The most-popular trade of 2023 was parking money in cash and cash equivalents: Money flooded into things like US dollar-denominated T-bills. As rates come down, much of that money will be looking for a new home. Where will it go?
Let’s assume this is the top of the rate cycle and you’re sitting on a pile of USD cash. Your mandate is to invest for 2030, where do you go?
A six-year Treasury still pays 3.65% so it’s compelling but the Magnificent Seven are trading at high multiples, as is the US market in general. So you look abroad?
US vs global equities
Europe is cheap but it’s tough to have confidence in its government. Some of the best investments in Europe in the past few years were hit by windfall taxes or at least threatened by them. Energy is an ongoing disaster that’s been somewhat spared by good weather but betting on six more years of good weather is certainly a risk. Moreover, European officials were recently touting their success in becoming the first jurisdiction to regulate AI — hardly a signature achievement in the most-important technology battle in the world.
Japan is compelling: it’s cheap and the yen hit 30-year lows in 2024. The change in the cycle is good news and Japan’s ability to evade both inflation and a debt crisis due to high rates indicates that it can weather the storm for a number of years. There are social levels Japan can pull to improve growth, so there’s lots to like here. Incredibly, the yen has been the worst G10 performer for three straight years — an unprecendented streak that points to an opportunity.
Where will Canadian growth come from?
Canada’s growth model for its first 130 years was about resource extraction and selling manufactured goods to the United States. In the past two decades, increasing globalization meant China or Mexico were much better places to build factories and the same time, Canadians lost interest in making the country an easy place to extract raw materials. With that, capacity to process those raw materials was also lost.
As the old model was slowly abandoned, it’s been filled over the past two decades by home-price appreciation and population growth; which was really a dividend on a hundred years of peace, order and reaonably good government.
I believe we’re at the end of that cycle. Housing probably won’t crash this year but the days of it being a driver of growth are done and that’s going to be a big drag going forward. Canadians are also rapidly turning against immigration.
So what can Canada do? In the same way that central banks spent the past two years manufacturing a soft landing, the best thing the Liberals can do in the remaining 20 months of their political life is manufacture a soft landing in immigration.
We’re starting to see steps in that direction but they’re still like a central bank trying to move in 25 bps increments when they need to start ‘hiking’ by 50 bps or more. Australia announced this month it would halve its immigration target. If Canada waits it on too long and anger builds, the risk for the whole country is a strong swing in the pendulum like we’re seeing in many parts of the world towards closed borders.
But that’s what should happen. In what will happen is what Trudeau said will happen: He spent the holidays saying he would double down on all his policies. There will be some curbs on temporary workers and students but ultimately, the opportunity for change won’t come until there is an election.
At this point, it’s safe to assume the Conservatives will be in power — likely with a large majority — for the remainder of the decade. That’s something the FX market will like. It’s also safe to assume that home-price growth and immigration won’t be the sources of GDP growth.
Canadian political leaders
So what will the model be for Canada? I’m not hearing great ideas out there.
One that’s always touted is productivity growth but that’s easy to promise and tough to deliver. I fear it would to some real pain in the labor market to achieve and that would make for an ugly few years for the loonie.
I’d certainly hope that construction and infrastructure will be a part of the solution. The US is having some real success right now with the CHIPS and IRA legislation; there’s an industrial-building boom in the US that Canada must try to replicate. However given long approvals, I’m not sure that’s possible right now. Still, political change can happen quickly when it’s expedient. Elizabeth Warren (of all people) is championing YIMBYism and building more to solve housing shortages.
Is there an ‘invest in growth’ mentality? I think it’s obvious that right now there isn’t. Can it be conjured? I think it can. Canada still has ample fiscal space; red tape is a problem but it’s also an opportunity.
Given the lack of any real catalysts, it’s tough to be optimistic about the loonie for the remainder of the decade but it’s critical to remember that the currency market isn’t absolute, it’s relative. Challenges abound: Europe’s energy crisis isn’t going away while Canada is blessed with abundant energy. The US political system is cracking while Canada’s strong parliamentary democracy ensures that real change is possible. The UK’s economy is less-dynamic than Canada. Japan’s demographics are far worse than Canada. Emerging markets are plagued by corruption while Canada is one of the least-corrupt places on the planet.
In the year ahead we should see the startup of TMX, Coastal Gaslink, LNG Canada and some other large projects. Those will move the needle but I don’t think I don’t think the world is going to beat a path to Canada until Canada makes itself an attractive place to invest. I think that will happen but the ceiling on the loonie this decade — barring a commodity boom — is probably 1.20, or a round 83-cents.
I was on BNN Bloomberg earlier talking about the outlook for the loonie.