Dealing with Downturn

By JoAnne Sommers

The U.S. economy has been sneezing non-stop lately but so far Canada seems relatively immune to its virus.

Although evidence is mounting that the world’s biggest economy has slipped into recession, the picture remains fairly positive on this side of the border. The question is, how long will it stay that way?

Much depends on the severity—and length—of the U.S. economic downturn, says Paul Ferley, assistant chief economist with RBC Financial Group in Toronto.

“If it’s more of a recession than a slowdown, that will play itself out in Canada as well,” he says. “We still think that Canada will outperform the U.S. this year but there will be a slowdown here, too.”

RBC is forecasting an average Canadian growth rate of one per cent in the first half of 2008, compared with negative growth of 0.5 per cent in the U.S.

Overall, the bank predicts that our economy will grow 1.6 per cent in 2008, down from 2.7 per cent in 2007. Growth will slow to a 0.8 per cent annual pace in the spring quarter but recover to just over two per cent in the third and fourth quarters, the bank says.
 
"RBC expects the drag from the trade sector in 2008 to be offset by Canada's strong terms of trade, continuing job growth and rising wages," it said in an April 4th news release. "These factors are expected to help buoy consumer spending through the year."

Growth will then recover to 2.3 per cent next year, it added.

Despite our heavy dependence on the U.S. market, Canada’s economy is likely to remain buoyed by high commodity prices, says Ferley.

“Those prices may weaken but they’ll likely remain at historically high levels. However, that could change if there’s more severe weakening in U.S. growth. In that case, there would be a greater negative impact on global growth, which could result in a much weaker price outlook for commodities.”

Uncertainty and volatility will continue to dominate the economic headlines for the rest of the year, says Adrian Mastracci, portfolio manager with KCM Wealth Management in Vancouver.

“Canada’s economic outlook is still dictated largely by the U.S.,” he says. “If their recession takes hold the way I think it will, we will feel the downdraft, although it may take three months to reach us.”

Canada sells about 75 per cent of its exports to the U.S. market and the drop in demand is already impacting export-dependent manufacturing industries such as forestry and automobiles.

“Ontario isn’t exporting autos and other manufactured goods to the U.S., which is hurting its economy,” says Mastracci. His words are echoed by RBC, which said recently that the province is teetering on the brink of recession.

Noting that Ontario’s labour markets are already showing signs of a slowdown — the province lost 25,000 full-time jobs in March — including cutbacks in manufacturing, finance and real estate, the bank forecast the province’s economic growth at less than one per cent this year.

Ontario’s pain is shared to some extent by British Columbia, whose forestry industry is suffering the effects of the U.S. housing crash. The sector is also being squeezed by lumber prices, which are down 40 per cent from two years ago, and the strong Canadian dollar. As a result, many lumber mills have been forced to scale back or close operations across the province.

The manufacturing sector’s woes may be eased later this year by a declining Canadian dollar, says Paul Ferley. “We think the U.S. dollar will strengthen by year end and commodity prices will drop a bit over the next couple of years.” As a result, he expects the loonie to finish the year at 91 cents U.S. and fall next year to 87 cents.

Canadian interest rates will continue to decline this year, he adds.

“The Bank of Canada will cut interest rates by another 75 basis points by mid-year, which means the overnight rate will fall from 350 to 275 basis points and stay there for the rest of 2008.”

Fortunately, the U.S. downturn may be short lived. “Their economy could come back in the second half of the year,” Ferley says.

That may be somewhat optimistic, says Adrian Mastracci. “The earliest things will turn around is September. Otherwise it will be the first quarter of 2009, probably next March.”

In the meantime, he says, expect things in the U.S. to be worse in the second quarter of 2008 than the first. Canada will probably follow suit, he adds, although not to the same degree.

“We won’t be as well off in six months as we are today,” says Mastracci. “My advice to investors is to get your economic house in order as soon as possible. If you don’t have the right investment mix now is the time to make changes.”