U.S. faces slowdown, not recession: BMO Harris

A slowdown in the U.S. economy is inevitable, but a full-fledged recession is not likely in the cards, according to the heads of investment at BMO Harris Private Banking.

“I still believe we have a strong global economic recovery in place, notwithstanding whatever slowing does occur south of the border, and as a result, we have the conditions that provide a fairly solid basis for the Canadian economy and the very resource-dependent Canadian equity market,” says Paul Taylor, chief investment officer, BMO Harris Private Banking, Toronto.

Taylor has not completely written off the chance of a U.S. recession, however, but says the odds are only 30% that this will happen. With relatively low inflation, the U.S. Federal Reserve is able to focus its monetary policy on stimulating the economy.

“The U.S. market has not only gotten accustomed to but maybe even addicted to Fed rate cuts to push values higher,” says Jack Ablin, CIO, Harris Private Bank in Chicago. “Just like his predecessor, Fed chairman [Ben] Bernanke is focused on the markets and does want to see an orderly flow.”

Concerns over disruption in the housing market are likely to keep interest rates low, Ablin says, which will also ease the current credit crunch. The fly in the ointment is that commodity prices continue to rise and increased costs will either squeeze corporate margins or be handed down to consumers.

“In Canada, it’s a very different story,” says Taylor. “We do not have an inflation issue in Canada at the national level — we have a regional inflation issue.”

As such, the Bank of Canada has some latitude to follow the lead of the Federal Reserve. If the Fed cuts its rate, the BoC will be able to stave off another run-up in the Canadian dollar by also cutting rates.

So where does this leave investors?

“There’s huge opportunity to pick up some incremental performance by identifying the markets that will tend to outperform,” says Ablin. “The good news is that identifying expensive markets and avoiding them isn’t as hard as it sounds.”

Relative price-to-earnings ratios alone can be useful if a given index contains enough constituents to make it statistically significant, such as the S&P 500 or the Russell 2000.

“We have a somewhat inefficient Canadian equity market, so we do focus on adding value through our Canadian equity management,” says Taylor. He uses a similar approach to Ablin in determining allocation among asset classes.

Strong demand for the commodities that Canada supplies to the world is expected to continue as emerging economies are increasingly fuelled by domestic demand. As the middle class in India and China grow, their consumption levels will lessen global reliance on the American economy.

Historically, Ablin says his team in Chicago has added commodities to their portfolios only when there are cyclical opportunities. Now they are considering commodities to be a permanent addition.

“This is not a 12- to 18-month issue,” Taylor says. “This is an issue that could be 12 to 18 to 30 years, in terms of how long it takes to play out.”

Filed by Steven Lamb, Advisor.ca, steven.lamb@advisor.rogers.com

(10/29/07)

Steven Lamb