The Bank of Canada Adds More ‘Insurance’

The gainsaying among financial pundits that typically follows any shift in monetary policy is truly something to behold.

Yesterday, the Bank of Canada lowered short-term interest rates by a quarter point for the second time this year, taking its benchmark overnight rate to 0.50%, the lowest level since the Global Financial Crisis.

A number of pundits declared that the rate cut will have little to no economic benefit, while further inflating the country’s housing bubble.

As investors, our own attitude is that we’ll gladly accept any monetary largesse the central bank is willing to offer. After all, it’s still too soon to tell the extent to which the oil shock, which is rippling through Canada’s economy, will be a drag on the economy.

Economists do have a history of overestimating the impact of oil shocks, so we can hope that their fears are greater than warranted. In recent weeks, however, other developments around the world have further complicated the picture.

In Europe, for instance, while Greek intransigence appears to have won yet more relief for the debtor nation, that doesn’t mean this whole episode is over.

And it’s not really Greece, itself, that worries investors so much–the country’s economy accounts for just a sliver of the eurozone’s output–it’s the possibility that a so-called Grexit presages the crack-up of the currency union, as other similarly beleaguered countries follow suit.

More worrisome is the crash in the Chinese stock market. After the Shenzhen Composite Index’s meteoric rise over the past year started coming undone in mid-June, the index fell as much as 40% in a matter of weeks. That triggered all sorts of extraordinary measures from the country’s central planners, including halting trading of roughly half the stocks on Chinese exchanges.

The Shenzhen finally bounced off its low, but that doesn’t mean the rout is over, or that the rapid deleveraging that occurred won’t have consequences beyond this period.

Even before the Middle Kingdom’s stock markets unraveled, China’s economy was already in the midst of a slowdown, which could now accelerate. And if you spend any time following economic matters closely, it quickly becomes apparent that many countries are counting on demand from China to boost growth.

Finally, the U.S. deal with Iran could add further to the glut of oil in the medium term, once Iranian crude–up to a millions barrels per day–starts trading again on the global markets.

As a result of these developments, the price of North American crude benchmark West Texas Intermediate, which had climbed as high as $61.43 per barrel in June and appeared to be stabilizing, has dropped by more than 16%, to $51.36 per barrel.

Lastly, the data we have so far on the second quarter suggest that Canada’s economy is likely to have had two consecutive quarters of negative growth, though there’s some quibbling over whether that meets the technical definition of a recession–the dreaded “R” word.

The Bank of Canada (BoC) concedes that it’s “puzzled” as to why exports outside the energy sector have been weaker than expected. In fact, central bank chief Stephen Poloz went so far as to tell one reporter, “If you get some good ideas, let me know.”

Meanwhile, energy sector spending, which had accounted for more than one-third of Canada’s business investment during boom times, has dropped by about 40%.

As such, the central bank lowered its estimate for growth this year to 1% from its earlier forecast of 1.9%.

Given all these factors, it makes sense for the Bank of Canada (BoC) to extend its monetary insurance policy with further easing.

From a U.S. investor perspective, the one immediate downside of the central bank’s rate cut is that it undermines support for the Canadian dollar. Following the announcement, the loonie dropped as low as USD0.773, a level which it hadn’t seen since the downturn.

At the same time, a lower exchange rate should help boost the bottom lines of portfolio companies that do significant business in the U.S.

And as we’ve seen in the U.S., falling interest rates can pump up dividend stocks.

Indeed, as one Toronto wealth manager told the Financial Post, “Anything that pays a dividend and has a history of raising dividends should be worth a lot more today than it was yesterday, because of that rate cut.”

That’s good news for Canadian Edge: We not only specialize in dividend stocks, our methodology is focused on finding companies that grow their payouts over time.