone are negative.
So you're an investor, you want to invest,
and you look and you see negative interest rates,
and then you turn to left and you see
interest rates in North America positive.
You go to North America,
that introduced more demand for our bonds
and therefore kept interest rates low
to the extent
that the market will start toying with the idea
that maybe, maybe the Bank of Japan
and the Eurozone, the ECB
will start slowing down the rate
at which they're printing money,
and maybe eventually, maybe 2019,
they actually will go to positive rates,
that will start shifting demand to their markets,
and therefore will have an upside
impact on our bond yields,
the five year rate.
So in a funny way, what's happening in the Eurozone
can impact our mortgage rates.
So I'm basically longing
the Euro against the pound.
I'm also positive on the Japanese market.
The Japanese market
is actually surprising on the upside.
We're revising economic focus
and consensus almost on a daily basis,
and it's always on the upside.
Why?
Because first of all, for the first time,
they're allowing foreign workers
into the country, and that's huge.
Already there are more than
one million foreign workers in Japan,
that's unheard of.
That's leading to some improvement
in the labor market.
And the second and the big issue
is the participation rate among women
in the labor market went up dramatically.
So yes, Japan is a demographic time bomb,
but when it comes to the labor market,
the participation rate in fact is rising
because of the fact that more
and more women are entering the market.
Actually, a significant stimulus
is coming from the fiscal side
due to government policies,
and you have a recipe
for an economy
that will surprise on the upside,
and therefore, potentially
even the stock market will do better.
So I'm actually relatively constructive
on the Japanese economy.
Now very, very quickly,
let's discuss energy.
[Oil Demand Upgrade Met by Non-OPEC supply (L),
Keeping Expected Deficit for 2017 at Slim Levels (R)]
Am I buying energy now or am I selling energy?
We know that oil prices went up nicely,
over 60 bucks,
and the question is why.
And the answer is that supply of course
is not there to the same extent that it used to be.
Now you look at the chart on the left
and you can see that
really the marginal supplier here is non-OPEC,
which is basically US production.
And we have seen a situation
in which we had this ping pong game,
when the oil prices went down,
OPEC pushed it back towards 50, 55,
then US production went up,
and the supply went up,
and then prices went down.
So we had this wonderful ping pong game
over the past two years.
The question is to what extent
we can continue to play this game.
At about 60, 65 bucks,
I think that the market is very well balanced.
Now it takes time for US production
to increase drilling activity.
If you look at their rig count,
namely how many rigs they have,
it usually takes about six months to go up
and increase supply,
and that's more or less where we are.
So we are not there yet.
So am I longing energy at this point?
No, I think that I would be neutral on energy
because I think we belong at about 55 to 65,
that's more or less where we belong.
I think that supply will rise,
coming from the US in the next few months,
and that would put the downward pressure on oil,
so I'm basically neutral on oil.
I'm not really jumping here saying
this is a long-term trend.
I think that we are very comfortable
at about say 60 bucks a barrel.
That's more or less where we belong.
Now very, very quickly
let's go to the US labor market
because one thing that happened
over the past two to three years is the following.
The labor market is strong
in Canada and in the US,
regardless how you look at it,
it is very strong.
Now usually in this kind of situation
when you have the unemployment rate
reaching new lows,
you have wages rising
because the bargaining power of labor is improving.
When wages go up, inflation goes up,
and when inflation goes up,
interest rates go up,
the economy goes down,
and that's a cycle,
and until recently, we haven't seen it.
Basically, we haven't seen wages rising
in any significant way despite the fact
[US Tight Labor Market - Slowing]
that the labor market is on fire.
The only reason, in the chart on the left,
why the labor market is slowing in the US
is simply because of the fact that
maybe they're running out of people.
If you look at the chart on the right,
the quit rate is almost at a record high,
which means that people
are confident enough to quit.
That's a very positive signal.
If you look at what's happening
[US Employment Recovery Still Has Some Room (L),
But Businesses Having Hard Time Filling Vacancies (R)]
in the prime-age employment-to-population rising,
it has the potential to continue to grow
but clearly reaching a peak.
If you look at job openings, record high,
a very, very strong labor market.
So the key question
is why wages are not in the sky.
