Investment 101…Again

Ever seen a particular stock do really well? It’s hard to resist buying in. And if it does consistently well year after year, well, it’s hard to resist devoting a huge chunk of the portfolio to it. That’s sort of what the US economy is to Canada. It has paid off so well for us over the years that we are deeply into it. As investment professionals would say, that’s too much single exposure. It has long since been said that Canada needs to diversify trade and international activities beyond the US; have we made any progress in recent years?

Canada was on a roll before the recession. For instance, back in 2000, we shipped a mere 5 per cent of our goods to emerging markets. That climbed to 11 per cent by 2008, a remarkable increase in a short space of time. Recession hit all economies, but the superior performance of emerging markets furthered our export diversification: by 2013, just under 15 per cent of Canada’s merchandise trade went to emerging markets. Since then, the share has flattened out, and interestingly some have concluded that the strong run is done. This has been accompanied by increased focus on the US market, abetted of course by our weaker Canadian dollar and nascent strength of US growth. Is that really the path forward?

For the time being, the US market will be hard to resist. As global growth engine, the US is sparking a lot of the world’s commercial activity, and is likely to do so over the near term period. Even so, Canada’s export sales to China, Mexico and India have consistently outperformed our US export growth over the past 5 years, and are likely to do so for some time to come. With the superior growth that is forecast for emerging markets as a whole, this trend is expected to become more widespread. As such, diversification of Canada’s trade will resume.

How significant is this movement? The US would still account for the lion’s share of Canadian trade; that’s not going away anytime soon. But that share would actually diminish from the current 75 per cent level down to 69 per cent by 2030, assuming that recent growth trends for emerging and developed markets persist.

However, that may be a conservative assumption, for a few reasons. First, emerging markets have generally had a rough ride over the past few years. Heavy stimulus programs started to ease off, and without a solid revival in developed markets, the emerging world lost some of its verve. Second, certain key emerging markets, notably Russia and Brazil, saw growth interrupted by negative developments on the home front. Third, the mid-2014 plunge in commodity prices stalled growth in countries dependent on the energy and mining industries. These developments are, in general, temporary, and as such we can expect to see a faster growth clip resume in the next few years.

But there’s more. Increasing wealth in emerging markets means that as time goes on, the balance of demand within these economies will shift. Without question, they will still generally need the basic resources that Canada produces. But prosperity will also cause a rise in demand for higher-value goods that we produce, like machinery, transportation products and a whole range of consumer goods. And as these demands will be growing from a lower base, the aggregate increase of our exports to high-growth markets are expected to be a lot higher than they are at present. The numbers suggest that diversification could well outpace the current straight-line projection.

Diversification isn’t just about emerging markets, though. Canada’s newly-inked CETA trade agreement with Europe is increasing opportunity in that more traditional space for Canada, and the reasonable possibility that activity there will count for a greater share of the total. And diversification isn’t just about trade in goods. Services exports are steadily becoming a greater share of Canada’s overall trade, and the share headed to the US – 55 per cent at latest count – is already much lower than for goods.

The bottom line?

Trade diversification seems to go in and out of vogue fairly regularly. Whether fashionable or not at any given moment, it remains a powerful force in the Canadian economy, and is likely to be so for a long time to come. Our traditional markets will still be our mainstay, but fast growth off the beaten path will be a key shaping influence well into the future.

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