B.C. Economy: Running with the Bull Market

Uh oh. As 2007 rolls around, we’re starting to hear many whisperings of the r word. That’s r for recession, a term for a macroeconomic malaise that, for the most part, is really the concern of accounting wonks, economists and fear-mongering politicians, but for some reason captivates the press and therefore the ordinary investor. And what usually happens when the r-word whispers get louder is that another r word starts to take hold in the minds of those ordinary investors. That’s r for retreat, as in sell off, run for cover and hunker down.

But not to fear. Here in B.C., at least, rumours of the death of the long-running bull are greatly exaggerated. Far from a decline in GDP, economists are predicting continued boom times in 2007, with economic growth continuing unabated. Canada is now a country with two economies. Central Canada, with about 65 per cent of Canada’s GDP, is currently in decline because its huge manufacturing base has been whacked by the high dollar. It’s already flirting with recession (technically defined as two consecutive quarters of declining GDP). But anybody in the West would look around at the continuing commodities boom, global trade, labour shortages, frantic building activity and sing a different tune. Helmut Pastrick, chief economist for Credit Union Central of B.C., laughs at the thought of a local recession. “Robust growth for a few years,” he cheerfully predicts. So does Business Council of B.C. economist and VP of policy Jock Finlayson. “Unless there’s a global calamity, I don’t see it happening. If anything, we’re too buoyant. We’ll be more than a percentage point above our natural long-term growth rate [of about 2.5 per cent],” he says. Sure, the two economists add, there may be some softening in traditional sectors like forestry, fishing and tourism, but domestic spending on consumer items and non-residential construction (some of it sparked by the 2010 Olympics) is taking up the slack. Also, says Pastrick, even if there is a wider recession in the works, it will be shallow and unlikely to last for long. “The business cycle is different now,” he explains. “Globalization, the opening up of trade, technological change, transportation improvements and the growth of multinational firms has moderated the imbalances in the world’s economy. We’re seeing fewer recessions and the ones we do have tend to be shorter.” In a more detailed look at B.C. in 2007, Finlayson lists some pretty joyous projections. He sees a consensus forecast for a GDP growth rate of 3.7 per cent, $101 billion in major construction projects on the order books and continuing job growth throughout the province. As a result, we’ll see continuing growth in the retail industry because of higher consumer spending. Further, he says, the province will likely see above-average growth over the next three to five years in oil and gas extraction; transportation (much of it Gateway-related); scientific, technical and engineering services; mineral exploration; financial services; and some technical areas such as software and new media. But there are some sectoral risks, says Finlayson. Chief among these is a softening U.S. demand for B.C.’s biggest export: lumber for homes. We ship about $5-billion-a-year worth of wood to the U.S., so any housing-bubble burst down there is going to hurt, likely resulting in some mill closures and layoffs. Even the refund of softwood lumber duties won’t soften the blow much for lumber producers if housing in the U.S. really takes it on the chin. Other sectors at some risk include tourism, film and pulp and paper, which are very dependent on the Canadian dollar. Most predictions have the loonie settling at about US$0.80 this year, but if it continues to fly higher, look for continuing woes in those areas. And, of course, any slowdown in the roaring global commodities market would have an impact on B.C. resource harvesters, such as metals producer Teck Cominco or chemical producer Methanex. Meanwhile, falling natural-gas prices have gas drillers in the Peace Country starting to talk about packing up their equipment and planning layoffs in 2007. So where do you put your money in 2007, besides toward a new plasma TV? In times of uncertainty, say most advisers, you move off the growth path and become more defensive. That means paring back on equities (stocks) and holding cash, says portfolio manager Nick Majendie of Vancouver-based national brokerage Canaccord Adams. Vancouver’s Odlum Brown brokerage says look for high-quality value stocks that hold up in tougher times. Odlum Brown analyst Felix Narhi says clients are being put into such generally boring but solid sectors as consumer staples, health care, financials and information technology, particularly in the U.S. where stocks in these sectors are still relatively cheap. “Defence is often the best offence,” Narhi explains. “Our position is that the recession risk is growing in the U.S., and that means resource-driven economies might get hurt. So we’ve been moving to more defensive positions, especially in the U.S. where many of the bigger listed companies are really global companies. We feel the big conservative U.S. stocks have some legs.” Narhi adds that there’s another factor in action as well: a five-to-six-year psychological cycle regarding investments, which means that most investors tend to fixate on the rearview mirror instead of looking through the windshield and putting their money in what’s been hot most recently. Commodities and energy have been hot, but their cycle is probably near its end, Narhi says; big-cap conservative stocks have been cold for some time, so are likely to come back in favour soon. Vancouver financial adviser Diane McCurdy, author of the retirement-planning book How Much is Enough? Balancing Today’s Needs With Tomorrow’s Retirement Goals, suggests that a well-diversified portfolio of blue chips, targeted real estate and income investments would likely see anyone through rough weather. And, she points out, don’t forget that in Canada (where there are 10 million of them), baby boomers are in their prime investing years, and that should drive the markets for some time. Let’s leave the last word to economist Pastrick, who observes that in B.C., where the economy is mostly made up of small businesses, most people’s investments flow to two main areas: housing and their businesses. We all know that housing’s been sucking up much of investors’ cash in the past couple of years, but that might cool off in 2007. But investment in business – whether through reinvestment by business operators (causing some of that job growth you keep hearing about) or through private equity buying up our companies – has been picking up. Pastrick sees that as this year’s local growth area. “If you look at the number of business start-ups going on or being planned, I think you can see where the money is going,” he says. There’s another factor around that might influence those with cash burning a hole in their pockets and a hankering for a new home: the matter of income trusts. Much strum and drang followed last November’s income-trust debacle, when the federal government decided to slap a tax on them come 2011. Everybody bellowed about how much money people “lost” and began toting up the fallen values of the booming trusts. Among B.C.-based income trusts, A&W Revenue Royalties Income Fund fell 23.77 per cent, Boston Pizza Royalties Income Fund was off 20.15 per cent, Keg Royalties Income Fund was down 19.93 per cent and Gateway Casinos Income Trust sank 19.16 per cent. Numbers like that were enough to put people off the sector forever. But the reality, advisers point out, is that many investors didn’t really lose anything, or if they did, it wasn’t that much. Losses are incurred if you have to sell off an investment for less than you paid for it: they aren’t determined by how much the investment was worth on paper at its peak. Unless they bought a week before the government move, investors didn’t actually lose money because trust prices have been climbing for some time. The S&P/TSX capped-trust index has been growing by roughly 10 per cent a year for five years. Trusts have also been paying out good yields, which add to investment profits. For example, if you bought Acme Income Trust for $10 three years ago and it’s been paying out 10 per cent annually, your cost is really only $7. And if Acme climbed to $20 and fell 25 per cent after the November crash to $15, you’ve still doubled your investment. And that original cost will keep falling as the fund continues to pay out tax-free for four more years. So don’t gnash your teeth and ignore income trusts, the advisers say. In fact, some contrarians, like Vancouver fee-only investment adviser Adrian Mastracci, president of KCM Wealth Management, suggest that for those who can handle the risk, now might be a good time to buy some because their prices are down and you have a four-year window to cash in on those yields. As with any investment, there are several riders, of course. Seek out quality. The field for some time has been full of trusts of dubious quality (if anything, the feds’ move might weed out the weaklings). And don’t make any big bets. Diversification might not make you as much in the short term, but it spreads risk and helps you weather the down times. For proof, look at some of the diversified trust funds. After the crash, one, Sentry Select Canadian Income, was actually still up marginally.