And I think that the chart to the right
is starting to give us maybe a clue.
And I believe that if you really search
for answers about the market,
about interest rates,
the labor market has most of the answers,
we just have to understand this labor market.
This opening rate is basically at a record high.
This might mean
that companies cannot find people.
So we have a very interesting mismatch
in the labor market.
We have people without jobs
and jobs without people.
We have people looking for jobs
that cannot find them,
and we have companies looking for people
that cannot find them.
That's very significant,
and maybe, one of the main factors
preventing wages
from rising to the same extent
that they used
to because we have to deal
with this mismatch in the labor market,
and this is something that we see everywhere.
[The Shrinking Middle Class]
This chart is telling you the story.
All the jobs created in the OECD
were created in the higher end of the market,
the labor market, and the lower end.
The middle, namely the middle class,
down, everywhere.
This is the story.
Yes, the headline numbers are strong,
but if you go deeper,
you find that not all is well
in the US labor market for example.
The duration of unemployment
is still relatively elevated.
Today in the US,
despite very strong numbers,
today, in the US, there are still
more people collecting disability insurance
than production workers.
That's not a normally functioning market.
Millions of people are not fully participating
in the recovery.
That's their cry
and Trump is the messenger.
So the reason why we don't see inflation rising
to the same extent that it used to,
the reason why wages are not rising,
and the reason why interest rates
are not rising as quickly as they used to,
and therefore,
the reason why this expansion is so long,
those are the same reasons
why Trump is the president today.
It's all connected.
The political scene,
and the economic scene,
and the stock market,
they're all part of the same story
which is reflected in the yellow bows
that are negative, that's their cry,
and Trump is the messenger.
And I think it would be naive to believe
that we in Canada are immune
to this trajectory, we are not.
We have the same problems.
In fact, I believe that the number one
socioeconomic issue facing Canada
is actually widening income gap.
It's widening, and widening,
and widening from a long-term perspective,
we see a situation which the quality
of employment in Canada is going down.
We see a situation in which the number of people
making below average wage is rising.
Yes, from a cyclical perspective,
we are doing fine.
We'll talk about it in a second.
But the structural story
is the story of a mismatch.
We don't have the time to get into it,
but one of the reasons
why we have this mismatch is simply the fact
that we have a mismatch
between what people are studying
and what the labor market needs
because this kind of mismatch
is also among very educated people.
Canada is the most educated country in the OECD,
but it's also the number one country
in terms of the number of educated people
that live in poverty.
Namely we cannot translate
those degrees into jobs,
and that's an issue
that we have to deal with.
This is not for now
because we simply don't have the time,
but the issue is that
from a short-term perspective,
and that's the elephant in the room,
that the problem that Trump is trying to solve,
the problem that Trudeau is trying to solve,
this problem simply does not have a solution.
That's the elephant in the room
that no politician will ever admit.
In the short term,
we simply cannot lift the yellow bar up.
And really, we are dealing
with the same problem.
Trump is trying to solve it using trade,
and Trudeau is trying
to solve it using a tax policy,
but they're dealing with the same problem,
and therefore, we have a wage mechanism
that is not functioning to the extent
that it used to because of this mismatch.
It doesn't mean that cyclical forces
will not take wages up,
but it means that the ability of those wages to rise,
and therefore, the ability of inflation to rise,
and therefore, the ability of interest rates
to rise and kill the economy is limited
because of those structural issues
that you cannot resolve,
you know, within a cycle.
Now very, very quickly,
another thing that Trump is trying to do
at this point is the tax story.
And I won't get too much into it,
but to me, this is a game changer.
The ability of Congress to pass
the tax package is big
with major implications for Canada.
We are talking about de facto
tax cuts significant to about 20%-21%,
that's significant
because the US was probably
the most expensive country
in terms of corporate tax,
the margin, marginal corporate tax,
now it's basically back to
where everybody else is, including Canada.
They are getting a significant break
when it comes to accelerated depreciation,
namely you can invest in them
and then expense it immediately,
that's a significant boost to cash flows,
and then you have cash repatriation
where $2.6 trillion sitting outside the country,
and basically Trump is telling you,
I'll give you a good deal,
just bring the money back.
President Bush in 2004
did the exact same thing.
