Est. 1964Est. 1964

Global Outlook 2006 – Global Outlook 2006 – Chicken Little or Chicken Little or

Peking Duck?Peking Duck?

Global Outlook 2006 – Global Outlook 2006 – Chicken Little or Chicken Little or

Peking Duck?Peking Duck?

Presented by:

Patricia CroftVice President & Chief Economist

Phillips, Hager & North Investment Management Limited

January 17, 2006January 17, 2006

Outlook 2006 It’s All About Oil and InflationOutlook 2006 It’s All About Oil and Inflation

Global growth still healthy and better balanced

Some improvement in Europe and Japan – Canada remains strong

Soaring energy prices have had little impact but…

Storm clouds on the horizon Tightening Fed

Housing bubbles and yawning current account deficit

Protectionist sentiment

Energy prices

10

20

30

40

50

60

70

0

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

US

$/b

arre

l

WTI Crude

Crude Oil Prices Still Elevated – Chicken Little?Crude Oil Prices Still Elevated – Chicken Little?

Long-term Price of Oil Has Increased – But to $45 not $100Long-term Price of Oil Has Increased – But to $45 not $100

Days of $22-28/barrel are behind us

Global demand shift

Alternative resources take time to develop

Refinery capacity is limited and inadequate

Central bank monetary policy normalization

1.00

1.75

0.00

0.50

1.75

3.50

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

U.S. Canada Australia U.K. Eurozone Japan

Per

cen

tag

e p

oin

ts

Tightening since trough

Tightening in last year

Estimated distance from neutral

Estimated neutal rate = LR core inflation target + LR potential real GDP growth rate

Monetary Policy: Key Theme for 2006Monetary Policy: Key Theme for 2006

House Prices Still HighHouse Prices Still High

50

100

150

200

250

300

1994 1996 1998 2000 2002 2004

Ind

ex, 1

994Q

1 =

100

U.K.AustraliaU.S.Canada

UK in a soft spot but has likely bottomed

Europe doing better – interest rates still low

Japan improving – end of deflation in sight?

China still strong – now bigger and better

Global growth holding up but likely to ease in 2007 as lagged effects of rate hikes start to hit home globally

Outside North America, Things Are Looking Up

-8

-6

-4

-2

0

2

4

6

8

10

12

1997 1998 1999 2000 2001 2002 2003 2004 2005

% c

han

ge

year

ag

o

Retail sales

Manufacturing output

UK Economy on the Mend?

Ye

ar-

ov

er-

ye

ar

% c

ha

ng

e

Germany

-10

-5

0

5

10

15

20

2000 2001 2002 2003 2004 2005

Real GDPPrivate expenditureFixed Capital FormationExports

France

-10

-5

0

5

10

15

20

2000 2001 2002 2003 2004 2005

Real GDPPrivate expenditure

Fixed Capital FormationExports

Italy

-10

-5

0

5

10

15

20

2000 2001 2002 2003 2004 2005

Real GDPPrivate expenditure

Fixed Capital FormationExports

Will 2006 Be Europe’s Year?

Corporate profits are improving and business investment is increasing

Private consumption and employment are increasing moderately

Exports and industrial production are picking up

Risk is the impact of oil prices on both domestic and overseas economies

Japan’s Recovery – Is This the Real Thing?

Japan’s Reliance on China Growing but U.S. Still Top Dog

Japan's key export markets

0

5

10

15

20

25

30

35

40

Jan

-99

Ap

r-99

Jul-

99O

ct-9

9Ja

n-0

0A

pr-

00Ju

l-00

Oct

-00

Jan

-01

Ap

r-01

Jul-

01O

ct-0

1Ja

n-0

2A

pr-

02Ju

l-02

Oct

-02

Jan

-03

Ap

r-03

Jul-

03O

ct-0

3Ja

n-0

4A

pr-

04Ju

l-04

Oct

-04

Jan

-05

Ap

r-05

Jul-

05O

ct-0

5

Per

cen

t o

f to

tal

Export share, USA

Export share, China

Export share, Other Asia

32.1

23.4

5.1

14.1

33.7

28.1

China Vaults to Number Four Global EconomyChina Vaults to Number Four Global Economy

Source: National Bureau of Statistics

Old GDP

Primary15%

Secondary53%

Tertiary32%

New GDP

Primary13%

Secondary46%

Tertiary41%

$1.6 trillion US $1.9 trillion US = 20% increase!

