Recovery will come late in 2009

Economic forecasts and pontification have bumped celebrity gossip off the front page since mid-September, but when top economists from the five biggest banks get together, it’s usually worth listening to what they have to say.

At a breakfast meeting hosted by the Economic Club of Toronto, the consensus was that the global recession will persist until late in 2009, with the first glimmer of recovery not expected until the fourth quarter.

“I think the first half of 2009 looks pretty terrible for Canada, more like what we’ve been seeing recently in the United States,” said Don Drummond. “[There will be] some kind of recovery in the second half of the year, particularly toward the end going into 2010, but then I think an extended period of sub-normal growth. Normally we come racing out of these periods of recession, [but] I don’t think that’s going to happen.”

He believes that upcoming Statistics Canada reports will prove that, in hindsight, the turning point for Canada came in the final quarter of 2008. He reminded the audience that the problem may have started in the U.S., but that Canada has inevitably fallen victim to worsening trade conditions with our biggest export market.

South of the border, the economy is likely still worsening, even after real GDP contracted by 6% in the fourth quarter of 2008, according to Sherry Cooper, chief economist, BMO Capital Markets.

“Sentiment has fallen sharply,” she said. “Households are reducing debt for the first time in a half century and rebuilding savings amid unprecedented wealth destruction — wealth destruction estimated at about $10 trillion in the past year.”

She says this is already shaping up to be the worst recession since the Second World War, and that four million jobs will be lost, boosting the unemployment rate to 9%.

“There’s no doubt that personal savings rates ought to increase,” said Cooper. “I think what the deleveraging of the North American economy implies is slower potential growth in the longer term. It’s just a fact that we can no longer grow at a non-inflationary rate of 3% or 4%. It will be closer to 2% to 2.5% in the future.”

Warren Jestin, chief economist, Scotiabank, pointed out that growth remains a challenge around the world. While emerging markets have clearly not decoupled from the U.S. economy after all, the new middle classes of India and China remain the best bet for a non-government driver of growth.

“The Main Street fallout on the average family is just starting, in terms of layoffs in this country,” he said. “The growth drivers in this cycle are shifting very much from consumers and businesses onto infrastructure and government. Lenders and borrowers are extraordinarily cautious in this type of environment, and there is a propensity to save, as opposed to boosting consumption.”

The next six to nine months will see a continued global retrenchment, lower inflation and lower interest rates.

“This is probably the biggest cyclical adjustment we’ve seen in our lives, but most importantly as well we’re seeing a very profound shift in the global economy — probably the biggest structural adjustment that we will see in our lives,” Jestin said.

If there was any good news to come out of Wednesday’s meeting of the minds, it was that equity markets are probably already priced for the worst possible news.

“Essentially the TSX is about where it was in mid-October,” said Avery Shenfeld, senior economist, CIBC World Markets. “That’s no small compliment, because during the period of time since October, the equity analysts who were bravely looking for 16% earnings growth for TSX for 2009 were slashing that to an outright decline.

“Despite that, the equity market has essentially been trending sideways, which I took as a sign that investors were actually moving ahead of economists and equity analysts.”

If the predictions of a late 2009 economic recovery are correct, he said, then the stock market should be on the verge of starting its recovery. But he points out that investors will not recover their losses in a hurry — that may still take three to five years.

There was another ray of hope, on the employment front, as Craig Wright , chief economist, RBC Financial Group, said it was not long ago that employers were plagued by a shortage of skilled workers. He suggested that employees with the right skills will be “hoarded” by employers seeking a competitive edge in tough economic times.

Earlier this week, federal Finance Minister Jim Flaherty suggested that the January 27 budget will include tax cuts aimed at stimulating the economy. That doesn’t sit well with Drummond.

“My biggest fear is that in the guise of short-term stimulus, we’ll see temporary tax relief, which, I don’t think, will accomplish anything,” he said. “If we need a reminder that temporary tax relief doesn’t do anything, we just need to look at the U.S. experience from last spring. Probably 20 cents on the dollar got spent and 50% of that went to imports, so they got 10 cents on the dollar out of the ongoing fiscal hit.”

The other danger he pointed out is that temporary tax breaks tend to become permanent, as the public typically sees the closing of the tax-relief window as a tax hike, rather than the end of a break.

Cooper recommends that Ottawa avoid propping up “declining industries,” pointing to the forestry sector as an example. She agrees that a better use of federal funds would be building infrastructure, especially in the transportation field, and passenger rail in particular.

Shenfeld said spending money on “digging holes and filling them in” may create jobs and boost GDP in the short term, but that spending must be dedicated to building tangible long-term assets.

“There’s always a political danger that when you start talking about infrastructure spending, the temptation is to do a little bit everywhere, without necessarily focusing on where the need really is,” he said.

(01/07/09)