The money did come back, 90% of it
went to stock buybacks and dividends,
again lifting the stock market,
so all those forces
are very stock market friendly.
The consensus is that this tax cut by itself
will add roughly 5% to 6% to US earnings,
and that's why I believe that, yes,
the US market is expensive,
but I think that it still has some potential
because you really have to price
in all the positive news,
and the market is already pricing
in 4%, 5%, 6%
earning growth in the US for the S&P 500,
and another 5% because of the tax cuts,
you're talking about 10%, 11% earning growth,
that's not insignificant,
clearly can support
the stock market for a while,
and I think that's exactly
what we are seeing now,
and it has potential to continue.
This is a big deal.
And of course,
it has negative implications for Canada.
Yes, you can find many Canadian companies
that can benefit from these tax cuts,
especially if they have significant US operations,
but overall, this is a negative.
So think about it from an investment perspective.
You are thinking at this point,
where do you want to be,
do you want to invest in Canada
or in the US
if you have a new facility to invest.
And let's face it.
You basically face the same tax rate,
before it was usually better for Canada,
now it's basically the same.
You get a huge benefit
from the accelerated capital depreciation.
This is a significant boost to your cash flow.
You can repatriate cash at a lower rate
if you want,
and you're not sure at the end of the day
if you will have access to the US
if you decide to locate your facility in Canada.
Yes, you will get the healthcare business in Canada,
yes, maybe better access to immigration,
and therefore better,
you know, set of skilled workers,
but all those benefits probably
will not be as significant
as the negative that you will face
if you don't have access to the market
or you don't get the cash flow
because of capital depreciation,
acceleration in capital depreciation.
So I think that, yes,
maybe we can compete with existing facilities.
I'm not sure about new facilities,
and that should have an impact
on the value of the Canadian dollar.
We'll talk about it in a second.
But before that,
I would like to discuss trade.
And, you know,
Trump has been signing executive orders
at the speed of light.
But I believe that when it comes to trade with China,
his pen will run out of ink
because I believe that when it comes to China,
and I'm not saying it lightly,
I believe that the US needs China
more than China needs the US.
I think that when it comes to his policies,
he simply cannot implement them on China.
For example, during the campaign
Trump was talking about a 45% tariff on China.
That's interesting, but he cannot do that
because what does it mean, de facto.
De facto, it's going to lead
to higher prices in Walmart.
Basically de facto tax on low income Americans,
your base, you're not going to do it.
Second, what is the fastest growing segment
of the global economy today?
By far, it is the consumer of emerging market.
[Consumer Spending in China to Rise at Double
the US Rate (L), Leaving it $1.4 tn higher in 2020 (R)]
You can see that this consumer
is basically the future
of North American manufacturing,
demand for consumption is rising.
We have the Y generation in China,
250 million young Chinese people
who never experienced poverty in their life,
their prosperity to consume
is higher than the average American teenager,
and what they want is a brand name,
quality products,
exactly what the Americans can sell them.
And we're starting to see it already.
[Chinese Takeout: Ordering Off a New Menu]
You look at the Chinese tourist basically taking over,
this is purchasing power that is the future
of the North American manufacturing
exactly at this point,
and exactly at this point when you are able
and willing to ship your products
to the fastest growing segment
of the global economy,
you're going to see your access being eliminated.
That will cost American manufacturers trillions
of dollars in lost opportunities.
And believe me,
Germany will be more than happy to take over,
you cannot do that.
Again, the US needs China
more than China needs the US.
[The North Korea File]
And then you have this guy.
Well, I don't know
what the solution with North Korea is,
but I do know one thing,
whatever the solution is,
China must be a big part of it.
And if China's a big part of it,
the last thing you want to do
is to start a trade war with China.
Therefore,
I believe that he will not go after China
when it comes to trade anytime soon
in any significant way.
But you need to show something on trade,
especially before the mid-term election.
So you go after the little ones,
the little ones, that's us.
And that's why NAFTA is a priority.
[First Specific Negotiation Objective]
If you want to deal with your trade situation,
you need to deal with the yellow part
which is mostly China,
but no, it's going after NAFTA
which is 12% of the US trade deficit.
