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Monthly Economic Letter

November 2020

Feature article

Technology investments should be a priority for entrepreneurs

Most Canadian entrepreneurs have faced major challenges as they cope with the COVID-19 pandemic this year. While government assistance programs have helped alleviate the cash flow difficulties of many businesses, entrepreneurs must still plan for how they are going to get through the crisis and benefit from the recovery.

This economic letter looks at research on how entrepreneurs are dealing with the pandemic and their investment intentions for the future. We also look at how consumer habits are changing.

Liquidity, then technology

In a new BDC study, The Response: How Entrepreneurs Are Adapting to the Pandemic, our economists Sylvie Ratté and Isabelle Bouchard report on the results of a survey of 1,000 Canadian entrepreneurs and 2,000 consumers.

For nearly 40% of the entrepreneurs, engineering a financial turnaround in their business over the next year is the top priority, the survey indicated. Many have taken loans to survive a sharp drop in revenues, especially during the spring lockdowns. In fact, the proportion of small and medium-sized businesses whose debt represents more than 25% of their revenue has more than doubled this year, from 10% to 22%.

Several survey respondents also want to build a more robust contingency fund for future emergencies, and this could be at the expense of new investments, at least in the short term.

At the same time, the survey suggests that entrepreneurs know they must invest to keep pace with trends that are accelerating during the pandemic. For example, three of their five top priorities (leveraging technology, telecommuting and selling online) will require more investment in technology.

Entrepreneurs are prudent but far-sighted

Still, investment intentions remain weak, according to our October survey. Across all sectors, a majority of entrepreneurs planned to reduce their investments in the next year.

This finding is consistent with the overriding desire of entrepreneurs to turn their company’s finances around. Many are waiting to see how the pandemic evolves before making longer-term investment decisions.

On a sectoral basis, only the resource industry had a positive investment outlook (+9; see definition in the chart’s footnote). Intentions in the manufacturing sector (-18) had particularly deteriorated since the summer. Wholesale and retail trade—sectors more affected by social distancing measures—also showed negative investment intentions (-2).

These low investment intentions reflect a reluctance to invest in tangible assets, such as buildings (-17) and machinery and equipment (-8).

Uncertainty about the duration of public health restrictions and the increased importance of telework partly explain the cautious approach of entrepreneurs toward investing in buildings and renovations. Many will re-evaluate their physical space requirements between now and the resolution of the pandemic.

With respect to investments in machinery and equipment, entrepreneurs are waiting for more clarity on the direction of the economic recovery. This will depend on the evolution of COVID infections and the development and distribution of an effective vaccine.

The good news is that a small majority of entrepreneurs said their companies plan to invest in technology assets over the next 12 months (+2). Planned investments would be aimed at making teleworking more efficient, at improving e-commerce platforms and at deploying additional cyber-security tools. All of these areas will continue to grow in importance over the next decade.

Consumers increasingly online

At the end of November, our team of economists will publish a new report on e-commerce platforms, entitled Profit from e-commerce: How to compete in the online marketplace. This report will recommend online strategies that our experts believe are best suited to Canadian small and medium-sized businesses.

The pandemic is accelerating the transition of Canadian consumers to online shopping, underlining the importance of investing in e-commerce.

In 2015, only 5.8% of retail sales in Canada were conducted online, compared to 7.2% in the United States, according to eMarketer, an e-commerce firm. As of 2019, Canada had caught up with its neighbour, as online sales accounted for 11% of total sales in both countries. The figure was then expected to rise to 15% by 2022.

However, this forecast predates the surge in e-commerce caused by the pandemic. Statistics Canada found that online sales by Canadian retailers increased from 2% to 4% of total sales between 2016 and 2019. (Note these figures exclude purchases by Canadian consumers from foreign-based retailers). Last April, sales jumped to more than 10% and have remained above 5% since then.

When foreign purchases are added, more than 15% of current Canadian retail sales are made online. With several provinces facing a second wave of infections and strengthened health measures, consumers are likely to turn more to digital platforms for holiday shopping and in the months afterward.

