Canada Election Preview: Trudeau Weathers Brownface Scandal

Canada Prime Minister Trudeau and his Liberals appear to have escaped negative fallout from recent scandals. Polls suggest the national vote will be very close, but closer analysis suggests the Liberals will likely win the most seats. While possibly falling short of winning an absolute majority, the Liberals appear to have the best chance of forming the next government.

RECENT DEVELOPMENTS

Federal elections will be held October 21. All 338 seats in the House of Commons will be contested. The Liberals are led by Justin Trudeau. The party won 39.5% of the vote and 184 seats in the 2015 elections. This was a come from behind victory, as polls had shown a very close race right up to the actual vote. It was quite a comeback for the Liberals, who had been relegated to third place in the disastrous 2011 elections when they won only 36 seats.

The Conservatives are newly led by Andrew Scheer. The party won 31.9% of the vote and 99 seats in 2015. Under Steven Harper, the Conservatives failed to win their fourth straight election and so he stepped down after serving nine years as Prime Minister. Scheer won a bruising battle for the leadership in 2017. He narrowly won the final vote against former Foreign Affairs Minister Bernier, by less than one percentage point.

The New Democratic Party are newly led by Jagmeet Singh. The party won 19.7% of the vote and 44 seats in 2015. NDP was founded in 1961 and generally resides to the left of the Liberals. In the 2011 elections, NDP won a record 103 seats and ousted the Liberals as the official opposition. NDP did poorly in 2015 elections, winning only 44 seats. Because of this poor showing, NDP leader Thomas Mulcair was ousted after only five years as leader, as Singh won the party leadership race.

Bloc Quebecois (4.7% and 10 seats) and the Green Party (3.5% and 1 seat) round out the field. Bernier quite the Conservatives last year to form his own People’s Party of Canada (PPC), a populist party running on a platform of curbing immigration and the so-called globalist agenda. This will be the first election for this new party, and polls suggest Bernier has gotten very little traction with voters.

Several pictures and videos surfaced last month of Prime Minister Trudeau wearing brownface. While the incidents were in the past, the news has dented Trudeau’s image as a progressive champion. The fact that Trudeau supported the controversial Trans Mountain pipeline project after becoming embroiled in a potential corruption scandal in Quebec hasn’t helped that image either.

Recent polls suggest that Trudeau’s most recent image problems have not had a significant impact on the Liberals. Prior to the brownface scandal, the Liberals and Conservative were basically neck and neck. In the ensuing week or so after the scandal broke, several polls showed support for the Conservatives on the upswing. However, most of those leads were within the margin of error, and polls are now back to showing a toss-up. The Canadian Broadcasting Corporation (CBC) has a poll-tracker that aggregates all publicly available polling data. It’s latest reading show the Liberals slightly ahead with 34.0% of the vote compared to 33.8% for the Conservatives. NDP comes in third with 14.3%, followed by the Greens with 9.6%, Bloc Quebecois with 5.0%, and the PPC with 2.0%.

Most election models suggest that neither the Liberals nor Conservatives will win outright majorities. Due to Canada’s first past the post system, the CBC model suggests the Liberals would win 163 seats to 135 for the Conservatives despite being neck and neck in the national polls. 170 seats are needed for a majority government. The NDP would likely win 19 seats, Bloc Quebecois 16, the Greens 4, and PPC 1. If no coalitions can be formed, then a minority government might be attempted but there are inherently unstable.

In general, the Liberals, NDP, and Greens are all running on platforms advocating a large government role in meeting their goals of economic development, equity, and social justice. Whilst there are clearly disagreements in many areas, a coalition of these three parties would make the most sense. Note NDP leader Singh has pledged never to support a Conservative government, and we suspect Bernier still holds antipathy towards Scheer.

When all is said and done, the Liberals appear to have the best chance to lead the next government. If so, we would expect a continuation of the current policies. Perhapswoever, the NDP and the Greens would drag a coalition further to the left. The CBC model puts 39% odds on the Liberals winning a majority vs. 7% for the Conservatives winning a majority. CBC also puts 30% odds on the Liberals winning the most seats but falling short of a majority vs. 24% for the Conservatives doing the same.

That said, what are the possible policy implications of a Conservative-led government? We will stay away from the social policies and stick to economics. Under Harper, Canada ran persistent budget surpluses until the Great Financial Crisis. The budget returned to balance in 2015 but moved back into deficit under the Liberals. We suspect the Conservatives would work to reverse Trudeau’s carbon tax but would most likely introduce other measure to make it revenue-neutral.

 

A BRIEF HISTORY LESSON

Canada’s petroleum industry can be traced back to events in 1851. Charles N. Tripp founded the International Mining and Manufacturing Company, making it the first registered oil company in North America. Tripp left the development to James Miller Williams, who drilled the first successful well in Ontario in 1857 and is often credited as the first to find oil in the New World. The well, known as Williams No. 1, triggered an oil boom for the region. Refineries were built to convert the oil into kerosene lamp oil, the main use for oil until the spread of automobiles in the early 1900s.

