Sector outlook: Financial services

Sectors in-the-know investors will definitely want to keep an eye on

A recent survey by Kelly Services found the 700,000 people employed in Canada's financial services sector are the country's third-happiest employees, after government workers and teachers. Presumably, the group is even more chuffed now that Canada's big banks have announced another round of record profits: $19 billion in fiscal 2006. But the good times extend right across the sector. Our big insurers, Manulife Financial Corp. and Sun Life Financial Inc., have had strong multi-year stock runs. The shares of TSX Group Inc. are still at record highs, even in the face of new competition from American rivals like Instinet. And Power Financial Corp. is feeling so rich that it has reportedly bid to buy Boston-based mutual fund giant Putnam Investments, for an amount estimated at US$3.5 billion or more.

Times are so good, in fact, that the industry seems to be sending a message to investors: cool your expectations. The Royal Bank of Canada, for one, has committed to only a 10% growth in earnings per share in the new year, not 40% as it delivered in 2006.

But is the party really winding down? A topic of conversation among academics these days is the remarkable ability of the worldwide financial system to absorb large shocks. If it feels like the global economy is more stable than it used to be, that's because it is, some maintain. Consider the overheated U.S. housing market: while prices have fallen remarkably fast, it hasn't witnessed the major calamity many expected.

As for the economic slowdown predicted in 2007 in the U.S. and parts of Canada, many expect it to be mild. In fact, the two countries are set up nicely to return to growth once we work through this current turn of the business cycle. Central banks in both countries are poised to begin cutting interest rates in the months ahead.

But there is another reason for optimism: Bank of Canada governor David Dodge recently spoke out on the benefits of bank mergers, suggesting they will be key to maintaining good health in the Canadian financial system. The International Monetary Fund concurred; in a recent report, the IMF advocated bank mergers, as well as the implementation of a single national securities regulator, as two ways in which Canada could act to maintain the strong momentum in the financial services sector. Over to you, Finance Minister Jim Flaherty.