Euro-zone fears awaken, Fed cool on QE3, commodities weaken

It had to happen. After a very buoyant first quarter – and a strong first day of the new quarter – European debt worries brought global equity markets back to earth Wednesday.

But instead of Greece being the focus of concern it was Spain. Specifically, a disappointing bond auction that failed to be fully bought sent 10-year Spanish debt yields north of 5.6% – the highest yield since early January – and well above Tuesday’s yield of 5.4%. The upshot of the weak auction and the rise in yields is that bond markets are beginning to question the country’s ability to rein in deficits and avoid a financial crisis. 

This came on the heels of Tuesday’s release of US Fed minutes that poured cold water on further quantitative easing, or QE3, which also winded the markets and broadsided commodities. At close of trade Wednesday, gold, silver, oil and copper had all slipped over the three sessions, which made the pain particularly acute for Canadian markets. The downward pressure on commodities was furthered by a rising US$ which jumped against the euro Wednesday. 

It was quite a turnaround from Monday when better-than-expected manufacturing activity was reported south of the border. The positive ISM-Manufacturing numbers outweighed negative European unemployment numbers that showed the number of Europeans out of work is approaching a 15-year high of 10.8% for March.

Markets

North American equities stage broad retreat  

In Canada, the TSX closed down for the three days to end Wednesday at 12,178. Also Wednesday, gold settled at US$1,620 an ounce, a 12-week low; silver dropped to $31.27 and crude found a seven-week low at $102.06. Gold may get a lift Thursday from Chinese buyers – the number two consumer of the yellow metal in the world – who have been on the sidelines since Monday celebrating a national holiday. 

South of the border, the Dow, the S&P 500 and the Nasdaq also ended lower by the close of Wednesday’s trade. Looking ahead, all eyes will be on the US employment numbers which are released Friday even in light of equity markets being closed for the holiday. The U.S. bond market will be open for two hours only on Good Friday following the release of the jobs data.

Our Recommendation

Stock selection increasingly important

Equities: with a U.S. Election ahead of us in November we are concerned that the summer months could be extremely quiet for both the news and stock trading volume. This makes stock selection and sector rotation within equity portfolios all the more important.

Fixed income: Term Call – given the recent decline in yields, we no longer see value in the mid-to-long end of the curve and recommend investors stay short at this time.

Big Picture

Cautious optimism in Greece, US considers another round of QE, Canada & EU hold rates flat

Greece managed to avoid default once again, announcing on Friday that it had reached its bond swap target with private holders of Greek debt—the largest sovereign debt overhaul in history. In the run up to a March 20^th bond redemption, bondholders have agreed to exchange their existing government bonds and take more than a 70 per cent “haircut”.  Germany’s main opposition continues to add pressure however, agreeing to support the European fiscal pact, but only if measures are added to impose a European financial-transaction tax.  Meanwhile, ECB President Mario Draghi pointed to some signs of stability in Europe’s economy and held interest rates steady.

In the US, the Federal Reserve leaked to the press that it was putting a third stimulus option on the table—so-called “sterilized” bond buying—in an attempt to limit inflation while holding down long-term borrowing costs. 

The Bank of Canada held its key interest rate steady at 1 per cent but suggested rates could rise sooner than expected due to growing signs of improvement both in Canada and abroad.  It pointed to household debt as the biggest domestic risk, even as housing affordability improved in Canada in the fourth quarter of 2011, the second improvement in a row. Canada’s outlook seems increasingly uncertain though, given that the economy shed 2,800 jobs in February and exports fell 2.3% in January.

Markets

US & Canadian markets rebound

While investors fled stocks early in the week due to concerns over the looming bond swap deadline in Greece, international markets rebounded on Wednesday and Thursday.  The Dow and S&P regained almost all of the ground they had lost on the first two days of the week while the S&P/TSX Composite recouped about half its losses.

