Outlook 2008/09 –
Life In the Aftermath of the
Great Global Credit Crisis
June 14th, 2008
Presented by:
Patricia Croft, Vice President & Chief Economist
Phillips, Hager & North Investment Management Limited
Est. 1964
Rare Events Have Become the Norm
 Worst U.S. housing market
recession since the 1930s
 U.S. dollar at record low
 Record oil, gold, rice prices
 Global credit crisis – run
on banks in U.S. and U.K.
 What’s next??
The Greatest Credit Bubble of
All Time
1. Liquidity – too much and too cheap
2. Trend to deregulation
3. Boom in securitization

Democratized credit provision but disconnected
lender and borrower
4. Overconfidence in financial models
* Source: The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit
Crash – by Charles R. Morris
Double Bubble
Bubble in Housing and Securitization
Securitized Residential Mortgages
Outstanding
Quarterly change at annual rates
S&P/Case-Shiller U.S. Home Price Index
25
600
500
15
400
10
U.S.$ billions
% change year-over-year
20
5
0
300
200
100
0
-5
-100
-10
-200
-15
-300
87 89 91 93 95 97 99 01 03 05 07
Source: MacroMarkets LLC
90 92 94 96 98 00 02 04 06
Source: Federal Reserve, NBF Financial
08
Third Banking Crisis Since 1930s
U.S. Bank and Thrift Failures
600
S&L Crisis
500
Today
400
300
200
Great
Depression
100
0
1934
1942
1950
1958
1966
1974
1982
1990
1998
2006
Source: Federal Deposit Insurance Corp., The Mortgage Lender Implode-O-Meter.com
U.S. Bank Earnings Plunge
S&P 500 Banks: Reported Earnings per Share
35
30
25
$
20
15
10
5
0
1996
1998
2000
2002
2004
2006
Note: Latest datapoint based on an estimate from Thomson Financial.
Source: RBC Capital Markets Quantitative Research, Thomson Financial
2008
Are We There Yet?
“ More than seven months on, the end is not in
sight, although it is safe to say that we have
reached the end of the beginning of the turmoil.”
Mark Carney, Governor of the Bank of Canada
March 13th 2008
Subprime’s Tangled Web
Banks
Housing/
Economy
Bond Insurers
Hedge
Funds
Regulators
SUBPRIME
Commercial
Paper
Market
Rating
Agencies
Private
Equity
U.S. in Recession – Now What?
1. How long and how deep?
2. What will the recovery look like?
3. What are the consequences for the rest
of the world?
4. What are the capital markets saying?
Not Your Average Credit Cycle
Banks Tightening Lending Standards
90
Diffusion Index
70
Commercial & Industrial Loans
Mortgages*
Credit card loans
All other consumer loans
Commercial real estate loans
50
30
10
-10
Shaded areas indicate U.S. recessions
-30
1990
1992
1994
1996
1998
2000
2002
Source: Federal Reserve Senior Loan Officer Opinion Survey
*2007 Q2 onward calculated by PH&N
2004
2006
2008
Single Biggest Risk Still Housing
US Unsold New Housing Inventory
(months' supply at current selling rates)
US Housing Affordability Index
160
Source: US National Association of Realtors
120
Index
100
90
80
70
60
Source: MacroMarkets LLC
2007
2005
2003
2001
1999
1997
1995
1993
1991
1989
50
40
1980
1985
1990
1995
Source: University of Michigan
2000
2005
2008
2003
1998
1993
US Consumer Confidence
110
1987
% change year-over-year
1988
Source: US Census Bureau
S&P/Case-Shiller US Home Price Index
25
20
15
10
5
0
-5
-10
-15
-20
1983
40
71
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
03
05
07
60
1978
80
LR average
1973
100
1968
Index
120
13.0
12.0
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
1963
Months' supply
140
Falling Homeowners Equity = Skewed
Incentives
US Owner's Equity, % of Household Real Estate
90
85
80
Banks & lenders own more of the average
American house than owner does!
%
75
70
65
60
55
50
45
1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007
Source: Federal Reserve Flow of Funds
www.youwalkaway.com - Jingle Mail
Signs of Recovery Expected Later
This Year
 Aggressive Fed easing – funds rate moved from
5.25% to 2.0% in eight months
 Provision of liquidity to non-bank financial
institutions
 Fiscal stimulus in hand
 Banking system recapitalization underway
Risks skewed to the downside
