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  • KPB & Co Research


A few weeks ago we wrote an article on why the 2019 budget should consider 3 important things in light of what is to come. Of course, none of these things were covered fully in the 2019 budget, but then an election is coming so what would one expect. In election years, governments in many parts of the world typically handout gifts and talk about how "great we have been since we have been in power". In our view, this is good politics but also bad economics, especially within the context of a shaky economy, built on a shaky housing market. Mr Morneau started out by outlining the "extraordinary achievements" of his government since coming to office in 2015, then went on to discuss things that Canadians are rightfully worried about. As Mr Morneau continued he then switched focus to more politically friendly rhetoric.

How Great The ECONOMY Has Been

The budget started out focused on how great the economy is doing relative to 2015, using a few headline numbers as proof. Record low unemployment rates at 5.5%, top tier GDP growth rate at 1.9%, rising business confidence, and a positive change in foreign direct investment. In our view, some these numbers are true, some half true, but they all only present half the story. There have been low unemployment rates and better GDP growth, but are they sustainable, and are they reflective of a healthier economy? We think not. Focusing on the change in foreign investment since 2018 is presents a rosier picture than the long term trends which are demonstrably negative. Business confidence in Ontario is better, but is not standing solid footing, as businesses have not yet seen positive affirmation of their confidence through higher profits. What the about the confidence of businesses in Alberta, not looking too good at all.

Figure 1 in Budget Presentation: Proof of Economic Progress
Ministry of Finance Canada

At the end of the day, the Finance Minister's own words show that he is aware that Canadians are not feeling the "Greatness". As he went on to say:


In 2019, however, there persists a sense among some Canadians that the promise of progress--the idea that with hard work, everyone can build a better life--may no longer hold true. Much more needs to be done to make sure all Canadians feel confident and secure about their future.
Too many Canadians are worried about making ends meet.
High housing costs, mounting household debt, a rapidly changing job market, and the steady erosion of things that used to offer a sense of security--like employer-sponsored pension plans--are adding to the sense of uncertainty.
Many Canadians still feel that they are working harder than ever, but not getting any further ahead.
They feel uncertain about the future for different reasons.
Some young people are worried about their ability to find and keep good jobs, and frustrated that even with a college or university degree, they might not have the skills that employers need. Some of them may want to build a future in the rural areas they grew up in, but have concerns about finding jobs in their field or that suit their skill sets.
For some parents, it's the rising cost of living, saving for their kids' education and their own retirement, and taking care of aging parents that may weigh most heavily.
Workers of all ages may wonder if their jobs are secure, or worry about how they'll get the skills needed to find new or better opportunities down the road.
And some seniors, who have earned a secure and dignified retirement after a lifetime of work, may be concerned about whether they have enough savings to support themselves through their retirement.


To us, all the concerns that Canadians have are symptoms of a weak economy that is in dire need of attention. In the short term, debt fuelled consumer spending can create jobs and record low unemployment rates, but this is unsustainable. Sooner or later the debt has to come down, the economy has to deflate and all the jobs created will disappear. In the long term, people's lives become better when they are more productive, i.e. one hour of work produces more stuff - more wages, and more goods and services. In fact, we have seen the opposite taking place as one of the complaints that Canadians have is that "they are working harder than ever but not getting any further ahead" and in many cases one hour of work is producing less.


Before we continue let us be clear, none of these problems started in or because of the Trudeau government. Moreover, none of these problems can be solved overnight or in one budget presentation. On the other hand, the competitive positioning of the country matters in solving these problems, and the economic landscape is changing rapidly. The 2019 budget should have demonstrated an appreciation of the flexibility needed to address ongoing needs that are changing quickly. Instead #Budget2019 focuses on a few gifts within the context of an election on the horizon, a tall glass of lemonade to keep Canadians cool as the weather gets warm.


The first Time Home Buyers Incentive

We don't need a pair of binoculars to see that the housing market is in trouble. Household debt is at epic proportions, interest rates are increasing and the price of homes are at the highest levels in decades. The government themselves recognize that the housing market is in a bubble, why else would they come up with mortgage stress test rules and are jacking up interest rates. In-spite of acknowledging the risks inherent in housing they decided to fan the flames with an incentive.



The incentive is essentially an interest free loan that the government provides for you to buy a home. The size of the loan can be between 5% or 10% of the purchase price. We wouldn't encourage a first time home buyer to get in at these prices as we are value investors at heart, but I am pretty sure many people will be happy for that opportunity.


