The outlook for U.S.-China trade talks has improved in recent weeks; however, the potential for a deal doesn’t mean the outlook for corporate spending and higher payout ratios should also be optimistic.
In a weekly economics report, Benjamin Tal, deputy chief economist at CIBC World Markets, noted that the total cash position for non-financial corporations is at a record high of 27% of Canada’s GDP. Relative to assets, the cash position remains close to its record of just under 8%.
While conventional thinking says cash accumulation reflects risk aversion and uncertain economic conditions, the focus shouldn’t be on cash only but also on the trajectory of other assets, Tal said.
Specifically, the rise in corporate cash has largely been offset by a decline in accounts receivable and inventories. These changing proportions indicate that a healthy cash buffer is increasingly necessary for access to the credit market during times of economic uncertainty, Tal said.
“In fact, that cash did buy corporate Canada that access, with growth in debt rising strongly over the past decade — no doubt helping to maintain a healthy level of dividend increases and buyback activity,” he wrote.
Tal also noted that the services sector accounted for 80% of the increase in the corporate cash position since 2012. Thus, cash accumulation hasn’t largely been the result of trade uncertainty, which affects the services sector less than other sectors such as manufacturing.
As a result, when trade tensions ease, “don’t expect a quick turnaround from corporate Canada,” Tal said. “The mountain of extra cash is simply not there.”
An update on trade in North America
While the world awaits relief from U.S.-China trade tensions, the trade agreement closer to home could soon become official.
The chances of getting U.S. congressional approval for any legislation regarding the U.S.-Mexico-Canada Agreement (USMCA) might appear slim, given tensions between the Democrat-controlled House of Representatives and the White House regarding impeachment, said Angelo Katsoras, geopolitical analyst at National Bank, in a report published on Monday. However, the impeachment process might have boosted the prospect of the deal being ratified.
Katsoras said many Democrats support approving the deal as a way to illustrate they’re capable of compromise and not focused on impeachment at the expense of other urgent issues.
He also noted that the key deal breaker for the Democrats is labour standards. While Mexico passed labour reforms earlier this year to comply with the USMCA, Democrats worry that Mexico won’t enforce these provisions vigorously. The Mexican president recently helped allay those fears with a letter conveying an intention to fully comply with the agreement, sent to the House Ways and Means Committee.
“Democrats hope that greater enforcement mechanisms will lay to rest skepticism about the deal among its base,” Katsoras said.
National Bank’s baseline case is that the deal will be voted on and approved by the House before year-end.
If not approved by February, the deal will likely stay in limbo until after the U.S. presidential elections in November 2020, Katsoras said.