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Banks had a lot to say about the economy this week: It’s complicated

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Though bank executives had lots to say about the economy during earnings calls with analysts, there was no definitive take.Andrew Vaughan/The Canadian Press

After Canadian banks finished reporting their latest quarterly financial results this week, investors hoping for some clarity on the economy may have come away disappointed. No clarity here, which could limit the recovery in bank stocks.

The banking sector is meandering between two very different outlooks: mild optimism that a recession will be brief or avoided altogether, while lending activity holds up and borrowers pay off their loans; and simmering pessimism that rising interest rates will wallop economic activity, pushing bank loan losses sharply higher.

Reflecting the optimistic take, bank stocks have risen by an encouraging 8 per cent this year, on average. Then again, pessimists will point out that these stocks are down more than 14 per cent since the start of 2022.

Though bank executives had lots to say about the economy during earnings calls with analysts, offering valuable insights given the banks’ unique perspective on lending activities and consumer indebtedness, there was no definitive take.

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Dave McKay, Royal Bank of Canada’s RY-T chief executive officer, said during an earnings call that the bank is forecasting a “softer landing, characterized by a modest recession” – which sounds like a good reason to buy bank stocks right now.

But Mr. McKay also said that banks were operating within a “complex and fluctuating macro and market environment,” characterized by stubbornly high inflation, labour shortages, geopolitical shocks and the lagging impact of central bank interest rate hikes.

Ugh. And if actions speak louder than words, then the banking sector’s reaction to rising borrowing costs and slowing economic activity merely added to the murky backdrop for investors.

The banks set aside more money in their fiscal first quarter to handle the prospect of defaults: The Big Six banks collectively reported nearly $2.5-billion in provisions for credit losses – or PCLs in banking jargon – up from a net $373-million in provisions in the same period a year ago, when some banks were booking recoveries from previous provisions.

The spike in provisions supports the bearish case against bank stocks, but there was an upbeat context here: Provisions were actually lower than what most analysts had been expecting, and executives framed the increase as a step toward historically normal losses after a period of unusually low losses a year ago.

“This is indicating that credit is deteriorating and we’re still not at historical averages. But the question becomes: Will PCLs just stop there or will they overshoot?” John Aiken, an analyst at Barclays, said in an interview.

“This is where both the bulls and the bears can look at the PCLs this quarter, and it can bolster their case,” Mr. Aiken added.

It’s little wonder, then, that bank stocks are also sending conflicting signals about whether this economically sensitive sector is in the midst of a further recovery or poised for another downturn.

Bank-stock valuations are slightly below the historical average, based on estimated price-to-earnings ratios. According to Gabriel Dechaine, an analyst at National Bank Financial, the discount was 8 per cent as of market close on Thursday.

But this discount is considerably narrower than it was at the start of the year, before stock prices rebounded. Valuations are no longer particularly cheap in the face of economic risks – suggesting that the collective wisdom of the market can’t figure out whether the sector should be avoided on fears that the economy is in trouble, or scooped up on hopes that central banks have beaten inflation.

Specific stocks within the sector reflect similar bafflement.

CIBC CM-T is leading the way among the Big Six bank stocks in 2023, with gains of nearly 15 per cent. The bank has a relatively large exposure to the domestic mortgage market, making the stock sensitive to economic data. The stock’s outsized gains this year suggest some investors are betting on a healthy economy.

But wait a minute: Over the past year, CIBC is near the bottom of the pack with a decline of more than 21 per cent. Compare that with RBC – a bigger and more diversified bank, making it a safer bet during economic uncertainty: The stock is down less than 2 per cent over the past year. RBC’s outperformance suggests that investors are still nervous.

The one thing that just about everyone can agree on? If the banking sector’s financial results were supposed to give investors a clearer view of the year ahead, they failed to deliver.

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Economy

Yellen Sounds Alarm on China ‘Global Domination’ Industrial Push – Bloomberg

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US Treasury Secretary Janet Yellen slammed China’s use of subsidies to give its manufacturers in key new industries a competitive advantage, at the cost of distorting the global economy, and said she plans to press China on the issue in an upcoming visit.

“There is no country in the world that subsidizes its preferred, or priority, industries as heavily as China does,” Yellen said in an interview with MSNBC Wednesday — highlighting “massive” aid to electric-car, battery and solar producers. “China’s desire is to really have global domination of these industries.”

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Opinion: The future economy will suffer if Canada axes the carbon tax – The Globe and Mail

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Open this photo in gallery:

Poilievre holds a press conference regarding his “Axe the Tax” message from the roof a parking garage in St. John’s on Oct.27, 2023.Paul Daly/The Canadian Press

Kevin Yin is a contributing columnist for The Globe and Mail and an economics doctoral student at the University of California, Berkeley.

The carbon tax is the single most effective climate policy that Canada has. But the tax is also an important industrial strategy, one that bets correctly on the growing need for greener energy globally and the fact that upstart Canadian companies must rise to meet these needs.

That is why it is such a shame our leaders are sacrificing it for political gains.

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The fact that carbon taxes address a key market failure in the energy industry – polluters are not incentivized to consider the broader societal costs of their pollution – is so well understood by economists that an undergraduate could explain its merits. Experts agree on the effectiveness of the policy for reducing emissions almost as much as they agree on climate change itself.

