Economy

THIS IS A RECOVERY?

Making sense of volatile markets and a shaky dollar amid official optimism about the Canadian economy

KATHERINE MACKLEM August 5 2002
Economy

THIS IS A RECOVERY?

Making sense of volatile markets and a shaky dollar amid official optimism about the Canadian economy

KATHERINE MACKLEM August 5 2002

THIS IS A RECOVERY?

Economy

KATHERINE MACKLEM

Making sense of volatile markets and a shaky dollar amid official optimism about the Canadian economy

HERE’S A RIDDLE: If the worth of your home is rising, but the value of your retirement nest egg is dropping, do you go ahead with those big renovations?

Well, OK, perhaps it’s less a riddle and more a personal tussle. But to economists, the answer—unpredictable as it is on a collective basis—is crucial to understanding the puzzling Canadian economy.

Until last week, Canadians had reason to feel secure, smug even. Yes, the stock market was lousy, and the corporate scandals appalling, but Canada’s economy was steaming along, stronger and faster than anyone had anticipated. The loonie was on an upswing, house prices were climbing and more people than ever had jobs. Consumer confidence in June was at its highest level since 1988. That’s not all. Canada’s economic outlook was at the top of the Group of Seven leading industrial nations—and it has been every month since April, according to London-based Consensus Economics Inc. Then in early July, the forecasters upped their numbers, predicting the Canadian economy would power ahead at an even more confidenceinspiring rate.

Reason enough, if it weren’t so rude, to put thumb to nose in a group nah-nah.

But then the stock market plunged precipitously, Canada’s dollar took the steep-

est two-day nosedive since the Parti Québécois was first elected in 1976, and extreme volatility took over on both fronts. All eyes were on Bank of Canada governor David Dodge, who mid-week delivered his scheduled quarterly policy update. Unlike Alan Greenspan, his counterpart at the U.S. Federal Reserve Board, who pointed the finger in July at “too many corporate executives,” Dodge was less direct. “Uncertainties associated with global corporate and financial market developments”—Dodge-speak for accounting scandals and market turbulence—could end up threatening economic growth in Canada, he cautioned. Overall, though, Dodge decided to “look through” the ups and downs of the stock market to announce he’s even more bullish than he was three months ago. The risks are balanced, he said, predicting growth for Canada this year of a solid three to four per cent, up nearly a point from his forecast in April. The economy is so robust that the central bank is poised, he allowed, to raise interest rates again.

The message was soothing, likely intentionally so, and for an afternoon it helped buoy the Canadian dollar. Still, as confident as Dodge declares himself to be, it’s tough to share his optimism, given the carnage in the markets. Just last week, $25

billion in value evaporated from the Toronto Stock Exchange’s main index. For individual investors, the shock came earlier when they opened their second quarter statements, often to dismal returns. In the first half of 2002, Canadian equity mutual funds, including small and large cap, and dividend funds, were trounced by poor market performance. Stripping out contributions made by investors to their hold-

REALITY CHECK

How are your savings faring in these turbulent times? We asked Morningstar Canada to crunch some mutual fund numbers for us. We picked Canada’s 10 largest fund companies and asked:

If you’d invested SI,000 on Jan. 1,2002 in their largest Canadian equitybased mutual fund, what would the value of your investment be today?

MUTUAL FUND NAME

Cl Harbour Fund

FUND ASSETS VALUE OF $1,000 PERCENTAGE AS OF JUNE 30 INVESTMENT CHANGE

AS OF JULY 25

$1.8 billion $950 -5.0

Investors Dividend

$5.7 billion

$944

-5.6

Mackenzie Ivy Canadian

$5.4 billion

$926

-7.4

Trimark 9elect Canadian Growth

$3.6 billion

$922

-7.8

Bissett Canadian Equity Class F

$638.4 million

$899

Royal Canadian Equity

$3.3 billion

$873

-12.7

Fidelity True North

$3.0 billion

$860

-14.0

AGF Canadian Dividend

$2.3 billion

$857

-14.3

TD Canadian Equity-I

$1.3 billion

$823

-17.7

CIBC Core Canadian Equity

$850.8 million

$819

Source: Morningstar Research Inc.

