January 30, 2014

Strengthening fundamentals brighten the outlook for investment in 2014

Following a 3% quarter-to-quarter increase in the second quarter of 2013 which was driven in large part by a post-Quebec construction strike rebound in commercial and institutional building, the volume of non-residential building construction rose by a further 2.7% quarter-to-quarter in the final quarter of the year.

Across the country, the volume of non-residential construction increased in eight of the ten provinces with the largest contribution to growth by far (44%) due to a solid 6.1% increase in commercial building in Alberta.

Other provinces which saw significant increases in non-res building in Q4 included Quebec (+3.6% quarter-to-quarter), Ontario (+1.1%) and British Columbia (+1.6%).

Looking forward, consistent with the improvement in the global economic outlook in general and the prospects for the United States in particular, several forward-looking indicators of business non-residential investment in Canada have turned solidly positive.

First, following a sharp 5.9% quarter-to-quarter decline in the second quarter of 2013, after-tax corporate profits rose by 7.5% quarter-to-quarter in the third quarter. This, the largest quarterly rise since the fourth quarter of 2011, was due to gains in after-tax profits of both non-financial (+11.2%) and financial (+3.5%) corporations.

Consistent with the solid gain in overall output in the third quarter, the industrial capacity utilization rate increased by 0.7% quarter-to-quarter following a decline of 0.1% in the second quarter.

In the third quarter, the operating rate rose in five of the six major industrial sectors primarily due to a very strong 2.8% rise in the operating rate of oil and gas extraction companies and a 0.8% rise in manufacturing capacity use.

The fact that the bulk of oil and gas extraction occurs in the West and the majority of manufacturing takes place in Central Canada suggests that the regional pattern of investment will be more balanced going forward than it has been in the past.

In addition to the stronger profits and rising capacity use, investor confidence as indicated by the S&P/TSX has increased by 9.6% over the past twelve months to the end of 2013, more than twice the 4% year-over-year gain the index recorded during the previous twelve months.

This improvement in investor confidence was reinforced by the most recent (Q4/2013) Bank of Canada (BOC) Business Outlook Survey. After trending lower for the past three quarters, the Bank reported that the net percentage of firms planning to spend more on machinery and equipment increased from 9 to 19 in Q4/2013, the highest value for this series since Q4/2012.

Although the Bank noted that the increase in spending plans was concentrated in the service sector, the above-noted increase in capacity use in oil and gas extraction and in manufacturing together with the third quarter gain in profits in non-financial industries suggests that investment in goods production will also strengthen over the next several quarters.

In addition to the positive outlook for the above-noted investment drivers, interest rates will probably remain low and lending conditions — as reported by the most recent BoC Survey of Senior Loan Officers — are unlikely to materially tighten over the near term.

John Clinkard has over 30 years’ experience as an economist in international, national and regional research and analysis with leading financial institutions and media outlets in Canada.

Business non-res investment vs after-tax profits & investment intentions

Data Sources: Statistics Canada, Bank of Canada (BOC)/Chart: Reed Construction Data, CanaData.

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