The economy is now being hit hard by a myriad of headwinds ranging from sputtering U.S. economic growth to the impact of the soaring loonie on Canada's crucial manufacturing and resource sectors to lingering affects of the SARS and mad cow outbreaks.
Evidence of that is already trickling in: Last month, Statistics Canada reported that its composite index of leading indicators, a gauge of forward-looking data, rose a tepid 0.2 per cent in May. A few days later, the government agency revealed that gross domestic product -- the broadest measurement of economic growth -- fell 0.2 per cent in April, the economy's first contraction in 1½ years on the back of SARS, the soaring Canadian dollar and the flagging U.S. economy.
But that's not to say the economy is a writeoff altogether. Experts still expect moderate economic growth, just not at the same rate as in previous quarters. So you could say our economy may be more like a toothless tabby than the much-ballyhooed Northern Tiger.
That sluggish scenario does not bode well for corporate profits and in turn, stocks. After a stagnant first quarter, sparked by uncertainty leading up to the war in Iraq, both Bay and Wall Streets posted stellar second quarters.
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Toronto's benchmark S&P/TSX composite index rose nearly 6 per cent during the first half of the year, buoyed by a 10-per-cent jump during the second quarter. The June 30 close was 23 per cent higher than the index's 52-week low of 5,678.28, touched on Oct. 10, 2002. On June 4, the TSX finished above 7,000 for the first time since last July.
In New York, the broad Standard & Poor's 500-stock composite index climbed 12 per cent during the first half of the year, propelled by a 15-per-cent runup during the second quarter. The June 30 close was 26 per cent higher than its 52-week low of 768.63, also touched in October.
Those steep runups are expected to result in some profit-taking and a period of choppy stock trading through the summer and fall, the experts predict.
What's more, the uninspiring economic growth is seen hampering corporate profits, which is also expected to put downward pressure on stocks.
Following an informal poll of five experts, gauging opinions on where we're heading the next six months, one thing appears certain: With the year half done, the glass is anything but half full.
Jeffrey Rubin
Chief economist and chief strategist of CIBC World Markets Inc.
"I think the Canadian economy, from here on will be underperforming the U.S. benchmark," he said, forecasting U.S. annualized growth of around 2.5 per cent and Canadian growth of around 2 per cent.
"We expect to see some pickup in the third quarter from the [U.S.] tax refunds, but the question is the sustainability of that pickup in the absence of either job creation or capital expenditures.
"Certainly, any further appreciation of the exchange rate has to be viewed as crippling to resource and manufacturing producers. . . . The problem for the pulp and steel guys is that not only is the Canadian dollar rising and wiping out whatever little margin is left on the table, but the underlying commodity market is weak. Prices are falling, not rising . . . the impacts are quite devastating."
Mr. Rubin recommends investing in high-yielding dividend stocks, especially those within the telecommunications and utilities sectors. "Right now, [some] dividend yields are already above the five-year Government of Canada bond rate, and by next year they could be above the 30-year Government of Canada bond rate."
He also suggests overweighting bank stocks, which also offer attractive dividend yields, and "long dated" government bonds.
Robert Spector
Head economist and chief strategist, Merrill Lynch Canada Inc.
"It's a good news, bad news scenario," Mr. Spector said.
"By the standards of Q2 [the second quarter], Q3 and Q4 are probably going to look good, in the 2.5-per-cent [growth] range. But that's way down from the growth Canadians have been used to over the past couple of years. And below the economy's potential of around 3 per cent."
Mr. Spector said the growth rate coupled with the rising dollar could result in a rise in this country's unemployment rate.
Also, he forecasts that the Bank of Canada will have two interest rate reductions during the second half.
He added that the S&P/TSX composite index should see-saw through the summer but expects it to end the year around the 7,000 level, relatively unchanged from its current mark of 7,001.88.
Still, he thinks analysts' profit estimates for the third and fourth quarters "look a little lofty" and that could put pressure on stocks if companies fail to meet targets or begin to guide lower.
The gold sector sits near the top of his list of favourites, forecasting gains on the back of decades-low interest rates in the United States and further depreciation of the U.S. dollar.
He also likes the energy sector, calling it "inexpensive" and thinks financial services stocks should be flat or slightly better by the year's end.
On the flip side, he's bearish on those companies that are involved in exporting, such as the industrial products and natural resources sectors because of the high Canadian dollar.
Neither does he expect a strong performance from technology stocks, anticipating a wave of profit-taking in that sector both in Canada and the United States after a sharp runup in the second quarter.
"The overall tone is, if you're a Canadian investor, and you're worried about the exporting companies and the resources because of the currency, you end up having to have a de facto defensive posture because you don't want be in those sectors that are going to get clobbered by the [high Canadian] dollar."
Derek Burleton
Senior economist, Toronto-Dominion Bank.
"Effectively, we're looking at a fairly listless second half of this year. We're going to see a bit of a bounce in growth from the SARS-affected second quarter -- so we're not looking for nearly as weak a performance as in the second quarter," he said. Mr. Burleton expects growth of between 2 per cent to 2.5 per cent during the second half.
"If anything, I don't think it's going to create a mood of exuberance within the stock markets. This picture does build in some rebound of the U.S. economy, but again, less than what some observers were hoping for.
But "by the same token, you do have some market participants pricing in a negative scenario, but over all, there are hopes that we're going to see a significant rebound in the second half, and we don't see that," he said.
"We see, if anything, a slower grind."
Douglas Porter
Senior economist, BMO Nesbitt Burns Inc.
"We do think growth will strengthen in the second half of the year, but I will be the first to admit that that would be entirely predicated on strong U.S. activity," he said.
"Last year, we saw Canada go its own way without a big helping hand from the U.S. but I think now, more than ever, Canada's outlook relies on a rebound in the U.S. economy. I do think there's reason to be optimistic there [the United States] -- basically they're throwing every ounce of stimulus they have at the economy and I think some of of it's going to stick."
After what he calls a "tremendous" second quarter in the stock markets, he expects some consolidation over the near term and says there is "upward potential" if the long-awaited U.S. recovery does take hold.
Like his market-watcher peers, he said the manufacturing sector is the most vulnerable to suffer declines on the back of an expected further rise of the loonie.
The media and retailing sectors, he said, could be among the beneficiaries of both an economic rebound and currency gains.
Roger Mortimer
Portfolio manager, AIM Canadian First Class FundFunds Management Inc.
"The Canadian economy is likely to grow at a somewhat slower rate in the back half of the year than it did during the front half," he said.
"Over all, the investment environment is a fairly benign environment -- where interest rates are unlikely to rise either in the U.S. or Canada," he said.
Within that scenario, sectors that combine earnings growth, financial stability and dividend yields look attractive, he said. Those include Canadian bank stocks and income trusts.
Another strategy, he said, is searching for stocks of domestic companies that are not vulnerable to dollar fluctuations and that have the ability to start raising fees, such as the cable, media and utility stocks. That includes high-profile names such as BCE Inc. and Telus Corp., he said.