Housing: A Tale of Two Markets
Size of Subprime Mortgage Lending Market
Existing House Prices, Canada & U.S.
20
25%
22%
Annual % change, 3-mth avg
15
20%
% of Total Loans
10
5
0
15%
10%
5%
5%
-5
-10
1995 1997 1999 2001 2003 2005
Source: Can. Real Estate Assoc.,
National Assoc. of Realtors
0%
2007
Canada
United States
Source: CIBC World Markets
Canadian Housing Hot
Index
210
Real House Prices
200
190
180
170
160
150
140
130
120
110
100
90
80
1975
United States
Canada
1980
1985
1990
1995
2000
Sources: US Office of Federal Housing Enterprise Oversight, BLS, CREA,
Statistics Canada, PH&N
2005
Canada’s Housing Market Not
Overvalued
35
25
20
15
10
Source: International Monetary Fund, National Bank Financial April 2008
Austria
Canada
Germany
Finland
U.S.
Japan
Italy
Sweden
Spain
Belgium
Denmark
France
Norway
-10
Australia
-5
UK
0
Netherlands
5
Ireland
House price gap (%)
30
Broad Based Gains in House Prices
Average House Prices (real terms),
Eastern Canada
220
Vancouver
Calgary
Edmonton
Winnipeg
Saskatoon
Victoria
Index, 1980 = 100
200
180
Toronto
Ottawa
Montreal
Halifax
160
140
120
100
Source: CREA, Statistics Canada, PH&N
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
80
2002
2004
2006
295
280
265
250
235
220
205
190
175
160
145
130
115
100
85
70
55
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
Index, 1980 = 100
Average House Prices (real terms),
Western Canada
Source: CREA, Statistics Canada, PH&N
A Tale of Two Consumers
Household Liabilities, % of Net Worth
Household Net Worth, % of Disposable Income
25
700
24
650
23
22
600
20
%
%
21
550
19
18
17
500
450
16
15
400
Source: Federal Reserve Flow of Funds, Statistics Canada National Balance Sheet Accounts
Shop ‘Til You Drop in Saskatchewan
Retail Sales Growth
18
Year-over-year % change
16
14
12
10
8
6
4
2
0
BC
PEI
ON
Source: Statistics Canada
AL
NS
QC
NB
Data to February 2008
NL
MB
SK
Canada Tied to U.S. Like
Maple Syrup to Pancakes
U.S. Share of Provincial Exports
100
90
2002
93
88
84
83
2007
86
81
80
80
75
69
70
%
84
62
71
61
60
60
50
40
30
20
Ont Alb Que Atl Man BC SK
Source: RBC Financial Group
Alb Ont Atl Que Man SK BC
C$ Driven by Oil and US Outlook
Canadian dollar and WTI
1.05
110
1.00
100
Correlation = 0.90
90
0.95
80
USD per CAD (left)
Crude Oil - WTI Spot (right)
70
0.85
60
0.80
50
40
0.75
30
0.70
20
0.65
10
0.60
1995
0
1997
1999
Source: Bank of Canada, Datastream
2001
2003
2005
2007
US$/barrel
US$ per C$
0.90
The Long and The Short of the C$
Net Long Non-Commercial C$ Positions
110
Canada- U.S. Exchange Rate
Actual
100,000
105
Purchasing Power Parity*
80,000
100
60,000
95
Cents U.S.
40,000
20,000
0
-20,000
90
85
75
-60,000
70
Data to Jan 22 2008
65
-100,000
1993
81.4
80
-40,000
-80,000
101.2
60
1997
2001
2005 2007
Source: U.S. Commodity Futures Trading Commission
1970
1978
1986
1994
Source: Bank of Canada, OECD
2002 2006
Gisele Wants to Be Paid In Euros
150
U.S. Dollar Trade-Weighted Index
140
130
Index
120
110
100
90
80
70
60
1973
Major currency index
Broad index
1979
Source: U.S. Federal Reserve
1985
1991
1997
2003 2006
Mixed Picture Outside of North America
 European economy slowing – ECB reluctant to
cut rates
 Bank of England weighing growth/inflation trade-
off
 Japan’s economy fragile
 India slowing somewhat
 China challenged
Pace of Global Growth Set to Slow
Food Price Inflation A New Threat
 Food prices up over 80% in past three years
 Rioting in Egypt, Senegal, Ethiopia, Mexico & Haiti
 World Bank says 33 countries at risk of social unrest –
food equals half or more of lower income consumption
 No relief in site

Low inventories, high costs

Strong demand for biofuel and rising incomes
Slower Growth = Weaker Commodity
Prices?
Soaring Energy and Grains Prices
Index, 1987=100
800
700
Reuters/CRB Energy Index
600
Reuters/CRB Grains Index
500
400
300
200
100
0
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007
Source: Datastream
Peak Oil?
 Crude oil up 100% y/y, up 33% ytd
 At $135/barrel demand & supply affected

