Investor update

Jun 1, 2011

All participants, please stand by. Your meeting is about to begin. Good morning, ladies and gentlemen. Welcome to the BMO Blue Book Economic Perspective from Across Canada conference call. I would now like to turn the meeting over to Mr. Peter E. Scott from BMO Financial Group. Please go ahead, Mr. Scott. Thank you, and good day, everyone. I am pleased to welcome you to today's conference call as we introduce our new publication, the BMO Blue Book. Published twice a year by BMO Capital Markets Economics and BMO Commercial Banking, the BMO Blue Book combines the expertise of BMO's economists with information provided by local business people to BMO's commercial bankers, people with feet on the street in local communities across the country. Just as the U.S. Federal Reserve's Beige Book has become a valuable resource in communities across the United States, it is our belief that the BMO Blue Book will provide similar benefits for Canadian businesses, policymakers, and journalists. Today, I am pleased to introduce four of the contributors to the first edition of the BMO Blue Book, which was released today. On the economic side, we have Douglas Porter, Deputy Chief Economist, BMO Capital Markets. On the commercial banking side, we have Victor Pellegrino, Vice President, Commercial Banking, Quebec, Jim Fallon, Vice President, Personal & Commercial Banking, Newfoundland and Labrador, and Bill Hogg, Vice President, Commercial Banking, Alberta. Each of our panelists will speak for a few minutes about their own contributions to the BMO Blue Book, Mr. Porter on the economic outlook, and our commercial bankers on what they have been hearing from business people in their regions. After this, we will be opening the line for questions. To start, I am pleased to introduce our Deputy Chief Economist, Douglas Porter. Doug? Thanks, Peter, and good morning, everyone. I am just basically going to give a brief overview of the broader Canadian economic outlook and go into some of the regional aspects of the outlook. In a nutshell, the Canadian economy got off to a blazing start in 2011, but has really since run into all kinds of heavy weather, both caused by a number of global events, but also there have been some domestic factors as well that have somewhat weighed on growth more recently. But while we have trimmed our growth forecast for this year slightly, we still see the economy advancing by 2.8% this year and by 2.6% in 2012, and both those numbers are more or less in line with the long run average for growth that we see for the Canadian economy of between 2.5% to 3%. Now, that forecast for this year is down a touch from our call earlier this year. But to put it in perspective, the March federal budget was based on the assumption of 2.9% growth for the Canadian economy in 2011. So despite all of the global risks that have erupted in recent months, the economic recovery here in Canada still looks to be maturing into the expansion phase. Now, with that broad backdrop for the broader Canadian economy, there are clear regional divergences developing across the country, and in some ways, we're starting to see a replay of the middle part of the past decade, where commodity-heavy provinces posted very strong growth, especially the three westernmost provinces in Newfoundland, while Central Canada and the rest of Atlantic Canada see much more subdued growth. The stronger fiscal position of most of the commodity-heavy provinces also means that they won't be as burdened by fiscal restraint in coming years. So we're looking for 3% growth or better, both this year and next, in each of Alberta, B.C., and Saskatchewan, while Ontario and Quebec will grow by close to 2.5% both years, and growth in the Maritime provinces will be around 2%. Now, Manitoba is a little bit of a special case. We've actually trimmed our call on this year's growth to 2.6%. That's a little bit below the national average, whereas before we had them a little bit higher than the Canadian average, largely because of the flooding impact on agricultural output, and despite the boost we think consumer confidence will get from the return of the NHL. The moderate growth backdrop means that the Bank of Canada will keep interest rates steady for some time yet. While they did indicate in yesterday's announcement that rates would eventually need to rise, they showed precisely zero urgency, and we're now calling for a total of just a half point increase in interest rates in the second half of this year, and then a further one and a half points of increase in 2012, and that would still leave the key overnight rate quite low at 3% by the end of next year. Now, one reason why the Bank of Canada can be so relaxed in its rate hike schedule is because the Canadian dollar is acting as a brake on growth, and that brake applies to all provinces. We actually continue to expect the Canadian dollar to rise a little bit further through the second half of this year from current levels back a bit above $1.05 before it begins to recede in 2012, when the U.S. Federal Reserve finally begins to raise