Faceoff: Is growth over?

By Kanupriya Vashisht | November 12, 2013 | Last updated on November 12, 2013
8 min read

Paul Taylor, Chief Investment Officer, Fundamental Equities, BMO Asset Management Inc.

Stance: Growth will pick up, albeit slowly

Two predominant themes emerging from the last 15 years have been the global debt super cycle, and the commodities super cycle, which is a result of rapid modernization in India and China (see “Debt and commodities super cycle,” next page).

Innovation ain’t dead

Exciting and game-changing technological advancements are underway. They will generate tremendous investment opportunities and wealth. The current social-networking phenomenon blossomed during the depths of the recession. Yearto- date, the technology stocks in our small cap portfolio are up 45%; most companies with innovative technologies and good products are doing extremely well. For instance, Avigilon is an industrial technology name we hold in our small cap portfolios that produces highpowered digital security cameras used by business and security services. We’re making a lot of money on them. Technology stocks in our portfolios that have performed well include Descartes, Redknee, Softchoice and Qualcomm. The technology sector on the whole is up 22%.

Growth and innovation also are happening in other sectors: healthcare, financials, even services.

For example, in our small cap portfolio we own Element Financial Corp, an equipment leasing company. Element has introduced a vendor finance partnership model where it co-invests in and manages asset-based financing for distributors and manufacturers of capital equipment across North America. The company finances programs that banks are unwilling to step into, and profitably fills that void. It has nearly doubled in our portfolio over the course of the last 12 to 18 months.

The industry structure might not evolve quickly and Element may build enough scale in the short to intermediate term to gain a sustainable competitive advantage in the space and be the winning long-term player in the vendor finance game.

There’s revolutionary innovation happening even in a sector as staid as energy. For example, hydraulic fracturing will be an absolute game changer in terms of North American energy selfsufficiency. The fracking process is more efficient, thus improving the economics of oil and gas extraction and reducing the cost of production. Other energy technologies such as wind and solar power have growing commercial potential, but they offer only a modest lift relative to the transformational change associated with fracking.

The worst is over

A lot of debt has been passed to the U.S. government, but consumer spending has picked up on bigticket items like homes and autos. Auto production bottomed out during the recession to about 8.8 million units. It has returned to healthy pre-recession levels of 15 million units.

At 15 million to 17 million units per year, production will merely maintain the current age of the existing fleet of automobiles in the U.S., which is already three years older than the historic average. As a result, the auto cycle in the U.S. looks well supported for the next three to five years, at least. Over the course of the next couple of years it is expected to hit 17 million units.

As a result of better consumer and investor sentiment, we’ll accelerate to about 2.5% growth as we transition to 2014. This provides comfort that the mid-term trend in economic growth is somewhat better; beyond that, it’s difficult to be confident in a more sustained period of elevated economic performance.

Investment opportunities

We’re dramatically underweight bonds, and overweight equities. The great rotation from bonds to equities is just starting. Some argue returns from equities will be more modest going forward as baby boomers retire and shift assets to a more conservative, incomeoriented profile. We disagree with that viewpoint.

Baby boomers recognize bond yields are at a generational low, and the return on bonds is unlikely to be strong in absolute terms and especially in real terms after adjusting for inflation. We expect baby boomers to continue to be a part of the so-called great rotation from bonds to equities in search of higher return potential.

We’re shying away from traditional interest-rate-sensitive sectors such as consumer staples, healthcare and utilities. They performed very well over the past five years since the recession, but now the market is rotating into more cyclical, risk-on sectors.

An example of promising growth from our small cap portfolio is Auto Canada, Canada’s only public auto dealership company, which currently owns 35 of the 35,000 dealerships in Canada. Most dealerships are owned by individual entrepreneurs, many of whom are getting older and looking to turn over their franchises. Auto Canada currently has immense potential to make acquisitions and consolidate its position in this fragmented industry. And that’s exactly what it’s doing.

We’re now seeking more cyclical sectors like commodities, specifically precious metals. We’re also leaning toward technology, industrials, financials (to an extent) and consumer discretionary. There’s promise in companies like Dollarama, which have a lot of growth potential and further scope to increase their price points.

Avery Shenfeld, Chief Economist of CIBC World Markets Inc.

Stance: Rejuvenation is ’round the bend

It would be misguided to interpret the current situation as the new normal. Sooner than later, we’ll recover from this hangover from the worst recession since the 1930s.

We may start seeing better global growth as early as 2014, when some of the drag from fiscal tightening and budget cuts in Europe and the United States begins to lighten up. We’re expecting global growth to top 4% next year, which is not as strong as the 5% average pace we were running in the few years prior to the recession, but it’s still solid.

