Checking In on Growth North and South of the Border

Last week we learned US GDP grew 4.9% annualized in Q3 on the back of strong consumer spending and inventory restocking. But what of the rest of North America? That question came into focus Tuesday, with Mexico and Canada’s seemingly divergent results exemplifying the global economy’s current theme: pockets of strength and weakness. For markets it is all old news, but it shows economic fundamentals ended Q3 on a pretty ok note.

Starting with the strong pocket, Mexican GDP rose 0.9% q/q, beating expectations for 0.8%.^[i] On a sectoral basis, agricultural output jumped 3.2% q/q, manufacturing rose 1.4% and services grew 0.6%.^[ii] There has been a lot of talk about Mexico benefiting from “near-shoring” manufacturing in the wake of COVID lockdowns and global shipping disruptions, and manufacturing’s nice jump appears to be evidence of that. But Mexico’s economy is far more than US factory space, and services’ growth indicates domestic demand is doing quite well. Mexico’s national statistics agency doesn’t include GDP contributions in its initial estimate, but the World Bank estimates Mexico’s services sector is nearly 60% of GDP, while manufacturing is just under 20%. So it seems to us domestic demand did a lot of the heavy lifting last quarter. The strong economic relationship with the US probably still plays a role here, but this isn’t a simple case of a big country pulling a smaller neighbor along. Rather, it is a sign of regional strength that should benefit companies doing business throughout the continent.

Of course, this is all before Hurricane Otis tragically struck Acapulco this month, causing widespread damage. Already, there is talk of spending on rebuilding adding to GDP in the quarters ahead, to which we say, hold your horses. Money spent on rebuilding leveled villages, replacing destroyed infrastructure and repairing property is money that would have been spent on and invested in other things if the hurricane hadn’t struck. Rebuilding isn’t economic stimulus. In most cases, it redirects money that might have gone to other and potentially more productive and profitable use. At best it is zero sum. Regardless, the estimated cost ($15 billion) is a tiny sliver of Mexico’s nearly $1.7 trillion in annual GDP.^[iii]

As for Canada, America’s neighbor to the north isn’t faring quite as well. The full Q3 GDP estimate isn’t out yet, but August’s monthly GDP report included rough estimates for September and Q3. Statistics Canada described each as “essentially unchanged.” Whether this is a slightly positive “essentially unchanged,” which was the case with August’s print, or a slightly negative “essentially unchanged” as in July, it is a big miss compared to the Bank of Canada’s recent forecast for a 0.8% annualized Q3 rise. Yet it also isn’t quite the “technical recession” some number crunchers are penciling in on the presumption that Q3 will be a slightly negative number. Following Q2’s -0.2% annualized decline, a Q3 contraction would meet one popular recession definition of two consecutive declines. But for now, that determination is way premature, and you have to do some weird math to get there. Regardless, if the contraction rounds to nothingness, recession fear seems pretty overwrought to us.

Either way, a look under the hood shows Canada isn’t uniformly weak. Manufacturing fell -0.2% m/m, but services—the lion’s share of Canadian output—grew 0.1%.^[iv] Mining, quarrying and oil and gas extraction jumped 1.0% m/m as higher prices encouraged more production—a boon to global energy supply and Western Canada’s economy (and a good sign of the ongoing recovery from springtime wildfires). Travel also rebounded, and financial services continued growing. Retail trade fell, but with services growing overall, it seems a stretch to say high rates are clobbering consumers, especially with vehicle sales the main source of the decline.

At any rate, Canada has pockets of strength and weakness just as the North American economy overall has pockets of strength and weakness—just like the full global economy. See the eurozone’s preliminary Q3 report—which showed a -0.1% q/q contraction in Germany, 0.1% growth in France, 0.3% growth in Spain and a flat Italy—for another example.^[v] Some countries are probably in recession, with Germany one notable example. Others aren’t, and they outnumber and outweigh the weaker areas. Is this a world firing on all cylinders? Nope. But it does seem to be a world that is growing in the face of pessimism about high rates and energy costs, which should be good enough for stocks once this correction runs its course and markets resume their day job of weighing fundamentals.