Canada seen as ‘safe harbour’ for investors

Advisor.ca Poll

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When the financial crisis first hit in the fall of 2008, many were shocked at how much damage the U.S. mortgage market could inflict.

Thanks to leverage and disintermediation, the sub-prime lending market took out hedge funds and investment banks, sent the U.S. economy to the brink of freezing up, and drove the U.S. deficit to a record $1.2 trillion.

Europe has not been immune, but until recently the list of victims consisted mostly of financial institutions and municipal investors left holding bags of collateralized debt.

Now the crisis has advanced to national and even multinational level, as the European Union sorts out how to deal with a pending sovereign debt crisis in Greece — which could well be the tip of a Mediterranean iceberg, with Spain, Italy and Portugal lining up as the next potential crisis centres.

Largely untouched, Canada is now seeing the upside of everyone else’s problems, as foreign investors race into the Canadian bond market, according to a report by CIBC World Markets. With over a decade of fiscal responsibility, Canada is seen as a “safe harbour.”

“For a number of European countries, Greece and Portugal chief among them, a fiscal reckoning is at hand, sparking concerns of broader contagion on and off the continent,” says Warren Lovely, government strategist with CIBC’s Macro Strategy Group. “As a sovereign debt crisis swirls, [Canada’s] relative standing has strengthened further. Simply put, highly-rated Canada offers safe harbour in today’s global debt storm.”

Not only is Canada’s economic outlook better than its G7 friends, but Lovely expects the stimulus-induced federal deficit will be eliminated by 2015.

“Notwithstanding Canada’s substantial stimulus efforts, the country’s fiscal rectitude is well proven,” says Lovely. “There’s a staunch commitment on the part of the main parties in Ottawa to restore fiscal health, and expect the upcoming federal budget to chart a course back to balance.

“Today, net debt is 35% of GDP and likely to turn lower starting fiscal 2011, with only 14 cents of every revenue dollar required to service the debt.” In 1995, net federal debt was around 70% of GDP, with interest costs consuming more than one-third of Ottawa’s revenue.

Any bailout of the weaker EU members could threaten the AAA rating on the sovereign debt of Germany and France, while Britain is already on a watch list for a downgrade. By contrast, Canada’s AAA rating is “rock solid,” Lovely says.

“We are decidedly more bullish on the outlook for the Canadian dollar, seeing 5-10% near-term upside for the loonie with the country’s rich endowment of natural resources providing longer-term support,” he says.

Of course, Canadian bonds cannot rise indefinitely, as pointed out by CIBC chief economist Avery Shenfeld. An upturn in the economy will likely send Canadian equity markets higher and probably spark a sell-off from the bond market.

The complete report is available on the CIBC World Markets website.

(02/11/10)