Wednesday Night #1202 Jacques Clément Report

CANADA
Following 2.8% economic growth last year, the Canadian economy is likely to grow by 2 1/2 -3% this year, led by continuing strong consumer spending, a steady housing sector, a 6% rise in business investments, fairly robust corporate profits, net government spending, increased inventories, strong wholesale and manufacturing sectors. The narrowing of the trade surplus with lower exports, will curtail growth. Productivity is expected to recover somewhat after 2004, the worst performance in eight years. Employment has picked up in the last three months, with over fifty thousand new jobs created and unemployment stable at 7%, despite continuing weakness in manufacturing employment. Manufacturing data for January bounced back with solid gains in new orders (over 7%), shipments close to 3½% and unfilled orders over 5%. The trade surplus narrowed by $1.2 billion to $4 billion with renewed decline in exports (-1.6%) and continuing rise in imports (+2%). Despite a rise of 4½ % in raw materials, inflation declined to 2% with core at 1.6%. Average weekly earnings rose last year by only 1.2%. With the Canadian dollar likely to trade between 83¢ U.S. and 85¢ U.S., exports will probably decline 2% monthly. But with business inventories rising by $33 billion in the second half of 2004 and the moderate pace of growth in the economy, imports are likely to slow down significantly after 6% rise in the last two months. The strength in corporate profits (up a record 19% last year) should continue to prevail in the first half and coupled with record foreign buying of Canadian stocks ($36 billion last year), steady employment growth, healthy consumer spending and robust resource prices should lead the T.S.X. index back over 10,000 by mid-year. [Sectors to invest in are resources: Inco, Falconbridge, etc.; banks. Bank of Canada is likely to hold interest rates steady with an overnight rate of 2½% to help the flagging domestic economy hurt by a strong dollar.

NEAR-TERM OUTLOOK

TSX will return to 10,000+ or just over by mid-year (gain of 280 points in 2^nd quarter)

Canadian $ will trade between 83 and 85 cents

U.S.
After close to 4½% growth last year, the U.S. economy will probably slow to 4% this year, led by robust consumer spending, a healthy housing market, close to 10% rise in business investments on machinery and equipment, a substantial rise in business inventories, employment rising by 150,000 monthly, unemployment declining to 5%, corporate profits rising by 5% – 10% and rise in net exports leading to a reduction in the trade deficit. Housing starts reached a twenty-one year record in the first two months of the year, rising by 6½%, despite new home sales declining by over 9% (January) and existing home sales declining by 2% because of bad weather. Given high gasoline prices, new car sales declined by nearly 2% in February. Manufacturing growth slowed for the third consecutive month following twenty-one consecutive months of expansion and was the lowest since September 2003. It should return to its broader trend in coming months. Durable goods orders also grew very moderately in January. Employment was very strong in the first two months of 2005 with almost 400,000 new jobs created and unemployment at 5.4%. The trade deficit increased by two billion dollars to over fifty-eight billion, – the second highest on record, as imports expanded by nearly 2% -, while growth in exports was marginal. It was, nevertheless, the third consecutive monthly rise in exports, for a rise of over 4%, while imports rose by 1.2% over the same period. Coupled with rising record fiscal and current account deficits [Figures released Wednesday show America’s fourth-quarter current-account deficit widened to $187.9 billion, a record. This is worrisome], the U.S. dollar will remain under pressure, particularly with no intention on the part of China to revalue the yuan.
Despite December inflation decline and core at 2.2%, the Federal Reserve is likely to tighten monetary policy for the seventh time (since June, 2004) to 2¾% Federal funds, its highest since October, 2001.

NEAR-TERM OUTLOOK

Euro: $1.33 U.S. – $1.35 U.S.
Gold: $445.00 U.S. – $450.00 U.S.
Crude: $55.00 U.S. – $60.00 U.S.
Dow-Jones: 11,000 by mid-year

With regard to recent pronouncements from China regarding a proposed slow-down, it is unlikely within the next 12 months. A slow-down in the economy requires tightened monetary policy. Also there would have to be a re-evaluation of the Yuan or RMB. This is not likely to happen while the infrastructure is in such bad shape. Banking system is in terrible shape: loan losses, instability of commercial banks (there have been bank closings), and until an exchange market is developed among the commercial banks, the Chinese will not do anything. Growth rate will continue at 8-9%.
A recent Morgan Stanley report underlines that Canada is prospering as a supplier of raw materials (aluminium, steel, copper, nickel) to the world, with a large proportion going to China and some to India, Singapore. Does the continuing growth in that country’s economy constitute an investment bubble? If so, will Canada be adversely affected when it bursts? It is likely to continue for the next year, Beijing is believed to be anxious to slow this down, but would like others (i.e. the Fed) to do the job, and they are also cutting back on loans to Chinese business while encouraging Chinese institutions to reinvest in North American stock market and treasuries; Canada is benefiting from this situation as well.