Stingy Investor Contact - Subscribe - Login
  Home | Articles | Screens | Links | SNW | Rothery Report
 
A weaker recession clue in Canada

The Bank of Canada boosted its policy interest rate to 3.25 per cent last week in an effort to tame inflation. The idea being that higher rates will dissuade people from borrowing and thereby put a damper on an overheated economy.

The central bank has a difficult task because inflation is running at 7.6 per cent based on the latest year-over-year reading from July. The bank's preferred measures of core inflation were also elevated, at between 5 per cent and 5.5 per cent.

Should inflation persist at similar rate, rather than decline to more moderate levels, as the bank hopes, monetary policy would still be expansive because borrowers get a free lunch thanks to inflation. The bank says, 'given the outlook for inflation, we continue to judge that the policy interest rate will need to rise further.'

The bank's job is made more difficult because the Canadian government bond yield curve recently inverted, with yields offered by short-term bonds now exceeding those on long-term bonds.

U.S. Spreads vs Recessions

That's worrisome because negative spreads (the difference between long-term and short-term yields) in the United States have heralded recessions almost like clockwork since the 1970s. The relationship is something Duke University finance professor Campbell Harvey pointed out in his 1986 PhD dissertation, and negative spreads have continued to presage economic downturns in the U.S. since then.

The first accompanying graph shows year-over-year growth in real gross domestic product (GDP) in the U.S. along with the spread between 10-year and three-month U.S. Treasury yields. (The graphs herein are based on calculations using data retrieved from the FRED service of the Federal Reserve Bank of St. Louis, with some supplemental data from the Bank of Canada. GDP growth is based on quarterly figures while the spreads use monthly data.)

You can see that spreads fall near, or below, zero roughly a year before GDP stalls.

I use GDP growth as my proxy for recessions rather than official data from the National Bureau of Economic Research to be able to apply the same measure in Canada. But, to my eye, GDP shrinkage does a pretty good job of flagging the major economic downturns of the last few decades.

You'd be right to quibble about the idea that negative spreads cause recessions in all cases. For instance, it is preposterous to think they were behind the 2020 recession, which was prompted by the pandemic and its related restrictions. (While an economic slowdown might have occurred in a world that didn't suffer from the COVID-19 pandemic, we can't turn back time to test the matter.)

Canadian Spreads vs Recessions

The spread between 10-year and three-month U.S. Treasury bond yields stands at 0.20 of a percentage point on Sept. 7, according to data from the U.S. Treasury Department. While the spread has yet to go negative, it is low enough to be worrisome because the U.S. Federal Reserve is expected to follow the Bank of Canada with a boost to its benchmark rate later this month of, perhaps, 0.75 of a percentage point.

While the linkage between negative spreads and recessions appears to be strong in the U.S., it has been weaker in our home and native land.

The second graph shows the history of the spread between 10-year Government of Canada bond yields and three-month yields, along with year-over-year real Canadian GDP growth.

I'll start with the good news and a touch of confirmation bias. Many significant slowdowns have occurred in Canada roughly a year after the yield spread turned negative. For instance, the hard times of 1982, 1990 and 2008 were all heralded by inverted yield curves.

On the other hand, it's easy to spot several notable whiffs. For instance, spreads predicted recessions in the late 1990s and early 2000s, but they failed to materialize. Hard times also occurred without accompanying negative spreads, such as the 2015 downturn that was fuelled by the collapse of the oil patch.

It's not clear why spreads failed to be a reliable predictor of recessions in Canada. It might be due to our smaller economy, the influence of our giant neighbour to the south, the significance of our energy and resource sectors, or a combination of these and other factors.

But the recent U.S. experience might also have arisen more by chance than cause and effect. There have only been a handful of economic downturns in recent times and it's easy to imagine that recessions might arise in other ways. After all, a prime example is provided by the recession of 2020.

Nonetheless, I think it's unwise to ignore the actions of the central banks when they are trying to cool the economy by aggressively boosting short-term interest rates. After all, such actions have led to some of the most painful recessions in the past, and cracks are already starting to appear in the Canadian real estate market. In my view, we'll be fortunate to avoid a serious economic slowdown over the next year or so.

First published in the Globe and Mail, September 12 2022.

 
Globe & Mail Articles
 The easy way
 Smaller stable dividend
 The 250 | Megastars
 Champagne portfolio
 Screaming Value
 Blended momentum
 Dividend monster
 Frugal dividend
 Stable dividend
 Speads and recessions
 TSX 60 for value investors
 Looking at 10-year returns
 Watching for a bottom
 Oh, bother!
 Indexing advice
 Media-shy stocks
 Curse of size
 Market uncertainty
 Be even lazier
 Scary beats safe
 Small, illiquid, value
 Use the numbers
 What value is good value?
 Sculpt for value
 Value vs CAPE
 Graham Rules
 CAPE vs PeakE
 Top value ratio
 Low Beta
 Value and dividends
 Walter Schloss
 Try unloved AIG
 Why I'm a value investor
 New world of ETFs
 Low P/Es possible
 10 yielders
 Be happier
 Long-Short
 Dividend Downside
 Shiller's P/E
 Copycat investing
 Cashing in on class
 Index roulette
 Theory collides
 Diving too deep
 3 retirement villains
 Scourge of inflation
 Economic omens
 Analyst Expectations
 Value stock scarcity
 It's all in the index
 How to pick good funds
 Low Beta Wins
 Hunt for dividend stocks
 Think garage sale

