Investment Outlook—1997

Head Table Guests

Carlyle Dunbar, Financial Journalist and an Honorary Director, The Empire Club of Canada; Rev. Bill Steadman, Minister, Rosedale United Church, Joseph Oliver, President and CEO, Investment Dealers Association; Gerry Shelf, Chairman and CEO, Gluskin Shelf & Associates Inc.; John Madden, Head, Fixed Income, ScotiaMcLeod Inc., Gilles Ouellette, Vice Chairman, Nesbitt Burns, Gene McBurney, Managing Partner, Griffiths McBurney & Partners; Blake C. Goldring, Senior Vice-President, National Sales and Marketing, AGF Management Limited and a Director, The Empire Club of Canada; Tom Hockin, President and CEO, The Investment Funds Institute of Canada; Jim McKnight, Vice-President and Director, Goepel Shields & Partners Inc.; and Lawrence Bloomberg, Chairman, First Marathon Securities Inc.

Introduction by Julie Hannaford

Over its 90-year history as North America's only speaking club of record, The Empire Club of Canada has been addressed by more than 2,500 men and women who have distinguished themselves in politics, industry, science, and statesmanship. Not surprisingly, our audiences for such addresses shift in terms of numbers and constituency in accordance with the topic and the speaker.

But if there is one thing that Directors and Officers of The Empire Club of Canada have learned, it is that we do best when we also respond to perceived interests in the Canadian community that makes up our audience. We have also learned that interest undergoes a dramatic transformation between the months of December and January. Almost exactly one month ago, The Empire Club of Canada closed off 1996 with its annual festive luncheon. At that time our audience is, if nothing else, mystical and often misty-eyed with thoughts of giving, goodwill and generosity overriding the atmosphere.

Almost as if transformed, each January, the eyes of our audience become cast over with the steely glint of saving.

Accordingly, the annual investment outlook offered by The Empire Club of Canada has evolved to respond to that which we understand occupies the minds and interests of our audience, and also as an alternative to the flights of fantasy that appear to dominate investment outlooks each January.

For those who wish to focus their investment decisions beyond baselines that involve the Super Bowl, the odd year, even year theory, the January barometre theory, the January effect, and the election hangover effect, we offer addresses from leading investment managers.

This forum as mentioned earlier is made possible by the generosity of our sponsors each year, and we are honoured and privileged this year to have the sponsorship of First Marathon Securities, Goepel Shields & Partners, Griffiths McBurney, Nesbitt Burns, and ScotiaMcLeod.

Our speakers this year are truly leaders in their industry. Donald Coxe is Chairman and Chief Strategist of Harris Investment Management, and Chairman of Jones Heward Investments Inc. He has been a bi-weekly columnist whom you have read and enjoyed in The Globe and Mail for the last nine years. His 27 years in institutional investing include a decade as CEO of a Canadian investment counselling firm, and six years on Wall Street as a sell-side portfolio strategist advising institutional investors. Michael Manford as Chief Economist at Scotia Capital Markets has been watching North America's Capital Markets for 20 years. Independent surveys rank Michael as one of Canada's top economists, and his bi-weekly letter, the Capital Markets Report is one of the most highly regarded guides to North American investment trends.

Ira Gluskin, President and Chief Investment Officer of Gluskin Sheff & Associates Inc., has acquired an international and legendary status as one of Canada's leading security analysts and most provocative and witty speakers who has brought wit and wisdom to the once rather dry field of financial forecasting. Together with Gerry Shelf, in 1984, he co-founded Gluskin Shelf & Associates Inc. He has been a regular columnist for the Financial Times and the Financial Post. His writings and his speaking engagements have made him synonymous with provocative, insightful, and unfailingly witty commentary on a topic once considered the domain of less than inspiring speakers.

Please join me in welcoming our guests of honour to The Empire Club of Canada. Donald Coxe will be addressing our luncheon meeting, followed by Michael Manford and Ira Gluskin.

