Business

Canada is Hot!

Why top Wall Street analysts see the country as a major ‘buy’

Andrew Phillips April 3 2000
Business

Canada is Hot!

Why top Wall Street analysts see the country as a major ‘buy’

Andrew Phillips April 3 2000

Canada is Hot!

Why top Wall Street analysts see the country as a major ‘buy’

Business

Andrew Phillips

Anyone who wants to be cheered up about Canada’s prospects need only ascend to the 11th floor of Morgan Stanley Dean Witter's impressive building in Times Square in the heart of New York City. There, in an office decorated with Canadian posters (“Let’s go, Canada!” reads the slogan on an old First World War recruiting appeal) and strewn with copies of Maclean's and The Globe and Mail, is the firm’s chief Canada-watcher, Jim Johnson. From where he sits, it looks as though the 21st century (or at least the first few years of it) really may belong to Canada. The stars are lining up, he says, for the country to turn in a stellar economic performance this year—and perhaps well beyond. “Canada,” says Johnson, “could be on the verge of a very prosperous period.” He’s not alone. The people who pay closest attention to Canada on Wall Street are unanimous: the outlook for the country has seldom been better. “The prospects are unbelievable,” says Gabriel de Kock, chief economist for Canada at Salomon Smith Barney Inc. “Canada right now is enjoying the best of all worlds,” adds Karim Basta, senior vicepresident and Canada specialist at Merrill Lynch & Co. Inc. And in a recent newsletter to clients, Carl Weinberg of High Frequency Economics, a consulting firm based in suburban Valhalla, N.Y., gushed: “The Canadian economy continues to amaze investors.” You don’t have to consult Wall Street, of course, to know that Canada’s economy is steaming along at an impressive rate—with growth at a robust 4.2 per cent last year, low inflation and falling unemployment. The surprise is that the outlook among these influen-

rial U.S. observers—whose views help to shape those of key players like mutual fund managers and foreign exchange dealers—is so much more positive than that typically found in Canada. While Canadians worry that the good times are fragile and fret that the country is missing out on the U.S. technology boom, the Americans see Canada as an increasingly active centre of cutting-edge innovation.

More and more, they say, Canada is shucking its reputation as a largely commodity-based economy and attracting attention for leading high-tech firms—both established leaders like Nortel Networks and BCE Inc., as well as sexy newcomers like fibre-optics leader JDS Uniphase Corp. of Ottawa, wireless e-mail pioneers Research In Motion Ltd. of Waterloo, Ont., and financial software specialists 724 Solutions Inc. of Toronto. Those and other companies are fuelling new interest by U.S. investors in the Toronto Stock Exchange—where gains in the past year have far outstripped those on the struggling New York Stock Exchange. Americans bought Canadian stocks worth $16.9 billion in 1999, more than double what they purchased in 1997. And a recent survey of U.S. portfolio managers by Broadgate Consultants of New York showed that all intend to increase their Canadian holdings this year. “The new economy stocks have really put the TSE on the map,” says Basta.

The difference is partly a matter of national psychology. Americans often bubble over with enthusiasm—even when things are going badly—while Canadians can find gloom in almost any situation. A Canadian who served in the senior ranks of the federal finance department in Ottawa and now observes his homeland from the executive suite of one of New York’s biggest banks, puts it this way: “Canadians are always looking for the cloud in any silver lining.”

More important, the divergent views are the result of bitter experience in Canada. Wall Street watched warily as the country struggled through most of the 1990s, starting the decade with a deep recession and exploding federal deficits. By the time the Liberal government came to power in November, 1993, the country’s crucial debt-to-GDP ratio was at 96.8 per cent and rising (it would hit a high of 99.2 per cent in 1993, second only to Italy among industrialized countries)—throwing into doubt its ability to continue to

borrow on international markets. “I think Canadas back was up against the wall,” says Johnson. “There’s no doubt.’’Those were the years when Finance Minister Paul Martin travelled to New York immediately after each budget to repair Ottawa’s damaged credibility with key foreign investors.

Even when Canada emerged from recession, it was plagued by slow growth, high taxes, deep spending cuts and persistent high unemployment. When commodity prices rose in 1994, the Canadian dollar should have gotten a boost on international markets—but it was sideswiped by the effects of the Mexican peso crisis that year and depressed by political uncertainty leading up to the 1995 Quebec referendum. The Asian economic crisis of 1997-1998 was another blow, depressing demand for Canadian commodities like minerals and lumber. The U.S. economy, meanwhile, took off—leaving Canadians pressing their noses to the window of their rich neighbour’s party. “It was a lousy decade—Canadians were awfully squeezed,” says de Kock. “And perceptions tend to lag behind real performance in the economy.”

