January 18, 2016

On Monday, the U.S. stock markets were closed while Toronto fell 1.1%.

Some of the big questions facing investors are how low will oil go?, how long will it stay down?, to what price might it recover? and how will low oil prices affect other aspects of the economy.

It appears that it takes a quite a few months before the impacts of lower oil prices show up in lower earnings in other sectors. The stock market however, tries to immediately anticipate and estimate the full impact on all future earnings and is capable of making the entire adjustment virtually instantly. It is also quite capable of getting its estimates very wrong. Stock market valuations tend to over-shoot to the upside when optimism abounds and to over-shoot to the downside when fear takes over. Where we are at the moment is a matter for debate.

Economists appear to think that the impact of lower oil prices on Alberta’s economy in 2016 will be rather tame. An ATB financial report dated January predicts that the Alberta’s GDP will decline in 2016, but only by 0.5%.


Given that energy was 25.5% of Alberta’s GDP in 2014 and construction was another 10.8%, it’s hard to believe that the GDP will basically be unchanged in 2016.

I believe the tiny dip in projected GDP has something to do with the fact that GDP is measured in “real” dollars. Statistics Canada measures GDP in something called 2007 chained dollars. Chained dollars attempt to remove the impact of inflation. Unfortunately it appears that chained dollars don’t use overall CPI for inflation. Instead it appears to use for energy the change in energy prices. It tries to measure activity and volumes as opposed to price. I suspect that in actual dollar terms Alberta’s GDP will decline more than 0.5% in 2016.

ATB appears to be projecting only a relatively modest decline in new home construction and in home prices. If that’s true then it would seem that the Melcor share price which is down over 50% has probably over-estimated the impact on Melcor’s future earnings.

ATB is also estimating that Alberta’s unemployment rate (now at 7.0%) will peak at something under 8%. That may be quite optimistic.

Overall, even in Alberta there is a certain inertia in the economy. There will not be any mass out-migration of people from Alberta in 2016. Unemployment rising from 4% to even 10% will still leave 90% of the working age population, that actively wants to work, employed. Unemployed workers who remain in the province will not stop spending entirely.

There will be an increase in corporate and personal; bankruptcies. But the vast vast majority of people and companies will not be bankrupt. Canadian Western Bank will face higher bad debt. But they are not projecting anything close to ruinous levels. (They fear lower profits if oil remains low but even in their stress-test case they projected to remain profitable).

Due to the inertia in the system it would likely take several years of low oil prices (such as under $40) before there would ever start to be significant out-migration from Alberta in turn leading to a real dearth of new home construction and sharply lower residential building lot prices.

I suspect that the more likely outcome is that Alberta’s economy will contract somewhat but will remain relatively robust. New home construction will continue. Prices will not likely collapse and Melcor’s share price will likely rise.

As I post this, China has announced that its GDP slowed to “just” 6.9% in 2015. I understand that the market was hoping for at least 7.0%. In any case there are many who will never trust China’s figures. As of right now the DOW futures are up 100 points. So, possibly the market will decide that China’s GDP number is not so bad. Tomorrow will likely be yet another non-boring day in the markets.


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