This article was originally published in Maclean's Magazine on December 8, 2008
Facing Financial Crisis, Experts Chart out the Future
Last week brought another massive plunge on world stock markets, followed by yet another government bailout of a troubled bank - this time a US$300-billion lifeline from the U.S. Federal Reserve to Citigroup. The S&P/TSX Composite index has now dropped by 44 per cent since June, wiping out more than four years of market gains, and marking the sharpest decline for Canadian stocks on record. Millions are wondering and worrying about job security, the value of their homes and what's happening to their dreams of retirement.
With North Americans now embarking on the biggest shopping season of the year, the economy is at a critical point, and Maclean's assembled five of Canada's brightest financial minds to answer some of the most pressing questions in the air:
• Patricia Croft, chief economist at RBC Global Asset Management
• Don Drummond, chief economist with TD Bank Financial Group
• David Rosenberg, chief North American economist at Merrill Lynch
• Avery Shenfeld, managing director and senior economist with CIBC World Markets
• George Vasic, equity strategist and chief economist at UBS Securities Canada.
Due to scheduling conflicts, Maclean's interviewed each participant separately. This is an edited transcript of their comments.
Maclean's: How would you describe what has happened on the stock markets over the past three months?
Vasic: Other than to say it's been traumatic? I'd say, we've certainly seen a historic plunge in markets on the back of a potential financial system collapse that was inconceivable in the minds of virtually all investors.
Croft: It's been absolutely incredible. This is the worst bear market in stocks since the Great Depression. In some ways it feels like a vortex. You get swept up in it every day.
Drummond: We've gone from a period in which the general expectation is that the U.S. economy, despite increasing signs of trouble, was going to go on growing rapidly forever, to a feeling now that it's just falling endlessly and has not reached a bottom.
Shenfeld: [The markets have] seen the typical selling you'd expect to see in a recession, coupled with a broader wave of forced selling by fund managers who've seen redemptions or have had to pay back loans. This sell-off has been much larger than what one would have expected from an ordinary recession and even worse than what we've seen in past financial crises.
M: We heard Stephen Harper sound a pretty grim tone at the APEC meetings over the weekend. What should we take from his comments?
Vasic: He's preparing us for the fact that the surplus is going to turn into a deficit. Canada has more fiscal firepower at its disposal than you'd see in the U.S. or Europe or anywhere. The real question is whether we want to deploy it or not. If I were Mr. Harper I wouldn't be very aggressive on using it. The history of all these fiscal initiatives [like massive increases in government spending] is that a) they come too late, and b) they're hard to get off once the economy recovers. That's how our fiscal problems got started in years past.
Croft: I think it's very refreshing that Harper has finally used the R-word [recession]. That's usually verboten for a politician or a central banker. But it's all about managing expectations. There is no magic bullet for Canada. We are unfortunately going to suffer much the same fate as every other major economy around the world. We have a very stable financial system, which will hold us in good stead, but we are a very open economy and a very small economy. Our major trade partner is in a very deep recession, and I don't think we've even really begun to feel the impact of that decline.
M: How bad is this likely to get for the Canadian economy?
Drummond: I would have expected a more profound impact than we've seen so far. One of the first places you'd expect it to slow as soon as we began seeing economic uncertainty would be car sales, and so far car sales have continued to increase in Canada, albeit modestly. We're even still creating jobs in Canada. That's a bit of a puzzle. But I still think we will see worse economic outcomes in Canada than we've seen so far. Not as deep as in the U.S., but it will get worse before it gets better.
Rosenberg: Now we are entering into the eye of the hurricane: the intense consumer leg of this recession. The U.S. consumer now accounts for over 70 per cent of U.S. GDP and almost 20 per cent of global GDP, and that's why as soon as the U.S. consumer started to give it up in late summer, that's when oil prices started to peel off. This is the most broadly based U.S. recession in post-World War II history, and it has gone global. In the U.S. we have already lost 1.2 million jobs, and we probably have at least another three million to go. In our forecasts, the unemployment rate peaks between 8.5 and nine per cent in the opening months of 2010.
In Canada, whatever happens in the States inevitably migrates north of the border. Anybody who was around in the early 1990s knows what that's about. Canada's vulnerability is that corporate profits are reliant on commodities - that's strike number one. Strike two is that Canada is disproportionately exposed to the auto sector. Strike three is that the principal buyers of Canadian products are U.S. consumers. On the other hand, Canada [benefits] from the fact that the banks aren't nearly as under-capitalized as they are in the U.S. And although house prices are deflating, they're not nearly as bad as in the U.S. Third point - the Canadian government, having started this with a balanced budget, has more room to ease fiscal policy than the U.S. So Canada has three strikes, but it also has three balls.
