Will the clouds on the Canadian financial horizon affect the stock market?

The main stock market index in Canada, S&P/TSX Composite Index, has shaken off the lack of an interest rate move by the Bank of Canada, which left its key interest rate unchanged last week at 0.5% and repeated its warnings about the “significant uncertainties” lying ahead for the Canadian economy. The uncertainties are mostly coming from expected protectionist tax and trade policies by the United States, while Canada’s export competitiveness is already struggling despite the persisting weakness of the Canadian dollar. After this statement by the Bank of Canada Governor Stephen Poloz, the dollar dived below the 75 US cents level and is currently at its 2-months lows.

CAD to USD Chart: March 2017

But the stock market may react to the somber tone of the CAD if the following news gets any traction: in its recent review, the Bank for International Settlements named Canada among the countries with early warning indicators for financial crises and domestic banking risks (see: business.financialpost.com). Canada’s 17.4% credit-to-GDP gap is well above the Bank’s threshold of 10%, and rising. The review notes that two-thirds of global banking crises were preceded by credit-to-GDP gaps that breached the 10% level during the three years before the crisis.

Credit-to-GDP gaps in major advanced economies (source: Bank for International Settlements, UCU) 

When and if this factor might affect the Canadian equity markets, which also heavily depend on the state of the US economy and commodity markets, remains to be seen. But the sluggish growth of the Canadian economy is already weighing on the Canadian stocks. The S&P/TSX Composite Index has risen by slightly more than 1% since the start of year, compared to the 5% growth in the U.S. S&P 500 index.

Ukrainian Credit Union Limited