British Columbia Investment Management Corporation
QUARTERLY ECONOMIC REPORT
Quarter Four - October to December 2008
GLOBAL RECESSION UNDERWAY
•
•
•
When the final numbers are in, it appears that the fourth
quarter of 2008 will be the worst quarter for global economic
growth since the early 1980s.
The Canadian economy appears to have shrunk at an annual
rate of 1.5-2% in Q4, while the deterioration in credit
markets caused U.S. growth to plunge by 3.8%.
Overseas economies began to catch the fall chill as well,
with the Eurozone clocking zero growth or maybe even
shrinking 1-2% in Q4. Japan also fared badly, as the sharp
appreciation of the yen hurt exports and is depressing
industrial production and business investment.
U.S. INFLATION EXPECTATIONS
5
•
•
•
•
Percent, quarterly survey
One year ahead
4
•
Average annual rate
over next 10 years
3
2
1
Macroeconomic Advisers’ one-year
and 10-year inflation forecasts made
in Jan. 2009
1.6
*
•
0
-1
1992
-0.9
1996
2000
2004
*
2008
Source: Survey of Professional Forecasters, Federal Reserve Bank of
Philadelphia (Nov. 2008), Macroeconomic Advisers LLC
•
Weakening global demand began to affect emerging
markets, with China and India both experiencing
sharp slowdowns in their growth as 2008 drew to a
close.
Inside This Issue*:
Economic Outlook
2
Canada
3
The collapse in commodity prices since mid-2008 is
another sign that the slowdown is affecting the fastergrowing regions of the world, as well as the
developed economies.
United States
5
Japan
6
China
7
The outlook for 2009 deteriorated very rapidly as it
became evident that the U.S. credit crunch was not
going to end soon and that the economic fallout
would be global.
Europe
8
As a result, forecasters were shaving their 2009
economic growth projections on a weekly basis
during Q4.
The International Monetary Fund lowered its forecast
for world economic growth from around 3.5% in
September to 0.5% today.
The Fund says that
growth of less than 3% means that the world
economy is in recession.
Also in contrast to 6 months ago, near-term inflation
fears have eased (see chart). Financial markets are
now worried about the risk of deflation as growth in
the major economies is running well below potential.
A few are concerned about medium-term inflation
risks given the magnitude of fiscal and monetary
stimulus to address the current situation.
Fourth Quarter - 2008
Research & Risk
Measurement
Daryl Jones
(250) 387-7149
Chris Lawless
(250) 387-4081
Philippe Monier, CFA
(250) 387-7134
www.bcimc.com
*This report incorporates information and data available
through January 30, 2009.
Page 1
QUARTERLY ECONOMIC REPORT
WORLD ON EDGE OF RECESSION
12
•
Having plundered global equity markets, the credit market freeze is about to
claim the world’s economy as its next victim.
•
The IMF expects growth of just 0.5% in 2009, well below the 3% break point
between global expansion and recession. As recently as November, the IMF
was predicting 2.25% growth in 2009.
•
Credit is the oxygen of the economy. The carnage on Wall Street is historic as
century-old institutions fell into bankruptcy or were taken over at fire-sale
prices. Even solvent financial institutions became reluctant to lend to their
customers, or to do business with other banks.
•
Despite the best efforts of the Federal Reserve and the U.S. Treasury to
encourage lending, trouble in credit markets has hit the real economy hard
including factories, malls, car dealers, hotels, and restaurants. If car dealers
can’t get money to finance inventory, and if the customers can’t lease or
borrow at reasonable interest rates, then the assembly lines will shut down
and workers will be laid off.
•
How bad will it get?
•
Most people under the age of 47 have not experienced a serious recession
during their working careers as the last major recession occurred in 1981-83.
During the 1981-83 recession, the unemployment rate peaked at close to 12%
in Canada and 11% in the U.S. The economy contracted nearly 3% from peak
to trough in Canada and in the U.S.