The ripple effect Canada’s export-fuelled economy has traditionally been fairly predictable: as the U.S. and global economies go, so goes our economy. But right now several big question marks are evenly dividing economists between pessimists and optimists. Will a U.S. housing slowdown spiral into a full-blown recession (technically defined as two or more successive quarters of declining GDP)? Will developing countries like China and India sustain their voracious appetites for our commodities, such as coal and metal? The pessimists (let’s call them the glass-half-empty gang) see the U.S. housing bubble bursting. In fact, the bubble has already started deflating as new-home prices fell 35 per cent in the fall. The glass-half-empty gang forecasts U.S. consumer and government debt growing (this has already begun); U.S. job growth stalling; and the mighty U.S. consumer, who has been on a spending spree fuelled by the high house prices, closing up his or her wallet. This will, in turn, wallop the entire U.S. and world economy, sparking a severe economic slowdown. This group expects a meagre 2007 growth rate of 1.7 per cent, which is not quite a recession, but is close enough to smell like one. So we could be looking at a big hit in Canada where we’ve been happily filling our hockey bags with export-created money for the past five years. The glass-half-full group tends to see the macroeconomics as evidence of a mere slowdown that is simply part of the normal business cycle, in which businesses (and economies) expand for a while and then take a breather until it’s time to start expanding again. The optimists point out that in a simple slowdown, only certain sectors of an economy go to sleep while others continue being as wired as a downtown dot-comer after the morning’s fourth Americano. This school predicts a Canadian growth rate of about 2.5 per cent, just off 2006’s 2.8 per cent.