UBS predicts a 'V-shaped' recovery in Canada

Eric Lam, Financial Post

While most economists generally agree Canada will experience some kind of economic recovery in 2010, UBS on Tuesday took the bold step of predicting a sharp and bullish "V-shaped" recovery, one of the first to do so.

George Vasic, strategist with UBS Securities Canada Inc., said the new prediction raises its outlook for economic growth next year to a healthy 2.9% from 2.4%, already above consensus of 1.8%. UBS had previously forecasted a more tepid "U-shaped" recovery.

"A few months ago people generally were saying it'd be very difficult to have any sort of recovery because credit market conditions would not recover quickly, there would only be a gradual thawing. But what we've seen since then is they've actually turned around quite remarkably," he said. "Sure it's a step from where we were and maybe two steps from where the consensus is, but we think effectively this is what's going to happen."

One of the main factors in Mr. Vasic's outlook is rising government and corporate bond yield curves, which have traditionally been a sign of improving fortunes for GDP growth.

"They're quite compelling. If you look at their correlations to GDP, they're about four quarters ahead," he said. "This isn't about the next quarter or the next month, it says when these things swing around it does assure you of some strong growth over the next year."

Sharp drops in GDP have also historically been followed by strong rebounds over the next year, he said.

Sheryl King, chief economist and strategist with Merrill Lynch Canada, was arguably the first bull out of the gate in July when she forecast a "burst" of 10% growth in the fourth quarter of 2009 and 7.5% in the first quarter of 2010. However, she stopped short of calling for a "V-shaped" recovery.

Other economists are not quite so bullish.
Benjamin Tal, economist with CIBC World Markets, expects only 2% annual growth from Canada. It's enough to outperform the other G7 countries, but not enough to justify a "V-shaped" forecast.

"It's like putting an average student in a class of underachievers," he said.
For Mr. Tal, a "V-shaped" recovery needs to be symmetrical, and he does not see that happening. Rather, he expects the economy to form a "fat U" shape with 2010 as the transition year.

"I just don't buy it. We need to see the labour market stop bleeding, export growth, strengthening in manufacturing," he said. "I think it will be a full year before we get back to potential."

Francis Fong, an economist with TD Economics, dislikes the alphabet-style designations but would characterize the recovery as a cross between a "V" and a "W", driven by consumer and government stimulus spending. TD's growth number, expected this month, will be higher than 1.8% but not at the level of Mr. Vasic's 2.9%, Mr. Fong said.

He also said that Canada's recovery also depends on how the United States performs, and a big part of the recent turnaround in this country has been fuelled by its biggest trading partner's economic stimulus plans.

"The ‘cash-for-clunkers' program was very successful, so there was lots of growth in the quarter. Is that sustainable?" he asked.

He forecasts a "W-shape" for the United States, as stimulus funds get pulled back in 2010.

However, Mr. Vasic argues stimulus will continue for at least the next year as governments on both sides of the border will be loath to switch policy gears.
"Even in turning [stimulus] off it takes time, so you'll have a period of time of good growth. No government is going to pull back stimulus when the unemployment rate is at 9%," he said.

Douglas Porter, deputy chief economist with BMO Capital Markets, has pegged Canada for 2.6% growth and does see signs of a "V-shape" recovery, particularly in the housing sector.

"But that's a factor of how far down the left side went. It depends on how the right-hand side will look," he said. "Even getting back to zero carves out a ‘V-shape.' "