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Bull or Bear? Market ripe for change, economist says

Q&A | Equity markets threatened by inflation, interest rates, according to Matthew Stewart, director of economics for the Conference Board of Canada
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Matthew Stewart, director of economics for the Conference Board of Canada

Q: The current American bull market began in 2009, following the Great Recession, and is now officially the longest in American history. Should that worry investors, or is there still room for this bull to run?

A: The lengthy bull market has been a result of several factors, most prominently healthy earnings for most corporations. This is due to two factors: weak wage gains since the end of the recession and low interest rates. Both these factors are linked to the slow growth in the U.S. economy since 2009 in the 2% range, which has kept inflation low and enabled the Federal Reserve Bank to maintain rock-bottom interest rates. The situation is changing quickly because of the Trump stimulus to the economy in the form of major tax cuts and higher government spending. The economy is currently expanding at a 3.5% to 4% pace, and this has led the Fed to increase interest rates at a quicker pace. Inflation and wages are also increasing although they remain contained. Higher inflation and interest rates would suggest an end to the rapid increase in equities but they likely have more room to run because of the Trump corporate tax cuts, which will continue to boost earnings going forward. However, the risk of a slump in equity markets is increasing.

Q: What factors are most likely to cause a market downturn if one is to take place?

A: Inflation remains contained but if it starts to accelerate above the Fed’s 2% target, monetary authorities would have little choice but to increase rates at a quicker pace – a development that would be bad for equities. The danger is that the Trump stimulus has pushed the U.S. unemployment rate well below 4% and if wages pick up steam, due to tightening labour markets, inflation could easily accelerate and force the Fed to take action to cool down the economy. The economy’s potential growth rate is around 2% and the economy is currently expanding at a pace well above this level. In the past, this has often led to higher inflation, and a similar development in 2019-20 can’t be ruled out.

Q: Canadian markets haven’t exactly mirrored American markets and have experienced a minor correction already. What are the implications for Canada if the U.S. markets experience a correction?

A: Canadian equities haven’t increased to the same degree as U.S. markets in part because our markets are more linked to commodities. Commodity prices have failed to rebound to the levels attained prior to 2014. This is especially true for oil prices. Nevertheless, a major drop in U.S. equities would send Canadian equity markets lower due to the close linkages between the two economies. This would transpire irrespective of what happens to commodity prices over the near term.  

Q: It has now been a decade since the last American recession, which was long, deep, severe and global in nature. Canada did not suffer as profoundly as the U.S. did, thanks to our banking system. Are we necessarily any more insulated now?

A: Our susceptibility to financial contagion in the banking system has not changed significantly since the last recession. However, high levels of consumer debt may make it more challenging for households and government to manage during the next downturn.

Q: The last financial crisis was triggered by subprime mortgage securities. What are the big risks today?

A: The big risks to the global economy today, which could trigger another recession, are the threat of a trade war triggered by the Trump administration’s imposition of tariffs on major allies like Canada and China and the subsequent retaliation. The other factor is rising U.S. interest rates that are already causing trouble for some developing countries like Argentina and Turkey. These risks likely aren’t as large as the subprime crisis in 2008 but must be monitored closely.

Q: Investor and business confidence has not been as strong in Canada as it has been in the U.S. Why do you think that is?

A: The Canadian economy isn’t growing nearly as fast as the U.S. economy, and this has a major impact on confidence. The U.S. economy is growing at a 3.5% to 4% pace compared with Canada’s 2%. Many Canadian firms are also concerned about the future of [the North American Free Trade Agreement] and the prospects of a global trade war. Then there is the difficulty that Canada is experiencing in getting pipelines built to move our oil to foreign markets in Asia. The most recent Federal Court ruling against the Trans Mountain pipeline certainly hasn’t helped the perception on the part of foreign investors that we’re a country encountering serious difficulties in developing our natural resources.