Sunday, June 7, 2009

The Weekly Bottom Line


  • GM files for bankruptcy protection in the U.S.
  • Employment losses in the U.S. moderate - 345,000 jobs shed in May
  • Canadian real GDP contracts by 5.4% in the first quarter; nominal GDP sinks 11.5%
  • Canadian economy sheds 41,800 jobs in May, confirming April's gain was just a blip
  • Bank of Canada, European Central Bank, Bank of England leave rates unchanged at 0.25%, 1.00% and 0.50%, respectively
  • Crude oil prices hit a 7-month high of US$69 per barrel


This week kicked off by creating yet again, another piece of history, as the world's largest automaker went bankrupt. GM is the largest manufacturer, and the third largest company to seek bankruptcy protection in the U.S., and comes just one month after fellow Detroit-automaker Chrysler landed itself in the same position. Similar to Chrysler, GM will engage in a "363 sale", whereby the 'good' assets will be sold to a new entity, while the 'bad' assets remain in bankruptcy protection. The U.S. and Canadian governments have agreed to finance the courtsupervised restructuring plan, with the Obama Administration extending another US$30 billion - in addition to the US$20 billion already loaned to the automaker - in exchange for a 60% stake in the new entity, and the Canadian and Ontario governments providing US$9.5 billion for a 12.5% stake in the new GM. The VEBA healthcare fund will hold a 17.5% stake and bondholders will acquire the remaining 10%. While definitely not the preferred route, this was the only path that would give GM an opportunity to return to profitability.

On a brighter note, recent economic data suggest that the pace of the economic contraction in the U.S. may be slowing. The manufacturing ISM index rose for a 5th consecutive month in May, reaching its highest level since September, while the non-manufacturing ISM index hit a 7- month high. Nonetheless, at 42.8 and 44.0, respectively, both indices remain below the expansion/contraction 50- threshold.

Perhaps even more telling, is the deceleration in job losses seen recently. Following an upwardly revised 504K drop in employment in April, the U.S. economy shed 345K jobs in May - largely due to a slowdown in the pace of private sector layoffs. But notwithstanding this moderation, the U.S. economy has still lost a total of 5.9 million jobs since the recession began and the unemployment rate is now running at 9.4% - the highest level since 1983. What's more, the aggregate number of hours worked slid 0.7% on the month, suggesting that some employers are cutting back hours rather than letting workers go.

As such, consumers have been tightening their purse strings. Personal spending slid 1.5% in April compared to year-ago levels, and in real terms (1.9%), dropped by even more. This more cautious spending nature exhibited by U.S. consumers has translated into a higher savings rate, which jumped to 5.7% in April, from 4.5% in March. This is a trend that will likely continue as consumers wait for an economic recovery to take hold.

But while the data is increasingly becoming 'less bad', it is important to note that several sectors of the economy remain quite weak. And as echoed by Fed Chairman Bernanke this week, "even once the recovery gets underway, the rate of growth of real economic activity is likely to remain below its longer-run potential for a while". Bernanke also expressed concern over the size of the U.S. fiscal debt. While supportive of the fiscal policy actions taken in the midst of a crisis, he noted that unless the U.S. "demonstrates a strong commitment to fiscal sustainability in the longer term, it will have neither financial stability nor healthy economic growth".


First quarter GDP numbers were released this week, and indicated that real economic activity slid by 5.4% (annualized). While this was better than markets were anticipating, it is still the worst quarterly contraction since 1991. Inventories played a key role in the decline, as businesses worked down their stockpiles enough to shave 3.3 ppts off GDP. This inventory correction does pose some upside for growth down the road, as these stocks will need to be built back up once the economy gains traction.

While the contraction in real GDP was quite steep, perhaps the bigger issue for the Canadian economy is the substantial loss in income that has transpired since last October. Indeed, following a 14% contraction in the fourth quarter of 2008, nominal GDP (a measure of activity that also takes into account price changes, including export prices) sank by 11.5% during the first quarter of this year. Combined, these declines are the worst on record (back to 1961). Owing in part to a slump in commodity prices, corporate profits plunged by a whopping 67% in the first quarter.

This decline in business profits has certainly not helped the labour market. Confirming that April's 36,000 job creation was a one time blip, May's job losses more than offset those gains. The Canadian economy shed 41,800 jobs on the month, pushing the unemployment rate up to an 11- year high of 8.4%. The bulk of the job losses were concentrated in the manufacturing sector (-58,000), as the restructuring of the auto sector left behind several casualties. Wage growth also abated, falling to 3.4% Y/Y on the month, from 4.3% Y/Y in April. Similar to the U.S., the rate of decline in employment is falling on a trend basis. Still, the job-loss tally (362,500 so far this recession) will likely grow throughout the year as several sectors continue to face major headwinds.