interest rates. But even so, even by the end of 2012, we still see the currency remaining above par, and that will act as a headwind, especially on manufacturing and our tourism sector across the country over the next year and a half. And that's the broad landscape that we see for the Canadian economy in the year ahead. I'll hand it back to you, Peter. Thank you very much, Doug. Now we will hear from our Vice President of Commercial Banking in Quebec, Victor Pellegrino. Victor? Good morning, everyone. Just to give you a very quick perspective on Quebec's situation. The economic prospects for Quebec remain relatively good. Modest growth is expected this year, as Doug mentioned, around 2.4%, which is a slight drop from 2010. This is largely due to some pullback in government spending. The stimulus packages that were in place over the last couple of years are starting to slow, and there is going to be some additional taxation that will have an impact. What we are seeing in our economy specifically is relatively stable growth in the manufacturing sector, despite the strong dollar. This has actually been a bit of a surprise. It continues to be so. There still remains a significant challenge on the export side, but many companies are also taking advantage of the strong dollar to purchase machinery and make some key acquisitions in markets that normally, their buying power wasn't as strong. The upside that many companies have right now, especially in technology, has been to take advantage of some specific programs to Quebec, as Investissement Québec partners with the financial institutions to give companies the opportunity to grow their businesses. The tech sector is doing extremely well in the Montreal area, especially in the gaming area. We have seen almost 8,000 jobs right now in the greater Montreal area, and that is leading the country as a whole. On the residential and construction front, things are very stable. There is good growth in housing in Quebec, based essentially on a strong boom around the 450 area code area, which is essentially the area surrounding the greater Montreal, the island of Montreal. So a lot of new construction, residential homes, and in businesses continues. That is giving the economy quite a boost in creating jobs as well. That is pretty much the prospects for Quebec at this moment. Thanks very much, Victor. Now we will move to our Vice President of Commercial and Personal Banking in Newfoundland and Labrador, Jim Cowen. Jim? Good morning, everybody. As Doug mentioned, Newfoundland and Labrador has benefited, I think, from a commodity-based economy over the last number of years, if not leading one of the fastest growing economies in the country for the last number of years. While we expect to see some cooling in the next little while, we're still going to look at some pretty strong growth numbers going forward. As I travel around the province, one thing, one word strikes to mind when I talk to business leaders and people in business and customers across the province, is optimism. We look at Newfoundland and Labrador, it weathered the recession very well, and of course looking forward, we see lots of great things on the horizon, mostly in the form of major projects across the province. One more well-known, I think, is the Lower Churchill, the Muskrat Falls development. Which of course will be a green energy project, mostly exciting for the province. That actually extends right into Nova Scotia, as they're participating as well in that particular project. Labrador in general, the Labrador part of the province, you look at things like mining iron ore. We continue to see an expansion in Labrador in the iron ore operations, either mines expanding and the natural site opening new mines in Labrador. First time in a long time that's happened. We're also seeing some major international players take an interest in Labrador. Tata Steel, for example, is now reactivating a mine that was formerly opened, run by IOC, and are actually looking at a number of other major projects in Labrador going forward. Another big mining project was the Vale Inco site. They suffered from a long labor strike, labor problems. That's behind them now, and what we're seeing is a reactivation of the construction of a new state-of-the-art processing facility here on the island portion of the province. That, again, is another mega project that's moving along quite nicely, and that's creating some opportunities here on the island as well. The Hebron Oil project is another mega project. We're in the engineering stages now, where we're starting to see the local management team form, the engineers in place. That's expected to actually be producing by 2017. One of the worries, I think, from talking to the business community is really around the issue of skilled labor. We're in an environment now where we have many retirements pending in a lot of the labor force. Of course, as these projects come on stream, they're going to be looking at attracting and retaining skilled labor. Probably, you'll see upward pressure on the wages paid to that skilled labor. As a lot