US stocks were also buoyed by news that the Fed reported US consumer spending surging, with debt rising to a seasonally adjusted $17.8 billion in January, much higher than the $10 billion forecast by Wall Street economists. Data on job growth was also encouraging as the US extended to three consecutive months, job gains over 200,000, the latest being 216,000 in February. At home, bank results continued to roll in, with Bank of Nova Scotia reporting net income of $1.4 billion in the first quarter, up 15% over last year, and CIBC announcing 9% profit growth in the same period.

Our Recommendation

Outlook improving but equities appear short-term overbought

Equities: Although equities appear overbought in the short-term, any pause or consolidation in the market should be seen as a buying opportunity.

Fixed income: Term Call – given the recent decline in yields, we no longer see value in the mid-to-long end of the curve and recommend investors stay short at this time. Sector Call – underweight Canada, overweight Municipals, Provincials and Corporates. Currency Call – we recommend Canadian investors remain in Canadian dollars for their fixed income holdings. Alternative Strategies – new call – marketweight high yield, marketweight Emerging Markets Debt, underweight inflation protected debt.

Portfolio strategy: Sustained equity outperformance could be challenged by slowing U.S. macro momentum post-Q1, weaker Chinese data, and Euro noise.

Greek debt talks hit snag; U.S. may ease

Greek debt-restructuring talks hit an impasse on Tuesday as private sector creditors pushed for a higher interest rate on the new bonds, arguing they are already taking a 50% write-down on existing bonds worth US$265-billion. A debt restructuring agreement is a precondition for Greece to receive its next installment of aid to stave off bankruptcy. The IMF cut its forecast for global economic growth to 3.3%, from 4%, in 2012 and warned the European crisis could tip the world into recession if decisive action is not taken soon.

The U.S. Federal Reserve announced interest rates should remain low well into 2014 and Chairman Bernanke appeared open to another round of stimulus, noting that bond buying is “an option that is certainly on the table.” A report on the quality of jobs in Canada revealed more people turned to lower paying positions or became self-employed in 2011. According to Stats Canada, the number of self-employed Canadians increased twice as fast as those in paid employment. Full-time employment increased by 1.5% in 2011; however, low-paying jobs grew four times faster than high-paying jobs. Asia will lead the world economy in 2012 with 7% growth, led by China, India and Indonesia, according to the head of the Asian Development Bank.

Markets

Fed sparks optimism; gold, oil, treasuries rise

Commodities and government bonds rallied for a second day Thursday, while the U.S. dollar weakened, after the Federal Reserve pledged to keep interest rates low and said it is considering more bond purchases. Research In Motion shares fell 9% Monday as founders and co-CEOs Jim Balsillie and Mike Lazaridis resigned after 20 years at the helm, handing over the reins to the company’s COO, Thorsten Heins. Chesapeake Energy, the second-biggest natural-gas producer in the U.S., will cut production in an industry-wide effort to reduce a massive surplus that has depressed prices to 10-year lows. Natural gas prices jumped 10% on the news.

The price of oil rose above $100 as the Fed outlook fueled optimism for increased oil consumption. The International Energy Agency (IEA) expects crude prices to reach US$247 a barrel by 2035, almost twice the US$133 assumed by OPEC, citing rising marginal costs to meet increased demand. Apple had another blowout quarter, marking its largest quarterly earnings ever, with record sales of 37 million iPhones, 15.4 million iPads and 5.2 million Mac computers. The fourth quarter of 2011 saw a breathtaking 118% jump in profit, leaving the tech giant with nearly US$100-billion in cash. 

Our Recommendation

Outlook improving but equities appear short term overbought

• Equities: Although investor risk appetite appears to be growing, in the short term equities are overbought and vulnerable to a modest pullback.
• Fixed income: Term Call – given the recent decline in yields, we no longer see value in the mid-to-long end of the curve and recommend investors stay short at this time. Sector Call – underweight Canada, overweight Municipals, Provincials and Corporates. Currency Call – we recommend Canadian investors remain in Canadian dollars for their fixed income holdings.
• Portfolio strategy: On an absolute basis, the S&P 500 rally is looking overbought. Relative to bonds, however, we could witness further equity outperformance through Q1.

