War. Scandal. Scary markets. Our money experts had a lot to talk about.
MACLEAN’S ROUNDTABLE OUTLOOK 2003
War. Scandal. Scary markets. Our money experts had a lot to talk about.
GIVEN THE STOCK MARKET chaos of 2002 and the prospect of war in 2003, there was plenty to consider for the four experts participating in Maclean’s annual roundtable on the economy and investment in the coming year. In the magazine’s boardroom in Toronto were Sherry Cooper, chief economist for BMO Nesbitt Burns, Gary Reamey, head of Edward Jones Canada, and Eric Sprott, CEO of Sprott Asset Management, whose mutual funds regularly top Maclean’s annual performance charts. On speakerphone from his new office in New York was ex-Torontonian David Rosenberg, chief North American economist for Merrill Lynch. They were hosted by Assistant Managing Editor Berton Woodward and National Business Correspondent Katherine Macklem. Highlights of the session:
How is the economy shaping up?
Cooper: I believe the clouds will part in 2003. And I’m referring mostly to the United States, of course, because there aren’t any clouds in Canada. For Canada, 2002 was an incredibly good year. But in 2003 I believe the Canadian economy will slow a bit to a growth pace of close to three per cent. And the U.S. economy is likely, as the year progresses, to become a bit more solid, around three per cent as well. We will see the weakening U.S. dollar begin to improve the U.S. competitive position. We’ll also see that low interest rates, the tremendous stimulus coming from the Federal Reserve, will continue
to have a positive effect. I don’t believe the Fed will be required to lower rates any further. Then, of course, we’ve got the Bush tax initiative, and I think a good deal of it will become law by the summer. The psychological effect of it is very big, and the impact on 2004 will also be substantial.
I do think in the next couple of months we’ll get a resolution in Iraq. Whether it’s a war or not, Saddam will be gone, in my view, by the end of this year. And that, in combination with some sort of diplomatic resolution to the North Korean situation, will be part of what allows the sun to begin to shine through. The positive effect of the geopolitical tensions easing is just enormous.
And it’s immeasurable in many ways, but I just think anybody who bets against the U.S. consumer is betting wrong. I think this is a buying opportunity in the stock market. Rosenberg: I guess I’m not quite as optimistic. I think the major economic theme for 2003 follows the Chinese calendar, because it’s the year of the sheep and this’ll be the year of the sheepish recovery, part two. What I see for the U.S. is a repeat performance-choppy and sloppy growth, GDP coming in at around 2.5 per cent, which is about the same as 2002. And the bottom line is that I can’t remember a time when the economy accelerated the year after the stock market was down more than 20 per cent and oil prices were up more than 50 per cent. So, if anything, there’s probably more downside than upside risk to the forecast.
In Canada, it looks like 2002 growth was around 3.25 per cent. I think we’re looking at 2.8 per cent this year. So it’s once again going to be a situation where Canada most likely outperforms the U.S. and it will still be a leader in the G7, but growth will certainly be more moderate.
With that backdrop, how should investors approach 2003?
Sprott: We’ve ended a mania, a financial mania of mammoth proportions. Perhaps one of the best books on what happens coming out of a mania is Robert Shiller’s Irrational Exuberance. One of his charts shows that stocks trade below 10 times earnings. In 1932 they traded below that. In ’74 they traded down to, I think, seven times earnings. Our view has been that we may yet see those levels. I’m not predicting it’s going to happen in ’03 but I think ultimately we’re going to see some real asset values go down. Cooper: There’s a case to be made that we don’t need to go to a 10. But I do agree that, particularly in a post-bubble valuation correction, you often overshoot on the downside and you can remain very, very cheap, very undervalued, for a very long time, just as we were very expensive and overvalued for quite a long time.
So Eric, you think we’re going to see the market lower by the end of the year?
Sprott: Yeah, that’s what I believe. I’m sort of a pragmatist, and I like looking at news
every day. I look at government revenues. The U.S. government having to raise an extra $300 billion this year—my view is that interest rates will go higher, notwithstanding Mr. Greenspan’s efforts to keep them lower. We look at U.S. retail sales. So far this year they’re up two per cent year-overyear. Every time retail sales growth is less than about 3.8 per cent, you go into a recession. We went into it in 2000-2001, we went into it in 1990, we went into it in 1981-82, and this would suggest that we’re in it today, because the growth is lower than even ’01 right now, and the weakness just continues.
So what’s an investor to do?