The bottom line is that consumers are likely to maintain their new shopping habits, accelerating trends that were expected to emerge over the next decade. As Canadian entrepreneurs compete with the rest of the world for market shares, they are increasingly realizing the importance of investing in a reliable and flexible digital platform.

What it means for entrepreneurs

  1. Difficult economic conditions have forced companies to lower their investment intentions over the next 12 months. In general, entrepreneurs are focused on getting their finances back on track.
  2. Despite a climate of uncertainty, our surveys indicate that a majority of entrepreneurs intend to increase their investments in technology.
  3. Leveraging technology, teleworking and selling online are top priorities for entrepreneurs for the coming year.
  4. BDC has a wealth of experience in advising clients on developing an online strategy. These articles could help guide your strategy:

Canadian economy at a glance

The state of the Canadian economy at the start of the second wave

The battle to contain the COVID-19 pandemic has taken a turn for the worse in recent weeks and the situation now threatens Canada’s economic recovery.

Fortunately, statistics released in recent weeks indicate the economy is relatively well positioned to cope with the second wave of infections observed in most provinces.

Growth continued to surpass expectations in August

The Canadian economy grew by 1.2% in August, with 15 of 20 sectors continuing to participate in the recovery that began in May. Preliminary data from Statistics Canada suggest GDP grew by 0.7% in September. If these expectations are confirmed, the economy would have reached 96% of its pre-pandemic peak.

On the goods production side, construction (+1.5%) and manufacturing (+1.2%) performed well and were respectively at 98% and 96% of their level observed last February.

In the services sector, growth was strong in professional services (+2.2%) and accommodation and food services (+7.3%), as well as in arts, entertainment and recreation (+13.7%). These last two sectors remained much weakened by the crisis, reaching only 72% and 53% of their pre-crisis level of activity, respectively.

Natural resources (83% of February's level) and transportation and warehousing (79%) are other industries where the recovery remained less robust.

After generating annualized growth of about 45% in the third quarter, the recovery is expected to slow significantly by the end of the year. The second wave in Canada—although less severe than in the U.S. and Europe—has forced partial lockdowns in several provinces, which will slow activity in some sectors, including food and beverage, transportation and recreation.

These new restrictions, combined with the fear of contracting COVID-19, will likely lead to barely positive annualized GDP growth (1% to 3%) in the last quarter of 2020. The annual contraction of GDP would then be about 5.5%.

As of November 5, however, the number of daily COVID-19 infections was increasing at about 86 per million population.

Employment increases at slower rate in October

The Canadian labour market slowed in October as 83,600 net jobs were added. As a result, 2.4 of the 3 million jobs lost in the spring have now been filled, representing a recovery rate of 79%, compared to 54% in the United States. The unemployment rate edged down from 9.0% to 8.9%.

The survey, conducted during the week of October 12, takes into account new public health measures imposed in Ontario and Quebec. Employment in these two provinces underperformed, especially in Quebec (-12,900).

A sectoral analysis suggests that the new restrictions have had a negative impact on the dynamism of the labour market. Employment was down in accommodation and food services (-48,200) and in information, culture and recreation (-11,300). The sector of professional services (+41,800) partially compensated for these losses.

In October, the number of jobs was 3.3% lower than the level recorded before the crisis. This situation is comparable to the gap observed at the bottom of the 2008-2009 financial crisis (minus 2.5%). We continue to anticipate a full recovery of the labour market won’t occur until the last half of 2022.

What it means for entrepreneurs

  1. The economic recovery continued in September, with Canada's GDP estimated to have reached 96% of its pre-pandemic level. This would correspond to GDP growth of about 45% annualized in the third quarter.
  2. The slowdown in the labour market (+83,600 jobs) was expected because of new restrictions to counter the pandemic that were put in place in early October. The sectors most affected during the first lockdowns are likely to experience a difficult winter.
  3. We expect the economy will slow significantly in the coming months. Progress will depend mainly on how the pandemic evolves. The number of new daily COVID cases has increased to 86 per million inhabitants. Additional lockdown measures are possible if the situation worsens.
  4. We expect annualized GDP growth to be between 1% and 3% in the final quarter of 2020. This would put the contraction of the Canadian economy for all of 2020 at about 5.5%.