In 1880, sixteen producers and refiners merged to form Imperial Oil. In 1898, Rockefeller’s Standard Oil Trust acquired control of Imperial Oil. Imperial remained a subsidiary of Standard Oil of New Jersey (later became Exxon) in 1911, when US authorities broke up Standard Oil. In 1947, Imperial Oil discovered its first major oil field at Leduc, Alberta. The development of Canada’s western oil fields had begun.

During the mid-1900s, domestic oil wells supplied only 10% of domestic consumption. The bulk was imported from the US and Latin America. Furthermore, the Canadian oil industry was dominated by the so-called Seven Sisters (Exxon, Royal Dutch Shell, British Petroleum, Mobil, Texaco, Gulf, and Standard Oil of California). By 1973, foreign oil companies took in about 90% of petroleum revenues in Canada.

After the OPEC oil embargo of 1973, the government took measures to improve the nation’s oil security. The Foreign Investment Review Act of 1974 and the establishment of Petro-Canada in 1975 were watershed moments. According to 2018 EIA data, Canada was the fourth largest oil producer in the world, accounting for 5% of global output and behind only the US (18%), Saudi Arabia (12%), and Russia (11%). Canada is also the fourth largest natural gas producer in the world. The energy sector directly employs nearly 300,000 and indirectly supports over 500,000 more jobs. Energy accounts for over 10% of GDP and nearly 25% of total goods exports.

 

ECONOMIC OUTLOOK

The economy is slowing. The IMF sees 2019 growth at 1.5% and 2020 growth at 1.9%. GDP rose 1.6% y/y in Q2. However, monthly data so far in Q3 suggest some further deceleration. For instance, GDP grew only 1.3% y/y in July. As such, we see some downside risks to these growth forecasts.

Price pressures are still slowing. Headline inflation slowed to 1.9% y/y in August, while common core CPI rose 1.8% y/y. September data will be reported October 16, with headline expected to tick up to 2.0% and common core expected to remain steady at 1.8% y/y. Inflation remains near the 2% target and is likely to remain there for the most part.

Bank of Canada started a tightening cycle back in July 2017 with a 25 bp hike to 0.50%. It has hiked four more times since then to 1.75%, the last moving coming in October 2018. Its language has tilted more dovish in recent meetings, supporting our view that it will eventually join the ranks of those cutting rates. WIRP suggests 21% odds of a cut at the October 30 meeting, rising to 35% December 4 and 54% January 22. Much will depend on the global backdrop and oil prices.

The fiscal accounts remain solid. The OECD sees the budget deficit falling to -0.4% of GDP this year and -0.2% next year from -0.9% in 2018. This trajectory will also depend on the global backdrop and oil prices, as well as on which party wins the election.

The external accounts are likely to deteriorate modestly. The IMF sees the current account deficit widening to -3.1% of GDP this year from -2.6% in 2018. Exports have contracted y/y in USD terms the last three months and in four of the past five. The 12-month trade deficit bottomed in June and has increase the past two months and so we see some slight downside risks to the current account forecasts. Lastly, Canada’s Net International Investment Position has risen to 31% of GDP, the highest on record. As such, Canada’s external vulnerability remains quite low.

 

INVESTMENT OUTLOOK

Both Brent and WTI oil recently tested their respective lows from August near 55.90 and 50.50, respectively. They have since seen a small bounce, but we believe the downside remains wide open due to the worsening global outlook. Softness is due to a combination of risk-off sentiment as well as a larger than expected build in DOE crude oil stockpiles. Studies show that amongst the majors, CAD has the highest correlation with oil prices now around 0.400.

The Loonie is outperforming after a poor showing last year. In 2018, CAD fell -8% and was the second worst performer in the majors behind AUD (-10%). So far in 2019, CAD is up 2.4% and is the best performer in the majors. Last week, USD/CAD traded at its highest level since September 3 but has since fallen back a bit as the dollar has been hit across the board. With the greenback recovering this week, we believe the pair is still on track to test the September 3 near 1.3385. The 200-day moving average is currently near 1.33 and has provided some near-term support. Looking further out, a break of the 1.3355 area would set up a test of the May 31 high near 1.3565.

Canadian equities continue to underperform. In 2018, MSCI Canada fell -12.8% compared to -11.5% for MSCI DM. So far in 2019, MSCI Canada is up 15.0% vs. 15.8% for MSCI DM. With growth likely to remain sluggish and oil prices still falling, we expect Canadian equities to continue underperforming, as suggested by the UNDERWEIGHT on Canada generated by our DM Equity Allocation model.

Canadian bonds are underperforming. The yield on 10-year local currency government bonds is -69 bp YTD and is behind only worst DM performers Japan (-22 bp), Singapore (-40 bp), Switzerland (-52 bp), and Norway (-59 bp). If inflation remains low and the BOC starts an easing cycle as we expect, Canadian bonds could start outperforming more. Our own sovereign ratings model shows Canada’s implied rating steady and solidly at AAA/Aaa/AAA.