A view from outside the US.
A Canadian brokerage house (Cannacord Capital) takes stock overnight.
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The US
The US economy continues its confusing tale. The industrial sector is
still in a recession. Industrial production is up on a year-over-year
basis, but is about 2% off its peak. This is very reminiscent of the
1995 and other near-recession periods. The rest of the economy may
not be very confident, but continues to spend. Consumer spending
i.e., over 60% of GDP) is on track for a 2-2.5% annualised hike in the
first quarter. Expected weakness in capital spending will likely hold
first quarter GDP in the 0.25-0.5% area. There are signs that the
manufacturing area is stabilizing and we expect it to be on the rise
by the third quarter. As a result, after a decidedly weak first half
the economy should grow by about 2.5-3% in the second half of the year.
But continued balance sheet weakness will limit real growth to the
2.5-2.7% area over the next two years.
We expect that the Fed will cut rates again, but only by about 25
basis points. Why? Inflation in the US is running at a 3.6%
year-over-year pace and even the core rate is running at a too high
2.8%. We expect that inflation will average about 3-3.5% this year
and next. What the Fed must now weigh carefully is the threat that
its rate cuts and lower taxes will overstimulate the US economy. With
liquidity continuing to be pumped into the economy, long-term rates
should run in a 5.25-5.75% band through the summer. But the twin
concerns of renewed real growth and stubbornly high inflation should
also push them to the 5.75-6.25% area by this time next year.
We expect the US stock markets to continue to build a base over the
next few months. However, valuations are now as extreme on the
negative side as they were on the positive side a year ago. That
suggests that once the basing process is completed, a return to
fair-value levels of valuation and higher profit growth expectations
should push the S&P500 index up by 15-20% over the next year.
Canada
The Canadian economy continues to look a lot better than its American
cousin. Unlike the US, balance sheets in Canada are only slightly
worse than average and tax cuts continue to benefit the economy.
However, with over 80% of Canada's exports going to the US, almost
two-thirds of which are autos and industrial goods, the recession in
the US industrial area will severely hurt Canadian growth. Even so,
we expect Real GDP to rise by about 2.5% this year and should rise by
a further 2.8% in 2002.
The Canadian dollar has weakened almost back to its low water marks.
The clue to that weakness may be that foreigners sold almost $17.5
billion in bonds and over $13 billion in securities at a time when
Canadian foreign investment continued to grow. This overhang should
keep the Canadian dollar under the $1.55-1.58 area (63.2-64.5 cents
for the FX challenged) in the near term. We expect the dollar to firm
into the $1.50-1.53 area as North America's economy stabilizes later
in the year.
Canada too has an inflation rate that is cause for concern. While the
Bank of Canada's core rate is in the middle of the 1-3% target band,
it is still a limiting factor on the Bank's policy. The recent
weakness of the dollar should also restrain the Bank. As a result, we
expect that the Bank will drop rates again, but only by 25-50 basis
points, keeping Canadian rates at or above US rates. Long-term rates
should follow US rates on the short run. But, as Canada's lower
inflation rate and far lower borrowing requirements are felt, the
Canada-US long-term yield spread may well ease into the 10-15 basis
point area by year-end.
The TSE 300 is extremely - and we mean extremely - undervalued in the
non-tech areas. But, as in the US the market is still in basing mode.
As the prospects for resumed cash flow growth and for a return to
more-normal valuations work their way into the markets, we expect to
see a rise of about 12-18% in the TSE 300 index over the next year. |
