• David Cockfield

The Big Picture


As Canadians learned from the crash between 2007 and 2008 you can’t ignore what is going on outside of your own borders. Despite having a strong and well regulated banking system, the collapse of Lehman Bros. in the U.S. and the meltdown of the U.S. financial system pushed Canada into recession, and the TSX remaining at levels below where they were in 2007. A look at the evolving worldwide economic picture is very useful in determining where we are likely to be going in the upcoming quarter.

Emerging economies such as Brazil, China and India have recently experienced slowing growth as demand for commodities and manufactured goods from the developed economies fell. However, concerns that China in particular was headed for recession have recently abated. Unfortunately investment funds that used to flow to the emerging economies from the developed countries have dried up, particularly for long term projects. Initially in the worldwide slowdown, the emerging economies continued to grow while Europe and North America showed little if any growth. This helped world growth numbers to stay positive. The more recent slowdown means the developed economies must pick up the slack to keep worldwide economic growth on the plus side.

Europe presents a mixed but improving picture. Germany continues to power along with low unemployment and positive GDP growth helped by the relatively cheap Euro. The Northern tier of the Euro zone is also in good shape. The southern tier- Greece, Italy, Spain, Ireland and Portugal continue to struggle with government deficits and high unemployment. Recently, however, while economic growth is elusive, economic activity seems to have stabilized in the southern tier. While further cuts in government expenditures are necessary, some stimulus would also seem appropriate. The euro zone should be paying attention to the apparent success of the U.S. in stimulating its own economy. Unfortunately the German public has been adamantly opposed to any stimulus particularly something that will require German financing. The current German Chancellor, Angela Merkel, (now that she has been re-elected), given her past pragmatic approach, could support some softening of the austerity policy presently in place. This would be very instrumental in producing better growth in the Eurozone.

In North America the U.S. has recently been generating quite encouraging economic numbers. Current low interest rates and the recent promise by Fed chairman Bernanke to keep them low, have provided the base for recovery in the housing sector. The importance of housing as a growth driver cannot be underestimated. New housing requires a wide range of inputs from lumber to washers and dryers, benefitting a wide range of industries and employers. For five years the U.S. has not met normal housing requirements to provide for population growth and family creation. Excess housing created in the boom of 2005 to 2007 has been absorbed and all that is required is continued home buyer confidence to keep this sector positive. The Federal Reserve has pledged to hold down interest rates until growth and employment reach certain levels, but an end to their asset purchasing program is expected to usher in a period of rising interest rates.

The U.S. corporate sector is also in excellent shape with earnings growth exceeding expectations quarter by quarter. US equity markets have moved to new highs but most U.S. corporations have continued to sit on high cash balances. This reluctance to spend on capital expansions or more employees has provided significant drag on the U.S. economy. Corporate confidence is improving and this combined with a more accommodating banking system should result in improving GDP numbers in upcoming quarters.

In Canada, as in the U.S., our corporate sector continues to generate good profit growth. Stable or higher commodity prices, particularly for oil, have improved future prospects for the very important energy sector. The steady recovery in the US should also provide a lift for the Canadian economy. The Canadian financial sector remains in excellent shape and housing starts and sales have continued to be strong despite the tightening of new mortgage rules. Unfortunately the tendency of financial markets to be driven by psychology is still with us. Despite the fact that the fears that drove down equity markets a number of times in the last two years have not materialized, the markets are still prone to periods of selling panic. Thus a sell strategy has profited the short sellers, and as long as this practice is profitable they will continue to reinforce any market decline. On a more positive note, the TSX, which so far this year has lagged US equity markets, has in the last quarter outperformed the Dow and the S&P 500. Hopefully this will encourage Canadian investors who have gone to US equities to return to the Canadian market. To summarize, while problems still face the world economy they are manageable. Predictions of imminent collapse that have frightened markets have died down. With the bond market facing the prospect of higher interest rates at some time in the future investors are becoming more inclined to move capital into equities. Equity markets will remain volatile but will climb the traditional “wall of worry”. We anticipate positive returns from equities will continue in the fourth quarter. We believe that investing in and holding good quality dividend paying investments should form the core of investor portfolios. With higher interest rates expected, non- traditional investments such as short-term mortgage funds, private real estate trusts, actively managed bond funds and private equity, offer good cash returns and/or capital gains and protection against rising rates.


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