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Late Cycle Musings

2023-08-11, Clement Chiang

“One of the greatest pieces of economic wisdom is to know what you do not know.” – John Kenneth Galbraith

As we know, every business cycle is different. Every expansion climbs a different wall of worry that is always seemingly standing in the way of economic inertia. New risks come to light, forcing revisions to market forecasts that were based on an extrapolation of the status quo.

The evolution of this current business cycle in Canada is no different. Taking past cycles as a barometer for this one has not worked as neatly as most forecasters have hoped. Our starting point was a once-in-a-century pandemic that led to large disruptions in the economy. As supply chains reopened and demand rebounded, central banks had to quickly reverse their wildly accommodative policies to fight inflationary pressures the world had not experienced in decades. Geopolitical tension and the war in Ukraine led to a global migration of people, which Canada welcomed with open arms. With failed commercial banks, hawkish central banks, etc., the economic engine has been humming along nicely down a rocky road to normalization.


Canada has recently experienced the strongest year-over-year population growth in decades, as shown below. Approximately 60% of this growth is the result of a strong influx of non-permanent residents (NPRs), according to National Bank Economics. But, however temporary in nature their stay may be, the economy needs to absorb this population growth via housing and jobs, as it has.

Source: Bloomberg, Statistics Canada, QV Investors

The Canadian labour market has been strong, even in the face of this immigration-fueled population surge. Technically, according to the lows we saw in our unemployment rate (4.9% in June 2022), the likelihood of finding a job was high if you were actively pounding the pavement. Canada experienced an extraordinarily tight labour market in 2022, but this seems to be slowly reversing.

Source: Bloomberg, Statistics Canada, QV Investors

Employment growth (labour demand) has slowed in recent months and has not kept pace with robust labour force growth (labour supply), as shown below. This is an important dynamic as we are likely to see excess labour supply widen further if this trend persists. Canada’s unemployment rate has already seen a steady rise over the last three months, from 5.0% in April to 5.5% in July. National Bank Economics extrapolated the rate of change in excess labour supply from the prior three months and estimates a jobless rate of 7.0% within a year’s time. The unemployment rate remains a critical measure for reliably assessing a nation’s economic health. Should this deterioration persist to meaningful levels, it will signal that a worsening economic outlook is likely on the horizon.

Source: NBF, Statistics Canada, as at July 2023


Claudia Sahm is an accomplished American economist that is also known for coining the early recession indicator known as the “Sahm Rule”. The rule states that a recession is certain if the three-month average unemployment rate rises at least 0.50% above its low point over the past 12 months. This indicator has seen a perfect track record in the U.S. with zero false positives. But the BMO Capital Markets Economics team found four false positives when applying this rule to Canada (1977, 1996, 2002 and 2015), and estimates that we would need to see a higher rise of 0.70% from the unemployment rate low to indicate a recession. Canada’s 3-month average unemployment rate bottomed at 5.0% in April and has risen to 5.4% in July. Accounting for the Sahm Rule as well as our outlook for greater labour market slack going forward, this suggests that an economic downturn could be in range.


The Bank of Canada (BoC) hiked its policy rate to 5.0% in July, surprising most market forecasters, perhaps even themselves, since initiating its first hike in March 2022. This restrictive level surpasses the 2004 to 2007 hiking cycle that saw a terminal rate (highest policy rate level in a hiking cycle) of 4.5%, but is marginally eclipsed by the 5.75% terminal rate last seen in the 1999 to 2000 hiking cycle. Regardless, aggregate debt levels today are much higher than in either of those periods, implying that interest rates are comfortably in restrictive territory already. The full effect of these restrictive rates is beginning to hit Canadian households as they slowly work their way through the financial system. CIBC Economics estimates that approximately one-third of Canadian mortgages will require refinancing at these higher rates from mid-2023 to end of year 2024. Defaults could still be avoided by selling at higher house values to help pay off the mortgage loan owed. As the cost of money makes a larger dent in pocketbooks, it is fair to expect real disposable incomes to slow as they have in recent years, suggesting that Canadian households are likely to face increased pressure to their discretionary spending going forward.

Source: CIBC Capital Markets, Bank of Canada


Considering inflation has declined from its 8.1% peak in June 2022 to 2.8% in June 2023 (within the BoC’s inflation target range of 1% to 3%), as well as the widening trends in labour market slack and headwinds to economic momentum, it seems reasonable to postulate that the BoC has reached its terminal rate. New developments can always introduce new risks to this outlook. But given the information at hand at this stage of the business cycle, it is a rational base view that the BoC is likely to maintain its overnight rate at this current level and watch these restrictive rates rebalance the economy to achieve its price stability mandate.


While we have laid out quite a convincing economic outlook, we need to remain open-minded that this is one of many scenarios that may unfold as new developments come to light. As Galbraith advises, acknowledging that we may be wrong, that no economic cycle is identical, and that we simply do not know the future is reason enough to ensure our investment decisions stem more from our bottom-up convictions than from a macroeconomic outlook.

But businesses do not operate in a vacuum and being eyes wide open to the evolving business cycle and potential scenarios that could lead to rare buying opportunities is compelling to us as long-term investors. Preparing for market volatility is a focus of ours. What would we be buying when most are selling? Where would the best risk-reward opportunities lie when valuations disconnect from fundamentals? We believe that maintaining a long-term horizon through all stages of the business cycle, trusting the growth and durability of our businesses, and being prepared for multiple scenarios will help us put the odds in our clients’ favour.

All views and projections are the expressed opinion of QV Investors Inc. and are subject to change without notice. This Update is provided for informational purposes only. QV Investors takes no legal responsibility from any losses resulting from investment decisions based on the content of this Update.


Clement Chiang | VP & Portfolio Manager, Fixed Income

Clement oversees QV’s investment process and makes portfolio decisions for the fixed income strategies.