Vasic: Well, it's going to get worse from here. We've really just recently fallen into the teeth of the economic slowdown. The thing that stands out is just how little Canadian employment has been affected so far. We know that capital spending cuts are coming [from major companies], we know that in central Canada there will be a lot more adjustments to come in the manufacturing sector, so the employment picture is going to deteriorate quite significantly in the next six to nine months. But we're coming off an employment situation that is very close to the best we've seen in 30 years, and that's worth remembering. If our unemployment rate goes [from around six per cent now] to 7.5 per cent, which we think it will, it's not a good thing. But for most of the past 30 years, we were above that anyway.
Croft: In the U.S. I think the unemployment rate is going to at least 8.5 per cent, and in Canada I think we're going up to 7.5 per cent. If you look at construction employment, it's at a record high in Canada at a time when residential real estate is cooling precipitously. Those jobs are at risk. I have to believe there are more job losses in manufacturing, too. And the auto sector - wow ... that's a significant concern.
M: What's the outlook for the stock market?
Rosenberg: People in Canada are going to be braced for some pretty tough times. The epicentre was in the U.S., but we don't live in a vacuum. It is a global recession, and Canada is tied to the global economy.
Croft: Anybody who says they know we're close to the bottom ... I just don't believe them. I don't know where the bottom is. I hope we're close to it, but we're not out of the woods in terms of the financial crisis, and we're just beginning to feel the economic impacts. The credit crisis has gone global and become a solvency crisis in the financial system, and an economic crisis. Markets could stumble around here for a few months.
Shenfeld: In normal times we could look at how far we've fallen relative to earnings, and be confident that we're near a bottom. In this environment that's a tougher call because so much of the selling has been forced by hedge funds losing their investors and their sources of credit, and other ripple effects of unwinding debts around the world. Stocks look cheap relative to earnings, but one can't be too confident that they won't get even cheaper for awhile.
Drummond: To me, the first sign of hitting a bottom in the economy is U.S. housing prices hitting bottom, and I think they need to come down another 10 to 15 per cent. I think they'll get there by spring 2009. But I think the stock markets will hit bottom before that ... somewhere between two weeks ago and April of 2009 [laughs] ... obviously I don't have the confidence to pinpoint a day.
I think these massive stimulus packages already announced by China and the U.K. and the United States should at least give some confidence for a recovery in the second half of 2009.
M: How long will this take to recover from?
Drummond: Eighteen months, same as the APEC ministers [said], not 17 and not 19. [laughs] We're going to go through a very extended period of de-leveraging around the world as companies and individuals pay down debts, and I think that will constrain growth. Maybe the worst will be over by the summer of 2009, but I think the problem will linger for a while. This is not just a one- or two-year wonder. Economies aren't going to come racing back, it'll be more of a limp.
Vasic: Well, getting back to the 15,000 level on the TSX is really going to require getting oil back up over $100 a barrel, and a recovery in other commodity markets as well, up to close to the levels of last spring. That'd be an event for 2010 or maybe 2011.
Rosenberg: I'm not even convinced we've seen the bottom yet. The answer lies in Japan - they are 19 years away from the peak. This is not some correction in a cyclical bull market. There are some fundamental, structural economic problems that still haven't been worked through. When will we hit the next peak in the Dow and the S&P 500? I'd say it's at least 10 years away. But let's focus on when we're going to hit bottom before we start talking about prior highs.
Shenfeld: On average it tends to take around three years to make up for the scale of losses we've seen on the stock market. But it could take up to five years if the recovery is less robust. And even that is going to require a lot of economic pump priming by government to restore growth.
M: Do you worry that some of these stimulus plans are going too far, and could create larger problems down the road with excessive debt and huge deficits?
Croft: No, not at all. And if they do, we'll deal with them later. Right now, the more pressing issue is deflation. That is the last thing you want to see. I think it's absolutely justifiable for Canada, and every other country out there, to run large budget deficits on a temporary basis to ensure a mild downturn doesn't morph into something deeper, more prolonged and more serious.
Shenfeld: I'm very encouraged that Ottawa has shifted away from planning to fight the deficit at all costs, to talking about possibly even expanding the deficit as a way to fight economic weakness.
Drummond: I think we're building up for some ugly long-term problems. We already have a U.S. government that's going to run trillion-plus deficits for the next couple of years. How are they ever going to get out of that? I think perversely some of the things being done to ease short-term pain are going to create longer-term pain. The rumour from the U.S. is Obama is considering a stimulus package of US$500 billion or more. They already have a debt problem much like the one Canada had in the mid-1990s.
M: Who in the world could finance all that debt?
Drummond: Well, the Chinese and Japanese central banks. But there is always a point at which they decide they don't want to do that anymore. And as the U.S. dollar returns to a trend decline, it'll occur to them that's a pretty lousy investment. That's the big risk.
M: How concerned should people be about the stability of their pension plans and their retirement?
Drummond: I think we have a fairly serious situation developing in Canada with regard to pensions. The Canada Pension Plan is fine but ... it's not really a comprehensive program. We know Canadians don't have huge amounts of money, I would argue they don't have adequate amounts of money in their private RRSPs. So it really comes down to employer-sponsored programs. There are basically no new companies in Canada offering either defined-benefit or defined-contribution plans. If you're lucky they're offering group RRSPs. We have a long-run issue - will there be adequate pension coverage? You really start to wonder whether what we need to do is bolster up the coverage of the CPP plan. I think it's a great worry.
