The worst of the credit crisis is most likely behind us – coordinated government and Central Bank interventions and massive financial stimulus has helped avert what might otherwise have led the economy into a depression.  
For the North American economies, the pace of recovery ahead rests in the hands of the US consumer; who collectively represent 70% of GDP.  The fact that consumers have in short order swung from negative savings (-2%) to austerity (+3%) is both remarkable and worrisome as billions of dollars have been reallocated from the US economy into savings (and/or debt repayment.)   So far we’ve experienced a “producer” recovery, especially in emerging economies such as China and India.  Canada’s economy has benefited because of our resources exports to producer nations.  Whether the consumer will step-up and buy the restocked shelves is yet to be seen…

In terms of the US consumer and their ability to refinance their borrowings – with the possibility of further weakness in (US) housing prices (in spite of what appear to be improving fundamentals,) and potentially another round of mortgage resets amongst Alt-A and Option-arm refinancing, recovery of consumption (consumer spending) could be meek this time as compared to a typical recovery scenario.  Considering that the US is our largest trading partner, economic recovery on this side of the border will also be/seem constrained as compared to past recoveries. 

Similar themes are reiterated globally with notable exceptions in select emerging economies as above; those deemed to be “producers” of goods to be consumed.  China for instance has proven to be one of the first foreign economies to exit recession and is expected to continue to post strong economic growth in 2010.  Recently China eclipsed Japan as the world’s second largest economy.

The cost of stimulus is another theme yet to play out – higher interest rates are forecast as a result.  Graduated rate increases are forecast; likely beginning in the latter half of 2010 and carrying through 2011 – a 2% increase in the bank rate over 2 years is projected.  The ramifications of rate increases will not immediately be clear, but it is the view of Scotia Economics that rate increases could hold-back the pace of recovery in North America – 2%-3% GDP growth is projected. 

Of course a stronger economy may lead to an early end to economic stimulus; especially in the US where twin deficits and the cost of banking and healthcare reform remain a politically charged topic.  As a result the Greenback is forecast to remain weak relative to many world currencies including the Canadian dollar.  Considering that our largest trading partner by far is in fact the United States (70% of Canada’s trade is with the US,) a trend toward a stronger Loonie would not generally be all that supportive of GDP on this side of the border.  Though the Bank of Canada is not likely to raise interest rates ahead of the US Federal Reserve, Scotia Economics forecasts suggest parity with the Greenback by mid-year (U$0.97 recently.) 

Though at least for the near-term interest rates are expected to remain low – for lack of a better alternative money flows are expected to continue to move in the direction of equity investments; though securities prices may not necessarily/always reflect sound fundamentals.

Still, equity investments generally appear to offer relatively superior potential returns as compared to fixed income investments; especially when considering that interest rates are expected to increase.  Though the equity risk/reward outlook is no longer as compelling as it was (in hindsight,) back in March, 2009 as equity markets bottomed-out, as a function of the forecast continued economic recovery, improved earnings growth, and positive fund flows, investors are likely to be rewarded for risk, though investors should expect more modest gains ahead.   

Recent data suggests the uptrend in forward earnings revisions will continue at least for the near-term.  Though cyclical investments may continue to outperform with economic recovery for the near term, portfolios should be rebalanced often and likely adopt a more defensive stance over time; as we digest rising interest rates and heightened financial and credit markets regulation...full report

Dale A. Swan, CFP, FMA, FCSI
Ch.P. - Strategic Wealth

ScotiaMcLeod Wealth Advisor

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email: dale@swanprinciple.ca

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