Now, de Kock and others see a happy confluence of positive factors. The U.S. economy continues its record boom, drawing in Canadian exports, with no end in sight. Most Asian countries are recovering briskly, and prices of the raw materials that still underpin much of Canada’s economy are rising—leading to a positive shift in the country’s terms of trade (the prices of its exports are rising faster than those of its imports). Ottawa is running surpluses rather than deficits; Quebec’s perennial strains on the national fabric are at a low ebb; and there is no sign that prosperity is leading to the kind

of upward pressure on wage costs that could spark inflation.

Instead, says Weinberg of High Frequency Economics, productivity gains are matching wage increases—a solid formula for growing prosperity. The ingredients, he adds, are in place for sustained growth without inflation: “a very benign setup.” Merrill Lynch forecasts four-per-cent growth this year, while Salomon Smith Barney sees 4.25 per cent and Weinberg says it could hit 4.5. All those estimates have been revised upward since the end of 1999—and all are higher than the 3.5 per cent projected by the Conference Board of Canada.

The forecasters also see a rise in the Canadian dollar, in Morgan Stanleys case to 71.5 cents (U.S.), by the end of the year (from last week’s level of 68.4 cents). The economy’s fundamentals would indicate a faster rise for the loonie—but currency dealers have been burned so often by overestimating its potential that they tend to be cautious. “The Canadian dollar is the currency foreign exchange dealers love to hate, or hate to love,” says de Kock, “because they’ve lost more money on it than on any other.” Still, he adds: “There’s a possibility that the perception may change and people will see the dollar not as a commodity currency but as a new economy currency. If that happens there’s a huge upside.”

All the good news means that Martin no longer makes his regular pilgrimages to New York. After February’s budget, the finance department sent several officials to meet with Wall Street analysts, but since Ottawa is no longer borrowing there to cover an annual deficit, it has less need to woo them. Still, Martin’s hard-won reputation as a fiscal conservative gives him a key role in reassuring U.S. markets that

Canadas virtuous new course will continue. Wall Street was impressed that Martin squarely addressed the issue of Canadas high taxes and lagging incentives for high-tech innovation in his February budget, and worries that he may step aside or be eased out due to the leadership tussle between him and Prime Minister Jean Chrétien.

As a result, the speculation over Martin’s future is carefully tracked in New York. “The belief here,” says Weinberg, who interviewed the finance minister in February for his client newsletter, “is that the only creative source of economic thinking in Ottawa is Paul Martin and the people around him.” Adds de Kock: “It would be negative if he leaves, because it would mean that the most important

advocate of redefining the role of government in the economy has given up.” Speculation over Martin’s future, he says, has already taken a toll: “It probably meant a cent off the Canadian dollar.” Nonetheless, Wall Street’s Canadawatchers do not fit any simplistic stereotype of know-nothing right-wingers demanding that Canada adopt U.S. models or suffer the consequences. After years of studying the country, they tend to have sophisticated and nuanced views. In the case of Morgan Stanley’s Johnson, a 33year-old native of Omaha, Neb., that outlook is enhanced by daily consumption of Canadian news media (including listening to CBC Radio over the Internet), frequent visits and a taste for reading Quebec literature in translation. “I’m

paid,” he says, “to sit in New York and think Canadian thoughts.”

Like many Canadians, Johnson applauds Martin’s efforts to bring down taxes. But in the next breath he adds that many Canadians exaggerate their tax burden because they do not take adequate account of the extra services they receive. “When Canadians feel their taxes are so high, it’s distorted because government is so much more important,” he says. “There’s a danger in making absolute comparisons to the States.”

Naturally, there are shadows amid the bright light of Canada’s emerging new economy as seen from Wall Street. Can the American boom, already the longest on record, continue? Will the roaring U.S. market in high-tech stocks collapse and

take the economy down with it? Will inflation, seemingly under control on both sides of the border, rear its head once again and choke off prosperity with higher interest rates? Johnson listened carefully to a recent speech by Bank of Canada governor Gordon Thiessen at the Harvard Club in Manhattan, and concluded that Thiessen is concerned about the U.S. economy overheating and will likely be more inclined to raise Canadian interest rates, as the bank did last week. At the same time, Johnson sees signs that the jump in oil prices—they have tripled in litde more than a year—may be overflowing into other costs. “That could be the catalyst that ends the party,” he worries. For now, though, the party continues— and Wall Street is cheering Canada on. GJ3

BUYING AND SELLING CANADIAN STOCKS Value of American transactions in Canadian shares (a negative shows more sold than bought) (billions)