The U.S. Slowdown Widens and Deepens; A Reality Check for Canada
Alex Carrick
The crisis in financial markets, which arose as an offshoot of subprime mortgage foreclosures in the U.S., is now having an impact on equities. The major stock markets in the United States and Canada have retreated. At 2007’s year end, all four major indexes were down 6% to 7% versus their 52-week highs. There has been further downward movement in the two weeks since then. Dow Jones Industrials (-11.7%), the Standard & Poors 500 (-11.1%) and NASDAQ (-14.7%) are all below their peaks in 2007 by double-digits. The Toronto Stock Exchange is off only -6.9%, largely due to the climb in price of crude oil to $100 US per barrel.
Corporations in the financial sector are among those under the most duress (joined by U.S. homebuilders). Lack of confidence in structured investment vehicles (SIVs) and collateralized debt obligations (CDOs) — with further questions about credit card debt and the solvency of bond insurers — has meant that many financial institutions have come under scrutiny with respect to their capital reserves.
Four Steps to Restore Confidence
Several steps have been needed to restore confidence and these are being taken. (1) Central Banks around the world have stepped in to ensure liquidity for creditworthy borrowers needing loans for normal business operations. (2) There have been early write-offs of bad debt and demands for full disclosure of liability. (3) A reduction in too-complicated and impenetrable lending practices is being forced on banks and other deposit agencies. And (4), there has been a shoring up of equity in companies under scrutiny through capital injections by external sources, often government investment agencies, and mainly from the Middle East and the Far East. Some of the largest firms to take this route have been Citigroup Inc., Morgan Stanley, Merrill Lynch and the Canadian Imperial Bank of Commerce.
A Marked U.S. Economic Slowdown is Underway
As a result of the financial crisis, the major question is whether or not the U.S. has slipped into recession. Gross Domestic Product (GDP) figures will determine the answer, but it is clear that a marked slowdown is underway. Strains in the U.S. economy have been evident in several sectors. The latest monthly housing starts are down nearly 50% versus their level at the peak of the cycle in early 2006. Also, the inventory of unsold homes is at a nine-months-supply, which is more than double the long-term norm. House prices have declined by perhaps as much as 6% nationwide and by much more in some regional markets. This is playing on the minds of consumers, who are also being battered by high fuel costs as oil prices keep climbing.
Another Piece of the Puzzle can be found in Labor Force Statistics
A further key piece of the puzzle can be found in the latest labor force statistics. The U.S. unemployment rate has risen to 5.0%. This is a still-relatively low number, but it is up 0.6 percentage points in the past nine months. Job growth in December was positive at +18,000, but this was the lowest increase since way back in mid 2003. Year-over-year job losses are being recorded in construction (-2.5%), manufacturing (-1.5%) and, not surprisingly, financial services (-0.2%). The year-over-year employment picture has essentially flattened out to 0% in retail trade, in transportation and warehousing and for information services.
In Canada, year-over-year employment growth dropped to +2.2% in December as a result of 18,000 fewer jobs in the month. Canada has become particularly vulnerable in manufacturing, where the year-over-year job loss is 6.2%, due to the double impact of slower U.S. growth and the higher-valued Canadian dollar. Canada’s economy has been backstopped by high commodity prices and a housing market that has continued to perform well almost up to the present. In December, however, housing starts showed their first significant decline in many years, dropping to only 187,500 units. Housing starts in Canada have been consistently higher than 200,000 units for the past six years.
More Interest Rate Cuts are Coming
Given all of the foregoing, there is little doubt that the Federal Reserve will lower interest rates, maybe by as much as 50 basis points (100 basis points = 1.0%), at the end of January. However, while the economy may be in slowdown mode, the U.S. Consumer Price Index — driven by higher gasoline and higher import prices as a result of the weaker U.S. dollar — rose 4.3% on a year-over-year basis in November. Interest rates are about to be lowered when the level of general price inflation is near its peak.
The U.S. slowdown, on its own, will cause a moderation in many prices. This will include the energy sector, where worldwide demand will be affected. For example, the U.S. (and more specifically Wal-Mart) is China’s largest customer. Nevertheless, when the next U.S. turnaround comes in late 2008, it is likely to be accompanied by a level of price inflation that is higher than normal coming out of a period of cyclical decline.
