North American Portfolio Strategist, Martin Roberge reflects on the Liberal majority. A Liberal majority implies higher bond yields and a lower Loonie. Among these asset classes, his conviction on higher bond yields is the highest. History aside, the Liberals’ platform provides the most stimuli to the economy. As such, investors could start pricing out future rate cuts by the Bank of Canada (BoC). Second, a less conservative fiscal plan is likely to give rise to “twin” deficits and tighter Canadian-US bond yield spreads. Figure 1 shows that it is nearly impossible for Canada’s current account (CA) to turn a surplus when Ottawa runs budget deficits which must be financed. The bond-to-CDN$ linkage is through the CA. As long as a CA deficit persists, the CDN$ should depreciate until Canadian bond yields climb high enough to attract foreign investors. Lastly, investors could demand a higher risk premium to buy Canadian debt due to the lack of policy backstops should the economy continue to grow subpar and/or fail to respond to stimuli. Liberals’ economic plan assumes Canadian GDP growth to average 2.4% from 2016 to 2020 (vs. 2% since the 2008-09 recession) in order to balance their book at the end of their mandate. Anything below and Liberals’ planned deficits could turn structural.
Martin notes the equity markets rebounded strongly on the back of dovish talks from the ECB on Thursday and further cuts to Chinese interest rates (-25bps) and RRRs (-50bps) this morning. Martin believes the ECB comments may have set in a positive loopback for stocks. With this week’s gains, the S&P 500 is back in positive territory while the S&P/TSX is still down ~5%. In Canada, the election of a Liberal majority government came unexpectedly. The S&P/TSX jumped nicely upon the results, maybe reacting to the fact that Canadian equities historically have performed better under Liberals vs. Conservatives. The Canadian dollar does not, and when adding the dovish comments from the BoC to the mix, the Loonie had a tough week. Lastly, Canada was also under the spotlight this week as its biggest drug company, Valent Pharmaceutical, has been accused of inflating its revenues through ownership of specialty pharmacies to which Valeant distributes products. Martin estimates that the drop in Valeant shares this week (~30%) removed ~200 points from the S&P/TSX.
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