Answer client questions about Canada’s economy

Canada’s economy is struggling.

Our market is tied closely to the volatile U.S., and we’re being weighed down by yo-yoing housing forecasts and national debt.

Read: Canadian economy is in transition: Tal

So, what should you tell clients about market prospects as they shift to equities?

A senior economist at Vanguard, Roger Aliaga-Díaz, answers common economic questions:

Q: There are some potential headwinds for Canada’s economy. What should investors keep in mind?

• Low growth does not translate directly to equity returns. There isn’t a one-to-one relationship because markets are forward-looking. They’ve already priced in the trends we’ve talked about. As a result, you could well have normal returns in a reasonably medium-term horizon despite growth being low.

• Many investors look at countries like Canada as a way to gain exposure to underlying commodities, but that doesn’t always work. The correlation of Canadian to global equities is much higher than the correlation between equities and commodities.

• It’s very difficult to time movements in commodity prices. The only thing you can control in the short-term is risk exposure and costs.

Q: What concerns do you have about Canada?

[I’m worried about] rising household debt. Also, Canada didn’t experience a housing bubble and a subsequent burst of that bubble like the U.S.

Read: Risk appetites to rise, says Laurentian

Instead, prices have kept increasing, though there was a little bit of deceleration during the recession. On a cumulative basis, housing prices in Canada have caught up with the U.S. over a period of 10 years, and have actually surpassed American prices after the correction.

Read: Canada won’t see U.S.-style housing meltdown

Q: How does this relate to the household debt issue?

At a much smaller scale, there’s a dynamic occurring that’s similar to what happened in the U.S. in the build-up phase to the housing bubble. Because of the prospect of rising prices, we see consumers and families tapping home equity, borrowing more, and becoming overextended in terms of expensive mortgages.

The level of debt for families and households is a major concern. Right now, it’s at a level of 160% of disposable income in Canada, which is much higher than what the U.S. reached at the top of the bubble. And while the U.S. has made some progress in terms of deleveraging and paying off debt, Canada’s households have increased their debt levels consistently.

Read: Who manages your household debt?

This will be a risk when the time comes for the Bank of Canada to increase rates. We could see inflationary pressures developing and the Bank of Canada will have to react to that.

Read: Long-term interest rates will remain stable

Q: Commodity prices play an important role in the Canadian economy. What do you foresee for this space?

Commodity prices and exports have been key drivers of growth over the last 10 years. But this is a double-edged sword since they drag on the economy when markets are weak globally.

Read: How to read the commodities market

Since June 2012, we have seen stabilization across the global stage. China’s growth has rebounded a bit and some of the key risks in Europe have receded. That has created more stability in commodity prices, and we expect that momentum to continue in 2013; there likely won’t be strong rebound in commodity prices, but they’ll remain at current levels and won’t drag on markets this year.

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