December 2019 Institutional Insights Overview Welcome to Institutional Insights, a quarterly newsletter to keep you informed with the latest economic data at the provincial, national and international level. We provide coverage for a wide array of economic topics. In this edition we cover:
• GDP forecasts • Complimentary copy of our recent article concerning the • The Alberta economy application of supply-side
economics Commentary James Hobson, CFA Canadian GDP Overview First Vice-President After beating the Bank of Canada’s GDP estimates for Q2 – coming in at Investment Advisor 403 260-0574 3.7% – the Canadian economy has seen growth decelerate in each [email protected] subsequent month, culminating in a fairly flat reading of 1.4% for Q3.
This drag was led by the maintenance at a major offshore oil production facility in Newfoundland and Labrador as well as a further scale back on Alberta’s mandated restraint on oil production. This caused the mining, oil and gas sectors to shave almost 0.2% off their growth. In July, the oil and gas industry as a whole was down 3%.
What saved the economy from contracting in Q3 was the wholesaling, retailing, utilities, and real estate sectors. A stronger housing market also provided a nice lift to the economy. This is following the rebound of average home prices from its 3-year low in February.
After two strong job gains with on-target inflation, the Bank of Canada stood pat on interest rates in September and October – contrary to the Fed’s cumulative 50bp cut. We have not had to make any major changes Charet Chahal, CFA Investment Advisor to our interest rate forecast as the economic backdrop looks about 403 260-0440 where it did a month or two ago. [email protected] Commentary (continued) However, there’s plenty of room for downside shocks, particularly through Canada’s ties to a slowing global economy. Despite the announcement of a “Phase 1” trade deal, there are still uncertainties surrounding the U.S.-China trade war and frictions between Canada and China could also deepen. Overseas, the ECB could fail to deploy fiscal stimulus in the false hope that negative interest rates will finally start working. For those reasons, we are forecasting a 25bp rate cut to 1.50% by the end of Q1 2020, 2019 GDP at 1.6% and 2020 GDP of 1.4%.
Source: CIBC World Markets Alberta - Into the New Year With 2019 GDP slated for a stagnant 0.5% growth, we see the Alberta economy outpacing national growth in the next few years. Growth will be supported by a gradual improvement in the labour market, solid exports, and business investment.
Premier Jason Kenney has continuously emphasized the importance of business investment in Alberta – particularly in the energy sector. The Premier has been advertising Alberta’s energy industry to foreign inves- tors who are increasingly focused on environmental, social, and governance (ESG) issues. Alberta oil sands have historically rated low on institutional investor’s ESG matrix. The Premier is making an effort to educate foreign intuitional investors to remove or dampen the stigma attached to Alberta’s leading industry.
Further, reductions in the corporate income tax rate will place Alberta among the most attractive investment destinations in North America by 2022. This, along with improved market access, will set the stage for increasing investment and employment. A relatively young and fast-growing population – supported mostly through immigration – will also underpin Alberta’s growth.
INSTITUTIONAL INSIGHTS - PAGE 2 The Opportunity Cost of Cash
Source: CIBC World Markets. Assumes an average bond yield rate of 2.49% and a money market return rate of 1.85%. Yield/Rates are as of 11/27/2019 and are subject to availability and change without notification. Minimum investment amounts may apply.
Source: CIBC World Markets. Yield/Rates are as of 11/27/2019 and are subject to availability and change without notification. Minimum investment amounts may apply.
INSTITUTIONAL INSIGHTS - PAGE 3 The National Picture
Source: Statistics Canada, Alberta Treasury Board (As of November 2019)
INSTITUTIONAL INSIGHTS - PAGE 4 Alberta at a Glance
Source: Government of Alberta (November 2019)
INSTITUTIONAL INSIGHTS - PAGE 5 Equity Markets - 1 Year
Source: Thomson Reuters (As of November 25, 2019) Fixed Income Rates - 1 Year
Source: Bank of Canada (As of November 25, 2019)
INSTITUTIONAL INSIGHTS - PAGE 6 Modern Supply-Side Economics
“A rising tide lifts all boats.” - Anonymous
The idea that improvements in the general economy will benefit all participants underpins the theory of supply-side economics. Commonly grouped together as “Reaganomics” or “trickle-down economics” by it’s critics, the theory favours tax-cuts and deregulation as a way to spur economic growth. Implemented most famously by Ronald Reagan in the 1980’s, most recently this theory has been further advocated by George W. Bush and Donald Trump. As Reagan began his Presidency at a time when unemployment and interest rates were hovering around 10% and 20%, the Former President immediately enacted drastic tax cuts on businesses, high-income earners, capital gains, and dividends. The top tax rate fell from 70% for those earning $108,000 or more to 28% for those earning $18,500 or more. The corporate tax rate went from 46% to 40%. The idea is that benefits for corporations and wealthy individuals would “trickle down” to all economic participants. This would result in increased short-term economic opportunity (higher corporate profits), followed by long term prosperity (increased wages and employment). Indeed, the US economy swiftly rebounded out of the 1981-1982 recession. With respect to Reagan’s policies, economic theory made-popular by Arthur Laffer states that a decrease in the tax rate increases tax revenue up to a certain threshold of maximum output. The Laffer Curve demonstrates that a tax rate of 0% or 100% generate the same revenue; therefore an unknown area of tax decreases, referred to as the “Prohibitive Range”, only creates economic benefit up to a certain point. Two different perspectives of the Laffer Curve are shown below. Note that the “Prohibitive Range” is not exactly 50% and could be anywhere between 0% and 100%.
