The sell-off in the Canadian dollar has been pronounced, especially after lumber tariffs were announced in April. Todd Mattina, Chief Economist & Strategist on the Mackenzie Asset Allocation Team, appeared on Bloomberg TV Canada on April 26, 2017, to discuss the performance of the loonie, NAFTA and the recent actions of Donald Trump.
Why Canadian Stocks May Outperform US on Value
Todd Mattina, Chief Economist & Strategist on the Mackenzie Asset Allocation Team speaks to Bloomberg TV Canada about the recent performance of the Canadian dollar.
Lily Jamali: All the NAFTA drama has loonie bears feeling good right now. The sell-off in the Canadian loonie has been pronounced to say the least – the loonie dropping to a 14-month low after the lumber tariffs were announced and the Mexican peso has gotten trounced with it. It calls to mind what we saw just after Trump’s election, only this time the Canadian dollar is getting hit way harder. Let’s take a dive inside the Bloomberg Terminal for a closer look. You can see the performance of the Canadian dollar here in blue and the Mexican peso in white – both of course relative to the greenback. The election took place smack in the middle of the timeline on this chart and the US strengthened against both, but much more dramatically back then against the peso – all that talk of a border wall had an impact and on NAFTA the conventional wisdom was that Mexico was the real target, with Canada maybe suffering some collateral damage. The tables have turned following the tariffs on Canadian lumber. While both currencies have weakened, this time the loonie is getting hit much harder. For some analysis, let’s bring in Todd Mattina. He’s chief economist and strategist at Mackenzie Investments, which has over $61 billion in assets under management and Todd, I want to start with your reaction to that chart. Is that the product of this trade talk, having already been priced in to the peso and not so much with the loonie?
Todd Mattina: Well first, thanks for having me today. I really think that the sharp move in the Canadian dollar, down to about 33 and a half cents, really reflects that these recent trade actions – the market is building in a risk premium for the risk anyway of increased trade action by the US against Canadian exports. This was really unexpected. It didn’t fit the market’s narrative that in Donald Trump’s crosshairs was really China and Mexico – countries with large trade balances or trade surpluses against the US, whereas Canadian goods trade is roughly balanced. I think what we are seeing now is the market building in a risk premium against the increased risk of more aggressive trade action against Canadian exports and the risk of a more aggressive posture in potential NAFTA renegotiations.
Lily Jamali: What do you think is the right approach in terms of digesting all of this news? I mean, we have been hearing reports all day that the Trump administration is preparing to withdraw from NAFTA – can’t tell if that is a negotiation tactic or a real possibility.
Todd Mattina: I think the noise we’ve heard about a possible renegotiation of NAFTA, it does increase legal and policy uncertainty, which for Canadian producers, is going to undermine confidence and undermine business investment. I think, as our minister had stated in her piece earlier, it’s in the US’ interest and mutual interest to have a level playing field. It’s really important I think to remember that even before NAFTA, average tariffs between Canada and the US weren’t that high. The real advantage of NAFTA is that it provided predictable legal and tariff environment that producers could count on. It provided a dispute settlement mechanism and it really banned both parties, especially the US, to avoid these kinds of protectionist policies against specific sectors. Going forward, if we were to lose NAFTA, I think that would increase the more specific risk for individual sectors like we’ve seen with softwood lumber, where we’ve seen a resurgence in that trade dispute.
Lily Jamali: Also hearing promises of the biggest tax ever from Trump and we actually got the details late in the day. What are you expecting on that front in terms of delivery, the actualization of this promise?
Todd Mattina: Right. Well today was very interesting. Donald Trump, of course laid down the broad principles of his tax plan, which will have a large fiscal price tag. The corporate income tax cuts alone will cost north of $2.2 trillion over the next 10 years and the personal income tax cuts he outlined will increase that price tag even further. This is really startling because when you put that in context of where the US public finances are heading, even before we build in Trump’s plan, we see that the government debt in the US is heading towards 90% of GDP in the next 10 years and the government budget deficit is going to hit somewhere in the neighbourhood of $1.4 trillion in 10 years. Trump has really prioritized deep tax cuts and stronger economic growth over having more balanced and sustainable public finances. I don’t think the fiscal conservatives in Congress are going to accept that large price tag, given that the baseline is already so unsustainable. My best guess is that we’ll see a final tax package that’s slimmed down in size, but that can be permanent and closer to revenue neutral.
Lily Jamali: So when we see whatever ultimately comes to pass, we’re assuming some kinds of cuts – the scope of them is up for debate – but when we do see this happen, what do you think is going to be the impact on the Fed’s schedule?
Todd Mattina: This is an interesting point. A large fiscal expansion at this point in the cycle would probably accelerate the pace of Fed rate hikes and very important for the Treasury is this idea that the large and deep tax cuts will increase economic growth, raising revenues and helping to pay for the tax cuts, but I think an important part of that assumption is that the Fed will maintain low interest rates. That seems unlikely if a large fiscal stimulus were to hit at this point of the US cycle, where we’re almost at full capacity, which will add inflationary pressure and lead the Fed into a more ambitious, more aggressive rate hiking cycle.
Lily Jamali: I want to amend what I said at the top of our show because in the very last moments of trading today, we saw US markets actually turn negative, just modestly, but they did end up finishing flat in the case of the NASDAQ and very slightly lower in the case of the S&P 500 and the Dow so just to get that out there. You think that Canadian stocks could very well perform US stocks this year.
Todd Mattina: It’s interesting. At Mackenzie Asset Allocation Team, our view is that investors shouldn’t give up on the global reflation trade. We see steady global growth and reflation in many parts of the world outside of the US, including in Canada. In Europe, we see resilient growth given easing political risk, China has stable growth backed up by solid policy and when you look in particular and importantly at the asset valuations in those parts of the world, in many cases, they’re much more attractive valuations than in the US. Based on that, we think in terms of the asset mix between stocks versus bonds, continuing global reflation will provide a nice tailwind for stocks to outperform bonds and in relative equity markets, we feel that investors are going to reassess the US outlook relative to the more favourable outlook in other parts of the world, where assets are more attractively valued. So the US stock market going forward may underperform some other regions including Canada.
- The market is building in a risk premium for the potential risk of increased trade action by the US against Canadian exports.
- A large fiscal expansion at this point in the US cycle would probably accelerate the pace of Fed rate hikes.
- The Mackenzie Asset Allocation Team sees steady global growth and reflation outside of the US.