Prime Minister Papademos warned Greece may default on its debts in March unless unions accept further salary cuts. Inspectors arrive on January 15 to assess Greece’s progress in cutting its deficit and to approve the next portion of bailout funds. France drew solid demand at its first debt auction of 2012 with yields rising only slightly despite fears for its AAA rating. Debt sales next week by Italy and Spain are seen as the year’s first big tests of eurozone countries’ ability to borrow at affordable levels. U.S. manufacturing grew at its fastest pace in six months in December, as the index of factory activity rose to 53.9, from 52.7 in November. Readings over 50 indicate expansion.

Many U.S. retailers reported solid sales gains for December, capping a tough holiday season that saw heavy discounting. More expensive stores such as Macy’s and Saks as well as specialty retailers such as Victoria’s Secret did well, while Target and J.C. Penney lowered their outlooks. A survey by the Canadian Federation of Independent Business found small business confidence rose in December to 65.0 – almost a point and a half higher than in November – with business owners in Alberta and Saskatchewan the most optimistic. A national survey found more than two-thirds of Canadians plan to contribute the same amount or more to their RRSP as last year, despite the tough economy.

Markets

U.S. starts year on upswing

U.S. stocks rose for a third day on Thursday, to a two-month high, as positive reports on manufacturing, construction and employment bolstered optimism. In China, the Shanghai Composite dropped to its lowest level since March 2009 on concerns that a European recession will curb exports. Ford was Canada’s top-selling automaker in 2011 for the second consecutive year, boosted by sales of the F-Series pickup truck, which make up three-quarters of its total sales. Chrysler Canada sales jumped 13% in 2011 to their highest level since 2002. Electric car sales sputtered in 2011, as high prices and supply bottlenecks led to lower-than-expected sales for both Nissan’s Leaf and General Motors’ Chevrolet Volt.

A European slowdown will impact global IT spending, according to two big research firms – Gartner lowered its 2012 growth forecast to 3.7% from 4.6%, while Forrester dropped its view to 5.4% from 9.6%. A record 1.2 billion apps were downloaded during Christmas week as an estimated 20 million Android and Apple devices were activated by people who received iPads and smartphones as gifts. Food price inflation will ease in 2012, according to the Food and Agriculture Organization; however, economic instability and currency market fluctuations will likely lead to continued volatility.

Our Recommendation

Outlook remains cautiously optimistic

• Equities: With a rather volatile and challenging 2011 behind us, we look ahead to 2012 with slightly more optimistic lenses as valuations look compelling, corporate balance sheets are strong, and dividend yields are attractive in this low interest rate environment.
• Fixed income: Term Call – given the recent decline in yields, we no longer see value in the mid-to-long end of the curve and recommend investors stay short at this time. Sector Call – underweight Canada, overweight Municipals, Provincials and Corporates. Currency Call – we recommend Canadian investors remain in Canadian dollars for their fixed income holdings.
• Portfolio strategy: Our 2012 objective will be to raise cyclical exposure when easing monetary policy is extended, China’s PMI index bottoms, and the S&P500 settles above its 200-day average.

Following all-night talks, leaders of 23 of the 27 European Union nations agreed to a new treaty with strict oversight over national budgets, seen as crucial to solving the debt crisis. Britain, Sweden, Hungary and the Czech Republic will not join the treaty. Ratings agency Standard & Poor’s put 15 eurozone countries on credit review on Monday, and warned that the AAA credit ratings of France and Germany were at risk. The European Central Bank cut its benchmark interest rate to a record low of 1%, the second rate cut in five weeks, in an effort to boost the economy. Falling output and rising job losses heightened fears that Britain is facing another recession. The U.K.’s industrial output fell 0.7% in October, its fastest decline in six months.

Brazil’s economy ground to a halt in the third quarter, as domestic consumption, as well as China’s demand for Brazilian exports like iron ore and soybeans, slowed. Economists expect Latin America’s largest economy to grow 3% this year versus 7.5% in 2010. Australia’s economy grew by 1% in the third quarter, spurred on by a boom in mining investment and strong household consumption, which was partly offset by falling government spending as stimulus programs unwind. Natural resource-rich provinces will lead Canada’s economic growth next year, with Saskatchewan and Alberta projected to expand 2.9% and 2.8%, respectively.

Markets
Rally pauses as investors weigh summit outcome:

U.S. and European stocks had rallied for more than a week leading up to the European summit. The S&P 500 index, up 8.8% since November 25, fell on Thursday after news that Germany rejected some draft proposals. The blue-chip Euro STOXX 50 index had surged 13% before Standard & Poor’s announced its credit review. Discount retailer Dollarama’s profit rose 33% by raising prices and improving efficiency, but customer traffic fell for the fourth consecutive quarter. Google’s Android hit a milestone with over 10 billion applications downloaded since its launch in October 2008.

Apple will lose the “iPad” trademark in China despite having paid US$54,000 to buy the name from a Hong Kong-based company in 2006. A Chinese court sided with the company, which claims that the “global rights” did not include China. Billionaire investor Warren Buffett bought a US$2-billion solar energy development in California in a move that could spur investment in a cash-strapped industry. Spending on Christmas trees is up for a third straight year in the U.S. after plunging almost 11% in 2008, signaling consumers aren’t cutting back on holiday purchases. U.S. jobs in the shale gas industry are predicted to rise to 870,000 by 2015, from 600,000 in 2010.

Our Recommendation
Macro overhang remains but outlook improving:

• Equities: Fundamentals will matter again at some point, and with a slowly improving outlook for the U.S. economy, prospects for more economically sensitive sectors, particularly for copper and energy, are brighter and not fully reflected in current valuations.
• Fixed income: Term Call – given the recent decline in yields, we no longer see value in the mid-to-long end of the curve and recommend investors stay short at this time. Sector Call – underweight Canada, overweight Municipals, Provincials and Corporates. Currency Call – we recommend Canadian investors remain in Canadian dollars for their fixed income holdings.
• Portfolio strategy: Based on our forecasts, equity total returns (8%) are expected to exceed bonds and cash in 2012. However, the high level of Euro uncertainty and softer Chinese data warrants a cautious cyclical stance to kick off 2012.

• If investors were able to consider in isolation recent U.S. economic statistics, corporate earnings, improving profit margins and strong balance sheets, all collectively known as “fundamental data”, current stock prices would be seen as exceedingly attractive; regrettably, in the current environment, fundamentals continue to be superseded by macro/political concerns.
• Although fundamentals will matter eventually, our cautious outlook remains the same for now from a trading perspective.
• Canadian and U.S. equity markets may extend the recent downward move (down 6%-8% over the past two weeks), but market technicals suggest investors should be prepared to add equity exposure soon.
• Global equities continued their decline last week on further contagion fears posed by the European debt crisis and the implications for the global banking system.
• Although the ECB (European Central Bank) has intervened by buying government bonds of weak members Italy, Spain, and Portugal, failure by senior members Germany and France to agree on the ultimate role of the ECB as backstop for the European Union has capital markets remaining anxious.  Agreement by Germany on a bailout is not likely forthcoming until they are forced by a severe crisis, not just the threat of one.
• Following the positive news last week of a new pro-austerity government in Italy, Spain elected a majority conservative government on the weekend yet Spanish bond yields still traded at record highs yesterday.
• And despite the failure of the so-called U.S. Congressional “super committee” to reach agreement yesterday on US$1.2 trillion in budget cuts, the U.S. dollar and U.S. treasury bonds remain the safe-haven of preference for global investors, pushing U.S. bond yields lower.
• The absence of an agreement by the super committee leads to automatic spending cuts of US$1.2 trillion over 10 years starting in 2013, half of which will come from the Defense budget.  Although supposedly “automatic”, expect the political jockeying to continue over efforts to block cuts, particularly as rhetoric heats up during the upcoming U.S. presidential election year.
• Given this backdrop, investors are showing little appetite for risk and becoming increasingly guarded, evidenced by continued equity and high yield bond selling.   Cash positions for both institutional and retail investors are near record levels.
• For fixed income exposure, the current low rate environment offers little value in the mid to long end of the curve and we recommend investors remain short duration at this time. From a sector weighting perspective, investors should be underweight Canada’s and overweight provincials, municipals and corporates. With the Canadian dollar expected to outperform most major currencies over the coming year, we recommend Canadian investors remain in Canadian dollars for their fixed income holdings.
• Although the trend has been down for equities, it should be noted that declines have been on relatively light trading volumes, implying a lack of conviction by investors. Volumes are expected to be particularly light this week as the U.S. effectively shuts down for the week in anticipation of their Thanksgiving holiday.

U.S economy revives; recession fears fade

U.S. economic growth increased at its fastest pace in a year, expanding 2.5% on an annualized basis in the third quarter versus just 1.3% in the second quarter. Consumer spending grew at 2.4% after slowing to a 0.7% pace in the second quarter, while business investment spending was the fastest in more than a year. Chinese investment in Europe is expected to double this year to US$8-billion, and surge over the next decade. The EU and Beijing are considering opening negotiations on an investment treaty that would make it easier for Chinese companies to invest in Europe. Flooding in Thailand could disrupt global electronics supply chains for several quarters, with the closure of major factories for semiconductors and hard drives.

The Bank of Canada left its key interest rate on hold and warned the eurozone is headed for a “brief recession.” Canadian payrolls rose by 238,400 positions, up 1.6% in August from a year earlier. Canadian workers can expect a 3.1% pay rise on average in 2012, following a 3% increase in 2011 and 2.7% in 2010. Retail sales in Canada rose a better-than-expected 0.5% in August after declining in July. Canadians are delaying retirement and staying on the job longer. A 50-year-old worker stayed in the labour force another 16 years in 2008 – 3.5 years longer than workers the same age in the mid-1990s.

Markets

Global stocks rally on euro deal

World stocks surged after European leaders convinced banks to accept 50% write-downs on Greek debt and boosted the rescue fund’s capacity to 1-trillion euros. U.S. stocks extended their best month since 1974, jumping 3.4% Thursday, after GDP data eased recession fears. About three-quarters of S&P 500 companies releasing quarterly results so far have beaten analysts’ expectations. Caterpillar reported a 44% jump in earnings year-over-year and forecast sales to increase between 10% and 20% in 2012. UPS posted a 5.1% increase in third-quarter earnings, although package volume was stagnant. 3M reported a 1% decline in earnings, falling well short of expectations, because of weakness in the electronics market.

Oil companies benefited from high oil prices – Exxon Mobil earnings surged 41% and Shell third-quarter profit doubled to US$7-billion from a year earlier. Potash Corp. profit doubled in a year reflecting the “unrelenting pressure on global food production,” according to the CEO. The long-awaited Boeing 787 Dreamliner made its first commercial flight Wednesday, from Japan to Hong Kong. Amazon quarterly sales were up 44%, but profit plunged 73% from a year ago as the company invested heavily in the Kindle Fire tablet.

Our Recommendation

Rally likely to continue into Christmas season

This week we saw a continuation of last week’s “Walking Dead” rally with Financials leading the way. Thursday’s rally was another 90% up day (90% of stocks went up) with elevated trading volume of 6.7 billion shares. A high volume rally is typically a bullish indicator and suggests that investors are coming off the sidelines. Another positive signal for the markets was that the 10-year US Treasury yield broke above 2.3/2.35%. A steepening yield curve is an encouraging sign for equities. A recovery in risk-appetite could lift valuations as the U.S. economy averts recession and Europe adopts a credible debt relief plan. We’re certainly not out of the woods just yet, however it’s likely that we will see further strength rather than future weakness going into 2012.

