Monday, March 30, 2009

The Weekly Bottom Line


  • U.S. housing data surprise on the upside
  • Fed begins buying Treasuries
  • Ontario Budget deficit projected at $14B

North American stock markets are on track for a third straight week in the black, with a 7.5% gain in the Dow Jones leading the way. The rally in equities came on the back of better-than-expected data out of the U.S., the Fed's first round of Treasury buying and some details on the U.S. government's plan to take bad assets off banks' books.

Too soon to call a bottom

A spate of positive U.S. housing market reports has instilled some optimism in the market that the housing sector has bottomed. Existing home sales rose 5.1% in February, while new home sales advanced 4.7% on the month. What's more, new home prices were up 1.7% (M/M) in January, bringing a 10 month slide to an end. But we caution against calling a bottom to the market this early. For one, these reports reflect only one month's worth of activity, which is not enough to be tagged as a new trend. Moreover, the inventory of both new and existing unsold homes, at 12.2 and 9.7 months respectively, is down from their record highs, but remain quite elevated compared to historical norms in the 4-6 month range. It will take several months of gains and a marked improvement in inventory levels before we will feel comfortable calling a turnaround in the housing market.

Elsewhere, durable goods orders shocked the market, posting a 3.4% gain in February - the first increase seen in seven months. While the report is encouraging on the surface, suggesting that businesses have stepped up their core capital goods orders, the inventory-to-shipments ratio, at 1.88, remains near the highs seen in the early 1990s. As such, even with a sustained increase in orders, inventories will need to be worked down before increased production occurs.

But despite a few bright data reports, the U.S. is still in the midst of a severe recession, with job losses expected to accelerate and economic activity to remain weak for at least another 2-3 quarters. This was evident in the personal income and spending report for February released this morning. Personal income slid 0.2% on the month, and in real terms, was down by 0.4%. Meanwhile, personal spending, although posting a slight gain on the month of 0.2%, is still down 1.4% compared to year ago levels. Furthermore, the 3-month annualized pace of real spending fell for a second straight month, to -1.9%.

U.S. government and Fed work to stabilize markets

In order for an economic recovery to take place, financial and credit markets need to be stabilized, and consumer confidence restored. The U.S. Federal Reserve and the federal government have been continuously devising plans to help make that happen. And the actions taken this week were well received by the markets. In an attempt to lower economy-wide borrowing rates, the Fed's plan to purchase Treasuries was put into action this week. The Fed bought US$7.5 billion (of $21.9 offered) worth of bonds in the 7- 10 year maturity range, and another $7.5 billion (of $23.4 offered) worth in the 2-3 year maturity range, suggesting that investors were eager to unload their Treasuries at the right price.

In an effort to reduce market uncertainty, U.S. Treasury Secretary Geithner provided some details of his plan to rid toxic assets from banks' books. With respect to loans, the Treasury will take a matching equity stake alongside each private investor, and then the FDIC will allow the investors to lever the total equity stake up by seven times. With respect to asset-backed securities, the Treasury will again match private sector investment, but also offer an additional loan to the private investor equal to their original investment. This program is very complex, however, markets have rendered the move a step in the right direction.

Geithner also expressed that the U.S. financial system needs to be completely overhauled - and now is as good a time as any, as it will help restore confidence in credit and financial markets. He proposed federal supervision of all large hedge funds, private equity firms and derivatives markets, whereby a regulator could force them to raise capital or curb borrowing. He also noted that new standards for executive compensation throughout the industry should be implemented. These initiatives will have to be passed by Congress before becoming law.

Ontario budget to boost competiveness

News out of Canada this week was not nearly as encouraging. The headwinds facing Canadian households became more pronounced this week, after reports indicated that bankruptcies jumped 22% in January, while the number of employment insurance beneficiaries ticked up for a fifth straight month, reaching the highest level since 2003. The largest increase in employment insurance claims stemmed from Ontario, the province hardest hit by the recession.

