Time to go easy. (incl. Excel Workbook)
Rate cuts will cause a credit boom. Beneficiaries will be those with a high debt burden. The junkier the better. Like Canadian subprime lending for example.
Disclaimer: The information contained in this article is not and should not be construed as investment advice. This is my investing journey and I simply share what I do and why I do that for educational and entertainment purposes.
TLDR Summary
A profound moment is upon us. Led by the Federal Reserve, central banks around the world are about to launch their cutting cycle. This was the most intense hiking cycle in perhaps ever and it happened to fight an inflation surge that was not just demand driven, but also very much supply driven. As a result, the Fed and other central banks have hopelessly overtightened, thereby crippling everyone with debt, especially US Dollar denominated debt. But as a side effect, some of them also jacked up a fiscal impulse, which supercharged private sector savings via reaccelerating public deficits. The result is a monstrous spring that is loaded and ready to jump. An incoming credit boom.
Perhaps for the first time ever, we are therefore about to experience a moment where rate cuts won’t happen into a slowdown of corporate earnings, but an acceleration thereof. This is true for the US, but even more for the rest of the world. An investor can benefit from this by pretty much buying any risk-on asset. But why not play it in a more targeted way? The biggest beneficiaries should be cyclical assets, ideally asset-heavy ones with big balance sheets like airlines, rental car operators, oil drillers, (commercial) real estate, banks or certain types of manufacturing. I have written about some of those before. The junkier the industry, the better it should do. How about Canadian subprime lending then?
The US is running loose fiscal policy and tight monetary policy which makes the economic big picture sometimes quite confusing. It also puts the timing and extent of near-term rate cuts into question. We don’t have that ‘problem’ in Canada. With a fairly balanced consolidated government budget, fiscal policy can reasonably be called tight. And with a central bank that is blindly following its southern neighbor and that is totally ignoring domestic circumstances with higher and shorter duration private sector debt, monetary policy can only be called ultratight. There is a time bomb ticking in Canadian household balance sheets from an upcoming refinancing wave in 2025/26 that makes the case for rate cuts even more obvious than it is in the US.
Once that happens, the population’s proclivity and ability to borrow will increase. This will be fueled by an unprecedented immigration wave growing the country’s population at a pace that has rarely happened before. Demand for credit will surge. But supply won’t necessarily be fully accommodating as the leading Canadian regulator is eager to implement stricter lending standards for banks to avoid another bubble from forming. Consumers will therefore turn to alternative lenders in droves.
The last time such a regulatory credit tightening happened was after the GFC. Stricter lending regulation from that crisis did in fact create the domestic alternative lending sector in its current shape. goeasy has emerged from that industry formation as a leader that seems to be extremely well managed. They remained growing and profitable through the entire hiking cycle.
The stock is currently trading at $160. If we can believe management’s mid-term guidance and assume stable valuation multiples from current levels, this is likely a $230+ stock two years down the road. It does not sound like huge upside, but this is a long term compounder and such a price target does not include the catalyst that I have outlined above. It’s free upside so to say.
Structural growth for credit demand
I have touched on the Canadian economy before in the two articles below:
