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Will 2006 prove to be the year of the downgrade?

Sectoral and geographic differences in the customer mix will likely prove significant in determining motor carrier fortunes in 2006 as the Canadian economy is expected to grow at a more uneven pace....

Sectoral and geographic differences in the customer mix will likely prove significant in determining motor carrier fortunes in 2006 as the Canadian economy is expected to grow at a more uneven pace.

Unlike the past two years, economic prospects for 2006 are proving harder to call. The differences in recent economic forecasts provided by TD Financial Group and RBC Financial Group for the Canadian economy are a good illustration of current market volatility and unpredictability. While TD Financial Group is forecasting a strong first quarter followed by successively weaker quarters for the remainder of the year, RBC is calling for mounting GDP growth for the first three quarters with a slight drop-off in the final quarter.

TD is basing its optimism for the first quarter on the stimulative effect of rebuilding New Orleans – there’s a great deal of material, services and expertise that will be required and Canadian business can only stand to benefit from the estimated US $100-$200B boost to the continent’s economy, according to Craig Alexander, vice president and deputy chief economist, TD Bank Financial Group.

But Alexander is also concerned about what he believes is a housing bubble ready to burst in the US, and hence the downgrading of both US and Canadian economic performance in the final two quarters included in TD’s forecast. Alexander explains that a considerable amount of property in the US is being purchased for speculative purposes, driving up prices. Housing affordability in the US has fallen to a 13-year low with the California, southern and eastern seaboard markets particularly hard pressed. At the same time, he says, Americans have been using their houses like ATM machines, lulled into perhaps a false sense of security by low mortgage rates into remorgaging their homes in order to indulge their spending habits.

“This is the sort of thing that makes economists’ stomachs churn because you know it’s going to burst,” Alexander says. “You can’t tell exactly when it will reverse but when it does the US economy will lose a lot of momentum. And I say it’s a question of when not if.”

He does caution, however, that this will make for a market correction, rather than a recession – a way for the North American economy to shake off some excess weight before gearing up for another growth spurt starting perhaps in 2007.

John Anania, assistant chief economist, RBC Financial Group, argues that Canada’s economy will head into an “excess demand” situation next year because the supply side of the economy is only growing by 2.5% while our GDP faces a healthy 3.4 % rise.

Right now the world economy is at the forefront of an inflationary trend that hasn’t yet started to move up to the consumer level in either the US or Canada, according to Anania, but it’s only a matter of time before we see it. There are several reasons why:

Natural gas and oil prices have been rising rather aggressively leading to higher import prices in the US. A higher US dollar means increased pricing power in the US economy. Finished product prices mimic core inflation trends, and these prices are already pointing north of 3%, he noted.

We’re also in a relatively tight labour market with wages rising faster than the long-term average. As the real cost of workers goes up, their productivity goes down. All of these trends will likely lead to an increase in interest rates by the US Federal Reserve in 2006, he said.

“You have to keep that in mind when you are financing your operations – the world of low interest rates is starting to go,” Anania advised attendees of the Ontario Trucking Association’s annual convention.

Canada, meanwhile, is in a healthy position, to many people’s disbelief, said Anania. We have a low 1.7% core inflation rate and low unemployment, having added 10% more jobs vs. the US’s 2% since the end of the last US-led recession in March 2001. Wages, meanwhile, are growing 4%.

“We haven’t seen that since 2000 before the big bubble implosion,” he said.

“In 2002 when the (Canadian) dollar dropped to 63 cents we stole a lot of manufacturing jobs from the US, and with them service sector jobs, and while we are now starting to shed manufacturing jobs the service sector is staying strong,” he added.

The strength of the manufacturing sector heading into 2006 is a key consideration as it’s a key customer base for motor carriers.

Manufacturing and other heavily export-oriented sectors will feel the impact of a slowing global business cycle, according to Stephen Poloz, senior vice-president, corporate affairs and chief economist, Export Development Canada. The world economy grew by more than 5% in 2004, and this momentum carried into the first half of 2005. That is too fast to be sustained, according to Poloz, so either a moderation will occur naturally or the always-vigilant central banks will make certain of it.

“In short, the sweetest part of the global cycle is behind us. The world will not fall off a cliff – rather, a moderation to more sustainable growth rates is in store,” Poloz says. “Throw a major energy price rise into the mix and we have a recipe for both stagflation and ‘Dutch disease’. Stagflation will see slowing growth as measured inflation picks up. ‘Dutch disease’ will see energy sectors boom and other sectors come under stress. This stress will come from a combination of higher raw materials prices and slower growth in sales. The latter, in turn, will intensify competitive pressures and limit firms’ ability to pass along higher energy costs.”

Our own Transportation Media Research found uneven expectations for growth across the country. Our second annual Transportation Buying Trends Survey, conducted in partnership with the Canadian Industrial Transportation Association and CITT, includes the responses of more than 700 shippers across Canada. Sixty one percent of respondents expected to increase their shipment levels in 2006, almost identical to the number that increased their shipment levels this year. When the manufacturing sector is looked at in isolation, however, the outlook for next year is not as rosy. Only 53% of manufacturers expected to increase shipment levels next year. And there are further differences when manufacturing is broken out on a geographic basis. While 58% of western manufacturers expect to boost their shipment levels next year, only 47% of central Canada manufacturers expect to do likewise.

Looking specifically at how shipment volumes will affect trucking next year, 47% of shippers across our survey sample expected to use more trucking services in 2005 (another 45% expected their use of trucking services to remain the same, while 6% expected to use less trucking and 2% were not certain). But only 40% of shippers in the manufacturing sector expect to boost shipments next year. And the spread is quite pronounced when comparing shippers by region. Forty five percent of Western Canada shippers expect to use more trucking services in 2006 compared to just 33% in Central Canada.

As David Bradley, CEO of the Canadian Trucking Alliance notes, “there has been a big difference if you were working for the oil patch versus hauling automotive parts or paper over the past year.” And, our research as well as provincial GDP forecasts indicate, that is a trend likely to be magnified in 2006.

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