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First Quarter 2010

May 21, 2010 • Print This Article

History has shown us that downturns like these can lead to innovation and opportunities to remodel our economy, our cities, our work-life balance and our focus/priorities/lifestyles. This essential part of the economic cycle shows us what is working and what needs to change, paving the way for renewed growth and prosperity.

The Markets

The economic recovery appears to be taking hold in Canada. Signs that the US recovery is underway continue to appear. India, China and much of the developing world's economies continue to expand. China recently became the #1 importer of Saudi oil, a position previously held by the US.

The recovery in equity markets slowed in the quarter. Headwinds from Europe, attempts by China to moderate growth, constrained government spending, and anticipated domestic interest rate increases will likely lead to increased volatility and moderate the pace of equity gains going forward.

Canada appears to be in a relatively good position to continue to outperform other developed economies. Continued growth in India and China should provide support for commodity producers. Canadian banks continue to be best in breed and they may avoid many of the punitive measures that may be placed upon the foreign banks that helped create the conditions that led to the recession. The Canadian real estate market never became as unbalanced as it was in the US. As a result, Canada has not suffered from ongoing foreclosure rates which appear to be hindering recovery in the US. Strength in the Canadian Dollar should help moderate inflation levels and future interest rate increases. Weakness south of the border should keep the Canadian economy from over-heating.

Europe is a concern. The fall out from the economic downturn appears to be threatening several weaker members of the European Union (Portugal, Italy, Ireland, Greece and Spain, the so called PIIGS). All eyes are upon Greece. Reliant on government spending for much of its GDP, burdened by tax evasion and structural deficits, Greece will have to restructure its entire government, economy and individual's attitudes to turn the corner. Bailouts alone will not create a meaningful, lasting recovery. Real austerity measures focused on deep government spending cuts and privatization to balance budgets will be required. Raising taxes will be counter productive as it could lead to even greater levels of tax avoidance and will lead to diminished productivity. Greece may look to measures taken by Ireland, Belgium, Finland and Sweden in the 1980's and 1990's as a road map of how to proceed. Although known as "the cradle of democracy", Greece was a dictatorship into the 1970's. The roots of democracy may not run deep. Even though the situation appears contained in terms of Greek default, the market remains nervous.

The US sub prime mortgage fiasco continues to unfold and may dampen the rate of US GDP growth for years to come. Foreclosure rates remain extremely high. The US home owner is still struggling with massive debt loads. As a result, growth in consumer spending should remain tepid. Although counter intuitive, this could be positive for equity markets on both sides of the border. Inflation should remain constrained, allowing interest rates to remain at historically low levels and moderating growth. This should help prevent a boom and bust cycle.

The recession has given manufacturers an opportunity to restructure. For example, the auto sector is beginning to rehire, however compensation rates are now much lower and it is doubtful that they will ever return to pre-recession levels. Although this will further constrain the consumer, corporate productivity and profitability may rise.


We continue to believe that the Canadian economy and Canadian equity markets are relatively well positioned going forward. It is increasingly apparent that Canada's recession was mild when compared to the economic contraction in the US. There was not the same level of government, corporate or individual indebtedness. The severity of job loss was less in Canada. Individual net wealth was impacted far less in Canada. As a result, the level of stimulus required to stabilize the economy in Canada was much lower, tax revenues held up better and the resulting deficit is far less of an issue. The US economy will feel the impact of the recession for many years as banks work through foreclosures, property values remain depressed and Municipal, State and Federal governments cope with large structural deficits. As a result, we continue to favour the Canadian market.

The relatively strong position of Canada should lead to a gradual appreciation of the Canadian Dollar. The improving Canadian economy should lead to Canada increasing interest rates well before the US which should support further Canadian Dollar strength. As interest rates increase bond prices should fall. Although the yield curve may well flatten somewhat, there appears to be capital risk at the long end of the bond market. As a result, we remain underweight in bonds and remain in the shorter end of the market.

We are of the opinion that dividends, which in many cases are at levels well above 10 year government bond yields, should provide share price support and could provide a major portion of the overall return for the next year. As a result, we favour equities which have relatively high yields, stable and growing earnings profiles and a history of regularly increasing dividend payouts.

We are of the opinion that the Greek economic and budget issues will be contained. If the Greek economy can be stabilized, the other PIIG countries should be able to manage through the current structural challenges. This is the first true test of the concept of a European Union. If the Union holds, Europe could emerge stronger in the future.

Concerns over the situation in Europe could roil equity markets in North America over the next few months. Although we feel the economic backdrop does not warrant a re-test of March 2009 lows, a correction in the range of 10% from the highs is possible and could provide a base for valuations moving forward.

Filed under: Quarterly Reports

The opinions, estimates and projections contained herein are those of the author as of the date hereof and are subject to change without notice and may not reflect those of Mackie Research Capital Corporation ("MRCC"). The information and opinions contained herein have been compiled and derived from sources believed to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. Neither the author nor MRCC accepts liability whatsoever for any loss arising from any use of this report or its contents. Information may be available to MRCC which is not reflected herein. This report is not to be construed as an offer to sell or a solicitation for an offer to buy any securities. Member-Canadian Investor Protection Fund / member-fonds canadien de protection des ├ępargnants.

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