U.S. economy at a glance

Enter the Biden administration

As expected, the U.S. GDP grew strongly in the third quarter of 2020. However, there were mixed signals about where the economy is headed.

Uncertainties associated with the U.S. election are now behind us, but if there is a division of power between a Democratic administration under Joe Biden in the White House and a potentially Republican controlled Senate (depending on the result of runoff elections in January), this may complicate the implementation of an economic stimulus plan.

The importance of stimulus was underlined by weak performance of the job market amid a powerful second wave of COVID-19 infections, which are reaching new highs in many states.

A tight election reveals deep divisions

Biden was elected the 46th President of the United States and will assume the presidency on January 20, 2021. The stock markets, which had feared a contested election, reminiscent of the Bush/Gore election in 2000, were reassured by the relatively smooth vote.

In the Senate, the Democrats were disappointed at failing to win enough seats to secure a majority (although this may change in January). The new Biden administration will therefore have to make compromises to adopt an economic stimulus package and enact other parts of its agenda. Several of Biden's campaign promises are unlikely to be realized by 2022, including investments in infrastructure, education and renewable energy.

In the meantime, expectations for a new stimulus plan remain high with household incomes declining at an annualized rate of 10.2% in the third quarter.

It is unclear whether an agreement on a package can be reached in the final months of Trump's presidency. Another source of potential volatility is a surge in COVID-19 infections, which are reaching new daily highs. A total of 121,000 new cases were reported on November 5 (332 daily cases per million population in the last week).

GDP surges in the third quarter

The U.S. economy experienced record annualized GDP growth of 33.1% in the third quarter (July to September), according to a preliminary estimate by the Bureau of Economic Analysis. This followed two quarters of contraction (Q1: -5.0%; Q2: -31.4%) due to large-scale lockdowns to fight the pandemic.

Consumer spending jumped 40.7% in the quarter, driven mainly by an increase in purchases of durable goods (+82.2%). Spending on services was held back by various public health restrictions but nevertheless increased by 38.4%.

Non-residential fixed investment grew by 20.3%, but only the equipment subcomponent gained ground (+70.1%). Investments in structures (-14.6%) and intellectual property (-1%) continued a decline that began at the outset of the crisis.

Exports increased by 59.7%, while government spending declined by 4.5%.

Despite these encouraging statistics, it is clear that there is still a long way to go before the U.S. economy fully recovers. GDP was, after all, still 3.5% below the peak reached at the end of 2019.

Consumption was down 3.3% from the last quarter of 2019, mainly due to a decline in spending on services (-7.7 per cent). Investment was down 2.9% overall, mainly due to weak non-residential investment (-4.9%, including a 14% contraction in structures). The decline in exports was greater (-15.3%) than that of imports (-7.1%), contributing to a deterioration of the U.S. trade balance. Improvements in the coming quarters will depend on whether or not the pandemic is under control.

In the near term, GDP growth is expected to slow in the last quarter of 2020 and could be barely positive, depending on the evolution of the health situation. At best, the U.S. economy will not reach new highs until the last quarter of 2021.

Job creation remains tepid

The October jobs report was a first indication of economic developments in the fourth quarter.

The creation of 638,000 net jobs in October represents a slight slowdown from the 672,000 net jobs added in September. The unemployment rate fell to 6.9%, a decrease from 7.9% in September.

Cumulative job losses in 2020 remain stubbornly high, as 9.6 million fewer Americans were employed compared to last December. Only 54% of the jobs lost in March and April have now been recovered. This is much lower than the proportion observed in Canada (79%).

