economic and investment outlook cia conference, toronto september 2009 warren a. thomson sevp &...
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Economic and Investment OutlookCIA Conference, TorontoSeptember 2009
Warren A. Thomson
SEVP & Chief Investment Officer
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22
Overview
Economic Indicators
Canadian Equities
Canadian Fixed Income
Alternative Assets
• Commercial Real Estate
• Oil & Gas
• Timber
• Agriculture
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33
Economic Indicators
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44
Is The Recession Over?
Signs of growth in China, Europe and Japan in Q2 2009
The US:
• Growth may be resuming as we speak (Q3 2009)
• Worst downturn since WWII – even a partial rebound could deliver startling % growth rates
• GDP: 2.5% loss vs. 3% trend growth implies at least 5.5% below potential now
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55
The Worst Seems To Be Behind UsHome Sales Finding A Bottom
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66
Initial Unemployment Claims Turn The Corner
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77
Retail Inventories Still Excessive, But Getting Less So
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88
ISM Indexes Still Below 50, But Past The Worst
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99
Canada: Basically Sound, But Tied To The US
Negatives: in a bad neighborhood• Too integrated with the US to avoid tracking US cycle• Spillovers from the demise of Detroit, particularly in Ontario
Positives: living within one’s means• Commodities will bounce back with global growth• Closer than other countries to sustainable budget and trade balances• Systemically important financial institutions are sound
Bottom line: less trauma than elsewhere• Slightly healthier GDP growth than the US• Employment probably not rebounding until 2010• Strengthening CAD may limit manufacturing competitiveness
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1010
Canadian Economy Improving
Canada - Leading IndicatorLevel ( ) and %Change Yr/Yr ( )
Source: OECDM1856 JUN 2009
105
100
95
90
85
80
15
10
5
0
-5
-10
-1597 98 99 00 01 02 03 04 05 06 07 08 09 10
87.6
-7.8
)
June 2009
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1111
Household Debt Levels Resulting in Paradox of Thrift
))Canada Personal Savings ( ) and Household Debt ( )
As Percent of Disposable Income
Consumer credit plus mortgage debtQ239 2009:2
25
20
15
10
5
0
130
120
110
100
90
80
70
60
50
401960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
4.5
128.6
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1212
MFC GIM’s Forecast
2004-08Average
2008 2009Forecast
2010Forecast
Real Economic Growth (% change in GDP)
World 3.5% 2.2% -2.2% 2.6%
United States 2.5% 1.1% -2.5% 2.7%
Canada 2.4% 0.4% -2.2% 3.0%
Eurozone 2.0% 0.6% -4.0% 1.1%
Japan 1.7% -0.7% -5.3% 1.6%
China 10.8% 9.0% 8.5% 10.0%
Inflation (% change in CPI)
United States 3.2% 3.8% -0.6% 2.0%
Canada 2.1% 2.4% 0.4% 1.9%
Eurozone 2.3% 3.2% 0.4% 1.6%
Japan 0.2% 1.4% -1.0% 0.0%
China 3.6% 5.9% -0.3% 1.1%
Source: MFC Global Investment Management, as at August 24, 2009
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1313
Canadian Equities
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1414
Commodity Prices Recovering
Commodity Price Indexes
Indexed to 100 at TroughD1039 2 SEP 09
180 180
170 170
160 160
150 150
140 140
130 130
120 120
110 110
100 100Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
2008 2009
CRB FuturesJournal of CommerceCRB Spot Industrials
September 2009
2008 2009
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1515
Equity Valuations are Reasonable
TSX Price-Earnings MultipleBased On Trailing Operating Earnings
Shaded Areas Represent U.S. Economic RecessionsM11 SEP 2009
40 40
35 35
30 30
25 25
20 20
15 15
10 10
5 5
0 01960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Median: 16.7Average: 17.0
15.6
50-yr Average
September 2009
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1616
S&P/TSX Earnings Near Trough
TSX Operating Earnings%Change Year/Year
Bottom-Up Forecast Based on CPMS ConsensusM1301 AUG 2009
60 60
40 40
20 20
0 0
-20 -20
-40 -40
-60 -6096 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14
TrailingBottom-Up FcstTop-Down Fcst
-29.0-25.3