I think it's going to have an impact. We've already seen a small uptick in the average age of retirement.
Rosenberg: As bad as the retirement problem is in Canada, it's worse in the U.S. The reality is, we went through the 1990s and peoples' retirement was the "Nasdaq nest egg." That got destroyed by [the dot-com] crash. We went right into this massive housing bubble. Then their retirement was the "for sale" sign on a 5,000-sq.-foot McMansion in the suburbs. Now that's destroyed. The reality is that savings rates are at record low. People are going to have to save more of their income for retirement. Relying on asset inflation to pay for retirement - that fairy tale is over. People are going to work as long as they can in order to ensure they can maintain their living standard in their golden years.
The boomers have spent their adult lives building up an incredible stockpile of consumer durable assets, but they have not prepared financially for their retirement. These concerns are real.
Shenfeld: They say that 50 is the new 40, because we've lost all the money we've saved over the past 10 years, and that's going to mean a later retirement date for many Canadians.
Croft: I think the concerns are well-founded. Obviously if you're 20 years old, you're not too worried. But if you're on the cusp of retirement or recently retired, I think the concern is real. That said, a lot of people have the tendency to look at what's happening now and think it's never going to get better. It will get better. But it might take a while for us to dig our way out of what has become a pretty deep hole.
M: How worried should we be about real estate?
Croft: Not too worried, but that said, I've been surprised by the rapidity of the decline. In the U.S. I think prices will be down 30 per cent before all is finished, and that's a tremendous impact on American wealth. Here in Canada we don't have that far to fall, maybe another five or 10 per cent.
M: What do you expect this holiday season to tell us about the condition of North American consumers?
Vasic: The U.S. consumer is clearly going to have a very difficult year. People aren't even over the shock of things yet. But in Canada, the decline in the stock market has had a negative impact on sentiment, but the employment shocks have not come, and for most Canadians this collapse has not yet affected them directly. They'll be spooked to some extent and rightly so, so I think it'll be soft, but not nearly as difficult as in the U.S.
Croft: Early indications from the U.S. are quite grim. That said, I went to Oakville Place on the weekend and couldn't get a parking space. People are in a mindset right now that if it's not 50 per cent off, I'm not going to buy it. People in Canada are going to delay their purchases and wait to see if prices come down. But down in the U.S. it's looking like a very frugal Christmas.
M: What do you think when you hear colleagues and pundits drawing comparisons to the Great Depression?
Shenfeld: The Great Depression, last I looked, didn't have a six per cent unemployment rate. I think what's fair to say is that the crisis in the global economy is one of the worst in decades. We could well have been headed for another depression if Herbert Hoover were still in the White House. But governments in the U.S., Canada, Asia and Europe are doing precisely the opposite of what got us into the Depression.
Drummond: Well, in economics all you've got is history and theory, so you might as well exploit whatever history you can to figure how this is going to end up. The origins of the Great Depression definitely have some similarities. But so far the policy response bears no resemblance. Back then, right until 1934 you had governments trying in vain to maintain budget balances, cutting spending and raising taxes. This time, you're going to see the opposite.
Rosenberg: This is not the Great Depression. We already had the Great Depression. This is a modern depression. We've got a framework now that we didn't have in the '30s - we didn't have deposit insurance, we didn't have welfare - so, the comparisons can only go so far. But there are lessons to be learned from the Great Depression, and from Japan in the 1990s.
Vasic: It's really the only dislocation that we've seen that was worse than the one we're currently going through, so comparisons are certainly natural. But most people don't appreciate the differences. We went to 25 per cent unemployment, and we learned a lot from that. The speed of the actions we've seen so far truly are unprecedented. This is the first time since the Great Depression that we've had this kind of potential market meltdown, and while our authorities have not acted perfectly, they have acted swiftly, and continue to act. I don't think we're heading anywhere close to a Great Depression.
The thing to bear in mind is that while this panic attack is justified, it can just as easily be reversed. Of the 10 worst days in the history of the TSX, five of them have happened in the past two months. But, of the 10 best days in TSX history, five of them have also occurred in the past two months, too. We could quite easily snap back to TSX 10,000 quite quickly, and then begin the process of repair.
M: So what can people do to get through this as best they can?
Rosenberg: Focus on cutting their debt loads. Find ways to cut costs and raise cash. Invest conservatively. We're not talking about having to go back to the days of Leave It to Beaver and Ozzie and Harriet, but I think that frugality is going to emerge as the new fashion. It's going to mean, instead of going out for dinner twice a month, have friends over for a potluck dinner. Instead of driving to work, maybe take transit or carpool. People think this is draconian, this frugal future, but people may find they're happier.
Maclean's December 8, 2008