Short Term Economic Outlook Improves
In the first half of 2010, Canadian economic growth is likely to rebound to about 3½ percent (at annual rates) driven by stimulative fiscal and monetary policy, inventory rebuilding, stabilization of the housing sector, and relatively robust growth in emerging markets. The unemployment rate is likely to peak at about nine percent. The policy interest rate should remain close to zero and credit spreads will narrow a little bit more.
The remainder of 2010 is highly contingent on governments' fiscal exit strategy. Domestic demand (consumption and business investment) should grow at three percent or more (at annual rates), but this will be off set somewhat by the slowing growth of government expenditures and a small drag from net exports. The policy rate of the Bank of Canada will begin to increase modestly although core CPI inflation will likely remain below two percent. In the face of strong Asian demand, commodity prices (except natural gas) will likely continue to firm. Commodity strength and continuing U.S. dollar weakness should contribute to modest appreciation of the Canadian dollar. Credit spreads should be stable but mid and longer term rates should rise as a consequence of increased rates on government bonds.
Economic Recovery a Priority
Prospects for an early Canadian election are receding as the official opposition works on longer term rebuilding. The Harper government will have more of a free rein in Parliament, focused on the economy. However, the political difficulty of making serious expenditure cuts, an unwillingness to increase taxes and relatively sluggish economic growth prospects will make it almost impossible to restore fiscal balance in the near term.
Credit Improves but Insolvencies Continue
Bank credit is beginning to loosen, though on tight terms. Consistent with previous recessions, insolvencies will continue to be a major market force for a number of years after the recession troughs. Lenders will more aggressively pursue rights as asset values improve and overall confidence begins to be restored. Unlike 2009, a combination of factors suggests a greater proportion of restructurings and fewer outright liquidations.
Revival in the Oil Patch
With oil prices having stabilized, or at least bounced off the floor, Alberta oil sands mega-projects will continue to come back to life, in post-boom moderation. Increased scrutiny of environmental issues will require some managing. Producers and midstream companies will jockey for land and infrastructure positions, particularly in north-east British Columbia. At the junior end of the market, which has largely resisted consolidation so far, continued moderate gas prices combined with falling production will push gas-tilted players to look for a partner. Finally, all eyes will be cast eastward for the next major investment from Asia.
Increasing M&A Activity
The warming trend in the mergers and acquisitions market will continue as still depressed stock prices combine with gradual improvement in credit markets. Income trust conversions (and acquisitions) will pick up as the December 31, 2010, deadline ending tax-free distributions approaches. The renewed commitment to the business judgment rule in the BCE decision and recent decisions of securities regulators in Ontario and Alberta may give directors more leeway in repelling hostile bids with poison pills. Watch for competing bidders and other dissidents to invoke the Canadian government's new power to review foreign investments on national security grounds as a competitive strategy.
Thickening of the U.S. Border
Continued high unemployment and an uncertain economic recovery in the U.S. make the prospect of an early unwinding of Buy America unrealistic. Government to government negotiations may continue but with little result. Heightened Canada-U.S. transfer pricing scrutiny, coupled with more aggressive customs audits, mean Canadian businesses can also expect to face more and potentially larger transfer pricing reassessments on one or both sides of the border.
The buzz will be around sustainability as businesses focus on eliminating or reducing environmental and social risks. Business continuity and business reputation will hang in the balance. Since Canada wants to dovetail its climate change policies with the U.S., political gridlock in Washington means little likelihood of serious greenhouse gas regulations being enacted in Canada in 2010. Watch for enhanced consultation between the Canadian government and industry as negotiations continue post-Copenhagen.
Executive Compensation Still a Hot Topic
Watch for increased investor interest in absolute pay levels, payment for performance, alignment (both in terms of how incentives are earned and how and when equity bonuses can be monetized), compensation that does not incent behaviours above acceptable risk profiles, and clawback mechanisms (such as when financial restatements demonstrate that bonuses were not properly earned). The Say-on-Pay campaign will continue, with more companies committing to advisory votes on their compensation reports.
Focus on Director Protection
Directors are getting the message that essential indemnification arrangements and D&O insurance must be customized to suit particular situations and examined closely to ensure that the fine print will not impair the coverage expected. Independent advice will increasingly be sought by new or independent directors, particularly as significant transactions are contemplated.
Ongoing Pension Reform
Though pension underfunding concerns have been partly alleviated by market recovery, pressure will mount on governments for longer term pension reform. Cost concerns will continue to influence business decisions respecting pension plan design and funding, while the potential for litigation will drive a continued focus on pension governance (including transparency) and disclosure to members.
Increased Vigilance for Fraud
With Canada having one of the highest rates of reported corporate fraud, expect more scrutiny of boards of directors, audit committees and management as to how they confront fraud risk and loss. An internal fraud prevention strategy, as well as the ability to quickly investigate a fraud and recover assets, will be more important than ever.
More Certified Class Actions
Reflecting U.S. experience, defendants in Canadian class actions have strongly resisted certification. But, with recent court decisions lowering the bar for certification, expect to see more class actions proceed past certification and a far greater number of securities class actions, many of them of tenuous merit.
Return of Commercial Real Estate
With renewed access to the public markets and improved borrowing costs, watch for an increase in activity levels by Canadian real estate entities both within Canada and internationally (particularly in emerging markets). Pension funds and other institutional investors will continue to seek the safe return of stable income-producing commercial real estate assets.
Ample Supply of PPP Projects
The Canadian government's $3.3-billion infrastructure plan will bring more projects to the growing Canadian public-private partnership (PPP) market. Financing structures will continue to evolve as financial markets recover appetite for longer term investment. International proponents will continue to grow their participation in this stable and well-developed market.
Technology Sector Up
With government stimulus spending now reaching the technology sector, the industry is poised for a considerable recovery. U.S. investors will once again explore Canadian financing opportunities, to some extent filling the void left by a domestic venture capital and private equity industry that has been unable to raise new capital. Tech spending will be up and, with that, revenues and IPO plans.