Transcript Global Outlook 2006 – Chicken Little or Peking Duck?

Global Outlook 2006 –
Chicken Little or
Peking Duck?
January 17, 2006
Presented by:
Patricia Croft
Vice President & Chief Economist
Phillips, Hager & North Investment Management Limited
Est. 1964
Outlook 2006
It’s All About Oil and Inflation
 Global growth still healthy and better balanced
 Some improvement in Europe and Japan – Canada
remains strong
 Soaring energy prices have had little impact but…
 Storm clouds on the horizon

Tightening Fed

Housing bubbles and yawning current account deficit

Protectionist sentiment

Energy prices
70
0
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
US$/barrel
Crude Oil Prices Still Elevated –
Chicken Little?
WTI Crude
60
50
40
30
20
10
Long-term Price of Oil Has Increased – But to
$45 not $100
 Days of $22-28/barrel are behind us
 Global demand shift
 Alternative resources take time to develop
 Refinery capacity is limited and inadequate
Monetary Policy: Key Theme for 2006
Central bank monetary policy normalization
Percentage points
4.0
Tightening since trough
3.50
3.5
Tightening in last year
3.0
Estimated distance from neutral
2.5
2.0
1.75
1.75
1.5
1.0
1.00
0.50
0.5
0.00
0.0
-0.5
U.S.
Canada
Australia
U.K.
Eurozone
Japan
Estimated neutal rate = LR core inflation target + LR potential real GDP growth rate
House Prices Still High
Index, 1994Q1 = 100
300
250
U.K.
Australia
U.S.
Canada
200
150
100
50
1994
1996
1998
2000
2002
2004
Outside North America, Things Are Looking Up
 UK in a soft spot but has likely bottomed
 Europe doing better – interest rates still low
 Japan improving – end of deflation in sight?
 China still strong – now bigger and better
 Global growth holding up but likely to ease in 2007 as
lagged effects of rate hikes start to hit home globally
UK Economy on the Mend?
12
% change year ago
10
Retail sales
Manufacturing output
8
6
4
2
0
-2
-4
-6
-8
1997
1998
1999
2000
2001
2002
2003
2004
2005
Will 2006 Be Europe’s Year?
20
Year-over-year % change
15
Real GDP
Private expenditure
Fixed Capital Formation
Exports
Italy
France
Germany
Real GDP
Private expenditure
20
Fixed Capital Formation
Exports
15
15
10
10
10
5
5
5
0
0
0
-5
-5
-5
-10
-10
-10
2000 2001 2002 2003 2004 2005
2000
2001
2002
2003
2004
Real GDP
Private expenditure
Fixed Capital Formation
Exports
20
2005
2000
2001
2002
2003
2004
2005
Japan’s Recovery – Is This the Real Thing?
 Corporate profits are improving and business
investment is increasing
 Private consumption and employment are
increasing moderately
 Exports and industrial production are picking up
 Risk is the impact of oil prices on both domestic
and overseas economies
25
0
Jan-99
Apr-99
Jul-99
Oct-99
Jan-00
Apr-00
Jul-00
Oct-00
Jan-01
Apr-01
Jul-01
Oct-01
Jan-02
Apr-02
Jul-02
Oct-02
Jan-03
Apr-03
Jul-03
Oct-03
Jan-04
Apr-04
Jul-04
Oct-04
Jan-05
Apr-05
Jul-05
Oct-05
Percent of total
Japan’s Reliance on China Growing but U.S. Still
Top Dog
Japan's key export markets
40
35 32.1
30
33.7
28.1
20
15
23.4
Export share, USA
Export share, China
Export share, Other Asia
14.1
10
5.1
5
China Vaults to Number Four Global Economy
New GDP
Old GDP
Tertiary
32%
Primary
15%
Secondary
53%
$1.6 trillion US
Source: National Bureau of Statistics
Tertiary
41%
Primary
13%
Secondary
46%
$1.9 trillion US = 20% increase!
China’s Far Reaching Impact
 It has altered world trading patterns, shifting income
 It has pressured wages of low skilled workers in rich
countries
 It has helped companies increase return on capital
without pressure from workers for higher wages
U.S. Economy Remarkably Resilient
 Despite higher oil prices, natural disasters and
consumer worries, real growth still strong
 Federal Reserve appears to be close to end of
tightening cycle
 Biggest risk: U.S. consumer

