Growth to remain steady, despite shifts

The Canadian economy is expected to continue its steady growth rate for as far out as anyone cares to predict, but the driver of that growth will shift in 2006, according to Watson Wyatt’s annual survey of Canadian financial organizations and research institutions.

“Over the past two years, Canadians have been spending at above-normal levels, while the personal savings rate has fallen below zero,” said Terence Yuen, research economist with Watson Wyatt Worldwide.

“Respondents do not expect this spending rate to be sustainable and therefore anticipate this shopping spree will cool down,” he says. “On the other hand, participants expect business investment to continue its upward trend in the short-term thanks to continued high energy and commodity prices, strong profit levels and rising capital utilization rates.”

Survey respondents predict business investment will grow 7.1% in 2006, while consumer spending will grow more slowly, at about 3%. The overall GDP growth rate is predicted to average 3% for as far out as 2020.

Stronger business investment is expected to drive growth in labour productivity, which has languished at below 1% growth for the past five years. Respondents see productivity increasing by 1.6% this year and growing by 2% over the long term.

With productivity driving corporate profits, unemployment is expected to remain relatively low. Over the longer term, demographics will play a role in lower unemployment, as retiring baby boomers create a vacuum in the workforce. Some predict the jobless rate will fall below 6%.

The increasing number of retirees will strain pensions from the demand side, while continued low interest rates will dig into fixed income portfolios. Three-month T-bills are expected to yield 3.75% this year, while 10-year bonds are seen edging higher to 4.3%, resulting in a relatively flat yield curve. Meanwhile equity returns are expected to be about 8%.

“With a single digit equity market return, a flat yield curve and the weak funding status of many pension plans, sponsors should brace themselves for another tough year,” said Ian Markham, director of pension innovation at Watson Wyatt.

“The yield on Canadian long bonds is not expected to bring any relief, so any improvement in pension funding status will have to come from sponsors’ contributions as opposed to market conditions,” he said.

Investment managers may not be able to rely on foreign investments to help much, either, as the Canadian dollar is expected to continue to rise. More than 61% of survey respondents predict the loonie will trade within a range of 85 to 90 cents U.S. for the next 10 years.

With increasing liabilities and diminishing returns, two-thirds of respondents said they planned to move away from the traditional “stocks and bonds” balanced portfolio and implement more creative strategies, including absolute return investing and matching returns to liability growth.