Donald Coxe

Thank you, Madam President and ladies and gentlemen. It is a pleasure to be with you this afternoon. My challenge is to give you in 10 minutes, a forecast for the global economy and global capital markets for the year, a truly daunting challenge. In preparing myself for this, I have researched the works of America's best known expert on giving you lines to use in speeches, and he's the most quoted American of our time: Yogi Berra. He had two extremely useful ones for me. First he was asked about forecasting, and he said, "Forecasting's awful difficult, particularly about the future." But on another occasion, he illustrated something that all of us forecasters need, which is to constrain the forecast. He was asked to forecast the impact on baseball, of the upcoming marriage of Joe DeMaggio to Marilyn Munroe. And he said, "I don't know what the impact on baseball will be, but it sure as hell beats rooming with Phil Risuto."

I come to you from Chicago, which is the centre of the world's futures industry. The entire ethos is permeated by the fact that that's where the futures industry is. The two leading sports teams in Chicago are, as one might expect, the Bulls and the Bears. I have discovered that probably the best single forecasting tool there is to see which of those teams is doing well. It is a fact that during the Michael Jordan era of the nineties, which has been a sustained bull market, the Bulls have been the championship team. Now there was some talk that this year the Bears might really do well and make it to the playoffs and there were a lot of bearish forecasts out there. It didn't work; the Bears didn't make it to the playoffs. The Bulls once again won the NBA championship and the S and P was up 24 per cent. The Bulls are still doing well and the Bears are still doing badly, so therefore it's going to be another great year for the markets.

My forecast is that this is going to be a different kind of world for the global economy and capital markets than we have been used to experiencing. It is going to be a world in which, instead of worrying about inflation, we worry about deflation. In the few minutes I've got I can't go into this in a lot of detail, but I do suggest that the last thing that you think about in looking forward is getting inflation hedges. You just don't need that. It's like getting flood insurance in the Sahara.

If we look at what gave us the era of inflation, one factor was the Cold War, because governments spent a lot of money on armaments at costs plus. It meant that government was growing. We had an era in which big government was believed in, and governments kept doing more and more for people. We had a growing work force. There was a beautiful correlation between the growth of the work force, particularly of people between age 15 and 25, and inflation. We had a growing money supply. Central bankers for years loved to print money to support the growing government debts and expenditures. Then we had aggressively growing banks. We had a banking era where the banks loved to lend money. We had then a situation of growing union powers. We had a situation in which there were no special technological breakthroughs. Technology was improving, but nothing that really changed the cost structure that much. Those were the things that gave us the era of inflation which then exploded when we had some major commodity price rises in the seventies.

That was a period in which the best asset to own was gold. That was the store of value. Well ladies and gentlemen, the game is over. Look at each of those facts. The Cold War ended in 1989. And that was the peak for the Japanese stock market, which was the most inflationary market at that time, and a long bear market thereafter. Governments more or less stopped growing and started shrinking. It took Canada a while to figure that out. Canada was very late to understand what was going on in the world. After all, this province actually elected Bob Rae years after the rest of the world had swung far to the right. But eventually even Canada caught up, which was a sign that the whole world was understanding where things were at. The work force stopped growing because of the declining birth rate. Central bankers who had been through the period of the seventies and had seen inflation spent their time fighting inflation. Banks got beaten up so badly by Third World debt, and then by real estate loans, that most of them started (with the exception of French banks and Japanese banks) to look at their loan portfolios so they no longer were engines of inflation. Union power got constricted all over the world because of competition from the Third World which became suddenly equal to the First World. Fifty per cent of global GDP now is the so-called Emerging World. And the cartel mentality, which had allowed companies to get together to raise prices, was washed away. We had the technological breakthrough, the micro chip. Those things together have given us first, disinflation, and now outright deflation. If you adjust U.S. inflation statistics for how much CPIs overstated inflation, the United States is already on the edge of deflation, except for oil and gas prices. The good news for you Canadians is that's one sector where you are still getting price increases. They are going to be hard to find elsewhere.

On a global basis this means that we've entered an era in which there will be two kinds of stores of value: long-term bonds of countries whose currencies have stopped being devalued, and Canada is near the head of that class, so that's the good news. The other asset class will be the companies that are true global companies in their ability to either serve the current baby boomer and retirement class with wealth management, or are able to serve the consumer needs in the new emerging middle class all over the world. It's these global companies which will become the new store of value. The bad news is that gold isn't going to be a store of value again for a long, long, long time. Now, oddly enough, oil and gas stocks fit into this on a global basis, because the big increase in demand for oil and gas is coming from those formerly poor countries. You take somebody in China off a bike and put them on a motorcycle--huge increase in energy demand. And that's what we're seeing.