Within it, you need a microscope to find Canada,
and all of it is basically energy.
So Canada is not really an issue
when it comes to trying to solve
the American trade situation.
Nevertheless, we are in the midst
of significant NAFTA negotiations
that are not going very, very well.
[Mexico Has Benefitted More From NAFTA (L),]
We know that Mexico was a major winner
[Unwinding Trade Links Wouldn't Be Easy
For Us Either (R)]
when it comes to NAFTA,
getting market share from Canada,
clearly the US in the other sector, and others.
And we know that those negotiations
are not going well.
In fact, Trudeau is telling you the negotiations
are not going well.
We have a situation
in which tomorrow Trump can wake up
and say NAFTA is dead.
And I mean it.
It can happen tomorrow,
with Trump, you never know.
And we have a situation
in which he can do that
because under the Constitution,
the authority over trade,
you have it to Congress
and of course the president,
congress under the umbrella of commerce,
and the president
under the umbrella of national security.
And you have a situation
in which he's basically telling you,
"I want out," and we can discuss
until we are blue the face
that that will hurt the US trade situation
and US workers.
That's irrelevant
because he's telling you he wants out.
So this is a real possibility.
And yes, if he decides to kill NAFTA tomorrow,
Congress would have to actively agree,
if not, they have to go
to the Supreme Court, big headache,
that will cause a fog of uncertainty.
And even without Congress,
under the Constitution,
the president has significant
power over the court house
and tariff and we're seeing it already.
So he can cause a lot of headache
even without Congress,
very important to remember.
And again, it's not just about tariff
because if tomorrow we don't have NAFTA,
we go back to the WTO,
World Trade Organization tariff situation,
where the tariffs are not very, very high,
but the issue is not tariff,
the issue is Chapter 19,
the dispute resolution issue
in which a bunch of judges
are basically telling you what's right,
the US versus Canada versus Mexico,
and in many cases,
Canada was winning the case
and Trump is basically telling you,
I don't want this Chapter 19,
I don't want this dispute resolution.
And Trudeau is saying,
absolutely not
because that's the only power I have,
you remove the dispute resolution,
we don't have anything,
and therefore, if NAFTA dies,
it will be over Chapter 19.
So the question is how the market is pricing it in,
[Markets Brushing Aside NAFTA Concerns
in Both Stocks (L) and Currencies (R)]
and the answer is it's not.
If you look at valuations
of auto parts manufacturers,
nothing is happening.
If you look at the Mexican peso,
you know, the currency that can lose significantly
if there is no Trump tomorrow,
you see that it went down dramatically
after the elections,
and then it was the fastest growing,
improving currency in the universe,
went down a little bit since then,
but still it is where, more or less,
it was before the elections.
Basically, the market is pricing nothing
when it comes to NAFTA,
despite the fact that everybody
is talking about the possibility of NAFTA dying.
And I think that when it comes to NAFTA,
this market is in la-la land.
I think that we are dreaming.
I think the risk of NAFTA is significant,
and if you're a CEO
and you don't know if you have NAFTA tomorrow,
you're not investing.
And that's something
that we have to take into account.
In fact, already two-thirds
of small businesses in Canada
are telling us that NAFTA is impacting
their decision-making process
in a negative way,
and this is just the beginning.
So the question is why the market is so numb
about a very clear risk coming from NAFTA?
Why the market is not pricing it in?
And the answer is,
and we talked to a lot of CEOs
and traders about it,
the answer I believe is simply
because of the fact that
it's simply too big, it's too complex.
You have so many possible scenarios
and the market is not very good
in dealing with many scenarios at once,
they can deal with zero and one,
black and white,
they cannot deal with different scenarios.
They simply don't know what to do.
So the market is frozen.
So the fact that
the market is not reacting to it
does not mean that NAFTA is not there.
The risk is there, I don't know
what will happen tomorrow with NAFTA.
What I do know, however,
is that when it comes to the market,
it's really not pricing it in.
Therefore, I am shorting the Mexican pesos.
I am shorting the Canadian dollar
because I believe those two currencies
are not responding to reality.
And this reality eventually
will force the market to recognize
that something is happening.
Again, I don't know what the solution will be,
but I know that between now and the solution,
there will be a lot of uncertainty
that will impact the ability of the market
to function in a normal way.
And in fact, the Bank of Canada,
when they raised interest rates today already
is telling us that NAFTA is an issue.
[Higher Wages and Better Job Composition]
We have a situation in which the labor market
from a cyclical perspective is improving.
We see average wages starting to rise finally.
We see the composition
of employment rising.
Again, this is not a structural story,
the structural story
is actually lower,
but we are talking about the cyclical story
that's eventually leading
to something very positive.
[Strong Rebound in Labour Income]
We see a nice rebound in labor income.
As I said, 2017 was very strong
and the labor market
is participating in the story.
And clearly, this is something
that we have to take into account.
And even the things that the Bank of Canada
[Basically All the Decline in Youth Participation Rate
is Due to Lower High School Student Participation]
are worried about, for example,
the participation rate of young people
in the labor force
because the Bank of Canada,
the governor just a few weeks ago gave a speech,
and basically,
the speech was what keeps me up at night.
One of the issues was
basically young people
are not participating in the labor market.
As you can see,
the chart on the left is absolutely right,
the participation went down
from 64% to about 60%,
so he's really losing sleep over it.
And I say, you know what,
you should sleep well at night
because that's not an issue.
Why it's not an issue?
Because all the increase...
All the decline in the participation rate
is due to a decline
in the participation rate
among high school students.
That's not a reason to lose sleep over
because those students should be studying,
not working, and therefore,
that's not a major macroeconomic force
that will prevent you
from raising interest rates.
So clearly, the Bank of Canada was willing
to raise interest rates reflecting
the very strong labor market,
the economy's surprising in the upside,
but now, they're telling us
we're not moving very fast on this month.
Why?
Because of NAFTA,
because of the tax package
coming from the US,
all the forces that, to me,
will work to weaken the Canada dollar,
also will work to reduce the ability
of the Bank of Canada to move.
And in fact,
I believe that the Bank of Canada
will move more slowly than the Fed.
So you have this issue
in which we have headwinds
coming our way through NAFTA
and the package,
the tax package in the US,
both very significant and negative for Canada,
and then we have other forces
that will impact the ability
and the willingness
of the Bank of Canada to move.
Another force of course is the Canadian dollar,
which is now at about 80 cents,
way too high.
As I said, I believe it will go down,
and the Bank of Canada will encourage that
because this Bank of Canada
is a bank with an agenda.
The agenda is a weaker Canadian dollar.
I believe that the Bank of Canada
would like to see
the Canadian dollar going down,
not up.
And if you raise interest rates
as quickly as the fed,
you actually prevent it from happening,
so another reason why I believe
that the Bank of Canada
will move more slowly.
[Interest Rates Sensitivity]
And then there is another reason
which is the debt situation.
As you know, the Bank of Canada
and everybody else is telling us
that we have too much debt.
The debt to income ratio
in Canada is 170%.
Everybody knows this number,
everybody in this country knows this number,
it's all over the media.
I think it should be part
of the citizenship test or something.
I believe that without getting into really
how much debt we have
because I think that this debt to income ratio
that everybody is quoting
is a Mickey Mouse type indicator,
it's not really a good indicator.
Regardless, clearly, as a society,
we are more sensitive
to the risk of higher interest rates
than in any other time in recent history.
During the crisis,
the US debt to income ratio went down
from 165% to 140%.
Ours went up from 140% to 165%,
reflecting the fact that
we did not experience a correction
in the housing market.
This means, as you can see from this chart,
that we are more sensitive
to the risk of higher interest rates.
So every basis point counts,
and it counts significantly,
[A Mighty Basis Point]
basically, monetary policy today is 20% more effective,
namely any basis point increase
is 20% more effective
in slowing down the economy than 5 years ago
and 40% 10 years ago.
That's very, very important to understand.
And what's important here
is that this sensitivity to higher interest rates
will prevent interest rates from rising.
Basically, the disease is also the cure,
namely the increased sensitivity to higher rates
will prevent interest rates
from rising to the sky
because they will be so effective.
But of course, you can raise interest rates
without raising interest rates.
[Growth in Mortgage Outstanding Could Slow Notably]
And here I'm getting to the Canadian housing market.
