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Strong inflation, anxious consumers add up to more worries that recession has already arrived
Air Transat second-quarter loss deepens amid pandemic-related flight cancellations, soaring fuel prices
Montreal-based airline and tour company Transat AT Inc.’s second-quarter loss deepened amid pandemic-related flight cancellations and soaring fuel prices.
Fuel prices rose 76 per cent in the quarter, helping to send the airline operator to a loss of to $98-million or $2.60 a share, compared with a loss of $69-million or $1.84 a year earlier. Driven by the war in Ukraine, jet fuel has risen by 150 per cent over the past year, said OAG, a British-based aviation data company.
Patrick Bui, Transat’s chief financial officer, said the surge in fuel prices is the biggest risk faced this summer by the company as it sees customers return while the pandemic appears to be easing.
Transat in June began a fuel hedging program to reduce the risk of further increases in the price of oil, Mr. Bui told analysts on a conference call held to discuss financial results. Seat prices for the summer have also been raised by an unspecified amount.
Transat’s adjusted April profit would have been positive for the first time in two years if fuel costs had not increased so much, Mr. Bui said.
Fuel hedging is a technique companies use to reduce their exposure to rising energy costs, and to establish fixed prices in the future. Mr. Bui declined to provide details on the amount or prices Transat has hedged.
OAG said jet fuel prices vary by continent, and are highest in North America, which accounts for 39 per cent of world consumption. In May, a barrel of jet fuel cost US$176, after rising as high US$200.
Fuel is one of an airline’s biggest expenses, along with labour. In North America, airlines will pay a combined US$115-billion for fuel in 2022, according to International Air Transport Association.
In the second quarter, Transat’s revenue rose to $358.2 million, compared with $7.6-million in the year-ago period, when the pandemic halted its operations.
In the most recent quarter, sales were hit by a drop in demand and customer cancellations after the Omicron variant struck and the federal government imposed new travel restrictions. Transat cancelled 30 per cent of its flights in January and February.
Annick Guerard, Transat’s chief executive officer, said the company is managing the higher costs by raising prices, reducing costs and adding fuel-efficient Airbus passenger jets. Transat said it was spending monthly cash reserves of $3-million, down from $27-million in the previous quarter. Cash burn is expected to rise as the airline prepares for a busier summer. To survive the pandemic, Transat signed an agreement that allows it to borrow as much as $743-million from the government.
The close: North American stock markets fall as rate pressures grow, U.S. inflation report looms
North American stocks tumbled Thursday following the latest reminder that central banks now care more about fighting inflation than propping up markets.
In New York, the Dow Jones industrial average was down 638.11 points at 32,272.79. The S&P 500 index was down 97.95 points at 4,017.82, while the Nasdaq composite was down 332.04 points or 2.8 per cent at 11,754.23.
The S&P/TSX composite index closed down 228.54 points to 20,563.89. The Canadian dollar traded for 79.09 cents US compared with 79.74 cents US on Wednesday.
Wall Street’s losses accelerated late in the day, as investors got their final opportunities to make trades before a highly anticipated report on U.S. inflation due Friday morning. The S&P 500′s drop more than doubled in the last hour of trading.
The weakness for markets started on the other side of the Atlantic after the European Central Bank said it would raise interest rates next month for the first time in more than a decade. Another hike is set for September, possibly by double July’s increase, and the central bank will halt its bond-buying program next month.
It marks a “sea change” in policy for the European Central Bank, according to Marilyn Watson, head of global fundamental fixed income strategy at BlackRock.
And it’s part of a growing global tide where central banks are removing ultra-low interest rates that goose borrowing, economic growth and stock prices. Instead, they’ve swung their focus toward raising interest rates and making other moves to slow growth in order to knock down high inflation.
The risk is that such moves could cause a recession if they’re too aggressive. Even if central banks can pull off the delicate balancing act and avoid a recession, higher interest rates put downward pressure on stocks and all kinds of investments regardless.
The wide expectation is that the Fed will raise its key interest rate next week by half of a percentage point, the second straight increase of double the usual amount. Investors expect a third to hit in July.