The great global banks, those that are involved in wealth management and those that have cleaned their loan portfolios, have a new era ahead of them, even in deflation. But the most obvious stocks in this environment are companies like Nestle, Proctor and Gamble and Gillette--companies that have a global franchise, know how to serve that franchise, and can serve it in the emerging markets. We also have the companies that are driving deflation by lowering price, which is the global computer and software companies. That includes companies such as Microsoft and Intel. And finally we have the global agricultural stocks--the companies that are improving food production around the world, whether through fertiliser or technology.

Those are the companies that are driving the world as it creates a new kind of environment. That environment will not be inflation; it will be fundamentally deflationary. It's good for those kinds of financial assets; it's horrid for inflation hedges. That's my outlook. Thank you.

Michael Manford

What I'd like to do today in 10 minutes (and most economists can't say hello in 10 minutes) is to go through the U.S. economy and then tell you the good news on the Canadian economy.

Let's talk about the U.S. The consensus forecast for the U.S. economy was that the economy would be growing slower at two per cent, the Fed would have to do nothing, there'd be no inflation, and nobody would have to worry about inflation. Somebody forgot to tell the bond market.

What's really happening? What would you think of an economy whose exports were growing at five per cent? Now that's mostly because of our largest trading partner--no, not Japan; Canada is growing. What would you think of an economy that has capital spending growing at seven or eight per cent because corporations basically don't want to hire anybody and they're hiring computers instead? What would you think of an economy where inventories are scarcer than ethics in Washington? What would you think of that economy? How are you enjoying the recession so far?

Well everybody says: "Yes, but Michael, the U.S. consumer is deeply in debt." My comment to that is: "They are Americans. This is normal." The interest payments on that mountain of debt are lower than they were in 1989. In fact, all that tells me is the U.S. consumer is back to spending his cash flow.

The story on cash flow in the U.S. economy is actually a very bright one. We saw a while ago when the non-farm payrolls came out that U.S. employment growth continues to stun people, coming along stronger than expected. We think that it will probably average two and a half per cent this year. It's not exciting, but it's okay. Real wages are growing, and that's very important because it means the average person who had a job all the way through the business cycle is getting real income growth.

So what do you think of this economy? It's got five-percent export growth. It needs to build a lot of inventory. It's got seven-per-cent capital-spending growth and the consumer is humming along at three per cent. What it means is the U.S. economy, contrary to the consensus forecast for this year, is going to probably grow in the area of three per cent.

I am the bearer of bad tidings, because that is not a non-inflationary rate of growth for the U.S. economy. I agree with a lot of what Don has just said, but in terms of cyclical moves for inflation the U.S. is in one of those up trends. Wages are growing about four per cent right now, and this Canadians would kill for. We're looking at a situation where our productivity growth is dying and I wouldn't be surprised at all if, with food prices and energy doing what they're doing, inflation in the United States reaches three and a half, maybe four per cent briefly. That's what's bothering the bond market.

I think the Feds are finally going to move. The Fed has sort of been in denial phase here for a while. The Feds are going to be in the game to enforce, to tighten, to put a mid-course correction into the U.S. economy here this year, probably raising rates by about 75 basis points. Before you start using the "R" word, that's recession, it takes a lot more than that to slow the U.S. economy down. That's a mid-course correction.

Long-term bond deals are in their bear phase. We think this phase will be over in the next two or three months. We're still looking for about seven and a half per cent on the long-term bonds as the bond markets do what they always do. That is, having been wrong about the two-percent no-inflation forecast, they will go way over to the other side and start worrying about the hyper-inflation and the economy growing too fast. Buy them at seven and a half because I think they will be at six fifty at the end of the year.

But enough of the U.S. economy. Let's get to the true driving force behind North America: Canada. Don't laugh. That wasn't funny. It sort of reminds me of a Yogi Berra story. I'm a fan of Yogi too. Yogi was asked in spring training by the equipment manager, "Yogi, what's your hat size?" He said, "I don't know, I just started spring training."

