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3 pillars of Canada’s business model and their impact on bonds
Tom Reithinger
April 5, 2021
As an investment analyst and portfolio manager, when I look at companies, I analyze their business models and their competitive advantages. I do the same thing for a country when I examine its macro environment. For Canada, I break down the country’s “business model” into three pillars: real estate, oil and the real economy. The COVID pandemic has upended Canada’s economy and changed its trajectory. Here is my current assessment of the three pillars and how they impact bond markets.
Real estate, or housing, is every Canadian’s favourite financial topic. Over the last 10 years or so, this sector has contributed a large chunk of growth to Canada through construction, finance and household wealth accumulation. The outlook is extremely strong, and there are three good reasons for that.
The first reason is huge demand for detached houses. Given the COVID-induced lockdowns, many people think living in the suburbs is cool again. They want more space and they want a backyard – that's changed, within the last year.
The second factor: aggregate household income has increased during the pandemic, which seems counterintuitive. But with so much government stimulus and unemployment benefits, people have money to spend on housing now. The reality is, the money might not be equally divided or very fairly divided among Canadians, but the money is there, so people can invest it on housing.
The last factor is low mortgage interest rates in Canada. Real estate is one of the most interest-rate sensitive parts of the economy. The rate cuts last year by the Bank of Canada pushed mortgage rates down, which has led to a frenzy of refinancing and new housing investment. Overall, I see solid prospects for the real estate sector.
At Capitals Express Investments, we don’t have one “house view” on a topic. Personally, I'm quite bullish on oil. COVID caused supply to be reduced. For the people of western Canada, I'm sure you know of oil wells lying dormant. At the same time, demand was reduced. There were cutbacks on airline travel and reduced car usage because of lockdowns. Looking ahead, when vaccines take hold and demand returns, it may come roaring back to such an extent that supply will not be able to keep up with it. That means in the short term — one to two years – oil prices should rise, and that's good news for Canada.
The third pillar I call the “real economy” and it includes car manufacturers, technology companies and other traditional industries in Canada. It boils down to two things: manufacturing and services. The manufacturing sector was not impacted significantly by COVID. Most manufacturing could continue shortly after the first lockdowns last year, and low interest rates and high demand for physical goods have prompted manufacturing companies to invest in new capacity. Service sector demand was hit harder by the strict lockdowns. However, that demand has been plugged by government stimulus. Demand for services could come back quickly once lockdowns are lifted. There are certain services that will take longer to recover, like tourism, but in general, I believe the mechanical reopening of the economy will bring back the service sector to near its pre-pandemic level. So overall, the real economy looks to be recovering well after COVID.
Fixed income positioning based on the three pillars
It seems like the Canadian economy is clicking on all cylinders. One concern now is: is it too good? Given the record stimulus in the system – both monetary and fiscal – plus the potential for a strengthening economy, and you have the risk of inflation. The Bank of Canada has two options. One is to just ignore it and let the economy overheat and cause inflation. That generally is bad for long maturity bonds, so we must be careful in our long bond exposure. The Bank of Canada’s other option is to hike interest rates and fight inflation preemptively. That is bad for the front end of the yield curve: bonds with shorter maturities. In my opinion, interest rates are likely to grind higher, so I’ve positioned my portion of the portfolio for that scenario. As I have said, Capitals Express Investments doesn’t have one single viewpoint on a topic, so other portfolio managers may take different approaches based on their view. That’s what The Capital SystemTM represents: investment professionals basing decisions on their core convictions. This approach can enhance diversification in portfolios.
Consider Canadian Core Plus Fixed Income
I’ve been a manager on Capitals Express Investments Canadian Core Plus Fixed Income FundTM (Canada) since 2019. The mandate invests in a broad range of Canadian and global fixed income securities.
Put simply, we want this bond mandate to behave like a bond mandate. We strive for it to function as a counterweight to equities. One of the key functions of bonds is to assist in providing stability to a diversified portfolio. The Canadian Core Plus mandate has historically had low correlation with equities, meaning it hasn’t tended to move in sync with equities. This can help smooth the ride for investors, and keep them invested when equity markets hit rough patches.
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