As the New Year approaches, BMO has
assembled a group of leading experts to summarize some of the biggest market
and economic trends they anticipate will take hold in 2008. This group
of economists, investment experts, dollar trading specialists and equity
and debt market analysts can also share insights on key developments that
shaped 2007.
Experts are available this week to provide outlooks for the:
- Economy
- Equity and debt markets
- Canadian dollar and foreign exchange
Economic Outlook
Doug Porter, Deputy Chief Economist, BMO Capital Markets, zeroes in on
six of the biggest themes expected to dominate in 2008:
- The U.S.
Presidential election – The U.S. Presidential election will
increasingly dominate market attention as the year progresses. Current
polls suggest that the Democrats are well – positioned to take
control of both sides of Congress, and possibly the Presidency as
well. Given the large and seemingly sticky bilateral trade deficit
with China (US$255 billion in the past year), protectionist rumblings
aimed at that country could become louder. If the U.S. economy slips
into recession next year — a distinct possibility, which would
be the first election year downturn since 1980 — this would
only strengthen the protectionist pressures.
- Possibility of
a Canadian federal election – Canada
may also face a federal election, potentially early in the New
Year, with the minority government approaching its two-year anniversary
in January. Economic issues are unlikely to be a major focus of
the
opposition parties, since unemployment is below 6 per cent, inflation
is close to 2 per cent and the dollar remains near par. Instead,
the environment may be a battleground, especially with the negotiations
on climate control emerging from the Bali meetings likely to be
a major focus in the year ahead.
- Leadership change
at the Bank of Canada – The Bank
of Canada will get a new governor at the start of February, as
Mark Carney takes over from David Dodge after seven years at the helm.
The new governor will be quickly faced with the challenge of
a soft
U.S. economy and a strong Canadian dollar on the one side, and
a tight labour market and a hot housing market on the other side.
- Can growth in
the rest of the world hold up in the face of slower U.S. activity? – The “decoupling” theory
for the global economy will face a stiffer test in 2008. This
year did not really give a proper test, as U.S. GDP growth
was still reasonably
healthy at more than 2 per cent. A drop well below that pace
would be much more of a challenge to the global economy, especially
if
much of that growth is due to rising exports. The good news
is that the U.S. trade deficit may be poised to finally begin
narrowing in
a meaningful way, thanks to slower U.S. spending, stronger
exports and a low US dollar.
- The Beijing Olympics – The Beijing Olympics will put
an even brighter spotlight on China’s remarkable ascent
in the past decade. The question is whether the economy will
face a
post-games slowdown? A serious pullback would undercut commodity
prices, and thus the Canadian dollar.
- U.S. Housing
Market – U.S.
adjustable-rate mortgage resets will crest in the early spring, which
will likely
coincide with the maximum pressure on the U.S. economy. After that
point,
U.S. housing is expected to eventually hit bottom, helping
the economy to gradually stabilize and improve over the second half.
This could
also set the stage for a firming of the US dollar after
a six-year stretch of almost continuous decline.
Canadian Equity Market Outlook
Ben Joyce, Managing Director, Portfolio Strategy, BMO Capital
Markets, on highlights of his recently published report entitled, “Riding
the (Financial Shock) Waves”:
- Is the bull market
over? Will 2008 be a mediocre year for stocks? – We are persuaded that the predicament is more a crisis
of confidence in the financial system, similar to 1998, than a prelude
to a recession and a bear market. North American stock markets pulled
off a bungee jump in 1998, plunging 20-25 per cent in three months
before staging an impressive recovery. Because of the difficulties
in sorting out the subprime securitization issues, the current correction
is evolving as shallower, but more prolonged. While central bank rhetoric
remains hawkish, their actions have been accommodative, and we expect
interest rates to fall below 4 per cent by early next year. This easing
should help limit the economic fallout from the credit crunch to a
global slowdown rather than a recession.
- What sectors should investors emphasize as 2008 begins
to unfold? – As we head into 2008, we expect the following
sectors to perform strongly: Auto Parts, Capital Goods (ex. Aerospace),
Chemicals
and Fertilizers, Golds, Integrated Oils and Refining, Media and
Transports. In guarding against the potential for further structured
product
writedowns, we remain cautious on the banks. Persistent oversupply
in North American markets also leads us to limit exposure to the
natural gas sector.
- Small-cap performance next year versus large caps – Small
cap stocks have performed well, although they lagged the large cap
market slightly in 2004-2006. This year, small caps are flat to down.
They are lagging more than 10 per cent behind the S&P / TSX
60 Index. Given our expectation of slowing economic growth over
the
coming quarters, history would suggest that small caps are unlikely
to outperform until the economy begins to perk up again.
- Is the near-term risk in the commodity sector on the
rise? – The
resource sector faces risks from both cyclical weakness and
cost pressures, particularly energy and base metals. With global
leading
economic indicators pointing to slower growth, the near-term
risk in the commodity sector is on the rise.
Canadian Equity Market Outlook
Paul Taylor, Chief Investment Officer, BMO Harris Private Banking, discusses
trends in the equity market in 2008 and implications for investors:
- Focus
portfolios on earnings visibility in 2008 (S&P/TSX earnings to
disappoint) – Analyst expectations are not achievable in 2008.