- Preet Banerjee

Every time stock markets tank, you can count on the same set of reactions. People question fees. If the investors had an adviser, they consider doing it themselves. If they were doing it themselves, some consider going back to an adviser. And invariably the debate of whether or not “this time it’s different” is brought up, which is code for asking if they should change their strategies.

Many investors in Canada use a buy and hold strategy. Whether that means buying individual stocks, bonds, mutual funds or ETFs, the idea is to weather the storms by sticking with a well-diversified portfolio.

And every time a market correction occurs, people start to second-guess themselves. If the market declines are small, usually it’s not an issue. Once we get to a 10 per cent decline, more people start asking if they should get out while the getting is good. Bear market territory (which is a 20 per cent decline from the previous peak) gets the crazies out. All of a sudden, market timing seems like a good idea.

Please.

The fact that the market has already fallen should be proof enough that you have no authority to suddenly become a market timer. If you were good at it, you would have taken your money off the table before the decline.

Not only would you have to get the exit right, you would have to gauge the re-entry and buy back in when the market reaches its lowest point. While everyone knows they should buy low and sell high, the lower prices drop, many bail on that strategy and essentially turn into buy high, sell low investors.

People label you a contrarian if you want to buy when everyone else is selling. How paradoxical is that?

The truth is, a well-diversified portfolio backed by an investment policy statement is going to be the most prudent approach to investing for the vast majority of people. But as the markets decline further and more and more people start asking if there is a better way, let’s put trading and market timing into context. Barry Ritholtz, CEO and director of equity research at Fusion IQ, believes the odds of becoming a successful trader are similar to becoming a professional athlete.

Citing some basketball statistics on his blog, www.ritholtz.com, not everyone makes the high school basketball team. Of the few that do, only 3 per cent of those high school players make it to the college NCAA level. Only 1.2 per cent of players make the next step to the professional ranks. This works out to 0.03 per cent of high school basketball players in the U.S. making it up to the NBA. He believes the success rate of traders is roughly the same.

With both trading and professional sports, there are some commonalities: dedication and long hours. The likelihood of a regular investor dumping their prudent strategy to try to beat the markets consistently over time through market timing and trading is about as wise as the average person dropping their careers to take a shot at making the NBA.

While clearly there are exceptions in both cases, they say white men can’t jump and I say most people can’t trade.

Preet Banerjee, BSc, FMA, DMS, FCSI is a W Network Money Expert.

• In a largely headline-driven market, there has been no shortage of negative commentary to induce lower confidence in the economic and market outlook; however, our message remains the same.
• As unsettling as global events have been recently, the current pullback in stock prices represents an opportunity for selective investment in equities.
• Global capital markets continue to fluctuate in response to ongoing concerns surrounding a deepening financial crisis in the eurozone.
• Germany and France are seeking ways to shore up their banking system in the likely and widely anticipated event of a default by Greece.
• Market volatility reflects uncertainty as there is seemingly any number of possibilities regarding potential solutions to the very heated and politically charged fiscal debate in Europe.
• And although the U.S. is quick to point fingers at Europe, America has its own issues with debt and budget deficits. Although President Obama felt compelled to address the employment problem in the U.S., his proposed solution would cost an additional US$447 billion at a time when the “Super Committee” is looking for $1.2 trillion in spending cuts.
• Investor sentiment remains largely negative with continuing talk of economic recession; arguably equities are pricing-in a recession and associated decline in corporate earnings.
• Whether or not the U.S. economy falls into technical recession, it has become increasingly clear that investors are facing a prolonged period of sluggish economic growth.