China’s Far Reaching ImpactChina’s Far Reaching Impact

It has altered world trading patterns, shifting income

It has pressured wages of low skilled workers in rich countries

It has helped companies increase return on capital without pressure from workers for higher wages

U.S. Economy Remarkably ResilientU.S. Economy Remarkably Resilient

Despite higher oil prices, natural disasters and consumer worries, real growth still strong

Federal Reserve appears to be close to end of tightening cycle

Biggest risk: U.S. consumer Negative personal savings rate

Rising debt servicing costs

Higher energy costs

Real estate reliant

Why is the Fed Still Tightening?

US capacity indicators

70

72

74

76

78

80

82

84

86

88

90

Q1

1970

Q4

1972

Q3

1975

Q2

1978

Q1

1981

Q4

1983

Q3

1986

Q2

1989

Q1

1992

Q4

1994

Q3

1997

Q2

2000

Q1

2003

Q4

2005

%

2

3

4

5

6

7

8

9

10

11

12

%

Capacity utilization rate, all industries (left)

Unemployment rate (right)

Cap U LR avg = 81.4%

4.9%

Will the Fed Tighten Too Much?

Yield Curve is Flat But Real Rates Still LowYield Curve is Flat But Real Rates Still Low

US yield curve slope - 10-year Treasury bond - 3-month T-bill

-1

0

1

2

3

4

5

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Per

cen

tag

e p

oin

ts

Real US 3-month T-bill rates

-3-2-101234567

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

%

Core Inflation Well Behaved – So Far

US consumer price inflation

-3

0

3

6

9

12

15

18

1960 1966 1972 1978 1984 1990 1996 2002

Per

cen

t, Y

ear-

ove

r-ye

ar

Core CPI

Headline CPI

US Real House Prices

90

100

110

120

130

140

150

160

170

1975 1980 1985 1990 1995 2000 2005

Ind

ex

Source: Office of Federal Houising Enterprise Oversight, Bureau of Labor Statistics

U.S. House Prices Continue to SurgeSustained low interest rates tend to fuel asset bubbles

U.S. Consumer Using Home as a Cash Machine

Source: "Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four Family Residence”, Kennedy and Greespan, Federal Reservce 2005

Net equity extraction through cash-out refinancing

As a percent of disposable income

-50

0

50

100

150

200

250

Q1

1990

Q2

1991

Q3

1992

Q4

1993

Q1

1995

Q2

1996

Q3

1997

Q4

1998

Q1

2000

Q2

2001

Q3

2002

Q4

2003

Q1

2005

US

$ B

illio

ns,

qu

arte

rly

rate

-2

0

2

4

6

8

10

12

% o

f d

isp

inco

me

Current Account Deficit Still a Dollar Risk

US Dollar and Current Account Balance

-7

-6

-5

-4

-3

-2

-1

0

1

2

1973 1975 1978 1980 1983 1985 1988 1990 1993 1995 1998 2000 2003 2005

% o

f G

DP

70

80

90

100

110

120

130

140

150

Ind

ex

% of GDP (left)

Trade-weighted value of US dollaragainst major currencies (right)

Canadian Economic Growth Strong But UnbalancedCanadian Economic Growth Strong But Unbalanced

Higher energy prices benefit Canada as we are a net energy exporter

However, high energy prices create a transfer of wealth from central Canada to Alberta

The Canadian dollar has become a petro currency – a stronger dollar will further challenge the manufacturing base

