October 15th, 2008

 

Title: Despite turmoil, Canadian economy likely to outperform

Sub-title: However the credit crisis and volatile stock markets have many Canadians wondering what is in store for them.

 

The last few days have seen a slew of reaction by world governments designed to restore stability to financial markets. The U.S. Treasury department announced that it would spend up the $250 billion buy preferred shares in qualifying U.S. financial institutions and European leaders pledged that none of its major financial institution will be allowed to fail. Here in Canada, the Canada Mortgage and Housing Corporation last week agreed to by up $25 billion worth of mortgages from the country’s banks.

 

Markets initially responded positively to these announcements. As these words were being written, both New York’s Dow Jones Industrial Average and Toronto’s S&P/TSX index were up sharply. Yet despite initial positive reactions, it is far from certain that the current turmoil has passed. In fact many volatile days almost surely lie ahead.

 

These developments present unique challenges for long-term forecasters at governments, banks and trade organizations. Despite the fact that Canada’s economy is rolling in heavy waves, the forecasters who are sitting on deck are faced with the unenviable task of trying to steady their telescopes, to provide an idea of what lies ahead. Is Canada headed for a recession? Will the current lag in the markets last? And how will this all affect ordinary folk?

 

Canadian economy set to bounce back next year

The good news is that the International Monetary Fund’s Regional Economic Outlook, one of the most consistent and reputable forecasts out there, recently predicted that next year Canada’s economy will grow faster than that of any other G-7 nation. True, growth has slowed sharply since mid-2007, a year in which it advanced by 2.7% in real terms to a projected 0.7% in 2008. However that pace is expected to rise to 1.2 per cent by 2009

 

That said, these numbers, even if achieved, do not ensure that the Canadian economy will avoid a recession, which is defined as two consecutive quarters of below-zero growth. However if the IMF’s forecasts hold true, it does imply that GDP growth will not fall below zero during their 2008 or 2009.

As mentioned previously, despite the IMF’s credibility, (which stems in large part from the fact that unlike many private sector forecasters it has little interest in making rosy projection) recent uncertainty means that the fund is dealing with substantial constraints. However recent indications are good. For example last month the Canadian economy created a stunning 107,000 new jobs. This is in stark contrast with our Southern neighbours where jobs have now been lost in each of the last nine straight months.

 

A buying opportunity for stocks?

Predicting the fate of the stock market is no easier a task than figuring out where the economy is going. As these words are being written, despite recent gains, both the DJIA and the S&P/TSX equities indexes were well off their 12-months highs. Furthermore, according to one expert, more bad news may be on the way.

 

“There is one place where the current grim situation is not yet reflected,” wrote Pierre Lapointe, assistant market strategist and quantitative analyst at National Bank Financial in a letter to clients last week. “Despite the rapid succession of hard blows, so far there has been little revision of (analysts) earnings estimates for calendar year 2009.”

 

According Lapointe, during slowing economic times, corporate profits tend to take a hard hit. Yet strangely, equity analysts continue to foresee strong rises for in earnings next year for both (U.S. + 22 percent) and Canadian companies (+19 percent). The upshot says Lapointe, is that eventually analysts will be forced to lower their earnings forecasts, a development that traditionally quickly hits the stock prices of the companies affected.

                                                                                       

However Lapointe does not go suggest that it is time for any massive selling of stocks, quite the contrary. In fact the S&P 500’s recent 45 percent decline from its recent peak was far greater than the average 22 percent bear market index decline. “For us, this once a century financial crisis could well be a once a century buying opportunity,” concludes Lapointe.

 

However investments in housing may be the surer bet

Lapointe may of course be right. But even if he is, only the coolest minds will be able to act on his advice. Canadian investors, many of whom are throwing their RRSP mutual fund statements unopened into the trash can to avoid seeing how their portfolio help up to the S&P/TSX’s more than 30 percent drop from peak levels, will probably be running in droves from stocks.

 

In fact one of the safest places for Canadians to park their money during coming years will likely continue to be their traditional favourite lot: residential real estate. Because even though Canadian real estate prices may be off by a couple of percentage points during the past year, that is the first time that occurred in several decades.

 

On the other hand, the Toronto Stock Exchange has fallen by several percentage points on numerous occasions just in the past few weeks. In short, no matter good a time it may be to buy stocks, Canadians, who are traditionally a risk averse bunch, will likely opt to remain on the fence, at least until they being to get the sense that things have calmed down a bit.

 

 

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