Third Eye Capital
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Fax: (416) 981-3393
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Toronto, Ontario, M5J 2T3

CEO Insights

CEO Insights

Filling the Glass Half Empty (Q4-16)

Filling the Glass Half Empty (Q4-16)

Better fundamentals in the U.S. have helped improve Canada’s economy from a weak first half in 2016. The merchandise trade balance in Canada posted its first surplus in November 2016 since September 2014. The gain in exports was volume-drive and broad-based with ten of eleven sectors rising (only motor vehicles and parts declined in volume terms). Exports to the U.S. rose while imports were down, widening Canada’s trade surplus with its largest trading partner to its largest level since June 2015. We remain sanguine about the Canadian economy and believe it will trend higher into 2017 as investment activity bottoms-out in the energy sector and exports continue to improve. Commodity prices appear to have stabilized too and affected industries are adjusting to lower absolute levels. According to the Bank of Canada’s Winter 2016-17 Business Outlook Survey, capacity pressures appear to be especially increasing at oil and gas companies. In the same survey, nearly every firm interviewed expect the U.S. economy to grow over the next 12 months and provide a positive outcome on sales expectations, either directly or indirectly (e.g., through the improved performance of their exporting customers).

Business confidence, a leading indicator of economic growth, is soaring in the U.S. and in Canada. In December 2016, the Index of Small Business Optimism published by the U.S. National Federation of Independent Business reached its highest reading since 2004. President Trump’s pledge to lower taxes and rollback or simplify regulations has improved business attitudes toward capital spending and job creation. Similarly, the Canadian Federation for Independent Business (“CFIB”) reported that its Business Barometer, which aims to measure future expectations on business performance, jumped to its highest reading since March 2015. More than half of the businesses surveyed by the CFIB said they expect to increase investment spending in the next few months due to higher order books and better pricing power. The U.S. election result was cited as one of the underpinning factors.

Recent U.S. and Canadian economic reports point to forward growth momentum. A further tailwind to economic growth will be fiscal expansion by governments on both sides of the border, which is inevitable as Trump and Trudeau take heed of the populist messages delivered at the ballot box. The World Bank estimates that Trump’s infrastructure plans alone could boost U.S. GDP to as high as 2.5% in 2017 (up from an expected 1.6% in 2016). Failing unemployment and better wages is also boosting confidence, which should increase consumer spending as well as business investment and inventory restocking. We believe all of these factors will lead to an expansion in business credit demand.

However, improving fundamentals and better business sentiment do not alter our opinion that weaker structural protections on existing loans in today’s market will cause a wave of restructurings. Edward Altman, a Professor of Finance at NYU’s Stern School of Business, notes that the corporate credit default rate currently exceeds the historical average for the first time since 2009. While the incidence of defaults might be postponed due to credit supply still outstripping demand, the potential for borrower problems to overwhelm uninitiated lenders lacking any loan workout experience is grave. In fact, if interest rates rise as expected in 2017, and given the ongoing political uncertainties worldwide, and industry-specific troubles particularly in the resource sector, distressed opportunities may outpace growth financings.

Excerpted from Third Eye Capital Management Inc.’s Q2 2016 Investor Letter.



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