Fiscal policy is loose – monetary policy is tightening

Canadian Job Creation Has Been Very Strong

Cumulative job creation since January 2004

0

50

100

150

200

250

300

350

400

450

500

Jan

-04

Mar

-04

May

-04

Jul-

04

Sep

-04

No

v-04

Jan

-05

Mar

-05

May

-05

Jul-

05

Sep

-05

No

v-05

Th

ou

san

ds

Total

Full-time

2006 provincial real GDP growth

0

1

2

3

4

5

6

7

BC AL SK MB ON QC NB NS PEI NL

%

Source: RBC Financial Group

Provincial labour markets

-2

0

2

4

6

8

10

12

14

16

NL PEI NB NS QC ON BC SK MB AL

%

Unemployment rate (ytd avg %)Job growth (ytd % change)

Provincial retail sales and housing

-15

-10

-5

0

5

10

15

AL SK MB QC NB BC ON PEI NS NL

%

Retail sales (ytd % change)Housing starts (ytd % change)

%

Provincial price pressures

0

1

2

3

4

5

6

7

8

9

PEI NS MB NL NB QC SK ON AL BC

CPI (ytd avg %)Wages & salaries (ytd % change)

Alberta Roars While Central Canada Reels

Canadian Inflation Indicators Flashing Yellow

Capacity utilization and unit labour costs

72

74

76

78

80

82

84

86

88

90

1987

1990

1993

1996

1999

2002

2005

%

-4

-2

0

2

4

6

8

An

nu

al %

ch

ang

e

Capacity utilizationUnit labour costs

For Now – Inflation Remains Tame

Canadian CPI inflation

Core (excl. 8 most volatile items)

Headline

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

%

Bank of Canada Back in Tightening ModeBank of Canada Back in Tightening Mode

Central bank policy interest rates

0

1

2

3

4

5

6

7

2001 2002 2003 2004 2005

(%)

Bank of Canada

U.S. Federal Reserve

Canadian Dollar Was A Star in 2005Canadian Dollar Was A Star in 2005

Performance of the Canadian dollar in 2005

0

2

4

6

8

10

12

14

16

18

20

U.S dollar New Zealanddollar

Australiandollar

UK pound Euro Yen

%

Change in value against selected currencies from Jan. 1 to Dec. 31 2005

Outlook 2006 - SummaryOutlook 2006 - Summary

Global growth set to slow as weakness in the U.S. is partially offset by renewed vigor in Europe and Japan

Canada strong for now – growing regional disparities will challenge policy makers

Monetary policy normalization process to continue

C$ overvalued – U.S. bear market at hand

Risks Energy prices/house prices

Geopolitical instability

Mother Nature

Protectionist sentiment

Easy Monetary Policy has Encouraged Risk Taking

CBOE Volatility Index (VIX)

10

15

20

25

30

35

40

45

50

55

60

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Ind

ex

Old VIX (based on S&P 100)New VIX (based on S&P 500)

Above 40 = Panic

Below 20 = Complacency

Black Monday

Gulf War I Asian Crisis

LTCM

9-11

Gulf War II

Yield curve slope, current and year ago

-50

0

50

100

150

200

250

Japan Eurozone Canada US UK

10 y

ear

- 3

mo

nth

yie

lds,

bp

s

year agocurrent

Global Yield Curves Flattening

Long Bond Yields Still Low and Range Bound

10-year government bond yields

Source: Datastream

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

2000 2001 2002 2003 2004 2005

%

0.0

0.5

1.0

1.5

2.0

2.5

%

Canada (left)US (left)Germany (left)Japan (right)

Japan Soars – U.S. SputtersJapan Soars – U.S. Sputters

Major stock markets since Jan. 2004

90

100

110

120

130

140

150

160

Jan-04 Jul-04 Jan-05 Jul-05 Jan-06

Ind

ex:

Jan

. 1 2

004

= 1

00

S&P 500

S&P/TSX

MSCI EAFE (US$)

Nikkei 225

P/E Ratios Have ConvergedP/E Ratios Have Converged

12

14

16

18

20

22

24

26

28

1998 1999 2000 2001 2002 2003 2004 2005

Rat

io

S&P 500TSXMSCI EAFE

Overweight equities, neutral on bonds, underweight cash

May add to U.S. or EAFE equity holdings

Corporate earnings still strong – corporations flush with cash

Valuation for stocks is reasonable, particularly in the U.S.

Proximity to end of Fed tightening cycle is a positive factor

Asset Mix Summary