•
Most forecasters do not think that the current recession will be as severe but
predictions made in uncharted waters can be hazardous. However, unlike the
1982-83 recession, which was caused by tight monetary policy designed to
slay double-digit inflation, policy makers are trying to mitigate the current
recession with massive monetary and fiscal stimulus.
Percentage change in real GDP
9.8
10
8.8
2008
2009
8
6
4
2
0
3.5
1.4
0.0
U.S.
0.7 0.5
1.2
3.0
0.6 0.6
0.5
Japan Euro-zone Canada
China
Source: Consensus Forecasts, Bank of Canada, IMF
World*
*Using PPP weights
CREDIT CRISIS TIPS U.S. INTO RECESSION
6.0%
Real GDP growth
Unemployment rate
5.0%
8.0%
7.0%
4.0%
6.0%
Forecast
3.0%
2.0%
5.0%
1.0%
4.0%
0.0%
3.0%
-1.0%
2.0%
-2.0%
-3.0%
< GDP
-4.0%
2007
2008
Unmployment Rate >
2009
1.0%
ECONOMIC OUTLOOK
0.0%
2010
Source: U.S. Dept. of Commerce, Macroeconomic Advisers LLC
Fourth Quarter - 2008
Page 2
QUARTERLY ECONOMIC REPORT
Economic growth is falling and not likely to reverse before 2010
COMPOSITE LEADING INDICATOR AND
REAL GDP
5
GDP % change
•
Demand for Canada’s main exports fell precipitously in the second half of
2008. In addition, prices plunged for many of the natural resources sold by
Canada. These negatives, combined with nervous investors moving their
capital to the safety of the larger economies, caused the trade-weighted value
of the Canadian dollar to fall by some 20% between July and November.
•
After a 2.7% increase in real GDP in 2007, the increase in 2008 is estimated
at only 0.6%. The mid January 2009 consensus forecast is for a decrease of
0.7% in 2009 before rising 2.3% in 2010.
•
The drop in economic activity is widespread across the country and across
most industries. To a large extent, the downturn in the U.S. is causing the
Canadian economic slow down, given our dependence on U.S. trade.
However, the drop in demand for Canada’s commodities from emerging
markets is also playing a significant role in the current downturn.
CLI % change
Annual % changes
4
10
3
Forecast
2
6
1
0
2
<= GDP
-1
-2
'04 Q1
CLI =>
-2
'05 Q1
'06 Q1
'07 Q1
'08 Q1
'09 Q1
'10 Q1
Source: Statistics Canada, and Forecasts from Consensus Economics (as of Dec. 8, 2009)
CONSUMER CONFIDENCE AND
RETAIL SALES
8
7
Retail sales annual % change
Index of Consumer Confidence
Retail Sales (3 month moving averages)
Conference Board of Canada's Index of Consumer Confidence
6
Consumers are now far more pessimistic than before
Consumers are clearly feeling that the economy is worsening with credit
becoming tighter (though still quite affordable to many) and, more
importantly, the job situation deteriorating rapidly. Consumption is also being
affected by the drop in value of personal assets, particularly the value of their
homes and investment portfolios.
•
The value of retail sales is plateauing as retailers are offering large discounts
to stimulate sales. Lenders are becoming more cautious in granting credit and
this adds to the drag on household consumption.
•
Consumer bankruptcies increased sharply in the second half of 2008, reaching
9,000 last October, compared to 7,300 in October 2007. On the positive side,
overall consumer prices fell in late 2008, particularly gasoline prices,
providing some welcome relief to consumers.
100
90
80
3
70
2
60
Jan-04 Sep-04 May-05 Jan-06 Sep-06 May-07 Jan-08 Sep-08
•
110
5
4
CANADA
Source: Conference Board of Canada and Statistics Canada
Fourth Quarter - 2008
Page 3
QUARTERLY ECONOMIC REPORT
Business confidence falling as business climate worsens
BUSINESS CONFINDENCE
Confidence Index
•
The Conference Board of Canada (CBOC)’s Index of Business Confidence
plunged in Q3, despite the fact that it had already experienced four quarters of
consecutive declines. Business executives were deeply worried about the
economic conditions and outlook. Given the deterioration in the financial and
economic situations since the survey was taken, the level of confidence has
likely worsened.
