Fred Lum/The Globe and Mail
Interest rates are at rock-bottom levels, inflation has been stagnant, and the loonie's been strong. How will these affect your investments in the coming months?
The head of Canadian Economics and Investment Strategy for Merrill Lynch Canada Inc. was tackling those questions and more of your own questions live at noon on Wednesday, July 15. Your questions and Ms. King's answers appear in the space below.
Ms. King was named head of Canadian Economics and Investment Strategy for ML Canada in May. Ms. King has been a senior U.S. economist at Merrill Lynch since 2004. Prior to joining Merrill Lynch, Ms. King worked at TD Bank Financial Group in Toronto for four years. Previously, she spent eight years at the Bank of Canada. She earned a BA in economics from Concordia University in Montreal and an MA in economics from Carleton University in Ottawa.
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Gordon Edall, deputy investment editor, The Globe and Mail: Hi Sheryl. Thank you for joining us today. With all the lingering anxiety out there about the state of the economy and the markets, we appreciate you taking the time to talk with us. The questions have been piling up, and I am going to dive right in with our first question from Ken:
From Ken: Inflation has been stagnant for a long time, but I do not believe this condition will last. I suspect that central banks will be forced to raise interest rates quickly to contain inflation in about six months, and will either over-react, plunging the economy into a double dip recession, or react too late allowing double digit inflation to take hold. Either scenario is fraught with danger for investors. Looking at theses two scenarios, how would a wise investor react in either case?
Sheryl King, head of Canadian Economics and Investment Strategy for Merrill Lynch Canada: The Bank of Canada's primary mandate is to achieve a 2 per cent target over the medium term and keep inflation between the 1 to 3 per cent band, believing that is the best way to produce maximum growth in the economy. I do not believe they will alter this objective and will move to tighten policy as spare capacity starts to become absorbed. It is admittedly a tricky situation for them not to overdo it and cause a second dip. So I think they will tread cautiously on removing stimulus, perhaps just backing off on their verbal attempts to keep long rates down, thus allowing the long end of the curve do some of the work for them.
From Carmen: When do you see inflation starting to take hold in Canada and the U.S.? What are the implications on the normal family?
Sheryl King, Merrill Lynch: I do not think that a rise in inflation is a serious possibility in either Canada or the U.S. The Bank of Canada and Federal Reserve will move policy to ensure it does not happen. They are aware that monetizing the federal debt (through inflation) would also impoverish domestic households through diminished purchasing power.
From Lyn: If the U.S. dollar is devalued as a result of the country's massive debt and quantitative easing, will the Canadian economy decouple from the downward trend in the U.S. or track it to the bottom of the economic barrel?
Sheryl King, Merrill Lynch: I think there is a strong case for the Canadian economy survive and thrive without the U.S. economy. The banking system has come through the financial crisis relatively unscathed, which means they are able and willing to lend to credit worthy borrowers. The Canadian manufacturing base is undergoing a massive restructuring to reduce their costs, and perhaps more importantly become more flexible in their cost structure - which makes me hopeful that productivity growth may accelerate and allow the economy to achieve a stronger trend pace of economic growth.
From Mark: Some economists are predicting imminent U.S. hyper-inflation and dollar devaluation from the Fed creating trillions to buy U.S. treasuries, other major countries proposing ways to avoid using the U.S. dollar as reserve currency, among other things. How do we as Canadians invest to hedge against that possibility?
Sheryl King, Merrill Lynch: The threat of the U.S. dollar losing reserve status is a hollow one, in my opinion. Emerging market countries continue to be significant managers of their currency in order to support their growing manufacturing base, which means their government must hold U.S. dollar denominated assets. And after all, the U.S. consumer is still the main destination for exported goods from emerging markets and by a wide margin.
From David Parkinson, investment reporter, The Globe and Mail: Sheryl, in my recent interview with you, you cited an old adage among economic/market forecasters: "If you give a forecast, don't give a time; if you give a time, don't give a forecast." I realize this saying is a tongue-in-cheek suggestion to make sure forecasters never put themselves in a position of being wrong, but to look at it more seriously, do you think the market is often too focused on specific numbers and targets, while paying too little attention to the logic behind those targets? Are we all more interested in reading "TSX to go to 15,000, analyst says" than to understand the mechanics driving the market? Just tell us where this bus is going, don't bore us with how the engine works? And how, as a professional forecaster, do you deal with that?
Sheryl King, Merrill Lynch: That's a good point. The main question investors should be asking themselves is whether the Canadian economy is going to come through this adjustment phase the better for it. I think it will, better and stronger. Will it be a smooth transition? Probably not and there could be more pullbacks in equities ahead. So you have to be careful in scaling in cyclical plays on the market. But I do think the equity market put in the cycle low earlier this year. In answering the question about forecasting, I will invoke Bob Farrell's rule number 9 "when all forecasters agree, something else is going to happen."
From sitbackandrelax (via our online comments): It appears that North Americans started saving, for fear of being laid off or simply for fear of the stock market, which doesn't help jump start the economy. However, many have seen years of savings wiped out. Are we in for a 'Japanese' decade, with little growth since out North American societies appear to have grown their GDP on credit alone (inflated house prices used for consumption), rather than real value creation?
Sheryl King, Merrill Lynch: The rise in North American saving is the result of many factors: putting more money in that rainy-day fund, tighter credit (which is preventing some from dis-saving), and balance sheet repair. The transition to higher savings is a painful one but once savings has risen to that appropriate level the economy can once more accelerate. Japan's lost decade was not due to higher savings - it was a result of allowing deflation to set in. The problem with Japan was a chronically impaired banking system that had so many nonperforming assets that they could not lend. It remains an issue in the US banking system, though to a far lesser extent, and much, much, less a factor for Canada's banks.
From gxb (via our comments): I have one question for you. How do we get out of $50-billion plus deficits without raising taxes - our prime minister and finance minister have already said they will not raise taxes to get of deficits? Hope you can give us better insight into deficits.
Sheryl King, Merrill Lynch: It may become a temptation to raise taxes, but there are other avenues to close the short-fall. Their first line of defence is to ensure the economy gets back up and running in order to raise revenues - those measures are in place courtesy of the Dept of Finance and the Bank of Canada. If the government is in a greater hurry to close the gap, cutting expenditures may be an option as well. I tend to think they will be patient and give the revenue side a chance to work. The last time the Federal government chose to slash deficits by cutting expenditures, back in the mid-1990s, they were driven to do so because of the risk premium that became embedded in the dollar as the debt swelled to 75 per cent of GDP. I think the debt burden will crest at far short of that marker.
Gordon Edall, The Globe and Mail: I think we are out of time for today, Sheryl. On behalf of our readers, I just wanted to say thank you for taking the time to talk with us. We can all use some perspective amid all the uncertainty out there, and your perspective is much appreciated. Is there anything else you wanted to add before we say goodbye for now?
Sheryl King, Merrill Lynch: Just thank you and that I look forward to other discussions with clients and readers in the future. I love to be challenged and never met one that I wasn't up to.