Slow Growth or Boom/Bust?
June 16, 2009
Equity markets on both sides of the border are working through the healing process and are up substantially from the bear market bottom reached in March. There is a growing consensus that economies will begin to see some growth in the fourth quarter of 2009. Economists refer to indicators showing that the decline in economies is slowing. However, it should be noted that the Canadian, American and European economies are still contracting. It is hoped that all the talk of “second derivative” and “green shoots” represents substantially more than wishful thinking.
The recovery will probably come in one of two forms: slow growth or boom/bust.
Slow growth: Most likely, economic recovery will be somewhat underwhelming (1-3%). Central banks will have to gradually tighten monetary conditions to avoid inflation. There also could be a trend toward higher taxes to bring deficits under control. There is considerable slack in manufacturing and employment. If there is a gradual expansion, inflation should not be an issue for some time.
Boom/bust: There is some concern that economies will begin to expand at a pace that will cause shortages in materials. Since there has been very limited exploration activity due to unavailability of credit, little new supply will be available to meet an increase in demand. Demand for commodities could cause prices to rise. An inflationary commodities boom might be followed by a bust as interest rates are forced higher to counteract inflation. An environment of rapidly rising interest rates could derail any recovery and lead to a new wave of defaults, foreclosures and bankruptcies. If an inflation triggered recession occurs within 2-3 years, central banks may not yet have recovered enough fiscal flexibility to provide adequate stimulus to prevent economies from falling into extended recessions.
In either scenario, interest rates at both the short and long end of the spectrum appear to be heading higher from historically very depressed levels. We remain underweight in bonds and are focused in the short end of the market.
We are of the opinion that the US Dollar could continue to weaken as the full impact of over 3 trillion dollars of bail-out and stimulus deficit spending becomes apparent on the Government’s balance sheet. We remain underweight in the US markets.
Canadian financial service companies emerged relatively unscathed compared to banks and insurance companies elsewhere in the world. As a result they have flexibility to take advantage of acquiring distressed assets at attractive valuations. Dividends at all Canadian banks and life insurance companies appear to be secure and equity values have bounced back nicely. Commodity prices should be firm as economies recover. This should benefit Canadian oil and gas producers, mining companies and agricultural suppliers. The Canadian market should benefit. We remain overweight in Canadian securities with a bias toward equities.
