Cool down in 2008

The consensus seems to be in: The United States is either in a recession or soon will be. And British Columbia's economy will be partially sheltered and suffer less than other provinces.

But that's the consensus this week. Not long ago, the idea of a recession south of the border was still just a dot on the probability chart.

Since then the housing market in the U.S. -- the main engine of the economy -- has continued its plunge. And the economic uncertainty has caused the continent's stock markets to yo-yo. The S&P/TSX composite index reached 14,625.00 at the end of October, before plummeting, with some bounces, to a low of 12,132.13 in January. Since then the index has peaked and troughed, and peaked and troughed again, and now sits precariously around 13,250.

And while the current view is B.C. will be at least partly insulated from the downturn because it relies less on the U.S. as a purchaser of its goods than the rest of Canada, businesses in B.C. are growing less optimistic about the future. In a survey carried out in March by the Canadian Federation of Independent Business, optimism among B.C.'s small- and medium-sized businesses dropped to its lowest level since 2003.

So what is in store for B.C.? The Vancouver Sun posed that and other questions to four local economy watchers. Here's what they had to say:

- What are the short-term (2008) impacts of a U.S. recession on economic growth, job creation and income in the Lower Mainland and the rest of B.C.?

Jock Finlayson (JF), executive vice-president at the Business Council of British Columbia: For 2008, we see economic growth in the province dropping to about 2.5 per cent after inflation, down from three per cent last year. While the unemployment rate will remain low, the pace of job creation and of overall income growth will slow. Economic conditions will be stronger in southwestern B.C. than in most other regions.

Murray Leith (ML), vice-president of investment research at Odlum Brown Ltd.: Canada will not be immune to weakness in the U.S. and global economies. As global growth slows, we expect commodity prices to come off their boil. That will undermine a key driver of the Canadian economy. The Canadian dollar should moderate with commodity prices, so that will be a helpful offset.

There will be a significant lag before changes in the U.S. and global economic conditions affect the B.C. economy. As such, we expect the B.C. economy to remain relatively buoyant in 2008. Expect slower growth in 2009.

Helmut Pastrick (HP), chief economist with Credit Union Central of B.C.: The Lower Mainland's economy is less impacted by the U.S. slowdown, the decline in lumber prices and the high Canadian dollar, given its more domestic, service-sector oriented industry mix, than the rest of B.C.

Cameron Muir (CM), chief economist for the B.C. Real Estate Association: The forest industry and tourism are facing the brunt of the fallout from the U.S. economic downturn. U.S. housing starts are down 50 per cent from two years ago and new home inventories are still swollen. Wood manufacturing employment in the province fell 20 per cent in the past year and there will be more layoffs in the coming months. A high Canadian dollar and belt tightening by U.S. consumers will continue to negatively impact tourism in B.C. this year.

- What's your prognosis for 2009?

HP: Modestly higher growth for B.C. at about three per cent, from 2.5 per cent to three per cent in 2008, due to substantial monetary stimulus and lower cost of credit as well as a faster growing U.S. economy, which means lumber exports stop falling. Domestic sectors, largely shielded from export exposure and the high dollar, perform well. The trade sector remains a drag on growth. Energy, metals, coal, and some non-resource manufacturing exports perform well.

JF: The outlook for B.C. in 2009 depends on how the American economy fares and whether U.S. housing starts reverse course after collapsing in 2007-08. Assuming some recovery in U.S. demand for imported goods, including lumber products, the value of B.C.'s exports should inch ahead after three years of consecutive declines. This, coupled with continued strength in key components of domestic demand, should be enough to lift B.C.'s economic growth rate back to the three-per-cent range.

CM: Softwood exports should experience a bounce as U.S. home building returns to form. The trade deficit is also expected to be less threatening. This will help B.C. economic growth increase from 2.5 per cent this year to 2.9 per cent in 2009. Labour markets will continue to be tight in most sectors, inducing higher wages and salaries. Consumers, buoyed by the health of their own balance sheets, will drive up retail sales. Tourism is expected to be bolstered by a more favourable exchange rate and pre-Olympic curiosity, while new home construction activity will remain robust, albeit not setting any records.

- Can forest-dependent communities in the Interior or on the coast expect any good news or is it just going to be bad news for the next two years?

HP: Mostly bad news about their main market, but an end to the U.S. housing recession in the second half of 2009 is likely with lumber exports hitting bottom or no longer declining soon thereafter. Lumber prices firm up as well but the Canadian dollar remains high.

CM: Forest companies that survive the great U.S. housing slump will find themselves with a larger market share. Stronger demand south of the border and supply constraints resulting from the pine-beetle devastation may induce much higher lumber prices and markedly increase profitability.

