COVER

BETTING ON CANADA

International investors say tensions will quickly fade

TOM FENNELL September 12 1994
COVER

BETTING ON CANADA

International investors say tensions will quickly fade

TOM FENNELL September 12 1994

BETTING ON CANADA

International investors say tensions will quickly fade

COVER

He keeps the economic forecast neatly typed on a small peach-colored card. And whenever Parti Québécois Leader Jacques Parizeau is pressed to counter arguments that an independent Quebec would be financially moribund, he quietly pulls it out of his vest pocket. With a slight smile, he reads a quote from an analyst at the prestigious New York City-based securities dealer, Salomon Brothers Inc., who claims that Quebec’s economy would eventually return to normal following independence. But what Parizeau conveniently forgets to mention is that the very same analyst also concludes that if Quebec were to separate, the province’s economy would suffer as shortterm borrowing costs soared, and that Quebec’s best economic option, by far, is to remain in Canada. Says Peter Plaut, the report’s author and senior bond analyst at Salomon: “Quebec is vulnerable to substantial political uncertainty.”

But for now, the international investment community is betting that opinion polls predicting that Quebec voters will ultimately reject sovereignty in a referendum are correct. In fact, despite the initial flurry of investor uncertainty that will likely follow the Quebec election, they are telling their clients to continue buying Canadian bonds and equities. Their reasoning: Canada’s economy is growing rapidly again, and once the short-term Quebec crisis passes, the market for Canadian bonds will rally and pull equities along for the ride. International analysts like Plaut appear to be basing such relatively benign assumptions on history. As in previous constitutional clashes, including the collapse of the Meech Lake accord in 1990, they believe the latest round of tensions in Quebec will quickly fade away. In the end, says Douglas Johnson, senior international investment strategist at Merrill Lynch & Co. in New York, Quebecers will opt for jobs over political turmoil and high interest rates.

Investors are also betting on the underlying strength of the Canadian economy to offset any doubts raised by the election of the Parti Québécois. And new statistics released last week seemed to support their assumption. According to Statistics Canada, the economy charged ahead at a 6.4-per-cent annual rate in the second quarter of this year—the fastest pace of economic growth since late 1987. That growth was all the more impressive because Canada’s inflation rate is running at less than one per cent annually. Even Canada’s beleaguered dollar, a barometer of how foreign investors view Canada’s political and economic climate, displayed a positive forecast last week, as it climbed over 73 cents (U.S.).

In fact, the international community may have fully discounted the outcome of the Quebec election already. The spread between 10-year U.S. and Canadian bonds, which shot up to more than 220 basis points, or 2.2 per cent, in June, has since dropped back to about 154 basis points. Karim Basta, Merrill’s vice-president in charge of international analysis, noted that the spread is narrowing because Canada’s low-inflation, high-growth economy is attracting international investors. “The Canadian dollar will stabilize and strengthen,” said Basta.

The uncertainty over the Quebec question is being further offset by the growing perception that such strong economic growth combined with recent federal and provincial budget restraint measures will eventually bring Canada’s debt burden under control. As well, continued economic growth could improve employment and re-

store Ottawa’s revenue flow from taxes over the next two years.

As well, some foreign analysts even suggest that the Quebec election will actually be positive for Canada’s equity markets. Johnson said international investors believe that Canadian companies, which are now coming out of the recession, will continue to post strong earnings in 1994 and 1995. And once the election is out of the way, Johnson said that bond prices will rally and

allow the market to more fully value the companies’ shares. The Toronto Stock Exchange, he added, could even outperform American markets in 1995.

Finally, if past performance is any indication of the future, Canada’s fixed-income and equity markets will quickly shrug off any surprises coming out of the Quebec election. According to a study completed by the Toronto investment firm Wood Gundy Inc., after past constitutional battles, “subsequent market rallies reversed virtually all of the damage” within three months. The same report also said that economic uncertainty will “create equally great opportunities to buy the Canadian market as they do to sell it.” And despite the ongoing debate over Quebec, buying into the Canadian market appears to be just what many international investors intend to do.

TOM FENNELL