Events

CIBC/Ben Tal's WEEKLY MARKET INSIGHT - WEEK ENDING OCTOBER 30TH, 2009

NORTH AMERICAN & INTERNATIONAL ECONOMIC HIGHLIGHTS
 
Q. What can the Bank of Canada do about the value of the dollar?

A. Usually the Bank can use monetary policy to impact the value of the dollar. But given that the bank rate is already as low as it can go; the Bank cannot use monetary policy to weaken the dollar. But the Bank can intervene directly in the FX market by buying American dollars and selling Canadian dollars. History suggests that such intervention can be useful—at least to a degree. So far, the Bank is not talking about it but if the dollar regains upward momentum in the near future, such an action from the Bank is a real possibility.
 

Q. Will rising real estate prices force the Bank of Canada to raise interest rates?

A. It is very clear that the recent increase in house prices in Canada reflects a dramatic improvement in affordability. But is it too much of a good thing? The problem with any kind of a bubble is that, in most cases, you know that it’s happening, but you are not sure what do about it. Some argue that the Bank of Canada should raise interest rates in order to make housing less affordable. While this policy makes sense in a booming economy, it does not make sense in an economy that is still trying to find its poles. The Bank will not raise rates just to deal with the housing market while sacrificing the rest of the economy and risk an even stronger Canadian dollar. So what to do? So far, the Bank is doing nothing, with the hope that we are simply stealing activity from next year. If that is the case then there is no urgency to do anything at this point. But if in the coming six months, house prices continue to rise at current rates and the economy is still in an early recovery mode, the market will start speculating about some direct intervention by the Bank/government in the housing market by altering current regulations  regarding insurance and securitization.
 

Q How sustainable is the economic growth seen in the US during the third quarter?

A. The 3.5% third quarter GDP growth in the US is clearly unsustainable. Most of the increase was temporary in nature and reflects government spending and a short-lived improvement in the auto sector. My focus at this point is on US business investment which is still falling. That is important given that an integral element in formatting the market’s current view is that the Fed will start hiking rates in the second half of 2010 and by that time, business capital spending in the US will be rising by no less than 5% on an annual basis. Given that business spending has been a huge contributor to the US GDP recession, the timing of its rebound will be critical to the timing of a turn to monetary tightening. The conventional wisdom was that the US recession in the past year was consumer-led, as opposed to the investment-led recession of 2001. But the reality is that the current slump in capital spending is, in fact, steeper than the IT meltdown. Back then, the burst of the bubble meant a 12% drop in real capital spending over a two-year period. Currently, as of the third quarter of 2009, and only a year removed from its peak, capital spending is already down by no less than 20%, qualifying it as the steepest slump in business spending in the post-war era. Even as a share of GDP, capital spending is already down to the level seen at the trough of the IT meltdown and it has been by far, the largest contributor to the overall decline in GDP since the beginning of the recession. Another misconception is that the current decline in US business spending is largely due to the weak state of the American commercial real estate market. But the reality is that, so far, the largest slump in spending was in the machinery and equipment category, which is now down by 21% since the beginning of the recession, compared to a 15% decline in the non-residential real estate component. 

Note that the descent in non-residential investment began 6-8 months after spending on machinery and equipment started its nosedive. This suggests that the adjustment in non-residential real estate investment is still in its early stages. Add to it the high correlation of this business investment category with employment growth and the fact that the industrial vacancy rate is now at a dazzling 12%—a record high and a full five percentage points above levels that in the past signaled a recovery, and it becomes painfully clear that any hopes of a turnaround in non-residential real estate investment by mid-2010 are nothing more than wishful thinking.

So, the continuing decline in business investment next year will leave the market’s overall US economic growth expectations light on fuel. While talk in some quarters of a double-dip recession looks to be too gloomy given the huge stimulus still flowing next year, the long wait for a capital spending turn will keep overnight rates at highly stimulative levels for longer than the market now thinks. 

Q. To what extent monetary and fiscal policies are coordinated?

A. Officially the Bank of Canada is independent, but it does not mean that it does not take fiscal policy into account while making decisions regarding interest rates. And given the fact that by 2011, fiscal policy will act as a negative for the economy as government will stop spending and start looking for ways to reduce the deficit, it is highly possible that this situation will work to postpone the first hiking move by the Bank, or at the minimum, limits the magnitude of the tightening cycle.

Benjamin Tal
Senior Economist

Analysts say Bank of Canada will ‘not pull an Australia' by raising interest rates

Virginia Galt, Globe and Mail Update Published on Tuesday, Oct. 20, 2009 

The Bank of Canadal "" left its benchmark interest rate at a record low 0.25 per cent Tuesday, stating that while the Canadian economy is recovering, the current strength of the Canadian dollar “is expected, over time, to more than fully offset the favourable developments since July.”