Nonetheless, we suspect that we have seen the worst of the recession in Canada. Real economic activity is likely to contract for the next two quarters; however, the rate of decline should moderate. Furthermore, the recent strength seen in commodity prices should bode well for nominal GDP in the second quarter. But while favourable for corporate income levels, the rise in commodity prices - in addition to the relative strength of the Canadian economy and the decline in the greenback - has also helped put the loonie back in full flight, as it has soared above 0.91 USD. This has raised some concern at the Bank of Canada.

At the interest rate decision meeting on Thursday, the Bank cited the "unprecedented rapid rise" of the Canadian dollar as worrisome, since a continuation of this appreciation could offset some of the positives that Canada has recently benefited from. Other than that, the Bank of Canada didn't have much else new to say. It left rates unchanged at 0.25%, and reiterated its intent to keep them there until the second quarter of 2010. There was no mention of quantitative easing, leading us to believe that it is nowhere in sight. The Bank did, however, acknowledge that the "major restructuring in a number of sectors", has left some degree of macroeconomic uncertainty. On the whole, it appears as though the Bank of Canada is comfortable with its current stance on monetary policy.


U.S. International Trade - April

  • Release Date: June 10/09
  • March Result: -$27.6B
  • TD Forecast: -$26.5B
  • Consensus: -$28.7B

The U.S. trade balance has benefited immensely from the weakening domestic economy as the combination of soft import demand and weak energy prices have combined to slash the trade deficit from a once daunting $62B in early 2008 to a much more modest $27.5B in March. This pattern is likely to remain largely intact, and we expect the trade deficit to narrow marginally to $26.5B. The key factor underpinning this call is our expectations for further weakness in imports, as we suspect the weakening domestic economy will likely push U.S. imports lower for the eighth straight month. Despite the decline in imports, the petroleum deficit should widen further as the gains in crude oil prices should put upward pressure on the energy import bill. Exports are also expected to be soft on the month, though the weakening dollar and greater export demand from China for heavy machinery (in light of the massive infrastructure spending in recent month) should limit the magnitude of the decline. In the months ahead, we expect the U.S. trade deficit to begin widening as rising crude oil prices offset the benefits that will invariably accrue from the weakening U.S. dollar.

U.S. Retail Sales - May

  • Release Date: June 11/09
  • April Result: total -0.4% M/M; ex-autos -0.5% M/M
  • TD Forecast: total 0.9% M/M; ex-autos 0.3% M/M
  • Consensus: total 0.4% M/M; ex-autos 0.2% M/M

After showing some encouraging signs of life in the first two months of this year, U.S. retail sales dip back into negative territory as consumer spending weakened in the last two months under the weight of the mounting job losses and weakening domestic economic fundamentals. In May, however, we expect retail sales to move back into positive territory with a rather respectable 0.9% M/M advance. Most of the gains are likely to come from auto sales, which have risen by a strong 6.4% M/M in May. Higher gasoline prices, which have climbed at a double-digit pace for the first time in two years, should also bolster the headline number. Excluding autos, sales should rise by a more modest 0.3% M/M. Looking ahead, it appears possible that the rebound in retail sales could gather some traction as the impact of the massive fiscal stimulus and the improvement in overall sentiment buoy consumer spending


Canadian Housing Starts - May

  • Release Date: June 8/09
  • April Result: 117.6K
  • TD Forecast: 125.0K
  • Consensus: 130.0K

The Canadian housing market correction has been particularly sharp, and homebuilding activity has plunged a staggering 57% since peaking at 273K in September 2007. The correction in building activity has been particularly pronounced in recent months as housing starts have fallen by double-digits in 4 of the last six months. Indeed, with the Canadian economy weakening dramatically, the worsening labour market conditions damping housing demand, and tight financial market conditions continuing to stifle access to credit for both home builders and buyers, we expect Canadian homebuilding activity to remain soft for some time. Even so, we expect a bit of an uptick in residential construction activity in May, and call for starts to rise to 125K. Much of the gains are likely to result from an expected bounce back in the volatile multi-units segment, which declined a massive 32.6% M/M in April. Single- family units, however, are also likely to remain soft. In coming months, we expect starts to remain with the 120K- 140K.

Canadian International Trade - April

  • Release Date: June 10/09
  • March Result: $1.1B
  • TD Forecast: $1.6B
  • Consensus: $0.8B

The dramatic improvement in the Canadian merchandise trade balance in March to $1.1B was on account of imports falling at a more dramatic pace than exports. This pattern is unlikely to change meaningfully in April, and our call is for the Canadian merchandise trade surplus to rise further to $1.6B on account of weaker trade. Indeed, with the Canadian dollar strengthening by 6.0% M/M in April, and overall energy prices falling by 5.7% M/M (despite the modest rebound in crude oil prices during the month), we expect Canadian exports to fall a further 1.0% M/M. On the other, the weakening Canadian economy and soft domestic consumer spending will continue to weaken Canadian appetite for foreign goods, thereby pushing imports down even more. As such, we expect imports to fall a further 2.5% M/M. In the months ahead, however, the rebound in commodity prices is likely to bolster exports, which should result in the merchandise trade surplus improving 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.