27.7
23.118.8
15.8
August 2009
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1717
Earnings Yield Still Above Government Bond Yields
TSX Forward Earnings Yield ( )And Long Term Canada Bond Yields ( )
M1941 SEP 2009
18 18
16 16
14 14
12 12
10 10
8 8
6 6
4 4
2 282 84 86 88 90 92 94 96 98 00 02 04 06 08 10
3.96
6.69
))
September2009
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1818
S&P/TSX Bear Markets – 1957 to 2009
Returns from end of bear market
Period# of
monthsDecline 3 months 6 months 12 months 24 months
May 57 – Dec 57 7 -26.9% 7.0% 14.2% 31.2% 37.3%
May 69 – Jun 70 13 -25.4% 13.2% 19.1% 27.5% 45.5%
Oct 73 – Sep 74 11 -35.9% 2.9% 22.1% 23.2% 35.9%
Jun 81 – Jun 82 12 -39.2% 18.7% 46.8% 86.9% 76.3%
Jul 87 – Nov 87 4 -25.4% 8.4% 10.9% 14.5% 42.1%
Dec 89 – Oct 90 10 -20.1% 7.3% 14.8% 18.6% 16.4%
Apr 98 – Aug 98 4 -27.5% 15.2% 15.1% 28.1% 109.4%
Aug 00 – Sep 02 25 -43.2% 7.5% 3.7% 22.5% 45.4%
Median -27.2% 8.0% 15.0% 25.4% 43.8%
Jun 08 – Mar 09 9 -50.2% 39.4% 45.4% ? ?
Source: CPMS/ Bloomberg
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1919
Summary
The worst is likely behind us from an equity market perspective
Markets are supported by:
• A resumption of global growth
• Commodity price recovery
• Earnings recovery
• Attractive valuations
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2020
Canadian Fixed Income
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2121
Short Term Rates at Record Lows
Canadian Government Yield Curves
Source: Bloomberg
Post-Crisis (September 9, 2009)
Pre-Crisis (June 30, 2007)
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2222
Spread Between LIBOR and T-Bills has Returned to More Normal Levels
Source: Bloomberg
US Interest Rates – September 17, 2004 to September 9, 2009
Lehman failure
Beginning of crisis
3 month US LIBOR
3 month US T-Bill
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2323
Strong Corporate Bond Returns as of August 31, 2009
Source: PC Bond Analytics, TSX
0.6% 0.2%
3.7%
7.4%
11.5%
-5%
0%
5%
10%
15%
1 month 3 month 1 year
Corporate Federal Government
1.7%
6.4%
11.5%
0.7% 1.0%
5.9%
-5%
0%
5%
10%
15%
1 month 3 month 1 year
Corporate Federal Government
Mid CrisisDecember 31, 2008
Post CrisisAugust 31, 2009
Canadian Bond Total Rates of Return
(0.3%)
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2424
Corporate Spread Compression Continues
050
100150200
250300
350400
Jun 99 Jun 00 Jun 01 Jun 02 Jun 03 Jun 04 Jun 05 Jun 06 Jun 07 Jun 08 Jun 09
Spre
ad (
bps)
Canadian Investment Grade Corporate Spreads
0200400600800
100012001400160018002000
Jun 99 Jun 00 Jun 01 Jun 02 Jun 03 Jun 04 Jun 05 Jun 06 Jun 07 Jun 08 Jun 09
Spre
ad (
bps)
US High Yield Spreads
Source: PC-Bond Analytics, Merrill Lynch, June 30, 2009
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2525
Canadian Bonds Are Expected to Perform Well Going Forward
Interest rates should increase modestly over time
Corporate spreads may tighten further• Modest improvement over time in line with economic
conditions
Corporate bond class should continue to outperform, but relative performance will moderate
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2626
Alternative Assets:Prospects and Challenges
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2727
Commercial Real Estate
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2828
US Market Is Stressed
Most property types and regions experiencing difficulty from increased vacancy and tight credit markets
Office market has settled into a stable but soft cycle
• Duration tied to the start of job creation
Erosion of operating income and valuations is increasing pressure on owners struggling to refinance their loans
Upcoming loan maturities and lower values necessitate new equity
Excessive use of leverage (debt) is the core problem
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2929
Canadian Market A Relatively Strong Performer
Market remains relatively healthy compared to rest of the world
Foreign buyers showing interest in acquiring institutional-grade
commercial real estate
Concentrated institutional ownership of large properties reduces
the likelihood of trades and value declines (due in part to reduced
use of leverage)
Pockets of weakness remain contained
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3030
Asian MarketOutlook Uncertain