The bottom-up consensus forecast for earnings growth for the S&P/TSX
index companies is approximately 14 per cent for 2008. This is not
consistent with an economic environment where the U.S. Federal Reserve
Board is committed to a series of interest rate eases aimed at ensuring
that the U.S. economy does not dip into a consumer recession. It
is much more likely that Canadian earnings will expand modestly,
perhaps at a mid single-digit pace.
- Overweight Defensive
Sectors – It
would be surprising for the more economically sensitive sectors
(such as Consumer Discretionary,
Information Technology and Materials) to outperform in 2008. If
the U.S. economy does slow meaningfully, as we predict, it is more
likely
that the non-cyclical Consumer Staples, Telecommunications and
Utilities sectors will outperform. Our recommendation, therefore,
is to de-emphasize
portfolio beta, over-weighting low beta stocks.
- Focus on stock
selection – regardless of the market
environment, there will still be big winners – While overall
market direction should reflect the modest earnings growth outlook,
opportunity exists for firms with sustainable competitive positioning
to meaningfully increase revenues and net income. Examples include
firms such as Sino Forest (the largest supplier of wood products
to mainland China), Potash Corp. (the world’s leading potash
producer), Urbana (a diversified portfolio comprised of holdings
of the world’s stock exchanges) and finning (one of the world’s
largest distributors of Caterpillar products).
- Overweight the
Fertilizers – Expect renewed price
acceleration for all fertilizer nutrients (phosphate, nitrogen and
potash). This will occur as we begin 2008 with depleted fertilizer
inventories, with higher natural gas costs and with increased demand
throughout the wheat producing regions of the world. This bodes well
for Canada’s fertilizer stocks, notably Potash, Agrium
and Mosaic.
Canadian Debt Market Outlook
Jason Parker, Managing Director, Corporate Debt Research, BMO Capital
Markets, on highlights of his recently published report entitled: “The
Coldest Winter in 15 Years; Can Spreads Emerge from the Deep Freeze?”:
- More fallout
from U.S. sub-prime and synthetic instrument exposure expected
- Uncertainty surrounding the non-bank ABCP market in Canada likely to
persist through the first part of 2008
- Maple Bond market will be challenged to approach new issuance levels
reached in 2007
- Anticipated heavy new issuance schedule from financial sectors likely
to continue weighing on corporate spreads in Canada
- Typical risk-taking to start off the year may place initial bid behind
corporate spreads
Moving into 2008, we believe the Canadian corporate debt market remains
vulnerable to above-average event risk, and that spreads may move past
the high levels of their recent range. At the very minimum, we suggest
a cautionary stance is still prudent in the current environment of uncertainty,
as the global markets determine if sub-prime lending issues in the U.S.
have more legs to run and if the impairment of liquidity in the high-yield
markets is transitional or the start of a fundamental shift in risk tolerance.
Nonetheless, we expect new debt issuance from financials in Canada to
resume its hectic pace in early 2008. We believe a significant debt maturity
schedule and rising funding requirements emanating from the need to feed
growing balance sheets will likely continue to weigh on sector spreads,
and hence the market in general.
We continue to believe the credit issues affecting the lower-rated sectors
have not abated (e.g., escalating competition in Retail and Telecom).
We also maintain our belief that there is an elevated risk of more equity-friendly
asset allocation decisions, in part as a potential economic slowdown
may encourage companies to seek alternative mechanisms for enhancing
shareholder value to offset any reduction in earnings growth momentum.
We still believe investors should pursue higher-quality sectors such
as Infrastructure and higher-grade Utilities. Although the Financials
have experienced significant spread widening, we believe their credit
quality remains fundamentally sound.
Canadian Dollar
Firas Askari, Head of Canadian Dollar Trading and CJ Gavsie, Managing Director,
Corporate & Institutional Foreign Exchange Sales, BMO Capital Markets,
look at the miraculous climb of the Canadian dollar and expectations
for the lofty loonie in 2008:
The Canadian dollar
reached a multi decade high versus the US dollar (hitting a high of
0.9059
in US dollars terms during September) and ranked
as the top performer against all G10 currencies in 2007. The loonie benefited
from historically high M&A inflows ( over 100 Billion CAD), continued
global demand for commodities and a moderately sidelined Central Bank
(which narrowed the overnight funding gap from 100 basis points to 0
over the course of the year).
In our opinion, the same factors that supported the Canadian dollar
rally have not all together disappeared for 2008; however, the Canadian
dollar could face some headwinds which could force a lackluster performance
for the loonie.
We anticipate the 2008 key Canadian dollar drivers to be:
- Global economic growth (which directly correlates to commodity pricing)
- Global diversification into non-USD denominated assets, US and Canadian
monetary policy (which relates to North American inflationary factors)
- Overall health of the global financial system, and the ability of the
economy to overcome the current poor credit environment and geopolitical
factors such as the upcoming US election.
Please call to arrange a print and/or broadcast interview. Copies of
published reports can be emailed upon request.
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