of people know, a lot of our labor force did move out West to the other oil-producing provinces now, but we're expecting a lot of those people may actually return to Newfoundland. We've seen as well some Newfoundland companies investing now in equipment and facilities based on the high Canadian dollar, which is a plus side for us as well. On the downside, the fishery, of course, because it's primary export business for us, they've suffered from the high Canadian dollar. On the plus side, again, inventories globally, particularly a couple of species of crab and shrimp, the demand is very high and causing prices to stay very high. That's improved that sector quite nicely. A lot of our product actually is even sold in Japan, so of course, they're looking, with their current situation, their demand will probably be strong because their domestic production is probably off as well. The fishery, again, they benefit, I guess, from the high Canadian dollar and the fact that they can purchase equipment, automation, those kind of things, to be able to compete better on the global scale. So overall, I think from a Newfoundland Labrador perspective, we're seeing optimism as the key word looking forward into 2011, 2012, and beyond. Thanks very much, Jim. Now we'll hear from our Vice President of Commercial Banking in Alberta, Bill Hogg. Bill? Yes. Good morning, everyone. Of course, the economy here is forecasted to perform very well as well as some of the other Western provinces such as Saskatchewan and B.C., led primarily by the commodity prices, the increases in commodity prices, and specifically to Alberta oil and gas. We're seeing lots of investment by the servicing companies here, purchasing equipment. Utilization of their equipment is getting up to now utilization rates that rivaled back in 2005 and 2006. The issue that the oil and gas servicing industry is seeing, and for that matter, the oil sands project, is labor. We're getting to see a tightening of the labor force again. We're starting to see wages increase, that, of course, affects all the rest of the industries in Alberta as well, because competition starts out for the labor market as it tightens up. I hear my clients saying that this is good that we're seeing good growth and everything, but they're worried again about going back to the 2005 era where labor was overpaid, input costs were too high, which starts to affect their profitability and their margins. Agriculture, it was a little bit of a worry here with the late planting in May, but it seems like we've got that under control now. Farmers have been out. They've had some good weather. Prices are good both on feed crops and grains as well as cattle. Probably the biggest soft or the softest spot we have in Alberta generally, especially in the major cities like Calgary and Edmonton, is residential construction. Housing starts are down year-over-year, that's primarily because there's so much inventory left over that was built up and not sold off. We haven't yet seen the prices on houses return to the pre-recession levels. So there's still people hanging on expecting to get those prices and trying to sell them at the prices that were there around 2005 to 2007. The prices haven't recovered yet. So a little bit slow there. Overall, I think business confidence from talking to my clients in Alberta, it's very strong. They see the economy continuing. They don't see a slowdown in the oil and gas prices, and oil and gas probably accounts for about 25%-30% of the GDP in Alberta. So they continue to see that being strong and people are willing to go invest and take advantage of the high Canadian dollar in buying some equipment and stuff from outside the country. That's about it. Thanks so much, Bill. Now I'm pleased to open the line for questions. I'm going to hand the call back over to our operator, who will provide you instructions. Thank you. Thank you. For telephone participants, if you are on a speakerphone today, please lift your handset before making your selection. You may press star one on your telephone keypad to ask a question, and if at any time you wish to cancel your question, you may press the pound key. Please press star one at this time if you have a question. There will be a brief pause while participants register for questions, and we thank you for your patience. Once again, please press star one on your telephone keypad if you would like to ask a question. There are no questions on the telephone lines at this time, Mr. Peter E. Scott. I will ask a question, and I will lead with Doug. Doug, you have been hearing, especially from the three commercial bankers who are on the call today, about the investment in equipment and processes because of the high Canadian dollar. This is something that you and your colleagues in the economics department have been speaking about for some time now with respect to the productivity number and its weakness. Are you seeing on the economic side, on the data side, the kind of things that our bankers are seeing? We definitely are. Of course, we just got the Q1 GDP numbers out on Monday, which does have