THE PROPHESY

Nearly six years ago, U.S. Federal Reserve Board chairman Alan Greenspan raised a yeilow caution flag over the tech-iaden stock market by questioning whether anyone would be able to determine when soaring stock prices had become so overvalued that a severe downturn was inevitable.

DGC. 5, 1996 “How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”

in his July, 2002, speech to Congress, Greenspan refrained from saying “I told you so" as he explained the current accounting and stock market crises.

July 16, 200z “An infectious greed seemed to grip much of our business community. Our historical guardians of financial information were overwhelmed. Too many corporate executives sought ways to ‘harvest’ some of those stock market gains.”

ings, the value of the stock-based funds fell by more than five per cent in June, wiping out $7.5 billion from May’s total of $136.9 billion, according to numbers culled for Maclean’s by Morningstar Research Inc., a Toronto-based investment research firm. July is expected to be even worse.

Much of the market turmoil has been caused by the seemingly unending pro-

cession of corporate swindlings—Enron, Adelphia and WorldCom, to name just a few—and that adds a new unquantifiable element to economic forecasts. The markets are often indicators of conditions to come, says Peter Drake, deputy chief economist of Toronto-Dominion Bank, and “they sometimes act like a smart-ass teenager: they know everything.” In a clean market, Drake adds, it’s the only way to properly price a stock. “Markets now believe they are acting without sufficiently good information. It’s one of the biggest problems we’ve got.”

How do you factor in the intangible of trust, asks Tim O’Neill, chief economist of the Bank of Montreal. “The problem is we don’t know—and we can’t know.” Suddenly, but not surprisingly, trust has become an issue—and it could be the factor that makes or breaks economic growth in Canada.

O’Neill is an optimist, and despite his words of caution, like Dodge he’s positive about the outlook for the Canadian economy. The fundamentals are solid, he says, pointing to low interest rates, a vibrant housing market and job creation at a spectacular high of 300,000 in the first half of 2002. As well, O’Neill is convinced the stock market is at its low point—“except for the most unremitting, unreconstructed pessimist, this is an undervalued stock market—and significantly so,” he says— although he acknowledges he can’t predict when it will turn around. Still, he is concerned about the U.S. recovery. “Is the market going to continue to decline, impact spending and stall the economy?” he asks. “The risk is not a made-in-Canada one, it’s a U.S. one.”

The battering of the Canadian dollar was also partly a made-in-the-U.S.A. phenomenon, as the loonie fell partly in reaction to a strengthening U.S. dollar. Two other economic factors—weak retail sales and a dip in Canada’s trade surplus—contributed to the decline, but were not powerful enough on their own to lay waste to the loonie. Really, the dramatic decline was driven by jitters. “I can’t think of any fundamental reason that the dollar suddenly took a hit,” says TD Bank’s Drake. “It was so fast simply because markets are in such a foul mood that they are looking for trouble.”

Markets looking for trouble have already caused real financial pain, as most Canadian investors know. Which is why the economic forecasters want to understand how consumers will react: Does a dearth of investor confidence put a drag on consumer confidence? Not necessarily, says money manager Tom Bradley, CEO of Vancouver-based Phillips, Hager & North Investment Management Ltd. Bradley suggests swings in investor confidence alone are almost always surprising. “Confidence swings without us ever seeing it,” he says. “People swing back from fear to greed and greed to fear. Those are very hard calls to make.”

It’s time to just sit out the storm, says Tom Caldwell, chairman and founder of the independent broker, Caldwell Securities Ltd. The firm has built as much cash reserves as it thought was prudent. “In retrospect,” admits Caldwell, “we should have built more. But I’m not going to panic and sell into this nonsense. So just put it on ice, take a Valium and have a nice summer.” I?1

ACCOUNTING FOR ETHICS