Canada’s Bid to Be the Comeback Kid

After two consecutive quarters of contraction, Canada’s economy finally picked up speed again. According to Statistics Canada, the country’s gross domestic product (GDP) grew 2.3% annualized during the third quarter—a faster pace than even the U.S. for that period.

Of course, in this challenging environment, good news is often accompanied by not-so-good news. The economy’s handoff to the fourth quarter was a fumble, with GDP declining by 0.5% during September.

Handoffs are important. A big factor in the third quarter’s strong showing was the economy’s reacceleration in June, which persisted through July.

In this environment, it should be no surprise that the continuing turmoil in the energy sector drove September’s decline. Oil and gas extraction fell 5.5% month over month, primarily due to production difficulties and maintenance shutdowns for non-conventional producers operating in Canada’s oil sands.

But even when excluding the drag from the resource space, GDP still declined by 0.1% during the final month of the third quarter.

Fortunately, the disruption in oil sands production has been resolved, and normal activity has resumed. So that should lead to stronger numbers in the months ahead.

Beyond that, a weak handoff isn’t cause to dismiss the overall third-quarter numbers. Indeed, given the first-half contraction, it’s worth celebrating the fact that third-quarter growth came in just below the minimum level at which Canada’s economy is estimated to operate at full capacity.

As economists with CIBC observed, “Exports were the major story for the third quarter, powering ahead at a 9.4% annualized pace after a lackluster first half.” Auto sales and energy exports were among the main drivers.

Which Themes Are Still Humming?

In addition to keeping tabs on the overall health of the economy, we also like to see which sectors are performing best to underscore existing investment themes or identify emerging ones.

In the goods-producing sector, agriculture is the one industry that’s grown over the past year, up 3.8%, to CAD25.2 billion.

The service sector is comprised of many more industries, and a number of them are showing meaningful year-over-year growth. The service industries with the biggest contribution to GDP, as well as the strongest growth, are real estate, up 3.1%, to CAD214.1 billion, and finance, up 3.1%, to CAD115.1 billion.

Despite the country’s economic woes, Canada is still in the midst of a housing boom, so the fate of these two industries is intertwined.

The big question is whether Canada’s policymakers will successfully engineer a soft landing for the housing market.

But that’s been the big question for a number of years now. Canada’s housing market has been so hot for so long, that I’ve been reading predictions of its imminent decline since 2009.

A country’s real estate market is really a patchwork of regional and local markets. And one real estate market worth watching is the one in Canada’s resource-rich province of Alberta, which has been rocked by the collapse in energy prices.

While it’s possible that the province’s real estate downturn could be contained, it also gives policymakers the first big opportunity in years to truly test their mettle.

Meanwhile, the financial industry continues to grind out growth.

During the third quarter, the major banks that constitute Canada’s Big Six, two of which we hold in our Dividend Champions Portfolio, delivered an average upside earnings surprise of 3.2%. That’s a big contrast to the average stock in the Canadian market, which fell short of estimates by 3.4%.

The banks’ actual numbers were even better. Revenue growth grew 4.1% year over year, powering earnings growth of 9.6%. And two of our favorites enjoyed double-digit earnings growth.

By comparison, their U.S. based counterparts saw sales decline by 3.0% and earnings drop by 4.7%.

Looking ahead, economists expect 2015 to be the trough for this cycle. Canada’s economy is projected to grow 2.0% next year and a further 2.2% the following year. That may not exactly be robust growth, but it shows that economists believe the country is making significant progress in working through the oil shock.

Our favorite bank stocks are yielding around 4% and have grown their dividends an average of 11% annually over the past three years. Subscribe to Canadian Edge to learn more about our top picks.

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