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Curb your enthusiasm

Financial experts see dark clouds inside silver linings

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An American, an Irishman and an Englishman discussing the economy sounds like it might be the start of a joke.

And to a large extent, a number of good laughs were to be had at the CFA (Chartered Financial Analyst) Society Winnipeg's Annual Forecast Dinner late last month.

During a lively debate, moderated by the very funny host of CBC Radio's The Debaters, Steve Patterson, three highly respected investment experts pontificated on the coming year ahead.

And despite all the recent business news declaring the worst is now behind us, they see the world through far-from-rosy lenses.

Lee Ferridge is the head of macro-strategy for North America at State Street Global Markets. While Boston-based, he is originally from England and is widely considered a leading expert on currency trading.

Matthew Philo, an American, is the head of the high-yield group at MacKay Shields in Manhattan and a top expert on so-called junk bond strategies.

Peter O'Reilly is the head of global equities at Investors Group Financial Services. Based in Dublin, he is the lead investment manager for Investors Global Fund, Investors Global Financial Services Fund and several others funds.

Although all three are obviously capitalists based on their careers, their comments at the event seemed less like those of financiers and more like the analysis of social radicals railing against the excesses of the one per cent.

All three argued ongoing systematic problems affecting virtually every asset class and geographic region pose very real risks to investment portfolios of all sizes, and threaten the livelihood and well-being of average middle-class families and the world's most economically disadvantaged.

And no blue skies are on the horizon, either.

So curb your optimism. A recovery might be at hand, but the cancers that have dogged developed economies for the last two decades are only in remission, they contend.

Of the three, O'Reilly was the most positive about the coming year -- a characteristic he attributes to being an "equities guy." Yet the recent past and near-term expected future growth are more symptomatic of a "normalization" of markets after years of upheaval and uncertainty, O'Reilly said.

In other words, he doesn't expect a "bejesus moment" any time soon, a term he and Irish colleagues used to describe the collapse of Lehman Brothers in 2008.

But there are palpable risks, such as slowing growth in emerging markets and China that could send unpleasant shock waves through the global economy, particularly affecting resource-based economies like ours.

And O'Reilly was the most optimistic of the three. His peers were more pessimistic.

Philo told the crowd of hundreds of analysts at the RBC Convention Centre Winnipeg while the current economic conditions bode well for corporations, they don't offer much hope for the middle class and the poor.

"People are facing a tough combination of high unemployment, stagnant wages and more inflation than people want to admit, but it's a good time to be a corporation," he said. "If you're talking about corporations, their cash flows have been great. They've improved their balance sheets, but that doesn't equal a good economy. It equals good cash flows."

That said, it is difficult to envision another year where companies' stock prices in the U.S. will continue to rise without the earnings growth to back up the exuberance.

Philo said companies have been able to cut their costs in recent years. They've been able to trim operations and take advantage of good borrowing conditions in a low-interest rate environment, while cost pressures such as rising wages have been non-existent.

Yet increased consumer confidence and the "virtuous economic growth" that comes along with it have not been part of the equation.

Ferridge was equally downcast because the problems that have plagued developed economies before 2008 continue today and, if anything, they're accelerating.

"There is a huge shift of wealth going on from the West to the East, and it's been going on for 20 years," he said, referring to the rise of emerging economies.

This wealth transfer is the result of established companies in developed nations having moved their manufacturing operations overseas to take advantage of lower labour costs. It's been good for their balance sheets, but it's been bad news for the middle class as steady, good-paying work has disappeared.

"What we're seeing in developed markets in the U.S. and elsewhere is this bifurcation of the labour market," he said. "You have a huge portion of the labour market that hasn't worked for a long time and may not work for a long time in the future."

But it's not unemployment numbers that reveal this malaise, it's the employment figures.

"The U.S. unemployment rates are coming down, but the employment (-to-population) rate remains at about 58 per cent."

That's four in 10 Americans of working age who are not gainfully employed, many of whom have given up hunting for jobs entirely or simply are unable to work.

The cure -- loose central banking polices -- has only served to exasperate problems. While printing money has been a boon for Wall Street, the rally has largely been missed by Main Street.

"The objective of QE (quantitative easing), whatever central bankers might contend publicly, is asset-price inflation," Ferridge said. "They've managed to achieve it in the equity market, but what the Fed is disappointed by is the fact that so few people in the U.S. own stocks anymore, that equity-price inflation didn't really help the average consumer."

The housing market has also been a beneficiary of loose monetary policy. Low interest rates and accommodative government policies in the U.S. might have spurred a so-called housing recovery.

Philo argued this is a false start. Rich investors are driving the market while families still struggle.

"If you look at a place like Palo Alto, it's up 46 per cent, but then you look at Oakland and it's down 54 per cent," he said. "It's the luxury markets that are doing well, and you can't have a real housing recovery without income growth and household formation."

The only way to get a booming middle-class housing market, Philo added, would be to go back to the NINJA (no income, no job, no assets) mortgage-lending Ponzi scheme of the last decade. And we all know the awful problems that caused.

Canada's market is a concern, too. To the outsider, it looks like a bubble ready to burst, O'Reilly said.

"I think the best trajectory is that wages grow into the prices, but that's really a Goldilocks-type outcome," he said.

Problems aside, 2014 could be the calm before the storm.

Although the U.S. Federal Reserve's recent announcement it will continue tapering its bond-buying program has sent markets trending downward, developed nations' central banks will likely continue favourable policies until their economies show signs of real expansion, such as meaningful job growth and inflation at more than two per cent.

It's a situation they all seemed to agree will serve to help the haves at the expense of a growing number of have-nots -- at least in the short term.

"It's likely a great time to be a U.S. corporation, but not a worker, in terms of the real economy," O'Reilly said.

Without real growth, however, it's liable to be bad news in the long term for companies and average folks alike.

And that's a joke that will have nobody laughing.

giganticsmile@gmail.com

Republished from the Winnipeg Free Press print edition February 1, 2014 B10

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