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Is Canada on the Verge of a Recession?

The Canadian government recently revealed its latest numbers that show Canada’s GDP falling again for the fifth month in a row. With oil prices slumping again, and energy producers announcing additional job and spending cuts, things may not get better for some time.

Unfortunately, investors can’t just blame the oil and gas industry anymore, as weakness is starting to spread to other industries. Economists are also concerned that recession fears could become a self-fulfilling prophecy, where businesses decide not to invest in new projects or hiring due to a weak economic forecast.

What’s going on, and can investors continue to rely on a previously stable economy?

One word: oil

After this year’s oil crash, prices continue to drift downward, causing pain in some of Canada’s largest provinces. The effect is even more severe than in other countries, as Canada’s heavy oil trades at a discount due to pipeline constraints and lower quality.

Major oil and gas employers can’t seem to lose money any more quickly, and jobs cuts have already begun. For example, Canadian Oil Sands Ltd. (TSX:COS) is Canada’s largest producer of synthetic oil made from oil sands. Last quarter, the company lost $128 million, portending thousands of jobs cuts in Alberta.

As we’ll see, oil and gas companies won’t be the only ones affected.

Banks can’t hide either

The major concern is that bad loans and falling stock prices will hurt bank balance sheets. Bank of Montreal (TSX:BMO)(NYSE:BMO), Royal Bank of Canada (TSX:RY)(NYSE:RY), and Bank of Nova Scotia (TSX:BNS)(NYSE:BNS) all have loan book exposures to the energy industry.

According to ratings agency Moody’s Corporation, “recessionary conditions along with low oil prices could lead to deteriorating asset quality for some of Canada’s largest banks.” This could end up forcing banks to raise lending standards or lift loan rates, causing a pervasive impact across the entire economy.

Banks have more than oil to worry about

Fears of a housing bubble are rising across most of the country’s major cities. Key metro areas such as Toronto and Vancouver have seen home prices rise by over 50% in recent years. Most years in recent memory have experienced double-digit price growth.

A run up in housing prices, along with overbuilding and a high home price-to-income ratio, has Toronto-Dominion Bank (TSX:TD)(NYSE:TD) predicting a “medium-to-moderate” chance of a “painful price adjustment.” The triple-whammy of falling oil prices, a deflating housing bubble, and crumbling bank balance sheets would surely be enough to send the Canadian economy overboard.

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Fool contributor Ryan Vanzo has no position in any stocks mentioned.

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