We are running out of time,
so I will go very, very quickly.
We are raising interest rates
without raising interest rates through regulations.
You're all familiar with the recent changes
by OSFI to raise
the qualification rates by 200 basis points.
This is significant.
We estimate that when you ask people to qualify
at 200 basis points higher than the actual rate,
that will impact roughly 12%,
12% of the market.
Namely, 12% of people,
potential buyers will feel it.
Now when I say it will impact,
it doesn't mean that demand or sales
will go down by 12%
because you should never underestimate
the creative imagination of Canadian borrowers.
They can go with lower duration,
they can increase amortization,
and of course,
they can go out to alternative lenders.
[Credit Unions and Private Lenders Will Benefit]
Credit unions will gain market share
after losing some market share recently
because of the fact that
they're not subject to those changes.
Also, alternative lenders,
private mortgage lenders
will benefit mostly mortgage
investment corporations already account
for 10% of the market,
on the way, I believe to 15%
because we are basically transferring risk
from the regulated segment of the market
to the unregulated segment of the market.
That's a negative derivative of the,
you know, OSFI trying to reduce risk
in the market.
I'm not sure that we are not
actually raising risk in the market.
Clearly, the private mortgage space will rise
because of that.
Very, very quickly, of course,
we cannot discuss housing
without discussing
what's happening in Toronto and Vancouver.
And I believe the first,
[The Best View of the Toronto Real Estate Horizon
is from the Vancouver Harbour]
the best view of the Toronto real estate horizon
is actually from the Vancouver Harbor.
Without getting too much into it,
I will say the following.
In 2015,
activity in Vancouver went up dramatically,
and then gravity took place
because simply this activity
did not make any sense,
there was some speculation,
some foreign buying, and of course,
things started to slow down in 2016.
And then the government introduced...
I apologize, the dots there,
red dots and the yellow dots
are not exactly where they should be,
but the government introduced
a 15% tax on foreigners in Vancouver.
And the tax itself really was not the reason
why Vancouver slowed down,
it's really because of the fact that
domestic buyers stop buying,
expecting to see some slowdown
due to the tax on foreign investment.
So it's not really the taxes,
what people believe the tax will do.
And of course, it went down,
and then as you can see,
the yellow line clearly,
Vancouver is recovering
because when you don't deal with the real issue,
which is supply, every fix is temporary.
Now take Toronto,
move it 14 months to the left
and you see the red line exactly the same thing.
The crazy year in Toronto was 2016.
We've seen huge increase
in valuations and activity
until the first quarter of 2017.
Again, a lot of it did not make sense up to 2015,
the market made sense, in 2016, it did not.
We have seen a lot of speculations,
a lot of flipping,
and maybe some foreign buyers,
and again, exactly at the peak,
when gravity started to take place,
we saw a situation in which the government,
the Ontario government introduced
the very famous 16-point program
to slow down the economy.
I won't get too much into it,
foreign investment was a part of it,
tax on foreign investment, and clearly,
a rent control,
which I think is a misguided policy.
So overall, this slowed down the market,
but again, it's not because of the policies
but because what people believe
the policies will do.
And as you can see and you feel probably,
Toronto is actually improving now again
because you're not dealing with a real issue.
The real issue is supply,
the Places to Grow Act
introduced by the Ontario government in 2006
is the number one reason why land prices
and therefore house prices in the GTA
have been rising for a long period of time.
So from a real estate perspective,
Toronto is like Vancouver,
it's basically an island with limited supply,
and yes, the changes to regulations,
that will slow down the market,
higher interest rates,
that will slow down the market.
The recession down the road,
that will slow down the market.
But from a long-term perspective,
we simply don't have the solution
for this affordability crisis
because we don't have a rental solution,
especially in Toronto
and we don't have enough supply.
So from a long-term perspective,
even if we go down
in the next year or two or three,
from a long-term perspective,
if you believe that the GTA
and Vancouver are unaffordable now,
you wait,
it will become even less affordable
a decade from now
if we don't introduce the right policies.
So I'm out of time.
Let me just summarize
what it is from an investor perspective.
I think that we are not
in a late cycle trajectory here
because I think that this cycle can continue
because this is old
but it's really younger than it looks,
given what we accomplished.