Last year the Canadian economy sort of ran at the pace of an 80-year-old racing car. This year is the payoff year. Everybody has been asking me for years, "Michael, we've been through five years of hell in this country. Fiscal drag to death and the economy is not doing anything. Why?" This is the payoff. If you look at the numbers coming out of the U.S. economy lately, its industrial sector, where 85 per cent of Canada's exports go, is on fire. And we think that probably the U.S. economy is going to have our exports growing about 15 per cent this year. That's 43 per cent of the Canadian economy sort of shifting from cruise speed to attack speed. And that's going to be a huge, huge boom for the Canadian economy. We too don't have enough inventories. And I think it's going to be very difficult for us to build them in the first half of the year with exports growing so fast. So all you business types are going to be very busy in the second half of the year trying to read the inventories.

Capital spending is growing at a fairly good pace. The real issue has always been the Canadian consumer. In 1994 we lit up exports. We built inventories like there was no tomorrow. We had capital spending coming out of our ears. And the consumer just couldn't respond. The reason is that this country got very close to killing the goose that lays the golden egg. For instance, the province of Ontario gets 85 per cent of its revenue from its consumers through sales taxes and income taxes. When you load the consumer up with the fiscal drag that we have, which added up to five per cent of our take-home pay, you're looking at a situation where the consumer couldn't respond.

But that was last year; this is 1997. 1 call this the year that is going to be the metamorphosis for the Canadian consumer. The first half of the year is going to look a lot like last year, but I've got good news. Real wages have caught up to inflation and we think that's no trick in Canada. We think they'll exceed inflation by a half a percent first half of the year, maybe one per cent towards the end of the year. Don't worry, we have lots of productivity to take care of that. But that's very unlike this time last year when the average person who had a job all the way through the business cycle, both of them, was suffering with a 1.3 per cent decline in income. They're now ahead of the game. Employment growth has picked up, and all of that suggests to us that the consumer is going to be looking at two-and-a-half per-cent growth in employment, about one-per-cent increase in real wages and something like three-and-a-half per-cent increase in real take-home pay by the end of the year, compared to 0.6 per cent at the end of last year. A lot of it's going to get spent. You saw some of that at Christmas; we'll see it again. And it means the Canadian economy--hold on to your hat--is going to grow at three-and-a-half per-cent this year, something in the order of 1.4 per cent last year.

So the central bank raises its rates tomorrow, right? Wrong. There is no inflation in Canada--and in fact, Canada, if you measure it with all the adjustments, is in deflation. Labour cost growth in Canada is zero, adjusted for productivity. That is the core rate of inflation. When you look at the Bank of Canada's core rate of inflation, it's going to sit in the bottom half of the target bed all year. In other words, get used to three-per-cent prime rates, because you'll have them at least through Thanksgiving.

Long-term bond deals: well I think we've had most of the back-up. As I said, the U.S. might give us some trouble, but we're looking for the Canadian dollar to rise up to the 130, 133 range. We think foreign investors will come in here and buy. So if I saw Canada at seven-fifty, which is not far from here, I'd be a buyer. I think they'll be at six-fifty by the early part of next year.

And the final piece of the puzzle? I hope you don't have a corporate president living beside you, because by this time next year they're going to get insufferable. Corporations in this country are going to make so much money, it's going to be unbelievable. We're looking for corporate profits to be up about 30 per cent to 35 per cent this year, versus zero to five per cent last year. My only problem with this whole thing is that I don't know how many bonds to buy and how many stocks to buy. But one thing I do know, is that it's going to be a very profitable year as Canada finally gets paid off. Thank you very much.

Ira Gluskin

Good afternoon, ladies and gentlemen. Someone asked me yesterday what I was going to say, and I said I was looking forward to finding out as much as them. I knew that whatever Donald was going to say I was going to go the opposite way. I've known him a long time and he is sincere about deflation but he's a home-run hitter, and he might go for inflation tomorrow. Manford publishes all the time, so I knew what he was going to say, but he was a little more emphatic.

Now I'm an investment manager. I'm sitting here minding my own business with a little bit more than a billion dollars in Canadian and American stocks. The likelihood of me standing up and telling you that these stocks are going down the drain is not too high. So that's the problem. One of my associates used to say I was congenitally bullish but I disagree with that.

If you want to learn about the investment business you should read Barrons. Barrons is a terrific publication. But every week since I was a child, Barrons has been negative on the stock market. And every week they find one brilliant person who can tell you about something that's really going to go wrong. And Barrons is no different from other financial press. The essence of the job is to figure out whether or not the so-called Goldilocks economy can continue. Now, Cox just told you there was going to be deflation, Manford hinted there might be inflation. Look every day in the Toronto Globe and Mail, the Financial Post, the Wall Street Journal, the New York Times, and wherever else, out of say 15 articles, five will say there's about to be deflation, five will say there's about to be inflation, and five will say things are going to stay the same.