•
The OECD’s business climate indicator points to a steady worsening of the
economic situation. The drop in the value of exports of goods and services is
impacting domestic demand. Growth in private plant and equipment
investment, which was already at a low level, is now falling.
•
On the positive side, business leaders also are having less difficulty finding
qualified staff and the growth of labour costs is decelerating.
•
Although major difficulties in obtaining corporate financing was mentioned by
more than a quarter of respondents to the CBOC survey, Canadian banks (e.g.
TD Bank) say that bank financing of businesses accelerated in October and
November. However, this was partially offset by reduced lending by non-bank
financial institutions.
Climate Index
<= CBOC's Business Confidence Index
OECD-based Canada's Business Climate =>
115
60
105
50
95
85
40
75
65
30
'04 Q1
'05 Q1
'06 Q1
'07 Q1
'08 Q1
'09 Q1
Source: Conference Board of Canada, and OECD for Canada’s Business Climate
PROFITS BEFORE AND AFTER TAXES
120
Quarter-on quarter % Change Annualized
Profit growth in Q3 was still healthy but expected to drop in Q4
Nominal Corporate Profits After Taxes
100
80
Nominal Corporate Profits Before Taxes
•
Firms in the oil and gas extraction business were the most profitable in Q3,
with profits up some 15%. However, the expectation for Q4 is for much lower
profitability due to the plunge in energy prices. The fall of the Canadian dollar
will only partly offset the price declines.
•
Operating profits of Canadian banks fell for the fourth consecutive quarter in
Q3, a situation not experienced since 1989. However, the financial sector as a
whole managed to generate some growth (3%) in profits in Q3, on the strength
of insurance carriers (essentially due to a reduction in expenses).
•
In January 2009, Consensus Economics estimated that pre-tax corporate profits
of Canadian companies rose 7.6% in 2008 but forecast that they will fall by
15.2% in 2009. They are forecast to rise by 7.0% in 2010.
60
40
20
0
-20
-40
-60
-80
Mar-99
Mar-02
Source: Statistics Canada
Mar-05
CANADA
Mar-08
Fourth Quarter - 2008
Page 4
QUARTERLY ECONOMIC REPORT
INDUSTRIAL PRODUCTION VS. COMPOSITE
LEADING INDICATOR
8
Industrial Production
Annual % Change
Composite Leading
Indicator (CLI)
6
Industrial production declining sharply
•
Industrial production last November was 5.5% below its level a year earlier.
The decline was widespread across industries, with few exceptions. The
auto industry was amongst the hardest hit.
•
The Conference Board’s composite leading indicator of the U.S. economy is
pointing to a deepening of the U.S. recession. The recession started in
December 2007, according to the National Bureau of Economic Research
(NBER), a U.S. non-profit economic research organization. The January
consensus forecast is that GDP will fall 1.8% in 2009, but rise by 2.3% in
2010.
•
So far, the massive amounts of funding approved by Congress to help the
economy have yet to be deployed. The Obama administration and Congress
are expected to act quickly on a fiscal stimulus plan. It reportedly will total
about $800 billion, including $300 billion in tax cuts and $500 billion in
infrastructure spending, including transfers to individuals as well as to state
and local governments.
106
104
4
102
2
0
100
-2
98
-4
Industrial Production Annual Growth Rate
-6
Composite Leading Indicator
-8
Jan-04
96
94
Jan-05
Jan-06
Jan-07
Jan-08
Source: Conference Board and Dept of Commerce
EMPLOYMENT VS. CONSUMER
2.5
Employment
Annual % Change
CONFIDENCE
Consumer
Confidence Index
Employment declines are accelerating
110
1.5
100
The employment situation is worsening fast with 3 million jobs lost between
December 2007 and December 2008, 2.4 million of which disappeared in
the last 6 months, and 1.7 million in the past quarter. As a result, the
employment level is back to its January 2006 level. The unemployment rate
reached 7.2% in December 2008, compared to only 4.9% in December 2007,
when the recession reportedly started.