MoneySaver Articles
 2 Graham Stocks for 2018
 2 Stingy Stocks for 2017
 2 Graham Stocks for 2017
 3 Stingy Stocks for 2016
 5 Graham Stocks for 2016
 3 Stingy Stocks for 2015
 3 Graham Stocks for 2015
 3 Stingy Stocks for 2014
 4 Graham Stocks for 2014
 8 Stingy Stocks for 2013
 6 Graham Stocks for 2013
 9 Stingy Stocks for 2012
 8 Graham Stocks for 2012
 Simple Way 2011
 5 Stingy Stocks for 2011
 7 Graham Stocks for 2011
 Simple Way 2010
 5 Stingy Stocks for 2010
 8 Graham Stocks for 2010
 Simple Way 2009
 Timing Temptation
 19 Stingy Stocks for 2009
 4 Graham Stocks for 2009
 Simple Way 2008
 Active at Passive Prices
 Unbundling ETFs 2008
 5 Stingy Stocks for 2008
 5 Graham Stocks for 2008
 Is your index too active?
 Graham's Simple Way
 Canadian Graham Stocks
 5 Stingy Stocks for 2007
 8 Graham Stocks for 2007
 Top SPPs
 The Simple Way
 A hole in your IPO?
 Monkey Business
 8 Stingy Stocks for 2006
 Graham Stock Gainers
 Blue-Chip Blues
 Are Dividends Safe?
 SPPs for 2005
 Graham's Simplest Way
 Selling Graham Stocks
 RRSP Money Market Funds
 Stingy Stocks for 2005
 High Performance Graham
 Intelligent Indexing
 Unbundling Canadian ETFs
 A history of yield
 A Dynamic Duo
 Canadian Graham Stock
 Dividends at Risk
 Thrifty Value Stocks
 Stocks in Short Supply
 The New Dividend
 Hunting Goodwill
 SPPs for 2003
 RRSP: don't panic
 Desirable Dividends
 Stingy Selections 2003
 10 Graham Picks
 Growth Eh?
 Timing Disaster
 Dangerous Diversification
 The Coffee Can Portfolio
 Down with the dogs
 Stingy Selections
 Frugal Funds
 Graham Revisited
 Just Spend It
 Ticker Temptation
 Stock Mortality
 Focus on Fees
 SPPs for the Long Term
 Seeking Solid Stocks
 Relative Strength
 The VR Approach
 The Irrational Investor
 Value Investing

Old MS Articles
 Cdn Top 200 2018
 Cdn Top 200 2017
 Cdn Top 200 2016
 Cdn Top 200 2015
 Cdn Top 200 2014
 Cdn Top 200 2013
 Cdn Top 200 2012
 Cdn Top 200 2011
 Cdn Top 200 2010
 Cdn Top 200 2009
 Cdn Top 200 2008
 Cdn Top 200 2007
 Cdn Top 200 2006
 Cdn Top 200 2005
 US Top 500 2018
 US Top 500 2017
 US Top 500 2016
 US Top 500 2015
 US Top 500 2014
 US Top 500 2013
 US Top 500 2012
 US Top 500 2011
 US Top 500 2010
 US Top 500 2009
 US Top 500 2008
 US Top 500 2007
 US Top 1000 2006
 Dividends 100 2017
 Dividends 100 2016
 Retirement 100 2015
 Retirement 100 2014
 Retirement 100 2013
 Retirement 100 2012
 Retirement 100 2011
 Retirement 100 2010
 Income 100 2009
 Income 100 2008
 Income 100 2007
 Top Trusts 2006
 Top Trusts 2005
 Hot Potato
 Buffett Buys
 FB IPO
 Stocks that pay
 Value in the S&P500
 Where to invest $100k
 Where to invest $10k
 Summer Simple Way
 A crystal ball for stocks?
 Cheap & safe
 Risky business
 Dividend investing
 Value investing
 Momentum investing
 Low P/E P/B
 Dividends
 Dividend growers
 Graham's prescription
 The case for optimism
 Wicked investments
 Simply spectacular
 Small stocks, big profits
 Value that sizzles
 So simple it works
 No assembly required
 Investing by the book
 Invest like the masters
 A simple way to get rich
 Stocks for cannibals
 Car bites dogs
 So easy, so profitable
 Dogs of the Dow
 Money for nothing
 Yield of dreams
 Return of the master

Advisor's Edge Articles
 Passive Rebundling
 Doing the math

Norm Speaks
Flip Books

Tools:
 Asset Mixer
 Periodic Table



 
About Us | Legal | Contact Us
Disclaimers: Consult with a qualified investment adviser before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, financial advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...