Geopolitical wild cards could derail growth in 2003, say economists

(January 27, 2003) Look out for wild cards such as a war with Iraq in 2003, economists say. Consulting firm Watson Wyatt gathers projections from Canada’s leading economists and portfolio managers for its annual survey of economic expectations, released last week.

The survey contains positive forecasts for some key economic indicators, with economists expecting the Canadian and U.S. economies to grow by about 3% in 2003. According to respondents, the Canadian economy will continue to outperform the U.S. in the short and medium terms, helping to boost corporate profits by 8.5% by the end of the year.

Geopolitical threats and the risk of war with Iraq are factors that could hinder economic performance, derailing recovery in the U.S and, subsequently, growth in Canada.

“The main risk with respect to the Canadian outlook is if recovery in the U.S. falters,” said Paul Ferley, assistant chief economist at the Bank of Montreal. “This implies the indirect risk of U.S. business confidence remaining weak and the risk of a major military conflict breaking out,” he said, both of which could have a dampening effect on activity in the U.S.

Leo de Bever, senior vice-president, research and economics at Ontario Teachers Pension Plan Board, also sees such political volatility as a threat to short-term growth. “To some degree this is going to condition near-term growth,” he said. “In particular there will be a lack of decision-making… during periods of war or the threat of war, people hang back until things clear up.”

“Given that the recession in the States was an investment recession to a large extent, that’s going to put a damper on the recovery because one of things that kept the economy going was consumer spending and that seems to have petered out,” de Bever said.

Looking at the outlook for equity markets, Patti Croft, managing director and chief economist at Sceptre Investment Counsel, talked about whether or not the current three-year bear market will stretch into four. Although she sees equities “at fair value at best,” she does think that earnings could bring some positive surprises on the up-side, especially in the U.S.

“Corporate profits are improving, cash flow is rising, there’s been a lot of balance sheet repair, and the fundamental backdrop is very positive,” she said.

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Last year economists surveyed really missed the mark, forecasting 9% to 12% returns on equity markets. In fact, the Toronto Stock Exchange experienced a 13.9% drop. This year, respondents predict Canadian and U.S. equity markets will produce returns of 9.5%, with international markets delivering 8.5% in 2003. These returns are 150 to 350 basis points lower than forecast last year.

De Bever is not positive about the overall outlook for asset returns. “It’s a bit of a Hobson’s choice,” he pointed out. “If you believe the equity premium is back, then the stock market is way over-valued. If you don’t think it’s back, then your floor for returns is going to be very low. So take your pick. I think if you can get CPI plus 3.5% out of the next 10 years you’ll be lucky.”

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What’s your reaction to these economists’ and portfolio managers’ predictions for the Canadian and U.S. economies? Will they miss the mark again this year, or are you as optimistic as they are? Share your predictions in the “Free for All” forum of the Talvest Town Hall on Advisor.ca.

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Caroline Cakebread is a Toronto-based investment writer.

(01/27/03)