More may be at stake for equity markets

TORONTO, March 31 /CNW/ - If recent history holds form, the outcome of the federal election will have little effect on market performance, finds a new report from CIBC World Markets Inc.

"Although the cliché is that markets abhor uncertainty, elections in the past few decades have not typically shaken market confidence," says Avery Shenfeld, chief economist at CIBC. "If anything, the period from the dissolution of parliament to the day after the vote has been one in which Canadian equities have fared well and outpaced those stateside, Canadian bond spreads have narrowed to Treasuries, and the Canadian dollar has gained modestly. That's particularly evident if one strips out the 2008 election, which had the misfortune of coinciding with the heights of the U.S. financial crisis.

He also found that there is also no evidence of a "post-election hangover, as judged by currency, bond and equity market performance in the weeks following a vote".

The report, coauthored by Warren Lovely, a senior economist at CIBC, states that for the bond market, the most important issue is whether the election result could take Canada off its deficit elimination track. It notes that historically there have not been any consistent turns in fiscal direction-as measured by the cyclically-adjusted budget balance-after changes between Liberal and Conservative parties, or between minority and majority governments.

"Opposition parties haven't come out strongly against deficit reduction as an objective, with platforms diverging largely on where the available fiscal room should be allocated (e.g., tax cuts vs. spending)," notes Mr. Shenfeld. "Best bets are that Canada will stay on a course of deficit reduction similar to the figures presented in the latest budget, regardless of the election outcome."

He also does not expect the election outcome to result in any significant changes to Canada's monetary policy. While the Bank of Canada's two per cent inflation target is up for renewal this year he expects the policy will be renewed. "The governing party of the day is likely to resist a lower target, given that it would entail a more stringent interest rate regime, and one not matched by the U.S. Fed," says Mr. Shenfeld.

He notes that Bank of Canada Governor, Mark Carney has also sounded unenthusiastic about shifting to price-level targeting, under which a period of higher than target inflation would have to be made up with a below target period. Where he thinks the election could affect monetary policy is in the timing of the next rate hike. Recent practice has seen the Bank signal a change in direction a month ahead and Mr. Shenfeld does not think Governor Carney would warn of a rate hike in the midst of the election campaign.

"With the bond and currency markets largely sidelined, the greater focus on the election could come from equity investors," he adds. "Here the most notable divergence in platforms thus far is the Conservative pledge to carry on with corporate tax cuts to 15 per cent by 2012, against a Liberal plan to return the rate to 18 per cent where it was in 2010."

He also says that companies that might benefit from a quick approval of the military's jet program have issues at stake in the election outcome. The energy sector will also be watching to see if the campaign draws out differences among the parties with regards to environmental policy.

"Thus far, markets have taken the election call in stride, with no response in the exchange rate, the bond market or equity performance. At the end of the day, if current polling holds up, this election could prove uneventful for financial markets.

"But keep tuned to the political channel. Five provinces are scheduled to hold general elections this year. For the bond market, the greater concerns these days lie in deficits and financing requirements at that level of government. It's too early to get a read on opposition platforms for these votes, but the debates over this week's Ontario budget will provide some clues on that front for the country's largest province."

The complete CIBC World Markets report is available at: http://research.cibcwm.com/economic_public/download/eimar11.pdf.

CIBC's wholesale banking business provides a range of integrated credit and capital markets products, investment banking, and merchant banking to clients in key financial markets in North America and around the world. We provide innovative capital solutions and advisory expertise across a wide range of industries as well as top-ranked research for our corporate, government and institutional clients.