As Ottawa beggars thy consumer, insiders tag along

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July 27, 2015 - The Canadian consumer put in a strong showing in May as retail sales jumped 1% over the previous month. That strength could be in jeopardy, however, as policies targeting a lower loonie may put a dent in the prosperity of most Canadians. In particular, if BMO Chief Economist Doug Porter and his colleagues are right, a weakening loonie could soon clobber the real spending growth of Canadians. According to their July 24 report, as the loonie rose from 2002 to 2008, real consumer spending growth in Canada averaged an annualized growth rate of 3.8% which compared favourably to the weak loonie period from 1992-2002 when real consumer spending rose only 2.4% per year. The bottom line, according to the BMO team, is that a weak loonie for the Canadian consumer "is bad news, period."

The weak loonie is what Mr. Porter and his team describe as "a net export story, as the currency shift rebalances growth from consumers to exporters." However, for business as a whole the BMO economists describe the weak currency as a "double-edged" sword.

Rebalancing is one way to characterize current Ottawa economic policy. It can also be described as a massive wealth transfer: moving millions of dollars from average Canadians to companies that the Bank of Canada and the Ministry of Finance like. Firms with straight forward export models are "in" while those that rely on importing discretionary items such as machinery and technology to boost productivity are "out". Meanwhile, those companies with complex global supply chains will just have to tough out the costs associated with a volatile currency and a central bank which is full of surprises.

But make no doubt about it, the big loser from the current economic policy mix in Ottawa is the average Canadian. Based on the assumption that inflation is set to rise 1% more under the recent round of rate cuts than it would otherwise be, the average household can expect to pay about $600 more on household expenditures of $61,522 this year (the household expenditure figure is based on the assumption of a 5% increase in the 2013 average household expenditures on goods and services of $58,592 as reported by Statistics Canada).  

And just how likely is inflation set to rise 1% more under the Poloz cuts than would otherwise be the case? We would argue very likely. As Mr. Porter and his team note, CPI inflation in Canada is 0.9% higher than in the U.S., and that is before the recent swoon in the loonie. Moreover, as we have been pointing out for months, core Canadian inflation is firmly above the Bank of Canada's 2% operating mid-point. Stephen Poloz is clearly prepared to allow inflation to move to the top, if not over, the 3% mark over the next few months. 

In terms implications for investors, these policy trends reinforce what we have been seeing among insiders for some time where companies with assets in the United States or which sell to American consumers are favoured. The trend continues in our July INK Edge Top 40 to be published Tuesday. Stocks in the Industrials and Consumer Cyclicals combined to make up 20% of the list and most of these firms have U.S. focused businesses.

However the big winner in the Top 40 this month is the Consumer Non-Cyclicals sector which gained the most ground in the list adding 4 new stocks. The jump reinforces the investment thesis that Canadian merchants which sell basic staples may be able to profit from the collapsing currency by increasing their margins along with rising prices. In addition, as foreign imports become more expensive, these merchants will have the opportunity to raise the sticker price of domestic substitutes without the fear of losing market share. Meanwhile, our INK Consumer Non-Cyclicals Indicator remains strong at 200% meaning there are two stocks with key insider buying for every one with selling.

Canadian to US Dollar Rate versus Consumer Non-Cyclical Stock George Weston (WN)

Canadian to US Dollar Rate versus Consumer Non-Cyclical Stock George Weston (WN)

Food retail & distribution company George Weston appears to be benefiting from a weakening loonie (rising exchange rate into US dollars).
Source: CanadianInsider.com

Another winner in the Top 40 allocation is Heathcare which gained 3 stocks. It is also worth noting that our sector indicator is on the rise, an impressive development considering that the S&P/TSX Health Care Index is up 44% year-to-date. While much of the performance has been driven by Valeant Pharmaceuticals (INK Edge outlook: mostly sunny; VRX), the Laval-based giant did not make the Top 40 cut. Instead our list is dominated by smaller firms in both the biotechnology and facilities areas.

Gold stock allocation lost ground in the Top 40 this month, perhaps reflecting deflationary fears out of China and the Fed's apparent determination to hike rates. Just as the Bank of Canada is in the process of risking its credibility on fighting upside inflation, the Fed seems to be gambling with its reputation, but in the opposite direction. Based on accidentally leaked documents (which were subsequently corrected and reposted) on the Federal Reserve's website which outlined staff projections on the economy over the next 5 and a half years, the Fed seems content to be raising rates even though inflation is not forecast to hit its 2% objective during that stretch. The apparent acceptance of below 2% inflation may explain some reluctance of gold insiders to jump in with the same level of buying like they did when gold crashed in spring 2013. Uncertainty with respect to China's stock market crash this summer and economy probably did not help either. Nevertheless, our Gold Indicator hit a two year high of 690% last week which signals a high degree of insider conviction that value now exists. 

Fears surrounding Fed tightening and China hit Canadian stocks hard last week as the INK Canadian Insider Index fell 2.80% while the S&P/TSX Composite dropped 3.12%. The INK Canadian Insider Index remains up 1.30% year-to-date while the S&P/TSX Composite is down 3.05%.

 

An earlier version of this post appeared before the market open on INKResearch.com.

 

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