Growth to remain steady, despite shifts

By Steven Lamb | January 16, 2006 | Last updated on January 16, 2006
4 min read

The Canadian economy is expected to continue its steady growth rate for as far out as anyone cares to predict, but the driver of that growth will shift in 2006, according to Watson Wyatt’s annual survey of Canadian financial organizations and research institutions.

“Over the past two years, Canadians have been spending at above-normal levels, while the personal savings rate has fallen below zero,” said Terence Yuen, research economist with Watson Wyatt Worldwide.

“Respondents do not expect this spending rate to be sustainable and therefore anticipate this shopping spree will cool down,” he says. “On the other hand, participants expect business investment to continue its upward trend in the short-term thanks to continued high energy and commodity prices, strong profit levels and rising capital utilization rates.”

Survey respondents predict business investment will grow 7.1% in 2006, while consumer spending will grow more slowly, at about 3%. The overall GDP growth rate is predicted to average 3% for as far out as 2020.

Stronger business investment is expected to drive growth in labour productivity, which has languished at below 1% growth for the past five years. Respondents see productivity increasing by 1.6% this year and growing by 2% over the long term.

With productivity driving corporate profits, unemployment is expected to remain relatively low. Over the longer term, demographics will play a role in lower unemployment, as retiring baby boomers create a vacuum in the workforce. Some predict the jobless rate will fall below 6%.

The increasing number of retirees will strain pensions from the demand side, while continued low interest rates will dig into fixed income portfolios. Three-month T-bills are expected to yield 3.75% this year, while 10-year bonds are seen edging higher to 4.3%, resulting in a relatively flat yield curve. Meanwhile equity returns are expected to be about 8%.

“With a single digit equity market return, a flat yield curve and the weak funding status of many pension plans, sponsors should brace themselves for another tough year,” said Ian Markham, director of pension innovation at Watson Wyatt.

“The yield on Canadian long bonds is not expected to bring any relief, so any improvement in pension funding status will have to come from sponsors’ contributions as opposed to market conditions,” he said.

Investment managers may not be able to rely on foreign investments to help much, either, as the Canadian dollar is expected to continue to rise. More than 61% of survey respondents predict the loonie will trade within a range of 85 to 90 cents U.S. for the next 10 years.

With increasing liabilities and diminishing returns, two-thirds of respondents said they planned to move away from the traditional “stocks and bonds” balanced portfolio and implement more creative strategies, including absolute return investing and matching returns to liability growth.

There are also signs that Canadian retail investors are lowering their expectations, following the past few years of exceptionally strong stock market returns. In fact, the 2006 TD Waterhouse Investor Poll found investors have continually lowered their expectations since 2002.

Despite a return of nearly 22% last year on the S&P/TSX, there are many who remain optimistic. The poll found 36% of investors expect better returns in 2006 than in 2005. That represents a sustained decline since 2002, when the survey found 52% expected they would do better the next year. That slipped to 49% in 2003 and again in 2004 to 43%.

“The poll demonstrates that people are becoming more sophisticated in their understanding of how markets operate,” said Patricia Lovett-Reid, senior vice president, TD Waterhouse Canada. “They know that there is an ebb and flow to markets and economies, and that you can’t base future expectations on past performance.”

Lovett-Reid says investor expectations are more aligned with the bank’s own economics department, which is calling for a late-2006 slowdown in the U.S. which will drag on the Canadian economy. Commodities have driven the Canadian market for the past few years, but TD expects resource exports will drop, trimming 15% from prices. Gold is expected to be the only commodity with further upside potential.

The bank is predicting GDP growth will drop from 3% to 2.5% in the second half, wile corporate profit growth will decline to single digits.

What advice does the bank offer investors? Stay invested, but rebalance your portfolio, as two years of double digit stock market gains have likely left many investors overweight in equities. Energy, gold and financials have been among the big winners, so investors may want to take some of their profits from these sectors and diversify.

Finally, TD reminds investors that there is a whole world of investment opportunities beyond the Canadian border, pointing to Europe’s relatively low price to earnings ratio, of 15 times earnings, compared to the TSX’s 20 times.

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Steven Lamb