In a slowing economy, retail investors should take a defensive position, say executives at BMO Harris Private Banking. The officers shared their 2008 fourth quarter outlook for North American equity markets with investors in a conference call on Thursday.

“Despite the fact that market is nearly 40% cheaper than it was at the beginning of this year, I still recommend a defensive position,” said Jack Ablin, chief investment officer of Harris Private Banking in Chicago.

For Ablin, a defensive position means shifting holdings from stocks to bonds and moving from high-yield or junk bonds into high-quality bonds. He also said his group has shifted from commodities into inflation protected treasury securities.

“We have also made upgrades within our equity mix and moved up to larger quality positions within the equities space, large in terms of market cap,” he said, with a focus on healthcare, consumer staples, utilities and energy.

“With respect to healthcare and consumer staples, these are sectors that don’t rely on the credit market to fund their operations… for the most part, they have revenue streams that are insulated from the activities of the economy,” Albin added.

A full-blown recession is where North American economic activity is headed, according to Paul Taylor, chief investment officer of BMO Harris Banking in Toronto, who covered the Canadian angle of the forecast.

As problems in the U.S. housing market began to brew in 2007, Taylor and his team originally forecasted U.S. consumers would gradually de-leverage their consumption over time. “Obviously in September, the situation took a different path,” said Taylor. “The corporate defaults in the financial sector in September caused a complete freeze in the credit markets, which is at the heart of issues we are facing right now.”

“What we are dealing with from a Canadian perspective are the secondary effects of this crisis,” said Taylor.

In his forecast, Taylor expects the diminishing demand for Canadian commodities to continue, as well as unemployment continuing to rise. “Patience is a virtue we are going to rely on as we go forward,” added Taylor, where recovery for equity markets and the economy will not be v-shaped, but gradual over time.

Across the border, a freeze of credit continues to plague markets in the near term, according to Ablin. “We’ve had a complete pull back in credit,” said Ablin, using the overnight, 1-year, 1-month and 3-month rates on treasury bills as his key indicators of confidence in the money markets.

“Despite the fact we have government guarantees, back stops and everything else, I find the one month treasury bill below half a percent. It has continued to be troubling. We are not seeing the unfreezing that I would of liked to have seen.”

Looming over a market turnaround is also what Ablin calls “de-leveraged for-selling,” where hedge funds or those investors who have late margin requirements, are cutting their borrowing when buying funds. “We see margin balances falling like a rock, they’ve been literally cut in half in the past month or so,” he said. “They probably need to come down another half to get to what I call a ‘multi-year long term trend line.’”

There is, however, “light at the end of the tunnel,” where the U.S. housing prices are concerned. “The breadth of the recline has been narrowed,” said Ablin. “The good news is that in markets where we see the biggest pull back, are the markets which are positioned to respond to the upside.” He listed Phoenix, Las Vegas, California as the real estate pockets most likely to rebound or stabilize once credit conditions improve, since Canadian consumers find them desirable spots for vacation homes.

“The good news is that equity is a wonderful barometer (and has) certainly anticipated the effect of the global economy slowing,” said Taylor.

For an economic turnaround to happen, according to Ablin, the economy’s reliance on debt has to shrink, which means the economy at large needs to shrink. “We have to get to a point, where a lot of this liquidity, instead of coming from trading partners, actually comes from Americans themselves,” Ablin said. “This means spending less than what we earn…that’s going to create a slowdown overall, based on some history, but more stability at the same time.”

The call will be archived at www.bmoharrisprivatebanking.com for seven days.

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