With expectations of a 2.5% contraction in Ontario GDP in 2009, (slightly better than TD Economics forecast for -2.7%) the provincial government unveiled its 2009-10 Budget this week, featuring a deficit of $14.1 billion for the fiscal year. While this would mark the largest deficit the province has ever seen in absolute terms, it is considerably smaller than the 4%+ of GDP reached during the recession of the early 1990s. The government also laid out its plan to eliminate the deficit over the next seven years, which in our opinion, appears to be highly achievable. Perhaps the most notable element of the budget was the new tax regime, which will come into effect July 1, 2010, consisting of sales tax harmonization (5% GST + 8% PST = 13% VAT or value added tax) and a significant reduction in corporate income tax rates. While there has been some criticism over the harmonization - with consumers being forced to pay more in sales tax due to a broadening tax base - we feel that the tax credits for low and middle income households, in addition to businesses passing on savings in the form of lower prices, will mitigate the impact on consumers. Overall, the measures set out in this budget will go a long way towards increasing Ontario's competitiveness, and will benefit both businesses and households in the long run. For more details, please see The 2009 Ontario Budget available on our website.


Canadian Real GDP - January

Release Date: March 31/09 December Result: -1.0% M/M TD Forecast: -0.5 % M/M Consensus: -0.6% M/M

The Canadian economy is well into what will likely be its most intense economic recession in many decades, and we expect weak domestic and global demand to remain a drag on overall economic activity. Moreover, with almost every economic indicator remaining in negative territory, it does appear that the Canadian economic recession may have intensified even further in recent months. Indeed, with wholesale sales, export trade, manufacturing shipments and housing sector activity all appearing to have taken a turn for the worse in January, we expect Canadian monthly GDP to contract rather significantly. The only exception has been the better than expected retail sales report for January, and this will only provide a partial offset. As such, our call is for Canadian economic activity to decline by a further 0.5% M/M in January, which will bring the period of consecutive monthly contraction to six months. The decline in GDP is expected to be broadly based, with economic activity in most industries likely to contract. If there are any risks to this call, they are to the downside. In the coming months, we expect Canadian economic growth to be very weak as the recession remains entrenched.

U.S. ISM Manufacturing Report - March

Release Date: April 1/09 February Result: 35.8 TD Forecast: 36.5 Consensus: 36.0

The U.S. manufacturing sector has become a major casualty of the ongoing global economic recession, and with the outlook for the world economy remaining grim, the decline in U.S. manufacturing sector activity looks set to continue for some time. Indeed, despite some modest improvements in the regional manufacturing sector indicators recently, all continue to point to further weakness in overall activity. The 3.4% M/M gain in durable goods orders in February, however, should provide some upward momentum to activity in the month, but it will only partially offset the downward pressures coming from the weak economic fundamentals. As such, we expect the ISM manufacturing index to increase for the third consecutive month, rising to 36.5 in March. In the months ahead, with domestic and foreign consumer demand likely to weaken even further, we believe that the headline ISM index and most of its sub-components will remain well south of the 50-threshold, suggesting further contraction in the U.S. manufacturing sector.

U.S. Nonfarm Payrolls - March

Release Date: April 3/09 February Result: -651K; unemployment rate 8.1% TD Forecast: -625K; unemployment rate 8.4% Consensus: -656K; unemployment rate 8.5%

It is not clear whether the peak of the job losses in the U.S. is now behind us, though we do forecast a better outcome for this month than the last. However, what is clear is that the continued weakness in the domestic economy will likely mean that the number of job cuts will remain brisk for some time. Indeed, the persistent high level of weekly jobless claims and the constant announcements of job layoffs are a ready reminder of the dismal U.S. labour market conditions. As such, our call is for an additional 625K positions to be eliminated from the U.S. nonfarm payrolls in March. And as has been the case in the past few months, the job losses are expected to be fairly broadly based, with cuts coming from both the goods and services producing sectors. Moreover, with the job destruction continuing to outpace job creation, the unemployment rate should rise even further, climbing to 8.4% in March. In the months ahead, with the U.S. economy expected to remain fairly soft, the number of job losses should remain quite brisk and the unemployment rate is expected to climb even further.

TD Bank Financial Group

The information contained in this report has been prepared for the information of our customers by TD Bank Financial Group. The information has been drawn from sources believed to be reliable, but the accuracy or completeness of the information is not guaranteed, nor in providing it does TD Bank Financial Group assume any responsibility or liability.