I really think that the Euro is a good opportunity,
especially against the pound.
I like the Euro against the pound.
I like Japan at this point
because of the fact that
they're able to surprise the market
when it comes to economic growth
because of the immigration,
because of the foreign workers,
women participation in the labor market,
and of course, monetary and fiscal policy.
I think that the US stock market
will outperform the Canadian stock market.
I will long in the US
those sectors that are more sensitive
to lower tax rates,
I'm talking about a small cap
that are more sensitive to the tax aspect.
I'm talking about industrial for example.
And I also like financials in the US
because I believe that we will see
some deregulations in the US.
Trump probably can do that,
and that's another positive for financials.
I think that Canada is going
to under-perform the US,
but even here, I see some opportunities.
I think that energy is neutral
and some names are actually good.
I think that if you look at the financials,
they give you a very good solid base
with very high dividends.
So they are basically a good,
safe place to be.
And I think that the commodity space in Canada,
given the global economy,
I think can still do okay in 2018
because I think that the global economy in 2018
will be even better
or better than expected at this point,
especially coming from China,
the Eurozone, even Japan, and the US
actually with the tax cuts
probably will surprise on the up side.
So I see some momentum in the global economy,
even in 2018,
probably a play on commodities
helping Canada.
I don't like the Mexican peso.
I will short it.
And I do believe that
the Canadian dollar is expensive,
given the headwinds
that we're going to get from NAFTA
and of course the tax cuts in the US.
So overall, there is some logic to this madness
if you read the economic map correctly.
This market is tradable,
and for the first time,
I'm actually trading Trump,
especially because of the policy on taxes.
I think that NAFTA is a major issue,
and the market is not pricing it in.
So again, there is some logic to this madness
if you read the economic map correctly
because after this recession,
this long recovery,
and especially the elections,
what was normal in the past is not normal
in the context of today's economy.
Thank you very much.
[Host:] Thank you, Benjamin.
That was an amazing presentation.
So while Ben reviews some of the questions,
[Q & A]
I just wanted our audience
who joined in later to know that
you can type your questions in the Q&A panel
located at the right-hand side of your screen.
And if you wish to listen to this webinar again,
a link will be mailed to anyone that registered.
Also, I would like to request
the audience to ask questions
more exclusive to today's topic
and to avoid asking questions
that are specific to the security
or a company.
So we do have some good questions coming in.
And without further delay,
let me turn this to Ben
so he can answer some of these questions.
[Speaker:] Okay, so first of all,
there is a question asking
for a copy of the presentation.
I'm sure that you can get it.
Another question is about
stability of the stock market prices.
I think that one of the reasons
why the stock market
is not panicking at this point
is because of the fact that
we are not in a late-cycle type situation.
As I suggested, we are probably
in the middle somewhere.
And the market is reflecting that.
The market is not panicking
because the economic signals
that we're getting are inconsistent
with the end of the cycle type situation.
So another question that is connected to that
is when is the next recession?
Well, I have no idea.
But I don't think it's next year.
I don't think it's 2019.
Again, we can go...
And actually this can be the longest expansion
ever given the fact
how slowly we'll be recovering.
So I don't think that the recession
is anytime soon.
Of course, there is always,
always the risk of monetary policy error,
every recession over the past 50 years
was helped
if not caused by monetary policy error
in which the central banks
basically sat on low interest rates
for a long period of time only to allow inflation
to surprise them on the upside,
and then you start raising interest rates
because you're chasing a lagging indicator,
and when you do that, you overshoot,
and when you overshoot,
you kill the economy.
That's exactly what happened in 1991 in Canada,
that's exactly what I believe happened
in 2004 in the US,
clearly, Greenspan did not kill the economy
but made the recession
worse by raising interest rates
from 1% to 5.25%
over the course of breakfast.
So that's something that we have to monitor,
and that's why I believe
the Fed started to move a bit earlier
because of the fact that they really
don't want to repeat past mistakes.
In fact, Yellen is telling us
that she doesn't want to repeat past mistake,
and that's something
that we have to take into account.
You know, people, of course,
asking about the volatility.
And the volatility in the market
is not reflecting any late-cycle behavior.
To me, this is very important.