Where the Fed goes on there depends on inflation’s path, which is why Wall Street is so keyed in on the latest reading for the U.S. consumer price index, which is due Friday morning. Economists expect it to show inflation slowed a touch to 8.2% in May from 8.3% a month earlier.
Investors have been searching for signs that inflation may have already passed its peak, which would be good for markets because it could mean a less aggressive Fed. Speculation has been rising and falling that the Fed could take a pause on rate hikes at its September meeting, swaying with every data point on the economy.
European stocks sank immediately after the European Central Bank’s announcement on rates, which came before U.S. markets opened. French stocks were down only slightly before the announcement, but the CAC 40 index fell to a 1.4% loss afterward. Germany’s DAX lost 1.7%.
In the U.S., Treasury yields rose following the move from Amsterdam, though they wobbled a bit after that. The 10-year Treasury yield got as high as 3.09% before paring back to 3.04%, up from 3.02% late Wednesday.
A report showed that slightly more U.S. workers filed for unemployment last week than economists expected. That’s a potentially negative signal, but the overall number still remains low compared with history. Economists also said seasonal factors may have affected the most recent numbers, overstating some things due to the Memorial Day holiday.
Higher gasoline prices have been putting a tighter squeeze on both consumers and households, upping the pressure on budgets. Crude oil prices were down about half a percent on Thursday, but they remain up by roughly 60% for the year. Much of the jump is due to Russia’s invasion of Ukraine.
The July crude contract was down 60 cents at US$121.51 per barrel and the July natural gas contract was up 26.4 cents at US$8.96 per mmBTU.
The August gold contract was down US$3.70 at US$1,852.80 an ounce and the July copper contract was down 7.4 cents at US$4.38 a pound.
Lockdowns in major Chinese cities because of COVID-19 have added more pressure to global supply chains, though some of the impact could be easing. China reported its exports surged 17% over a year earlier in May, up from April’s 3.7% growth, as coronavirus precautions were eased in Shanghai and other cities.
Many investors are bracing for big swings to continue for a while given the deep uncertainties about where inflation and the Fed’s policies are heading. Stocks have been clawing back since hitting a bottom in the middle of last month, but the S&P 500 remains down 15.7% for the year so far.
“Even if the market bottomed in May, we will see another sell-off at some point,” Nancy Tengler, CEO of Laffer Tengler Investments, wrote in a research note, “and some of us will feel worse than we thought we could because we thought it was over.”
IMF expects further cut in global growth outlook
The International Monetary Fund expects to further cut its forecast for global economic growth in 2022 next month, an IMF spokesperson said on Thursday, following moves by the World Bank and Organization for Economic Co-operation and Development (OECD) to cut their own forecasts this week.
That would mark the IMF’s third downgrade this year. In April, the IMF had already slashed its forecast for global economic growth by nearly a full percentage point to 3.6% in 2022 and 2023.
Fund spokesperson Gerry Rice told a regular IMF briefing that the overall outlook still called for growth across the globe, albeit at a slower level, but that some countries may be facing a recession.
“Clearly a number of developments have taken place that could lead us to revise down further,” Rice told reporters. “So much has happened and (is) happening very quickly since we last came with our forecast.”
The IMF is due to release an update to its World Economic Outlook in mid-July.
The World Bank on Tuesday slashed its global growth forecast by nearly a third to 2.9% for 2022, citing compounding damage from Russia’s invasion of Ukraine and the COVID-19 pandemic, while warning about the rising risk of stagflation.
A day later, the OECD cut its forecast by 1.5 percentage points to 3%, although it said the global economy should avoid a bout of 1970s-style stagflation.
Rice said the expected downgrade was due to the continuing war in Ukraine, volatile commodity prices, very high food and energy prices, and a more severe than expected slowdown in the Chinese economy, as well as rising interest rates in a number of advanced economies. He gave no details on China’s outlook.
“We’re seeing this confluence of crises … the combination of all of these things going in the same direction of downside risks materializing,” he said.
Canadian bank stocks continue to outperform global peers
Credit Suisse analyst Joo Ho Kim reports that Canadian bank stocks continue to outperform their global peers,
“The Canadian banks have outperformed their international peers by a wide margin (~32%), based on indexed performance since the start of the pandemic (end of 2019) (Figure 1). Taking a longer-term view, the banks have also generated a significant relative return (~4.5x the peer average return) since the beginning of 2000. More recently, we saw the relative performance gaps narrow, with the group trading essentially in line with their international counterparts from the end of 2021… From a valuation standpoint, we see that the Canadian banks have been outperforming their international peers this year, with a ~4% contraction in the NTM P/E [next 12 months price to earnings ratio] for the banks vs. a ~12% contraction on average across the largest U.S., Australian, the U.K., and Nordic banks … Although the Y/Y consensus growth implied in F2023E for the Canadian banks looks muted vs. peers, we see a much stronger growth relative to F2019 for the banks on a relative basis … Relative to the historical levels, the Canadian banks are currently trading 14%-points above its historical discount to the TSX, whereas peers are essentially in-line to their respective historical levels on average.”
“Canadian banks continue to outperform global peers (CS):” – (research excerpt) Twitter
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TD Securities’ Market Musings report discussed my biggest worry for the Canadian economy – that high debt and inflation will result in an abrupt halt in domestic consumption,
“Higher interest rates and surging inflation have introduced a material headwind to the outlook for household consumption in 2022 and 2023. BoC rate hikes will push the debt service ratio into record territory by 2023, while stronger inflation forces households to increase nominal spending to maintain their standard of living. Excess savings accrued through the pandemic will help to support household consumption amid these headwinds, but they may not be enough to maintain real consumption through 2023. This could produce a scenario where household consumption maintains its current trajectory through 2022, before slowing sharply next year. A sharp erosion of household confidence or protracted slowdown in housing would introduce new risks to this scenario, and we have already seen cracks emerge on this front.”
I note that the U.S. housing market is weakening quickly – taking lumber prices lower with it – as mortgage rates climb, and the U.S. debt disposable income ratio is over 100 percentage points lower than Canada’s .
“Yup, this is exactly what I’m worried about (TD): “BoC rate hikes will push the debt service ratio into record territory by 2023″ – (research excerpt) Twitter
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BofA Securities strategist Anthony Cassamassino updated his top short term U.S. investment ideas, dropping Target Corp. from buy to neutral after the firm’s analyst downgraded the company,
“The List for Q2 still includes eight longs and one short idea across 9 industries. The picks for Q2 are based on our views of potential significant market and business-related catalysts that we think will affect these stocks. Our remaining Buys are Alaska Air, Advanced Micro, Camden Property, DR Horton, lululemon, Signature Bank, Teledyne Tech, and Valero. Our Underperform is AutoZone. Ideas will generally remain on the list through the quarter unless coverage is dropped or the recommendation changes. Any security that is removed will not be replaced.”
Saputo anticipates recovery in 2023 after capping year with lower fourth-quarter profits
Saputo Inc. SAP-T +1.70%increase expects profits to recover next year after it capped a difficult fiscal year with net income plunging 64 per cent in the fourth quarter as it endured challenging market conditions that mainly impacted its U.S. operations.
The Montreal-based dairy company pointed to labour shortages, supply chain disruptions and inflationary pressures.
Saputo reported a profit of $37-million or nine cents per diluted share for the fourth quarter ended March 31, compared with a profit of $103-million or 25 cents per diluted share a year earlier.
Adjusted profits were $108-million or 26 cents per share, down from $124-million or 30 cents per share in the fourth quarter of 2021.
Revenue totalled $3.96-billion for the quarter, up 15 per cent from $3.44-billion in the same quarter a year earlier.
Saputo was expected to report 25 cents per share in adjusted profits on $3.69-billion of revenues, according to financial data firm Refinitiv.
“Our fourth quarter was challenging, notably in the U.S., as we navigated through commodity price volatility, increases in input and logistics costs, and labour and supply constraints, made even tougher by the Omicron surge,” stated board chairman and CEO Lino Saputo Jr.