Negative personal savings rate

Rising debt servicing costs

Higher energy costs

Real estate reliant
Why is the Fed Still Tightening?
2
4.9%
88
3
86
4
84
5
Cap U
LR avg = 81.4%
6
%
82
80
7
78
8
76
Q4 2005
Q1 2003
10
Q2 2000
Q3 1997
Q4 1994
Q1 1992
Q2 1989
Q3 1986
Q4 1983
Q1 1981
70
Q2 1978
11
Q3 1975
Unemployment rate (right)
Q4 1972
72
Q1 1970
9
74
Capacity utilization rate,
all industries (left)
12
%
90
US capacity indicators
Will the Fed Tighten Too Much?
Yield Curve is Flat But Real Rates Still Low
US yield curve slope - 10-year Treasury bond - 3-month T-bill
Percentage points
5
4
3
2
1
0
-1
%
Real US 3-month T-bill rates
7
6
5
4
3
2
1
0
-1
-2
-3
Core Inflation Well Behaved – So Far
US consumer price inflation
Percent, Year-over-year
18
15
Core CPI
12
Headline CPI
9
6
3
0
-3
1960
1966
1972
1978
1984
1990
1996
2002
U.S. House Prices Continue to Surge
Sustained low interest rates tend to fuel asset bubbles
US Real House Prices
170
160
Index
150
140
130
120
110
100
90
1975
1980
1985
1990
1995
2000
2005
Source: Office of Federal Houising Enterprise Oversight, Bureau of Labor Statistics
U.S. Consumer Using Home as a Cash Machine
12
Net equity extraction through cash-out refinancing
As a percent of disposable income
10
8
150
6
100
4
50
2
Q1 2005
Q4 2003
Q3 2002
Q2 2001
Q1 2000
Q4 1998
Q3 1997
Q2 1996
Q1 1995
-2
Q4 1993
-50
Q3 1992
0
Q2 1991
0
% of disp income
200
Q1 1990
US$ Billions, quarterly rate
250
Source: "Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four
Family Residence”, Kennedy and Greespan, Federal Reservce 2005
Current Account Deficit Still a Dollar Risk
US Dollar and Current Account Balance
2
150
1
140
130
-1
120
-2
110
-3
100
-4
-5
% of GDP (left)
-6
Trade-weighted value of US dollar
against major currencies (right)
90
80
-7
70
1973 1975 1978 1980 1983 1985 1988 1990 1993 1995 1998 2000 2003 2005
Index
% of GDP
0
Canadian Economic Growth Strong But
Unbalanced
 Higher energy prices benefit Canada as we are a net
energy exporter
 However, high energy prices create a transfer of
wealth from central Canada to Alberta
 The Canadian dollar has become a petro currency –
a stronger dollar will further challenge the
manufacturing base
 Fiscal policy is loose – monetary policy is tightening
Canadian Job Creation Has Been Very Strong
Cumulative job creation since January 2004
500
400
Total
350
Full-time
300
250
200
150
100
Nov-05
Sep-05
Jul-05
May-05
Mar-05
Jan-05
Nov-04
Sep-04
Jul-04
May-04
0
Mar-04
50
Jan-04
Thousands
450
Alberta Roars While Central Canada Reels
2006 provincial real GDP growth
7
6
4
%
%
5
3
2
1
0
BC AL
SK MB ON
Source: RBC Financial Group
QC
NB
NS
PEI
NL
16
14
12
10
8
6
4
2
0
-2
Provincial labour markets
Unemployment rate (ytd avg %)
Job growth (ytd % change)
NL
PEI
Provincial retail sales and housing
15
ON
BC
SK
MB
AL
AL
BC
CPI (ytd avg %)
Wages & salaries (ytd % change)
8
7
6
%
%
QC
9
5
0
5
4
-5
3
2
-10
-15
NS
Provincial price pressures
Retail sales (ytd % change)
Housing starts (ytd % change)
10
NB
1
AL
SK
MB
QC
NB
BC
ON
PEI
NS
NL
0
PEI
NS
MB
NL
NB
QC
SK
ON
Canadian Inflation Indicators Flashing Yellow
Capacity utilization and unit labour costs
90
8
Capacity utilization
Unit labour costs
6
86
4
82
2
80
78
0
76
-2
2005
2002
1999
1996
1993
72
1990
74
1987
%
84
-4
Annual % change
88
For Now – Inflation Remains Tame
5.0
4.5
Canadian CPI inflation
Core (excl. 8 most volatile items)
Headline
4.0
3.5
%
3.0
2.5
2.0
1.5
1.0
0.5
0.0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Bank of Canada Back in Tightening Mode
Central bank policy interest rates
7
6
(%)
5
Bank of Canada
U.S. Federal Reserve
4
3
2
1
0
2001
2002
2003
2004
2005
Canadian Dollar Was A Star in 2005
Performance of the Canadian dollar in 2005
20
18
Change in value against selected
currencies from Jan. 1 to Dec. 31 2005
16
14
%
12
10
8
6
4
2
0
U.S dollar New Zealand Australian
dollar
dollar
UK pound
Euro
Yen
Outlook 2006 - Summary
 Global growth set to slow as weakness in the U.S. is
partially offset by renewed vigor in Europe and Japan
 Canada strong for now – growing regional disparities
will challenge policy makers
 Monetary policy normalization process to continue
 C$ overvalued – U.S. bear market at hand
 Risks