We have been here over an hour. These two guys are profound but no-one has mentioned the province of Quebec. If we go back a year and a quarter when the Canadian stock market had lagged behind every stock market including Ecuador for decades, what was the reason? Well, we had a bunch of rotten politicians, we had rotten economics and we had an unsolvable communication problem. I don't know how it got solved. I don't read the paper. I go right to the business section, I must admit. But if it was solved, I missed it. So this is the principal risk in the Canadian stock market. This is why you wouldn't put all your money into Canada.

I agree with Manford. The Canadian economy is terrific. I've discovered that there actually is a bit of a barometre. In my former life I used to be a real estate analyst and I noticed that if you'd followed real estate it was quite predictive of the economy. For those of you who don't know, the real estate economy is having a tremendous recovery. There are very few Canadian public real estate companies so there is very little coverage about this, but it is going on as we talk. Now, it is not that surprising. The U.S. has had a great real estate recovery for about three and a half years. Well, Canadians are a little slow to learn about the rest of the world, but it is happening. We're just two years behind. And the economy, the real estate economy, is recovering as we talk. And so I'm very positive about the Canadian economy.

But the big issue is not about whether the economy is about to go down the drain. There are people who think that there is something wrong with the stock market. There are these five out of 15 mentioned earlier. It's the same thing they said for roughly two years every week in Barrons. They say that the stock market is completely fuelled by a mutual-fund boom resulting from low interest rates, and that basically these are uninformed people who otherwise would be putting their money in the bank. They have been throwing their money into mutual funds without knowing why and this has caused mutual-fund managers, who are overgrown schoolboys, to throw their money into the stock market indiscriminately. This is going to end and when it ends there will be a collapse because most of the people who bought mutual funds are greenhorns. They don't know anything about the bear market. When they see a bear market they'll be very unhappy and they'll redeem, which will cause all these worthless stocks to be sold because they were of no fundamental value in the first place.

You can read this every week in Barrons. And, sometimes, I'm afraid, it is true. But then I looked around in Canada, a country I have studied for a long time. I'm not biased. We don't sell mutual funds but I know all the

mutual-fund managers. I was at this business many years ago when it was very, very limited, and I've watched it grow. Some of our big stocks are mutual-fund management companies. The people who manage Canadian mutual funds are just as conservative as every other Canadian manager. There is a boom in Canadian mutual funds. There's millions of dollars of advertising going on. Canadians are throwing their money into mutual funds.

And the point of it all is it's not a bad product. It's the only product for the masses that's as good as a high-class product. One of my big stocks is Four Seasons Hotels. I would never pretend to anyone that Four Seasons Hotels was the same price as Journey's End. You want a premium product, you go to Four Seasons Hotels. We're not bad managers. We're just as good as anybody else but I would never say that we're any better than some of the great mutual funds around. They offer a great product for the people, the people understand it and they're buying it. The mutual funds are very, very conservative. That's the whole point; you don't have to worry.

What are people investing in? What are the hot companies? They're called bank stocks. The problem in the stock market is that most of the action is in the big stocks. Medium stocks are sitting around minding their own business. Speculative stocks you can't give away. Gold stocks are in the doldrums. Technology stocks are in the doldrums. Canadians are inherently very conservative. The people that manage these mutual funds are just as conservative as anybody else. And they're not throwing their money indiscriminately because they really don't know how. The chance of a mutual-fund collapse in Canada is very small. If you look around you'll see that it's dominated by very, very conservative companies, and the managers are quite conservative, and there's a very modest amount of speculation. Now, I hope we'll get some speculation, and that the forecast here a year from now will say, wow, after that tremendous growth we've had in Canada, now you have to watch out. But I don't think that's the case. I would be very positive about Canada. Thank you very much.

The appreciation of the meeting was expressed by Blake C. Goldring, Senior Vice-President, National Sales and Marketing, AGF Management Limited and a Director, The Empire Club of Canada and Julie Hannaford, Partner, Borden & Elliot and President, The Empire Club of Canada.