It was just a few months ago that Canadian economists thought America’s financial misfortunes would turn around in the second half of this year. But according to a new report by Scotiabank, those predictions were premature.
“Don’t expect a U.S. recovery anytime soon,” says Warren Jestin, Scotiabank’s chief economist. “The core message in our report is that U.S. growth will be weaker this year.”
That forecast is a deviation from what most economists outlined back in January. Jestin admits that a lot of his colleagues got it wrong, but he says that in 35 years in the business, this has been the “toughest period of time to gauge economic trends.”
Part of the reason for the flip-flopping is that uncertain inflation, commodity prices and general unsteadiness in the American and European markets have made playing the economic fortune teller difficult. Now, however, Jestin is certain that the U.S. will be in trouble for some time.
“It’s become very evident that what started as a sub-prime mortgage crisis in the U.S. has been spreading into other areas,” he says, pointing to the pressure regional banking is facing along with softer commercial real estate prices.
Jestin explains that the U.S. is facing a deleveraging crisis, which is destroying the economy’s momentum. “The economic downturn comes from one simple thing,” he says. “In the last dozen years, the U.S. economy has been propelled ahead by leveraging up; now we’re in a time where the American economy is forced to deleverage.”
While Jestin and other economists are now calling for more doom and gloom down south, many Americans might be thinking that things are starting to look up. Why? Well, the economy has actually been looking somewhat better this past month.
“Big doses of monetary and fiscal stimulus, widespread official actions to contain mortgage defaults, and unprecedented injections of term liquidity by the Federal Reserve have had some success in mitigating the heavy negative fallout from the sub-prime crisis,” writes Jestin in his report.
But the relatively positive economic news might create false hopes in America’s financial industry. “Today’s market has found a happy place and stocks are rallying,” Jestin explains. “People are going to be disappointed, though, by sad news in the U.S., which still has a lot more adjustments to go.”
The household sector, he points out, has sapped all the energy that’s needed to revive the economy, meaning consumers are in no shape to launch a major recovery. “Business investments are unlikely to expand dramatically when demand is high and profit is under pressure,” he adds. “A lot of investment opportunities will be found abroad.”
Making Jestin’s outlook on the U.S. economy even more dire is his prediction that the Federal Reserve Board won’t raise interest rates anytime soon, despite what other industry experts believe. “It’s going down in Canada and the U.S.,” he says. “It’s hard to ratchet up inflation when the economy is geared down.”
While America’s prospects aren’t looking too hot, Canada still has a positive future ahead. That’s not to say our economy is immune to America’s financial woes — Jestin says Canada’s growth will be softer than most people predicted at the beginning of the year — but generally the Great White North is a bright spot in an otherwise struggling global economy.
Jestin chalks up Canada’s good fortune to three things: there’s less leverage and more caution in the country’s residential housing sector; Canada’s stimulus is coming from surpluses, not building up deficits; and we’re in a “very sweet spot” thanks to being a “resource-rich country in a resource-short world.”
“We have such a broad base in commodities that, with a few exceptions, are in very strong demand,” says Jestin. “It’s not just oil and gas; potash, uranium, coal and wheat are also doing well.”
That doesn’t mean prices will always be high, he explains, but if prices remain profitable and at historically high levels, then Canada’s economy will stay strong.
Of course, the manufacturing and auto sectors have taken a huge hit lately, and Jestin doesn’t gloss over the negative impact that has had on the economy. However, he points out that, compared to other countries, the manufacturing sector is doing relatively well.
“The difficult ongoing adjustments in the Canadian manufacturing must be kept in perspective,” he says. “Since the start of the decade, domestic manufacturing employment has fallen by 11%, only half the 22% decline in the United States. In the Euro zone, manufacturing employment has dropped by close to 25% since 1990.”
The fact that Canada is doing well isn’t a surprise, yet many investors are starting to worry that the country’s valuations are too high. “That’s a quintessentially Canadian trait — when the weather is good to be worried about bad weather around the corner,” says Jestin, throwing cold water on the notion that managers should stay away from Canadian investments. “Fundamentals, household commodities — they’re a whole lot better than other countries we’ve traditionally compared ourselves to.”
U.S. equity isn’t a bad place to park your client’s dollars either, despite the economists’ forecast for more troubles ahead. He says investors should look at companies with strong balance sheets, focus on global markets, and make sure they have the ability to weather a bumpy economic period that could last a couple of years.
And there are plenty of American companies that fit that bill. By going that route, investors can find good deals with businesses that, while based in the U.S., are playing in the less damaged global market.
If there are any companies to stay far away from, says Jestin, it’s businesses that “don’t have earnings, that are selling a story based on consumer spending and have weak balance sheets. These companies could very well be in trouble in this type of economic environment.”
Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com
(07/21/08)