Another worrisome sign is that the participation rate remains much lower than at the onset of the crisis (61.7% in October 2020; 63.3% in October 2019). This could cause long-term damage to the labour market.

Confidence remains high despite the virus

Despite an increase in COVID-19 infections, the inability of Congress to approve an economic stimulus package and uncertainty surrounding the election, confidence remained relatively strong in October.

The Conference Board's consumer confidence index declined slightly to 100.9. This level is comparable to that observed in early summer (98.3) but is still well below the average score for 2019 (128). A drop in disposable income in the third quarter will likely lead consumers to manage their budgets more tightly in the coming months.

Companies in the manufacturing sector, for their part, showed an increase in optimism, as the ISM index rose to 59.3, a peak not seen since September 2018. An indicator above 50 indicates that a majority of companies expect more favourable conditions in the coming year. Confidence in the service sector (non-manufacturing ISM) was down slightly to 56.6.

What it means for Canada

  1. Biden's election should lead to a normalization of trade relations between Canada and the United States. However, U.S. protectionist rhetoric may continue until the economic recovery is more sustainable.
  2. GDP growth is expected to slow significantly in the coming quarters. The weak recovery in the labour market and the tightening of public health restrictions to counter the pandemic are the main reasons for this.
  3. Household and business confidence remains stable, despite the deteriorating situation in the face of the pandemic. Progress will be possible once a vaccine can be distributed in the coming months.

Oil market update

The situation in Europe threatens the oil price recovery

After several months of stability, oil prices experienced more volatility in recent weeks. Despite stable production, the outlook for demand has deteriorated, particularly in the short term.

In general, crude prices remain 30% lower than pre-pandemic levels, well below the recovery of many other commodities, including metals.

In October, Brent and West Texas Intermediate (WTI) had their most difficult month since last spring, declining by about 10%. As of November 5, their respective values were US$41 and US$39 per barrel. Western Canadian Select (WCS) followed suit, reaching US$29 per barrel.

The recent volatility can be explained by uncertainty over the outcome of the U.S. election and the anticipated impact of the pandemic on international oil demand.

The recovery in demand was already losing steam

During the first lockdowns, gasoline demand in the U.S. initially fell by more than 50% before rebounding strongly as states reopened their economies.

The Bureau of Economic Analysis estimates, however, that the recovery virtually grounded to a halt in September, when demand rose by only 1.5%. With demand still 25% below pre-pandemic levels, the recovery was showing serious signs of running out of steam.

Since then, the situation has probably deteriorated further. The new wave of COVID-19 infections, which is hitting Europe and North America simultaneously, will have a significant impact on oil demand. Already in September and October, travel was stable or slightly down in both North America and several European countries, including Germany (relatively unscathed in the first wave), according to Google's reports on community mobility.

Partial lockdowns announced in most major European countries, notably France, the United Kingdom and Germany, will impact transportation demand in the coming months. Despite less stringent measures than last spring (schools remain open, for the most part), people will be asked to minimize their trips.

The situation is less clear in the U.S., which continues to report increasing cases (121,000 cases on November 5). President-elect Joe Biden reiterated his confidence in top infectious disease official Dr. Anthony Fauci, who believes lockdowns may be necessary to overcome the wave hitting the country. Trump's intentions during the last two months of his presidency are still unknown.

Will production adjust?

The International Energy Agency (IEA) noted a slight decline in supply of 0.6 million barrels per day (mb/d) in September, bringing international production to 91.1 mb/d. This represents a reduction of 8.7 mb/d compared to September 2019.

Meanwhile, OPEC+ members continued to respect their agreement on production cuts. In the U.S., partial closures caused by hurricanes in August will result in a marginal increase in production, the IEA estimates.

According to the organization, Canadian production declined in September after a partial leak on the Polaris pipeline. Canadian production was slightly less than 5 mb/d, a reduction of about 20% compared to a year ago. The IEA says it expects Canadian production to reach new highs (about 5.7 mb/d) by the end of 2021.

