Economists’ predictions for 2008

As 2007 comes to a close, it’s only natural in the financial world’s forecast-happy climate that a number of institutions have already started predicting what will happen next year.

The general consensus is that the Canadian dollar will remain somewhere around par, the U.S. economy will slow down further, and the markets will be just as volatile as they were this summer.

Ernie Ankrim, chief investment strategist at Russell Investments, says that while markets will be disruptive in early 2008, look for things to calm down in the latter half of next year. “Continued uncertainty and sub-prime write-offs early in 2008 will likely give way to more transparency and finally liquidity for structured investments,” he says. “Some terrible pain aside, the markets should celebrate this development and the removal of the uncertainty as we head into the second half of the year.”

An economist at the Bank of Montreal also expects the sub-prime fallout to cause continued problems in the stock market in the first half of the year, but it shouldn’t force North America into a recession. “We are persuaded that the predicament is more a crisis of confidence in the financial system… than a prelude to a recession and a bear market,” says Ben Joyce, managing director, portfolio strategy, at BMO Capital Markets. “Because of the difficulties in sorting out the sub-prime securitization issuers, the current correction is evolving as shallower but more prolonged.”

Joyce expects the central bank to cut interest rates to below 4% by early next year. He says this easing “should help limit the economic fallout from the credit crunch to a global slowdown rather than a recession.”

TD Waterhouse is also on the side of no recession in 2008. Bob Gorman, chief portfolio strategist for TD Waterhouse, says there’s been so much made of the sub-prime mess that it’s already been factored into current market prices. “Therefore, other strong fundaments, when combined with the stimulative effect on markets of the presidential cycle, will outweigh the sub-prime impact and keep the economy out of recession territory,” he says.

In fact, Gorman predicts that the U.S. stock market will rise for the sixth consecutive year. He says that some downward pressure on the Canadian dollar will help the value of U.S. investments, and presidential election years usually bring “solid, positive” stock market returns.

For many economists, the U.S. housing market is still a big issue. Gorman says the faltering U.S. housing sector has been offset by “surging” U.S. exports, but Doug Porter, deputy chief economist at BMO Capital Markets, says more mortgage resets will occur in the first half of 2008. “After that point, U.S. housing is expected to eventually hit bottom,” he says.

However, the latter half of ’08 could see an improved housing sector as the market begins to recover. If that happens, Porter explains, the U.S. dollar could improve after “a six-year stretch of almost continuous decline.”

It’s still unclear what kind of impact future sub-prime woes would have on the corporate debt market, so BMO says investors should be cautious. Despite the uncertainty, the bank still expects financial institutions to issue new debt. “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,” says the bank’s economists.

No one argues that the Canadian dollar had a pretty spectacular year, and most economists think the buck will stay strong — though not quite as robust as it has been the past few months.

BMO says many of the same factors that supported the dollar’s appreciation — high M&A flows, global demand for commodities — will help drive the loonie in 2008. The bank says that the dollar’s performance next year will be based on several key factors including global economic growth, global diversification into non-American-denominated assets, U.S. and Canadian monetary policy, and the overall health of the global financial system.

As for investing, TD Waterhouse expects large caps to dominate the U.S. market. Tech companies in particular, such as Microsoft and Oracle, will benefit from “pent-up demand for their products, strong balance sheets among their corporate clients and surging U.S. exports.”

Russell Investments also thinks large cap will do well next year. Ankrim says large, internationally diversified companies will outperform small stocks.

Fixed income investors will likely earn between 4% and 4.5% in 2008, says TD. Economists predict slower economic growth to translate into a lack of upward pressure on bond yields.

TD’s economists say investors should be weary of emerging markets next year. They explain that the group as a whole isn’t cheap anymore and monetary policy is tightening in many cases, such as in China, where investors need to look out for rising inflation. The sector is also as volatile as ever and that could have a negative effect on emerging market stock prices.

Even though 2008 hasn’t started yet, already there’s talk that 2009 will be a great year for the economy. That hopeful forecast could have a positive effect on next year’s economic climate. “Optimistic outlooks for the economy in 2009 should cause earnings multiples on equities to rise ahead of the anticipated positive developments,” says Ankrim. “This would cause equity returns to approach mid- to upper-teens even while ’08 earnings grow at a slow pace.”

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(12/28/07)

Bryan Borzykowski