Here's what the analysts had to stay after parsing the bank's statement:

Bank Governor Mark Carney ‘a man in no hurry'

“Financial markets tend to get edgy sitting still, but Bank of Canada Governor Carney is a man in no hurry to act,” Avery Shenfeld, chief economist at Canadian Imperial Bank of Canada, said in a research note.

“Drawing a parallel with Australia, where a rate hike came earlier than expected, investors have recently been pushing up Canadian short-term yields in anticipation that Canada wouldn't be far behind. To those expecting an early rate hike in Canada, the bank's message was ‘not so fast.'

“After citing a list of fresh positives – including better-than-expected global growth and improvements in financial market conditions – the Bank asserts that these will be ‘more than offset' by the drag from persistent Canadian dollar\l "" strength,” Mr. Shenfeld said.

“For the near term, before the currency impacts have had a chance to bite, the bank has ‘slightly' raised its 2009 second half forecast,” Mr. Shenfeld said. “Hitting its -2.4 per cent real GDP [gross domestic product] forecast for 2009 as a whole implies that the bank's forecast for fourth quarter growth must be close to 4 per cent.”

‘The bank is serious about implications of a further rise in the loonie to above parity'

Investment adviser Andrew Pyle of ScotiaMcLeod said the Bank of Canada employed some of “its toughest language” in warning about the threat to economic growth posed by the high level of the Canadian dollar.

Mr. Pyle said the bank's comments tell us two things:

“The Bank is serious about the implications of a further rise in the loonie to above parity [and] it is not going to pull an Australia and raise interest rates\l "" prematurely.”

Some of the loonie's recent appreciation has been attributed to speculation that the Bank of Canada would follow the lead of the Reserve Bank of Australia and raise its benchmark interest rate\l "" sooner than originally planned. However, on Tuesday, the bank repeated its conditional commitment to keep the rate at 0.25 per cent until well into next year.

“Now if we were to see sustained momentum in the U.S. economy, from the domestic sector, then the bank might ease off on this stance, but so far we're not seeing signs of that,” Mr. Pyle said in a research note.

“The U.S, is getting pumped off exports and inventories this half, while Canada is left to get its growth from consumers and builders. This combination cannot persist forever, especially if the loonie goes back and retests the highs of November, 2007 [when it hit a peak of $1.10 U.S.]”

Bank of Canada ‘sticks to its guns' on rates

“The Bank of Canada has clearly dealt a blow to the near-term rate-hike camp, recommitting to leave the overnight rate unchanged through mid-2010,” economist Eric Lascelles of TD Securities Inc., said.

“The strong housing market barely attracted a mention, while rhetoric about the damage of Canadian dollar strength was ramped up substantially. The Bank of Canada now believes the economy will not return to full capacity until the third quarter of 2011 instead of the prior view of the second quarter of 2011,” he said.

“As with previous decisions, the bank argues that it maintains ‘considerable flexibility' in its conduct of monetary policy, though we do not expect any lengthening of the conditional commitment [on interest rates] or shift into quantitative easing this the juncture.”

Quantitative easing effectively dilutes the value of a currency by increasing money supply.

Currency markets ‘shouldn't have been surprised'

The Canadian dollar was down 1.70 cents to 95.45 cents (U.S.) by midmorning after the Bank of Canada' rate announcement.

“Markets shouldn't have been surprised in this manner,” economists Derek Holt and Karen Cordes of Scotia Capital said in a research note.

“We remain of the view that the global market tendency to blindly lump Canada with the Reserve Bank of Australia's dynamics …was ill-advised, given the night-and-day differences in the Canadian economy's export exposures and currency sensitivities,” the Scotia Capital team wrote.

“Canada's exports are hitched to the weak U.S. economy versus Australia's exports to China, and Canada has among the higher degrees of import content to domestic economic activity of many industrialized economies, which mutes inflationary pressures via an elevated Canadian dollar.”

What's next? ‘On to Thursday…'

Look to the Bank of Canada's quarterly monetary policy report, to be released Thursday, for more detail on the Bank of Canada's economic outlook and its policy options, economist Michael Gregory of BMO Nesbitt Burns said.

Market-watchers were not expecting any more concrete action – beyond tough talk – to dampen the level of the loonie.

“There was no concrete action on the Canadian dollar, but the Bank of Canada jawboned its concerns more aggressively than in the last statement,” the Scotia Capital economists noted Tuesday.
 

