Real GDP growth in Canada will increase modestly to 2.8% in 2004 from 1.6% in 2003, held back in part by the strength of the Canadian dollar, Merrill Lynch & Co. said today in a report on the outlook for the Canadian economy.

But Canadian stocks should outperform “on a global perspective” with the S&P/TSX composite closing the year at 8700, up from 8522 at start of this week, says the report by Robert Spector, chief Canadian economist at Merrill Lynch.

Spector pegs the C$ at US$0.82 by yearend. It began the week at US$0.77.

In 2004 Canada will benefit directly from improved growth in the U.S. economy and overall global growth of 3.5%, according to the report. However, that benefit will be offset by the continued impact of the soaring C$, which is expected to shave roughly one percentage point off Canadian economic growth in 2004, Spector said.

“It almost goes without saying that this year will be a better year for the Canadian economy than 2003, given the shocks that we endured,” said Spector. “While the effects of the shocks will fade further in 2004, the economy will continue to feel the aftershocks of perhaps the most enduring one of the past 12 months – the unprecedented rise in the Canadian dollar.”

Merrill Lynch also predicts the fair value for the S&P/TSX composite at 8700, up from 8522 at start of this week.

The forecasts were issued in a Merrill Lynch conference today entitled “Canada: The Year Ahead 2004.” The conference also included commentary on the Canadian financial services, gold, the oil & gas sectors and the North American economy.


Merrill Lynch expects a slowdown in consumer spending in Canada in 2004. “With record consumer debt levels, modest income gains, weaker job growth and an all-time-low savings rate, a slowdown in consumer spending looms, even if household balance sheets are not showing deep strain,” Spector said. As a result, business spending – not consumer spending – will drive domestic demand in 2004. The rise of the C$ will continue to put pressure on productivity, meaning Corporate Canada is likely to take steps to improve efficiency. That, in turn, points to a more muted job environment in 2004, especially given the fast pace of employment creation over the past two years, according to Spector.

Merrill Lynch expects inflation to be benign in 2004. The Bank of Canada is expected to resume its easing cycle in early 2004, with an additional rate cut of 50 basis points in the first half of the year, according to the report.

The two biggest risks facing the Canadian equity markets in 2004 will be aggressive tightening from the Federal Reserve, which would undermine the positive liquidity cycle; or some negative shock that derails the commodity bull market and threatens the Canadian dollar rally.

Nevertheless, Spector sees a strong year ahead for Canadian equities. Canadian equities can be expected outperform on a global perspective – and the S&P, in particular – in 2004, Spector said. A rising C$ and compelling relative valuations suggest continued relative market gains unless global sector positioning turns defensive again.