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Economic and Investment Outlook
CIA Conference, Toronto
September 2009
Warren A. Thomson
SEVP & Chief Investment Officer
Overview
 Economic Indicators
 Canadian Equities
 Canadian Fixed Income
 Alternative Assets
• Commercial Real Estate
• Oil & Gas
• Timber
• Agriculture
2
2
Economic Indicators
3
3
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
4
4
The Worst Seems To Be Behind Us
Home Sales Finding A Bottom
5
5
Initial Unemployment Claims Turn The Corner
6
6
Retail Inventories Still Excessive,
But Getting Less So
7
7
ISM Indexes Still Below 50,
But Past The Worst
8
8
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
•
9
9
Canadian Economy Improving
Canada - Leading Indicator
) and %Change Yr/Yr ( )
Level (
105
)
15
10
100
5
95
0
90
June 2009
-5
87.6
-7.8
85
-10
-15
80
97
M1856
10
10
98
99
00
01
02
03
04
Source: OECD
05
06
07
08
09
10
JUN 2009
Household Debt Levels Resulting in
Paradox of Thrift
Canada Personal Savings ( )
) and Household Debt (
As Percent of Disposable Income
25
))
128.6
130
120
20
110
100
15
90
80
10
70
60
5
4.5
50
0
40
1960
11
11
Q239
1965
1970
1975
1980
1985
1990
Consumer credit plus mortgage debt
1995
2000
2005
2010
2009:2
MFC GIM’s Forecast
2004-08
Average
2008
2009
Forecast
2010
Forecast
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%
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%
Inflation (% change in CPI)
12
12
Source: MFC Global Investment Management, as at August 24, 2009
Canadian Equities
13
13
Commodity Prices Recovering
Commodity Price Indexes
180
180
CRB Futures
Journal of Commerce
CRB Spot Industrials
170
170
160
160
150
150
140
140
130
130
September 2009
120
110
110
100
100
Oct
2008
D1039
14
14
120
Nov
2008
Dec
Jan
2009
Feb
Mar
Apr
May
2009
Indexed to 100 at Trough
Jun
Jul
Aug
Sep
2 SEP 09
Equity Valuations are Reasonable
TSX Price-Earnings Multiple
Based On Trailing Operating Earnings
40
Median: 16.7
Av erage: 17.0
40
35
35
30
30
25
25
20
September
20
2009
50-yr Average
15.6
15
10
10
5
5
0
0
1960
M11
15
15
15
1965
1970
1975
1980
1985
1990
1995
Shaded Areas Represent U.S. Economic Recessions
2000
2005
2010
SEP 2009
S&P/TSX Earnings Near Trough
TSX Operating Earnings
%Change Year/Year
60
60
Trailing
Bottom-Up Fcst
Top-Down Fcst
40
40
27.7
23.1
20
18.8
20
15.8
0
0
-20
-20
August 2009
-25.3
-29.0
-40
-40
-60
-60
96
M1301
16
16
97
98
99
00
01
02
03
04
05
06
07
08
09
Bottom-Up Forecast Based on CPMS Consensus
10
11
12
13
14
AUG 2009
Earnings Yield Still Above Government
Bond Yields
TSX Forward Earnings Yield ()
)
And Long Term Canada Bond Yields )(
18
)
18
16
16
14
14
12
12
10
10
8
8
6.69
6
6
4
3.96
September
2009
2
82
M1941
17
17
84
86
88
90
92
94
96
98
00
02
04
06
08
4
2
10
SEP 2009
S&P/TSX Bear Markets – 1957 to 2009
Returns from end of bear market
# of
months
Decline
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%
-27.2%
8.0%
15.0%
25.4%
43.8%
-50.2%
39.4%
45.4%
?
?