The worst may be behind us, not just in the U.S. but in Europe as well. Not that the fiscal policy can suddenly ease up, but the scale of new budget cuts and tax increases—in Europe and the U.S.—may be a bit lighter than they have been, allowing more growth to shine through. In the U.S., for example, the budget numbers recently approved by Congress will, if extended through the year, imply a smaller hit than last year. And unlike 2013, there is no tax hike planned for the household sector next year. Europe has already seen a turn to positive growth this year, in part due to a less severe regime of new spending cuts and tax increases.


With current research and experimentation in robotics and smart machines, nanotechnology and material science, we can’t even begin to appreciate what they might do to economic growth and investment opportunities over the coming decades. Much of this activity is initially seen in private companies or university research labs, but the innovations will ultimately back gains for publicly traded manufacturers.

The whole medical field is gearing for an eruption in innovation— the use of genetics and DNA sequencing for tailor-made cures for various diseases, and bioengineering that will facilitate mechanical replacement parts for people. In both fields there are tremendous surprises and opportunities ahead.

Not all of these are commercially viable without government support, but the healthcare sector has been a strong performer in the Toronto equity market in the past year, led by companies involved in both pharmaceuticals and health benefits management.

Macro growth

Economic growth has been weak in recent years, with the current year’s roughly 3% pace for the global economy falling well short of the 5% clip achieved in the three years prior to the recession.

One reason the Canadian economy has been sluggish is that business spending in the resource sector has been weak in the past year, with survey data pointing to an outright decline in capital outlays in 2013. But if global growth picks up, there will be heightened confidence to proceed with some of the mega projects currently on the drawing board, including oil sands projects that were put on hold in the past year, as well as more drilling in conventional oil.

As oil production ramps up over the next several years, there will be a good deal of infrastructure spending on pipelines and rail capacity to go along with that. While some of the proposed pipelines still face hurdles in the approval process, we expect enough of them to move forward to facilitate further development of Canada’s resource base. There are still parts of the world that have a lot of catching up to do, even if they aren’t all growing at a frenetic pace. China adds the size of a South Korean economy every two years. There’s also ample room ahead for per capita income growth in India, Southeast Asia, and Africa. Canadian companies that have historically focused on the U.S. as an export market will shift their vision further afield to participate in these newer engines of global growth.

As boomers age, certain dormant sectors where older people spend their money—such as leisure travel, wealth management, healthcare—will also witness a boom. The service sector too will continue to advance as incomes improve.

Although the very elderly tend to wind down their portfolios, the bulk of the baby boom population will, in the coming years, still be in the pre- or early post-retirement phase of their lifecycle, thereby driving growth in wealth management. Upcoming generations typically have weaker pension coverage that will require them at some point to direct more of their income toward savings vehicles.

We’ve likely exhausted the role of homebuilding as a near-term driver of growth in Canada. The volume of construction will begin to slow down as the number of condos being completed exceeds the pace of new starts. Housing starts reached 215,000 in 2012, but population growth is running at a pace that will only support an average trend of about 180,000 units per year.

Debt and commodities super cycle

Consumers in industrialized nations have accumulated unsustainable levels of debt over the last decade and a half. That will have a lingering impact on global—particularly U.S.—economic output, and will probably take another 15 years to fully shake off. But it won’t result in a catastrophic blowup of the global financial system.

The United States has made significant progress in this area, much more so than the Eurozone. Over the next five years, they’ll both accelerate to more normalized growth levels.

As for commodities, the implications of rapid urbanization in the world’s most populous nations have been positive, especially for resource-based economies like Canada. The high prices for commodities, including industrial metals and oil, have boosted our revenues. But many say the cycle, which lasted from 2000 to 2011, is now over.

Still, the rapid changes unleashed by India and China are irreversible, and will continue to bolster commodity prices for decades to come. If this was a chapter book, I’d say we’re done with the first but there’s more to the story.

Dissecting healthcare

The healthcare sector is dynamic, says Bob Deresiewicz, partner and senior vice president at Wellington Management Company. He offers a breakdown of the main areas of the sector.

About half the companies operating in the space are biopharmaceutical businesses, which develop and sell protein or small-molecule drugs, for example.

There are also medicaldevice businesses, which produce artificial joints and organs, as well as equipment like cardiac pacemakers.

And generic drug manufacturers sell medications that are copies of those developed by biopharmaceutical companies.

In the case of the generic manufacturers, “a big company will develop a drug and enjoy patent protection for a while, [but that] patent will lapse or wane at some point. Then, the field is ripe for generic companies to come in,” Deresiewicz says.

The healthcare services division is also crucial. It includes hospital companies, drug distributors and retail pharmacies.

And growth will continue in western markets because their populations are aging, he says. As such, people in these developed countries will consume more healthcare services.

As the healthcare services sector expands, Deresiewicz suggests investors focus on companies that have quality management, advanced information systems and scale.

Kanupriya Vashisht is a Toronto-based financial writer.

Kanupriya Vashisht