business investment spending, and that was by far and away the strongest component of growth in the first quarter. Business investment rose at about a 13.5% annual rate in the first quarter, and that is if anything, a little bit milder than what we had seen in the prior three quarters. For the year as a whole, that is about the kind of pace we are looking for, and it is being led by machinery and equipment spending, in particular, not so much non-residential construction. Frankly, that is not that surprising at this stage of the business cycle. Usually, it is business investment. As the expansion matures, it does tend to lead the way, and it is being accentuated by the strong Canadian dollar and relatively strong profit growth we have seen over the past year. Now, the question is: Can business investment alone or is it enough to offset what is starting to be a bit of a weakening consumer spending trend? Overall, we think it will be strong enough. The economy as a whole will cool a bit. We are not going to see the kind of growth we saw in 2010 because business investment, frankly, is not big enough to offset a bit of a cooling off in consumer spending. Okay. Victor, I would like to talk a little bit about the government program that you refer to in the BMO Blue Book, the joint program between government and banks and Investissement Québec. You put a lot of stock into their ability to help companies with their investments. Combined with the high dollar, you are seeing a lot of success in this area? We are, in fact. The Quebec government has been a very strong partner of business with the program for export and growth. Companies that can take advantage of exposing themselves, especially if they are working towards exporting products. The government comes in and helps guarantee a portion of loss, potentially, for example, on a line of credit or some operating loans or some of their term loans. This allows businesses to perhaps invest larger amounts and move forward on projects a little faster. It has been very successful. It is very unique to the Quebec market, and it has become a real boost for small and medium businesses. A lot of our customers take advantage of it. We see a lot of concentration in the technology sector, in particular, less of a bricks and mortar business. That has been a real boost there and has been one of the drivers in the gaming industry and the technology startups that we are seeing across the greater Montreal region. Operator, one more check for questions. Yes, we have a question on the line from Tim Kiladze from The Globe and Mail. Please go ahead. Morning, guys. Can you hear me? Yes, we can. Hey there. I was just wondering to what extent there is, I guess you could say, a bifurcation between the provinces. I know that some of the western provinces have been touting that, even though their resources are helping their economies, it actually also helps places like Ontario and Quebec because a lot of the things that are used in services, equipment, et cetera, are manufactured here or something to that extent. Do you see that at all or hear that at all, or is there quite a strong divide? Well, I think even in the heat of the boom in 2005 to 2007, the last commodity boom, even though Ontario did lag throughout that piece, we were clearly seeing a spillover in the manufacturing. It was one of the reasons why the manufacturing sector performed relatively well, given the fact that currency was first poking its head above par during that period. I do think we are going to see an echo of that in the next couple of years. I think it's a reason to believe that even with what's obviously a subpar recovery in the U.S., that Ontario and Quebec can still do relatively well because they do get a bit of a spillover from the very strong growth that we are likely to see in Western Canada. It's one of the reasons why the differential isn't even greater in the growth rates between Western and Central Canada than what we're projecting. But looking at a bigger picture, there's no doubt there is a bifurcation between the commodity-heavy provinces and those who are a bit commodity-light. Okay, perfect. Thank you. We have a question on the line from Julian Beltrame from The Canadian Press. Please go ahead. Hi, this is probably directed at Mr. Porter. The parliamentary budget officer just came out with a report. In it, he's projecting that the economy is going to be much weaker than the consensus forecast that Ottawa is going to be using in the budget. He says 2012 and 2013 will see growth of 2.2 and 2.3. That's about a half point below. I guess he's doing his own forecasting now for the first time. Do you see anything of merit there? There have been rather bleak and dark news in the last month or so, and maybe his forecasts are a little more up to date than what the consensus is. It's one opinion, and of course, everybody's welcome to their own forecast. All I will say is over time, and this has been shown in the U.S., that the consensus, at least in terms of GDP growth, is the single best forecaster that's out there. No individual forecaster