Period
Median
Jun 08 – Mar 09
18
18
Source: CPMS/ Bloomberg
9
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
19
19
Canadian Fixed Income
20
20
Short Term Rates at Record Lows
Canadian Government Yield Curves
Pre-Crisis
(June 30, 2007)
Post-Crisis
(September 9, 2009)
21
21
Source: Bloomberg
Spread Between LIBOR and T-Bills has
Returned to More Normal Levels
US Interest Rates – September 17, 2004 to September 9, 2009
Lehman
failure
Beginning
of crisis
3 month US LIBOR
3 month US T-Bill
22
22
Source: Bloomberg
Strong Corporate Bond Returns as of
August 31, 2009
Canadian Bond Total Rates of Return
15%
11.5%
10%
Mid Crisis
December 31, 2008
7.4%
3.7%
5%
0.6%
0.2%
(0.3%)
0%
1 month
-5%
3 month
Corporate
1 year
Federal Government
15%
Post Crisis
August 31, 2009
11.5%
10%
6.4%
5%
1.7%
0.7%
5.9%
1.0%
0%
1 month
-5%
23
23
Source: PC Bond Analytics, TSX
3 month
Corporate
1 year
Federal Government
Corporate Spread Compression Continues
Spread (bps)
Spread (bps)
400
350
24
24
Canadian Investment Grade Corporate Spreads
300
250
200
150
100
50
0
Jun 99
2000
1800
1600
1400
1200
1000
800
600
400
200
0
Jun 99
Jun 00
Jun 01
Jun 02
Jun 03
Jun 04
Jun 05
Jun 06
Jun 07
Jun 08
Jun 09
Jun 07
Jun 08
Jun 09
US High Yield Spreads
Jun 00
Jun 01
Jun 02
Jun 03
Source: PC-Bond Analytics, Merrill Lynch, June 30, 2009
Jun 04
Jun 05
Jun 06
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
25
25
Alternative Assets:
Prospects and Challenges
26
26
Commercial Real Estate
27
27
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
28
28
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
29
29
Asian Market
Outlook 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
30
30
Oil & Gas
31
31
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
32
32
Source: FirstEnergy Capital, World Crude Oil Markets, August 27, 2009
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
33
33
Source: BMO Capital Markets, Monthly Commodity Watch, August 2009; IHS CERA – Monthly Briefing “North American
Natural Gas”, August 2009
Timber
34
34
Timber Markets in a Deep Cyclical Trough
2,200
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
77
70
63
56
49
42
35
28
21
14
7
0
Lumber Consumption
(billion BF per year)
Housing Starts
(1000 units per year)
US Housing Starts and US Lumber Consumption
1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
35
35
Housing Starts
Housing Starts Forecast--RISI
Lumber Consumption
Lumber Consumption Forecast--RISI
Source: Resource Information Systems, Inc. (RISI)
Demand For Pulp Has Also Declined
12,000
120
11,500
100
11,000
80
10,500
60
10,000
40
9,500
20
9,000
0
Q1/05
Q1/06
Market Pulp Demand
36
36
Q1/07
Softwood Pulpwood Price
Source: Wood Resources International and Hawkins Wright Ltd.
Q1/08
Q1/09
Hardwood Pulpwood Price
Global Average Pulpwood Price
(US$ per ODMT)
Market Pulp Shipments
(1,000 tons)
Global Pulpwood Demand and Pricing
Timberland Values Are Stressed
240
2,400
220
2,200
200
2,000
180
1,800
160
1,600
140
1,400
120
1,200
100
1,000
80
800
60
600
40
400
20
200
0
0
1990
1992
1994
1996
1998
Operating Cash
37
37
2000
2002
2004
2006
2008
Property Value
Sources: NCRIEF and HTRG Research. Methodology detailed in “Explaining Timberland Values in the United States,”
Journal of Forestry, December 2004.
Property Value
Operating Cash
Operating Cash and Value for Prototypical All Age
US Timberland Property (nominal $ per acre)
Agriculture
38
38
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
39
39
Long-Term Upward Trend in Farmland Value
Average Value per Acre of US Farmland, 1940–2008
US Aggregate Net Farm Income (billions), 1940–2018F
40
40
Source: USDA Economic Research Service. Actual numbers through 2008, forecast through 2018
Strong Financials and Balance Sheets For
the US Farm Sector
US Farm Sector Balance Sheet, 1970-2008
US Farm Sector Debt Ratios 1970-2008
41
41
Source: USDA Economic Research Service 1970-2008
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
42
42
Questions & Answers