Exports to U.S. expected to drop to 60 per cent of Canadian trade by end of the decade

TORONTO, Oct. 3, 2011 /CNW/ - Canadian companies are lessening their dependence on the U.S. as a trade partner with exports now 30 per cent more diversified than a decade ago, finds a new economic report from CIBC World Markets.

"The main catalyst here is the surge in exports to emerging markets and the significant decline in exports to the U.S., which are currently back to the pre-NAFTA levels," says CIBC Deputy Chief Economist Benjamin Tal. "At this rate, the U.S. share of total exports will fall to 60 per cent by the end of the decade, with emerging markets picking up nearly 90 per cent of the gain."

The report notes that Canadian companies are taking advantage of historically low interest rates to finance investments - some of which is being directed towards expanding export opportunities.

"Growth in business investment outperformed growth in exports to the U.S. for 30 out of the past 36 quarters—by far the longest duration of outperformance on record," adds Mr. Tal. "And while real exports to the U.S. hardly changed over the past decade, business investment managed to grow by an average annual rate of more than four per cent—again a record performance gap."

He doesn't put much stock in the fact that a strong Canadian dollar is the reason for this surge in capital expenditures. He found that real imports of machinery and equipment are rising today at roughly the same rate as they did when the loonie was much weaker.

Mr. Tal notes that while targeting increased export markets requires extra investment, it also means an improved bottom line. Academic research on the link between export diversification and corporate profits show that the relationship is highly non-linear. Both extremes (too high or too low levels of diversification) act as a negative for profits with the main improvement seen in the move from the low to medium level of diversification.

"With exports to the U.S. still accounting for a sizeable 75 per cent of total exports, it is clear that Canada is currently in the optimal stage of its diversification process, with any increase in diversification adding notably to the bottom line," he says. "Already, exports to the U.S. as a share of Canadian corporate sales are hovering around their lowest rate since the early 1990s—implying a notable reduction in the sensitivity of corporate profits to exports to the U.S. This sensitivity will continue to decline as Canadian exporters increase their exposure to alternative markets."

Diversification comes in two ways - increasing the markets we trade with and increasing the products we sell. On the surface it appears while we've made progress on the market front, we've lagged behind in terms of the range of goods exported. "The surge in the share of energy exports (in terms of both volume and value) has resulted in a 10 point reduction in the diversification measure of Canadian exports by product," notes Mr. Tal.

"However, this broad measure masks a more promising trend when one zooms in on manufacturing and industrial products. In this space, when measured by volume, overall diversification has improved by more than 30 per cent over the decade. Key here are sectors that contributed to both product and destination diversification such as wood and paper, chemicals, metals and minerals, agriculture food, machinery and equipment, and aerospace."

He adds that increased diversification of exports by destination and product is not only necessary to maintain profitability, but is also required to hedge against the increased economic volatility that is likely to be an integral part of the economic landscape going forward. The past decade was characterized by reduced volatility in the economy, in general, and corporate profitability, in particular. The role of increased consumer borrowing was key in smoothing economic variability during this period.

He believes that credit will likely play a lesser role in the new economic mix and the economy will lose its main shock absorber. He expects the recent uptick in volatility to continue in the foreseeable future and for corporate Canada to adapt to the new reality by becoming more flexible and responsive.

"These changes will be characterized by actions such as adapting variable hiring practices, more conservative finance practices, increased use of sales force to identify changes in the marketplace, increased ability to switch product type which, in turn, might require different capital equipment, and a higher capability to change the composition of sales during the cycle.

"The post-Great Recession era, and the new mix of economic growth that will define it, could provide corporate Canada with a golden opportunity to restructure itself in a way that simultaneously reduces its dependence on the U.S. economy, and improves its bottom line. Key here will be continued deliberate attempts to diversify export activity by both destination and product with the realization that such an action is no longer a choice but a necessity."

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/if-20111003.pdf.

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