Energy prices/house prices

Geopolitical instability

Mother Nature

Protectionist sentiment
Easy Monetary Policy has Encouraged Risk
Taking
60
55
CBOE Volatility Index (VIX)
Old VIX (based on S&P 100)
New VIX (based on S&P 500)
Black Monday
50
LTCM
Above 40 = Panic
40
Gulf War II
35
9-11
Asian Crisis
Gulf War I
30
25
20
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
10
Below 20 = Complacency
1987
15
1986
Index
45
Global Yield Curves Flattening
Yield curve slope, current and year ago
10 year - 3 month yields, bps
250
year ago
current
200
150
100
50
0
-50
Japan
Eurozone
Canada
US
UK
Long Bond Yields Still Low and Range Bound
10-year government bond yields
7.0
2.5
6.5
2.0
6.0
5.5
1.5
%
%
5.0
4.5
4.0
3.5
3.0
2.5
2000
1.0
Canada (left)
US (left)
Germany (left)
Japan (right)
0.5
0.0
2001
Source: Datastream
2002
2003
2004
2005
Japan Soars – U.S. Sputters
Major stock markets since Jan. 2004
Index: Jan. 1 2004 = 100
160
150
140
S&P 500
S&P/TSX
MSCI EAFE (US$)
Nikkei 225
130
120
110
100
90
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
P/E Ratios Have Converged
28
S&P 500
TSX
MSCI EAFE
26
Ratio
24
22
20
18
16
14
12
1998
1999
2000
2001
2002
2003
2004
2005
Asset Mix Summary
 Overweight equities, neutral on bonds,
underweight cash
 May add to U.S. or EAFE equity holdings
 Corporate earnings still strong – corporations flush
with cash
 Valuation for stocks is reasonable, particularly in
the U.S.
 Proximity to end of Fed tightening cycle is a
positive factor