Sprott: Well, I can tell you what we do. Back in ’99, 2000, we took a very defensive posture. How do you make money in a secular bear market? Historically there’s one way. You own gold or gold shares or have cash. You could also have long bonds; I just happen not to be an expert. I’m a huge believer in physical gold. I think Canadians should consider owning it. It’s about the only thing that’s shown it would hold its value in the last two or three years. We also own some oil and gas shares, and some income trusts, but again, very, very defensive positions. Rosenberg: I’d say stick with what’s worked, and that means sticking with a conservative theme—quality and yield. I think it’s still a very speculative stock market, and the multiples are still very high. When you take a look at high-quality stocks, they’re trading at a discount to low-quality stocks. So you’re actually paying a premium to take on risk. The lingering story is that too much earnings growth is still priced in. There are geopolitical risks out there, prospects of a war, and an economy, I think, that’s going to surprise the consensus to the low side. Reamey: Listening to the group, I guess at Jones we’re pretty optimistic about the equity markets—both in the United States and Canada—over this year. We see perhaps a five to 10 per cent increase in terms of the TSX and the S&P 500. As Sherry mentioned, the growth rate in Canada may be three per cent. Consumers feel pretty good in Canada. On the U.S. side we’re probably more like David, around 2.5 per cent. I have relatives in both countries and I can tell you in the States they’re not feeling quite as good as they are in Canada. So for conservative individual investors, we would say you probably ought to have at least 50 per cent of your as-
sets in good quality equities, in companies with a strong earnings history and a history of increasing dividends on their stock. Having said that, you want to be diversified—if you’re owning individual stocks, over maybe five different industries to get appropriate diversification.
Reamey: In Canada, we like Sun Life. We think their merger with Clarica is going to bring some benefits. Molson looks good. We’ve got a lot of people reaching their twenties pretty quick, and those are the prime beer-drinking years. And Enbridge,
with a 3.5 per cent dividend yield and a chance for growth that looks attractive. On the U.S. side, Pfizer, Emerson and Oracle look most attractive.
Rosenberg: I think the U.S. dollar has emerged as a major theme. This means you want to be invested outside the U.S., because the currency can affect your total return substantially. It’s probably good news for basic materials and gold stocks. Anything priced in U.S. dollars will be appreciating. Energy fits in there as well; it has a fabulous long-term supply-demand picture in any event.
And for the first time in six years, I think
the U.S. consumer is going to underperform GDP. What is the outlook for the consumer after we’ve destroyed $5 trillion of net worth over the past three years? That’s unprecedented. Households diluted their home equity, borrowing against their house. House prices are no longer rising, not nearly at the rate they were last year. I think you basically want to avoid consumer discretionary stocks. Technology, with extremely high valuations, is still our biggest underweight. We’re also very cautious about financials. Cooper: I’m going to weigh in here with one thing. I think interest rates—long-term interest rates—will be higher at year-end than
they are today. I think buying a government bond at this stage of the game you’re going to earn no better than the coupon, and, in fact, you may have a capital loss on that.
We do also like the energy sector, and the gold sector. But as I’ve said, I’m more optimistic about the outlook. I think there’s a really good chance we’re going to see the stock market take off. The demographics are such that mountains and mountains of money continue to pour into financial assets, and that money’s gotta go somewhere. People are only going to put up with one-percent yields on their money market mutual funds for so long.
Reamey: I think one of the major risks for individual investors today is sitting on the sidelines too long. The markets are up in both Canada and the U.S. by 15 to 20 per cent since October. And sure, they’re going to be choppy because you’ve got Iraq and you’ve got North Korea and lots of other things, but serious long-term investors still want to retire financially independent. You’re better off as a long-term investor being in the market with some of your money than sitting on the sidelines waiting until the bold headline in the paper says now’s the time to get in, which historically hasn’t worked too well.
What kind of investor reaction are you seeing in the wake of the corporate scandals?
Reamey: Actually, our customers feel better today than they did 12 months ago. They’re starting to come off the sidelines and make investments. They’re still nervous if something in the headlines causes the market to be volatile, but they’re more positive. I think most of them are certainly not happy with the corporate scandal thing, but probably feel like that’s behind us.
You’ve all mentioned the possibility of a war with Iraq. How much impact on the market would it have?
Cooper: I can only go by what the experts in the military say, and from all of the reading that I do and the people whose opinions I respect, it appears that a U.S. endeavour would be rapid and successful. If it’s long, if it’s drawn-out, if it’s unsuccessful, obviously it’s extremely negative for the economy, for financial markets, for everything but gold, Eric, and that’s another reason why gold investments are a reasonable hedge at this stage. But if the fighting is over in a matter of weeks, and there aren’t huge numbers of American body bags, I think we will see a repeat of what happened in the first Gulf War. Initially, oil prices rise, gold prices rise, the stock market doesn’t like it. There is a flight to so-called safe-haven currencies, to bonds relative to stocks, and sentiment is very concerned, worried, nervous. People are glued to CNN and they’re not shopping, they’re not doing anything, it’s focus on the war. But once it is complete and successful, all of those things are retraced and more so. After the Gulf War, you got a big rally in the stock market, you saw the U.S. dollar come back, gold prices declined, oil prices declined sharply. And we move on. fifl
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