ML: It is hard to believe conditions in the forest sector can get any worse. Not only are lumber prices very depressed, but the Canadian dollar is taking a huge bite out of profits. With reduced industry capacity and some relief on the exchange rate likely if commodity prices moderate with slower global growth, it is quite possible that conditions in the forest sector will improve modestly later in the year and into 2009.

JF: Again, this hinges on how quickly the U.S. housing market stabilizes. I expect no good news on this front in 2008 but at least some improvement in housing starts, and hence lumber prices, by the second half of 2009.

The pulp and paper industry is also present in the B.C. interior and recent forecasts point to a fairly solid pricing environment for key pulp and paper products, in part due to robust demand from Asia. But the high Canadian dollar continues to squeeze the margins of Canadian producers.

- Given the volatility in the commodity, equity and currency markets, what should British Columbians do, if anything, to their investment portfolio? Specifically, do the old principles of diversification and buy and hold still hold sway?

ML: Slower economic growth is not de facto bad news for investors. In fact, economic setbacks and stock market corrections (as we have had) set the stage for the next bull market. There is plenty of good value in the stock market, especially relative to alternatives in fixed income markets. Investors that focus on large, quality businesses with solid balance sheets will do well. Diversification always makes sense, however, investors would be best to tilt portfolios toward sectors such as financials, consumer staples and health care that have underperformed recently. Not only are these businesses much less susceptible to an economic slowdown than cyclical resource stocks, but valuations in these areas are quite depressed.

Investors would be wise to take advantage of the high level of the Canadian dollar and buy some world-class U.S. businesses trading at the best valuations we have seen in a couple of decades. Examples include Johnson & Johnson, Starbucks, Microsoft, Wal-Mart and Coca-Cola. We also like the Canadian banks, with TD, Royal and Scotiabank being our favourites. Other good defensive holdings include Manulife Financial, Shoppers Drugmart and Saputo.

JF: It's probably still too early to plunge back into equities. But given low returns in fixed income markets, prudent investors may want to start nibbling at beaten-up financial, consumer and utility stocks with good dividend track records. As for resource stocks (metals, energy, food), some analysts believe the world has entered a long-term commodity up-cycle. On this score, I would be cautious: the onset of somewhat slower global economic growth will take a toll on commodity prices.

- Do you see a plateau or a price decline when it comes to housing in Metro Vancouver? Or do you see prices rising?

CM: Home prices are facing less upward pressure. The combination of eroding affordability, some warts on the economy, and tightening credit are trending the market toward balance. This means it is unlikely home sales will post any records this year or in 2009. A 10-per-cent increase in home listings is also providing more selection for home buyers and reducing the chance of multiple offers on the same property.

Expect homes sales to edge down six per cent and home prices to climb nine per cent this year and a further six per cent in 2009. A diverse housing stock, longer mortgage amortizations and a relatively strong economy are aiding affordability. However, the days of double-digit price increases are drawing to a close.

ML: Homes in B.C. are simply not affordable. It is the same fundamental problem that existed in the U.S. before the bursting of their bubble -- home prices are too high relative to incomes. Either incomes will catch up to home prices over time or home prices will correct to be more appropriately aligned with incomes. We think we are close to a peak in B.C. home prices.

- Is there anything the provincial government can do to cushion us against all this bad economic news?

JF: There isn't much Victoria can do to mitigate the impact of a slowing U.S. economy and an overvalued Canadian dollar. In the short-term, government should avoid imposing new costs on trade-exposed industries and continue to follow sound fiscal and taxation policies. Looking beyond 2008, B.C. policy-makers need to understand that a prosperous economy requires competitive and growing export clusters. This is where the province is in trouble.

HP: Not much. The provincial government has limited tools, and in any case, the subprime induced financial crisis and the U.S. housing recession are beyond its control. The provincial government can assist in the transition during the economic adjustments in the lumber industry and it can get the economic, fiscal, and regulatory fundamentals right for improved overall economic performance while balancing the necessary trade-offs with non-economic objectives.

CM: It's not all bad news. In fact, B.C. economic growth is expected to outpace the national average again this year. Employment and wages are rising, net migration is strong, unemployment is low, and consumer spending is robust.

There is likely little the government can do in the short term, other than assist in the re-training of displaced workers. Tax competitiveness is important and there is room for further reform. B.C.'s property transfer tax, for example, is the least competitive in Canada by a country mile.

ML: Probably not in the short run. Economic cycles are inevitable. Over the long term, government can conduct its business and operations efficiently and make the province an attractive place for entrepreneurs and business by making taxes competitive.

(Source: Vancouver Sun)