Asia has benefited from financial easing during the first half of 2009
Lower rental rates have resulted from weak space demand and threat of rising vacancy rates
Continued high acquisition activity expected
Property fundamentals remain uncertain into 2010
Risks are lower due to decreased use of leverage relative to rest of world
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3131
Oil & Gas
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3232
Oil Price Stability Expected to Resume in 2010
Short term oil prices likely to remain volatile
• Bloated inventory levels
• Tighter oil supply than at start of the year
• Some signs of global economic improvement
Oil price stability should replace volatility in 2010
• Global economic recovery signs begin to take hold
• No suitable substitute for transportation fuel
Source: FirstEnergy Capital, World Crude Oil Markets, August 27, 2009
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3333
Natural Gas Price Outlook Remains Weak
Short Term – Natural gas currently challenged by:
• High inventories
• Weak industrial demand
• Growing US domestic production
Long Term – Few catalysts for a rebound in prices
• Inventory continues to build
• Increasing unconventional supply may insulate price spikes
Weak natural gas prices are a stimulus to the broader economy
Source: BMO Capital Markets, Monthly Commodity Watch, August 2009; IHS CERA – Monthly Briefing “North American Natural Gas”, August 2009
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3434
Timber
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3535
0200400600800
1,000
1,2001,4001,6001,8002,0002,200
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
Hou
sin
g S
tart
s
(10
00
un
its
per
year)
0714212835
424956637077
Lum
ber
Consu
mption
(bill
ion B
F per
year)
Housing Starts Housing Starts Forecast--RISI
Lumber Consumption Lumber Consumption Forecast--RISI
US Housing Starts and US Lumber Consumption
Timber Markets in a Deep Cyclical Trough
Source: Resource Information Systems, Inc. (RISI)
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3636
9,000
9,500
10,000
10,500
11,000
11,500
12,000
Q1/05 Q1/06 Q1/07 Q1/08 Q1/09
Mark
et
Pu
lp S
hip
men
ts
(1,0
00
ton
s)
0
20
40
60
80
100
120
Glo
bal A
vera
ge P
ulp
wood P
rice
(US
$ p
er
OD
MT)
Market Pulp Demand Softwood Pulpwood Price Hardwood Pulpwood Price
Global Pulpwood Demand and Pricing
Demand For Pulp Has Also Declined
Source: Wood Resources International and Hawkins Wright Ltd.
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3737
0
20
40
60
80
100
120
140
160
180
200
220
240
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
Opera
ting C
ash
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
2,000
2,200
2,400
Pro
pert
y V
alu
e
Operating Cash Property Value
Sources: NCRIEF and HTRG Research. Methodology detailed in “Explaining Timberland Values in the United States,” Journal of Forestry, December 2004.
Operating Cash and Value for Prototypical All Age US Timberland Property (nominal $ per acre)
Timberland Values Are Stressed
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3838
Agriculture
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3939
Farmland Market Fundamentals
US farmland values are expected to moderate in near-term and grow in long-term driven by:
• Strong US net farm income
• Healthy balance sheet fundamentals
• Continued strength in the agricultural export markets
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4040
Average Value per Acre of US Farmland, 1940–2008
Long-Term Upward Trend in Farmland Value
US Aggregate Net Farm Income (billions), 1940–2018F
Source: USDA Economic Research Service. Actual numbers through 2008, forecast through 2018
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4141
Strong Financials and Balance Sheets For the US Farm Sector
Source: USDA Economic Research Service 1970-2008
US Farm Sector Debt Ratios 1970-2008
US Farm Sector Balance Sheet, 1970-2008
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4242
Summary
Canada remains sound, but tied to the US
Commodity prices are recovering and equity valuations are reasonable
Short term rates at record lows, with interest rates expected to rise modestly over time
The worst may be behind us, but it is still too soon to declare that the recession is over
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Questions & Answers