Russia scrambling to cut taxes

Brazil discovers oil offshore

US Congress considering lifting ban on
domestic drilling

Asian countries cutting subsidies

Americans driving less
Commodities Detach From NearTerm Reality…
Global Commodity Derivative Trading
Contract Turnover
Global Trade and Commodity Futures
50
Global Trade (3 month avg.)
500
CRB Commodity Futures Index
Number of Contracts
Percent year-over-year
40
600
30
20
10
0
400
300
200
100
-10
-20
94 95 96 97 98 99 00 01 02 03 04 05 06 07 08
Source: Commodity Research Bureau, IMF, Datastream
0
Source: Bank for International Settlements
. . . Leading to New Business
Opportunities!
500
450
400
Number of Commodity Hedge Funds
350
300
250
200
150
100
50
0
2000
2001
2002
2003
2004
Source: RBC Capital Markets, Milken Institute
2005
2006
2007
2008
2008/09 – Risky Business
1. U.S. recession
2. Further fall out from subprime crisis –
contagion to commercial real estate, credit
card and auto loans, bank failures
3. Inflation
4. Geopolitical factors/protectionism/China
5. US election
Change or Continuity?
Aggressive Federal Reserve Action
Monetary Policy:
Central bank policy interest rates
6
5
Bank of Canada
U.S. Federal Reserve
 Federal Reserve has
responded to economic
risks
4
(%)
 Inflation trends differ
3
vastly
2
 Close to end of easing
cycle
1
0
2003
2004
2005
2006
2007
2008
Bond Market Volatility High
Gov’t of Canada & Corporate
Bond Yields
Central Bank Policy Rates
5.5
6.5
U.S. Federal Reserve
Bank of Canada
5.0
4.5
3.00%
3.5
2.5
2.00%
Yield (%)
Central Bank Rate (%)
5.5
4.5
4.0
1.5
0.5
1999
Mid Term Corporates
Mid Term Canadas
2001
2003
2005
2007
2008
3.5
2004
2005
2006
2007
0
Source: Bloomberg
Mar-08
Feb-08
Jan-08
Dec-07
Nov-07
Oct-07
Sep-07
Aug-07
Jul-07
Jun-07
May-07
Apr-07
Mar-07
Feb-07
Jan-07
Dec-06
Nov-06
Oct-06
Sep-06
Index
Tentative Signs Credit Crisis is
Easing
CDX Index
200
180
160
140
120
100
80
60
40
20
Risky Assets Are Being Re-Priced
U.S. High Yield Bond Index
(Spread over U.S. Fed Funds target rate)
800
Emerging Market Bond Index
(Latest two years, daily data)
300
280
260
Basis points
Basis points
700
600
500
240
220
200
180
400
160
140
300
120
200
2006
Source: Merrill Lynch
2007
2008
100
2006
Source: JP Morgan
2007
2008
Credit Crisis Brings Opportunities
Royal Bank of Canada 5-year Sub-debt Spreads
200
Russian Debt/
LTCM Crisis
180
Enron/Worldcom
Credit Crunch
Subprime
Credit Crisis
140
120
100
80
60
40
Dec-08
Dec-07
Dec-06
Dec-05
8 months
Dec-04
Dec-03
Dec-01
7 months
Dec-00
Dec-99
Dec-98
4 months
0
Dec-02
20
Dec-97
Spread (%)
160
Canadian Banks – Undervalued Assets
Earnings Yield as a Percentage of Canadian
Long Bond Yield
280
Valuations on bank stocks are currently
attractive on every measure: P/E, P/E
relative to TSX, P/B and Relative to bond
yields (this chart). North American banks
have only been this inexpensive during
previous periods of financial crisis.
260
240
220
200
180
160
140
120
100
80
1980
1984
1988
1992
Source: RBC CM Quantitative Research
1996
2000
2004
2008
Title Markets Signal the Worst is Over –
Equity
For Now
290
S&P 500
S&P/TSX
MSCI EAFE
MSCI Emerging
Index, Jan. 2000 = 100
240
Emerging
190
140
90
40
2000
EAFE
* Data to May 1 2008
2001
2002
2003
2004
2005
2006
2007
2008
Bond Market Trend Intact – For Now
16
10-year Treasury bond yield
14
10-year average
%
12
10
8
6
4
2
Source: U.S. Federal Reserve
PH&N’s Asset Mix
Less Defensive
PH&N Balanced Fund at May 20st, 2008
U.S.
Equities
12.6%
Canadian
Equities
34.0%
EAFE
Equities
13.0%
Bonds
34.0%
Cash &
Short-term
6.4%