•
Consumer confidence is at an all-time low, according to the Conference
Board, which started its survey back in 1967. The index now stands at only
38 compared to a recent peak of 112 in July 2007. Consumers’ outlook
grew substantially worse in December, when retail sales fell 2.7%.
90
0.5
80
0.0
70
-0.5
60
-1.0
-1.5
Employment Level Annual Percent Change
50
-2.0
Conference Board Consumer Confidence Index
40
-2.5
Jan-04
•
120
2.0
1.0
USA
30
Jan-05
Jan-06
Jan-07
Jan-08
Source: Conference Board and Dept of Labour
Fourth Quarter - 2008
Page 5
QUARTERLY ECONOMIC REPORT
JAPAN
High ¥ depresses corporate profits
CAPITAL INVESTMENTS & PROFITS
Annual % changes
Capital Investments
8
Corporate Profits
6
•
Corporate profits fell 22% in Q3 from a year earlier, with drops of 28% and
19% in manufacturing and non-manufacturing, respectively. The negative
sentiment about economic conditions is widespread and deepening among
business leaders, which explains the continuing decline in capital investments.
•
Indeed, the economic situation has worsened substantially. The consensus
forecast is that real GDP did not change in 2008 but it is expected to fall by
1.7% in 2009 before rising by 1.1% in 2010. Consensus Economics expects
the current account balance to be unchanged in 2009, in ¥ terms.
•
The current account surplus has fallen from ¥24.8 trillion in 2007 to an
estimated ¥18.5 trillion in 2008. In fact, the goods and services trade balance
has been in deficit every month since August 2008. These are the first trade
deficits since January 1985.
•
Weaker demand and the sharp appreciation of the Yen against most major
currencies in 2008 has reduced the competitiveness of Japanese exporters, and
contributed to the shrinking current account balance. The Yen is back up to its
mid 2002 and mid 1995 values relative to the Euro and U.S. dollar,
respectively.
40
30
4
20
2
0
10
-2
0
-4
-10
<= Capital Investments
-6
-20
Corporate Current Profits All Industries =>
-8
-10
Mar-02
-30
Mar-04
Mar-06
Mar-08
Source: Japan Min. of Finance and OECD
HOUSEHOLD CONSUMPTION & CONSUMER
PRICES
3
Household Consumption
Household consumption is almost flat in real terms
CPI All-Items
Annual % changes
6
2
4
1
2
•
There was an increase in nominal household consumption in the second half
of 2008 from a year earlier. This was due largely to the increase in consumer
prices. The drop in commodity prices and weak consumer demand are
expected to contribute to a steady drop in consumer prices, with a consensus
forecast of a 0.4% decrease in CPI in 2009, after an increase of 1.5% in 2008.
Consumer confidence has plunged since mid-2007 with so far no sign of
optimism returning.
•
The negative impact of the economic downturn on the labour market is so far
quite small, with a small increase in unemployment, a limited pool of new
jobs and no increase in wages. However, the rising uncertainty about
employment is expected to put downward pressure on household
consumption.
0
0
-2
CPI All Items =>
<=Household Consumption Nominal
<= Household Consumption Real
-1
-2
Jan-02
-4
-6
Apr-03
Jul-04
Oct-05
Jan-07
Apr-08
Source: Japan Min. of Internal Affairs & Communication, and Cabinet
Office’s Economic & Social Research Institute
Fourth Quarter - 2008
Page 6
QUARTERLY ECONOMIC REPORT
PRODUCTION INDICATORS
30%
Activity cools
•
The momentum of industrial output and electricity production, two important
indicators, have slipped considerably in recent months. This corroborates
media stories of large numbers of factory closures and worker layoffs.
•
Exports also appear to be slowing sharply as demand from Japan, the United
States and Europe slows.
•
While China is not as export-dependent as is often suggested, clearly the
global downturn is starting to have an impact. Until now, China and much of
Asia, has avoided the effects of the credit crunch since their financial systems
are not as integrated with those in the industrial economies.