has ever consistently beat the consensus. He's welcome to his own opinion, but I would say that there's a lot of wisdom in the consensus when you're talking about growth rates, perhaps not so much on financial market forecasts, but in terms of growth rates, I would tend to think that the consensus has a pretty good long-term track record. There's no doubt about it that in the last month or so, there has been a slew of weaker than expected U.S. economic indicators. Some of that might be due to the incredibly unfavorable weather we've had recently. Some of it could be due to the aftermath of the Japanese production difficulties. It remains to be seen to what extent we'll recoup that in the second half of the year. The one thing I would point out is we went through a real lull in both the Canadian and U.S. economies last spring as well, and it really didn't turn out to be that meaningful. We ended up seeing quite a nice finish for both economies in late 2010. While it is discouraging, I wouldn't read too much into the weakness we've seen in the last month, and I certainly wouldn't be marking down my 2013 forecast based on the economic indicators we've seen over the last month. Your recommendation would be that the government should stick to a consensus forecast for its budget planning? Well, of course, the other thing they do, Julian, is they then have been putting in a prudence factor, allowing for an undershoot of growth of as much as half a percent, which actually would bring the consensus into line with what the PBO is calling. I think that's a reasonable way to go, to basically take the consensus and then shade down the forecast to leave a little bit of margin for downside surprise. I think that's a very reasonable plan to use. Yep. Thanks. Okay. Thank you. We have a question on the line from a participant with Reuters. Please state your name followed by your question. Hi, Doug. Jeff Hodgson calling from Reuters. I just wanted to ask you very quickly if you could elaborate just a little bit more on your thoughts on the outlook for consumer. Again, as you mentioned, we saw that drag on the Q1 data. I'm just wondering how long you think, how far out you think this sort of lackluster growth is going to extend. Are we looking at well into next year as well, or do you have any views on this? Well, of course, it's tough to sort out to what extent the weakness we've seen in consumer spending so far this year is due to the weather or oil prices or the removal of some of the HST subsidies we've seen. I actually believe the second quarter is going to be on the soft side as well for Canadian consumers, partly because of the miserable spring most of the country just went through. I think that will weigh, as well as the high gasoline prices. Presumably, the weather will improve. There has been a tendency for gasoline prices to march up the hill in the first half of the year and then come back down in the second half. I wouldn't be surprised if that's what we see again this year. We think the consumer will be on a somewhat better footing in the second half of the year. Now, having said that, I don't believe that the consumer can be the force that it has been through the early part of the recovery. I think we're probably on balance, looking at a more modest consumer outlook over the next year and a half. We're calling for average growth of about 2.5% for real Canadian consumer spending through the second half of this year in 2012. That's down from initial start to the recovery of between 3% and 3.5%. Consumer spending will cool, but I don't think it's going to completely fall out of bed here. Okay, great. Thanks. If I could jump in for just a moment. Bill, I know that your piece in the BMO Blue Book referred to some optimism on the retail side. To that point, could you elaborate a little bit on the retail positivity you've been seeing in Alberta? Yeah. My observation about the retail sector was when I've been going through the cities through Alberta, I haven't seen a lot of vacant retail space, which you would expect after going through. It seems to be getting all leased up. When I've been going into the stores and into the malls and stuff, seeing lots of activity, lots of shoppers out there. So I think it's been steady and that's just my observation, just sort of anecdotal that I've seen as I've gone through shopping centers and traveled through the cities and the provinces. Perfect. Operator, any further questions? There are no further questions on the lines at this time, sir. Okay, we'll stop there. Thank you very much, operator, and thank you so much to Doug, Victor, Jim, and Bill for joining us today. The BMO Blue Book is available for download on the BMO Capital Markets Economics website at www.bmocm.com/economics. If you're interested in any further interviews regarding the BMO Blue Book with BMO Economics or any of the 12 commercial bankers from across Canada who contributed to the publication, please contact BMO Corporate Communications at 416-867-3996. Thank you very much for your participation today. Thank you. The conference call has concluded.