Sector shifts present challenges

(January 5, 2005) Experts predict a very different Canadian economy will emerge in 2005. While they remained upbeat, economists gathered this morning at the Economic Club of Toronto told members that making money for clients in the year to come will be a more difficult task.

In short, growth in the economy needs to come from the domestic sector. Interest rates are expected to remain steady or go lower, while Canadian equities and income trusts will still appeal to investors. But corporate profits are at an all-time high and the dollar is wreaking havoc in vocal, albeit small parts of the economy, notably in the manufacturing and export sectors.

“Those of you in wealth management have a tough job in 2005,” says Don Drummond, chief economist at TD Bank Financial Group. “I don’t think it’s an easy environment.”

But the news is not all bad. Corporate balance sheets across the country are looking healthy and firm corporate investment activity is expected in 2005.

“Corporate balance sheets are in great shape,” says Drummond. It’s good news, especially for manufacturing companies and others feeling the pinch created by a higher Canadian dollar. To offset that, companies are widely expected to invest in technology and productivity upgrades while the higher currency lowers the cost of machinery and technology imports. Layoffs, however, might be the negative result likely from a push for greater productivity.

Overall, economists put growth projections between 2.5% and 3%. “This year is going to feel a lot like last year,” says Craig Wright, chief economist at RBC Financial Group. The change is showing up in sector shifts, with the spending money generated from the housing boom in 2004 is beginning to dry up slightly, and investment is moving from real estate to other sectors of the economy.

South of the border, U.S. consumers are starting to show signs of being tapped out, or “Bushed,” after four years of tax cuts and record low interest rates. “There are only so many cars you can stuff in the driveway,” says Drummond.

On the other hand, the U.S. bond market is still well supported by the Central Bank of China and the Bank of Japan. “Like it or not, Asia will continue to buy U.S. treasuries even though they know at some point they will take a loss in those positions. It’s really a cheap form of industrial policy to keep their economies moving,” says Avery Shenfeld, senior economist at CIBC World Markets. “The U.S. bond market will remain well supported even though the Federal Reserve probably has another couple of rate hikes to come.”

Meanwhile, in Canada, consumers seem to be holding their own. Although debt levels are rising, and income levels are not increasing to match spending rates, Canadians are positive, and continued low interest rates here are contributing to “near historic” lows in debt servicing numbers. “It’s not in any way restraining consumer spending,” says Wright. “We’re looking at fairly solid consumer spending as we go forward.”

Filed by Kate McCaffery, Advisor.ca, kate.mccaffery@advisor.rogers.com