•
Consequently, the contagion from the U.S. sub-prime market that swept
through Europe had little impact on Japanese or China’s financial markets.
However, the weakness in global demand has now reached China’s shores.
Year/year percentage change
25%
20%
15%
10%
5%
0%
Electricity
-5%
Industrial Production
-10%
2003
2004
2005
2006
2007
2008
Source: Bloomberg
Year/year percentage change
12
Growth forecasts are trimmed
2009 CONSENSUS OUTLOOK
TRIMMED
10
8
Real GDP
•
Six months ago, there was considerable confidence that China would avoid
the worst effects of the credit crunch. Of course, at that time, the expectation
was that global economy would slow rather than slip into a recession. The
standard forecast for 2009 at the time was for growth in the 9% range.
•
Now, forecasts have been cut to around 7.4%. Policymakers fear that these
rates of growth will fail to mop up surplus labour from manufacturing
industry cutbacks and unskilled workers that have crowded into the big cities.
Protests are occurring, which is of great concern to the authorities.
•
The government has responded with a fiscal stimulus program of 4 trillion
RMB, or about C$740 billion. This is close to 15% of China’s nominal GDP,
but the actual new stimulus is probably about one-quarter of the advertised
total since much of the program is previously announced initiatives.
•
In addition, the central bank has cut interest rates again and enacted measures
to ease credit and stimulate spending.
Consumer Prices
7.4
6
4
2
0
Forecasts Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan
made in: 2008
2009
Source: Bloomberg
CHINA
Fourth Quarter - 2008
Page 7
QUARTERLY ECONOMIC REPORT
EUROPE
Economy will shrink until mid-2009
EUROZONE REAL GDP GROWTH
•
The European Central Bank (ECB) projects growth of –1.0 to 0% in 2009,
after growth of 0.8 to 1.2% in 2008. The still-wide range for 2008 implies a
lot of uncertainty about Q4 (annualized growth of anywhere from –4.0% to
+1.5%), when it appears that global economic activity fell off a cliff.
•
The ECB expects the weakest area of the Eurozone economy to be nonresidential investments, which will be affected by tight credit conditions.
Residential investments is expected to be weak as well but uneven across the
Eurozone.
•
Falling employment and reductions in housing and equity wealth will
depress consumer spending .
•
The only positive contributor for the economy, net exports, still reflects
weak global conditions: export volumes will fall, but less than imports
Percentage change
Private consumption
2008
Gov't consumption
2009
Capital investment
Exports
Imports
Real GDP
-5
-4
-3
-2
-1
0
1
2
3
4
Source: European Central Bank
5
Pressures on the EMU?
•
January 1, 2009 was the 10th anniversary of the establishment of the European
Monetary Union (EMU) or Eurozone. Its 16th member, Slovakia, was
welcomed into the club. At the same time, the anniversary caused some to
question whether the EMU will remain together for another 10 years.
•
The currency union appears to have been successful in keeping inflation under
control and enforcing modest fiscal discipline through the Maastricht Treaty
rules (particularly among new entrants, although there was a lot of ‘fudging’ by
others). However, some think it might collapse under the weight of a serious
recession, where conditions could diverge widely across countries and regions.
•
Their logic is that this will make a single exchange rate untenable from a
political standpoint, forcing some countries to exit the Eurozone to get relief
from an overvalued currency. Wider interest rate spreads between the stronger
and weaker members of the Eurozone are cited by some as evidence that the
market thinks that the desire for a break-up is a growing.
•
Perhaps, but the upside to exiting the euro seems limited. Any country that did
would see its currency depreciate but also would likely face much higher
interest rates due to uncertainty about its monetary and fiscal policies.
INTEREST RATE DIFFERENTIALS
250
200
10-year gov’t bonds; basis points above German yields
Jan. 13
1 year ago
150
100
50
0
Source: Bloomberg
1 basis point = 1/100th of a percent
Fourth Quarter - 2008
Page 8