Canada Slides Into Recession

My critics said I wasn’t educated. They said I didn’t understand the Canadian banking system. Some asserted that I had an agenda.

Indeed, my article from January 2015 about the tough times that lie ahead for Canada struck a nerve.

No one likes to be told that their home is overvalued or that the stocks they own are likely to fall.

To be clear, I have no hidden agenda and I’m not allowed to trade the securities I write about. I’m just trying to identify risks and, to some extent, predict the future.

At this point, we know that the Canadian economy has effectively entered a recession. Last week, the Bank of Canada (BoC) “unexpectedly” cut the benchmark lending rate to 0.5% and slashed its economic growth estimates for 2015. The BoC noted, “Real GDP is now projected to have contracted modestly in the first half of the year.”

Clearly, the decline in commodities prices is having a bigger impact than many expected. It boggles my mind when Canadians downplay the importance of natural resources for the Canadian economy. Yet even the Bank of Canada appears guilty, given its rosy economic projections at the beginning of the year.

The foreign exchange market has it right, in my opinion. The Canadian dollar hit its lowest level against the U.S. dollar since March 2009. Of course, the equity markets will be slow to grasp the enormity of the situation, as usual. However, the cracks are already starting to show.

Home Capital Group Inc. (HMCBF), a large Canadian subprime lender, fell 19% on July 13 after the company reported that residential mortgage originations fell more than expected in the second quarter. The stock has declined over 30% year to date and is the worst performer of all Canadian financials this year.

As I’ve said in the past, the Canadian banking system will come under more stress, though I never said that Canadian bank stocks are going to zero. When I label something as “dangerous yield,” I mean that the relatively high dividend yield is insufficient to compensate you for the risk of holding the shares. A 4% dividend yield is a small consolation if the share price declines by 20%. You just lost the equivalent of five years of dividends.