Source: https://www.heritage.org/taxes/report/the-laffer-curve-past-present-and-future Source: https://www.thebalance.com/what-is-the-laffer-curve-explanation-3305566
INSTITUTIONAL INSIGHTS - PAGE 7 After the dotcom bubble burst, George W. Bush cut taxes in both 2001 and 2003 – citing the effectiveness of Reagan’s policies during a similar economic situation. What followed was economic expansion for the next half decade. Most recently, Donald Trump cut corporate taxes in 2018. Rooted in Trump’s protectionist views, the goal was to encourage business investment in the US. And it did exactly that. As shown below, US business investment is higher than the Congressional Budget Office projected in 2017, before accounting for the 2018 tax cuts.
All of this sounds great. Basically, a get out-of-jail-free card for policy makers during recessionary times. However, economists argue as to the validity of “Reaganomics” serving as stimulus contrary to monetary policy. In both 1981 and 2001 the Federal Open Market Committee implemented aggressive easing policy to spark expansion. Now that brings our attention to the tax reform in 2018. This tax cut occurred earlier in the current bull-market and mid-to-late in the economic cycle. In fact, during that time, Jerome Powell, Chairman of the Federal Reserve, was tightening policy! Yet, US business investment beat forecasts. Supply-side economics must drive gross domestic product no matter what. Let me briefly go over some simple economics and statistics: GDP is the sum of consumer spending, government spending, business investment, and net exports. Consumer spending makes up about 70% of total US GDP with the middle- to low-income earners driving this sector. It is also estimated that low- to middle-income earners save on average 2.4% of their annual income. For high-income earners, that number jumps to 38%. The table below illustrates the impact these statistics have on consumer spending. The table assumes income per $1000, however, what impacts the statistic is the proportion of spending and saving.
Source: Economics Explained * Calculations based on savings rates of 2.4% and 38% for low-to-middle income and high income, respectively.
** Calculations based on $1000 for both classes of earners.
INSTITUTIONAL INSIGHTS - PAGE 8 Further, the International Monetary Fund published a report outlining the effects that supply-side economics have on GDP growth. It states that if the income share of the top 20% increases, then GDP growth actually declines over the medium term. Even a mere 1% increase in wealth for 20% of low-income earners yields a 0.38% growth in GDP. On the other hand, increasing the income of the top 20% results in a negative 0.08% growth in GDP. In conclusion, it can be argued that monetary policy was in fact the stimulus that kickstarted the economy during recessionary times. On the contrary, Laffer Curve theory supports tax cuts until rates areata “Prohibitive Range” of maximum participation. Although according to the IMF, the data from their report implies the need for multiple Laffer Curves – one corresponding to each income class. For maximized medium - to long-term GDP growth, the data suggests that the “Prohibitive Range” for lower income earners is lower than higher income earners. The “sweet spot” for each progressive tax rate implies equilibrium in aggregate supply and aggregate demand, therefore maximizing output in the long-run.
“They used to say a rising tide lifted all boats. Now the rising tide just seems to lift the yachts.” - Ed Miliband
Sources: CIBC World Markets, Statistics Canada, Government of Alberta, Bloomberg, Thomson Reuters, Bank of Canada, Alberta Treasury Board of Finance, TheBalance, Economics Explained, CBO, Bureau of Economic Analysis, TheTimes, TheHeritageFoundation, International Monetary Fund James Hobson, CFA, PM, Investment Advisor at 403-260-0574 or 1 (800) 665-6864 Charet Chahal, CFA, PM, Investment Advisor at 403-260-0440
This information, including any opinion, is based on various sources believed to be reliable, but its accuracy cannot be guaranteed and is subject to change. CIBC and CIBC World Markets Inc., their affiliates, directors, officers and employees may buy, sell, or hold a position in securities of a company mentioned herein, its affiliates or subsidiaries, and may also perform financial advisory services, investment banking or other services for, or have lending or other credit relationships with the same. CIBC World Markets Inc. and its representatives will receive sales commissions and/or a spread between bid and ask prices if you purchase, sell or hold the securities referred to above. © CIBC World Markets Inc. 2019. CIBC Wood Gundy is a division of CIBC World Markets Inc., a subsidiary of CIBC and a Mem- ber of the Canadian Investor Protection Fund and Investment Industry Regulatory Organization of Canada. James Hobson and Charet Chahal are Investment Advi- sors with CIBC Wood Gundy in Calgary The views of James Hobson and Charet Chahal do not necessarily reflect those of CIBC World Markets Inc. If you are cur- rently a CIBC Wood Gundy client, please contact your Investment Advisor. Clients are advised to seek advice regarding their particular circumstances from their personal tax and legal advisors.
INSTITUTIONAL INSIGHTS - PAGE 9