Again, many people asking
about the real estate market,
it's a very complex market,
the GTA, Vancouver, Montreal is picking up.
I believe that clearly
if you look at the market now
after the changes to regulations,
we are talking about a situation
in which the low-rise segment of the market,
namely the more expensive segment
of the market is going down
because that's where
the affordability issue is.
The condo market is taking off.
But now there are some big changes,
for example,
the Ontario Municipal Board
is not functioning anymore
because of changes to regulations.
This means that even developers
will not be able to develop
to the extent that they want to.
So supply would be an issue.
So to me,
the rental market is really the key.
And without the ability to raise rent
because of rent control,
then you have very limited,
what we call, purpose-built.
And if you don't have purpose-built rental,
you really have lack of supply
and the rental market will be on fire.
So again, from a short-term perspective,
yes, it can go down,
it can stabilize, it can slow down.
But from a long-term perspective,
without really dealing with the issue,
this place is actually going up, not down,
and we will have a major affordability issue,
and of course, we need transportation,
we all know about that,
but we don't have time for that.
Yeah, people asking about China.
China is a very, very important
part of the story.
China is slowing down.
China is slowing down
because, you know, demographically,
their labor force in fact is shrinking, China, why?
Of course, the one-child policy
is actually slowing them down.
They're trying to change the economy in a way
that you have more consumption,
less investment, trying to do it,
not so easy
because the minute you slow down,
you really want to prevent the social unrest,
unemployment rising,
so they go back to what they know best,
which is really investment.
So this transition of power
from investment to consumption
is not happening as smoothly,
but that's more or less what we see in China.
China will be able to maintain
6% to 7% GDP growth
simply because of the fact that they can.
Yes, they're sitting
on significant amount of debt,
but this is something that...
It's not an event.
It's not something that will crash tomorrow.
Same goes for another question
about the US debt situation.
And yes, the US debt situation will be there.
Trump is going to add $1.5 trillion
to the debt over the next 10 years
just because of the tax cut.
So the tax cuts are positive for now,
clearly negative from a long-term perspective.
This clearly will put an upward pressure
on the long end of the curve,
namely long-term interest rates in the US
will rise because of that.
So that's a major issue.
But again, it's not an event,
it's not something that will happen tomorrow.
You cannot even trade it.
It would be a slow process
that will raise long-term rates
and will limit the potential
of the economy to grow.
Of course,
there are many questions about Bitcoin,
it's a bubble.
Let's face it, Bitcoin is a bubble,
but it's a bubble that could be with us
for a long time.
We know that if you take
just the money coming from billionaires in China
and you put only 1% of this money
into Bitcoin, it can triple in value.
So we know that it has potential,
it does serve a purpose,
but the minute
you introduce regulations on it,
that will be the end of it.
I see Bitcoin
and many other of those currencies
actually playing a significant role
in the future monetary policy.
Banks will not resist it,
they will be a part of it.
But I think what we're seeing
now is nothing more than a bubble,
but it will have a significant
part of the economy.
Again, if you look at the correlation
between Bitcoin and the Chinese Yuan,
you can see that the correlation is extremely tight.
It means that
a lot of it is coming from China,
there's no question about it.
So I would be very careful about it.
It will play a role, but it will not be...
It will not be something
that I would get too much into
because it's too risky.
There is a question about the Bank of Canada,
and that will be the last question.
The Bank of Canada is actually changing
the way they look at the economy,
and for the first time,
they're admitting that NAFTA
and the tax cuts coming
from the US is a significant force
that will influence
their decision-making process.
Therefore, we believe that the Bank of Canada
will move more slowly than the Fed.
I'm guessing maybe one more hike this year
and they will take a break.
[Host:] Thank you, Benjamin.
[Thank you]
It looks like that's all the time we have for today.
I'm sure I speak on behalf of all the audience
that I thoroughly enjoyed listening
to your presentation.
Thank you for such a great presentation
and your precious time.
On behalf of CIBC Investor's Edge,
I would like to thank the audience.
We really appreciate you being here.
Should you have any questions or comments,
please visit out Investor's Edge website
or please feel free to get in touch with us
by phone, chat, or email.
Thank you for joining us today,
and we will see you next time.