However, it remains unlikely prices in 2021 will return to 2019 levels. Although the reduction in production in September resulted in a slight decline in inventories, they remained elevated at around 3.2 billion barrels.

Given the impact of new European (and potentially U.S.) lockdowns, inventory levels will depend on the responsiveness of producers to deteriorating oil demand. While some can afford lower crude oil prices, this is not the case for those who rely heavily on oil royalties to finance social programs.

In summary

Oil had a difficult October, as uncertainty about the U.S. elections and an upsurge in COVID-19 infections weighed on the demand outlook.

Partial lockdown measures in Europe (and possibly the U.S.) are likely to weigh on oil demand in the coming months. Indeed, the recovery was slowing even before the current wave of infections hit.

High oil inventories could force major producers to limit production in the coming months. An additional build-up of inventories would further limit the rise in oil prices in the medium term.

Other economic indicators

Interest rates likely to stay low until 2023

In its latest interest rate announcement, the Bank of Canada kept its overnight rate at a very low 0.25%. The overnight rate will be kept at this level until inflation returns to the central bank’s 2% target, which it doesn’t expect to occur until 2023.

The bank also stated that it intends to continue its ongoing quantitative easing program indefinitely, which has contributed to the good functioning of markets since its introduction in March 2020. Moving forward, it plans to orient its asset purchases more towards long-term bonds—the asset class that has the most influence on household and business borrowing rates. To date, the Bank of Canada holds an estimated 34% of the bonds issued by the federal government.

The pace of bond purchases is expected to gradually slow from $5 billion a week to $4 billion. According to the bank, which made these announcements on October 28, the combined adjustments will provide monetary stimulus similar to that seen since the program was introduced.

In September, the Bank of Canada's balance sheet was holding $10 billion less in assets, as an increase in Government of Canada bonds was more than offset by a decrease in treasury bills and securities purchased under resale agreements. Assets held by the Bank of Canada, which are equal to just over 20% of GDP, remain proportionally smaller than those held by the U.S. Federal Reserve (slightly less than 40% of U.S. GDP).

The Canadian dollar remains at around US$0.76

Despite the uncertainty in the international economy, the loonie remained around US$0.76, its average level over the last five months.

A deterioration in global sentiment resulting from a second wave of the COVID-19 pandemic and the imposition of containment measures in various countries could lead to a depreciation of the Canadian dollar. The evolution of the pandemic would also have an impact on oil prices, an important determinant of the value of the dollar (see section on oil).

Loss of optimism on the part of entrepreneurs

With COVID infections on the rise in most provinces, a return of containment measures is causing entrepreneurs to revise their outlook downward.

The Canadian Federation of Independent Business's Business Barometer Index fell 6 points to 53.3 in October. An indicator above 50 suggests that entrepreneurs continue to expect their situation to improve over the next 12 months. Similar to the evolution of the pandemic, the shorter-term indicator is more pessimistic at 35.6.

Ten sectors out of 13 showed a decline, most notably transportation services (-6.6), accommodation and food services (-5.7), and health and education (-8.1).

As entrepreneurs deal with the second pandemic wave, the federal government is maintaining its business support programs, including the Canada Emergency Wage Subsidy (CEWS) and the Canada Emergency Commercial Rent Assistance. Entrepreneurs should keep an eye out for the various programs available. (Click on this link for a complete list of programs and details for each.)

Inflation remains below target

Inflation remained low in September, increasing from 0.1% to 0.5% on an annualized basis.

This low inflation was mainly due to the year-over-year reduction in prices for gasoline (-10.7%) and clothing and footwear (-4.1%). Inflationary pressures were greatest for housing (+1.7%), health and personal care (+1.6%), and food (+1.6%).

Inflation, according to the Bank of Canada, is expected to remain below the target range of 1% to 3% until early 2021.

It also expects inflation to remain below the 2% target throughout the projection period. A return to 2% is expected to occur in 2023 at the earliest—a minimum condition before the Bank raises its policy rate.

Key indicators—Canada