“Nevertheless, our Canada, Argentina and U.K. businesses continued to perform well and were in line with our expectations.”
For the full-year, Saputo earned $274-million on $15-billion of revenues, compared with $626-million on $14.3-billion of revenues in 2021.
Nutrien planning major potash production increase as war in Ukraine puts pressure on global supplies
Nutrien Ltd. is planning a major ramp up in potash production as the war in Ukraine exerts relentless pressure on global supplies of the key fertilizer.
Saskatoon-based Nutrien, the world’s biggest fertilizer producer, said on Thursday it intends to boost its annual potash production to 18 million tonnes by 2025, about 21.5 per cent higher than current levels. This year, Nutrien expects to produce about 14.8 million tonnes, a figure that had already been revised upwards several times.
Before the war in Ukraine, Russia and Belarus accounted for roughly 40 per cent of global potash production. But exports fell about 20 per cent in the first quarter compared to the previous year owing to sanctions imposed by the West. Sanctions in Belarus predate those imposed on Russia.
“Nutrien is really the only major player with idle capacity on the planet,” said Steve Hansen, an analyst with Raymond James in an interview. “That three million tonnes [of excess production] is sorely needed.”
To meet its higher production targets, Nutrien intends to make further investments in underground mining equipment, mine development, and hire about 350 people.
Nutrien said on Thursday it is also weighing a possible increase in production of nitrogen, another critical crop nutrient, saying annual sales could rise to 13.5 million tonnes by 2027.
Citing “escalated concerns for global food security,” Ken Seitz, interim chief executive officer with Nutrien, said in a release that he sees the potential for “multiyear strength” in agriculture and crop input fundamentals.
The company earned a record US$1.4-billion in the first quarter and doubled its profit forecast for the entire year, as it benefitted from a surge in fertilizer prices and fears over further supply shortfalls.
After hitting a record of $148 apiece in April, Nutrien shares have fallen by more than one fifth. That’s primarily because North America nitrogen prices fell sharply after an inventory buildup following a late planting session in major markets like North Dakota, Minnesota, South Dakota and Western Canada. Still, with Russia being the world’s biggest exporter of nitrogen, Nutrien is anticipating possible supply shortfalls in the future. Last month, it announced it was evaluating the construction of a new $2-billion plant at its existing Geismar nitrogen facility in Louisiana.
Nutrien was formed in 2018 after Agrium Inc. merged with PotashCorp of Saskatchewan. It has recently come through a tumultuous period that saw it terminate two CEOs in the span of about eight months. Mayo Schmidt was let go in January after personality clashes with subordinates, poor performance in marketing meetings with investors, and tension with the board, the Globe and Mail reported. His predecessor, Chuck Magro, was cut loose in April of 2021 after a strategic fallout with the board over a possible joint venture deal with Australian mining giant BHP Group Ltd. on the multibillion-dollar Jansen potash project in Saskatchewan, the Globe also reported.
BHP later announced it will build Jansen on its own. The project won’t help alleviate current potash capacity constraints in the market as it isn’t scheduled to come online for another five years. Raymond James’s Mr. Hansen isn’t ruling out that Nutrien could still elect to team up eventually with BHP on Jansen, despite the talks fizzling last year.
“Never say never,” said Mr. Hansen. For BHP, a partner would help it split the costs of construction and risks around execution.
Shares in Nutrien were up 2.3 per cent in midday trading on the Toronto Stock Exchange.
Bank of Canada warns high household debt and elevated home prices pose top risks to economy
The Bank of Canada has warned that household vulnerabilities have worsened over the past year and could lead to stress in the financial system as people struggle to service their debts.
In its latest Financial System Review, the central bank identified high levels of household debt and elevated home prices as the top two vulnerabilities, saying they could even result in a financial crisis.
The cost of borrowing has spiked over the past few months and is expected to continue on that path as the Bank of Canada aggressively raises interest rates to combat high inflation.
“Our primary focus is getting inflation back to target. Monetary policy is not housing policy,” central bank governor Tiff Macklem said at a news conference.