HOUSING MARKETS REBOUND SHARPLY, SIDESTEPPING THE WORST, Oct 8 2009

TD Canada Trust followed the BoC announcement today and lowered our prime lending rate by 50 basis points to 2.50 per cent, effective March 4, 2009. 

Real estate: Where to buy now
by Duncan Hood, Moneysense

Real estate agents like to tell you that what matters is location, location, location. They're partly right. But what also matters is timing, timing, timing. Every city moves to its own economic rhythms. Smart real estate investing is a matter of knowing when to jump into the market and when to stay out.

How do you know when the time is ripe? Rather than relying upon gut feel, we decided to take a more scientific approach to the question. We compiled data on the 35 major markets tracked by Canada Mortgage and Housing Corp. We analyzed each market in three different ways — by Value, by Momentum, and by Economic Strength. We assigned each market a letter grade in each of the three categories, then combined all that info into one overall grade. We awarded an A to the top 20% of cities. Average prospects had to make do with a B, while lacklustre prospects were handed a C or worse.

Many individual factors went into each grade. To calculate Value, for instance, we began by comparing average rents to average home prices, since we figured that the most basic indicator of a home's value is how much rent it can put in your pocket. High rents indicate that, if you were hit by a financial crisis, you could rent out your home for a reasonable sum. Even if you never plan to rent out your home that is still a comforting thought.

To help us gain an even better sense of a city's Value, we looked at local wages and figured out the number of years of average household income that it would take to purchase the typical local home. We downgraded communities where local residents couldn't afford to buy homes easily; we gave highest marks to cities where they could. Our reasoning was that places where homes are affordable are places where real estate prices are solidly rooted in economic fundamentals and are therefore unlikely to plunge. The differences between communities can be huge. In Regina, a typical family needs two-and-a-half years of income to buy a home; in Vancouver, a typical family needs nearly eight years of income. Talking strictly in terms of bang for buck, Regina is a much better place to buy.

But, of course, Value isn't everything. Some cities have enjoyed surging real estate markets for reasons that have little to do with local rents or typical wages. Some of these red-hot markets are cities that have lured outsiders with their natural beauty (think Vancouver); others are communities that have enjoyed bonanzas because of skyrocketing oil prices (that's you, Calgary).

To give these cities their due we rated each of our 35 cities on Momentum, a measure of how hot each market is. To gauge Momentum, we looked at home sales in comparison to new real estate listings — a high number of sales-to-listings indicate that homes are selling relatively quickly and market momentum is therefore high. We also looked at how much home prices in each city have gone up over the last year and over the last four years. To top things off, we considered how much rents have gone up over the past four years, since rapidly rising rents indicate a community with pent-up demand for housing. If you've been following the real estate news, it probably won't surprise you to learn that the runaway winners in our Momentum survey are Regina and Saskatoon.

The problem is that the same forces that conspire to drive up prices in a city can also turn in the opposite direction. To avoid being taken in by cities with weakening economies, we devoted our final grade to Economic Strength. We looked at how fast each community grew between 2001 and 2006 (the most recent year for which figures are available). We also factored in unemployment rates (based on 2007 data) and discretionary income levels, as well as a forecast from Canada Mortgage and Housing for unemployment in each city in 2008. The Economic Strength grades that resulted from all this number crunching held some surprises: it turns out that mighty Toronto and bustling Calgary have weaker economic outlooks than Fredericton and Barrie, Ont.

Finally, we rolled our grades for Value, Momentum and Economic Outlook into one overall grade for each community. We had no runaway winners, but we did find seven cities that deserve an A-. They're a diverse lot. At the top are three Prairie cities — Regina, Saskatoon and Winnipeg — with relatively low home prices, strong momentum and good economic prospects. Just behind is Barrie, where home prices are higher and momentum is weaker, but the economic outlook is outstanding. By comparison, Sudbury, another mid-sized Ontario city, offers better home prices and stronger momentum, but dimmer economic prospects. Finally, Fredericton and Moncton demonstrate that New Brunswick has a lot to offer bargain hunters, especially as the province’s economy shows signs of life.

Our analysis suggests you can find decent prospects in each part of Canada. We caution you, though, to use our results with care. Nobody can gauge what a city's economy will be like in 10 years. Our research, though, can help you analyze each city's current strengths. And that's a good starting point for any investor.

Go West, young investor

Three Prairie cities top our list of best places to buy now

OTTAWA — Major central banks took the extraordinary step of deeply cutting interest rates in a coordinated move on Wednesday, a development that serves to underline the deterioration of the world's banking system and the threatened global recession. Central banks in Canada, the United States, Britain, the European Union, Switzerland and Norway cut their key lending rates by half a percentage point. Only Japan, among the major central banks, opted out given that its rates are already at rock bottom.

