There are many ways a nation can make history in a positive vein. This week’s rail stoppage by Canadian National Railway (CNR) and Canadian Pacific Kansas City (CPKC) isn’t one of them.  After lengthy and ultimately failed negotiations between the two companies and the Teamsters union, a work stoppage was put into effect yesterday morning.  This also coincided with the end of the 72-hour strike notice period announced by the union last Sunday. Given that more than a billion dollars’ worth of freight are handled each day, a prolonged stoppage would have not only a negative impact on supply lines in key areas like agriculture, natural resources, automakers and consumer products, but potentially on prices as well.

 

There have been labour disruptions at both railways over the years – the most recent one being the 60-hour strike by CP workers in 2022 – but this was the first time in history that the rails have gone silent for both at that same time. As businesses and economists started to analyze the potential hit to the economy from this stoppage, the federal government did what many thought it wouldn’t do and stepped in to prevent things from going off the rails. Last night it was reported that the Labour Minister had invoked Section 107 of the Labour Code and sent the disputes to Canada Industrial Relations Board (CIRB) for arbitration. Both rail companies were already planning on restarting operations by today.

 

 

The swiftness of the government’s response isn’t exactly a surprise considering the stakes on the table. The lagged effects of the significant rise in interest rates during 2022-23 have shown up across most major economic indicators in Canada. Real GDP growth has continued to moderate into 2024 and the year-over-year change fell for the seventh straight quarter in Q1 to just 0.5%.  The chart above tells a similar story with respect to monthly industrial production.  In the first quarter, we saw annual growth turn negative and the recovery in the second quarter was modest at best.  We don’t know what happened in June or July, but a protracted rail stoppage would have put a serious dent in production late-August and into September.

 

Labour market conditions haven’t been great, but we haven’t seen a collapse in employment growth either.  The unemployment rate, however, has risen from 5% at the end of 2022 to 6.4% as of last month. Similar to the U.S., we can attribute a certain amount of this increase to immigration in terms of the labour force growing and creating a greater pool of individuals actively seeking work. Still, it is clear employment conditions have cooled and even if the true lift in the unemployment rate has been smaller than what the data suggests, it can have a negative influence on consumer confidence.

 

 

Even though the monthly Refinitiv/Ipsos Consumer Sentiment Index posted a surprise gain of 3 points this month, back to the 50 level, this probably had more to do with a reaction to two straight interest rate cuts by the Bank of Canada and less to do with underlying confidence in the economy. The subdued level of confidence since before the Bank began tightening is also reflected in spending. The above chart shows monthly retail sales, excluding motor vehicle dealers, and it has essentially been a flat line since the summer of 2022.  U.S. sales were also weak in the second half of 2022, but since the first quarter of 2023, we have seen a decent pick-up.  Since consumer spending makes up the lion’s share of GDP, this lack of growth in Canadian sales explains much of why the economy has stagnated.

 

This train journey hasn’t been entirely bad though.  With output growth at or below stall speed, excess capacity in the economy has built up and this has allowed inflation to moderate at a faster clip than what we have seen in the U.S. As the chart below shows, Canadian headline CPI inflation fell to just above 2.5% in July, compared to 2.9% south of the border. If this trend holds, then the Bank of Canada will achieve its inflation goal before we head into 2025 and that will support a continued series of rate cuts. That said, in his remarks this morning to the annual Jackson Hole central bankers conference, Federal Reserve Chair J. Powell said that the “time has come” to cut interest rates.

 

 

The big question is whether a faster shift to less restrictive monetary policy in Canada takes place soon enough to prevent a further deterioration in economic growth? If real growth does not pick up, then nominal GDP growth may not get back to a pace that is sufficient for corporate revenue growth to improve, especially with the support from higher price inflation diminishing. If so, then Canadian equity valuations today may be somewhat overdone compared to what we see in the U.S.  With just over a month left in the quarter, the TSX hasn’t done that bad, with a gain of 6.4%, compared to a 5.1% lift in the Dow Jones and 3.3% rise in the S&P500. Since the start of the year, it has also outpaced the Dow, but this will likely change if growth doesn’t improve.  In fact, we have been increasing our weighting to U.S. large and small-cap stocks relative to Canada in recent weeks.

 

For now, it does look like Canada dodged an economic bullet from a rail stoppage. While workers have returned to their jobs, it is premature to say that we are in the clear. At the time of writing, the Teamsters announced that it would file a constitutional challenge to the government’s referral to the CIRB.  Stay tuned.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.   

Andrew Pyle

 

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Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.

 

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