Higher interest rates have already slowed real estate activity, with sales declining nationwide and home prices falling in some of the country’s hottest markets. Several private-sector economists have forecast double-digit declines in prices this year, but the central bank said it was too soon to say whether this was the start of a substantial correction.
At the press conference, Mr. Macklem repeatedly stressed that the central bank’s priority was to get inflation back to normal even if that meant a cooldown in the housing market. The bank has raised interest rates at three consecutive rate decisions and has said that intends to keep pushing borrowing costs higher.
“Some moderation in housing would be healthy,” said Mr. Macklem. He did not say how much moderation would be healthy. But in some places like Halton, an affluent region just west of the city of Toronto, the typical home price has dropped 13 per cent over the past three months.
The bank listed several worrisome trends that it has observed over the course of the latest real estate boom: households have increasingly stretched themselves financially to purchase property; home buyers have made smaller down payments relative to the purchase price in recent quarters; and investors have increasingly leveraged the homes they already own to buy new properties.
The high amounts of household debt could eventually become problematic for the financial system as central banks around the world raise interest rates. The global economy could soon start to slow or slip into a recession. That could lead to job losses and make it harder for mortgage holders to make their loan payments.
If home prices drop, that could further restrain homeowners’ ability to use the equity in their homes. Homeowners may be forced to reduce their spending and/or sell their properties.
“If the shock is large enough to cause many households to be in this situation, the size of the impact could create a negative feedback loop between the real economy and the financial system,” the report said. “The likelihood of this risk materializing and its impact on the economy are greater today than in the past.”
The central bank is primarily concerned about the highly indebted Canadians who took out mortgages over the past two years. Borrowers with a loan-to-income ratio above 450 per cent account for over 25 per cent of all mortgage holders – a record high.
Central bank economists have calculated that those borrowers would see a significant jump in mortgage payments at renewal time. If a borrower took out a variable-rate mortgage in 2020 or 2021, they would see a median increase of $1,000 in their monthly payments in 2025 or 2026, the report said.
Despite the growing risks, the central bank said commercial banks remain well-positioned to weather an economic downturn or shock coming from the housing market.
In the event of a “severe and prolonged recession,” Canadian banks would experience a significant hit to their capital buffers but would likely be able to continue lending to businesses and households, the bank said. This is supported by sound mortgage underwriting practices, solid capital ratios and a “robust capacity to generate revenues even in times of stress.”
The Bank of Canada offered a relatively upbeat assessment of corporate balance sheets. The ratio of debt to assets for non-financial companies has declined continuously since its peak in the second quarter or 2020. Meanwhile, the ratio of cash to debt has reached an all-time high.
“This improvement is due in part to the favourable impact that rising commodity prices are having on corporate balance sheets in the resource sector – a sector where firms have historically been more financially vulnerable,” the bank noted.
Companies that use bond markets to raise money will face higher borrowing costs as interest rates rise. But the central bank noted that most outstanding bonds are not set to mature in the next five years.
Still, companies could face challenges servicing their debts if the economy moves into recession, the bank said: “The direct impact of higher interest rates on the financing costs of most publicly listed firms will likely be small but could be problematic if higher rates are accompanied by a shock to firms’ revenues.”
The Financial System Review noted a range of other risks that appear to be growing. Russia’s invasion of Ukraine has increased the chance of a state-sponsored cyberattack against Canadian banks, the central bank said.
Meanwhile, financial stability concerns related to climate change remain a pressing issue. The worry is that asset prices and company valuations do not properly account for risks related to a transition to a lower-carbon economy.
The bank also expanded its analysis of cryptocurrencies. It reiterated its view that cryptocurrencies are “not yet of systemic importance” to the Canadian financial system. Although it did note that interest in the asset class is growing rapidly and expanding from retail investors to institutional investors.
In 2021, about 13 per cent of Canadians owned bitcoin, up from 5 per cent in 2020. The median holding was about $500.
The bank’s principal concern is the lack of regulation in the sector. Many cryptocurrency companies function like traditional financial institutions but with far less oversight.
European Central Bank confirms July rate hike plans, raises inflation projections significantly