The move came after a sharp overnight drop in Asian markets and U.S. stock futures that threatened to spark another North American selloff on Wednesday. The Dow Jones Industrial Average lost 508 points Tuesday, bringing down markets globally. Britain also was rattled by a deepening banking crisis yesterday, forcing the government to announce a $80-billion bailout package.

The move gave some comfort to worried economists, but they warned the extraordinary action is not enough to end the deepening financial crisis.

“Today's co-ordinated half-point cuts from all the major central banks ... will provide at least a temporary boost to confidence, but we fear there is still a lot more work to do,” said economists at London-based Capital Economics. “For a start, the fact that the central banks have had to take such extreme measures underlines how bad market conditions have become.”

The Bank of Canada lowered its key rate to 2.5 per cent, from 3 per cent, but tried to assure the public that Canada's banks were still solid.

“The intensification of the global financial crisis is having a marked impact on all countries. In recent weeks conditions in global financial markets have deteriorated sharply, the U.S. economy has weakened further, and commodity prices have fallen abruptly,” the Bank of Canada said in a statement it issued alongside the joint statement with other countries.

“As a result of these developments, credit conditions in Canada have tightened significantly, despite the relative health of our financial institutions.”

The central bank warned that a U.S. recession and weakness in key trading partners is hurting Canada's exports. Plus, the domestic side of the economy is no longer on fire as commodity prices drop and the Canadian dollar slides, the bank noted

Toronto - By this time next year, the cost of borrowing in Canada may be a full percentage point higher, and the recent easing in oil prices will be a distant memory, notes a new report from CIBC World Markets.

"Investors are likely underestimating just how much (interest) rates will rise over the next 18 months," advise Peter Buchanan and Meny Grauman, senior economists, in the latest Canadian Portfolio Strategy Outlook.

With U.S. inflation already at 17-year highs, policy makers in Canada and south of the border will be forced to "shift their focus from supporting growth to preventing a material spillover from energy and food to core inflation," say the two economists, who expect rate hikes to begin after the U.S. presidential election and carry through into 2009.

Canadians though will see a smaller rate increase over the same period, says Mr. Buchanan, as signs increasingly point to a rapid slowing in the economy. Canada "will be in no rush to match" a forecast 200-point rise in U.S. interest rates, he says, but "above-target inflation will make it difficult for (Bank of Canada) Governor Carney to turn a completely blind eye to policy changes stateside."
As for the recent 20 per cent drop in the price of West Texas Intermediate (WTI) crude oil, Mr. Buchanan says it's just a detour on the road to higher prices. "Driven by emerging markets, global demand is still advancing," he says, noting that oil consumption in the U.S. fell by 500,000 barrels per day in the first half of 2008 year-on-year but non-OECD demand grew nearly three times that, by 1.3 million barrels. "The past year's drop in crude demand is just a quarter of the reduction that will be needed over the next five years to free capacity to fill the gas tanks of millions of new motorists in places like China and India. That adjustment is unlikely to occur without even high crude prices."

CIBC World Markets has updated its model investment portfolio based on how current market complexities are affecting Canada's main stock index, the S&P/TSX Composite.

While an "overweight" position in the materials group is maintained, a percentage point has been shifted from base to precious metals to protect against rising inflation. "Gold bullion is a traditional inflation hedge, and our analysis indicates the same holds for Canadian gold and silver mining stocks," says Mr. Buchanan. "In the absence of a sizeable move up or down in the U.S. dollar, we expect changes in inflation to be the main force affecting bullion prices over the balance of 2008."

CIBC World Markets has also taken a percentage point from its "underweight" position in bonds and added that to an already "overweight" position in cash. The shift is a defensive move against investors underestimating the potential for appreciable rate hikes in the coming year.

"That makes us less enthusiastic about fixed income investments," says Mr. Buchanan.

The model portfolio also maintains its previous "market-weight" position in equities, and long-standing "overweight" stance in energy.
Mr. Buchanan also recommends underweighting the financials, industrials, telecom services and consumer discretionary sectors. A continuing tough operating environment will make it difficult for financial shares to hang onto all of their recent gains, he says. The skid in U.S. auto sales to 15-year lows in June points to difficult times for auto parts makers as well.

While CIBC has maintained its previous targets for oil of US$125/bbl this year and US$150 in 2009, the firm has trimmed its target for natural gas to an average US$11/Mn Btu this year and $13 in 2009. Although rapid supply growth has dented gas recently, Mr. Buchanan notes the potential for firmer prices down the road as climate worries force more utilities to switch to the fuel from coal.

Susan Lambert
Regional Business Manager
Ottawa
Phone:  1-613-447-6169
e-mail:  lambersu@firstline.com