But not all the news is negative as there has been some positive data lately:

1. the Baltic Dry Index, which tracks global shipping demand through prices of dry bulk cargoes and is seen as a leading indicator of future economic growth and production, has bounced off its lows seen in mid-August and moved progressively higher.
2. the August U.S. ISM Manufacturing Purchasing Manufacturing Index (PMI), another leading indicator came in with a reading of 50.6, ahead of consensus estimates, and being above 50, suggesting economic expansion and not contraction.
3. similarly, the August U.S. Non-Manufacturing Composite PMI also beat expectations with a reading of 53.3.
4. corporate profitability remains strong and even if forward earnings decline somewhat from current levels due to a slowdown in the economy, balance sheets are still solid as evidenced by large cash positions and dividend increases.
5. merger and acquisition (M&A) activity continues, suggesting corporate management are sufficiently confident to grow their businesses through consolidation, if not through building capacity directly.
6. equity valuations are very attractive, already implying or pricing in an earnings retraction of some 15 -20% from current levels.

• Notwithstanding all the negativity in the market, current weakness offers investors a chance to buy shares of quality companies at a significant discount. In the context of an ongoing low interest rate environment, our investment bias still favours equities over other asset classes and there are several blue chip stocks that can now be bought with a dividend yield well in excess of that offered by government bonds.
• Current market weakness signals a crisis in confidence in the global economy and the political leaders responsible for its stewardship; we remain buyers on weakness but are also inclined to sell partial positions into any sustained strength as we believe markets will likely trade within a narrow band for an extended period, creating trading opportunities to add value to longer term portfolio returns.
• For fixed income exposure, the current low rate environment offers little value in the mid to long end of the curve and we recommend investors remain short duration at this time. From a sector weighting perspective, investors should be underweight Canada’s and overweight provincials, municipals and corporates. With the Canadian dollar expected to outperform most major currencies over the coming year, we recommend Canadian investors remain in Canadian dollars for their fixed income holdings.
• Equities had been range bound, but the recent global equity market sell-off has most indices breaking below this range. We expect volatility to continue in the near-term, yet investors should be adding to positions on weakness, particularly in higher quality, dividend-paying stocks as our intermediate and longer term bias still favours equities over all other asset classes.

Brent Keylock, CFP, FMA, FCSI
Wealth Advisor & Financial Planner
ScotiaMcLeod – Central Alberta
403-356-7032

Canada’s economy, which stalled in the second quarter, is likely to pick up speed and outperform its developed-nation peers by the end of the year, according to a new report by the Organization for Economic Cooperation and Development.

The forecast comes as Statistics Canada data released Thursday showed the nation’s trade deficit almost halved in July as exports rose and building permits matched a record high originally set in May 2007.

Canada’s economy shrank by .4% in the second quarter. It will grow by 1% in the third quarter before strengthening to expand 1.9% in the final three months of the year, the Paris-based economic think-tank said. That compares with growth of just .2% in the G7, with Europe’s three largest economies forecast to shrink.

Higher company profits and improved credit conditions will add to increased spending by businesses on equipment and machinery to help drive economic growth. The unemployment rate will also decline as the global economy improves, it said.

However, the OECD warned the Bank of Canada not to be complacent about rising prices. It said short-term inflation is edging higher and the central bank needs to resume raising rates soon “at a moderate pace.”

The central bank on Wednesday left rates on hold and its comments on the economic outlook led private economists to predict that further increases aren’t likely for the remainder of this year at the very least.

“In light of slowing global economic momentum and heightened financial uncertainty, the need to withdraw monetary policy stimulus has diminished,” the bank said in a statement, adding the global economic outlook is deteriorating.

The OECD’s forecast for major industrialized countries outside of Canada was also gloomy.

“Growth is turning out to be much slower than we thought three months ago, and the risk of hitting patches of negative growth going forward has gone up,” OECD Chief Economist Pier Carlo Padoan said.

The debate over fiscal policy in the U.S., Europe’s debt crisis and the fact that governments have fewer options to boost growth this time around are driving business and consumer confidence lower, it said.

There is also a growing risk that high unemployment could be here to stay as hiring intentions are deteriorating, it said.