Budget 2019: First Time Home Buyer Incentive
Ministry of Finance Canada


What About Alberta The Forgotten Child

The word Alberta is in the budget twice, one for environmental concerns and another for economic diversification. We like economic diversification, but we don't think that providing C$100Mn over three years is a credible attempt at diversification for an entire province. Neither do we think it appreciates the immediacy of issues the province is facing. Just to put the numbers into perspective, the budget provides:


Natural Resources Canada with $130 million over five years, starting in 2019-20, to deploy new recharging and refuelling stations in workplaces, public parking spots, commercial and multi-unit residential buildings, and remote locations.


in addition:

Budget 2019 proposes to provide $5 million over five years, starting in 2019-20 to Transport Canada to work with auto manufacturers to secure voluntary zero-emission vehicle sales targets to ensure that vehicle supply meets increased demand.


in addition:

Budget 2019 proposes to provide $300 million over three years, starting in 2019-20, to Transport Canada to introduce a new federal purchase incentive of up to $5,000 for electric battery or hydrogen fuel cell vehicles with a manufacturer's suggested retail price of less than $45,000. Program details to follow.


and this just to start off. Yet Alberta gets C$100Mn over three years to diversify, remember this not to support the energy industry, but to diversify an entire province that relies on energy to survive today. Again we like diversification, but the reality of the situation is that there is no way they are going to diversify with C$100Mn . If it is believed that diversification is an incredible strategy for Alberta, the government ought to inform the public of their long term plan to facilitate the construction of infrastructure, that allows Canadian crude to be monetized more efficiently. In the end, providing C$435Mn appears a bit more pleasing to people who would love to drive a Tesla on their way to work.


What WE Do Like, But Not Enough To Ignore The Bigger Issues Are

A Focus on Lowering The Cost of Medicine: This is a key issue across many developed countries where the cost of medication is prohibitive to a healthier society. The budget provides for the creation of a national Canadian Drug Agency to negotiate drug prices on behalf of Canadians. According to the minister this will help to reduce the cost of drugs by C$3Bn per year or approximately C$120 per working Canadian per year.


More Emphasis on Protecting Pensioners: The 2019 budget places emphasis on protecting the income of pensioners, where the GIS earnings exemption has been expanded on employment and self employment income for each recipient and their spouse. The full exemption amount has been expanded to C$5K per year plus an additional exemption of 50% of the excess above C$5K up to a maximum of C$10K.


The budget is also devoting resources to securing work place pensions in corporations that file for bankruptcy protection. The government is looking at legislative changes to the Companies' Creditors Arrangement Act, the Bankruptcy and Insolvency Act, the Canada Business Corporations Act, and the Pension Benefit Standards Act with the goal of incentivizing more responsible decision making in pension administration. This is to be done through: 1) giving the courts more power to review executive pay in the lead up to insolvency, 2) requiring publicly traded corporations to disclose their policies regarding workers, pensioners, and executive compensation, or explain their absence, 3) requiring publicly traded corporations to hold and disclose the results of non-binding shareholder votes on executive compensation, 4) allowing defined benefit plans to fully transfer pension assets and liabilities to a regulated life insurance company through the purchase of an annuity, and 5) clarifying pension law to emphasize the idea that a pension plan should provide the same benefits before and after it is wound-up. In our view, most of these strategies will help to secure pensioners' life savings, but additional resources are needed to ensure effective policing of these laws when they are implemented.


Approval of 33,000 Infrastructure Projects: The government has approved 33k projects across Canada which is funded to the tune of C$19Bn, with a majority of the project underway. The budget also accounts for a one time transfer of C$2.2Bn through the the federal Gas Tax Fund to fund short term infrastructure needs in various municipalities.


Budget 2019: Infrastructure Projects
Ministry of Finance

However there are still delays and it appears that the delays will persist for while. Phase 2 type projects are slow to get out of the blocks. This will likely lead to less than anticipated impact to GDP in the future as the impact of the legacy projects dissipate.


In closing, with elections around the corner you would expect the liberals to focus on more popular policies instead of stabilizing the economy. After all, the view of many including the government is that though in the short term the economy will slowdown, it will recover in the quarters ahead. In our view, there are many risks to consider, a housing bubble, a slow down in the oil patch, and high debt levels. It more likely that the downside risks will have their way than up side risks will. As such caution and a more accommodative environment to growth is warranted.



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