Compared to the other seven members of the G7, Canada’s economy has been fairly steaming ahead, but that may be about to change.

The collapsing European economy, now with both the German and French economies retracting as well as their neighbors, is beginning to weigh on the Canadian economy and America, Canada’s biggest trading partner, is seeing its growth rate slowing despite massive quantitative easing and a zero interest rate policy.

Canada has been steering a path of economic growth since the beginning of 2010, but this looks like it might be about to change.

The IMF is positive on Canada – or is it?

The IMF believes that Canada should put in place a fiscal framework to set aside tax revenue from the booming oil and gas industry. It believes that production will double in the coming few years, which will help the economy grow more strongly in the second half of 2013 when compared to the first. However, it does see the economic risks tilted to the downside.

More trouble around the corner

The job market has been fairly buoyant in Canada, and especially so in the last quarter of 2012.  In November and December new jobs increased by 87,500, but in January the jobs train came off the tracks with a fall of 21,900. In isolation this could be taken as, perhaps, a one off figure, maybe even an aberration, but at the same time official figures pointed to other worrying developments.

Canada’s trade deficit narrowed in December, almost halving to $901 million from $1.7 billion, with imports declining by more than three times the rate of exports. Exports fell by 0.9%, while imports fell by 2.8%. The detail of the numbers points to a rapidly cooling economy.

Don’t count on construction to build the economy back

Canada’s housing boom has gone fairly untarnished since the turn of the millennium. Sure it got mixed up a little with the fallout from America’s housing crisis in 2008 but has come back onto the path of powerful price rises since. That might be about to change.

Canada Mortgage and Housing Corporation recently announced a large drop of in residential building starts in January, with a fall of 15% – to little under 161,000 from a shade above 197,00 – in a month.

The IMF is bearish on the Canadian housing market, estimating that it is overpriced by 10% when compared to international markets. It even hinted that the Bank of Canada might consider raising rates to help cool the market.

Debt isn’t just sovereign

House prices have risen by more than 25% since the second quarter of 2009, in contrast to the United States housing market where house prices have risen by less than a third of this figure. But with the rise in house prices has come a massive increase in household debt. Since the housing crisis in the United States, American households have been busy paying down their debts. Canadian workers have increased theirs to 165% of income. That’s about the level that American household debt had risen to just before its housing market came crashing to earth.

There’s always the energy market and commodities

Much of the booming Canadian economy has been fuelled by rising commodity prices as world governments raced to reverse economic fortunes after the 2008 financial crisis. To some extent these measures have worked, and commodities have been sucked in by companies and governments building infrastructure.

This has helped the resource heavy Canadian economy, but with the global economy now weakening commodity prices are falling too. That’s bad news for Canadian companies and Canadian jobs. The January trade balance and jobs numbers confirm this.

The impending energy boom may be here for several years, but that boom is going to depend on produced fuel prices remaining low and competitive. That’s going to keep margins down.

The end of the line for above par growth?

American households have addressed their debt problems – even if its government hasn’t – and this could help it fight the effects of the 2% tax increase imposed by the Fiscal Cliff deal recently made.

Canada, on the other hand, has a domestic sector buried deep in debt. If global demand for resources subsides further, this debt could become unsustainable. Households may struggle to keep up with debt payments should working hours fall or the unemployed numbers rise. Moody’s, the rating agency, has given this as the reason for its recent downgrading of the credit ratings of six of Canada’s largest banks.

The steam train that is the Canadian economy, fuelled for so long by the coals of a housing boom and increasing household debt, may be about to fall off the tracks.

Select stocks carefully

Though the economy may be weakening, there will still be companies that should produce good returns. Here are a few ideas for you:

  • Oil and gas producers may see margins falling, but electricity companies should benefit from lower fuel prices. There will still be a need for fuel, and distributors could do well as Europe looks for cheaper gas and oil to be transported across the Atlantic.
  • If consumer spending becomes sluggish, then it will be time to take profits from holdings in consumer discretionary stocks and rotate into defensive staples, health and pharmaceuticals.
  • New housing construction companies may prove a poor investment as unemployment rises, but home improvement companies may, in the short term at least, benefit as homeowners look to improve their current lot rather than move to a new property.
  • Investors should also be wary of those companies which make profits from financing buyers of their goods and services. Car manufacturers spring immediately to mind.

In summary, now is the time to take a defensive stance on Canadian stocks. Act with care and remain profitable.