It is not just that pollution is bad for us. That a patchwork of policies supporting clean industries is proliferating across the United States, China and the European Union means that Canada needs its own hospitable ecosystem for clean-energy companies to set up shop and eventually compete abroad. The earlier we nurture such industries, the more benefits our energy and adjacent sectors can reap down the line.

But with high fixed costs of entry and non-negligible technological hurdles, domestic clean energy is still at a significant disadvantage relative to fossil fuels.

A nuclear energy company considering a reactor project in Canada, for example, must contend with the fact that the upfront investments are enormous, and they may not pay off for years, while incumbent oil and gas firms benefit from low fixed costs, faster economies of scale and established technology.

The carbon tax cannot address these problems on its own, but it does help level the playing field by encouraging demand and capital to flow toward where we need it most. Comparable policies like green subsidies are also useful, but second-best; they weaken the government’s balance sheet and in certain cases can even make emissions worse.

Unfortunately, these arguments hold little sway for Pierre Poilievre’s Conservatives, who called for a vote of no-confidence on the dubious basis that the carbon tax is driving the cost-of-living crisis. Nor is it of much consequence to provincial leaders, who have fought the federal government hard on implementing the tax.

Not only is this attack a misleading characterization of the tax’s impact, it is also a deeply political gambit. Most expected the vote to fail. Yet by centering the next election on the carbon tax debate, Mr. Poilievre is hedging against the possibility of a new Liberal candidate, one who lacks the Trudeau baggage but still holds the line on the tax.

With the reality of inflation, a housing crisis and a general atmosphere of Trudeau-exhaustion, Mr. Poilievre has plenty of ammunition for an election campaign that does not leave our climate and our clean industries at risk. The temptation to do what is popular is ever-present in politics. Leadership is knowing when not to.

Nor are the Liberals innocent on this front. The Trudeau government deserves credit for pushing the tax through in the first place, and for structuring it as revenue-neutral. But the government’s attempt to woo Atlantic voters with the heating oil exemption has eroded its credibility and opened a vulnerable flank for Conservative attacks.

Thus, Canadian businesses are faced with the possibility of a Conservative government which has promised to eliminate the tax altogether. This kind of uncertainty is a treacherous environment for nascent companies and existing companies on the precipice of investing billions of dollars in clean tech and processes, under the expectation that demand for their fossil fuel counterparts are being kept at bay.

The tax alone is not enough; the government and opposition need to show the private sector that it can be consistent about this new policy regime long enough for these green investments to pay off. Otherwise, innovation in these much-needed technologies will remain stagnant in Canada, and markets for clean energy will be dominated by our more forward-thinking competitors.

A carbon tax is not a panacea for our climate woes, but it is central to any attempt to protect a rapidly warming planet and to develop the right businesses for that future. We can only hope that the next generation of Canadian leaders will have a little more vision.

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Business leaders say housing biggest risk to economy: KPMG survey – BNN Bloomberg

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Business leaders see the housing crisis as the biggest risk to the economy, a new survey from KPMG Canada shows.

It found 94 per cent of respondents agreed that high housing costs and a lack of supply are the top risk, and that housing should be a main focus in the upcoming federal budget. The survey questioned 534 businesses.

Housing issues are forcing businesses to boost pay to better attract talent and budget for higher labour costs, agreed 87 per cent of respondents. 

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“What we’re seeing in the survey is that the businesses are needing to pay more to enable their workers to absorb these higher costs of living,” said Caroline Charest, an economist and Montreal-based partner at KPMG.

The need to pay more not only directly affects business finances, but is also making it harder to tamp down the inflation that is keeping interest rates high, said Charest.

High housing costs and interest rates are straining households that are already struggling under high debt, she said.

“It leaves household balance sheets more vulnerable, in particular, in a period of economic slowdown. So it creates areas of vulnerability in the economy.”

Higher housing costs are themselves a big contributor to inflation, also making it harder to get the measure down to allow for lower rates ahead, she said. 

Businesses have been raising the alarm for some time. 

A report out last year from the Ontario Chamber of Commerce also emphasized how much the housing crisis is affecting how well businesses can attract talent. 

Almost 90 per cent of businesses want to see more public-private collaboration to help solve the crisis, the KPMG survey found.

“How can we work bringing all stakeholders, that being governments, not-for-profit organizations and the community and the private sector together, to find solutions to develop new models to deliver housing,” said Charest.

“That came out pretty strong from our survey of businesses.”

The federal government has been working to roll out more funding supports for other levels of government, and introduced measures like a GST rebate for rental housing construction, but it only has limited direct control on the file. 

Part of the federal funding has been to link funding to measures provinces and municipalities adopt that could help boost supply. 

The vast majority of respondents to the KPMG survey supported tax measures to make housing payments more affordable, such as making mortgage interest tax deductible, but also want to maintain the capital gains tax exemption for a primary residence.

The survey of companies was conducted in February using Sago’s Methodify online research platform. Respondents were business owners or executive-level decision makers.

About a third of the leaders are at companies with revenue over $500 million, about half have revenue between $100 million and $500 million, with the rest below. 

This report by The Canadian Press was first published March 27, 2024.

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