BMO: Canada, emerging markets still strong

Investors should be cautiously optimistic about the outlook for Canada and emerging markets, two top experts at BMO said during a conference call today.

The Canadian scene

“On the economic front, we continue to perform relatively well,” said Paul Taylor, chief investment officer, BMO Harris Private Banking. Both June and July were positive months—GDP rose 0.3% in July—following a weak April and May. “But we certainly are feeling the headwinds of weak growth south of the border and the noise from euroland.”

On the equity market front, Canada’s been a relative underperformer on a year-to-date basis. “We’re well behind the U.S. equity markets. Year-to-date the S&P/TSX is down 13.1%, compared to the S&P 500, down 7.7% year-to-date. Canada has suffered along with other global equity markets,” Taylor said.

He suggested the main driving force behind present conditions in the Canadian economy and particularly the Canadian equity market is the lack of visibility on the global macro scene. “The question is whether there a comprehensive plan that will emerge over the short to medium term related to solvency of key sovereigns in euroland. Because the systemic risk related to that is meaningful and as investors we have to see that there is a comprehensive plan to deal with the fundamental root causes of the issues,” Taylor said.

The situation in the U.S. is very different from that in the eurozone, he explains. “It’s not necessarily a solvency issue but a political issue [in the U.S.]. There are lots of different levers folks on Capitol Hill can pull to right the debt and deficit situation. They just have to get their act together, and it’s nice they’re going into an election year because hopefully that can come together.

“From a Canadian perspective, there is a massive cloud that hangs over both the U.S. and in particular euroland, and domestic conditions here will turn worse if things don’t improve in the near term.”

Taylor concluded his remarks by suggesting key opportunities in Canada centre on high-quality dividend paying stocks.

Trouble abroad

Serge Pépin, head of investments at BMO Investments Inc., notes Asian financial markets have not been immune to the ills of the major North American and European economies. “The impact should not be dismissed as Europe still represents a major market for China and other exporting Asian and emerging markets,” he said.

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“This quarter was one of the worst on record in terms of equity returns for many Asian markets. As we turn the page on Q3 the Hang Seng recorded a 21% loss, Japan experienced an 11% retreat, and we awoke to news this morning that China’s industrial output had eased for a third consecutive month. In September, the PMI (Purchasing Managers Index) remained below 50, which is the magic number that divides expansion from contraction. This suggests the world’s second largest economy is not immune to global headwinds as domestic and overseas demand remain weak.”

Pépin says the silver lining in all of this is that the rate of decline has moderated a little, which could mean the slowdown is beginning to stabilize.

“I don’t believe China will experience a hard landing, as economic growth is expected to remain around the 8.5%-9.5% range,” he said. “The dismal equity returns we’ve seen so far out of the Chinese equity markets seem to have much more to do with worries about Beijing’s policy tightening measures and the quality of loans made by Chinese banks.”

Pépin suggests the U.S. consumer can’t be relied upon to get us out of the current economic malaise. “We’re of the opinion that developing markets hold the key to economic revival. The combination of inflation peaking and a growing middle class in many Asian nations is making emerging markets compelling and attractive propositions.”

Indonesia, the Philippines, and South Korea are prime examples of countries benefiting from growing domestic demand, strong economic growth potential, less global macroeconomic exposure, and increased spending power, according to Pépin.

“Inflation is still a concern in many emerging markets, India being a case in point, but again inflation seems to be approaching a cyclical peak in many of these countries so maybe that allows a start to an easing of the pace of tightening measures,” he said.

Yet there are still a number of risks faced by investors looking to emerging markets. For example, “in India, government corruption is a big problem and that’s dissuading investment. The positive thing is there are widespread anti-corruption demonstrations; the government has agreed to discuss proposals for an anti-corruption framework which could encourage investment.”